The difference between futures contracts and forward contracts is that _____.

futures contracts are traded on exchanges, while forward contracts are traded over the counter

Suppose Gambler Green buys a three-month forward contract from Widower White for an ounce of gold at $415. Suppose also that the contract calls for cash settlement, and that the price of gold at expiration is $400 an ounce. Then the contract will be settled by ____.

Gambler green giving Widower White $15 in cash.

The basic idea behind the Hunt brothers’ scheme to corner the silver market and drive up the price was to ____ silver on the forward market and ____ silver on the spot market.

buy; buy

A farmer sells futures contracts for wheat at $6 per bushel because he will be unable to repay his bank loan if he has to sell his upcoming wheat crop at less than $6.

An airline buys futures contracts for the amount of jet fuel it believes it will need in three months in order to lock in the price.

the seller to maintain a higher margin; the buyer to maintain a higher margin

can be exercised anytime before maturity instead of only at maturity

An investor who was sure the price of a stock was going to

rise and wanted to use options to profit from the increase could either ____.

buy a call or write a put

In Question 34, an investor who was sure the price of the stock would rise but believed the price would rise

only moderately would likely choose to ____.

write a put

a lower premium

Increase if the option is a call.

&

Decrease if the option is a put.

increase whether the option is a put or a call

Big Bank can borrow at a relatively low rate in the long-term bond market because it is well known. However, it holds mostly short-term business loans. Small Bank can obtain short-term deposits at a relatively low rate from local depositors. However, it holds mostly long-term mortgages. Suppose the two banks engage in an interest rate swap to reduce their maturity mismatches. Then ____ will be the buyer of the swap. Each period, it will

owe to the other bank an amount equal to ____ times the notional amount of the swap and will be owed by the other bank an amount equal to ____ times the notional amount.

Small Bank; the agreed-upon fixed rate; Libor plus the agreed-upon spread

only the interest payments are at risk and they are netted

buyer of the CDS does not own the underlying asset

the underlying asset is most likely to default in bad economic times, when the CDS writer

is least able to satisfy the contract

mainly to bank mergers

more; a long history of restricting the geographic expansion of banks

Glass-Steagall Act of 1933; financial holding company; and securities firms

decreased

lower; lower

core deposits; both cheaper and more stable

Removal of deposit rate ceilings in the late 1970s and early 1980s.

Development of commercial paper and junk bonds.

Growth of money market mutual funds.

increases its loan loss reserves; reduce net income and decrease total assets and total equity

To avoid registering its commercial paper with the SEC and having to meet the SEC’s documentation requirements, a firm must do which of the following?

Issue only commercial paper with maturity of 270 days or less.

Sell the commercial paper mainly to institutional rather than individual investors

Use the proceeds to finance current assets

One of the first episodes in which investors lost confidence in commercial paper was ____.

the failure of Penn Central Railroad

Originally issuers of asset-backed paper invested in ___. However, in the late 1990s they started investing in _____, which exposed them to significant _____.

short-term assets like accounts receivables; long-term assets like MBS; rollover risk

asset-backed paper

money-market mutual funds

increased concern about the quality of subprime MBS in summer 2007; Lehman Brothers failure

the inability of borrowers to pay off balloon mortgages in the 1930s led the government to promote a different type of mortgage contract

remains constant; increases

call the bond

Mortgage interest rates have fallen

The borrower wants to cash out some of the equity in his home.

The borrower wants to buy a bigger house

The tendency for the price of a mortgage subject to prepayment to behave like the price of a

short-term bond when interest rates fall but like the price of a long-term bond when interest rates rise is called ____.

negative convexity

enable low-income home buyers to obtain mortgages by guaranteeing the mortgages

promote the secondary market for mortgages by securitizing home mortgages and

guaranteeing the securities

is not guaranteed by FHA

meets the underwriting criteria used by Fannie Mae and Freddie Mac in buying mortgages

It was an official part of the U.S. federal government.

 It could deal only with mortgages insured by the FHA or VA.

 It could not purchase mortgages and re-package them into securities

originate-to-distribute; both originate-to-hold and originate-to-distribute

collateralized mortgage obligation

pass-through security

senior; AAA

jumbo mortgages

mortgage lenders lowered standards to prop up lending when the refinancing boom ended

teaser rates on ARMs enabled low-income borrowers to afford initial mortgage payments

the surge in subprime mortgage caused the housing bubble; the housing bubble caused the surge in subprime lending

low-rated tranches of subprime MBS; repackaged them as CDOs

Suppose that the current one-year bond rate is 5% and that the one-year bond rate is expected to be 6% a year from now and 7% two years from now. According to the expectations theory of the yield curve, the current two-year rate bond should be ___ and the current three-year bond rate should be ___, implying that the yield curve is ___.

5.5%; 6%; upward sloping

Under normal circumstances, a bond rated CC by Standard & Poor’s should pay a ___ rate than a bond rated AAA because the CC-rated bond will have ____ default risk.

higher; higher

Suppose investors believe the Fed is likely to keep short-term interest rates unchanged for a long time but that there is some chance it will either raise or lower short-term rates in response to changes in the economy. In these circumstances, the risk premium theory of the yield curve would suggest that the yield curve will _____ because _____.

slope upward; the risk of capital gains or losses increases with maturity

flatten the yield curve; long-term rates will need to fall relative to short-term rates to induce investors to hold more short-term and fewer long-term bonds

become steeper; the higher inflation will be expected to lead to higher nominal interest rates

7.50%

rises; upward

more; lower

charging companies a fee for rating their bonds

It is debt issued by any government agency, whether international, national, or local.

The firms seeking funds know more about their condition and future prospects than the investors or lenders providing the funds.

The firms most willing to take funds are the ones that investors or lenders would least like to provide with funds if they knew the firms’ true condition and prospects.

adverse selection in the used car market

moral hazard in the insurance market

firms are sure to have enough income to repay their debt but managers cannot be prevented from diverting funds to their own uses

overvalued

some borrowers fail to receive credit even though they are willing to pay higher rates than borrowers of similar characteristics who do receive credit

moral hazard and adverse selection can make it impossible for banks to increase

expected loan returns by raising loan rates

Reduce the free-rider problem by allowing the bank to reap most of the benefit of the information it collects.

Allow the bank to gather more information about its loan customer than if they stayed with the bank only a short time.

Adverse selection

 Moral hazard

Sarbanes-Oxley Act; the accounting scandals in the tech boom

the character of local borrowers and local economic conditions; the financial capacity of large, complex borrowers and national economic conditions

own shares in privately held companies; takeover firms buy established companies while VC firms invest in start-up companies

issuing equity; neither better nor worse than issuing debt

I. Corporate profits are taxed and interest expense is tax-deductible

II. A firm’s assets may have to be liquidated at a big loss if it declares bankruptcy.

III. Adverse selection may arise in the market for equity if investors are unable to distinguish between productive and unproductive firms

IV. Adverse selection may arise in the market for debt if default is possible and investors are unable to distinguish between safe and risky firms

Consider a firm with the following characteristics:

Market value of debt = $1 million

Market value of equity = $3 million

Expected rate of return required by investors on firm’s equity = 16%

Expected rate of return required by investors on firm’s debt = 8%

If there were no taxes on corporate profits, the firm’s weighted average cost of capital would be _____.

the difference between the price at which a dealer is willing to buy a security and the price at which he is willing to sell it

over-the-counter markets for trading stocks; do not require either brokers or dealers

investors would bid more aggressively for securities in the single-price system, lowering the Treasury’s interest expense

non-competitive bidders submit only a desired quantity and not a desired yield, while competitive bidders submit both a desired quantity and a desired yield

increase; are less liquid

sells a security to; buy the security back at a higher price; borrowing funds overnight

tied to the prices of other assets

increase; more responsive; increasing

.

The "Greenback" introduced in the U.S. during the Civil War is an example of _____.

fiat money

If the market price of a bond exceeds the face value, which of the following statements about the bond is most likely to be true?

It is a coupon bond.

Which of the following statements about the holding period return on an asset is true?

It includes both capital gains and losses and income received during the period.

Over long periods of time, which of the following statements about the annual returns on U.S. stocks and long-term corporate bonds is true?

The average return is higher on stocks than bonds

is highly averse to bearing risk

the use of money as a medium of exchange

You deposit $4,000 in a bank specializing in consumer loans.

greater; less

financial development; economic growth

lending to people who borrow as a part of a group

the U.S. and U.K

buying government securities

"Sweep" programs used by banks to shift customers’ funds between their checking accounts and money-market deposit accounts tended to _____ M1 and ____ M2.

decrease; have no effect on

Changes in money demand are due mainly to changes in transaction technology or financial innovation unrelated to people’s desire to spend

Which of the following statements about a decrease in stock prices is

true?

I. A decrease in stock prices reduces investment spending by increasing the cost to firms of raising funds through new equity issues.

II. A decrease in stock prices reduces consumption spending by decreasing wealth.

III. A decrease in stock prices can result from an unexpected increase in the Fed’s interest rate target.

Which of the following are

not actions the Fed would take if it were following a conventional Taylor Rule?

Raise the nominal interest rate to prevent an asset price bubble from developing.

increased; increased lending to banks; large-scale asset purchases

reduce mortgage rates and long-term interest rates

M1 would decrease.

Which of the following statements about the "Too Big to Fail Policy" is

false?

The policy was first put into effect after the banking panics of the Great Depression.

The standard deviation of monthly returns.

Raise the interest rate on reserves.

According to the Efficient Markets Hypothesis, which of the following statements is

false?

The change in the price of a stock can be predicted by using all available information about past changes in the price.

lends against sound collateral; solvent but illiquid

Which of the following statements about asset price bubbles is

false?

Bubbles usually deflate gradually.

$200; $500

Consider three bonds that are currently selling at the same price. Bond 1 is a 30-year zero-coupon bond. Bond 2 is a 30-year coupon bond. Bond 3 is a 30-year annuity, which means that it pays the same amount each year with no lump sum payment at the end (like a mortgage or car loan). For which bond will the price be

least sensitive to changes in the interest rate?

`

Bond 3

An investor has invested all his money in Johnson & Johnson stock. He is thinking about replacing half of his Johnson & Johnson stock with Apple stock. The Apple stock has both a higher standard deviation and a higher expected return, and the returns on the two stocks have a correlation coefficient of 0.3. Which of the following statements about the new portfolio including both stocks is

true?

The new portfolio

could have a lower standard deviation, because Apple stock is not perfectly positively correlated with Johnson & Johnson stock.