Questions and Answers of Financial Markets Institutions

Why was the development of mortgage insurance necessary before secondary mortgage markets could develop?
Assume you set up a REMIC that guaranteed that the class B tranche would bear all the credit risk, and the class A tranche would lose only if the class B tranche holders were not repaid. What is the
Explain why mortgage investors demand a higher yield for investing in securities with call risk and extension risk. Why would a mortgage investor view mortgage prepayments negatively?
Suppose you are interested in buying a home valued at $500,000 and 30-year fixed-rate mortgages have an interest rate of 6%. What is your minimum down payment assuming you will borrow with a
Suppose your gross monthly income is $5,000. Assume that property taxes, homeowner’s insurance, and mortgage insurance payments total $200 a month. In addition, assume you have automobile and
Describe the factors that affect a borrower’s ability to qualify for a mortgage.
If your mortgage balance was $60,000 and you had a floating-rate mortgage that called for you to pay interest at an annual rate of 2.75 percent over the one-year T-bill rate and the T-bill rate has
If you had a 7 percent, $100,000 30-year fixed-rate mortgage, how long would it take before you had repaid half the loan balance due? If you paid an extra $100 per month to reduce the principal due
What is a credit spread? What happened to credit spreads during the financial crisis of 2007-2009 and afterwards?
Are Yankee bonds and Samurai bonds examples of Eurobonds? Why or why not?
Describe the different forms of financial guarantees seen in the bond market.
Explain how securities are brought to market under(a) A competitive offering(b) A negotiated offering. How do the two methods of sale differ?
Define the following terms:(a) Private placement,(b) Asset-backed security,(c) Callable securities,(d) Sinking fund provisions,(e) Convertible features of securities.
What features make municipal bonds attractive to certain groups of investors? Why don’t other groups invest much in municipal securities?
Give a concise definition for the following types of municipal bonds:(a) General obligation,(b) Revenue,(c) Industrial development,(d) Mortgage-backed.
Why are private placements of securities often popular with both the buyer and the seller of the securities?
Suppose a trust is established to securitize $100 million in auto loans that paid 13% interest and the average rate paid on the tranches issued was 10%, whereas financial guarantees to protect
If a corporate bond paid 9% interest, and you are in the 28% income tax bracket, what rate would you have to earn on a general obligation municipal bond of equivalent risk and maturity in order to be
If a bond dealer bought a $100,000 municipal bond at 90% of par and sold it at 93% of par, how much money did the dealer make on the bid-ask spread?
Calculate the gross profit that an underwriter would make if it sold $10 million worth of bonds at par (face value) and paid the firm that sold the bonds 99.25% of par.
What did the Federal Reserve do to stabilize the money markets from 2007 to 2009?
Why did many asset-backed and financial commercial paper issuers find it difficult to raise funds from 2007 to 2009 but nonfinancial commercial paper issuers did not?
Suppose 7-day fed funds trade at 1.65 percent annually. What is the yield on fed funds on a bond-equivalent basis?
Suppose Fargood Corporation engages in a repurchase agreement with The NationalBank of Nebraska. In the agreement, Fargood sells $9,987,950 worth of Treasury securities to the bank and agrees to
Explain how repurchase agreement transactions provide short-term investments to businesses. In what sense is a repo a collateralized loan?
Why is the banker's acceptance form of financing ideal in foreign transactions?
Why is a bank line of credit necessary to back up an issue of commercial paper?
What types of firms issue commercial paper? What are the characteristics critical to being able to issue commercial paper?
How are the Treasury and federal agency securities different? What difference primarily explains the yield differential between the two securities?
What are the characteristics of money market instruments? Why must a financial claim possess these characteristics to function as a money market instrument?
Calculate the bond equivalent yield for a 180-day T-bill that is purchased at a 6%asked yield. If the bill has a face value of $10,000, calculate its price.
If interest rates are expected to increase, identify what happens to the following factors using the expectations theory.
What is the preferred habitat theory? Explain how it differs from the market segmentation theory.
An investor has an investment horizon of four years. The yield on a 2-year security today is 6 percent and the implied forward rate on a 2-year security two years from now is 6.75 percent. What
Assume that the term structure of U.S. Treasury securities includes the following rates:SecurityAnnual Yield (%)3-month bill4.506-month bill4.571-year bill4.522-year note4.513-year note4.48Using this
You are the holder of a variable-coupon bond that is convertible to a fixed-coupon bond. If you expect interest rates to rise, should you exercise your conversion option? Explain. What if you expect
Suppose you expect interest rates to increase in the future. You are not indifferent toward interest rate risk and desire to maximize expected return. If you hold a portfolio consisting of 50 percent
Suppose you hold a corporate bond that is convertible into the firm's stock. Stock prices are falling and interest rates are also falling. Would it be a good idea to exercise your conversion option
Suppose the 7-year spot interest rate is 9 percent and the 2-year spot rate is 6 percent. The forecasted 3-year rate two years from now is 7.25 percent. What is the implied forward rate on a 2-year
Under which scenario, rising interest rates or falling interest rates, would a bond investor be most likely to exercise a put option on a bond? Explain.
Historically, the yield curve typically has been upward sloping. Why would you expect this to be the case?
A new-issue municipal bond rated Aaa by Moody's Investor Service is priced to yield 8 percent. If you are in the 33 percent tax bracket, what yield would you need to earn on a taxable bond to be
Define marketability. Explain why marketability of a security is important to both investor and issuer.
Explain the importance of a call provision to investors. Do callable bonds have higher or lower yields than similar non-callable bonds? Why?
Why do most commercial banks hold portfolios of municipal bonds and relatively few corporate bonds?
What do bond ratings measure? Explain some of the important factors in determining a security's bond rating.
Define default risk. How does the default risk premium vary over the business cycle? Explain your answer.
A commercial bank made a five-year term loan at 13 percent. The bank's economics department forecasts that one and three years in the future, the two-year interest rate will be 12 percent and 14
Summarize the expectation theory and the preferred-habitat theory of the term structure of interest rates. Are these theories in any way related or are they alternative explanations of the term
Using the Federal Reserve Bulletin, the Federal Reserve Bank of St. Louis website (FRED), or the Wall Street Journal, plot the yield curve for U.S. Treasury securities on a quarterly basis for this
You purchase a 6‐year maturity annual payment bond that has a 5 percent coupon and a 7 percent yield. If your investment horizon is 5 years find the bond’s potential return if interest rates fall
You have a 7‐year investment horizon and you are considering one of three bonds to purchase, Bond A with a 10‐year maturity and a 7‐year duration, Bond B with a 15‐year maturity and a
If the coupon rate on a bond is equal to the market rate of interest on similar bonds, what is the price of the bond? What are these bonds commonly called?
Assume a depository institution holds vault cash of $3 million and reserve deposits at the Fed of $25 million, and has borrowed $2 million at the discount window. If that institution holds $300
If a country named Lower Slobovia decided to use U.S. dollars as a medium of exchange and therefore withdrew $10 billion in cash from its transaction deposits in the U.S., what would happen to the
What is the difference between M1 and M2? Why are there different measures of money?
Suppose the current reserve requirements set by the Federal Reserve are as follows:Type of LiabilityRequirementPercentage of liabilitiesTransaction deposits $0 to $14.5 million0Transaction
What is TARP? How much did it cost taxpayers? Why was TARP necessary? Why was it unpopular?
Why does the Fed not use the discount rate to conduct monetary policy? How does the Fed use the discount rate?
If two bonds are identical in all respects, except one bond compounds annually and the other semiannually, which bond has the higher price? Why?
When reducing interest rate risk, why is duration matching superior to maturity matching?
Explain what the convexity of a bond is. When pricing bonds, under what circumstances is convexity a problem?
Identify the price of a Morgan Stanley bond from the Wall Street Journal section titled “Corporate Bonds” or from Yahoo Finance. The bond should have a maturity of at least 4 years. Assume
Consider a bond that has a coupon of 8% paid semiannually and has a maturity of 5 years. The bond is currently selling for $1,047.25. Use Excel to do the following analysis.a. What is its yield to
A bond with 3 years to maturity and a coupon of 6.25% is currently selling at $932.24. Assume annual coupon payments.a. What is its yield to maturity?b. Compute its duration using Equation 5.7 and
Calculate the duration for a $1000, 4-year bond with a 4.5% annual coupon, currently selling at par. Use duration to estimate the percentage change in the bond’s price for a decrease in the market
Define interest rate risk. Explain the two types of interest rate risk. How can an investor with a given holding period use duration to reduce interest rate risk?
Calculate the duration of a $1,000, 12-year zero coupon bond using annual compounding and a current market rate of 9%.
Calculate the duration of a $1,000 4-year bond with an 8% coupon (annual payments) that is currently selling at par.
David Hoffman purchases a $1,000 20-year bond with an 8% coupon rate (annual payments). Yields on comparable bonds are 10%. David expects that, two years from now, yields on comparable bonds will
Carol Chastain purchases a one-year discount bond with a face value of $1,000 for $862.07. What is the yield of the bond? $862.07 $1000 (1 +i)'
What is the relationship between bond price volatility and term to maturity? What is the relationship between bond price volatility and the coupon rate?
Explain why yields and prices of debt-instruments are inversely related.
What is the yield-to-maturity of a corporate bond with a 3-year maturity, 5 percent coupon (semi-annual payments), a $1,000 face value, if the bond sold for $978.30?
Find the price of a corporate bond maturing in 5 years that has a 5% coupon (annual payments), a $1,000 face value, and an AA rating. A local newspaper's financial section reports that the yields on
Write the equation which expresses the present value (or price) of a bond that has a 10% coupon(annual payments), a 5-year maturity, and a principal of $1,000, if yields on similar securities are 8%.
Julie Orzabal deposits $5,000 in a savings account offering 5.125% compounded daily. Assuming she makes no further deposits, what will be the balance in her account after 5 years?
Explain how the strong U.S. dollar has helped the Fed keep interest rates low.
Suppose that Brazil is worried that the local currency, the Real, is likely to depreciate sharply and reduce much needed foreign financial investment into the country. How could the Brazilian central
In financial markets, we occasionally observe negative interest rates. Reconcile the contradiction between the statement “The nominal rate of interest will never decline below zero” with the
Explain what is meant by the term negative interest rate. Why have we seen negative interest rates recently?
Explain what is meant by the realized rate of return. How does it differ from the real rate of interest?
Explain when the market rate of interest is equal to the real rate of interest.
Explain why it is important to adjust financial contracts for inflation. What is the relevant inflation factor?
What is the value of money? How does the value of money vary with aggregate price-level changes?
Explain how the market rate of interest is determined applying the loanable fund interest rate model.
Explain how the equilibrium real rate of interest is determined.
Explain what is meant by the term positive time preference for consumption. How does it affect the rate of interest?
Explain what the nominal rate of interest is and how it is related to the real rate of interest.
If the realized real rate of return turns out to be positive, would you rather have been a borrower or a lender? Explain in terms of the purchasing power of the money used to repay a loan.
An investor purchased a 1-year Treasury security with a promised yield of 10 percent.The investor expected the annual rate of inflation to be 6 percent; however, the actual rate turned out to be 10
Explain how forecasters use the flow-of-funds approach to determine future interest rate movements.
What is the track record of professional interest rate forecasters? What do you think explains their performance?
Under what conditions is the loss of purchasing power on interest in the Fisher effect an important consideration?
The following annual inflation rates have been forecast for the next 5 years:Year 1....................................3%Year 2....................................4%Year
The 1-year real rate of interest is currently estimated to be 4 percent. The current annual rate of inflation is 6 percent, and market forecasts expect the annual rate of inflation to be 8 percent.
What is the Fisher effect? How does it affect the nominal rate of interest?
If the money supply is increased, what happens to the level of interest rates?
What factors determine the real rate of interest?
In your opinion, what were the three most important factors that caused the 2008 financial crisis?

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