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Questions and Answers of Money Banking Financial Markets

An article in the Wall Street Journal notes this about Burton Malkiel: “Even before index funds existed, the now-retired Princeton University professor argued that they could outperform actively
A friend has started a business selling software. The software is a great success, and the firm quickly grows large enough to sell stock. Your friend’s firm promises to pay a dividend of $5 per
Charles Dow was the original editor of the Wall Street Journal. He was the originator of “Dow Theory,” which holds that the prices of transportation stocks, such as Heartland Express, can predict
Suppose that Facebook’s profits are expected to grow twice as fast as Amazon’s. Which firm’s stock should be the better investment for you? Briefly explain.
A company is expected to pay a dividend per share of $20 per year forever. If investors require a 10% rate of return to invest in this stock, what is its price?
Economist Peter Temin of MIT argues: “If the crash of 1929 was an important independent shock to the economy, then the crash of 1987 should have been equally disastrous.”a. What does Temin mean
An article in the Economist noted that while economic growth in China was slowing, Chinese “stocks have more than doubled in value.” The article states that unlike in developed countries, where
Mutual funds that follow a “momentum trading” strategy are known on Wall Street as “ momos.” How might a mutual fund manager use a momentum trading strategy? Why might the fund manager expect
An article in the Wall Street Journal contained the following: “Norfolk Southern Corp. on Thursday reported a surprise 25% profit jump in the first quarter.” The article also noted that after the
At the beginning of the year, you buy a share of IBM stock for $120. If during the year you receive a dividend of $2.50, and IBM stock is selling for $130 at the end of year, what was your rate of
Suppose that you have $1,000 to invest in the bond market on January 1, 2018. You could buy a one-year bond with an interest rate of 4%, a two year bond with an interest rate of 5%, a three-year bond
Aflac bond mentioned in the chapter opener was rated A− by Moody’s, while the AMD bond was rated CCC.a. Do these ratings help explain the difference in the yields on the firms’ bonds noted in
Suppose that the interest rate on a one-year Treasury bill is currently 1% and that investors expect that the interest rates on one-year Treasury bills over the next three years will be 2%, 3%, and
According to an article in the Wall Street Journal, bonds issued in 2016 by the toy store chain Toys “R” Us that matured in 2018 and had a 10% coupon were trading at “31 cents on the dollar.”
In the spring of 2016, an article on cnbc.com noted: “Yields on the benchmark 10-year JGB [Japanese government bond] have turned negative, which essentially means that bondholders are paying for
In 2016, an article in the Economist about the bond market in China noted that the “spreads between yields on AAA-rated corporate bonds and government bonds fell to historic lows of less than 0.4
An article in the Wall Street Journal quoted an anonymous billionaire investor as asking: “Has there ever been a carry trade that hasn’t ended badly?” What is a carry trade? Why might it end
According to an article in the Wall Street Journal, in May 2016, “Social Finance Inc., known as SoFi, for the first time received the highest possible credit rating from Moody’s on a new bond
Interest rates on U.S. Treasury bills are typically much lower than interest rates on U.S. Treasury notes and bonds. If the federal government wants to reduce the interest charges it pays when it
According an article published in the Wall Street Journal in 2016, “Moody’s Investors Service has agreed to pay $130 million to end a prominent lawsuit alleging crisis-era misconduct.” The
Use the data on Treasury securities in the table to answer the following question:Assuming that the liquidity premium theory is correct, what did investors on this day expect the interest rate to be
Beginning in 2009, Congress authorized “Build America Bonds,” which states and cities could issue to build roads, bridges, and schools. Unlike with regular municipal bonds, however, the coupons
In 2016, when the interest rate on 10-year German government bonds became negative, an article in the Wall Street Journal noted that the interest rate on 10-year bonds depended in part on
An article appeared in the New York Times under the headline “Spanish Bond Yields Soar.”a. Can we tell from the headline whether the demand for Spanish government bonds was increasing or
The following quote from an article in the Wall Street Journal describes events in the market for Treasury securities that day: “Treasurys prices were mixed, with the shorter end of the curve
According to an article on the junk bond market in Europe published in the Economist in 2016, “The spread (the interest premium over government borrowing rates) paid by junk-bond issuers has risen
In 2016, an article in the Wall Street Journal argued that the “latest drop in the 10-year yield has caused a flattening of the yield curve … that is disconcerting.”a. What does the article
Suppose that, holding yield constant, investors are indifferent as to whether they hold bonds issued by the federal government or bonds issued by state and local governments (that is, they consider
Go to the web site of macrotrends (macrotrends.net) and click the S&P 500 – 90 year historical chart. Describe how stock prices move just before, during, and just after a recession. Is the
Why are stocks called “equities”? Are bonds also equities?
What is the relationship between the price of a financial asset and the payments investors expect to receive from owning that asset?
How might an investor use a pricing anomaly to earn above-average returns?
How is behavioral finance related to behavioral economics?
In what ways are dividends similar to coupons on bonds? In what ways are dividends different from coupons on bonds?
What is the relationship between the required return on equities and the equity cost of capital?
What is the relationship between rational expectations and the efficient markets hypothesis?
How might an investor use mean reversion or excess volatility to earn above-average returns?
What do economists mean when they describe investors as behaving rationally?
What is the difference between a stock exchange and an over-the-counter market? What are the three most important stock market indexes?
In words and symbols, write the two components of the rate of return on a stock investment for a holding period of one year.
According to the efficient markets hypothesis, are stock prices predictable? What is a random walk?
Why are supporters of the efficient markets hypothesis unconvinced that differences between the theoretical and actual behavior of financial markets actually invalidate the hypothesis?
How can herd behavior lead to a bubble in a financial market?
How do fluctuations in stock prices affect the economy?
What is the fundamental value of a share of stock?
An article in the Economist notes that according to the efficient markets hypothesis: “buying shares in Google because its latest profits were good, or because of a particular pattern in the price
The policy committee of the Federal Reserve meets eight times per year in Washington, DC. After each meeting, the committee makes a public announcement about monetary policy. According to an article
A student makes the following observation: “The Dow Jones Industrial Average currently has a value of 17,500, while the S&P 500 has a value of 2,000. Therefore, the prices of the stocks in the
Write the equation for the Gordon growth model. What key assumption does this model make?
An article in the Wall Street Journal in 2016, observed that the price of Apple’s stock had started to decline a year before “when fears of an iPhone slowdown surfaced.” At the time the article
An article in the Wall Street Journal describes one investment strategy that involves buying stocks on the London Stock Exchange at the beginning of November, selling them at the end of April, and
Former Federal Reserve Chairman Alan Greenspan has argued that it is very difficult to identify bubbles until after they pop. What is a bubble, and why might bubbles be difficult to identify?
A student remarks: “135,000,000 shares of General Electric were sold yesterday on the New York Stock Exchange, at an average price of $25 per share. That means General Electric just received over
Suppose that the price of Goldman Sachs stock is currently $142 per share. You expect that the firm will pay a dividend of $1.40 per share at the end of the year, at which time you expect that the
Worry,” Wall Street Journal, April 24, 2016. 3.6 The following is from an article on cnbc.com: Typically stock prices increase when the economy is expanding. But on a day when a measure of
A columnist in the Economist argues that the efficient markets hypothesis has been “dealt a series of blows” because “in the late 1990s dot-com companies with no profits and barely any earnings
The British economist John Maynard Keynes once wrote that investors often do not rely on computing expected values when determining which investments to make:Most, probably, of our decisions to do
An article in the Economist notes: “If other people are making a fortune by buying tech stocks, or by trading up in the housing market, then there is a huge temptation to take part, in case one
In a column in the Wall Street Journal, economist Burton Malkiel notes: “Preferred stock is a kind of hybrid security that sits between bonds and common stock.”a. In what sense is a share of
According to Moody’s, “Obligations rated Aaa are judged to be of the highest quality, subject to the lowest level of credit risk.”a. What “obligations” is Moody’s referring to?b. What
Suppose that you want to invest for three years to earn the highest possible return. You have three options:(a) Roll over three one-year bonds, which pay interest rates of 8% in the first year, 11%
Why might the bond rating agencies lower their ratings on a firm’s bonds? Draw a demand and supply graph for bonds that shows the effect on a bond that has its rating lowered. Be sure to show the
The chapter opener noted that in mid-2016, you could earn an interest rate of 0.25% by buying a 3-month Treasury bill or an interest rate of 2.6% by buying 30-year Treasury bond. Briefly explain how
Compare the tax treatment of the coupons on the following three bonds: a bond issued by the city of Houston, a bond issued by Apple, and a bond issued by the U.S. Treasury.
Briefly describe the three theories of the term structure.
What are the two types of income an investor can earn on a bond? How is each taxed?
What are three key facts about the term structure?
How does the interest rate on an illiquid bond compare with the interest rate on a liquid bond? How does the interest rate on a bond with high information costs compare with the interest rate on a
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and for the period from January 1997 to the present, download to the same graph the data series for the BofA
How does the Treasury yield curve illustrate the term structure of interest rates?
How is a bond’s rating related to the bond issuer’s creditworthiness?
Go to www.treasury.gov and find the page “Daily Treasury Yield Curve Rates.” Briefly describe the current shape of the yield curve. Can you use the yield curve to draw any conclusion about what
In his memoir, former Federal Reserve Chair Ben Bernanke remarked: “In setting longer-term rates, market participants take into account their expectations for the evolution of short-term rates.”
Briefly explain why bonds that have the same maturities often do not have the same interest rates.
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and for the period from January 1957 to the present download to the same graph the data series for the 3-month
We saw that former Federal Reserve Chairman Ben Bernanke argued that low interest rates in the United States during the mid-2000s were due to a global savings glut rather than to Federal Reserve
How would the following events affect the demand for loanable funds in the United States?a. Many U.S. cities increase business taxes to help close their budget deficits.b. Widespread use of tablet
A report on 401(k) plans notes: “Younger participants tended to favor equity funds … while older participants were more likely to invest in fixedincome securities such as bond funds.”a. What
According to an article in the Economist, in Germany 80% of household wealth is in the form of bank deposits, as opposed to only 20% in the United States. The article notes: “If German … savers
Some economists argue that a boom in stock prices is a sign that profitable business opportunities are expected in the future. Use a demand and supply graph for bonds to show the effect of a boom in
In a large open economy, how would each of the following events affect the equilibrium interest rate?a. A natural disaster causes extensive damage to homes, bridges, and highways, leading to
According to an article in the Wall Street Journal in early 2016: U.S. government bonds maturing in more than 25 years returned a negative 1.2% in the month through Thursday … after chalking up a
Use a demand and supply graph for bonds to illustrate each of the following situations. Be sure that your graph shows any shifts in the demand or supply curves, the original equilibrium price and
The following is from a column on marketwatch.com: “There are lots of things we more or less know will happen…. But what are the potential black swans?”a. What does the columnist mean by a
Suppose that in a large open economy, the quantity of loanable funds supplied domestically is initially equal to the quantity of funds demanded domestically. Then suppose that an increase in business
An article in the Wall Street Journal begins: “Yields on the 10-year government debt of Germany and the U.K. fell to all-time lows, a stark demonstration of the modern era of scant inflation, weak
For each of the following situations, explain whether the demand curve for bonds, the supply curve for bonds, or both would shift. Be sure to indicate whether the curve(s) would shift to the right or
A financial planner writing in the New York Times gave the following sarcastic investment advice: “On Jan. 1 of each year, just figure out which asset class will do really well and move all your
The federal government in the United States has been running large budget deficits.a. Use the loanable funds approach to show the effect of the U.S. budget deficit on the world real interest rate,
What is the difference between market risk and idiosyncratic risk? How does diversification reduce the risk of a financial portfolio?
Suppose that the inflation rate increases, and the Federal Reserve responds by taking actions to raise the short-term nominal interest rate. Use a money market graph to show the result of the Fed’s
According to an article in the Economist about interest rates on European government bonds in 2016, investors were concerned that “European equities are almost 20% below their levels of a year ago;
Briefly explain whether each of the following statements is true or false:a. The higher the price of bonds, the greater the quantity of bonds demanded.b. The lower the price of bonds, the smaller the
When are economists most likely to use the bond market approach to analyze changes in interest rates? When are economists most likely to use the loanable funds approach?
In what sense do investors face a trade-off between risk and return?
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and find the most recent values and values from the same month five years earlier for the 10-Year Treasury
Explain what will happen to the equilibrium price and equilibrium quantity of bonds in each of the following situations. (If it is uncertain in which direction either the equilibrium price or
If the current price in the bond market is above the equilibrium price, explain how the bond market adjusts to equilibrium.
How do economists define expected return and risk? Are investors typically risk averse or risk loving? Briefly explain.
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and download to the same graph the following data series from January 1957 until the most recent available

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