Investment valuation models

the value of any investment is found by computing theA. present value of all future salesB. present value of all future liabilitiesC. future value of all future expensesD. present value of all future cash flows

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using the one period valuation model, assuming a year end divident of 1.00, an expected sales price of 100 and a required rate of return of 5%, the current price of the stock would beA. 110.00B. 101.00C. 100.00D. 96.19

in the generalized dividend model the current stock price is the sum ofA. the actual value of the future dividend streamB. the present value of the future dividend streamC. the present value of the future dividend stream plus the actual future sales priceD. the presend value of teh future sales price

in the gordon growth mode, a decrease in the required rate of return on equityA. increases the current stock priceB. increases the future stock priceC. reduces the future stock priceD. reduces the current stock price

using the gordon growth formul if D1 is 2.00 ke is 12% or .12, and g is 10% or .10, then the current stock price isA. 20B. 50C. 100D. 150

one of the assumptions of the gordon growth model is that dividends will continue growing at ________ rate.A. an increasingB. a fastC. a constantD. an escalating

inthe gordon growth model the growth reate is assumed to be ________ the required return on equity.A. Greater thanB. equal toC. less thanD. proportional to

In asset markets and asset’s price isA. set equal o the highest price a seller will acceptB. set equal to the highest price a buyer is willing to payC. set equal to the lowest price a seller is willing to acceptD. set by the buyer willing to pay the highest price

information plays an important role in asset pricing because it allows the buyer to moe accurately judgeA. liquidityB. riskC. capitalD. policy

New information that might lead to a decrease in a stock’s price might beA. an expected decrease int he level of future dividendsB. a decrease in the required rate of returnC. an expected increase in the dividends growth rateD. an expected increase in the future sales price

A change in percieved risk of stock changesA. the expected dividend growth rateB. the expected sales priceC. the required reate of returnD. the current dividend

A monetary expansion ______ stock prices due to a decrease in the _______ and an increase in the ________, everything else held constant.A. reduces; future sales price; expected rate of returnB. reduces; current dividend; expected rate of returnC. increase; required rate of return; future sales priceD. increases; required rate of return; dividend growth rate

the global financial crisis lead to a decline in stock prices becauseA. of a lowered expected divident growth rateB. of a lowered required return on investment in equityC. higher expected future stock pricesD. higher current dividends

A share of stock in Bodah Corporation pays an annual dividend of $5. The current market price is $75. From the list of individuals below, identify who is likely to be a buyer or a seller of this stock. (Each person currently owns 100 shares.)
Individual, Required Return, Expected Growth in Dividends, Buy or Sell?Janey 5% 0% ____Jimmy 8% 0% ____Jonny 15% 0% ____

BuySellSell

A share of stock in DuWop Corporation pays an annual dividend of $4. From the list of individuals below, calculate the value each person is likely to place on a share of this stock. (Round your responses to the nearest penny.)Hannah12%4%$________
Henry8%3%$________
Heather10%6%$________
If the current market price is $50 and these three individuals are representative of the market as a whole, this share price is likely to_______ (rise, fall, stay the same)

Hannah12%4%$52
Henry8%3%$82.4
Heather10%6%$106.00
If the current market price is $50 and these three individuals are representative of the market as a whole, this share price is likely torise

if expectations of the future inflations rate are formed solely on the basis of a weighted average of past inflation rates, the economics would say that expectation formation isA. irrationalB. RationalC. adaptived. reasonable

in rational expectations theory, the term “optimal forecast” is essentially synonymous withA. correct forecastB. the correct guessc. the actual outcomeD. the best guess

if a forecast is made using all available information then economists say that the expectation formation isA. rationalB. irrationalC. adaptiveD. reasonable

if a forecast made using all available information is not perfectly accurate then it isA. still a rational expectationB. not a rational expectationC. a second−best expectation.D.an adaptive expectation.

if expectations are formed rtaionally then individualsA. will have a forecast that is 100% accurate all of the timeB. change their forecast when faced with new infoC. use only the information from past data on a single variable to form their forecast

an expectation may fail to be rational ifA. relevant info was not available at the time the forecast is madeB. relevant info is available but ignored at the time the forecast is madeC. information changes after the forecast is madeD. information was available to insiders only.

Rational expectations forecast errors will on average be _____ and therefore _____ be predicted ahead of timeA. positive; canB. positive; cannotC. negative; canD. zero; cannot

if market participants notice that a variable behave differently now thtan in the past, then according to rational expectations theory, we can expect market participants toA. change the way they form expectations about future values of the variableB. begin to make systematic mistakesC. no longer pay close attention to movements in this variableD. give up trying to forecast this variable

If monetary policy becomes more transparent about the future course of interest rates, how would that affect stock prices, if at all?
A.Stock prices will decrease because investors are now aware of stock prices and won’t overpay.
B.Stock prices will increase, as the risk and required return on the investment will be reduced.
C. Stock prices will remain unchanged, as increased transparency will not affect investment decisions.
D.Stock prices will be unaffected, as stock prices and transparent monetary policy are unrelated.

If the public expects a corporation to lose $5 per share this quarter and it actually loses $4, which is still the largest loss in the history of the company, what does the efficient market hypothesis say will happen to the price of the stock when the $4 loss is announced?
be revised upwardbe revised downward

be revised upward

the theory of rational expectation, when applied to financial markets, is known asA. monetarismB. the efficient markets hypothesisC. the theory of strict liabilityD. Theory of impossibility

according to the efficient markets hypothesis, the current price of a financial securityA. is the discounted net present value of future interest paymentsB. is determined by the highest successful bidderC. fully reflects all available relevant informationD. is a result of non of the above

Another way to state the efficient markets conditiion is: in an efficient market,A. unexploited profit opportunities will be quickly eliminatedB. unexploited profit opportunities will never existC. arbitragers guarantee that unexploited profit opportunities never existD. every financial market participant must be well informed about securities

_______ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminat e the unexploited profit opportunityA. ArbitrageB. MediationC. Asset capitalizationD. Market intercession

If future changes in stock prices are unpredictable, then we say that the stock prices follow aA. straight and narrow path.B. generalized walk.C. meandering path.D. random walk.

You have observed that the forecasts of an investment advisor consistenly outperform the other reported forecast. the efficient markets hypothesis says that future forecasts by this advisorA. may or may not be better than the other forecasts. past performance is no guarantee of the futureB. will always be the best of the groupC. will definitely be worse in the future. what goes up must come down

Which of the following types of information most likely allows the exploitation of a profit opportunityA. financial analysts’ published recommendationsB. technical analysisC. Hot tips from a stockbrokerD. insider information

You read a story in the newspaper announcing the proposed merger of Dell computer adn gateway. the merger is expected to greatly increase Gateway’s profitability. if you decide to invest in gateway stock yu can expect to earnA. about average returns since you will share in higher profitsB. about average returns since your stock price will definitely appreciate as higher profits are earnedC. below average returns since computer makers have low profit ratesD. a normal return since stock prices adjust to reflect expected changes in profitability amost immediately

The efficient markets hypothesis suggests that investorsA. do better on average if they adopt a “buy and hold” strategy.B.can use the advice of technical analysts to outperform the market.C.let too many unexploited profit opportunities go by if they adopt a “buy and hold” strategy.D.do better if they purchase loaded mutual funds.

The efficient markets hypothesis suggests that investorsA. should purchase no load mutual funds which have low management feesB. can use the advice of technical analysts to outperform the marketC. let too many unexploited profit opportunities go by if they adopt a hbuy and hold strategy

If you read in the Wall Street Journal that the “smart money” on Wall Street expects stock prices to fall, you should:A. sell all of your stocks like the experts because you can earn a better return on your investment.B. sell all of your stocks like the experts because you will benefit from this information when you sell your stocks.C. not sell all of your stocks because the Wall Street Journal is not a reputable publication.D. not sell all of your stocks because this is publicly available information and is already reflected in stock prices.

A company has just announced a 3-for-1 stock split, effective immediately. Prior to the split, the company had a market value of $10 billion with 120 million shares outstanding. Assuming that the split conveys no new information about the company, what is the value of the company, the number of shares outstanding, and price per share after the split?
~The market value of the company is $ ___ billion.
~The number of shares after the split is $____million.
~The new price per share is $________ per share.
~If the actual market price immediately following the split is $31.00 per share, what does this tell us about market efficiency?A. The market is efficient. The company is actively developing, and the stock return is expected to increase. Therefore, the price fully reflects available information.
B. No market failure is present. The market value of the securities is underestimated; therefore, the price per share is rising until Upper R Superscript of equals Upper R starRof=R*.
C. Market efficiency is uncertain. The price could indicate both market efficiency or failure depending on whether or not the stock split actually conveyed information about the company.
D. The market is inefficient. Some type of anomaly may have occurred and the stock price should be higher.

~The market value of the company is $10 billion. (Round your response to the nearest whole number.)
~The number of shares after the split is 360 million. (120×3)
~The new price per share is $27.78 per share. (10,000,000,000/360,000,000.)
~If the actual market price immediately following the split is $31.00 per share, what does this tell us about market efficiency?A. Market efficiency is uncertain. The price could indicate both market efficiency or failure depending on whether or not the stock split actually conveyed information about the company.

The current price Pt of a share of DuWop (a publicly traded company) is $25. Which of the following price movements (in the next time period,Pt+1) is consistent with a random walk?A. Pt+1 is $28 with a probability of 0.50 and Pt+1 is $24 with a probability of 0.50.B. Pt+1 is $22 with a probability of 0.25 and Pt+1 is $26 with a probability of 0.75.C. Pt+1 is $22 with a probability of 0.10 and Pt+1 is $28 with a probability of 0.90.D. Pt+1 is $26.

The current price of DuWop (a publicly traded company) is $25. The following rules describe the random-walk behavior of price movements in the future:1. Gains and losses are equally likely (i.e., pr(gain) = pr(loss) = .50).2. Gains are equal to $2.3. Losses are equal to $1.

Upper P Subscript tPtUpper P Subscript t plus 1Pt+1Upper P Subscript t plus 2Pt+2Upper P Subscript t plus 3Pt+3$25$25.50$26.00$26.50
You observe in time period 3 that the price, Upper P Subscript t plus 3Pt+3, of DuWop is equal to $31. Does this imply that this particular stock does not follow a random walk?
No

What does the stronger view of the efficient market hypothesis imply?A.Security prices can be used by managers to assess their cost of capitalSecurity prices can be used by managers to assess their cost of capital.
B. An inefficient capital marketAn inefficient capital market.
C. Upper A security’s price only reflects a fraction of available information about the market value of the securityA security’s price only reflects a fraction of available information about the market value of the security.
D. An investment can be compared to another comma but market prices do not reflect the actual valueAn investment can be compared to another, but market prices do not reflect the actual value.

____ is the field of study tat applies concepts from social sciences such as psychology and sociology to help understand the behavior of securities pricesA. behavioral financeB. Strategical FinanceC. Methodical FinanceD. procedural finance

Chapter 8

1) Of the following sources of external finance for American nonfinancial businesses, the least important isA) loans from banks.B) stocks.C) bonds and commercial paper.D) nonbank loans.

Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are true?A) Stocks are a far more important source of finance than are bonds.B) Stocks and bonds, combined, supply less than one-half of the external funds.C) Since 1970, more than half of the new issues of stock have been sold to American households.D) Financial intermediaries are the least important source of external funds for businesses.

Regulation of the financial systemA. protects the jobs of employees of financial institutions.B.ensures the stability of the financial system.C.occurs only in the United States.D. protects the wealth of owners of financial institutions.

A ________ is a provision that restricts or specifies certain activities that a borrower can engage in.A) residual claimantB) risk hedgeC) restrictive barrierD) restrictive covenant

Which of the following is NOT one of the eight basic puzzles about financial structure?A) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets.B) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower.C) There is very little regulation of the financial system.D) Collateral is a prevalent feature of debt contracts for both households and business.

Which firms are most likely to use bank financing rather than to issue bonds or stocks to finance their activities?A.State-owned business firms.B. Multinational firms.C. Sole proprietorships, partnerships, and small corporations.D. Industrial firms producing manufactured goods.

The following statements are not true except the one that indicates thatA. in the United States, bonds are a lessless important source of external funds than stocks.B. stocks areare the most important source of external funds for businesses in the United States.C. over 90 % of American households own securities.over 90% of American households own securities. nothingD. although banks are the most important source of external funds to businesses worldwide comma their role is shrinking slightly

Which of the following statements is true?A. Stocks and bonds are the largest source of external funds to businesses.B. Direct finance is much more important than indirect finance as a source of external funds to businesses.C. Firms raise more funds with bonds than with stocks.D. Firms raise more funds with bonds than with bank loans.

The following statements are true except the one that indicates thatA. although banks are the most important source of external funds to businesses worldwide comma their role is shrinking slightlyalthough banks are the most important source of external funds to businesses worldwide, their role is shrinking slightly over time.over time.B. over 90 % of American households own securities.C. in the United States, bonds are a moremore important source of external funds than stocks.D. stocks are notare not the most important source of external funds for businesses in the United States.

Which of the following is not a benefit to an individual purchasing a mutual fund?A. diversificationB. free−ridingC. lower transactions costsD. reduced risk

Financial intermediaries’ low transaction costs allow them to provide ________ services that make it easier for customers to conduct transactions.A. transcendentalB. equitableC. liquidityD. conduction

How can economies of scale help explain the existence of financial intermediaries?A. Financial intermediaries are relatively large institutions.B. Financial intermediaries with their vault technology can specialize in keeping deposits safe.C. Financial intermediaries are able to operate with lower transaction costs relative to individual lenders or borrowers.D. Financial intermediaries have exclusive access to communications technology in the financial sector.

If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem ofA) moral hazard.B) adverse selection.C) free-riding.D) costly state verification

A borrower who takes out a loan usually has better information about the potential returns and risks of the investment projects he plans to undertake than the lender does. This inequality of information is calledA) moral hazard.B) asymmetric information.C) noncollateralized risk.D) adverse selection.

An example of the __________ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds.a. costly state verificationb. agencyc. moral hazardd. adverse selection

The analysis of how asymmetric information problems affect economic behavior is called ________ theory.A) parallelB) principalC) agencyD) uneven

Wealthy people often worry that others will seek to marry them only for their money. Is this a problem of adverse selection?

Yes

Do you think the lemons problem would be more severe for stocks traded on the New York Stock Exchange or those traded over-the-counter?
Stocks traded _______ are more likely to be affected by the lemons problem.Over the counterNew York Stock Exchange

Over the counter

Would you be more willing to lend to a friend if she put all of her life savings into her business than you would if she had not done so?A.Whether or not she puts her life savings into her business has no bearing on whether she repays the loan or not. Therefore, it should have no effect on your decision to loan her moneyB.You would be more willing because putting her life savings into her business provides you protection against the problem of moral hazardC.You would be less willing because putting her life savings into a business that can potentially fail makes it more risky for you to loan her money. If the business fails, she will protect her investment before she considers repaying youD.You would be more willing because putting her life savings into her business provides you protection against the problem of adverse selection

In December 2001, Argentina announced it would not honor its sovereign (government-issued) debt. Many investors were left holding Argentinean bonds priced at a fraction of their recent value.Which of the following correctly summarizes the situation in Argentina as described above?A.The risk on Argentinean debt rose, its yield fell, and its price fell.B.The risk on Argentinean debt rose, its yield rose, and its price fell.C.The risk on Argentinean debt fell, its yield rose, and its price fell.D.The risk on Argentinean debt rose, its yield fell, and its price rose.

How do standardized accounting principles help financial markets work more efficiently?A.They provide standardized information about a firm to combat the problem of asymmetric information.B.They provide standardized information about a firm, whereas investors have perfect information.C.They provide easy to understand information about a firm.D.They make information publicly available to any consumer or investor.

How can the existence of asymmetric information provide a rationale for government regulation of financial markets?A.The production of good information is so costly that all potential buyers of this information are priced out of the marketB.The production of information to combat these asymmetries is subject to the free-rider problemC.The production of information to combat these asymmetries is subject to moral hazardD.Good information becomes quickly obsolete

’The more collateral there is backing a loan, the less the lender has to worry about adverse selection.’ Is this statement true, false, or uncertain?This statement is ____ because collateral______the adverse selection problem.1. ▼uncertaintruefalse
2.▼increasesreducesnegates

1. True2. Reduces

25 math– chapter 8

…

Adverse selection is a problem associated with equity and debt contracts arising fromA) the lender’s relative lack of information about the borrower’s potential returns and risks of his investment activities.B) the lender’s inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults.C) the borrower’s lack of incentive to seek a loan for highly risky investments.D) none of the above.

…

Adverse selection is a problem associated with equity and debt contracts arising fromA. the lender’s inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults.B. the lender’s relative lack of information about the borrower’s potential returns and risks of his investment activities.C. the borrower’s lack of incentive to seek a loan for highly risky investments.D. the lender’s inability to restrict the borrower from changing his behavior once given a loan.

In the United States, the government agency requiring that firms that sell securities in public markets adhere to standard accounting principles and disclose information about their sales, assets, and earnings is theA. Federal Reserve System.B. Securities and Exchange Commission.C. Federal Trade Commission.D. Federal Communications Commission.

A lesson of the Enron collapse is that government regulationA. increases the problem of asymmetric information.B. can reduce but not eliminate asymmetric information.C. should be reduced.D. always fails.

That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediariesA. have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars.B. have solved the moral hazard problem by providing valuable information to their customers.C. have failed to solve adverse selection problems in this market because “lemons” continue to be traded.D. are able to prevent potential competitors from freeminus−riding off the information that they provide.

Analysis of adverse selection indicates that financial intermediaries, especially banks,A. have advantages in overcoming the freeminus−rider problem, helping to explain why indirect finance is a more important source of business finance than is direct finance.B. must buy securities from corporations to diversify the risk that results from holding nonminus−tradable loans.C. provide better−known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations which rely to a greater extent on the new issues market for funds.D. despite their success in overcoming freeminus−rider problems, nevertheless play a minor role in moving funds to corporations.

As information technology improves, the lending role of financial institutions such as banks should ________.A. stay the sameB. increase significantlyC. decreaseD. increase somewhat

Net worth can perform a similar role to ________.A. intermediationB. diversificationC. collateralD. economies of scale

A problem for equity contracts is a particular type of ________ called the ________ problem.A. moral hazard; principal−agentB. moral hazard; free−riderC. adverse selection; free−riderD. adverse selection; principal−agent

Managers (________) may act in their own interest rather than in the interest of the stockholderminus−owners (________) because the managers have less incentive to maximize profits than the stockholderminus−owners do.A. agents; agentsB. agents; principalsC. principals; principalsD. principals; agents

The name economists give the process by which stockholders gather information by frequent monitoring of the firm’s activities isA. debt intermediation.B. costly avoidance.C. costly state verification.D. the free−rider problem.

Government regulations designed to reduce the moral hazard problem includeA. state verification subsidies.B. state licensing restrictions.C. laws that force firms to adhere to standard accounting principles.D. light sentences for those who commit the fraud of hiding and stealing profits.

One financial intermediary in our financial structure that helps to reduce the moral hazard from arising from the principalminus−agent problem is theA. money market mutual fund.B. pawn broker.C. venture capital firm.D. savings and loan association.

A venture capital firm protects its equity investment from moral hazard through which of the following means?A. It requires a 50% stake in the company.B. It prohibits the borrowing firm from replacing its management.C. It writes contracts that prohibit the sale of an equity investment to the venture capital firm.D. It places people on the board of directors to better monitor the borrowing firm’s activities.

A debt contract is incentive compatibleA. if the borrower’s net worth is sufficiently low so that the lender’s risk of moral hazard is significantly reduced.B. if the lender has the incentive to behave in the way that the borrower expects and desires.C. if the debt contract is treated like an equity.D. if the borrower has the incentive to behave in the way that the lender expects and desires, since doing otherwise jeopardizes the borrower’s net worth in the business.

Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses areA. restrictive covenants.B. illegal.C. risk insurance.D. limited−liability clauses.

12) Because of transaction costs in financial markets, we can say thatA. more investors will find it profitable to keep their money in the financial markets.B. investors choose to invest a smaller amount on stocks.C. some investors may find it less profitable to invest in something else other than financial markets.some investors may find it less profitable to invest in something else other than financial markets.D. investors are less likely to invest in different stocks.investors are less likely to invest in different stocks.
One solution to the problem of high transaction costs is to bundle the funds of many investors to take advantage of ____________.

DEconomies of Scale

13) The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________.A. free−riding; costly state verificationB. adverse selection; moral hazardC. costly state verification; free−ridingD. moral hazard; adverse selection

CHAPTER 9

Rank the following bank assets from most liquid (1) to least liquid (4): Commercial loans, securities, reserves, and physical capital.

3, 2, 1, 4

A bank finds that its ROE is too low because it has too much bank capital. Which of the following will not raise its ROE?A. The bank can sell part of its holdings of securities and hold more excess reservesB. The bank can pay out more dividendsC. The bank can increase the amount of its assets by acquiring new fundsD. The bank can buy back some of its shares

Which of the following is the greatest source of funds to commercial banks in the pastin the past?A. bank capitalB. borrowingsC. checkable depositsD. nontransaction deposits

Banks also obtain funds by borrowing from the Federal Reserve System. These borrowings are known as

discount loans

Reserves, cash items in process of collection, and deposits at other banks are collectively calledA. bank capitalB. cash itemsC. discount loansD. secondary reserves

Short-term U.S. government securities are called _______because of their high liquidity.

secondary reserves

Which of the following statements are true?A. A bank’s liabilities are its uses of funds.B. A bank’s assets are its sources of funds.C. A bank’s balance sheet shows that total assets equal total liabilities plus equity capital.D. A bank’s balance sheet indicates whether or not the bank is profitable.

Which of the following are reported as liabilities on a bank’s balance sheet?A. Checkable depositsB. ReservesC. Consumer loansD. Deposits with other banks

The share of checkable deposits in total bank liabilities hasA. expanded moderately over time.B. remained virtually unchanged since 1960.C. shrunk over time.D. expanded dramatically over time.

Banks make profits by selling liabilities with one set of characterisitics and using the proceeds to buy assets with a different set of characteristics. This process is known as ___________.

Asset transformation

Banks earn profits by selling ________ with attractive combinations of liquidity, risk, and return, and using the proceeds to buy ________ with a different set of characteristics.A. loans; depositsB. assets; liabilitiesC. liabilities; assetsD. securities; deposits

Asset transformation can be described asA. borrowing short and lending long.B. borrowing long and lending short.C. borrowing and lending for the long term.D. borrowing and lending only for the short term.

When Jane Brown writes a $100 check to her nephew, and he cashes the check, Ms. Brown’s bank ________ assets of $100 and ________ liabilities of $100.A. gains; losesB. loses; gainsC. gains; gainsD. loses; loses

When you deposit $50 in currency at Old National Bank,A. its reserves increase by less than $50 because of reserve requirements.B. its assets increase by less than $50 because of reserve requirements.C. its liabilities increase by $50.D. its liabilities decrease by $50.

If the bank you own has no excess reserves and a sound customer comes in asking for a loan, should you automatically turn the customer down, explaining that you don’t have any excess reserves to lend out? Why or why not? What options are available for you to provide the funds your customer needs?A. Yes. Although excess reserve are not the only source of new lending, the cost of acquiring the excess reserves for lending are higher than the expected return on the loan.B. No. There are only two sources of funds that can used to acquire reserves. The bank can borrow at the discount window or in the federal funds market.C. No. There are several ways that reserves can be acquired. For example, the bank can borrow at the discount window or in the federal funds market, or it can acquire funds by issuing negotiable CDs.D. Yes. In response to the subprime mortgage meltdown, the Federal Lending Act of 2008 stipulates that excess reserves are the only source of new lending.

If a bank doubles the amount of its capital and ROA stays constant, what will happen to ROE?A. Given the ROA, if bank capital doubles, then ROE will fall by half.B. Even if the bank doubles its amount of capital, if ROA is constant, then ROE will remain unchanged.C. Given the ROA, if bank capital doubles, then ROE will also double.D. The effect on ROE cannot be determined based on the information provided.

Which of the following is not true regarding how banks manage their assets? Banks seek assets thatA. provide diversification.B. generate high returnsC. are liquid.D. have no default risk

Which of the following are primary concerns of the bank manager?A. Acquiring funds at a relatively high cost, so that profitable lending opportunities can be realizedB. Maintaining sufficient reserves to minimize the cost to the bank of deposit outflowsC. Maintaining high levels of capital and thus maximizing the returns to the owners.D. Extending loans to borrowers who will pay low interest rates, but who are poor credit risks

Bankers’ concerns regarding the optimal mix of excess reserves, secondary reserves, borrowings from the Fed, and borrowings from other banks to deal with deposit outflows is an example ofA. liability management.B. managing credit risk.C. managing interest rate risk.D. liquidity management.

“Because diversification is a desirable strategy for avoiding risk, it never makes sense for a bank to specialize in making specific types of loans.” Is this statement true or false? Explain your answer.A. False. A bank may have developed expertise in screening and monitoring a particular type of loan, thus improving its ability to handle problems of adverse selection and moral hazard.B. True. A bank can reduce its risk by using diversification, just like individuals can.C. False. A bank does not gain anything by diversifying; the bank only raises its costs when it diversifies.D. True. Diversification is a desirable strategy for a bank, so it does not make sense for a bank to specialize in certain types of lending.

In order to reduce the ________ problem in loan markets, banks often insist on collateral from potential borrowers.A. asymmetric informationB. moral hazardC. principal-agentD. adverse lending

In one sense ________ appears surprising since it means that the bank is not ________ its portfolio of loans and thus is exposing itself to more risk.A. credit rationing; diversifyingB. specialization in lending; diversifyingC. screening; rationingD. specialization in lending; rationing

If you are a banker and expect interest rates to rise in the future, would you want to make short-term or long-term loans?A. You would want to make short-term loans since there is no guarantee that the interest rate will rise as expected.B. You would want to make short-term loans so you can reinvest the funds at higher interest rates after their maturity.C. You would want to make long-term loans to secure the higher interest rate for an extended period of time.D. Both short-term and long-term loans will be profitable with an expected interest rate increase.

Why has noninterest income been growing as a source of bank operating income?A. Banks are able to offer their employees higher salaries and bonuses, which reduces the moral hazard problem.B. Banks can increase profits by engaging in noninterest income, or off-balance-sheet activities.C. Banks are able to reduce the principal-agent problem by engaging in off-balance-sheet activities.D. Banks are more likely to engage in speculation; it can be risky but the profits are worth the risk.

Gap analysis measures the difference between a bank’s:A. deposits and loansB. long-term securities and short-term securitiesC. rate-sensitive liabilities and rate-sensitive assetsD. assets and liabilities

If a bank has ________ rate−sensitive assets than liabilities, then ________ in interest rates will increase bank profits.A. more; a declineB. more; an increaseC. fewer; an increaseD. fewer; a surge

If a bank’s liabilities are more sensitive to interest rate movements than are its assets, thenA. an increase in interest rates will increase bank profits.B. an increase in interest rates will reduce bank profits.C. a decrease in interest rates will reduce bank profits.D. interest rates changes will not impact bank profits.

Which of the following may not be used as a backup line of credit?A. Loan commitmentsB. Overdraft privilegesC. Standby letters of creditD. Mortgages

The principal-agent problem that exists for bank trading activities can be reduced by:A. combining trading activities with bookkeeping activitiesB. eliminating internal controlsC. eliminating the regulation of the financial industryD. the physical separation of trading activities from bookkeeping activities

All of the following are examples of offminus−balance sheet activities that generate fee income for banks exceptA. selling negotiable CDs.B. foreign exchange trades.C. back−up lines of credit.D. guaranteeing debt securities.

Offminus−balance sheet activities involving guarantees of securities and backminus−up credit linesA. greatly reduce the risk a bank faces.B. slightly reduce the risk a bank faces.C. have no impact on the risk a bank faces.D. increase the risk a bank faces.

Traders working for banks are subject to theA. double−jeopardy problem.B. principal−agent problem.C. free−rider problem.D. exchange−risk problem.

The bank you own has the following balance sheet
AssetsReserves $ 75 millionDeposits $500 millionLiabilitiesLoans $525 millionBank capital $100 million
If the bank suffers a deposit outflow of $50 million with a required reserve ratio on deposits of 10%, what actions can you take to keep your bank from failing?
A. You can borrow reserves in the federal funds market.B. You can go to the discount window.C. You can call in or sell off loans.D. Any of the above are appropriate actions to take.

Which of the following is not truenot true regarding how banks manage their assets? Banks seek assets thatA. have no default risk.have no default risk.B. provide diversification.C. generate high returns.generate high returns.D. are liquid.
Suppose that a bank’s balance sheet consists of the following: On the liability side it has $93 of deposits and $7 of capital, while on the asset side it has $10 of reserves and $90 of loans.This bank can then sustain $_________ of bad loans before it becomes solvent. (Round your response to the nearest whole number.)

A
7

If a bank has $10 million of checkable deposits, a required reserve ratio of 10 percent, and it holds $2 million in reserves, then it will not have enough reserves to support a deposit outflow of
A. $1.2 million.B. $1.1 million.C. $1 million.D. $900,000.

CHAPTER 13

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When the charter of the Second Bank of the United States expired in 1836:A. bank panics and losses to depositors declined.B. there was no lender of last resort to provide reserves to the banking system.C. the Treasury assumed the role as lender of last resort.D. it created a central bank to help prevent future bank panics.

The first central bank in the United States was___________.

the First Bank of the United States

The Federal Reserve System was established in 1913A. to ensure banking services for the Treasury.B. because the public became convinced a central bank was needed to avoid bank panics.C. to keep the stock markets from crashing.D. because of distrust of moneyed interests and centralized power.

The Second Bank of the United StatesA. had its charter renewal vetoed in 1832.B. was disbanded in 1811 when its charter was not renewed.C. is considered to be the primary cause of the bank panic of 1907.D. None of the above.

The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced thatA. the Second Bank of the United States had failed to serve as a lender of last resort.B. a central bank was needed to prevent future panics.C. the Federal Reserve System had failed to serve as a lender of last resort.D. the First Bank of the United States had failed to serve as a lender of last resort.

Why was the Federal Reserve System set up with twelve regional Federal Reserve banks rather than one central bank, as in other countries?A. With twelve regional banks, the Federal Reserve could easily influence politics in all parts of the United States.B. The writers of the Federal Reserve Act wanted to ensure the Fed’s power was not centralized in a single location.C. By creating twelve regional banks, writers of the Federal Reserve Act could ensure that finances from all parts of the country would flow through the Federal Reserve System.D. With twelve regional banks, employees of the Federal Reserve could quickly and easily get to a monetary crisis point anywhere in the United States.

Should the Federal Reserve redraw its district boundaries, similar to how congressional districts are periodically realigned?A. No. To ensure a separation of the monetary and political process, the Federal Reserve Act states that Federal Reserve district boundaries must always remain unchanged.B. Yes. If congressional districts are periodically redrawn to improve the political process, then redrawing Federal Reserve district boundaries should only improve the monetary policy process.C. Uncertain. This would require Congress to rewrite the Federal Reserve Act, which could create opportunities for political interests to interfere with the monetary policy process.

In what ways can the regional Federal Reserve Banks influence the conduct of monetary policy?A. By having five of their presidents sit on the FOMC.B. By having members serve on the Federal Advisory Council.C. Through their administration of the discount facilities at each bank.D. All of the above are correct.

Which of the following functions is not performed by the twelve Federal Reserve Banks?A. Withdrawing damaged currency and issuing new currency.B. Clearing checks.C. Acting as liaisons with the business community.D. Setting the reserve requirement.

Why is the New York Federal Reserve always a voting member on the FOMC?A. The New York Federal Reserve district contains many of the largest commercial banks in the United States.B. It is the only Federal Reserve bank that is a member of the Bank for International Settlements (BIS).C. The New York Federal Reserve is actively involved in the bond and foreign exchange markets.D. Only A and C are correct.E. All of the above are correct.

Although neither _____ nor the _____ is officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee.A. margin requirements; discount rateB. reserve requirements; discount rateC. margin requirements; federal funds rateD. reserve requirements; federal funds rate

Referring to the figure about the Federal Reserve System above, we find thatA. all districts have more than one Federal Reserve bank branch.B. there are 12 federal reserve bank cities.C. there are no branches aside from the main Federal Reserve bank in district 12.D. there is a main Federal Reserve Bank in Denver.

Each Federal Reserve district has _________ main Federal Reserve bank/banks.

One

Each of the Federal Reserve banks is considered a quasi-public institution because of the following statements except
A. it is owned by the private commercial banks in its district that are members of the Federal Reserve SystemB. member banks have purchased stock in their district Federal Reserve bank.C. many of the directors of district banks are elected by member banks.D. it uses its staff of professonal economists to research topics related to the conduct of monetary policy

The Board of Governors appoints _________ directors of each district bank.

Three

Reserve requirements are set by the __________ and advised upon by the __________.A. Board of Governors; FOMCB. Federal Advisory Council; open market deskC. New York Federal Reserve Bank; member banksD. Chair of the Board of Governors; twelve regional Federal Reserve banks

The Board of Governors is not involved in which of the following activities?A. approval of bank loansB. determining open market operationsC. setting margin requirementsD. effectively sets the discount rate through the review and determination process

Monetary policy is determined by the ___________.

Federal Open Market Committee

The Federal Open Market Committee is comprised ofA. the seven members of the Board of Governors plus five of the twelve Federal Reserve Bank presidents.B. the five members of the Board of Governors plus seven of the twelve Federal Reserve Bank presidents.C. the five members of the Board of Governors plus the twelve Federal Reserve Bank presidents.D. the seven members of the Board of Governors plus the twelve Federal Reserve Bank presidents.

Do the fourteen-year nonrenewable terms for governors effectively insulate the Board of Governors from political pressure?A. No. The only way to effectively insulate the Board of Governors from political pressure is to remove the term limit, thus allowing them to serve as many consecutive terms as they choose.B. Yes. The fourteen-year nonrenewable terms for governors effectively insulate the Board of Governors from political pressure.C. No. In order to gain additional power to regulate the financial system, the governors need the support of Congress and the president to pass favorable legislation.D. Yes. Members of the Board of Governors can serve 14-year terms, while the president is limited to eight years if reelected. Thus, the longer term insulates the Board from any political pressure.

How does the Federal Reserve have a high degree of instrument independence?A. The Federal Reserve can choose any method it wants in order to achieve a given set of policy objectives.B. The Federal Reserve is not subject to the influence of Congress.C. The Federal Reserve is able to set the goals of monetary policy.D. The Federal Reserve can contract with independent experts to choose the appropriate fiscal instruments.

If the Federal Reserve has a specific mandate from Congress to achieve “maximum employment and low, stable prices,” then how does the Fed have goal independence?A. The Fed is free to discuss the assigned goals with Congress.B. The Fed is free to interpret exactly what these objectives mean.C. The Fed can choose any method it wants in order to achieve the assigned goal.D. The Fed is able to change its goals frequently.

What is the primary tool that Congress uses to exercise some control over the Fed?A. The threat that Congress will acquire greater control over the Fed’s finances and budget.B. The threat that Congress can remove some members of the Board of Governors on a whim.C. The threat that Congress can withhold the Fed’s appropriations.D. All of the above are correct.

‘The independence of the Fed leaves it completely unaccountable for its actions.’ Why is this statement not true?A. The Fed has to report to Congress on a semiannual basis to explain its actionsB. The legislation that structures the Fed is written by Congress and is subject to changeC. The president can appoint a new chairman of the Board of Governors every four yearsD. Only A and B are correctE. All of the above are correct

The Federal Reserve is remarkably free from political pressure becauseA. the chairman of the Board of Governors is appointed by the Federal Reserve Bank presidents.B. it has an independent source of revenue.C. its structure cannot be changed by Congress through legislation.D. like members of the Supreme Court, members of the Board of Governors serve lifetime appointments.

While the Fed enjoys a relativity high degree of independence for a government agency, it feels political pressure from the president and Congress becauseA. the president can dismiss a Fed Governor at any time.B. the Fed must go to Congress each year for operating revenues.C. Congress could limit Fed power through legislationD. Congress reappoint Fed Governor positions every three years.

The ability of a central bank to set monetary policy instruments isA. instrument independence.B. goal independence.C. policy independence.D. political independence.

Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would:A. impart an inflationary bias to monetary policy.B. force monetary authorities to sacrifice the long-run objective of price stability.C. make the so-called political business cycle less pronounced.D. Only A and B are correct.E. All of the above are correct.