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Fin 353

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					San Francisco State University
FIN 353
2006 Spring
Sample Exam for Midterm I

1. Asset transformation consists of:
    a. Altering the liquidity and maturity features of funds sources used to finance the
       FI's assets portfolio.
    b. Granting loans to transform funds deficits into funds surplus units.
    c. Receipt of securities across electronic payment systems.
    d. None of the above
    e. All of the above

2. Maturity intermediation occurs when
   a. intermediaries accept small amounts if saving s from individual customers and
      these funds to make large loans.
   b. financial intermediaries are willing to make risky loans and at the same time issue
      relatively safe security to savers.
   c. financial intermediaries borrow short term funds and lend long term.
   d. All of the above.

3. Financial intermediaries (FIs) can offer savers a safer, more liquid investment than a
    capital market security, even though the intermediary invests in risky illiquid
    instruments because:
    A) FIs can diversify away some of their risk
    B) FIs closely monitor the riskiness of their assets
    C) The federal government requires them to do so
    D) Both a) and b)
    E) Both a) and c)

4. Safety and soundness regulations include all of the following layers of protection
    except
    A) the provision of guaranty funds.
    B) requirements encouraging diversification of assets.
    C) the creation of money for those FIs in financial trouble.
    D) minimum levels of capital.
    E) monitoring and surveillance.

5. The federal government extends a safety net to FIs consisting of
        A) deposit insurance, discount window borrowing, and reserve requirements.
        B) deposit insurance and discount window borrowing.
        C) deposit insurance, unemployment insurance, and discount window borrowing.
        D) deposit insurance, open market operations, and discount window borrowing.
        E) deposit insurance protection.
6. Classify each of the following in terms of their effect on interest rates (increase or
    decrease):
    I.    Covenants on borrowing become more restrictive
   II.    The Federal Reserve increases the money supply
   III.   Total household wealth increases
   A) I increases, II increases, III increases
   B) I increases, II decreases, III decreases
   C) I decreases, II increases, III increases
   D) I decreases, II decreases, III decreases
   E) None of the above

7. According to the liquidity premium theory of interest rates
   a. Long term spot rates are higher than the average of current and expected future
      short term rates.
   b. Investors prefer certain maturities and will not normally switch out of those
      maturities.
   c. Investors are indifferent between different maturities if the long term spot rates
      are equal to the average of current and expected future short term rates.
   d. The term structure must always be upward sloping.
   e. Long term spot rates are totally unrelated to expectations of future short term
      rates.

8. Inflation causes the demand curve for loanable funds to shift to the _____ and causes
    the supply curve to shift to the _____.
    a. Right; right
    b. Right; left
    c. Left; left
    d. Left; right

9. An individual desires to earn a real return of 3%. Prices are expected to rise over the
   investment period by 4%. The investor has a federal tax rate of 28% and state and
   local tax rate of 6%, what is the investor's expected after tax rate of return?
   a. 7.006%
   b. 10.61%
   c. 5.04%
   d. 4.62%
   e. 6.58%

10. According to the loanable funds theory, expectations for improved profitability and/or
    higher earnings for businesses would
    a. decrease the supply of loanable funds and increase market interest rates.
    b. increase the supply of loanable funds and decrease market interest rates.
    c. increase the demand for loanable funds and increase market interests rates.
    d. decrease the demand for loanable funds and decrease market interest rates.


11. Answer the following question based on the information presented below.
   Actual rate of interest on a one year-security = 5.40%
   Actual rate of interest on a two-year security = 5.50%
   Actual rate of interest on a three-year security = 5.70%
   Actual rate of interest on a four-year security = 6.00%

   What is the forward rate of interest on a one-year security three years from today?
   a. 6.10%
   b. 6.33%
   c. 6.67%
   d. 6.91%

12. If we observe a one-year Treasury security rate less than the two-year Treasury
    security rate, according to the unbiased expectations theory:
    a. The one-year rate expected one year from now is less than the one-year Treasury
        rate.
    b. The one-year rate expected one year from now is greater than the one-year
        Treasury rate, but less than the two year rate.
    c. The one-year rate expected one year from now is less than both the one and two
        year Treasury rates.
    d. The one-year rate expected one year from now is greater than the one-year
        Treasury rate and the two-year Treasury rate.
    e. No inference can be made about the expected one-year rate.

13. According to the loanable funds theory, a Federal Reserve action that increases bank
    reserves would
    a. decrease the supply of loanable funds and increase market interest rates.
    b. increase the supply of loanable funds and decrease market interest rates.
    c. increase the demand for loanable funds and increase market interest rates.
    d. decrease the demand for loanable funds and decrease market interest rates.

14. Calculate the nominal rate of interest using the Fisher equation (not the simplified
    version) assuming the real rate of interest is 3 percent and the expected rate of
    inflation is 4 percent.
    a. 6.84%
    b. 7.12%
    c. 7.23%
    d. 7.44%

15. If R1 = 8%, R2 = 6% and the unbiased expectations theory of the term structure of
    interest holds, what is the expected one year interest rate expected one year from
    now: E(r2)?
    a. 2%
    b. 4.04%
    c. 6.2%
    d. 7%
    e. 10.04%
16. The _____ the coupon and the _____ the maturity; the _____ the duration of a bond,
ceteris paribus.
    a. Larger, longer, longer
    b. Larger, longer, shorter
    c. Smaller, shorter, longer
    d. Smaller, shorter, shorter
    e. None of the above

17. A 10 year maturity coupon bond has a 6 year duration. An equivalent 20year bond
    with the same coupon has a duration
    a. Equal to 12 years
    b. Less than 6 years
    c. Less than 12 years
    d. Equal to 6 years
    e. Greater than 20 years

18. Calculate the duration of a two-year corporate bond paying 6 percent interest
    annually, selling at par. Principal of $10,000,000 is due at the end of two years.
    A) 2 years.
    B) 1.91 years.
    C) 1.94 years.
    D) 1.49 years.
    E) 1.75 years.

19. A bond has a 6% required return. Interest rates are projected to rise 25 basis points.
    The bond's duration is 5 years. What is the predicted price change?
    a. –1.18%
    b. 4.71%
    c. 1.25%
    d. –1.25%
    e. 1.18%

20. A decrease in interest rates will
    A) Decrease the bond's FPV
    B) Increase the bond's duration
    C) Lower the bond's coupon rate
    D) Change the bond's payment frequency
    E) Not affect the bond's duration

21. For large interest rate increases, duration _____ the fall in security prices and for
    large interest rate decreases, duration _____ the rise in security prices.
    a. Overpredicts, overpredicts
    b. Overpredicts, underpredicts
    c. Underpredicts, overpredicts
    d. Underpredicts, underpredicts
    e. None of the above
 Use the following example for Questions 22-24: A bond is scheduled to mature in five
years. Its coupon rate is 9 percent with interest paid annually. This $1,000 par value
bond carries a yield to maturity of 10 percent.


22. What is the bond's price?
    A) $962.09
    B) $961.39
    C) $1,000
    D) $1,038.90
    E) $995.05

23. What is the duration of the bond?
    A) 4.677 years.
    B) 5.000 years.
    C) 4.674 years.
    D) 4.328 years.
    E) 4.223 years

24. Calculate the percentage change in this bond's price if interest rates on comparable
    risk securities decline to 7 percent. Use the duration valuation equation.
    A) +8.58 percent
    B) +12.76 percent
    C) 12.75 percent
    D) +11.80 percent
    E) +11.52 percent

25. Ceteris paribus, if the Fed was targeting the quantity of money supplied and money
    demand dropped the Fed would likely ______________. If the Fed was instead
    targeting interest rates and money demand dropped the Fed would likely
    _______________.
    a. increase the money supply, do nothing.
    b. do nothing, decrease the money supply.
    c. decrease the money supply, do nothing.
    d. do nothing, increase the money supply.
    e. increase the money supply, decrease the money supply.

26. The primary policy tool used by the Fed to meet its monetary policy goals is:
    A) Changing the discount rate
    B) Changing reserve requirements
    C) Devaluing the currency
    D) Changing bank regulations
    E) Open market operations

27. A decrease in reserve requirements could lead to a(n)
   a.   Increase in bank lending
   b.   Increase in the money supply
   c.   An increase in the discount rate
   d.   Both A and B
   e.   Both A and C

28. If the Fed sells $100 million of Treasury bonds from its holding to a security dealer,
given a reserve ratio of 10% and a currency ratio of 20%, how much the money supply
will be affected?
    a. Increases by $100 million
    b. Decreased by $100 million
    c. Increases by $400 million
    d. Decreases by $400 million

29. Bank A has an increase in deposits of $10 million dollars and reserve requirements
    are 10%. Bank A loans out 90% of the increase. This amount winds up deposited in
    Bank B. Bank B lends out 90%, and this amount winds up deposited in Bank C.
    What is the total increase in deposits resulting from these three banks?
    a. $10.00 million
    b. $19.00 million
    c. $22.33 million
    d. $27.10 million
    e. $30.00 million

30. The Fed changes reserve requirements from 10% to 8%, thereby creating $450
    million in excess reserves. The total change in deposits (with no drains) would be
    a. $486 million
    b. $5.625 billion
    c. $0.489 billion
    d. $3.795 billion
    e. None of the above

Answers:
1. a           11. d          21. b
2. c           12. d          22. a
3. d           13. b          23. e
4. c           14. b          24. e
5. b           15. b          25. b
6. b           16. e          26. e
7. a           17. c          27. d
8. b           18. c          28. d
9. d           19. a          29. d
10. c          20. b          30. b

				
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