Question 1

Securities that repay both interest and loan principal during their life are known as:

Accepted Answer

Loan-backed securities, such as mortgage-backed securities, repay both interest and principal over their life.

Question 2

The risk faced by investors in loan-backed securities that some of the loans backing these securities will be paid off early is known as:

Accepted Answer

Prepayment risk is the risk that loans backing securities will be paid off early, which can affect the returns investors expect from these securities.

Question 3

The greater the prepayment risk, the

Accepted Answer

Prepayment risk affects loan-backed securities by potentially reducing the amount of interest income investors receive if loans are paid off earlier than expected. This risk makes these securities less attractive, leading to a lower price.

Question 4

Announcements from a security-issuing institution that affect the market value of the issuer's securities are an example of ____ risk.

Accepted Answer

Event risk refers to the risk that an unexpected event will negatively affect the market value of a security. Announcements from a security-issuing institution that affect the market value of the issuer's securities are a prime example of event risk, as these announcements can significantly impact investor perception and the security's value.

Question 5

The Orange County, California case is a clear example of what kind of risk in the financial markets?

Accepted Answer

The answer of The Orange County, California case is a...

Question 6

A liquid financial asset:

Accepted Answer

A liquid financial asset is one that can be easily and quickly converted into cash without significant loss of value. This means that it is readily marketable (A), and that its price tends to be stable over time (B). It also means that it can be sold with little risk of loss (C).

Question 7

Newly-issued 30-year Treasury bonds (usually referred to as "on the run" bonds) typically carry lower market interest yields than ("off the run") 30-year Treasury bonds which were issued in the past. This is because:

Accepted Answer

The new issue of Treasury bonds is more liquid because it is the most current issue, making it more desirable for investors who value liquidity. This increased demand can lead to lower yields compared to older, less liquid "off the run" bonds.

Question 8

Finance theory suggests that yield curves on higher-risk (speculative) corporate bonds tend to have a downward (negative) slope or are humped or bowed in shape. Why this might be true is that:

Accepted Answer

Speculative bonds are perceived as riskiest when they are newly issued, and as time passes and the issuing company remains solvent, these bonds often appear to improve in quality, leading to a decrease in yield requirements by investors. This can result in a downward-sloping or humped yield curve for these bonds. Choices A and B do not generally explain the shape of yield curves for speculative bonds.

Question 9

Recently, the junk bond market has enjoyed a rally in bond prices and an upward surge in new offerings. Reasons for this include:

Accepted Answer

All of the listed options contribute to the rally in junk bond prices and the increase in new offerings. New junk bond mutual funds provide a significant demand for these bonds, companies are increasingly bypassing traditional bank loans in favor of bond issuance, and a rise in corporate mergers financed through junk bonds adds to the demand and issuance of these financial instruments.

Question 10

Which of the following financial contracts may help to protect an investor from the risks of rising borrowing costs or a decline in the value of the risky assets in his/her investment portfolio?

Accepted Answer

The answer of Which of the following financial contracts may...

Question 11

The failures of Argentina and Enron Corporation in 2001 reflect:

Accepted Answer

The answer of The failures of Argentina and Enron Corporation...

Question 12

By early March 2009, the difference between long-term interest rates on corporate bonds, Baa and the 10 year US treasury notes has decreased to around:

Accepted Answer

In early March 2009, the difference between long-term interest rates on corporate bonds rated Baa and the 10-year US Treasury notes decreased to around 5.25%. This spread is a measure of the risk premium investors demand to hold corporate bonds over safer government securities.

Question 13

When agency ratings on securities are different, the accepted practice is to take the:

Accepted Answer

The answer of When agency ratings on securities are different,...

Question 14

Among the most popular default risk hedging tools today are credit derivatives, which:

Accepted Answer

Credit derivatives are financial contracts (B) that allow parties to manage or transfer credit risk (C), making option D (B and C above) the correct answer. They are not necessarily zero cost.

Question 15

Credit swaps:

Accepted Answer

Credit swaps are indeed a form of credit derivative and can be used to diversify risk, making both B and C correct.

Question 16

The marginal tax for people making $15,000 a year in taxable income is:

Accepted Answer

The marginal tax rate for individuals making $15,000 typically falls within the 10% bracket in the U.S. federal income tax system.

Question 17

The marginal tax rate on corporations with taxable income less than $50,000 is:

Accepted Answer

The marginal tax rate on corporations with taxable income less than $50,000 is 15%. This is a standard rate applied in the U.S. tax code for small corporations.

Question 18

The lowest marginal tax rate applied to corporations is:

Accepted Answer

The lowest marginal tax rate applied to corporations is 15%.

Question 19

The difference between the promised yield and the expected yield is the:

Accepted Answer

The difference between the promised yield and the expected yield does not specifically correspond to any of the options provided (A-D). It generally reflects the risk that the actual returns will differ from the promised or anticipated returns due to various factors, none of which are explicitly mentioned in the choices.

Question 20

Junk bonds, which refers to the probability that full repayment of these long-term debt securities are significantly below that for bonds rated investment quality, are rated:

Accepted Answer

The answer of Junk bonds, which refers to the probability...

Quiz 8: Understanding Risk and Market Factors in Financial Securities