Question 1

Which of the following statements about indexed bonds is correct?

Accepted Answer

Indexed bonds exist both in the United States and in England. They have a nominal interest rate that is adjusted for inflation, meaning that the interest rate increases when the inflation rate rises. Therefore, all of the above statements are correct.

Question 2

Equity finance is represented by which of the following?

Accepted Answer

Equity finance refers to the sale of shares of stock, which represents ownership in a company. Borrowing from banks (A) and selling bonds (B) are forms of debt finance, where the company is borrowing money and must pay it back with interest. Drawing down retained earnings (D) is using profits that were previously earned by the company and kept in reserve, and selling off part of its capital stock (E) is essentially the same as selling shares of stock.

Question 3

The fundamental value of a share of stock is equal to which of the following?

Accepted Answer

The fundamental value of a share of stock represents the present value of all expected future dividends. Therefore, the best choice is B, which is the present value of expected dividends. Choices A and C (sum of expected dividends and coupon payments) do not account for the time value of money, while choices D and E (present value of coupon payments and expected yield) are not applicable to stocks as they are concepts related to bonds.

Question 4

For this question,assume that there is perfect arbitrage in the stock market.Given this assumption,economists believe that

Accepted Answer

If there is perfect arbitrage in the stock market, any price discrepancies between two assets will immediately be exploited by investors through buying the undervalued asset and short selling the overvalued asset, leading to a correction in prices. This means that stock prices will be determined by fundamental factors such as company earnings, rather than being easily predictable or diverging from their fundamental value. Therefore, economists believe that movements in stock prices are largely unpredictable in a perfectly arbitrageable market.

Question 5

A share of stock will pay a dividend of $25 in one year,and will be sold for an expected price of $500 at that time.If the current one-year interest rate is 5%,the current price of the stock will be approximately equal to

Accepted Answer

The answer of A share of stock will pay a...

Question 6

Suppose financial market participants expect short-term rates in the future to be less than current short-term interest rates.Given this information,we would expect

Accepted Answer

When market participants expect short-term rates in the future to be less than current short-term rates, the yield curve is more likely to slope downwards. This is because investors will demand higher yields on longer-term bonds to compensate for the lower expected future short-term rates. Hence, the longer-term bonds will have lower prices and higher yields, resulting in a downward sloping yield curve.

Question 7

A bond has a face value of $10,000,a price of $12,000,and coupon payments of $2000 for two years.The coupon rate of this bond is

Accepted Answer

The coupon rate is calculated as the annual coupon payment divided by the face value of the bond. Here, the annual coupon payment is $2,000 and the face value is $10,000, so the coupon rate is $2,000 / $10,000 = 0.20 or 20%.

Question 8

Suppose the current one-year interest rate is 4%.Also assume that financial markets expect the one-year interest rate next year to be 5%,and expect the one-year rate to be 6% the year after that.Given this information,the yield to maturity on a three-year bond will be approximately

Accepted Answer

The yield to maturity on a three-year bond is the average of the expected future one-year interest rates. Therefore, the yield to maturity can be calculated as (4% + 5% + 6%)/3 = 5%. Therefore, choice B is the best answer.

Question 9

Suppose there is a decrease in the short-term interest rate.Give this reduction in the current short-term interest rate,which of the following will most likely occur?

Accepted Answer

A decrease in short-term interest rates often leads to a decrease in long-term rates, but typically the change in long-term rates is less pronounced due to factors like inflation expectations and risk premiums.

Question 10

For this question,assume that one-year and two-year bonds have the same risk; therefore,you can ignore risk here.Assuming that there is arbitrage between one-year bonds and two-year bonds,we know that the expected rate of return on two-year bonds

Accepted Answer

In an arbitrage-free market, the expected rate of return on two-year bonds should equal the expected rate of return from holding a one-year bond for one year, assuming risk is the same and ignoring any other factors. This is because if the returns were different, investors would buy the bond with the higher return and sell the bond with the lower return, leading to an arbitrage opportunity until the returns equalize.

Question 11

A discount bond is a bond

Accepted Answer

A discount bond is a bond that is sold at a price less than its face value, and does not make any coupon payments during its life. This means that the interest rate on the bond is effectively zero, and the face value is not zero. Discount bonds are also known as zero-coupon bonds.

Question 12

Among the following,which is the broadest measure of stock prices in the United States?

Accepted Answer

The Standard and Poor's 500 Composite Index is the broadest measure of stock prices in the United States as it includes 500 large-cap common stocks that represent industries in the US economy. The Dow Jones Index only includes 30 blue-chip stocks, the FT index includes stocks from the London Stock Exchange, the Nikkei Index includes stocks from the Tokyo Stock Exchange, and the Term Structure Index is not a measure of stock prices but rather a measure of the relationship between short-term and long-term interest rates.

Question 13

Assume that the current one-year rate is 5% and the two-year rate is 7%.Given this information,the one-year rate expected one year from now is

Accepted Answer

The answer of Assume that the current one-year rate is...

Question 14

An upward-sloping yield curve suggests that financial market participants expect short-term interest rates will

Accepted Answer

An upward-sloping yield curve suggests that long-term interest rates are higher than short-term interest rates, indicating that financial market participants expect short-term interest rates to rise in the future. This may be due to expectations of higher inflation or an increase in economic growth.

Question 15

A "junk bond" is a bond with a

Accepted Answer

A junk bond is a bond with a high default risk, which means there is a higher probability that the issuer will default on the bond and not repay the investor. Junk bonds offer a higher yield to compensate for the increased risk.

Question 16

Which of the following bonds (of equal maturity)would have the largest risk premium?

Accepted Answer

Junk bonds have the highest default risk and therefore command a higher risk premium compared to other bonds of equal maturity.

Question 17

A bond has a face value of $1,000,a price of $1,200,and coupon payments of $100 for two years.The "current yield" of this bond is

Accepted Answer

The current yield is calculated as the annual coupon payment divided by the bond's current price. Here, it's $100 / $1,200 = 0.0833 or 8.33%.

Question 18

Suppose the current one-year interest rate is 4%,and financial markets expect the one-year interest rate next year to be 8%.Given this information,the yield to maturity on a two-year bond will be approximately

Accepted Answer

The yield to maturity on a two-year bond can be calculated as the average of the one-year interest rates for the two years. Using the information given, the average of 4% and 8% is 6%. Therefore, the answer is choice B.

Question 19

Which of the following best explains why the long-term interest rate will generally change by less than 1% when the short-term interest rate changes by 1%?

Accepted Answer

Financial market participants will not expect the increase in the short-term interest rate to persist fully in the future, and they will adjust their expectations for long-term rates accordingly. This will cause long-term interest rates to change less than short-term rates.

Question 20

The length of time over which a bond promises to make payments to the holder is called which of the following?

Accepted Answer

The length of time over which a bond promises to make payments to the holder is referred to as the bond's maturity or term to maturity, not specifically mentioned in the provided options.

Quiz 15: Financial Markets and Expectations