Question I (5 Points Each Part)

Question I (5 points each part)

a)Give examples of how you use money as

i)A means of payment ______

ii)A unit of account ______

iii)A store of value ______

b)What is the difference between a stock and a bond?

c)What is an asset included in the M2 definition of money but not in the M1 definition of money? Why is this asset not considered part of the M1 money supply?

d)What aredollar-denominated deposits held in a Frankfurt bank called?

What are euro-denominated deposits held in a New York bank called?

e)Can the same financial instrument be bought and sold in both a primary and a secondary financial market? Give an example.

Question II (5 points each part)

a)How much money must you put out to interest at 6% today to have $1000 in two years? Show how this is computed but do not necessarily do the calculation yourself.

b)What is the yield to maturity of a $1000 face value discount bond that matures in 6-months and is currently selling for $960? Show how this is computed but do not necessarily do the calculation yourself.

c)Suppose a5 ½ percent $1000 face value coupon bond that matures in five years is currently selling for $1100. What is the bond’s current yield? Is its yield to maturity less than or greater than its current yield? Explain why.

d)What is the present value of an 5 ½ percent $1000 face value coupon bond that matures in five years and is currently selling for $1100?

e)Why do long-term US Treasury bonds typically offer higher interest rates than shorter-term US Treasury bonds?

Question III

a) An investor sees a current twelve month rate on Treasury bills of 4% and expects the following future twelve month rates for each of the subsequent years; 4.5%, 5.5% and 6.0%. If this investor views a four-year maturity at 5.65% as equal to four consecutive one year securities, what is his/her risk premium? Show your calculation and explain the logic of your answer. (10 points)

b)What is the holding period rate of return for a $1000 face value bond with a $60 annual coupon purchased for $970.00 and sold three years later for $1060.00? Show how you would calculate the return over the three-year holding period but do not try to solve for this rate of return. (10 points)

c) An investment pays $1,200 a quarter of the time; $1,000 half of the time; and $800 a quarter of the time. What is the expected value and standard deviation of this investment? Show your calculations (you can express your answer for standard deviation as a square root). (10 points)

Question IV

a) Would it ever make sense to pay $1100 for a coupon bond with a $1000 face value? Why? (5 points)

b) Why do people hold money when they can earn (more) interest by buying government bonds? (5 points)

c)Why may mayors of cities that need to borrow for infrastructure improvements not look favorably on large reductions in federal income tax rates? (5 points)

d)If an economy is experiencing rapid economic growth, explain what you would expect to happen to the yield curve.Why? (10 points)

What does it mean to say that an asset is “liquid”?

Rank the following assets from most liquid to least liquid.

a) Common stockb) Housesc) Currency d) Savings accountse) Checking account deposits.

Credit cards usually charge higher rates of interest than most other forms of lending. In terms of information, collateral and monitoring, how might these higher rates be explained?

Why might a life insurance company insist on an individual having a physical exam before agreeing to provide life insurance to the individual?

Why are options referred to as derivative instruments?

A high school basketball player decides to bypass college and go right into the NBA, (the National Basketball Association). Describe the risk the individual is taking and a contract that might transfer the risk.

Describe what is likely to happen to the average price of a share of stock if the stock markets decide to close every Friday and Monday to provide workers at the exchanges with longer weekends.

Where would you expect prices to be more volatile, on instruments traded in the money market or instruments traded in the bond (capital) market? Explain

Explain why a company offering homeowners insurance policies would want to insure homes across a wide geographic area.

If a saver is looking for the opportunity to make a very large return in a very short period of time, would you recommend diversification for this individual?

If a bond is purchased at a discount, meaning for less than face value, could the yield to maturity ever be less than the coupon rate? Could the holding period return be less than the coupon rate? Explain.

In mid-2004 there was speculation that the Federal Reserve would be raising interest rates before the end of the year. What impact should this news have on the bond market and why?

Commercial paper refers to ______

Why do yield curves usually slope upwards?

Why do economists pay particular attention to inverted yield curves?

Explain why many mayors of cities facing the need to borrow for infrastructure improvements, may not look favorably on a large federal income tax rate reduction?

During economic slowdowns why would you expect the risk premium to increase the most between U.S. Treasury bonds and junk bonds?

How does the Standard & Poor's 500 Index differ from the Dow Jones Industrial Index.

Why does the Theory of Efficient Markets imply that stock price movements are unpredictable?