1

University of Windsor
Odette School of Business


0472-378
Financial Markets and Institutions


Assignment #1


Dr. Keith C.K. Cheung Due: October 12, 2011


Student Name: ___________________________________________
(Print)

Student ID Number: _____________________________________



INSTRUCTIONS


1. No late assignment will be accepted
2. Solution can be found in the CLEW on October 19
3. The complete set has 70 multiple-choice questions.
4. Leave your answers in the scantron provided. Each correct response is
worth one point.
5. Incorrect answers will not be penalized. Make an educated guess if
needed.
6. This assignment is worth 10% of the overall grade.





KEEP QUESTION PAPER INTACT

2


MULTIPLE-CHOICE QUESTIONS are designed to test general
understanding of a variety of concepts, as well as knowledge of various specific points.


1. What distinguishes financial institutions (FIs) from industrial firms?
____
A) FI balance sheets are almost totally comprised of financial securities whereas industrial
firms hold substantial amounts of real assets
B) Industrial firms are the customers of FIs
C) FIs deal exclusively in primary securities while industrial firms specialize in secondary
securities
D) Industrial firms produce real goods or services while FIs only manipulate money
E) Industrial firms are unregulated while FIs are heavily regulated


2. How much will you pay for a 181-day $1,000 Treasury bill to have an annual yield at
11.1% with simple interest calculation?
____
A) $1,000.00
B) $973.00
C) $947.41
D) $900.00
Hint:
|
|
.
|

\
|

|
|
.
|

\
|
=
days P
P F
i
d
d
db
365



3. Secondary securities
____
A) Can only be converted into cash with huge transaction costs
B) Are assets backed by primary securities
C) Are issued by non-financial institutions
D) All of the above
E) None of the above


4. The origination of a home mortgage loan is considered to be
____
A) Primary security because this is the FIs primary source of business
B) Secondary security because mortgages are typically resold in the secondary market
C) Primary security because the mortgage IOU is backed with real assets
D) Secondary security for re-sales of existing homes and a primary security for new home
sales
E) None of the above due to insufficient information

3

(The following information relates to Questions 5 and 6)

ABC Bank (seller) has made a three against six forward rate arrangement (FRA) with XYZ
Bank (buyer). The notional amount is $75,000,000. The settlement rate is 5.15%. The
agreement rate is 5.25%. The actual number of days in this three-month agreement is 90.


5. Which of the following is true?
____
A) ABC Bank will pay XYZ Bank a cash settlement at the beginning of the 90-day FRA
period
B) XYZ Bank will pay ABC Bank a cash settlement at the beginning of the 90-day FRA
period
C) ABC Bank will pay XYZ Bank a cash settlement at the end of the 90-day FRA period
D) XYZ Bank will pay ABC Bank a cash settlement at the end of the 90-day FRA period


6. The payment amount under this FRA is
____
A) $12,510
B) $22,526
C) $18,750
D) None of the above
Hint:
) 360 / ( ) ( 1
) 360 / ( ) ( $
days SR
days AR SR
FRA
+

=


7. A moderately upward-sloping yield curve indicates that
____
A) Short-term rates are expected neither to rise nor fall in the near future
B) Short-term rates are expected to remain relatively unchanged, but that long-term rates are
expected to fall
C) Short-term rates are expected neither to rise nor fall, but that long-term rates are expected
to rise moderately
D) Short-term rates are expected to rise moderately in the near future


8. The current yield on a $6,000, 10% coupon bond selling for $5,000 is
____
A) 5%
B) 10%
C) 12%
D) 15%
E) Undetermined

4

9. Compared to interest rates on long-term Canada bonds, interest rates on three-month
treasury bills fluctuate ____ and are ____ on average.
____
A) More; lower
B) Less; lower
C) More; higher
D) Less; higher


10. Which of the following is an example of indirect finance?
____
A) A wealthy individual buys commercial paper in the primary market
B) A bank buys a treasury bill from one of its depositors
C) A corporation buys commercial paper issued by another corporation
D) All of the above
E) None of the above


11. The Four Pillars refer to
____
A) Banks, insurance companies, trust companies, and mutual funds
B) Banks, insurance companies, finance companies, and pension funds
C) Banks, insurance companies, investment banks, and finance companies
D) Banks, insurance companies, trust companies, and investment dealers


12. An analyst collects the following information regarding spot rates of interest:
1-year rate = 4% 2-year rate = 5% 3-year rate = 6% 4-year rate = 7%
Using the pure expectation theory of the term structure of interest rates, the expected
annualized 2-year interest rate two years from today is
____
A) 10.05%
B) 9.04%
C) 8.03%
D) 7.02%
Hint: | | 1 ) 1 )...( 1 )( 1 )( 1 (
/ 1
1 13 12 11
+ + + + =
n
n n
i i i i i


13. The real interest rate is
____
A) Never negative
B) The rate on a 3-month Treasury bill
C) Always equal to the inflation rate
D) Equal to the nominal interest rate minus the percentage change in prices
5

14. A bond has a coupon rate of 5% and a par value of $1,000. The bonds yield-to-maturity
(YTM) is also 5%. Ignoring accrued interest, the current price of the bond is
____
A) $1,166
B) $1,000
C) $975
D) More information is needed to answer this question
Hint:

=
+
=
n
t
t
t
k
CF
P
1
0
) 1 (



15. A 5-year corporate bond yields 7.25%. 5-year T-bonds yield 4.8%. Real risk-free rate is
2.75%. Inflation premium for 5-year bonds is 1.65%. Default risk premium is 1.2%.
Maturity risk premium for all bonds is (t 1)(0.1%) where t = years of maturity. What
is the liquidity premium of the T-bond?
____
A) 1.65%
B) 1.30%
C) 0.45%
D) 0.00%
Hint: MRP LP DRP R I
e
+ + + + = t


16. A forward discount means that a currency is
____
A) More expensive in the forward market than in the spot market
B) Less expensive in the forward market than in the spot market after adjusting for the
difference in interest rates
C) Being heavily bought by speculators
D) More expensive in the forward market than in the spot market after adjusting for the
difference in interest rates
E) Less expensive in the forward market than in the spot market


17. Suppose six months ago a British investor bought a 6-month Canadian T-bill at a price of
$9,708.74, with a maturity value of $10,000. The exchange rate ($/) at that time was
1.9516. Today, at maturity, the exchange rate ($/) is 2.0751. What is the annualized
rate of return to this British investor?
____
A) -6.26%
B) -4.13%
C) 6.00%
D) 8.25%
Hint: (1 + R) = (1 + R
in foreign currency
) (1 + R
foreign exchange
)

6

18. Someone who lends $5,000 at a 6 percent rate of interest and expects the inflation rate to
be 5 percent anticipates a
____
A) Capital gain
B) Nominal rate of return of 11 percent
C) Real rate of return of 6 percent
D) Nominal rate of return of 1 percent
E) Real rate of return of 1 percent


19. To be trade in wholesale markets and not in a retail market, instruments must
____
A) Be financial assets
B) First be sold in primary markets
C) Have a very large monetary value
D) Have long-term maturities
E) All of the above


20. Which of the following would tend to cause interest rates to fall?
____
A) Foreign interest rates decline
B) The public wants to hold less money
C) Supply of loan-able funds increases
D) Reductions in government debt
E) All of the above


21. Financial intermediaries
____
A) Bring together surplus-spending units (SSUs) and deficit-spending units (DSUs)
B) Borrow $1 and lend $1
C) Issue claims on themselves
D) Are usually profit-seeking institutions
E) All of the above


22. The liquidity premium exists because, on the margin,
____
A) Lenders prefer to lend short term and borrowers prefer to borrow short term
B) Lenders prefer to lend long term and borrowers prefer to borrow long term
C) Markets are extremely segmented
D) Lenders prefer to lend short term and borrowers prefer to borrow long term
E) Lenders prefer to lend long term and borrowers prefer to borrow short term


7

23. Which of the following is true?
____
A) Floating-rate securities have more interest rate (price) risk than fixed-rate securities
B) Reinvestment risk can be eliminated by holding floating-rate securities
C) Interest rate (price) risk can be removed by holding zero-coupon securities
D) All of the above
E) None of the above


24. When the corporate bond market becomes less liquid, other things equal, the demand
curve for corporate bonds shifts to the ___ and the interest rate on bonds will ____.
____
A) Right; fall
B) Right; rise
C) Left; fall
D) Left; rise


25. Commercial papers
____
A) Are issued only by the largest and most creditworthy corporations
B) Are unsecured securities
C) Never have a term to maturity exceeding 270 days
D) Carry an interest rate that varies according to the issuers risk level
E) All of the above


26. Although individuals and households are the largest purchasers of capital market
securities, they frequently buy these securities through financial institutions such as
____
A) Money market mutual funds
B) Pension funds
C) Commercial banks
D) Insurance companies
E) None of the above


27. Which of the following is true?
____
A) Interest rates are higher on mortgage loans on which lenders provide incentives
B) Mortgage rates are closely tied to Canada bond rates, but mortgage rates tend to stay
below Canada rates because mortgages are secured with collateral
C) Longer-term mortgages have higher interest rates than shorter-term mortgages
D) All of the above
E) None of the above

8

28. Negotiable certificates of deposit (CDs)
____
A) Are issued by all banks
B) Have a maturity of at least one year
C) Are illiquid assets because the normal denomination is $1 million or more
D) Have an active secondary market
E) All of the above


29. In an economy without a financial industry,
____
A) People would not want to defer consumption
B) No one would want to borrow
C) Savers could accumulate only currency or physical assets
D) People would not wish to lend
E) Barter would be the only means of making exchanges


30. In a typical mortgage securitization, the actual mortgages are legally owned by
____
A) The bank that originated the mortgages
B) The purchasers of the bonds collateralized by the mortgages
C) A special purpose vehicle
D) The Canadian Mortgage Housing Corporation
E) The investment house that put together the securitization


31. The Bank of Canada can influence the overnight funds interest rate by
____
A) Buying securities that removes settlement balance, thereby raising the overnight funds
interest rate
B) Buying securities that adds settlement balance, thereby lowering the overnight funds
interest rate
C) Buying securities that removes settlement balance, thereby lowering the overnight funds
interest rate
D) Buying securities that adds settlement balance, thereby raising the overnight funds
interest rate


32. Government bonds are subject to ____ risk, but are free of ____ risk.
____
A) Default; liquidity
B) Default; interest rate
C) Interest rate; exchange rate
D) Interest rate; default

9

33. Assume that interest rates on British-pound securities and comparable dollar securities
are identical. If investors become bearish on British-pound securities, such a feeling
will be reflected in
_____
A) An increase in interest rate on British-pound securities
B) The depreciation of the British-pound in the spot foreign-exchange market
C) Both (A) and (B)
D) Neither (A) nor (B)


34. If the bid and ask prices are $1.50/ and $1.51/, respectively, the corresponding bid and
ask prices are
____
A) 0.6667/$; 0.6623/$
B) $1.51/; $1.50/
C) 0.6623/$; 0.6667/$
D) Both (A) and (B)
E) Both (B) and (C)


35. Suppose that a banks bid-ask spread on the Hong Kong dollar (HK$) is HK0.001 per US
dollar (USD). The bank will buy Hong Kong dollar at the rate of HK$7.839/USD. If a
customer wishes to buy Hong Kong dollar, the rate will
____
A) Be 7.840 HK dollars per USD
B) Be 7.839 HK dollars per USD
C) Be 7.838 HK dollars per USD
D) Be 7.940 HK dollars per USD
E) Change the bid-ask spread to reflect the new demand and supply


(The following information relates to Questions 36 and 37)

The Bank of Canada announced the auction of $10 billion of 3-month T-bills on October 28,
2009. The auction results were released after the auction. The lowest yield was 5.25% and the
highest yield was 5.3%. The non-competitive tenders amounted to $66,594,000 with all of these
accepted. The total amount of competitive bids tendered was $16,215,097,000, with
$9,934,570,000 accepted.


36. What was the stop (cut-off) yield?
____
A) 5.300%
B) 5.275%
C) 5.250%
D) Undetermined
10

37. What was the bid-to-cover ratio?
___
A) 1.639
B) 2.045
C) 1.993
D) 1.628

38. Which of the following is true regarding Treasury bills?
____
A) The market for Treasury bills is extremely thin and illiquid
B) Occasionally, investors find that earnings on T-bills do not compensate them for changes
in purchasing power due to inflation
C) By volume, most Treasury bills are sold to individuals who submit non-competitive bids
D) All of the above

39. The most influential participant(s) in the Canadian money markets is (are)
____
A) Investment banks that underwrite securities
B) Banks and deposit-taking institutions
C) Corporations
D) Bank of Canada

40. Which of the following is false regarding bankers acceptance (BA)?
____
A) They can be bought and sold until they mature
B) They are relatively new money market securities that arose in the 1960s as international
trade expanded
C) They are orders to pay a specified amount of money to the bearer on a given date
D) They carry low interest rates because of the very low default risk
E) None of the above

41. Governments never issue stock because
____
A) They cannot sell ownership claims
B) The constitution expressly forbids such an issuance
C) Both (A) and (B)
D) Neither (A) nor (B)

42. Which of the following is true?
____
A) The best known capital market securities are stocks and bonds
B) Securities having an original maturity that is greater than one year are traded in capital
markets
C) Firms and individuals use the capital markets for long-term investments
D) All of the above
11

43. The over-the-counter (OTC) market in corporate shares
____
A) Is the dominant market for these securities
B) Is restricted to the shares of only a few firms
C) Is the third market in corporate shares
D) Is based in Toronto and Montreal only
E) Includes national trading in some shares and trading among local investors in others

44. Which of the following is true regarding Canada real return bonds?
____
A) The principal amount used to compute the interest payment varies with the consumer
price index (CPI)
B) The interest payment rises when inflation occurs
C) At maturity the securities pay the greater of face-value or inflation-adjusted principal
D) All of the above
E) None of the above

45. Most of the time, the interest rate on Canada bonds is ____ that on money market
securities because of ____ risk.
____
A) Above; interest rate
B) Above; default
C) Below; interest rate
D) Below; default

46. Bonds with a 10% coupon rate will trade at the following price when the appropriate
market interest rates are 10%.
____
A) 105
B) 100
C) 95
D) Insufficient information

47. The market price is $1,130 for a 10% non-callable corporate bond with a par value of
$1,000 and 14 years to maturity. It pays interest semi-annually. The required rate of
return on similar bonds is presently 8.4%. How much accrued interest would have to be
paid if you purchased the bond on February 8, 2010, if the bond matures on June 30,
2024?
____
A) $5.34
B) $10.41
C) $10.68
D) Insufficient information
Hint: Accrued interest = Par amount Coupon rate (Timer period/365)
12

48. A bond that is issued by a Japanese company in Canada that is denominated in U.S.
dollars is an example of a
____
A) Domestic bond
B) Foreign bond
C) Eurobond
D) Maple bond

49. To sell an old bond when interest rates have ____, the holder will have to ____ the bond
until the yield to the buyer is the same as the market rate.
____
A) Fallen; discount
B) Fallen; inflate
C) Risen; discount
D) Risen; inflate

50. Blue-chip bonds
____
A) Are considered highly risky by rating agencies such as Standard and Poor
B) Pay higher rates of interest than those bonds that are considered less than blue-chips
C) Are government bonds
D) Go in and out of vogue with surges in corporate takeovers
E) None of the above

(The following information relates to Questions 51 and 52)

Assume that a $500 million pool of mortgages backs a new MBS issue. The projected
prepayment speed is 140% PSA.

51. What is the single monthly mortality (SMM) rate for the first month?
____
A) 0.01668%
B) 0.02243%
C) 0.02336%
D) 0.02535%
Hint: For months 1 t 30 based on 100% PSA, SMM = 1 (1 - 0.2% t)
(1/12)


52. If the estimated prepayment for the first month will be $116,776.64, what is the
scheduled principal repayment for this period?
_____
A) $100,000
B) $150,000
C) $200,000
D) Undetermined
13

53. An individual needs a mortgage loan of $190,000 while he has put up a 25% down
payment. How much is the purchase price of the property?
____
A) $275,000
B) $142,500
C) $253,300
D) $237,500


54. Canadian law requires interest on fixed-rate mortgages to be compounded semi-annually.
With an effective annual rate of 11.30%, what is the posted rate?
____
A) 10.54%
B) 11.00%
C) 11.62%
D) Undetermined
Hint: 1 1
(

+ =
m
EAR
m
R
R


(The following information relates to Questions 55 and 56)

A condo costs $100,000 with a 5% down payment requirement. The stated interest rate is 7.85%
per annum. The original term of the mortgage is 25 years. Loan repayments are made monthly.


55. What is the effective monthly rate?

____
A) 0.6434%
B) 0.6558%
C) 0.6612%
D) 0.6723%
Hint: EMR = (1 + EAR)
1/m

56. How much is the scheduled principal and interest (P&I) payment for the first month?

____
A) $580.25
B) $632.03
C) $816.67
D) $715.74
Hint:
(

+
=
+
r
r
F PICF
t T t t
) 1 (
1
1
1



14

(The following information relates to Questions 57 and 58)

Assume a 3-month add-on money market instrument with $1,000 face value and 4.65% interest
is to be purchased. A typical 3-month security covers 91 days.


57. How much will this add-on security be worth at maturity?
____
A) $1,011.75
B) $1,000.00
C) $988.25
D) Undetermined


58. What is annualized holding period return on this instrument?
____
A) 3.95%
B) 4.23%
C) 4.65%
D) 4.71%
Hint:
t P
P P
i
t
t t
yt
365
1

=
+


59. The liquidity of mortgage loan has changed in recent years due to
____
A) Securitization
B) Amortization
C) Higher computer costs
D) Growth in consumer installment debt

60. A borrower who qualifies for a CMHC mortgage loan enjoys the advantage that
____
A) The mortgage payment is much lower
B) Only a very low or zero down payment is required
C) The cost of private mortgage insurance is lower
D) The government holds the lien on the property
E) All of the above

61. An interest rate futures contract is
____
A) Only associated with the stock market
B) Used in the derivatives markets to protect owners from increases in interest rates
C) Used to avoid a large loss in times of inflation
D) Used in the derivatives markets to protect owners from a decrease in interest rates

15

62. The primary economic function of the derivatives market is
____
A) Risk transfer
B) Income generation
C) Time value of money adjustments
D) Speculation

63. A futures contract trades with all delivery months. A company is hedging the purchase of
the underlying asset on June 15.
____
A) The May contract
B) The June contract
C) The July contract
D) The August contract

64. Futures differ from forward contracts in that
____
A) Futures have more counterparty risk than do forward contracts
B) Futures are marked-to-market and forward contracts are not
C) Futures prices are based on the cost of carry but forward prices are not
D) Futures involves delivery at a future time but forward contracts do not

65. Options are ____ while futures are ____.
____
A) Rights; promises
B) Securities; contracts
C) Paid for; margined
D) All of the above