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Financial Markets Institutions
If the United States runs a deficit in its current account of $100 billion and receives a net inflow of $60 billion on long-term investments in a year, by how much will its short-term capital flows
Assume that the spot and one-year forward rates for the British pound are $1.60 and $1.55, respectively and are $0.90 and $0.92 per euro, respectively. If interest rates are 4 percent in the United
If a dollar can buy 98 Japanese yen and a British pound costs $1.50, how many yen would it take to buy £1? If a pound of copper costs £1 in Britain, ¥160 in Tokyo, and $1.45 in the United States,
If a bushel of corn costs ₤3.00, and a British pound is worth $1.50, how many dollars would a person receive for 100,000 bushels of corn sold in Britain in the spot market? If the delivery were to
Do you think swap contracts will have more or less counter party default risk after the rules in the Dodd-Frank Wall Street Reform Protection Act are implemented? Why?
A bank has entered into an interest rate swap. The swap has a notional principal amount of $100 million and calls for the bank to make annual fixed interest rate payments of 5 percent and to receive
Refer to Exhibit 11.6. What is the time value and what is the intrinsic value of a call option on Wells Fargo with a strike price of $23.00 and October expiration? What is the time value and what is
If your bank held 1 percent of the units issued by a unit trust and the mortgages in the trust repaid $10,500,000 in interest and $1,500,000 in principal in its first year, how much principal and
The observed yields on 1-year and 3-year securities are 8 percent and 11 percent, respectively. What is the expected yield on a 2-year security 1 year from now?
Assume the initial margin on a Eurodollar futures contract is $878 and the maintenance margin is $650 (the contract size is $1mln). If the contract price declines by 25 basis points, by how much do
Assume that in March a farmer and a baker enter into a forward contract on 1,000 bushels of wheat at a price of $3.00 per bushel for delivery in September. In September the spot price of wheat is
Futures contracts on stock indices are very popular. Why do you think that is so? How do you think they might be used?
Explain the difference in the gain and loss potential of a call option and a long futures position. Under what circumstances do you think someone would prefer the option to the futures or vice versa?
Why do you think exchanges are more concerned with writers of naked options than with writers of covered options?
Explain the difference between a put and a call. Draw a diagram showing the payoffs of puts and calls at expiration. Draw it from the prospective of both the option buyer and the option seller.
Why do you think some futures contracts are more widely traded than others?
How can a thrift institution guarantee its costs of funds for a period of time by using the futures market?
What role does the exchange play in futures transactions?
What is the difference between the forward and the futures markets? What are the pros and cons associated with using each one?
You have decided to create stock market indexes using three representative stocks. At the end of day one, stock X has a price of $20 per share and 20 million shares outstanding, stock Y has a price
Explain the difference between systematic and unsystematic risk. Explain how beta captures systematic risk.
The market's required return on Paul Bunyan Oil Company stock is currently 13.8 percent. If the expected return on the market portfolio is 12.6 percent and the risk-free rate is 3.5 percent, what is
Farrell Motors stock has a beta of 1.3. If the market has an expected return of 9 percent and the risk-free rate is 1 percent, what is the expected return of the stock according to the security
You purchase 100 shares of Adams Trading Company stock today for $22.50 per share. At the end of one year, you collect a dividend of $2.75 and then sell the stock at $24.50 per share. What is your
Patty’s Gardening Supplies is a young start-up company. It plans to pay no dividends over the next five years because it must reinvest all earnings in the firm to finance planned growth. The firm
Dolezilek Power Company promises to maintain dividends of $5.00 per share on its preferred stock, indefinitely. The stock currently sells at $37.50 per share. What is the required return on the stock?
Winters Hi-Hook Inc., a golf club manufacturer, is currently paying dividends of $.50 per share. These dividends are expected to grow at a 20 percent rate for the next two years and at a 3 percent
Val believes the price of ABC is too high at $35/share. She shorts 100 shares. A week later, the price is $32/share when she covers a short position. How much money did Val make?
Rachel and Mary have both decided to buy 100 shares of WWW.COM, a hot Internet stock. The market price is $240 per share when Rachel places a market order and Mary places a limit order at $230 per
Explain how an American Depository Receipt (ADR) works.
Briefly describe the role of the NYSE specialists. How does this role differ from that of a dealer?
Explain why investors look at a stock’s P/E ratio rather than its price to determine if the stock is cheap or expensive.
Arbuckle Corporation is selling two million shares of common stock in its initial public offering (IPO). The company’s investment banker, Jones Securities, will offer the stock to the public at
Weber Corporation has 10 million shares of a preferred stock issue outstanding that pays a cumulative $6 annual dividend on a quarterly basis. As a result of poor profitability, however, the company
Valerie Apparel Lines (VAL) has 100 million shares of common stock outstanding and the company is electing seven directors by means of cumulative voting. If a group of minority shareholders controls
Why are convertible securities more attractive to investors than simply holding a firm's preferred stock or corporate bonds?
If mortgage bankers originate more mortgages than other types of financial institutions, why don't they also hold more mortgages in their asset accounts?
Why have CMOs and REMICs made it easier for the mortgage markets to compete for funds with corporate bonds? What problems do their residuals pose?
If you expect prices and incomes to rise, would you rather have a conventional mortgage, FRM or ARM? What if you expected prices to fall? Explain your answer. Also explain how your answer would
What is the difference between conventional mortgages and FHA and VA mortgages?
How has the government encouraged the development of secondary mortgage markets?
Why have mortgage market interest rates become more uniform across the country in recent years?
Explain how mortgage-related securities have become more similar to capital market instruments over time.
How has the development of secondary mortgage markets allowed mortgage issuers to attract additional funds from the capital markets?
Why was the development of mortgage insurance necessary before secondary mortgage markets could develop?
Assume you set up a REMIC that guaranteed that the class B tranche would bear all the credit risk, and the class A tranche would lose only if the class B tranche holders were not repaid. What is the
Explain why mortgage investors demand a higher yield for investing in securities with call risk and extension risk. Why would a mortgage investor view mortgage prepayments negatively?
Suppose you are interested in buying a home valued at $500,000 and 30-year fixed-rate mortgages have an interest rate of 6%. What is your minimum down payment assuming you will borrow with a
Suppose your gross monthly income is $5,000. Assume that property taxes, homeowner’s insurance, and mortgage insurance payments total $200 a month. In addition, assume you have automobile and
Describe the factors that affect a borrower’s ability to qualify for a mortgage.
If your mortgage balance was $60,000 and you had a floating-rate mortgage that called for you to pay interest at an annual rate of 2.75 percent over the one-year T-bill rate and the T-bill rate has
If you had a 7 percent, $100,000 30-year fixed-rate mortgage, how long would it take before you had repaid half the loan balance due? If you paid an extra $100 per month to reduce the principal due
What is a credit spread? What happened to credit spreads during the financial crisis of 2007-2009 and afterwards?
Are Yankee bonds and Samurai bonds examples of Eurobonds? Why or why not?
Describe the different forms of financial guarantees seen in the bond market.
Explain how securities are brought to market under(a) A competitive offering(b) A negotiated offering. How do the two methods of sale differ?
Define the following terms:(a) Private placement,(b) Asset-backed security,(c) Callable securities,(d) Sinking fund provisions,(e) Convertible features of securities.
What features make municipal bonds attractive to certain groups of investors? Why don’t other groups invest much in municipal securities?
Give a concise definition for the following types of municipal bonds:(a) General obligation,(b) Revenue,(c) Industrial development,(d) Mortgage-backed.
Why are private placements of securities often popular with both the buyer and the seller of the securities?
Suppose a trust is established to securitize $100 million in auto loans that paid 13% interest and the average rate paid on the tranches issued was 10%, whereas financial guarantees to protect
If a corporate bond paid 9% interest, and you are in the 28% income tax bracket, what rate would you have to earn on a general obligation municipal bond of equivalent risk and maturity in order to be
If a bond dealer bought a $100,000 municipal bond at 90% of par and sold it at 93% of par, how much money did the dealer make on the bid-ask spread?
Calculate the gross profit that an underwriter would make if it sold $10 million worth of bonds at par (face value) and paid the firm that sold the bonds 99.25% of par.
What did the Federal Reserve do to stabilize the money markets from 2007 to 2009?
Why did many asset-backed and financial commercial paper issuers find it difficult to raise funds from 2007 to 2009 but nonfinancial commercial paper issuers did not?
Suppose 7-day fed funds trade at 1.65 percent annually. What is the yield on fed funds on a bond-equivalent basis?
Suppose Fargood Corporation engages in a repurchase agreement with The NationalBank of Nebraska. In the agreement, Fargood sells $9,987,950 worth of Treasury securities to the bank and agrees to
Explain how repurchase agreement transactions provide short-term investments to businesses. In what sense is a repo a collateralized loan?
Why is the banker's acceptance form of financing ideal in foreign transactions?
Why is a bank line of credit necessary to back up an issue of commercial paper?
What types of firms issue commercial paper? What are the characteristics critical to being able to issue commercial paper?
How are the Treasury and federal agency securities different? What difference primarily explains the yield differential between the two securities?
What are the characteristics of money market instruments? Why must a financial claim possess these characteristics to function as a money market instrument?
Calculate the bond equivalent yield for a 180-day T-bill that is purchased at a 6%asked yield. If the bill has a face value of $10,000, calculate its price.
If interest rates are expected to increase, identify what happens to the following factors using the expectations theory.
What is the preferred habitat theory? Explain how it differs from the market segmentation theory.
An investor has an investment horizon of four years. The yield on a 2-year security today is 6 percent and the implied forward rate on a 2-year security two years from now is 6.75 percent. What
Assume that the term structure of U.S. Treasury securities includes the following rates:SecurityAnnual Yield (%)3-month bill4.506-month bill4.571-year bill4.522-year note4.513-year note4.48Using this
You are the holder of a variable-coupon bond that is convertible to a fixed-coupon bond. If you expect interest rates to rise, should you exercise your conversion option? Explain. What if you expect
Suppose you expect interest rates to increase in the future. You are not indifferent toward interest rate risk and desire to maximize expected return. If you hold a portfolio consisting of 50 percent
Suppose you hold a corporate bond that is convertible into the firm's stock. Stock prices are falling and interest rates are also falling. Would it be a good idea to exercise your conversion option
Suppose the 7-year spot interest rate is 9 percent and the 2-year spot rate is 6 percent. The forecasted 3-year rate two years from now is 7.25 percent. What is the implied forward rate on a 2-year
Under which scenario, rising interest rates or falling interest rates, would a bond investor be most likely to exercise a put option on a bond? Explain.
Historically, the yield curve typically has been upward sloping. Why would you expect this to be the case?
A new-issue municipal bond rated Aaa by Moody's Investor Service is priced to yield 8 percent. If you are in the 33 percent tax bracket, what yield would you need to earn on a taxable bond to be
Define marketability. Explain why marketability of a security is important to both investor and issuer.
Explain the importance of a call provision to investors. Do callable bonds have higher or lower yields than similar non-callable bonds? Why?
Why do most commercial banks hold portfolios of municipal bonds and relatively few corporate bonds?
What do bond ratings measure? Explain some of the important factors in determining a security's bond rating.
Define default risk. How does the default risk premium vary over the business cycle? Explain your answer.
A commercial bank made a five-year term loan at 13 percent. The bank's economics department forecasts that one and three years in the future, the two-year interest rate will be 12 percent and 14
Summarize the expectation theory and the preferred-habitat theory of the term structure of interest rates. Are these theories in any way related or are they alternative explanations of the term
Using the Federal Reserve Bulletin, the Federal Reserve Bank of St. Louis website (FRED), or the Wall Street Journal, plot the yield curve for U.S. Treasury securities on a quarterly basis for this
You purchase a 6‐year maturity annual payment bond that has a 5 percent coupon and a 7 percent yield. If your investment horizon is 5 years find the bond’s potential return if interest rates fall
You have a 7‐year investment horizon and you are considering one of three bonds to purchase, Bond A with a 10‐year maturity and a 7‐year duration, Bond B with a 15‐year maturity and a
If the coupon rate on a bond is equal to the market rate of interest on similar bonds, what is the price of the bond? What are these bonds commonly called?
Assume a depository institution holds vault cash of $3 million and reserve deposits at the Fed of $25 million, and has borrowed $2 million at the discount window. If that institution holds $300
If a country named Lower Slobovia decided to use U.S. dollars as a medium of exchange and therefore withdrew $10 billion in cash from its transaction deposits in the U.S., what would happen to the
What is the difference between M1 and M2? Why are there different measures of money?
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