Financial Markets

End Term Examination

MBA (2022-2023)

Answer all questions

Time 120 minutes

A penalty of 0.25 Mark will be imposed for objective questions

Q1. An 18-year T-bond can be stripped into how many separate securities? [1 Mark]

A. 18

B. 19

C. 36

D. 37

D. 38

Q2. An investor is in the 28 percent federal tax bracket and pays a 9 percent state tax
rate and 4 percent in local income taxes. For this investor, a municipal bond paying
6 percent interest is equivalent to a corporate bond paying ____ interest.
[1 Mark]

A. 11.79 percent

B. 10.17 percent

C. 9.08 percent

D. 9.68 percent

D. 8.47 percent

Q3. Standard revenue bonds are: [1 Mark]

A. backed by the full taxing authority of the municipality.

B. collateralized by the earnings from a specic project.

C. backed by mortgages.

D. backed by the U.S. Treasury.

D. always oered with a best eorts oering.

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Q4. In the T-bill auction process, the competitive bidder is guaranteed a _____ and a
noncompetitive bidder is guaranteed a _____. [1 Mark]

A. minimum price; maximum price.

B. maximum price; minimum price.

C. maximum price; given quantity.

D. minimum price; maximum quantity.

E. None of these choices are correct.

Q5. Money market securities exhibit which of the following? [1 Mark]

I. Large denomination

II. Maturity greater than one year

III. Low default risk

IV. Contractually determined cash ows

A. I, II, and III

B. I, III, and IV

C. II, III, and IV

D. I and III

E. I, II, III, and IV

Q6. A banker's acceptance is: [1 Mark]

A. a time draft drawn on the exporter's bank.

B. a method to help importers evaluate the creditworthiness of exporters.

C. a liability of the importer and the importer's bank.

D. an add-on instrument.

E. for a maturity of greater than one year.

Q7. If your rm enters into an overnight reverse repurchase agreement, your rm is:
[1 Mark]

A. borrowing Fed funds temporarily.

B. selling a security now while agreeing to buy it back tomorrow.

C. giving an unsecured loan to the counterparty.

D. procuring a banker's acceptance.

E. None of these choices are correct.

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 Q8. Interest rates are important to nancial institutions since an interest rate increase
_____ the cost of acquiring funds and _____ the income from assets. [1 Mark]

A. decreases; decreases

B. increases; increases

C. decreases; increases

D. increases; decreases

E. None of these choices are correct.

Q9. Which of the following can be described as involving indirect nance?. [1 Mark]

A. A bank buys a U.S. Treasury bill from one of its depositors.

B. A corporation buys commercial paper issued by another corporation.

C. A pension fund manager buys commercial paper in the primary market.

D. Both A and C of the above.

E. None of these choices are correct.

Q10. Adverse selection is a problem associated with equity and debt contracts arising
from: [1 Mark]

A. the lender's relative lack of information about the borrower's potential returns
and risks of his investment activities.

B. the lender's inability to legally require sucient collateral to cover a 100 per-
cent loss if the borrower defaults.

C. the borrower's lack of incentive to seek a loan for highly risky investments.

D. None of these choices are correct.

Q11. Assume a 182-day money market security with a face value of $7,000. The bond
equivalent yield is 3.574%. Calculate the price of the instrument? [2 Marks]

Q12. In a world without information and transaction costs, nancial intermediaries
would not exist. Is this statement true, false, or uncertain? Explain your answer.
[3 Marks]

Q13. Who issues federal funds, and what is the usual purpose of these funds? [3 Marks]

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 Q14. Consider a bond that promises the following cash ows. The required discount rate
is 12%.

Year 0 1 2 3 4
Promised Payments 160 170 180 230

You plan to buy this bond, hold it for 2.5 years, and then sell the bond.

a. What total cash will you receive from the bond after the 2.5 years? Assume
that periodic cash ows are reinvested at 12%. [2
Marks]

b. If immediately after buying this bond, all market interest rates drop to 11%
(including your reinvestment rate), what will be the impact on your total cash
ow after 2.5 years? How does this compare to part (a)? [2
Marks]

c. Assuming all market interest rates are 12%, what is the duration of this bond?
[2 Marks]

d. An investor is trying to decide between a muni paying 5.75 percent or an equiv-

alent taxable corporate paying 8.25 percent. What is the minimum marginal
tax rate the investor must have to consider buying the municipal bond? [2
Marks]

Q15a. If a yield curve looks like the one shown here [Figure 1], what is the market predict-
ing about the movement of future short-term interest rates? What might the yield
curve indicate about the market's predictions about the ination rate in the future?
[2 Marks]

Q15b. If a yield curve looks like the one below [Figure 2], what is the market predicting
about the movement of future short-term interest rates? What might the yield
curve indicate about the market's predictions about the ination rate in the future?
[2 Marks]

Q16. Distinguish between competitive bidding and noncompetitive bidding for Treasury
securities. [3 Marks]

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Figure 1:

Figure 2: