Question: Briefly describe the origin of the Federal

> How are the interest rate, the required rate of return on a stock, and the valuation of a stock related?

> Describe the dividend discount valuation model. What are some limitations when using this model?

> Explain the difference between weak-form, semistrong-form, and strong-form efficiency. Which of these forms of efficiency is most difficult to test? Which is most likely to be refuted? Explain how to test weak-form efficiency in the stock market.

> In the movie Wall Street, Bud Fox is a broker who conducts trades for Gordon Gekko’s firm. Gekko purchases shares of firms that he believes are undervalued. Various scenes in the movie offer excellent examples of concepts discussed in this chapter. a. B

> Explain how to estimate the beta of a stock. Explain why beta serves as a measure of the stock’s risk.

> Identify the factors that affect a stock portfolio’s volatility and explain their effects.

> Explain the use of the price-earnings (PE) ratio for valuing a stock. Why might investors derive different valuations for a stock when using the price-earnings method? Why might investors derive an inaccurate valuation of a firm when using the price-earn

> What does it mean to “flip” shares? Why would investors want to flip shares?

> Describe a lockup provision and explain why it is required by the lead underwriter.

> Explain the use of a prospectus developed before an IPO. Why does a firm do a road show before its IPO? What factors influence the offer price of stock at the time of the IPO?

> During the credit crisis, U.S. interest rates were extremely low, which enabled businesses to borrow at a low cost. Holding other factors constant, this should have resulted in a higher number of feasible projects, which should have encouraged businesses

> Many financial institutions borrow heavily in the money markets using mortgages and mortgage-backed securities as collateral. Write a short essay about the lessons of the credit crisis to the deficit units and the surplus units that participate in the mo

> Explain the difference between obtaining funds from a venture capital firm and engaging in an IPO. Explain how the IPO may serve as a means by which the venture capital firm can cash out.

> Why do firms engage in IPOs? What is the amount of fees that the lead underwriter and its syndicate charge a firm that is going public? Why are there many IPOs in some periods and few IPOs in other periods?

> What is the danger of issuing too much stock? What is the role of the securities firm that serves as the underwriter, and how can it ensure that the firm does not issue too much stock?

> Describe how the interaction between buyers and sellers affects the market value of a firm and explain how that value can subject a firm to the market for corporate control.

> How does the initial rate on adjustable rate mortgages (ARMs) differ from the rate on fixed-rate mortgages? Why? Explain how caps on ARMs can affect a financial institution’s exposure to interest rate risk.

> What is the general relationship between mortgage rates and long-term government security rates? Explain how mortgage lenders can be affected by interest rate movements. Also explain how they can insulate themselves against interest rate movements.

> Explain how a mortgage company’s degree of exposure to interest rate risk differs from other financial institutions.

> Compare the secondary market activity for mortgages to the activity for other capital market instruments (such as stocks and bonds). Provide a general explanation for the difference in the activity level.

> Is the price of a long-term bond or the price of a short-term security more sensitive to a change in interest rates? Why?

> Assume that breaking news causes bond portfolio managers to suddenly expect much higher economic growth. How might bond prices be affected by this expectation? Explain. Now assume that breaking news causes bond portfolio managers to suddenly anticipate a

> Consider the prevailing conditions for inflation (including oil prices), the economy, the budget deficit, and the Fed’s monetary policy that could affect interest rates. Based on these conditions, do you think interest rates will likely increase or decre

> Explain how bond prices may be affected by money supply growth, oil prices, and economic growth.

> When tensions rise or war erupts in the Middle East, bond prices in many countries tend to decline. What is the link between problems in the Middle East and bond prices? Would you expect bond prices to decline more in Japan or in the United Kingdom as a

> An analyst recently suggested that there will be a major economic expansion that will favorably affect the prices of high-rated fixed-rate bonds, because the credit risk of bonds will decline as corporations improve their performance. Assuming that the e

> Explain the concept of bond price elasticity. Would bond price elasticity suggest a higher price sensitivity for zero-coupon bonds or high-coupon bonds that are offering the same yield to maturity? Why? What does this suggest about the market value volat

> Why can convertible bonds be issued by firms at a higher price than other bonds?

> Are variable-rate bonds attractive to investors who expect interest rates to decrease? Explain. Would a firm that needs to borrow funds consider issuing variable-rate bonds if it expects interest rates to decrease in the future? Explain.

> What are the advantages and disadvantages to a firm that issues low- or zero-coupon bonds?

> Explain how the downgrading of bonds for a particular corporation affects the prices of those bonds, the return to investors who currently hold these bonds, and the potential return to other investors who may invest in the bonds in the near future.

> Explain the conditions that led to the debt crisis in Greece.

> Explain the guidelines for credit rating agencies That resulted from the Financial Reform Act of 2010.

> Explain why financial institutions are highly exposed to systemic risk during a financial crisis.

> Explain how the credit crisis that began in 2008 affected the default rates of junk bonds and the risk premiums offered on newly issued junk bonds.

> What is a bond indenture? What is the function of a trustee, with respect to the bond indenture?

> Explain how each of the following would use banker’s acceptances: (a) exporting firms, (b) importing firms, (c) commercial banks, and (d) investors.

> How can small investors participate in investments in negotiable certificates of deposits (NCDs)?

> Who issues commercial paper? Which types of financial institutions issue commercial paper? Why do some firms create a department that can directly place commercial paper? Which criteria affect the decision to create such a department?

> How do you think the shape of the yield curve for commercial paper and other money market instruments compares to the yield curve for Treasury securities? Explain your logic.

> Why do financial market participants closely monitor money supply movements?

> Compare the recognition lag and the implementation lag.

> When does the Fed use a stimulative monetary policy and when does it use a restrictive-monetary policy? What is a criticism of a stimulative monetary policy? What is the risk of using a monetary policy that is too restrictive?

> Explain how the Fed's facility programs improved liquidity in some debt markets.

> Explain how each type of financial institution serves as a financial intermediary.

> Explain how the Fed influences the monthly mortgage payments on homes. How might the Fed indirectly influence the total demand for homes by consumers?

> Should the Fed or Congress decide the fate of large financial institutions that are near bankruptcy?

> The Fed focuses its control on the federal funds rate, yet indirectly influences many other types of interest rates. Explain.

> Why do the Fed’s open market operations have a different effect on money supply than do transactions between two depository institutions?

> Explain how the Fed’s “quantitative easing” strategies differed from the traditional strategy of buying short-term Treasury securities.

> What was TALF, and why did the Fed create it?

> Why did the Fed purchase long-term Treasury securities in 2010, and how did this strategy differ from the Fed’s usual operations?

> Why and how did the Fed intervene in the commercial paper market during the credit crisis?

> Explain the motivation behind the Fed’s policy of purchasing massive amounts of mortgage-backed securities during the 2008 credit crisis. What could this policy accomplish that its traditional monetary policy might not accomplish?

> Assume that your publicly traded company attempts to be completely transparent about its financial condition, and provides thorough information about its debt, sales, and earnings every quarter. Explain why there still may be much uncertainty surrounding

> What should be the Fed’s role? Should it focus only on monetary policy? Or should it engage in the trading of various types of securities in an attempt to stabilize the financial system when securities markets are suffering from investor fears and the po

> Explain why participating in the eurozone causes a country to give up its independent monetary policy and control over its domestic interest rates.

> Assume an expectation of lower interest rates in the future arises quite suddenly. What would be the effect on the shape of the yield curve? Explain.

> Explain how a yield curve would shift in response to a sudden expectation of rising interest rates, according to the pure expectations theory.

> Do investors in high tax brackets or those in low tax brackets benefit more from tax-exempt securities? Why? Do municipal bonds or corporate bonds offer a higher before-tax yield at a given point in time? Why? Which has the higher after-tax yield? If tax

> If the segmented markets theory causes an upward-sloping yield curve, what does this imply? If markets are not completely segmented, should we dismiss the segmented markets theory as even a partial explanation for the term structure of interest rates? Ex

> Why is it important for long-term debt securities to have an active secondary market?

> What is the function of a mutual fund? Why are mutual funds popular among investors? How does a money market mutual fund differ from a stock or bond mutual fund?

> What factors influence the shape of the yield curve? Describe how financial market participants use the yield curve.

> What is the difference between the nominal interest rate and real interest rate? What is the logic behind the implied positive relationship between expected inflation and nominal interest rates?

> Different types of financial institutions commonly interact. Specifically, they may provide loans to each other, and take opposite positions on many different types of financial agreements, whereby one will owe the other based on a specific financial out

> Assume that if the U.S. dollar strengthens, it can place downward pressure on U.S. inflation. Based on this information, how might expectations of a strong dollar affect the demand for loanable funds in the United States and U.S. interest rates? Is there

> If the federal government planned to expand the space program, how might this change affect interest rates?

> Explain why some stocks in the marijuana industry were mis-valued when several states legalized the recreational use of marijuana.

> What are the functions of securities firms? Many securities firms employ brokers and dealers. Distinguish between the functions of a broker and those of a dealer and explain how each type of professional is compensated.

> What type of information do investors rely on in order to determine the proper value of stocks?

> Assume the following information for an existing bond that provides annual coupon payments: Par value = $1,000 Coupon rate = 11% Maturity = 4 years Required rate of return by investors = 11% a. What is the present value of the bond? b. If the required

> Assume that the U.S. economy experienced deflation during the year, and that the consumer price index decreased by 1 percent in the first six months of the year, and by 2 percent during the second six months of the year. If an investor had purchased infl

> An inflation-indexed Treasury bond has a par value of $1,000 and a coupon rate of 6 percent. An investor purchases this bond and holds it for one year. During the year, the consumer price index increases by 1 percent every six months. What are the total

> Montana Bank wants to determine the sensitivity of its stock returns to interest rate movements, based on the following information: Use a regression model in which Montana’s stock return is a function of the stock market return and th

> Use the balance sheet for San Diego Bank in Exhibit A (below and next page) and the industry norms in Exhibit B (page following Exhibit A) to answer the following questions: a. Estimate the gap and determine how San Diego Bank would be affected by an inc

> Some countries do not have well established markets for debt securities or equity securities. Why do you think this can limit the development of the country, business expansion, and growth in national income in these countries?

> Assume the following information: Mexican one-year interest rate = 15% U.S. one-year interest rate = 11% If interest rate parity exists, what would be the forward premium or discount on the Mexican peso’s forward rate? Would covered interest arbitrage be

> Wisconsin Inc. purchased a call option on Treasury bond futures at a premium of 2-00. The exercise price is 92-08. If the price of the Treasury bond futures rises to 93-08, should Wisconsin Inc. exercise the call option or should it let the option expire

> Purdue Savings and Loan Association purchased a put option on Treasury bond futures with a September delivery date and an exercise price of 91-16. Assume the put option has a premium of 1-32. Assume that the price of the Treasury bond futures decreases t

> a. Evanston Insurance Inc. has purchased shares of Stock E at $50 per share. It will sell the stock in six months. It considers using a strategy of covered call writing to partially hedge its position in this stock. The exercise price is $53, the expirat

> Smart Savings Bank desired to hedge its interest rate risk. It was considering two possibilities: (1) sell Treasury bond futures at a price of 94-00, or (2) purchase a put option on Treasury bond futures. At the time, the price of Treasury bond futures w

> a. How is the maximum expected loss on a stock affected by an increase in the volatility (standard deviation), based on a 95 percent confidence interval? b. Determine how the maximum expected loss on a stock would be affected by an increase in the expect

> Describe how bond convexity affects the theoretical linear price-yield relationship of bonds. What are the implications of bond convexity for estimating changes in bond prices?

> a. When using the CAPM, how would the required rate of return on a stock be affected if the risk-free rate were lower. b. When using the CAPM, how would the required rate of return on a stock be affected if the market return were lower. c. When using the

> How would the return on a stock be affected by a lower initial investment (and higher loan amount)? Explain the relationship between the proportion of funds borrowed and the return.

> Assume that in the previous problem, an investor has invested $10 million in the stock of concern. Estimate the maximum dollar one-day loss based on a 95 percent confidence level.

> Assume that countries A and B are of similar size, that they have similar economies, and that the government debt levels of both countries are within reasonable limits. Assume that the regulations in country A require complete disclosure of financial rep

> The portfolio manager of Ludwig Company has excess cash that is to be invested for four years. He can purchase either (1) four-year Treasury notes that offer a 9 percent yield, or (2) new 20-year Treasury bonds for $2.9 million that offer a par value of

> Sun Devil Savings has just purchased bonds for $38 million that have a par value of $40 million, five years remaining to maturity, and a coupon rate of 12 percent. It expects the required rate of return on these bonds to be 10 percent two years from now.

> Bulldog Bank has just purchased bonds for $106 million that have a par value of $100 million, three years remaining to maturity, and an annual coupon rate of 14 percent. It expects the required rate of return on these bonds to be 12 percent one year from

> Ash Investment Company manages a broad portfolio with this composition: Ash expects that in four years, investors in the market will require an 8 percent return on the zero-coupon bonds, a 7 percent return on the Treasury bonds, and a 9 percent return on

> a. Determine how the annualized yield of a T-bill would be affected if the purchase price were lower. Explain the logic of this relationship. b. Determine how the annualized yield of a T-bill would be affected if the selling price were lower. Explain the

> a. Determine how the appropriate yield to be offered on a security is affected by a higher risk-free rate. Explain the logic of this relationship. b. Determine how the appropriate yield to be offered on a security is affected by a higher default risk pre

> Hankla Company plans to purchase either (1) zero-coupon bonds that have ten years to maturity, a par value of $100 million, and a purchase price of $40 million, or (2) bonds with similar default risk that have five years to maturity, a 9 percent coupon r

> a. Determine the forward rate for various one-year interest rate scenarios if the two-year interest rate is 8 percent, assuming no liquidity premium. Explain the relationship between the one-year interest rate and the one-year forward rate, holding the t

> a. A corporation is planning to sell its 90-day commercial paper to investors offering an 8.4 percent yield. If the three-month Treasury bill’s annualized rate is 7 percent, the credit risk premium is estimated to be 0.6 percent and there is a 0.4 percen

> Assume that interest rates for one-year securities are expected to be 2 percent today, 4 percent one year from now and 6 percent two years from now. Using only the pure expectations theory, what are the current interest rates on two-year and three-year s

> Describe how a country’s laws can influence the degree of its financial market liquidity.

> Cardinal Company, a U.S.-based insurance company, considers purchasing bonds denominated in Canadian dollars, with a maturity of six years, a par value of C$50 million, and a coupon rate of 12 percent. The bonds can be purchased at par by Cardinal and wo