Merrito Inc. is a large U.S. firm that issued bonds several years ago. Its bond ratings declined over time, and about a year ago, the bonds were rated in the junk bond classification. Yet, investors continued to buy the bonds in the secondary market because of the attractive yield they offered. Last week, Merrito defaulted on its bonds, and the prices of most other junk bonds declined abruptly on the same day. Explain why news of Meritto’s financial problems could cause the prices of junk bonds issued by other firms to decrease, even when those firms had no business relationships with Merrito. Explain why the prices of those junk bonds with less liquidity declined more than those with a high degree of liquidity.
> Explain why securities firms from the United States have expanded into foreign markets.
> What is a best-efforts agreement?
> Describe the underwriting function of a securities firm.
> Describe the origination process for corporations that are about to issue new stock.
> What is the purpose of the SIPC?
> Explain how the bond market facilitates a government’s fiscal policy. How do you think the bond market could discipline a government and discourage the government from borrowing (and spending) excessively?
> What is asset stripping?
> Explain how the income generated by a mutual fund is taxed when it distributes at least 90 percent of its taxable income to shareholders.
> Explain how changes in foreign currency values can affect the performance of international mutual funds.
> Describe the ideal mutual fund for investors who wish to generate tax-free income but also maintain a low degree of interest rate risk.
> Support or refute the following statement: Investors can avoid all types of risk by purchasing a mutual fund that contains only Treasury bonds.
> Like mutual funds, commercial banks and stock-owned savings institutions sell shares; yet, proceeds received by mutual funds are used in a different way. Explain.
> Explain the difference between load and no-load mutual funds.
> How do open-end mutual funds differ from closed-end funds?
> Explain the difference between equity REITs and mortgage REITs. Which type would likely be a better hedge against high inflation? Why?
> Explain why some hedge funds failed as a result of the credit crisis of 2008-s009.
> Explain why the market for auction-rate securities suffered in 2008.
> Is the value of a money market fund or a bond fund more susceptible to increasing interest rates? Explain.
> Explain the relative risk of the various types of securities in which a money market fund may invest.
> According to research, have mutual funds outperformed the market? Explain. Would mutual funds be attractive to some investors even if they are not expected to outperform the market? Explain.
> Explain how the interest rate risk of finance companies differs from that of savings institutions.
> Describe the kinds of regulations that are imposed on finance companies.
> Explain how finance companies provide financing through leasing.
> Explain how finance companies benefit from offering consumers a credit card.
> Describe the major uses of funds by finance companies.
> Explain why some finance companies are associated with automobile manufacturers. Why do some of these finance companies offer below-market rates on loans?
> Explain how the credit risk of finance companies differs from that of other lending financial institutions.
> Explain what exchange-traded notes are and how they are used. Why are they risky?
> How might a firm’s board of directors discourage its managers from attempting to manipulate financial statements to create a temporarily high stock price?
> Is the cost of funds obtained by finance companies very sensitive to market interest rate movements? Explain.
> Explain how savings institutions could use interest rate futures to reduce interest rate risk.
> How did the creation of money market deposit accounts influence the savings institution’s overall cost of funds?
> What criteria do regulators use when examining a savings institution?
> How does high economic growth affect an SI?
> What are the alternative forms of ownership of a savings institution?
> Who regulates CUs? What are the regulators’ powers? Where do credit unions obtain deposit insurance?
> Who are the owners of credit unions? Explain the tax status of credit unions and the reason for that status. Why are CUs typically smaller than commercial banks or savings institutions?
> Explain how the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) reduced the perceived risk of savings institutions.
> An insurance company purchased bonds issued by Hartnett Company two years ago. Today, Hartnett Company has begun to issue junk bonds and is using the funds to repurchase most of its existing stock. Why might the market value of those bonds held by the in
> Explain why many savings institutions experience financial problems at the same time.
> Explain why the loan loss provisions of most banks could increase in a particular period.
> What are some of the more common reasons for a bank to experience a low ROA?
> What does the assets/equity ratio of a bank indicate?
> Why have large money center banks’ noninterest income levels typically been higher than those of smaller banks?
> Suppose the net income generated by a bank is equal to 1.5 percent of assets. Based on past experience, would the bank experience a loss or a gain? Explain.
> How could a bank generate higher income before tax (as a percentage of assets) when its net interest margin has decreased?
> What has been the trend in noninterest income in recent years? Explain.
> If a bank shifts its loan policy to pursue more credit card loans, how will its net interest margin be affected?
> What are likely reasons for weak bank performance?
> Why do you think some banks suffered larger losses during the credit crisis than other banks?
> How can gross interest income rise, while the net interest margin remains somewhat stable for a particular bank?
> Assume that a bank expects to attract most of its funds through short-term CDs and would prefer to use most of its funds to provide long-term loans. How could it follow this strategy and still reduce interest rate risk?
> What is the formula for the net interest margin? Explain why it is closely monitored by banks.
> If a bank is very uncertain about future interest rates, how might it insulate its future performance from future interest rate movements?
> List some rate-sensitive assets and some rate-insensitive assets of banks.
> If a bank expects interest rates to decrease over time, how might it alter the rate sensitivity of its assets and liabilities?
> How do banks resolve illiquidity problems?
> Given the liquidity advantage of holding Treasury bills, why do banks hold only a relatively small portion of their assets as T-bills?
> Does the use of floating-rate loans eliminate interest rate risk? Explain.
> Explain why investors that provided guarantees on commercial paper were exposed to so much risk during the credit crisis.
> If a bank has more rate-sensitive liabilities than rate-sensitive assets, what will happen to its net interest margin during a period of rising interest rates? During a period of declining interest rates?
> Why might a bank retain some excess earnings rather than distribute those funds as dividends?
> Do all commercial borrowers receive the same interest rate on loans?
> Can a bank simultaneously maximize return and minimize credit risk? If not, what can it do instead?
> Why do loans that can be prepaid on a moment’s notice complicate the bank’s assessment of interest rate risk?
> How do banks use duration analysis?
> What is accomplished when a bank integrates its liability management with its asset management?
> Explain how the CAMELS ratings are used.
> Describe the main provisions of the DIDMCA that relate to deregulation.
> What led to the establishment of FDIC insurance?
> Explain how systemic risk is related to the commercial paper market. That is, why did problems in the market for mortgage-backed securities affect the commercial paper market?
> Explain why the moral hazard problem may have received so much attention during the credit crisis.
> Explain why the credit crisis caused concerns about systemic risk.
> Why were bank regulators concerned with credit default swaps?
> Explain why regulators might argue that the assistance they provided to Bear Stearns during the credit crisis was necessary.
> Why are bank regulators more concerned about a large bank failure than a small bank failure?
> Assume an investor purchased a six-month T-bill with a $10,000 par value for $9,000 and sold it ninety days later for $9,100. What is the yield?
> Determine how the after-tax yield from investing in a corporate bond is affected by higher tax rates, holding the before-tax yield constant. Explain the logic of this relationship.
> A money market security that has a par value of $10,000 sells for $8,816.60. Given that the security has a maturity of two years, what is the investor’s required rate of return?
> Select a commercial bank whose income statement data are available. Using recent income statement data about that bank, assess its performance. How does the performance of this bank compare to the performance of other banks? Compared with other banks, is
> If a bank earns $75 million net profits after tax and has $7.5 billion invested in assets and $600 million equity investment, what is its return on equity?
> Explain why the credit crisis affected the ability of financial institutions to access short-term financing in the money markets.
> If a bank earns $169 million net profit after tax and has $17 billion invested in assets, what is its return on assets?
> Suppose a bank earns $201 million in interest revenue but pays $156 million in interest expense. It also has $800 million in earning assets. What is its net interest margin?
> Assume the following information: British pound spot rate = $1.58 British pound one-year forward rate = $1.58 British one-year interest rate = 11% U.S. one-year interest rate = 9% Explain how U.S. investors could use covered interest arbitrage to lock in
> Assume the following exchange rate quotes on British pounds: Explain how locational arbitrage would occur. Also explain why this arbitrage will realign the exchange rates.
> Use the following information to determine the probability distribution of net gains per unit from purchasing a call option on British pounds: The spot rate of the British pound = $1.45 The premium on the British pound option = $.04 per unit The exercise
> Use the following information to determine the probability distribution of per unit gains from selling Mexican peso futures. The spot rate of peso is $.10. The price of peso futures per unit is $.102 per unit. Your expectation of peso spot rate at maturi
> Iowa City Bank purchases a three-year interest rate floor for a fee of 2 percent of notional principal valued at $80 million, with an interest rate floor of 6 percent, and LIBOR representing the interest rate index. The bank expects LIBOR to be 6 percent
> Northbrook Bank purchases a four-year cap for a fee of 3 percent of notional principal valued at $100 million, with an interest rate ceiling of 9 percent, and LIBOR as the index representing the market interest rate. Assume that LIBOR is expected to be 8
> Assume that as of today, the annualized interest rate on a three-year security is 10 percent, while the annualized interest rate on a two-year security is 7 percent. Use this information to estimate the one-year forward rate two years from now.
> Cleveland Insurance Company has just negotiated a three-year plain vanilla swap in which it will exchange fixed payments of 8 percent for floating payments of LIBOR + 1 percent. The notional principal is $50 million. LIBOR is expected to 7 percent, 9 per
> Apply the term structure of interest rate theories that were discussed in Chapter 3 to explain the shape of the existing commercial paper yield curve.
> Coral Inc. has purchased shares of stock M at $28 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 $32, the expiration date is six
> DePaul Insurance Company purchased a call option on a stock index futures contract. The option premium is quoted as $6. The exercise price is $1,430. Assume the index on the futures contract becomes $1,440. Should DePaul exercise the call option or let i
> A put option on Indiana stock specifies an exercise price of $23. Today the stock’s price is $24. The premium on the put option is $3. Assume the option will not be exercised until maturity, if at all. Complete the following table:
> A put option on Iowa stock specifies an exercise price of $71. Today the stock’s price is $68. The premium on the put option is $8. Assume the option will not be exercised until maturity, if at all. Complete the following table for a sp
> A call option on Michigan stock specifies an exercise price of $55. Today the stock’s price is $54 per share. The premium on the call option is $3. Assume the option will not be exercised until maturity, if at all. Complete the followin
> A call option on Illinois stock specifies an exercise price of $38. Today’s price of the stock is $40. The premium on the call option is $5. Assume the option will not be exercised until maturity, if at all. Complete the following table
> Marks Insurance Company sold stock index futures that specified an index of 1690. When the position was closed out, the index specified by the futures contract was 1,720. Determine the profit or loss, ignoring transaction costs.
