Chapter 01

Question 1

The material wealth of a society is a function of …

Answer 1

all real assets

Question 2

… is/are a real asset(s).

Answer 2

Land, machines and knowledge are real assets

Question 3

The means by which individuals hold their claims on real assets in a well-developed economy are

Answer 3

Financial assets

Question 4

… is/are financial assets.

Answer 4

Stocks and bonds

Question 5

… financial asset(s).

Answer 5

Derivatives and U.S. Agency bonds are

Question 6

Financial assets …

Answer 6

indirectly contribute to the country’s productive capacity

Question 7

A fixed-income security pays …

Answer 7

a fixed stream of income or a stream of income that is determined according to a specified formula for the life of the security

Question 8

A debt security pays …

Answer 8

a fixed stream of income or a stream of income that is determined according to a specified formula for the life of the security

Question 9

Money market securities …

Answer 9

are short term, highly marketable, and generally very low risk

Question 10

An example of a derivative security is/are …

Answer 10

a commodity futures contract and a call option on Intel stock

Question 11

The value of a derivative security …

Answer 11

depends on the value of the related security

Question 12

Although derivatives can be used as a speculative instruments, businesses most often use them to

Answer 12

hedge risks

Question 13

Financial assets can permit all of the following except …

Answer 13

elimination of risk

Question 14

The … refers to the potential conflict between management and shareholders.

Answer 14

agency problem

Question 15

A disadvantage of using stock options to compensate managers is that

Answer 15

it can create an incentive for managers to manipulate information to prop up a stock price temporarily, giving them a chance to cash out before the price returns to a level reflective of the firm’s true prospects.

Question 16

Which of the following are mechanisms that have evolved to mitigate potential agency problems?

I) Compensation in the form of the firm’s stock options
II) Hiring bickering family members as corporate spies
III) Underperforming management teams being forced out by boards of directors
IV) Security analysts monitoring the firm closely
V) Takeover threats

Answer 16

I, III, IV and V

Question 17

Corporate shareholders are best protected from incompetent management decisions by

Answer 17

the threat of takeover by other firms

Question 18

Theoretically, takeovers should result in …

Answer 18

improved management and increased stock price

Question 19

During the period between 2000 and 2002, a large number of scandals were uncovered. Most of these scandals were related to

I) Manipulation of financial data to misrepresent the actual condition of the firm.
II) Misleading and overly optimistic research reports produced by analysts.
III) Allocating IPOs to executives as a quid pro quo for personal favours.
IV) Greenmail

Answer 19

I, II, and III

Question 20

The Sarbanes-Oxley Act …

Answer 20

requires corporations to have more independent directors and requires the firm’s CFO to personally vouch for their firm’s accounting statements. It also prohibits auditing firms from providing other services to clients.

Question 21

Asset allocation refers to …

Answer 21

the allocation of assets into broad asset classes

Question 22

Security selection refers to …

Answer 22

choosing which securities to hold based on their valuation.

Question 23

Which of the following portfolio construction methods starts with security analysis?

Answer 23

Bottom-up

Question 24

Which of the following portfolio construction methods starts with assets allocation?

Answer 24

Top-down

Question 25

... are examples of financial intermediaries.

Answer 25

Commercial banks, insurance companies, investment companies, and credit unions

Question 26

Financial intermediaries exist because small investors cannot efficiently ...

Answer 26

diversify their portfolios, assess credit risk of borrowers, or advertise for needed investments

Question 27

... specialise in helping companies raise capital by selling securities.

Answer 27

investment bankers

Question 28

Commercial banks differ from other businesses in that both their assets and their liabilities are mostly

Answer 28

financial

Question 29

New issues of securities are sold in the ... market(s).

Answer 29

primary

Question 30

Investors trade previously issued securities in the ... market(s).

Answer 30

secondary

Question 31

Investment bankers perform in the following role(s) ...

Answer 31

market new stock and bond issues for firms, provide advice to the firms as to market conditions, price, etc, and design securities with desirable properties

Question 32

Until 1999, the ... Act(s) prohibited banks in the United States from both accepting depositis and underwriting securities.

Answer 32

Glass-Steagall

Question 33

The spread between the LIBOR and the Treasury-bill rate is called the ...

Answer 33

TED spread

Question 34

Mortgage-backed securities were created when ... began buying mortgage loans from originators and bundling them into large pools that could be traded like any other financial asset.

Answer 34

FNMA and FHLMC

Question 35

The sale of a mortgage portfolio by setting up mortgage pass-through securities is an example of ...

Answer 35

securitisation

Question 36

Which of the following is true about mortgage-backed securities? I) They aggregate individual home mortgages into homogenous pools. II) The purchases receives monthly interest and principal payments received from payments made on the pool. III) The banks that originated the mortgages maintain ownership of them. IV) The banks that originated the mortgages continue to service them.

Answer 36

I, II and IV

Question 37

... were designed to concentrate the credit risk of a bundle of loans on one class of investor, leaving the other investors in the pool relatively protected from that risk.

Answer 37

Collaterised debt obligations

Question 38

... are in essence an insurance contract against the default of one or more borrowers.

Answer 38

Credit default swaps