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74 Cards in this Set
- Front
- Back
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1. What are interest rates? What function do they serve?
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a. Price for borrowing money. As any other price it helps allocate resources. When prices are incorrect, resource allocation is inefficient
b. Low interest rates – very hard to save for retirement |
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2. What are the determinants of interest rates?
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a. Vertical axis – Price
b. Horizontal – goods c. Intersect – Most efficient scenario probable Amount of loanable funds |
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3. Who supplies loanable funds?
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a. Consumer savings, Business savings, State and local government budget surplus, federal government budget surplus, Federal Reserve increase in money supply.
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4. Who demands loanable funds?
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a. Consumer credit purchases, business investment, state and local government budget deficit, federal government budget deficit
b. Borrowing. It doesn’t always push interest rates up |
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5. What relation does Fisher Equation explain?
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a. It estimates the expected annual rate of inflation by using the real rate of interest and the observed nominal rate of interest
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6. What is the difference between real and nominal interest rates?
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a. Real Interest ratei. Compensation for delayed consumption, compensation for risk
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7. How can we decompose real interest rates?
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a. Money supply increase = price goes down
b. If GDP increases = Price goes up = borrowing more c. Expected inflation increases = Price goes up = Borrowing more d. Unemployment is high = price goes down = borrowing less |
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8. What are some of the variables used to predict interest rates?
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a. Money supply, government expenditures, GDP, inflation, unemployment rate
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9. Can we predict interest rates?
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a. They are very hard to predict
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1. What is the term structure of interest rates?
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a. Relationship between yield and term to maturity on securities that differ only in maturity
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2. What is the Treasury yield curve?
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a. Shows what interest rates are expected to do in the futurei. If its lower they will go down
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3. What does the Expectation theory state?
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a. A borrower should pay the same total expected interest rate on 1 year loans renewed annually for three years and on one 3 year loan
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4. What does the Liquidity Premium theory state?
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a. As long term debt is less liquid, it will pay liquidity premium
b. Short term interest rates are lower than long term interest rates |
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5. What does the Market Segmentation theory state?
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a. Market is segmented and interest rates for each maturity are determined by supply and demand of that maturity
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6. What does the Preferred Habitat theory state?
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a. Investors will not hold securities outside of their preferred maturities (habitat) without an additional reward
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7. How are yield curves related to the expected business cycles?
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a. Lower interest rates lead to less borrowingb. Interest rates on long term securities are slightly higher than short term- than there won’t be much change in the futurec. Interest rates are lower than normal so interest rates and economic activity are expected to go down
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9. Which bond rating agencies are approved by the government?
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a. Standard and Poor’s, Moody’s, and Fitch
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10. What do different ratings mean?
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a. AAA means the lowest risk, C is the highest risk
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11. What ratings do investment (speculative) grade bonds have?
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a. BB (Ba) is the lowest risk for speculative grade bonds
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12. What is different about the taxation of state or local government debt?
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a. All coupon income earned on state or local government debt are exempt from federal taxes, such debt tends to have lower interest rates
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13. What can be included in bond contracts?
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a. Give rights to buyers or sellers to change the bond contract under certain conditions. This may make bonds less or more valuable
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14. What is a callable bond?
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a. Allow the issuer to redeem the bond before its maturity at a fixed price.
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3. What is the economic role of money markets?
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a. The money market is a market for liquidityb. Provides a place for Fed’s reserve transactions (open market operations), Indicator of economic conditions
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4. What are the main characteristics of money market instruments?
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a. Low default risk, Short maturity, High marketability (liquidity)b. If you have an asset how quickly can you sell it without a loss of value
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5. What are the main characteristics of U.S. Treasury bills?
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a. Sold on discount basis
b. Maturities up to one year c. Minimum denomination is usually $10,000 d. Usually considered free of default risk |
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a. Bank discount yield
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i. Tends to understate the actual yield
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b. Bond equivalent yield
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i. Is used to compare the yield on treasury bills to other bonds
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7. How are Treasury bills sold?
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a. Sold through an auction process using competitive and noncompetitive bids
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i. Competitive Selling
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1. Specify quantity and price desired2. Minimum $10,0003. Mostly professionals – dealers and bankers
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ii. Non-competitive
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1. Specify quantity only
2. All bids are accepted 3. Max of $5,000,000 4. Mostly individuals and small investors 5. Pay the same price as competitive bids accepted |
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8. What is a book-entry security? Give an example.
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a. No physical securities: only record entries
b. Most of marketable treasury debt is now in book entry form c. Participants in treasury direct program are book entry accounts |
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9. What are the types of federal agencies? How can they borrow?
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a. Farm credit agencies – loans to farmers
b. Housing credit agencies – loans and secondary market support for mortgage market c. Other agencies – special purpose d. Federal Financing Bank – Purchases securities of agencies and issues its own obligations |
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10. Does the government guarantee the debt of federal agencies?
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a. They only guarantee the debt of government owned agencies
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11. What are federal funds? What are their characteristics?
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a. Short term lending and borrowing between banks
b. The most liquid of all financial assets c. Usually one day unsecured loans d. Traded in immediately available funds e. Quoted yield assumes 360 day year |
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12. What are repurchase agreements? What are their characteristics?
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a. Sale of securities with an agreement to buy it back later at a higher pricei. Difference in price is interestii. Securities serve as collateralb. Value of securities usually exceeds the sale and repurchase prices – Very safe
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13. What are commercial papers? What are their characteristics?
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a. Unsecured corporate debtb. Issued by high quality borrowersc. Maturities 1 to 270 daysd. Large denominations - $100,000 and upe. A wholesale money market instrument – few individual investorsf. Sold at a discount from par value
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14. How do banks help with commercial paper issues?
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a. Provide backup lines of credit, act as agents in issuance, hold notes in safekeeping
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15. How risky are commercial papers? Why?
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a. The vast majority of issues are in the top two rating categoriesb. Backup lines of credit from banks reduce risk
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16. How are commercial papers placed?
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a. Directly by a sales force of the borrowing firmb. Indirectly through dealers
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17. What are negotiable certificates of deposits? What are their characteristics?
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a. Large time deposits (>100,00), maturity less than six monthsb. Negotiable – may be sold and traded before maturityc. Issued at face value, interest is based on a 360 day yeard. Interest rates depend on the issuing bank’s credit worthiness
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18. What are banker’s acceptances? Why are they created? What are their characteristics?
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a. Seller of goods, buyer of goods, seller’s bank, buyer’s bankb. Time draft – order to pay in futurec. Mostly related to international traded. Secondary market – dealer markete. Discounted when traded to reflect yieldf. Standard maturities: 30,60, or 90 day; maximum 180 daysg. Interest they pay depend on the credit worthiness of the bank that accepted them
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19. What are money market mutual funds?
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a. an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely (though not necessarily accurately) regarded as being as safe as bank deposits yet providing a higher yield.
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20. Which money market instruments are on the balance sheets of commercial banks (The U.S. Treasury, money market mutual funds, non-financial corporations)? Are these instruments assets or liabilities for these financial institutions?
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a. Assets
i. Treasury bills ii. Agency securities b. Assets and Liabilities i. Commercial paper ii. Banker’s acceptances iii. Negotiable CDsiv. Federal Fundsv. Repurchase agreements |
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1. What are capital markets? What is their purpose?
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a. Brings together long term borrowers and investors (over 1 year)
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2. Who are major issuers (investors) in capital markets?
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a. Households and foreign investors
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4. What are the different types of capital markets?
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a. Bonds b. Mortgagesc. Corporate Stock
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5. What are the main characteristics of Treasury notes and bonds?
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a. Notes – One to ten year maturityb. Bond over ten year maturityc. Sold in auction by the treasury departmentd. Trend is toward more short term financing, less long term
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7. What are inflation-indexed notes and bonds (TIPS)? How can we estimate how high inflation the market expects in the future?
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a. Principal adjusts for inflationb. Fixed coupon rate determined by auction process ( payment amount changes as principal changes)c. Difference between yield on a regular treasury bond and TIPS shows the expected inflation
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8. How can we separately trade interest and principal payments? Why is this attractive to investors?
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a. Each interest payment and principal payment become a separate security (zero coupon bond)b. Financial institutions by treasury securities and create STRIPsc. Zero coupon bonds are much easier to use when managing interest rate risk
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9. What are municipal bonds? What are their characteristics?
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a. State and local government bondsb. Not backed by the federal governmentc. General obligation – backed by taxing power of political entityd. Revenue – paid back with cash from a specific projecte. Industrial development bonds – public financing of private businessf. Interest exempt from federal income taxes
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10. What are the characteristics of the municipal bond market?
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a. Primaryi. Many individual smaller issuersii. Underwritten by investment bankersb. Secondary Marketi. Not well developed – OTC market made by dealersii. Limited marketability – larger bid ask spreads and higher yields
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11. What are the characteristics of corporate bonds?
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a. Debt contracts require borrower to make periodic payments of interest and repay principal, usually 1000 at maturity date
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Collateral Bonds |
i. Mortgage bond – land or building pledged
ii. Equipment trust certificates – Specific, titled, or identifiable equipment iii. Collateral bonds – secured by financial assets iv. Debentures- unsecured bonds |
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Claims on assets |
i. Senior debt – first priority to general assetsii. Subordinated – asset claim ranking below senior or specific general creditors
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13. What is a sinking fund (call) provision?
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a. Sinking fundi. Fund building a sum for retirement of bondsii. The periodic retirement of a number of bonds
b. Call provisioni. Borrower right to retire bond before maturity |
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15. Who are major investors in corporate bonds? Why?
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a. Life insurance companiesb. Pension fundsc. Householdsd. Foreign investors
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16. How are public sales of corporate bonds organized?
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a. Open to all interested buyersi. Competitive sale – public auction among underwritersii. Negotiated sale – underwriting contract signed with specific underwriters
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17. What are the characteristics of the secondary market for corporate bonds?
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a. Through dealers vs exchangesb. Low trading volume – wide bid ask spreadsc. Less marketable than money market instruments
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18. How are private placements of corporate bonds organized?
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a. Sold to a limited number (<35) of sophisticated buyers avoiding SEC registrationb. Increase when interest rates are high or market conditions are unstable
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19. What are junk bonds?
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a. Low rated (high default) corporate bondsb. Higher yieldsc. An alternative to borrowing from banks for riskier companies
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20. What are the financial guarantees? Why do firms use them?
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a. Provided for a fee by commercial banks and insurance companiesb. Cover the payment of principal and interest in the event of defaultc. Substitutes the credit standing of the guarantor for that of the issuer
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21. What is securitization? Why do financial firms engage in it?
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a. Securitizationi. Is packaging loans and selling claims to future cash flows of the loansii. Value of new securities exceeds value of loan cash flows, providing incentives to securitize
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What are tranches?
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b. Tranchesi. Can vary from very high to very low riskii. Financial guarantees reduce the risk of the low end tranchesiii. Residual or non-guaranteed tranches have a higher risk/return profile
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22. What does the Securities and Exchange Commission (SEC) do
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a. Principal regulator of financial marketsb. Scope ranges from disclosure requirements to proper operation of capital marketsc. Public firms file regular reports with the sec
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23. Who are other regulators of financial markets?
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a. States have security laws b. Privatei. National Association of security dealersii. Exchanges
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25. What are foreign bonds (Eurobonds)?
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a. Issued by foreign companyb. Denominated in the currency of a country where they are issuedc. Have to comply with the regulations of the country where they are issued.
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1. Government imposes some unnecessary costs on businesses. What impact do such costs have on companies (e.g., investing, creation of jobs)? What impact do such costs have on economy’s ability to recover?
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a. Railroads cars won’t have to install the current expensive technology, and hospitals will be able to skip around federal paper work. Changes like this can end up saving businesses 10 billion over the next five year. By the businesses saving money they will have ability to reinvest more money into the economy and create more jobs.
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2. What is the impact on the prosperity of a country when some people are employed doing meaningless jobs?
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a. The employees that are working the meaningless jobs will help contribute to the economy more than if a person was un-employed. If they are receiving a wage that they then can put back toward the economy.
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3. What were the changes in taxes in Illinois in 2011?
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a. Democrats passed a $2 billion dollar tax hike. Income tax rose 67% and the effective corporate tax rose to 9.5%
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4. Does an increase in a tax rate necessarily increase government tax income? Why?
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a. No because even though there has been a tax hike the state has still failed to raise revenue and there is still a budget deficit.
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5. What impact did the increase in taxes have on businesses?
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a. It caused certain companies to leave the states they were in to do business where taxes were much lower.
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6. Why did some companies get exceptions about paying taxes? How does that affect capital allocation?
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a. Tax passes were given to the most influential 1%. The 1% of politically connected businesses would benefit at the expense of the other 99%.
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7. Why is efficient capital allocation important? How does it affect financial markets
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a. By taxing at higher rates it is taking earning away from companies. Instead of allowing this money to be reinvested back into the economy it is going to the government.
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8. Why is it a problem that government helps some companies with their international business?
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a. Because if the government is providing money to certain companies then it means it is taking away from others. If they are helping grow international business it most likely means they are taking away money they could use to help business grow within the country.
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