Capital Markets
Exam Solutions
Course Introduction
Capital Markets explores the structure, functioning, and significance of financial markets where long-term debt and equity securities are traded. The course provides an in-depth understanding of how capital markets facilitate the allocation of resources in the economy, focusing on the roles of participants such as issuers, investors, and intermediaries. Key topics include market instruments, primary and secondary markets, risk and return, regulatory environment, and the impact of global events on capital flows. Through theoretical frameworks and practical analysis, students learn how capital markets support corporate financing, investment decisions, and economic growth.
Recommended Textbook Financial Markets and Institutions 11th Edition by Jeff Madura
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Page 2
Chapter 1: Role of Financial Markets and Institutions
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Sample Questions
Q1) ____ are classified as a depository institution.
A)Credit unions
B)Pension funds
C)Finance companies
D)Securities firms
Answer: A
Q2) If markets are perfect, securities buyers and sellers to not have full access to information and cannot always break down securities to the precise size they desire.
A)True
B)False Answer: False
Q3) Money market securities are commonly issued in order to finance the purchase of assets such as buildings, equipment, or machinery.
A)True
B)False
Answer: False
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Chapter 2: Determination of Interest Rates
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Q1) According to the loanable funds theory, market interest rates are determined by the factors that control the supply of and demand for loanable funds.
A)True
B)False
Answer: True
Q2) Other things being equal, a ____ quantity of U.S. funds would be demanded by foreign governments and corporations if their domestic interest rates were ____ relative to U.S. rates.
A)smaller; high
B)larger; high
C)larger; low
D)none of the above
Answer: B
Q3) The relationship between interest rates and expected inflation is often referred to as the loanable funds theory.
A)True
B)False
Answer: False
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4
Chapter 3: Structure of Interest Rates
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Q1) All other characteristics being equal, securities with ____ liquidity would have to offer a ____ yield to be preferred.
A)lower; higher
B)higher; higher
C)lower; lower
D)none of the above
Answer: A
Q2) Assume an investor's tax rate is 25 percent. The before-tax yield on a security is 12 percent. What is the after-tax yield?
A)16.00 percent
B)9.25 percent
C)9.00 percent
D)3.00 percent
E)none of the above
Answer: C
Q3) The higher a bond rating, the lower the perceived default risk.
A)True
B)False
Answer: True
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Page 5
Chapter 4: Functions of the Fed
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Q1) When the Fed purchases securities, the total funds of commercial banks ____ by the market value of securities purchased by the Fed. This activity initiated by the FOMC's policy directive is referred to as a(n) ____ of money supply growth.
A)increase; loosening B)decrease; tightening C)decrease; loosening D)increase; tightening E)none of the above
Q2) The Fed's primary goal has historically been to add liquidity to the mortgage market by continuously purchasing mortgage-backed securities.
A)True
B)False
Q3) The ____ is made up of seven individual members, and each member is appointed by the president of the U.S.
A)Board of Governors
B)Federal Reserve district bank
C)Federal Open Market Committee (FOMC)
D)Securities and Exchange Commission
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Chapter 5: Monetary Policy
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Q1) In 2012, the Fed stated that it would continue to purchase Treasury bonds in the financial markets until GDP growth increased to a target level.
A)True
B)False
Q2) When the Fed purchases Treasury securities, the account balances of the investors who sell their securities to the Fed _________, and there are _________ in the account balances of other financial institutions.
A)increase; offsetting decreases
B)increase; no offsetting decreases
C)decrease; offsetting increases
D)decrease; no offsetting increases
Q3) The time between when the Fed adjusts the money supply and when interest rates change reflects the
A)recognition lag.
B)implementation lag.
C)impact lag.
D)open-market lag.
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Chapter 6: Money Markets
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Sample Questions
Q1) T-bills and commercial paper are sold
A)with a stated coupon rate.
B)at a discount from par value.
C)at a premium about par value.
D)A and C
E)none of the above
Q2) Credit guarantees for commercial paper:
A)ensures that the issuer of commercial paper will use the funds obtained to provide credit.
B)are issued by the Federal Reserve Bank of New York.
C)are only as good as the credit of the guarantor.
D)A and C
Q3) An investor, purchases a six-month (182-day) T-bill with a $10,000 par value for $9,700. If the Treasury bill is held to maturity, the annualized yield is ____ percent.
A)6.02
B)1.54
C)1.50
D)6.20
E)none of the above
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Chapter 7: Bond Markets
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Sample Questions
Q1) If a firm believes that it will have sufficient cash flows to cover interest payments, it may consider using ____ debt and ____ equity, which implies a ____ degree of financial leverage.
A)more; less; lower
B)more; less; higher
C)less; more; higher
D)none of the above
Q2) The yield to investors on Treasury bonds reflects the risk-free rate because these bonds are virtually free from credit (default) risk.
A)True
B)False
Q3) Investors in Treasury notes and bonds receive ____ interest payments from the Treasury.
A)annual
B)semiannual
C)quarterly
D)monthly
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Page 9
Chapter 8: Bond Valuation and Risk
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Q1) Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return.
A)True
B)False
Q2) An insurance company purchases corporate bonds in the secondary market with six years to maturity. Total par value is $55 million. The coupon rate is 11 percent, with annual interest payments. If the expected required rate of return in 4 years is 9 percent, what will the market value of the bonds be then?
A)$52,115,093
B)$55,341,216
C)$55,000,000
D)$56,935,022
Q3) A $1,000 par bond with five years to maturity is currently priced at $892. Annual interest payments are $90. What is the yield to maturity?
A)13 percent
B)12 percent
C)11 percent
D)10 percent
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Chapter 9: Mortgage Markets
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Sample Questions
Q1) A financial institution may service a mortgage even after selling it.
A)True
B)False
Q2) When financial institutions originate residential mortgages, the mortgage contract should not specify
A)whether the mortgage is federally insured.
B)the amount of the loan.
C)whether the interest rate is fixed or adjustable.
D)the maturity.
E)the mortgage contract should specify all of the above
Q3) From the perspective of the lending financial institution, there is a ____ degree of interest rate risk for ____-maturity mortgages.
A)higher; shorter
B)higher; longer
C)lower; shorter
D)lower; higher
E)Answers B and C are correct.
Q4) Non-U.S. financial institutions never hold mortgages on U.S. property.
A)True
B)False
Page 11
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Chapter 10: Stock Offerings and Investor Monitoring
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Sample Questions
Q1) Shelf-registration allows firms quick access to funds without repeatedly being slowed by the registration process.
A)True
B)False
Q2) According to financial research, there is evidence that the stock price associated with an IPO typically rises on the first day but then declines over time.
A)True
B)False
Q3) Shareholders can most easily measure a firm's performance by monitoring changes in its ____ over time.
A)share price
B)employee job descriptions
C)board of directors
D)asset size
Q4) As a result of the Sarbanes-Oxley Act, firms were able to reduce their costs of compiling and reporting financial information.
A)True
B)False
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Page 12
Chapter 11: Stock Valuation and Risk
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Sample Questions
Q1) Investors can avoid unsystematic risk by:
A)using the capital asset pricing model.
B)investing in stocks with low PE ratios.
C)holding diversified portfolios.
D)using the free cash flow model.
Q2) According to the capital asset pricing model, the required return by investors on a security is
A)inversely related to the risk-free rate.
B)inversely related to the firm's beta.
C)inversely related to the market return.
D)none of the above
Q3) The ____ is not a factor used in the capital asset pricing model (CAPM) to derive the return of an asset.
A)prevailing risk-free rate
B)dividend growth rate
C)market return
D)covariance between the asset's returns and market returns
E)All of the above are factors used in the CAPM.
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13
Chapter 12: Market Microstructure and Strategies
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Sample Questions
Q1) When a brokerage firm demands more collateral from investors who have borrowed from the brokerage firm to buy stocks, it is making a
A)margin call.
B)short sale.
C)proxy fight.
D)hedge.
Q2) The risk of a short sale is that the stock price
A)may decrease over time.
B)will remain the same.
C)may increase over time.
D)none of the above
Q3) Marziano Co. stock is quoted by a broker as bid $21.20, ask $21.40. The bid-ask spread is ____ percent.
A)0.94
B)0.93
C)0.20
D)none of the above
Q4) Trading halts are intended to prevent insider trading.
A)True
B)False
Page 14
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Chapter 13: Financial Futures Markets
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Sample Questions
Q1) The prices of stock index futures
A)are always the same as the prices of the stocks representing the index.
B)are always a little above the prices of the stocks representing the index.
C)are always a little below the prices of the stocks representing the index.
D)none of the above
Q2) Financial futures contracts on stock indexes are referred to as interest rate futures.
A)True
B)False
Q3) Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This means that the mutual fund
A)liquidates its stocks whenever it expects a market downturn.
B)maintains a constant buy position in stock index futures.
C)maintains a constant sell position in stock index futures.
D)none of the above
Q4) Some specialized futures contracts are sold over the counter, whereas standardized financial futures contracts are traded on exchanges.
A)True
B)False
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Chapter 14: Options Markets
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Q1) A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified period of time.
A)call option
B)put option
C)sale of a futures contract
D)purchase of a futures contract
Q2) Stock options can be used by speculators to benefit from their expectations and by financial institutions to reduce their risk.
A)True
B)False
Q3) The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of the stock price.
A)be negative
B)decline
C)increase
D)be unaffected
E)A and B
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Page 16
Chapter 15: Swap Markets
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Sample Questions
Q1) Buyers of credit default swaps are most likely going to receive a payment from the seller of credit default swaps when the economy:
A)is very weak.
B)is stable.
C)experiences high growth.
D)experiences low inflation.
Q2) A firm is involved in an agreement in which it receives payments in periods when a market interest rate falls below an interest rate level specified in the agreement. This means that the firm has
A)purchased an interest rate cap.
B)sold an interest rate cap.
C)purchased an interest rate floor.
D)sold an interest rate floor.
Q3) AIG's financial problems during the credit crisis were attributed to:
A)its weak returns on its investments in junk bonds.
B)its potential losses from its life insurance policies.
C)fraud from avoiding taxes on its gains from credit default swaps.
D)its potential losses from credit default swaps.
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17
Chapter 16: Foreign Exchange Derivative Markets
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Sample Questions
Q1) Which of the following is not a method of forecasting exchange rate volatility?
A)using the volatility of historical exchange rate movements
B)using a time series of volatility patterns in previous periods
C)using the volatility of future exchange rate movements
D)using the exchange rate's implied standard deviation
Q2) When countries experience substantial net outflows of funds, they commonly use indirect intervention by raising interest rates to discourage excessive outflows of funds and therefore limit any downward pressure on the value of their currency.
A)True
B)False
Q3) The Bretton Woods Era was the era
A)of free-floating exchange rates.
B)of floating rates without boundaries, but subject to government intervention.
C)in which governments maintained exchange rates within 1 percent of a specified rate.
D)in which exchange rates were maintained within 10 percent of a specified rate.
Q4) Financial institutions rarely use the forward market.
A)True
B)False
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Page 18
Chapter 17: Commercial Bank Operations
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Sample Questions
Q1) When a bank obtains funds through a ____, the provider of the funds receives collateral.
A)retail CD
B)NOW account
C)repurchase agreement
D)money market deposit account
Q2) Transaction deposits do not include
A)demand deposits.
B)NCDs.
C)NOW accounts.
D)all of the above are transactions deposits
Q3) Which of the following is not an off-balance sheet activity?
A)highly leveraged transactions (HLTs)
B)standby letters of credit
C)forward contracts
D)swap contracts
Q4) The yield on repurchase agreements is slightly higher than the federal funds rate at any given point in time.
A)True
B)False
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Chapter 18: Bank Regulation
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Q1) Which of the following is not true regarding the Financial Services Modernization Act of 1999?
A)It provided more momentum for the consolidation of financial services.
B)Financial institutions were finally able to offer a diversified set of financial services without being subjected to stringent constraints on the form or amount of financial services that they could offer.
C)Banks and other financial service firms were given more freedom to merge, but were forced to divest some of the financial services that they acquired.
D)Financial institutions no longer had to search for loopholes or monitor their business to ensure that the degree of financial services offered remained within the regulatory constraints that were previously imposed.
E)all of the above are true
Q2) The key reason for regulatory examinations (such as CAMELS ratings) is to A)rate past performance.
B)detect problems of a bank in time to correct them.
C)check for embezzlement.
D)monitor reserve requirements.
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Chapter 19: Bank Management
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Q1) In general, the duration of zero-coupon securities with short maturities is ____ than the duration of zero-coupon securities with long maturities. A)higher than B)lower than C)equal to D)A or B, depending on the issuer of the securities
Q2) Other things being equal assets with ____ maturities and ____ frequent coupon payments have shorter durations.
A)shorter; more B)shorter; less C)longer; more D)longer; less
Q3) An effective way to align bank managers' interests with shareholders' goal of higher returns is to compensate the managers with fixed salaries without a bonus. A)True
B)False
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Chapter 20: Bank Performance
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Q1) Even if other external forces (such as interest rates) are unchanged, a commercial bank's expected cash flows can change in response to a change in its management skills.
A)True
B)False
Q2) Which of the following banks would likely have the highest return on equity?
A)high return on assets, high capital ratio
B)high return on assets, low capital ratio
C)low return on assets, low capital ratio
D)low return on assets, high capital ratio
Q3) A(n) ____ in interest rates could reduce a commercial bank's expected cash flows because the interest paid on deposits may ____ than the interest earned on loans and investments.
A)increase; increase to a greater degree
B)increase; increase to a lesser degree
C)decrease; increase to a greater degree
D)decrease; increase to a lesser degree
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Chapter 21: Thrift Operations
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Q1) Under the Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), all federally chartered savings institutions are to be regulated by the Federal Reserve, so these savings institutions no longer have an incentive to go regulator shopping.
A)True
B)False
Q2) Credit unions obtain most of their funds from
A)issuing common stock.
B)retained earnings.
C)share deposits by members.
D)issuing long-term bonds.
Q3) Savings institutions can obtain capital by:
A)issuing stock.
B)repurchasing stock.
C)borrowing from the Federal Reserve.
D)borrowing in the federal funds market.
Q4) In general, savings institutions are larger than commercial banks.
A)True
B)False
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Chapter 22: Finance Company Operations
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Sample Questions
Q1) ____ finance companies concentrate on purchasing credit contracts from retailers and dealers.
A)Consumer
B)Sales
C)Commercial
D)None of the above
Q2) If finance companies with a greater rate-sensitivity of liabilities than assets wanted to reduce interest-rate risk, they could
A)shorten their average asset life.
B)lengthen their average asset life.
C)shorten the maturity of debt that they issue.
D)make greater use of fixed-rate loans.
Q3) ____ provide loans to firms that cannot obtain financing from commercial banks.
A)Consumer finance companies
B)Sales finance companies
C)Commercial finance companies
D)None of the above
Q4) Finance companies are exempt from state regulations.
A)True
B)False
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Chapter 23: Mutual Fund Operations
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Q1) Shares of exchange-traded funds can be sold _________, and shares of open-end mutual funds can be sold _________.
A)at any time during trading hours; at any time via private trading networks
B)only at the end of the day; at any time during trading hours
C)at any time via private trading networks; at any time during trading hours
D)at any time during trading hours; only at the end of the day
Q2) A(n) ____ fund contains a sales charge.
A)load
B)no-load
C)closed-end
D)open-end
E)none of the above
Q3) ____ are not exchange-traded funds.
A)Spiders
B)Growth mutual funds
C)Diamonds
D)Sector Spiders
Q4) A mutual fund's performance is usually unrelated to market conditions.
A)True
B)False
25
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Chapter 24: Securities Operations
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Q1) Which of the following statements is incorrect?
A)A private bond placement avoids the underwriting fee.
B)Private placements of stocks are more common than private placements of bonds.
C)The provisions of a privately placed bond issue can be tailored to the desires of the purchaser.
D)A possible disadvantage of a private placement is that the demand may not be as strong as for a publicly placed issue.
Q2) As a result of a spinoff, the ownership of a firm's is separated into two parts with separate ownership.
A)True
B)False
Q3) Securities firms avoided exposure to mortgages during the credit crisis because they sold their mortgage holdings before the crisis began.
A)True
B)False
Q4) During the credit crisis, many commercial banks were forced to convert into securities firms.
A)True
B)False
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Chapter 25: Insurance and Pension Fund Operations
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Q1) In recent years, defined-contribution plans have commonly been replaced by defined-benefit plans.
A)True
B)False
Q2) Pension portfolios managed by trusts are expected to offer ____ returns than those managed by insurance companies and have a(n) ____ degree of risk.
A)lower; higher
B)lower; lower
C)the same; equal
D)higher; lower
E)higher; higher
Q3) A life insurance policy that protects the policyholder until death, or as long as premiums are promptly paid is a
A)whole life policy.
B)term policy.
C)universal life policy.
D)B and C
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