Corporate Finance
Exam Materials
Course Introduction
Corporate Finance is a foundational course that explores how corporations manage their financial resources to maximize shareholder value. The course covers key topics such as capital budgeting, investment evaluation, risk and return analysis, cost of capital, capital structure decisions, dividend policy, and working capital management. Students will develop analytical tools for valuing projects and companies, understand the impact of financial decisions on firm value, and examine real-world financial strategies and challenges faced by managers in the corporate sector. The course combines theoretical frameworks with practical case studies to prepare students for decision-making roles in finance-related fields.
Recommended Textbook
Foundations of Financial Markets and Institutions 4th Edition by Frank J. Fabozzi
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1746 Flashcards
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Chapter 1: Introduction
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Q1) Name and describe some of the ways to classify financial markets.
Answer: There are many ways to classify financial markets.
(a) One way is by the nature or type of the financial claim, such as debt markets and equity markets.
(b) Another is by the maturity of the claim, such as short-term and long-term. For example, there is a financial market for short-term debt instruments, called the money market, and one for longer-maturity financial assets, called the capital market.
(c) Financial markets can also be categorized as those dealing with financial claims that are newly issued, called the primary market, and those for exchanging financial claims previously issued, called the secondary market or the market for seasoned instruments.
NOTE:Other classifications are: Markets can be classified as either cash or derivative instruments markets and also by their organizational structure such as an auction market, an over-the-counter market, or an intermediated market.
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3
Chapter 2: Financial Institutions, Financial Intermediaries, and Asset Management Firms
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Q1) Because of uncertainty about the timing and/or the amount of the cash outlays, a financial institution must be prepared ________.
A) to have sufficient cash to satisfy its obligations.
B) to have sufficient projects to satisfy its capital budget constraints.
C) to have sufficient risk to satisfy its obligations.
D) to have sufficient risk to satisfy its conservative investors.
Answer: A
Q2) To understand the reasons managers of financial institutions invest in particular types of financial assets and the types of investment strategies they use, it is necessary to have a general understanding of the ________ that they face.
A) investment/employee problem
B) risk management /dividend problem
C) shot-term/long-term asset problem
D) asset/liability problem
Answer: D
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Chapter 3: Depository Institutions: Activities and Characteristics
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Q1) What is a corporate credit union?
Answer: One might think that a corporate credit union is a credit union set up by employees of a corporation. It is not. Federal and state-chartered credit unions are referred to as "natural person" credit unions because they provide financial services to qualifying members of the general public. In contrast, corporate credit unions provide a variety of investment services, as well as payment systems, only to natural person credit unions. Almost all corporate credit unions are federally insured. The U.S. Central Credit Union acts as the chief liquidity center for corporate credit unions by investing surplus funds from the other corporate credit unions.
Q2) Credit union assets consist of ________.
A) small consumer loans, residential mortgage loans, and securities.
B) large consumer loans, residential mortgage loans, and securities.
C) small consumer loans, business mortgage loans, and securities.
D) small consumer loans, residential auto loans, and securities.
Answer: A
Q3) Savings banks are institutions similar to, although much younger than, S&Ls.
A)True
B)False
Answer: False
Page 5
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Chapter 4: The US Federal Reserve and the Creation of Money
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Q1) Assume the Fed's required reserve ratio is 12%. Further assume that the Fed buys $10 million of U.S. Treasury securities from a dealer who deposits the check, which is drawn on the Fed, in his bank. His bank's reserve account with the Fed has increased by $10 million and so have its (demand) deposits, its total reserves, and the overall level of M . However, required reserves have risen only by $1.2 million. This leaves an additional $8.8 million that the bank is free and eager to invest in order to improve its income.
A)True
B)False
Q2) The Fed often employs variants of simple open market purchases and sales, and these are called ________.
A) the trading agreements of the Federal Reserve Bank of New York.
B) the repurchase agreement (or repo) and the reverse repo.
C) matched sale or a matched sale-purchase transaction
D) open market operations
Q3) Many deposit accounts pay interest, so holding cash does not impose an opportunity cost.
A)True
B)False
Q4) Briefly discuss the nature of a closed economy and an open economy.
Page 6
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Chapter 5: Monetary Policy in the United States
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Q1) Policies expanding the money supply and stimulating growth are beneficial for all circumstances.
A)True
B)False
Q2) A "weak" dollar contributes to inflation, as U.S. buyers pay more for the many goods they do import.
A)True
B)False
Q3) ________ is helpful because it allows a constant reallocation of labor and leads to increased efficiency in the work force.
A) Zero inflation
B) Full employment
C) Frictional unemployment
D) Excess demand
Q4) Interestingly, in recent years, many central banks have adopted inflation, despite certain problems in measurement, as a key intermediate variable.
A)True
B)False
Q5) Identify and briefly describe three of the major goals of Fed policy.
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Chapter 6: Insurance Companies
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Q1) Traditionally, insurance companies have been stock, but they are increasingly remutualizing due to the perceived benefits of having a publicly traded stock.
A)True
B)False
Q2) Mutual insurance companies can adopt a longer time frame in their investments, which will most likely make possible a higher long-term return.
A) Stock insurance companies can adopt a longer time frame in their investments, which will most likely make possible a higher long-term return.
B) Mutual insurance companies can adopt a shorter time frame in their investments, which will most likely make possible a higher long-term return.
C) Mutual insurance companies can adopt a longer time frame in their investments, which will most likely make possible a lower long-term return.
D) None of these
Q3) Name and briefly describe four major types of insurance.
Q4) Explain how insurance companies are regulated and rated?
Q5) Describe and contrast the various types of IRAs.
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Chapter 7: Investment Companies and Exchange Traded Funds
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Q1) Explain what is meant by an index fund. In your answer contrast it with an active fund.
Q2) The mutual fund enters into a contract with a distributor or broker-dealer to manage the fund's portfolios. The distributor can be an affiliate of a brokerage firm, an insurance company, a bank, an investment management firm, or an unrelated company.
A)True
B)False
Q3) The open-end aspect of mutual funds is ________; that is, investors invest funds directly in or withdraw funds from the mutual fund. The open-end aspect of ETFs is ________ in that the investors buy the ETF in a closed-end manner like closed-end funds and then the authorized participant ________ between the ETF and the underlying portfolio, providing the indirect open-end aspect of the ETF.
A) direct; straight; trades
B) direct; straight; arbitrages
C) indirect; direct; trades
D) direct; indirect; arbitrages
Q4) What is a family of funds? In your answer specify two advantages of an investor belonging to a family of funds.
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Chapter 8: Pension Funds
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Q1) In addition to money managers, advisors called plan sponsor consultants provide other advisory services to pension plan sponsors. Which of the below is NOT a service that consultants provide to advisors?
A) Consultants give general and comprehensive research
B) Consultants give actuarial advice (liability modeling and forecasting)
C) Consultants measure and monitor the performance of the fund's money managers
D) Consultants search for and recommend money managers to pension plans
Q2) The Pension Protection Act of 2006 (PPA) provides ________.
A) significant changes in the operations of private pension plans.
B) insignificant changes in the operations of public pension plans.
C) reduces some tax incentives for retirement savings.
D) reduces all tax incentives for retirement savings.
Q3) In a defined-contribution plan, the amount contributed is typically ________.
A) a percentage of the employee's salary.
B) either a percentage of the employee's salary and/or a percentage of the employer's profits.
C) a percentage of the employee's salary,
D) a percentage of the employee's tenure.
Q4) The Pension Protection Act of 2006 (PPA) contains two major parts. Describe these two parts.
Page 10
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Chapter 9: Properties and Pricing of Financial Assets
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Q1) It is important to be able to measure the price sensitivity of an asset or liability to interest rate changes and the appropriate measure is the modified duration.
A)True
B)False
Q2) An asset's price is the present value of its expected cash flows, discounted at an appropriate rate.
A)True
B)False
Q3) The price of a complex asset is the sum of the prices of its component parts.
A)True
B)False
Q4) The fundamental principle of finance is that the true or correct price of an asset equals the ________ of all cash flows that the owner of the asset expects to receive during its life.
A) present value
B) future value
C) projected value
D) asset value
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11
Chapter 10: The Level and Structure of Interest Rates
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Q1) Which of the below statements about the rate of interest and cost of capital is FALSE?
A) The maximum that a firm will invest depends on the rate of interest, which is the cost of loans; the firm will invest only as long as the marginal productivity of capital exceeds or equals the rate of interest.
B) Firms will reject only projects whose gain is not less than their cost of financing.
C) The firm's demand for borrowing is negatively related to the interest rate; if the rate is high, only limited borrowing and investment make sense.
D) At a low rate of interest, more projects offer a profit, and the firm wants to borrow more; his negative relationship exists for each and all firms in the economy.
Q2) The loanable funds theory is an extension of Fisher's theory and proposes that the equilibrium rate of interest reflects the demand and supply of funds, which depend on savers' willingness to save, borrowers' expectations regarding the profitability of investing, and the government's action regarding money supply.
A)True
B)False
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Chapter 11: The Term Structure of Interest Rates
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Q1) More recently market participants have come to realize that the traditionally constructed Treasury yield curve is ________ measure of the relation between required yield and maturity with the key reason is that securities with the same maturity may actually provide ________.
A) an unsatisfactory; different yields
B) an unsatisfactory; very similar yields
C) a satisfactory; different yields
D) a satisfactory; very similar yields
Q2) Which of the below statements is TRUE?
A) The pure expectations theory pays attention to the risks inherent in investing in bonds and like instruments.
B) In regards to the uncertainty about the return over some investment horizon, one risk involves the uncertainty about the price of the bond at the beginning of the investment horizon.
C) An investor who plans to invest for five years would not consider the alternative of investing in a 30-year bond and selling it at the end of five years.
D) The risk that the price of the bond will be lower than currently expected at the end of the investment horizon is called price risk.
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Chapter 12: Risk/Return and Asset Pricing Models
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Q1) Objections to the fully rational approach are that the ________.
A) calculations needed to implement this approach are somewhat difficult to do.
B) "alleged psychology biases are arbitrary."
C) experiments performed by research that find alleged psychological biases are arbitrary.
D) empirical evidence in the finance literature does not support rational behavior by investors.
Q2) The multifactor CAPM says that investors want to be compensated only for market risk.
A)True
B)False
Q3) Consider an investor who holds a risky portfolio that has the same risk as the market portfolio. If the beta is one then the investor should expect to earn ________. Consider another investor who holds a riskless portfolio such as Treasury bills. If the beta is zero then the investor should earn ________.
A) the riskless rate of return; the market portfolio rate of return.
B) the risky return; the riskless rate of return.
C) the market portfolio rate of return; the riskless rate of return.
D) the market portfolio rate of return; the corporate bond rate of return.
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Page 14
Chapter 13: Primary Markets and the Underwriting of Securities
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Q1) Demonstrate how a rights offering works. In your illustration, demonstrate the effect on the economic wealth of shareholders and how the terms affect an issuer's need for an underwriter.
Q2) The gross spread earned by the underwriter depends on numerous factors.
A)True
B)False
Q3) When all bidders buy the amount allocated to them, then the auction is referred to
A) as a multiple-price auction or a Dutch auction.
B) as a single-price auction or a German auction.
C) as a single-price auction or a Dutch auction.
D) as a multiple-price auction or a German auction.
Q4) The type of information contained in the registration statement includes
A) the nature of the business of the issuer and key provisions or features of the security.
B) the nature of the investment risks associated with the security and the background of management.
C) the nature of the business of the issuer and the background of management.
D) All of these
Page 15
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Chapter 14: Secondary Markets
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Q1) In the United States, secondary trading of common stock occurs ________.
A) in a number of trading locations.
B) in Dallas, Texas.
C) in each major city.
D) None of these
Q2) The same Wall Street firms that have been the major market makers in bonds have also been the ________ of electronic trading in bonds.
A) cynics
B) attackers
C) supporters
D) detractors
Q3) Commissions are all of the brokerage costs of transacting.
A)True
B)False
Q4) In the secondary market, an issuer of securities (whether it is a corporation or a governmental unit) may obtain regular information about the value of the asset.
Describe the nature of this information and value that a secondary market offers.
Q5) Trace the historical evolution of transaction costs charged by the brokerage industry.
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Chapter 15: Treasury and Agency Securities Markets
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Q1) Describe the types of issued by non-U.S. central governments such as the British government and the Canadian government.
Q2) Which of the below statements is FALSE?
A) The TVA was established by Congress in 1933, primarily to provide flood control, navigation, and agricultural and industrial development, and to promote the use of electric power in the Tennessee Valley region.
B) In the 1930s, Congress created a federally related institution, the Federal National Mortgage Association, popularly known as "Fannie Mae," which was charged with the responsibility to create a liquid secondary market for mortgages.
C) The Federal Agricultural Mortgage Corporation (popularly known as "Farmer Mac") provides a secondary market for first mortgage forestry land loans.
D) In 1970, Congress created the Federal Home Loan Mortgage Corporation (Freddie Mac). The reason for the creation of Freddie Mac was to provide support for conventional mortgages.
Q3) The Treasury does not issue zero-coupon notes or bonds.
A)True
B)False
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Page 17
Chapter 16: Municipal Securities Markets
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Q1) Give two reasons why a municipality would want to issue a taxable municipal bond and thereby have to pay a higher yield than if it issued a tax-exempt municipal bond?
Q2) Specifically speaking, the difference in yield between tax-exempt securities and Treasury securities is measured as the percentage of the yield on a municipal security relative to a comparable Treasury security and is called the yield ratio.
A)True
B)False
Q3) Which of the below statements is FALSE?
A) Municipal bonds are issued with one of two debt retirement structures or a combination of both.
B) A serial maturity structure requires a portion of the debt obligation to be retired each year.
C) A provision that permits the early redemption of a term bond is the call privilege.
D) None of these
Q4) Describe an insured bond. In your description point out its backing, the nature of its agreement, and its term.
Q5) Contrast the yield on municipal bonds with that on Treasuries.
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Page 18
Chapter 17: Markets for Common Stock: The Basic
Characteristics
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Q1) There are two major components of transaction costs: explicit costs and implicit costs.
A)True
B)False
Q2) ________ involves the sale of a security not owned by the investor at the time of sale.
A) Short buying
B) Long selling
C) Short selling
D) Long buying
Q3) With the exception of the ________, all of the most widely used indexes are market-value weighted.
A) Wilshire 5000
B) S&P 500
C) Dow Jones averages (such as the DJIA)
D) Russell 3000
Q4) The Wilshire 4500 includes all stocks in the Wilshire 5000 except for those in the Dow Jones 500.
A)True B)False
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Chapter 18: Markets for Common Stock: Structure and Organization
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Q1) A fundamental difference between U.S. and international exchanges involves
A) their method of trading.
B) their market structure.
C) the nature of the exchanges' business organizations.
D) All of these
Q2) ________ is an entity independent of a registered securities exchange that collects and disseminates securities quotes and trades.
A) Trade Reporting Facility (TRF)
B) Automated Confirmation Transaction System (ACT)
C) An alternative display facility (ADF)
D) The National Exchange (NSX)
Q3) Direct market access (DMA) refers to the use of electronic systems to access various liquidity pools and execution venues directly, without the intervention of a sell-side firm trading desk or broker.
A)True
B)False
Q4) There are two overall market models for trading stocks. Name and describe these two market models.
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Chapter 19: Markets for Corporate Senior Instruments: I
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Q1) Which of the below statements is FALSE?
A) One possible way for the lessor to finance the purchase of the equipment is to provide all the financing from its own funds and therefore be at risk for 100% of the funds used to purchase the equipment.
B) One possible way for the lessor to finance the purchase of the equipment is for the lessor to use only a portion of its own funds to purchase the equipment, and to borrow the balance from a bank or group of banks.
C) Basically, leasing is a vehicle by which tax benefits can be transferred from the user of the equipment, who may not have the capacity to take advantage of the tax benefits associated with equipment ownership, to another entity who can utilize them.
D) There are only two parties to a leveraged lease agreement: the lessee and the lender.
Q2) ________ are those that are not subsidiaries of equipment manufacturing firms or bank holding companies.
A) Bank holding companies
B) Dependent finance companies
C) Captive finance companies
D) Independent finance companies
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Chapter 20: Markets for Corporate Senior Instruments: II
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Q1) Which of the below statements is FALSE?
A) A guaranteed bond is an obligation guaranteed by another entity.
B) Refunding is much more comprehensive than call protection because it prohibits the early redemption of the bonds for any reason
C) Most corporate issues have a call provision allowing the issuer an option to buy back all or part of the issue prior to maturity.
D) A callable corporate bonds is generally callable at a premium above par with the amount of the premium declining as the bond approaches maturity.
Q2) The law governing bankruptcy in the United States is the Bankruptcy Reform Act of 1978. One purpose of the act is to set forth the rules for a corporation to be liquidated or reorganized. Distinguish between a liquidation and a reorganization.
Q3) ________ of the bankruptcy act deals with the liquidation of a company; ________ covers reorganization.
A) Chapter 1; Chapter 2
B) Chapter 7; Chapter 12
C) Chapter 7; Chapter 11
D) Chapter 11; Chapter 17
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Page 22
Chapter 21: The Markets for Bank Obligations
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Q1) Of all depository institutions, ________ are by far the largest holders of federal funds.
A) Eurodollar banks
B) S&Ls
C) commercial banks
D) thrifts
Q2) CDs issued with a maturity greater than one year are called ________.
A) long-term CDs.
B) term CDs.
C) maturity CDs.
D) thrift CDs.
Q3) A bank may sell its bankers acceptances directly to investors, or may sell all or part to dealers.
A)True
B)False
Q4) The federal funds rate is lower than the repo rate because the lending of federal funds is done on an unsecured basis.
A)True
B)False
Q5) What are the four types of CDs, according to the issuing institution.
Page 23
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Chapter 22: The Residential Mortgage Market
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Q1) The two primary quantitative underwriting standards are (1) the payment-to-income ratio (PTI), and (2) the loan-to-value ratio (LTV). Describe these two ratios.
Q2) The LTV has proven to be a good predictor of default: the ________ the LTV, the ________ the likelihood of default.
A) higher; lesser B) higher; greater C) lower; greater
D) None of these
Q3) The loan applications being processed and the commitments made by a mortgage originator together are called its pipeline. Pipeline risk refers to the risks associated with originating mortgages. This risk has two components. Name and describe the two components.
Q4) Pipeline risk refers to what we call market risk and dropdown risk. A)True
B)False
Q5) What is prepayment risk? Discuss.
Q6) What is the mission of Freddie Mac and Fannie Mae? What does their federal charter allow for?
Q7) What does the lien status of a mortgage loan indicate?
Page 24
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Chapter 23: Mortgage-Backed Securities Market
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Q1) Which of the below are NOT two forms of credit enhancement?
A) junior-subordinate structure and monoline insurance
B) multiline insurance and overcollateralization
C) undercollateralization and excess spread
D) None of these
Q2) The cash flow of a mortgage pass-through security depends on the cash flow of the underlying mortgages, which consists of monthly mortgage payments representing interest, the scheduled repayment of principal, and any prepayments.
A)True
B)False
Q3) In early 1987, stripped mortgage-backed securities began to be issued allocating all the interest to one class [called the ________ class] and the entire principal to the other class [called the ________ class].
A) principal-only (PO); interest-only (IO)
B) interest-only (IO); prepayment-only (PO)
C) interest-only (IO); principal-only (PO)
D) stripped-only (SO); payment-only (PO)
Q4) What does the creation of a CMO accomplish? Briefly explain.
Q5) What is an IO?
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Chapter 24: Market for Commercial Mortgage Loans and Commercial Mortgage-Backed Securities
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Q1) In regards to commercial mortgage loans, which of the below statements is FALSE?
A) Commercial mortgage loans are typically balloon loans requiring substantial principal payment before the end of the balloon term.
B) If the borrower fails to make the balloon payment, the borrower is in default.
C) The lender may extend the loan and in so doing will typically modify the original loan terms.
D) Balloon risk is the risk that a borrower will not be able to make the balloon payment because the borrower either cannot arrange for refinancing at the balloon payment date or cannot sell the property to generate sufficient funds to pay off the balloon balance.
Q2) Commercial mortgage loans are ________, which means that if the borrower fails to make the contractual payments, the lender can only look to the income-producing property backing the loan for interest and principal repayment.
A) nonpayment loans
B) contractless loans
C) remedial loans
D) nonrecourse loans
Q3) Are CMBS and nonagency RMBS structures similar or different? Discuss.
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Chapter 25: Market for Asset-Backed Securities
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Q1) Securitizations require credit enhancement and the mechanism for credit enhancing a structure are classified as internal and external.
A)True
B)False
Q2) Securitization is a vehicle for raising funds directly in the public market without the need for a financial ________. That is, securitization is said to result in ________.
A) liaison; accounting discrimination
B) advisor; accounting disintermediation
C) go-between; financial interpretation
D) intermediary; financial disintermediation
Q3) External credit enhancement involves a guarantee from a third party. The most common form of external credit enhancement is ________.
A) monoline wrap
B) bond envelope
C) bond insurance
D) surety stock
Q4) What is the key benefit of securitization to financial markets?
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Chapter 26: Financial Futures Markets
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Q1) Equity futures contracts listed in the United States include stock index futures contract, single stock futures contracts, and narrow-based stock index futures contract.
A)True
B)False
Q2) ________ is an agreement between a buyer and a seller, in which the ________ agrees to take delivery of something at a specified price at the end of a designated period of time, and the ________ agrees to make delivery of something at a specified price at the end of a designated period of time.
A) An option contract; seller; buyer
B) An option contract; buyer; seller
C) A futures contract; seller; buyer
D) A futures contract; buyer; seller
Q3) Suppose an investor buys (takes a long position in) an S&P 500 futures contract at 1000 and sells it at 1100. What profit does this investor realize if the multiple is $200?
A) $20,000
B) $15,000
C) $10,000
D) $5,000
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Chapter 27: Options Markets
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Q1) Which of the below statements is FALSE?
A) An option is a contract in which the writer of the option grants the buyer the right, but not the obligation, to purchase from or sell to the writer something at the exercise (or strike) price within a specified period of time (until the expiration date).
B) The price paid by the option buyer is called the option price or option premium.
C) A call option grants the option buyer the right to buy something from the option writer, and a put option grants the option buyer the right to sell something to the option writer.
D) None of these
Q2) The profit and loss profile of the short call position (that is, the position of the call option writer) is the ________ the profit and loss profile of the long call position (the position of the call option buyer).
A) same as
B) the identical image of
C) mirror image of
D) All of these
Q3) Describe an outperformance option and illustrate with an example.
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Chapter 28: Pricing of Futures and Options Contracts
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Q1) Because of the assumptions required for the binomial model described above, such models may have limited applicability to the pricing of options on ________.
A) call options
B) hedge ratios
C) dividend paying securities.
D) fixed-income securities.
Q2) An option buyer can realize the value of a position taken in the option by ________.
A) exercising the option.
B) selling the option for its exercise price.
C) buying a put option.
D) selling a put option.
Q3) The actual futures price will diverge from the theoretical futures price because of interim cash flows, differences between lending and borrowing rates, transaction costs, restrictions on short selling, and uncertainty about the deliverable asset and the date it will be delivered.
A)True
B)False
Q4) What do we assume when we illustrate arbitrage strategies?
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Chapter 29: The Applications of Futures and Options
Contracts
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Q1) When a futures contract is used to hedge a position where either the portfolio or the individual financial instrument is not identical to the instrument underlying the futures, it is called cross hedging. Cross hedging is common in asset/liability and portfolio management and in hedging a corporate bond issuance. Answer the below questions.
(a) Why is cross hedging common?
(b) What does it introduce?
(c) What two factors determine the effectiveness of a cross hedge?
Q2) A protective put buying strategy can be used to reduce the risk exposure of a stock portfolio to a decline in stock prices, guaranteeing a maximum price equal to the strike price plus the cost of buying the put option.
A)True
B)False
Q3) Buying a futures contract decreases a market participant's exposure to a market; selling a futures contract decreases a market participant's exposure to a market.
A)True
B)False
Q4) Explain how a "protective put buying strategy" works.
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Chapter 30: OTC Interest Rate Derivatives: Forward Rate
Agreements, Swaps, Caps, and Floors
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Q1) Which of the below statements is FALSE?
A) In an interest rate cap and floor, the buyer pays an upfront fee, which represents the maximum amount the buyer can lose and the maximum amount the writer of the agreement can gain.
B) The seller (writer) of an interest rate cap benefits if the underlying interest rate rises above the strike rate because the buyer must compensate the buyer.
C) In essence, interest rate caps and interest rate floors contracts are equivalent to a package of interest rate options.
D) The buyer of an interest rate floor benefits if the interest rate falls below the strike rate because the seller (writer) must compensate the buyer.
Q2) What is forward start swap?
Q3) There are three general types of transactions in the secondary market for swaps. These include (1) a swap reversal, (2) a swap sale (or assignment), and (3) a swap buy-back (or close-out or cancellation). Describe a swap reversal.
Q4) Describe an interest rate cap and an interest rate floor.
Q5) What is a forward rate agreement (FRA)? Describe the elements associated with an FRA.
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Chapter 31: Market for Credit Risk Transfer Vehicles: Credit
Derivatives and Collateralized Debt Obligations
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Q1) Which of the below statements is TRUE?
A) In a credit default swap index, the credit risk of a standardized basket of reference entities is not transferred between the protection buyer and protection seller.
B) The mechanics of a credit default swap index are entirely different from that of a single-name credit default swap.
C) The parties to a credit default swap are the credit protection buyer and the credit protection seller, the latter providing protection should a credit event occur for a reference entity or pool of reference entities during the life of the contract and the former making periodic payments for the protection.
D) There are only two types of credit default swaps: single-name credit default swap and credit default swap indexes.
Q2) What can a CRT vehicle result in? Explain by commenting on the concern with the banking system.
Q3) What is credit-linked note (CLN)? Can it be complicated?
Q4) What is the most controversial credit event that may be included in a credit derivative product? When does this controversial credit event occur?
Q5) By whom and for what reasons are credit derivatives used? Give an example.
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Chapter 32: The Market for Foreign Exchange and Risk
Control Instruments
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Q1) To qualify as a participating country in the EMU requires that a country satisfy certain economic standards. Describe these standards. Have they been achieved?
Q2) The development of the swap market reduced arbitrage opportunities.
A)True
B)False
Q3) Which of the below statements is FALSE?
A) Interest rate parity provides that a borrower who hedges in the forward exchange rate market realizes the same domestic borrowing rate whether borrowing domestically or in a foreign country.
B) In deriving the theoretical forward exchange rate using the arbitrage argument, we assume the investor faces commissions or bid-ask spread when exchanging in the spot market today and at the end of the investment horizon.
C) In deriving the theoretical forward exchange rate using the arbitrage argument, we assume that the borrowing and lending rates in each currency are the same.
D) Any restrictions on foreign investing or borrowing in each country impede arbitrage and may cause a divergence between actual and theoretical forward exchange rates.
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