Financial Markets and Institutions
Exam Review
Course Introduction
This course explores the structure, functions, and operations of financial markets and institutions within the global economy. Students will examine the role of financial markets, such as stock, bond, and money markets, in facilitating the allocation of resources and risk. The course covers the various types of financial institutions, including commercial banks, investment banks, insurance companies, and mutual funds, analyzing how they operate and interact with each other and with regulatory authorities. Key topics include interest rate determination, the impact of monetary policy, risk management, financial innovation, and the implications of financial crises. Through real-world examples and case studies, students will develop a comprehensive understanding of the complex financial system and its significance to economic stability and growth.
Recommended Textbook
Foundations of Financial Markets and Institutions 4th Edition by Frank J. Fabozzi
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32 Chapters
1746 Verified Questions
1746 Flashcards
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Chapter 1: Introduction
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Q1) Which of the below is NOT a factor that has led to the integration of financial markets?
A) A factor is liberalization of markets and the activities of market participants in key financial centers of the world.
B) A factor is deregulation of markets and the activities of market participants in key financial centers of the world.
C) A factor is technological advances for monitoring world markets, executing orders, and analyzing financial opportunities.
D) A factor is decreased institutionalization of financial markets.
Answer: D
Q2) Liquidity-generating innovations can increase the liquidity of the market, allow borrowers to draw upon new sources of funds, and permit market participants to circumvent capital constraints imposed by regulations.
A)True
B)False
Answer: True
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Chapter 2: Financial Institutions, Financial Intermediaries, and Asset Management Firms
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Q1) The costs of writing loan contracts are referred to as ________.
A) asset costs.
B) loan costs.
C) information processing costs.
D) contracting costs.
Answer: D
Q2) Depository institutions include ________.
A) commercial banks.
B) savings and loan associations.
C) savings banks and credit unions.
D) All of these.
Answer: D
Q3) Funding liquidity risk is the risk that the financial institution will be unable to obtain funding to obtain cash flow necessary to satisfy its obligations.
A)True
B)False
Answer: True
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Page 4
Chapter 3: Depository Institutions: Activities and Characteristics
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Q1) Traditionally, the only assets in which S&Ls were allowed to invest include
A) mortgages, mortgage-backed securities, and foreign enterprises
B) mortgages, mortgage-backed securities and U.S. government securities.
C) mortgage-backed securities, non-U.S. government securities and mortgages.
D) mortgages, foreign securities and U.S. government securities.
Answer: B
Q2) Because of their important role, ________ are afforded special privileges such as access to federal deposit insurance and access to a government entity that provides funds for liquidity or emergency needs..
A) NOW accounts
B) repository institutions
C) depository invitations
D) depository institutions
Answer: D
Q3) After 1981, the bulk of the liabilities of S&Ls consisted of passbook savings accounts and time deposits.
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) The money multiplier is ________ when households and banks do not deposit or lend.
A) totally unaffected
B) about the same
C) higher
D) lower
Q2) The Fed provides ________ to banks and also requires banks to hold, as ________, a portion of the deposits that the public holds at the banks..
A) reserves; loans
B) loans; reserves
C) credits; reserves
D) reserves; reserves
Q3) There is widespread agreement that the central bank should be independent of the government so that decisions of the central bank will not be influenced for long-term business purposes such as pursuing a monetary policy to expand the economy but at the expense of inflation.
A)True
B)False
Q4) Describe the four monetary aggregates.
Page 6
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Chapter 5: Monetary Policy in the United States
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Q1) In the mid 1980s, two developments of note occurred. The first was the need for the Fed, which it publicly acknowledged, to become concerned with the level and stability of the U.S. dollar's foreign currency exchange rate. What was the second development?
A) It was the shocking fall in equity prices around the world in October 1987.
B) It was the shocking increase in equity prices around the world after the fall in prices in October 1987.
C) It was the realization that nothing could be done to curb the instability in the financial markets.
D) It was the realization that nothing could be done to provide necessary liquidity.
Q2) The Fed's policy necessarily represents trade-offs among its various goals, which have different levels of relative importance at different times, depending on the state of the economy.
A)True
B)False
Q3) In the Keynesian view, the Fed's decision to reduce the fed funds rate, by increasing the banking system's excess reserves, should have certain consequences. Explain these consequences.
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Page 7
Chapter 6: Insurance Companies
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Questions
Q1) The risk insured by ________ is insurance against financial loss caused by damage, destruction, or loss to property as the result of an identifiable event that is sudden, unexpected, or unusual.
A) long-term health care companies
B) disability insurance companies
C) umbrella insurance companies
D) property and casualty insurance companies
Q2) Whereas a life insurance company provides the guarantee of a minimum dividend on its term life policies, the policies' actual dividend may increase if the investment portfolio performs well.
A)True
B)False
Q3) Insurance products can be sold to individuals or groups. Describe the groups for which insurance products are typically sold to and the products sold to these groups.
Q4) Explain the concept of a multiline company.
Q5) In 1933, Congress passed the Glass-Steagall Act. Trace the history of this act through the 20th century.
Q6) Name and briefly describe four major types of insurance.
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Chapter 7: Investment Companies and Exchange Traded Funds
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Q1) The Investment Company Institute (ICI) provides data that permit the assessment of investors to the annual expense sales including the sales charge or load.
A)True
B)False
Q2) In order to meet investor needs, mutual funds offered in the market differ by a variety of measures. Which of the below is not ONE of these?
A) asset category
B) management style
C) management segment
D) market segment
Q3) Large fund families offer economic benefits and usually include a variety of fund types such as money market funds, U.S. bond funds, global stock and bond funds, and broadly diversified and specialized U.S. stock funds.
A)True
B)False
Q4) Name three alternatives to mutual funds.
Q5) What are variable annuities?
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Chapter 8: Pension Funds
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Q1) In regards to the defined-benefit pension assets under its control, a plan sponsor chooses ________.
A) to use out-of-house staff to manage all the pension assets itself.
B) to use in-house staff to manage part of the pension assets.
C) to distribute the pension assets to one money management firm to manage.
D) to distribute the pension assets to one or more money management firms to manage.
Q2) Defined-contribution pension plans come in several legal forms: 401(k) plans, money purchase pension plans, and employee stock ownership plans (ESOPs).
A)True B)False
Q3) Describe the essence of a qualified fund.
Q4) Describe the players chosen by a plan sponsor to manage the defined-benefit pension assets.
Q5) The largest share of both defined-benefit and defined-contribution pension fund assets is invested in common stocks, often a U.S. stock index.
A)True B)False
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Chapter 9: Properties and Pricing of Financial Assets
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Q1) Approximate percentage change in a financial asset's price equals what?
A) It equals -Duration x (Yield change in decimal forms) x 100.
B) It equals [-Duration / (Yield change in decimal forms)] x 100.
C) It equals -Duration x [(Yield change in decimal forms) / 100].
D) It equals +Duration x (Yield change in decimal forms) x 100.
Q2) Assume that the market thinks the real rate is 2.00%, the inflation premium is 2.70%, the bond's default risk justifies a premium of 2.10%, the maturity premium is 0.50%, and the liquidity premium is 1.10%. Since the cash flows are denominated in euros, the foreign-exchange rate premium is 1.50%. What is the discount rate?
A) 8.90%
B) 9.70%
C) 9.90%
D) None of these
Q3) The larger an asset's coupon rate, the greater its price sensitivity to a change in the discount rate, other things being constant.
A)True
B)False
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Chapter 11: The Term Structure of Interest Rates
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Q1) Which of the below statements about the pure expectations theory is FALSE.
A) According to the pure expectations theory, the forward rates exclusively represent the expected future rates.
B) The entire term structure at a given time reflects the market's current expectations of the family of future short-term rates.
C) A rising term structure must indicate that the market expects short-term rates to rise throughout the relevant future.
D) A flat term structure reflects an expectation that future short-term rates will always be constant, while a falling term structure must reflect an expectation that future short rates will decline rapidly.
Q2) Ilmanen investigated the effect of the behavior of ________ using historical average returns on U.S. Treasury securities.
A) the bond risk premium
B) the convexity bias
C) market's expectations
D) different maturities
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Chapter 12: Risk/Return and Asset Pricing Models
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Q1) There have been two major attacks on standard portfolio theory. Which of the below is ONE of these?
A) One is the attack by the behavioral finance camp as to how consumers make decisions.
B) One is the attack on the nature of the return distribution based on what has been theoretically decreed for financial assets.
C) One is the attack on binomial distribution of returns assumed for financial assets.
D) One is the attack by the behavioral finance camp as to how investors make decisions.
Q2) The multifactor CAPM approach entails that a security's return has ________.
A) an alpha like sensitivity to each factor.
B) a riskless performance for each factor.
C) a standard deviation type performance for each factor.
D) a beta like sensitivity to each factor.
Q3) Describe the multifactor CAPM and how it extends the CAPM.
Q4) Supporters of the APT model argue that it has several major advantages over the CAPM or the multifactor CAPM. Describe two of these advantages.
Q5) Explain the concept of framing.
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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) A variation for underwriting securities is the auction process. In this method, ________.
A) the issuer announces the terms of the issue, and interested parties submit bids for part of the issue.
B) the auction form is mandated for certain securities of regulated public utilities but not for municipal debt obligations.
C) the issuer announces the terms of the issue, and interested parties submit bids for the entire issue.
D) mandated for many municipal debt obligations but not for certain securities of regulated public utilities.
Q3) The Securities Acts allow three exemptions from federal registration. Describe two of these three exemptions.
Q4) What is the waiting period? What do underwriters do during the waiting period?
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Chapter 14: Secondary Markets
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Q1) There are a variety of types of electronic trading systems for bonds. The two major types of electronic trading systems are ________.
A) the customer-to-dealer systems and the exchange systems.
B) the dealer-to-customer systems and the leverage systems.
C) the broker-to-dealer systems and the exchange systems.
D) the dealer-to-customer systems and the exchange systems.
Q2) The ________ can be viewed as the price charged by dealers for supplying immediacy together with short-run price stability (continuity or smoothness) in the presence of short-term order imbalances.
A) bid-ask fee
B) bid-ask price
C) bid-ask spread
D) bid-ask imbalance
Q3) Secondary markets hurt investors by providing liquidity.
A)True
B)False
Q4) Name and describe the two different major types of exchange systems.
Q5) What is a broker and how can a broker act on behalf of an investor.
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Chapter 15: Treasury and Agency Securities Markets
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Q1) The purpose of ________ is to facilitate adequate, dependable credit and related services to the agricultural sector of the economy.
A) Freddie Mac
B) Fannie Mae
C) the Tennessee Valley Authority
D) the Federal Farm Credit Bank System (FFCBS)
Q2) A government-chartered entity is classified as either a government-owned corporation or a government-sponsored enterprise (GSE).
A)True
B)False
Q3) Financial theory tells us that the theoretical value of a Treasury security should be equal to the present value of the cash flow where each cash flow is discounted at the appropriate theoretical spot rate.
A)True
B)False
Q4) When the Fed buys collateral for its own account, this is called a collateral system.
A)True
B)False
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Chapter 16: Municipal Securities Markets
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Q1) In a competitive process, the bidder submitting the highest bid price for the security gets the right to market the debt to investors.
A)True
B)False
Q2) In regards to the yields on municipal bonds, the yield ratio has changed over time.
The ________, the more attractive the tax-exempt feature and the ________.
A) lower the tax rate; lower the yield ratio
B) higher the tax rate; higher the yield ratio
C) higher the tax rate; lower the yield ratio
D) None of these
Q3) Tax-backed debt includes ________.
A) general obligation debt.
B) appropriation-backed obligations.
C) debt obligations supported by public credit enhancement programs.
D) All of these
Q4) What is The Bond Buyer.
Q5) A general obligation bond is secured by the issuer's limited taxing power.
A)True
B)False
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Chapter 17: Markets for Common Stock: The Basic
Characteristics
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Q1) Active investment strategies, consisting of efforts to time purchases and select stocks, are pursued by investors who believe that securities are mispriced enough that it is possible to capitalize on strategies that are designed to exploit the perceived inefficiency.
A)True
B)False
Q2) During the past 50 years, common stock holdings in the United States have become increasingly institutionalized. The major institutional holders include ________.
A) pension funds and asset management companies.
B) life insurance companies and bank trusts.
C) endowments and foundations.
D) All of these
Q3) ________ 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
Q4) Name and describe the three different forms of pricing efficiency.
Page 19
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Chapter 18: Markets for Common Stock: Structure and Organization
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Q1) The OTCBB is a regulated electronic quotation service that displays real-time quotes, last sale prices, and volume information in the OTC equity securities.
A)True
B)False
Q2) ________ permit intermediaries to provide liquidity. Intermediaries may be brokers (who are agents for the naturals); dealers or market-makers (who are principals in the trade); and specialists, as on the New York Stock Exchange (who act as both agents and principals). Dealers are independent, profit-making participants in the process.
A) A limit-driven market
B) An auction market
C) A dealer-driven market
D) A quote-driven market
Q3) Price discovery is a dynamic process that involves customer orders being translated into trades and transaction prices; however because price discovery is not instantaneous, individual participants have an incentive to "market-time" the placement of their orders.
A)True
B)False
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Chapter 19: Markets for Corporate Senior Instruments: I
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Q1) The Loan Syndications and Trading Association (LSTA) has helped foster the development of ________ for bank loans by establishing market practices and settlement and operational procedures.
A) an illiquid and opaque secondary market
B) a liquid and transparent primary market
C) an illiquid and opaque primary market
D) a liquid and transparent secondary market
Q2) Which of the below statements is FALSE?
A) Directly placed paper is sold by the issuing firm directly to investors without the help of an agent or an intermediary.
B) Dealer-placed commercial paper requires the services of an agent to sell an issuer's paper.
C) Eurocommercial paper is issued and placed outside the jurisdiction of the currency of denomination.
D) While an issuer in Europe must have unused bank credit lines, it is possible to issue commercial paper without such backing in the U.S. commercial paper market.
Q3) Describe a medium-term note. In your answer comment on its maturity and registration.
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21
Chapter 20: Markets for Corporate Senior Instruments: II
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Q1) Business risk is the risk associated with operating cash flows.
A)True
B)False
Q2) There are various types of preferred stock but fixed-rate is not one these types.
A)True
B)False
Q3) In assessing the credit risk of a corporate issuer, the rating agencies never look at the protections afforded to debt holders that are provided by covenants limiting management's discretion.
A)True
B)False
Q4) 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.
Q5) Electronic bond trading makes up about 30% of corporate bond trading. Name three major advantages of electronic trading over traditional corporate bond trading in the over-the-counter market.
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22
Chapter 21: The Markets for Bank Obligations
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Q1) The transactions in which bankers acceptances are created include the ________.
A) exporting of goods into the United State.
B) importing of goods from the United States to foreign entities.
C) storing and shipping of goods between two foreign countries where neither the importer nor the exporter is a U.S. firm.
D) None of these
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) Yankee banks are foreign banks with U.S. branches. Included in this group are non-Japanese branches of foreign banks, such as Credit Lyonnais and Deutsche Bank.
A)True
B)False
Q4) Banks in the United States can be classified into four groups. Name three of these four groups.
Q5) The yields posted on CDs vary depending on three factors. Name these three factors.
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Chapter 22: The Residential Mortgage Market
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Q1) Homeowners seldom repay all or part of their mortgage balance prior to the scheduled maturity date.
A)True
B)False
Q2) Mortgage originators can protect themselves against fallout risk by entering into an agreement with a government-sponsored enterprises (GSE) or private conduit for mandatory rather than optional delivery of the mortgage.
A)True
B)False
Q3) The principal originators of residential mortgage loans are ________.
A) thrifts, commercial banks, and the government.
B) thrifts, commercial banks, and mortgage bankers.
C) thrifts, pension funds, and mortgage bankers.
D) the secondary market, commercial banks, and mortgage bankers.
Q4) There are four main risks associated with investing in mortgages: credit risk, liquidity risk, price risk, and prepayment risk.
A)True
B)False
Q5) Can a borrower face penalties if a loan is prepaid? Discuss.
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Chapter 23: Mortgage-Backed Securities Market
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Q1) The securitization of subprime loans works by dividing pools of credit into classes, or tranches, separated by the amount of risk each class represents.
A)True
B)False
Q2) Describe "excess spread" as a from of credit enhancement.
Q3) Suppose that an investor owns a pass-through in which the remaining mortgage balance at the beginning of some month is $300 million. Assuming that the CPR is 5.00% and the scheduled principal payment is $4 million, what is the estimated prepayment for the month?
A) $1,242,789
B) $1,262,534
C) $1,273,128
D) $1,284,465
Q4) Which of the below statements is FALSE?
A) The PO security is purchased at a substantial discount from par value.
B) A PO is a security whose price would rise when interest rates decline and fall when interest rates rise.
C) In contrast to the PO investor, the IO investor wants prepayments to be slow.
D) A PO has no par value.
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Chapter 24: Market for Commercial Mortgage Loans and Commercial
Mortgage-Backed Securities
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Q1) Regardless of the property type, the two measures that have been found to be key indicators of the potential credit performance are the ________.
A) debt-to-equity leverage ratio and the loan-to-value ratio.
B) debt-to-service coverage ratio and the loan-to-value ratio.
C) debt-to-service coverage ratio and the value-to-loan ratio.
D) debt-to-equity leverage ratio and the value-to-loan ratio.
Q2) Balloon risk associated with a commercial mortgage loan is the risk that a borrower will not be able to make the balloon payment because either the borrower cannot arrange for refinancing at the balloon payment date or cannot sell the property to generate sufficient funds to pay off the balloon balance.
A)True
B)False
Q3) In a CMBS transaction, the special servicer is responsible for overseeing the deal, verifying that all servicing agreements are being maintained, and facilitating the timely payment of interest and principal.
A)True
B)False
Q4) What is a prepayment lockout?
Page 26
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Chapter 25: Market for Asset-Backed Securities
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Q1) In regards to credit card receivable-backed securities, which of the below statements is FALSE?
A) Credit card receivable-backed securities are backed by the cash flow of a pool of credit card receivables.
B) The cash flow consists of finance charges collected, fees, and principal.
C) Finance charges collected represent the periodic interest the credit card borrower is charged based on the unpaid balance after the grace period but these fees do not include late payment fees and any annual membership fees.
D) Interest to the bond classes is paid periodically (e.g., monthly, quarterly, or semiannually) and may be fixed or floating.
Q2) Securitizations require credit enhancement and the mechanism for credit enhancing a structure are classified as internal and external.
A)True
B)False
Q3) There are benefits of securitization causing no concerns about its impact.
A)True
B)False
Q4) What is the key benefit of securitization to financial markets?
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Page 27
Chapter 26: Financial Futures Markets
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Q1) Most financial futures contracts have settlement dates in the months of ________.
A) January, April, July, October
B) March, June, September, or December.
C) February, May, August, November
D) All of these
Q2) 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
Q3) A party to a futures contract cannot liquidate a position prior to the settlement date by taking an offsetting position in the same contract.
A)True
B)False
Q4) Futures contracts are leveraged instruments that can be used to control risk.
A)True
B)False
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28
Chapter 27: Options Markets
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Q1) Futures contracts allow ________.
A) investors to hedge the risks associated with favorable and known price movements.
B) market participants to lock in a price and thereby take on price risk.
C) investors to acquire the opportunity to benefit from a favorable price movement.
D) market participants to trade off the benefits of a favorable price movement for protection against an adverse price movement.
Q2) The buyer of a call option benefits if the price of the underlying is unchanged or falls.
A)True
B)False
Q3) In the case of a ________, both buyer and seller are obligated to perform.
A) call option contract
B) put option contract
C) futures contract
D) All of these
Q4) Differentiate between a call option and a put option.
Q5) Describe and summarize the meaning of the four option positions.
Q6) Describe an outperformance option and illustrate with an example.
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Page 29
Chapter 28: Pricing of Futures and Options Contracts
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Q1) You lend $2,000 at 12% per year for three months and proceed to short sell Asset XYZ for $2,000 in the cash market. You are required to pay $200 to the lender of Asset XYZ (which is the proceeds the lender would have received). You then immediately buy a futures contract at $1,850 for delivery of asset XYZ in three months (this will cover your short position). What is the net profit or loss from your strategy of lending money, short selling, and buying the futures contract?
A) $30
B) $20
C) $10
D) $0
Q2) Solving for the theoretical futures price, we get ________.
A) F = P + P(y - r).
B) F = P + P(r - y).
C) F = P - P(r + y).
D) P = F + F(r - y).
Q3) The price of an option can be separated into two parts, its extrinsic value and its risk premium.
A)True
B)False
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Chapter 29: The Applications of Futures and Options Contracts
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Q1) Give two examples of how interest rate futures can be used to hedge against adverse interest rate movements by locking in either a price or an interest rate.
Q2) Market participants can employ interest rate futures in various ways. These include
A) speculating on the movement of risk-free rates.
B) controlling the interest rate risk of a bond.
C) hedging against known interest rate movements.
D) enhancing returns when futures are mispriced.
Q3) The purchase of a call option can be used to guarantee that the maximum price that will be paid in the future is the strike price plus the option price.
A)True
B)False
Q4) An investor who wants to speculate that interest rates will rise (fall) can sell (buy)
A) interest rate futures.
B) stock index futures.
C) bond index futures.
D) interest rate movements.
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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 TRUE?
A) Vanilla or generic swaps have evolved as a result of the asset / liability needs of borrowers and lenders.
B) A nonamortizing swap is one in which the notional principal amount decreases in a predetermined way over the life of the swap.
C) An amortizing swap is one in which the notional principal amount increases at a predetermined way over time.
D) In a generic or plain vanilla swap, the notional principal amount does not vary over the life of the swap.
Q2) A position in an interest rate swap can be interpreted as a position in a package of forward contracts but not in a package of cash flows from buying and selling cash market instruments.
A)True
B)False
Q3) Describe an interest rate cap and an interest rate floor.
Q4) There are two types of swaptions - a payer swaption and a receiver swaption. Describe each of these two types of swaptions.
Q5) Illustrate an interest rate / equity swap.
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Chapter 31: Market for Credit Risk Transfer Vehicles: Credit
Derivatives and Collateralized Debt Obligations
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Q1) Portfolio managers can have a dealer create a ________ equal to the maturity of the reference obligation or have it constructed for a shorter time period to match the manager's investment horizon.
A) tutor
B) tenor
C) maturity
D) length
Q2) Credit default swaps ________.
A) are used to shift credit exposure to a credit protection seller.
B) have a secondary purpose to hedge the credit exposure to a particular asset or issuer.
C) have one reference obligation called a single-name credit default swap.
D) are referred to as a basket credit default swap when there is a single reference entity.
Q3) Arbitrage transactions can be divided into two types depending on the primary source of the proceeds from the collateral to satisfy the obligation to the tranches.
Describe these two types.
Q4) What is the most controversial credit event that may be included in a credit derivative product? When does this controversial credit event occur?
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Chapter 32: The Market for Foreign Exchange and Risk
Control Instruments
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Q1) To derive the theoretical forward exchange rate using the arbitrage argument, we made several assumptions. When the assumptions are violated, the actual forward exchange rate may deviate from the theoretical forward exchange rate. Describe two of these assumptions.
Q2) Foreign-exchange risk ________.
A) is the risk that a currency's value may change adversely.
B) is an unimportant consideration for all participants in the international financial markets.
C) cannot affect an international investor's return after adjusting for changes in the exchange rate.
D) cannot affect issues denominated in a foreign currency (e.g., in terms of the effective value of the cash payments owed to investors).
Q3) From the perspective of a U.S. investor, the cash flows of assets denominated in a foreign currency offer the investor to certainty as to the actual level of the cash flow measured in U.S. dollars.
A)True
B)False
Q4) What is the spot (or cash) exchange rate market? Are exchange rates free to float?
Page 34
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