87. The theory that states that the yield curve reflects the market’s current expectations of future short-term rates is called the _____________.
A. Market segmentation theory
B. Liquidity premium theory
C. Unbiased expectations theory
D. Inverted forward theory


88. Which of the following statements is incorrect?
A. The over-the-counter market operates in a fixed location to conduct trades for local stocks.
B. Liquidity is the ease with which an asset can be converted into cash.
C. An initial public offering is an example of a primary market transaction.
D. Money market instruments have maturities of less than one year.


89. All of the following are secondary market transactions except ___________.
A. GE sells $30 million of new preferred stock
B. Microsoft sells $2 million of IBM preferred stock out of its marketable securities portfolio
C. The Magellan Fund buys $100 million of Apple previously issued bonds
D. All-State Insurance Co. sells $5 million in IBM bonds


90. Which of the following is not correct with respect to derivative securities?
A. They are among the riskiest of securities in the financial securities markets.
B. They can be used for hedging purposes.
C. Examples of derivatives include futures, options and swaps.
D. All of these are correct statements about derivatives.


91. Which of the following is not correct with respect to financial institutions?
A. Financial institutions channel funds from those with shortages to those with surplus funds.
B. Commercial banks, insurance companies and mutual funds are examples of financial institutions.
C. Financial institutions reduce monitoring costs and liquidity costs.
D. Financial institutions reduce price risk.


92. All of the following are factors that influence interest rates for individual securities except ________.
A. The security’s term to maturity
B. Inflation
C. Special provisions regarding the use of funds raised by a particular security issuer
D. The home mortgage rate


93. The real interest rate is _______________________.
A. The rate charged to the corporations with the best credit rating or least amount of default risk
B. The rate that a security would pay if no inflation were expected over its holding period
C. The rate that a security would pay if the security had no maturity risk
D. None of these statements is a correct definition.


94. All of the following special provisions benefit security holders except ____________.
A. Tax-free status
B. Convertibility
C. Callability
D. All of these provisions are beneficial to security holders.


95. An example of an illiquid asset is _____________________.
A. U.S. Treasury bill
B. Bonds issued by GM
C. Common stock issued by Apple Inc.
D. Common stock issued by a small but financially strong firm


96. All of the following are common shapes for the yield curve except ____________.
A. Elliptical
B. Upward-sloping
C. Flat
D. Inverted



Short Answer Questions
97. Classify the following transactions as taking place in the primary or secondary markets:

a. A company issues new common stock.
b. A company issues common stock in an IPO.
c. A shareholder sells preferred stock out of its marketable securities portfolio.
d. A mutual fund buys previously issued bonds.
e. An insurance company sells another company’s common stock.
f. A company buys another company’s stock from a mutual fund.





98. Classify the following financial instruments as money market securities or capital market securities:

a. Common Stock
b. Corporate Bonds
c. Mortgages
d. U.S. Treasury Bills
e. U.S. Treasury Notes
f. U.S. Treasury Bonds
g. State and Government Bonds





99. What is a derivative security and what determines its value?






Essay Questions
100. What shape does the term structure usually take? Why?





101. What does the “term structure of interest rates” mean?





102. Why is it useful to calculate forward rates?





103. George Washington wants to invest in one of two corporate bonds issued by separate firms. One bond yields 7% with a 10-year maturity; the other offers a 10% yield with a 9-year maturity. George thinks the 9-year bond is the better deal since the rate is higher. Is this necessarily so? Explain what factors George should consider before making a choice.





104. How do Financial Intermediaries (FIs) act as asset transformers?



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