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Explain why banks, which would seem to have a comparative advantage in gathering information, have not eliminated the need for the money markets. What are three characteristics of money market securities? Do money market rates usually move together over time? Why or why not? Why would an investor use money market securities instead of putting their money in the stock market, bond market, or a bank? A borrower?

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Irving Heathcote
Irving HeathcoteLv2
28 Sep 2019

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3.) Explain why banks, which would seem to have a comparative advantage in gathering information, have not eliminated the need for the money markets. What are three characteristics of money market securities? Do money market rates usually move together over time? Why or why not? Why would an investor use money market securities instead of putting their money in the stock market, bond market, or a bank? A borrower?

4.) How have mortgages changed over the last 200 years? Why has online lending become more popular over the last decade, and what are the main advantages and disadvantages? Why do banks typically sell mortgages to other investors? How do banks profit off selling loans if they are immediately sold to another investor? Explain why mortgages are bundled before they are sold to investors.

Mortgage markets have developed significantly since the early 1970s through the creation of secondary market instruments in the form of mortgage pass-throughs, collateralized mortgage obligations (CMOs), and REMICs. These collectively have been generally referred to as mortgage backed securities (MBS). In many ways, these instruments carry the characteristics of their underlying assets -- individual mortgages.

a. Why is the cash flow of a mortgage, or a MBS, uncertain in the sense that the investor in the mortgage has granted the borrower a call option to prepay the mortgage? Compare a mortgage cash flow with a Treasury coupon bearing bond paying interest semi-annually and a payment of principal at maturity.

b. What does this call option depend upon and why?

c. The cash flow for a mortgage pass-through typically is based on some prepayment speed benchmark. Why is the assumed prepayment speed necessary to price the MBS?

d. Suppose a bank has decided to invest in a MBS and is considering the following two securities: a Freddie Mac pass-through with a WAM of 340 months and an average life of 7 years or a PAC tranche of a Freddie Mac CMO issue with an average life of 2 years. In terms of prepayment risk, contraction risk and extension risk, which MBS would probably be best for the bank’s asset/liability management perspective when it is known that liabilities generally have a duration less than 1 year and that assets have durations in the 2-year to 7-year range?

1. Different financial institutions have different levels of service. What is the main reason for this?

a. The Federal regulations relating to the institutions make them provide the services at different levels.

b. Levels of financial service are determined in part by the ownership structure of the financial institution, and different financial institutions have different ownership structures.

c. Financial services require specific expertise and the design of financial institutions favors one type of institution over the other.

d. None of these explain the difference between levels of service at different institutions.

2. Which of the following is not an example of a financial intermediary?

a. Savings and Loans.

b. Commercial banks.

c. Pension funds.

d. Stock markets.

e. All of these are examples of financial intermediaries.

3. Which of the following branches of the Federal Reserve Bank has a permanent seat on the Federal Open Market Committee?

a. New York

b. Cleveland

c. St. Louis

d. Boston

e. None of these.

4. Who owns the Federal Reserve Banking system?

a. No one, it owns itself.

b. The member banks.

c. The US Government.

d. The Chinese Government.

e. The shareholders of the Federal Reserve Corporation.

5. Who is the most important member of the Federal Open Market Committee and often thought of as the second most powerful person in the United States?

a. The President of the United States

b. The Treasury Secretary.

c. The Chairman of the Federal Reserve Bank.

d. The President of the Federal Reserve Bank of New York.

e. None of these.

6. Which of the following markets is the most stable?

a. The market for corporate bonds.

b. The real estate market.

c. The market for Treasury bonds.

d. The New York Stock Exchange.

e. The Chicago Mercantile Exchange.

7. All of the following show interactions between markets except:

a. Purchase of a mortgage issued by Freddie Mac by the Federal Reserve Bank.

b. Sale of stock to raise equity for a new company to an insurance provider.

c. Increase in short term target rates by the Fed on the bond market resulting in stock market increases when announced in the press.

d. Restrictions in bank lending as the result of increasing capital requirements resulting in lower real estate prices and fewer sales on the real estate market.

e. All of these are examples of market interactions.

8. Which of the following acts was repealed by the Gramm-Leach-Bliley Act of 1999:

a. The Depository Institutions Deregulation and Monetary Control Act of 1980.

b. The Banking Act of 1933.

c. The Garn-St Germain Depositary Institutions Act of 1982.

d. The Civil Rights Act of 1964

e. None of these.

9. Which of the following problems was a reason for bank panics prior to the establishment of the Federal Reserve bank:

a. Currency was not uniform in value.

b. Currency was not backed by the full faith and credit of the United States Government.

c. Currency could become worthless if the issuing bank went bankrupt.

d. Lack of regulation of the financial markets often led to bank runs.

e. All of these were elements of the bank panics that occurred prior to the establishment of the Federal Reserve system.

10. Why is the Federal Reserve Bank considered to be relatively but not completely free of political influence in the United States?

a. The Federal Reserve Chairman must be appointed by the President and confirmed by the Senate.

b. The Federal Reserve is not owned by the US Government.

c. The Federal Reserve System is designed to divide power among member banks from different regions of the country.

d. The Federal Reserve appointments are for sufficient length of time that it takes at least 8 years for a majority of members to be appointed by one President.

e. All of these are important in defining the degree of independence of the Federal Reserve from political influence.

11. Which of the following examples is an illustration of interest rate risk?

a. A consumer buys a house with a fixed mortgage that will not change for 30 years.

b. A consumer buys a car with a fixed rate loan at 5.99% for five years.

c. A bank borrows funds from the Federal Reserve discount window for 0.25% and lends that money to a consumer for a car or auto loan of longer duration.

d. A consumer opens a passbook savings account.

e. None of these illustrate interest rate risk

12. If the yield curve is said to be steep, this means:

a. Banks will make a lot of money lending at long term rates that are higher than the short term rates at which they borrow money.

b. The bond market expects inflation to increase in the future.

c. The bond market expects that the economy will grow in the immediate future.

d. None of these are conclusions that can be reached from a steep yield curve.

e. a, b and c are all conclusions that can be reached when the yield curve is steep.

13. According to the expectations theory of interest rates:

a. The total interest rate is equal to the sum of the real interest rate and the expected inflation rate.

b. The total interest rate is equal to the sum of the real interest rate, the expected inflation rate, and a series of additional premiums based on the risks taken in the instrument of interest.

c. The Fed sets interest rates, which cannot be changed by the market.

d. The interest rate in the economy is a balance between the supply and demand of funds.

e. None of these are true.

14. If the real interest rate in the economy is 3% and the expected inflation is 2% per year over a five year period, assuming the maturity risk premium is 0, what is the interest rate that the expectations theory would predict for a five year Treasury note?

a. 10%

b. 3%

c. 2%

d. 6%

e. 5%

15. What is the most important economic function of the money markets?

a. To provide an efficient means of liquidity adjustment for businesses, individuals and governments.

b. To provide a place where buyers and sellers can negotiate a price of funds.

c. To provide a social interaction between borrowers and sellers of funds, allowing for easier relationship-based transactions in the future.

d. To provide a place where stocks and bonds can be sold.

e. None of these are important economic functions of the money markets.

16. The ideal instrument sold in a money market has all of the following characteristics except:

a. High liquidity

b. Low Default Risk

c. Are long term obligations

d. Are short term obligations

e. None of these are characteristics of an ideal money market instrument.

17. What is the reason for the 35% rule in the bid process for Treasury securities?

a. It prevents a single entity from controlling the interest rate in the market.

b. It allows regular consumers access to the treasury market through non-competitive bids.

c. It prevents the government from controlling and regulating banks.

d. It prevents the Chinese from buying too many treasury bills.

e. None of these are reasons for the establishment of the 35% rule.

18. What is the name for the risk that a financial institution might not receive promised cash flows in the form of interest and principal payments from its borrowers?

a. Interest Rate Risk

b. Financial Payment and Principal Risk

c. Market Risk

d. Credit Risk

e. None of these are the correct term.

19. The risk that a financial institution might have to sell a lot of assets in a short period of time at below market prices to pay obligations demanded by its creditors is called:

a. Liquidity Risk

b. Market Risk

c. Credit Risk

d. Interest Rate Risk

e. None of these

20. What is the main difference between firm-specific and systemic credit risk?

a. Firm specific risk can be managed by proper underwriting and diversification in a loan portfolio.

b. Systemic risk affects all borrowers.

c. Firm-specific risk is determined by the individual circumstances of the firm involved.

d. Derivitives can be used to manage systemic risk

e. The Federal Reserve Bank of New York uses open market operations to manage firm-specific risk.

21. A credit crisis in the financial markets can improve bank efficiency by:

a. Focusing the bank underwriting department on firm-specific risk factors associated with default.

b. Forcing banks to reduce staffing needs by eliminating wasteful or unnecessary functions.

c. Marking banks compete more rigorously for customers in a tougher market.

d. None of these are reasons that a recession helps improve bank efficiency.

e. Items a, b and c are all reasons that a bank improves efficiency during a recession.

22. A mutual fund that invests only in Treasury funds has which of the following risk exposures?

a. Interest Rate Risk

b. Liquidity Risk

c. Default Risk

d. Treasury’s are risk free, so a mutual fund that invests in them is also risk free.

e. Credit risk

23. Foreign Stocks carry additional risks beyond those of US companies for US investors. Which of the following risks is not an additional risk that a US investor in foreign stocks faces?

a. Interest Rate Risk

b. Foreign Currency Risk

c. Sovereignty Risk

d. Both a and b are additional risks faced by these investors.

e. All of these risks (a, b and c) are faced by investors in domestic and foreign stocks.

24. According to the theory of Purchasing Power Parity, if the price of a widget in the US is $3.00 and the Euro is worth $1.50, the price of the widget in Germany would be:

a. €5.00

b. €3.00

c. €4.50

d. €7.00

e. €10.00

25. For many years, the current account of the United States has been in deep deficit. In theory, this should lead to a weak dollar. What factors could counteract the effect of the current account deficit on the strength of the dollar?

a. Foreigners use dollars as stores of value

b. When inflation is expected to be low in the USA and interest rates are high, foreigners want to invest here, driving up the price of the dollar.

c. The Dollar is king in the world currency markets

d. Dollars are backed by the full faith and credit of the US Government and therefore maintain a constant value on the market.

e. None of these explains the relative strength of the dollar in the global currency market.

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