1. The existence of financial intermediaries greatly increases the efficiency of financial markets because, without them, savers would have to provide funds directly to borrowers, which would be a much costlier process._________
2. One advantage of using common stock as a source of funds is that common stock does not legally obligate the firm to make payments to stockholders._______
3. The Federal Open Market Committee is the U.S. government agency that regulates the issuance and trading of stocks and bonds.__________
4. Under a best efforts arrangement, the investment bank purchases all of the shares from the firm and then resells the shares to the public. Under this arrangement the investment banks assumes significant risk.__________
5. One of the potential benefits of investing early for retirement is that an investor can receive greater benefits from the compounding of interest.__________
6. Discounting is the process of converting today's values, which are termed present value, to future value._________
7. The difference between an ordinary annuity and an annuity due is that each of the payments of the annuity due earns interest for one additional year (period).__________
8. During or near peaks of business activity, yield curves that are flat or downward sloping (possibly with humps) often are prevalent.__________
9. The yield curve is downward sloping, or inverted, if the long-term rates are higher than the short-term rates.________.
10. If you have information that a recession is ending, and the economy is about to enter a boom, and your firm needs to borrow money, it should probably issue long-term rather than short-term debt.__________
Short Answer (3 POINTS EACH)
1. Treasury bills, which represent debt of the U.S. government, have maturities less than one year. As a result, in which type of financial market do outstanding, or already issued, Treasury bills trade?
2. Stock sold by an insurance company to adjust its portfolio of assets, not to fund its own capital structure, would trade in which market?
3. What would a large, well-known public corporation use to save time registering and issuing securities?
4. What do the letters "IPO" stand for, AND what types of securities would be issued in this way?
5. What is the difference between (1) an underwritten arrangement and (2) a best-efforts arrangement?
6. What happens to the present value of a future amount if the interest (discount) rate increases? What type of a relationship exists between present value and interest (discount) rate?
7. Explain why the present value of an amount to be received in the future is less than the future value.
8. What is the difference between and annuity due and an ordinary or deferred annuity?
9. List the 3 theories that dictate/predict the shape of yield curves and briefly explain each.
10. a. What is implied by a normal, upward-sloping yield curve?
b. What is implied by an inverted, downward-sloping curve?
PROBLEMS (5 Points each-be sure to show your work for partial credit).
1. You plan to invest an amount of money in a five-year certificate of deposit at your bank. The stated interest rate is 12 % compounded monthly. How much must you invest if you want your investment to be worth $8,500 in 5 years?
2. Sarah is thinking about purchasing an investment from HiBond Investing. She will receive $100 every 3 months for 5 years, with the first $100 payment due as soon as she purchases the investment. If she requires a rate of return of 16%, how much should she pay for this investment?
3. If the annual rate of interest on a 2-year Treasury note is 10.5% and the rate on a 1-year Treasury note is 12%, what rate of interest should you expect on a 1-year Treasury note one year from now?
To complete your last year in business school and then go on to law school, you will need $10,000 per year for a total of 4 years, starting next year (that is, you will need to withdraw the first $10,000 one year from today). Your uncle offers to put you through school, and he will deposit in a bank paying 7% interest compounded annually a lump sum of money that is sufficient to provide the four payments of $10,000 each. His deposit will be made today.
a) How large must the deposit be?
b) How much will be in the account immediately after you make the first withdrawal?
c) How much will be in the account immediately after you make the last withdrawal? Show the value in the account before and after each withdrawal at the end of years 2, 3, and 4