FINA441, Study Guide, Test 1, Mid-Term Exam, Chapters 2-15
The mid-term exam will consist of two parts.
 The first part of the exam will be closed-book and will cover the subject material on the
study guide below. This part of the exam should take no more than one-hour. Expect a
mixture of objective questions (e.g. T/F, MC) and short answers. No cheat sheets are
allowed.
 The second part of the test will be open-book, open-note and will also take about one
hour. You may use your laptops or go to the computer lab. Expect objective questions
similar to those on the group quizzes. Also expect questions over anything we have
covered so far this quarter (in the textbook or out of the textbook). Doing your
assignments, paying attention in class and reading your chapters are prerequisites for
doing well on this part.
Both parts of the test should be completed within the two-hour period, so if you take too long on
the closed-book portion, there will be little time left for the open-book portion.
What follows are questions/topics that you should be able to answer for the closed-book portion.
Answer to the questions can be found in the text, from your assignments, or from notes available
on the course webpage.
Chapter 2
1.
Why charge interest? How to Christians and Muslims feel about interest? Some central
banks have created negative short-term rates. Why?
2.
What causes interest rates to change? How would each of the following affect interest
rates: Increase in economic growth? Expected increase in inflation? Federal Reserve
increases money supply? Increase in the federal budget deficit? Increase in foreign
supply of funds?
3.
What causes inflation? How is it measured? How is the annual inflation rate
calculated? Why do investors hate inflation? Why do borrowers love inflation? Why is
real return more relevant than nominal return to a fixed-income investor? Is the current
real return on most bank accounts positive or negative? What is the Fisher Effect? Be
able to calculate real returns using the exact and the approximate formulas?
Chapter 3
4.
How do debt and equity securities differ in terms of cash flow timing and risks?
5.
What are the differences between the four types of Treasury Securities (bills, notes,
bonds, and TIPS) in terms of features and risks? (See also Ch. 6&7). Which of these
types of Treasury securities is used the most for Federal borrowing?
6.
What is the approximate level of the gross US debt? How does debt compare to the
annual GDP?
7.
Be able to intelligently discuss risk and return. Know which types of investments carry
which types of risks. In other words, review the assignment questions over Ch. 3
covering the following risks: default (or credit) risk, liquidity risk (or marketability) risk,
taxability risk, call (or prepayment) risk, interest-rate (or maturity) risk, and inflation risk.
Questions you should be able to answer include:
Why is a T-Bill considered to be the most risk-free investment? What risks does it not
have and why? What type of risk does a T-note have that a TIPS does not have? What
type of risk does a T-bond have that T-bill does not have? What type(s) of risk does a
corporate bond have that T-bond doesn’t have? What types of risks do penny stocks have
that large-company stocks do not have? What type of risk would a T-bond have that a
municipal bond would not have? What type of risk would a municipal bond have that Tbond would not have? Would a 30-year corporate bond rated B have a greater or smaller
return than a corporate bond rated A? Why? Would a 1-year CD offer a higher or lower
interest rate than a 6-month CD? Why? Would bonds with call features have a higher or
lower interest rate than similar bonds without call features? Why? Would convertible
bonds have a higher or lower interest rate than similar non-convertible bonds? Why?
8.
Be able to intelligently explain the shape of a normal Treasury yield curve (term structure
of interest rates). What is the shape of the yield curve during periods of expected normal
growth and inflation? Why is it shaped that way? (e.g. what two risks cause T-bonds to
offer higher rates than T-bills?) What is the shape of the curve during economic
expansion following a recession? What has been the shape in periods preceding an
economic recession? What is its current shape?
Chapter 4
7.
In what year was the current Federal Reserve system put into place? Why then?
8.
Who owns the Fed?
9.
How many Fed districts are there? Why is our district, the 12th district, so geographically
large? What do the Fed District Banks do?
10.
Who appoints the Fed Governors? How long do they serve? Who is the current and
most recent chair? How is the Fed insulated from political pressures? Why is Fed
independence important? Why might the Fed and the President disagree about monetary
policy?
11.
What are the three traditional monetary policy tools available to the Fed. Which one is
the most powerful? Which one is used the most? The least?
12.
Why do reserve requirements exist? What is the approximate reserve requirement
percentage for large banks? From what two sources can banks get extra reserves in order
to meet their weekly reserve requirements?
13.
How does the money multiplier effect work? What is the formula? What factors might
limit the multiplier effect?
14.
What is the Fed’s discount window? How does the Fed discourage borrowing from the
discount window?
15.
What specific interest rate does the FOMC target? Why does the FOMC only prepare a
target range for this rate? What specific actions would the FOMC take to increase this
rate? Decrease it?
16.
Regarding the Federal Funds rate and the Discount Rate (Primary Credit Rate), over
which of these does the Fed have direct control? Indirect control? What does it mean
when the financial press reports that the Fed Funds Rate is a benchmark rate? Are
movements in the Fed Funds and Discount Rates usually correlated?
17.
What are three measures of the money supply? Why is M1 more volatile than M2?
18.
If the economy is growing too fast, what is the Fed primarily concerned about and what
options does the Fed have to slow it down (at least 4 options)? What does it mean when
we say the Fed’s job is to take the punch bowl away just as the party is getting good?
If the economy is growing too slowly (or not at all), what is the Fed concerned about and
what options does the Fed have to speed it up (at least 4 options)?
19.
What action (or inaction) did the Fed take at its last FOMC meeting? What does QE
stand for and what is the objective? Why has it been criticized?
Chapter 5
20.
In the last few decades, has the Fed followed mostly a Keynesian or a Monetarist policy?
What is the difference between the two?
21.
What are the three main goals of Fed monetary policy? Which goals can be achieved
simultaneously and which cannot? Which goals do the executive and legislative branches
of government (elected branches) favor the most? Which goal does the Fed favor the
most (according to Monetarists)?
22.
What’s the basic premise of the Phillips Curve?
23.
One difficulty the Fed faces is lags. What are three thee lags in the effectiveness of
monetary policy?
24.
What is monetizing the debt? What is good about it and what is bad?
25.
Critics of the Fed claim that it is a grand counterfeiting racket, controlled by private
banks. How would you respond?
Chapter 6
26.
How are money market securities defined?
27.
What purpose do they serve to investors? To borrowers?
28.
Be able to identify the unique advantages/disadvantages/risks of each of the following
money market securities: T-Bills, commercial paper, negotiable certificates of deposit,
repurchase agreements, and banker’s acceptances.
29.
In the Fall/08, why did T-Bill yields go to below zero? Why did commercial paper rates
skyrocket and then in a few weeks come back down (steeple shaped)?
30.
In the Fall/08, some MM Mutual Funds (such as Reserve Primary) “broke the buck.”
What does this mean and why did it occur?
Chapter 7/8
31.
If an organization needs to borrow lots of money, why does it go to the bond market
instead of its local bank?
32.
If an organization needs long-term financing, why does it usually prefer to sell bonds
rather than stock?
33.
Why do fixed-rate bond prices move in opposite directions to interest rates?
34.
Would callable bonds usually offer a slightly higher or lower interest rate? Why?
35.
Would a bond rated BBB have a higher or lower interest rate than a bond rated AAA?
Why?
36.
What are junk bonds?
37.
Why do bond prices move inversely to interest rates? (Did I ask that question already? I
did? Hmm.)
38.
Which are more price-sensitive to a given change in interest rates: Short-term or longterm bonds? Low-coupon or high-coupon bonds? If interest rates are expected to
increase, which would a bond investor prefer to hold: short-term or long-term bonds?
Low-coupon or high-coupon bonds? Why?
Chapter 9
39.
What risks does a banker face who invests in L/T fixed-rate mortgages and borrows from
short-term variable-rate demand deposits? (See quiz completed in class regarding Walla
Walla Community Bank). Be able to identify the types of risks faced by a bank and a
couple possible actions to limit each of the following:
Risk that interest rates will increase and cause a net loss.
Risk that interest rates will decrease and good-paying mortgages will be prepaid early.
Risk that depositors want to withdraw all of their money at once.
Risk that a borrower may default on the mortgage payments.
40.
How would interest rates on each of the following usually compare/rank: 30-year fixedrate mortgage, 15-year fixed-rate mortgage, and adjustable rate mortgage? Why?
41.
What are three separate activities in the mortgage market? Are these activities usually
done within one type of institution or are they often spread over several types of
institutions? For example, would it be unusual for a bank to invest in mortgages, which
are originated by a mortgage company, and serviced by a third company?
42.
What do the following organizations do and how do they differ: Ginnie Mae? Fannie
Mae? Freddie Mac?
43.
Regarding the sub-prime mortgage crisis, what were the main causes (who can we blame
and why)?
Chapters 10
44.
What is the difference between venture capital and private equity? What is crowd
funding?
45.
For what reasons would a company choose to “go public” through an IPO?
46.
What are the main steps in the IPO process? Make sure to check the instructor notes on
this topic, which provide more detail than the text.
47.
How well do initial investors who flip their shares the first day typically perform in an
IPO? Are IPO investors predominantly institutional or individual? Why? How does the
typical long-term performance of an IPO compare with the short-term performance?
48.
Be able to distinguish among the Wilshire 5000, S&P500, and DJIA and what they each
represent. What are the weaknesses of the DJIA?
49.
How does an OTC market differ from an organized exchange? How does the NYSE
differ from the NASDAQ? What stock market options are there for small public
companies with low-priced shares (penny stocks)?
Chapter 12
50.
What is a margin account? Why does the Federal Reserve set initial margin requirements
and not the SEC? What is the required initial margin percentage? What is the required
maintenance margin? What is a margin call? How does margin affect gain/loss
percentages, compared to buying stock without margin?
51.
What is a short sale and how does it work? What does an increase in the short-interest
ratio indicate? What does “days-to-cover” mean?
52.
What are the advantages of an index mutual fund over a managed fund? What are the
advantages of an ETF over an index mutual fund? Disadvantages? What is one common
example of an ETF?
53.
What do NYSE marker-makers/specialists do? How are they similar to Nasdaq dealers?
54.
What is program or high-frequency trading? Is it good or bad, in your opinion? Why?
55.
What is the purpose of circuit breakers and trading halts?
56.
What did Regulation FD attempt to correct?
57.
What is an ADR?
Chapter 13-15
58.
Be able to discuss intelligently at least two famous cases of how derivative securities
were used to wildly speculate.
59.
Be able to discuss intelligently how derivative securities can be used to hedge risks and to
discuss examples in several different industries.
60.
How do futures, forwards, and options differ from each other?
61.
What are credit default swaps, how were they used to speculate in mortgage-backed
securities, and what was the result?
62.
Would bond investors buy or sell Treasury futures if they expected interest rates to
increase (and thus bond prices to decrease)? Why? [Answer: anytime you expect the
price of asset to decrease, you want to be a short position on your futures, which means
you will sell Treasury futures now, and then buy them back a lower price.]
Would bond investors buy or sell Treasury call options if they expected interest rates to
increase (and thus bond prices to decrease)? Why? [Answer: sell]
Would bond investors buy or sell Treasury put options if they expected interest rates to
increase (and thus bond prices to decrease)? Why? [Answer: buy]
63.
Why would a mutual fund, pension fund, or insurance company who holds stock
investments consider selling stock index futures or purchasing put options?
64.
How do put and call options differ?
Suppose you thought a stock price was going to decrease. Would you rather purchase a
put or call option on that stock? Would you rather sell a put or call option on that stock?