Final Exam Part 1

The price of a consol can be calculated using the formula Price = Coupon / Interest Rate. In this case, the coupon is $50 and the interest rate is 6%. Therefore, the price of the consol is $50 / 0.06 = $833.33.

A bond with a face value of $1000 and a coupon rate of 4.25% means that the bond owner will receive an annual coupon payment equal to 4.25% of the face value. Therefore, the annual coupon payment will be $1000 * 0.0425 = $42.50.

Credit cards are not considered one of the six parts of the financial system because they are not an essential component of the infrastructure that facilitates the functioning of the financial system. The six parts of the financial system typically include financial markets, central banks, financial institutions, regulatory bodies, payment systems, and financial instruments. While credit cards are a widely used financial tool, they are not a fundamental part of the financial system's structure and operations.

The statement "risk requires compensation" suggests that people will only be willing to take risks if they are rewarded for doing so. This implies that individuals are motivated by incentives and are more likely to engage in risky behavior if they perceive a benefit or gain from it. It indicates that people are not likely to take risks without some form of compensation or reward, highlighting the importance of incentives in decision-making processes related to risk-taking.

Insurance companies are not considered depository institutions because they do not accept deposits from customers. Depository institutions are financial institutions that accept and hold deposits from individuals and businesses, such as commercial banks, credit unions, and savings banks. Insurance companies, on the other hand, provide insurance coverage and manage risk for their policyholders, but they do not offer deposit-taking services.

When the price level increases, the purchasing power of money decreases. This is because as prices rise, the same amount of money can buy fewer goods and services. In other words, the value of money decreases as the price level increases. Therefore, individuals have less buying power and their money is able to purchase less than before.

Investing in financial instruments in today's economy is made easier by the use of mutual funds. Mutual funds allow individuals to pool their money together with other investors, which provides them with access to a diversified portfolio of stocks, bonds, and other securities. This allows investors to achieve greater diversification and potentially higher returns compared to investing in individual securities. Additionally, mutual funds are managed by professional fund managers who make investment decisions on behalf of the investors, which can alleviate the need for individual investors to actively manage their investments.

A society without any money would have to rely strictly on barter. This means that individuals would have to directly exchange goods and services with each other, without the use of a medium of exchange like money. In such a society, people would need to negotiate and agree on the value of the items being exchanged, which could be time-consuming and inefficient compared to using a standardized currency. However, it would also encourage self-sufficiency as individuals would be motivated to produce everything they need themselves, since they cannot rely on purchasing goods or services with money.

The introduction of money market substitutes for basic checking accounts was fueled partially by the relatively high rates of inflation that existed in the late 1970s and early 1980s. This is because during periods of high inflation, the value of money decreases over time. As a result, individuals and businesses may seek alternative financial instruments, such as money market substitutes, that offer higher interest rates and can help protect against the eroding value of money.

Information asymmetry refers to a situation where one party in a transaction has more information or knowledge than the other party. In this case, the borrower has information that it is not sharing with the lender, creating an imbalance of information between the two parties. This can be problematic for the lender as they may not have a complete understanding of the borrower's financial situation or ability to repay the loan, leading to potential risks and uncertainties. Therefore, the correct answer is information asymmetry.

The bond rating of a security reflects the likelihood that the lender/borrower will be repaid by the borrower/issuer. Bond ratings are assigned by credit rating agencies and indicate the creditworthiness of a bond issuer. A higher bond rating suggests a lower risk of default, meaning that the borrower/issuer is more likely to repay the lender/borrower. This information is important for investors as it helps them assess the risk associated with investing in a particular bond and make informed investment decisions.

A car insurance policy is not considered a financial instrument used primarily as a store of value because it is an insurance contract that provides coverage for potential damages or losses related to a car. Unlike the other options listed, a car insurance policy does not hold or generate value over time, but rather provides protection against potential financial losses.

A pure discount bond is also known as a zero-coupon bond because it does not pay any periodic interest or coupon payments. Instead, it is issued at a discount to its face value and the investor receives the full face value of the bond at maturity. This type of bond is attractive to investors who are looking for a fixed return at a future date without the need for regular interest payments.

The unit of account characteristic of money means that all prices are expressed in terms of money. This implies that money serves as a common measure or unit for comparing the value of different goods and services. It provides a standardized way to express the worth or cost of items, making it easier to compare and evaluate the relative prices of goods and services in the economy.

The given correct answer is "Stability creates risk." This statement contradicts the core principles of money and banking because stability is usually seen as a desirable outcome in the financial system, not something that creates risk. The other options - risk requires compensation, time has value, and information is the basis for decisions - align with the core principles of money and banking as they reflect the fundamental concepts and considerations in financial decision-making and management.

When an individual obtains a car loan and makes all of the regular monthly payments, the sum of the payments made will exceed the purchase price of the car. This is because time has value. Over time, the individual will be paying interest on the loan, which adds to the overall cost of the car. The longer it takes to pay off the loan, the more interest will accumulate, resulting in a higher total payment than the initial purchase price. Therefore, the concept of time having value explains why the sum of the payments made will exceed the purchase price of the car.

Financial markets serve various roles, including providing liquidity, pooling and communicating information, and sharing risk. However, they do not eliminate risk. In fact, financial markets involve various types of risks, such as market risk, credit risk, and liquidity risk. These risks are inherent in any investment or financial transaction. Financial markets provide mechanisms and tools to manage and mitigate these risks, but they cannot completely eliminate them. Therefore, eliminating risk is not a role served by financial markets.

M2 is a measure of the money supply that includes M1 (currency in circulation, demand deposits, and traveler's checks) along with other types of deposits such as savings deposits and large denomination time deposits. It also includes certain types of financial assets like stock and bond mutual fund shares. However, it does not include money market deposit accounts. Therefore, M2 encompasses a broader range of financial instruments and is a more comprehensive measure of the money supply than M1.

Financial instruments refer to various types of contracts or agreements that represent a financial asset. These instruments can be used to transfer both resources and risk between individuals or entities. They enable the transfer of resources such as money, securities, or commodities, as well as the transfer of risk associated with these assets. Therefore, the statement "Financial instruments can transfer resources and risk between people" accurately describes the nature and purpose of financial instruments.

A derivative instrument gets its value and payoff from the performance of the underlying instrument. This means that the value of the derivative is derived from the price movements of the underlying asset or instrument. Derivatives can be used for various purposes such as hedging against price fluctuations, speculating on future price movements, or gaining exposure to certain markets or assets without directly owning them. The value of a derivative instrument is directly linked to the performance of the underlying instrument, making it a useful tool for investors and traders to manage risk and potentially generate profits.

The risk premium for a bond is the additional return that investors demand for taking on the risk of investing in that bond compared to a risk-free investment, such as a government bond. In this case, the risk premium can be calculated by subtracting the current return on one-year, zero-coupon U.S. government bonds (3.5%) from the yield on the Fly-By-Night bonds, which is implied by their selling price. The implied yield can be calculated by dividing the difference between the face value ($100) and the selling price ($92) by the face value and then converting it to a percentage. The risk premium is therefore 5.2%.

The coupon rate for a coupon bond is equal to the annual coupon payment divided by the face value of the bond. This is because the coupon rate represents the annual interest payment as a percentage of the bond's face value. It is a fixed percentage that is determined at the time of issuance and remains constant throughout the life of the bond. The face value of the bond is the amount that will be paid back to the bondholder at maturity, and the annual coupon payment is the periodic interest payment made by the issuer to the bondholder. Therefore, dividing the annual coupon payment by the face value of the bond gives the coupon rate.

A 30-year bond issued by the U.S. Treasury would be most likely to earn an AAA rating from Standard & Poor's because the U.S. Treasury is considered to have the highest creditworthiness and lowest risk of default. The U.S. government has a long history of meeting its financial obligations and is backed by the full faith and credit of the country. This makes its bonds highly secure and attractive to investors, resulting in a AAA rating.

The borrower earns a total of $75 in interest on a $1000 loan, which is a nominal interest rate of 7.5% ($75/$1000). The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate. In this case, the inflation rate is 2%, so the real interest rate is 5.5% (7.5% - 2%). Therefore, the correct answer is a nominal rate of 7.5% and a real rate of 5.5%.

Money as a means of payments refers to anything that is generally accepted as payment for goods and services. This includes not only actual currency and coins, but also credit cards and any other form of payment that is widely accepted.

Financial instruments can allow for the transfer of risk, which sets them apart from money. While money serves as a medium of exchange and a unit of account, it does not possess the capability to transfer risk. Financial instruments, on the other hand, enable individuals or entities to transfer or manage risk through various mechanisms such as insurance, derivatives, or hedging strategies. This ability to mitigate risk is a distinguishing characteristic of financial instruments that differentiates them from money.

Tom borrowed $5000.00 from ABC Bank and repaid $5400.00 at the end of the year. The difference between the amount repaid and the amount borrowed is $5400.00 - $5000.00 = $400.00. This $400.00 represents the interest that Tom paid on the loan. To find the interest rate, we divide the interest amount by the principal amount borrowed and multiply by 100. So, the interest rate is ($400.00 / $5000.00) * 100 = 8.00%.

The present value of $200 promised two years from now at 5% annual interest can be calculated using the formula for present value of a future sum of money. The formula is PV = FV / (1 + r)^n, where PV is the present value, FV is the future value, r is the interest rate, and n is the number of years. Plugging in the values, we get PV = $200 / (1 + 0.05)^2 = $200 / (1.05)^2 = $200 / 1.1025 = $181.41. Therefore, the correct answer is $181.41.

The given correct answer states that the more valuable is the promise to make the payment when it is made sooner. This is because time is valuable in the context of financial instruments. When the promised payment is made sooner, it indicates a higher level of reliability and trustworthiness, which increases the value of the promise. Therefore, the sooner the payment is made, the more valuable the promise becomes.

The one-year holding period return is calculated by taking the change in price of the bond ($1,100 - $1,200 = -$100) and adding the coupon payment ($50). Then, this total return ($-100 + $50 = -$50) is divided by the initial price of the bond ($1,200). Finally, multiplying this result by 100 gives the percentage return. In this case, the one-year holding period return is -4.17%.

If the interest rate is zero, it means that there is no opportunity cost for holding money over time. In this case, a promise to receive a $100 payment one year from now is equal in value to receiving $100 today because there is no advantage or disadvantage in waiting to receive the payment. Therefore, the value of the promise is the same as the value of the immediate payment.

Yield to maturity is the total return anticipated on a bond if it is held until it matures. It takes into account the bond's current market price, its face value, the coupon rate, and the time remaining until maturity. If a bond is purchased for face value and held until maturity, the yield to maturity will be the same as the coupon rate. This is because the investor will receive the coupon payments as well as the face value of the bond at maturity, resulting in a total return equal to the coupon rate.

Money does not need to have intrinsic value to be considered as money. Intrinsic value refers to the inherent value of an object, independent of any monetary or economic value. However, money's value is derived from its acceptance as a medium of exchange and its ability to facilitate transactions. Therefore, the absence of intrinsic value does not prevent something from being considered as money.

Farou invests $2,000 at 8% interest. To find out how long it will take for his investment to double, we can use the rule of 72. The rule of 72 states that you can estimate the time it takes for an investment to double by dividing 72 by the interest rate. In this case, 72 divided by 8 gives us 9. Therefore, it will take approximately 9 years for Farou to double his investment.

When the interest rate is lower, the present value of an investment increases. This is because a lower interest rate means that the value of money in the future is worth more in the present. Therefore, the present value of an investment is higher when the interest rate is lower.

The price of a one-year Treasury bill per $100 of face value can be calculated by subtracting the annual interest rate from 1 and then multiplying the result by the face value. In this case, 1 - 0.05 = 0.95. Multiplying 0.95 by $100 gives us $95.00. Therefore, the correct answer is $95.00.

The car loan is Tom's liability and an asset for Old Town Bank because Tom is responsible for repaying the loan, making it his liability. At the same time, the bank considers the loan as an asset because they expect to receive interest and principal payments from Tom over time, which will generate income for the bank.

When a bond's rating improves, it indicates that the creditworthiness and reliability of the issuer has increased. This leads investors to perceive the bond as less risky and more likely to be repaid, resulting in an increased demand for the bond. As a result, the price of the bond will rise and its yield will decrease, since the yield is inversely related to the price. Therefore, the correct answer is that the demand for this bond will increase, all other factors constant.

The New York Stock Exchange is not a financial intermediary because it does not directly intermediate between savers and borrowers. It is a stock exchange where buyers and sellers trade stocks and other securities. Financial intermediaries, such as banks, insurance companies, and mutual funds, play a role in channeling funds from savers to borrowers and facilitating the flow of money in the economy.

A financial intermediary is involved in indirect finance because it acts as a middleman between borrowers and lenders. It collects funds from savers and channels them to borrowers, facilitating the flow of funds in the economy. This allows savers to earn interest on their savings while providing borrowers with access to capital. Financial intermediaries include banks, credit unions, insurance companies, and investment funds. They play a crucial role in the financial system by reducing information asymmetry, pooling resources, and providing liquidity.

Debt instruments that have maturities less than one year are traded in the money market. The money market is a segment of the financial market where short-term borrowing and lending of funds take place. It includes various instruments such as Treasury bills, commercial papers, certificates of deposit, and short-term government securities. These instruments are traded in the money market due to their short-term nature and the need for liquidity by investors.

As inflation increases, the purchasing power of money decreases. This means that the same amount of money can buy fewer goods and services. Therefore, the real value of the fixed nominal interest rate decreases because the interest earned is not sufficient to compensate for the loss in purchasing power. Thus, the correct answer is that the real interest rate decreases.

The current yield is calculated by dividing the annual coupon payment by the purchase price of the bond. In this case, the bond has an annual coupon of $60 and was purchased for $965.00. Therefore, the current yield is (60/965) = 0.0622, or 6.22%.

The risk spread, also known as the default-risk premium, refers to the additional return that investors demand for taking on the risk of default by the issuer of a bond. This premium compensates investors for the higher likelihood of not receiving their principal or interest payments. Since the risk spread is a measure of the bond's riskiness, it should have a direct relationship with the bond's price. As the risk spread increases, the bond's price decreases, and vice versa. Similarly, the risk spread should have an inverse relationship with the bond's yield. As the risk spread increases, the bond's yield increases, and vice versa. The risk spread is not always constant and can vary based on market conditions and the creditworthiness of the issuer.

A or D

When an individual stores wealth in art rather than money, they will incur higher transaction costs when they ultimately make purchases. This is because buying or selling art involves additional expenses such as fees for appraisals, commissions for art dealers, and transportation costs. Unlike money, which can be easily exchanged for goods and services, art transactions require more effort and resources, leading to higher transaction costs.

The coupon payment on this bond is equal to $75 because the coupon rate is given as 7.5% and the face value of the bond is $1,000. To calculate the coupon payment, we multiply the face value by the coupon rate: $1,000 x 0.075 = $75.

If the U.S. government's borrowing needs decrease, it means that they will issue fewer bonds. This decrease in supply of bonds will result in an increase in their price. This is because with a lower supply, the demand for bonds will remain constant or may even increase, leading to a higher price as investors compete for the limited available bonds.

When interest rates are expected to rise, the demand for bonds decreases. This is because investors can now earn higher returns by investing in other options, such as savings accounts or newly issued bonds with higher interest rates. As a result, bond prices fall to attract buyers and compensate for the lower demand. Therefore, the correct answer is "Fall, due to the demand for bonds decreasing."

The yield to maturity is the total return anticipated on a bond if held until it matures. It is expressed as an annual percentage rate. In this case, the bond with the lowest yield to maturity would be the one selling for $1,100 because the higher purchase price reduces the overall return on the investment. The other bonds are either selling for the face value or at a discount, which would result in a higher yield to maturity.