Saving, Investment, and the Financial System 6299
37. Two bonds have the same term to maturity. The first was issued by a state government and the
probability of default is believed to be low. The other was issued by a corporation and the
probability of default is believed to be high. Which of the following is correct?
a. Because they have the same term to maturity the interest rates should be the same.
b. Because of the differences in tax treatment and credit risk, the state bond should have the
higher interest rate.
c. Because of the differences in tax treatment and credit risk, the corporate bond should have the
higher interest rate.
d. It is not possible to say if one bond has a higher interest rate than the other.
38. On which of these bonds is the prospect of default most likely?
a. a junk bond
b. a municipal bond
c. a U.S. government bond
d. a corporate bond issued by Proctor & Gamble Corporation
6300 Saving, Investment, and the Financial System
39. On which of these bonds is the prospect of default least likely?
a. a junk bond
b. a bond issued by the state of Arizona
c. a bond issued by the federal government
d. a bond issued by General Electric Corporation
40. Which bond is likely to have higher interest rate due to a higher default risk?
a. A share of stock issued by Apple.
b. A corporate bond issued by Apple.
c. A junk bond.
d. A U.S. government bond.
Saving, Investment, and the Financial System 6301
41. Assume the bonds below have the same term and principal and that the state or local government
that issues the municipal bond has a good credit rating. Which list has bonds correctly ordered
from the one that pays the highest interest rate to the one that pays the lowest interest rate?
a. corporate bond, municipal bond, U.S. government bond
b. corporate bond, U.S. government bond, municipal bond
c. municipal bond, U.S. government bond, corporate bond
d. U.S. government bond, municipal bond, corporate bond
42. Other things the same, as the maturity of a bond becomes longer, the bond will pay
a. a lower interest rate because it has less risk.
b. a lower interest rate because it has more risk.
c. a higher interest rate because it has more risk.
d. the same interest rate, because there is no relationship between term and risk.
6302 Saving, Investment, and the Financial System
43. Suppose the issuer of a bond fails to pay some of the interest or principal that was promised to the
bondholders. This failure is referred to as a
a. breach.
b. default.
c. risk.
d. term failure.
44. Suppose the city of Des Moines has a high credit rating, and so when Des Moines borrows funds
by selling bonds,
a. the city’s high credit rating and the tax status of municipal bonds both contribute to a lower
interest rate than would otherwise apply.
b. the city’s high credit rating and the tax status of municipal bonds both contribute to a higher
interest rate than would otherwise apply.
c. the city’s high credit rating contributes to a lower interest rate than would otherwise apply,
while the tax status of municipal bonds contributes to a higher interest rate than would
otherwise apply.
d. the city’s high credit rating contributes to a higher interest rate than would otherwise apply,
while the tax status of municipal bonds contributes to a lower interest rate than would otherwise
apply.
Saving, Investment, and the Financial System 6303
45. Municipal bonds pay a relatively
a. low rate of interest because of their high default risk and because the interest they pay is
subject to federal income tax.
b. low rate of interest because of their low default risk and because the interest they pay is not
subject to federal income tax.
c. high rate of interest because of their high default risk and because federal taxes must be paid
on the interest they pay.
d. high rate of interest because of their low default risk and because the interest they pay is not
subject to federal income tax.
46. A municipal bond is
a. issued by the federal government.
b. issued by state and local governments.
c. issued by corporations.
d. issued by households.
6304 Saving, Investment, and the Financial System
47. Owners of municipal bonds
a. are not required to pay federal income tax on the interest income.
b. usually receive a higher interest rate compared to bonds issued by corporations.
c. usually receive a higher interest rate compared to stock issued by corporations.
d. pay taxes on the dividends earned from these bonds.
48. Which of the following is true concerning interest rates on bonds?
a. The tax treatment of interest earned on municipals bonds makes the interest rate on them
higher than otherwise. High default risk makes the interest rate on a bond higher than
otherwise.
b. The tax treatment of interest earned on municipals bonds makes the interest rate on them
higher than otherwise. High default risk makes the interest rate on a bond lower than
otherwise.
c. The tax treatment of interest earned on municipals bonds makes the interest rate on them
lower than otherwise. High default risk makes the interest rate on a bond higher than
otherwise.
d. The tax treatment of interest earned on municipals bonds makes the interest rate on them
lower than otherwise. High default risk makes the interest rate on a bond lower than otherwise.
Saving, Investment, and the Financial System 6305
49. Which of the following bond buyers did not buy the bond that best met his or her objective?
a. Jackie wanted a bond with a high interest rate and was willing to take a lot of risk. She
purchased a junk bond.
b. Andrew wanted a bond that would allow him to legally avoid paying federal income taxes. He
purchased a municipal bond.
c. Suzy wanted to purchase a bond whose seller was unlikely to default. She purchased a bond
that Standards and Poor’s rated a low credit risk.
d. Cecilia held long-term bonds rather than short-term bonds to avoid risk.
50. You hold bonds issued by the city of Sacramento, California. The interest you earn each year on
these bonds
a. is not subject to federal income tax and so these bonds pay a higher interest rate than
otherwise comparable bonds issued by the U.S. government.
b. is not subject to federal income tax and so these bonds pay a lower interest rate than otherwise
comparable bonds issued by the U.S. government.
c. is subject to federal income tax and so these bonds pay a higher interest rate than otherwise
comparable bonds issued by the U.S. government.
d. is subject to federal income tax and so these bonds pay a lower interest rate than otherwise
comparable bonds issued by the U.S. government.
6306 Saving, Investment, and the Financial System
51. Other things the same, bonds are likely to have higher interest rates if they have
a. tax exemptions and short terms.
b. tax exemptions and long terms.
c. no tax exemptions and short terms.
d. no tax exemptions and long terms.
52. Other things the same, which bond would you expect to pay the highest interest rate?
a. a bond issued by the U.S. government
b. a bond issued by Microsoft Corporation
c. a bond issued by the state of Montana
d. a bond issued by a new chain of Brazilian-style restaurants
53. Other things the same, which bond would you expect to pay the lowest interest rate?
a. a bond issued by a state with a very good credit rating
b. a bond issued by the U.S. government
c. a bond issued by a fairly new company doing genetic research
d. a bond issued by Nabisco
Saving, Investment, and the Financial System 6307
54. You are thinking of buying a bond from Bluestone Corporation. You know that this bond is long
term and you know that Bluestone’s business ventures are risky and uncertain. You then consider
another bond with a shorter term to maturity issued by a company with good prospects and an
established reputation. Which of the following is correct?
a. The longer term would tend to make the interest rate on the bond issued by Bluestone higher,
while the higher risk would tend to make the interest rate lower.
b. The longer term would tend to make the interest rate on the bond issued by Bluestone lower,
while the higher risk would tend to make the interest rate higher.
c. Both the longer term and the higher risk would tend to make the interest rate lower on the bond
issued by Bluestone.
d. Both the longer term and the higher risk would tend to make the interest rate higher on the
bond issued by Bluestone.
55. Jerry has the choice of two bonds, one that pays 5 percent interest and one that pays 2 percent
interest. Which of the following is most likely?
a. The 2 percent bond is more risky than the 5 percent bond.
b. The 5 percent bond is a U.S. government bond, and the 2 percent bond is a junk bond.
c. The 2 percent bond has a longer term than the 5 percent bond.
d. The 2 percent bond is a municipal bond, and the 5 percent bond is a U.S. government bond.
6308 Saving, Investment, and the Financial System
56. Morgan, a financial advisor, has told her clients the following things. Which of her statements is
not correct?
a. “U.S. government bonds generally pay a higher rate of interest than corporate bonds.”
b. “The interest received on corporate bonds is taxable.”
c. “U.S. government bonds have the lowest default risk.”
d. “If you purchase a municipal bond, you can sell it before it matures.”
57. The sale of stocks
a. and bonds to raise money is called debt finance.
b. and bonds to raise money is called equity finance.
c. to raise money is called debt finance, while the sale of bonds to raise funds is called equity
finance.
d. to raise money is called equity finance, while the sale of bonds to raise funds is called debt
finance.
Saving, Investment, and the Financial System 6309
58. ABC Co. sells newly issued bonds. JLG Co. sells newly issued stocks. Which company is raising
funds in financial markets?
a. only ABC
b. only JLG
c. both ABC and JLG
d. neither ABC nor JLG
59. The sale of bonds
a. and stocks to raise money is called debt finance.
b. and stocks to raise money is called equity finance.
c. to raise money is called debt finance, while the sale of stocks to raise funds is called equity
finance.
d. to raise money is called equity finance, while the sale of stocks to raise funds is called debt
finance.
6310 Saving, Investment, and the Financial System
60. Northwest Wholesale Foods sells common stock. The company is using
a. equity financing and the return shareholders earn is fixed.
b. equity financing and the return shareholders earn depends on how profitable the company is.
c. debt financing and the return shareholders earn is fixed.
d. debt financing and the return shareholders earn depends on how profitable the company is.
61. Stock represents
a. a claim to a share of the profits of a firm.
b. ownership in a firm.
c. equity finance.
d. All of the above are correct
62. The bond market
a. is a financial market, whereas the stock market is a financial intermediary.
b. is a financial intermediary, whereas the stock market is a financial market.
c. is a financial market, as is the stock market.
d. is a financial intermediary, as is the stock market.
Saving, Investment, and the Financial System 6311
63. Which of the following would likely make the interest rate on a bond higher than otherwise?
a. both high credit risk and a long term
b. high credit risk but not a long term
c. a long term but not a high credit risk
d. neither high credit risk nor a long term
64. Which of the following bonds has the highest interest rate?
a. a high credit risk and a short term.
b. a low credit risk and a short term.
c. a long term and a high credit risk.
d. a long term and a low credit risk.
6312 Saving, Investment, and the Financial System
65. People who buy newly issued stock in a corporation such as Crate and Barrel provide
a. debt finance and so become part owners of Crate and Barrel.
b. debt finance and so become creditors of Crate and Barrel.
c. equity finance and so become part owners of Crate and Barrel.
d. equity finance and so become creditors of Crate and Barrel.
66. People who buy stock in a corporation such as General Electric become
a. creditors of General Electric, so the benefits of holding the stock depend on General Electric’s
profits.
b. creditors of General Electric, but the benefits of holding the stock do not depend on General
Electric‘s profits.
c. part owners of General Electric, so the benefits of holding the stock depend on General
Electric‘s profits.
d. part owners of General Electric, but the benefits of holding the stock do not depend on General
Electric‘s profits.
Saving, Investment, and the Financial System 6313
67. If Huedepool Beer runs into financial difficulty, the stockholders as
a. part owners of Huedepool are paid before bondholders get paid anything at all.
b. part owners of Huedepool are paid after bondholders get paid.
c. creditors of Huedepool are paid before bondholders get paid anything at all.
d. creditors of Huedepool are paid after bondholders get paid.
68. As chief financial officer you sell newly issued bonds on behalf of your firm. Your firm is
a. borrowing directly.
b. borrowing indirectly.
c. lending directly.
d. lending indirectly.
6314 Saving, Investment, and the Financial System
69. Which of the following people purchased the correct asset to meet his or her objective?
a. Michelle wanted to be a part owner of Mamma Rosa’s Pizza, so she purchased a bond issued
by Mamma Rosa’s Pizza.
b. Tim wanted a high return, even if it meant taking some risk, so he purchased stock issued by
Specific Electric instead of bonds issued by Specific Electric.
c. Jennifer wanted to buy equity in Honda, so she purchased bonds sold by Honda.
d. All of the above are correct.
70. If a firm sells a total of 100 shares of stock, then
a. each share represents 1 percent of the firm’s indebtedness.
b. each share represents ownership of 1 percent of the firm.
c. the firm is engaging in term finance.
d. All of the above are correct.
Saving, Investment, and the Financial System 6315
71. If a firm sells a total of 100 shares of stock, then
a. the supply of, and demand for, those shares determine the price per share.
b. each share represents ownership of 1 percent of the firm.
c. the firm is engaging in equity finance.
d. All of the above are correct.
72. The prices of stock traded on exchanges are determined by
a. the Corporate Stock Administration.
b. the administrators of NASDAQ.
c. the supply of, and demand for, the stock.
d. All of the above are correct.
73. Which of the following is not an important stock exchange in the United States?
a. New York Stock Exchange
b. American Stock Exchange
c. Chicago Mercantile Exchange
d. NASDAQ
6316 Saving, Investment, and the Financial System
74. All else equal, when people become more optimistic about a company’s future, the
a. supply of the stock and the price will both rise.
b. supply of the stock and the price will both fall.
c. demand for the stock and the price will both rise.
d. demand for the stock and the price will both fall.
75. Suppose the government finds a major defect in one of a company’s products and demands that
the product be taken off the market. We would expect that the
a. supply of existing shares of the stock and the price will both rise.
b. supply of existing shares of the stock and the price will both fall.
c. demand for existing shares of the stock and the price will both rise.
d. demand for existing shares of the stock and the price will both fall.
Saving, Investment, and the Financial System 6317
76. World Wide Delivery Service Corporation develops a way to speed up its deliveries and reduce
its costs. We would expect that this would
a. raise the demand for existing shares of the stock, causing the price to rise.
b. decrease the demand for existing shares of the stock, causing the price to fall.
c. raise the supply of the existing shares of stock, causing the price to rise.
d. raise the supply of the existing shares of stock, causing the price to fall.
77. In the late summer of 2005 some regions of the country were suffering from drought. What
effect would we expect this to have on the stock of companies such as John Deere that
manufacture farm equipment?
a. raise the demand for existing shares of the stock, causing the price to rise
b. decrease the demand for existing shares of the stock, causing the price to fall
c. raise the supply of the existing shares of stock, causing the price to rise
d. raise the supply of the existing shares of stock, causing the price to fall
6318 Saving, Investment, and the Financial System
78. In the Coen Brothers’ movie The Hudsucker Proxy the board of directors picks someone to run
the company who they believe will make poor decisions. If things turn out as they plan,
a. the price of a share of stock in the Hudsucker corporation should decline as the demand for
shares falls.
b. the price of a share of stock in the Hudsucker corporation should rise as the demand for shares
rises.
c. the price of a share of stock in the Hudsucker corporation should decline as the supply of
existing shares falls.
d. the price of a share of stock in the Hudsucker corporation should rise as the supply of existing
shares rises.
79. Suppose that the tires of a certain tire manufacturer are discovered to be defective. Other things
the same, this news would cause
a. the demand for this company’s stock to decrease, so the price would rise.
b. the demand for this company’s stock to decrease, so the price would fall.
c. the supply of this company’s stock to decrease, so the price would fall.
d. the supply of this company’s stock to decrease, so the price would rise.