27) The investment banker performs what three basic functions?
A) underwriting, distributing, and regulating
B) underwriting, advising, and price-pegging
C) underwriting, distributing, and advising
D) underwriting, distributing, and negotiating
28) When an investment banking firm “underwrites” an issue of securities, the firm is performing
which of the following?
A) agreeing to market the securities to investors for a fee
B) giving legal advice to the firm that is issuing the securities
C) offering to purchase the securities from the firm, thereby assuming the risk of resale to
investors
D) agreeing to provide insurance that the firm’s securities will sell for a price that is established
by the firm
29) Investment banking firms offer to facilitate the sale of securities to the public in a variety of
ways. Which of the following methods guarantees the corporation with a pre-determined price
for the securities?
A) a best efforts basis
B) a commission basis
C) a competitive bid
D) an underwriting
30) A “Dutch auction” was used by Google to raise money in 2004. A Dutch auction involves
A) selling bonds in Europe.
B) allowing investors to submit bids saying how many shares they’d like to buy and at what
price.
C) allowing investment banking firms to submit bids on how many shares they are willing to sell
and at what price.
D) hiring a Dutch firm to sell a company’s securities at auction.
31) Commercial banks that also provide investment banking services are called
A) conglomerate banks.
B) multi-purpose banks.
C) investment enhanced banks.
D) universal banks.
2.3 Learning Objective 3
1) Only individual investors participate in public offerings, while institutional investors
participate in private placements.
2) Registration of securities by the SEC indicates to investors that the risk of those securities is
reasonable.
3) Preferred stock is traded in the money market, while common stock is traded in the capital
market.
4) In a private placement, the securities are offered and sold to a limited number of investors.
5) The process of shelf-registration is beneficial to the issuing firm because it will reduce the
time needed for the firm to take an issue to market.
6) The provisions of the Sarbanes-Oxley Act of 2002, or SOX, apply to all U.S.-based
corporations, as well as to foreign corporations conducting business in U.S. markets.
7) Which of the following statements concerning private placements is most correct?
A) Private placements do not involve investment bankers.
B) Although not selling the securities to the public, investment bankers may provide advice on
the evaluation of prospective buyers and the terms of sale for private placements.
C) Private placements are limited to stocks, not bonds.
D) More than half of all private placements are sold to federal, state, or local governments or
government agencies.
8) Which of the following is an advantage of using private placements for debt?
A) reduced costs from the elimination of the registration statement for the SEC, investment-
banking underwriting fees and distribution costs
B) lower interest costs
C) fewer and less burdensome restrictive covenants
D) the possibility of future SEC registration
9) Which of the following statements is most correct concerning flotation costs?
A) flotation costs are the same for common stock, preferred stock and bonds because they reflect
mainly printing costs and legal fees.
B) flotation costs are generally higher for bonds rather than stocks because the dollar amounts
involved are much higher, allowing for economies of scale
C) flotation costs as a percentage of gross proceeds increase as the size of the security issue
increases
D) flotation costs are higher for common stocks than for preferred stocks and bonds due to the
higher level of risk associated with owning common stock
10) Private placements are
A) limited to debt securities.
B) limited to equity securities.
C) available for both debt and equity securities, but the market is dominated by equity issues.
D) especially appealing to new, small, and medium-sized companies.
11) All of the following are typically advantages of private placements except:
A) speed.
B) reduced flotation costs.
C) financial flexibility.
D) the possibility of future SEC registration.
12) Advantages of private placements do not include which of the following?
A) more financing flexibility
B) lower flotation costs
C) investor protection through extensive regulation
D) funds which are available more quickly than through a public offering
13) Private placements usually have several advantages associated with them, but also tend to
suffer from specific disadvantages. Which of the following is a disadvantage of a private
placement when compared to other methods of selling new securities?
A) strictly standardized features/terms
B) higher interest costs
C) reduced flotation costs
D) avoidance of registration with the SEC
14) Which of the following would not normally be considered a “flotation cost?”
A) underwriter’s spread
B) dividends
C) legal fees
D) printing and engraving expenses
15) The costs associated with issuing securities to the public can be high. Some types of
securities have greater expenses associated with them than others. Which of the following is the
most costly security to issue?
A) common stock
B) corporate bonds
C) preferred stock
D) all of the above
16) The Sarbanes-Oxley Act of 2002, in order to protect investors, requires a higher level of
accountability for which of the following groups?
A) corporate officers
B) public accountants
C) boards of directors
D) all of the above
17) The Sarbanes-Oxley Act of 2002 holds all of the following groups strictly accountable in a
legal sense for any instances of misconduct except:
A) company officers.
B) outside members of the board of directors.
C) lawyers.
D) investors.
18) The Sarbanes-Oxley Act, or SOX,
A) holds corporate advisors strictly accountable in a legal sense for any instances of misconduct.
B) pretexts the interests of shareholders by providing greater protection against accounting fraud
and financial misconduct.
C) reduces the cost of financial reporting by standardizing reporting requirements.
D) accomplishes both A and B.
19) A commitment fee is
A) an amount paid on the unused portion of a loan in a private placement.
B) an amount paid by an investment banker to ensure the sale of securities.
C) paid by investors to guarantee that a company will borrow from them.
D) paid by bondholders to secure the right to convert bonds into common stock.
2.4 Learning Objective 4
1) Over time, there has been a high correlation between actual rates of return on securities and
the securities’ standard deviations of returns.
2) The rate of return available on the next best investment alternative for the saver refers to the
opportunity cost of funds.
3) Investors expect to receive the highest returns from government-issued securities because the
government will not default on securities that it has issued.
4) The nominal interest rate is 7% and the expected inflation rate is 2%. Based on the Fisher
effect, the real rate of interest is
A) 5.0%.
B) 6.86%.
C) 5.1%.
D) 4.9%.
5) A basis point is equal to
A) one percent.
B) one-tenth of one percent.
C) one-hundredth of one percent.
D) one-half of one percent.
6) The prime lending rate is the base rate on
A) mortgage loans.
B) home equity loans.
C) auto loans.
D) corporate loans.
7) The real rate of return is the return earned above the
A) default risk premium.
B) risk-adjusted return.
C) inflation risk premium.
D) variability of returns measured by standard deviation.
8) The risk premium would be greater for an investment in an oil and gas exploration in
unproven fields than an investment in preferred stock because
A) oil and gas exploration investments have a greater variability in possible returns.
B) the preferred stock is more liquid.
C) the inflation rate would vary more with oil and gas exploration investments.
D) both A and B
9) What was the average annual rate of return on 3-month U.S. Treasury bills during the period
1984 to 2008?
A) 3.84%
B) 4.23%
C) 4.76%
D) 5.68%
10) What was the average annual rate of return on long-term government bonds (30-Year
Treasury Bonds) during the period 1984 to 2008?
A) 4.14%
B) 5.88%
C) 6.89%
D) 7.82%
11) What was the average annual rate of return on long-term corporate bonds during the period
1926 to 2008?
A) 8.3%
B) 6.5%
C) 6.2%
D) 5.9%
12) What was the average annual rate of return on common stocks of small firms during the
period 1926 to 2008?
A) 17.4%
B) 21.6%
C) 16.4%
D) 19.5%
13) Over the period 1926 to 2008 the standard deviation of returns has been the greatest for
which of the following:
A) treasury bills.
B) corporate bonds.
C) common stocks.
D) common stocks of small firms.
14) Which of the following represents the correct ordering of returns over the period 1926 to
2008 (from lowest to highest return)?
A) Treasury bills, Long-term corporate bonds, Common stocks, Small firm common stocks
B) Small firm common stocks, Common stocks, Long-term corporate bonds, Treasury bills
C) Treasury bills, Common stocks, Long-term corporate bonds, Small firm common stocks
D) Long-term corporate bonds, Treasury bills, Common stocks, Small firm common stocks
15) Which of the following represents the correct ordering of standard deviation of returns over
the period 1926 to 2008 (from highest to lowest standard deviation of returns)?
A) Treasury bills, Long-term corporate bonds, Common stocks, Small firm common stocks
B) Small firm common stocks, Common stocks, Long-term corporate bonds, Treasury bills
C) Treasury bills, Common stocks, Long-term corporate bonds, Small firm common stocks
D) Treasury bills, Common stocks, Small firm common stocks, Long-term corporate bonds
16) During the period 1984 to 2008, the average yield on 3-Month U.S. Treasury bills was
4.76%, the average inflation rate was 2.97%, the average yield on 30-year Treasury bonds was
6.89%, and the average return on 30-year Aaa-Rated Corporate Bonds was 7.73%. The real risk-
free short-term interest rate is
A) 1.79%.
B) 2.13%.
C) 2.97%.
D) 4.76%.
17) Which of the following securities will likely have the highest liquidity premium?
A) U.S. Treasury Bond maturing in 2027
B) Bbb-rated corporate bond maturing in 2020 actively traded on a major exchange
C) Aaa-rated corporate bond maturing in 2015 not actively traded
D) U.S. Treasury Bill
18) Which of the following securities will likely have the highest default risk premium?
A) U.S. Treasury Bond maturing in 2027
B) Bbb-rated corporate bond maturing in 2020 actively traded on a major exchange
C) Aaa-rated corporate bond maturing in 2015 not actively traded
D) U.S. Treasury Bill
19) Suppose the following rates are averages for banks in your area: interest checking accounts
pay 1%, savings accounts pay 2%, and one-year certificates of deposit pay 3%. All accounts are
federally insured by the FDIC. The difference in rates can be explained mainly by
A) liquidity premiums.
B) default risk premiums.
C) maturity premiums.
D) inflation risk premiums.
20) Examine the securities below and identify the security with the highest liquidity premium,
the highest default risk premium, and the highest maturity premium.
a. 30-Year U.S. Government Treasury Bond maturing in 2025
b. 25-Year Bbb-rated Corporate Bond maturing in 2030, actively traded on the New York
Exchange
c. 10-Year Aaa-rated Corporate Bond maturing in 2020, thinly traded on a regional exchange
d. 3-Month U.S. Treasury Bill
2.5 Learning Objective 5
1) The term structure of interest rates usually indicates that longer terms to maturity have higher
expected returns.
2) In response to the banking crisis and economic collapse of 2007 and 2008, the U.S.
government moved to increase interest rates in order to attract foreign capital seeking high
returns in U.S. banks.
3) Which of the following securities will likely have the highest maturity risk premium?
A) U.S. Treasury Bond maturing in 2027
B) Bbb-rated corporate bond maturing in 2020 actively traded on a major exchange
C) Aaa-rated corporate bond maturing in 2015 not actively traded
D) U.S. Treasury Bill
4) The one-year interest rate is 4%. The interest rate for a two-year security is 6%. According to
the unbiased expectations theory, the one-year interest rate one year from now must be equal to
A) 5.00%.
B) 8.00%.
C) 8.04%.
D) 10.00%.
5) The one-year interest rate is 4%. The interest rate for a two-year security is 6%. The one-year
interest rate one year from now is 8.34%. According to the liquidity preference theory, the risk
premium for the second one-year investment is
A) 0.50%.
B) 0.34%.
C) 0.30%.
D) 1.66%.
6) You are considering an investment in a U.S. Treasury bond but you are not sure what rate of
interest it should pay. Assume that the real risk-free rate of interest is 1.0%; inflation is expected
to be 1.5%; the maturity risk premium is 2.5%; and, the default risk premium for AAA rated
corporate bonds is 3.5%. What rate of interest should the U.S. Treasury bond pay?
A) 8.5%
B) 6.0%
C) 5.0%
D) 2.5%
7) You are considering an investment in a AAA-rated U.S. corporate bond but you are not sure
what rate of interest it should pay. Assume that the real risk-free rate of interest is 1.0%; inflation
is expected to be 1.5%; the maturity risk premium is 2.5%; and, the default risk premium for
AAA rated corporate bonds is 3.5%. What rate of interest should the U.S. corporate bond pay?
A) 8.5%
B) 6.0%
C) 5.0%
D) 2.5%
8) What is the term for a graphical representation of the relationship between interest rates and
the maturities of debt securities?
A) term curve
B) maturity chart
C) yield curve
D) inflationary expectations
9) Which of the following is not a valid theory that attempts to explain the shape of the term
structure of interest rates?
A) the unbiased expectations theory
B) the liquidity preference theory
C) the market segmentation theory
D) the Fisher Effect theory
10) A “normal” yield curve is
A) downward sloping.
B) downward sloping, then upward sloping.
C) upward sloping.
D) upward sloping, then downward sloping.
11) Given the anticipated rate of inflation (i) of 1.7% and the real rate of interest (R) of 1.4%,
find the nominal rate of interest (r).
12) Given the rate information in the table below, estimate the nominal rate for a AA-rated
corporate bond. Assume a liquidity premium of 8 basis points. Identify as part of your answer
the inflation risk premium, the default risk premium, the maturity premium, and the liquidity
premium.
3-month T-bills 2.0%
30-year Treasury Bonds 5.0%
AA-rated Corp. Bonds 8.0%
Inflation Rate 1.0%
13) An investor buys a 20-year Bbb-rated corporate bond with a nominal annual rate of return of
10%. The average inflation rate is expected to be 2%. The default risk premium is expected to
be 5% and the maturity premium is 4%. Calculate the real rate of interest.
14) The current rate of return on a one-year U.S. Government security is 3%. The rate of return
on a two-year U.S. Government security is 5%. According to the expectations theory, what is
the return on a one-year U.S. Government security purchased one year from today?
15) The date today is January 1, 2010. A one-year security maturing on 1/1/11 yields 3%. A
two-year security maturing on 1/1/12 yields 6%. A three-year security maturing on 1/1/13 yields
11%. Calculate the expected annual return on a two-year security beginning 1/1/11 and maturing
on 1/1/13.
16) If provided the nominal rate of interest (r) of 7.4% and the anticipated rate of inflation (i) of
4.5%, what is the real rate of interest (R)?
17) Given the anticipated rate of inflation (i) of 2.13% and the real rate of interest (R) of 3.1%,
find the nominal rate of interest (r).
18) The yield curve in 2009 was very low, with short-term rates close to zero and long-term rates
below 5 percent. What factors contributed to such low interest rates?
2.6 Learning Objective 6
1) An actively traded, AAA-rated, Intel Corporation bond, maturing in 2015, provides an
expected yield of 8%. The AAA-rated bond of a local Chicago-based company, not actively
traded on any exchange, maturing in 2015, provides an expected yield to investors of 10%. The
difference in expected yields is primarily due to
A) inflation premium.
B) default risk premium.
C) maturity risk premium.
D) liquidity premium.