TEST BANK

to accompany

Werner and Stoner

FUNDAMENTALS OF FINANCIAL
MANAGING
3rd Edition
2 Chapter4

CHAPTER 4

MONEY RATES

1. As interest rates change, present values change:

a. Directly.
b. There is no connection between interest rates and present values.
c. Inversely.
d. Upward.

2. When interest rates rise, present values:

a. Increase.
b. Decrease.
c. Remain the same.
d. First rise, then fall.

3. When interest rates fall, present values:

a. Increase.
b. Decrease.
c. Remain the same.
d. First fall, then rise.

4. The present value of cash flows to be received in the near term:

a. Is more volatile than the present value of cash flows to received further in the
future.
b. Is equally volatile as the present value of cash flows to received further in the
future.
c. Is less volatile than the present value of cash flows to received further in the
future.
d. Has no relationship to the present value of cash flows to received further in the
future.

5. In the Fisher model, nominal rates are comprised of the pure rate, the inflation
premium, and the:
a. Expected base level of rates.
b. Transaction premium.
c. Risk premium.
d. Expected rate of inflation.
6. The interest rates listed daily in The Wall Street Journal are considered
interest rates.
a. Real.
b. Risk-adjusted.
c. Nominal.
d. Forward.

7. The rate of interest that would exist if there were no anticipated inflation or
forecasted risk is the:
a. Pure rate.
b. Nominal rate.
c. Forward rate.
d. Risk-free rate.

8. The inflation premium represents inflation and is built into nominal

interest rates to compensate for their expected loss in purchasing
power.
a. Historic; lenders
b. Expected; lenders
c. Anticipated; borrowers
d. Historic, borrowers

9. The risk premium compensates investors for:

a. Foreign exchange.
b. Changing interest rates.
c. Exposure to inflation.
d. Assuming the risks of the investment.

10. Using the multiplicative form of the Fisher model, what is the nominal rate of
interest if the pure rate is 4 percent, inflation premium is 5 percent, and the risk
premium is 6 percent?
a. 15.00%.
b. 15.75%.
c. 120.00%.
d. Not enough information is available to calculate the answer.
4 Chapter4

11. If the nominal rate of return on a corporate bond is 9%, the risk premium is 4%, and
the inflation premium is 2%, what is the pure rate (multiplicative form) of interest?
a. 0%.
b. 2.75%.
c. 3%.
d. 6.08%.

12. What is the real rate of interest (multiplicative form) on a corporate bond when the
pure rate of interest is 4%, the inflation premium is 5%, and the risk premium is 7%?
a. 9.20%.
b. 11.28%
c. 12.35%.
d. 16.84%.

13. What is the risk-free rate of interest (multiplicative form) when the pure rate and the
inflation premium are both 4% and the risk premium is 5%?
a. 8.0%.
b. 8.2%.
c. 9.2%.
d. 13.6%.

14. The Fisher model explains interest rate differences between countries by which three
factors?
a. Governmental budget levels, expected inflation rates, and risk differences
between countries.
b. Expected inflation rate, pure rate, and risk differences among countries.
c. Differences in nominal rates, risk-free rates, and expected inflation.
d. Variations in economic growth, nominal rates, and pure rates.

15. The theories of the term structure of interest rates attempt to measure variations in
interest rates by:
a. Time.
b. Risk differences.
c. Issuer of securities.
d. Anticipated inflation.

16. The term structure of interest rates refers to the relationship between:
a. Time and tax rate.
b. Risk and time.
c. Liquidity and risk.
d. Yield and maturity.

17. A graphic presentation of the term structure of interest rates is called:

 a. A supply and demand curve.
b. A normal presentation.
c. A time series plot of interest rates.
d. A yield curve.

18. The expectations hypothesis of the term structure of interest rates may be stated as:
a. Short-term rates represent expected long-term rates.
b. Long-term rates are averages of current and expected short-term rates.
c. Long-term rates are established by the Federal Reserve System in anticipation of
lending and borrowing.
d. A normal yield curve anticipates future decreases in the level of interest rates.

19. The liquidity preference hypothesis of the term structure of interest rates argues that
long-term rates must be _________ than short term rates due to _____________.
a. lower; default risk.
b. higher; interest rate risk.
c. lower; expected inflation.
d. higher; market segmentation.

20. The segmentation or hedging hypothesis of the term structure of interest rates
assumes that:
a. Investors select the maturities of their investments to hedge their liabilities.
b. All maturities of bonds have the same yield.
c. Companies that hedge their risks issue short-term bonds.
d. Investment markets are segmented by geography.

21. All of the following risks are associated with the risk premium in the Fisher model
except:
a. Default risk.
b. Inflation risk.
c. Call risk.
d. Interest rate risk.

22. The risk that a borrower will be unable to make payments on a loan is:
a. Default risk.
b. Interest-rate risk.
c. Reinvestment risk.
d. Call risk.

23. The risk that rising interest rates will reduce security values is:
a. Default risk.
b. Interest-rate risk.
6 Chapter4

c. Reinvestment risk.
d. Marketability risk.

24. The risk that low interest rates will provide poor investment opportunities when
previous investments mature is:
a. Default risk.
b. Interest-rate risk.
c. Reinvestment risk.
d. Call risk.

25. The risk that an investor will have to take a loss due to difficulty in selling a security
is:
a. Default risk.
b. Interest-rate risk.
c. Reinvestment risk.
d. Marketability risk.

26. The risk that the issuer of a security might terminate the loan prior to maturity is:
a. Default risk.
b. Interest-rate risk.
c. Reinvestment risk.
d. Call risk.

27. Calculate the after-tax yield on an 8% U.S. Treasury security when the Federal tax
rate is 28% and the state tax rate is 6%?
a. 2.72%.
b. 5.28%.
c. 5.76%.
d. 8.00%.

28. Gus Poyet, who lives in Chicago, recently purchased a Illinois state bond with a
before-tax yield of 5%. If Gus=s federal tax rate is 30% and state tax rate is 5%,
what is the after-tax yield?
a. 3.50%.
b. 4.20%.
c. 3.25%.
d. 5.00%.

29. A foreign exchange rate is:

a. The price of a dollar in the U.S.
b. The price of a unit of currency.
c. The price of a unit of currency in terms of another currency.
 d. The price of trading with foreign nations.

30. The Bretton Woods agreement established all but which one of the following?
a. A system of fixed exchange rates.
b. A new international financial system including the World Bank.
c. A system of market-determined exchange rates.
d. Added U.S. dollars as an international reserve currency.

31. The Bretton Woods system fixed the rate of exchange of every currency to:
a. The U.S. dollar.
b. The British pound.
c. The Japanese yen.
d. Each other.

32. All but which one of the following exchange rate systems are in use today?
a. Floating exchange rate system.
b. Fixed exchange rate system.
c. Managed float system.
d. Pegged float system.

33. For a U.S. resident, the number of U.S. dollars required to purchase one unit of
foreign currency is called a:
a. Nominal rate.
b. Real rate.
c. Reciprocal rate.
d. Direct rate.

34. For a Canadian resident, the number of Canadian dollars required to purchase one
unit of foreign currency is called a:
a. Nominal rate.
b. Real rate.
c. Reciprocal rate.
d. Direct rate.

35. For a U.S. resident, the amount of foreign currency required to purchase U.S. dollar
is called a:
a. Nominal rate.
b. Real rate.
c. Reciprocal rate.
d. Direct rate.
8 Chapter4

36. Direct rates are also known as:

a. Reciprocal rates.
b. Cross rates.
c. European rates.
d. American rates.

37. Reciprocal rates are also known as:

a. Forward rates.
b. Cross rates.
c. European rates.
d. American rates.

38. When the direct rate in the United States for one Canadian dollar is $0.7237 U.S.
per Canadian dollar, the reciprocal rate is:
a. CAD 0.2630 per USD.
b. USD 0.2630 per CAD.
c. CAD 1.3818 per USD.
d. USD 1.3818 per CAD.

39. When the reciprocal rate in the United States for one Japanese yen is -120.00 per
U.S. dollar, the direct rate is:
a. USD 0.008333 per JPY.
b. JPY 0.008333 per USD.
c. USD 880.00 per JPY.
d. JPY 880.00 per USD.

40. If the price of a U.S. dollar is 110.00 Japanese yen and also 1.05 euros, what is the
yen/euro cross rate?
a. 0.00955 yen/euro.
b. $104.76.
c. 104.76 yen/euro.
d. 115.50 yen/euro.

41. Exchange rates for transactions today are called:

a. Forward rates.
b. Reciprocal rates.
c. Spot rates.
d. Continental rates.

42. Exchange rates for transactions to take place at a specified future date are called:
a. Forward rates.
b. Reciprocal rates.
c. Spot rates.
 d. Continental rates.

43. A forward exchange contract:

a. Is not signed until a specified future date.
b. Is illegal if one of the currencies is U.S. dollars.
c. Is useless if the currency you are holding has lost value.
d. Binds the parties to making a trade of currencies.

44. The annualized forward when the Canadian dollar/U.S. dollar exchange
rates are CAD1.38 per USD spot and CAD1.42 per USD quoted on a six month
forward contract is .
a. Discount; 5.80%.
b. Discount; 5.80%.
c. Premium; 5.80%.
d. Premium; 5.80%.

45. The foreign exchange risk associated with day-to-day transactions is called:
a. Translation exposure.
b. Inflation exposure.
c. Transaction exposure.
d. Economic exposure.

46. The foreign exchange risk associated with accounting income and values is called:
a. Translation exposure.
b. Inflation exposure.
c. Transaction exposure.
d. Economic exposure.

47. The foreign exchange risk associated with the risk of change of value of assets,
liabilities, and cash flows is called:
a. Translation exposure.
b. Inflation exposure.
c. Transaction exposure.
d. Economic exposure.

Solutions

1. C
2. B
3. A
4. C
10 Chapter4

5. C
6. C
7. A
8. B
9. D
10. B
11. B
12. B
13. B
14. B
15. A
16. D
17. D
18. B
19. B
20. A
21. B
22. A
23. B
24. C
25. D
26. D
27. C
28. D
29. C
30. C
31. A
32. B
33. D
34. D
35. C
36. D
37. C
38. C
39. A
40. C
41. C
42. A
43. D
44. C
45. C
46. A
47. D