FINANCIAL MARKETS AND INSTITUTIONS

Mock General Exam

You have one hour to complete this exam. It consists of 31 questions, and each question
is worth 1 point. You are allowed to use simple calculators. No programmable
calculators are allowed. No notes or other aids are allowed.

1. There are two possible states of the world, each occurring with probability 50%. Asset A
pays 100 if the first state of the world occurs and 185 if the second state of the world occurs.
Assume that the firm that issued Asset A has undergone significant changes, so that now
Asset A pays 200 in the first state of the world and 310 in the second state of the world.
Everything else remains the same. As a result,

A. the price of Asset A can go up or down, depending on investors' preference towards risk.

B. the price of Asset A should go down.

C. the price of Asset A should go up.

D. nothing should happen to the price of Asset A.

2. Money market securities should have, among others, which of the following characteristics?

I. High liquidity
II. Little price risk
III. High rate of return
IV. Life greater than one year

A. II and IV

B. III and IV

C. I and III

D. I and II
3. An investment pays 240 in one year, X amount of dollars in two years, and 460 in 3 years.
The total present value of all the cash flows (including X) is equal to 1500. If the yield is
6%, what is X? (Round your result if necessary).

A. $997.04

B. $811.64

C. $800

D. $887.36

4. A 3-year corporate bond has a 7% coupon rate and a face value of $1000. What should be
the bond's price if the current market interest rate is 6% and the bond pays coupons
semiannually?

A. $1027.09

B. $949.49

C. $1216.69

D. $1000

5. An annual coupon bond with a $1000 par value has a 5% coupon rate, a 6% YTM, and 3
years to maturity. What is the bond's duration?

A. 2.86 years

B. 2.51 years

C. 2 years

D. 3 years
6. Consider a 5 year bond with a 10% coupon whose present yield to maturity is 8%. If interest
rates remain constant, one year from now the price of the bond will be:

A. can not be determined from the information given

B. the same

C. lower

D. higher

7. Assume that on any given day about 10% of market participants make large mistakes in
pricing stocks and engage in transactions that cause them to lose money. This fact

A. does not invalidate the Efficient Market Hypothesis.

B. invalidates the strong form of the Efficient Market Hypothesis.

C. invalidates the semi-strong form of the Efficient Market Hypothesis.

D. invalidates all forms of the Efficient Market Hypothesis.

8. A stock is currently selling at $60, which you think is a fair price. It has just paid a dividend
of $6. You expect the dividend to grow this year and perpetually afterwards at 7% per year.
What must be the required rate of return on this stock (round to the closest integer)?

A. 10%

B. 7%

C. 18%

D. 27%
9. A forward contract

A. has substantially higher default risk than an equivalent futures contract.

B. is traded on an organized exchange.

C. has substantially lower default risk than an equivalent futures contract.

D. is marked to market daily and is subject to margin requirements.

10. On September 30, 2013, Trader Y sold one futures contract for October 30, 2013 delivery.
The contract was written for the delivery of one share of stock. When the trader entered the
market, the spot price was $28 and the futures price for October 30 delivery was $40. He
closed his position on October 9, 2013, when the spot price was $18 and the futures price
for October 30 delivery was $70. As a result,

A. Trader Y made a profit of $10.

B. Trader Y made a loss of $30.

C. Trader Y made a profit of $42.

D. Trader Y made a loss of $22.

11. A stand-alone option means that the writer of the option does not enter any other transaction
besides the option. Writing a stand-alone call option

A. results in a potentially limited gain and a potentially unlimited loss.

B. is only possible if the writer of the option possess the asset on which the option is
written.

C. results in a potentially unlimited gain and a potentially limited loss.

D. is the only way to hedge.

12. A bank wants to finance its asset expansion and has two options. It can either attract
additional deposits or issue commercial paper. The required reserve ratio is 10%. If the
bank has to pay 4.6% on its deposits and 5% on its commercial paper, which one should it
choose?

A. none of the above

B. commercial paper

C. the bank is indifferent between the two options.

D. deposits

13. If you invest $10,000 in a mutual fund with a NAV of $50 per share and a 5.5% back-end
load, you will:

A. receive more than 200 shares in the fund.

B. receive exactly 200 shares in the fund.

C. receive less than 200 shares in the fund.

D. none of the above

14. Which of the following could result in a negative NIM, all else equal?

A. Higher non-interest income

B. Growth in net interest income

C. Decline in net interest income

D. Lower non-interest expense

15. Long-term lending relationships have which of the following benefits?

I. They enable financial institutions to observe borrower behavior more closely.

II. They increase competition between banks.
III. They alleviate moral hazard because the borrower cares about remaining on good terms
with the lender.
IV. They enable existing customers to obtain new loans more easily.
V. They make it easier for regulators to assess risk-taking by financial institutions.

A. I, II, and V only

B. II, IV, and V only

C. I, III, and IV only

D. III and IV only

16. An open-end mutual fund owns 1500 shares of Krispy Kreme priced at $12. The fund also
owns 1,000 shares of Ben & Jerry's priced at $43, and 2,000 shares of Pepsi priced at $50.
There are no other assets or liabilities in the fund. The fund has 3,500 shares outstanding.
What is the NAV of a fund's share?

A. $66

B. $56

C. $46

D. $36
17. You are a manager at XYZ Firm. You annual base salary is $60,000. A project comes
along, which will yield your firm $1,000,000 if it succeeds and 0 if it fails (all other projects
and your base salary are unaffected by this new project). If you work hard on this project, it
will succeed with probability 80%. Otherwise, it will succeed with only a 20% probability.
Working hard requires additional effort from you over and above what you would normally
do. What minimum stake in the project will induce you to work hard if you value this
additional effort at $30,000?

A. 3.5%

B. 5.0%

C. 4.375%

D. 17.5%

18. When potential borrowers know more than lenders about the future prospects of a project to
be undertaken with borrowed funds, the lender faces the problem of

A. asymmetric information

B. free-riding

C. government regulation

D. default risk
19. A positive duration gap implies which of the following?

I. The liabilities of the financial institution have a relatively shorter duration than its assets.
II. The net worth of the financial institution will increase when interest rates go up.
III. The net worth of the financial institution will decrease when interest rates go up.
IV. This financial institution is not a bank.

A. I and III only.

B. II and IV only.

C. I, III, and IV only.

D. III and IV only.

20. Government safety net in general, and deposit insurance in particular,

I. support the depositors' faith in the banking system.

II. ensure that bank managers avoid taking excessive risk.
III. increase moral hazard on behalf of bank managers.
IV. lead to more adverse selection because risky entrepreneurs are likely to want to become
bank managers.
V. add unnecessary regulatory burden on financial institutions.
VI. increase competition between banks.

A. I, III, and IV only.

B. III and IV only.

C. II, IV, V, and VI only.

D. II and V only.
21. Specialization in lending

A. enables banks to analyze information more effectively.

B. prevents borrowers from defaulting on their loans.

C. can reduce the ability of financial institutions to diversify.

D. both A and C.

22. Bank capital performs which of the following functions?

I. It is a cushion against bank failure.

II. It increases competition in the financial system.
III. It enables bank managers to engage in excessive risk-taking.
IV. It aligns the incentives of bank owners with those of depositors because banks that have
a lot of capital have more to lose if they take on excessive risks.
V. It makes it more difficult for regulators to assess risk-taking by banks.

A. II, III, and V only.

B. I and IV only.

C. I and III only.

D. I, III, and IV only.

23. Bank A has the following assets: reserves of $100, high-quality government bonds of $500,
and residential mortgages of $500. Bank A's net worth is $100. Bank B has the following
assets: reserves of $50, municipal bonds of $400, and corporate loans of $50. Bank B's net
worth is $75. Which bank will be considered riskier according to the Basel methodology?
Assume that the following risk weights apply:

Reserves — 0%
High-quality government bonds — 0%
Residential mortgages — 50%
Municipal bonds — 50%
Corporate loans — 100%.

A. The relative riskiness of the two banks cannot be determined from the information
provided.

B. Bank B is riskier.

C. Bank A is riskier.

D. Both banks have the same level of risk.

24. Regulators may attempt to restrict bank competition in order to

A. increase prices of financial products for bank customers.

B. restrict asset holdings by banks.

C. reduce the efficiency of the financial system.

D. lessen banks' incentives to take on excessive risks.

25. Delevereraging occurs when banks cut lending after their net worth declines. This process

A. leads to higher economic growth because banks become healthier.

B. negatively affects economic activity because firms find it more difficult to finance their
operations.

C. leads to higher inflation because people save less and consume more.

D. leads to greater bank regulation.

26. Suppose the Fed stops paying interest on excess reserves. Then in the market for
reserves:

A. The supply curve will shift to the right

B. The demand curve will become vertical

C. The demand curve will become flat at 0

D. The demand curve will shift to the left

27. When the Fed sells securities on the open market

A. The supply of reserves will move to the left

B. The supply of reserves will move to the right

C. The demand for reserves will move to the right

D. The supply of reserves will no longer be vertical

28. A firm makes an (unexpected) announcement that its future profitability will go up and it
will therefore be able to pay higher dividends to its shareholders. The announcement is
credible (i.e., market participants believe it). Which of the following would be
inconsistent with the semi-strong form of the Efficiant Markets Hypothesis?

A. The price of the firm's shares increases several days before the announcement as well
as on the announcement date itself.

B. The price of the firm's shares is flat before the announcement but rises sharply after
the announcement.

C. The price of the firm's shares remains flat both before and after the announcement.

D. None of the other options

29. An investor will give cash to an Authorized Participant (AP) and will receive X. The AP
will give a basket of securities to an ETF manager and will receive Y. What are X and
Y?

A. X=Securities, Y=ETF Shares

B. X= ETF Shares, Y=ETF Creation Units

C. X= ETF Shares, Y=Securities

D. X= ETF Creation Units, Y= ETF Shares

30. The rate of return on a coupon bond is composed of 2 elements. One is the current yield
and the other? [Recall the definition of the current yield on a coupon bond]

A. Yield to maturity

B. Coupon rate

C. Capital gains

D. Real rate

31. Assume that there is a portfolio of two European options with identical exercise date and
the same underlying asset. One of the options is a call option with strike X, whereas the
other one is a put option with strike Y. If it is moreover known that for some spot price P
of the underlying asset on the exercise date, the entire option portfolio has zero value,
one can infer that

A. Y ≥ P ≥ X.

B. Y ≤ P ≤ X.

C. Y = X < P.

D. X = Y > P.