Mock Midterm

Multiple Choice (12 questions; 5 points each)  

Clearly circle the best response. You may only circle a single response for each question.

1. All of the following are terms for or examples of financial claims except

1. bonds.
2. money.
3. loans.
4. commodities.

1. Deficit spending units (DSUs) receive funds in the primary market; surplus spending units (SSUs) sell claims in the

1. intermediation market.
2. direct financial market.
3. federal funds market.
4. secondary market.

1. If the coupon rate on a bond increases, all else equal, the price volatility of the bond

1. decreases.
2. stays the same.
3. increases.

1. Suppose the Fed changes reserve requirements from 10% to 7%, thereby creating $900 million in excess reserves. The total change in deposits (with no drains) would be

1.         $3,000 million.
2.         $12,857 million.   = 900/rr = 900/0.07
3.         $13,652 million.
4.         $15,795 million.

1. In direct financing, the lender

1. trades a financial claim for money.
2. trades money for a financial claim issued by a financial institution.
3. trades money with a broker who owns the financial claims of a borrower.
4. trades money for the financial claim of the borrower.

1. The money supply

1. is exclusively controlled by the Fed. (Fed cannot exclusively control deposit activity)
2. is smaller than the monetary base.
3. excludes any interest-bearing deposits.
4. none of the above

1. If the real rate of interest is 3% and the expected inflation rate is 7%, a loan at 11%

1. would reward the lender at the borrower’s expense.
2. would reward the borrower at the lender’s expense.
3. would penalize the lender at the borrower’s expense.
4. none of the above

1. A $1,000 bond with a coupon rate of 10%, interest paid semiannually, matures in eight years and sells for $1,120. What is the yield to maturity?

1. 10.8%
2. 11.0%
3. 7.9%
4. 7.6%

1. The yield to maturity measure assumes that coupon interest is reinvested at

1. the yield to maturity.
2. the changing market rates.
3. the coupon rate.
4. the Treasury bond rate.

1. The Federal Reserve’s discount window

1.         is the most common way for depository institutions to raise loanable funds.
2.         relates to the Fed’s “lender of last resort” function.
3.         is a relatively recent innovation in the design of the Federal Reserve System.
4.         is available only during emergencies.
5. all of the above

1. Which statement is true about interest rate movements?

1. Interest rates move counter-cyclically with the business cycle.
2. Long-term interest rates have greater swings than short-term rates.
3. The expected rate of inflation impacts the level of interest rates.
4. Bond prices and interest rates move directly with one another.

1. If a 7% coupon (semiannual) bond purchased at par sells 2 years later for $990, what is the realized yield (annualized)?

1. 3.26%
2. 5.75%
3. 6.52%
4. 7.32%

Short Answer Questions (3 questions) 

1. (15 POINTS) The following questions pertain to the Federal Reserve’s implementation of monetary policy over the past decade.

1. What is the zero lower bound (“ZLB”)? How does it constrain conventional monetary policy? Discuss very briefly (1-2 sentences).

The zero lower bound refers to the fact that interbank lending rates cannot be negative. Consequently, when such lending rates approach zero, traditional expansionary monetary policy cannot further reduce short term interest rates and consequently is unlikely to impact real economic activity. NOTE: the ZLB does not refer to the practice of charging negative interest rates on excess reserves as the Bank of Japan recently announced. 

1. Name three specific policy strategies proposed by macroeconomists to deal with adverse effects associated with the ZLB:

1. Aggressively lower short term rates when deflation or a severe downturn threatens.
2. Central bank should pledge to keep short term rates “lower for longer.” One way to accomplish this is via forward guidance, such as the Fed’s announcements regarding the likely timing of rate liftoff during the 2009-2014 period.
3. “Quantitative easing”: central bank purchases assets of longer duration such as longer-maturity government bonds

1. From the following list of assets, circle those that were purchased in significant quantities by the Federal Reserve from 2009-2014:

Agency debt and MBS

High-grade corporate bonds

Equities

Gold

US Treasury bills

US Treasury bonds

2.        (15 POINTS) Suppose that an on-the-run 6-month Treasury bill currently trades at $98.361 (per $100 of FV). In addition, an on-the-run 1-year Treasury note paying a 2.75% coupon semi-annually currently trades at $99.234.  What is the most you can say about the current trading price of an on-the-run 52-week Treasury bill? Recall that the latter is a discount bond.  

Write the PV of the 1-year Treasury note as