Rotman School of Management

University of Toronto

RSM 230 – Mid Term Exam

November 11, 2011

INSTRUCTIONS:

You have 90 minutes for this exam.

Complete your Scantron and use it to answer Part A of the exam.
Answer Part B directly on this exam in the space provided.
All cell phones and portable electronic devices must be turned off.

This is a closed book exam. No formula sheet is allowed.

No calculators are permitted.

Please remain in your seats during the last 15 minutes of the exam period so
you do not disturb others.

PLEASE SUPPLY THE FOLLOWING INFORMATION:

Student #__________________ Student Name___________________

Circle your Instructor’s Name: Booth Huggins

Please indicate your class time:

Tuesday: 8:00-10:00
Tuesday:10:00-12:00
Tuesday 6:00-8:00
Wednesday 8:00-10:00
Wednesday 10:00-12:00

1
PART A – Multiple choice questions. (75% of total grade)
Please answer in pencil on the Scantron provided. All questions have equal
weight (75% weight)

1. The three most important real assets in the economy are:

a) Residential and non-residential structures and inventories

b) Consumer durables, machinery and equipment and residential structures
c) Land and residential and non-residential structures
d) Net foreign assets, land and non-residential structures
e) Land, residential structures and consumer durables

2. Generally in the Canadian financial system:

a) Firms and Households lend and Government borrows,

b) Non-residents, Government and Households all borrow
c) Households lend and all others borrow
d) Government and Households lend and Firms borrow
e) None of the above

3. The current Bank Rate and Prime are:

a) 3.25% and 1.50%

b) 1.25% and 3.25%
c) 1.25% and 3.00%
d) 1.00% and 3.00%
e) None of those combinations

4. Financial intermediation is designed to reduce all the following problems of direct

intermediation except:

a) Liquidity costs
b) Inflationary costs
c) Search costs
d) Information costs
e) Contracting costs.

5. The following are all examples of financial intermediaries except:

a) Mutual funds, credit unions and chartered banks

b) Pension funds, trust companies and credit unions
c) Mutual funds, insurance companies and chartered banks
d) Investment broker dealers, chartered banks and credit unions
e) All of the above are examples of financial intermediaries

2
6. Asset transformation occurs when the following happens:

a) Insurance companies issue life insurance policies

b) Securities dealers set up discount brokerage accounts
c) Banks create money through chequing account liabilities
d) Pension funds establish defined benefit pension plans
e) All of the above

7. All of the following are features of commercial paper except:

a) They are generally discount notes

b) They are sold by large companies primarily to big institutions
c) They are largely sold via a prospectus to retail investors
d) Usual terms are for 30, 60 or 90 days
e) All the issuers are rated by DBRS and S&P

8. Money market securities are traded

a) On the Toronto Stock Exchange

b) On the Vancouver Stock exchange
c) On Thursdays via an auction; the same as Treasury bills
d) Continuously by selling to a buyer via an investment dealer
e) Once a week through an auction marketed by a chartered bank

9. If one year commercial paper has a yield of 8% and a similar Treasury Bill 5%, then
the implied default probability with a zero payoff is:

a) Can’t be determined from the data provided

b) 97.2%
c) 3.78%
d) 96.22%
e) 2.78%

10. The interest rate difference between Treasury bills and Bankers Acceptances indicates
the:

a) Mark-up charged by banks when they lend out deposits

b) Perceived riskiness of banks relative to the government
c) Default probability of the government
d) Real rate of return on government bonds
e) Difference between the Bank of Canada’s lending rate and Prime

3
11. If a 90 day US Government Treasury Bill with a $1000 face value is sold at a 4%
discount, its effective yield is:

a) 16%
b) 4.167%
c) 17.71%
d) 16.67%
e) None of the above

12. The interest rate that the Bank of Canada charges on purchase and resale agreements
(PRAs) is called

a) The discount rate

b) The Bank rate
c) The Prime rate
d) The LIBOR rate
e) The Banker’s Acceptance or BA rate

13. Which of the following bonds would you hold if you believe that interest rates will
decrease by 1% over the next few months?

a) Government of Canada 6% maturing on June 1, 2020

b) Government of Canada 1% maturing on June 1, 2020
c) Government of Canada 6% maturing on June 1, 2030
d) Government of Canada 1% maturing on June 1, 2030
e) None of the above

14. Core CPI will always be lower than Headline CPI if:

a) Food prices are rising relative to the rest of the CPI basket
b) Energy prices are falling relative to the rest of the CPI basket
c) The Bank of Canada's inflation targets are exceeded
d) Both energy and food prices are rising relative to the rest of the CPI basket
e) The Bank of Canada's growth estimates are exceeded

15. The following options are sometimes included in bond indentures except

a) The option to retract the maturity of the bond

b) The option to convert a corporate bond into the underlying common shares
c) The option to sell (put) the bond back to the company in the event of a takeover
d) The option not to make interest payments at the discretion of the issuer
e) All of the above are sometimes included

4
16. A 5 year maturity 6% semi-annual coupon bond is selling for $900, what is its
approximate semi-annual yield to maturity?

a) 6%
b) 3.2%
c) 4.2%
d) 8.4%
e) 8.6%

17. As of this Fall the correct ranking in terms of yields for the following sovereigns is:

a) Ireland > Greece > Germany

b) Greece > Germany > Ireland
c) Greece < Ireland > Germany
d) Greece > Ireland > Germany
e) Ireland>Greece>Germany

18. A Bankers Acceptance in Canada involves all of the following except:

a) Arises as a result of international trade

b) Involves a bank guarantee of commercial paper
c) Generates fee income for the bank
d) Allows a non-investment grade credit to access the money market
e) All of the above are involved

19. A typical securitization of mortgages in the US involved all of the below except

a) A mixture of mortgages around the US to diversify risk

b) A maximum loan to value ratio of 85%
c) Documentation verifying the mortgagee’s income
d) The absence of a teaser or low initial interest rate
e) None of the above

20. Which of the following statements about the Bank of Canada are not true

a) The Bank of Canada is a Federal Crown Corporation

b) The Governor of the Bank of Canada is appointed by Parliament after a general
election
c) The Deputy Minister of Finance sits on the main policy committee of the Bank of
Canada
d) The Federal Government has ultimate authority over monetary policy
e) There are 12 directors of the Bank of Canada that appoint both the Governor and the
Deputy Governor of the Bank

5
21. The following are all benefits of low inflation except

a) Reduces uncertainty and contracting problems

b) Avoids inflationary spirals
c) Increases the spread between the real and nominal bond yield
d) Fosters confidence in the financial system
e) Preserves purchasing power for those on fixed incomes

22. Which of the following statements about the spread between the yield on long term
bonds and treasury bills is not correct:

a) Currently indicates recession in Canada since it has been increasing

b) Gets smaller as we approach the top of the business cycle
c) Reflects the actions of the central bank in changing the overnight rate
d) Is very large in the US as they are still recovering from the recession
e) All of the above are correct

23. In Basel 1 a bank with $200 in residential mortgages, $100 in sovereign loans, $400
in corporate loans and a $300 line of credit extended to another bank would have the
following:

a) On balance sheet risk adjusted credit of $1,000

b) Total risk adjusted credit exposure of $800
c) Total credit exposure of $700
d) On balance sheet risk adjusted credit exposure of $600
e) None of those values

24. Tier 1 capital in Basel 1 is:

a) Not allowed to exceed the Cooke Ratio

b) Must be made up of mostly long term subordinated debt and preferred shares
c) Set at a minimum of 8% of total assets
d) Must be made up of at least 50% common equity
e) Is set at 4% of risk weighted assets

25. Basel 3 involves all of the following except:

a) A liquidity ratio that ensures banks can cover 30 days of new cash flows
b) A capital conservation buffer to offset a downturn
c) An increased minimum common equity ratio to 4.5%
d) A new overall leverage ratio of 3.0%
e) Increased dependence on wholesale money market deposits

6
PART B – Short Answer Questions. (25% of total grade)
Please answer briefly on this paper in the space provided. All questions have
equal weight.
1. Why is the size of a central bank’s balance sheet important and explain what
major factors have influenced its recent change in both the US and Canada.

7
2 How does a stock market help solve some of the basic problems that make non-
market intermediation inefficient?

8
3) Explain the Cooke ratio in Basel 1 and discuss how its implementation may have
inadvertently contributed to the financial crisis in the US and also in Europe. That
is, what are the weights on different loan groups and what loans have contributed
to the recent and current crises?

9
4) Discuss the difference between positive and negative covenants in a bond contract
and give an example of each.

10
5) A City of Toronto councilor has proposed that the City start a bank as a way of
paying off the City’s debt, solving its deficit problems, funding “worthwhile”
loans and using the City’s property tax revenues as an asset. Evaluate whether this
proposal makes sense in terms of the basic areas in bank management.

11