FIN 3403 Exam 1 Corrections

4. You read a headline that the Ukraine crisis has “rolled capital markets.” Based on your
understanding of the meaning of the capital markets, the price of which of the following
securities is Least likely to have been affected? (Hint: which security is not part of capital
markets?)
A) 3-month U.S Treasury bills
B) 10-year U.S. Treasury bonds
C) Shares of Tesla stock
D) A BBB-rated corporate bond maturing in two years
E) The SPDR S&P 500 trust [ticker: SPY], an exchange-traded fund designed to track the S&P
500 stock market index.

Me: B
Correct: A

Reason: 3-month U.S Treasury bills are not part of the capital markets compared to treasury
bonds.

23) Suppose marginal tax rates increase. This would likely have the effect of _____ the
demand for municipal bonds and _______ the demand for U.S. Treasury bonds.
A) Increasing; Increasing
B) Increasing; Decreasing
C) Decreasing; Increasing
D) Decreasing; Decreasing

Me: C
Correct: B

Reason: The demand for municipal bonds will increase muni bonds to not pay a marginal tax
rate on the bond compared to U.S Treasury bonds

26.) The liquidity premium theory of the term structure of interest rates:
A) indicates that today's long-term interest rate equals the average of short-term interest rates that
people expect to occur over the life of the long-term bond.
B) assumes that bonds of different maturities are perfect substitutes.
C) predicts a flat yield curve
D) predicts yield curves that are more steeply upward sloping than those predicted by pure
expectations theory

Me: A
Correct:
Reason: Liquidity premium theory is defined as investors will pay more for short term bonds that
return high liquidity. The high liquidity allows them to transfer them to cash more easily.

27.) When the yield curve is upward sloping:

A) expectations theory predicts that short-term interest rates are expected to fall
B) expectations theory predicts that short-term interest rates are expected to rise
C) market segmentation theory predicts that short-term interest rates are expected to fall
D) liquidity premium theory predicts that short-term interest rates are expected to fall

Me: B
Correct: A

Reason: Expectations theory tries to predict what the short term interest rates will be in the
future using the known long-term rates today. So when there is a rise in interest rates, the yields
will rise and bond prices will decrease.

34.) Why are the Fed’s goals sometimes called the “dual mandate” even though there are
three
goals?
A) If prices are stable then employment will be high.
B) To achieve moderate long-term interest rates, inflation must be low.
C) If employment is high then moderate long-term interest rates will be high.
D) Low inflation and high employment are effectively the same goal.

Me: C
Correct: B

Reason: If you have moderate long-term rates it is not likely you will have high inflation, so it
must be low.

35.) True or False: If the Fed lowers interest rates it will decrease unemployment in the
short-run and help prevent inflation.
A) True
B) Fasle

Me: A
Correct: B

Reason: Unemployment and inflation are inversely related, so when interest rates decrease this
will decrease unemployment but at the same time increase inflation.
38.) Which of the following is true about the discount window and the federal funds rate:
A) The discount window saw extensive use during the Great Recession of 2007-2009.
B) The discount rate is set above the fed funds rate target.
C) The Fed directly sets the fed funds rate.
D) All of these are true.

Me: D
Correct: C

Reason: The Fed will set the federal funds rate that the depository institutions—banks, savings
and loans, and credit unions, charge one another overnight.

5 Things I Learned
1. The Fed will set the federal funds rate that the depository institutions—banks, savings
and loans, and credit unions, charge one another overnight. I guess i never thought about
it like this.
2. Unemployment and inflation are inversely related, so when interest rates decrease this
will decrease unemployment but at the same time increase inflation. I did not know these
would be inversely related.
3. 3-month U.S Treasury bills are not part of the capital markets compared to treasury
bonds.
4. The demand for municipal bonds will increase muni bonds to not pay a marginal tax rate
on the bond compared to U.S Treasury bonds
5. Expectations theory tries to predict what the short term interest rates will be in the future
using the known long-term rates today. So when there is a rise in interest rates, the yields
will rise and bond prices will decrease.