G345 EXAM 1 QUESTIONS AND ANSWERS
Functions of Money - Answers - medium of exchange, unit of account, store of value
Medium of Exchange - Answers - generally accepted as payment for goods and
services and in the repayment of debt
promotes efficiency by eliminating double coincidence of wants and allows for
specialization of labor
distinguishes money from other assets
Unit of Account - Answers - used to measure value in the economy, thus reduces
number of prices needed in the economy
Store of Value - Answers - is a repository of purchase value over time
Wealth - Answers - total collection of pieces of property that serves to store value
(stock)
Income - Answers - flow of earnings per unit of time
Fiat Money - Answers - Paper currency decreed by a government as legal tender
commodity money - Answers - objects that have value in themselves and that are also
used as money
M1` - Answers - includes currency, checkable deposits, traveler's checks
m2 - Answers - includes m1 plus short term investments (small denomination time
deposits, savings deposits, mmda's, money market mutual fund shares)
Gresham's Law - Answers - observation that bad money drives out good money. People
hoard good money and break it down into more of the valuable substance
Chapter 2: Understanding Interest Rates - Answers -
Yield to Maturity - Answers - interest rate that equates the PV of future cash flows of a
debt instrument to it's PV today
most accurate measure of interest rates
Consol/Perpetuity - Answers - a bond with no maturity date that does not repay principal
but pays fixed coupon payments forever
, interest rate equals current yeild i=c/P
Relationship Between Price and YTM - Answers - Price and YTM are negatively related
Return vs. Interest Rate - Answers - Return- how well a person does by holding a bond
or any other security over a particular time period
Does NOT necessarily equal the YTM
Current Yeild+Cap Gains Yeild= Return
Key Findings about Interest Rates and Returns - Answers - 1.) When term to maturity
equals the holding period, the return equals yeild.
2.) For bonds with a maturity greater than the holding period, interest rate increases
causes prices to fall, reducing return and creating a capital loss
3.) Longer the maturity, greater is price changed associated with interest rate changes
4.) Longer the maturity, greater is return change associated with interest rate changes
5.)Bonds with high interest rates initially can still have negative returns if interest rate
rises substantially
Interest Rate Risk - Answers - riskiness of an asset's return that results from interest
rate changes
Conclusion about Volatility and Maturity - Answers - Prices and returns for long-term
bonds are more volatile than those for short-term bonds due to higher interest rate risk
There's no interest rate risk when holding period equals the time to maturity for the bond
Duration - Answers - the weighted average of the time it takes to receive each of the
bond's cash flows
Duration Facts - Answers - 1.) Longer the term to maturity, the longer the duration
2.) When interest rates rise, duration falls
3.)the higher the coupon rate, the shorter the duration
4.) Duration is additive
Real Interest Rate - Answers - interest rate that is adjusted for expected inflation
When real is low, there are great incentives to borrow, but not to lend
Functions of Money - Answers - medium of exchange, unit of account, store of value
Medium of Exchange - Answers - generally accepted as payment for goods and
services and in the repayment of debt
promotes efficiency by eliminating double coincidence of wants and allows for
specialization of labor
distinguishes money from other assets
Unit of Account - Answers - used to measure value in the economy, thus reduces
number of prices needed in the economy
Store of Value - Answers - is a repository of purchase value over time
Wealth - Answers - total collection of pieces of property that serves to store value
(stock)
Income - Answers - flow of earnings per unit of time
Fiat Money - Answers - Paper currency decreed by a government as legal tender
commodity money - Answers - objects that have value in themselves and that are also
used as money
M1` - Answers - includes currency, checkable deposits, traveler's checks
m2 - Answers - includes m1 plus short term investments (small denomination time
deposits, savings deposits, mmda's, money market mutual fund shares)
Gresham's Law - Answers - observation that bad money drives out good money. People
hoard good money and break it down into more of the valuable substance
Chapter 2: Understanding Interest Rates - Answers -
Yield to Maturity - Answers - interest rate that equates the PV of future cash flows of a
debt instrument to it's PV today
most accurate measure of interest rates
Consol/Perpetuity - Answers - a bond with no maturity date that does not repay principal
but pays fixed coupon payments forever
, interest rate equals current yeild i=c/P
Relationship Between Price and YTM - Answers - Price and YTM are negatively related
Return vs. Interest Rate - Answers - Return- how well a person does by holding a bond
or any other security over a particular time period
Does NOT necessarily equal the YTM
Current Yeild+Cap Gains Yeild= Return
Key Findings about Interest Rates and Returns - Answers - 1.) When term to maturity
equals the holding period, the return equals yeild.
2.) For bonds with a maturity greater than the holding period, interest rate increases
causes prices to fall, reducing return and creating a capital loss
3.) Longer the maturity, greater is price changed associated with interest rate changes
4.) Longer the maturity, greater is return change associated with interest rate changes
5.)Bonds with high interest rates initially can still have negative returns if interest rate
rises substantially
Interest Rate Risk - Answers - riskiness of an asset's return that results from interest
rate changes
Conclusion about Volatility and Maturity - Answers - Prices and returns for long-term
bonds are more volatile than those for short-term bonds due to higher interest rate risk
There's no interest rate risk when holding period equals the time to maturity for the bond
Duration - Answers - the weighted average of the time it takes to receive each of the
bond's cash flows
Duration Facts - Answers - 1.) Longer the term to maturity, the longer the duration
2.) When interest rates rise, duration falls
3.)the higher the coupon rate, the shorter the duration
4.) Duration is additive
Real Interest Rate - Answers - interest rate that is adjusted for expected inflation
When real is low, there are great incentives to borrow, but not to lend
