Investment and Money Market Instruments Quiz

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Questions and Answers

Which of the following statements about Eurodollars is true?

They yield lower interest rates than U.S. deposits.

They are primarily used for funding government projects.

They are deposits held exclusively in European banks.

They are dollar-denominated time deposits outside the U.S. (correct)

What characterizes a repurchase agreement (RP)?

It allows investors to buy stocks without margin requirements.

It entails a pledge of future income as collateral.

It is a short-term loan collateralized by securities. (correct)

It involves the sale of stocks with shared ownership.

In the context of money market instruments, what distinguishes LIBOR from other interest rates?

It is exclusively for time deposits in the United States.

It is the only rate applicable to government bonds.

It is the interest rate for loans between central banks.

It is the base rate for loans and derivatives among large banks. (correct)

What is one of the main characteristics of brokers' calls?

They allow brokers to call in loans if margins decrease. Signup and view all the answers

Which factor likely influences the quoted yields on money market instruments?

The par value of instruments relative to market conditions. Signup and view all the answers

What type of yield is typically associated with Commercial Paper?

Discount Signup and view all the answers

How is the yield on Municipal Bonds typically compared to Treasury Bonds?

Varies based on interest type and risk level Signup and view all the answers

For Treasury Inflation Protected Securities (TIPS), how is principal adjusted?

Aligned with changes in the Consumer Price Index Signup and view all the answers

Which of the following formulas correctly represents the relationship between taxable and tax-exempt yields?

rtax exempt = rtaxable × (1 - tax rate) Signup and view all the answers

Which of these instruments would typically NOT be classified under the Money Market Instruments category?

Municipal Bonds Signup and view all the answers

Which yield type is often used to measure the return of instruments in the Money Market?

Discount Yield Signup and view all the answers

What distinguishes Bankers’ Acceptances from other Money Market Instruments?

They are used for international trade Signup and view all the answers

Which calculation is essential for determining Bond Equivalent Yield?

Discount from face value Signup and view all the answers

How are Eurodollars primarily classified concerning their yield structure?

Bond Equivalent Yield Signup and view all the answers

Which characteristic is NOT associated with Commercial Paper?

Guaranteed by government agencies Signup and view all the answers

Which factor is considered when calculating the Bond Equivalent Yield for a T-bill?

The price paid for the T-bill Signup and view all the answers

When calculating the Bond Equivalent Yield, what does 'n' represent in the formula?

The number of days to maturity Signup and view all the answers

In the context of the formula for Bond Equivalent Yield, which scenario would lead to a higher yield?

A longer duration until maturity with a lower price paid for the T-bill Signup and view all the answers

How does the assumption of 360 days affect the yield calculations for money market instruments?

It increases the perceived yield by assuming more days than actual Signup and view all the answers

Which formula correctly describes how to calculate the Bond Equivalent Yield?

$(10,000 - P) / (P imes n) imes 365$ Signup and view all the answers

What does a Bond Equivalent Yield of 5.13% indicate in the given example?

The yield from the T-bill over its maturity period is equivalent to 5.13% annually Signup and view all the answers

Which aspect is NOT a consideration when adjusting the bank discount rate for comparison purposes?

The market conditions at the time of purchase Signup and view all the answers

Why can’t a T-bill be compared directly to a bond?

T-bills and bonds have different bases for yield calculations Signup and view all the answers

What does the variable 'P' represent in the Effective Annual Yield formula?

The price of the T-bill Signup and view all the answers

If the price of a T-bill is $9,875 and its face value is $10,000, what is the yield calculation based on the example provided?

0.0523 or 5.23% Signup and view all the answers

How is the Effective Annual Yield (rEAY) calculated in the formula?

Using the number of days to maturity as a factor Signup and view all the answers

What can be inferred if rEAY is greater than rBD?

The effective yield is higher than the bond discount yield. Signup and view all the answers

If the number of days to maturity increases, what effect does it have on rEAY assuming price remains constant?

Decreases rEAY Signup and view all the answers

What is the difference between Bond Equivalent Yield (rBEY) and Effective Annual Yield (rEAY)?

rEAY factors in compounding, while rBEY does not. Signup and view all the answers

Which of the following statements about money market instruments is accurate?

They include T-bills, commercial paper, and certificates of deposit. Signup and view all the answers

In the example calculation, what is the numerical value of 'n' when calculating rEAY for a T-bill?

90 days Signup and view all the answers

What would happen to the Effective Annual Yield if the price of a T-bill increases while the face value remains constant?

Decrease in rEAY Signup and view all the answers

Which yield is typically used to compare the short-term interest rates to long-term bond yields?

Bond Equivalent Yield (rBEY) Signup and view all the answers

What is the dividend yield if a stock is purchased for $50, pays a $1 dividend, and is sold for $54?

2% Signup and view all the answers

If a stock is bought for $50 and sold for $54, what is the capital gain yield?

8% Signup and view all the answers

What is the formula for calculating total return on a stock investment?

(PSell - PBuy + Div) / PBuy Signup and view all the answers

In a price-weighted average index, how is the average calculated?

By adding the prices and dividing by a divisor Signup and view all the answers

What characterizes a market value-weighted index?

Returns are proportional to market value of each security Signup and view all the answers

What is the method for constructing an equally weighted index?

Using the average return of selected securities Signup and view all the answers

In what way does the inclusion of dividends affect total returns in stock investments?

They increase the overall return Signup and view all the answers

What happens to the capital gains yield when a stock is sold for less than its purchase price?

It becomes negative Signup and view all the answers

Which scenario would lead to a higher total return?

A low dividend yield with a high capital gain Signup and view all the answers

What is indicated if a stock's capital gains yield is significantly higher than its dividend yield?

Both A and C are correct Signup and view all the answers

Study Notes

Investment Value

A year can be assumed to have 360 or 365 days, with 366 days for leap years.
Simple and compound interest are two important concepts in investment calculations.

Bond Equivalent Yield

Used to compare T-bills with bonds, considering 360 vs. 365 days and par vs. price paid.
The Bond Equivalent Yield (BEY) formula:
- rBEY = ($10,000 - P) * 365 / (P * n)
P: price of the T-bill
n: number of days to maturity

Money Market Instruments

Treasury Bills, Certificates of Deposit, Commercial Paper, Bankers’ Acceptances, Eurodollars, Federal Funds, Repurchase Agreements (RPs), and Reverse RPs are common money market instruments.

Money Market Instrument Yields

Different instruments might use different yields.
Factors influencing "quoted" yields include par value, price paid, and the number of days to maturity.

Money Market Instruments: T-Bills

Treasury Bills are short-term debt securities issued by the US government.
Sold at a discount to their face value and mature at par.
The yield is based on the discount rate.

Money Market Instruments: Certificates of Deposits

Certificates of Deposit (CDs) are time deposits at banks, with a fixed interest rate and maturity date.
Issued by banks and offered to investors.
Yield is calculated using the bond equivalent yield.

Money Market Instruments: Commercial Paper

Commercial Paper is short-term unsecured debt issued by corporations to finance working capital.
Maturity typically less than 270 days
Yield is based on the discount rate.

Money Market Instruments: Bankers’ Acceptances

Bankers’ Acceptances are time drafts guaranteed by a bank.
Used for international trade financing.
The yield is based on the discount rate.

Money Market Instruments: Eurodollars

Eurodollars are dollar-denominated time deposits held in banks outside the United States.
Yield is based on the bond equivalent yield.

Money Market Instruments: Federal Funds

Federal Funds are overnight loans between banks, providing liquidity to the banking system.
The Federal Funds rate is a key interest rate in the economy.
Yield is based on the bond equivalent yield.

Money Market Instruments: Repurchase Agreements (RPs)

Repurchase Agreements (RPs) are short-term, collateralized loans where securities are sold with a promise to repurchase at a higher price.
Many RPs are overnight, but "term" RPs can have maturities of up to a month.

Money Market Instruments: Reverse RPs

Reverse RPs are the opposite of RPs.
Involves lending money and receiving security title as collateral.

Money Market Instruments: Brokers’ Calls

Brokers’ Calls are loans taken by investors buying stock on margin.
The call money rate is applied to these loans, and the broker can "call in" the loan.

Effective Annual Yield (EAY)

The EAY is the annualized yield taking into account the effect of compounding.
It provides a more accurate measure of the actual return on an investment.
EAY formula:
- rEAY = (1 + ($10,000 - P) / P) ^ (365/n) - 1
P: price of the T-bill
n: number of days to maturity

Capital Market: Fixed-Income Instruments

Government Issues: U.S. Treasury Bonds and Notes are long-term debt obligations issued by the U.S. government.
Bonds have maturities of 10 years or more.
Notes have maturities of less than 10 years.
Denomination is $1,000, with interest paid semi-annually.
Treasury Inflation Protected Securities (TIPS) are issued by the U.S. Treasury with principal adjusted for changes in the Consumer Price Index.
TIPS are marked with a trailing "i" in quote sheets.

Capital Market: Municipal Bonds

Municipal bonds are debt securities issued by state and local governments.
They are generally tax-exempt at the federal level, which makes them attractive to investors in high tax brackets.
Risks related to the issuer's creditworthiness and tax status.
Municipal bonds can be divided into two primary categories: general obligation (G.O.) bonds and revenue bonds.
General Obligation (G.O.) bonds are backed by the full faith and credit of the issuer.
Revenue bonds are backed by the revenue generated by a specific project or facility.
Industrial Development bonds are used to finance projects for private businesses.
Taxation: rtax exempt = rtaxable * (1 - tax rate).

Bond Market: Equivalent Taxable Yields

The Equivalent Taxable Yield is a bond's effective return after considering its tax exemption.
The formula used to calculate the equivalent taxable yield: rtax exempt = rtaxable * (1 - tax rate).

Stock Market: Returns

Equity securities represent ownership in a company.
Total Return can be further divided into:
Dividend yield: percentage of the investment return based on dividends.
Capital gains yield: percentage of the investment return based on the increase in the stock price.
Total Return = (PSell − PBuy + Div) / PBuy.
Dividend Yield = Div / PBuy.
Capital Gains Yield = (PSell − PBuy) / PBuy.

Stock and Bond Market Indexes

Market indexes track the performance of a group of securities.
Weighting schemes can differ:
Price-weighted average: Sum of prices divided by a "divisor".
Market value-weighted index: Weighted average return of each security, based on market value.
Equally weighted index: Simple average of returns.

Stock and Bond Market Indexes: Weighting schemes

Stock weighting is important in index construction.
Price-weighted indexes give more weight to higher priced stocks.
Value-weighted indexes give more weight to stocks with larger market capitalization.
Equally weighted indexes treat every stock as equally important.
These differences can lead to variations in index performance.

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Description

Test your knowledge on investment values, bond equivalent yields, and various money market instruments. This quiz covers key concepts in calculating yields, especially focusing on Treasury Bills and other short-term securities. Dive deep into the formulas and factors influencing investment returns.