CBE CBE Financial Markets and Instruments 2 — Questions and Answers
Question 1: The equity risk premium (ERP) is best defined as:
- The return on risk-free government bonds
- The excess return investors demand for holding stocks over risk-free assets (Correct answer)
- The volatility of the stock market index
- The dividend yield of the S&P 500
Correct answer: The excess return investors demand for holding stocks over risk-free assets
The ERP is the additional return investors expect from equities above the risk-free rate as compensation for bearing greater risk.
Question 2: In the U.S. capital markets, which regulatory body oversees securities exchanges and broker-dealers?
- Federal Reserve
- FDIC
- SEC (Correct answer)
- OCC
Correct answer: SEC
The Securities and Exchange Commission (SEC) regulates U.S. securities markets, exchanges, and investment firms to protect investors.
Question 3: A futures contract differs from a forward contract primarily because futures contracts are:
- Negotiated privately between two parties
- Standardized and traded on exchanges (Correct answer)
- Only used for currency hedging
- Not subject to margin requirements
Correct answer: Standardized and traded on exchanges
Futures contracts are standardized, exchange-traded agreements with daily mark-to-market settlement, unlike over-the-counter forward contracts.
Question 4: Which of the following best describes an asset-backed security (ABS)?
- A stock issued by an asset management company
- A bond secured by collateral in the form of pooled financial assets (Correct answer)
- A derivative contract tied to commodity prices
- A government bond backed by tax revenue
Correct answer: A bond secured by collateral in the form of pooled financial assets
An ABS is a financial instrument backed by a pool of underlying assets such as auto loans, credit card receivables, or mortgages.
Question 5: Market capitalization of a publicly traded company is calculated as:
- Total assets minus total liabilities
- Net income divided by shares outstanding
- Share price multiplied by total shares outstanding (Correct answer)
- Book value per share times shares outstanding
Correct answer: Share price multiplied by total shares outstanding
Market capitalization equals the current share price multiplied by total shares outstanding, reflecting the market's total valuation of the company.
Question 6: The Federal Open Market Committee (FOMC) primarily influences financial markets by:
- Setting corporate income tax rates
- Regulating stock market trading rules
- Setting the federal funds rate target (Correct answer)
- Approving corporate bond issuances
Correct answer: Setting the federal funds rate target
The FOMC meets eight times per year to set the target range for the federal funds rate, which influences borrowing costs throughout the economy.
CBE CBE Financial Markets and Instruments 2
The equity risk premium (ERP) is best defined as: