These are original Marlbridge practice questions, not past exam questions. All questions use Valdoria, a fictional country whose currency is the valda (VD); all people, prices and rates are fictional. The rubrics are a suggested Marlbridge rubric to help you check your work; they are not an official scoring guideline. Assumptions: cash and demand deposits pay no interest unless stated; bond issuers pay in full; a four-function calculator is enough; round money to VD 0.01.
Question 1 (multiple choice · foundation)
Which of the following assets is the most liquid?
- (A) A ten-year Valdorian government bond
- (B) Shares in a Valdorian mining company
- (C) A balance in a checking account that can be spent by debit card at any time
- (D) A savings certificate that cannot be cashed until two years from now
Answer and explanation
Answer: (C). A checking-account balance is a demand deposit. It can be spent at once without losing value, so it is one of the most liquid forms of money, alongside cash.
- (A) A bond must be sold before it can be spent, and its price may have changed, so it is less liquid.
- (B) Shares must also be sold first, and their price can move sharply, so they are less liquid still.
- (D) A locked certificate cannot be used at all for two years, so it is very illiquid.
Question 2 (multiple choice · core)
The market interest rate on new Valdorian government bonds rises from 5% to 7%. What happens to the price of bonds issued last year at 5%, and to the rate of return a new buyer earns on them?
- (A) The price rises, and the buyer’s rate of return rises.
- (B) The price falls, and the buyer’s rate of return rises.
- (C) The price falls, and the buyer’s rate of return falls.
- (D) The price is unchanged, because the interest payment on the bond is fixed.
Answer and explanation
Answer: (B). The old bonds pay fixed interest that is now below the market rate. Their price must fall until a buyer earns about 7%, the same as on new bonds. A lower price for the same fixed payments means a higher rate of return.
- (A) has the price moving the wrong way. Bond prices and interest rates are inversely related.
- (C) gets the price right but not the return. Paying less for the same payments raises the return.
- (D) is true about the payment but wrong about the price. Because the payment is fixed, the price is what adjusts.
Question 3 (multiple choice · core)
A previously issued bond will pay its owner VD 2,140 in one year (face value VD 2,000 plus 7% interest). The market interest rate on similar new one-year bonds falls to 5%. What price will buyers now pay for the bond?
- (A) VD 1,963.30
- (B) VD 2,000.00
- (C) VD 2,038.10
- (D) VD 2,100.00
Answer and explanation
Answer: (C). Price = 2,140 ÷ 1.05 = VD 2,038.10. Check: (2,140 − 2,038.10) ÷ 2,038.10 × 100 = 5.00%, the new market rate.
- (A) is 2,140 ÷ 1.09: it treats a fall in rates as a rise of 2 points. A lower market rate must give a higher price.
- (B) is the price at the original 7% rate. It ignores the change in market rates.
- (D) is 2,000 × 1.05, the amount a new VD 2,000 bond would pay back at 5%. It is not what buyers would pay for this bond.
Question 4 (multiple choice · core)
What is the opportunity cost of holding wealth as money?
- (A) The fall in the purchasing power of money when prices rise
- (B) The interest that could have been earned by holding other financial assets, such as bonds
- (C) The fees a bank charges to run a checking account
- (D) The price that must be paid to buy a bond
Answer and explanation
Answer: (B). The best alternative to holding money is an interest-bearing asset. The interest given up is the opportunity cost.
- (A) describes a cost of inflation (Topic 2.5). Bonds and other assets with fixed money payments also lose purchasing power, so this is not what you give up by choosing money.
- (C) is a possible explicit cost of one account, not the value of the best alternative.
- (D) is a payment for a different asset, not a cost of holding money.
Question 5 (calculation · core)
A Valdorian bus company keeps an average of VD 40,000 in a demand deposit to pay wages and fuel bills.
(a) Bonds pay 6% a year and the deposit pays nothing. Calculate the yearly opportunity cost of holding the money. (b) The bond rate falls to 3%. Calculate the new opportunity cost. (c) Predict how the company is likely to change the amount it holds as money after the change in (b). Explain. (d) Suppose instead that the deposit pays 1% and bonds pay 6%. Calculate the opportunity cost.
Worked solution
(a) 40,000 × 0.06 = VD 2,400 a year.
(b) 40,000 × 0.03 = VD 1,200 a year.
(c) Holding money now costs half as much in interest forgone, so the company is likely to hold more money (and fewer bonds). The benefit of liquidity is the same, but its cost has fallen.
(d) The company gives up the extra interest only: 40,000 × (0.06 − 0.01) = VD 2,000 a year.
Suggested mark points (4): 1 each for (a) and (b); 1 for (c), which must link the lower interest rate to a lower opportunity cost; 1 for (d) using the difference in rates.
Question 6 (constructed response · core)
Leila has VD 15,000. She needs VD 3,000 of it to pay her rent next week. She is saving the remaining VD 12,000 for her child’s university fees in twelve years. She can choose between cash, a demand deposit, Valdorian government bonds and shares in Valdorian companies.
(a) Define liquidity. (b) Identify the most suitable asset for the rent money. Explain using liquidity. (c) Explain one reason why Leila might hold shares rather than bonds for the university savings. (d) Explain one reason why she might prefer bonds to shares for the university savings.
Worked solution and suggested Marlbridge rubric
(a) Liquidity is how easily and quickly an asset can be used to buy things, or turned into money, without losing value.
(b) A demand deposit (or cash). She must pay in a week. A demand deposit can be spent at once without any loss of value, whereas bonds or shares would have to be sold, perhaps at a lower price than she paid. (Cash is equally liquid; accept either.)
(c) Over twelve years she does not need liquidity. Shares offer a higher expected rate of return than bonds, so her savings are likely to grow more, and she has time to wait for prices to recover if they fall.
(d) Shares carry more risk: their prices can fall sharply, and nothing is promised. Bonds pay a fixed interest income, so the result is more predictable. If she cannot afford to lose part of the fund, the lower risk may matter more than the higher expected return.
| Point | What earns it |
|---|---|
| 1 | Correct definition of liquidity, including spending or converting without loss of value |
| 1 | Demand deposit or cash, justified by liquidity and the need to pay soon |
| 1 | Shares: higher expected return, linked to the long time horizon |
| 1 | Bonds: lower risk or more predictable fixed interest |
Answers that say “shares are better” or “bonds are better” with no attribute named do not earn the point.
Question 7 (constructed response · stretch)
A Valdorian bank bought a one-year bond for VD 5,000 when the market interest rate was 6%. The bond pays VD 5,300 at maturity. Before the bank can resell it, the market interest rate on similar one-year bonds rises to 8%. The rate changes in this question happen so soon after the purchase that you should treat the bond as still having one full year to maturity.
(a) Calculate the price the bank can now get for the bond. (b) Calculate the bank’s capital loss if it sells at that price. (c) Explain why no buyer would pay VD 5,000 for this bond now. (d) Later, market interest rates fall to 4%. Calculate the new price of the bond and the rate of return a buyer would earn at that price.
Model answer and suggested Marlbridge rubric
(a) 5,300 ÷ 1.08 = VD 4,907.41.
(b) 5,000 − 4,907.41 = VD 92.59.
(c) At VD 5,000 the bond returns only VD 300, which is 6%. A new bond earns 8%. A buyer with VD 5,000 would choose the new bond, so the old bond can only be sold at a lower price, one that gives the buyer 8%: (5,300 − 4,907.41) ÷ 4,907.41 × 100 = 8.00%.
(d) 5,300 ÷ 1.04 = VD 5,096.15. Return = (5,300 − 5,096.15) ÷ 5,096.15 × 100 = 4.00%. The price has risen and the return has fallen to the new market rate, which shows the inverse relationship again.
| Point | What earns it |
|---|---|
| 1 | VD 4,907.41 |
| 1 | Capital loss of VD 92.59 (carried forward from (a) if needed) |
| 1 | Explains that buyers can earn more on new bonds, so the old bond’s price must fall until its return matches the market rate |
| 1 | VD 5,096.15 and a return of 4.00% |
In (c), “bond prices and interest rates are inversely related” with no reasoning does not earn the point.
How did you do?
- Q1 or Q6(a)–(b) wrong: re-read “The three attributes: liquidity, rate of return and risk” in the study guide.
- Q2, Q3 or Q7 wrong: revisit “Bond prices and interest rates” and Worked example 1.
- Q4 or Q5 wrong: revisit “Why the opportunity cost of holding money is interest” and Worked example 2.
- Q6(c)–(d) wrong: look again at the return and risk patterns in the asset table.
Then tick off the topic checklist.