- When people use money by trading it for goods and services, money is serving the role of a a. medium of exchange.
- unit of account. c. store of value.
- standard of deferred payment.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- As a medium of exchange, money makes exchanges easier by reducing a. inflation.
- transactions costs.
- c. production costs of
- legal costs in negotiating loan contracts.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- Costs of trading are referred to as costs. a. trading
- menu
- c. shoe-leather transactions
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- When two producers are trading without money, each must want what the other produces. This requirement is referred to as
- a. the barter
- double coincidence of wants.
- c. comparative
- specialization in production.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- Which of the following functions of money encourages specialization in the production of goods and services?
- a. Unit of account
- Store of value
- c. Standard of deferred payments
- Medium of exchange
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- When money is used as a value in which prices are denoted, money is serving the role of a a. medium of exchange.
- unit of account. c. store of value.
- standard of deferred payment.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- Gresham’s Law states that
- a. the more you make, the more you b. bad money drives out good money.
- c. money supply creates its own
- money is not a suitable medium of exchange.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: Gresham’s Law and Money in P.O.W. Camps
OTHER: Factual
- According to Gresham’s law
- a. the product of the money supply and velocity of money is always equal to the transactions demand for b. increases in interest rates increases the speculative demand for money.
- c. whenever there are two different types of money circulating, people hoard the good one, and use the bad one as a medium of
- as an economy grows, the inequality in the distribution of income in the economy initially increases, then reaches a maximum, after which it eventually decreases.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: Gresham’s Law and Money in P.O.W. Camps
OTHER: Factual
- When people keep money for some period instead of spending it or investing it, money is serving the role of a a. medium of exchange.
- unit of account. c. store of value.
- standard of deferred payment.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- 10. Inflation affects money by
- a. increasing money’s efficiency as a medium of b. limiting money’s role as a store of value.
- c. reducing the supply of
- reducing transactions and search costs.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- 11. Higher the rate of inflation
- a. slower will be the rate at which money will lose b. lower will be the will to spend money.
- c. lower will be the will to hold
- lower will be the will to invest money.
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate
TOPICS: How We Use Money
OTHER: Conceptual
- 12. Hyperinflation occurs when
- a. the inflation rate is extremely
- a dollar today has the same real value as one million dollars last year. c. the inflation rate is negative.
- the inflation rate is positive and below 10%.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- 13. An inflation rate exceeding 50 percent per month is referred to as a.
- deflation.
- c.
- core inflation.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
- 14. When you buy something one day and pay for it later, the repayment you make is denoted in terms of money. In this case, money is serving the role of a
- a. medium of b. unit of account.
- c. store of
- standard of deferred payment.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- 15. The law states that a lender must accept money in the repayment of debts. This means that money is a a. unit of
- medium of exchange.
- c. facilitator of barter d. legal tender.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- 16. If money is a legal tender, it implies that a must accept in the repayment of debts, by a. lender; only non-monetary payments
- borrower; money
- c. borrower; only non-monetary payments lender; money
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- 17. Which of the following is NOT a function of money?
- a. It acts as a medium of b. It acts as a Store of value.
- c. It enables barter
- It can be used as a standard of deferred payment.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How We Use Money
OTHER: Factual
- 18. The set of mechanisms used for making transactions is called the a. outside money
- payments system.
- c. inside money
- standard of deferred payments.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 19. Outside money is
- a. money created by the government or by
- money created by the private sector, such as checking accounts at banks. c. foreign currency.
- checks that are in the process of clearing but have not cleared yet.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 20. Money whose value is determined by its value as a material is referred to as
- a. inside b. outside money.
- c. commodity d. artificial money.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
- 21. If money is gold or silver, it is called money a. fiat
- inside
- c. commodity glitter
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 22. Another name for commodity money is a. fiat
- glitter money.
- c. full-bodied d. inside money.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 23. Which of the following statements is true of commodity money?
- a. The manufacturing cost is cheaper than that of fiat b. Large quantities of commodity money may not be portable.
- c. The most common example of commodity money is paper
- Commodity money has value because it is decreed by the government.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 24. Money that has value in large part by the government’s proclamation is known as a. fiat
- M1.
- c. full-bodied d. inside money.
ANSWER: a
- 25. S. currency is currently a. representative money. b. full-bodied money.
- c. inside d. fiat money.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 26. Which of the following statements correctly identifies a disadvantage of fiat money?
- a. It is very expensive to
- It cannot be used for international transactions. c. It is possible to create counterfeit fiat money.
- It can be created only in the private sector.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 27. Which of the following statements correctly differentiates between commodity money and fiat money?
- a. Commodity money is created by the government while fiat money is created in the private b. Fiat money is created by the government while commodity money is created by the government.
- c. Commodity money can be used for transactions in the international market, while fiat money cannot be used for transactions in the international
- Fiat money has value decreed by the government, while commodity money is valued because of the material it is made of.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 28. Money that is created in the private sector, such as checking accounts at banks, is referred to as:
- a. representative b. commodity money.
- c. outside d. inside money.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 29. An example of inside money is a.
- silver.
- c. a traveler’s d. $100 bills.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 30. Which of the following statements correctly identifies a difference between inside money and outside money?
- a. Inside money has value because the government decrees that it has value for payment of taxes, while outside money has value because it is made using expensive
- Inside money consists of wages and salaries earned by employees in the private sector, while outside money consists of wages and salaries earned by employees of the government sector.
- c. Inside money cannot be used for making purchases from foreign sellers, while outside money can be used for making purchases from foreign
- Inside money is created in the private sector, while outside money is created by the government or by nature.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 31. Which of the following statements correctly identifies an advantage of checking accounts over cash?
- a. Checks are more convenient to use for day to day
- Checks are accepted by almost all sellers while cash may not be accepted.
- c. Checks are more liquid than
- Lost or stolen checks cannot be used unless they have the account holder’s signature.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 32. A mechanism by which a short-term loan is made, allowing a shopper to purchase goods or services today and pay for it at a later date, is known as a
- a. debit
- commodity c. credit
- fiat
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 33. Currently in the United States, money in checking accounts is a. commodity
- outside money. c. inside money. d. illegal tender.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 34. A type of inside money that allows a shopper to prepay some amount and then spend it at her will is a a. debit
- credit
- c. commodity stored-value
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 35. Fedwire is called a(n) payment a. real-time
- real-good c. inside
- fiat
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Payments System
OTHER: Factual
- 36. The Fed measures the money supply following a system based mainly on a. the liquidity and size of various bank
- the interest rate on different assets.
- c. the correlation of different assets with GDP d. legal requirements.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 37. The liquidity of a monetary asset is
- a. the difference between the interest rate on the asset and the interest rate on short-term government
- how quickly and easily it can be used to purchase goods and services. c. its time to maturity.
- also called its principal value.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 38. Which of the following monetary assets is likely to be most liquid?
- a. Currency
- Traveler’s checks
- c. Funds in checking accounts
- Money held as certificate of deposits
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 39. Which of the following monetary assets is likely to be least liquid?
- a. Coins and currency Travelers checks
- c. Funds held in checking accounts
- Funds held as certificate of deposits
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
- 40. A measure of the total supply of money in the economy is referred to as a. monetary
- liquidity total.
- c. the velocity of d. inside money.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 41. M1 consists of
- a. coins, paper currency, and travelers
- coins, paper currency, travelers checks, and amounts in checking accounts.
- c. coins, paper currency, travelers checks, and amounts in checking accounts and savings
- coins, paper currency, travelers checks, and amounts in checking accounts and retail money-market mutual funds.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 42. M2 includes
- a. large-denomination time b. term repurchase agreements.
- c. stockholder’s equity of d. M1.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 43. M2 consists of
- a. amounts in savings accounts, money-market mutual funds (held by individuals), and small time deposits (under
$100,000).
- amounts in savings accounts, and money-market mutual funds (held by individuals).
- c. M1 plus amounts in savings accounts, money-market mutual funds (held by individuals), small time deposits
(under $100,000), and repurchase agreements issued by banks.
- M1 plus amounts in savings accounts, money-market mutual funds (held by individuals), and small time deposits (under $100,000).
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 44. Suppose your bank lowers its minimum balance requirement by $500. So you take $500 out of your checking account and put it into a money market deposit account. What is the overall effect on M1 and M2?
- a. M1 falls by $500, M2 rises by $500. M1 is unchanged, M2 is unchanged. c. M1 falls by $500, M2 is unchanged. d. M1 is unchanged, M2 rises by $500.
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate TOPICS: Counting Money OTHER: Conceptual
- 45. In an economy, the amount of money held in currency and coins is $3,500, the amount of money held as traveler’s check is $1,000, the amount of money held as checkable deposits is $2,000, the amount of money held in savings deposit is $4,000, and the amount of money held with retailed money market mutual funds is $700. M1 in the economy equals
- a. $3,500. $6,500. c. $10,500. d. $11,300.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 46. Aaron takes $100 out of his checking account and puts it in his savings account while Biff withdraws $200 from his money-market mutual fund in the form of cash. The total effect is that M1 and M2 .
- a. is unchanged; falls by $100 is unchanged; is unchanged c. rises by $100; falls by $100 d. rises by $100; is unchanged
ANSWER: d
POINTS: 1
DIFFICULTY: Moderate TOPICS: Counting Money OTHER: Conceptual
- 47. The reason why people are putting more funds in checking and savings account rather than in time deposits is that a. checking and savings account accept fiat money, while time deposits do
- long-term interest rates have declined in recent years, relative to short term interest rates.
- c. liquidity of money held in checking and savings accounts is less than that of money held in time d. only a few banks accept time deposits, while most banks accept checking and savings accounts.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 48. The demand for S. currency increased in the early 1990s mainly because a. banks began charging higher ATM fees.
- demand increased from Eastern Europe. c. people began hoarding coins.
- interest rates declined, reducing the opportunity cost of holding cash.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 49. Most S. currency is held by a. U.S. citizens.
- banks.
- c. the Federal d. foreigners.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 50. Credit cards are
- a. not counted as money because they represent borrowings and not b. counted as part of M1.
- c. the same as stored-value
- counted as part of M2, but not M1.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 51. Carter’s $150,000 CD matures and he deposits the funds into his checking account so he can buy a house. The total effect is that M1 and M2 .
- a. is unchanged; falls by $150,000 rises by $150,000; is unchanged
- c. rises by $150,000; falls by $150,000 rises by $150,000; rises by $150,000
ANSWER: d
POINTS: 1
DIFFICULTY: Moderate TOPICS: Counting Money OTHER: Conceptual
- 52. Dividing the amount of S. currency in circulation by the number of people in the United States shows that, on an average, each person holds almost $3,000 in cash. The most important explanation for this remarkably large sum is that
- a. the underground economy in the United States is huge, with many dollar b. huge amounts of cash have been lost over time.
- c. most of the cash is circulating in foreign
- banks keep huge amounts of cash in their ATMs and bank vaults.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 53. Which of the following statements is true?
- a. Assets counted in M1 are more liquid than assets counted in b. M2 is a part of M1.
- c. Credit card spending is counted as part of d. Savings deposits are included in M1.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 54. M1 – coins and currency – amount in travelers checks equals a.
- amount held in checking accounts. c. amount held in savings deposits.
- amount held in time deposits.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: Counting Money
OTHER: Factual
- 55. In the United States, coins are produced by and distributed around the country by . a. the S. Mint; the Federal Reserve.
- the Bureau of Engraving and Printing; the Treasury Department. c. the U.S. Mint; the Treasury Department.
- the Bureau of Engraving and Printing; the Federal Reserve.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: What Do You Do With Your Change?
OTHER: Factual
- 56. Under the fiat money system, the revenue that the government makes on every coin issued is referred to as
- a. fiat
- fullbodied revenue.
- c. money
- seignorage revenue.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
- 57. The main source of the S. coin shortage in 1999 was a. increased demand for coins from foreign countries.
- a new law allowing coins to be melted for their metal content. c. the introduction of the state quarter program.
- the introduction of the Sacagawea golden dollar.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: What Do You Do With Your Change?
OTHER: Factual
- 58. The new coin introduced in 2000, which added to the coin shortage that had begun in 1999, was the a. Sacagawea golden
- Virginia state quarter. c. Buffalo nickel.
- Dale Earnhardt dollar.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: What Do You Do With Your Change?
OTHER: Factual
- 59. Describe each of the four functions of money and provide an example of how money serves these
ANSWER: Money’s role as a medium of exchange occurs when money is used to purchase goods and services; for example, someone writes a check to buy groceries. Money’s role as a unit of account occurs when prices of goods are quoted in terms of money; for example, stores in the United States almost invariably
list prices in terms of dollars. Money’s role as a store of value occurs because money can be used to buy goods and services in the future; for example, people keep money in their wallets over time in case they need it to buy something, though such cash earns no interest. Money’s role as a standard of deferred payment occurs when loans are repaid in terms of money; for example, someone taking out a mortgage loan for $100,000 must repay interest plus the $100,000 in principal in dollars in the future.
POINTS: 1
TOPICS: How We Use Money
- 60. A bill is introduced into Congress proposing that the S. go back to the gold standard, in which only gold coins could circulate as money. What are the major drawbacks of such a proposal?
ANSWER: The major drawbacks are that the government would need to spend resources digging up gold from the ground to create money (whereas fiat money can be produced at a much lower cost) and the value of money would fluctuate with the worldwide price of gold, which would likely lead to substantial periods of inflation and deflation.
POINTS: 1
TOPICS: The Payments System
- 61. Describe the difference between inside money and outside money, and explain whether each of the following items represent inside money or outside money:
- a. Checking accounts b. Coins
- c. Travelers checks
- d. Money-market mutual funds e. $100 bills
ANSWER: Inside money is created by the private sector, whereas outside money is created by the government or nature.
- a. Checking accounts represent inside b. Coins represents outside money.
- c. Travelers check represents inside
- d. Money-market mutual funds represents inside money e. $100 bills represent outside
POINTS: 1
TOPICS: The Payments System
- 62. Gary Goldwater has $5,000 in cash. He deposits $1,000 in his checking account, buys $500 of traveler’s checks, puts
$1,500 in his money-market mutual fund, and buys a $2,000 CD. How does this transaction affect M1 and M2?
ANSWER: The $5,000 in cash was in M1, therefore also in M2. Of the $5,000, he keeps $1,500 in accounts that are part of M1 (checking account + travelers checks). Since he puts $1,500 in his money-market mutual fund, M1 declines by $5,000 − $1,500 = $3,500. Both the MMMF and CD are part of M2, so M2 does not change.
POINTS: 1
TOPICS: Counting Money
- 63. Donovan’s $200,000 CD matures. He deposits $20,000 into his checking account, buys a CD for $150,000, and puts
$30,000 into his money-market mutual fund. How does this affect M1 and M2?
ANSWER: He cashed in a large time deposit, which was not part of M1 or M2. He put $20,000 into an M1 asset (checking account) and $30,000 into an M2 asset (MMMF). M1 rises by $20,000. Because M1 is part of M2, M2 rises by $20,000 + $30,000 = $50,000.
POINTS: 1
TOPICS: Counting Money
- 64. Donovan’s $200,000 CD matures. He deposits $20,000 into his checking account, buys a CD for $80,000, and puts
$100,000 into his money-market mutual fund. How does this affect M1 and M2?
ANSWER: He cashed in a large time deposit, which was not part of M1 or M2. He put $20,000 into an M1 asset (checking account), and $180,000 in M2 assets (MMMF and small time deposit). M1 rises by $20,000. Since M1 is part of M2, M2 rises by $20,000 + $180,000 = $200,000.
POINTS: 1
TOPICS: Counting Money
- 65. Why did M1 grow so rapidly in the early 1990s, whereas M2 did not?
ANSWER: M1 grew rapidly because of demand for U.S. currency by people in Eastern Europe. M2 grew slowly because the economy was growing slowly. The difference in growth rates is possible because currency is a much larger fraction of M1 than it is of M2.
POINTS: 1
TOPICS: Counting Money
- 66. What is seignorage revenue and how does it apply to S. coins?
ANSWER: Under the fiat money system, the government makes a profit, known as seignorage revenue, on every coin that is issued.This is because fiat money is worth more in exchange of goods and services than the value of the materials of which it is made. Since, coins act as fiat money in the United States, the government earns some revenue on every coin issued.
POINTS: 1
TOPICS: What Do You Do with Your Change?
- 67. Describe the coin shortage of 1999 and 2000 and describe why it occurred. What ended the shortage?
ANSWER: The coin shortage began when people demanded an unexpectedly high number of state quarters in 1999.
The U.S. Mint was unable to keep up with the demand. As a result, it shifted production to state quarters from other coins.Eventually, people began hoarding the state quarters, and spending occurred with other denominations, which also fell short of supply. In 2000, production of the Sacagawea golden dollar added to the problem as it diverted production away from the popular state quarters. As the popularity of the state quarter program declined in 2001 and the production capacity of the U.S. mint increased, the shortage ended.
POINTS: 1
TOPICS: What Do You Do With Your Change?
- Shareholders are also called a. bondholders.
- brokers.
- c. d. debt-holders.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- Which of the following statements is true?
- a. Stockholders benefit when the price of the stocks they hold rises and lose when the price of the stocks they
hold falls.
- Stockholders benefit when the price of the stocks they hold falls and lose when the price of the stocks they
hold rises.
- c. Stockholders have the right to participate in the decision making of a company but are not entitled to dividend
payments.
- Stockholders are entitled to dividend payments but do not have the right to participate in the decision making
of a company.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
OTHER: Factual
- A place where people buy or sell stocks is known as a stock a. exchange.
- index. c. fund.
- holding.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- A stock index tells you
- a. the average price of a collection of
- the expected changes in the prices of select stocks over a year. c. where to buy or sell stocks.
- what stocks to buy or sell.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- Which of the following statements correctly identifies a difference between a stock exchange and a stock index?
- a. A stock exchange refers to a market where stocks of government-owned enterprises are traded, while a stock index refers to a market where the stocks of privately-owned enterprises are
- A stock index refers to a market where stocks of government-owned enterprises are traded, while a stock exchange refers to a market where the stocks of privately-owned enterprises are traded.
- c. A stock exchange refers to a market where stocks are traded, while a stock index reflects the average price of a collection of
- A stock index refers to a market where stocks are traded, while a stock exchange reflects the average price of a collection of stocks.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- The S&P 500 stock index is an index of
- a. all the companies whose shares trade at a price more than $500.
- all the companies whose shares trade on the New York Stock Exchange. c. 500 major companies whose shares trade in U.S. markets.
- the largest 500 companies in the world.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- An index that measures the average stock prices of small firms in the United States is the a. Russell 2000 index.
- NYSE index.
- c. Dow Jones Industrial d. S&P 500.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- An index of thirty major U.S. industrial companies is the a. NASDAQ index.
- NYSE index.
- c. Dow Jones Industrial d. S&P 500.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- The Wilshire 5000 stock index is
- a. an index of the 2000 largest industrial companies whose shares trade in S. markets. b. an index of all the companies with U.S. headquarters whose shares trade in the U.S. c. an index of 5000 major companies whose shares trade in U.S. markets.
- an index of the average stock prices of many small firms operating in the U.S.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 10. Which of the following statements is true?
- a. Different stock indexes normally show the same total b. Stock indexes do not provide information on dividends.
- c. Mutual funds encourage investors to invest in the same security instead of d. The S&P 500 is an example of a mutual fund.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 11. A mutual fund is
- a. a hedge fund that only wealthy people may invest
- a company that buys a share of each stock in the entire stock market.
- c. an investment company that buys stocks in companies that are not growing
- an investment company that pools the funds of many investors and buys a large number of different stocks.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 12. An index fund is
- a. a mutual fund that mimics a stock
- an investment company that pools the funds of many investors and buys government bonds. c. a mutual fund that buys mortgage-backed securities (MBSs).
- a company that rates companies in terms of their financial strength.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 13. Which of the following statements is true?
- a. Dividend payments of firms are independent of how much profit the firm is
- Stock prices of firms are independent of how much profit the firm is making.
- c. A share of stock gives an investor complete ownership of the corporation that issued the
- A share of stock gives an investor partial ownership of the corporation that issued the stock.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 14. A stock which was bought for $1,000 pays annual dividends of $250. The first quarter dividend yield of the stock can be calculated at
- a. 75 percent. b. 3 percent.
- c. 25 percent. d. 6.25 percent.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Conceptual
- 15. An investor buys a stock for $10,000 and earns dividends of $250 during the course of the year. At the end of the year, the stock is worth $9,300. The dividend yield for the year is
- a. −5 percent. b. 2.5 percent. c. 4.5 percent. d. −7.0 percent.
ANSWER: b
POINTS: 1
DIFFICULTY: Moderate TOPICS: The Stock Market OTHER: Conceptual
- 16. An investor buys a stock for $10,000 and earns dividends of $250 during the course of the year. At the end of the year, the stock is worth $9,300. The capital-gains yield for the year is
- a. 5 percent. b. −2.5 percent. c. −4.5 percent. d. −7.0 percent.
ANSWER: d
POINTS: 1
DIFFICULTY: Moderate TOPICS: The Stock Market OTHER: Conceptual
- 17. An investor buys a stock for $10,000 and earns dividends of $250 during the course of the year. At the end of the year, the stock is worth $9,300. The total return for the year is
- a. 5 percent. b. −2.5 percent. c. −4.5 percent. d. −7.0 percent.
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate TOPICS: The Stock Market OTHER: Conceptual
- 18. An investor earns dividends of $450 during the course of a year. At the end of the year, the stock is worth $10,700.
If the capital-gains yield on the stock over the year is calculated at 8 percent the approximate worth of the stock at the beginning of the year was
- a. $9,007. $9,457. c. $9,907. d. $10,357.
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate TOPICS: The Stock Market OTHER: Conceptual
- 19. An investor earns dividends of $450 on a stock during the course of the year. At the end of the year, the stock is worth $10,142. Over the year, the total return on the stock was 12 percent. At the beginning of the year, the stock must have been approximately worth
- a. $9,007. $9,457. c. $9,907. d. $10,357.
ANSWER: b
POINTS: 1
DIFFICULTY: Challenging TOPICS: The Stock Market OTHER: Conceptual
- 20. An investor earns dividends of $360.27 during the course of the year. At the end of the year, the stock is worth
$10,700. If the dividend yield on the stock over the year was calculated at 4%, the approximate worth of the stock at the beginning of the year was
- a. $9,007. $9,457. c. $9,907. d. $10,357.
ANSWER: a
POINTS: 1
DIFFICULTY: Moderate TOPICS: The Stock Market OTHER: Conceptual
- 21. Identify the correct statement from the
- a. Dividend payments are subject to taxes while realized capital gains are b. Realized capital gains are subject to taxes while dividend payments are not. c. Both dividend payments and realized capital gains are subject to taxes.
- Neither dividend payments nor realized capital gains are subject to taxes.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 22. Implicit capital gains are
- a. increases in the capital stock required to operate stock b. capital gains realized by foreign investors.
- c. capital gains that have been realized by domestic d. capital gains that have been accrued but not yet realized.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 23. Which of the following statements is true?
- a. If a company retains profits instead of paying dividends, the price of their stock is expected to b. Investors need not pay taxes on dividend earnings.
- c. Dividend earnings are legally not allowed to be invested and can only be used for
- The annual dividend yield on a stock is always greater than the annual capital-gains yield on the same stock.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 24. Which of the following statements is true?
- a. Both realized and implicit capital gains are
- Realized capital gains are taxed, while implicit capital gains are not taxed. c. Implicit capital gains are taxed, while realized capital gains are not taxed. d. Neither realized capital gains, nor implicit capital gains are taxed.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 25. Realized capital gains are
- a. increases in the value of a firm that occur because a firm has retained earnings that are exempt from corporate profits
- capital gains that are owned by foreigners.
- c. capital gains that an investor receives from actually selling
- capital gains that have been accrued but not yet received because the stock has not been sold.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 26. The lock-in effect occurs when
- a. the price of all stocks traded in an exchange b. short selling of stocks is not allowed.
- c. stock prices decline more than 5 percent in one
- an investor doesn’t sell a stock so she can avoid paying capital-gains taxes.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 27. The lockin effect
- a. allows stocks to be priced
- will be smaller in magnitude if tax rates are lower.
- c. is likely to reduce the volume of stocks being traded in a
- states that when stock prices rise, they will continue to do so for prolonged time periods.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 28. An investor earns $400 in dividends and $800 in capital gains over a year. If the tax rate on these earnings is 15%, what is the total tax that the investor is liable to pay on these earnings?
- a. $0. $60. c. $120. d. $180.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 29. An investor buys a stock for $1,200 at the beginning of a year. The stock pays him a dividend of $150 over the year, and the worth of the stock appreciates by $300 at the end of the year. If the annual rate of inflation is 6%, what is the loss in principal value due to inflation?
- a. $18 $27 c. $72
- $247.5
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 30. An investor buys stock for $10,000 at the beginning of the year. She earns dividends of $300 during the course of the year. At the end of the year, the stock is worth $10,800. The tax rate on dividends and capital gains is 15 The inflation rate is 3 percent. What is the real return accrued on the stock at the end of the year, provided the investor does not sell the stock?
- a. 35 percent. b. 6.95 percent. c. 7.55 percent. d. 8 percent.
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate TOPICS: The Stock Market OTHER: Conceptual
- 31. An investor buys stock for $10,000 at the beginning of the year. She earns dividends of $300 during the course of the year. At the end of the year, the stock is worth $10,800.The tax rate on dividends and capital gains is 15
The inflation rate is 3 percent. What is the investor’s after tax real return if she sells the stock at the end of the year?
- a. 35 percent. b. 6.95 percent. c. 7.55 percent. d. 8.15 percent.
ANSWER: a
POINTS: 1
DIFFICULTY: Moderate TOPICS: The Stock Market OTHER: Conceptual
- 32. A benefit of mutual funds that mainly buy stocks and hold them is that a. the price of the stocks they hold always
- dividend payments on such stocks are not taxed.
- c. they help avoid taxes as the capital gains on these stocks are
- they promise annual returns of more than 50% of the principal amount.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 33. Which of the following statements is true?
- a. When an investor diversifies his investments, the total risk involved b. Dividends paid on stocks are legally not liable to attract taxes.
- c. When a company increases its retained earnings, the dividends paid by it
- As a company increases its retained earnings, the stock price of the company is expected to reduce.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 34. In the United States, an investor who bought the average stock in 1929 and sold it in 1959 would have had a a. negative or zero real capital gain on his
- 50 percent real capital gain on his stock. c. 100 percent real capital gain on his stock. d. 1000 percent real capital gain on his stock.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 35. In recessions, the average real return to the stock market is often a.
- between 0% to 5%. c. between 5% to 10%. d. between 10% to 20%.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
- 36. In the second half of the 1990s, the average annual real return to the stock market was about each a. 23 percent.
- 10 percent. c. 5 percent. d. 2 percent.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: The Stock Market
OTHER: Factual
- 37. The idea that stock prices fully reflect all available information is called a. asymmetric
- random walk theory.
- c. volatile markets
- the efficient markets hypothesis.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 38. The efficient market hypothesis assumes that
- a. there are only a few buyers and sellers in a stock market and stocks are b. there are many buyers and sellers in a stock market and stocks are illiquid.
- c. there are only a few buyers and sellers in a stock market and stocks are d. there are many buyers and sellers in a stock market and stocks are liquid.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 39. If sales of a firm exactly equals investor expectations, stock price of the firm
- a. is expected to b. is expected to decrease.
- c. is expected to remain the
- can increase or decrease depending on the volume of stocks being traded.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
- 40. When stock prices are unpredictable, they are said to a. be
- follow a random walk. c. lack a martingale.
- be ex-dividend.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 41. If the stock market is efficient and investors are risk neutral, then a. capital gains are always
- stock prices are predictable.
- c. the CAPM model works d. stock prices follow a random walk.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 42. An anomaly is
- a. a stock that has greater than average
- a mutual fund that only invests in government securities. c. an odd lot of stock.
- an incident of predictable patterns to stock prices, that investors could exploit.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 43. An observation that does not fit a model is called a. a
- an anomaly.
- c. a random
- a beta coefficient.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
- 44. Which of the following is an example of an anomaly?
- a. The discovery that stock prices fully reflect all available b. The discovery that stock prices follow a random walk.
- c. The discovery that returns to stock tend to be negative in periods of d. The discovery that stocks have a higher than average return in early January.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 45. According to the capital asset pricing model (CAPM), the return to a stock a. follows a random
- depends on oil prices, interest rates, and economic growth.
- c. depends on how risky the stock is compared with the market d. depends on the stock’s risk and the risk to bonds.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 46. In the CAPM, the risk to a stock’s return that is attributable to the fluctuations in the overall stock market is referred to as
- a. idiosyncratic b. explicit risk.
- c. systematic
- unsystematic risk.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 47. In the CAPM, the risk to a stock’s return that is not attributable to the fluctuations in the overall stock market is referred to as
- a. idiosyncratic b. explicit risk.
- c. systematic d. market risk.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 48. Which of the following statements is true?
- a. Systematic risk is also referred to as idiosyncratic risk, while unsystematic risk is also referred to as implicit
- Unsystematic risk is also referred to as implicit risk, while systematic risk is also referred to as idiosyncratic risk.
- c. Systematic risk can be reduced by diversification, while unsystematic risk cannot be reduced by
- Unsystematic risk can be reduced by diversification, while systematic risk cannot be reduced by diversification.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 49. In the CAPM, the only source of systematic risk is a. changes in government
- changes in inflation rates.
- c. fluctuations in the foreign exchange d. overall movement of the stock model.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 50. In the CAPM, systematic risk
- a. is also known as idiosyncratic b. can be diversified away.
- c. is also known as market
- is the risk to a stock’s return that is not attributable to the fluctuations in the overall stock market.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 51. In the CAPM, unsystematic risk a. is also known as market b. can be diversified away.
- c. is the risk to a stock’s return that is attributable to the fluctuations in the overall stock d. is assumed to be zero.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 52. In the CAPM, if a stock has a large beta coefficient, then
- a. the stock’s return is less volatile than the market’s average
- the stock’s return is about as volatile as the market’s average return. c. the stock’s return is more volatile than the market’s average return. d. the stock’s risk is greater than its expected return.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 53. In the CAPM,
- a. larger the value of β for a stock, larger is the unsystematic risk involved in investing in the b. larger the value of β for a stock, smaller is the unsystematic risk involved in investing in the stock. c. larger the value of β for a stock, larger is the systematic risk involved in investing in the stock.
- larger the value of β for a stock, smaller is the systematic risk involved in investing in the stock.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 54. In the CAPM, if a stock has a beta coefficient near one, then
- a. the stock’s return is less volatile than the market’s average
- the stock’s return is about as volatile as the market’s average return. c. the stock’s return is more volatile than the market’s average return. d. the stock’s risk is greater than its expected return.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 55. In the CAPM, if a stock has a beta coefficient near zero, then
- a. the stock’s return is less volatile than the market’s average
- the stock’s return is about as volatile as the market’s average return. c. the stock’s return is more volatile than the market’s average return. d. the stock’s risk is greater than its expected return.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 56. In the CAPM, a stock has a beta coefficient of 5. The average returns to all stocks in the market is 8%. If the interest rate on three-month T-bills is at around 3 percent, what is the expected return to this stock? Assume that unsystematic risk is zero.
- a. 5 percent b. 3.5 percent c. 5.5 percent d. 7.0 percent
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Conceptual
- 57. In the CAPM, a stock has a beta coefficient of 1. The average returns to all stocks in the market is 10%. If the interest rate on three-month T-bills is at around 2 percent, what is the expected return to this stock? Assume that unsystematic risk is zero.
- a. 5 percent b. 5.0 percent c. 7.5 percent d. 10.0 percent
ANSWER: d
POINTS: 1
DIFFICULTY: Moderate
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Conceptual
- 58. A model of stock prices that allows for more sources of risk than just the stock market’s excess return is the
________ theory. a. excess-return
- random-walk
- c. arbitrage-pricing idiosyncratic-risk
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 59. The arbitrage-pricing theory was developed as an alternative to the a. the efficient market
- the random walk theory.
- c. capital asset pricing d. rational expectations theory.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 60. You are planning to buy a stock, the risk on which is dependent on two factors: (1) the change over the last year in the inflation rate and (2) the spread between ten-year Treasury bonds and three-month Treasury bills. Suppose the average risk-free interest rate is 1 percent. The beta coefficients of the stock associated with the change in inflation rate and spread between ten-year Treasury bonds and three-month Treasury bills are -2 and 5 respectively. If you expect the inflation rate to rise 1 percentage point and you think the spread will be 3 percentage points. What is the expected return to this stock? Use the arbitrage-pricing
- a. 11 percent 12 percent c. 14 percent d. 18 percent
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Conceptual
- 61. You are planning to buy a stock, the risk on which is dependent on two factors: (1) the change in the inflation rate over the last year and (2) the spread between ten-year Treasury bonds and three-month Treasury Suppose the average risk-free interest rate is 3 percent. The beta coefficients of the stock associated with the
change in inflation rate and the spread between ten-year Treasury bonds and three-month Treasury bills are -2 and 4 respectively. If you expect the inflation rate to rise 6 percentage point and you think the spread will be 8 percentage points. What is the expected return to this stock? Use the arbitrage-pricing theory.
- a. 11 percent 12 percent c. 18 percent d. 23 percent
ANSWER: d
POINTS: 1
DIFFICULTY: Moderate
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Conceptual
- 62. Fundamental value is the market as a
- a. past
- future
- c. expected present
value of expected earnings of a company or of all companies in the stock
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 63. If stock prices exceed their fundamental values, a. the stock market is
- the stock market is undervalued. c. the stock market is rightly valued.
- investors have rational expectations.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 64. If stock prices are below their fundamental values, a. the stock market is
- the stock market is undervalued.
- c. investors have rational
- mutual funds will be worth more than their price.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 65. Consider two stocks: A and B. The price of stock A is $400, while the price of stock B is $600. If the fundamental value of both stocks is $500,
- a. stock A is overvalued and stock B is b. stock A is undervalued and stock B is overvalued. c. both stocks are undervalued.
- both stocks are overvalued.
ANSWER: b
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Conceptual
- 66. The fundamental value of a stock varies a. directly with the rate of
- inversely with the growth rate of earnings on the stock.
- c. directly with previous year’s actual earnings on the d. inversely with the time frame for which a stock is held.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 67. An investor expects earnings from a stock to grow at a constant rate of 3% over time and the investors’ rate of discount is constant at 4%. If earnings last year were $152, then the fundamental value of the stock would be
- a. $152. $190.
- c. $1,520. $15,656.
ANSWER: d
POINTS: 1
DIFFICULTY: Moderate
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Conceptual
- 68. An investor expects earnings from a stock to grow at a constant rate of 2% over time and the investors’ rate of discount is constant at 5%. If earnings last year were $37, then the fundamental value of the stock would be
- a. $74. $111.
- c. $1,258. $11,100.
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Conceptual
- 69. A theory that investors use all the information available to them about companies future prospects in determining their buying and selling decisions is called
- a. rational irrational c. adaptive d. realized
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 70. If people have rational expectations,
- a. the stock market may be b. the stock market may be undervalued. c. stock prices are nonvolatile.
- stock prices always equal their fundamental value.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 71. The
theory states that the stock market goes through periods in which stock prices rise higher than their
fundamental value and other periods where stock prices fall below their fundamental value. a. rational expectations
- adaptive expectations c. irrational expectations d. realized expectations
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: How Can an Investor Profit in the Stock Market?
OTHER: Factual
- 72. The average amount by which the returns on stocks exceeds the return on debt securities is referred to as a. beta
- gamma coefficient. c. return spread.
- equity premium.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: Application to Everyday Life: Comparing Stocks with Bonds and Other Financial Investments
OTHER: Factual
- 73. The equity-premium puzzle refers to the surprising result that a. stock prices are inversely related to interest
- the transactions costs for buying stocks may be as high as 5 percent of the total value of those stocks, greatly reducing the net returns to stocks.
- c. equity prices are much too high when compared with the fundamental value of the stock market, as determined by using the present-value
- people will not pay to avoid risk in everyday situations, but when it comes to the stock market, people are willing to give up large potential returns to stocks in order to buy safer Treasury securities.
ANSWER: d
POINTS: 1
DIFFICULTY: Basic
TOPICS: Application to Everyday Life: Comparing Stocks with Bonds and Other Financial Investments
OTHER: Factual
- 74. In the United States, the average annual real return on stocks from 1960 to 2012 has been approximately a. 1
- 2 percent. c. 7 percent. d. 10 percent.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: Application to Everyday Life: Comparing Stocks with Bonds and Other Financial Investments
OTHER: Factual
- 75. In the United States, the average annual real return on short-term Treasury securities since 1960 to 2012 has been approximately
- a. 5 percent. b. 4 percent.
- c. 25 percent. d. 10 percent.
ANSWER: a
POINTS: 1
DIFFICULTY: Basic
TOPICS: Application to Everyday Life: Comparing Stocks with Bonds and Other Financial Investments
OTHER: Factual
- 76. One of the advantages of holding real estate over stocks is that a. real estate assets are more liquid than
- monetary return on real estate is always greater than the monetary return on stocks.
- c. part of the returns on real estate are not subject to tax payments, while all returns on stocks are subject to tax
payments.
- principal amount required for investing in real estate is often smaller than the principal amount required to invest in stocks.
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: Application to Everyday Life: Comparing Stocks with Bonds and other Financial Investments
OTHER: Factual
- 77. Which of the following is the best example of a nonfinancial security?
- a. Coupon bonds Stocks
- c. Human capital
- Foreign exchange
ANSWER: c
POINTS: 1
DIFFICULTY: Basic
TOPICS: Application to Everyday Life: Comparing Stocks with Bonds and Other Financial Investments
OTHER: Factual
- 78. Suppose an investor purchased 100 shares of JDSU stock at a price of $50 per share on December 31, 2011. On December 31, 2012, JDSU paid dividends of $1.50 per share, and the investor received the dividends, then sold the stock at a price of $65 per
- a. If there were no taxes or inflation, what was the total return?
- b. If there were no taxes, but inflation was 5 percent, what was the real return?
- c. If the tax rate was 15 percent on dividends and capital gains, what was the after-tax real return?
ANSWER: a. Income = dividends + capital gains = $1.50 + ($65 − $50) = $16.50
Loss of principal value to
inflation = inflation rate × principal value
= 0.035 × $50 = $1.75
- c. Taxes = (0.15 × dividends) + (0.15 × capital gains)
= (0.15 × $1.50) + (0.15 × $15)
= $0.225 + $2.25
= $2.475
After-tax real income = $16.50 − $1.75 − $2.475 = $12.275
POINTS: 1
TOPICS: The Stock Market
- 79. An investor buys stock for $5,000 at the beginning of the year. She earns dividends of $200 during the course of the year. At the end of the year, the stock is worth $5,150. The tax rate on dividends and capital gains is 15 percent. The inflation rate is 2
- a. Calculate the investor’s after-tax real return if she does not sell the stock at the end of the
- b. Calculate the investor’s after-tax real return if she sells the stock at the end of the
ANSWER: a. Income = dividends + capital gains = $200 + ($5,150 − $5,000) = $350
Loss of principal value to
inflation = inflation rate × principal value
= 0.02 × $5000 = $100
Taxes = (0.15 × dividends) + (0.15 × capital gains) = 0.15 × dividends
= 0.15 × $200 = $30
After-tax real income = $350 − $30 − $100 = $220
After-tax real return = $220/$5,000 = 0.044 = 4.4%
- b. Taxes = (0.15 × dividends) + (0.15 × capital gains) = 15 × income
= 0.15 × $350 = $52.50
POINTS: 1
After-tax real income = $350 − $52.50 − $100 = $197.50
After-tax real return = $197.50/$5,000 = 0.0395 = 3.95%.
TOPICS: The Stock Market
- 80. Answer the questions
- a. Write the equation for the capital-asset pricing
- b. Describe, in words, what the CAPM is trying to explain, and describe each element of the equation in part a.
Use the capital-asset pricing model to predict the returns next year of the following stocks, if you expect the return to holding stocks to be 12 percent on average, and the interest rate on three-month T-bills will be 2 percent. Show your calculations.
- c. A stock with a beta of −3 d. A stock with a beta of 0.7 e. A stock with a beta of 1.6
ANSWER: a. Ri i i
t = rt + β (Rt − rt) + ε t
- b. The capital asset pricing model (CAPM) relates a stock’s return (relative to the risk-free rate) to the market return (relative to the risk-free rate):
: The realized return to holding stock i at date t rt: The interest rate on a risk-free bond
Rt − rt: The market’s excess return
Rt: The average return to all stocks in the market
: The part of the return that is unexplained by the market’s return
Returns on different stocks react differently to changes in the market’s excess return, so the coefficient βi differs across stocks.
t + 1 t 1 t
t + 1 t 1 t
t + 1 t 1 t
|
c. | E(Ri ) = E(r | ) + βi (R
+ 1 t + |
− r |
) = 2% + (−0.3 × 10%) = −1%
+ 1 | |
d. |
E(Ri ) = E(r |
) + βi (R
+ 1 t + |
− r |
) = 2% + (0.7 × 10%) = 9%
+ 1 | |
POINTS: |
e.
1 |
E(Ri ) = E(r |
) + βi (R
+ 1 t + |
− r |
) = 2% + (1.6 × 10%) = 18%
+ 1 |
|
|
TOPICS: How Can an Investor Profit in the Stock Market?
- 81. Suppose the following version of the APT is a good model of risk in the stock market. There are three factors: (1) the stock market’s excess return, in percentage points; (2) the change over the last year in the inflation rate, in percentage points; and (3) the spread between ten-year Treasury bonds and three-month Treasury bills, in percentage points. Suppose the stock market’s average excess return is 7 percentage points and the average risk- free interest rate is 1 percent, the average change in the inflation rate is 0 percentage points, and the average spread between ten-year Treasury bonds and three-month Treasury bills is 2 percentage points. Each of the following
stocks has the beta coefficients shown in the table below:
Goldcrafters 3 2 −1
State Farm 0 −2 0
- a. What is the expected return to each of the three stocks? Show your
If the market’s excess return were to rise 10 percentage points in a particular year (that is,
- b. instead of the average of 7 percent, the market’s excess return will be 17 percent), what would you expect the effect to be on the return to each of the three stocks? Show your
calculations.
If the inflation rate was expected to rise 2 percentage points in a particular year (that is,
- c. instead of the average of 0 percent, the inflation rate will rise by 2 percentage points), what would you expect the effect to be on the return to each of the three stocks?
If the interest-rate spread rose 2 percentage points in a particular year (that is, instead of the d. average of 2 percentage points, the interest-rate spread will be 4 percentage points), what
would you expect the effect to be on the return to each of the three stocks?
ANSWER: a. From the APT equation Ri = rt
+ β1i f 1
+ β2i f 2
+ … + βki f kt
+ εi , we use the expected return
E(Ri ) = rt
+ β1i f 1
+ β2i f 2
+ … + βki f k .
Microsoft: 1% + (2 × 7%) + (−1 × 0) + (1 × 2%) = 17% Goldcrafters: 1% + (3 × 7%) + (2 × 0) + (−1 × 2%) = 20% State Farm: 1% + (0 × 7%) + (−2 × 0) + (0 × 2%) = 1%
- b. The first factor is 17 percent instead of 7
Microsoft: 1% + (2 × 17%) + (−1 × 0) + (1 × 2%) = 37% Goldcrafters: 1% + (3 × 17%) + (2 × 0) + (−1 × 2%) = 50% State Farm: 1% + (0 × 17%) + (−2 × 0) + (0 × 2%) = 1%
- c. The second factor is 2 percent instead of 0
Microsoft: 1% + (2 × 7%) + (−1 × 2%) + (1 × 2%) = 15% Goldcrafters: 1% + (3 × 7%) + (2 × 2%) + (−1 × 2%) = 24% State Farm: 1% + (0 × 7%) + (−2 × 2%) + (0 × 2%) = −3%
- d. The third factor is 4 percent instead of 2
POINTS: 1
Microsoft: 1% + (2 × 7%) + (−1 × 0) + (1 × 4%) = 19% Goldcrafters: 1% + (3 × 7%) + (2 × 0) + (−1 × 4%) = 18% State Farm: 1% + (0 × 7%) + (−2 × 0) + (0 × 4%) = 1%
TOPICS: How Can an Investor Profit in the Stock Market?
- 82. Suppose the following version of the APT is a good model of risk in the stock market. There are three factors: (1)
the stock market’s excess return, in percentage points; (2) the unemployment rate minus its natural rate (the level the unemployment rate would be if the economy were at full employment), in percentage points; and (3) the real federal funds rate minus its long-run equilibrium value. Suppose the natural rate of unemployment is 4.5 percent and the
long-run equilibrium value of the real federal funds rate is 3.0 percent. Each of the following stocks has the beta coefficients shown in the table below:
| β1i | β2i | β3i |
| Royal Dutch Shell | 3 | −3 | 4 |
| Merck | 2 | 6 | 0 |
| Wachovia | 1 | −3 | −8 |
If your forecast for next year is that the risk-free interest rate next year will be 1.0 percent,
- a. the overall stock market will return 0 percent, the unemployment rate will be 5.0 percent, and the real federal funds rate will be 2.0 percent, what is the expected return (in percent,
with two decimals) to each of the three stocks? Show your calculations.
If your forecast for next year is that the risk-free interest rate next year will be 2.0 percent,
- b. the overall stock market will return 0 percent, the unemployment rate will be 4.0 percent, and the real federal funds rate will be 4.0 percent, what is the expected return (in percent,
with two decimals) to each of the three stocks? Show your calculations.
ANSWER: a. From the APT equation Ri t = rt + β1i f 1 + β2i f 2 + … + βk i f k + εi , we use the expected return
t t t t
E(R i ) = r + β1i f 1 + β2i f 2 + … + βk i f k .
t t t t t
Royal Dutch
Shell:
1.0% + [3 × (10.0% − 1.0%)] + [−3 × (5.0% − 4.5%)] + [4 × (2.0% − 3.0%)] = 1.0% + 27.0% −
1.5% − 4% = 22.5%
Merck: 1.0% + [2 × (10.0% − 1.0%)] + [6 × (5.0% − 4.5%)] + [0 × (2.0% − 3.0%)] = 1.0% + 18.0% +
3.0% + 0% = 22.0%
Wachovia: 1.0% + [1 × (10.0% − 1.0%)] + [−3 × (5.0% − 4.5%)] + [−8 × (2.0% − 3.0%)] = 1.0% + 9.0% −
1.5% + 8.0% = 16.5%
- From the APT equation Ri t = rt + β1i f 1 + β2i f 2 + … + βk i f k + εi , we use the expected return
t t t t
E(Ri t) = rt + β1i f 1 + β2i f 2 + … + βk i f k .
t t t
Royal Dutch
Shell:
2.0% + [3 × (20.0% − 2.0%)] + [−3 × (4.0% − 4.5%)] + [4 × (4.0% − 3.0%)] = 2.0% + 54.0% +
1.5% + 4.0% = 61.5%
POINTS: 1
Merck: 2.0% + [2 × (20.0% − 2.0%)] + [6 × (4.0% − 4.5%)] + [0 × (4.0% − 3.0%)] = 2.0% + 36.0% −
3.0% + 0.0% = 35.0%
Wachovia: 2.0% + [1 × (20.0% − 2.0%)] + [−3 × (4.0% − 4.5%)] + [−8 × (4.0% − 3.0%)] = 2.0% + 18.0%
+ 1.5% − 8.0% = 13.5%
TOPICS: How Can an Investor Profit in the Stock Market?
- 83. Write a formula for the equity
ANSWER: Let ep = the equity premium, s = the average percentage return on stocks, and d = the average percentage return on debt securities. Then,
ep = s – d
POINTS: 1
TOPICS: Application to Everyday Life: Comparing Stocks with Bonds and Other Financial Investments
