Deck 18: Theory Versus Reality

Question 1

Higher interest rates

A) Decrease the quantity of loanable funds.
B) Decrease the level of risk.
C) Increase the quantity of loanable funds.
D) Increase the level of risk.

Answer 1

C

Question 2

The supply of loanable funds is determined by all of the following except

A) Time preferences.
B) Demand for loanable funds.
C) Interest rates.
D) Risk.

Answer 2

B

Question 3

The present discounted value of a future payment can be calculated using which of the following formulas?

A) [(1 + Interest rate) ^N] ÷ (Current payment).
B) (Current payment) ÷ [(1 + Interest rate) ^N].
C) [(1 + Interest rate) ^N] ÷ (Future payment).
D) (Future payment) ÷ [(1 + Interest rate) ^N].

Answer 3

D

Question 4

Risk premiums do all of the following except

A) Help explain why banks charge different customers different interest rates.
B) Allocate limited resources only to the safest investors.
C) Are the difference in the rates of return on risky and safe investments.
D) Compensate people who finance risky ventures.

Question 5

The decision to save is influenced by all of the following except

A) Time preferences.
B) Interest rates.
C) The level of risk.
D) Occupation.

Question 6

Financial intermediaries make the allocation of resources more efficient by

A) Transferring purchasing power from savers to dissavers.
B) Lending or investing the savings they hold.
C) Reducing search and information costs for savers and investors.
D) Spreading risk out over many individuals.

Question 7

Higher interest rates

A) Reflect a higher opportunity cost of money.
B) Raise the present value of future payments.
C) Lower the future value of current dollars.
D) Result in a higher risk premium.

Question 8

As long as interest-earning opportunities exist, present dollars are worth

A) More than future dollars.
B) Less than future dollars.
C) More than previous periods' dollars.
D) Less than inflation-adjusted dollars.

Question 9

Which of the following is an example of a financial intermediary?

A) Stock markets.
B) Flea markets.
C) Real estate markets.
D) Gun shows.

Question 10

Which of the following statements about money is not true?

A) Income-earning investment opportunities exist.
B) Present dollars are worth more than future dollars.
C) There is an opportunity cost of money.
D) Currency can be exchanged for gold only in the United States and Europe.

Question 11

Which of the following is an example of a financial intermediary?

A) Banks.
B) The Federal Reserve.
C) The U.S. Treasury.
D) The department of finance.

Question 12

All of the following statements about banks in Zimbabwe in 2009 are true except

A) Political instability increased the risk of bank failures.
B) Banks were paying 100,000 percent interest on deposits.
C) Few people deposited their money into Zimbabwe banks.
D) The risk of losing deposits at Zimbabwe banks, even if they failed, was low because of deposit insurance.

Question 13

Present discounted value refers to the

A) Future value of today's dollars.
B) Value today of future payments adjusted for inflation.
C) Value today of future payments adjusted for interest accrual.
D) Value today of future payments adjusted for risk.

Question 14

If the interest rate is 8 percent, then the present discounted value of $100 to be received two years from now is closest to

A) $128.00.
B) $116.00.
C) $86.00.
D) $96.00.

Question 15

Market participants are likely to save a portion of current income if they

A) Place a higher value on future consumption than on current consumption.
B) Place a higher value on current consumption than on future consumption.
C) Believe that banks might fail.
D) Believe that money will lose much of its value in the future.

Question 16

Financial intermediaries

A) Increase search and information costs for savers and investors.
B) Transfer purchasing power from spenders to savers.
C) Spread the risk of investment failure over many individuals.
D) Always allocate funds to the least productive investments.

Question 17

The risk premium is the

A) Interest rate paid to savers.
B) Interest rate charged to borrowers.
C) Difference in rates of return on safe and risky investments.
D) Interest rate divided by the expected value.

Question 18

Lower interest rates

A) Lower the present value of future payments.
B) Raise the future value of current dollars.
C) Reflect a lower opportunity cost of money.
D) Reflect a higher opportunity cost of money.

Question 19

An institution that makes savings available to investors is known as

A) A financial repository.
B) An independent financial association.
C) A financial intermediary.
D) A stock and bond intermediary.

Question 20

The function of financial intermediaries is to transfer purchasing power from

A) Dissavers to consumers.
B) Consumers to savers.
C) Savers to dissavers.
D) Dissavers to savers.

Question 21

If the present discounted value of a payment is $1,000,000 and there is a 40 percent chance that the payment will not occur, then the expected value is

A) $600,000.
B) $400,000.
C) $1,000,000.
D) $1,400,000.

Question 22

The present discounted value of $100 to be received one year from now, if the interest rate is 2.5 percent, is closest to

A) $98.
B) $100.
C) $103.
D) $95.

Question 23

As the uncertainty attached to a future payment _______, the expected value _______.

A) decreases; decreases
B) increases; stays the same
C) decreases; increases
D) increases; becomes positive

Question 24

Expected value refers to the

A) Future value of a current payment.
B) Present value of a future payment.
C) Probable value of a future payment.
D) Difference in the rates of return on risky and safe investments.

Question 25

Which of the following is the equation for determining an expected value?

A) (1 - Risk factor) × PDV.
B) (Risk factor - 1) × PDV.
C) (1 - Risk factor) ÷ PDV.
D) (Risk factor - 1) ÷ PDV.

Question 26

The present discounted value of $60,000 to be received at the end of three years when the interest rate is 10 percent is closest to

A) $45,079.
B) $49,587.
C) $60,000.
D) $79,860.

Question 27

In the loanable funds market,

A) The price is the interest rate.
B) The demand curve reflects the behavior of lenders.
C) The supply curve reflects the behavior of borrowers.
D) If interest rates rise, firms borrow more.

Question 28

The present discounted value of a future payment will increase when the

A) Interest rate decreases.
B) Future payment is moved further into the future.
C) Risk of nonpayment increases.
D) Opportunity cost of money increases.

Question 29

The expected value of a future payment differs from the present discounted value in that the expected value

A) Takes into account the possibility of nonpayment.
B) Uses a lower interest rate in its calculation.
C) Uses a higher interest rate in its calculation.
D) Assumes that future payments take place over a longer period of time.

Question 30

Suppose Regis has a 25 percent chance of not collecting $1,000 in one year. If the interest rate is 10 percent, what is the expected value of the future payment?

A) $750.
B) $682.
C) $227.
D) $909.

Question 31

As interest rates decline, all of the following will result except

A) Quantity demanded of loanable funds increases.
B) Quantity supplied of loanable funds decreases.
C) Cost of borrowing diminishes.
D) Demand curve for money shifts to the left.

Question 32

As the interest rate increases, ceteris paribus, the trade-off between present and future consumption

A) Makes it more appealing to sacrifice current consumption.
B) Is not affected.
C) Encourages less saving.
D) Makes it less appealing to sacrifice present consumption.

Question 33

If the expected rate of return decreases

A) The demand for loanable funds will increase.
B) The demand for loanable funds will decrease.
C) Market participants will save less money.
D) The time value of money will increase.

Question 34

The price paid for the use of money is defined as the

A) Rental rate.
B) Interest rate.
C) Profit rate.
D) Inflation rate.

Question 35

The value of future payments is affected by

A) The level of dividends.
B) Capital gains.
C) The par value.
D) The probability of nonpayment.

Question 36

The present discounted value of a future payment will decrease when the

A) Interest rate increases.
B) Future payment is closer to the present.
C) Risk of nonpayment increases.
D) Opportunity cost of money decreases.

Question 37

The intersection of the demand for loanable funds and the supply of loanable funds determines the

A) Real interest rate.
B) Par value.
C) Prevailing interest rate.
D) Price ÷ earnings ratio.

Question 38

The quantity of loanable funds available to a corporation depends on the

A) Dividends the company is willing to pay.
B) Present worth of the company's dividends.
C) Price of its stock.
D) Interest rate the company is willing to offer.

Question 39

Which of the following will cause the demand for loanable funds to increase?

A) The expected profitability of a project declines.
B) The cost of funds increases.
C) The expected rate of return increases.
D) Households increase their rate of savings.

Question 40

As the prevailing interest rate increases, all of the following occur except

A) Quantity demanded of loanable funds decreases.
B) Quantity supplied of loanable funds increases.
C) Cost of borrowing rises.
D) Supply curve for savings shifts to the right.

Question 41

Which of the following is not a reason to hold stock?

A) To receive payments on the firm's debt.
B) To receive potential capital gains.
C) To take part in the selection of the board of directors.
D) To receive potential dividends.

Question 42

The amount of corporate profits not paid out in dividends is known as

A) The par value.
B) Retained earnings.
C) The price/earnings ratio.
D) Corporate stock.

Question 43

The owners of which type of firm have the least liability?

A) Corporation.
B) Partnership.
C) Proprietorship.
D) Limited partnership.

Question 44

Capital gains are

A) The only motive for purchasing stock.
B) Profits used for investment in new plants and equipment.
C) An increase in the market value of an asset.
D) The amount of corporate profit paid out for each share of stock.

Question 45

Figure 32.1 represents the market for loanable funds. Which of the following is true at the equilibrium interest rate?

A) The rate of return on capital equals the interest rate.
B) The rate of return on capital is less than the interest rate.
C) The rate of return on capital is greater than the interest rate.
D) There is no relationship between the rate of return on capital and the interest rate.

Question 46

In which form of business is a single individual responsible for the repayment of any debts?

A) Proprietorship.
B) Corporation.
C) Partnership.
D) Family-run business.

Question 47

The owners of which type of firm have the most liability?

A) Corporation.
B) Partnership.
C) Proprietorship.
D) Limited partnership.

Question 48

Dividends are equal to

A) Capital gains minus retained earnings.
B) Corporate profits.
C) Corporate profits plus retained earnings.
D) Corporate profits minus retained earnings.

Question 49

A motivation for holding stock is

A) To receive interest payments on the firm's debt.
B) The anticipation of capital gains.
C) To have a direct role in the operation of the corporation.
D) To own a low-risk, illiquid asset.

Question 50

The first sale to the general public of stock in a corporation is referred to as

A) An original public sale.
B) An initial public offering.
C) A public bond offering.
D) A public stock auction.

Question 51

Shares of ownership in a corporation are known as

A) Corporate stock.
B) Corporate bonds.
C) Retained earnings.
D) Savings bonds.

Question 52

Retained earnings are

A) The only motive for purchasing stock.
B) Equal to corporate profits.
C) Direct increases to shareholder wealth.
D) The amount of corporate profit not paid out in dividends.

Question 53

The purpose of an initial public offering is to

A) See if there is a demand for a company's new product.
B) Change the membership of the board of directors.
C) Borrow funds for investment and growth.
D) Raise funds for investment and growth by selling shares of the company to the public.

Question 54

As the prevailing interest rate decreases, the opportunity cost of money

A) Increases for both lender and borrower.
B) Increases for the borrower and decreases for the lender.
C) Decreases for both lender and borrower.
D) Decreases for the borrower and increases for the lender.

Question 55

Dividends are

A) The amount of corporate profit paid out for each share of stock.
B) Profits used for investment in new plants and equipment.
C) An increase in the market value of an asset.
D) The only motive for purchasing stock.

Question 56

In a publicly traded corporation, which of the following is responsible for business debts and activities?

A) The individual stockholders.
B) The board members.
C) The owners.
D) The corporation itself.

Question 57

Figure 32.1 represents the market for loanable funds. The equilibrium interest rate

A) Is less than the rate of return on capital.
B) Is greater than the rate of return on capital.
C) Represents the price paid for the use of money.
D) Is equal to the risk premium.

Question 58

A corporation can elect to allocate corporate profits into either

A) Interest payments or dividends.
B) Bonds or stocks.
C) Dividends or retained earnings.
D) Capital gains or dividends.

Question 59

An increase in the value of an asset, such as a stock, is called

A) Interest.
B) Profit.
C) A capital gain.
D) A dividend.

Question 60

The owners of a corporation are

A) Liable for its debts.
B) Those people who own the bonds issued by the corporation.
C) The shareholders of the corporation's stock.
D) The board of directors.

Question 61

Ceteris paribus, the price of a stock will definitely increase when the

A) Supply of the stock increases.
B) Prevailing interest rate increases.
C) Demand for the stock increases.
D) Demand for the stock and supply of the stock both decrease.

Question 62

The price of a stock will increase, ceteris paribus, when

A) Future earnings expectations decrease.
B) Consumer confidence increases.
C) The interest rate increases.
D) Terrorists cause people to be fearful.

Question 63

All of the following are allowed to issue bonds except

A) General Motors.
B) The U.S. Treasury.
C) The City of Arlington.
D) The Federal Reserve.

Question 64

Bonds may be issued by the U.S.

A) Congress.
B) Treasury.
C) Federal Reserve Bank.
D) Immigration and Naturalization Agency.

Question 65

The price of a stock will increase, ceteris paribus, when

A) Future earnings expectations increase.
B) The interest rate increases.
C) The supply of the stock increases.
D) There is a surplus of the stock at the current price.

Question 66

The price/earnings (P/E) ratio is the price of a stock share ($100) divided by earnings (profit) per share ($20), which is equal to 5.

Question 67

Bonds may be issued by all of the following except

A) Corporations.
B) The federal government.
C) Local governments.
D) Individuals.

Question 68

The Dow Jones Industrial Average is an arithmetic average of _____ blue-chip industrial stocks.

A) 30
B) 50
C) 75
D) 500

Question 69

The initial bond purchaser

A) Earns par value on the bond.
B) Borrows funds directly from the bond issuer.
C) Lends funds directly to the bond issuer.
D) Shares in the company's profits.

Question 70

The advantage to a corporation of issuing bonds instead of stock is that

A) The owners keep control of the company.
B) Bond prices do not fluctuate.
C) The owners do not have to make interest payments on the loan.
D) The possibility of default is lower when bonds are issued.

Question 71

The price of a stock will decrease, ceteris paribus, when

A) Future earnings expectations increase.
B) People move money out of the bond market and look for other options.
C) Terrorists cause people to be fearful.
D) Congress makes sound budget decisions.

Question 72

A bond is

A) A share in a corporation.
B) A coupon used to collect a dividend.
C) An insurance policy investor's purchase to protect against the possibility of falling stock prices.
D) A promise to repay a loan.

Question 73

The primary economic role of financial markets is to

A) Gain profits for investors.
B) Allocate resources to profitable businesses and away from businesses with losses.
C) Earn dividends for shareholders.
D) Provide the federal government with a source of loanable funds when it has a budget deficit.

Question 74

The price of a stock will decrease, ceteris paribus, for all of the following reasons except

A) There is a surplus of the stock at the current price.
B) The demand for the stock decreases.
C) The supply of the stock increases.
D) Consumer confidence increases.

Question 75

Large swings in stock prices are usually caused by

A) A decrease in interest rates.
B) Widespread changes in expectations.
C) A decrease in the supply of stocks.
D) An increase in dividend payments by corporations.

Question 76

The price of a stock will decrease, ceteris paribus, when

A) There is a shortage of the stock at the current price.
B) The interest rate increases.
C) The supply of the stock decreases.
D) Future earnings expectations increase.

Question 77

An initial public offering

A) Allows a company to borrow funds for investment and growth.
B) Allows a company to raise money without increasing debt.
C) Indicates the demand for a company's new product.
D) Increases the percentage of the company owned by the management and original entrepreneurs.

Question 78

The most important determinant of how much an individual will pay for a share of stock is

A) The average daily volume for the corporation's shares.
B) The expectation of future profit.
C) How well the CEO is compensated.
D) The structure of the market.

Question 79

The P/E ratio, or price to earnings ratio of a stock, can be computed using which of the following formulas?

A) (Revenue per share) ÷ (Price of stock share).
B) (Price of stock share) ÷ (Revenue per share).
C) (Earnings per share) ÷ (Price of stock share).
D) (Price of stock share) ÷ (Earnings per share).

Question 80

When a corporation issues a bond, it is

A) Issuing dividends to shareholders.
B) Lending money to the owners of the corporation.
C) Borrowing funds from the initial buyer of the bond.
D) Making an initial public offering.