Deck 22: Managing Incentives

Question 1

A mutual fund pools money from many customers and invests the money in many firms. The fees charged by fund managers are:

A) lower in bond funds.
B) higher in passive funds.
C) lower in passive funds.
D) higher in bond funds.

Answer 1

C

Question 2

Which of the following are advantages of saving your money in a mutual fund? I. You have professional fund management. II. Mutual funds have always outperformed the S&P 500. III. People with smaller amounts of money can diversify risk.

A) I only
B) I and II only
C) I and III only
D) I, II, and III

Answer 2

C

Question 3

The fact that the majority of stock mutual funds cannot outperform the stock market averages is consistent with:

A) the no free lunch principle.
B) the risk-return trade-off principle.
C) the efficient markets hypothesis.
D) the active trading hypothesis.

Answer 3

C

Question 4

John Stossel's dart-throwing experiment showed that:

A) picking stocks at random can outperform the stock picks of major Wall Street experts.
B) Wall Street experts have inside information, which makes beating their stock picks difficult.
C) Companies with longer names are likely to outperform market averages.
D) Economic theory regarding the stock market is flawed.

Question 5

The text argues that which of the following is TRUE about Warren Buffett?

A) His past performance has been purely a result of luck.
B) He has not been able to beat the market at any time.
C) He always beats the market using inside information.
D) It has become harder for him to beat the market over time.

Question 6

According to the efficient markets hypothesis, the person who most likely earns the highest return for holding the stock of Company ABC on a single day is:

A) a person who follows a buy-and-hold strategy.
B) an active trader who knows the historical prices of ABC.
C) ABC's CEO who has inside information about the company's new projects.
D) None of the answers is correct: No one can outperform anyone else at any time.

Question 7

Some skeptical economists say that successful brokers like Warren Buffett are:

A) able to see the future.
B) just lucky.
C) incredibly smart at picking winning stocks.
D) likely to remain successful.

Question 8

Which of the following refers to a mutual fund for which its manager buys and sells stocks regularly in order to maximize the fund's returns?

A) liquid fund
B) efficient market fund
C) active fund
D) passive fund

Question 9

(Figure: Mutual Funds) Refer to the figure. From this Mutual Funds figure, John Stossel dart-throwing experiment we can say that:

A) mutual funds typically outperform the S&P 500.
B) mutual fund managers are no smarter than monkeys.
C) knowledge of stock market behavior does not guarantee its predictability.
D) mutual funds can never outperform the stock market.

Question 10

Which of the following are helpful in stock investment strategies?

A) buying undervalued stocks
B) holding stocks for a long period of time
C) lucky picks
D) All of the answers are correct.

Question 11

Over a long period of time which investment strategy is typically more profitable?

A) active
B) passive
C) introversive
D) subversive

Question 12

According to the efficient markets hypothesis, stock prices:

A) reflect all publicly available information about the stock market.
B) reflect all private company information that is known only to company insiders.
C) contain both public and private information that is helpful for some investors to outperform other investors.
D) contain no useful information.

Question 13

The efficient markets hypothesis implies that in the stock market:

A) everyone can earn more than everyone else some of the time.
B) no one can systematically earn more than the average market return.
C) people with more funds earn higher returns.
D) people can use technical analysis to systematically earn high returns.

Question 14

Which of the following statements is TRUE? I. A mutual fund pools money from many different investors and uses that money to invest in many different firms. II. Mutual funds that are run by managers who try to pick the best performing stocks usually outperform the S&P 500. III. Passive mutual funds do not try to select winning stocks; they mimic broader markets like the S&P 500.

A) I only
B) I and II only
C) I and III only
D) II and III only

Question 15

The major difference between active and passive mutual funds is that:

A) active funds are classed as mutual funds, but passive funds are not.
B) active funds involve stock picks by managers, while passive funds involve stock picks by the investors themselves.
C) active funds are more risky than passive funds.
D) active funds involve stock picks by managers, while passive funds match the movements of a broad market index.

Question 16

Suppose 1,000 experts flip a coin once each year and half say the market will go up, while the other half say the market will go down. After six years how many experts would have been correct every year?

A) 15
B) 62
C) 8
D) 31

Question 17

In a market of 2,000 investors who each year flip a coin to predict market success or failure, how many investors will have been consistently right after five years? Assume the coin tosses yield heads exactly 50 percent of the time.

A) 31
B) 62
C) 500
D) 1,000

Question 18

Which of the following is TRUE of mutual funds? I. Active funds generally give higher returns than passive funds. II. Most mutual funds generally give higher returns than broad stock indexes.

A) I only
B) II only
C) both I and II
D) neither I nor II

Question 19

John Stossel picked Wall Street stocks at random, and his portfolio outperformed what proportion of expert stockbrokers and fund managers?

A) 50 percent
B) 60 percent
C) 80 percent
D) 90 percent

Question 20

If each of the approximately 320,000 securities and financial service agents in the United States bet on whether the market would go up or down for each of the next 10 years by flipping a coin, we would expect that approximately 312 agents would have been right 10 years in a row. This example suggests that:

A) it is easy to beat the market averages.
B) famous investors like Warren Buffett may have merely been lucky.
C) there are above-normal profit opportunities in the stock market.
D) All of the answers are correct.

Question 21

One of the problems with investment advice that claims you should buy stock in a certain company or sector of the economy is that:

A) no one else knows such advice.
B) asset prices likely reflect that information already.
C) investment advice is not regulated.
D) sellers know less than buyers in the financial markets.

Question 22

To diversify, a person who already holds stocks that move in the opposite direction of the stock market as a whole should:

A) always buy more of the same stocks.
B) buy stocks that move in the same direction of the stock market as a whole.
C) buy stocks that have about the same expected returns as the stocks she already holds.
D) sell all her stocks immediately.

Question 23

If the efficient markets hypothesis is valid, then a person should: I. buy mutual funds. II. diversify. III. follow a buy-and-hold strategy.

A) I and II only
B) I and III only
C) II and III only
D) I, II, and III

Question 24

Which of the following statements is TRUE? I. For every transaction in the stock market there is a buyer and a seller. II. At any point in time, the price of a stock tends to reflect all available public information about the company's future prospects. III. A revolutionary cancer treatment pill will be released next year. An investor will get rich by buying stock in that company now.

A) I and II only
B) III only
C) II and III only
D) I, II, and III

Question 25

The efficient markets hypothesis implies that an investor:

A) cannot systematically outperform the market as a whole over time.
B) should rely on publicly available information to outperform the market.
C) should buy and sell lower volumes of shares.
D) can manage a portfolio and regularly outperform the whole market.

Question 26

When Chernobyl melted down in the Soviet Union, the:

A) price of U.S. basketballs increased.
B) prices of assets reacted slowly to the information.
C) price of U.S. potatoes increased.
D) stock prices of U.S. nuclear plants increased.

Question 27

Which of the following individuals is using information outside the efficient markets hypothesis? Someone who:

A) has information about the aging U.S. population and expects stock for companies that cater to senior citizens to increase in value.
B) reads in the newspaper about a merger between two profitable firms and expects the stock prices for these companies to rise.
C) while auditing a dishonest company realizes that its profit estimates are greatly inflated and immediately sells her stock in the company.
D) hears a rumor that a top bank may be in trouble, and decides to sell his stock in that company.

Question 28

Consider the market for ABC Company's stock. What should happen in this market after an announcement that the company is having financial difficulties?

A) The demand for the stock would shift to the left.
B) The demand for the stock would shift to the right.
C) The supply of the stock would shift to the left.
D) The supply of the stock would shift to the right.

Question 29

Which of the following statements is TRUE? I. The riskiest stocks tend to move in sync with the economy. II. A relatively safe stock is one that does not vary much with the state of the economy. III. Health care stocks are some of the riskiest stocks.

A) III only
B) I and II only
C) II and III only
D) I only

Question 30

If a person follows a buy-and-hold strategy, she will initially hold stocks:

A) until the stock prices rise.
B) until the stock prices fall.
C) until the stock prices stabilize.
D) whether or not stock prices rise or fall.

Question 31

Popular U.S. stock indexes include: I. FDIC II. Dow Jones Industrial Average III. NASDAQ

A) I and II only
B) I and III only
C) II and III only
D) I, II, and III

Question 32

Which of the following tends to be least risky in its stock value when the economy is in a deep recession?

A) an automobile manufacturer
B) a homebuilder
C) a high-end department store
D) a utility company that supplies water to government buildings

Question 33

Consider the market for ABC Company's stock. What should happen to the stock for this company if there is a rumor that the company is set to merge with another very profitable company?

A) The demand for the stock would shift to the left.
B) The demand for the stock would shift to the right.
C) The supply of the stock would shift to the left.
D) The supply of the stock would shift to the right.

Question 34

Stocks are a good investment if: I. one is prepared to hold them for a while through market fluctuations. II. one can buy them immediately after prices have fallen. III. one is not averse to risk.

A) I only
B) I and II only
C) I and III only
D) I, II, and III

Question 35

Consider the market for ABC Company's stock. What should happen to the stock for ABC Company after a merger with a highly successful supply firm is announced?

A) The demand for the stock would shift to the left.
B) The demand for the stock would shift to the right.
C) The supply of the stock would shift to the left.
D) The supply of the stock would shift to the right.

Question 36

In a stock market, a riskier stock typically has:

A) a higher covariance with the market as a whole.
B) a lower covariance with the market as a whole.
C) a higher correlation with some stocks and a lower correlation with other stocks.
D) a lower correlation with the market as a whole.

Question 37

If a person diversifies her stock portfolio, then:

A) the expected return of her portfolio will increase.
B) the risk of her portfolio will decrease.
C) both the risk and expected return of her portfolio will increase.
D) neither the risk nor the expected return of her portfolio will change.

Question 38

About the only way to beat a well-functioning market and make money in the short run is: I. through the efficient markets hypothesis. II. if one has insider information. III. through extreme speed and foresight.

A) I only
B) II and III only
C) II only
D) I, II, and III

Question 39

An efficient stock market means that:

A) it is difficult to outperform the market, since stock prices convey all relevant public information about a company.
B) traders with inside information cannot even outperform market averages.
C) new information is slowly reflected in stock prices.
D) All of the answers are correct.

Question 40

Technical analysis:

A) looks for patterns in stock prices.
B) can systematically beat market averages, according to research economists.
C) is useful for predicting when stocks will stay above certain price thresholds.
D) All of the answers are correct.

Question 41

Which of the following individuals has a poor diversification strategy? Someone who buys:

A) stock in gun manufacturing, ammunitions, and rifle companies.
B) stock in textbook publishing, tea and coffee production, and the technology sector.
C) T-bills, corporate bonds, and technology stocks.
D) government bonds, technology stocks, and agricultural stocks.

Question 42

Why would stock for a high-end store with expensive clothing be considered risky in a recession?

A) Consumers demand cheaper clothes in times of recession, and that company would be expected to make lower profits.
B) Consumers do not buy stock when recessions occur.
C) High-end clothing store stocks have low covariance with the market.
D) Stocks from such companies depend heavily on oil prices.

Question 43

A buy-and-hold strategy would work best for which of the following people? Someone who

A) will retire in three years
B) is 25 years old and just started a good job
C) lives hand-to-mouth
D) lives on Social Security checks

Question 44

A risk-loving individual would choose which of the following investment instruments?

A) government bonds
B) stocks from a company listed on the Dow Jones Industrial Average
C) stock from a very new company that has high growth potential
D) a low-risk mutual fund

Question 45

The NASDAQ:

A) weights individual stocks equally.
B) gives greater weight to low-tech stocks than does the Dow.
C) gives greater weight to small stocks than does the Dow.
D) has 500 stocks.

Question 46

The best trading strategy is to:

A) buy low and sell high.
B) buy high and sell low.
C) buy a couple of stocks and hold them for the long run.
D) buy a large bundle of stocks and hold them for the long run.

Question 47

A risk-averse individual would choose which of the following investment instruments?

A) stocks that are negatively correlated with the rest of one's portfolio
B) agricultural stocks in a foreign agricultural economy
C) oil stocks
D) technology stocks

Question 48

Which of the following is NOT a typical index used to practice a buy-and-hold strategy?

A) The Dow Jones Industrial Average
B) The Moody Index Scorecard
C) The Standard and Poor's 500
D) The NASDAQ Composite Index

Question 49

Which of the following is NOT a major stock index?

A) The Heathrow 2,000
B) The Dow Jones Industrial Average
C) The Standard and Poor's 500
D) The NASDAQ Composite Index

Question 50

Diversification:

A) increases risk and return.
B) decreases risk and return.
C) increases risk.
D) decreases risk.

Question 51

Which of the following stock portfolios offers the greatest diversification?

A) 3M and Raytheon
B) Adobe Systems and Sara Lee
C) Nucor and Wyeth
D) Ashland, Baker Hughes, Bemis, BMC Software, CA Inc., Century Telephone, Dean Foods, Dover Corp., Eastman Kodak, EQT Corp., Exxon Mobil, Ford Motor, General Dynamics, Genworth Financial, Google, Hasbro, Home Depot, Intuit, Johnson Controls, Kohl's, Legg Mason, Netapp, Pall Corp., Pfizer, QLogic, Ryder System, SLM Corp., Target, UPS, Viacom, Waters Corp., XL Capital, Yahoo, Zimmer Holdings

Question 52

A risky portfolio is one that: I. is poorly diversified. II. has a volatile stock in a basket of 200 stocks. III. has a positive correlation between most of its stock prices.

A) I only
B) II and III only
C) I and III only
D) I, II, and III

Question 53

The Dow Jones Industrial Average:

A) weights larger companies' stocks more than small companies' stocks.
B) has stocks from thousands of companies.
C) has stocks from 500 companies.
D) has stocks from 30 companies.

Question 54

A stock that has a high covariance with market conditions is considered risky because:

A) the stock belongs to a small company.
B) the stock does not fluctuate in value.
C) the stock moves against the market.
D) when the market is declining, that stock will decline too.

Question 55

Which of the following individuals seems to have followed a diversification strategy? Someone who has purchased stock in:

A) lumber, paper, and furniture companies.
B) oil, telecommunications, and clothing companies.
C) silicon chips, computer, and cell phone companies.
D) cat food, dog food, and dog bone companies.

Question 56

When a stock index rises, it means that:

A) all stocks on the index have risen in value.
B) the weighted average of all stock prices in the index has risen.
C) all stocks on that index are equally weighteC.
D) All of the answers are correct.

Question 57

The NASDAQ:

A) weights individual stocks equally.
B) gives greater weight to larger stocks than does the Dow.
C) gives greater weight to high-tech stocks than does the Dow.
D) has 30 stocks.

Question 58

If your investment money is evenly divided among stocks in your investment portfolio, which of these four stock portfolios would suffer the most from an Adobe Systems bankruptcy?

A) Adobe Systems
B) Adobe Systems and Best Buy
C) Adobe Systems, Nucor, and Wyeth
D) Adobe Systems, Ashland, Baker Hughes, Bemis, BMC Software, CA Inc., Century Telephone, Dean Foods, Dover Corp., Eastman Kodak, EQT Corp., and Exxon Mobil

Question 59

A) Mutual Fund A
B) Mutual Fund B
C) Mutual Fund C
D) Mutual Fund D

Question 60

A) Vanguard 500
B) California Investment
C) Vantagepoint 500
D) All of these funds provide equal real returns.

Question 61

Compared to stocks, art investments have _____ monetary returns because they offer ______ nonpecuniary returns.

A) lower; lower
B) higher; higher
C) lower; higher
D) higher; lower

Question 62

Which of the following statements is TRUE?

A) One should avoid investing in bonds because they give lower returns than do stocks.
B) If you need your money for something in two years, avoid putting it in stocks.
C) Retirees should allocate more of their investments to stocks.
D) Recent college graduates should allocate more of their money to bonds than to stocks.

Question 63

For a mutual fund, a load is:

A) the expected return of the fund.
B) the risk of the fund.
C) the fee for managing the fund.
D) the charge for insuring the fund.

Question 64

How fast will a $10,000 portfolio double if it is earning 10 percent annual returns?

A) every 10 years
B) every 7 years
C) every 5 years
D) every 14 years

Question 65

Which of the following choices correctly describes the relationship between risk and return?

A) Risk and return have no relationship.
B) Risk and return have a positive relationship.
C) Zero risk instruments have the highest returns.
D) The lower the risk is, the higher the return.

Question 66

Suppose you invest $1,000 in a mutual fund. If the annual return of that fund is 5 percent, how many years will it take before your fund is worth $2,000?

A) 10 years
B) 14 years
C) 20 years
D) never

Question 67

A) A, B, C, D
B) C, B, A, D
C) B, A, D, C
D) C, D, A, B

Question 68

A person purchases stocks of two companies in 2009. One has an annual return of 2.5 percent and the other's return is 3 percent. The difference between the dollar returns on the two company stocks would be the greatest in:

A) 2010.
B) 2012.
C) 2013.
D) None of these is correct: The difference in dollar returns is always the same.

Question 69

In financial investment, a riskier asset typically has:

A) a higher expected return.
B) a lower expected return.
C) the same expected return as a less risky asset.
D) a higher or lower expected return, depending on the industry.

Question 70

Historically, stocks offer __________ returns than bonds in the long run.

A) higher
B) lower
C) the same
D) None of these is correct: It depends on the types of stocks or bonds.

Question 71

Which of the following refers to the ability of an asset to generate returns, which are then reinvested in order to generate their own returns?

A) buy and hold
B) compounding
C) simple returns
D) extrapolation

Question 72

Which of the following statements is TRUE?

A) In the long run, stock returns are higher than bond returns.
B) Passive investments underperform active investments.
C) One can earn higher returns by investing in funds with high loading costs.
D) The efficient markets hypothesis only holds in the short run.

Question 73

A financial investor faces the lowest risk by investing in:

A) a corporate bond.
B) a three-month U.S. Treasury bill.
C) the stocks of a new company.
D) a mutual fund of small company stocks.

Question 74

The textbook uses the "no free lunch principle" in financial investment to indicate that:

A) investment opportunities with high expected returns come with higher risk.
B) investment opportunities with high expected returns come with lower risk.
C) there is no relationship between risk and expected returns.
D) there is always risk in holding any investment opportunity.

Question 75

Stockbrokers make _____ commissions the _____ their clients buy and sell stocks.

A) lower; more frequently
B) higher; more frequently
C) higher; less frequently
D) zero; more frequently

Question 76

Stocks are better than bonds:

A) in the short run.
B) because stocks have guaranteed returns.
C) in the long run.
D) because bonds are issued only by companies in financial distress.

Question 77

What is the risk-return trade-off?

A) Assets with the least risk tend to outperform the market.
B) To invest in less risky assets, means higher returns.
C) Bonds earn higher returns than stocks because bonds are riskier.
D) To earn higher rates of return, a person must accept higher risk.

Question 78

Why does it make sense to avoid paying high fees when investing with mutual funds or stock brokers?

A) The funds with high fees are too expensive.
B) The funds with high fees likely hire managers who are not experts.
C) The funds with high fees do not perform any better than other funds.
D) It does make sense, since you should pay high fees to get access to experts.

Question 79

The textbook recommends buying mutual funds that:

A) charge high commissions.
B) charge large management fees.
C) have high loads.
D) have the lowest fees.

Question 80

A real return of 10 percent per year means that a $10,000 investment will grow to $20,000 in:

A) 10 years.
B) 7 years.
C) 15 years.
D) 20 years.