Deck 16: Financial Markets: Equities and Bonds

Question 1

Which of the following is not a feature of a standard equity security?

A) It is an ownership claim
B) Dividend payments are made before corporation tax
C) It pays dividends decided by the firm
D) It gives voting rights
E) Equity holders cannot force a firm into bankruptcy

Answer 1

Dividend payments are made before corporation tax

Question 2

Under which of the following conditions would a firm's stock price rise following an interest rate hike by the central bank?

A) the firm simultaneously announces a poor profit report
B) the rate hike was fully anticipated by the market
C) investors perceive the rate hike as a response to rapid inflation
D) investors had expected an interest rate decrease
E) market participants had anticipated a larger increase in rates than actually occurred

Answer 2

market participants had anticipated a larger increase in rates than actually occurred

Question 3

Which sector of the economy tends to be a net holder of financial assets (i.e.assets greater than liabilities)?

A) Corporate Sector
B) Government Sector
C) Overseas Sector
D) Household Sector
E) Financial Sector

Answer 3

Household Sector

Question 4

For an individual whose coefficient of relative risk aversion is 1 (and who displays constant relative risk aversion as income changes),utility is equal to the natural logarithm of income. That is, where X denotes income. For such an individual,what income level is the certainty equivalent of a risky income with a 50% chance of being $90,000 and a 50% chance of being $40,000?

A) $50,000
B) $60,000
C) $65,000
D) $70,000
E) $80,000

Question 5

The difference in rates of return between corporate stocks and US government Treasury bills is called

A) capital gains
B) the dividend yield
C) the equity premium
D) covered interest parity
E) the sacrifice ratio

Question 6

Suppose the dividend yield is currently 5%. If annualized short term nominal interest rates are 6%,expected inflation is 1% per year,and the equity risk premium is 3%,then annual dividend growth is expected to be

A) 1%
B) 2%
C) 3%
D) 4%
E) 5%

Question 7

For an individual whose utility is equal to twice the square root of income, where X denotes income,and the coefficient of relative risk aversion is ½. For such an individual,what income level is the certainty equivalent of a risky income which has a 50% chance of being $9 and a 50% chance of being $4?

A) $5.00
B) $5.75
C) $6.25
D) $6.50
E) $7.75

Question 8

Which of the following could cause a retail chain's stock price to fall?

A) a profit report which exceeds expectations
B) announcement of a merger with a more profitable firm
C) an unexpected increase in the money supply by the central bank, which reduces interest rates
D) the opening of a new, national, competing retail chain
E) the announcement that the firm will retire 10% of its outstanding shares

Question 9

If a publicly traded firm wants its share price to rise from $20 to $25 and the required rate of return in the market is 10%,then the firm could

A) begin paying a dividend of $2.50 per year
B) split the stock until the price reaches $25 per share
C) issue 25% more shares
D) sell off its most profitable line of business
E) issue $250 bonds at a 10% discount

Question 10

Which of the following is not a feature of a standard debt security?

A) It is not an ownership claim
B) Interest payments are made before corporation tax
C) It pays pre-agreed interest payments
D) It gives no voting rights
E) Debt holders cannot force a firm into bankruptcy

Question 11

Which of the following is a correct statement of the efficient markets theory of stock price movements?

A) unpredictable fluctuations in share prices can occur only as the result of irrational behavior by investors
B) volatility in share prices imply a perfectly functioning stock market
C) if the stock market is efficient, stock prices will display an unpredictable, random path
D) predicting changes in investor expectations permits forecasts of future share prices despite random drift
E) economic fundamentals (interest rates and corporate profits) determine the fluctuations in stock prices around a trend created by psychological factors

Question 12

The next questions refer to the following.
Suppose that a firm's dividends have been growing by 4% annually and this year's dividend is $10 per share.
If the required rate of return is 8%,then

A) no one will purchase this stock
B) the stock must generate capital gains of 4% per year
C) the current stock price is $250 per share
D) the stock is over-valued by 4%, and its share price will decline according to Tobin's q
E) the stock is yielding capital losses of 4% annually

Question 13

In the long run,the price of a firm's stock is determined by

A) the expected rate of capital gains and the capital gains tax rate
B) the discounted value of the future stream of dividends
C) the price of its output divided by the number of shares of stock outstanding
D) regulatory restrictions on share prices imposed by the SEC
E) the resale value of its capital stock

Question 14

If a stock pays a $1 dividend every year and the required rate of return on stocks of this type is 25%,then the share price should be

A) $1
B) $2
C) $3
D) $4
E) $5

Question 15

An investor wishes to hold a stock for 1 year. If the stock is expected to pay a $15 dividend and sell for $300 in one year from now,the investor will buy the stock if

A) the required rate of return is 15% and the current share price is at least $275
B) the required rate of return is 12% and the current share price is below $281.25
C) the required rate of return is 10% and the current share price is not above $291.67
D) the required rate of return is 8% and the current price is $296.36
E) the required rate of return is 5% and the current share price is at least $295

Question 16

If long term GDP growth is 2.5% annually,inflation is 3% per year,the dividend yield is 4%,and short term interest rates are 6%,then

A) inflation-adjusted capital gains must be 0.5% per year
B) the equity risk premium must be 3.5%
C) dividends must be growing by 5% per year
D) dividends are not growing and share prices are showing capital losses of 1% per year
E) any broad-based stock market index (such as the S&P 500) will be rising at a rate of 9.5% per year

Question 17

A Secondary Market is where

A) Companies issue new shares
B) Governments issue bonds
C) bank loans are organized
D) existing securities are traded after they have been issued
E) IPOs occur

Question 18

An investor wishes to hold a stock for 1 year and demands a 10% rate of return. If the stock price is currently $250 and a $5 dividend is expected,the investor buys the stock if she expects

A) the share price to reach $260 by the end of the year
B) a capital gain of $15
C) an 8% capital gain
D) other stocks to generate capital losses
E) a stock split by year's end

Question 19

Historically,after adjusting for inflation,the highest long run rates of return are on

A) stocks
B) bonds
C) short term US Treasury bills
D) gold
E) savings accounts at banks

Question 20

The next questions refer to the following.
Suppose that a firm's dividends have been growing by 4% annually and this year's dividend is $10 per share.
If investors perceive the stock to have become riskier and demand a 9% rate of return,then

A) the share price rises by 1/8
B) the share price falls by 20%
C) the dividend yield declines by 1 percentage point
D) the firm will reduce the dividend by 25%
E) the equity premium declines by 1/9

Question 21

Robert Shiller's critique of the efficient markets hypothesis is based on

A) the partial and imperfect nature of information available to investors regarding corporate performance
B) the existence of monopoly power and insider trading
C) the heterogeneity of stocks in different industries
D) the apparently excessive risk aversion of investors
E) the greater volatility observed in the market than would result from investors with rational expectations

Question 22

A risk averse investor with utility function where X denotes wealth is indifferent between purchasing a stock or a bond for $100. The bond yields a safe return of 5%. The stock has a 50% chance of yielding a -19% rate of return (a capital loss of 19% and no dividend). The risk premium on the stock is then

A) 38%
B) 29%
C) 9.5%
D) 4.05%
E) 1.55%

Question 23

The tendency for share prices on an upward trend to continue to rise whilst those on a downward trend tend to fall is called

A) Mean reversion
B) Excess Volatility
C) Momentum
D) The equity premium puzzle
E) A random walk

Question 24

When assets are known to be overvalued but the price continues to rise,the market exhibits

A) a random walk with drift
B) a speculative asset bubble
C) mean reversion
D) an equity premium puzzle
E) sample selection bias

Question 25

Mean reversion in stock prices

A) results from efficient market arbitrage
B) makes stock prices fundamentally unpredictable
C) depends on an infinitely elastic demand for shares
D) lacks empirical credibility
E) implies that deviations from trends set by economic fundamentals are temporary and inefficient

Question 26

For someone whose utility is equal to twice the square root of income, where X denotes income,and the coefficient of relative risk aversion is ½. If this individual's income is currently $25,what insurance premium would (s)he pay to avoid a 20% chance of having income fall to $9?

A) $1.79
B) $2.20
C) $3.20
D) $3.84
E) $4.02

Question 27

The next questions refer to the following.
Suppose a stock exhibits no dividend growth; the current dividend is $21, and the required rate of return is 7%. The share price is currently $360.
To maintain a 7% expected rate of return with a $21 annual dividend,the expected stock price next year must be

A) $364.21
B) $379.63
C) $381.00
D) $385.20
E) $406.20

Question 28

The rate of return that makes the present discounted value of a bond's future payment stream equal to its current market price is called the

A) coupon rate
B) yield
C) par value
D) residual maturity
E) face value

Question 29

The next questions refer to the following.
Suppose a stock exhibits no dividend growth; the current dividend is $21, and the required rate of return is 7%. The share price is currently $360.
The stock is currently

A) undervalued by 10%
B) undervalued by 20%
C) overvalued by 10%
D) overvalued by 15%
E) overvalued by 20%

Question 30

A one-year,zero-coupon bond with a face value of $1,000 which sells for $930 has a yield of approximately

A) 3.9%
B) 5.7%
C) 7.0%
D) 7.5%
E) 9.3%

Question 31

The next questions refer to the following.
A five-year bond is to be issued with a face value of $1,000 and a coupon rate of 5%.
A potential buyer who demands a 9% rate of return would be willing to pay a price up to,but not more than

A) $647.50
B) $812.00
C) $844.41
D) $901.10
E) $953.62

Question 32

A graph of the relationship between a bond's price and it's yield is

A) linear
B) positively sloped
C) convex
D) increasing at a decreasing rate
E) unpredictable

Question 33

Which empirical phenomenon is regarded as the equity premium puzzle?

A) the higher rates of return on the US stock market than those in Western Europe
B) the much higher rates of return on stocks than bonds and banks accounts
C) the greater risk aversion displayed by female investors than male investors
D) the greater proportion of bonds than stocks in Danish and Swiss portfolios
E) why some investors seek dividends while others seek capital gains

Question 34

Critics of the efficient markets hypothesis attribute stock price volatility to

A) speculative bubbles
B) herding behavior
C) extrapolation of recent trends
D) rumors
E) all of the above

Question 35

Bonds that guarantee a real rate of return are called

A) consols
B) zero-coupon bonds
C) index-linked bonds
D) guaranteed income contracts
E) fixed income securities

Question 36

Which of the following may help to explain the equity premium puzzle?

A) sample selection bias
B) self-fulfilling prophecies
C) mismeasured rates of return
D) risk neutrality, or indifference to risk
E) none of the above

Question 37

A three-year bond with a face value of $1,000 and a coupon rate of 5% which sells at par has a yield to maturity of

A) 3%
B) 5%
C) 15%
D) $150
E) $350

Question 38

The next questions refer to the following.
Suppose a stock exhibits no dividend growth; the current dividend is $21, and the required rate of return is 7%. The share price is currently $360.
The dividend yield is currently

A) 1.17%
B) 5.83%
C) 7.00%
D) 20.00%
E) 27.00%

Question 39

The next questions refer to the following.
A five-year bond is to be issued with a face value of $1,000 and a coupon rate of 5%.
After two years have elapsed,the bond's price should be

A) $898.75
B) $812.00
C) $789.92
D) $715.63
E) $687.94

Question 40

The next questions refer to the following.
Suppose a stock exhibits no dividend growth; the current dividend is $21, and the required rate of return is 7%. The share price is currently $360.
Suppose there is a 20% chance of mean reversion. Then if the bubble persists during the current period,the price will

A) rise 3.025%
B) rise 5.63%
C) rise 7.00%
D) rise 27.00%
E) remain constant

Question 41

Compared to bonds with otherwise identical characteristics,which of the following unambiguously raises a bond's price?

A) a lower coupon rate
B) a lower face value
C) a longer term to maturity
D) a lower yield
E) none of the above

Question 42

A bond sells at a premium when

A) the coupon rate exceeds the desired yield
B) the face value exceeds the current bond price
C) the duration exceeds the term to maturity
D) it costs more than a share of stock issued by the same corporation
E) it has a zero coupon rate

Question 43

All else being equal,which of the following would cause nominal bond yields to rise?

A) a reduced risk of default
B) the expectation that the currency in which the bond was issued will depreciate
C) the expectation of price deflation
D) expansionary monetary policy
E) declining coupon rates

Question 44

The difference,or spread,between short-term and long-term bond yields is

A) a strong empirical predictor of future short-term yields
B) a weak predictor of future yields and a better signal of inflation
C) inversely related to the difference in time to maturity
D) used by forecasters to predict future long-term yields
E) regulated by the government in most economies

Question 45

The yield curve depicts the relationship between

A) bond prices and interest rates
B) bond prices and coupon rates
C) maturity and duration
D) time to maturity and yield
E) bond yields and stock market returns

Question 46

Yields on long term bonds are,in principle,equal to

A) an average of current and expected future money market rates
B) rates of return on stock issued by the same companies
C) the fed funds rate
D) the difference between the bond prices and par values, expressed as a percentage of current prices
E) the rate of inflation expected in the economy

Question 47

The yield on a bond

A) is fixed in advance, like the interest rate on a bank account
B) is directly proportional to the term to maturity
C) is inversely related to the bond price
D) is inversely related to the face value of the bond
E) in unrelated to the coupon rate

Question 48

An inverted,or downward-sloping,yield curve signals

A) a high risk premium on long term bonds
B) an expectation of falling bond prices
C) expectations of rising inflation
D) an expectation of declining short term interest rates
E) the onset of an economic expansion

Question 49

Central banks

A) influence the money market but not the bond market
B) have influence over short term interest rates but no influence over long term interest rates
C) can influence bond yields but not bond prices
D) can raise long term yields, if they create credible expectations of rising short term rates
E) can reduce yields on long term bonds by issuing new debt

Question 50

Higher short term interest rates

A) benefit bondholders
B) benefit those who issue bonds
C) benefit depositors at banks
D) benefit borrowers at banks
E) benefit governments with large national debts

Question 51

Contractionary monetary policy can be expected to

A) reduce bond yields
B) reduce bond prices
C) increase bond duration
D) cause bonds to sell at par
E) increase residual maturity