Deck 14: Financial Economics

Question 1

There are three common features that all investments share; they are:

A) risk, Return, Cost
B) risk, equity, debt
C) all of the above
D) none of the above

Answer 1

risk, Return, Cost

Question 2

An investor purchases a bond today. What is the earliest time that the investor could sell the bond.

A) just before the bond matures
B) after the first interest payment
C) at any time.
D) half way through the life of the bond

Answer 2

at any time.

Question 3

How much would you approximately be willing to pay today, for a security that yields 7 percent a year for 5 years and is promised to be worth $4,500 at the end of that time:

A) $4,815
B) $4,500
C) $3,208
D) $4,206

Answer 3

$3,208

Question 4

You receive a gift of $2,000 today, and in 8 year's you're told that it will be worth $3,500. Assuming interest is compounded annually, what is the approximate interest paid on the investment.

A) 7.54%
B) 8.25%
C) 3.67%
D) 7.25%

Question 5

A characteristic of a passively managed fund is:

A) lower management fees relative to an actively managed fund
B) constantly buying and selling of securities
C) it invests solely in bonds
D) it invests solely in stocks

Question 6

The limited liability rule:

A) exposes the investor to an unlimited risk.
B) discourages the investors to invest in stocks.
C) forces each shareholder to be responsible for the entire company's loss.
D) limits the risks involved in investing in corporations.

Question 7

Suppose you own a stock of a company that you really like, and have no intentions of selling it. The stock pays a quarterly dividend of $0.75. Suppose you purchased the stock for $15 and one year later it is worth $17.25. If you decide to sell your stock, how much has the investment returned to you? Ignore interest on quarterly dividends throughout the year:

A) 4.41%
B) 5%
C) 17.65%
D) 35%

Question 8

What is the key point that encourages people to invest in stocks vs bonds:

A) capital gains
B) dividends
C) limited liability
D) both A and B

Question 9

A mutual fund is:

A) indexed to a benchmark
B) an actively managed fund whose goal it is to have a return that beats a benchmark, e.g. S&P TSX 60
C) a company which maintains a professionally managed portfolio, or collection of stocks or bonds.
D) none of the above

Question 10

Over the next 4 years, you are expecting to receive $300, $400, $600, and $500 respectively. If you can invest this money at 5 percent per year over four years, how much will that money be worth at the end of that period?

A) $2,014.20
B) $1,578.18
C) $2,031.54
D) $1,800

Question 11

The main difference between an economic investment and a financial investment is:

A) an economic investment has solely to do with financial products, while financial investment is similar to purchasing a house
B) financial investments include both physical and financial assets where economic investments only include physical asset
C) economic investments include both physical and financial assets where financial investments only include physical
D) there is no difference between economic and financial investments

Question 12

You expect to receive $1,000 at the end of each year, for the next 10 years, If you can invest this money at 4 percent per year over 10 years, how much will the stream of payment be worth today?

A) $8,637.56
B) $12,006.11
C) $8,110.90
D) $10,000

Question 13

Assume that you purchase 100 shares of a stock today at $56.50. A year from now the stock price will rise to $100. To realize the gain, you sell all of the shares. What is the percentage rate of return, assuming the stock will not pay any dividends:

A) 76.99%
B) 43.5%
C) 42%
D) 19.25%

Question 14

A dividend is:

A) the gain an investor receives after they sell the stock
B) payment out of the profits of a company.
C) similar to an interest payment on debt, only it is paid to the company's shareholders.
D) splitting a company's stock

Question 15

In the event of a bankruptcy, control of a corporation's assets is given to the:

A) shareholders
B) a bankruptcy judge
C) corporation itself
D) CEOs of the corporation

Question 16

What formula would you use if you wanted to find the current value of a potential investment with a payout in five years:

A) X(1 + i)^t = FV
B) X/(1 + i) = PV
C) X/(1 + i)^t = PV
D) (1 + i)^t/X = PV

Question 17

An example of an economic investment would be:

A) A stock
B) A bond
C) An old factory
D) A new house

Question 18

One of the basic principles behind the present value model is:

A) FV/PV = X
B) an asset's price should exactly equal the total future value of all the asset's present payments
C) the Security Market Line
D) an asset's price should exactly equal the total future value of all the asset's future payments

Question 19

Over the next 5 years, you are expecting to receive $500, $600, $600, $800, and $900 respectively. If you can invest this money at 7.5 percent per year over five years, how much will that money be worth at the end of that period?

A) $2,693B) $4,337
B) $3,400
C) $3,000

Question 20

This day last year, you purchased a rare hockey card of your favorite player for $20. Now one year later, that player has done really well. Knowing the card is worth $45, what would be your rate of return if you sold the card today:

A) 70%
B) 26.67%
C) 125%
D) 75%

Question 21

What influences the slope of the Security Market Line (SML)?

A) Risk free rate
B) Rate of returned
C) Investors attitude towards risk
D) Beta of the security

Question 22

How do investors calculate a potential investments risk level:

A) by the average expected rate of return
B) by calculating investments' beta
C) by an investment systemic risk
D) by the security market line of the investment

Question 23

What is the horizontal axis of the Security Market Line?

A) Beta
B) Average Rate of Return
C) Standard Deviation
D) Present value

Question 24

Diversifiable risk could be defined as:

A) the risk specific to a given investment
B) the risk specific to a particular market
C) the risk associated with investing in a company which conducts business within a specific country
D) the risk specific to a stock that can be used in a arbitrage situation

Question 25

Which of the following statements best describes why the SML is important to financial theory?

A) It`s a graphical representation of portfolio diversification
B) It describes the relationship between Present value and future value
C) It describes the relationship between expected return and beta
D) It describes the theory of arbitrage

Question 26

Given two portfolios: A, which has an expected return of 14% and a beta of 1.2; and B, which has an expected return of 15% and a beta of 1.6. Which of the two portfolios has high level of relative risk?

A) Portfolio A, because of its expected return
B) Portfolio B, because of its expected return
C) Portfolio A, because of its Beta
D) Portfolio B, because of its Beta

Question 27

How long can an arbitrage opportunity of two similar assets last?

A) Infinitely, because assets prices are fixed
B) Only until the rates of return of the two assets are equal
C) Once you buy and sell other assets
D) Arbitrage opportunities do not exist

Question 28

The Bank of Canada expects inflation to exceed its target level in the next year. To combat this it initiates contractionary fiscal policy. Following this, investor's attitude towards risk lessens and they become more cautious about what they invest in. What would the SML look like in the next year:

A) Flatter and shifted up
B) Steeper and shifted up
C) Flatter and shifted down
D) Steeper and shifted down

Question 29

Why are short-term Canadian government bonds considered to be "risk free"?

A) There is near certainty that the bonds will be paid back
B) The high rate of return that they pay
C) It is the highest rated debt in the world
D) The Beta of the bonds is negative

Question 30

You are given the choice between four investments and their respective rates of return; A yielding 16%, B yielding 6%, C yielding 13%, and D yielding 18%. Investments A and D are from different sectors, and different market weightings. Investments B and C are from the same sector and their market weightings are similar in size. How would you realize an arbitrage opportunity?

A) sell A and buy D
B) sell B and buy C
C) buy B and sell A
D) sell C and buy D

Question 31

What type of risk could be reduced by Portfolio diversification?

A) Idiosyncratic risk and systemic risk
B) Just systemic risk
C) Just idiosyncratic risk
D) Neither types

Question 32

Although counterintuitive, what is the reason for a risk free asset providing a rate of return?

A) Time preference
B) Compensating for idiosyncratic risk
C) Creating a market for the instrument
D) Diversification

Question 33

Diversification is similar to the saying:

A) " a bird in the hand is worth two in the bush"
B) "a fool and his money are soon parted"
C) "the risk to the portfolio is increased by diversification "
D) "don't put all your eggs in one basket"

Question 34

The investment's rate of return and its price are:

A) positively related.
B) for some investments positively and for some inversely related.
C) not related.
D) inversely related.

Question 35

Investment X has a 30% chance of achieving a 7% rate of return, 45% chance of returning 13.5% and a 25% chance of returning 25%. What is the average expected rate of return for Investment X:

A) 15.2%
B) 17.4%
C) 13.0%
D) 14.4%

Question 36

An investment has a 20% chance of achieving a 5% rate of return, 25% chance of returning 10%, a 15% of returning 25%, and a 40% of returning 15%. What is the average expected rate of return for Investment X:

A) 13.25%
B) 14.6%
C) 13.0%
D) 15.4%

Question 37

What is the vertical axis of the Security Market Line?

A) Beta
B) Average Rate of Return
C) Standard Deviation
D) Present value

Question 38

You are given three investments with the same level of risk. Two of the investments have relatively the same level of return. The third investment has a return that is relatively higher than the other two investments. Assuming that the two investments with the same level of return lie on the SML, how would you classify the third investment?

A) ``Over-sold``, investors rush to buy it
B) ``Over-bought``, investors rush to sell it
C) ``Over-sold``, investors rush to sell it
D) ``Over-bought``, investors rush to buy it

Question 39

Which of the following theories deal with the time preference?

A) Average Expected Return
B) Beta
C) Present value
D) Diversification

Question 40

Assume that you are a growth-oriented investor and wish to beat the market's rate of return. Which of the following portfolios would you choose based solely on the portfolio's beta:

A) Portfolio A, Beta = .9
B) Portfolio B, Beta = -.6
C) Portfolio C, Beta = 1
D) Portfolio D, Beta = 1.4

Question 41

The major benefit derived from portfolio diversification is risk infusion.

Question 42

In Canada, during the Severe Contraction of 2008-2009:

A) the risk-free interest rate fell and stock market prices rose.
B) the risk-free interest rate rose and stock market prices rose.
C) the risk-free interest rate fell and stock market prices fell.
D) the risk-free interest rate rose and stock market prices fell.

Question 43

In Canada, during the Severe Contraction of 2008-2009:

A) the intercept of the SML dramatically fell and the SML became much steeper.
B) the intercept of the SML dramatically rose and the SML became much steeper.
C) the intercept of the SML dramatically fell and the SML became flatter.
D) the intercept of the SML dramatically rose and the SML became flatter.

Question 44

The price of an asset should approximately equal the total future value of all the asset's present payments.

Question 45

An investment's rate of return is negatively related to its price.

Question 46

The riskier the investment, the steeper the SML

Question 47

Risk and return are negatively related.

Question 48

To stimulate growth, the Bank of Canada decreases interest rates. Investors' attitude regarding investing stays the same. What happens to the SML in the next period?

A) Steeper
B) Flatter
C) Shifted up
D) Shifted Down

Question 49

A bond is a debt contract that is most often issued by governments and corporations.

Question 50

In Canada, during the Severe Contraction of 2008-2009 the intercept of the SML dramatically fell and the SML became much steeper.

Question 51

One of the characteristic of owning a stock is equity or ownership in a corporation.