Question 1

You believe that a corporation's dividends will grow 5% on average into the foreseeable future.If the company's last dividend payment was $5 what should be the current price of the stock assuming a 12% required return?

Accepted Answer

Use the Gordon Growth Model.
$5(1 + .05)/(.12 - .05)= $75

Question 2

If market participants notice that a variable behaves differently now than in the past,then,according to rational expectations theory,we can expect market participants to

Accepted Answer

A)  change the way they form expectations about future values of the variable.
B)  begin to make systematic mistakes.
C)  no longer pay close attention to movements in this variable.
D)  give up trying to forecast this variable. A

Question 3

Using the Gordon growth model,a stock's current price decreases when

Accepted Answer

A)  the dividend growth rate increases.
B)  the required return on equity decreases.
C)  the expected dividend payment increases.
D)  the growth rate of dividends decreases. D

Question 4

Economists have focused more attention on the formation of expectations in recent years.This increase in interest can probably best be explained by the recognition that

Accepted Answer

A)  expectations influence the behavior of participants in the economy and thus have a major impact on economic activity.
B)  expectations influence only a few individuals,have little impact on the overall economy,but can have important effects on a few markets.
C)  expectations influence many individuals,have little impact on the overall economy,but can have distributional effects.
D)  models that ignore expectations have little predictive power,even in the short run.

Question 5

The theory of rational expectations,when applied to financial markets,is known as

Accepted Answer

A)  monetarism.
B)  the efficient markets hypothesis.
C)  the theory of strict liability.
D)  the theory of impossibility.

Question 6

________ is the field of study that applies concepts from social sciences such as psychology and sociology to help understand the behavior of securities prices.

Accepted Answer

A)  Behavioral finance
B)  Strategical finance
C)  Methodical finance
D)  Procedural finance

Question 7

Using the Gordon growth formula,if D₁ is $1.00,kₑ is 10% or 0.10,and g is 5% or 0.05,then the current stock price is

Accepted Answer

A)  $10.
B)  $20.
C)  $30.
D)  $40.

Question 8

The view that expectations change relatively slowly over time in response to new information is known in economics as

Accepted Answer

A)  rational expectations.
B)  irrational expectations.
C)  slow-response expectations.
D)  adaptive expectations.

Question 9

In the Gordon growth model,a decrease in the required rate of return on equity

Accepted Answer

A)  increases the current stock price.
B)  increases the future stock price.
C)  reduces the future stock price.
D)  reduces the current stock price.

Question 10

If expectations of the future inflation rate are formed solely on the basis of a weighted average of past inflation rates,then economists would say that expectation formation is

Accepted Answer

A)  irrational.
B)  rational.
C)  adaptive.
D)  reasonable.

Question 11

The small-firm effect refers to the

Accepted Answer

A)  negative returns earned by small firms.
B)  returns equal to large firms earned by small firms.
C)  abnormally high returns earned by small firms.
D)  low returns after adjusting for risk earned by small firms.

Question 12

Using the Gordon growth model,if D₁ is $.50,kₑ is 7%,and g is 5%,then the present value of the stock is

Accepted Answer

A)  $2.50.
B)  $25.
C)  $50.
D)  $46.73.

Question 13

In the generalized dividend model,if the expected sales price is in the distant future

Accepted Answer

A)  it does not affect the current stock price.
B)  it is more important than dividends in determining the current stock price.
C)  it is equally important with dividends in determining the current stock price.
D)  it is less important than dividends but still affects the current stock price.

Question 14

Another way to state the efficient markets hypothesis is: in an efficient market

Accepted Answer

A)  unexploited profit opportunities will be quickly eliminated.
B)  unexploited profit opportunities will never exist.
C)  all prices can be accurately predicted.
D)  every financial market participant must be well informed about securities.

Question 15

According to rational expectations

Accepted Answer

A)  expectations of inflation are viewed as being an average of past inflation rates.
B)  expectations of inflation are viewed as being an average of expected future inflation rates.
C)  expectations formation indicates that changes in expectations occur slowly over time as past data change.
D)  expectations will not differ from optimal forecasts using all available information.

Question 16

Which of the following types of information most likely allows the exploitation of a profit opportunity?

Accepted Answer

A)  financial analysts' published recommendations
B)  technical analysis
C)  hot tips from a stockbroker
D)  insider information

Question 17

A change in perceived risk of a stock changes

Accepted Answer

A)  the expected dividend growth rate.
B)  the expected sales price.
C)  the required rate of return.
D)  the current dividend.

Question 18

The advantage of a "buy-and-hold strategy" is that

Accepted Answer

A)  net profits will tend to be higher because there will be fewer brokerage commissions.
B)  losses will eventually be eliminated.
C)  the longer a stock is held,the higher will be its price.
D)  profits are guaranteed.

Question 19

Evidence in support of the efficient markets hypothesis includes

Accepted Answer

A)  the failure of technical analysis to outperform the market.
B)  the small-firm effect.
C)  the January effect.
D)  excessive volatility.

Question 20

Stockholders are residual claimants,meaning that they

Accepted Answer

A)  have the first priority claim on all of a company's assets.
B)  are liable for all of a company's debts.
C)  will never share in a company's profits.
D)  receive the remaining cash flow after all other claims are paid.

Exam 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis