Q&A Hero

Q: The price of a stock at the beginning of a year is $50. There is a 70 percent chance of its price rising to $55 by the end of the year and a 30 percent chance of its price falling to $45. The stock will pay an amount of $2 at the end of the year. The current yield of the security is____a. 4 percentb. 5 percentc. 70 percentd. 30 percent

Q: Which type of analyst should generally outperform market index according to the Efficient Markets Hypothesis? A) technical analysts B) fundamental analysts C) those that follow the random walk D) none of the above

Q: Above-normal returns on stock investments can be expected by investors who A) possess insider information. B) are wealthy enough to hold the stock of many different companies in their portfolios. C) are risk seeking. D) concentrate their investments in one or two stocks.

Q: Consider the following: an investor in the U.S. is pondering a one-year investment. She can purchase a domestic bond for $1,000 that has an interest rate of i or she can purchase a bond in England for 1,500 British pounds (£) that pays an interest rate of if. The current exchange rate is $1.50/£. She considers the bonds to be of equal risk. If i = if, the expected returns are not equal. What do you know? A. The exchange rate is fixed between the U.S. and BritainB. The bonds initially sold for different pricesC. Arbitrage doesn't workD. The exchange rate must be flexible

Q: The income an investor receives in some period divided by the value of the security at the beginning of that period is known as______ yield.a. capital-gainsb. expectedc. currentd. realized

Q: Employees of brokerage firms that rely on forecasting future profits of firms in order to forecast future stock prices are called A) rational analysts B) adaptive analysts C) technical analysts D) fundamental analysts

Q: A nonmarketable security is one that a. is not widely advertised.b. has a present value of zero.c. cannot be resold in a secondary market.d. has only a current yield and not a capital-gains yield.

Q: An implication of the efficient markets hypothesis is that A) only sophisticated investors will be able to earn above-normal profits from financial investments. B) above-normal profits are available only to major traders. C) above-normal profits will be eliminated in the trading process. D) unless he or she acts recklessly, the average investor should be able to make above-normal profits.

Q: In the long run, a country's exchange rate is determined by: A. domestic monetary.B. purchasing power parity.C. the domestic inflation rate.D. supply and demand.

Q: Which of the following statements is true?a. Over the last fifty years, the risk spread between Aaa bonds and Baa bonds always remained positive except inb. The risk spread between Aaa bonds and Baa bonds became negative only in the mid-1960s.c. For most of the last twenty years, the risk bread between Aaa bonds and Baa bonds remained negative.d. Over the last fifty years, the risk spread between Aaa bonds and Baa bonds never became negative

Q: If the bonds of two different countries are identical, their expected returns will: A. be equal if capital flows freely internationally.B. always be equal.C. be equal only if the exchange rate between the two countries is fixed.D. be equal only if the inflation rate is the same in each country.

Q: Under the efficient markets hypothesis, for news about a company's prospects to have a large impact on the price of the company's stock the news must A) have an impact on the company's profitability in the short term. B) have an impact on the company's profitability in the long term. C) significantly increase the likelihood that the company will go bankrupt. D) significantly reduce the liquidity of the company's stock.

Q: Suppose you are an investor with a choice between three securities that are identical in every way except in terms of their rates of return and risk. Which security has the least risk? Note: You can answer this question intuitively, without calculating the standard deviation. However, if you want to calculate the standard deviation, the equation is:Standard deviation = S = Investment A: total return = 10 percent with probability 50 percent total return = 20 percent with probability 50 percent Investment B: total return = 12 percent with probability 50 percent total return = 20 percent with probability 50 percent Investment C: total return = 5 percent with probability 60 percent total return = 25 percent with probability 40 percent Investment D: total return = 5 percent with probability 60 percent total return = 7 percent with probability 40 percenta. Investment Ab. Investment Bc. Investment Cd. Investment D

Q: Let if be the interest rate being paid on a foreign bond, and let i be the interest rate being paid for a domestic bond; let P be the price of the domestic bond and let Pf be the price of the foreign bond. If exchanges rates are fixed and the bonds are equal in terms of risk: A. if = i.B. P = Pf times units of domestic currency/unit of foreign currency.C. the expected return from the foreign bond = the expected return from the domestic bond.D. all of the answers given are correct.

Q: Risk that cannot be eliminated by diversification is referred to as a. idiosyncratic risk.b. market risk. c. default risk.d. interest-rate risk.

Q: International capital mobility: A. contributes to the rigidity of exchange rates.B. contributes to the equalization of expected returns across countries.C. eliminates arbitrage opportunities.D. makes interest rates equal across countries.

Q: According to the efficient markets hypothesis, who is most likely to benefit from frequently moving funds from one asset to another? A) your broker B) small investors C) big investors D) only those who consistently beat the market

Q: Suppose you are an investor with a choice between three securities that are identical in every way except in terms of their rates of return and risk. Which investment provides the highest expected return?Investment A: Total return = 10 percent with probability 50 percent Total return = 20 percent with probability 50 percent Investment B: Total return = 12 percent with probability 50 percent Total return = 20 percent with probability 50 percent Investment C: Total return = 5 percent with probability 60 percent Total return = 25 percent with probability 40 percent Investment D: Total return = 5 percent with probability 60 percent Total return = 7 percent with probability 40 percenta. Investment Ab. Investment Bc. Investment Cd. Investment D

Q: When arbitrage occurs across countries with a flexible exchange rate and when the bonds in each country are identical and there are no barriers to capital flows then the: A. interest rates on the bonds will be identical.B. expected return on the bonds will be identical.C. inflation rates in each country will be identical.D. prices of the bonds will be identical.

Q: Consider three investments, where expected return is the expected value of the total return and risk is measured by the standard deviation. The investments are identical in every way except for their expected return and risk:Investment A: expected return = 2 percent, risk = 5 percentInvestment B: expected return = 5 percent, risk = 4 percentInvestment C: expected return = 14 percent, risk = 20 percentInvestment D expected return = 6 percent, risk = 12 percentIf a risk-averse investor can buy only one of the three investments and compares each investment with the other three, which investment option would he never choose?a. Investment A, because its expected return is lower than Investment B and its risk is higher.b. Investment B, because its expected return is so much lower than Investment C.c. Investment C, because its risk exceeds its expected return.d. Investments D, because the expected return to investment D is so much lower than Investment C.

Q: In the short run, a country's exchange rate is determined by: A. monetary policy.B. purchasing power parity.C. the domestic inflation rate.D. supply and demand.

Q: Consider the following four debt securities, which are identical in every characteristic except as noted: W: A corporate bond rated AAAX: A corporate bond rated BBBY: A corporate bond rated AAA with a shorter time to maturity than bonds W and XZ: A corporate bond rated AAA with the same time to maturity as bond Y that trades in a more liquid market than bonds W, X, or YWhich of the following is the most likely order of the interest rates (yields to maturity) of the bonds from highest to lowest?a. X, W, Y, Zb. W, X, Z, Yc. X, Y, Z, Wd. X, Z, W, Y

Q: According to the efficient markets hypothesis, A) common stock prices should be constant. B) the price of a corporation's stock is likely to fluctuate substantially in response to news about changes in the company's short-term prospects. C) the price of a corporation's stock will fluctuate significantly only in response to news about changes in the company's long-term prospects. D) price fluctuations in common stock are a response to fads and are only infrequently the result of changes in the expected profitability of the companies involved.

Q: When arbitrage occurs across countries with flexible exchange rates and when the bonds in each country are identical and there are no barriers to capital flows: A. the interest rates on the bonds will be identical.B. the prices of the bonds will be identical.C. the inflation rates in each country will be identical.D. none of the answers provided is correct.

Q: Purchasing power parity is a good theory of explaining exchange rate behavior: A. over very short periods.B. over periods lasting six to twelve months.C. over very long periods, such as decades.D. over both long and short periods.

Q: Under the efficient markets hypothesis, what would be the price per share of a company whose current dividend is $10.00 and whose dividends are expected to grow by 3% per year (assume the risk-adjusted interest rate is 10%)? A) $74.62 B) $79.23 C) $142.86 D) $147.14

Q: Suppose you are an investor facing a choice between three investments that are identical in every way except in terms of their rates of return and taxability. Which investment provides the highest after-tax return?Investment A: interest rate 10 percent, tax rate 40 percent of interest income.Investment B: interest rate 8 percent, tax rate 25 percent of interest income.Investment C: interest rate 5 percent, tax rate 0 percent.Investment D: interest rate 5 percent, tax rate 1 percent.a. Investment Ab. Investment Bc. Investment Cd. Investment D

Q: Assuming the free flow of capital across borders, which of the following statements is most correct? A. A central bank can have both a fixed exchange rate and an independent inflation policy.B. A central bank cannot have both a fixed exchange rate and an independent inflation policy.C. The central banks of most industrialized countries focus on fixed exchange rates.D. While most central banks of industrialized countries favor fixing exchange rates, their primary concern is on domestic inflation.

Q: In an efficient market with rational expectations, the actual price of an asset A) will equal its expected price. B) will often be below its expected price. C) will often be above its expected price. D) equals its expected price plus a random error term.

Q: According to the Efficient Markets Hypothesis, prices of securities A) change infrequently. B) change frequently to reflect news about changes in the fundamental values of the securities. C) change frequently as evaluations of existing information about the securities change. D) are not allowed, under federal securities laws, to change more frequently than once a month.

Q: One lesson learned from the financial crisis of 2008 was thata. government regulators need to respond slowly when financial practices threaten the economy.b. unregulated financial firms need to be prevented from growing so large that their failure would severely damage the economy.c. the ease of owning a home has no relationship to the efficiency of the financial system.d. unregulated financial firms need to be prevented from growing so small that their success would have no or little effect on the economy.

Q: Assuming the free flow of capital across borders, if country A wants to fix its exchange rate with country B, then: A. country A's inflation rate will have to match country B's.B. country A's monetary policy must be conducted so the inflation rate in country A matches the inflation rate in country B.C. country A's monetary policy will not be able to be used to address domestic issues.D. all of the answers given are correct.

Q: If major traders believe the price of a stock should be higher than its current market price, A) they have an incentive to sell the stock. B) their actions will result in the information they possess being incorporated into the price of the stock. C) there is little they can do because government regulation precludes their acting on what they know. D) they should petition the Securities and Exchange Commission to authorize an adjustment in the price of the stock.

Q: In the Asian crisis, which began in 1997,a. investors began to pull their financial investments out of Asia with urgency.b. large banks from Asia began purchasing large American banks, threatening the health of the U.S. financial system.c. mutual funds in Asia began to fail in large numbers.d. savings-and-loan institutions in Asia began to fail in large numbers.

Q: According to the efficient markets hypothesis, A) the equilibrium price of an asset equals the optimal forecast of fundamental value based on available information. B) the actual and expected prices of an asset will be equal. C) the actual price of an asset reflects only information on past returns on the asset. D) the expected price of an asset incorporates only information on past returns on the asset.

Q: Discuss what experience concerning required reserves occurred during the Great Depression that contributes to the decision today not to use required reserves as an active tool of monetary policy.

Q: If market participants have rational expectations, then the best forecast of the price of a stock in the next period is A) equal to an average of the prices of the stock in previous periods. B) equal to the price of the stock in the current period. C) dependent upon all information available in the current period, including, but not limited to, the price of the stock in the current period. D) dependent on information available in the previous period.

Q: In the 1980s, the United States suffered one of its worst financial crises when ______began to fail in large numbers.a. commercial banksb. stock brokersc. money market mutual fundsd. savings and loan institutions

Q: The efficient markets hypothesis A) assumes that market participants form their expectations adaptively. B) applies rational expectations to the pricing of assets. C) applies to the stock market, but not to the bond market. D) indicates that the stock market is efficient, but not rational.

Q: The amount of debt and equity outstanding in the United States is more than____ times the nation's GDP.a. 2b. 3c. 4d. 5

Q: Imagine the inflation rate begins to rise rapidly, the FOMC meets and it is believed that the target interest rate needed to stem the inflation could easily exceed 20 percent. Many members of the committee believe the Fed cannot announce this high of a target for political reasons. Discuss what the FOMC could do in terms of targets and what change occurred in 2002 that is going to make their job a bit more difficult.

Q: If the prices of financial assets follow a random walk, then A) they should be easy to forecast, provided market participants have rational expectations. B) they should be easy to forecast, provided market participants have adaptive expectations. C) the change in price from one trading period to the next is not predictable. D) major traders in the market must not be making use of all available information about the assets.

Q: Suppose the quantity demanded for a security isBD= 150 − 1b,and the quantity supplied of the security isBS= 50 + 1b,where bis the price of the security in dollars. Suppose that the supply curve shifts toBS= 75 + 1b.The equilibrium quantity of the securitya. rises by 12.5.b. rises by 2.5. c. falls by 2.5. d. falls by 12.5.

Q: How does policy forward guidance influence the economy and inflation?

Q: Another name for an equity security isa. bond.b. debt.c. option.d. stock.

Q: What are the advantages from the 2002 change in the Fed's lending policy?

Q: The quantity demanded of a security is QD= 220 - 2b and the quantity supplied of it is QS=100 + 2b. The equilibrium price of the security is______ .a. $300b. $280c. $420d. $500

Q: When market participants have rational expectations, the deviation of the expected price from the actual future price is A) zero. B) predictable, provided all relevant information is made use of. C) not predictable. D) predictable under certain circumstances, but not under others.

Q: What were the 3 unconventional policy approaches used by the Fed during the financial crisis of 2007-2009?

Q: A contract that makes the owner of a security a part owner of the company that issued the security is known as a. a debt security.b. an equity security.c. a bond.d. an option.

Q: Could the Fed enter the federal funds market to make sure the market and target rates are always equal, and if they could, why don't they?

Q: Which of the following statements is true of rational expectations? A) Rational expectations forecasts are always correct. B) For a trader with rational expectations, the expectation of an asset's price equals the optimal price forecast. C) If traders have rational expectations, any announcement by a company will have an effect on its stock price, even if the market was already aware of the facts being announced. D) If a trader really has rational expectations, he or she was always earn a greater than normal return on his or her financial portfolio.

Q: Suppose the quantity demanded for a security isBD= 150 − 1b,and the quantity supplied of the security isBS= 50 + 1b,where bis the price of the security in dollars. Suppose that the supply curve shifts toBS= 75 + 1b.The equilibrium price of the security a. rises by $50.b. rises by $125. c. falls by $125. d. falls by $50.

Q: What is your response to the following: "The Taylor rule shows a strong correlation between the target rate actually set by the FOMC and the one predicted by the rule. Since the Taylor rule would provide accountability, credibility, and transparency, the FOMC committee should be dissolved and replaced by a form of the Taylor rule."

Q: A contract that promises to pay a given amount of money to the owner of a security at specific dates in the future is known asa. a debt security.b. an equity security. c. stock.d. an option.

Q: How do targeted asset purchases alter the outlook for the economy and inflation?

Q: If traders in a market have rational expectations, then A) the price of an asset equals its fundamental value. B) prices of riskier assets are higher than prices of less risky assets. C) past prices of assets do not affect market participants' expectations of future asset prices. D) they make use of less information than they would if they had adaptive expectations.

Q: Given the following Taylor rule:Target federal funds rate = 2 + current inflation + ½(inflation gap) + ½(output gap);Explain what happens to the real interest rate and why it happens, each time inflation increases by 1 percent.

Q: A contract whereby a borrower, who seeks to obtain money from someone, promises to compensate the lender in the future is known asa. a warrant.b. an exchange rate.c. a derivative security. d. a financial security.

Q: An asset's fundamental value equals A) its face value. B) its maturity value. C) the market's best guess of the present value of the asset's expected future returns. D) the weighted sum of its market price over the recent past.

Q: Given the following Taylor rule:Target federal funds rate = 2 + current inflation + ½(inflation gap) + ½(output gap);Since the coefficients on the inflation and output gaps are equal, does this mean the central bank will respond to a one percent increase in inflation with the same change in the target rate as they would initiate from a one percent increase in the output gap? Explain.

Q: According to the Gordon-Growth model, what is the value of a stock with a dividend of $2, required return on equity of 8% and expected growth rate of dividends of 4%? A) $25 B) $26 C) $50 D) $52

Q: An equation that relates the interest rate to the output gap and the inflation rate is a. the Phillips relation.b. the Sharpe ratio. c. Okun's law.d. the Taylor rule.

Q: Rational expectations involve the assumption that A) market participants make use only of information on the past performance of an asset in determining what they believe its price should be. B) market participants rarely change their minds about the correct price of an asset. C) financial markets are good at increasing liquidity, but poor at transmitting information. D) market participants makes use of all available information.

Q: According to the Gordon-Growth model, what is the value of a stock with a dividend of $1, required return on equity of 10% and expected growth rate of dividends of 5%? A) $2 B) $10 C) $20 D) $21

Q: Given the following Taylor rule:Target federal funds rate = 2 + current inflation + 2x(inflation gap) + x(output gap);What do the coefficients on the inflation and output gaps (2x, x) reveal?

Q: The percentage by which real gross domestic product is above or below its potential level is called thea. inflation rateb. output gapc. real interest rated. rate of compounding

Q: When market participants have rational expectations, A) the information they use contains only past experiences. B) the information they use contains not only past experiences, but also their expectations for the future. C) the information they use contains only their expectations for the future. D) their forecasts are always correct.

Q: The fundamental value of a stock equals A) the future value of all future dividends. B) the present value of all future dividends. C) the present value of current and future dividends. D) the present value of all future capital gains.

Q: Is the Taylor rule the specific formula followed by the FOMC? Explain.

Q: In the long run, the only economic variable that the Federal Reserve can affect is a. inflation.b. output.c. unemployment.d. the exchange rate.

Q: When market participants have rational expectations, A) they use all information available to them. B) they only slowly adjust their expectations to news which could affect prices or returns. C) they are less likely to make accurate forecasts than if they have adaptive expectations. D) they are able to forecast interest rates more accurately than inflation rates.

Q: During the 2000s, banks became complacent about making mortgage loans because a. there was not a single bank failure in the decade.b. bank stocks performed better than the rest of the stock market. c. the banks counted on housing prices to keep appreciating.d. the government eliminated the FDIC.

Q: Discuss the key criteria for success and the advantages of a central bank adopting the framework of inflation targeting.

Q: The rate of return of a stock held for one year equals A) the change in the price of the stock. B) the dividend yield plus the rate of capital gain. C) the rate of capital gain minus the dividend yield. D) the dividend yield minus the rate of capital gain.

Q: The Federal Reserve creates money bya. printing bills and circulating them in public meetings. b. giving dollar bills to banks to circulate.c. changing a number in its computer system. d. spending money on government purchases.

Q: Discuss why the Fed can either select a quantity or a price (interest rate) target but not both. If it helps, you can use the market for reserves for an example.

Q: Buying stocks gives an investor a. a very low but safe return.b. ownership in corporations.c. the riskiest asset available in the market. d. a pure and random speculative gamble.

Q: Suppose you plan to hold a stock for one year. You expect that, in one year, it will sell for $30 and pay a dividend of $3 per share. If your required return on equity is 10%, what is the most you should be willing to pay for the share today? A) $3.30 B) $23 C) $30 D) $33

Q: We saw in Chapter 18 that many central banks have turned to a policy framework of inflation targeting. Discuss if this would be effective in a country experiencing deflation.