Macroeconomics Chapter 9

. Diversification of a portfolio a. can eliminate market Risk, but it cannot eliminate firm-specific Risk. b. can eliminate firm-specific Risk, but it cannot eliminate market Risk. c. increases the portfolio's standard deviation. d. is not necessary for a person who is Risk averse.

B

. Stockholders of ComfortAir Corporation, an air conditioner and furnace manufacturer, are concerned that the company's executives may take on greater Risks than stockholders desire. This example illustrates a. moral hazard and market Risk. b. moral hazard and firm specific Risk. c. adverse selection and market Risk. d. adverse selection and firm specific Risk.

B

. The field of finance primarily studies a. how society manages its scarce resources. b. the implications of time and risk for allocating resources over time. c. firms' decisions concerning how much to produce and what price to charge. d. how society can reduce market risk.

B

A manufacturing company is thinking about building a new factory. The factory, if built, will yield the company $300 million in 7 years, and it would cost $220 million today to build. The company will decide to build the factory if the interest rate is a. no less than 4.53 percent. b. no greater than 4.53 percent. c. no less than 5.81 percent. d. no greater than 5.81 percent.

B

Suppose you will receive $500 at some point in the future. If the annual interest rate is 7.5 percent, then the present value of the $500 is a. $411.26 if the $500 is to be received in 5 years and $338.95 if the $500 is to be received in 10 years. b. $348.28 if the $500 is to be received in 5 years and $242.60 if the $500 is to be received in 10 years. c. $291.11 if the $500 is to be received in 5 years and $272.89 if the $500 is to be received in 10 years. d. $291.11 if the $500 is to be received in 5 years and $236.49 if the $500 is to be received in 10 years.

B

Suppose you win a small lottery and you are given the following choice: You can receive (1) an immediate payment of $10,000 or (2) two annual payments, each in the amount of $5,200, with the first payment coming one year from now, and the second payment coming two years from now. You would choose to take the immediate payment of $10,000 if the interest rate is a. 2 percent, but not if the interest rate is 1 percent. b. 3 percent, but not if the interest rate is 2 percent. c. 4 percent, but not if the interest rate is 3 percent. d. 5 percent, but not if the interest rate is 4 percent.

B

The problem of moral hazard arises because a. life is full of all sorts of Risks. b. after people buy insurance, they have less incentive to be careful about their Risky behavior. c. a high-Risk person is more likely to apply for insurance than is a low-Risk person. d. insurance companies go to great effort to avoid paying claims to their policy holders.

B

Which of the following is the correct way to compute the future value of $X that earns r percent interest for N years? a. $X(1 + rN)N b. $X(1 + r)N c. $X(1 + rN) d. $X(1 + r/N)N

B

You are considering buying a share of stock in XYZ Corporation. At the end of years 1, 2, and 3 the stock will pay you a dividend of $15. In addition, at the end of the third year you expect to sell the share of stock for $100. If the interest rate is 3%, how much is the share of XYZ stock worth to you today? a. $123.14 b. $133.94 c. $137.96 d. $145.00

B

. Fourteen years ago William put money in his account at First National Bank. William decides to cash in his account and is told that his money has quadrupled. According to the rule of 70, what rate of interest did Alfred earn? a. 5 percent b. 7 percent c. 10 percent d. 14 percent

C

. Risk a. can be reduced by placing a large number of small bets rather than a small number of large bets. b. can be reduced by increasing the number of stocks in a portfolio. c. Both A and B are correct. d. Neither A nor B are correct.

C

. Robert put $15,000 into an account with a fixed interest rate two years ago and now the account balance is $16,917.66. What rate of interest did Robert earn? a. 4.5 percent b. 5.4 percent c. 6.2 percent d. 8.0 percent

C

26 Refer to Figure 27-2. Suppose Britney begins with $1,050 in wealth. Starting from there, a. she would be willing to accept a coin-flip bet that would result in her winning $300 if the result was "heads" or losing $300 if the result was "tails." b. the pain of losing $300 of her wealth would equal the pleasure of adding $300 to her wealth. c. the pain of losing $300 of her wealth would exceed the pleasure of adding $300 to her wealth. d. the pleasure of adding $300 to her wealth would exceed the pain of losing $300 of her wealth.

C

29 Refer to Figure 27-5. From the appearance of the utility function, we know that a. Dexter is Risk averse. b. Dexter gains less satisfaction when his wealth increases by X dollars than he loses in satisfaction when his wealth decreases by X dollars. c. the property of diminishing marginal utility does not apply to Dexter. d. All of the above are correct.

C

A person who is Risk averse might accept a 50% chance of losing $100 today in exchange for a 50% chance of winning $125 in two years if the interest rate was a. 9% but not 10% b. 10% but not 11% c. 11% but not 12% d. None of the above is correct; a Risk averse person would not accept any of the above bets.

C

Clint puts $200 into an account when the interest rate is 8 percent. Later he checks his balance and finds that he has a balance of about $272.10. How many years did Clint wait to check his balance? a. 3 years b. 3.5 years c. 4 years d. 4.5 years

C

Imagine that someone offers you $100 today or $200 in 10 years. You would prefer to take the $100 today if the interest rate is a. 4 percent. b. 6 percent. c. 8 percent. d. All of the above are correct.

C

The future value of $500 saved for two years at an interest rate of 5% is a. $550.25. b. $550.00. c. $551.25. d. None of the above are correct.

C

You are expecting to receive $3,500 at some time in the future. Which of the following would unambiguously increase the present value of this future payment? a. Interest rates rise and you get the payment sooner. b. Interest rates rise and you have to wait longer for the payment. c. Interest rates fall and you get the payment sooner. d. Interest rates fall and you have to wait longer to get the payment.

C

You may be unwilling to buy a used car because you suspect the last owner found out the car was a lemon. You may treat a car you rented with a little less care than you would use on your own car. a. Both examples primarily illustrate adverse selection. b. Both examples primarily illustrate moral hazard. c. The first example primarily illustrates adverse selection; the second primarily illustrates moral hazard. d. The first example primarily illustrates moral hazard; the second primarily illustrates adverse selection.

C

. In general, as a person includes fewer stocks and more bonds in his portfolio, a. both Risk and expected return rise. b. Risk rises but expected return falls. c. Risk falls, but expected return rises. d. both Risk and expected return fall.

D

Chloe talked to several stockbrokers and made the following conclusions. Which, if any, of Chloe's conclusions are correct? a. It is relatively easy to reduce firm-specific Risk by increasing the number of companies one holds stock in. b. Stock prices, even if not exactly a random walk, are very close to it. c. Some people have made a lot of money in the stock market by using insider information, but these cases are not contrary to the efficient markets hypothesis. d. All of Chloe's conclusions are correct.

D

James offers you $1,000 today or $X in 7 years. If the interest rate is 4.5 percent, then you would prefer to take the $1,000 today if and only if a. X < 1,045.00. b. X < 1,188.89. c. X < 1,266.67. d. X < 1,360.86.

D

Risk aversion helps to explain various things we observe in the economy, including a. adherence to the old adage, "Don't put all your eggs in one basket." b. insurance. c. the Risk-return trade-off. d. All of the above are correct.

D

Suppose you put $500 into a bank account today. Interest is paid annually and the annual interest rate is 3 percent. The future value of the $500 after 1 year is a. $485.44. b. $496.50. c. $509.28. d. $515.00.

D

Svetlana is Risk averse. Which of the following is correct about Svetlana? a. Her marginal utility of wealth increases as her income increases. b. She will always accept a bet if the probability of winning a dollar is the same as the probability of losing a dollar. c. Her utility function is a straight line. d. None of the above are correct.

D

The financial system a. involves bank accounts, mortgages, stock prices, and many other items. b. involves decisions and actions undertaken by people at a point in time that affect their lives in the future. c. coordinates the economy's saving and investment. d. All of the above are correct.

D

You have been promised a payment of $400 in the future. In which of the following cases is the present value of this payment the lowest? a. You receive the payment 4 years from now and the interest rate is 4 percent. b. You receive the payment 4 years from now and the interest rate is 5 percent. c. You receive the payment 5 years from now and the interest rate is 4 percent. d. You receive the payment 5 years from now and the interest rate is 5 percent.

D

You put $75 in the bank one year ago and forgot about it. The bank sends you a notice that you now have $81 in your account. What interest rate did you earn? a. 5 percent b. 6 percent c. 7 percent d. 8 percent

D

28. Refer to Figure 27-5. From the appearance of the graph, we know that a. Dexter's level of satisfaction increases by more when his wealth increases from $1,001 to $1,002 than it does when his wealth increases from $1,000 to $1,001. b. Dexter's level of satisfaction increases by less when his wealth increases from $1,001 to $1,002 than it does when his wealth increases from $1,000 to $1,001. c. Dexter's level of satisfaction increases by the same amount when his wealth increases from $1,001 to $1,002 as it does when his wealth increases from $1,000 to $1,001. d. None of the above answers can be inferred from the appearance of the utility function.

A

A company that produces wallpaper is considering buying some new equipment that it expects will increase future profits. If the interest rate falls, then the present value of these future earnings a. rises. The company is more likely to buy the equipment. b. rises. The company is less likely to buy the equipment. c. falls. The company is more likely to buy the equipment. d. falls. The company is less likely to buy the equipment.

A

Cleo promises to pay Jacques $1,000 two years from today. If the interest rate is 4 percent, then how much is this future payment worth today? a. $924.56 b. $931.44 c. $937.87 d. None of the above are correct to the nearest cent.

A

David's Utility Function Wealth Utility $60,000 500 $61,000 505 $62,000 509 $63,000 512.5 If David's current wealth is $61,000, then a. his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. David is Risk averse. b. his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. David is not Risk averse. c. his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. David is Risk averse. d. his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. David is not Risk averse.

A

HydroGrow is considering building a new greenhouse in which to grow tomatoes. The board meets and decides that this is the right thing to do. Before they can put their plans into action, the interest rate increases. The present value of the returns from this investment project a. is now lower than it was before, and so Hydro Grow is less likely to build the building. b. is now lower than it was before, and so HydroGrow is more likely to build the building. c. is now higher than it was before, and so HydroGrow is less likely to build the building. d. is now higher than it was before, and so HydroGrow is more likely to build the building.

A

Melissa offers you $1,000 today or $1,500 in 5 years. You would prefer to take the $1,500 in 5 years if the interest rate is a. 8 percent. b. 9 percent. c. 10 percent. d. All of the above are correct.

A

Other things the same, an increase in the interest rate makes the quantity of loanable funds supplied a. rise, and investment spending rise. b. rise, and investment spending fall. c. fall, and investment spending rise. d. fall, and investment spending fall.

A

Susan is planning to invest in one of four stock portfolios, and her financial advisor has given her details regarding the Risk associated with each portfolio. Which of the following portfolios would you expect to have the lowest average annual rate of return? a. A portfolio with a standard deviation of 3%. b. A portfolio with a standard deviation of 6%. c. A portfolio with a standard deviation of 9%. d. A portfolio with a standard deviation of 12%.

A

27 Refer to Figure 27-4. From the appearance of Alex's utility function, we know that a. the pain that Alex would experience if he lost $500 of his wealth would exceed the pleasure that he would experience if he added $500 to his wealth. b. the pleasure that Alex would experience if he added $500 to his wealth would exceed the pain that he would experience if he lost $500 of his wealth. c. the property of increasing utility does not apply to Alex. d. the property of diminishing marginal utility does not apply to Alex.

d

Figure 27-2. The figure shows a utility function for Britney. 25. Refer to Figure 27-2. From the appearance of the utility function, we know that a. Britney is Risk averse. b. Britney gains less satisfaction when her wealth increases by X dollars than she loses in satisfaction when her wealth decreases by X dollars. c. the property of diminishing marginal utility applies to Britney. d. All of the above are correct.

d