Macroeconomics Exam 3 Study Guide/ECON 2313 set II

all publicly available information has been incorporated into a) asset/stock b)informationally efficient - the financial news travels at such a high speed that the stock market prices are affected (i.e. stock prices on election night)

The EMH states:

all publicly available information has been incorporated into asset price

define informational efficiency

a

A firm's stock price will be higher when the interest rate is ____ and the value of the firm's expected future profits are ____. a. lower; larger b. lower; smaller c. higher; larger d. higher; smaller

b

A lower interest rate will increase the present value of future income and thereby a. decrease the market value of stocks. b. increase the market value of stocks. c. have no effect on the market value of stocks. d. decrease the discounted market value of stocks.

c

An indexed equity mutual fund a. is directly tied to either the consumer price index or the GDP deflator. b. is a fund that hires a manager who will try to pick the stocks that will increase most in value in the future. c. merely holds stocks in the same proportion as they exist in a broad stock market index like the Standard & Poor's 500. d. will have high operating costs because these funds engage in a substantial amount of stock trading.

c

Check My Work (I) The market for new issues of stock is called the primary market. (II) The New York Stock Exchange is an example of a secondary market in which previously issued shares are traded between investors. a. I is true; II is false. b. I is false; II is true. c. Both I and II are true. d. Both I and II are false.

b

Compared to other investments such as bonds, historically a diverse set of stocks held over a lengthy time period (for example, 30 or 40 years) has yielded a a. low average real rate of return, and the variation in that return has been extremely high. b. high average real rate of return, and the variation in that return has been relatively small. c. low average real rate of return, and the variation in that return has been relatively small. d. high average real rate of return, and the variation in that return has been extremely high.

c

Currently, about ____ of U.S. households own stock, either directly or through an equity mutual fund. a. 10 percent b. 20 percent c. 50 percent d. 80 percent

b

During 1982-1997, stock prices increased substantially. Which of the following helped to boost stock prices during this period? a. higher interest rates and rapid growth of corporate profits b. lower interest rates and rapid growth of corporate profits c. higher interest rates and slow growth of corporate profits d. lower interest rates and slow growth of corporate profits

c

During the 1970s, the price/earnings ratio of stocks in the S&P 500 was relatively low. This low P/E ratio was a. surprising because the inflation rate was high during the 1970s. b. not surprising because interest rates were low during the inflationary 1970s. c. not surprising because interest rates were high during the inflationary 1970s. d. surprising because the inflation rate was low during the 1970s.

b

During the last two centuries, after adjustment for inflation, a. corporate bonds have yielded a real return of approximately 7 percent annually, compared to a real return of about 3 percent for corporate stocks. b. corporate stocks have yielded a real return of approximately 7 percent annually, compared to a real return of about 3 percent for bonds. c. both corporate stocks and bonds have yielded a real rate of return of about 3 percent. d. both corporate stocks and bonds have yielded a real rate of return of about 7 percent.

c

Historically, when a diverse set of stocks is held over a lengthy time period, stocks have yielded a ____ rate of return, and the variation in the rate of return has been ____. a. low; low b. low; high c. high; low d. high; high

c

Historically, which of the following has had the highest average annual rate of return? a. corporate bonds b. money market mutual funds c. corporate stocks d. U.S. Treasury bonds

b

Investment in a broad portfolio of stocks is most attractive for a. short-term investors. b. long-term investors. c. investors seeking a steady rate of return. d. investors who will need the funds for other purposes in about 10 years.

b

Investors are often willing to pay positive prices for shares of firms that have never earned a profit because the investors a. do not know the firms have never earned a profit. b. expect the firms to have positive net earnings in the future. c. expect that interest rates will rise in the future. d. expect that higher rates of inflation will push stock prices higher in the future.

a

Investors can make their investments in corporate stocks less risky by a. purchasing shares of a mutual fund, which holds the stocks of many diverse corporations. b. buying stocks and holding them each for only for short periods of time. c. investing in firms that are in the same, rather than different, industries. d. none of the above.

c

Since 1802, the American stock market has yielded an average annual real return (the return adjusted for inflation) of approximately a. 3 percent. b. 5 percent. c. 7 percent d. 11 percent.

b

Since 1802, the average annual compound return for stock holdings, adjusted for inflation, has been approximately a. 2 percent. b. 7 percent. c. 15 percent. d. 30 percent.

b

Stock analysts often argue that lower interest rates are good for the stock market. Does this argument make sense? a. No; lower interest rates will tend to slow down the economy and this will be bad for the stock market. b. Yes; the lower rates of interest will increase the value of future income (and capital gains) and stock prices will rise to reflect this factor. c. No; the lower rates of interest will reduce the value of future income (and capital gains) and this will cause stock prices to fall. d. Yes; the lower interest rates will cause inflation and inflation is generally good for the stock market.

b

Stock market analysts often argue that lower interest rates are good for the stock market. Does this argument make sense? a. No; lower interest rates will tend to slow down the economy, and this will be bad for the stock market. b. Yes; the lower rates of interest will increase the value of future income (and capital gains), and stock prices will rise to reflect this factor. c. No; the lower rates of interest will reduce the value of future income (and capital gains), and this will cause stock prices to fall. d. Yes; the lower interest rates will cause inflation, and inflation is generally good for the stock market.

b

Suppose that monetary policy becomes more expansionary, and as a result, the future rate of inflation is higher. Will this be good for the stock market? a. Yes; the inflation will lead to higher wages, and this will be good for both the economy and the stock market. b. No; the inflation will lead to higher nominal interest rates, and this will reduce the present value of the future net earnings derived from stocks. c. Yes; the inflation rate will reduce the long-run rate of unemployment, and this will be good for the stock market. d. No; the expansionary monetary policy will lead to lower real interest rates, and this is generally bad for both the economy and the stock market.

a

The market for new issues of stock is called the a. primary market. b. secondary market. c. The New York Stock Exchange (NYSE). d. The Chicago Board of Trade.

d

The present value of $1 million to be received in the future will a. increase if the interest rate rises. b. increase if the payment is received at a more distant time in the future. c. be greater than $1 million. d. increase if the interest rate were to fall from 8 percent to 4 percent.

d

The random walk theory implies that stock prices a. go down, then up, and then down again. b. follow systematic trends. c. can be forecast accurately by experts who are knowledgeable about how the stock market works. d. will change as the result of unexpected factors that are virtually impossible to forecast accurately.

d

The random walk theory implies that stock prices a. go down, then up, and then down again. b. go up and then down in a predictable pattern. c. follow systematic trends. d. are unpredictable based on past trends.

c

The random walk theory indicates that a. investors can make money by purchasing stocks that are widely expected to earn substantial profits in the future. b. while changes in the prices of specific stocks are difficult to predict, experts are able to forecast the future direction of broad stock market indexes with a high degree of accuracy. c. changes in stock prices are driven by surprise occurrences that are difficult for anyone to predict accurately. d. managed mutual funds will persistently outperform indexed funds.

c

The random walk theory of stock prices indicates that a. if they are willing to do a little research, even beginning investors will be able to pick the stocks that will increase most in price in the future. b. managed mutual funds will persistently earn a higher rate of return than indexed funds. c. current stock prices already reflect information about factors influencing future stock prices that can be forecast with any degree of accuracy. d. stock market investors can expect to earn a steady real rate of return of about 7 percent annually.

c

The stock price of a firm is primarily a reflection of the a. firm's current net earnings per share. b. firm's expected future net earnings per share. c. discounted value of the firm's expected future net earnings per share. d. firm's current net earnings per share multiplied by the interest rate. e. book value of the firm.

a

The theory that stock prices reflect all available information and that the future movement of stock prices is unpredictable is called the a. random walk theory. b. inefficient market theory. c. technical analysis theory. d. charting theory.

b

The variation in the rate of return one can expect from ownership of stocks will generally be smaller if a. all of the funds are invested in a specific sector of the economy such as the automobile industry. b. a diverse set of stocks is held over a lengthy period of time such as 30 or 40 years. c. all of the funds are invested in a single stock. d. the funds are invested for a relatively short period of time.

b

To the extent that current profits are directly related to future profits, a high price/earnings ratio would indicate that stocks are a. inexpensive. b. expensive. c. going to increase in value in the future. d. most likely to fall in value if interest rates decline.

1) distribution of stock prices over time - do the stock prices move randomly? Run a test on the difference in prices (error) 2) Examine professional investors and see if they "beat the market" - research shows that since the 50's, no financial managers have ever 'beat the market'

What are the 2 major ways to test the EMH theory?

news

What drives informationally efficient information?

d

Which of the following indicates why the role of vigilant investors and investment fund managers is important for the efficient operation of an economy? a. These investors generally serve on the boards of directors of corporations. b. These investors tend to buy and sell stocks in a way that rewards good management. c. These investors help allocate capital efficiently among firms and among investment projects. d. Both b and c are true.

c

Which of the following is a risk that investors undertake when purchasing stocks? a. An individual stock can rise and fall unpredictably. b. Nearly all stocks in the stock market may rise or fall together, when expectations about the entire economy change. c. Both a and b are true. d. Neither a nor b is true.

c

Which of the following is true of stocks? a. Stock ownership is risky because the investor can never be sure what return they will earn or what the value of their stock holdings will be in the future. b. The riskiness of stocks is one reason why their average rate of return has been higher than investments like bonds that guarantee a specified nominal amount in the future. c. Both a and b are true. d. Neither a nor b is true.

b

Which of the following is true? a. An increase in the interest rate will tend to increase stock prices. b. A reduction in the interest rate will tend to increase stock prices. c. An increase in the inflation rate will tend to increase stock prices. d. There is no reason to believe that changes in interest rates will influence stock prices.

b

Which of the following is true? a. Investment in the stock market is a relatively foolproof method for an investor to earn a high rate of return during the next five years. b. Current stock prices already reflect information that is known with a high degree of certainty. c. Experts are able to predict changes in the direction of the broad stock market indexes with a high degree of accuracy. d. While changes in the prices of specific stocks are difficult to predict, it is relatively easy to predict the future direction of the broad stock market. e. Both c and d are true.

c

Which of the following is true? a. Managed equity funds generally outperform indexed equity mutual funds. b. Managed equity funds merely hold stocks in the same proportion they are represented in a broad stock market index such as the Standard & Poor's 500. c. Indexed equity funds generally have lower management and operating costs than managed funds. d. Indexed equity funds generally engage in more stock trading than managed funds.

c

Which of the following is true? a. Managed equity funds that have yielded attractive returns during the last 5 or 10 years can generally be counted on to yield similar returns in the future. b. Managed funds generally outperform indexed equity mutual funds. c. An investment strategy that yielded a high rate of return in the past will often be disastrous in the future. d. Indexed equity mutual funds are usually tied directly to either the Consumer Price Index or the GDP deflator.

c

Which of the following is true? a. Most stockholders own stock because they want to participate in the daily decision making of the firms that they own. b. The shareholders of a large well-established firm can be reasonably sure that they will earn a real rate of return of about 7 percent in the future. c. The potential losses of shareholders are limited to the amount of their investment. d. Ownership of a corporate bond provides the bondholder with an ownership right to a fraction of the firm's future profits.

a

Which of the following is true? a. The P/E ratio provides information on the price of a stock relative to its current earnings. b. The P/E ratio provides information on the price of a stock relative to its future earnings. c. The P/E ratio provides information on the price of a stock relative to its past earnings. d. The P/E ratio average from 1950-2008 was 26.

d

Which of the following is true? a. The buyer of a firm's stock is purchasing a fractional share in the firm's future net revenues. b. When investors believe that a business decision by the management of a firm will increase the firm's future earnings, the price of the firm's stock will tend to rise. c. Changing stock prices provide the board of directors and managers of a firm with a strong incentive to make good decisions and undertake productive projects. d. All of the above are true.

a

Which of the following is true? a. The stock market helps channel the savings of individuals into business activities that create wealth. b. Individual investors can reduce their risk by holding a large share of their wealth in the form of the stock ownership of a single company. c. Historically, the long-term real rate of return of stocks has generally been less than that of bonds. d. Mutual funds that have done well in the past are more likely to outperform the market average in the future.

c

Which of the following provides the strongest argument for young people making regular payments into a retirement program that invests these funds in a diverse set of stocks? a. The prices of stocks tend to fluctuate more than the prices of bonds. b. Over short periods of time, variation in the real rate of return of stocks is greater than bonds. c. When held over lengthy periods like 30 or 40 years, historically, the rate of return on stocks has been both higher and less variable than that of bonds. d. Lower interest rates will lead to higher bond prices.

b

Which of the following types of mutual funds best describes one in which an "expert" seeks to pick the stock holdings in a way that maximizes the rate of return? a. indexed equity mutual fund b. managed equity mutual fund c. supervised equity mutual fund d. marked equity mutual fund

d

Which of the following will tend to result in the least variation in the expected real rate of return from the ownership of stocks? a. ownership of a single stock for a short period of time b. ownership of a single stock over a lengthy period of time c. ownership of stocks from a specific sector (for example, the automobile industry) over a lengthy period of time d. ownership of a diverse set of stocks (the Standard & Poor's 500, for example) over a lengthy period of time

d

Which of the following would be most likely to cause the price/earnings ratio of stocks to rise? a. the expectation of a recession in the near future b. the expectation of inflation in the near future c. higher interest rates d. lower interest rates

c

Which of the following would be most likely to push stock prices higher? a. higher interest rates and the expectation of larger future corporate profits b. higher interest rates and the expectation of smaller future corporate profits c. lower interest rates and the expectation of larger future corporate profits d. lower interest rates and the expectation of smaller future corporate profits

c

Which of the following would tend to increase the value of a future stream of income? a. an increase in the rate of inflation b. an increase in the interest rate c. a reduction in the interest rate d. a reduction in the size of the expected future income

formalized by Eugene Fama

Who formalized the EMH?

Warren Buffet

Who is the one person who "beat the market"?

it is mathematically impossible because emotions trump rationality

Why do people who spend their lives trying to beat the market end up losing and/or under performing?

Passive

__________ funds are always better than active funds

1. Stock price movements are random (unpredictable) 2. Impossible to consistently beat the market (or to earn returns exceeding the overall market) Proof/Evidence Supporting: Louis Bachelier looked up stock prices on Parisian Boise in the 1910's; his PHD was rejected, he was called crazy. In the 40's, students bought his PHD dissertation and it sat around until discovered by Paul Samuelson in the 50's; Samuelson tested the NYSE along the same theory. In the 60's, Fama officially developed the EMH. There are 2 ways to test the EMH theory: 1. statistical testing of movement of stock prices and whether or not the prices move randomly 2. test to see if investors consistently "beat the market"

what are the implications of all publicly traded information being informationally efficient?

outperforming a particular market segment after accounting for taxes, transaction costs, and fees

what does it mean to beat the market?