Econ 202 Chapter 14

The term "efficient markets hypothesis" refers to

"Informational efficiency" of the stock market.

Whenever the price of an asset rises above what appears to be its fundamental value, the market is said to be experiencing a

"speculative bubble"

Sasha deposited $1500 into an account three years ago. The first two years the interest rate was 5%, whereas the third year the interest rate was 6%. How much money does Sasha have in her account today?

$1,752.98

You would be equally happy, assuming that the interest rate is 4%, if you received a gift of either $100 today or a gift of

$112.49 three years from today.

A year ago, Bertha created a new saving account, which earned 4%. Now, the bank statement shows that she has $130 in her account. How much did Bertha deposit one year ago?

$125.00

You consider whether to buy a bond that would pay $20,000 in 4 years. If the interest rate is 6%, you will buy the bond only if its price today is no greater than

$15,841.87.

A scholarship gives you $2,000 today and promises to pay you $1,000 one year from today. Which formula determines the present value of these payments?

$2,000 + $1,000/(1 + r)

Keira deposited $2,000 into an account two years ago. The first year the interest rate was 5%; the second year the interest rate was 6%. How much money does Keira have in her account today?

$2,226.00

Which of the following is the present value of $4,000 to be received in 6 years, if the interest rate is 4%?

$3,161.26

Anna deposited $5,000 into an account three years ago. The first year she earned 12% interest, the second year the interest rate was 8%, and the third year the interest rate was 4%. How much money does she have in her account today?

$6,289.92.

Which of the following formulas determines the future value of $600 put into an account that earns 2% interest for 10 years?

$600 × (1 + 0.02)10

At an annual interest rate of 7%, about how many years will it take $200 to double in value?

10

Suppose Klara is a risk averse person, which of the following games might she play?

A game where she has a 60% chance of winning $1 and a 40% chance of losing $1

Which of the following investment options would a risk averse investor of $100,000 prefer?

A risk-free government bond that pays 3% each year for two years.

Which of the following describes the difference between compounding and discounting?

Compounding produces a future value, whereas discounting produces a present value.

Which of the following most accurately describes what data are included in fundamental analysis of the value of a stock?

Dividends, the expected final sale price, and the ability of the corporation to earn profits.

An index fund holds only stocks and bonds that are indexed to inflation.

False

As the number of stocks in a person's portfolio increases, the risk of the portfolio decreases, as indicated by the increasing value of the standard deviation of the portfolio.

False

Bertha is risk averse but only in the wealth range from $10,000 to $12,000

False

Compounding refers to finding the future value of a present sum of money.

False

Diminishing marginal utility of wealth implies that the utility lost from losing a $100 bet is less than the utility gained from winning it.

False

Diversification of a portfolio can eliminate market risk, but it cannot eliminate firm-specific risk.

False

If the efficient markets hypothesis is correct then some stocks may be better buys than other.

False

Refer to the Figure. Dexter's utility function exhibits the property of diminishing marginal utility.

False

Refer to the Figure. If most people's utility functions look like Amir's utility function, then it is easy to explain why people buy various types of insurance.

False

Suppose that Black&White Company announces that its revenue in the last quarter decreased by less than its investors had anticipated. According to the efficient markets hypothesis, the value of the company's stock will decline.

False

The efficient market hypothesis implies that news has no effect on stock prices.

False

The efficient markets hypothesis implies that building a portfolio based on a published list of the "most respected" companies is likely to produce a better than-average return.

False

Today, you deposit $350 into a bank account, which pays an annual interest rate of 6%. The future value of the $350 in 4 years is $1,400.

False

You would prefer $100 today to receiving $200 in 10 years if the interest rate were 5%.

False

An index fund includes only the best stocks available in the stock market.

False.

Suppose, the annual interest rate is 3.45%. In which of the following instances is the future value of the present payment of $1,000 the largest?

In 7 years.

Which of the following does the efficient market hypothesis imply?

Index funds should outperform professionally managed funds. And they usually do.

Three friends go to the bank to cash in their accounts. Keira kept her money in the bank for 25 years at 4% interest. Sasha held her money for 20 years at 5% interest. Anna held her money for 5 years at 20% interest. If each of them originally deposited $1,000, who gets the most money when they cash in their accounts?

Keira

The efficient markets hypothesis implies that a worse-than-expected news about a company's performance will

Lower the price of the stock.

Which of the following is an example of stock market irrationality?

Speculative bubbles in the stock market occur because the price that people pay for stock depends on what they think someone else will pay for it in the future.

Which of the following is consistent with the efficient market hypothesis?

Stock prices follow a random walk.

If today you deposit $600 into a bank account, which pays the annual interest rate of 3%, in 1 year, the future value the deposit will be

618

Suppose that you deposited $175 in the bank. In one year, the bank statement shows that you have $190 in your account. What interest rate did your account earn?

8.6%

Insured people tend to be less careful than uninsured people about their risky behavior. This is called

the moral hazard problem.

The value of a stock is based on the present values of the dividend stream and final price. As a result,

the value of a stock falls when interest rates rise.

Suppose that your research shows that the present value of a stock's dividend stream and future price exceeds its price. This should lead you to believe that the stock is

undervalued and you should consider buying it.

Fundamental analysis shows that the stock of Gold Fish corporation has a present value that is lower than its price. Which of the following is true?

The stock is overvalued

Suppose that fundamental analysis indicates a particular company's stock is overvalued. Which of the following is true?

The stock's value will decline soon.

A public company announces that it has hired a new chief executive officer who has a reputation of successfully raising the profitability of the corporation. Which of the following is the most likely consequences of the announcement?

The value of the companies stock will rise.

All other things being the same, the future value of a deposit in a savings account will be larger the higher the interest rate is.

True

All other things being the same, the future value of a deposit in a savings account will be larger the longer a person waits to withdraw the funds.

True

As the number of stocks in a person's portfolio increases, the risk of the portfolio decreases, as indicated by the decreasing value of the standard deviation of the portfolio.

True

Bertha is a risk averse person. Therefore she will be upset losing $1,000 on a bet more than pleased winning $1,000 on a bet.

True

Discounting refers to finding the present value of a future sum of money.

True

Diversification of a portfolio can eliminate firm-specific risk, but it cannot eliminate market risk.

True

From the standpoint of the economy as a whole, the role of insurance is not to eliminate the risks inherent in life, but to spread them around more efficiently.

True

Fundamental analysis refers to a detailed analysis of a company to determine its value.

True

If stock prices follow a random walk, it means that stock prices are just as likely to rise as to fall at any given time.

True

If today you deposit $700 into a bank account, which pays the annual interest rate of 2.5%, in 2 years, the future value the deposit will be $735.44.

True

Refer to the Figure . The utility function shows that if wealth increased from $1,050 to $1,350, then utility would increase by less than if wealth decreased by the same amount from $1,050 to $750.

True

Refer to the Figure. The property of diminishing marginal utility does not apply to Amir, which implies that Amir is not risk averse.

True

Refer to the Figure. The property of diminishing marginal utility does not apply to Dexter's utility function.

True

Suppose that Orange Company announced that it hired a new CEO away from its successful competitor. The efficient markets hypothesis implies that the price of the stock should increase.

True

Suppose that Purple Company unexpectedly announces a significant improvement in the production technology. The efficient markets hypothesis implies the price of the stock should increase. Suppose this news has no effect on the price of the stock. Fundamental analysis would now show that the company's stock is undervalued.

True

The formula $X × (1 + r)n determines the future value of $X that earns r percent interest for n years.

True

You have to choose between $200 today and $400 in 10 years. Suppose that the interest rate is 5%. You would prefer the $200 today if the interest rate were 8% but would rather wait for the future amount if the interest rate were 5%.

True

You will receive $500 at some point in the future. If the annual interest rate is 7.5%, then in 5 years, the present value of the $500 is $348.28. In 10 years, the present value of the $500 will decrease to $242.60.

True

If the interest rate is 4.5%, you are better off having $1,000 today than $X in 7 years if and only if X is less than $1,360.86 (or X < $1,360.86).

True.

Suppose that Bertha's wealth is $11,000. Which of the following explains why Bertha is risk averse?

Utility gain from additional $1,000 is less than utility loss from losing $1,000.

You have to decide between $X today or $2,500 in 5 years. If the interest rate is 4%, you are better off taking the $X today if and only if

X > $2,054.82.

Suppose you believe in the efficient markets hypothesis. Which of the following is true?

You believe that stock prices follow a random walk.

Suppose fundamental analysis indicates that a stock is undervalued. Which of the following is true?

You should add the stock to your portfolio

Refer to the Figure. Suppose Bertha begins with $1,050 in wealth. Which of the following coin-flip bets would she definitely not be willing to accept?

If it is "heads," she wins $150; if it is tails, she loses $150.

In the 1990s, Fed Chairperson Alan Greenspan questioned whether the stock market

boom at that time reflected "irrational exuberance".

The utility function exhibits the property of

diminishing marginal utility.