ECON 311 EXAM 2

When yield curves are downward sloping A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates.

B) short-term interest rates are above long-term interest rates.

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

B. $20 --> 1.00 / (0.10 - 0.05)

Currently, a three-month Treasury bill has a yield of 5% while the yield on a ten-year Treasury bond is 4.7%. What is the risk premium of the typical A-rated ten-year corporate bond with a yield of 5.5%? A. 0.5% B. 0.8% C. 1.17% D. 5.5%

B. 0.8%

_____ is the field of study that applies concepts from social sciences such as psychology and sociology to help understand the behavior of securities prices. A. Procedural finance B. Behavioral finance C. Methodical finance D. Strategical finance

B. Behavioral finance

"_____" measures the sensitivity of a stock's price to changes is the value of the entire stock market. A. expected return B. beta C. default risk D. interest rate risk

B. Beta

Under the liquidity premium theory, a flat yield curve indicates that investors expect future short-term rates to A. remain constant B. fall C. either fall or remain constant D. rise

B. fall

In the capital asset pricing model, the required return on equity investments reflects both market risk and _____. A. interest rate risk B. firm-specific risk C. the expected appreciation of the domestic currency D. liquidity

B. firm-specific risk

According to the efficient markets hypothesis, the current price of a financial security A. is the discounted net present value of future interest payments B. fully reflects all available relevant information C. is determined by the lowest successful bidder D. is a result of none of the above

B. fully reflects all available relevant information

The expectations theory A. accounts well for the fact that yield curves usually slope upward. B. has difficulty explaining why yield curves usually slope upward. C. has difficulty explaining why U.S. Treasury securities have lower yields than corporate bonds. D. has difficulty explaining why yields on bonds of different maturities move together.

B. has difficulty explaining why yield curves usually slope upward.

In the liquidity preference model, when interest rates are high, the opportunity cost of holding money is ____, so the quantity of money demanded will be ____. A. low; high B. high; low C. low; low D. high; high

B. high; low

Everything else held constant, the interest rate on municipal bonds rises relative to the interest rate on Treasury securities when A. corporate bonds become riskier B. income tax rates are lowered C. municipal bonds become more widely traded D. income tax rates are raised

B. income tax rates are lowered

Default risk A. is also known as market risk. B. is the probability that a borrower will not pay in full the promised coupon or principal. C. is zero for bonds issued by cities and states. D. exists only for the bonds of small corporations.

B. is the probability that a borrower will not pay in full the promised coupon or principal.

Suppose Apple announces that its earnings for the fourth quarter of 2016 rose to $2 billion. As a result of this announcement the price of Apple's stock does not change. The best explanation of this is A. market participants expected Apple's earnings to be less than $2 billion. B. market participants expected Apple's earnings to be $2 billion. C. market participants have adaptive expectations D. market participants were expecting Apple's earnings to be greater than $2 billion.

B. market participants expected Apple's earnings to be $2 billion.

It is possible that when the money supply rises, interest rates may _____ if the ___ effect is more than offset by changes in income, the price level, and expected inflation. A. fall; risk B. rise; liquidity C. fall; liquidity D. rise; risk

B. rise; liquidity

The risk structure of interest rates refers to A. the amount of additional interest necessary to compensate savers for the greater risk of default on some bonds. B. the relationship among the interest rates on bonds with the same maturity. C. the relationship among interest rates on similar bonds with different maturities D. the amount of additional yield necessary to compensate savers for the lesser liquidity of some bonds.

B. the relationship among the interest rates on bonds with the same maturity.

Which of the following is NOT true of the yield curve for U.S. Treasury securities? A. Typically, it slopes upward B. it depicts the relationship among yields on securities of different maturities C. Typically, it slopes downward D. Typically, it shifts up or down rather than twists

C. Typically, it slopes downward

The default risk premium is measured A. by an index published monthly by the Securities and Exchange Commission. B. by an index published monthly by The Wall Street Journal. C. as the difference between the yield on a non-Treasury security and the yield on a U.S. Treasury security of the same maturity. D. as the difference between the nominal yield on the security and the real after-tax yield on the security.

C. as the difference between the yield on a non-Treasury security and the yield on a U.S. Treasury security of the same maturity.

Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the A. income effet B. price level effect. C. liquidity effect. D. expected inflation effect.

C. liquidity effect

When the yield curve is downward-sloping A. the inflation rate is expected to rise. B. the bond market is anticipating the U.S. Treasury may default on its obligations. C. short-term yields are higher than long-term yields. D. long-term yields are higher than short-term yields.

C. short-term yields are higher than long-term yields.

Under the liquidity premium theory, the expectation that future short-term rates will be constant results in a yield curve that A. is flat B. slopes downward C. slopes upward D. is flat, slopes upward, or slopes downward, depending on the size of the term premium at each maturity

C. slopes upward

If a forecast made using all available information is NOT perfectly accurate, then it is A. a second-best expectation B. not a rational expectation C. still a rational expectation D. an adaptive expectation

C. still a rational expectation

Using the one-period valuation model, assuming a year-end dividend of $1.00, an expected sales price of $100, and a required rate of return of 5%, the current price of the stock would be A. $110.00. B. $101.00. C. $100.00. D. $96.19.

D. $96.19. (1 / (1+.05)) + (100 / (1+.05)) = 0.952 + 95.23 = $96.19

Table 5.1 1 year: 1.50% 2 years: 2.25% 3 years: 3.25% Table 5.1 shows the interest rates for Treasury securities of different maturities. Assume that the liquidity premium theory is correct. On this day, what did investors expect the interest rate to be on the one-year Treasury bill in two years if the term premium on a two-year Treasury note is 0.25%? A. 1.875% B. 2.25% C. 2.375% D. 2.5%

D. 2.5%

Which of the following expressions gives the present value of future dividends for a company whose current dividend is $5.00 and whose future dividends are expected to grow at rate g? A. [$5.00(1 - g)] / (Ke - g) B. [$5.00(1 + g)] / (Ke + g) C. [$5.00(1 - g)] / (Ke + g) D. [$5.00(1 + g)] / (Ke - g)

D. [$5.00(1 + g)] / (Ke - g)

If the expected path of 1-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of A. two years. B. three years. C. four years. D. five years.

D. five years.

A(n) ___ in the riskiness of corporate bonds will ___ the price of corporate bonds and ___ the yield on corporate bonds, all else equal. A. decrease; decrease; decrease B. increase; increase; increase C. decrease; increase; increase D. increase; decrease; increase

D. increase; decrease; increase

In the liquidity preference model, an increase in the price level will result in a(n) ______ in the demand for money and cause the interest rate to ______. A. decrease; decrease B. decrease; increase C. increase; decrease D. increase; increase

D. increase; increase

The yield on a thirty-year Treasury bond is 8% at the same time the yield on a two-year Treasury note is 5%. This occurrence A. is largely explained by the favorable tax treatment of Treasury notes. B. indicates that the bond market is anticipating that inflation will fall. C. indicates that the yield curve is downward sloping D. is well explained by the segmented markets theory.

D. is well explained by the segmented markets theory.

An increase in the foreign interest rate causes the demand for domestic assets to shift to the ____ and the domestic currency to ____, everything else held constant. A. left; appreciate B. right; appreciate C. right; depreciate D. left; depreciate

D. left; depreciate

In the liquidity preference model, individuals are assumed to hold their wealth in two forms A. stocks and bonds. B. money and gold. C. real assets and financial assets. D. money and bonds.

D. money and bonds.

If a one-year bond currently yields 5% and is expected to yield 7% next year, the liquidity premium theory predicts that the yield today on a two-year bond should be A. 5% B. less than 6%, but more than 5% C. 6% D. more than 6%

D. more than 6%

Which type of stock should result in the best return according to the efficient markets hypothesis? A. a firm that is considered to be undervalued B. a firm that is expected to be highly profitable in the future C. a firm expected to earn little profit in the future D. none of the above

D. none of the above

Under the expectations theory, an upward-sloping yield curve indicates that investors expect future short-term rates to A. remain constant. B. fall. C. either rise or remain constant. D. rise.

D. rise

In the capital asset pricing model, the required return on a particular stock is comprised of the risk premium on that stock PLUS the: A. beta B. default risk premium C. marginal tax rate D. risk free rate of return

D. risk free rate of return Kei = Kf + B(Km - Kf)

In the generalized dividend model, a future sales price far in the future does not affect the current stock price because A. the stock may never be sold B. the sales price does not affect the current price C. the present value cannot be computed D. the present value is almost zero

D. the present value is almost zero

The exchange rate is A. the value of a currency relative to inflation. B. the price of one currency relative to gold. C. the change in the value of money over time. D. the price of one currency relative to another.

D. the price of one currency relative to another.

Default

When the issuer of the bond is unable or unwilling to make interest payments when promised or pay off the face value when the bond matures.

Which of the following will cause the money demand curve to shift to the right? A. an increase in the price level B. a decrease in the supply of money C. a decrease in real GDP D. an increase in the nominal interest rate

A. an increase in the price level

An increase in the foreign interest rate causes the demand for domestic assets to ____ and the domestic currency to ____, everything else held constant. A. decrease; depreciate B. increase; appreciate C. decrease; appreciate D. increase; depreciate

A. decrease; depreciate

According to the interest parity condition, if the domestic interest rate is 10 percent and the foreign interest rate is 12 percent, then the expected ____ of the foreign currency must be ___ percent. A. depreciation; 2 B. appreciation; 2 C. appreciation; 4 D. depreciation; 4

A. depreciation; 2

According to the Gordon growth model, which of the following can cause the value of a stock to decline? A. increased required return on equity B. increase in the current dividend C. higher expected growth rate of dividends D. decreased required return on equity

A. increased required return on equity Decrease D1 / (Ke - g)

Three factors explain the risk structure of interest rates A. liquidity, default risk, and the income tax treatment of a security. B. maturity, default risk, and the income tax treatment of a security. C. maturity, liquidity, and the income tax treatment of a security. D. maturity, default risk, and the liquidity of a security.

A. liquidity, default risk, and the income tax treatment of a security.

Under the expectations theory, if market participants expect that future short-term rates will be higher than current short-term rates, the yield curve will A. slope upward B. slope downward C. be flat. D. slope upward, slope downward, or be flat, depending on risk, liquidity, cost of Information, and tax considerations.

A. slope upward

Using the Gordon growth model, a stock's current price will increase if A. the dividend growth rate increases. B. the expected sales price rises. C. the required rate of return on equity rises. D. the growth rate of dividends falls.

A. the dividend growth rate increases.

The expectations theory suggests that A. the slope of the yield curve depends on the expected future path of short-term rates. B. the yield curve should usually be upward-sloping C. the slope of the yield curve reflects the risk premium incorporated into the yields on long-term bonds. D. the yield curve should usually be downward-sloping.

A. the slope of the yield curve depends on the expected future path of short-term rates.

The efficient markets hypothesis predicts that an investor A. will not be able consistently to earn above-normal profits from buying or selling stocks. B. will be able consistently to earn above-normal profits so long as stock prices in general are rising. C. will be able consistently to earn above-normal profits from buying or selling stocks so long as he or she makes use of rational expectations. D. will be able consistently to earn above-normal profits from buying or selling stocks so long as he makes use of adaptive expectations

A. will not be able consistently to earn above-normal profits from buying or selling stocks.

Other things being equal, an increase in the default risk of corporate bonds shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds to the ________. A) right; right B) right; left C) left; right D) left; left

C) left; right

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

C. $30

1 year --> 1.50% 2 years --> 2.25% 3 years --> 3.25% The data above shows the interest rates for Treasury securities of different maturities. Assume that the liquidity premium theory is correct. On this day, what did investors expect the interest rate to be on the one-year Treasury bill in two years if the term premium on a two-year Treasury note is 0.25% and the term premium on a three-year Treasury note is 0.75%? A. 2.375% B. 3.25% C. 3.50% D. 4.75%

C. 3.50%

According to the liquidity premium theory, what does a flat yield curve indicate? A. Long-term interest rates are expected to fall. B. Short-term interest rates are expected to remain stable. C. Short-term interest rates are expected to fall D. Short-term interest rates are expected to rise

C. Short-term interest rates are expected to fall

What is the most important contrast between the segmented markets theory and the expectations theory? A. The expectations theory does a better job of explaining why yield curves typically are upward-sloping. B. The segmented markets theory states that investors view similar assets that differ only with respect to maturity as perfect substitutes. C. The expectation theory states that investors view similar assets that differ only with respect to maturity as perfect substitutes. D. The segmented markets theory does a better job of explaining why yields on instruments of different maturities tend to move together.

C. The expectation theory states that investors view similar assets that differ only with respect to maturity as perfect substitutes.

You read a story in the newspaper announcing the proposed merger of Dell Computer and Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to invest in Gateway stock, you can expect to earn A) above average returns since you will share in the higher profits. B) above average returns since your stock price will definitely appreciate as higher profits are earned. C) below average returns since computer makers have low profit rates. D) a normal return since stock prices adjust to reflect expected changes in profitability almost immediately.

D) a normal return since stock prices adjust to reflect expected changes in profitability almost immediately.

If investors expect interest rates to fall significantly in the future, the yield curve will be inverted. This means that the yield curve has a ________ slope. A) steep upward B) slight upward C) flat D) downward

D) downward