Quiz 3

What is the opportunity cost of holding $1500 in cash if the relevant interest rate is 5 percent? The opportunity cost is:

($1,500 * 5%) = $75

Would you be more or less willing to buy a share of Microsoft stock in the following situations: 1. Your wealth falls 2. You expect the stock to appreciate in value 3. The bond market becomes more liquid 4. You expect gold to appreciate in value 5. Prices in the bond market become more volatile

1. Less willing 2. More willing 3. Less willing 4. Less willing 5. More willing

"No one who is risk-averse will ever buy a security that has a lower expected return, more risk, and less liquidity than another security." Is this statement true, false, or uncertain? A. True because for a risk-averse person, those characteristics make a security less desirable. B. False because by diversifying or hedging your portfolio, it is possible to avoid risks and increase your expected return. C. Uncertain because there may be other crucial characteristics to consider when purchasing a security.

A. True because for a risk-averse person, those characteristics make a security less desirable.

Suppose you visit with a financial adviser, and you are considering investing some of your wealth in one of three investment portfolios: stocks, bonds, or commodities. Your financial adviser provides you with the following table, which gives the probabilities of possible returns from each investment: (Table Question 6 Quiz 3) To maximize your expected return, you should choose: A. commodities. B. stocks. C. bonds. D. All of the portfolios have the same expected return.

A. commodities (multiply probability by return and sum up the total for each)

In 2010 and 2011, the government of Greece risked defaulting on its debt due to a severe budget crisis. Using bond market graphs, determine how default would affect the risk premium between U.S. Treasury debt and Greek debt with comparable maturity. (refer to graph on quiz 3) In the case of default, what would happen to the risk premium between U.S. Treasury debt and comparable maturity Greek debt? A. The risk premium would decrease, which corresponds to segment A on the graphs above. B. The risk premium would increase, which corresponds to segment B on the graphs above. C. The risk premium would increase, which corresponds to segment C on the graphs above. D. The risk premium would not change and therefore would equal zero.

B. The risk premium would increase, which corresponds to segment B on the graphs above.

Prior to 2008, mortgage lenders required a house inspection to assess its value, and often used the same one or two inspection companies in the same geographical market. Following the collapse of the housing market in 2008, mortgage lenders required a house inspection, but this was arranged through a third party. How does this illustrate a conflict of interest similar to the role that credit-rating agencies played in the global financial crisis? A. Fees for home inspections may have been unreasonably high to ensure high profits for the inspection company. B. Mortgage lenders may have wanted to increase home sales without assuming the additional costs to add more inspection companies. C. Inspection companies may have provided overly optimistic assessments of home values to ensure continued work in the future. D. This situation does not illustrate any conflict of interest, as the services provided by credit-ratings agencies and home inspection companies are unrelated.

C. Inspection companies may have provided overly optimistic assessments of home values to ensure continued work in the future.

What would happen to the risk premium on corporate bonds if brokerage commissions were lowered in the corporate bond market? A. Lower brokerage commissions for corporate bonds would make them more desirable to hold and thus increase demand; consequently, this would raise interest rates and thus raise the risk premium B. Lower brokerage commissions for corporate bonds would only reduce the cost of buying and selling the bonds, which would have no impact on the risk premium C. Lower brokerage commissions for corporate bonds would make them more liquid and thus increase demand, which would lower the risk premium D. None of the above

C. Lower brokerage commissions for corporate bonds would make them more liquid and thus increase demand, which would lower the risk premium

If monetary policy becomes more transparent about the future course of interest rates, how would that affect stock prices, if at all? A. Stock prices will remain unchanged, as increased transparency will not affect investment decisions. B. Stock prices will decrease because investors are now aware of stock prices and won't overpay. C. Stock prices will increase, as the risk and required return on the investment will be reduced. D. Stock prices will be unaffected, as stock prices and transparent monetary policy are unrelated.

C. Stock prices will increase, as the risk and required return on the investment will be reduced.

Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so? A. During an economic expansion, there is greater inflationary pressure driving interest rates upward. B. In anticipation of a recession, the Federal Reserve will begin to lower interest rates. C. As an economy enters a recession, business firms are less likely to default on their debt. D. As the economy enters an expansion, there is greater likelihood that borrowers will be able to service their debt.

D. As the economy enters an expansion, there is greater likelihood that borrowers will be able to service their debt.

What effect will a sudden increase in the volatility of gold prices have on interest rates? A. Interest rates will increase because bonds will become relatively more risky, which decreases the demand for bonds B. Interest rates will increase because bonds will become relatively less risky, which increases the demand for bonds C. Interest rates will decrease because bonds will become relatively more risky, which decreases the demand for bonds D. Interest rates will decrease because bonds will become relatively less risky, which increases the demand for bonds

D. Interest rates will decrease because bonds will become relatively less risky, which increases the demand for bonds