Chapter 8 Money and Banking

76. Management fees for mutual funds are: A. Different across funds and can significantly impact the return to an investor. B. Fixed by regulation. C. Fixed by regulation but can vary by the size of the fund. D. Usually a percentage of the return achieved by fund managers.

A

8. Which of the following is not a feature of common stock? A. Stockholders receive regular fixed payments on their shares B. Stockholders have limited liability C. Stock holders are residual claimants D. Stockholders have voting rights

A

81. Stock market bubbles can lead to all of the following except: A. An efficient allocation of resources. B. Stock market crashes. C. Patterns of volatile returns from the stock market. D. Gaps between actual stock prices and those warranted by the fundamentals.

A

85. The stock market bubble of the late 1990's and early 2000: A. Saw Internet and computer technology companies over-invest. B. Saw an efficient allocation of resources toward the high-growth computer/Internet sector. C. Was a good example of the theory of efficient markets. D. Was an example that not all bubbles burst.

A

9. What do bondholders and stockholders have in common? A. Both are claimants B. Both have voting rights C. Both are shareholders in the company D. Both receive fixed payments on their securities each year

A

69. According to the theory of efficient markets, mutual fund managers may be expected to earn above-average returns if they: A. Take on less risk. B. Have access to illegal, private information. C. Participate in efficient markets. D. Have learned from investing in the same stocks repeatedly.

B

46. As the corporation uses more debt financing, which of the following holds true for the stockholders? A. The expected return to the stockholders decreases and the standard deviation of that return decreases B. The expected return to the stockholders increases and the standard deviation of the return decreases C. The expected return to the stockholders increases and the standard deviation of the return increases D. The expected return to the stockholders decreases and the standard deviation of the return increases

C

49. Consider the effect of business cycles on bondholders versus stockholders. We expect that business cycles will affect: A. Bondholders and stockholders about the same B. Bondholders more since the amount they receive depends on profits C. Stockholders more since they are residual claimants D. Bondholders more since they do not have any claim to property

C

52. All other things equal, a decrease in the equity risk premium leads to a(n): A. Increase in the required return on stock. B. Decrease in the present value of stock. C. Increase in the price of equity shares. D. Decrease in dividend growth

C

68. According to the theory of efficient markets: A. Investors use rules of thumb to make choices about which stocks to buy and sell. B. Investors are able to use forecasts based on the dividend-discount model to generate above-average returns. C. A money market manager who charges no commission should not, on average, outperform an individual investor with access to the same funds. D. The stock price should remain constant.

C

51. As a company issues more debt: A. Its leverage decreases. B. The share of financing from equity increases. C. The expected return to equity holders falls. D. Risk increases.

D

54. The required stock return an investor seeks can best be represented by which of the following? A. Risk Premium - Risk-free Return B. Risk-free Return x Risk Premium C. (Risk-free Return + Risk Premium)/(1 + i) D. Risk-free Return + Risk Premium

D

55. Which of the following will cause a reduction in the current price of a stock? A. A decrease in the current dividend B. An increase in the risk-free return C. A decrease in the growth rate of the dividend D. Both a decrease in the current dividend and an increase in the risk-free return

D

11. Which of the following stock price indexes is a price-weighted index? A. Dow Jones Industrial Average B. Standard & Poor's 500 Index C. Nasdaq D. Wilshire 5000

A

19. If each company that made up the Dow Jones Industrial Average increased the number of their shares outstanding by 10%, but the share prices did not change, the value of the index would: A. Not change B. Increase by 10% C. Increase, but by less than 10% D. Decrease since there are more shares outstanding

A

22. Considering the S&P 500 Index, if each company's stock price increased by 10%: A. The weights in the index would remain the same B. The companies with the most shares outstanding would have even greater weight after the increase C. The companies with fewer shares would gain more weight at the expense of the companies with greater shares D. The weights in the index would change to reflect the percentage changes in the prices of the various stocks

A

24. The Nasdaq Composite Index: A. Is a value-weighted index B. Is a price-weighted index C. Is made up of over 5000 companies traded on the NYSE D. Is made of mainly older firms and is heavily weighted by manufacturing

A

32. You start with a portfolio valued at $500. Over the next twelve months it loses 40%; the following year it has a gain of 30%. At the end of two years your portfolio is worth: A. $390 B. $450 C. $300 D. $410

A

34. You have a portfolio valued at $10,000. Over the next twelve months it loses 50% of its value. What return does the portfolio need to earn over the following twelve months to be restored to its original value? A. 100% B. 50% C. 200% D. 25%

A

35. The dividend-discount model of stock valuation: A. Is an application of the net present value formula B. Takes the net present value of expected dividends and add it to the future sale price of the stock C. Takes the net present value of the expected future price of the stock and adds the annual dividend D. Takes the annual dividend, adds it to the expected future selling price and divides by the number of years to get the current price

A

4. The fact that common stockholders are residual claimants means A. The stockholders have a claim against the revenue that remains after everyone else is paid B. The stockholders receive their dividends before any other residuals are paid C. The stockholders are paid any past due dividends before other claims are paid D. The stockholders are paid before the bondholders but after any taxes are paid

A

43. The dividend-discount model predicts that stock prices: A. Should be high when dividends are high B. Will be high when interest rates are high C. Will be higher when the growth rate of dividends is low D. Should be high when dividends are low

A

56. Which of the following will cause an increase in the current price of a stock? A. A decrease in the risk-free return B. A decrease in the current dividend C. A decrease in the dividend growth rate D. Both an increase in the risk-free return or an increase in the current dividend

A

58. Suppose there is a reduction of the return provided on U.S. Treasury bonds. We should expect the current price of stocks to: A. Increase since the risk-free return is now lower. B. Decrease since U.S. Treasury bonds are safer. C. Increase since the risk premium on the stocks will increase. D. Stay the same; there is no effect on stock prices from this reduction.

A

61. The theory of efficient markets implies: A. Stock prices should be highly unpredictable. B. The price at which stocks currently trade only reflect past information. C. Expectations do not play a role in stock prices because this isn't real information. D. The chartists are in fact correct that there are patterns in stock prices.

A

73. Professor Jeremy Siegel, of the University of Pennsylvania, conducted research that showed that: A. Over the long run, stocks are less risky than bonds. B. Over the long run, bonds are less risky than stocks. C. Over the long run, bonds frequently outperform stocks. D. Investors should only own stocks for short periods of time to maximize returns.

A

10. Which of the following statements is most correct? A. Managers, directors, and stockholders almost always share the same interest B. Managers' and directors' interests often conflict with stockholders' interest C. Managers and stockholders have the same interests, but this usually conflicts with the interests of directors D. Directors and stockholders have the same interests, but this usually conflicts with the interests of managers

B

14. The Dow Jones Industrial Average is: A. A simple average B. A price-weighted index C. A value-weighted index D. A total-value index

B

2. Two characteristics that make owning stock attractive are: A. Unlimited liability and first claim on assets B. Share prices are relatively inexpensive and are transferable C. Each share represents a large percentage of ownership and dividends are fixed D. Dividends are paid before any other distributions are made and stocks are transferable

B

21. The Standard & Poor's 500 Index: A. Gives more weight to large companies than small companies B. Actually includes more than 500 of the largest corporations in the U.S C. Is a price-weighted index D. Assigns equal weight to all the prices of all the stocks in the index

B

26. The most broadly based stock index in use is: A. The Nasdaq Composite Index B. The Wilshire 5000 C. The Dow Jones Industrial Average D. The Standard and Poor's 500 Index

B

30. The dividends that stockholders receive: A. Are fixed by contract and paid annually B. Are distributions from profits C. Are paid before all other obligations of the company are met D. Are always equal to the average amount of interest paid to a bond holder, adjusting for the value of the holdings

B

37. A stock has a current annual dividend of $6.00 per year and it is expected to grow by 3% (0.03) a year. It is expected that two years from now the stock will sell for $90.00 a share. If the interest rate is 5% (0.05), the dividend discount model predicts the stock's current price should be: A. $94.90 B. $93.12 C. $101.30 D. $94.30

B

38. A stock currently does not pay an annual dividend. An investor expects this policy to remain in force. She believes, however, the stock of this company will sell for $110.00 per share four years from now. If she has an interest (discount) rate of 7% (0.07), the dividend discount model predicts the current price of this stock should be: A. You cannot apply the model to this example since it requires a dividend be offered B. $82.00 C. $83.92 D. $86.35

B

48. Without the stockholders' limited liability, the risk from the use of leverage: A. Would be significantly less B. Would be significantly greater C. Would still be the same D. Would be irrelevant; limited liability eliminates the risk from leverage

B

59. The impact from rapid dividend growth on a stock's current price will be: A. Negative, since the company is paying out profits to stockholders. B. Positive since rapid dividend growth causes stockholders to expect higher future dividends. C. Zero; only current dividends are used to determine the current price of a stock. D. Positive, but only if the corporation does not have any debt.

B

60. The theory of efficient markets assumes that: A. Prices of bonds, but not stocks, reflect all available information. B. The prices of all financial instruments reflect all available information. C. Stock prices are relatively rigid because it takes a while for information to efficiently move through the market. D. The best approach to determining stock prices is to follow the chartists.

B

62. The theory of efficient markets means A. Professional fund managers should be able to consistently beat the market average. B. A professional fund manager should really not expect to beat the market average consistently. C. A professional fund manager who beats the market average one year should expected to beat the market average the next year. D. A professional fund manager who beats the market average one year should be expected to not beat the market average the next year.

B

64. The notion that stock prices reflect all current available information: A. Makes the risk of holding stocks greater. B. Indicates that mutual fund managers will not, on average, outperform market averages. C. Says stock prices should be more rigid than they are. D. Makes it easier to predict the movements in the price of a stock.

B

65. People who claim to have the ability to accurately predict the future prices of stocks: A. Are strong advocates of the theory of efficient markets. B. Should be looked at cynically, unless they have information not available to others. C. Are unusually lucky, and should be listened to intently. D. Are always psychologists.

B

66. Consider a game that involves the tossing of a fair coin. The winner is the individual who calls the outcome correctly, the loser obviously called the wrong outcome. The theory of efficient markets would say: A. Part of the key information is to know the outcomes of the previous tosses. B. The key information to know are the probabilities of the outcomes and the expected payoff. C. Part of the key information is to know the skill of the person you are playing against. D. Outcomes of events that require luck cannot be evaluated.

B

70. Under what circumstances are stocks less risky than bonds? A. When stockholders have limited liability. B. When investors buy stocks and hold them for long periods of time. C. When investors actively buy and sell stocks in response to new information. D. When the economy goes into a period of economic recession.

B

72. Professor Jeremy Siegel, of the University of Pennsylvania, did research showing that: A. Owning stocks over the long run produces returns below the risk-free return. B. If an investor owns stocks for a very short time the risk is greater than if the stocks are held for a long time. C. The return on the S&P 500 for a 25-year period often produces returns below zero. D. Bonds really are less risky to hold over the long term.

B

78. When stock prices reflect fundamental values: A. All investors will have positive returns. B. The allocation of resources will be more efficient. C. All companies will have an easier task of obtaining financing for investment projects. D. The overall level of the stock market should move higher.

B

79. The fact that returns from the stock market are less volatile over long-periods of time suggests that: A. Investors are more risk averse over the long run. B. Stock markets are efficient. C. People get comfortable with the stocks they own. D. Stock market bubbles have become more common.

B

80. Stock market bubbles are: A. The increase in a stock's price resulting from reported higher profits by a firm. B. Persistent and expanding gaps between stocks' actual prices and the prices warranted by the fundamentals. C. Synonymous to stock market crashes. D. Those periods of time when the overall level of the stock market is rising at a slow rate reflecting market fundamentals.

B

86. Stock market bubbles impact consumers by: A. Encouraging greater consumption of luxury goods and greater saving. B. Encouraging greater consumption of luxury goods and less saving. C. Encouraging more work and delaying retirement. D. Resulting in less investment in home ownership and more into stocks.

B

87. Some good did come from the Internet bubble of the late 1990s. One good thing was that: A. People learned they should not invest in dotcom companies. B. Start-up companies found they could bypass venture capitalists and raise funds directly from the capital markets. C. Stock market bubbles do not have to result in an inefficient allocation of resources. D. The theory of efficient markets doesn't always hold and consistently better-than-market returns are achievable.

B

75. Management fees for mutual funds are: A. Fixed by regulation. B. Fixed by regulation and can vary by the size of the fund. C. Usually a percentage of the gains the fund achieves. D. Usually a percentage of the funds under management.

D

1. A share of common stock represents: A. A claim from a lender against a borrower B. A share in the company's debts C. A share of ownership of the company D. An unlimited liability to the owner of the stock

C

12. An index number is valuable because: A. It provides useful information to the viewer B. It is more stable than the data it reflects C. It provides a meaningful measurement scale to calculate percentage changes D. It does not require any calculations to compute percentage changes

C

13. The Dow Jones Industrial Average is: A. An index made up of the stock prices of the 100 largest corporations in the U.S B. An index that measures the value of purchasing 100 shares in each of the corporations that make up the index C. The average price of stock in 30 of the largest companies in the U.S. D. The broadest measure of stock market performance

C

16. If the Dow Jones Industrial Average is currently at 10,000 and the price of one stock included in the index increases by $10, the Dow Jones Industrial Average will: A. Not change; it is a value-weighted index B. Increase by the size of the Dow Jones divisor C. Increase by (10/Dow Jones divisor)/10,000 D. Increase by 0.1%

C

17. If the Dow Jones Industrial Average is at 10,205 and it is up 4% from the previous day, what was the index at the close of the market the previous day? A. 10,201.0 B. 9,805.0 C. 9,812.5 D. 9800.0

C

25. The Nasdaq Composite Index: A. Is made up of over 50,000 firms traded on the Over-the-Counter market B. Is a price-weighted index C. Is made up of mainly newer firms, and heavily influenced by technology and Internet companies D. Is the most broadly based index in use

C

29. People differ on the method by which stock should be valued. Some people are chartists, others behavioralists. The basic difference between these groups is: A. Chartists rely on astrological charts to predict stock values, behavioralists rely on psychology B. Behavioralists are finance based, chartists study charts of investor psychology C. Chartists study charts of stock prices; behavioralists focus on investor psychology and behavior D. Chartists and behavioralists are the same in their approach; essentially there aren't any differences

C

31. You start with a $1000 portfolio; it loses 50% over the next year, the following year it gains 50% in value. At the end of two years your portfolio is worth: A. $1000 B. $500 C. $750 D. $950

C

33. You have a portfolio valued at $1000. Over the next twelve months it loses 75% of its value. What return does the portfolio need to earn over the following twelve months to restore the portfolio to its original value? A. 75% B. 200% C. 300%

C

36. A stock has an annual dividend of $10.00 and it is expected not to grow. It is believed the stock will sell for $100 one year from now, and an investor has a discount (interest) rate of 6% (0.06). The dividend discount model predicts the stock's current price should be: A. $94.67 B. $116.00 C. $103.77 D. $106.60

C

39. Next year, the price of a stock is expected to be $2200 and the stock will pay a $55 dividend. The interest rate is 10%. Based on the dividend-discount model, what is the current price of this stock? A. $1980 B. $2000 C. $2050 D. $2035

C

77. Index funds are often preferred to mutual funds because: A. They offer greater diversification. B. They are managed better. C. They have greater liquidity. D. On average they have lower management fees.

D

41. A company currently pays a dividend of $4.00 per share. It expects the growth rate of the dividend to be 3% (0.03) annually. If the interest rate is 6% (0.06) what does the dividend-discount model predict the current price of the stock should be? A. $103.33 B. It doesn't, you need an expected future selling price to use the model C. $137.33 D. $66.67

C

44. Suppose that the current dividend for a stock is Dtoday, the expected dividend growth rate is r, and the interest rate is i. If we ignore risk, which of the following represents the dividend-discount model formula for the fundamental price of a stock? A. Dtoday / (i+g) B. (i+g) / Dtoday C. Dtoday (1+g) / (i-g) D. Dtoday / (i-g)

C

53. The basic dividend-discount model is a bit of an oversimplification for valuing stocks because: A. It ignores expected dividend growth. B. It ignores the value of future dividends. C. It ignores the risk involved in holding stocks. D. It cannot handle stocks that do not pay dividends.

C

57. If a company reports that it is going to have a difficult time meeting its debt obligations, you would expect the Ptoday: A. To fall since the risk-free return will rise. B. To rise since the Dtoday will likely fall. C. To fall since the risk premium will likely rise. D. To remain about the same until the Dtoday actually changes.

C

6. The concept of limited liability says a stockholder of a corporation: A. Is liable for the corporation's liabilities, but nothing more B. Cannot receive dividends that exceed his/her investment C. Cannot lose more than his/her investment D. Is only responsible for any taxes that the corporation may owe but not its other debts

C

63. The theory of efficient markets: A. Rules out high returns due to chance. B. Says insider information makes markets less efficient. C. Allows for higher than average returns if the investor takes higher than average risk. D. Assumes people have equal luck.

C

67. In the first calendar quarter a company reports that it expects profits to rise in the fourth quarter. The theory of efficient markets says we should expect the price of the company's stock to: A. Rise in the fourth quarter when the higher profits are actually seen. B. Fall immediately as stockholders will be disappointed about having to wait until the fourth quarter for higher profits. C. Rise immediately on the expectation of higher profits in the future. D. Rise around the third quarter since this information will take time to disseminate

C

71. Stocks appear to present risk, yet many people have substantial parts of their wealth invested in them. This behavior could be explained by: A. People are irrational in their investment behavior, only focusing on positive outcomes. B. People are not very risk-averse and do not require a risk premium for stocks. C. Investing in stocks over the long run is not as risky as short-term holdings. D. People are not efficient users of information

C

74. Mutual funds are characterized by the fact that the all: A. Have the same management fee set by regulation. B. Require the same minimum investment of $10,000. C. Provide some degree of diversification. D. Provide the same degree of liquidity.

C

82. Which of the following could cause a stock market bubble? A. Changes in the real interest rate B. Changes in the risk premium C. Investor euphoria D. Changes in dividends

C

15. The Dow Jones Industrial Average: A. Gives equal weight to a change in the price of the stock of any company in the index B. Reflects that a 10% increase in a share of stock selling for $30 will have the same affect on the index as a 10% increase in the price of a stock selling for $60 C. Is a value-weighted index D. Gives greater weight to shares with higher prices

D

18. The stocks that make up the Dow Jones Industrial Average: A. Are dominated by the automobile industry B. Are the same ones that were originally used to construct the index C. Are not a broad measure of the market since they do not include any technology companies D. Have changed as the structure of the economy has changed

D

20. The Standard & Poor's 500 Index differs from the Dow Jones Industrial Index because: A. It takes into account the stock prices of 500 of the largest firms, which is less than the DJIA B. It is a price-weighted index, where the DJIA is a value-weighted index C. Larger firms are less important in the S&P 500 than in the DJIA D. It takes into account the prices of more stocks and it uses a different weighting scheme

D

23. Which of the following statements is not true? A. A value-weighted index is a better index to use to reflect changes in the economy's overall wealth B. A price-weighted index is a better index to use to reflect the average change in the price of a typical share of stock C. The Dow Jones Industrial Average is a price-weighted index D. The S & P 500 is a price-weighted index

D

27. When studying world stock indexes, we observe that: A. The S&P 500 is largest in terms of index value B. Most of the world's indexes are price-weighted C. The indexes are very comparable D. The indexes are comparable but only in percentage terms

D

28. When comparing stock indexes around the world we: A. Find that a given percentage change across all indexes has the same value B. Observe that they tend to move together C. Can see that the numeric change in indices allows investors to make easy comparisons of value D. We can examine their respective movements if we look at them in percentage terms

D

3. Voting rights in a corporation are held by: A. The board of directors B. The preferred stockholders C. The corporate bondholders D. The common stockholders

D

40. The price of a stock is currently $750 and the stock will pay a $43 dividend. The interest rate is 7.5%. Based on the dividend-discount model, what is the expected price of this stock for next year? A. $651.17 B. $657.67 C. $691.17 D. $763.25

D

42. A company currently pays an annual dividend of $6.50 per share. It expects the growth rate of the dividend will be 2.5% (0.025) annually. If the interest (discount) rate is 5% (0.05) what does the dividend-discount model predict the current price of the stock should be? A. It doesn't, you need an expected future price to use the model B. $257.50 C. $130.00 D. $266.50

D

45. A share of stock resembles a consol in all of the following ways except that: A. The share of stock does not have a maturity date B. The annual dividend the stock pays resembles the coupon on a consol C. The prices of both can be computed using a variation of the net present value formula D. They are both residual claims

D

47. The fact that many corporations use debt financing as well as equity financing creates all of the following except: A. The opportunity for a greater expected return for the stockholders B. Greater risk for the stockholders C. Leverage for the stockholders D. Consistently lower debt-to-equity ratios

D

5. If a public corporation goes bankrupt and does not have enough assets to pay off all creditors: A. The stockholders are personally liable for the balance B. The fact that stockholders are residual claimants means they may have to pay in additional capital to cover the obligations C. The stockholders receive any dividends due before the other creditors are paid D. The stockholders cannot lose more than their investment

D

50. In the event of bankruptcy, stockholders: A. Are paid before bondholders. B. Receive at least their initial investment due to limited liability. C. Could lose more than their initial investment. D. Are the last to be paid and could end up losing what they have invested.

D

7. Which of the following statements is most correct? A. Stockholders have limited liability and have no control over corporate leadership B. Stockholders can dislodge the managers of the corporation but not the board of directors C. Stockholders have unlimited liability and can dislodge members of the board of directors D. Stockholders can dislodge members of the board and have limited liability

D

83. Why are stock market bubbles costly for the economy? A. They imply that the actual stock price is equal to the fundamental value of the stock. B. They hurt consumers more than corporations. C. They lead to a reduction in real investment in both the short-term and long-term. D. They lead to a misallocation of resources in both the short-term and long-term.

D

84. Companies whose stocks increase the most during a stock market bubble will: A. Have a difficult time raising investment capital. B. Tend to under-invest. C. Usually rebound faster once the bubble bursts. D. Find it difficult to put their capital to profitable use after the bubble bursts.

D