Macro Ch. 13-14 test review
Crowding out
investment goes down when government runs a budget deficit.
Possibility of speculative bubbles
Value of the stock to a stockholder depends on: Stream of dividend payments Final sale price
Stocks are:
Undervalued if Price < Value Overvalued if Price > Value Fairly valued if Price = Value
Asset Valuation
Use fundamental analysis to pick a stock
how to determine the quantity of loanable funds supplied.
(Y-T-C) + (T-G) = loanable funds
National Saving
= (Y-T-C) + (T-G) = Y-C-G
Public saving
= T - G
Private Saving
= Y - T - C
Closed economy case
= Y = C + I +G solve for I through national saving equation
If the inflation rate is 2 percent and the real interest rate is 3 percent, then the nominal interest rate is a. 5 percent. b. 1 percent. c. 1.5 percent d. 0.67 percent.
A - 5 percent lets do the math real interest rate ≈ nominal interest rate − inflation rate 3 = x - 2 2+3 = 5
If the efficient market hypothesis is correct, then a. index funds should typically beat managed funds, and usually do. b. index fund should typically beat managed funds, but usually do not. c. mutual funds should typically beat index funds, and usually do. d. mutual funds should typically beat index funds, but usually do not.
A - index funds should typically beat managed funds, and they usually do.
Economists have developed models of risk aversion using the concept of a. utility and the associated assumption of diminishing marginal utility. b. utility and the associated assumption of increasing marginal utility. c. income and the associated assumption of diminishing marginal wealth. d. income and the associated assumption of increasing marginal wealth.
A - utility and the associated assumption of diminishing marginal utility. risk aversion - a dislike of uncertainty
The supply of loanable funds slopes a. upward because an increase in the interest rate induces people to save more. b. downward because an increase in the interest rate induces people to save less. c. downward because an increase in the interest rate induces people to invest less. d. upward because an increase in the interest rate induces people to invest more.
A- Upward because an increase in the interest rate induces people to save more
Market risk
Affects all companies in the stock market
Firm-specific risk
Affects only a single company
Moral hazard
After people buy insurance - less incentive to be careful
Suppose that in a closed economy GDP is equal to 11,000, Taxes are equal to 2,500, Consumption equals 7,000, and Government purchases equal 3,000. What are private saving and public saving? a. 1500 and -500 b. 1500 and 500 c. 1000 and -500 d. 1000 and 500
Answer - A - 1500 & -500 lets do the math Y= 11,000 T= 2,500 C= 7,000 G= 3,000 Private saving = Y-T-C Public saving = T-G Private - 11,000 - 2500-7,000 = 1500 Public - 2500- 3000 = -500
The efficient markets hypothesis
Asset prices reflect all publicly available information about the value of an asset Each company listed on a major stock exchange is followed closely by many money managers Equilibrium of supply and demand sets the market price
If the interest rate is 7.5 percent, then what is the present value of $4,000 to be received in 6 years? a. $2,420.68 b. $2,591.85 c. $2,996.33 d. $3,040.63
B - $2,591.85 Lets do the math - PV = FV / (1+r)^n FV= ? r= 7.5% = 0.075 n= 6 years PV= 4,000 4000 / (1+0.075)^6 4000 / 1.54 = 2,591.85
If the demand for loanable funds shifts left, the equilibrium interest rate a. and quantity of loanable funds rise. b. and quantity of loanable funds fall. c. rises and the quantity of loanable funds falls. d. falls and the quantity of loanable funds rises.
B - Interest rate and quantity of loanable funds fall
Which of the following is a financial intermediary? a. a mutual fund b. the stock market c. a U.S. government bond d. a wealthy individual who regularly buys and holds large quantities of government bonds
B - a mutual fund
If the efficient markets hypothesis is correct, then a. the number of shares of stock offered for sale exceeds the number of shares of stock that people want to buy. b. the stock market is informationally efficient. c. stock prices never follow a random walk. d. All of the above are correct.
B - the stock market is informationally efficient
At an annual interest rate of 14 percent, about how many years will it take $100 to double in value? a. 3 b. 4 c. 5 d. 7
C - 5 lets do the math - using the rule of 70 r= 14 70/14 = 5
When the government runs a budget deficit, a. interest rates are lower. b. national saving are higher. c. investment is lower. d. All of the above are correct.
C - Investment is lower A budget deficit is a shortfall of tax revenue from government spending Investment is spending on business capital, residential capital, and inventories
From the standpoint of the economy as a whole, the role of insurance is a. to entice risk-loving people to become risk averse. b. to promote the phenomenon of adverse selection. c. not to eliminate the risks inherent in life, but to spread them around more efficiently. d. not to spread risks, but to eliminate them for individual policy holders.
C - Not to eliminate the risks inherent in life, but to spread them around more efficiently
An insurance company
Cannot perfectly distinguish between high-risk and low-risk customers Cannot monitor all of its customers' risky behavior
Scenario 1. Assume the following information for an imaginary, closed economy. GDP = $120,000; consumption = $70,000; private saving = $9,000; national saving = $12,000. Refer to Scenario 13-1. For this economy, government purchases amount to a. $12,000. b. $18,000. c. $28,000. d. $38,000.
D - 38,000 lets do math - Y= 120,000 C= 70,000 Private = 9,000 I = 12,000 NS= 12,000 Y = C + I +. G 70,000 + 12,000 = 82,000 120,000 - 82000 = 38000
The financial system a. involves bank accounts, mortgages, stock prices, and many other items. b. involves decisions and actions undertaken by people at a point in time that affect their lives in the future. c. coordinates the economy's saving and investment. d. All of the above are correct.
D - all of the above
The future value of a deposit in a savings account will be larger a. the longer a person waits to withdraw the funds. b. the higher the interest rate is. c. the larger the initial deposit is. d. All of the above are correct.
D - all of the above are correct
Compounding refers directly to a. finding the present value of a future sum of money. b. finding the future value of a present sum of money. c. changes in the interest rate over time on a bank account or a similar savings vehicle. d. interest being earned on previously-earned interest.
D - interest being earned on previously-earned interest
Suppose that in a closed economy GDP is equal to 11,000, taxes are equal to 1,500, consumption equals 7,500, and government purchases equal 2,000. What is national saving? a. -500 b. 0 c. 2,000 d. None of the above is correct
D - none of the above test it with the math
Risk of a portfolio of stocks
Depends on number of stocks in the portfolio The higher the standard deviation (risk) The riskier the portfolio
Informational efficiency
Description of asset prices Rationally reflect all available information stock markets exhibit informational efficiency
Example, two types of assets
Diversified group 8% return and 20% standard deviation Safe alternative 3% return and 0% standard deviation
How much would you have to deposit in a bank right now to yield $200 in N years?
Future value = $200 in N years Interest rate = r Present value = $200/(1+r)N
The Rule of 70
Given the interest rate the rule of 70 tells us how long it will take the present value of the deposit to be doubled. example : PV (1+r)^n = FV PV (1+r)^n = 2(PV) *the PV cancels out* (1+r)^n n * ln (1+r) = ln(2)
Adverse selection
High-risk person - more likely to apply for insurance
Diversification Reduces Risk
Increasing the number of stocks in a portfolio reduces firm-specific risk through diversification ...but market risk remains.
demand =
Investment / borrows
Market irrationality
Movement in stock market is hard to explain - news that alter a rational valuation
If you put $100 in a bank account today, how much will it be worth in N years?
Present value = $100 Interest rate = r Future value = ... (1+r) ˣ $100 after 1 year, (1+r) ˣ (1+r) ˣ $100 = (1+r)2 ˣ $100 after 2 years, (1+r)3 ˣ $100 after 3 years, ...
What are the different kinds of savings?
Private saving Public saving National saving
Diversification
Reduction of risk By replacing a single risk with a large number of smaller, unrelated risks "Don't put all your eggs in one basket" Diversification Can eliminate firm-specific risk Cannot eliminate market risk
Price of insurance
Reflects the actual risks that the insurance company will face after the insurance is bought
Implication of efficient markets hypothesis
Stock prices should follow a random walk Changes in stock prices are impossible to predict from available information
Fundamental analysis
Study of a company's accounting statements and future prospects To determine its value
Financial System
The group of institutions in the economy that help one persons saving with another persons investment
The trade-off
The more a person puts into stocks, the greater the risk and the return
What would happen in the market for loanable funds if the government were to increase the tax on interest income? a. Interest rates would rise. b. Interest rates would be unaffected. c. Interest rates would fall. d. The effect on the interest rate is uncertain.
a - interest rates would rise
If Congress instituted an investment tax credit, the interest rate would a. rise and saving would rise. b. fall and saving would fall. c. rise and saving would fall. d. fall and saving would rise.
a - rise and saving would rise
The bond market
a bond is a certificate of indebtedness
Which of the following lists correctly identifies the four expenditure categories of GDP? a. consumption, government purchases, investment, net-exports b. consumption, investment, depreciation, net-exports c. consumption, saving, investment, depreciation, d. consumption, government purchases, investment, savings
a. consumption, government purchases, investment, net-exports remember : CGIN c-GIN for zeta
Tami knows that people in her family die young, and so she buys life insurance. Preston knows he is a reckless driver and so he applies for automobile insurance. a. These are both examples of adverse selection. b. These are both examples of moral hazard. c. The first example illustrates adverse selection, and the second illustrates moral hazard. d. The first example illustrates moral hazard, and the second illustrates adverse selection.
a. These are both examples of adverse selection. Moral hazard is to buy insurance after, as a moral, if you ****ed up
The supply of loanable funds would shift to the right if either a. tax reforms encouraged greater saving or the budget deficit became smaller. b. tax reforms encouraged greater saving or investment tax credits were increased. c. the budget deficit became larger or investment tax credits were increased. d. the budget deficit became larger or tax reforms discouraged saving.
a. tax reforms encouraged greater saving or the budget deficit became smaller.
Which of the following is the correct way to compute the future value of $1 put into an account that earns 5 percent interest for 16 years? a.$1(1 + .05)16 b.$1(1 + .05 x 16) x 16 c.$1(1 + .05 x 16) d.$1(1 + 16/.05)16
a.$1(1 + .05)^16
Your financial advisor tells you that if you earn the historical rate of return on a certain mutual fund, then in three years your $20,000 will grow to $23,152.50. What rate of interest does your financial advisor expect you to earn? a.5 percent b.6 percent c.7 percent d.8 percent
a.5 percent
The efficient markets hypothesis says that beating the market consistently is a.impossible. Many studies find that beating the market is, at best, extremely difficult. b.impossible. Many studies find that beating the market is relatively easy. c.relatively easy. Many studies find that beating the market is, at best, extremely difficult. d.relatively easy. Many studies find that beating the market is relatively easy.
a.impossible. Many studies find that beating the market is, at best, extremely difficult.
When a country saves a larger portion of its GDP, it will have a- more capital and higher productivity b- more capital and lower productivity c- less capital and higher productivity d- less capital and lower productivity
answer - A - more capital and higher productivity
At an annual interest rate of 10 percent, about how many years will it take $100 to double in value? a.5 b.7 c.9 d.11
b - 7 lets do the math Rule of 70!!!! 70/10 = 7
If you put $125 into an account that paid 3.25 percent interest, then how much money would you have in the account after 20 years? a.$285.83 b.$236.98 c.$202.04 d.$145.65
b.$236.98 lets do math Future value - (1+r)^n x $ (1 + 0.0325)^20 x $125 = 236.98 Remember - future value multiples and present value divides
Suppose you will receive $500 at some point in the future. If the annual interest rate is 7.5 percent, then the present value of the $500 is a.$411.26 if the $500 is to be received in 5 years and $338.95 if the $500 is to be received in 10 years. b.$348.28 if the $500 is to be received in 5 years and $242.60 if the $500 is to be received in 10 years. c.$291.11 if the $500 is to be received in 5 years and $272.89 if the $500 is to be received in 10 years. d.$291.11 if the $500 is to be received in 5 years and $236.49 if the $500 is to be received in 10 years.
b.$348.28 if the $500 is to be received in 5 years and $242.60 if the $500 is to be received in 10 years. lets do the math formula - $ / (1+r)^n 500/(1+0.075)^5= 348.28 500/(1+0.075)^10 = 242.60
Suppose you are deciding whether to buy a particular bond. If you buy the bond and hold it for 4 years, then at that time you will receive a payment of $10,000. If the interest rate is 6 percent, you will buy the bond if its price today is no greater than a.$8,225.06. b.$7,920.94. c.$7,672.58. d.$6,998.98.
b.$7,920.94. lets do the math 10,000 / (1. 0.06)^4 = 7,920.94
Which of the following events would shift the supply curve from S1 to S2? a.In response to tax reform, firms are encouraged to invest more than they previously invested. b.In response to tax reform, households are encouraged to save more than they previously saved. c.Government goes from running a balanced budget to running a budget deficit. d.Any of the above events would shift the supply curve from S1 to S2.
b.In response to tax reform, households are encouraged to save more than they previously saved.
Which of the following events could explain a shift of the demand-for-loanable-funds curve from D1 to D2? a.The tax code is reformed to encourage greater saving. b.The tax code is reformed to encourage greater investment. c.The government starts running a budget deficit. d.The government starts running a budget surplus.
b.The tax code is reformed to encourage greater investment.
Fundamental analysis shows that stock in Cedar Valley Furniture Corporation has a price that exceeds its present value. a.This stock is overvalued; you should consider adding it to your portfolio. b.This stock is overvalued; you shouldn't consider adding it to your portfolio. c.This stock is undervalued; you should consider adding it to your portfolio. d.This stock is undervalued; you shouldn't consider adding it to your portfolio.
b.This stock is overvalued; you shouldn't consider adding it to your portfolio.
Diversification of a portfolio a.can eliminate market risk, but it cannot eliminate firm-specific risk. b.can eliminate firm-specific risk, but it cannot eliminate market risk. c.increases the portfolio's standard deviation. d.s not necessary for a person who is risk averse.
b.can eliminate firm-specific risk, but it cannot eliminate market risk
If a person is risk averse, then as wealth increases, total utility of wealth a.increases at an increasing rate. b.increases at a decreasing rate. c.decreases at an increasing rate. d.decreases at a decreasing rate.
b.increases at a decreasing rate.
The value of a stock is based on the a.present values of the dividend stream and final price. As a result, the value of a stock rises when interest rates rise. b.present values of the dividend stream and final price. As a result, the value of a stock falls when interest rates rise. c.future values of the dividend stream and final price. As a result, the value of a stock rises when interest rates rises. d.future values of the dividend stream and final price. As a result, the value of a stock falls when interest rates rise.
b.present values of the dividend stream and final price. As a result, the value of a stock falls when interest rates rise.
The field of finance primarily studies a.how society manages its scarce resources. b.the implications of time and risk for allocating resources over time. c.firms' decisions concerning how much to produce and what price to charge. d.how society can reduce market risk.
b.the implications of time and risk for allocating resources over time.
Financial Intermediaries
institutions through which savers can indirectly provide funds to borrowers ex- banks and mutual funds
Scenario 1. Assume the following information for an imaginary, closed economy. GDP = $120,000; consumption = $70,000; private saving = $9,000; national saving = $12,000. Refer to Scenario 1. For this economy, investment amounts to a. $4,000. b. $9,000. c. $12,000. d. $16,000.
c - 12,000 lets do math Y = 120,000 C= 70,000 PS= 9,000 NS= 12,000 I = Public savings + Private savings we are not given public savings so we find it through NS NS = public + Private = 12,000-9,000= 3,000 I = 9000+3000 = 12000 yay this one took me a bit to figure out
Scenario 1. Assume the following information for an imaginary, closed economy. GDP = $120,000; consumption = $70,000; private saving = $9,000; national saving = $12,000. Refer to Scenario 13-1. For this economy, taxes amount to a. $28,000. b. $38,000. c. $41,000. d. $44,000.
c - 41,000 lets do math Y= 120,000 C= 70,000 private = 9000 public = 3000 NS= 12,000 I= 12,000 G= 38,000 to find G = T- G = Public saving 38,000 + Public (3,000) = 41,000
Cleo promises to pay Jacques $1,000 in two years. If the interest rate is 6 percent, how much is this future payment worth today? a.$883.60 b.$887.97 c.$890.00 d.None of the above are correct to the nearest cent.
c.$890.00 FV=PV(1+r)^n 1000 / (1+0.06)^2
For an imaginary closed economy, T = $5,000; S = $11,000; C = $50,000; and the government is running a budget deficit of $1,000. Then a. private saving = $10,000 and GDP = $54,000. b. private saving = $10,000 and GDP = $58,000. c. private saving = $12,000 and GDP = $67,000. d. private saving = $12,000 and GDP = $72,000.
c. private saving = $12,000 and GDP = $67,000. lets do math - T= $5,000 S= 11,000 C= 50,000 G= 1,000 FOR IMAGINARY CLOSED ECONOMY = Y= C + I + G 50,000 + 11,000 + 1,000 + 5,000 = 67,000 Private - 67,000-5,000-50,000 = 12,000
Which of the following games might a risk-averse person play? a. a game where she has a 50 percent chance of winning $1 and a 50 percent chance of losing $1 b. a game where she has a 50 percent chance of winning $100 and a 50 percent chance of losing $100 c. a game where she has a 60 percent chance of winning $1 and a 40 percent chance of losing $1 d. a game where she has a 40 percent chance of winning $1 and a 60 percent chance of losing $1
c. a game where she has a 60 percent chance of winning $1 and a 40 percent chance of losing $1 common sense
Kathleen is considering expanding her dress shop. If interest rates rise she is a. less likely to expand. This illustrates why the supply of loanable funds slopes downward. b. more likely to expand. This illustrates why the supply of loanable funds slopes upward. c. less likely to expand. This illustrates why the demand for loanable funds slopes downward. d. more likely to expand. This illustrates why the demand for loanable funds slopes upward.
c. less likely to expand. This illustrates why the demand for loanable funds slopes downward. REMEMBER - if interest rates rise demand goes downnnn
A larger budget deficit a. raises the interest rate and investment. b. reduces the interest rate and investment. c. raises the interest rate and reduces investment. d. reduces the interest rate and raises investment.
c. raises the interest rate and reduces investment.
Yoyo's Frozen Yogurt, Inc. is thinking of building a new warehouse. They believe that this will give them $50,000 of additional revenue at the end of one year, $60,000 additional revenue at the end of two years, and $70,000 in additional revenue at the end of three years. If the interest rate is 5 percent, Yoyo would be willing to pay a.$140,000, but not $150,000. b.$150,000, but not $160,000. c.$160,000, but not $170,000. d.$170,000, but not $180,000.
c.$160,000, but not $170,000.
Greg's Tasty Ice Cream is considering building a new ice cream factory that costs $8.3 million. The company accountants believe that, not accounting for interest costs, building the factory will increase profits by $5 million the first year, $4 million the second year and have no value thereafter. Greg's Tasty Ice Cream should build the factory if the interest rate is a.3% but not if it is 4%. b.4% but not if it is 5%. c.5% but not if it is 6%. d.6% but not if it is 7%.
c.5% but not if it is 6%.
Which of the following methods of picking stocks is not consistent with fundamental analysis? a.doing research such as thoroughly reading and analyzing companies' annual reports b.choosing mutual funds that are managed by individuals with good reputations c.viewing individual stock prices as unpredictable d.relying upon the advice of Wall Street analysts
c.viewing individual stock prices as unpredictable
The primary economic function of the financial system is to a. keep interest rates low. b. provide expert advice to savers and investors. c. match one person's consumption expenditures with another person's capital expenditures. d. match one person's saving with another person's investment.
d. match one person's saving with another person's investment.
A judge requires Harry to make a payment to Sally. The judge says that Harry can pay her either $10,000 today or $11,000 two years from today. Of the following interest rates, which is the lowest one at which Harry would be better off paying $11,000 two years from today? a.2 percent b.3 percent c.4 percent d.5 percent
d.5 percent 0.05+1^2 / 11000
You put $75 in the bank one year ago and forgot about it. The bank sends you a notice that you now have $81 in your account. What interest rate did you earn? a.5 percent b.6 percent c.7 percent d.8 percent
d.8 percent lets do the math A = P + I = P + (Prt), and finally A = P(1 + rt)
The position and/or slope of the Supply curve are influenced by a.the level of public saving. b.the level of national saving. c.decisions made by people who have extra income they want to save and lend out. d.All of the above are correct.
d.All of the above are correct.
Two years ago Lenny put some money into an account. He earned 6 percent interest on this account and now he has about $1,000. About how much did Lenny deposit into his account two years ago? a.about $860 b.about $870 c.about $880 d.about $890
d.about $890 lets do the math $ / (1 + r)^n 1000/(1+0.06)^2 = 889.8
The possibility of speculative bubbles in the stock market arises in part because a.stock prices may not depend at all on psychological factors. b.fundamental analysis may be the correct way to evaluate the value of stocks. c.future streams of dividend payments are very hard to estimate. d.the value of shares of stock depends not only on the future stream of dividend payments but also on the price at which the stock will be sold.
d.the value of shares of stock depends not only on the future stream of dividend payments but also on the price at which the stock will be sold.
General formula for discounting:
r, interest rate X, amount to be received in N years (future value) Present value = X / (1+r)N
Supply =
savings
Compounding
the accumulation of a sum of money in, say, a bank account, where the interest earned remains in the account to earn additional interest in the future to remember - compounding, adding more.
The financial System
the group of institutions that matches the savings of on person with the investment of another
Supply moves upward when
the investment rate is higher
Efficient markets hypothesis
the theory that asset prices reflect all publicly available information about the value of an asset