ECO 029 Midterm 1
If you lend money at a 10% nominal interest rate, but you expect inflation to be 6% over the life of the loan, then you expect your purchasing power to grow at a rate of __________%. The real interest rate is negative when the nominal interest rate is _________ the inflation rate. If the nominal interest rate is 2% and the expected rate of inflation is 2%, then the real interest rate is A. 1%. B. −1%. C. 3%. D. 0%. E. 2%.
4 less than D
Assume you just deposited $1,200 into a bank account. The current real interest rate is 3%, and inflation is expected to be 5% over the next year. What nominal rate would you require from the bank over the next year? The required nominal rate would be ________%. How much money will you have at the end of one year? You will have $_______ at the end of the year. If you are saving to buy a fancy bicycle that currently sells for $1,250, will you have enough to buy it? A. No. With such a low real interest rate, you will not earn enough to purchase the bicycle. B. No. Because of expected inflation, the bicycle will cost $1,313; therefore, you will not have enough to buy it. C. Yes. Since the nominal rate is higher than the real interest rate, you will have enough money for the bicycle. D. Uncertain. It depends on whether the price of the bicycle increases with inflation.
8 1296 D
What is the yield to maturity on a 1-year, $1,000 discount bond with a current price of $920? Yield to maturity = __________ percent.
8.70
What is the opportunity cost of holding $1,500 in cash if the relevant interest rate is 6 percent? The opportunity cost is $________. If interest rates rise, this opportunity cost will _______, and individuals will hold _______ cash balances.
90 increase smaller
A financial adviser has just given you the following advice: "Long-term bonds are a great investment because their interest rate is over 20%." Is the financial adviser necessarily right? A. No. If interest rates rise sharply in the future, long-term bonds may suffer a sharp fall in price, causing their return to be quite low. B. Yes. If the interest rate remains unchanged until maturity, the price of the bond will be more than its face value. C. No. When making an investment decision, you should take the yield to maturity into account, not the interest rate. D. Yes. The higher the annual interest rate, the higher the annual income on bonds.
A
According to the Generalized Dividend Model, the final sales price of a stock depends on the following except the A. price of the stock in the last period. B. required return on investments in equity. C. dividend payments. D. number of periods.
A
Is it better for bondholders when the yield to maturity increases or decreases? Bondholders are better off when the yield to maturity: A. decreases, since this represents an increase in the price of the bond and a decrease in potential capital losses. B. increases, since this represents a decrease in the bond maturity and a decrease in potential capital losses. C. decreases, since this represents an increase in the coupon payment and an increase in potential capital gains. D. increases, since this represents a decrease in the price of the bond and an increase in potential capital gains.
A
What basic principle of finance can be applied to the valuation of any investment asset? A. Present value B. Price-earnings ratio C. Cash flow analysis D. Internal rate of return
A
What would happen to the demand for Rembrandt paintings if the stock market undergoes a boom? A. The demand for Rembrandt paintings would increase because of the increase in people's wealth B. The demand for Rembrandt paintings would increase because bond values would decline C. The demand for Rembrandt paintings would decrease because people would want to use their wealth for other things D. The demand for Rembrandt paintings would increase because people would want to hold more stocks
A
When interest rates decrease, how might businesses and consumers change their economic behavior? A. There will be more consumption spending on interest-sensitive items and more investment by businesses. B. Consumers and businesses will hold smaller (average) cash balances. C. Consumers and businesses will spend less and save more. D. Consumers and businesses will invest in bonds or similar debt instruments.
A
Would fiscal policy makers ever have reason to worry about potentially inflationary conditions? A. Yes, higher inflation leads to a higher debt service burden and increases the costs of financing deficit spending. B. No, fiscal policy makers have enough policy instruments available to them to stave off or contain inflation. C. No, policy makers view potential inflation as a positive for the economy, as it increases demand on the most liquid assets such as Treasury bonds. D. Yes, if people expect higher potential inflation, it increases spending and causes M1 and M2 to increase too rapidly.
A
'Forecasters' predictions of inflation are notoriously inaccurate, so their expectations of inflation cannot be rational.' This statement is: A. false, as expectations can be highly inaccurate and still be rational B. true, as optimal forecasts are not necessarily accurate C. false, as inaccurate forecasts are never rational D. true, as a forecast is optimal if it is the best possible forecast even if the forecast errors are large
A
If John, Jennifer, Arthur, and Lisa are the only prospective buyers of a stock, and they have the discount rates 11%, 15%, 7% and 12%, respectively, then the buyer who will be able to obtain the stock is _______.
Arthur
A share of Microsoft common stock is: A. a liability to the shareholder because it must be sold to realise a capital gain. B. an asset for its owner, which Microsoft shows as shareholder equity on its balance sheet. C. identical to a bond issued by Microsoft. D. an asset for Microsoft because it allows Microsoft to invest in capital equipment or other companies.
B
According to the Generalized Dividend Model, the final sales price of a stock depends on the following except the A. dividend payments. B. price of the stock in the last period. C. number of periods. D. required return on investments in equity.
B
Can a person with rational expectations, given new information about the search technology industry, expect the price of a share of Google to rise by 10% in the next month? A. Yes, but only if Google is paying dividends to its stockholders. B. Yes, if this information is such that expectations of growth prospects or desired yields justify such a change. C. No, 10% per month is more than 100% per year. This growth rate in stock prices is unrealistic with any available information. D. No, such a dramatic change in stock price would present significant opportunities for profit—opportunities that would have already been realized.
B
"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. False because by diversifying or hedging your portfolio, it is possible to avoid risks and increase your expected return. B. True because for a risk-averse person, those characteristics make a security less desirable. C. Uncertain because there may be other crucial characteristics to consider when purchasing a security.
B
John values ABC stock at $10 per share. Susan values it at $15 per share, and Bill values it at $20 per share. In a free-market auction, the individual who ends up buying the item is ________.
Bill
An expectation may fail to be rational if A. information changes after the forecast is made. B. information was available to insiders only. C. relevant information is available but ignored at the time the forecast is made. D. relevant information was not available at the time the forecast is made.
C
Which of the following statements about rational expectations is not true? A. Rational expectations may not be accurate. B. Rational expectations are different from adaptive expectations. C. Rational expectations theory suggests that forecasts errors of expectations are sizable and can be predicted. D. Rational expectations are identical to optimal forecasts. Suppose that the average growth rate of the economy has been 4%. Given a forecast of 5% growth this year, if rational expectations hold, then the expected forecast error is _________%. The efficient market hypothesis is an application of the theory of ____________.
C 0 rational expectations
If expectations are formed adaptively, then people A. use more information than just past data on a single variable to form their expectations of that variable. B. often change their expectations quickly when faced with new information. C. never change their expectations once they have been made. D. use only the information from past data on a single variable to form their expectations of that variable.
D
Milton Friedman called the response of lower interest rates resulting from an increase in the money supply the ________ effect. A. expected−inflation B. income C. price level D. liquidity
D
Which of the following bonds would you prefer to be buying? A. A $10,000 face−value security with a 10 percent coupon selling for $10,000 B. A $10,000 face−value security with a 9 percent coupon selling for $10,000 C. A $10,000 face−value security with a 7 percent coupon selling for $10,000 D. A $10,000 face−value security with a 10 percent coupon selling for $9,000
D
Why are financial markets important to the health of the economy? A. They allow consumers to time their purchases better B. They eliminate the need for financial intermediaries C. They identify and shut down inefficient firms D. They channel funds from savers to investors
D
If you lend money at a 8% nominal interest rate, but you expect inflation to be 5% over the life of the loan, then you expect your purchasing power to grow at a rate of 3%. The real interest rate is negative when the nominal interest rate is _________ the inflation rate. If the nominal interest rate is 3% and the expected rate of inflation is 2%, then the real interest rate is A. 3%. B. 2%. C. 0%. D. -1%. E. 1%.
E
These long-term bonds are issued by corporations with very strong credit ratings.
corporate bonds
If the nominal interest rate was originally 13% while the expected inflation rate was 12%, and then both changed to 7% and 1%, respectively, then the real interest rate ____________. The interest rate that is adjusted for actual changes in the price level is called the _________.
increased ex-post real interest rate
As a bank, you make a loan to an individual seeking funds to open a coffee shop. When the loan is made, the borrower uses the funds to take a vacation to Greenland. This is an example of a __________.
moral hazard
Explain why you would be more or less willing to buy gold under the following circumstances: You would be _______ willing to buy gold if gold again becomes acceptable as a medium of exchange because__________. You would be ______ willing to buy gold if prices in the gold market become more volatile because ______. You would be ______ willing to buy gold if you expect inflation to rise, and gold prices tend to move with the aggregate price level because ________ . You would be _______ willing to buy gold if you expect interest rates to rise because _______.
more;gold has become relatively more liquid less;gold has become relatively more risky more; the value of gold will offset the rising prices to keep your real value the same more; now gold has a better expected return than bonds
'Anytime it is snowing when Joe Commuter gets up in the morning, he misjudges how long it will take him to drive to work. When it is not snowing, his expectations of the driving time are perfectly accurate. Considering that it snows only once every ten years where Joe lives, Joe's expectations are almost always perfectly accurate.' This statement is _______ because Joe's expectations could still be improved by accounting for a snowfall in his forecasts.
not rational
The interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a liquidity premium (also referred to as a term premium) that responds to supply and demand conditions for that bond.
preferred habitat
If the yield curve suddenly becomes steeper, how would you revise your predictions of interest rates in the future? You would _______ your predictions of future interest rates.
raise
The interest rate for each bond with a different maturity is determined by the supply of and demand for that bond, with no effects from expected returns on other bonds with other maturities.
segmented markets
If the interest rate is 10%, what is the present value of a security that pays you $1,150 next year, $1,230 the year after, and $1,335 the year after that? Present value is $_________.
$3,064.99
What is the present value of $400 to be paid in one year if the interest rate is 20%? PV = $_________
$333.33
What is the opportunity cost of holding $500 in cash if the relevant interest rate is 3 percent? The opportunity cost is $ _______. If interest rates rise, this opportunity cost will ________, and individuals will hold _______ cash balances.
15 increase smaller
Compute the price of a share of stock that pays a $2.00 per year dividend and that you expect to be able to sell in one year for $20, assuming you require a 10% return. The price of the share is $______.
20
After careful analysis, you have determined that a firm's dividends should grow at 5%, on average, in the foreseeable future. The firm's last dividend was $2.00. Compute the current price of this stock, assuming the required return is 10%. The current stock price is $_______.
42.00
If you borrow $200 from a friend and in 3 years that friend wants $250 back from you, what is the yield to maturity in the loan? Yield to maturity = ________ percent
7.72
If a forecast is made using all available information, then economists say that the expectation formation is A. rational. B. irrational. C. reasonable. D. adaptive.
A
If a $5,000 face−value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A. 0 percent. B. 5 percent. C. 10 percent. D. 20 percent.
A
In asset markets, an asset's price is A. set by the buyer willing to pay the highest price. B. set equal to the lowest price a seller is willing to accept. C. set equal to the highest price a seller will accept. D. set equal to the highest price a buyer is willing to pay.
A
In Keynes's liquidity preference framework, individuals are assumed to hold their wealth in two forms: A. money and bonds. B. real assets and financial assets. C. money and gold. D. stocks and bonds.
A
One of the factors contributing to the financial crisis of 2007-2009 was the widespread issuance of subprime mortgages. How does this demonstrate adverse selection? A. Lenders loaned money to a pool of potential homeowners with the highest credit risk and lowest net wealth. B. Financial intermediaries provided funds to potential homeowners under strict conditions. C. Potential homeowners borrowed funds for high-yield, high-risk investments instead of mortgages. D. Lenders consciously loaned money to the riskiest homeowners with the highest interest rates to increase their profits.
A
Suppose that a certain stock is being sold for $80. If the expected dividend for next period is $3 and the rate of growth of the dividend is 2%, then the required rate of return on equity investments of the buyer of the stock is equal to ________%. The following are associated with an increase in the required rate of return on the equity investment except A. an increase in the current price of the stock. B. an increase in the dividend paid. C. a one-time increase in the constant growth rate. D. a decrease in the current price of the stock.
A
Which of the following is true regarding the pricing of assets? A. Other things being the same, the price is set by buyers with the most amount of information regarding the stock. B. The price is set by the buyer who can least take advantage of the asset. C. The price is set by the buyer willing to pay the lowest price. D. Those with the most wealth pay the highest price for assets.
A
If the demand for bonds shifts to the left, the price of bonds A. decreases, and interest rates rise. B. increases, and interest rates fall. C. decreases, and interest rates fall. D. increases, and interest rates rise. If the supply of bonds shifts to the left, the price of bonds ________, and the interest rate ________. When the wealth of individuals increases, A. both the price of bonds and interest rates increase. B. both the price of bonds and interest rates decrease. C. the price of bonds increases while the interest rates decrease. D. the price of bonds decreases while the interest rates increase.
A increases decreases C
These long-term bonds are issued by institutions such as Ginnie Mae, the Federal Farm Credit Bank, and the TVA. Many of these securities are guaranteed by the federal government.
Agency Securities
Everything else held constant, when real estate prices are expected to decrease A. the demand curve for bonds shifts to the left and the interest rate rises. B. the demand curve for bonds shifts to the right and the interest rate falls. C. the demand curve for bonds shifts to the left and the interest rate falls. D. the supply curve for bonds shifts to the right and the interest rate falls.
B
If a company called Advanced Technologies has yet to pay a dividend on its stock, the generalized dividend model predicts that the company's stock may still have value because A. all companies are legally required to pay dividends within ten years of the initial public offering of stock. B. people expect Advanced Technologies to pay dividends in the future. C. all companies that have any physical assets have value. D. the required return on investment for high technology companies is zero.
B
In the fall of 2008, AIG, the largest insurance company in the world at the time, was at risk of defaulting due to the severity of the global financial crisis. As a result, the U.S. government stepped in to support AIG with large capital injections and an ownership stake. How would this affect, if at all, the yield and risk premium on AIG corporate debt? A. The yield will rise and attract investors; however, as demand for AIG corporate debt rises, the risk premium will fall. B. The yield and risk premium will fall since demand for AIG corporate debt will increase. C. The yield and risk premium will not change as normal operations will resume at AIG after the government bailout. D. The yield and risk premium will continue to rise due to expectations of potential default.
B
The bond supply curve is ________ sloping, indicating a(n) ________ relationship between the price and quantity supplied of bonds everything else equal. A. downward; inverse B. upward; direct C. downward; direct D. upward; inverse
B
To pay for college, you have just taken out a $1,000 government loan that makes you pay $126 per year for 25 years. However, you don't have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than 12% (this is the yield to maturity on a normal $1,000 fixed-payment loan in which you pay $126 per year for 25 years)? A. This is the case because the loan has a government guarantee. B. This is the case because the first payment due begins at a future date. C. This is the case because of the known effects of inflation. D. This is the case because market interest rates are less than 12%.
B
Economists have focused more attention on the formation of expectations in recent years. This increase in interest can probably best be explained by the recognition that A. models that ignore expectations have little predictive power, even in the short run. B. expectations influence many individuals, have little impact on the overall economy, but can have distributional effects. C. expectations influence the behavior of participants in the economy and thus have a major impact on economic activity. D. expectations influence only a few individuals, have little impact on the overall economy, but can have important effects on a few markets.
C
Everything else held constant, when the government has higher budget deficits A. the demand curve for bonds shifts to the left and the interest rate rises. B. the supply curve for bonds shifts to the right and the interest rate falls. C. the supply curve for bonds shifts to the right and the interest rate rises. D. the demand curve for bonds shifts to the left and the interest rate falls.
C
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 decrease because investors are now aware of stock prices and won't overpay. B. Stock prices will remain unchanged, as increased transparency will not affect investment decisions. 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
Retired persons often have much of their wealth placed in savings accounts and other interest-bearing investments, and complain whenever interest rates are low. Which of the following, if true, would be a valid complaint? A. There has not been significant growth of nominal interest rates for the last 5 years. B. Expected inflation is falling at the same rate as nominal interest rates. C. Expected inflation is falling at a slower rate than nominal interest rates. D. Nominal interest rates decrease, while there is a slight increase in real interest rates.
C
The bond supply curve is ________ sloping, indicating a(n) ________ relationship between the price and quantity supplied of bonds everything else equal. A. downward; inverse B. downward; direct C. upward; direct D. upward; inverse
C
The opportunity cost of holding money is A. the level of income. B. the discount rate. C. the interest rate. D. the price level.
C
Financial markets improve economic welfare because: A. they channel funds from savers to investors B. they allow consumers to time their purchases better C. they eliminate the need for financial intermediaries D. both A and B are correct E. all of the above are correct
D
How might a sudden increase in people's expectations of future real estate prices affect interest rates? A. Interest rates would decrease because real estate would have a relatively lower rate of return compared to bonds, which would cause the demand for bonds to increase. B. Interest rates would increase because real estate would have a relatively lower rate of return compared to bonds, which would cause the demand for bonds to increase. C. Interest rates would decrease because real estate would have a relatively higher rate of return compared to bonds, which would cause the demand for bonds to decrease. D. Interest rates would increase because real estate would have a relatively higher rate of return compared to bonds, which would cause the demand for bonds to decrease.
D
If a company called Advanced Technologies has yet to pay a dividend on its stock, the generalized dividend model predicts that the company's stock may still have value because A. the required return on investment for high technology companies is zero. B. all companies that have any physical assets have value. C. all companies are legally required to pay dividends within ten years of the initial public offering of stock. D. people expect Advanced Technologies to pay dividends in the future.
D
These long-term debt instruments are issued by the U.S. Treasury to finance the deficits of the federal government.
Government security
Would you be more or less willing to buy a share of Microsoft stock in the following situations: Your wealth falls. ________ You expect the stock to appreciate in value. ______ The bond market becomes more liquid. _______ You expect gold to appreciate in value. _______ Prices in the bond market become more volatile. ____
Less willing More willing Less willing Less willing More willing
If you suspect that an airline will go bankrupt next week, which would you rather hold, bonds issued by the company, or equities issued by the company? You would prefer to hold _______.
bonds
What will happen to interest rates on a corporation's bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future? Interest rates on corporate bonds will _______.
decrease
The interest rate on a long-term bond will equal an average of the short-term interest rates that people expect to occur over the life of the long-term bond.
expectations theory
These are loans to households or firms to purchase housing, land, or other real structures, where the structure or land itself serves as collateral for the loans.
mortgages
Suppose the interest rates on one-, five-, and ten-year U.S. Treasury bonds are currently 3%, 6%, and 6%, respectively. Investor A chooses to hold only one-year bonds, and Investor B is indifferent with regard to holding five- and ten-year bonds. Which theories best explain the behavior of Investors A and B? Investor A's preferences are best explained by the _________ theory, while Investor B's are best explained by the ______ theory.
segmented markets expectations
These are equity claims on the net income and assets of a corporation.
stocks