1.Most Financial Decisions Involve Two Related Elements

1.Most financial decisions involve two related elements:

a. / advice and consent.
b. / investment and taxes.
c. / time and risk.
d. / saving and consumption.

2.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.

3.The field of finance primarily studies

4.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.

5.If the interest rate is 4 percent, then you would be equally happy if you received a gift of either $100 today or a gift of

a. / $110.00 two years from today.
b. / $112.49 three years from today.
c. / $116.00 four years from today.
d. / $123.67 five years from today.

6.Imagine that someone offers you $X today or $1,500 in 5 years. If the interest rate is 4 percent, then you would prefer to take the $X today if and only if

a. / X > 1,055.56.
b. / X > 1,120.89.
c. / X > 1,232.89.
d. / X > 1,338.26.

7.One way to characterize the difference between compounding and discounting is to say that

a. / compounding involves the assumption that the interest rate is zero, whereas discounting does not involve that assumption.
b. / discounting involves the assumption that the interest rate is zero, whereas compounding does not involve that assumption.
c. / the process of compounding produces a future value, whereas the process of discounting produces a present value.
d. / the process of compounding produces a present value, whereas the process of discounting produces a future value.

8.A manufacturing company is thinking about building a new factory. The factory, if built, will yield the company $300 million in 7 years, and it would cost $220 million today to build. The company will decide to build the factory if the interest rate is

a. / no less than 4.53 percent.
b. / no greater than 4.53 percent.
c. / no less than 5.81 percent.
d. / no greater than 5.81 percent.

9.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.

10.What is the future value of $450 at an interest rate of 9 percent two years from today?

a. / $534.65
b. / $546.35
c. / $565.18
d. / $574.13

11.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

12.At an annual interest rate of 10 percent, about how many years will it take $100 to triple in value?

a. / 8
b. / 10
c. / 12
d. / 14

13.You put $150 in the bank two years ago and forgot about it. The bank sends you a notice that you now have $169.34 in your account. What interest rate did you earn?

a. / 5.50 percent
b. / 5.65 percent
c. / 6.25 percent
d. / 7.05 percent

14.Braden says that $400 saved for one year at 4 percent interest has a smaller future value than $400 saved for two years at 2 percent interest. Lefty says that the present value of $400 to be received one year from today if the interest rate is 4 percent exceeds the present value of $400 to be received two years from today if the interest rate is 2 percent.

a. / Braden and Lefty are both correct.
b. / Braden and Lefty are both incorrect.
c. / Only Braden is correct.
d. / Only Lefty is correct.

15.Anna deposited $10,000 into an account three years ago. The first year she earned 12 percent interest, the second year she earned 8 percent interest, and the third year she earned 4 percent interest. How much money does she have in her account today?

a. / $12,579.84
b. / $12,596.80
c. / $12,597.12
d. / None of the above are correct to the nearest cent.

16.The price of a bond is equal to the sum of the present values of its future payments. Suppose a certain bond pays $50 one year from today and $1,050 two years from today. What is the price of the bond if the interest rate is 5 percent?

a. / $1,050.00
b. / $1,045.35
c. / $1,000.00
d. / $945.35

17.Zoey wants to have about $750,000 when she retires in 10 years. She has $300,000 to deposit now. At which of the following interest rates would Zoey’s deposit come closest to $750,000 after 10 years?

a. / 9.6 percent
b. / 9.9 percent
c. / 10.2 percent
d. / 10.5 percent

18.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.

19.Diminishing marginal utility of wealth implies that the utility function

a. / has increasing slope and a person is risk averse.
b. / has increasing slope and a person is not risk averse.
c. / has decreasing slope and a person is risk averse
d. / has decreasing slope and a person is not risk averse.
Figure 27-2. The figure shows a utility function for Britney.

20.Refer to Figure 27-2. From the appearance of the utility function, we know that
a. / Britney is risk averse.
b. / Britney gains less satisfaction when her wealth increases by X dollars than she loses in satisfaction when her wealth decreases by X dollars.
c. / the property of diminishing marginal utility applies to Britney.
d. / All of the above are correct.
21.Refer to Figure 27-2. From the appearance of the utility function, we know that
a. / Britney is risk averse.
b. / Britney gains more satisfaction when her wealth increases by X dollars than she loses in satisfaction when her wealth decreases by X dollars.
c. / the property of increasing marginal utility applies to Britney.
d. / All of the above are correct.
22.Refer to Figure 27-2. Suppose the vertical distance between the points (0, A) and (0, B) is 5. If her wealth increased from $1,050 to $1,350, then
a. / Britney’s subjective measure of her well-being would increase by less than 5 units.
b. / Britney’s subjective measure of her well-being would increase by more than 5 units.
c. / Britney would change from being a risk-averse person into a person who is not risk averse.
d. / Britney would change from being a person who is not risk averse into a risk-averse person.
23.Refer to Figure 27-2. From the appearance of the utility function, we know that
a. / if Britney owns a house, she would not consider buying fire insurance.
b. / Britney would prefer to hold a portfolio of stocks with an average return of 8 percent and a standard deviation of 2 percent to a portfolio of stocks with an average return of 8 percent and a standard deviation of 5 percent.
c. / Britney would prefer to hold a portfolio of stocks with an average return of 8 percent and a standard deviation of 5 percent to a portfolio of stocks with an average return of 6 percent and a standard deviation of 3 percent.
d. / All of the above are correct.
24.Refer to Figure 27-2. Suppose Britney begins with $1,050 in wealth. Starting from there,
a. / she would be willing to accept a coin-flip bet that would result in her winning $300 if the result was “heads” or losing $300 if the result was “tails.”
b. / the pain of losing $300 of her wealth would equal the pleasure of adding $300 to her wealth.
c. / the pain of losing $300 of her wealth would exceed the pleasure of adding $300 to her wealth.
d. / the pleasure of adding $300 to her wealth would exceed the pain of losing $300 of her wealth.
25.Refer to Figure 27-2. Suppose Britney begins with $1,050 in wealth. Which of the following coin-flip bets would she definitely not be willing to accept?
a. / If it is “heads,” she wins $100; if it is tails, she loses $95.
b. / If it is “heads,” she wins $150; if it is tails, she loses $150.
c. / If it is “heads,” she wins $150; if it is tails, she loses $140.
d. / She definitely would not accept any of these bets.
26.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.
27.The problem of moral hazard arises because
a. / life is full of all sorts of risks.
b. / after people buy insurance, they have less incentive to be careful about their risky behavior.
c. / a high-risk person is more likely to apply for insurance than is a low-risk person.
d. / insurance companies go to great effort to avoid paying claims to their policy holders.
28.As the number of stocks in a person’s portfolio increases,
a. / the risk of the portfolio increases, as indicated by the increasing value of the standard deviation of the portfolio.
b. / the risk of the portfolio increases, as indicated by the decreasing value of the standard deviation of the portfolio.
c. / the risk of the portfolio decreases, as indicated by the increasing value of the standard deviation of the portfolio.
d. / the risk of the portfolio decreases, as indicated by the decreasing value of the standard deviation of the portfolio.
29.The largest reduction in a portfolio’s risk is achieved when the number of stocks in the portfolio is increased from
a. / 80 to 100.
b. / 40 to 80.
c. / 10 to 20.
d. / 1 to 10.
30.Risk
a. / can be reduced by placing a large number of small bets rather than a small number of large bets.
b. / can be reduced by increasing the number of stocks in a portfolio.
c. / Both A and B are correct.
d. / Neither A nor B are correct.
31.Which of the following defines an annuity?
a. / For a fee, an insurance company provides you with regular income until you die.
b. / A surcharge is added to life-insurance premiums paid by persons in dangerous occupations.
c. / Annuity is another name for stock funds managed by mutual fund managers.
d. / Annuity is another name for any diversified portfolio.
32.In effect, an annuity provides insurance
a. / against the risk of dying and leaving one’s family without a regular income.
b. / against the risk of living too long.
c. / to people who are not risk-averse.
d. / to people whose utility functions do not display the usual properties.
33.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.
34.Chloe talked to several stockbrokers and made the following conclusions. Which, if any, of Chloe’s conclusions are correct?
a. / It is relatively easy to reduce firm-specific risk by increasing the number of companies one holds stock in.
b. / Stock prices, even if not exactly a random walk, are very close to it.
c. / Some people have made a lot of money in the stock market by using insider information, but these cases are not contrary to the efficient markets hypothesis.
d. / All of Chloe’s conclusions are correct.
35.Which of the following is a source of market risk?
a. / Holding stocks in many companies carries the risk of a reduced average return.
b. / Real GDP varies over time and sales and profits move with real GDP.
c. / When a paper producer has declining sales, it is likely that so will other paper producers.
d. / If stockholders become aggravated with the way a CEO runs a company, the price of that company’s stock might fall in the stock market.
36.Samantha holds stocks in four companies. If she adds stocks of several more companies she will decrease
a. / firm specific risk and market risk.
b. / firm specific risk but not market risk.
c. / market risk but not firm specific risk.
d. / neither firm specific nor market risk.
37.When a person engages in detailed analysis of a company to determine its value, he or she is engaging in
a. / standard deviation analysis.
b. / informational analysis.
c. / fundamental analysis.
d. / efficiency analysis.
38.Which of the following is correct concerning diversification?
a. / It only reduces firm-specific risk, but most of the reduction comes from increasing the number of stocks in a portfolio to well above 30.
b. / It only reduces firm-specific risk; much of the reduction comes from increasing the number of stocks in a portfolio from 1 to 30.
c. / It only reduces market risk, but most of the reduction comes from increasing the number of stocks in a portfolio to well above 30.
d. / None of the above is correct.
39.Fundamental analysis is
a. / the study of the relation between risk and return of stock portfolios.
b. / the determination of the allocation of savings between stocks and bonds based on a person’s degree of risk aversion.
c. / the study of a company’s accounting statements and future prospects to determine its value.
d. / a method used to determine how adding stocks to a portfolio will change the risk of the portfolio.
40.Suppose that fundamental analysis indicates a particular company’s stock is overvalued.
a. / This means its present value is less than its price. You should consider adding the stock to your portfolio.
b. / This means its present value is less than its price. You shouldn’t consider adding the stock to your portfolio.
c. / This means its present value is more than its price. You should consider adding the stock to your portfolio.
d. / This means its present value is more than its price. You shouldn’t consider adding the stock to your portfolio.
41.If stock prices follow a random walk, it means
a. / long periods of declining prices are followed by long periods of rising prices.
b. / the greater the number of consecutive days of price declines, the greater the probability prices will increase the following day.
c. / stock prices are unrelated to random events that shock the economy.
d. / stock prices are just as likely to rise as to fall at any given time.
42.According to the efficient markets hypothesis, which of the following would increase the price of stock in the Simpson Corporation?
a. / Simpson announces, just as everyone had expected, that it has hired a new highly respected CEO.
b. / Simpson announces that its profits were low, but not as low as the market had expected.
c. / Analysis by a column in a business weekly indicates that Simpson is overvalued.
d. / All of the above would increase the price.
43.Fundamental analysis shows that Quadrangle Company is fairly valued. Then Quadrangle Company unexpectedly improves its production techniques and unexpectedly hires a new CEO away from another very successful competitor. Suppose this has no effect on the price of the stock of Quadrangle Company.
a. / Fundamental analysis would now show the corporation is overvalued. The fact that the price was unchanged is consistent with the efficient markets hypothesis.
b. / Fundamental analysis would now show the corporation is overvalued. The fact that the price was unchanged is not consistent with the efficient markets hypothesis.
c. / Fundamental analysis would now show the corporation is undervalued. The fact that the price was unchanged is consistent with the efficient markets hypothesis.
d. / Fundamental analysis would now show the corporation is undervalued. The fact that the price was unchanged is not consistent with the efficient markets hypothesis.
44.Whenever the price of an asset rises above what appears to be its fundamental value, the market is said to be experiencing a
a. / conjectural mistake.
b. / fundamental mishap.
c. / speculative bubble.
d. / temporary inefficiency.
45.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.
46.If asset markets are driven by the “animal spirits” of investors, then
a. / those markets reflect rational behavior.
b. / those markets reflect irrational behavior.
c. / the efficient markets hypothesis is correct.
d. / the stock market exhibits informational efficiency.
47.If more people think a corporation’s stock is overvalued than think it is undervalued then there is a
a. / surplus, so its price will rise.
b. / surplus, so its price will fall.
c. / shortage, so its price will rise.
d. / shortage, so its price will fall.
48.Writing in the Wall Street Journal in 2009, economist Jeremy Siegel argued that, in the years leading up to the financial crisis of 2008–2009,
a. / financial firms acted in too risky a fashion.
b. / the Federal Reserves’s efforts to rein in the risky behavior of certain financial firms were inadequate.
c. / falling house prices “crashed the banks and the economy.”
d. / All of the above are correct.
49.Stock market fluctuations
a. / often go hand in hand with fluctuations in the economy more broadly.
b. / rarely have anything to do with fluctuations in the economy more broadly.
c. / have few, if any, macroeconomic implications.
d. / are attributable to the widespread belief that the efficient markets hypothesis is correct.
50.Economists disagree as to whether
a. / the stock price of a company should reflect the company’s expected profitability.
b. / the basic tools of finance reflect valid ideas.
c. / stock prices reflect rational estimates of a company’s true worth.
d. / there is any relationship between stock market fluctuations and fluctuations in the economy more broadly.