Deck 40: Social Security

Question 1

Explain why a stock market must exist for the re-sale of stock first issued many years ago for newly issued stock (an IPO) to garner significant interest among investors.

Answer 1

There is a quintessential feature of the stock market that it provides liquidity to those shares of stocks also that were previously issued. IPOs only have value when their owners have a prior information that they can sell them any time if they wish to convert their investments into cash. Without such a market for previously issued securities, it would be overly costly to issue new ones.

Question 2

Stock market crashes tend to result when stocks get _____ their fundamental values.

A) too far below
B) too close to
C) too far above
D) confused with

Answer 2

The objective is to understand the stock market crash.
Note that the term "stock market crash" is used when the value of the stocks gets way too lower than their fundamental values as in that situation, no one would be ready to buy it. That rapid action of the stock holders to sell their stocks in such situation causes the stocks to crash at the lowest level. Thus we can say that is the correct answer.

Question 3

Explain how the "bubble" process, in which expectations get way out in front of reality on the upside, can be duplicated on the downside, causing a stock to fall below a reasonable level.

Answer 3

A bubble is the state of a market where the current price is far above its face value as determined by the fundamentals. Just as the bubble makes the stock price rise substantially, it can bring the prices down heavily causing a vicious cycle of downfall.
Whenever a bubble bursts with the fall in the prices of stocks, it indicates that they will be worth less next year. In an anticipation of losing money, investors start selling their stocks and this bring the prices of stocks further down. This the vicious circle that spirals the value of stocks down happening swiftly.

Question 4

A stock market exists

A) only to service the sale of new issues, called IPOs.
B) to provide liquidity to all stocks, including recent IPOs.
C) to help policy makers predict the future.
D) to make the rich richer.

Question 5

The principal-agent problem centers on the separation of

A) supply and demand.
B) investors and savers.
C) owners and managers.
D) interest and dividends.

Question 6

The fundamental value of a share of stock is based on the present value of expected future

A) dividends.
B) revenues.
C) profits.
D) costs.

Question 7

Explain why the announcement of higher interest rate targets by the Federal Reserve (if they were at least somewhat of a surprise) would likely result in lower stock prices.

Question 8

A stock index is

A) essentially the weighted sum of stock prices.
B) the simple sum of stock prices.
C) the geometric average of stock prices.
D) the consensus view of professional economists.

Question 9

Explain why, if a company's profits are growing at rates greater than the current interest rates and have been expected to continue doing so for several more years, a stock price can greatly exceed what might otherwise seem reasonable for the sum of the assets of that company.

Question 10

If you invested in 20 different companies and chose those companies at random, you would be counting on the _____ market hypothesis and its implication that you would do as well as you would with any other investment strategy.

A) random
B) complete
C) stock
D) efficient