Deck 7: Market Efficiency and the Flow of Funds Among Sectors

Question 1

The _________________________ holds that the prices of all financial instruments reflect the true fundamental value of the instruments.

A)efficient markets hypothesis
B)stronger version of the efficient markets hypothesis
C)weak version of the efficient markets hypothesis
D)rational expectations theory

Answer 1

B

Question 2

The _________________________ holds that the prices of all financial instruments are based on the optimal forecast arrived at by using all available information.

A)efficient markets hypothesis
B)stronger version of the efficient markets hypothesis
C)weak version of the efficient markets hypothesis
D)rational expectations theory

Answer 2

A

Question 3

The difference between the efficient markets hypothesis and the stronger version of the efficient markets hypothesis is that

A)although both theories hold that financial prices are equal to optimal forecasts, the stronger version holds that the optimal forecast is also the fundamental value of the financial instrument.
B)the efficient markets hypothesis uses adaptive expectations while the stronger version uses rational expectations.
C)according to the efficient markets hypothesis, prices are equal to optimal values only in equilibrium, while according to the stronger version, prices are always equal to optimal values.
D)according to the efficient markets hypothesis, prices are always equal to optimal values, while according to the stronger version, prices are equal to optimal values only when markets are in equilibrium.

Answer 3

A

Question 4

The expected return on a share of stock, say, over a year, is

A)the interest rate plus the inflation rate.
B)the expected dividend plus the expected change in the price of the stock, all divided by the share price at the time of purchase.
C)the interest rate minus the inflation rate.
D)Two of these answers are correct.

Question 5

The expected return to a newly-issued bond is

A)the current interest rate.
B)the current inflation rate.
C)the dividend rate divided by the interest rate.
D)the dividend rate.

Question 6

The face value of the bond multiplied by the coupon rate is

A)the rate of inflation less the nominal interest rate.
B)the coupon payment.
C)the rate of interest.
D)the federal funds rate.

Question 7

The expected return on previously-issued bonds is the coupon rate plus the expected percentage change in the ________ over the course of the year.

A)inflation rate
B)federal funds rate
C)bond's price
D)interest rate

Question 8

As long as returns among various financial instruments are not perfectly correlated, diversification _______ risk for any given expected return.

A)increases
B)reduces
C)has no impact on
D)indifferently affects

Question 9

Adaptive expectations are formed by looking at

A)the average changes of a variable.
B)changes in all substitute variables.
C)both past and expected future values of a variable.
D)past values of a variable.

Question 10

Rational expectations are formed by looking at

A)the average changes of a variable.
B)changes in all substitute variables.
C)both past values and at all currently available information about the economy.
D)past values of a variable.

Question 11

Which of the following are implications of rational expectations?

A)As new information becomes available, market participants should adjust expectations accordingly.
B)Recent years are weighted more heavily than earlier years.
C)If there is a change in the way a variable moves, the way in which expectations of the variable formed will also change
D)both a and c are correct.

Question 12

The optimal forecast is

A)the best guess possible arrived at by using the smallest amount of information possible.
B)the best guess possible arrived at by using adaptive expectations.
C)the best guess possible arrived at by using all the information available.
D)the worst guess possible arrived at by using all the information available.

Question 13

The efficient market hypothesis states that when financial markets are in equilibrium

A)the prices of financial instruments reflect all readily available information.
B)the economy will eventually reach its steady state, long run, equilibrium.
C)the future markets will become more efficient than in previous years.
D)all financial instruments have the same amount of risk.

Question 14

The stronger version of the efficient markets hypothesis states that

A)the prices of all financial instruments reflect only the optimal forecast of the financial instrument.
B)the prices of all financial instruments reflect not only the optimal forecast of the financial instrument but also the true fundamental value of the instrument.
C)many factors have a direct effect on future income streams of the financial instruments.
D)many factors have a direct effect on value of the assets and the expected income systems of those assets on which the financial instruments represent claims.

Question 15

Which of the following is false with regards to adaptive expectations?

A)Adaptive expectations is backward looking.
B)Adaptive expectations makes use of all available information.
C)Adaptive expectations are formed as a weighted average of past values.
D)Adaptive expectations may give more recent values a greater weight in forming expectations.

Question 16

The ________________ states that in equilibrium, prices of financial instruments reflect all available information.

A)efficient markets hypothesis
B)stronger version of the efficient markets hypothesis
C)fundamental value theory
D)rational expectation theory.

Question 17

Which of the following is false?

A)If information about a financial instrument is expected, then an announcement of the information will have little or no effect on the instrument's price.
B)An implication of the efficient markets hypothesis is that it is impossible to beat the market (earn an above average return).
C)When interest rates change, there is no effect on default risk and therefore risk premiums are unaffected.
D)Powerful mood swings of optimism or pessimism can sweep markets and become part of the changing information that affects prices.

Question 18

The allocation of surplus funds to a variety of financial instruments instead of holding just one asset is called

A)investment
B)diversification
C)hedging
D)saving

Question 19

A stock represents

A)credit risk by the issuer.
B)ownership of a part of the issuing firm.
C)debt of the issuer.
D)the yield to maturity.

Question 20

A bond represents

A)credit risk by the issuer.
B)ownership of part of the issuing firm.
C)debt of the issuer.
D)the yield to maturity.

Question 21

The size of a shareholder's ownership position depends on

A)the price of the stock only.
B)the liquidity of the stock.
C)the number of shares owned relative to the total number of shares outstanding.
D)the value the company declares the stock is worth.

Question 22

In general, as current and expected future earnings rise

A)the stock's price declines.
B)the stock's price also rises.
C)the stock's price remains constant.
D)there is no relationship between future earnings and stock prices.

Question 23

There is often a __________ correlation between the growth of current and stock prices.

A)positive.
B)negative.
C)inverse.
D)none of the above.

Question 24

If you pay $100 for a share of stock, and the expected dividend is $5 per share, and you expect the price to rise $10 over the year, the expected return is:

A)1 percent
B)5 percent
C)10 percent
D)15 percent

Question 25

If the face value of a bond is $500 and the coupon rate is 4 percent, then the coupon payment is

A)$20
B)$40
C)$60
D)$80

Question 26

Price expectations are related to all of the following except

A)expected changes in production costs.
B)possible unknown future government intervention in the economy.
C)expected changes in national income.
D)current and past prices.

Question 27

Adaptive expectations are formed by looking at

A)the average changes of a variable.
B)changes in all substitute variables.
C)both past and expected future values of a variable.
D)past values of a variable.

Question 28

What is the percentage return over time when the current price of the stock is $200, the price of the stock at the end of the time period is $250, and the dividend payment made during the time period is $15.

A)15.5 percent
B)32.5 percent
C)45.5 percent
D)53.5 percent

Question 29

If inflation had been 4 percent for four years, but then inflation increased to 8 percent in the past two years, given the adaptive expectations theory, expected inflation in the next year will be closer to

A)4 percent
B)6 percent
C)8 percent
D)10 percent

Question 30

A sector in which the combined deficits of the deficit spending units are greater than the combined surpluses of the surplus spending units is a

A)financial sector.
B)business sector.
C)surplus sector.
D)deficit sector.

Question 31

Which sector is not included in the flow of funds social accounting system

A)household sector
B)business sector
C)marketing sector
D)rest-of-the-world sector

Question 32

A sector in which the combined surpluses of the surplus spending units are greater than the combined deficits of the deficit spending units is a

A)financial sector.
B)business sector.
C)surplus sector.
D)deficit sector.

Question 33

Which statement best describes the uses of funds for any sector:

A)the combined surpluses of all spending units in the sector
B)the combined deficits of all deficit spending units in the sector
C)the income and borrowing of any sector
D)the current spending and changes in financial instruments held by any sector

Question 34

Which statement best describes the sources of funds for any sector:

A)the combined surpluses of all spending units in the sector
B)the combined deficits of all deficit spending units in the sector
C)the income and borrowing of the sector
D)the current spending and changes in financial instruments held by any sector

Question 35

_____________________ are factors that have a direct effect on future income streams of the instruments including the value of the assets and the expected income streams of those assets on which the financial instruments represent claims.

A)The efficient markets hypothesis
B)Market fundamentals
C)The flow of funds
D)The sources and uses of funds

Question 36

_______________assert(s) that when financial markets are in equilibrium, the prices of financial instruments reflect all readily available information.

A)The efficient markets hypothesis
B)Market fundamentals
C)The flow of funds
D)The sources and uses of funds

Question 37

In equilibrium, differences in rates of return on financial instruments are based on differences in

A)future expectations of interest rates.
B)liquidity and risk.
C)the stronger version of the efficient markets hypothesis.
D)future expectations about the economy.

Question 38

The __________________ states that in equilibrium, prices of financial instruments reflect the true fundamental value of the firm.

A)efficient markets hypothesis
B)stronger version of the efficient markets hypothesis
C)fundamental value theory
D)rational expectation theory.

Question 39

The efficient markets hypothesis is based on the ________________ theory.

A)rational expectations
B)adaptive expectations
C)fundamental value
D)optimal value theory

Question 40

The ______________ states that expectations of financial prices will be equal to optimal forecasts arrived at by using all available information.

A)adaptive expectations theory
B)rational expectations theory
C)fundamental value theory
D)optimal value theory

Question 41

If the price of a financial asset is $100 at the beginning of the period, $120 at the end of the period and a $5 dividend was paid, what was the percentage return?

A)20 percent
B)5 percent
C)25 percent
D)15 percent

Question 42

If the price of a financial asset is $100 at the beginning of the period, pays a $5 dividend, and earns a 10 percent return over the period, what is the price at the end of the period?

A)$110
B)$105
C)$115
D)$120

Question 43

If the price of a financial asset is $120 at the end of a period where no dividend was paid, what was the price at the beginning of the period if a 20 percent return was earned?

A)$140
B)$120
C)$100
D)It is impossible to know, given the information provided.

Question 44

Which of the following is false?

A)When interest rates change, some spending units that were net borrowers become net lenders and vice versa.
B)When interest rates changes, the surpluses and deficits within any sector can change so that a sector that was a surplus sector before the change can become a deficit sector and vice versa.
C)Changes in interest rates cause changes in the flow of funds among sectors.
D)Within any sector, the combined surpluses always equal the combined deficits.

Question 45

The _____________ is the best guess possible arrived at by using all of the available information.

A)fundamental value
B)rational value
C)optimal forecast
D)efficient value

Question 46

The ________________________hypothesizes that expectations will on average be equal to the optimal value.

A)theory of adaptive expectations
B)theory of rational expectations
C)optimal forecast theory
D)fundamental value theory

Question 47

Expectations formed by looking both forward and backward are

A)rational expectations.
B)optimal expectations.
C)adaptive expectations.
D)based on fundamental values.

Question 48

Which of the following is true?

A)Shareholders are entitled to be paid dividends before bondholders are paid interest.
B)The coupon payment is the current interest rate multiplied by the face value of the bond. It is irrelevant what the interest rate was at the time the bond was issued.
C)The coupon payment is the face value of the bond multiplied by the coupon rate.
D)When interest rates go up, bond prices also go up.

Question 49

Which of the following will causes prices of financial instruments to change?

A)current earnings
B)expected future earnings
C)Both a and b are correct.
D)None of the above is correct.

Question 50

A decrease in the expected future earnings of a stock

A)will have a positive impact on the stock's price.
B)will have a negative impact on the stock's current price.
C)will affect the stock's future price but not the current price.
D)will not affect the stock's price.

Question 51

Bonds represent

A)debt of the issuer.
B)debt of individual.
C)ownership of part of a firm.
D)ownership of part of a firm project.

Question 52

Dividends are

A)a firm's total profit.
B)a distribution of profits to stockholders.
C) both a and b.
D) total shares owned by a stockholder.

Question 53

There is a __________________ correlation between national expected future earnings and stock prices.

A)negative
B)lack of
C)positive
D)inverse

Question 54

The expected return on a stock is the expected _________________ plus the expected _______________ in the price of a stock, all divided by the ____________________price at the time of purchase.

A)dividend, stock, change
B)stock, change, dividend
C)stock, change, stock
D)dividend, change, stock

Question 55

If you pay $100 a share, the expected dividend is $9, and you expect the price to rise $4, the expected return is

A)130 percent.
B)8 percent.
C)4 percent.
D)13 percent.

Question 56

The expected percentage return on a bond is the _______________ plus the expected percentage change in the bond's price.

A)current interest rate
B)coupon rate
C)dividend
D)change in the interest rate

Question 57

Research suggests that all of the following are important in shaping the public's expectations of future prices, except

A)current and past prices.
B)expected changes in presidential terms.
C)expected changes in national income.
D)expected changes in production cost.

Question 58

Expectations formed by looking back at past values of a variable are

A)historic adaptations.
B)past-oriented adaptations.
C)rational expectations.
D)adaptive expectations.

Question 59

The theory of rational expectations is the theory that expectations will on average be equal to

A)optimal forecasts.
B)adaptive expectations.
C)market changes.
D)actual values.

Question 60

The optimal forecast is the best guess possible arrived at by using

A)past information.
B)all available information.
C)future expectations.
D)none of the above.

Question 61

An implication of rational expectations is that as new information becomes available market participants (the public) should adjust accordingly. But there is a _____________; the lag is believed to be _________________.

A)lag, lengthening
B)lag, shortening
C)understatement, lengthening
D)overstatement, shortening

Question 62

The efficient market hypothesis states that when markets are in _______________ the prices of financial instruments reflect all readily available information.

A)equilibrium
B)an inflationary cycle
C)disequilibrium
D)motion

Question 63

Financial markets are in equilibrium when the quantity demanded of any security is _________________ the quantity supplied of that security.

A)more than
B)less than
C)equal to
D)none of the above

Question 64

Which of the following is true?

A)In equilibrium, the risk-adjusted return to owning stock will be equal to the risk-adjusted return to owning bonds.
B)The risk-adjusted return to owning stock is the nominal return less compensation for the higher risk of owning stock.
C)In equilibrium, differences in returns on various financial instruments represent only differences in risk and liquidity.
D)All of the above are true.

Question 65

The rationale behind the efficient markets hypothesis is that the drive for profits ensures that

A)most unexploited opportunities will be exhausted.
B)all unexploited opportunities will be exhausted.
C)people use most available recent information.
D)people buy only valuable stocks and bonds.

Question 66

Market fundamentals are factors that have a

A)direct affect on future income streams of the financial instruments.
B)indirect affect on future income streams of the financial instruments.
C)negative influence on stock and bond prices.
D)major impact on bond prices but not on stock prices.

Question 67

The flow of funds is a social accounting system that divides the economy into a number of sectors. The sectors include all of the following, except the

A)household sector.
B)tax sector.
C)government sector.
D)financial sector.

Question 68

Sources of funds for any sector are

A)spending and accounting.
B)spending and taxing.
C)income and taxing.
D)income and borrowing.

Question 69

Uses of funds for any sector are

A)past spending on financial instruments.
B)current spending and changes in financial instruments held.
C)future spending plans.
D)future consumption plans.

Question 70

Which of the following is false?

A)Short term interest rates are determined by income, the money supply, and expected inflation.
B)Expected short term interest rates are determined by expected income, the expected money supply, and expected inflation.
C)Prices of financial instruments adjust so that the expected value of the forecast is equal to the optimal forecast given all the available information.
D)The expected return to owning stock is the dividend less any change in the price of the stock.

Question 71

Basing expectations on the past and giving more weight to the recent past is an example of which of the following?

A)rational expectations
B)adaptive expectations
C)illusional expectations
D)the expectations theory