Deck 6: The Stock Market, information, and Financial Market Efficiency

Question 1

The difference between a firm's assets and its liabilities is known as

A) limited liability.
B) stock.
C) equity.
D) profit.

Answer 1

equity.

Question 2

If a corporation pays a dividend,which group receives priority in receiving the dividend?

A) bond holders
B) holders of common stock
C) holders of preferred stock
D) Dividends are evenly divided by holders of common and preferred stock.

Answer 2

holders of preferred stock

Question 3

As of 2015,which of the following was the largest stock exchange in terms of total value traded?

A) New York Stock Exchange
B) London Stock Exchange
C) Shanghai Stock Exchange
D) Tokyo Stock Exchange

Answer 3

New York Stock Exchange

Question 4

In what way do owners of stocks have limited liability?

Question 5

From April 2000 to June 2016,the price of Apple stock has

A) consistently increased.
B) consistently decreased.
C) varied considerably, but has risen considerably overall.
D) varied considerably, but has remained relatively unchanged overall.

Question 6

Falling stock prices ________ the funds that firms can raise,which ________ their spending on physical capital.

A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases

Question 7

Financial securities are exchanged by dealers linked by computers in a

A) stock exchange.
B) public exchange.
C) financial exchange.
D) over-the-counter market.

Question 8

Rising stock prices ________ household wealth,which ________ consumption spending.

A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases

Question 9

The Dow-Jones Industrial Average is the best-known measure of the performance of the U.S.stock market,and is an average of the stock prices of

A) the 500 largest corporations in the United States.
B) 30 large corporations.
C) over 3,200 high-tech stocks.
D) all major banking and financial companies.

Question 10

A corporation's market capitalization is best described as

A) the total value of its stocks and bonds.
B) the total value of its common and preferred stock.
C) its total profit for a particular year.
D) its average profit over a period of years.

Question 11

For index numbers like stock market indexes

A) the numbers are measured in dollars and their values are meaningful by themselves.
B) the numbers are measured in dollars and changes in their values are more important that the values themselves.
C) the numbers are not measured in dollars or any other units and their values are meaningful by themselves.
D) the numbers are not measured in dollars or any other units and changes in their values are more important that the values themselves.

Question 12

Which group of investors vote for a corporation's board of directors?

A) bond holders
B) holders of preferred stock
C) holders of common stock
D) both holders of common and preferred stock

Question 13

In what way can the stock market affect the overall economy?

A) It's an important source of funds for corporations.
B) It can affect consumer and business sentiment.
C) It is an important factor affecting consumer wealth and thus consumer spending.
D) all of the above

Question 14

With respect to the stock market crash of 1929 being the primary cause of the Great Depression

A) most economists agree that this is true.
B) most economists agree that this is not true.
C) economists are all in agreement that this is, in fact, correct.
D) economists disagree on how large an impact the crash had on the economy.

Question 15

Dividends are

A) payments made to stockholders.
B) payments made to bond holders.
C) the total profit earned by a corporation.
D) payments to holders of common stock, not preferred stock.

Question 16

Which of the following is NOT a popular stock market index?

A) Dow Jones Industrial Average
B) NASDAQ
C) S&P 500
D) Moody's Market Index

Question 17

In Wall Street jargon,a "Bear Market" typically means

A) stock prices have declined by at least 20%.
B) stock prices have declined by at least 50%.
C) stock prices have risen by at least 20%.
D) stock prices have risen by at least 50%.

Question 18

What are the differences between common stock and preferred stock?

Question 19

The S&P 500 declined by more than 20%,its largest one day decline ever,in

A) October 1929.
B) August 1934.
C) October 1987.
D) December 2007.

Question 20

Limited liability can best be defined as the legal provision that

A) shields owners of a corporation from losing more than what they invested in a firm.
B) protects bond holders from being sued by other creditors.
C) gives holders of preferred stock priority over holders of common stock.
D) reduces the exposure of sole proprietorships to law suits.

Question 21

A primary criticism of preferential tax treatment of dividends and capital gains is

A) there is not a double taxation of dividends.
B) it adversely affects the distribution of after-tax income.
C) there is no locked-in effect resulting from taxation of capital gains.
D) it does not have any impact on efficiency.

Question 22

According to the Gordon growth model,which of the following can cause the value of a stock to decline?

A) higher expected growth rate of dividends
B) increase in the current dividend
C) increased systemic risk
D) decreased required return on equity

Question 23

How can stock prices affect spending by businesses and households?

Question 24

According to the Gordon growth model,what is the value of a stock with a dividend of $1,required return on equity of 10% and expected growth rate of dividends of 5%?

A) $2
B) $10
C) $20
D) $21

Question 25

According to the Gordon growth model,if the stock price is $21,required return on equity is 10% and the current dividend is $1,what is the expected growth rate of dividends?

A) 2%
B) 5%
C) 10%
D) 15%

Question 26

Suppose you plan to hold a stock for one year.You expect that,in one year,it will sell for $30 and pay a dividend of $3 per share.If your required return on equity is 10%,what is the most you should be willing to pay for the share today?

A) $3.30
B) $23
C) $30
D) $33

Question 27

According to the Gordon growth model,an increase in the required return on equity

A) increases the future value of the stock.
B) reduces the current dividend.
C) reduces the value of a stock.
D) reduces the expected growth rate of the dividend.

Question 28

Which of the following expressions gives the present value of future dividends for a company whose current dividend is $5.00 and whose future dividends are expected to grow at rate g?

A) [$5.00(1 - g)]/(i - g)
B) [$5.00(1 + g)]/(i + g)
C) [$5.00(1 - g)]/(i + g)
D) [$5.00(1 + g)]/(i - g)

Question 29

The double taxation of dividends typically refers to

A) dividends being taxed first as corporate profits and then as income after being paid to stock holders.
B) stockholders paying both income and social security taxes on dividends.
C) stockholders paying an income tax and dividend surtax on dividends.
D) dividends being taxed at both the state and local level.

Question 30

The fundamental value of a stock equals

A) the future value of all future dividends.
B) the present value of all future dividends.
C) the present value of current and future dividends.
D) the present value of all future capital gains.

Question 31

The rate of return of a stock held for one year equals

A) the change in the price of the stock.
B) the dividend yield plus the rate of capital gain.
C) the rate of capital gain minus the dividend yield.
D) the dividend yield minus the rate of capital gain.

Question 32

Suppose you are considering buying shares of a stock to hold for one year.The stock has an expected annual dividend of $2 and an expected price at the end of the year of $25.If your required rate of return is 10%,what is the most that you should be willing to pay for the stock? Round off to the nearest cent.

Question 33

According to the Gordon growth model,what will be the percentage change in the value of the stock of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% per year but now are expected to grow by 1% per year?

A) -4.0%
B) -23.7%
C) -31.1%
D) -66.0%

Question 34

Since capital gains are only taxed when an investor sells an asset and realizes the gain,a possible result is

A) the locked-in effect.
B) double taxation.
C) an increase in capital losses.
D) limited liability.

Question 35

According to the Gordon growth model,what is the value of a stock with a dividend of $2,required return on equity of 8% and expected growth rate of dividends of 4%?

A) $25
B) $26
C) $50
D) $52

Question 36

According to the Gordon growth model,what will be the percentage change in the value of a stock of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% but now are expected to grow by 4% per year?

A) 4.0%
B) 17.8%
C) 25.0%
D) 33.3%

Question 37

The required return on equity for an individual stock includes which of the following?

A) systemic risk
B) idiosyncratic risk
C) risk-free interest rate
D) all of the above

Question 38

Which of the following is NOT a result of the double taxation of dividends?

A) Because profits that firms distribute to stockholders are taxed a second time, firms have an incentive to retain profits rather than to distribute them to stockholders.
B) The return investors receive from buying stocks is reduced, which reduces the incentive people have to save in the form of stock investments and increases the costs to firms of raising funds.
C) It gives firms an incentive to take on what may be an excessive level of debt rather than issue stock.
D) The decline in retained profits results in increased inefficiency.

Question 39

A key point made by the Gordon growth model is that the

A) value of a stock depends on investor's expectations about the future profitability of a firm.
B) past trends in a stock's behavior indicate future price trends.
C) dividends have little to do with a stock's value.
D) risk has little effect on a stock's value.

Question 40

Suppose you buy a stock that sells for $20.It's expected annual dividend is $2 and you expect its price to be $25 in one year.What is your expected rate of return on the stock?

Question 41

Suppose you buy 100 shares of 3M at $86 a share and sell all shares one year later for $99 a share.During the year,you earned a dividend of $2.10 a share.What was your rate of return? Report your answer in percentages with one decimal point.

Question 42

If market participants rely only on past stock prices to forecast future stock prices

A) they will be better able to forecast future price increases than future price decreases.
B) they will be better able to forecast future price decreases than future price increases.
C) they have adaptive expectations.
D) they have rational expectations.

Question 43

If traders in a market have rational expectations,then

A) the price of an asset equals its fundamental value.
B) prices of riskier assets are higher than prices of less risky assets.
C) past prices of assets do not affect market participants' expectations of future asset prices.
D) they make use of less information than they would if they had adaptive expectations.

Question 44

If major traders believe the price of a stock should be higher than its current market price

A) they have an incentive to sell the stock.
B) their actions will result in the information they possess being incorporated into the price of the stock.
C) there is little they can do because government regulation precludes their acting on what they know.
D) they should petition the Securities and Exchange Commission to authorize an adjustment in the price of the stock.

Question 45

Suppose 3M pays a dividend of $2 per share which the investor is expected to receive immediately.The dividend is expected to grow by 5% per year and the investor has a required rate of return of 8%.What should be the current price of the stock according to the Gordon growth model?

Question 46

In an efficient market with rational expectations,the actual price of an asset

A) will equal its expected price.
B) will often be below its expected price.
C) will often be above its expected price.
D) equals its expected price plus a random error term.

Question 47

What are the effects of the double taxation of dividends?

Question 48

When market participants have rational expectations

A) the information they use contains only past experiences.
B) the information they use contains not only past experiences, but also their expectations for the future.
C) the information they use contains only their expectations for the future.
D) their forecasts are always correct.

Question 49

When market participants have rational expectations,the deviation of the expected price from the actual future price is

A) zero.
B) predictable, provided all relevant information is made use of.
C) not predictable.
D) predictable under certain circumstances, but not under others.

Question 50

An asset's fundamental value equals

A) its face value.
B) its maturity value.
C) the market's best guess of the present value of the asset's expected future returns.
D) the weighted sum of its market price over the recent past.

Question 51

Rational expectations involve the assumption that

A) market participants make use only of information on the past performance of an asset in determining what they believe its price should be.
B) market participants rarely change their minds about the correct price of an asset.
C) financial markets are good at increasing liquidity, but poor at transmitting information.
D) market participants make use of all available information.

Question 52

George is trying to forecast the future price of IBM's common stock.To do so he makes use only of past prices of IBM stock.George

A) has adaptive expectations.
B) has rational expectations.
C) is likely to rapidly adjust his forecast to news affecting the future profitability of IBM.
D) is likely to make forecasts that reflect closely IBM stock's fundamental value.

Question 53

When market participants have rational expectations

A) they use all information available to them.
B) they only slowly adjust their expectations to news which could affect prices or returns.
C) they are less likely to make accurate forecasts than if they have adaptive expectations.
D) they are able to forecast interest rates more accurately than inflation rates.

Question 54

Explain what is meant by the "double taxation of dividends"?

Question 55

If market participants have rational expectations,then the best forecast of the price of a stock in the next period is

A) equal to an average of the prices of the stock in previous periods.
B) equal to the price of the stock in the current period.
C) dependent upon all information available in the current period, including, but not limited to, the price of the stock in the current period.
D) dependent on information available in the previous period.

Question 56

Expectations of asset values by participants in financial markets

A) are not possible to model, given the current state of economic knowledge.
B) determine market prices, but are not related to changes in market prices.
C) generally do not change.
D) determine current market prices and changes in market prices.

Question 57

When market participants have adaptive expectations

A) they use all information available to them.
B) they only slowly adjust their expectations to news which could affect prices or returns.
C) they are more likely to make accurate forecasts than if they have rational expectations.
D) they are able to forecast interest rates more accurately than inflation rates.

Question 58

Why do some economists think that taxing capital gains results in a locked-in effect?

Question 59

Which of the following statements is TRUE of rational expectations?

A) Rational expectations forecasts are always correct.
B) For a trader with rational expectations, the expectation of an asset's price equals the optimal price forecast.
C) If traders have rational expectations, any announcement by a company will have an effect on its stock price, even if the market was already aware of the facts being announced.
D) If a trader really has rational expectations, he or she will always earn a greater than normal return on his or her financial portfolio.

Question 60

If the prices of financial assets follow a random walk,then

A) they should be easy to forecast, provided market participants have rational expectations.
B) they should be easy to forecast, provided market participants have adaptive expectations.
C) the change in price from one trading period to the next is not predictable.
D) major traders in the market must not be making use of all available information about the assets.

Question 61

According to the efficient markets hypothesis,the difference between today's price for a share of stock and tomorrow's price is

A) predictable given currently available information.
B) equal to today's price minus yesterday's price.
C) unforecastable.
D) zero.

Question 62

According to the efficient markets hypothesis,who is most likely to benefit from frequently moving funds from one asset to another?

A) your broker
B) small investors
C) big investors
D) only those who consistently beat the market

Question 63

According to the efficient markets hypothesis

A) the equilibrium price of an asset equals the optimal forecast of fundamental value based on available information.
B) the actual and expected prices of an asset will be equal.
C) the actual price of an asset reflects only information on past returns on the asset.
D) the expected price of an asset incorporates only information on past returns on the asset.

Question 64

According to the efficient markets hypothesis,prices of securities

A) change infrequently.
B) change frequently to reflect news about changes in the fundamental values of the securities.
C) change frequently as evaluations of existing information about the securities change.
D) are not allowed, under federal securities laws, to change more frequently than once a month.

Question 65

In comparing actively managed mutual funds with those funds that simply buy and hold a large market portfolio (index funds),we would expect that

A) the actively managed funds provide a higher return than the index funds.
B) the index funds provide a higher return after expenses than the actively managed funds.
C) actively managed funds and index funds provide the same returns.
D) index funds provide a lower return than actively managed funds only if taxes are taken into consideration.

Question 66

Technical analysis is a version of

A) insider trading.
B) adaptive expectations.
C) rational expectations.
D) efficient markets.

Question 67

One implication of the efficient markets hypothesis is that investors should

A) concentrate their investments in just a few well-chosen assets.
B) hold a diversified portfolio of assets.
C) buy stocks rather than bonds.
D) buy bonds rather than stocks.

Question 68

The long-run average annual return on investments in the stock market is ________ than the annual returns on investments in Treasury bills and ________ than the annual returns on investments in bank CDs.

A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower

Question 69

Under the efficient markets hypothesis,what would be the price per share of a company whose current dividend is $10.00 and whose dividends are expected to grow by 3% per year (assume the risk-adjusted interest rate is 10%)?

A) $74.62
B) $79.23
C) $142.86
D) $147.14

Question 70

According to the efficient markets hypothesis

A) common stock prices should be constant.
B) the price of a corporation's stock is likely to fluctuate substantially in response to news about changes in the company's short-term prospects.
C) the price of a corporation's stock will fluctuate significantly only in response to news about changes in the company's long-term prospects.
D) price fluctuations in common stock are a response to fads and are only infrequently the result of changes in the expected profitability of the companies involved.

Question 71

Suppose Exxon-Mobil announces that its profits in the third quarter of 2016 were $40 billion.This will cause the price of Exxon-Mobil stock to

A) rise.
B) fall.
C) remain unchanged.
D) rise, fall, or remain unchanged depending on the expectations of market participants before the announcement.

Question 72

An investor will generally find that hiring an investment firm to actively manage his or her portfolio will

A) result in a higher return than would be received from an index mutual fund.
B) be less expensive than simply placing money in an index mutual fund.
C) result in a higher return, but will be more expensive than placing money in an index mutual fund.
D) result in about the same return, but will be more expensive than placing money in an index mutual fund.

Question 73

An implication of the efficient markets hypothesis is that

A) only sophisticated investors will be able to earn above-normal profits from financial investments.
B) above-normal profits are available only to major traders.
C) above-normal profits will be eliminated in the trading process.
D) unless he or she acts recklessly, the average investor should be able to make above-normal profits.

Question 74

Under the efficient markets hypothesis,for news about a company's prospects to have a large impact on the price of the company's stock,the news must

A) have an impact on the company's profitability in the short term.
B) have an impact on the company's profitability in the long term.
C) significantly increase the likelihood that the company will go bankrupt.
D) significantly reduce the liquidity of the company's stock.

Question 75

The efficient markets hypothesis

A) assumes that market participants form their expectations adaptively.
B) applies rational expectations to the pricing of assets.
C) applies to the stock market, but not to the bond market.
D) indicates that the stock market is efficient, but not rational.

Question 76

"Tips" published in leading commercial or financial publications are unlikely to lead to profitable trades because

A) only wealthy individuals can buy stocks in the volume necessary to take advantage of tips.
B) whatever is gained by trading on the basis of tips will be taxed away by the government.
C) the news will already be reflected in the market prices of the assets.
D) the news contained in the tips is usually inaccurate.

Question 77

The efficient markets hypothesis predicts that an investor

A) will not be able consistently to earn above-normal profits from buying or selling stocks.
B) will be able consistently to earn above-normal profits from buying or selling stocks so long as he or she makes use of rational expectations.
C) will be able consistently to earn above-normal profits from buying or selling stocks so long as he makes use of adaptive expectations.
D) will be able consistently to earn above-normal profits so long as stock prices in general are rising.

Question 78

Suppose that Google announces that its profits for the third quarter of 2016 were $1.6 billion.As a result of this announcement the price of Google's stock declines.The best explanation of this is

A) market participants expected Google's profits to be greater than $1.6 billion for the third quarter.
B) market participants expected Google's profits to be less than $1.6 billion for the third quarter.
C) the stock market is not an efficient market.
D) market participants have adaptive expectations.

Question 79

Above-normal returns on stock investments can be expected by investors who

A) possess inside information.
B) are wealthy enough to hold the stock of many different companies in their portfolios.
C) are risk seeking.
D) concentrate their investments in one or two stocks.

Question 80

Suppose Apple announces that its earnings for the fourth quarter of 2016 rose to $2 billion.As a result of this announcement the price of Apple's stock does not change.The best explanation of this is

A) market participants were expecting Apple's earnings to be greater than $2 billion.
B) market participants expected Apple's earnings to be $2 billion.
C) market participants expected Apple's earnings to be less than $2 billion.
D) market participants have adaptive expectations.