Deck 27: Saving, Investment and the Financial System

Question 1

Long-term bonds usually pay a higher interest rate than do short-term bonds because long-term bonds are riskier.

Answer 1

True

Question 2

The financial system consists of those institutions in the economy that help to match one person's saving with another person's investment.

Answer 2

True

Question 3

Capital investments can be financed through:

A) borrowing money from a bank
B) borrowing money from a friend or relative
C) sharing ownership and profits with someone who has sufficient money
D) all of the above

Answer 3

all of the above

Question 4

Import receipts are not an addition to a country's GDP.

Question 5

The price of a share in the newspaper is the last price at which the share was traded.

Question 6

Shares enable firms to raise debt financing as the firm is in debt to its owners.

Question 7

Government policies are incapable of influencing interest rates and, therefore, cannot affect society's allocation of scarce resources.

Question 8

Financial markets are the institutions through which a person who wants to save can directly supply funds to a person who wants to borrow.

Question 9

The national income accounting identity S = I shows that saving and investment are equal for every individual household or firm.

Question 10

Dividends are the only way shareholders increase their wealth owning shares.

Question 11

An excess of tax revenue over government spending is called a budget deficit.

Question 12

A low P/E ratio indicates that the share price of a company is expensive compared to the company's expected earnings.

Question 13

The P/E ratio is the price of the share divided by the amount the corporation earned in the last financial year.

Question 14

Banks play two primary roles in the economy: they take in deposits from savers and lend these to borrowers, and they facilitate purchases of goods and services by allowing people to write cheques against their deposits.

Question 15

When the government borrows to finance its budget, private borrowers are still able to finance investment.

Question 16

When a country saves a small portion of its GDP:

A) less investment will take place
B) less resources will be available for investment in capital
C) more resources will be available for investment in capital
D) the country's productivity will fall

Question 17

The market for loanable funds can be modeled on a supply and demand schedule even though there are many exogenous circumstances that affect the price of funds.

Question 18

Investing in managed funds is an attempt to diversify risk across a range of investment options.

Question 19

The GDP of a closed economy is the sum of consumption, investment, government purchases and imports.

Question 20

When setting up a business, you might need to purchase a building, computer, filing cabinets and furniture. This type of purchase would be called ____ by an economist.

A) capital investment
B) business consumption expenditures
C) investment in human capital
D) none of the above

Question 21

A price-earnings ratio is:

A) the price of a firm's stock divided by the firm's dividend over the past year
B) the price of a firm's stock divided by the amount the firm earned per share over the past year
C) the earnings of a firm over the past year divided by the price of the stock at the end of the year
D) the price of a firm's stock divided by the earnings of the firm over the past year

Question 22

All else being equal, when people become less optimistic about a company's future, then:

A) the demand for the stock (and thus the price) rises
B) the demand for the stock (and thus the price) falls
C) the supply of the stock (and thus the price) rises
D) the supply of the stock (and thus the price) falls

Question 23

The type of bond that never matures is called:

A) the duration
B) the indefinite
C) the perpetuity
D) the term

Question 24

The financial system moves the economy's scarce resources from:

A) the government to citizens
B) higher-valued uses to lower-valued uses
C) savers to borrowers
D) borrowers to savers

Question 25

The yield curve is a graph of the interest rate on bonds of different terms, with the term shown on the horizontal axis and the interest shown on the vertical axis. Based on the discussion in chapter 10, what slope would you expect the yield curve to have?

A) No slope - flat
B) A negative slope - downward-sloping
C) A positive slope - upward-sloping
D) Negative at first, then positive

Question 26

The term of a bond is:

A) the interest rate of the bond
B) the credit risk rating of the bond
C) the principal amount of the bond
D) the length of time until the bond matures

Question 27

The demand for loanable funds shows the:

A) quantity of loanable funds demanded at each possible nominal interest rate
B) quantity of loanable funds demanded at each possible real interest rate
C) equilibrium quantity of money that will be borrowed at each possible real interest rate
D) equilibrium quantity of money that will be borrowed at each possible nominal interest rate

Question 28

Financial markets are:

A) the institutions in which a person who wants to save can directly supply funds to a person who wants to borrow
B) the financial institutions through which savers can indirectly provide funds to borrowers
C) the institutions that sell shares to the public and use the proceeds to buy various types of stocks and/or bonds
D) the same thing as banks
E) all of the above

Question 29

Private saving is:

A) the amount of income that businesses have left after paying for the factors of production
B) the amount of tax revenue that the government has left after paying for its spending
C) the amount of income that households have left after paying their taxes and paying for their consumption
D) always equal to investment

Question 30

Gina has the choice of two bonds, one that pays 5 per cent interest and one that pays 10 per cent interest. Which of the following is most likely?

A) The 10 per cent bond has a shorter term than the 5 per cent bond
B) The 10 per cent bond is a government bond, and the 5 per cent bond is a junk bond
C) The 10 per cent bond is more risky than the 5 per cent bond
D) All of the above are equally likely

Question 31

IIn a closed economy, national saving:

A) is usually greater than investment
B) is usually less than investment because of the leakage of taxes
C) must equal investment
D) must equal government tax revenue

Question 32

A bond is:

A) a certificate of credit that specifies the credit of the holder of the bond
B) a capital investment
C) a certificate of indebtedness that specifies the obligations of the issuer to the holder of the bond
D) a factor of production

Question 33

Which of the following equations represents the GDP in an open economy?

A) Y = C + I + G
B) S = I - G
C) Y = C + I + G + NX
D) I = Y - C + G

Question 34

Financial intermediaries are:

A) the same as financial markets
B) financial institutions through which savers can indirectly provide funds to borrowers
C) the markets that facilitate stock and bond transactions
D) financial institutions through which savers can directly provide funds to borrowers

Question 35

A budget surplus is created when the government:

A) spends more than it receives in tax revenue
B) buys back more bonds than it issues
C) receives more tax revenue than it spends
D) raises interest rates

Question 36

Public saving is:

A) the amount of income that businesses have left after paying for the factors of production
B) the amount of tax revenue that the government has left after paying for its spending
C) the amount of income that households have left after paying their taxes and paying for their consumption
D) always equal to investment

Question 37

A dividend yield is:

A) the stock price as a percentage of the dividend
B) the inflation-adjusted dividend payment
C) the dividend as a percentage of the stock price
D) the real rate of interest on the stock

Question 38

The supply of loanable funds shows the:

A) quantity of loanable funds supplied at each possible nominal interest rate
B) equilibrium quantity of money that will be offered by savers at each possible nominal interest rate
C) equilibrium quantity of money that will be offered by savers at each possible real interest rate
D) quantity of loanable funds supplied at each possible real interest rate

Question 39

In a closed economy, national saving can be expressed by the equation S = (Y - T - C) + (T - G). What does (Y - T - C) represent?

A) Private saving
B) Government tax revenue
C) Public saving
D) Investment

Question 40

Australian government bonds are considered as being less risky and pay relatively low interest rates because:

A) they have a very high credit risk
B) they are considered to be a very safe credit risk
C) they are not backed by gold
D) they are considered part of a national debt that is extremely large

Question 41

Since all free markets, including financial markets, use the forces of supply and demand to determine prices, how do financial markets differ from other markets?

Question 42

A company is looking to see what rate of return it is receiving from a project when the project's initial investment is $14 million today and will receive $18.5 million in four years.

A) 7.22 per cent
B) 32.14 per cent
C) 19.8 per cent
D) 6.2 per cent

Question 43

If the real interest rate and the nominal interest rate was 3 per cent in 2005, then the inflation rate in 2005 would be:

A) 6 per cent
B) 3 per cent
C) 0 per cent
D) -3 per cent

Question 44

Sony is thinking about investing in a new project. Suppose that the project costs $10 million and will yield the company $20 million in 10 years. If the interest rate is 5 per cent, what is the present value of the yield in 10 years?

A) $9.5 million
B) $10.5 million
C) $12.3 million
D) $16.3 million

Question 45

Dean Martin's income was $1000 in 1950. If the annual interest rate was 5 per cent, then the present value of his 1950 income in the year 2000 would be:

A) $9524
B) $10 500
C) $70 400
D) $114 674

Question 46

What would happen to investment if the government were to increase the tax on interest income?

A) Investment spending would fall
B) Investment spending would rise
C) Investment would be unaffected
D) Investment could rise, fall or remain unchanged

Question 47

The demand for loanable funds is downward-sloping because:

A) as the interest rate falls, the demand for loanable funds increases
B) as the interest rate falls, the demand for loanable funds falls
C) as the interest rate rises, the quantity of loanable funds demanded rises
D) as the interest rate rises, the quantity of loanable funds demanded falls

Question 48

Using the national income accounting identity, derive the relationship between national saving and investment. Also decompose national saving into private saving and public saving.

Question 49

An investment tax credit:

A) reduces the supply of loanable funds
B) shifts the demand curve for loanable funds to the right
C) does not affect the interest rate
D) lowers the interest rate

Question 50

If a company's bond can be purchased today and expects to earn investors 5% p.a, paying $100 at the end of 25 years, what is today's price? What could occur, to the price of the bonds if the company's level of risk increases? Why?

Question 51

Using a graph representing the market for loanable funds, show and explain what happens to interest rates and investment if the investment tax credit is abolished.

Question 52

Which of the following statements is not correct about notional accounting identity?

A) S = (Y - T - C) - (T - G)
B) S = Y - C - G
C) S = I
D) Y = C + I + G

Question 53

A budget deficit:

A) raises the interest rate
B) lowers the interest rate
C) does not affect the interest rate
D) shifts the supply curve for loanable funds to the right

Question 54

Which of the following is not necessarily a motive for investment?

A) Desire to increase profits
B) Desire to improve market share in the long term
C) Desire to improve the status of the economy in the long term
D) Desire to satisfy consumer demand

Question 55

A company invested $50 million in building a factory 10 years ago when the annual interest rate was 2 per cent. What is the present value of the yield now?

A) $49 million
B) $51 million
C) $61 million
D) $70 million

Question 56

The supply of loanable funds is upward-sloping because:

A) as the interest rate falls, the supply of loanable funds increases
B) as the interest rate falls, the supply of loanable funds falls
C) as the interest rate rises, the quantity of loanable funds supplied falls
D) as the interest rate rises, the quantity of loanable funds supplied rises

Question 57

When James Tobin received a Nobel prize in economics, partly for demonstrating theoretically the rationale for diversifying a portfolio of assets, Charles Kindleberger, President of the American Economic Association, remarked that Tobin had received the prize for proving that 'it doesn't pay to put all your eggs in one basket'. Why might a saver decide to diversify his or her portfolio of assets?

Question 58

What would happen in the market for loanable funds if the government were to decrease the tax on interest income?

A) The demand for loanable funds would increase
B) The demand for loanable funds would decrease
C) The supply of loanable funds would decrease
D) The supply of loanable funds would increase

Question 59

If the nominal interest rate is 8 per cent and the rate of inflation is 3 per cent, then the real interest rate is:

A) 11 per cent
B) 3 per cent
C) 5 per cent
D) -5 per cent

Question 60

Playworld is thinking about investing in a new theme park. Suppose that the project costs $7 million and will yield the company $20 million in 10 years. If the interest rate is 5%, what is the present value of the yield in 10 years? What will be the future value of the $7 million investment? Should Playworld invest in the project?

Question 61

Discuss whether the Rudd stimulus package to shield the economy was successful.

Question 62

When the $700 billion bailout occurred in 2008 did this send a dangerous signal to the banks?