Deck 17: Financial Economics

Question 1

Economic investment refers to:

A) Buying a financial asset for a gain
B) Selling a financial asset for a gain
C) Postponing purchases of goods and services
D) Making new additions to a firm's stock of capital

Answer 1

Making new additions to a firm's stock of capital

Question 2

A bond pays a coupon (or interest) rate of 5 percent each year for five years, with a future (face) value of $200. If the bond was sold today, what would be the present value of the bond?

A) $200
B) $157
C) $150
D) $145

Answer 2

$157

Question 3

A bank account pays 4% interest per year. If you deposit $1,000 into this account at the start of each year for three years, how much will your account balance be at the end of three years?

A) $3,122
B) $3,246
C) $3,600
D) $4,206

Answer 3

$3,246

Question 4

Other factors constant, the present value will be larger:

A) The smaller is the future value
B) The higher is the interest rate
C) The larger is the number of periods t
D) The shorter is the time period t

Question 5

Which one of the following is an example of a financial investment but not an economic investment?

A) A renovation of a shopping mall
B) An addition to a petroleum refinery
C) Building a new store
D) Buying gold to sell later at a higher price

Question 6

Which of the following would best be a brief definition of present value?

A) Assets minus liabilities incurred to acquire the assets
B) Benefits of an minus its costs
C) The sum of all the past values of an asset
D) The current value of the expected future returns on an asset

Question 7

The present value model of investment states that an asset's current price should be equal to the:

A) Sum of the present values of all of its future payments or earnings
B) Sum of all of its future payments or earnings times the number of years of its life
C) Life of the asset times the present values of all of its future payments or earnings
D) Present values of all of its future payments or earnings divided by its life in years

Question 8

The correct formula that relates present value (PV) to future value (FV), if interest rate is i% per year over n years is:

A) PV = FV (1 + i)ⁿ
B) FV = PV (i)ⁿ
C) PV = FV/(1 + i)ⁿ
D) FV = PV (1 + i) (n)

Question 9

Compound interest describes increases in value when interest is paid, or compounded, on:

A) Only the original amount invested
B) Only the previously accumulated interest payments
C) The original amount invested and previously accumulated interest payments
D) The original amount invested minus any previously accumulated interest payments

Question 10

Which one of the following is an example of an economic investment?

A) Putting money in a bank CD
B) Buying a corporate bond or stock
C) Purchasing shares of a mutual fund
D) Building a new bank office

Question 11

Other factors constant, the future value will be smaller:

A) The larger is its present value
B) The higher is the interest rate
C) The shorter is the time period t
D) The larger is the number of periods

Question 12

Time value of money refers to the idea that a specific amount of money:

A) Can be converted into other currencies in the foreign exchange market
B) Is needed to purchase goods and services
C) Is more valuable the sooner it is received
D) Can buy less goods and services if inflation occurs over time

Question 13

You deposit $5,000 in a 5-year bank CD that pays 3% interest per year. How much will you get from this deposit be at maturity?

A) $5,155
B) $5,751
C) $5,796
D) $6,500

Question 14

A bond that pays no annual interest (or coupons) and has a face value at maturity will fetch a price today that is equal to the:

A) Future value of its face value
B) Number of years in the life of the bond times its face value
C) Present value of the number of years in the life of the bond times its face value
D) Present value of its face value

Question 15

If an amount "$AAA" today earns interest at a rate of "i"% per year, then the accumulated amount at the end of "n" years will be:

A) $AAA × n × i
B) $AAA × iⁿ
C) ($AAA)ⁿ × (1 + i)
D) $AAA × (1 + i)ⁿ

Question 16

Financial investment refers to:

A) The same idea as economic investment
B) Earning profits from producing goods and services
C) Purchasing or building an asset for monetary gain
D) Making new additions to the capital stock

Question 17

A bond that pays annual interest (or coupons) and a face value at maturity will fetch a price today that is equal to the:

A) Future value of its annual coupons and face value
B) Future value of its annual coupons minus its face value
C) Present value of its annual coupons and face value
D) Present value of its annual coupons minus its face vale

Question 18

A bank makes an auto loan for $10,000 at an annual rate of 6 percent. Assuming no repayment is made at all during the period, after two years the borrower will owe:

A) $10,000
B) $10,600
C) $11,236
D) $11,910

Question 19

A manufacturing firm takes out a $500,000 loan to expand its plant. The loan has an annual interest rate of 7 percent. What would be the total compounded interest on the loan at the end of five years, excluding the principal?

A) $175,000
B) $35,075
C) $150,750
D) $201,275

Question 20

A promised amount $FV "n" years into the future is worth how much today, if the interest rate is "i%" per year?

A) $FV/(1 + i)ⁿ
B) ($FV/n) (i%)
C) (1 + i)ⁿ/$FV
D) [$FV/(1 + i)]ⁿ

Question 21

Bankruptcy of a firm means that it:

A) Earned less revenues than its total costs
B) Cannot meet its contractual obligations to its stockholders
C) Has a lot of debt owed to its bondholders
D) Is unable to make timely promised payments on its debt

Question 22

Which of the following statements about stocks and bonds is true?

A) Stocks pay interest while bonds pay dividends
B) One can lose with stocks, but not with bonds
C) The U.S. Federal government issues bonds, but not stocks
D) Bonds are long term while stocks are short term investments

Question 23

You estimate that a piece of real estate for investment will be worth $700,000 in five years. The current interest rate is 3 percent. What is the present value of this investment?

A) $604,000
B) $624,000
C) $680,000
D) $700,000

Question 24

A stock investor may expect returns in the form of:

A) Present and future values
B) Interest and dividends
C) Interest and capital gains
D) Dividends and capital gains

Question 25

Tracy won a $100 million jackpot. She can receive the jackpot as a $5 million payment each year for 20 years, or she can ask to receive the present value of all those payments all at once now. Assume an annual interest rate of 5 percent. If she decides to take the present value payment, about how much will she receive?

A) $52.1 million
B) $62.3 million
C) $71.4 million
D) $78.6 million

Question 26

The primary risk that bondholders face is that:

A) The bond will reduce in price
B) The bond issuer will default
C) Inflation will decrease
D) The rate of return will increase

Question 27

The limited liability rule means that if a corporation goes bankrupt:

A) Shareholders are responsible for all the debts of the firm
B) Bondholders are responsible for all the debts of the firm
C) Shareholders can only lose the amount they invested
D) Bondholders only lose the face value of the bond

Question 28

Equal shares of a firm's profit are paid out to stockholders as:

A) Interest
B) Dividends
C) Capital gains
D) Net earnings

Question 29

Xavier is a baseball player negotiating a contract to play for a team for one year. He is usually paid $10 million a year for playing, but the salary caps for his team means that he will have to be paid $5 million this year and the remainder next year. If the interest rate is 8 percent, how much should that remaining amount be next year?

A) $5.0 million
B) $5.1 million
C) $5.4 million
D) $6.1 million

Question 30

Joe and Linda have the opportunity to purchase a new home. The house in Glen Oaks is currently worth $250,000 but is predicted to be worth $270,000 in a year. What is the rate of appreciation for the house from one year to the next?

A) 5 percent
B) 6 percent
C) 7 percent
D) 8 percent

Question 31

Which one of the following is a feature of all investments?

A) They provide regular interest payments
B) They are typically long term
C) They have minimal risk for future payments to be made
D) They give owners a chance to receive future payments

Question 32

Which of the following is a popular type of investment?

A) Dividends
B) Portfolios
C) Mutual funds
D) Capital gains

Question 33

Orange Computers, Inc., is planning to spend $200,000 on the promotion of its new portable music player next year. The current market interest rate is 5 percent. What is the present value of this promotional budget?

A) $175,146
B) $185,123
C) $190,476
D) $200,000

Question 34

Which one of the following is a feature of all investments?

A) The future payments are typically risky
B) The periodic payments they provide are regular
C) They typically are short term
D) They give the investor a stream of future payments, not just one payment

Question 35

Matt, a star basketball player, is looking to join a new NBA team. The Bulls are offering him $24 million for one year. The Heat is offering him $10 million this year and $7.0 million in each of the next two years. The market interest rate is 5 percent. What is the present value of the offer from The Heat in millions (rounded to the nearest one hundred thousand dollars)?

A) $22.5 million
B) $23.0 million
C) $24.0 million
D) $25.2 million

Question 36

If stockholders sell their shares for more than they paid for those shares, the stockholders:

A) Realize a share of equal profits
B) Receive a dividend
C) Realize a capital gain
D) Obtain a mutual fund

Question 37

You would like to have $50,000 for a new car in six years. If you deposit money today in a bank CD that pays 4% per year, how much must your deposit be?

A) $38,050
B) $39,516
C) $40,323
D) $42,108

Question 38

What do stocks represent?

A) Shares of ownership in a corporation and a guaranteed stream of profits
B) Shares of ownership in a corporation and an entitlement to its future profits
C) Debt contracts with a corporation and regular interest payments on the loan
D) Debt contracts with a corporation and variable interest payments on the loan

Question 39

Roger has the opportunity to invest $100,000 in two different assets. The investment in Asset #1 will have a present value of $120,000. The investment in Asset #2 is expected to have a future value of $140,000 in four years. If the market interest rate is 5 percent a year, which one would be the better investment?

A) Asset #2, because its future value is greater than the present value of Asset #1
B) Asset #1, because its present value is greater than the future value of Asset #2
C) Asset #2, because its present value is greater than the present value of Asset #1
D) Asset #1, because its present value is greater than the present value of Asset #2

Question 40

What do bonds represent?

A) Shares of ownership in a corporation and a guaranteed stream of profits
B) Shares of ownership in a corporation and an entitlement to its future profits
C) Debt contracts with corporations or governments, and regular interest payments on the loan
D) Debt contracts with corporations or governments, and some unspecified interest payments on the loan

Question 41

Alma recently purchased a Mexican restaurant for $450,000 from which she expects to earn a monthly profit of $1,500. Her expected annual rate of return is:

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

Question 42

An investor owns bond #1 that has a rate of return of 10 percent, but a similar bond #2 has an 11 percent return and equal risk. By selling bond #1 and buying bond #2 to earn a higher return, the investor is engaging in:

A) Pooling
B) Arbitrage
C) Diversification
D) Time preference

Question 43

Assume that there are two investments very similar in all respects, but Investment X has a higher rate of return than does Investment Y. As a result of the arbitrage process, the price of Investment:

A) X will fall and its rate of return will fall
B) Y will rise and its rate of return will fall
C) X will fall and its rate of return will rise
D) Y will fall and its rate of return will rise

Question 44

Rupert recently purchased a non-maturing bond for $10,000 that pays $350 semi-annual coupons. His expected rate of return per year on the bond is:

A) 4 percent
B) 7 percent
C) 10 percent
D) 12 percent

Question 45

Investments that are designed to match exactly the performance of a group of stocks like the Dow Jones Industrial Average or the S&P-500 are called:

A) Index funds
B) Dividend funds
C) Portfolio funds
D) Capital gain funds

Question 46

Assume that two firms (Firm A and Firm B) are very similar in all respects, but Firm A's stock has a higher rate of return than Firm B's stock. Arbitrage will occur as investors:

A) Sell Firm A's stock and buy Firm B's stock
B) Buy Firm A's stock and buy Firm B's stock also
C) Sell Firm A's stock and sell Firm B's stock also
D) Buy Firm A's stock and sell Firm B's stock

Question 47

Which of the following statements is true about investing in stocks and bonds?

A) Issuers of stocks can default on their stock obligations
B) Investing in stocks involve less risk because the future payments are less uncertain
C) In case of bankruptcy, bondholders get paid first ahead of stockholders
D) Bankruptcy occurs when the issuing firm is unable to fulfill its stock obligations

Question 48

A mutual fund company uses the funds of its investors to:

A) Produce goods and services for consumers
B) Buy stocks and bonds
C) Build factories and other infrastructure
D) Buy capital and other resources for other firms

Question 49

The U.S. Federal government is unlikely to default on its bonds because:

A) The bonds are all long term bonds and they are insured
B) The Federal government has the ability to collect taxes and to sell securities to the Fed
C) Foreigners are willing to buy the Federal government bonds and lend to the U.S. government
D) The Federal government can always borrow from the states and from businesses

Question 50

A bond that is currently selling at $1000 offers to pay $50 annually. What is the percentage rate of return on the bond?

A) 5 percent
B) 10 percent
C) 20 percent
D) 50 percent

Question 51

Susan recently purchased a home for $150,000. She plans to rent it out for $1,000 per month for a year. Had the house cost $200,000 instead, her expected rate of return would have:

A) Decreased by 1 percentage point
B) Decreased by 2 percentage point
C) Increased by 2 percentage point
D) Increased by 3 percentage point

Question 52

Terri buys a house for $200,000 and expects to sell it in three years for $300,000. Her expected percentage rate of return over that three-year period is:

A) 25 percent
B) 33 percent
C) 50 percent
D) 67 percent

Question 53

If the demand for an asset increases, its:

A) Price will increase and the rate of return for new investors of this asset will increase
B) Price will decrease and the rate of return for new investors of this asset will increase
C) Price will decrease and the rate of return for new investors of this asset will decrease
D) Price will increase and the rate of return for new investors of this asset will decrease

Question 54

Which one of the following would best describe a mutual fund?

A) An investment that is available at many banks and is FDIC insured
B) A company that manages a portfolio that is purchased by pooling the money of its investors
C) A debt contract that is issued by a company and offers interest payment on the loan
D) Ownership of shares in a corporation with no guarantee the company will be profitable

Question 55

One fundamental concept in financial economics is that an investment's rate of return is:

A) Positively related to the price paid for it
B) Inversely related to the price paid for it
C) Inversely related to the riskiness of the investment
D) Inversely related to the maturity of the investment

Question 56

Shawna bought an antique table for $200 last year and is now selling it for $250. Her rate of return on the table is:

A) 10 percent
B) 20 percent
C) 25 percent
D) 30 percent

Question 57

Which of the following statements is true?

A) Passively managed funds do not pay dividends
B) Passively managed funds have only one asset in their portfolio
C) Actively managed funds constantly buy or sell assets to generate better returns
D) Actively managed funds adjust assets to match the performance of a particular index

Question 58

Rick recently purchased a convenience store for $500,000. He expects monthly profits to be $10,000 in the next year. If a recession had struck, and Rick had instead paid $300,000 while his monthly profits was reduced to $6,000, his expected rate of return would have:

A) Increased by 2 percentage points
B) Increased by 3 percentage points
C) Decreased by 2 percentage points
D) Remained the same

Question 59

An index fund:

A) Is a passively managed mutual fund
B) Has higher trading costs than an actively managed mutual fund
C) Has higher trading costs than a passively managed mutual fund
D) Is an actively managed mutual fund

Question 60

The buying and selling activities that tend to equalize the rates of return on identical or nearly identical assets is called:

A) Beta
B) Risk
C) Arbitrage
D) Diversification

Question 61

The underlying cause of risk in finance is:

A) Danger
B) Uncertainty
C) Fear
D) Complexity

Question 62

One asset has a beta of 1.5 and another asset has a beta of 0.75. The difference in beta mean that the asset with a beta of 0.75 has:

A) 75 percent less nondiversifiable risk than the asset with a beta of 1.5
B) 75 percent more nondiversifiable risk than the asset with a beta of 1.5
C) Twice as much nondiversifiable risk as the asset with a beta of 1.5
D) One-half of the nondiversifiable risk of the asset with a beta of 1.5

Question 63

Investors evaluate an investment by estimating its average expected rate of return, and this estimation process assigns higher weights to:

A) Higher returns
B) More likely outcomes
C) Higher risks
D) Smaller returns

Question 64

If we observe that many investors are selling Bond A and buying a similar Bond B, this suggests that the expected returns on:

A) Bond A will start falling
B) Bond B will start rising
C) Bond A was higher than that of Bond B
D) Bond A will start rising

Question 65

Risk in finance means:

A) Mostly positive outcomes
B) Mostly negative outcomes
C) Either positive or negative outcomes
D) The same thing as risk in health science

Question 66

If an investment is 80 percent likely to gain 40 percent but also 20 percent likely to lose 10 percent, then its average expected rate of return is:

A) 34 percent
B) 32 percent
C) 30 percent
D) 12 percent

Question 67

The type of risk that pushes the returns from all investment in the same direction at the same time is:

A) Idiosyncratic
B) Diversifiable
C) Systemic
D) Time preference

Question 68

Which of the following statements best describes the relationship between asset prices and average expected returns?

A) More risky assets will have similar prices as less risky assets
B) Less risky assets will have lower prices than more risky assets
C) Less risky assets will have higher prices than more risky assets
D) More risky assets will have higher prices than less risky assets

Question 69

The so-called market portfolio used as a benchmark in financial economics is:

A) The lowest risk portfolio
B) The most diversified portfolio
C) The portfolio with the highest expected return
D) The portfolio with zero systemic risk

Question 70

Investors face the risk that the economy could go into another recession. This risk is:

A) Idiosyncratic
B) Diversifiable
C) Systemic
D) Time preference

Question 71

If an investor owns a well-diversified portfolio, then:

A) His portfolio does not involve any risk
B) The idiosyncratic risk in his portfolio is minimized
C) The systemic risk in his portfolio is minimized
D) His portfolio will have the highest expected return

Question 72

An asset with a beta of 0.5 has:

A) 5 percent more risk than the risk-free asset
B) 50 percent more risk than the risk-free asset
C) Half the nondiversifiable risk as in a market portfolio
D) 5 times the nondiversifiable risk as in a market portfolio

Question 73

An investor wants to invest in the oil industry, but does not know which major companies will produce the greatest return. As a result, the investor buys shares in several oil companies. By buying several companies to reduce risk, the investor is seeking to reduce:

A) Systemic risk
B) The risk premium
C) Idiosyncratic risk
D) Nondiversifiable risk

Question 74

The average expected rate of return is a:

A) Volume-weighted average
B) Price-weighted average
C) Probability-weighted average
D) Value-weighted average

Question 75

Risk in finance means that an asset:

A) Does not pay dividends
B) Does not pay capital gains
C) Has a present value that is negative
D) Has future payments that are uncertain

Question 76

Diversification in one's investments reduces:

A) Idiosyncratic risk
B) Pooling risk
C) Systemic risk
D) Time preference risk

Question 77

"Do not put all your eggs in one basket" is an advice that seeks to reduce:

A) Idiosyncratic risk
B) Non-diversifiable risk
C) Systemic risk
D) Market risk

Question 78

Which of the following statements best describes the relationship between risk and the average expected return of investments?

A) Less risky assets will have similar average expected rates of return to more risky assets
B) Less risky assets will have higher average expected rates of return than more risky assets
C) More risky assets will have higher average expected rates of return than less risky assets
D) More risky assets will have lower average expected rates of return than less risky assets

Question 79

A strategy that attempts to reduce the overall risk of an entire investment portfolio by investing in a variety of assets is called:

A) Pooling
B) Arbitrage
C) Diversification
D) Weighted average

Question 80

What does the 'beta' of an asset measure?

A) How the nondiversifiable risk compares with diversifiable risk for an asset
B) How the expected return compares with the diversifiable risk of a given asset
C) How the expected return compares with the nondiversifiable risk of the market portfolio
D) How the nondiversifiable risk of a given asset compares with that of the market portfolio