Question 1

Which of the following is true?
A) The stock market helps channel the savings of individuals into business activities that create wealth.
B) Individual investors can reduce their risk by holding a large share of their wealth in the form of the stock ownership of a single company.
C) Historically, the long-term real rate of return of stocks has generally been less than that of bonds.
D) Mutual funds that have done well in the past are more likely to outperform the market average in the future.

Accepted Answer

The stock market is a means through which individual savings are directed towards business ventures that result in creating wealth.

Question 2

Which of the following would reduce the risk of an investment in the stock market?
A) investing in a portfolio of diverse firms
B) holding the investment for a long period of time
C) both a and b
D) neither a nor b

Accepted Answer

Investing in a portfolio of diverse firms and holding the investment for a long period of time both reduce the risk of an investment in the stock market. Diversification spreads risk across multiple companies and industries, while holding for a longer period of time allows for potential fluctuations in the market to smooth out over time.

Question 3

If an investor's primary stock holding is currently Exxon Mobil, the purchase of which of the following stocks would provide the investor with the largest reduction in risk?
A) BP / Amoco.
B) Shell Oil Corporation.
C) General Motors.
D) Texaco.

Accepted Answer

The answer of If an investor's primary stock holding is...

Question 4

The random walk theory implies that stock prices
A) go down, then up, and then down again.
B) go up and then down in a predictable pattern.
C) follow systematic trends.
D) are unpredictable based on past trends.

Accepted Answer

The random walk theory states that stock prices are unpredictable and do not follow any predictable pattern based on past trends.

Question 5

Which of the following represents a method for a firm to obtain funds for growth and product development?
A) use of retained earnings
B) borrowing money
C) selling stock
D) all of the above

Accepted Answer

All of the above options (use of retained earnings, borrowing money, selling stock) are methods that firms can use to obtain funds for growth and product development. Using retained earnings means reinvesting profits back into the company, borrowing money involves taking out loans, and selling stock involves issuing shares to outside investors who provide funds in exchange for ownership in the company.

Question 6

Which of the following is true?
A) People who invest in the stock market are virtually certain to make money.
B) Investors in the stock market can reduce their risk if they hold shares of specific stocks for only short periods of time.
C) The risk of stock market investments can be reduced through the holding of a diverse portfolio of unrelated stocks over long periods of time.
D) In the long run, corporate bonds can be expected to yield a higher real rate of return than ownership of stocks.

Accepted Answer

Diversification through holding stocks over long periods of time in a diverse portfolio has been shown to reduce the risk of stock market investments. A and B are both false, as there is no guarantee of making money in the stock market, and holding shares for short periods of time can increase risk. D is also false, as historically stocks have provided a higher real rate of return than bonds over the long run.

Question 7

A lower interest rate will increase the present value of future income and thereby
A) decrease the market value of stocks.
B) increase the market value of stocks.
C) have no effect on the market value of stocks.
D) decrease the discounted market value of stocks.

Accepted Answer

A lower interest rate means that future income streams are discounted at a lower rate, making them more valuable in today's dollars. This makes stocks more attractive to investors, causing an increase in demand for stocks and thus increasing their market value.

Question 8

The present value of $1 million to be received in the future will
A) increase if the interest rate rises.
B) increase if the payment is received at a more distant time in the future.
C) be greater than $1 million.
D) increase if the interest rate were to fall from 8 percent to 4 percent.

Accepted Answer

The answer of The present value of $1 million to...

Question 9

An indexed equity mutual fund
A) is directly tied to either the consumer price index or the GDP deflator.
B) is a fund that hires a manager who will try to pick the stocks that will increase most in value in the future.
C) merely holds stocks in the same proportion as they exist in a broad stock market index like the Standard & Poor's 500.
D) will have high operating costs because these funds engage in a substantial amount of stock trading.

Accepted Answer

An indexed equity mutual fund simply holds stocks in the same proportion as they exist in a broad stock market index like the Standard & Poor's 500. It does not hire a manager to pick stocks, nor is it directly tied to the consumer price index or the GDP deflator. While trading may occur in these funds, they typically have lower operating costs compared to actively managed funds.

Question 10

Stock analysts often argue that lower interest rates are good for the stock market. Does this argument make sense?
A) No; lower interest rates will tend to slow down the economy and this will be bad for the stock market.
B) Yes; the lower rates of interest will increase the value of future income (and capital gains) and stock prices will rise to reflect this factor.
C) No; the lower rates of interest will reduce the value of future income (and capital gains) and this will cause stock prices to fall.
D) Yes; the lower interest rates will cause inflation and inflation is generally good for the stock market.

Accepted Answer

Lower interest rates decrease the cost of borrowing for companies and individuals, which can lead to increased spending, investment, and economic growth. This growth can be reflected in future income and capital gains for companies, making their stocks more valuable. Therefore, the argument that lower interest rates are good for the stock market makes sense.

Question 11

According to the random walk theory, which of the following is true?
A) Stock prices reflect all available information about factors that affect stock prices.
B) Future movements of stock prices are unpredictable.
C) Changes in stock prices are driven by surprise occurrences.
D) All of the above are true.

Accepted Answer

The random walk theory suggests that stock prices reflect all available information, making future movements unpredictable and driven by new, unexpected information.

Question 12

Which of the following is true?
A) The P/E ratio provides information on the price of a stock relative to its current earnings.
B) The P/E ratio provides information on the price of a stock relative to its future earnings.
C) The P/E ratio provides information on the price of a stock relative to its past earnings.
D) The P/E ratio average from 1950-2008 was 26.

Accepted Answer

The P/E ratio (price-to-earnings ratio) compares a stock's current market price to its earnings per share (EPS) over the past 12 months, providing information on the price of a stock relative to its current earnings. B and C are incorrect because the P/E ratio does not take into account future or past earnings, only current earnings. D is irrelevant to the question being asked.

Question 13

(I) The market for new issues of stock is called the primary market. (II) The New York Stock Exchange is an example of a secondary market in which previously issued shares are traded between investors.
A) I is true; II is false.
B) I is false; II is true.
C) Both I and II are true.
D) Both I and II are false.

Accepted Answer

The statement in option I is true as the market in which new issues of stock are sold is called the primary market. The statement in option II is also true as the New York Stock Exchange is an example of a secondary market where previously issued shares are traded between investors. Therefore, both statements I and II are true.

Question 14

Since 1802, the American stock market has yielded an average annual real return (the return adjusted for inflation) of approximately
A) 3 percent.
B) 5 percent.
C) 7 percent
D) 11 percent.

Accepted Answer

According to historical data, the average annual real return of the American stock market since 1802 has been approximately 7 percent.

Question 15

If the interest rate were 12.5 percent, how much would people be willing to pay for a stock that was certain to yield a $20 per share stream of net earnings continuously in the future?
A) $20
B) $25
C) $160
D) $250

Accepted Answer

To calculate the price people would be willing to pay, we can use the perpetuity formula: 
Price = Annual net earnings / Interest rate
Plugging in the values, we get:
Price = $20 / 0.125
Price = $160

Question 16

The current market value of a stock option contract to purchase 1,000 shares of IBM stock at a price of $100 that can be exercised five years from now would
A) increase if the expected future price of IBM stock rose.
B) increase if the expected future price of IBM stock fell.
C) decrease if the expected future price of IBM stock rose.
D) remain unchanged regardless of the expected future price of IBM stock.

Accepted Answer

The current market value of a stock option contract to purchase IBM stock at a price of $100 in five years will increase if the expected future price of IBM stock rises, as this increases the likelihood that the option will be in the money (i.e. the stock price is higher than the strike price) at the time of exercise. This increases the potential profit for the investor holding the option, leading to an increase in market value.

Question 17

Historically, when a diverse set of stocks are held over a lengthy time period, stocks have yielded a ____ rate of return and the variation in the rate of return has been ____. (Fill in the blanks.)
A) low; low
B) low; high
C) high; low
D) high; high

Accepted Answer

Historically, a diverse set of stocks held over a long period has yielded a high rate of return with low variation, due to the benefits of diversification and the general upward trend of stock markets over time.

Question 18

"My broker studies the stock market and the management of specific firms. When he advises me to buy, I listen because he is an expert." Analyze this view.

Accepted Answer

The answer of "My broker studies the stock market and...

Question 19

Which of the following types of mutual funds best describes one in which an "expert" seeks to pick the stock holdings in a way that maximizes the rate of return?
A) indexed equity mutual fund
B) managed equity mutual fund
C) supervised equity mutual fund
D) marked equity mutual fund

Accepted Answer

A managed equity mutual fund involves an expert or team of experts actively selecting which stocks to buy and sell in an attempt to generate higher returns than the overall market. An indexed equity mutual fund, on the other hand, tracks a specific stock index and does not involve expert stock picking. Supervised equity mutual fund and marked equity mutual fund are not commonly used terms in the mutual fund industry.

Question 20

Investors can make their investments in corporate stocks less risky by
A) purchasing shares of a mutual fund, which holds the stocks of many diverse corporations.
B) buying stocks and holding them each for only for short periods of time.
C) investing in firms that are in the same, rather than different, industries.
D) none of the above.

Accepted Answer

By investing in a mutual fund, investors can spread their investments across a diverse portfolio of stocks from multiple corporations, reducing the overall risk of their investment. This is because if one stock performs poorly, it may be offset by the gains of others in the fund. Buying and selling stocks frequently (Option B) can increase risk due to transaction fees and potential losses from market fluctuations. Investing in firms in the same industry (Option C) can increase risk because they may be affected by similar market forces or events.

Quiz 16: Applying the Basics: Special Topics in Economics

Which of the following is true?

Which of the following would reduce the risk of an investment in the stock market?

If an investor's primary stock holding is currently Exxon Mobil, the purchase of which of the following stocks would provide the investor with the largest reduction in risk?

The random walk theory implies that stock prices

Which of the following represents a method for a firm to obtain funds for growth and product development?

Which of the following is true?

A lower interest rate will increase the present value of future income and thereby

The present value of $1 million to be received in the future will

An indexed equity mutual fund

Stock analysts often argue that lower interest rates are good for the stock market. Does this argument make sense?

According to the random walk theory, which of the following is true?

Which of the following is true?

(I) The market for new issues of stock is called the primary market. (II) The New York Stock Exchange is an example of a secondary market in which previously issued shares are traded between investors.

Since 1802, the American stock market has yielded an average annual real return (the return adjusted for inflation) of approximately

If the interest rate were 12.5 percent, how much would people be willing to pay for a stock that was certain to yield a $20 per share stream of net earnings continuously in the future?

The current market value of a stock option contract to purchase 1,000 shares of IBM stock at a price of $100 that can be exercised five years from now would

Historically, when a diverse set of stocks are held over a lengthy time period, stocks have yielded a rate of return and the variation in the rate of return has been . (Fill in the blanks.)

"My broker studies the stock market and the management of specific firms. When he advises me to buy, I listen because he is an expert." Analyze this view.

Which of the following types of mutual funds best describes one in which an "expert" seeks to pick the stock holdings in a way that maximizes the rate of return?

Investors can make their investments in corporate stocks less risky by