Question 1

Historically, which of the following has had the highest average annual rate of return?
A) corporate bonds
B) money market mutual funds
C) corporate stocks
D) U.S. Treasury bonds

Accepted Answer

Historically, corporate stocks have had the highest average annual rate of return, with an average annual return of around 10% over the long term. This is compared to U.S. Treasury bonds with an average annual return of around 5%, corporate bonds with around 6%, and money market mutual funds with around 2-3%. However, it is important to note that this high return comes with a higher risk of volatility and potential losses.

Question 2

Consider a stock with a 50 percent probability of zero net earnings and a 50 percent probability of net earnings equal to $20 per share each year continuously in the future. Furthermore, assume that people are risk averse: That is, they will have to be compensated for uncertainty accompanying variation in their future wealth. If the interest rate were 5 percent, how much would people be willing to pay for a share of this stock?
A) $10
B) $200
C) less than $200
D) more than $200
E) $400

Accepted Answer

The answer of Consider a stock with a 50 percent...

Question 3

Since 1802, the average annual compound return for stock holdings, adjusted for inflation, has been approximately
A) 2 percent.
B) 7 percent.
C) 15 percent.
D) 30 percent.

Accepted Answer

According to historical data, the average annual compound return for stock holdings adjusted for inflation has been around 7 percent since 1802.

Question 4

Which of the following would be most likely to push stock prices higher?
A) higher interest rates and the expectation of larger future corporate profits
B) higher interest rates and the expectation of smaller future corporate profits
C) lower interest rates and the expectation of larger future corporate profits
D) lower interest rates and the expectation of smaller future corporate profits

Accepted Answer

Lower interest rates make it cheaper for companies to borrow money, which could lead to higher earnings and therefore higher stock prices. The expectation of larger future corporate profits also tends to boost stock prices. Therefore, the combination of lower interest rates and the expectation of larger future corporate profits is most likely to push stock prices higher.

Question 5

Which of the following is true?
A) An increase in the interest rate will tend to increase stock prices.
B) A reduction in the interest rate will tend to increase stock prices.
C) An increase in the inflation rate will tend to increase stock prices.
D) There is no reason to believe that changes in interest rates will influence stock prices.

Accepted Answer

When interest rates are reduced, borrowing becomes cheaper, and investors tend to borrow money to invest in the stock market. The increased demand for stocks tends to drive up stock prices. On the other hand, when interest rates are increased, borrowing becomes more expensive, and investors tend to shy away from borrowing money to invest in the stock market. Therefore, a reduction in the interest rate will tend to increase stock prices.

Question 6

Which of the following is true?
A) Most stockholders own stock because they want to participate in the daily decision making of the firms that they own.
B) The shareholders of a large well-established firm can be reasonably sure that they will earn a real rate of return of about 7 percent in the future.
C) The potential losses of shareholders are limited to the amount of their investment.
D) Ownership of a corporate bond provides the bondholder with an ownership right to a fraction of the firm's future profits.

Accepted Answer

The answer of Which of the following is true?
A) Most...

Question 7

During the last sixty years, the broad stock market (Standard and Poor's 500 Index) yielded an average annual nominal rate of return of approximately ____ and real rate of return of approximately ____.
A) 5 percent; 2 percent
B) 10 percent; 7 percent
C) 17 percent; 9 percent
D) 9 percent; 17 percent

Accepted Answer

Over the last sixty years, the stock market (S&P 500 Index) yielded an average annual nominal rate of return of approximately 10 percent and real rate of return of approximately 7 percent. This is based on historical data analysis.

Question 8

A firm's stock price will be higher when the interest rate is ____ and the value of the firm's expected future profits are ____.
A) lower; larger
B) lower; smaller
C) higher; larger
D) higher; smaller

Accepted Answer

The answer of A firm's stock price will be higher...

Question 9

If the interest rate were 10 percent, how much would people be willing to pay for a stock that was certain to yield a $2 per share stream of net earnings continuously in the future?
A) $2
B) $10
C) $20
D) $100

Accepted Answer

The price people would be willing to pay for a stock that yields a continuous $2 per share stream of net earnings can be calculated using the formula Price = Earnings/Interest Rate. Therefore, Price = $2/0.1, which equals $20. Thus, people would be willing to pay $20 for a stock that yields a continuous $2 per share stream of net earnings, assuming an interest rate of 10 percent.

Question 10

Which of the following is true of stocks?
A) Stock ownership is risky because the investor can never be sure what return they will earn or what the value of their stock holdings will be in the future.
B) The riskiness of stocks is one reason why their average rate of return has been higher than investments like bonds that guarantee a specified nominal amount in the future.
C) Both a and b are true.
D) Neither a nor b is true.

Accepted Answer

Stock ownership involves risk because the value of stocks can fluctuate significantly and is uncertain. However, the historical data shows that despite the higher risk, stocks have provided higher average returns than other types of investments like bonds, which have a guaranteed rate of return. Therefore, both options A and B are true statements.

Question 11

Suppose that monetary policy becomes more expansionary, and as a result, the future rate of inflation is higher. Will this be good for the stock market?
A) Yes; the inflation will lead to higher wages, and this will be good for both the economy and the stock market.
B) No; the inflation will lead to higher nominal interest rates, and this will reduce the present value of the future net earnings derived from stocks.
C) Yes; the inflation rate will reduce the long-run rate of unemployment, and this will be good for the stock market.
D) No; the expansionary monetary policy will lead to lower real interest rates, and this is generally bad for both the economy and the stock market.

Accepted Answer

When the future rate of inflation is higher, nominal interest rates rise. When the interest rates rise, the present value of the future net earnings from stocks decreases. This is because future cash flows are discounted at a higher rate. Therefore, stock prices decline, and it is not good for the stock market. Hence, option B is the correct answer. Options A and C are incorrect because higher inflation doesn't necessarily lead to a boost in wages or lower long-run unemployment. Option D is incorrect because lower real interest rates are often considered good for the stock market.

Question 12

The market for new issues of stock is called the
A) primary market.
B) secondary market.
C) The New York Stock Exchange (NYSE).
D) The Chicago Board of Trade.

Accepted Answer

The primary market is where new securities are issued, including stocks, and sold to the public for the first time. The secondary market includes trading of already issued securities, such as stocks, between investors. The NYSE and the Chicago Board of Trade are specific stock exchanges, but they are not the same as the primary market for new stock issues.

Question 13

Which of the following is true?
A) The buyer of a firm's stock is purchasing a fractional share in the firm's future net revenues.
B) When investors believe that a business decision by the management of a firm will increase the firm's future earnings, the price of the firm's stock will tend to rise.
C) Changing stock prices provide the board of directors and managers of a firm with a strong incentive to make good decisions and undertake productive projects.
D) All of the above are true.

Accepted Answer

All of the statements are true. A) When someone buys stock in a company, they are buying a fractional ownership of the company, and thus a share of the future net revenues. B) If investors believe that a company's management has made a decision that will increase earnings, then the value of the stock will increase, as investors anticipate receiving a greater portion of those future earnings. C) When stock prices change, it can incentivize the board of directors and managers to make decisions and undertake projects that will increase the company's value and thus, the value of the stock.

Question 14

Which of the following is true?
A) The stock market provides investors with an opportunity to own a fractional share of the firm's future profits.
B) A new stock issue is often an excellent way for a firm to raise funds for future expansion.
C) Changes in stock prices provide information about what investors think of various business decisions.
D) All of the above are true.

Accepted Answer

All of the statements are true. A) Investing in the stock market allows investors to own a portion of the firm's future profits. B) Companies often issue stocks to raise capital for expanding their operations. C) Fluctuations in stock prices can indicate how investors perceive a company's decisions and financial health.

Question 15

During the last two centuries, after adjustment for inflation,
A) corporate bonds have yielded a real return of approximately 7 percent annually, compared to a real return of about 3 percent for corporate stocks.
B) corporate stocks have yielded a real return of approximately 7 percent annually, compared to a real return of about 3 percent for bonds.
C) both corporate stocks and bonds have yielded a real rate of return of about 3 percent.
D) both corporate stocks and bonds have yielded a real rate of return of about 7 percent.

Accepted Answer

According to the text, during the last two centuries, after adjustment for inflation, corporate stocks have yielded a real return of approximately 7 percent annually, compared to a real return of about 3 percent for corporate bonds.

Question 16

Which of the following is a risk that investors undertake when purchasing stocks?
A) An individual stock can rise and fall unpredictably.
B) Nearly all stocks in the stock market may rise or fall together, when expectations about the entire economy change.
C) Both a and b are true.
D) Neither a nor b is true.

Accepted Answer

Both options a and b are true risks that investors undertake when purchasing stocks. The value of individual stocks can experience unpredictable fluctuations due to various factors such as company performance or market volatility. In addition, overall market trends can impact stocks in a similar fashion, leading to changes in the values of most stocks simultaneously. Therefore, investors should be aware of both risks when considering buying stocks.

Question 17

If the interest rate were 5 percent, how much would people be willing to pay for a stock that was certain to yield a $10 per share stream of net earnings continuously in the future?
A) $10
B) $20
C) $200
D) $400
E) $2,000

Accepted Answer

To calculate the present value of a perpetuity, we divide the annual payment by the interest rate. In this case, the annual payment is $10, and the interest rate is 5%, so the present value is $10 / 0.05 = $200. Therefore, people would be willing to pay $200 for a stock that yields a $10 per share stream of net earnings continuously in the future.

Question 18

Which of the following would tend to increase the value of a future stream of income?
A) an increase in the rate of inflation
B) an increase in the interest rate
C) a reduction in the interest rate
D) a reduction in the size of the expected future income

Accepted Answer

The answer of Which of the following would tend to...

Question 19

Which of the following would be most likely to cause the price/earnings ratio of stocks to rise?
A) the expectation of a recession in the near future
B) the expectation of inflation in the near future
C) higher interest rates
D) lower interest rates

Accepted Answer

A lower interest rate environment makes stocks more attractive to investors as they seek higher returns on their investments, causing the demand for stocks to increase and subsequently driving up the price/earnings ratio.

Question 20

To the extent that current profits are directly related to future profits, a high price/earnings ratio would indicate that stocks are
A) inexpensive.
B) expensive.
C) going to increase in value in the future.
D) most likely to fall in value if interest rates decline.

Accepted Answer

A high price/earnings ratio indicates that investors are willing to pay a higher price for each dollar of current earnings. This suggests that the earnings growth of the company is expected to be strong in the future, leading to higher future profits. Therefore, stocks with high price/earnings ratios are considered expensive as the expected future profits are already reflected in the current price.

Quiz 16: Applying the Basics: Special Topics in Economics

Historically, which of the following has had the highest average annual rate of return?

Since 1802, the average annual compound return for stock holdings, adjusted for inflation, has been approximately

Which of the following would be most likely to push stock prices higher?

Which of the following is true?

Which of the following is true?

During the last sixty years, the broad stock market (Standard and Poor's 500 Index) yielded an average annual nominal rate of return of approximately and real rate of return of approximately .

A firm's stock price will be higher when the interest rate is and the value of the firm's expected future profits are .

If the interest rate were 10 percent, how much would people be willing to pay for a stock that was certain to yield a $2 per share stream of net earnings continuously in the future?

Which of the following is true of stocks?

Suppose that monetary policy becomes more expansionary, and as a result, the future rate of inflation is higher. Will this be good for the stock market?

The market for new issues of stock is called the

Which of the following is true?

Which of the following is true?

During the last two centuries, after adjustment for inflation,

Which of the following is a risk that investors undertake when purchasing stocks?

If the interest rate were 5 percent, how much would people be willing to pay for a stock that was certain to yield a $10 per share stream of net earnings continuously in the future?

Which of the following would tend to increase the value of a future stream of income?

Which of the following would be most likely to cause the price/earnings ratio of stocks to rise?

To the extent that current profits are directly related to future profits, a high price/earnings ratio would indicate that stocks are