Deck 13: The Financial Markets

Question 1

The total return on a share of stock is

A) the total of dividends plus the change in the stock price over a year.
B) the original price of the stock, divided by the change in the stock price.
C) the change in the stock price, plus the dividend, divided by the original price.
D) the total of dividends over a year, divided by the change in the stock price.

Answer 1

C
Explanation: The total return on a share of stock is the change in the stock price, plus the dividend, divided by the original price.

Question 2

If the demand for loans increases,the interest rate will fall.

Answer 2

False
Explanation: If demand increases, the demand curve shifts to the right, pushing interest rates up along the supply curve for loans.

Question 3

Borrowing generally slows an economy down because borrowers must pay interest as well as returning the principal of the loan.

Answer 3

False
Explanation: Interest is payable to the lender, who gains, and borrowers are able to make productive use of the borrowed funds, so the borrowing helps the economy.

Question 4

The time value of money is

A) the benefit of borrowing money.
B) the opportunity cost of not having your money available to you.
C) also known as the credit score.
D) also known as price appreciation.

Question 5

Which of the following describes the risk-return principle?

A) In most financial markets, the greater the risk, the lower the rate of return.
B) In a financial market, the only way to get consistently higher returns over the long run is to take more risks.
C) In a stock market, the higher the price of the stock, the greater the risk incurred by the investor.
D) An investment or loan has less risk if it is likely to lose value at the same time your other investments or loans do.

Question 6

Financial intermediaries that provide start-up capital for risky new businesses are called

A) stock markets.
B) investment banks.
C) stockbrokers.
D) venture capital firms.

Question 7

The possibility of not getting paid back on a loan is known as

A) the risk of default.
B) arbitrage.
C) financial intermediation.
D) deposit risk.

Question 8

Which of the following is a loan that entitles the lender to get regular interest payments over time,and then to get back the principal at the end of the term of the loan?

A) A share of stock.
B) A bond.
C) A mutual fund.
D) A revolving credit account.

Question 9

A share of stock indicates that the company owes money to the person owning the share.

Question 10

The danger that the overall price level will rise faster than anticipated,so that the lender is being paid back in dollars that are worth less than expected,is called

A) credit risk.
B) event risk.
C) inflation risk.
D) default risk.

Question 11

The S&P 500 is a list of the 500 most successful stock market investors.

Question 12

In the United States,bank deposits up to a certain amount are insured by the FDIC.

Question 13

Public companies are companies that

A) are owned or managed by the federal government.
B) have not yet had an initial public offering.
C) act as financial intermediaries.
D) have sold shares of stock to the general public.

Question 14

Publicly traded companies are required by law to pay out their profits to shareholders in payments called dividends.

Question 15

When companies first sell shares to the public,this is called

A) an initial public offering.
B) venture capital funding.
C) microcredit financing.
D) primary lending.

Question 16

Bonds are considered fixed-income securities because they pay a fixed amount of interest per quarter or per year for the term of the loan.

Question 17

Splitting money across different investments (diversification)reduces risk but also reduces the rate of return,according to the risk-return principle.

Question 18

The U.S.government funds the federal budget deficit by

A) selling securities such as Treasury bonds and Treasury bills.
B) selling stock in government-owned corporations
C) selling shares in gold owned by the Federal Reserve via special drawing rights.
D) borrowing from large private banks at favorable terms and low interest rates.

Question 19

A stronger economy will typically result in a shift of the demand curve for loans to the left.

Question 20

The length of a loan is called the term.

Question 21

Event risk is the possibility that

A) a borrower will face some circumstance that will prevent the borrower from paying the loan back.
B) a major catastrophic occurrence, such as a hurricane, flood, or terrorist attack, will lower the return on the investment.
C) the overall price level will rise faster than expected, so that the lender is repaid in dollars that are worth less than the lender expected.
D) the lender will go bankrupt before the loan is fully repaid.

Question 22

The main way corporations and governments raise money is through

A) the stock market.
B) the bond market.
C) loans from banks.
D) the equity credit channel.

Question 23

In addition to interest on loans,another major source of funds for banks is

A) the fees charged to depositors.
B) interest-free loans from the Federal Reserve to banks.
C) subsidies from the U.S. Treasury.
D) inflation.

Question 24

A share of ownership in a company is called a

A) bond.
B) dividend.
C) share of stock.
D) mortgage.

Question 25

Individual investors wishing to buy shares of stock will typically purchase them from

A) venture capital firms.
B) investment banks, through an initial public offering.
C) stockbrokers.
D) the company that initially issued the shares of stock.

Question 26

A share of stock is best defined as a

A) nontransferable loan backed by real estate.
B) transferable loan backed by the assets of the company.
C) share of ownership in a company.
D) loan that commits the borrower to make regular interest payments over time, and then repay the principal.

Question 27

Which of the following would you expect to see for borrowers with a high risk of default?

A) A surplus of loans to these borrowers.
B) A supply curve that is further to the right than the supply curve for low-risk borrowers.
C) A lower interest rate.
D) A higher interest rate.

Question 28

Which of the following statements about the stock market is true?

A) Government regulation ensures that the stock market will go up each year, even if month to month there may be declines in stock values.
B) People who want to buy shares of stock in an established company will generally contact a representative of a venture capital firm.
C) Some investors diversify by investing in a group of many different stocks, such as those in the S&P 500 Index.
D) Diversifying by buying shares of stock in many different companies can eliminate the risk taken by the stock investor.

Question 29

Which of the following is the best definition of a stock index?

A) A measure of the prices of a group of stocks, such as the Dow Jones Industrial Average or the S&P 500.
B) A mutual fund made up of a group of stocks and sold through a firm such as Vanguard or Fidelity.
C) A category of stocks whose value is indexed to the inflation rate to safeguard the investor against inflation risk.
D) A control the Federal Reserve places on the stock market via margin requirements, whereby the Fed indexes margin requirements to inflation.

Question 30

For one person to be willing to lend money to another person,the interest rate must be high enough to compensate the lender for

A) the risk of deflation and bearing the risk of default.
B) the time value of money and bearing the risk of default.
C) the opportunity cost of risk and the principal.
D) the certainty of default and the certainty of inflation.

Question 31

Suppose you come up with a wonderful new invention,and after borrowing as much as you can from a bank,you believe that additional capital is needed to make the invention marketable.Your small new company would be most likely to find additional capital from

A) issuing bonds.
B) borrowing from a different bank.
C) an initial public offering.
D) a venture capital firm.

Question 32

Which of the following is not a type of consumer loan?

A) A student loan.
B) Credit card purchases for household items.
C) A mortgage used to purchase an owner-occupied house.
D) A loan taken out by a young entrepreneur to finance the purchase of a lawnmower for a summer landscaping business.

Question 33

A bond is best defined as a

A) revolving loan that allows the borrower to borrow as needed from a line of credit at a bank.
B) share of ownership in a company.
C) loan that commits the borrower to make regular interest payments over time, and then repay the principal at the end of the loan period.
D) nontransferable loan backed by real estate.

Question 34

Measures of the prices of groups of stocks,such as the Dow Jones Industrial Average and the S&P 500,are called

A) Mutual funds.
B) Secondary markets.
C) Index funds.
D) Stock indexes.

Question 35

Which of the following would you tend to see in a growing economy?

A) The demand curve for loans shifting to the right.
B) The supply curve for loans shifting to the left.
C) The interest rate falling.
D) The quantity of loans falling.

Question 36

The supply curve for loans to high-risk borrowers is _________ the supply curve for loans to low-risk borrowers.

A) below
B) more elastic than
C) to the right of
D) to the left of

Question 37

Which of the following statements about stock-issuing firms is FALSE?

A) Firms that issue stock for the first time do so through an initial public offering, handled by an investment bank.
B) Firms that pay dividends cannot lose money for their investors because the stockholders can at least count on the dividend payment every year.
C) Firms that issue new stock a second time are making a secondary public offering.
D) Firms that issue stock are participating in the equity credit channel.

Question 38

Funds that banks lend to borrowers come from

A) the Federal Reserve.
B) depositors.
C) the U.S. Treasury.
D) the bank's stockholders.

Question 39

Which of the following will happen if the supply of loans increases?

A) The interest rate will fall, and the quantity of money borrowed will increase.
B) The interest rate will fall, and the quantity of money borrowed will decline.
C) The interest rate will rise, and the quantity of money borrowed will increase.
D) The interest rate will rise, and the quantity of money borrowed will decline.

Question 40

Which of the following statements about venture capital firms is FALSE?

A) Venture capital firms get most of their capital from pension funds, large university endowments, and other institutions that can take substantial risks with a small portion of their funds.
B) Most start-up companies that acquire venture capital eventually turn out to be successes.
C) Venture capital firms invest in high-risk, high-potential firms.
D) Companies that acquire their funds from venture capital firms may initially have trouble acquiring capital from other channels.

Question 41

Suppose the interest rate falls,and the quantity of money borrowed (and lent)increases.Which of the following could have caused this to occur?

A) A decrease in the supply of loans to the lending market.
B) A decrease in the demand for loans in the lending market.
C) An increase in the supply of loans to the lending market.
D) An increase in the demand for loans in the lending market.

Question 42

Where do banks get their money,and what do they do with the money once they have it? How do banks make a profit?

Question 43

A secondary public offering occurs when a

A) stockbroker resells stock to a customer in the secondary market.
B) bankrupt firm's assets are sold to bondholders at auction.
C) venture capital firm takes a successful acquisition and goes public with it, selling its stock on the open stock market.
D) firm that has already issued stock issues new stock again.

Question 44

How are banks and venture capital firms different?

A) Banks are financial intermediaries.
B) Venture capital firms provide funds to businesses.
C) Banks receive funds from the suppliers of capital.
D) Venture capital firms expect quite a few of their investments to fail.

Question 45

The Federal Reserve

A) did not pay close enough attention to derivatives in the period leading up to the financial crisis.
B) should not have promoted the use of complicated financial derivatives the way it did during the financial crisis.
C) could have prevented the financial crisis through the use of complicated financial derivatives.
D) is not legally authorized to monitor or regulate complicated financial derivatives.

Question 46

Treasury securities with terms as short as one month are known as

A) Treasury bonds.
B) Treasury loans.
C) Treasury bills.
D) Treasury dollars.

Question 47

Suppose the price of one share of a particular stock fell from $26.25 to $24.75 over the course of a year,and the stock paid a dividend of $0.90 per share during the same year.What was the total return on the share of stock?

A) -5.7 percent.
B) 9.1 percent.
C) 2.4 percent.
D) -2.3 percent.

Question 48

Which of the following best describes inflation risk?

A) The chance that a borrower will fail to repay a loan on time or default on the loan.
B) The chance that a major destructive event will reduce the rate of return on an investment.
C) The chance that the Federal Reserve will reduce the money supply, causing the borrower to have difficulty repaying the loan.
D) The danger that the overall price level will rise faster than the lender expected, so that the lender is paid back in dollars that are worth less than expected.

Question 49

The principal on a bond is generally paid back

A) right away, before any interest has been paid.
B) at the end of the term of the bond, after the interest has been paid.
C) in small increments over the term of the bond, at the same time that any interest has been paid.
D) never, because bonds offer only interest payments, not principal repayment.

Question 50

Which of the following is NOT true about banks?

A) Banks are tightly regulated by state and federal governments.
B) Banks are required to keep a certain amount of cash reserves.
C) Banks are an example of a financial intermediary.
D) Banks are sellers, not buyers, in the market for money.

Question 51

In a well-functioning financial market,the only way to get consistently higher returns over the long run is to take more risks.This is known as the

A) risk-return principle.
B) diversification principle.
C) fixed income principle.
D) price appreciation principle.

Question 52

Banks generally do NOT provide

A) Mortgages to individuals.
B) Consumer loans.
C) Venture capital funding.
D) Loans to well-established businesses.

Question 53

Which of the following companies would be most likely to use the bond market to raise capital?

A) A sole proprietorship grossing $100,000 a year, in which the owner is a full-time consultant and has no employees.
B) A large, growing firm trying to expand its business.
C) A small technology firm with high potential but a great deal of risk.
D) A partnership of five attorneys that wishes to borrow money to buy a larger office building.

Question 54

Why is the interest rate on U.S.Treasury securities lower than on other types of bonds?

Question 55

Suppose the price of one share of a particular stock rose from $10.15 to $12.05 over the course of a year,and the stock paid a dividend of $1.00 per share during the same year.What was the total return on the share of stock?

A) 28.6 percent.
B) 18.7 percent.
C) 8.9 percent.
D) 15.8 percent.

Question 56

Suppose the price of one share of a particular stock rose from $9.00 to $9.15 over the course of a year,and the stock paid a dividend of $0.60 per share during the same year.What was the total return on the share of stock?

A) 1.7 percent.
B) 6.7 percent.
C) 8.3 percent.
D) 25.0 percent.

Question 57

The financial crisis of 2007-2009 was primarily the result of

A) the bursting of the stock market bubble.
B) the bursting of the housing market bubble.
C) excessive tax rates.
D) inflation fighting by the Federal Reserve.

Question 58

Show,using a supply and demand diagram,why we would expect a stronger economy to result in higher interest rates.

Question 59

When buyers believe that rising prices will continue to rise,this can lead directly to

A) bankruptcy.
B) deflation.
C) a bubble.
D) a burst.

Question 60

With respect to financial markets,how were the late 1990s like the early part of the 2000s?

A) In both periods, there were bubbles in important markets.
B) During both periods, the housing market experienced wild ups and downs.
C) A stock market bubble burst during both periods.
D) These two periods are not alike in any way relative to financial markets.

Question 61

Suppose the ABC Corporation had a stock price of $56.80 on December 31,2006.On December 30,2007,it has a stock price of $60.15.Over the year,it paid $2.00 in dividends per share.Calculate the total return of a share of ABC Corporation stock in 2007,showing your work.

Question 62

Paul has started a small software company and has used his personal savings and personal loans from banks and relatives so far.However,a substantial amount of money is still needed to fund expansion if Paul's company is to have a chance to grow and succeed.Briefly describe four different sources of capital,and explain which one you think Paul will use.