Deck 15: Financial Markets and Expectations

Question 1

Which of the following statements about indexed bonds is correct?

A)they were relatively recently introduced in the United States.
B)they exist in England.
C)they have a nominal interest rate that rises when the inflation rate rises.
D)all of the above
E)none of the above

Answer 1

D

Question 2

Equity finance is represented by which of the following?

A)when a firm borrows money from banks
B)when a firm sells bonds
C)when a firm sells shares of stock
D)when a firm draws down retained earnings
E)when a firm sells off part of its capital stock

Answer 2

C

Question 3

The fundamental value of a share of stock is equal to which of the following?

A)the sum of expected dividends
B)the present value of expected dividends
C)the sum of coupon payments
D)the present value of coupon payments
E)the present value of the expected yield

Answer 3

B

Question 4

For this question,assume that there is perfect arbitrage in the stock market.Given this assumption,economists believe that

A)movements in stock prices can be easily predicted.
B)movements in stock prices are largely unpredictable.
C)most stocks will diverge from their fundamental value.
D)stocks will generally earn a lower rate of return than bonds.
E)the rate of return on stocks will be equal to the rate of return on bonds.

Question 5

A share of stock will pay a dividend of $25 in one year,and will be sold for an expected price of $500 at that time.If the current one-year interest rate is 5%,the current price of the stock will be approximately equal to

A)$100.
B)$475.
C)$500.
D)$525.
E)none of the above

Question 6

Suppose financial market participants expect short-term rates in the future to be less than current short-term interest rates.Given this information,we would expect

A)an upward sloping yield curve.
B)a downward sloping yield curve.
C)an upward shifting yield curve.
D)a downward shifting yield curve.
E)a horizontal yield curve.

Question 7

A bond has a face value of $10,000,a price of $12,000,and coupon payments of $2000 for two years.The coupon rate of this bond is

A)10%.
B)16.7%.
C)20%.
D)30%.
E)none of the above

Question 8

Suppose the current one-year interest rate is 4%.Also assume that financial markets expect the one-year interest rate next year to be 5%,and expect the one-year rate to be 6% the year after that.Given this information,the yield to maturity on a three-year bond will be approximately

A)4%.
B)5%.
C)6%.
D)15%.

Question 9

Suppose there is a decrease in the short-term interest rate.Give this reduction in the current short-term interest rate,which of the following will most likely occur?

A)the long-term interest rate will increase.
B)the long-term interest rate will remain the same.
C)the long-term interest rate will decrease by more than the short-term rate.
D)the long-term interest rate will decrease by the same amount as the short-term rate.
E)the long-term interest rate will decrease,but by less than the short-term rate.

Question 10

For this question,assume that one-year and two-year bonds have the same risk; therefore,you can ignore risk here.Assuming that there is arbitrage between one-year bonds and two-year bonds,we know that the expected rate of return on two-year bonds

A)will equal the expected rate of return from holding a one-year bond for one year.
B)will equal the expected rate of return from holding a one-year bond for two years.
C)will be larger than the expected rate of return from holding a one-year bond for one year.
D)will be smaller than the expected rate of return from holding a one-year bond for one year.
E)will be exactly half the rate of return on one-year bonds.

Question 11

A discount bond is a bond

A)with no coupon payments.
B)where the price of the bond is greater than its face value.
C)where the interest rate is zero.
D)where the face value is zero.
E)that never matures.

Question 12

Among the following,which is the broadest measure of stock prices in the United States?

A)Dow Jones Index
B)FT index
C)Nikkei Index
D)Term Structure Index
E)Standard and Poor's 500 Composite Index

Question 13

Assume that the current one-year rate is 5% and the two-year rate is 7%.Given this information,the one-year rate expected one year from now is

A)5%.
B)6%
C)7%
D)9%
E)12%

Question 14

An upward-sloping yield curve suggests that financial market participants expect short-term interest rates will

A)rise in the future.
B)fall in the future.
C)be unstable in the future.
D)not change in the future.
E)be equal to zero in the future.

Question 15

A "junk bond" is a bond with a

A)low yield to maturity.
B)value of zero.
C)low face value,but high coupon rate.
D)high default risk.
E)very low maturity.

Question 16

Which of the following bonds (of equal maturity)would have the largest risk premium?

A)U.S.government bonds
B)German government bonds
C)the bonds of a financially stable corporation,like IBM
D)Bondsbrated Aaa by Moody's
E)junk bonds

Question 17

A bond has a face value of $1,000,a price of $1,200,and coupon payments of $100 for two years.The "current yield" of this bond is

A)8.33%.
B)10%.
C)12%.
D)83%.
E)none of the above

Question 18

Suppose the current one-year interest rate is 4%,and financial markets expect the one-year interest rate next year to be 8%.Given this information,the yield to maturity on a two-year bond will be approximately

A)4%.
B)6%.
C)8%.
D)12%.
E)none of the above

Question 19

Which of the following best explains why the long-term interest rate will generally change by less than 1% when the short-term interest rate changes by 1%?

A)the mathematical calculations are more difficult for analysts in the case of long-term bonds.
B)long-term rates are always lower than short-term rates,so there is less room for them to change.
C)financial market participants will not expect this increase in the short-term interest rate to persist fully in the future.
D)financial markets are often affected by bubbles and fads.
E)none of the above

Question 20

The length of time over which a bond promises to make payments to the holder is called which of the following?

A)the term structure of interest rates
B)the face value
C)the yield to maturity
D)the holding period
E)none of the above

Question 21

An expected tax increase will tend to cause

A)an increase in stock prices.
B)a reduction in stock prices.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 22

Suppose there are two types of bonds (one-year bonds and two-year bonds)and that the yield curve is initially upward sloping in period t.Note: For this question assume that: (1)expected inflation is zero; and (2)the relevant interest rate on the vertical axis of the IS-LM model is the one-year interest rate.Based on our understanding of the IS-LM model,of the yield curve and of financial markets,we know with certainty that an announcement in period t of a partially unexpected future increase in taxes (to be implemented in period t+1)will have which of the following effects?

A)stock prices will increase in period t
B)stock prices will fall in period t
C)the yield curve will become steeper in period t
D)none of the above

Question 23

Suppose policy makers implement a fiscal expansion that is NOT fully anticipated by financial market participants.We know that this will

A)always cause stock prices to fall.
B)always cause stock prices to rise.
C)tend to cause stock prices to rise if the LM curve is very flat.
D)tend to cause stock prices to rise if the LM curve is vertical.

Question 24

An unexpected reduction in the money supply will tend to cause

A)an increase in stock prices.
B)a reduction in stock prices.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 25

An expected reduction in the money supply will tend to cause

A)an increase in stock prices.
B)a reduction in stock prices.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 26

Which of the following represents the ratio of coupon payments to the face value of a bond?

A)the interest rate
B)the discount rate
C)the coupon rate
D)the risk premium
E)the current yield

Question 27

An expected tax cut will tend to cause

A)an increase in stock prices.
B)a reduction in stock prices.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 28

An expected increase in the money supply will tend to cause

A)an increase in stock prices.
B)a reduction in stock prices.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 29

Assume that the one-year interest rate is on the vertical axis of the IS-LM model and that the yield curve is initially upward sloping.Suppose that financial market participants expect that the central bank will pursue a monetary contraction in the future.Given this information,we would expect which of the following to occur?

A)the yield curve will become steeper
B)the yield curve will become flatter
C)the yield curve will become horizontal
D)the yield curve will become downward sloping

Question 30

Which of the following variables would NOT influence the ex-dividend price of a share of stock at time t?

A)i1et+1
B)i1t
C)$Det+1
D)none of the above

Question 31

Suppose policy makers implement an unexpected fiscal expansion.Further assume that monetary policy is expected to keep interest rates constant in response to this unexpected fiscal expansion.Given this information,we would expect that

A)stock prices will rise.
B)stock prices will remain constant.
C)this policy will have an ambiguous effect on stock prices.
D)the effect on stock prices will depend on the slope of the IS curve.

Question 32

Which of the following does NOT represent a form of debt finance?

A)bonds
B)loans
C)stock
D)all of the above

Question 33

An unexpected increase in the money supply will tend to cause

A)an increase in stock prices.
B)a reduction in stock prices.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 34

Suppose households unexpectedly increase consumption.Which of the following will occur as a result of this unexpected increase in consumption?

A)an increase in stock prices
B)a reduction in stock prices
C)no change in stock prices
D)an ambiguous effect on stock prices

Question 35

Suppose the central bank implements a monetary expansion that is NOT fully anticipated by financial markets.Given this information,we would expect

A)stock prices to rise.
B)stock prices to fall.
C)stock prices to remain unchanged.
D)an ambiguous effect on stock prices.
E)none of the above

Question 36

Suppose a bond promises to make a single payment at maturity.These types of bond are called

A)junk bonds.
B)indexed bonds.
C)corporate bonds.
D)discount bonds.
E)constant maturity bonds.

Question 37

Suppose the central bank implements a monetary contraction that is fully expected by financial market participants.Given this information,we would expect

A)stock prices to rise.
B)stock prices to fall.
C)stock prices to remain unchanged.
D)an ambiguous effect on stock prices.
E)stock prices to fall and the interest rate to rise.

Question 38

Which of the following represents a form of equity finance?

A)stock
B)loans
C)bonds
D)all of the above
E)none of the above

Question 39

Which of the following represents a stock's fundamental value?

A)the price the stock would sell at in the midst of a rational bubble
B)the price the stock would sell at if the interest rate were zero
C)the present value of its expected future dividend payments
D)the simple sum of its future dividend payments
E)none of the above

Question 40

Suppose households unexpectedly decrease consumption.Which of the following will occur as a result of this unexpected reduction in consumption?

A)an increase in stock prices
B)a reduction in stock prices
C)no change in stock prices
D)an ambiguous effect on stock prices

Question 41

The yield curve is

A)the term structure of interest rates.
B)the relation between maturity and yield of a bond.
C)maturity.
D)both A and B
E)all of the above

Question 42

As the LM curve becomes steeper,an unexpected decrease in consumer confidence

A)will cause a relatively large increase in output and relatively large increase in the interest rate.
B)will cause a relatively small increase in output and relatively small increase in the interest rate.
C)is more likely to cause stock prices to rise.
D)is more likely to cause stock prices to fall.

Question 43

As the LM curve becomes steeper,an unexpected increase in consumer confidence

A)will cause a relatively large increase in output and relatively large increase in the interest rate.
B)will cause a relatively small increase in output and relatively small increase in the interest rate.
C)is more likely to cause stock prices to rise.
D)is more likely to cause stock prices to fall.

Question 44

Suppose that financial market participants expect that the central bank will pursue a monetary expansion in the future.Also assume that the yield curve is initially upward sloping.Given this information,we would expect which of the following to occur?

A)the yield curve will become steeper
B)i2t will increase
C)i2t will decrease
D)the yield curve will become downward sloping

Question 45

Suppose the yield curve is initially horizontal.Suppose the current one-year interest rate increases by 4% while the expected future one-year interest rate does not change.Which of the following will tend to occur?

A)i2t will increase by 4%
B)i2t will increase by 2%
C)i2t will increase by less than 2%
D)i2t will decrease by 2%

Question 46

Which of the following represents the ratio of coupon payments to the price of a bond?

A)the interest rate
B)the discount rate
C)the coupon rate
D)the risk premium
E)the current yield

Question 47

For this question,assume that the Fed is expected to respond to any event by keeping the interest rate constant (i.e.,equal to its initial level).An unexpected tax increase will cause

A)stock prices to fall.
B)stock prices to rise.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 48

When interpreting bond prices as present values,discuss what factors determine the price of a two-year discount bond.Include in your answer an explanation of how changes in each of these factors affects the price of a two-year discount bond.

Question 49

Which of the following bonds (of equal maturity)would have the lowest risk premium?

A)U.S.government bonds
B)German government bonds
C)the bonds of a financially stable corporation,like IBM
D)Bonds rated Aaa by Moody's
E)junk bonds

Question 50

Explain what the term structure of interest rates represents.

Question 51

A bond has a face value of $10,000,a price of $12,000,and coupon payments of $2000 for two years.The current yield of this bond is

A)10%.
B)16.7%.
C)20%.
D)30%.
E)none of the above

Question 52

Suppose that financial market participants now expect a future tax increase in one year.Also assume that the yield curve is initially upward sloping.Given this information,we would expect which of the following to occur?

A)the yield curve will become steeper
B)i2t will increase
C)i2t will decrease
D)the yield curve will become downward sloping

Question 53

For this question,assume that the Fed is expected to respond to any event by keeping the interest rate constant (i.e.,equal to its initial level).An unexpected tax cut will cause

A)stock prices to fall.
B)stock prices to rise.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 54

Suppose that financial market participants now expect a future tax cut and that the yield curve is initially upward sloping.Given this information,we would expect which of the following to occur?

A)the yield curve will become steeper
B)the yield curve will become flatter
C)the yield curve will become horizontal
D)the yield curve will become downward sloping

Question 55

A share of stock will pay a dividend of $20 in one year,and will be sold for an expected price of $500 at that time.If the current one-year interest rate is 5%,the current price of the stock will be approximately equal to

A)$100.
B)$495.
C)$500.
D)$525.
E)none of the above

Question 56

The yield curve indicates that the two-year interest rate will be a function of what variables? Include in your answer an explanation of how changes in these variables will affect the two-year interest rate.

Question 57

For this question,assume that the Fed is expected to respond to any event by keeping output constant (i.e.,equal to its initial level).An unexpected increase in taxes will cause

A)stock prices to fall.
B)stock prices to rise.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 58

Assume that the current one-year rate is 3% and the two-year rate is 5%.Given this information,the one-year rate expected one year from now is

A)5%.
B)6%.
C)7%.
D)9%.
E)12%.

Question 59

Suppose the current one-year interest rate is 3%,and financial markets expect the one-year interest rate next year to be 5%.Given this information,the yield to maturity on a two-year bond will be approximately

A)4%.
B)6%.
C)8%.
D)12%.
E)none of the above

Question 60

For this question,assume that the Fed is expected to respond to any event by keeping output constant (i.e.,equal to its initial level).An unexpected increase in government spending will cause

A)stock prices to fall.
B)stock prices to rise.
C)no change in stock prices.
D)an ambiguous effect on stock prices.

Question 61

Suppose the Fed implements a monetary expansion that is at least partially unexpected.Explain what effect this will have on stock prices.

Question 62

Suppose the central bank implements a monetary contraction in the current period and is not expected to continue this policy in the future.Explain what effect this policy will have on the shape of the yield curve and on stock prices.

Question 63

Give two explanations why stock prices might deviate from their fundamental values.

Question 64

Suppose a cut in government spending occurs that is at least partially unexpected.Explain what effect this will have on stock prices.

Question 65

Suppose individuals expect an increase in future taxes.Explain what effect this expected increase in future taxes will have on the yield curve and on stock prices in the current period.

Question 66

Some economists argue that there were good reasons for housing price to rise.Explain their argument.

Question 67

Suppose an increase in government spending occurs that is at least partially unexpected.Explain what effect this will have on stock prices.

Question 68

Suppose the central bank implements a monetary expansion in the current period and is not expected to continue this policy in the future.Explain what effect this policy will have on the shape of the yield curve and on stock prices.

Question 69

Explain what is meant by the fundamental value of a share of stock.

Question 70

Suppose individuals expect a cut in future taxes.Explain what effect this expected reduction in future taxes will have on the yield curve and on stock prices in the current period.

Question 71

Suppose the yield curve is downward sloping.How should one interpret this particular yield curve?

Question 72

Suppose the yield curve is upward sloping.How should one interpret this particular yield curve?

Question 73

Suppose there is a report that the unemployment rate unexpectedly increased in the previous month.To what extent will the expected central bank response to this news affect how stock prices will respond to this report of a higher than expected unemployment rate? Explain.