Question 1

If the demand for an asset increases, its price will
A)increase and the rate of return for new investors of this asset will increase.
B)decrease and the rate of return for new investors of this asset will increase.
C)decrease and the rate of return for new investors of this asset will decrease.
D)increase and the rate of return for new investors of this asset will decrease.

Accepted Answer

When the demand for an asset increases, its price typically increases due to higher competition for the asset. However, for new investors buying at this higher price, the future rate of return is likely to be lower compared to buying at a lower price, as the potential for price appreciation is reduced and the cost of investment is higher.

Question 2

Assume that two firms (Firm A and Firm B) are 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.

Accepted Answer

If Firm A's stock has a higher rate of return than Firm B's stock, investors will buy Firm A's stock and sell Firm B's stock in order to profit from the difference in returns. This is known as arbitrage. Therefore, the best choice is to buy Firm A's stock and sell Firm B's stock.

Question 3

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.

Accepted Answer

Risk in finance refers to the uncertainty or likelihood of a financial outcome being different than expected, which could be positive or negative. Therefore, it is not mostly positive or negative (A and B), nor is it the same thing as risk in health science (D).

Question 4

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, Rick had instead paid $300,000, and his monthly profits were 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.

Accepted Answer

Without a recession, the annual profit is $10,000 * 12 = $120,000, so the rate of return is $120,000 / $500,000 = 24%. With a recession, the annual profit is $6,000 * 12 = $72,000, so the rate of return is $72,000 / $300,000 = 24%. Thus, the rate of return remains the same.

Question 5

An investor owns bond #1, which 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.

Accepted Answer

The investor is engaging in arbitrage, which involves taking advantage of price differences between two securities with equal risk to earn a higher return.

Question 6

"Do not put all your eggs in one basket" is advice that seeks to reduce
A)idiosyncratic risk.
B)nondiversifiable risk.
C)systemic risk.
D)market risk.

Accepted Answer

The advice "do not put all your eggs in one basket" is related to the concept of diversification, which aims to reduce idiosyncratic (or company-specific) risk by spreading investments across different companies or assets. By investing in a variety of assets, an investor can decrease the impact that any one asset may have on their overall portfolio. Therefore, choice A is the correct answer. Nondiversifiable risk (also known as systematic or market risk) relates to factors that affect the entire market, such as changes in interest rates or geopolitical events, and cannot be mitigated through diversification. Systemic risk is similar to nondiversifiable risk, as it refers to risks that affect an entire system or industry. Market risk relates to the risk of losses due to market movements.

Question 7

Assume that there are two investments 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.

Accepted Answer

The answer of Assume that there are two investments similar...

Question 8

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.

Accepted Answer

Risk in finance refers to uncertainty about future payments or returns on an asset. Therefore, the best answer is D, which states that the asset has future payments that are uncertain. Choices A and B are incorrect, as dividends and capital gains refer to the actual payments or returns on an asset, not the uncertainty surrounding them. Choice C is also incorrect, as the present value of an asset can be negative even if it is not risky.

Question 9

The underlying cause of risk in finance is
A)danger.
B)uncertainty.
C)fear.
D)complexity.

Accepted Answer

The underlying cause of risk in finance is uncertainty. Financial decisions involve predicting future events and outcomes, which are inherently uncertain. This uncertainty creates risk, as there is a possibility that actual outcomes will differ from predicted outcomes.

Question 10

Diversification in one's investments reduces
A)idiosyncratic risk.
B)pooling risk.
C)systemic risk.
D)time preference risk.

Accepted Answer

Diversification helps to reduce idiosyncratic risk, which is the risk inherent to a particular asset or company. By investing in a variety of different assets or companies, an investor can spread out this risk and potentially reduce overall portfolio volatility. Pooling risk refers to the concept of spreading risk across multiple investors, which is not directly related to diversification within an individual's portfolio. Systemic risk is the risk of a widespread economic or financial collapse, which cannot be completely eliminated through diversification. Time preference risk refers to the potential for an investor to miss out on higher returns by waiting too long to invest, which is not directly related to diversification.

Question 11

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.

Accepted Answer

Arbitrage is the process of taking advantage of price differences in different markets to make a profit. In finance, it refers to the buying and selling activities that tend to equalize the rates of return on identical or nearly identical assets, thereby eliminating opportunities for risk-free profit. This involves buying an asset in one market where the price is low and simultaneously selling it in another market where the price is high, to create a profit. The continuous buying and selling of assets in this manner helps to keep prices and returns even across all markets.

Question 12

Investment risks vary across different countries.The International Country Risk Guide in 2015 ranked which of the following countries to have the least composite risk?
A)Switzerland
B)China
C)United States
D)India

Accepted Answer

Switzerland has consistently ranked as having the least composite risk according to the International Country Risk Guide in recent years due to its stable political and economic environment, high level of government efficiency, and low levels of corruption and crime. China, the United States, and India have all been ranked as having higher levels of risk due to various factors such as economic instability, political uncertainty, and social unrest.

Question 13

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.

Accepted Answer

The type of risk that pushes the returns from all investments in the same direction at the same time is known as systematic or market risk. It cannot be diversified away by investing in a variety of assets since it impacts the entire market, making it impossible to eliminate. Examples of systematic risk include interest rate fluctuations, political instability, natural disasters, and inflation. Therefore, option C is the correct answer.

Question 14

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.

Accepted Answer

Diversification is the strategy of investing in a variety of assets to reduce the overall risk of a portfolio. By spreading investments across different asset classes, such as stocks, bonds, real estate, and commodities, investors can reduce their exposure to any one particular asset or market. This can help to minimize the impact of market fluctuations, economic downturns, or other unexpected events on the overall value of the portfolio. Pooling, arbitrage, and weighted average are not specific strategies for reducing risk through diversification.

Question 15

Investors face the risk that the economy could go into another recession.This risk is
A)idiosyncratic.
B)diversifiable.
C)systemic.
D)time preference.

Accepted Answer

The risk that the economy could go into a recession is a systemic risk, meaning it is a risk that affects the entire market and cannot be eliminated through diversification. It is not idiosyncratic as it is not specific to any one company or sector, and it is not related to an individual's time preference.

Question 16

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.

Accepted Answer

The estimation process assigns higher weights to more likely outcomes, as they are considered more reliable in calculating the average expected rate of return.

Question 17

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.

Accepted Answer

According to the risk-return tradeoff principle, more risky assets are expected to have higher average expected rates of return than less risky assets. This is because investors require a higher rate of return to compensate for the higher risk involved in investing in a more volatile asset. Therefore, choice C is the correct answer.

Question 18

Which of the following statements best describes the relationship between asset prices and average expected returns?
A)More risky assets will have similar prices to 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.

Accepted Answer

According to the capital asset pricing model, investors require a higher return for investing in more risky assets. Therefore, less risky assets will have higher prices (and lower expected returns), while more risky assets will have lower prices (and higher expected returns).

Question 19

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.

Accepted Answer

Idiosyncratic risk, also known as unsystematic risk, refers to the risk that is inherent to a specific company or industry. By investing in several companies within the oil industry, the investor is diversifying their investment to reduce the impact of risks that may affect any single company, thereby mitigating idiosyncratic risk.

Question 20

The average expected rate of return is a
A)volume-weighted average.
B)price-weighted average.
C)probability-weighted average.
D)value-weighted average.

Accepted Answer

The average expected rate of return is a probability-weighted average, which means it takes into account the likelihood (probability) of various outcomes and calculates the average return based on these probabilities.

Quiz 17: Part C: Financial Economics

If the demand for an asset increases, its price will

Assume that two firms (Firm A and Firm B) are 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

Risk in finance means

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, Rick had instead paid $300,000, and his monthly profits were reduced to $6,000, his expected rate of return would have

An investor owns bond #1, which 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

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

Assume that there are two investments 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

Risk in finance means that an asset

The underlying cause of risk in finance is

Diversification in one's investments reduces

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

Investment risks vary across different countries.The International Country Risk Guide in 2015 ranked which of the following countries to have the least composite risk?

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

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

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

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

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

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

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

The average expected rate of return is a