Question 1

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

Accepted Answer

If there is perfect arbitrage in the stock market, then any discrepancies in stock prices would be quickly corrected by arbitrageurs buying low and selling high, which would make movements in stock prices largely unpredictable. Additionally, the presence of perfect arbitrage would also mean that all stocks are priced at their fundamental value, so choice C is incorrect. The answer cannot be D or E as they are unrelated to the assumption of perfect arbitrage in the stock market.

Question 2

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?

Accepted Answer

Expectations of a future tax increase can lead to expectations of slower economic growth, which may cause long-term interest rates (i₂t) to decrease as investors anticipate lower inflation and reduced demand for borrowing.

Question 3

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

Accepted Answer

The answer of Suppose the yield curve is downward sloping.How...

Question 4

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.

Accepted Answer

The answer of Suppose the central bank implements a monetary...

Question 5

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

Accepted Answer

The fundamental value of a share of stock is based on its expected future dividends. Therefore, the present value of those expected future dividends would be the most accurate measure of the stock's fundamental value. Choices A and C are incorrect because they only consider the sum of expected or actual dividends, without discounting for time value of money. Choices D and E are incorrect because coupon payments and yield are more appropriate measures for bonds, not stocks.

Question 6

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

Accepted Answer

To find the current yield, we need to use the formula:
Current Yield = Annual Coupon Payment / Market Price

The annual coupon payment is $2000, so for two years, the total coupon payment is $4000.

The market price is $12,000.

Current Yield = $4000 / $12,000 = 0.333 or 33.3%

However, we need to divide this by 2 to get the annual current yield.

Annual Current Yield = 33.3% / 2 = 16.7%

Therefore, the answer is choice B, with a current yield of 16.7%.

Question 7

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.

Accepted Answer

The answer of The yield curve indicates that the two-year...

Question 8

Explain what the term structure of interest rates represents.

Accepted Answer

The answer of Explain what the term structure of interest...

Question 9

The yield curve is

Accepted Answer

The yield curve reflects the term structure of interest rates as it shows the relationship between the yield or interest rate of a bond and its maturity. Therefore, both options A and B are correct, making option D the best choice. Option C, maturity, is a component of the yield curve, but it does not encompass the full meaning of the curve. Option E is incorrect as it includes option C, which is not a comprehensive answer.

Question 10

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

Accepted Answer

The current yield represents the ratio of the annual interest payments (coupon payments) to the current market price of the bond, not the original price or face value. This provides an indication of the income return on the bond investment relative to its current price.

Question 11

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

Accepted Answer

The Standard and Poor's 500 Composite Index is the broadest measure of stock prices in the United States. It includes 500 large-cap stocks from various sectors of the economy and is considered a better gauge of overall market performance than the Dow Jones Industrial Average, which only includes 30 blue-chip stocks. The FTSE index is a measure of UK stock prices, the Nikkei index measures Japanese stock prices, and the Term Structure index is not a stock index at all, but rather a measure of the relationship between short-term and long-term interest rates.

Question 12

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.

Accepted Answer

The answer of When interpreting bond prices as present values,discuss...

Question 13

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

Accepted Answer

The yield to maturity on a two-year bond, given the current one-year interest rate of 3% and the expected one-year interest rate next year of 5%, can be approximated by averaging these two rates. This gives (3% + 5%) / 2 = 4%. This approximation assumes a linear relationship and does not account for compounding, but it provides a simple estimate.

Question 14

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

Accepted Answer

If the monetary contraction is fully expected by financial market participants, the information is already priced into the stock market, so stock prices would likely remain unchanged.

Question 15

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

Accepted Answer

A monetary expansion that is not fully anticipated by financial markets would likely lead to an increase in stock prices. This is because the expansion would increase the money supply and lower interest rates, making it cheaper for firms to borrow and invest in projects, leading to higher profits and thus, higher stock prices.

Question 16

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?

Accepted Answer

If financial market participants expect a future tax cut, they may increase their expectations of future economic growth, which would lead to an increase in bond yields on longer-term maturities. This would cause the yield curve to become even steeper. Therefore, the correct choice is A.

Question 17

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

Accepted Answer

The answer of Suppose the yield curve is upward sloping.How...

Question 18

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

Accepted Answer

The answer of A share of stock will pay a...

Question 19

Equity finance is represented by which of the following?

Accepted Answer

Equity finance refers to raising funds by selling shares of stock to investors. Therefore, option C is the correct choice. Options A and B refer to debt financing, while option D refers to using profits that are already retained in the business. Option E could potentially refer to equity finance if the capital stock sold off is in the form of shares, but it is not a clear or definitive answer.

Question 20

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

Accepted Answer

The expected one-year rate one year from now can be calculated using the formula for forward rates: (1 + two-year rate)^2 = (1 + current one-year rate) * (1 + expected one-year rate). Solving for the expected one-year rate gives approximately 7%.

Quiz 14: Financial Markets and Expectations