Question 1

If the bank real interest rate is 2 percent, the percent gain in physical capital gain is 2 percent, the marginal product of capital is 3 percent, and the percent dividend return is 5 percent, what is the financial capital gain?

Accepted Answer

The financial capital gain is the difference between the marginal product of capital and the real interest rate. In this case, the marginal product of capital is 3 percent and the real interest rate is 2 percent, so the financial capital gain is 3 percent - 2 percent = 1 percent.

Question 2

Refer to the following figure when answering the following questions.
Figure 17.2: Dow Jones Industrial Average: 2000-2012  (Source: Federal Reserve Economic Data, St. Louis Federal Reserve)
-Your uncle asks you to explain stock prices based on the financial capital arbitrage equation. He shows you the graph shown in Figure 17.2. He asks you to explain the cause in the rise of stock prices for the years 2002-2006. What do you tell him?

Accepted Answer

As the DJI rises, there are financial capital gains that drive up stock prices.

Question 3

If the bank real interest rate is 4 percent, the percent gain in physical capital gain is 3 percent, the marginal product of capital is 2 percent, and the capital gain of financial capital is 1 percent, what is the percent dividend return?

Accepted Answer

The percent dividend return can be calculated by subtracting the capital gain of financial capital (1%) from the bank real interest rate (4%), resulting in a 1% dividend return.

Question 4

Which of the following represents the financial asset arbitrage equation?

Accepted Answer

The answer of Which of the following represents the financial...

Question 5

In 2001, the P/E ratio:

Accepted Answer

The P/E ratio peaked at over 40 in 2001, marking a high point in the stock market before the dot-com bubble burst.

Question 6

If the real interest rate is, more or less, constant, and the growth rate of dividends falls sharply:

Accepted Answer

A fall in the growth rate of dividends would lower expected future earnings for the firm, leading to a decline in stock prices. The price-earnings ratio would also decrease because earnings would be relatively smaller compared to the stock price.

Question 7

Refer to the following figure when answering the following questions.
Figure 17.2: Dow Jones Industrial Average: 2000-2012  (Source: Federal Reserve Economic Data, St. Louis Federal Reserve)
-Your grandmother is a follower of the financial press and decides to quiz you about your knowledge of financial markets. She asks you to explain the price of stock prices based on the financial capital arbitrage equation. She shows you the graph shown in Figure 17.2. She asks you to explain the cause in the rise of stock prices for the years 2008-2012. What do you tell her?

Accepted Answer

The answer of Refer to the following figure when answering...

Question 8

If we divide both sides of the equation  by earnings, we get:

Accepted Answer

Dividing both sides of the equation by earnings gives us the ratio of the stock price to earnings, which is the price-earnings ratio.

Question 9

Since 1980, interest rates have been trending downward. Given this information, what does this theory suggest happened to stock prices?

Accepted Answer

According to the theory that interest rates and stock prices are inversely related, as interest rates decrease, stock prices tend to rise. Therefore, since interest rates have been trending downward since 1980, this theory suggests that stock prices have risen.

Question 10

If the savings interest rate rises, to maintain the financial asset arbitrage equality, either the ________ or the ________, or both.

Accepted Answer

If the savings interest rate rises, the expected return on savings increases, making stocks less attractive. To maintain the financial asset arbitrage equality, the dividends need to rise, or capital gains need to rise, or both. This will increase the expected return on stocks and maintain financial asset arbitrage equality.

Question 11

Between 1880 and 2015, the average P/E ratio was ________ percent.

Accepted Answer

According to historical data, the average P/E ratio between 1880 and 2015 was 16.7.

Question 12

The payment the owner of a stock receives from a firm is called the:

Accepted Answer

The payment the owner of a stock receives from a firm is called the dividend.

Question 13

In the equation  is the:

Accepted Answer

The answer of In the equation  is the:
...

Question 14

In the equation  , the left side of the equation is:

Accepted Answer

The answer of In the equation  , the left...

Question 15

We can write the stock price as:

Accepted Answer

The answer of We can write the stock price as:
...

Question 16

According to the financial asset arbitrage equation, all else equal, a rise in the capital gain for a stock implies:

Accepted Answer

The answer of According to the financial asset arbitrage equation,...

Question 17

If the marginal product of capital is 3 percent, the real interest rate is 4 percent, and the capital depreciation rate is 10 percent, what is the equilibrium stock price?

Accepted Answer

The equilibrium stock price cannot be determined with the given information because it requires additional data such as earnings, dividends, or cash flows related to the stock.

Question 18

The P/E ratio will ________ if ________.

Accepted Answer

Dividends are a portion of earnings paid out to shareholders. If dividends rise, it means that earnings are also rising, which will lead to a higher P/E ratio.

Question 19

In the simple model of financial asset model arbitrage, we assume that:

Accepted Answer

In a simple model of financial asset arbitrage, it is often assumed that there is no uncertainty about stock prices, meaning they are predictable and can be arbitraged for profit.

Question 20

If the marginal product of capital is 3 percent, the real interest rate is 4 percent, growth is 2.5 percent, and the capital depreciation rate is 10 percent, what is the equilibrium stock price?

Accepted Answer

The equilibrium stock price can be calculated using the Gordon Growth Model or a similar valuation model that accounts for the marginal product of capital, growth, and depreciation. In this case, the net return on capital is the marginal product of capital (3%) minus the depreciation rate (10%), which gives a negative value, indicating the formula might not directly apply. However, considering the context of equilibrium stock price calculation, a more fitting approach involves considering the real interest rate and growth. The formula for the equilibrium stock price in a simplified model considering growth and real interest rate is P = E / (r - g), where E is earnings, r is the real interest rate, and g is growth. Assuming earnings are equivalent to the marginal product of capital and adjusting for depreciation and growth, the calculation does not directly align with the given options without specific earnings data. However, the closest match to a standard interpretation would involve considering the net benefits or returns to capital, suggesting a need for clarification or a different approach to match the given options. Given the information and typical financial formulas, none of the options directly correlate without additional assumptions about earnings or capital allocation. Thus, the response indicates a need for a more detailed formula or additional information to accurately select from the provided choices.

Quiz 17: Investment