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```More Chapter 19 Questions
True/False
Indicate whether the statement is true or false.
____
1. If the interest rate is 8 percent, then the present value of \$1,000 to be received in 4 years is \$735.03.
____
2. If a savings account pays 5 percent annual interest, then the rule of 70 tells us that the account value will double
in approximately 14 years.
____
3. The present value of \$100 to be paid in two years is less than the present value of \$100 to be paid in three years.
____
4. The future value of \$1 saved today is \$1/(1 + r).
____
5. The present value of any future sum of money is the amount that would be needed today, at current interest
rates, to produce that future sum.
____
6. The sooner a payment is received and the higher the interest rate, the greater the present value of a future
payment.
____
7. A company that can build a project that will cost \$50,000, but returns \$52,000 in one year would make a good
decision by turning this project down if the interest rate were 3 percent.
____
8. As the interest rate increases, the present value of future sums decreases, so firms will find fewer investment
projects profitable.
____
9. According to the rule of 70, if you earn an interest rate of 3.5 percent, your savings will double about every 20
years.
____ 10. The rule of 70 applies to a growing savings account but not to a growing economy.
____ 11. If you are faced with the choice of receiving \$500 today or \$800 6 years from today, you will be indifferent
between the two possibilities if the interest rate is 8.148 percent.
____ 12. The concept of present value helps explain why the quantity of loanable funds demanded decreases when the
interest rate increases.
____ 13. An increase in the interest rate causes a decrease in the future value of \$1,000 that you have in a bank account
today.
____ 14. The present value of a payment of \$500 to be made two years from today is greater if the interest rate is 7%
than if it is 6%.
____ 15. PZX Corporation has the opportunity to undertake an investment project that will cost \$10,000 today and yield
the company \$13,310 in 3 years. PZX will forgo the project if the interest rate is higher than 10 percent.
____ 16. ZZL Corporation has the opportunity to undertake an investment project that will cost \$20,000 today. If the
interest rate is 20 percent and if the project will yield the company \$30,000 in 3 years, then ZZL will undertake
the project.
____ 17. Risk aversion simply means that people dislike bad things to happen.
____ 18. Risk-averse individuals like good things more than they dislike comparable bad things.
____ 19. People who are risk averse dislike bad outcomes more than they like comparable good outcomes.
____ 20. The market for insurance is an example of diversification.
____ 21. A person’s subjective measure of well-being or satisfaction is called aversion.
____ 22. Historically, stocks have offered higher rates of return than bonds.
____ 23. Historically the return on stocks has been higher than the return on bonds. In part this reflects the higher risk
from holding stock.
____ 24. Risk-averse persons will take no risks.
____ 25. The market for insurance is one example of reducing risk by using diversification.
____ 26. A person with diminishing marginal utility of wealth is risk averse.
____ 27. Adverse selection is illustrated by people who take greater risks after they purchase insurance.
____ 28. Increasing the number of corporations whose stocks are in your portfolio reduces market risk.
____ 29. Diversification can reduce firm-specific risk.
____ 30. The fact that we observe a trade-off between risk and return is puzzling to economists, because that observation
conflicts with the notion that most people are risk averse.
____ 31. From the standpoint of the economy as a whole, the role of insurance is to greatly reduce or eliminate the risks
inherent in life.
____ 32. If a person had increasing marginal utility, then the decline in utility from losing \$1,000 would be greater than
the increase in utility from gaining \$1,000.
____ 33. Moral hazard is illustrated by people who take greater risks after they purchase insurance.
____ 34. Diversification cannot reduce market risk.
____ 35. When the price of an asset rises above what appears to be its fundamental value, the market is said to be
experiencing a speculative bubble.
____ 36. Because the statistic called the standard deviation measures the volatility of a variable, it is used to measure the
return of a portfolio.
____ 37. The value of a stock depends on the ability of the company to generate dividends and the expected price of the
stock when the stockholder sells her shares.
____ 38. According to fundamental analysis, when choosing stocks for your portfolio, you should prefer undervalued
stocks.
____ 39. According to the efficient markets hypothesis, at any moment in time, the market price is the best estimate of
the company's value based on publicly available information.
____ 40. According to the efficient markets hypothesis, stocks follow a random walk so that stocks that increase in price
one year are more likely to increase than decrease in the next year.
____ 41. According to the efficient markets hypothesis, the number of people who think a stock is overvalued exactly
balances the number of people who think a stock is undervalued.
____ 42. Studies find that mutual fund managers who do well in one year are likely to do well the next year.
____ 43. Managed mutual funds usually outperform mutual funds that are supposed to follow some stock index.
____ 44. Speculative bubbles may arise in part because the value of the stock to a stockholder depends on the final sale
price.
____ 45. Available evidence indicates that stock prices, even if not exactly a random walk, are very close to a random
walk.
____ 46. If you wish to rely on fundamental analysis to choose a portfolio of stocks, then you have no choice but to do all
the necessary research yourself.
____ 47. If you believe the stock market is informationally efficient, then it is a waste of time to engage in fundamental
analysis.
____ 48. Actively managed mutual funds usually fail to outperform index funds, and this fact provides evidence in favor
of the efficient markets hypothesis.
____ 49. In the 15 years ending June 2010, most active portfolio managers failed to beat the market.
Multiple Choice
Identify the choice that best completes the statement or answers the question.
____
1. Most financial decisions involve two related elements:
b. investment and taxes.
c. time and risk.
d. saving and consumption.
____
2. The field of finance primarily studies
a. how society manages its scarce resources.
b. the implications of time and risk for allocating resources over time.
c. firms’ decisions concerning how much to produce and what price to charge.
d. how society can reduce market risk.
____
3. The financial system
a. involves bank accounts, mortgages, stock prices, and many other items.
b. involves decisions and actions undertaken by people at a point in time that affect their lives
in the future.
c. coordinates the economy’s saving and investment.
d. All of the above are correct.
____
4. Which of the following statements best describes the economist’s view of finance and the financial system?
a. The financial system is very important to the functioning of the economy, and the tools of
finance are often helpful to us as individuals when we find ourselves making certain
decisions.
b. The financial system, while interesting, is not very important to the functioning of the
economy; however, the tools of finance are often helpful to us as individuals when we find
ourselves making certain decisions.
c. The financial system is very important to the functioning of the economy; however, the
tools of finance are not particularly helpful to us as individuals since we seldom make
decisions for which those tools are useful.
d. The field of finance is intimately concerned with the financial system and the tools of
finance, and financial economists see great importance in them; however, the “mainstream”
economist sees little value in studying financial markets or the tools of finance.
____
5. Suppose you put \$350 into a bank account today. Interest is paid annually and the annual interest rate is 6
percent. The future value of the \$350 after 4 years is
a. \$414.09.
b. \$434.00.
c. \$441.87.
d. \$481.24.
____
6. Suppose you put \$500 into a bank account today. Interest is paid annually and the annual interest rate is 5.5
percent. The future value of the \$500 is
a. \$637.50 after 5 years and \$822.09 after 10 years.
b. \$637.50 after 5 years and \$775.00 after 10 years.
c. \$653.48 after 5 years and \$854.07 after 10 years.
d. \$688.36 after 5 years and \$915.56 after 10 years.
____
7. If the interest rate is 7.5 percent, then what is the present value of \$4,000 to be received in 6 years?
a. \$2,420.68
b. \$2,591.85
c. \$2,996.33
d. \$3,040.63
____
8. Risk aversion helps to explain various things we observe in the economy, including
b. insurance.
d. All of the above are correct.
____
9. Economists have developed models of risk aversion using the concept of
a. utility and the associated assumption of diminishing marginal utility.
b. utility and the associated assumption of increasing marginal utility.
c. income and the associated assumption of diminishing marginal wealth.
d. income and the associated assumption of increasing marginal wealth.
____ 10. For a risk averse person,
a.
b.
c.
d.
the pleasure of winning \$1,000 on a bet exceeds the pain of losing \$1,000 on a bet.
the pain of losing \$1,000 on a bet exceeds the pleasure of winning \$1,000 on a bet.
the utility function exhibits the property of increasing marginal utility.
the utility function gets steeper as wealth increases.
____ 11. Matt’s Utility Function
Wealth
\$50,000
51,000
52,000
53,000
Utility
7000
7250
7499
7746
If Matt’s current wealth is \$51,000, then
a. his gain in utility from gaining \$1,000 is greater than his loss in utility from losing \$1,000.
Matt is risk averse.
b. his gain in utility from gaining \$1,000 is greater than his loss in utility from losing \$1,000.
Matt is not risk averse.
c. his gain in utility from gaining \$1,000 is less than his loss in utility from losing \$1,000.
Matt is risk averse.
d. his gain in utility from gaining \$1,000 is less than his loss in utility from losing \$1,000.
Matt is not risk averse.
Figure 27-1. The figure shows a utility function.
C
B
A
0
\$400
\$600
\$800
Wealth
____ 12. Refer to Figure 27-1. What is measured along the vertical axis?
a. risk aversion
b. marginal utility
c. utility
d. the number of units of a good that can be purchased
____ 13. Refer to Figure 27-1. The utility function that is shown exhibits the property of diminishing
a. wealth.
b. utility.
c. marginal wealth.
d. marginal utility.
____ 14. Refer to Figure 27-1. Which distance along the vertical axis represents the marginal utility of an increase in
wealth from \$600 to \$800?
a. the distance between the origin and point B
b. the distance between the origin and point C
c. the distance between point A and point C
d. the distance between point B and point C
____ 15. Refer to Figure 27-1. Let 0A represent the distance between the origin and point A; let AB represent the
distance between point A and point B; etc. Which of the following ratios best represents the marginal utility per
dollar when wealth increases from \$400 to \$600?
a.
b.
c.
d.
____ 16. Refer to Figure 27-1. For the person to whom this utility function applies,
a. the more wealth she has, the less utility she gets from an additional dollar of wealth.
b. the more wealth she has, the more utility she gets from an additional dollar of wealth.
c. her level of satisfaction will be enhanced more by an increase in wealth from \$600 to \$800
than it would be by an increase in wealth from \$400 to \$600.
d. her level of satisfaction will be enhanced equally by an increase in wealth from \$600 to
\$800 or by an increase in wealth from \$400 to \$600.
____ 17. Refer to Figure 27-1. Suppose the person to whom this utility function applies begins with \$600 in wealth.
Starting from there,
a. she would be willing to accept a coin-flip bet that would result in her winning \$200 if the
result was “heads” or losing \$200 if the result was “tails.”
b. the pain of losing \$200 of her wealth would equal the pleasure of adding \$200 to her wealth.
c. the pain of losing \$200 of her wealth would exceed the pleasure of adding \$200 to her
wealth.
d. the pleasure of adding \$200 to her wealth would exceed the pain of losing \$200 of her
wealth.
____ 18. Refer to Figure 27-1. The properties exhibited by this utility function help to explain various things we
observe in the economy, including
b. insurance.
c. diversification.
d. All of the above are correct.
Figure 27-2. The figure shows a utility function for Mary Ann.
Utility
C
B
A
0
\$750
\$1,050
\$1,350
Wealth
____ 19. Refer to Figure 27-2. From the appearance of the utility function, we know that
a. Mary Ann is risk averse.
b. Mary Ann gains less satisfaction when her wealth increases by X dollars than she loses in
satisfaction when her wealth decreases by X dollars.
c. the property of diminishing marginal utility applies to Mary Ann.
d. All of the above are correct.
____ 20. Refer to Figure 27-2. From the appearance of the utility function, we know that
a. Mary Ann is risk averse.
b. Mary Ann gains more satisfaction when her wealth increases by X dollars than she loses in
satisfaction when her wealth decreases by X dollars.
c. the property of increasing marginal utility applies to Mary Ann.
d. All of the above are correct.
____ 21. Refer to Figure 27-2. Suppose the vertical distance between the points (0, A) and (0, B) is 5. If her wealth
increased from \$1,050 to \$1,350, then
a. Mary Ann’s subjective measure of her well-being would increase by less than 5 units.
b. Mary Ann’s subjective measure of her well-being would increase by more than 5 units.
c. Mary Ann would change from being a risk-averse person into a person who is not risk
averse.
d. Mary Ann would change from being a person who is not risk averse into a risk-averse
person.
____ 22. Refer to Figure 27-2. From the appearance of the utility function, we know that
a. if Mary Ann owns a house, she would not consider buying fire insurance.
b. Mary Ann would prefer to hold a portfolio of stocks with an average return of 8 percent and
a standard deviation of 2 percent to a portfolio of stocks with an average return of 8 percent
and a standard deviation of 5 percent.
c. Mary Ann would prefer to hold a portfolio of stocks with an average return of 8 percent and
a standard deviation of 5 percent to a portfolio of stocks with an average return of 6 percent
and a standard deviation of 3 percent.
d. All of the above are correct.
____ 23. Refer to Figure 27-2. Suppose Mary Ann begins with \$1,050 in wealth. Starting from there,
a. she would be willing to accept a coin-flip bet that would result in her winning \$300 if the
result was “heads” or losing \$300 if the result was “tails.”
b. the pain of losing \$300 of her wealth would equal the pleasure of adding \$300 to her wealth.
c. the pain of losing \$300 of her wealth would exceed the pleasure of adding \$300 to her
wealth.
d. the pleasure of adding \$300 to her wealth would exceed the pain of losing \$300 of her
wealth.
____ 24. Refer to Figure 27-2. Suppose Mary Ann begins with \$1,050 in wealth. Which of the following coin-flip
bets would she definitely not be willing to accept?
a. If it is “heads,” she wins \$100; if it is tails, she loses \$95.
b. If it is “heads,” she wins \$150; if it is tails, she loses \$150.
c. If it is “heads,” she wins \$150; if it is tails, she loses \$140.
d. She definitely would not accept any of these bets.
Figure 27-3. The figure shows a utility function for Rob.
Utility
C
B
A
0
\$500
\$700
\$900
Wealth
____ 25. Refer to Figure 27-3. From the appearance of Rob’s utility function, we know that
a. the pain that Rob would experience if he lost \$200 of his wealth would exceed the pleasure
that he would experience if he added \$200 to his wealth.
b. the pleasure that Rob would experience if he added \$200 to his wealth would exceed the
pain that he would experience if he lost \$200 of his wealth.
c. the property of increasing utility does not apply to Rob.
d. the property of diminishing marginal utility does not apply to Rob.
____ 26. Refer to Figure 27-3. From the appearance of Rob’s utility function, we know that
a. if Rob owns a house, then he definitely would buy fire insurance provided the cost of the
insurance were reasonable.
b. Rob would voluntarily exchange a portfolio of stocks with a high average return and a high
level of risk for a portfolio with a low average return and a low level of risk.
c. Rob is risk averse.
d. Rob is not risk averse.
____ 27. Refer to Figure 27-3. If most people’s utility functions look like Rob’s utility function, then it is easy to
explain why
a. people buy various types of insurance.
b. we observe a trade-off between risk and return.
c. most people prefer to hold diversified portfolios of assets to undiversified portfolios of
assets.
d. None of the above are correct.
Figure 27-4. The figure shows a utility function for Dexter.
Utility
C
B
A
\$800
\$1,300
\$1,800
Wealth
____ 28. Refer to Figure 27-4. In what way(s) does the graph differ from the usual case?
a. The utility function shown here is upward-sloping, whereas in the usual case the utility
function is downward-sloping.
b. The utility function shown here is bowed downward (convex), whereas in the usual case the
utility function is bowed upward (concave).
c. On the graph shown here, wealth is measured along the horizontal axis, whereas in the usual
case saving is measured along the horizontal axis.
d. On the graph shown here, utility is measured along the vertical axis, whereas in the usual
case satisfaction is measured along the vertical axis.
____ 29. Refer to Figure 27-4. From the appearance of the graph, we know that
a. Dexter’s level of satisfaction increases by more when his wealth increases from \$1,001 to
\$1,002 than it does when his wealth increases from \$1,000 to \$1,001.
b. Dexter’s level of satisfaction increases by less when his wealth increases from \$1,001 to
\$1,002 than it does when his wealth increases from \$1,000 to \$1,001.
c. Dexter’s level of satisfaction increases by the same amount when his wealth increases from
\$1,001 to \$1,002 as it does when his wealth increases from \$1,000 to \$1,001.
d. None of the above answers can be inferred from the appearance of the utility function.
____ 30. Refer to Figure 27-4. From the appearance of the utility function, we know that
a. Dexter is risk averse.
b. Dexter gains less satisfaction when his wealth increases by X dollars than he loses in
satisfaction when his wealth decreases by X dollars.
c. the property of diminishing marginal utility does not apply to Dexter.
d. All of the above are correct.
____ 31. Refer to Figure 27-4. From the appearance of the utility function, we know that
a. Dexter is risk averse.
b. Dexter gains more satisfaction when his wealth increases by X dollars than he loses in
satisfaction when his wealth decreases by X dollars.
c. the property of decreasing marginal utility applies to Dexter.
d. All of the above are correct.
____ 32. Refer to Figure 27-4. Suppose the vertical distance between the points (0, A) and (0, B) is 12. If his wealth
increased from \$1,300 to \$1,800, then
a. Dexter’s subjective measure of his well-being would increase by less than 12 units.
b. Dexter’s subjective measure of his well-being would increase by more than 12 units.
c. Dexter would change from being a risk-averse person into a person who is not risk averse.
d. Dexter would forgo the insurance he bought when his wealth was \$1,300.
____ 33. Refer to Figure 27-4. Suppose Dexter begins with \$1,300 in wealth. Starting from there,
a. the pain of losing \$500 of his wealth would equal the pleasure of adding \$500 to his wealth.
b. the pain of losing \$500 of his wealth would exceed the pleasure of adding \$500 to his
wealth.
c. the pleasure of adding \$500 to his wealth would exceed the pain of losing \$500 of his
wealth.
d. This cannot be determined from the graph.
____ 34. From the standpoint of the economy as a whole, the role of insurance is
a. to entice risk-loving people to become risk averse.
b. to promote the phenomenon of adverse selection.
c. not to eliminate the risks inherent in life, but to spread them around more efficiently.
d. not to spread risks, but to eliminate them for individual policy holders.
____ 35. The problem of moral hazard arises because
a. life is full of all sorts of risks.
b. after people buy insurance, they have less incentive to be careful about their risky behavior.
c. a high-risk person is more likely to apply for insurance than is a low-risk person.
d. insurance companies go to great effort to avoid paying claims to their policy holders.
____ 36. As the number of stocks in a person’s portfolio increases,
a. the risk of the portfolio increases, as indicated by the increasing value of the standard
deviation of the portfolio.
b. the risk of the portfolio increases, as indicated by the decreasing value of the standard
deviation of the portfolio.
c. the risk of the portfolio decreases, as indicated by the increasing value of the standard
deviation of the portfolio.
d. the risk of the portfolio decreases, as indicated by the decreasing value of the standard
deviation of the portfolio.
____ 37. The largest reduction in a portfolio’s risk is achieved when the number of stocks in the portfolio is increased
from
a. 80 to 100.
b. 40 to 80.
c. 10 to 20.
d. 1 to 10.
____ 38. Diversification of a portfolio
a. can eliminate market risk, but it cannot eliminate firm-specific risk.
b. can eliminate firm-specific risk, but it cannot eliminate market risk.
c. increases the portfolio’s standard deviation.
d. is not necessary for a person who is risk averse.
____ 39. Mary Beth is risk averse and has \$1,000 with which to make a financial investment. She has three options.
Option A is a risk-free government bond that pays 5 percent interest each year for two years. Option B is a
low-risk stock that analysts expect to be worth about \$1,102.50 in two years. Option C is a high-risk stock that
is expected to be worth about \$1,200 in four years. Mary Beth should choose
a. option A.
b. option B.
c. option C.
d. either A or B because they are the same to her.
____ 40. A measure of the volatility of a variable is its
a. present value.
b. future value.
c. return.
d. standard deviation.
____ 41. A risk-averse person
a. has a utility curve where the slope increases with wealth, and might take a bet with a 70
percent chance of wining \$400 and a 30 per chance of losing \$400.
b. has a utility curve where the slope increases with wealth, and would never take a bet with a
70 percent chance of wining \$400 and a 30 per cent chance of losing \$400.
c. has a utility curve where the slope decreases with wealth, and might take a bet with a 70
percent chance of wining \$400 and a 30 per chance of losing \$400.
d. has a utility curve where the slope decreases with wealth, and would never take a bet with a
70 percent chance of wining \$400 and a 30 per cent chance of losing \$400.
____ 42. If a person is risk averse, then she has
a. diminishing marginal utility of wealth, implying that her utility function gets flatter as
wealth increases.
b. diminishing marginal utility of wealth, implying that her utility function gets steeper as
wealth increases.
c. increasing marginal utility of wealth, implying that her utility function gets flatter as wealth
increases.
d. increasing marginal utility of wealth, implying that her utility function gets steeper as
wealth increases.
____ 43. If Robert is risk-averse, then he will always
a. choose not to play a game where he has a 50 percent chance of winning \$1 and a 50 percent
chance of losing \$1.
b. choose not to play a game where he has a 75 percent chance of winning \$1 and a 25 percent
chance of losing \$1.
c. choose to play a game where he has a 52 percent chance of winning \$1 and a 48 percent
chance of losing \$1.
d. All of the above are correct.
____ 44. Which of the following games might a risk-averse person play?
a. a game where she has a 50 percent chance of winning \$1 and a 50 percent chance of losing
\$1
b. a game where she has a 50 percent chance of winning \$100 and a 50 percent chance of
losing \$100
c. a game where she has a 60 percent chance of winning \$1 and a 40 percent chance of losing
\$1
d. a game where she has a 40 percent chance of winning \$1 and a 60 percent chance of losing
\$1
____ 45. Which of the following games might a risk-averse person play?
a. a game where she has a 70 percent chance of winning \$1 and a 30 percent chance of losing
\$1
b. a game where she has a 60 percent chance of winning \$100 and a 40 percent chance of
losing \$100
c. a game where she has a 60 percent chance of winning \$2 and a 40 percent chance of losing
\$1
d. All of the above are correct.
____ 46. Which of the following is correct concerning a risk-averse person?
a. She would not play games where the probability of winning and losing a dollar are the same.
b. She might not buy health insurance if she thinks her risks are low.
c. Her marginal utility of wealth decreases as her income increases.
d. All of the above are correct.
____ 47. Svetlana is risk averse. Which of the following is correct about Svetlana?
a. Her marginal utility of wealth increases as her income increases.
b. She will always accept a bet if the probability of winning a dollar is the same as the
probability of losing a dollar.
c. Her utility function is a straight line.
d. None of the above are correct.
____ 48. The utility function of a risk-averse person has a
a. positive slope and gets steeper as wealth increases.
b. positive slope but gets flatter as wealth increases.
c. negative slope but gets steeper as wealth increases.
d. negative slope and gets flatter as wealth increases.
____ 49. A risk-averse person has
a. utility and marginal utility curves that slope upward.
b. utility and marginal utility curves that slope downward.
c. a utility curve that slopes down and a marginal utility curve that slopes upward.
d. a utility curve that slopes upward and a marginal utility curve that slopes downward.
____ 50. Diminishing marginal utility of wealth implies that the utility function is
a. upward-sloping and has decreasing slope.
b. upward-sloping and has increasing slope.
c. downward-sloping and has decreasing slope.
d. downward-sloping and has increasing slope.
____ 51. If a person is risk averse, then as wealth increases, total utility of wealth
a. increases at an increasing rate.
b. increases at a decreasing rate.
c. decreases at an increasing rate.
d. decreases at a decreasing rate.
____ 52. Given that Tamar is a risk-averse person, she might accept a bet with a 50 percent chance of losing \$100 today
if she had a 50 percent
a. chance of winning \$120 in two years and the interest rate was 11%.
b. chance of winning \$114 in two years and the interest rate was 7%.
c. chance of winning \$110 in two years and the interest rate was 3%.
d. None of the above are correct; a risk averse person would not accept any of the above bets.
____ 53. Risk
a. can be reduced by placing a large number of small bets rather than a small number of large
bets.
b. can be reduced by increasing the number of stocks in a portfolio.
c. Both A and B are correct.
d. Neither A nor B are correct.
____ 54. The last \$2,000 of Rolanda's wealth adds less to her utility than the previous \$2,000. Based on this information,
Rolanda has
a. increasing marginal utility of wealth and is risk averse.
b. increasing marginal utility of wealth and is not risk averse.
c. decreasing marginal utility of wealth and is risk averse.
d. decreasing marginal utility of wealth and is not risk averse.
____ 55. Recently, Lisa’s wealth increased by \$500. If her wealth were to increase by another \$500 in the near future,
then her utility would increase, but not by as much as it increased with the recent increase to her wealth. Based
on this information, Lisa's utility function
a. and marginal utility function are both upward sloping.
b. and marginal utility function are both downward sloping.
c. is upward sloping and her marginal utility function is downward sloping.
d. is downward sloping and her marginal utility function is upward sloping.
____ 56. Suppose that Thom experiences a greater loss in utility if he loses \$50 than he would gain in utility if he wins
\$50. This implies that Thom’s
a. marginal utility diminishes as wealth rises, so he must be risk averse.
b. marginal utility diminishes as wealth rises, but we can’t tell from this if he is risk averse.
c. marginal utility increases as wealth rises, so he must be risk averse.
d. marginal utility increases as wealth rises, but we can’t tell from this if he is risk averse.
____ 57. Which of the following defines an annuity?
a. For a fee, an insurance company provides you with regular income until you die.
b. A surcharge is added to life-insurance premiums paid by persons in dangerous occupations.
c. Annuity is another name for stock funds managed by mutual fund managers.
d. Annuity is another name for any diversified portfolio.
____ 58. In effect, an annuity provides insurance
a. against the risk of dying and leaving one’s family without a regular income.
b. against the risk of living too long.
c. to people who are not risk-averse.
d. to people whose utility functions do not display the usual properties.
____ 59. Which of the following actions best illustrates adverse selection?
a. A person adds risky stock to his portfolio.
b. A person who has narrowly avoided many accidents applies for automobile insurance.
c. A person is unwilling to buy a stock when she believes its price has an equal chance of rising
or falling \$10.
d. A person purchases homeowners insurance and then checks his smoke detector batteries
less frequently.
____ 60. Which of the following actions best illustrates moral hazard?
a. A person adds risky stock to his portfolio.
b. A person who has narrowly avoided many accidents applies for automobile insurance.
c. A person is unwilling to buy a stock when she believes its price has an equal chance of rising
or falling \$10.
d. A person purchases homeowners insurance and then checks his smoke detector batteries
less frequently.
____ 61. Tami knows that people in her family die young, and so she buys life insurance. Preston knows he is a reckless
driver and so he applies for automobile insurance.
a. These are both examples of adverse selection.
b. These are both examples of moral hazard.
c. The first example illustrates adverse selection, and the second illustrates moral hazard.
d. The first example illustrates moral hazard, and the second illustrates adverse selection.
____ 62. Abby buys health insurance because she knows that she has health risks that wouldn’t be obvious to an
insurance company. Brad buys home owners insurance and then is less careful to make sure he’s put out his
cigarettes. The example with Abby
b. and the example with Brad illustrate moral hazard.
____ 63. Which of the following is adverse selection?
a. the risk associated with selecting stocks in only a few specific companies
b. the risk that a person will become overconfident in his ability to select stocks
c. a high-risk person being more likely to apply for insurance
d. after obtaining insurance a person having less incentive to be careful
____ 64. Which of the following best illustrates moral hazard?
a. After a person obtains life insurance, she takes up skydiving.
b. A person obtains insurance knowing he is in poor health.
c. A person holds stock only in very risky corporations.
d. A person holds stocks from only a few corporations.
____ 65. When you rent a car, you might treat it with less care than you would if it were your own. This is an example of
a. market risk.
b. moral hazard.
d. risk aversion.
____ 66. Financial intermediaries typically require mortgage borrowers to have homeowner's insurance and do credit
checks before making the loan.
a. The insurance requirement and the credit check are both designed primarily to reduce
b. The insurance requirement and the credit check are both designed primarily to reduce the
risk of moral hazard.
c. The insurance requirement is designed primarily to reduce adverse selection; the credit
check is designed primarily to reduce the risk of moral hazard.
d. The insurance requirement is designed primarily to reduce the risk of moral hazard; the
credit check is designed primarily to reduce adverse selection.
____ 67. You may be unwilling to buy a used car because you suspect the last owner found out the car was a lemon. You
may treat a car you rented with a little less care than you'd use on your own car.
a. Both examples primarily illustrate adverse selection.
b. Both examples primarily illustrate moral hazard.
c. The first example primarily illustrates adverse selection; the second primarily illustrates
moral hazard.
d. The first example primarily illustrates moral hazard; the second primarily illustrates adverse
selection.
____ 68. Over the past two centuries, the average annual rates of return were about
a. 5 percent for stocks and about 1.5 percent for short-term government bonds.
b. 6 percent for stocks and about 2.5 percent for short-term government bonds.
c. 8 percent for stocks and about 3 percent for short-term government bonds.
d. None of the above is correct.
____ 69. Risk-averse people will choose different asset portfolios than people who are not risk averse. Over a long period
of time, we would expect that
a. every risk-averse person will earn a higher rate of return than every non-risk-averse person.
b. every risk-averse person will earn a lower rate of return than every non-risk-averse person.
c. the average risk-averse person will earn a higher rate of return than the average
non-risk-averse person.
d. the average risk-averse person will earn a lower rate of return than the average
non-risk-averse person.
____ 70. Which of the following is not correct?
a. The higher average return on stocks than on bonds comes at the price of higher risk.
b. Risk-averse persons will take the risks involved in holding stocks if the average return is
high enough to compensate for the risk.
c. Insurance markets reduce risk, but not by diversification.
d. Risk can be reduced by placing a large number of small bets, rather than a small number of
large bets.
____ 71. Roger determines that if Aim Corporation has high revenues, then Zest Corporation will have low revenues, and
that if Aim Corporation has low revenues, Zest Corporation will have high revenues. He buys stock in both
corporations.
a. He has reduced firm-specific risk but not market risk.
b. He has reduced market risk, but not firm-specific risk.
c. He had reduce both firm-specific risk and market risk.
d. He has reduced neither firm-specific risk nor market risk.
____ 72. Amanda talks with several different brokers at a social gathering. She hears the following advice from brokers
A, B, and C. Which broker, if any, gave her incorrect advice?
a. Broker A: “There are risks in holding stocks, even in a highly diversified portfolio.”
b. Broker B: “Portfolios with smaller standard deviations have lower risk.”
c. Broker C: “Stocks with greater risks offer lower average returns.”
d. They all gave her correct advice.
____ 73. Mary talked to several stockbrokers and made the following conclusions. Which, if any, of her conclusions are
correct?
a. It is relatively easy to reduce firm-specific risk by increasing the number of companies one
holds stock in.
b. Stock prices, even if not exactly a random walk, are very close to it.
c. Some people have made a lot of money in the stock market by using insider information, but
these cases are not contrary to the efficient markets hypothesis.
d. All of Mary’s conclusions are correct.
____ 74. Other things the same, as the number of stocks in a portfolio rises,
a. risk increases and the standard deviation of the return rises.
b. risk increases and the standard deviation of the return falls.
c. risk decreases and the standard deviation of the return rises.
d. risk decreases and the standard deviation of the return falls.
____ 75. Other things the same, as the stocks of a greater number of corporations are held in a portfolio,
a. risk increases at an increasing rate.
b. risk increases at a decreasing rate.
c. risk decreases at an increasing rate.
d. risk decreases at a decreasing rate.
Figure 27-5. On the graph, x represents risk and y represents return.
10 y
9
8
7
6
5
4
A
3
2
1
D
C
B
5
10
15
20 x
____ 76. Refer to Figure 27-5. Point A represents a situation in which
a. all of a person’s savings are allocated to a class of safe assets.
b. the person knows with certainty that his or her return will be 3 percent.
c. the standard deviation of the person’s portfolio is zero.
d. All of the above are correct.
____ 77. Refer to Figure 27-5. Which of the following statements is correct?
a. At point A the standard deviation of the portfolio is 3.
b. A risk averse person always will choose to be at point A.
c. At point D the portfolio consists of about 15 percent stocks and 85 percent safe assets.
d. The figure shows that the greater the risk, the greater the return.
____ 78. Diversification reduces
a. only market risk.
b. only firm-specific risk.
c. neither market or firm-specific risk.
d. both market and firm-specific risk.
____ 79. Which of the following is a source of market risk?
a.
b.
c.
d.
Holding stocks in many companies carries the risk of a reduced average return.
Real GDP varies over time and sales and profits move with real GDP.
When a paper producer has declining sales, it is likely that so will other paper producers.
If stockholders become aggravated with the way a CEO runs a company, the price of that
company’s stock might fall in the stock market.
____ 80. There are many concerns for risk-averse lenders. Consider the following: 1. Lenders are concerned that
borrowers with the greatest risk are the ones most likely to actively pursue loans. 2. Lenders are concerned that
real GDP will decline leading to reduced corporate profits. 3. Lenders are concerned that products produced by
certain corporations will become obsolete.
a. 1 is market risk; 2 is firm-specific risk
b. 2 is market risk; 3 is firm-specific risk
c. 3 is market risk; 1 is firm-specific risk
d. 2 is firm-specific risk; 3 is market risk
____ 81. Which of the following is not correct?
a. A risk averse person might be willing to hold stocks.
b. Other things the same, a portfolio with the stocks of a large number of companies has less
risk.
c. Other things the same, the larger a portion of savings a person invests in stocks, the greater
his expected return.
d. Diversification can eliminate market risk but not firm-specific risk.
____ 82. An increase in the number of corporations in a portfolio from 1 to 10 reduces
a. market risk by more than an increase from 110 to 120.
b. market risk by less than an increase from 110 to 120.
c. firm-specific risk by more than an increase from 110 to 120.
d. firm-specific risk by less than an increase from 110 to 120.
____ 83. An increase in the number of corporations in a portfolio from 110 to 120 reduces
a. market risk by more than an increase from 1 to 10.
b. market risk by less than an increase from 1 to 10.
c. firm-specific risk by more than an increase from 1 to 10.
d. firm-specific risk by less than an increase from 1 to 10.
____ 84. Angela reads financial advice columns and concludes the following. Which, if any, of her conclusions are
incorrect?
a. Higher average returns come at the price of higher risk.
b. People who are risk averse should never hold stock.
c. Diversification cannot eliminate all of the risk in stock portfolio.
d. None of her conclusions are incorrect.
____ 85. Ben decided to increase the number of stocks in his portfolio. In doing so, Ben reduced
a. both the firm-specific risk and the market risk of his portfolio.
b. the firm-specific risk, but not the market risk of his portfolio.
c. the market risk, but not the firm-specific risk of his portfolio.
d. neither the market risk nor the firm-specific risk of his portfolio.
____ 86. David increases the number of companies in which he holds stocks.
a. This reduces risk's standard deviation and firm-specific risk.
b. This reduces risk's standard deviation and market risk.
c. This raises market risk, but lowers firm-specific risk. What happens to overall risk is
unclear.
d. This raises firm-specific risk, but lowers market risk. What happens to overall risk is
unclear.
____ 87. Phillip is a mortgage broker, who is paid by commission. When interest rates decline, he does a lot of business
and earns a lot of money, as more people buy houses or refinance their mortgages. But when interest rates rise,
business falls substantially. To diversify, Phillip should choose investments that
a. provide a higher return than the market average.
b. provide a lower return than the market average.
c. pay higher returns when interest rates rise and lower returns when interest rates fall.
d. pay lower returns when interest rates rise and higher returns when interest rates fall.
____ 88. To diversify, a homeowner with a variable-rate mortgage should choose investments that
a. pay higher returns when interest rates rise and lower returns when interest rates fall.
b. pay lower returns when interest rates rise and higher returns when interest rates fall.
c. provide a higher return than the market average.
d. provide a lower return than the market average.
____ 89. Dakota rearranges her portfolio so that it has a higher average return. In doing this rearranging, she
a. raised both firm-specific risk and market risk.
b. raised firm-specific risk, but not market risk.
c. raised market risk, but not firm-specific risk.
d. None of the above is correct.
____ 90. Marcus puts a greater proportion of his portfolio into government bonds. Marcus’s action
a. increases both risk and the average rate of return.
b. decreases both risk and the average rate of return.
c. increases risk, but decreases the average rate of return.
d. decreases risk, but increases the average rate of return.
____ 91. Manufacturers of Weightbegone are concerned that genetic advances in weight control might reduce the
demand for their diet snacks. This is an example of
a. firm-specific risk, which will likely raise shareholders’ demand for higher return.
b. firm-specific risk, which will likely not likely raise shareholders’ demand for higher return.
c. market risk, which will likely raise shareholders’ demand for higher return.
d. market risk, which will likely not raise shareholders’ demand for higher return.
____ 92. Suppose that fundamental analysis indicates a particular company’s stock is overvalued.
a. This means its present value is less than its price. You should consider adding the stock to
b. This means its present value is less than its price. You shouldn’t consider adding the stock to
c. This means its present value is more than its price. You should consider adding the stock to
d. This means its present value is more than its price. You shouldn’t consider adding the stock
____ 93. A risk-averse person has
a. a utility function whose slope gets flatter as wealth rises. This means they have increasing
marginal utility of wealth.
b. a utility function whose slope gets flatter as wealth rises. This means they have
diminishing marginal utility of wealth.
c. a utility function whose slope gets steeper as wealth rises. This means they have increasing
marginal utility of wealth.
d. a utility function whose slope gets steeper as wealth rises. This means they have
diminishing utility of wealth.
____ 94. The idea of insurance
a. would not appeal to a risk-averse person.
b. is, other things the same, to reduce the probability of a fire, accident, or death.
c. is to share risk.
d. is to provide a sure thing, not a gamble.
____ 95. Which of the following actions best illustrates adverse selection?
a. A person purposely chooses bonds of corporations with high default risk because of the high
returns.
b. A person dislikes losing \$400 more than he likes winning \$400.
c. After obtaining automobile insurance a person drives less carefully than before.
d. A person intending to take up dangerous hobbies applies for life insurance.
____ 96. Which of the following best illustrates diversification?
a. A company that produces many different products decides to produce fewer.
b. After selling stock, corporate management spends funds on projects with greater risks than
c. Instead of holding only the stocks of companies engaged in the banking business, a person
decides to hold stock in a number of different companies producing different goods and
services.
d. A person decides to purchase only stocks that have paid high dividends in the past.
____ 97. As the number of stocks in a portfolio rises,
a. both firm-specific risks and market risk fall.
b. firm-specific risks fall; market risk does not.
c. market risk falls; firm-specific risks do not.
d. neither firm-specific risks nor market risk falls.
____ 98. In general, as a person includes fewer stocks and more bonds in his portfolio,
a. both risk and expected return rise.
b. risk rises but expected return falls.
c. risk falls, but expected return rises.
d. both risk and expected return fall.
____ 99. According to fundamental analysis, a saver should prefer to buy stocks that are
a. undervalued. This means the price of the stock is low given the value of the corporation.
b. undervalued. This means the value of the corporation is low given the price of stock.
c. overvalued. This means the price of the stock is high given the value of the corporation.
d. overvalued. This means the value of the corporation is high given the price of stock.
____ 100. People who hold well-diversified portfolios of stocks have greatly reduced or eliminated
a. firm-specific risk, and so they do not need to worry about their wealth decreasing as a result
of recessions.
b. market risk, and so they do not need to worry about their wealth decreasing as a result of
recessions.
c. firm-specific risk, but still they have reason to worry about their wealth decreasing as a
result of recessions.
d. market risk, but still they have reason to worry about their wealth decreasing as a result of
recessions.
____ 101. If Cara’s utility falls more by losing \$600 than it rises by gaining \$600, she has
a. increasing marginal utility of wealth and is risk averse.
b. increasing marginal utility of wealth but is not risk averse.
c. decreasing marginal utility of wealth and is risk averse.
d. decreasing marginal utility of wealth but is not risk averse.
____ 102. Diversifying
a. increases the standard deviation of the value of a portfolio indicating its risk has increased.
b. increases the standard deviation of the value of a portfolio indicating its risk has decreased.
c. decreases the standard deviation of the value of a portfolio indicating its risk has increased.
d. decreases the standard deviation of the value of a portfolio indicating its risk has decreased.
____ 103. A person who is risk averse might accept a 50% chance of losing \$100 today in exchange for a 50% chance of
winning \$125 in two years if the interest rate was
a. 9% but not 10%
b. 10% but not 11%
c. 11% but not 12%
d. None of the above is correct; a risk averse person would not accept any of the above bets.
____ 104. Suppose interest of 5% for two years can be earned on \$1,000 saved today with no risk. What is the least
amount a person would need to have a 50% chance of winning to be willing to face a 50% chance of losing
\$1,000 today and be considered risk averse?
a. \$907.03 to be paid in two years
b. \$1,000.01 to be paid in two years
c. \$1,100.01 to be paid in two years
d. \$1,102.51 to be paid in two years
____ 105. By holding insurance a person
a. reduces the risk of a bad outcome, such as their house burning down.
b. shares risk and so reduces the burden of risk.
c. Both A and B are correct.
d. Neither A nor B are correct.
____ 106. Consider the following two situations. Nicole accepts a job where she will be driving in dangerous traffic, so
she seeks auto insurance. After Braden buys health insurance, he visits the gym less frequently. Which of
these person’s actions illustrates moral hazard?
____ 107. Which of the following make(s) insurance premiums higher than otherwise?
a. adverse selection and moral hazard
b. adverse selection, but not moral hazard
c. moral hazard, but not adverse selection
d. neither adverse selection nor moral hazard
____ 108. A bank might make mortgages to people in different regions of the country. By doing so
a. the bank reduces the risk it faces from falling house prices in its region and falling prices in
all regions.
b. the bank reduces the risk it faces of falling house prices in its region but not from falling
prices in all regions.
c. the bank reduces the risk it faces of falling house prices in all regions, but not the risk it faces
from falling house prices in its regions.
d. the bank reduces neither the risk it faces from falling house prices in its region nor falling
prices in all regions.
____ 109. Samantha holds stocks in four companies. If she adds stocks of several more companies she will decrease
a. firm specific risk and market risk.
b. firm specific risk but not market risk.
c. market risk but not firm specific risk.
d. neither firm specific nor market risk.
____ 110. Suppose that Albert can buy a bond for \$1,000 that matures in two years and pays Albert \$1,102.5 with
certainty. He is indifferent between this bond and one that has some risk but on which the interest rate is 3%
higher. How much, to the nearest penny, does the riskier bond pay in two years?
a. \$1,160.00
b. \$1,166.40
c. \$1,168.65
d. \$1,169.64
____ 111. By diversifying, the risk of holding stock
a. can be eliminated. On average over the past two centuries stocks paid a higher average real
return than bonds.
b. can be eliminated. On average over the past two centuries stocks paid a lower average real
return than bonds.
c. can be reduced but not eliminated. On average over the past two centuries stocks paid a
higher average real return than bonds.
d. can be reduced but not eliminated. On average over the past two centuries stocks paid a
lower average real return than bonds.
____ 112. If a stock or bond is risky
a. risk averse people may be willing to hold it as part of a diversified portfolio.
b. risk averse people may be willing to hold it if the expected return is high enough.
c. both A and B are correct.
d. risk averse people will not hold it.
____ 113. From the standpoint of the economy as a whole, the role of
a. the interest rate is to make sure that the price of bonds increases over time.
b. diversification is to eliminate market risk.
c. insurance is to reduce the risks inherent in life.
d. insurance is to spread risks around more efficiently.
____ 114. Which of the following statements is correct?
a. A high-risk person is more likely to apply for insurance than a low-risk person because a
high-risk person would benefit more from insurance protection.
b. A low-risk person is more likely to apply for insurance than a high-risk person because a
low-risk person would benefit more from insurance protection.
c. Insurance companies can fully guard against the problem of adverse selection, but they
cannot fully guard against the problem of moral hazard.
d. Insurance companies can fully guard against the problem of moral hazard, but they cannot
fully guard against the problem of adverse selection.
____ 115. Kayla faces risks and she pays a fee to ABC Company; in return, ABC Company agrees to accept some or all of
Kayla’s risks. ABC Company is
a. a mutual fund.
b. an insurance company.
c. a diversified company.
d. an equity-financed company.
____ 116. April, who currently owns stock in four companies, has decided to expand her portfolio by purchasing stock in
virtually every company that sells stock. In doing so, April will
a. increase the risk of her portfolio.
b. decrease some, but not all, of the risk of her portfolio.
c. decrease all of the risk of her portfolio.
d. leave the risk of her portfolio unchanged from its present level.
____ 117. Which of the following pairs of portfolios exemplifies the risk-return tradeoff?
a. For Portfolio A, the average return is 6 percent and the standard deviation is 15 percent; for
Portfolio B, the average return is 6 percent and the standard deviation is 25 percent.
b. For Portfolio A, the average return is 5 percent and the standard deviation is 15 percent; for
Portfolio B, the average return is 8 percent and the standard deviation is 15 percent.
c. For Portfolio A, the average return is 5 percent and the standard deviation is 25 percent; for
Portfolio B, the average return is 8 percent and the standard deviation is 15 percent.
d. For Portfolio A, the average return is 5 percent and the standard deviation is 15 percent; for
Portfolio B, the average return is 8 percent and the standard deviation is 25 percent.
____ 118. The risk of a portfolio
a. increases as the number of stocks in the portfolio increases.
b. is usually measured using a statistic called the standard diversification.
c. is positively related to the average return of the portfolio.
d. bears no relationship to the average return of the portfolio.
____ 119. When a person engages in detailed analysis of a company to determine its value, he or she is engaging in
a. standard deviation analysis.
b. informational analysis.
c. fundamental analysis.
d. efficiency analysis.
____ 120. By purchasing shares in a mutual fund that holds a portfolio of stocks, a person can
a. benefit from fundamental analysis, since the mutual fund requires its shareholders to
perform fundamental analysis on their own.
b. benefit from fundamental analysis, since the mutual fund hires one or more individuals to
perform fundamental analysis for the fund.
c. eliminate market risk.
d. reduce the standard deviation of his or her portfolio to zero.
____ 121. If the efficient markets hypothesis is correct, then
a. the number of shares of stock offered for sale exceeds the number of shares of stock that
b. the stock market is informationally efficient.
c. stock prices never follow a random walk.
d. All of the above are correct.
____ 122. If you believe that stock prices follow a random walk, then probably you
a. do not believe that there is positive relationship between risk and return.
b. do not believe that stock prices reflect all available information.
c. believe in the validity of the efficient markets hypothesis.
d. believe that it is a good idea to engage in fundamental analysis.
____ 123. The performance of index funds
a. usually falls short of the performance of actively-managed funds.
b. provides evidence in support of the notion that stock prices do not depend upon supply and
demand.
c. provides evidence in support of the efficient markets hypothesis.
d. provides evidence in support of the notion that stock-market participants are irrational.
____ 124. Which of the following is correct concerning diversification?
a. It only reduces firm-specific risk, but most of the reduction comes from increasing the
number of stocks in a portfolio to well above 30.
b. It only reduces firm-specific risk; much of the reduction comes from increasing the number
of stocks in a portfolio from 1 to 30.
c. It only reduces market risk, but most of the reduction comes from increasing the number of
stocks in a portfolio to well above 30.
d. None of the above is correct.
____ 125. Which of the following is correct?
a. Risk-averse people will not hold stock.
b. Diversification cannot reduce firm-specific risk.
c. The larger the percentage of stock in a portfolio, the greater the risk, but the greater the
average return.
d. Stock prices are determined by fundamental analysis rather than by supply and demand.
____ 126. Dividends
a. are the rates of return on mutual funds.
b. are cash payments that companies make to shareholders.
c. are the difference between the price and present value per share of a stock.
d. are the rates of return on a company’s capital stock.
____ 127. A high-ranking corporate official of a well-known company is unexpectedly sentenced to prison for criminal
activity in trading stocks. This should
a. raise the price and raise the present value of the corporation’s stock.
b. raise the price and lower the present value of the corporation’s stock.
c. lower the price and raise the present value of the corporation’s stock.
d. lower the price and lower the present value of the corporation’s stock.
____ 128. Fundamental analysis is
a. the study of the relation between risk and return of stock portfolios.
b. the determination of the allocation of savings between stocks and bonds based on a person’s
degree of risk aversion.
c. the study of a company’s accounting statements and future prospects to determine its value.
d. a method used to determine how adding stocks to a portfolio will change the risk of the
portfolio.
____ 129. Fundamental analysis shows that stock in Garske Software Corporation has a present value that is higher than
its price.
a. This stock is overvalued; you should consider adding it to your portfolio.
b. This stock is overvalued; you shouldn't consider adding it to your portfolio.
c. This stock is undervalued; you should consider adding it to your portfolio.
d. This stock is undervalued; you shouldn't consider adding it to your portfolio.
____ 130. Fundamental analysis shows that stock in Cedar Valley Furniture Corporation has a price that exceeds its
present value.
a. This stock is overvalued; you should consider adding it to your portfolio.
b. This stock is overvalued; you shouldn't consider adding it to your portfolio.
c. This stock is undervalued; you should consider adding it to your portfolio.
d. This stock is undervalued; you shouldn't consider adding it to your portfolio.
____ 131. Fundamental analysis shows that stock in Lodgefire Restaurants has a present value below its price.
a. This stock is overvalued; you should consider adding it to your portfolio.
b. This stock is overvalued; you shouldn't consider adding it to your portfolio.
c. This stock is undervalued; you should consider adding it to your portfolio.
d. This stock is undervalued; you shouldn't consider adding it to your portfolio.
____ 132. Fundamental analysis determines the value of a stock based on
a. dividends.
b. the expected final sale price.
c. the ability of the corporation to earn profits.
d. All of the above are correct.
____ 133. If stock prices follow a random walk, it means
a. long periods of declining prices are followed by long periods of rising prices.
b. the greater the number of consecutive days of price declines, the greater the probability
prices will increase the following day.
c. stock prices are unrelated to random events that shock the economy.
d. stock prices are just as likely to rise as to fall at any given time.
____ 134. Some people claim that stocks follow a random walk. What does this mean?
a. The price of stock one day is about what it was on the previous day.
b. Changes in stock prices cannot be predicted from available information.
c. Stock prices are not determined by market fundamentals such as supply and demand.
d. Prices of stocks of different firms in the same industry show no or little tendency to move
together.
____ 135. If stock prices follow a random walk, then stock investors can make large profits by
a. buying stocks whose prices have been falling for several days.
b. buying stocks whose prices have been rising for several days.
c. performing fundamental analysis of stocks using data contained in annual reports.
d. using inside information.
____ 136. The efficient markets hypothesis says that
a. only individual investors can make money in the stock market.
b. it should be easy to find stocks whose price differs from their fundamental value.
c. stock prices follow a random walk.
d. All of the above are correct.
____ 137. According to the efficient market hypothesis, which of the following statements is not correct?
a. Stock market prices tend to rise today if they rose yesterday.
b. As judged by the typical person in the market, all stocks are fairly valued all the time.
c. At the market price, the number of shares being offered for sale matches the number of
d. All of the above statements are incorrect.
____ 138. According to the efficient markets hypothesis, worse-than-expected news about a corporation will
a.
b.
c.
d.
have no effect on its stock price.
raise the price of the stock.
lower the price of the stock.
change the price of the stock in a random direction.
____ 139. An index fund
a. holds only stocks and bonds that are indexed to inflation.
b. holds all the stocks in a given stock index.
c. guarantees a return that follows the index of leading economic indicators.
d. typically has a lower return than a managed fund.
____ 140. If the efficient market hypothesis is correct, then
a. index funds should typically beat managed funds, and usually do.
b. index fund should typically beat managed funds, but usually do not.
c. mutual funds should typically beat index funds, and usually do.
d. mutual funds should typically beat index funds, but usually do not.
____ 141. Research studies have shown that
a. the correlation between how well a stock does one year and how well it does the next is
significantly greater than zero.
b. managed mutual funds generally outperform indexed mutual funds.
c. people tend to be overconfident when making investment decisions.
d. All of the above are correct.
____ 142. Which of the following is correct?
a. Managed funds typically have a higher return than indexed funds. This tends to refute the
efficient market hypothesis.
b. Managed funds typically have a higher return than indexed funds. This tends to support the
efficient market hypothesis.
c. Index funds typically have a higher rate of return than managed funds. This tends to refute
the efficient market hypothesis.
d. Index funds typically have a higher rate of return than managed funds. This tends to support
the efficient market hypothesis.
____ 143. Which of the following is not consistent with the efficient market hypothesis?
a. Stock prices should follow a random walk.
b. Index funds should typically outperform highly managed funds.
c. News has no effect on stock prices.
d. There is little point in spending many hours studying the business pages looking for
undervalued stocks.
____ 144. According to the efficient markets hypothesis, which of the following would increase the price of stock in the
Gerhardt Corporation?
a. Gerhardt announces, just as everyone had expected, that it has hired a new highly respected
CEO.
b. Gerhardt announces that its profits were low, but not as low as the market had expected.
c. Analysis by a column in a business weekly indicates that Gerhardt is overvalued.
d. All of the above would increase the price.
____ 145. Suppose that interest rates unexpectedly rise and that Carter Corporation announces that revenues from last
quarter were down but not as much as the public had anticipated they would be down. According to the efficient
markets hypothesis, which of the these things make the price of Carter Corporation Stock fall?
a. both the interest rate rising and the revenue announcement
b. neither the interest rate rising nor the revenue announcement
c. only the interest rate rising
d. only the revenue announcement
____ 146. Fundamental analysis shows that Moonlight Company is fairly valued. Then Moonlight Company
unexpectedly improves its production techniques and unexpectedly hires a new CEO away from another very
successful tea producer. Suppose this has no effect on the price of the stock of Moonlight Company.
a. Fundamental analysis would now show the corporation is overvalued. The fact that the price
was unchanged is consistent with the efficient markets hypothesis.
b. Fundamental analysis would now show the corporation is overvalued. The fact that the price
was unchanged is not consistent with the efficient markets hypothesis.
c. Fundamental analysis would now show the corporation is undervalued. The fact that the
price was unchanged is consistent with the efficient markets hypothesis.
d. Fundamental analysis would now show the corporation is undervalued. The fact that the
price was unchanged is not consistent with the efficient markets hypothesis.
____ 147. In the 1990s, Fed Chairperson Alan Greenspan questioned whether the stock market
a. boom at that time reflected “irrational exuberance.”
b. decline at that time reflected “irrational funk.”
c. boom at that time reflected “rational exuberance.”
d. decline at that time reflected “rational funk.”
____ 148. In the 1990s, Fed Chair Alan Greenspan believed that the market was
a. undervalued, and evidence later showed that this was clearly correct.
b. undervalued, but whether it was remains debatable.
c. overvalued, and evidence later showed that this was clearly correct.
d. overvalued, but whether it was remains debatable.
____ 149. Which of the following is not correct?
a. There is a greater reduction in risk by increasing the number of stocks in a portfolio from 1
to 10, than by increasing it from 100 to 120 stocks.
b. The historical rate of return on stocks has been about 5 percentage points higher than the
historical rate of return on bonds.
c. Stock in an industry that is very sensitive to economic conditions is likely to have a higher
average return than stock in an industry that is not so sensitive to economic conditions.
d. If you had information about a corporation that no one else had, you could earn a very high
rate of return. This contradicts the efficient market hypothesis.
____ 150. Which of the following is correct concerning stock market irrationality?
a. Bubbles could arise, in part, because the price that people pay for stock depends on what
they think someone else will pay for it in the future.
b. Economists almost all agree that the evidence for stock market irrationality is convincing
and the departures from rational pricing are important.
c. Some evidence for the existence of market irrationality is that informed and presumably
rational managers of mutual funds generally beat the market.
d. All of the above are correct.
____ 151. Whenever the price of an asset rises above what appears to be its fundamental value, the market is said to be
experiencing a
a. conjectural mistake.
b. fundamental mishap.
c. speculative bubble.
d. temporary inefficiency.
____ 152. Which of the following terms is used to describe a situation in which the price of an asset rises above what
appears to be its fundamental value?
a. “random walk”
b. “random bubble”
c. “speculative bubble”
d. “speculative hedge”
____ 153. An asset market is said to experience a speculative bubble when
a. the price of the asset rises above what appears to be its fundamental value.
b. the price of the asset appears to follow a random walk.
c. the market cannot establish an equilibrium price for the asset.
d. the asset is a natural resource and its supply is manipulated by foreign nations and foreign
firms.
____ 154. The possibility of speculative bubbles in the stock market arises in part because
a. stock prices may not depend at all on psychological factors.
b. fundamental analysis may be the correct way to evaluate the value of stocks.
c. future streams of dividend payments are very hard to estimate.
d. the value of shares of stock depends not only on the future stream of dividend payments but
also on the price at which the stock will be sold.
____ 155. If asset markets are driven by the “animal spirits” of investors, then
a. those markets reflect rational behavior.
b. those markets reflect irrational behavior.
c. the efficient markets hypothesis is correct.
d. the stock market exhibits informational efficiency.
____ 156. Diversification
a. increases the likely fluctuation in a portfolio’s return. Thus, the likely standard deviation
of the portfolio’s return is higher.
b. increases the likely fluctuation in a portfolio’s return. Thus, the likely standard deviation
of the portfolio’s return is lower.
c. reduces the likely fluctuation in a portfolio’s return. Thus, the likely standard deviation of
the portfolio’s return is higher.
d. reduces the likely fluctuation in a portfolio’s return. Thus, the likely standard deviation of
the portfolio’s return is lower.
____ 157. The value of a stock is based on the
a. present values of the dividend stream and final price.
when interest rates rise.
b. present values of the dividend stream and final price.
when interest rates rise.
c. future values of the dividend stream and final price.
when interest rates rises.
d. future values of the dividend stream and final price.
when interest rates rise.
As a result, the value of a stock rises
As a result, the value of a stock falls
As a result, the value of a stock rises
As a result, the value of a stock falls
____ 158. Suppose that an increased risk of mortgage defaults lowers the expected profitability of banks. Then we would
expect to see
a. the demand for bank stocks rise which would raise the prices of bank stocks.
b. the demand for bank stocks rise which would reduce the prices of bank stocks.
c. the demand for bank stocks fall which would raise the prices of bank stocks.
d. the demand for bank stocks fall which would reduce the prices of bank stocks.
____ 159. A soup manufacturer unexpectedly announces that it has hired a new manager. It is widely believed that this
manager will raise the profitability of the corporation. At the same time interest rates unexpectedly rise.
Which of the above would tend to make the price of the stock rise?
a. the announcement and the rise in interest rates
b. the announcement but not the rise in interest rates
c. the rise in interest rates, but not the announcement
d. neither the announcement nor the rise in interest rates
____ 160. The efficient markets hypothesis implies
a. that all stocks are fairly valued all the time and that no stock is a better buy than any other.
b. that all stocks are fairly valued all the time, but that some stocks may be better buys than
other.
c. that some stocks may be better buys than others and stock experts can determine which
ones.
d. that no stock is efficiently valued.
____ 161. The efficient markets hypothesis implies that
a. building a portfolio based on a published list of the “most respected” companies is likely to
produce a better-than-average return.
b. if a stock rose in price last year, it is likely to rise in price this year.
c. managed mutual funds should generally outperform indexed mutual funds.
d. None of the above are correct.
____ 162. The efficient markets hypothesis says that beating the market consistently is
a. impossible. Many studies find that beating the market is, at best, extremely difficult.
b. impossible. Many studies find that beating the market is relatively easy.
c. relatively easy. Many studies find that beating the market is, at best, extremely difficult.
d. relatively easy. Many studies find that beating the market is relatively easy.
____ 163. If you are convinced that stock prices are impossible to predict from available information, then you probably
also believe that
a. the efficient markets hypothesis is not a correct hypothesis.
b. the stock market is informationally efficient.
c. the stock market is informationally inefficient.
d. there is no reason to establish a diversified portfolio of stocks.
____ 164. A person who believes strongly in the use of fundamental analysis to choose a portfolio of stocks
a. has a better chance of outperforming the market if stock prices follow a random walk than if
they do not follow a random walk.
b. almost always chooses to hold index funds in his or her portfolio rather than
actively-managed funds.
c. is spending his or her time wisely if the efficient markets hypothesis is correct.
d. is interested in the likely ability of a corporation to pay dividends in the future.
____ 165. Which of the following methods of picking stocks is not consistent with fundamental analysis?
a. doing research such as thoroughly reading and analyzing companies’ annual reports
b. choosing mutual funds that are managed by individuals with good reputations
c. viewing individual stock prices as unpredictable
d. relying upon the advice of Wall Street analysts
____ 166. The available evidence indicates that
a. about one-half of all managers of active mutual funds consistently outperform index funds.
b. outperforming the market on a consistent basis is extremely difficult to do.
c. there is little truth to the notion that there is a trade-off between risk and return.
d. there is little truth to the efficient markets hypothesis.
____ 167. The word “efficient” in the term “efficient markets hypothesis” refers to the idea that
a. fundamental analysis is an efficient way to go about choosing which stocks to buy or sell.
b. stock prices move upward and downward “efficiently,” rather than following a “random
walk.”
c. the stock market is “informationally efficient.”
d. All of the above are correct.
____ 168. A pharmaceutical company unexpectedly announces that it just developed an important new drug. This news
should
a. raise the price of the corporation's stock; if it does not the stock is overvalued.
b. raise the price of the corporation's stock; if it does not the stock is undervalued.
c. reduce the price of the corporation's stock; if it does not the stock is overvalued.
d. reduce the price of the corporation's stock; if it does not the stock is undervalued.
____ 169. If your research leads you to believe that the present value of a stock’s dividend stream and future price is less
than its price then you believe the stock is
a. overvalued so you should consider buying it.
b. overvalued so you should not consider buying it.
c. undervalued so you should consider buying it.
d. undervalued so you should not consider buying it.
____ 170. If unexpected news raised people’s expectations of a corporation’s future dividends and price, then before the
price changes this corporation’s stock would be
a. overvalued, so its price would rise.
b. overvalued, so its price would fall.
c. undervalued, so its price would rise.
d. undervalued, so its price would fall.
____ 171. If more people think a corporation’s stock is overvalued than think it is undervalued then there is a
a. surplus, so its price will rise.
b. surplus, so its price will fall.
c. shortage, so its price will rise.
d. shortage, so its price will fall.
____ 172. According to the efficient market hypothesis
a. changes in the prices of stocks are predictable. Evidence shows that managed funds
typically do better than indexed funds.
b. changes in the prices of stocks are predictable. Evidence shows that indexed funds
typically do better than managed funds.
c. changes in the prices of stocks are not predictable. Evidence shows that managed funds
typically do better than indexed funds.
d. changes in the prices of stocks are not predictable. Evidence shows that indexed funds
typically do better than managed funds.
____ 173. During a financial crisis the possibility of bank failures rose. An increase in the likelihood of a bank failing
shifts demand for its stock
a. right, so the price rises.
b. right, so the price falls.
c. left, so the price rises.
d. left, so the price falls.
____ 174. After the 1982 recession, the U.S. and world economies entered into a long period
a. of high unemployment rates.
b. high inflation rates.
c. that has become known as the “Great Moderation.”
d. that has become known as the “Great Recession.”
____ 175. Writing in the Wall Street Journal in 2009, economist Jeremy Siegel argued that, in the years leading up to the
financial crisis of 2008–2009,
a. financial firms acted in too risky a fashion.
b. the Federal Reserves’s efforts to rein in the risky behavior of certain financial firms were
c. falling house prices “crashed the banks and the economy.”
d. All of the above are correct.
____ 176. Writing in the Wall Street Journal in 2009, economist Jeremy Siegel pointed out that the efficient markets
hypothesis
a. was responsible for the financial crisis of 2008-2009.
b. was responsible for the Great Depression of the 1930s.
c. claims that prices observed in financial markets are always “right.”
d. claims that prices observed in financial markets are mostly “wrong.”
____ 177. No particular stock is a better buy than any other stock if
a. stock prices are driven by investors’ “animal spirits.”
b. the random-walk theory of stock prices is incorrect.
c. the efficient markets hypothesis is correct.
d. actively managed mutual funds always outperform index funds.
____ 178. Scott Adams, creator of the comic strip Dilbert, has a theory that you should
a. buy stock in the companies you love the most.
b. buy stock in the companies you hate the most.
c. make use of technical analysis when you are deciding which stocks to buy.
d. examine companies’ track records when you are deciding which stocks to buy.
____ 179. Stock market fluctuations
a. often go hand in hand with fluctuations in the economy more broadly.
b. rarely have anything to do with fluctuations in the economy more broadly.
c. have few, if any, macroeconomic implications.
d. are attributable to the widespread belief that the efficient markets hypothesis is correct.
____ 180. Economists disagree as to whether
a. the stock price of a company should reflect the company’s expected profitability.
b. the basic tools of finance reflect valid ideas.
c. stock prices reflect rational estimates of a company’s true worth.
d. there is any relationship between stock market fluctuations and fluctuations in the economy
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