True/False
Indicate whether the
sentence or statement is true or false.
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1.
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If the prevailing interest rate is 10 per cent, a
rational person should be indifferent between receiving €1,000 today and €1,000 one year
from today.
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2.
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You are going to receive a €100,000
inheritance in ten years. If the prevailing interest rate is 6 percent, the present value of your
inheritance is €55,839.48.
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3.
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The rule of 70 suggests that, on average,
people's incomes double every 70 years.
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4.
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If interest is compounded annually, €100
placed in a bank account earning 10 percent interest should generate €30 interest after three
years.
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5.
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According to the rule of 70, if your income grows
at 7 percent per year, it will double in ten years.
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6.
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The present value of a future sum is the amount of
money today that would be needed, at prevailing interest rates, to produce that future
sum.
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7.
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If people are risk averse, the utility gained from
winning €1,000 is equal to the utility lost from losing a €1,000 bet.
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8.
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If someone's utility function exhibits
diminishing marginal utility of wealth, this person is risk averse.
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9.
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The insurance market demonstrates the problem of
adverse selection when those that are sicker than average seek health insurance.
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10.
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People can reduce what is known as aggregate risk
by diversifying their portfolios.
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11.
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Increasing the diversification of a portfolio from
1 share to 10 shares reduces the portfolio's risk by the same amount as increasing the
diversification from 10 to 20 shares.
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12.
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As a person allocates more of his savings to shares
and less to government bonds, he will earn a higher rate of return but he must accept additional
risk.
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13.
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The efficient markets hypothesis suggests that
since markets are efficient, it is easy to engage in fundamental analysis to purchase undervalued
shares and then earn greater than average market returns.
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14.
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If the efficient markets hypothesis is true, share
prices follow a random walk. Therefore, buying a diversified portfolio, by purchasing an index fund
or by throwing darts at the share prices page in a newspaper, is probably the best that you can
do.
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15.
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The value of a share is based on the present value
of the future stream of dividend payments and the final sales price.
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Multiple Choice
Identify the
letter of the choice that best completes the statement or answers the question.
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16.
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The amount today that would be needed, at
prevailing interest rates, to produce a particular sum in the future is know as
a. | future value. | b. | fair value. | c. | present
value. | d. | compound value. | e. | beginning value. |
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17.
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If a depositor puts €100 in a bank account
that earns 4 percent interest compounded annually, how much will be in the account after five
years?
a. | €400.00 | b. | €104.00 | c. | €121.67 | d. | €123.98 | e. | €120.00 |
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18.
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JCB (which makes agricultural and construction
equipment) has the opportunity to purchase a new factory today that will provide them with a £50
million return four years from now. If prevailing interest rates are 6 percent, what is the maximum
that the project can cost for JCB to be willing to undertake the project?
a. | £43,456,838 | b. | £53,406,002 | c. | £34,583,902 | d. | £39,604,682 | e. | £50,000,000 |
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19.
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An increase in the prevailing interest
rate
a. | increases the present value of future returns from
investment, and increases investment. | b. | decreases the
present value of future returns from investment, and decreases investment. | c. | decreases the present value of future returns from investment, and increases
investment. | d. | increases the
present value of future returns from investment, and decreases
investment. |
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20.
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If two countries start with the same real
GDP/person, and one country grows at 2 percent while the other grows at 4 percent,
a. | one country will always have 2 percent more real
GDP/person than the other. | b. | the standard of
living in the country growing at 4 percent will start to accelerate away from the slower growing
country due to compound growth. | c. | the standard of
living in the two countries will converge. | d. | next year the
country growing at 4 percent will have twice the GDP/person as the country growing at 2
percent. |
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21.
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Using the rule of 70, if your income grows at 10
percent per year, your income will double in approximately
a. | 70 years. | b. | 7 years. | c. | 10
years. | d. | There is not enough information to answer this
question. | e. | 700 years. |
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22.
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Using the rule of 70, if your parents place
€10,000 in a deposit for you on the day you are born, approximately how much will be in the
account when you retire at 70 years old if the deposit earns 3 percent per year?
a. | €20,000 | b. | €300 | c. | €70,000 | d. | €80,000 | e. | €3,000 |
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23.
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If people are risk averse, then
a. | none of these answers are
true. | b. | all of these answers are
true. | c. | they dislike bad things more than the like comparable
good things. | d. | the utility they
would lose from losing a €50 bet would exceed the utility they would gain from winning a
€50 bet. | e. | their utility
functions exhibit the property of diminishing marginal utility of
wealth. |
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24.
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Which of the following does not help reduce the
risk that people face?
a. | increasing the rate of return within their
portfolio | b. | diversifying their portfolio | c. | All of these answers help reduce risk. | d. | buying insurance |
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25.
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Which of the following is an example of moral
hazard?
a. | After Guiseppe buys fire insurance, he begins to smoke
cigarettes in bed. | b. | None of these
answers demonstrate moral hazard. | c. | Martin has been
feeling poorly lately so he seeks health insurance. | d. | Both of Suzanne’s parents lost their teeth due to gum disease, so
Suzanne buys dental insurance. | e. | All of these
answers demonstrate moral hazard. |
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26.
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Idiosyncratic risk is the
a. | uncertainty associated with the entire
economy. | b. | uncertainty associated with specific
companies. | c. | risk associated
with adverse selection. | d. | risk associated
with moral hazard. |
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27.
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Diversification of a portfolio can
a. | reduce aggregate risk. | b. | eliminate all risk. | c. | increase the
standard deviation of the portfolio's return. | d. | reduce idiosyncratic risk. |
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28.
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Compared to a portfolio composed entirely of
shares, a portfolio that is 50 percent government bonds and 50 percent shares will have
a
a. | lower return and a lower level of
risk. | b. | lower return and a higher level of
risk. | c. | higher return and a lower level of
risk. | d. | higher return and a higher level of
risk. |
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29.
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The study of a company's accounting statements
and future prospects to determine its value is known as
a. | information analysis. | b. | risk management. | c. | fundamental
analysis. | d. | diversification. |
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30.
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If the efficient markets hypothesis is true,
then
a. | shares tend to be overvalued. | b. | the stock market is informationally efficient so share prices should follow a
random walk. | c. | all of these
answers | d. | fundamental analysis is a valuable tool for increasing
one's returns from investing in shares. | e. | an index fund is a
poor investment. |
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31.
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Which of the following reduces risk in a portfolio
the greatest?
a. | Increasing the number of shares from 10 to
20 | b. | All of these answers provide the same amount of risk
reduction. | c. | Increasing the
number of shares in the portfolio from 1 to 10 | d. | Increasing the
number of shares from 20 to 30 |
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32.
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Which of the following should cause the price of a
share of stock to rise?
a. | None of these answers | b. | An increase in expected dividends | c. | A reduction in aggregate risk | d. | A reduction in the interest rate | e. | All of these answers |
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33.
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Speculative bubbles may occur in the shares
market
a. | during periods of extreme pessimism because so many
stocks become undervalued. | b. | only when people
are irrational. | c. | when stocks are
fairly valued. | d. | because rational
people may buy an overvalued share if they think they can sell it to someone for even more at a later
date. |
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34.
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Share prices will follow a random walk
if
a. | shares are overvalued. | b. | people behave irrationally when choosing shares. | c. | markets reflect all available information in a rational
way. | d. | shares are
undervalued. |
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35.
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It is difficult for an actively managed investment
fund to out perform an index fund because
a. | stock markets tend to be
inefficient. | b. | all of these
answers | c. | index funds are able to buy undervalued
stocks. | d. | actively managed funds trade more often and charge fees
for their alleged expertise. | e. | index funds
generally do better fundamental analysis. |
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