True/False
Indicate whether the
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
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. | €104.00 | b. | €120.00 | c. | €121.67 | d. | €123.98 | e. | €400.00 |
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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
per cent while the other grows at 4 per cent,
a. | one country will always have 2 per cent more real GDP/person than the
other. | b. | the standard of living in the country growing at 4 per cent 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 per cent
will have twice the GDP/person as the country growing at 2 per cent. |
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21.
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Using the rule of 70, if your income grows at 10 per cent per year, your income
will double in approximately
a. | 7 years. | b. | 10 years. | c. | 70
years. | d. | 700 years. | e. | There is not enough information to answer this
question. |
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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 per cent per year?
a. | €300 | b. | €3,000 | c. | €20,000 | d. | €70,000 | e. | €80,000 |
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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 per
cent government bonds and 50 per cent shares will have a
a. | lower return and a lower level of risk. | c. | higher return and a lower level of
risk. | b. | lower return and a higher 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. | c. | fundamental analysis. | b. | risk
management. | 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 financial markets will be operating at
their optimal levels | 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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