Exam 12: Investment and Financial Markets

The theory of investment that links investment spending to stock prices is known as the

When the nominal rate of interest and the rate of inflation are the same, the real interest rate is zero.

Suppose you have $400 to invest at a nominal interest rate of 5 percent. If the inflation rate is 2 percent, then the real return on your investment is approximately

The relationship between interest rates and investment spending is graphed as

What are three options a company has when it wants to finance a new project?

Borrowers and lenders make transactions based on the

Table 12.2 Returns on Investment -Referring to Table 12.2, if the nominal interest rate is 3.5 percent and there is no inflation, which investments will be undertaken?

Expected real interest rates are the

Recall the Application about opting for a lump sum of $500,000 for your retirement or $35,000 per year for the rest of your life to answer the following question(s). -Assume the retiree had a third option: receive a lump sum of $750,000 five years from now. If the interest rate is 4 percent, approximately how much is the future $750,000 to be received in 5 years worth today?

Scenario 12.1: Jennifer has decided to give up her pack-a-day smoking habit and invest the money she would have spent on cigarettes in a retirement account. At $6.00 a pack, Jennifer is currently spending $2,190 per year on cigarettes. Jennifer is 25 years old and plans to retire in 35 years, at age 60. She has chosen a retirement account that will earn a long-term average return of 5 percent per year. Jennifer is currently earning $40,000 annually. Assume that the average annual inflation rate will be 5 percent per year, that the cost of cigarettes will increase with inflation, and that Jennifer's income will also rise with the inflation rate. -Refer to Scenario 12.1. By what approximate percentage will Jennifer's income increase from age 25 to age 60?

A business borrows from a bank at 7 percent but expects 3 percent general inflation in the economy. What are the nominal and real rates of interest facing this borrower?

Risk can often be reduced by investing in a large number of projects.

Recall the Application about the number of homeowners in the year 2012 who owed more on their homes than their homes were worth to answer the following question(s). To assist homeowners who are behind on their payments and may eventually lose their homes to foreclosure, many in Congress have advocated for reduction on the amount of money they actually owe-or principal reduction. The hope is that with a reduction in the amount they owed they would start making timely payments on their mortgages and avoid a messy default. -According to this Application, for approximately 12 million homeowners in 2012, the amount owed on mortgages was higher than the actual value of the homes. These homeowners used borrowed funds to purchase their homes, a practice known as

When the level of the stock market is high, investment spending tends to be high, ceteris paribus.

Table 12.1 Expected Real Rates of Interest for Five Countries Source: Trading Economics, September, 2010 -Refer to Table 12.1. The nominal interest rate for the United States is

If the real interest rate is 5 percent and the nominal interest rate is 2 percent, this implies an expected inflation rate of

Accelerator theory refers to the theory of

When investors reduce their investment spending, it is a sign that they are ________ about the economy.

The Q-theory of investment is based on high investments being funded by high stock prices of a company.

The risk of investing in the stock market can be eliminated by diversification.