Question 1

Refer to the graph. Each labeled point represents a different asset. For which of these assets would we expect arbitrage to cause movement to a different point?

Accepted Answer

A)  D and F 
B)  G and H 
C)  D, F, G and H 
D)  D, E, and F 
A)  D and F 
B)  G and H 
C)  D, F, G and H 
D)  D, E, and F

Question 2

Katie buys a house for $200,000 and rents it for $1,000 per month. Katie's annual rate of return

Accepted Answer

A)  is 0.5 percent. 
B)  is 5 percent. 
C)  is 6 percent. 
D)  cannot be determined until she sells the house. 
A)  is 0.5 percent. 
B)  is 5 percent. 
C)  is 6 percent. 
D)  cannot be determined until she sells the house.

Question 3

The U.S. federal government is unlikely to default on its bonds because

Accepted Answer

A)  the bonds are all long-term bonds and they are insured. 
B)  the federal government has the ability to collect taxes and to sell securities to the Fed. 
C)  foreigners are willing to buy the federal government bonds and lend to the U.S. government. 
D)  the federal government can always borrow from the states and from businesses. 
A)  the bonds are all long-term bonds and they are insured. 
B)  the federal government has the ability to collect taxes and to sell securities to the Fed. 
C)  foreigners are willing to buy the federal government bonds and lend to the U.S. government. 
D)  the federal government can always borrow from the states and from businesses.

Question 4

(Advanced analysis) Indy has $2,000 invested in a ﬁnancial asset earning an annually compounded interest rate of 6 percent. Approximately how many years will it take before Indy's investment is
Worth $5,000?

Accepted Answer

A)  25 
B)  10.5 
C)  12.8 
D)  15.7 
A)  25 
B)  10.5 
C)  12.8 
D)  15.7

Question 5

Rates of return on short-term U.S. government bonds are compensation for

Accepted Answer

A)  both the level of risk and the delaying of consumption. 
B)  delaying consumption only. 
C)  the level of risk only. 
D)  factors other than risk and delaying consumption. 
A)  both the level of risk and the delaying of consumption. 
B)  delaying consumption only. 
C)  the level of risk only. 
D)  factors other than risk and delaying consumption.

Question 6

If the Federal Reserve conducts an open-market purchase, then the SML will

Accepted Answer

A)  shift up. 
B)  shift down. 
C)  rotate and become steeper. 
D)  rotate and become ﬂatter. 
A)  shift up. 
B)  shift down. 
C)  rotate and become steeper. 
D)  rotate and become ﬂatter.

Question 7

Bobbie is contemplating buying a lottery ticket for $1 that has a 1 percent chance of paying $100. What is Bobbie's average expected rate of return on this "investment?"

Accepted Answer

A)  practically zero percent 
B)  1 percent 
C)  50 percent 
D)  $1 
A)  practically zero percent 
B)  1 percent 
C)  50 percent 
D)  $1

Question 8

Assume that two ﬁrms (Firm A and Firm B) are similar in all respects, but Firm A's stock has a higher rate of return than Firm B's stock. Arbitrage will occur as investors

Accepted Answer

A)  sell Firm A's stock and buy Firm B's stock. 
B)  buy Firm A's stock and buy Firm B's stock also. 
C)  sell Firm A's stock and sell Firm B's stock also. 
D)  buy Firm A's stock and sell Firm B's stock. 
A)  sell Firm A's stock and buy Firm B's stock. 
B)  buy Firm A's stock and buy Firm B's stock also. 
C)  sell Firm A's stock and sell Firm B's stock also. 
D)  buy Firm A's stock and sell Firm B's stock.

Question 9

Diversiﬁcation in one's investments reduces

Accepted Answer

A)  idiosyncratic risk. 
B)  pooling risk. 
C)  systemic risk. 
D)  time preference risk. 
A)  idiosyncratic risk. 
B)  pooling risk. 
C)  systemic risk. 
D)  time preference risk.

Question 10

Burt bought a house for $250,000 and plans to rent it out for $2,000 per month. His expected annual rate of return from renting the house is approximately

Accepted Answer

A)  8.0 percent. 
B)  9.6 percent. 
C)  19.2 percent. 
D)  20 percent. 
A)  8.0 percent. 
B)  9.6 percent. 
C)  19.2 percent. 
D)  20 percent.

Question 11

Which of the following statements is true about buying an old factory?

Accepted Answer

A)  It is a ﬁnancial investment but not an economic investment. 
B)  It is an economic investment but not a ﬁnancial investment. 
C)  It is both an economic and a ﬁnancial investment. 
D)  It is neither an economic nor a ﬁnancial investment. 
A)  It is a ﬁnancial investment but not an economic investment. 
B)  It is an economic investment but not a ﬁnancial investment. 
C)  It is both an economic and a ﬁnancial investment. 
D)  It is neither an economic nor a ﬁnancial investment.

Question 12

The average expected rate of return on most ﬁnancial assets is the sum of the rates that compensate for

Accepted Answer

A)  nondiversiﬁable risk and time preference. 
B)  diversiﬁable risk and time preference. 
C)  nondiversiﬁable and diversiﬁable risk. 
D)  nondiversiﬁable and diversiﬁable risk, and time preference. 
A)  nondiversiﬁable risk and time preference. 
B)  diversiﬁable risk and time preference. 
C)  nondiversiﬁable and diversiﬁable risk. 
D)  nondiversiﬁable and diversiﬁable risk, and time preference.

Question 13

The present value model of investment states that an asset's current price should be equal to the

Accepted Answer

A)  sum of the present values of all of its future payments or earnings. 
B)  sum of all of its future payments or earnings times the number of years of its life. 
C)  life of the asset times the present values of all of its future payments or earnings. 
D)  present values of all of its future payments or earnings divided by its life in years. 
A)  sum of the present values of all of its future payments or earnings. 
B)  sum of all of its future payments or earnings times the number of years of its life. 
C)  life of the asset times the present values of all of its future payments or earnings. 
D)  present values of all of its future payments or earnings divided by its life in years.

Question 14

(Last Word) Actively managed funds

Accepted Answer

A)  generate lower costs than passively managed funds. 
B)  generally outperform passively managed funds. 
C)  generally perform the same as passively managed funds. 
D)  are generally outperformed by passively managed funds. 
A)  generate lower costs than passively managed funds. 
B)  generally outperform passively managed funds. 
C)  generally perform the same as passively managed funds. 
D)  are generally outperformed by passively managed funds.

Question 15

A stock investor may expect returns in the form of

Accepted Answer

A)  present and future values. 
B)  interest and dividends. 
C)  interest and capital gains. 
D)  dividends and capital gains. 
A)  present and future values. 
B)  interest and dividends. 
C)  interest and capital gains. 
D)  dividends and capital gains.

Question 16

In the accompanying graph, bracket B represents the

Accepted Answer

A)  amount of arbitrage for this asset. 
B)  rate of return for the market portfolio. 
C)  risk premium for an asset's risk level. 
D)  compensation for time preference for an asset. 
A)  amount of arbitrage for this asset. 
B)  rate of return for the market portfolio. 
C)  risk premium for an asset's risk level. 
D)  compensation for time preference for an asset.

Question 17

What are the two ways that a stock investor can gain ﬁnancially from owning stocks?

Accepted Answer

The two ways a stock investor can gain ﬁ

Question 18

The decision of the Federal Reserve to reduce the short-term interest rate will shift the Security
Market Line upward.

Accepted Answer

A) True 
 B)False

Question 19

In general, risk levels and average expected rates of return are

Accepted Answer

A)  not related. 
B)  inversely related. 
C)  directly related. 
D)  as often inversely related as they are directly related. 
A)  not related. 
B)  inversely related. 
C)  directly related. 
D)  as often inversely related as they are directly related.

Question 20

The Security Market Line depicts the inverse relationship between the average expected rates of
return and risk levels of ﬁnancial assets.

Accepted Answer

A) True 
 B)False

Exam 17: Financial Economics

Refer to the graph. Each labeled point represents a different asset. For which of these assets would we expect arbitrage to cause movement to a different point?

Katie buys a house for $200,000 and rents it for $1,000 per month. Katie's annual rate of return

The U.S. federal government is unlikely to default on its bonds because

(Advanced analysis) Indy has $2,000 invested in a ﬁnancial asset earning an annually compounded interest rate of 6 percent. Approximately how many years will it take before Indy's investment is Worth $5,000?

Rates of return on short-term U.S. government bonds are compensation for

If the Federal Reserve conducts an open-market purchase, then the SML will

Bobbie is contemplating buying a lottery ticket for $1 that has a 1 percent chance of paying $100. What is Bobbie's average expected rate of return on this "investment?"

Assume that two ﬁrms (Firm A and Firm B) are similar in all respects, but Firm A's stock has a higher rate of return than Firm B's stock. Arbitrage will occur as investors

Diversiﬁcation in one's investments reduces

Burt bought a house for $250,000 and plans to rent it out for $2,000 per month. His expected annual rate of return from renting the house is approximately

Which of the following statements is true about buying an old factory?

The average expected rate of return on most ﬁnancial assets is the sum of the rates that compensate for

The present value model of investment states that an asset's current price should be equal to the

(Last Word) Actively managed funds

A stock investor may expect returns in the form of

In the accompanying graph, bracket B represents the

What are the two ways that a stock investor can gain ﬁnancially from owning stocks?

The decision of the Federal Reserve to reduce the short-term interest rate will shift the Security Market Line upward.

In general, risk levels and average expected rates of return are

The Security Market Line depicts the inverse relationship between the average expected rates of return and risk levels of ﬁnancial assets.

The Market System and the Circular Flow

Demand, Supply, and Market Equilibrium

Market Failures Caused by Externalities Asymmetric Information

Public Goods, Public Choice, and Government Failure

An Introduction to Macroeconomics

Measuring Domestic Output and National Income

Economic Growth

Business Cycles, Unemployment, and Inflation

Basic Macroeconomic Relationships

The Aggregate Expenditures Model

Aggregate Demand and Aggregate Supply

Fiscal Policy, Deficits, and Debt

Money, Banking, and Financial Institutions

Money Creation

Interest Rates and Monetary Policy

Extending the Analysis of Aggregate Supply

Current Issues in Macro Theory and Policy

International Trade

The Balance of Payments, Exchange Rates, and Trade Deficits

The Economics of Developing Countries

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