Question 1

Explain why being a residual claimant can increase the risk from owning stocks.

Accepted Answer

The stockholders, being residual claiman

Question 2

The dividend-discount model of stock valuation:

Accepted Answer

A)  is an application of the net present value formula. 
B)  takes the net present value of expected dividends and add it to the future sale price of the stock. 
C)  takes the net present value of the expected future price of the stock and adds the annual dividend. 
D)  takes the annual dividend, adds it to the expected future selling price and divides by the number of years to get the current price. 
A)  is an application of the net present value formula. 
B)  takes the net present value of expected dividends and add it to the future sale price of the stock. 
C)  takes the net present value of the expected future price of the stock and adds the annual dividend. 
D)  takes the annual dividend, adds it to the expected future selling price and divides by the number of years to get the current price.

Question 3

Why isn't the actual level of an index, for example the Dow Jones Industrial Average, very useful on its own?

Accepted Answer

For many indexes, the real value is to b

Question 4

Professor Jeremy Siegel, of the University of Pennsylvania, did research showing that:

Accepted Answer

A)  owning stocks over the long run produces returns below the risk-free return. 
B)  if an investor owns stocks for a very short time the risk is greater than if the stocks are held for a long time. 
C)  the return on the S&P 500 for a 25-year period often produces returns below zero. 
D)  bonds really are less risky to hold over the long term. 
A)  owning stocks over the long run produces returns below the risk-free return. 
B)  if an investor owns stocks for a very short time the risk is greater than if the stocks are held for a long time. 
C)  the return on the S&P 500 for a 25-year period often produces returns below zero. 
D)  bonds really are less risky to hold over the long term.

Question 5

The theory of efficient markets assumes that:

Accepted Answer

A)  prices of bonds, but not stocks, reflect all available information. 
B)  the prices of all financial instruments reflect all available information. 
C)  stock prices are relatively rigid because it takes a while for information to efficiently move through the market. 
D)  the best approach to determining stock prices is to follow the chartists. 
A)  prices of bonds, but not stocks, reflect all available information. 
B)  the prices of all financial instruments reflect all available information. 
C)  stock prices are relatively rigid because it takes a while for information to efficiently move through the market. 
D)  the best approach to determining stock prices is to follow the chartists.

Question 6

After one year, a company will pay $20 in dividends. It commits to paying $21 two years from the current date. This growth rate in dividends is expected to continue indefinitely. The interest rate is 8%. Compute the current price of this stock, using the dividend-discount model.

Accepted Answer

First, we need to compute the growth rat

Question 7

Discuss the effects on the current price of a stock from each of the following:
a) An increase in the growth rate of the dividend;
b) A decrease in the risk-free interest rate;
c) An increase in the equity-risk premium; and finally
d) A decrease in the annual dividend.

Accepted Answer

We can use the dividend-discount model t

Question 8

Considering the return an investor requires from a stock, what are the two components that make up that return? Briefly explain each of these components.

Accepted Answer

We saw in the chapter; that the required

Question 9

Briefly explain the different focus of valuing stocks taken by behavioralists, chartists, and fundamentalists.

Accepted Answer

The behavioralists estimate the value of

Question 10

Why are stock market bubbles costly for the economy?

Accepted Answer

A)  They imply that the actual stock price is equal to the fundamental value of the stock. 
B)  They hurt consumers more than corporations. 
C)  They lead to a reduction in real investment in both the short-term and long-term. 
D)  They lead to a misallocation of resources in both the short-term and long-term. 
A)  They imply that the actual stock price is equal to the fundamental value of the stock. 
B)  They hurt consumers more than corporations. 
C)  They lead to a reduction in real investment in both the short-term and long-term. 
D)  They lead to a misallocation of resources in both the short-term and long-term.

Question 11

The impact from rapid dividend growth on a stock's current price will be: $ \mathrm{P}_{\text {today }}=\frac{\mathrm{D}_{\text {today }}(1+g)}{r f+r p-g} $

Accepted Answer

A)  negative, since the company is paying out profits to stockholders. 
B)  positive since rapid dividend growth causes stockholders to expect higher future dividends. 
C)  zero; only current dividends are used to determine the current price of a stock. 
D)  positive, but only if the corporation does not have any debt. 
A)  negative, since the company is paying out profits to stockholders. 
B)  positive since rapid dividend growth causes stockholders to expect higher future dividends. 
C)  zero; only current dividends are used to determine the current price of a stock. 
D)  positive, but only if the corporation does not have any debt.

Question 12

Explain why the willingness to purchase stocks is influenced heavily by shareholders' legal rights with respect to control of the corporation.

Accepted Answer

Shareholders' legal rights include the a

Question 13

This is a two-part question: We have a firm that needs $1000 to obtain a new machine for its business. It can either issue stock or bonds, or some combination of both. If it issues bonds it will have to pay $8.00 in interest for every $100 borrowed. Finally, assume the company will earn $150 in good years and $75 in bad years, with equal probability. The first part of the question is to (a) determine the payment to the equity holders under the following three scenarios: (i) the first is the firm uses 0% debt financing; (ii) the second is the firm uses 50% debt financing, and (iii) the third finds the firm using 80% debt financing.
The second part of the question is to (b) determine the expected equity return (%) under each scenario.

Accepted Answer

The payment to the equity holders and th

Question 14

Which of the following stock price indexes is a price-weighted index?

Accepted Answer

A)  Dow Jones Industrial Average 
B)  Standard & Poor's 500 Index 
C)  Nasdaq 
D)  Wilshire 5000 
A)  Dow Jones Industrial Average 
B)  Standard & Poor's 500 Index 
C)  Nasdaq 
D)  Wilshire 5000

Question 15

Does the concept of limited liability make owning stocks more or less attractive? Explain.

Accepted Answer

Limited liability makes owning stocks (e

Question 16

A share of common stock represents a(n):

Accepted Answer

A)  claim from a lender against a borrower. 
B)  share in the company's debts. 
C)  share of ownership of the company. 
D)  unlimited liability to the owner of the stock. 
A)  claim from a lender against a borrower. 
B)  share in the company's debts. 
C)  share of ownership of the company. 
D)  unlimited liability to the owner of the stock.

Question 17

Suppose that the current dividend for a stock is Dtₒdₐᵧ, the expected dividend growth rate is r, and the interest rate is i. If we ignore risk, which of the following represents the dividend- discount model formula for the fundamental price of a stock?

Accepted Answer

A)  Dtₒdₐᵧ / (i + g) 
B)  (i + g) / Dtₒdₐᵧ 
C)  Dtₒdₐᵧ (1 + g) / (i - g) 
D)  Dtₒdₐᵧ / (i - g) 
A)  Dtₒdₐᵧ / (i + g) 
B)  (i + g) / Dtₒdₐᵧ 
C)  Dtₒdₐᵧ (1 + g) / (i - g) 
D)  Dtₒdₐᵧ / (i - g)

Question 18

All other things equal, a decrease in the equity risk premium leads to a(n):

Accepted Answer

A)  increase in the required return on stock. 
B)  decrease in the present value of stock. 
C)  increase in the price of equity shares. 
D)  decrease in dividend growth. 
A)  increase in the required return on stock. 
B)  decrease in the present value of stock. 
C)  increase in the price of equity shares. 
D)  decrease in dividend growth.

Question 19

The Nasdaq Composite Index is:

Accepted Answer

A)  a value-weighted index. 
B)  a price-weighted index. 
C)  made up of over 5000 companies traded on the NYSE. 
D)  made of mainly older firms and is heavily weighted by manufacturing. 
A)  a value-weighted index. 
B)  a price-weighted index. 
C)  made up of over 5000 companies traded on the NYSE. 
D)  made of mainly older firms and is heavily weighted by manufacturing.

Question 20

The stocks that make up the Dow Jones Industrial Average:

Accepted Answer

A)  are dominated by the automobile industry. 
B)  are the same ones that were originally used to construct the index. 
C)  are not a broad measure of the market since they do not include any technology companies. 
D)  have changed as the structure of the economy has changed. 
A)  are dominated by the automobile industry. 
B)  are the same ones that were originally used to construct the index. 
C)  are not a broad measure of the market since they do not include any technology companies. 
D)  have changed as the structure of the economy has changed.

Exam 8: Stocks, Stock Markets and Market Efficiency

Explain why being a residual claimant can increase the risk from owning stocks.

The dividend-discount model of stock valuation:

Why isn't the actual level of an index, for example the Dow Jones Industrial Average, very useful on its own?

Professor Jeremy Siegel, of the University of Pennsylvania, did research showing that:

The theory of efficient markets assumes that:

After one year, a company will pay $20 in dividends. It commits to paying $21 two years from the current date. This growth rate in dividends is expected to continue indefinitely. The interest rate is 8%. Compute the current price of this stock, using the dividend-discount model.

Discuss the effects on the current price of a stock from each of the following: a) An increase in the growth rate of the dividend; b) A decrease in the risk-free interest rate; c) An increase in the equity-risk premium; and finally d) A decrease in the annual dividend.

Considering the return an investor requires from a stock, what are the two components that make up that return? Briefly explain each of these components.

Briefly explain the different focus of valuing stocks taken by behavioralists, chartists, and fundamentalists.

Why are stock market bubbles costly for the economy?

The impact from rapid dividend growth on a stock's current price will be: Ptoday =Dtoday (1+g)rf+rp−g \mathrm{P}_{\text {today }}=\frac{\mathrm{D}_{\text {today }}(1+g)}{r f+r p-g} Ptoday ​=rf+rp−gDtoday ​(1+g)​

Explain why the willingness to purchase stocks is influenced heavily by shareholders' legal rights with respect to control of the corporation.

Which of the following stock price indexes is a price-weighted index?

Does the concept of limited liability make owning stocks more or less attractive? Explain.

A share of common stock represents a(n):

Suppose that the current dividend for a stock is Dtₒdₐᵧ, the expected dividend growth rate is r, and the interest rate is i. If we ignore risk, which of the following represents the dividend- discount model formula for the fundamental price of a stock?

All other things equal, a decrease in the equity risk premium leads to a(n):

The Nasdaq Composite Index is:

The stocks that make up the Dow Jones Industrial Average:

An Introduction to Money and the Financial System

Money and the Payments System

Financial Instruments, Financial Markets, and Financial Institutions

Future Value, Present Value and Interest Rates

Understanding Risk

Bonds, Bond Prices, and the Determination of Interest Rates

The Risk and Term Structure of Interest Rates

Derivatives: Futures, Options, and Swaps

Foreign Exchange

The Economics of Financial Intermediation

Depository Institutions: Banks and Bank Management

Financial Industry Structure

Regulating the Financial System

Central Banks in the World Today

The Structure of Central Banks: The Federal Reserve and the European Central Bank

The Central Bank Balance Sheet and the Money Supply Process

Monetary Policy: Stabilizing the Domestic Economy

Exchange Rate Policy and the Central Bank

Money Growth, Money Demand and Modern Monetary Policy

Output, Inflation, and Monetary Policy

Understanding Business Cycle Fluctuations

Modern Monetary Policy and the Challenges Facing Central Bankers

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The impact from rapid dividend growth on a stock's current price will be: $\mathrm{P}_{\text {today }}=\frac{\mathrm{D}_{\text {today }}(1+g)}{r f+r p-g}$