Question 1

In general, as a person includes fewer stocks and more bonds in his portfolio,

Accepted Answer

A)  both risk and expected return rise. 
B)  risk rises but expected return falls. 
C)  risk falls, but expected return rises. 
D)  both risk and expected return fall. 
A)  both risk and expected return rise. 
B)  risk rises but expected return falls. 
C)  risk falls, but expected return rises. 
D)  both risk and expected return fall.

Question 2

Tami knows that people in her family die young, and so she buys life insurance. Preston knows he is a reckless driver and so he applies for automobile insurance.

Accepted Answer

A)  These are both examples of adverse selection. 
B)  These are both examples of moral hazard. 
C)  The first example illustrates adverse selection, and the second illustrates moral hazard. 
D)  The first example illustrates moral hazard, and the second illustrates adverse selection. 
A)  These are both examples of adverse selection. 
B)  These are both examples of moral hazard. 
C)  The first example illustrates adverse selection, and the second illustrates moral hazard. 
D)  The first example illustrates moral hazard, and the second illustrates adverse selection.

Question 3

Suppose you put $500 into a bank account today. Interest is paid annually and the annual interest rate is 8 percent. The future value of the $500 after 2 years is

Accepted Answer

A)  $428.67. 
B)  $470.00. 
C)  $580.00. 1. 
D)  $583.20. 
A)  $428.67. 
B)  $470.00. 
C)  $580.00. 1. 
D)  $583.20.

Question 4

Diversification of a portfolio

Accepted Answer

A)  can eliminate market risk, but it cannot eliminate firm-specific risk. 
B)  can eliminate firm-specific risk, but it cannot eliminate market risk. 
C)  increases the portfolio's standard deviation. 
D)  is not necessary for a person who is risk averse. 
A)  can eliminate market risk, but it cannot eliminate firm-specific risk. 
B)  can eliminate firm-specific risk, but it cannot eliminate market risk. 
C)  increases the portfolio's standard deviation. 
D)  is not necessary for a person who is risk averse.

Question 5

Cash payments that companies make to shareholders are called

Accepted Answer

A)  annuities. 
B)  dividends. 
C)  premiums. 
D)  favorables. 
A)  annuities. 
B)  dividends. 
C)  premiums. 
D)  favorables.

Question 6

You are a financial advisor and a client tells you he is concerned about the amount of risk in his portfolio. Assuming your client hasn't already done them, what two things can you suggest to reduce your client's risk? What additional information about reducing risk should you provide?

Accepted Answer

The client can reduce his risk by furthe

Question 7

Which of the following best illustrates moral hazard?

Accepted Answer

A)  After a person obtains life insurance, she takes up skydiving. 
B)  A person obtains insurance knowing he is in poor health. 
C)  A person holds stock only in very risky corporations. 
D)  A person holds stocks from only a few corporations. 
A)  After a person obtains life insurance, she takes up skydiving. 
B)  A person obtains insurance knowing he is in poor health. 
C)  A person holds stock only in very risky corporations. 
D)  A person holds stocks from only a few corporations.

Question 8

If you put $400 into a bank account today and it promises to pay 5% interest for 6 years, how much is in the account at the end of the six years?

Accepted Answer

A)   
B)   
C)   
D)   
A)   
B)   
C)   
D)

Question 9

According to the rule of 70, if you earn an interest rate of 3.5 percent, your savings will double about every 20 years.

Accepted Answer

A) True 
 B)False

Question 10

The problem of moral hazard arises because

Accepted Answer

A)  life is full of all sorts of risks. 
B)  after people buy insurance, they have less incentive to be careful about their risky behavior. 
C)  a high-risk person is more likely to apply for insurance than is a low-risk person. 
D)  insurance companies go to great effort to avoid paying claims to their policy holders. 
A)  life is full of all sorts of risks. 
B)  after people buy insurance, they have less incentive to be careful about their risky behavior. 
C)  a high-risk person is more likely to apply for insurance than is a low-risk person. 
D)  insurance companies go to great effort to avoid paying claims to their policy holders.

Question 11

Which of the following is not correct?

Accepted Answer

A)  A risk averse person might be willing to hold stocks. 
B)  Other things the same, a portfolio with the stocks of a large number of companies has less risk. 
C)  Other things the same, the larger a portion of savings a person invests in stocks, the greater his expected return. 
D)  Diversification can eliminate market risk but not firm-specific risk. 
A)  A risk averse person might be willing to hold stocks. 
B)  Other things the same, a portfolio with the stocks of a large number of companies has less risk. 
C)  Other things the same, the larger a portion of savings a person invests in stocks, the greater his expected return. 
D)  Diversification can eliminate market risk but not firm-specific risk.

Question 12

Fundamental analysis determines the value of a stock based on

Accepted Answer

A)  dividends. 
B)  the expected final sale price. 
C)  the ability of the corporation to earn profits. 
D)  All of the above are correct. 
A)  dividends. 
B)  the expected final sale price. 
C)  the ability of the corporation to earn profits. 
D)  All of the above are correct.

Question 13

Imagine that someone offers you $X today or $1,500 in 5 years. If the interest rate is 4 percent, then you would prefer to take the $X today if and only if

Accepted Answer

A)  X > 1,055.56. 
B)  X > 1,120.89. 
C)  X > 1,232.89. 
D)  X > 1,338.26. 
A)  X > 1,055.56. 
B)  X > 1,120.89. 
C)  X > 1,232.89. 
D)  X > 1,338.26.

Question 14

Moral hazard is illustrated by people who take greater risks after they purchase insurance.

Accepted Answer

A) True 
 B)False

Question 15

Risk aversion helps to explain various things we observe in the economy, including

Accepted Answer

A)  adherence to the old adage, "Don't put all your eggs in one basket." 
B)  insurance. 
C)  the risk-return trade-off. 
D)  All of the above are correct. 
A)  adherence to the old adage, "Don't put all your eggs in one basket." 
B)  insurance. 
C)  the risk-return trade-off. 
D)  All of the above are correct.

Question 16

What is the present value of a payment of $100 one year from today if the interest rate is 5 percent?

Accepted Answer

A)  $95.50 
B)  $95.24 
C)  $95.00 
D)  None of the above are correct to the nearest cent. 
A)  $95.50 
B)  $95.24 
C)  $95.00 
D)  None of the above are correct to the nearest cent.

Question 17

Will is risk averse and has $1,000 with which to make a financial investment. He has three options. Option A is a risk-free government bond that pays 5 percent interest each year for two years. Option B is a low-risk stock that analysts expect to be worth about $1,102.50 in two years. Option C is a high-risk stock that is expected to be worth about $1,200 in four years. Will should choose

Accepted Answer

A)  option A. 
B)  option B. 
C)  option C. 
D)  either option A or option B because Will is indifferent between those two options and they are superior to option C. 
A)  option A. 
B)  option B. 
C)  option C. 
D)  either option A or option B because Will is indifferent between those two options and they are superior to option C.

Question 18

The present value of a payment of $500 to be made two years from today is greater if the interest rate is 7% than if it is 6%.

Accepted Answer

A) True 
 B)False

Question 19

A company has an investment project that will cost $2 million today and yield a payoff of $3 million in 5 years. What interest rate represents the cutoff between profitability and nonprofitability for this project?

Accepted Answer

The present value of the futur

Question 20

Suppose that an increased risk of mortgage defaults lowers the expected profitability of banks. Then we would expect to see

Accepted Answer

A)  the demand for bank stocks rise which would raise the prices of bank stocks. 
B)  the demand for bank stocks rise which would reduce the prices of bank stocks. 
C)  the demand for bank stocks fall which would raise the prices of bank stocks. 
D)  the demand for bank stocks fall which would reduce the prices of bank stocks. 
A)  the demand for bank stocks rise which would raise the prices of bank stocks. 
B)  the demand for bank stocks rise which would reduce the prices of bank stocks. 
C)  the demand for bank stocks fall which would raise the prices of bank stocks. 
D)  the demand for bank stocks fall which would reduce the prices of bank stocks.

Exam 19: The Basic Tools of Finance

In general, as a person includes fewer stocks and more bonds in his portfolio,

Tami knows that people in her family die young, and so she buys life insurance. Preston knows he is a reckless driver and so he applies for automobile insurance.

Suppose you put $500 into a bank account today. Interest is paid annually and the annual interest rate is 8 percent. The future value of the $500 after 2 years is

Diversification of a portfolio

Cash payments that companies make to shareholders are called

You are a financial advisor and a client tells you he is concerned about the amount of risk in his portfolio. Assuming your client hasn't already done them, what two things can you suggest to reduce your client's risk? What additional information about reducing risk should you provide?

Which of the following best illustrates moral hazard?

If you put $400 into a bank account today and it promises to pay 5% interest for 6 years, how much is in the account at the end of the six years?

According to the rule of 70, if you earn an interest rate of 3.5 percent, your savings will double about every 20 years.

The problem of moral hazard arises because

Which of the following is not correct?

Fundamental analysis determines the value of a stock based on

Imagine that someone offers you $X today or $1,500 in 5 years. If the interest rate is 4 percent, then you would prefer to take the $X today if and only if

Moral hazard is illustrated by people who take greater risks after they purchase insurance.

Risk aversion helps to explain various things we observe in the economy, including

What is the present value of a payment of $100 one year from today if the interest rate is 5 percent?

The present value of a payment of $500 to be made two years from today is greater if the interest rate is 7% than if it is 6%.

A company has an investment project that will cost $2 million today and yield a payoff of $3 million in 5 years. What interest rate represents the cutoff between profitability and nonprofitability for this project?

Suppose that an increased risk of mortgage defaults lowers the expected profitability of banks. Then we would expect to see

Ten Principles of Economics

Thinking Like an Economist

Interdependence and the Gains From Trade

The Market Forces of Supply and Demand

Elasticity and Its Application

Supply, Demand, and Government Policies

Consumers, Producers, and the Efficiency of Markets

Application: The Costs of Taxation

Application: International Trade

Externalities

Public Goods and Common Resources

The Costs of Production

Firms in Competitive Markets

Monopoly

Measuring a Nations Income

Measuring the Cost of Living

Production and Growth

Saving, Investment, and the Financial System

Unemployment

The Monetary System

Money Growth and Inflation

Aggregate Demand and Aggregate Supply

The Influence of Monetary and Fiscal Policy on Aggregate Demand

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