ECON 303 Chapter 7 Study Questions
1) Stockholders are residual claimants, meaning that they
(a) have the first priority claim on all of a company’s assets.
(b) are liable for all of a company’s debts.
(c) will never share in a company’s profits.
(d) receive the remaining cash flow after all other claims are paid.
(e) have a higher claim on cash flow than bond holders.
Answer: D
2) In the one-period valuation model, the value of an investment depends upon
(a) only the present value of the expected sales price.
(b) only the present value of the future dividends.
(c) the actual value of the dividends and expected sales price received in one year.
(d) the future value of dividends and the actual sales price.
(e) the present value of both dividends and the expected sales price.
Answer: E
3) Using the one-period valuation model, assuming a year-end dividend of $0.50, an expected sales price of $50, and a required rate of return of 10%, the current price of the stock would be
(a) $50.50.
(b) $50.00.
(c) $45.91.
(d) $45.00.
(e) indeterminate.
Answer: C
4) Using the Gordon growth model, a stock’s price will increase if
(a) the dividend growth rate increases.
(b) the future sales price increases.
(c) the required rate of return increases.
(d) all of the above occur.
(e) both (a) and (b) of the above.
Answer: A
5) Using the Gordon growth formula, if D1 is $2.00, ke is 12% or 0.12, and g is 10% or 0.10, then the current stock price is
(a) $20.
(b) $50.
(c) $100.
(d) $150.
(e) $200.
Answer: C
6) Using the Gordon growth formula, if the current stock price is $25, ke is 12% or 0.12, and g is 10% or 0.10, then D1 is
(a) $0.25.
(b) $0.50.
(c) $0.75.
(d) $1.00
(e) $1.25.
Answer: B
7) Dishonest corporate accounting procedures caused stock prices to
(a) remain unchanged.
(b) decrease due to lower expected dividend growth and lower required return.
(c) decrease due to lower expected dividend growth and higher required return.
(d) increase due to higher expected dividend growth and lower required return.
(e) increase due to higher expected dividend growth and higher future sales price.
Answer: C
8) If market participants notice that a variable behaves differently now than in the past, then, according to rational expectations theory, we can expect market participants to
(a) change the way they form expectations about future values of the variable.
(b) begin to make systematic mistakes.
(c) no longer pay close attention to movements in this variable.
(d) give up trying to forecast this variable.
Answer: A
9) According to the efficient markets hypothesis, the current price of a financial security:
(a) is the discounted net present value of future interest payments.
(b) is determined by the highest successful bidder.
(c) fully reflects all available relevant information.
(d) is a result of none of the above.
Answer: C
10) During the past decade, the average rate of monetary growth has been 5%, and the average inflation rate has been 5%. If the Federal Reserve announces that the new rate of monetary growth will be 10%, the rational expectation forecast of inflation will be
(a) 5%.
(b) between 5 and 10%.
(c) less than 5%.
(d) 10%.
(e) more than 10%.
Answer: D
11) If the optimal forecast of the return on a security exceeds the equilibrium return, then:
(a) the market is inefficient.
(b) an unexploited profit opportunity exists.
(c) the market is in equilibrium.
(d) only (a) and (b) of the above are true.
(e) only (b) and (c) of the above are true.
Answer: D
12) The number and availability of discount brokers has grown rapidly since the mid-1970s. The efficient markets hypothesis predicts that people who use discount brokers
(a) will likely earn lower returns than those who use full-service brokers.
(b) will likely earn about the same as those who use full-service brokers, but will net more after brokerage commissions.
(c) are going against evidence suggesting that full-service brokers can help outperform the market.
(d) are likely to be poor.
(e) are likely to outperform the market by a wide margin.
Answer: B
13) Assume a stock’s price falls after higher quarterly profits are announced. This occurrence is
(a) clearly inconsistent with the efficient markets hypothesis.
(b) possible if market participants expected lower profits.
(c) consistent with the efficient markets hypothesis.
(d) not possible.
Answer: C
14) That favorable earning reports do not always result in increases in stock prices suggests that
(a) the stock market is not efficient.
(b) people trading stocks sometimes incorrectly estimate companies’ earnings.
(c) stock prices tend to be biased measures of future corporate earnings.
(d) all of the above are true.
(e) both (a) and (c) of the above are true.
Answer: B
15) The small-firm effect refers to the
(a) lower than average returns earned by small firms.
(b) fact that small firms earn returns equal to large firms.
(c) abnormally high returns earned by small firms.
(d) fact that small firms earn low returns after adjusting for risk.
(e) fact that small firms generally earn negative returns.
Answer: C
16) The January effect refers to
(a) the fact that most stock market crashes have occurred in January.
(b) the fact that stock prices tend to fall in January.
(c) the fact that stock prices have historically experienced abnormal price increases in January.
(d) the fact the football team winning the Super Bowl accurately predicts the behavior of the stock market for the next year.
(e) the fact that stock prices are excessively volatile only in the month of January.
Answer: C
17) A phenomenon closely related to market overreaction is
(a) the random walk.
(b) the small-firm effect.
(c) the January effect.
(d) mean reversion.
(e) excessive volatility.
Answer: E
18) Mean reversion refers to the fact that
(a) small firms have higher than average returns.
(b) stocks that have had low returns in the past are more likely to do well in the future.
(c) stock returns are high during the month of January.
(d) stock prices fluctuate more than is justified by fundamentals.
(e) markets overreact.
Answer: B
19) Evidence against market efficiency includes
(a) the January effect.
(b) the excessive volatility of stock prices.
(c) the random walk behavior of stock prices.
(d) all of the above.
(e) both (a) and (b) of the above.
Answer: E
20) According to the efficient markets hypothesis, purchasing the reports of financial analysts
(a) is likely to increase one’s returns by an average of 10%.
(b) is likely to increase one’s returns by about 3 to 5%.
(c) is not likely to be an effective strategy for increasing financial returns.
(d) is likely to increase one’s returns by an average of about 2 to 3%.
(e) guarantees negative returns.
Answer: C
21) Which of the following types of information most likely allows the exploitation of a profit opportunity?
(a) Financial analysts’ published recommendations
(b) Technical analysis
(c) Hot tips from a stockbroker
(d) Insider information
Answer: D
22) The tech stock crash of 2000 is evidence in support of
(a) the efficient markets hypothesis.
(b) a rational bubble.
(c) rational expectations.
(d) all of the above.
(e) both (a) and (c) of the above.
Answer: B
23) A situation when an asset price differs from its fundamental value is a(n)
(a) random walk.
(b) inflation.
(c) deflation.
(d) efficient market.
(e) bubble.
Answer: E
24) In a rational bubble, investors can have
(a) irrational expectations.
(b) adaptive expectations.
(c) rational expectations.
(d) myopic expectations.
(e) autoregressive expectations.
Answer: C