M1 Practice Questions (1).pdf

ECO3223 Fall 2024 Midterm 1 Practice Questions 1) If the interest rate is zero, a promise to receive a $100 payment one year from now is A) more valuable than receiving $100 today. B) less valuable than receiving $100 today. C) equal in value to rece...

ECO3223 Fall 2024 Midterm 1 Practice Questions 1) If the interest rate is zero, a promise to receive a $100 payment one year from now is A) more valuable than receiving $100 today. B) less valuable than receiving $100 today. C) equal in value to receiving $100 today. D) equal in value to receiving $101 today. 2) Present value is higher when the future value of the payment is. A) higher, the time until payment is shorter, and the interest rate is lower. B) lower, the time until payment is shorter, and the interest rate is higher. C) higher, the time until payment is longer, and the interest rate is lower. D) lower, the time until payment is shorter, and the interest rate is higher. 3) The following equations express Demand and Supply in the bond market where Qd is quantity demanded, Qs is quantity supplied, and P is price per bond. Demand: Qd = 1,000 – 6P/5 Supply: Qs = P – 100 At a price of $400 in this market, A) the market clears. B) there is an excess supply of bonds. C) there is an excess demand for bonds. D) the bond market is in equilibrium. 4) The economy enters a period of robust economic growth that is expected to last for several years. How would this be reflected in the risk structure of interest rates? A) an inverted yield curve B) a decrease in the term spread C) a decrease in the interest rate spread D) an increase in yields on tax-exempt bonds 1 5) When expected inflation increases, for any given nominal interest rate the A) bond demand curve shifts right. B) bond supply curve shifts left. C) price of bonds increases. D) yield on bonds will increase. 6) Which one of the following would lead to an increase in bond supply? A) a decrease in government spending relative to revenue B) a decrease in the nation’s wealth C) a decrease in expected inflation D) an improvement in general business conditions 7) Suppose that the expected return on bonds falls relative to other assets. In the bond market this will result in A) the bond supply curve shifting left. B) a movement down the bond demand curve. C) a shift to the left of the bond demand curve. D) an increase in the price of bonds. 8) Which one of the following statements about the result of a deterioration in business conditions that also causes a decrease in a nation's wealth is false? A) The impact on bond prices will be ambiguous since both the bond demand and supply curves shift left. B) The price of bonds will increase if bond supply decreases more than bond demand. C) Interest rates will increase if bond demand decreases more than bond supply. D) Neither bond demand nor bond supply will shift. 2 9) Which of the following is true of interest-rate risk? A) It is the risk that the coupon rate for a bond will change, affecting current bondholders' coupon payments. B) It refers to the probability that a borrower will default on debt obligations. C) It is the risk that the face value of a bond will change before maturity. D) Individuals owning long-term bonds are exposed to greater interest-rate risk. 10) Assume that it is expected that the Federal Reserve will be raising interest rates before the end of the year. How would this affect the bond market and why? 11) Use our model of the bond market (supply and demand) to explain what happens if an economy continued to grow at robust rates for a long period of time. 12) If a bond's rating improves, we would expect A) the demand for this bond to increase, all other factors constant. B) the demand for and the yield of this bond to increase, all other factors constant. C) the demand for this bond to decrease, and its yield to increase, all other factors constant. D) both the demand for and the price of the bond to decrease, all other factors constant. 13) Fatima holds a one-year $200 face value, taxable bond with a coupon rate of 5%. Suppose she faces a tax rate of 20%. How much tax will she pay for income earned on the investment? And what is the return on the investment when taxes are taken into account? A) She will pay $2 in taxes and earn a return of 4%. B) She will pay $2 in taxes and earn a return of 5%. C) She will pay $10 in taxes and earn a return of 4%. D) She will pay $10 in taxes and earn a return of 5%. 3 14) I purchase a 10 percent coupon bond. Based on my purchase price, I calculate a yield to maturity of 8 percent. If I hold this bond to maturity, then my return on this asset is A) 10 percent. B) 8 percent. C) 12 percent. D) there is not enough information to determine the return. 15) What is the present value of $500.00 to be paid in two years if the interest rate is 5 percent? A) $453.51 B) $500.00 C) $476.25 D) $550.00 16) Which of the following $5,000 face-value securities has the highest yield to maturity? A) a 6 percent coupon bond selling for $5,000 B) a 6 percent coupon bond selling for $5,500 C) a 10 percent coupon bond selling for $5,000 D) a 12 percent coupon bond selling for $4,500 17) If a $1,000 face value coupon bond has a coupon rate of 3.75 percent, then the coupon payment every year is A) $37.50. B) $3.75. C) $375.00. D) $13.75 4 18) A $1,000 face value bond, with an annual coupon of $40, one year to maturity, and a purchase price of $980 has a A) current yield that equals 4.00%. B) coupon rate that equals 4.08%. C) current yield that equals 4.08% and a market interest rate that equals 6.12%. D) current yield that equals 4.08% and a market interest rate that equals 4.0%. 19) When the ________ is below the coupon rate, the bond sells at ________ A) market interest rate for a bond; a premium B) market interest rate for a bond; a discount C) market interest rate for a bond; par D) none of the above. 20) A 30-year Treasury bond has a face value of $1,000 and a price of $1,200 with a $50 coupon payment. Assume the price of this bond decreases to $1,100 over the next year. The one-year holding period return is equal to A) −9.17%. B) −8.33%. C) −4.17%. D) −3.79%. 21) Suppose there is a decrease in the price at which a bondholder sells her bond. In this case, the holding period return will A) increase, since yields and prices are inversely related. B) decrease, since this lowers the capital gain. C) be negative. D) equal the coupon rate. 5 22) Holding liquidity and default risk constant, an investor earning 6% from a tax-exempt bond who is in a 25% tax bracket would be indifferent between that bond and a taxable bond with a(n) A) 8% yield. B) 4.5% yield. C) 6.25% yield. D) 7.5% yield. 23) In examining the yield curve for U.S. Treasury securities, we find all of the following except A) Long-term yields tend to be higher than short-term yields. B) Interest rates of different maturities tend to move together. C) Long-term rates tend to equal short-term rates. D) Yields on short-term securities are more volatile than yields on long-term bonds. 24) The one-year holding period return on a $1,000 face value, 5 percent coupon bond that initially sells at par and sells for $950 next year is A) -10 percent. B) -5 percent. C) 0 percent. D) 5 percent. 25) In which of the following situations would you prefer to be the borrower? A) The nominal interest rate is 9 percent, and the expected inflation rate is 7 percent. B) The nominal interest rate is 4 percent, and the expected inflation rate is 1 percent. C) The nominal interest rate is 13 percent, and the expected inflation rate is 15 percent. D) The nominal interest rate is 25 percent, and the expected inflation rate is 50 percent. 26) The default-risk premium A) should vary directly with the bond's yield and inversely with its price. B) is less than 0 (zero) for a U.S. Treasury bond. C) should be lower for a highly speculative bond than for an investment-grade bond. D) should vary directly with the bond's yield and the bond's price. 6 27) A decrease in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Treasury bonds, everything else held constant. A) increase; increase B) reduce; reduce C) reduce; increase D) increase; reduce 28) Which of the following securities has the lowest interest rate? A) junk bonds B) U.S. Treasury bonds C) corporate Aa bonds D) corporate Baa bonds 29) Corporate bonds are not as liquid as Treasury bonds because A) fewer corporate bonds for any one corporation are traded, making them more costly to sell. B) the corporate bond rating must be calculated each time they are traded. C) corporate bonds have a higher default risk. D) corporate bonds cannot be resold. 30) When the Treasury bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________. A) right; right B) right; left C) left; right D) left; left 31) A(n) ________ in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the yield on corporate bonds, all else equal. A) increase; increase; decrease B) increase; decrease; decrease C) decrease; increase; increase D) decrease; decrease; decrease 7 32) Which of the following statements is TRUE? A) State and local governments cannot default on their bonds. B) Bonds issued by state and local governments are called municipal bonds. C) All government issued bonds—local, state, and federal—are federal income tax exempt. D) The coupon payment on municipal bonds is usually higher than the coupon payment on Treasury bonds. 33) Everything else held constant, if federal income tax rates were lowered, then A) the interest rate on municipal bonds would fall. B) the interest rate on Treasury bonds would rise. C) the interest rate on municipal bonds would rise. D) the price of Treasury bonds would fall. 34) Three factors explain the risk structure of interest rates A) maturity, liquidity, and the income tax treatment of a security. B) maturity, default risk, and the income tax treatment of a security. C) liquidity, default risk, and the income tax treatment of a security. D) maturity, default risk, and the liquidity of a security. 35) The term structure of interest rates is A) the relationship among interest rates of different bonds with the same maturity. B) the structure of how interest rates move over time. C) the relationship among the term to maturity of different bonds. D) the relationship among interest rates on bonds with different maturities. 36) Assume the expectations hypothesis regarding the term structure of interest rates is correct. If the current one-year interest rate is 3% and the one-year-ahead expected one-year interest rate is 5%, then the current two-year interest rate should be A) 3%. B) 5%. C) 4%. D) 8%. 8 37) The addition of the liquidity premium theory to the expectations hypothesis allows us to explain why A) yield curves usually slope upward. B) interest rates on bonds of different maturities move together. C) long-term interest rates are less volatile than short-term interest rates. D) yield curves are flat 38) An investor sees the current one-year rate at 4% and expects the following future one-year rates for each of the subsequent years to be 4.5%, 5.5% and 6.0%. If this investor views a four- year maturity at 5.65% as equal to four consecutive one-year securities, what is their risk premium? [Hint: use the formula for the interest-rate on a multi-year bond under the liquidity premium theory.] 39) An inverted yield curve predicts that short-term interest rates A) are expected to rise in the future. B) will rise and then fall in the future. C) will remain unchanged in the future. D) will fall in the future. 40) When we compare GDP growth over time to the risk spread on Baa bonds compared to 10- year U.S. Treasury bonds for the same time frame, what relationship can be inferred? 41) Two characteristics that make owning stock attractive are: A) unlimited liability and owners having first claim on assets. B) share prices that are relatively inexpensive and transferable. C) that each share represents a large percentage of ownership and dividends are fixed. D) dividends that are paid before any other distributions are made and transferability of stocks. 9 42) The fact that common stockholders are residual claimants means the stockholders A) have a claim against the revenue that remains after everyone else is paid. B) receive their dividends before any other residuals are paid. C) are paid any past due dividends before other claims are paid. D) are paid before the bondholders but after any taxes are paid. 43) Which one of the following stock price indexes is a price-weighted index? A) Dow Jones Industrial Average. B) Standard & Poor's 500 Index. C) Nasdaq. D) Wilshire 5000 44) The Standard & Poor's 500 Index A) gives more weight to large companies than small companies. B) actually includes more than 500 of the largest corporations in the United States. C) is a price-weighted index. D) assigns equal weight to all the prices of all the stocks in the index. 45) The Nasdaq Composite Index is A) a price-weighted index. B) made up of over 5000 companies traded on the NYSE. C) a value-weighted index. D) made of mainly older firms and is heavily weighted by manufacturing. 46) In the one-period valuation model, an increase in the required rate of return A) increases the expected sales price of a stock. B) increases the current price of a stock. C) reduces the expected sales price of a stock. D) reduces the current price of a stock. 10 47) Using the one-period valuation model, assuming a year-end dividend of $0.11, an expected sales price of $110, and a required rate of return of 10%, the current price of the stock would be A) $110.11. B) $121.12. C) $100.10. D) $100.11 48) Using the Gordon constant growth model, a stock's current price decreases when A) the dividend growth rate increases. B) the required return on equity decreases. C) the expected dividend payment increases. D) the growth rate of dividends decreases. 49) A company currently pays a dividend of $4.00 per share. It expects the growth rate of the dividend to be 3% (0.03) annually. If the required return on investments in equity is 6% (0.06) what does the Gordon constant growth model predict the current price of the stock should be? A) $33.33. B) $66.67. C) $103.33. D) $137.33. 50) Discuss how changes in economic conditions are likely to affect the equity risk premium and stock prices. Considering the risks associated with investing in stocks (over short periods of time), what types of investments would you expect investors to buy during an economic recession? 51) Discuss the inefficiencies that can be caused by stock market bubbles, especially focusing on firms and consumers. 11 52) A company currently has $5 in dividends per year. It commits to paying $5.30 one year from the current date. This growth rate for dividends is expected to continue indefinitely. The required stock return is equal to the risk-free yield on U.S. Treasury bond of 8% plus an equity-risk premium is equal to 2.5%. Compute the required stock return and current price of this stock, using the Gordon constant growth model. 53) 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 lowest successful bidder. C) fully reflects all available relevant information. D) is a result of none of the above. 54) The efficient markets hypothesis implies that future changes in stock prices should for all practical purposes be A) unpredictable. B) set by each country. C) increasing. D) decreasing. 55) In the event of bankruptcy, stockholders A) are paid before bondholders. B) receive at least their initial investment due to limited liability. C) could lose more than their initial investment. D) are the last to be paid and could end up losing what they have invested. 56) In the first calendar quarter, a company issues a surprising report saying that it expects profits to rise in the fourth quarter. The theory of efficient markets says we should expect the price of the company's stock to A) rise in the fourth quarter when the higher profits are actually seen. B) fall immediately as stockholders will be disappointed about having to wait until the fourth quarter for higher profits. C) rise immediately on the expectation of higher profits in the future. 12  D) rise around the third quarter since this information will take time to disseminate. 57) Stock market bubbles are A) the increase in a stock's price resulting from reported higher profits by a firm. B) persistent and expanding gaps between stocks' actual prices and the prices warranted by the fundamentals. C) synonymous to stock market crashes. D) those periods of time when the overall level of the stock market is rising at a slow rate reflecting market fundamentals. 58) Stock market bubbles are costly for the economy because they A) imply that the actual stock price is equal to the fundamental value of the stock. B) hurt consumers more than corporations. C) lead to a reduction in real investment in both the short term and long term. D) lead to a misallocation of resources in both the short term and long term. 59) Stocks appear to present risk, yet many people have substantial parts of their wealth invested in them. This behavior could be explained by the fact that A) people are irrational in their investment behavior, only focusing on positive outcomes. B) people are not very risk-averse and do not require a risk premium for stocks. C) investing in stocks over the long run is not as risky as short-term holdings of stocks. D) people are not efficient users of information. 60) In early 2020, the U.S. stock market experienced one of its fastest bear market declines ever. The DJIA fell more than 35% in a single month. According to research that shows that 25-year returns on bonds are much smoother than 1-year returns, investors should have A) continued to hold stocks for the long run. B) moved investments out of the stock market. C) switched to investing in bonds, which are less risky. D) let year-to-year fluctuations in stock values guide investing. 13