M1 Practice Questions Answer Key (1).pdf

ECO3223 Fall 2024 Midterm 1 Practice Questions Answer Key 1) C 2) A 3) C 4) C 5) D 6) D 7) C 8) D 9) D 10) The expected increase in interest rates by the Federal Reserve would cause the value of bonds to decrease. As we saw in class, an increase in the expected future inte...

ECO3223 Fall 2024 Midterm 1 Practice Questions Answer Key 1) C 2) A 3) C 4) C 5) D 6) D 7) C 8) D 9) D 10) The expected increase in interest rates by the Federal Reserve would cause the value of bonds to decrease. As we saw in class, an increase in the expected future interest rate makes bonds less attractive. This will lower the demand for bonds, causing bond prices to decrease and yields to increase. Moreover, the change in bond prices and yields will occur before the actual interest rate changes since existing and prospective bondholders will act on their expectations. 11) Growth in the economy should result in greater supply of bonds, the bond supply curve shifting right, as more firms seek resources to finance expansion and inventories. The increase in supply by itself would result in lower bond prices and higher interest rates. From the demand side, the robust economy should also cause an increase in wealth. The increases in wealth would cause bond demand to increase (the curve shifts right), which would drive up bond prices and decrease interest rates. The net effect will be determined by which shift is larger. If supply shifts by an amount greater than demand, the bond prices will fall and yields will rise. On the other hand, if demand increases by more than supply, the bond prices will rise and yields will fall. 12) A 13) A 14) B 15) A 16) D 17) A 18) C 19) A 20) C 21) B 22) A 23) C 24) C 25) D 1 26) A 27) D 28) B 29) A 30) B 31) A 32) B 33) C 34) C 35) D 36) C 37) A 38) 0.65% 39) D 40) There seems to be an inverse relationship between GDP growth and the size of the risk spread. As GDP growth slows, the risk spread increases and vice versa. 41) B 42) A 43) A 44) A 45) C 46) D 47) C 48) D 49) D 50) If investors expect a recession, it is likely this will lead to an increase in the equity-risk premium. The potential losses associated with stocks are greater during economic downturns, so investors will have a higher required return on stock. All other things equal, this will lead to a decrease in stock prices. During an economic recession, U.S. Treasury securities are relatively more attractive than stocks, so we would expect that investors would purchase more of them relative to equity shares. Recall that stockholders are residual claimants. With bankruptcy more likely during a recession, the expected losses associated with being a residual claimant are higher. 51) Stock market bubbles can lead to the inefficient allocation of investment funds. Those companies that are positively affected by the bubble and see their stock prices increase will find it relatively less expensive to raise funds and consequently may over-invest. On the other hand, those firms who are not the object of stockholder euphoria will find it more expensive to attract funds and as a result may under-invest. For consumers, the bubbles can lead to increased wealth for some individuals who as a result may consume more, save less, buy expensive automobiles, homes, vacations etc. These individuals may even work less or retire early. When the bubble bursts these individuals are left trying to 2  adjust, which can be not only inefficient but traumatic. Also, the companies that geared up to provide these luxury goods are left to adjust. So the result is the bubbles and their subsequent bursts result in real investment and spending that is inefficient. 52) The required stock return is 8 +2.5 = 10.5%. To find the price of the stock, we need to compute the growth rate of dividends: 6% = ($5.3-$5)/$5. Now, we can compute the current price of the stock: Ptoday = Dtoday(1 + g)/( 𝑘 - g) Ptoday = $5(1 + 0.06)/(0.105 - 0.06) Ptoday = $117.78 53) C 54) A 55) D 56) C 57) B 58) D 59) C 60) A 3