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Unformatted text preview: Econ 2035 Money, Banking, and Macroeconomic Activity, Fall 2011 Practice Midterm 2 1. A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium. a. positive; lower b. positive; raise c. negative; raise d. negative; lower 2. Everything else held constant, if the tax-exempt status of municipal bonds were eliminated, then a. the interest rates on municipal, Treasury, and corporate bonds would all increase. b. the interest rate on municipal bonds would equal the rate on Treasury bonds. c. the interest rates on municipal bonds would still be less than the interest rate on Treasury bonds. d. the interest rate on municipal bonds would exceed the rate on Treasury bonds. 3. According to the expectations theory of the term structure a. when the yield curve is steeply upward sloping, short-term interest rates are expected to remain relatively stable in the future. b. yield curves should be equally likely to slope downward as slope upward. c. investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward. d. when the yield curve is downward sloping, short-term interest rates are expected to remain relatively stable in the future. 4. If 1-year interest rates for the next three years are expected to be 4, 2, and 3 percent, and the 3-year term premium is 1 percent, then the 3-year bond rate will be a. 1 percent. b. 2 percent. c. 3 percent. d. 4 percent. 5. An inverted yield curve a. has a U shape. b. slopes up. c. slopes down. d. is flat. 6. The spread between the interest rates on bonds with default risk and default-free bonds is called the a. risk premium. b. bond margin. c. junk margin. d. default premium. 7. An increase in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Treasury bonds, everything else held constant. a. reduce; increase b. increase; increase c. increase; reduce d. reduce; reduce 8. The additional incentive that the purchaser of a Treasury security requires to buy a long-term security rather than a short-term security is called the a. term premium. b. market premium. c. tax premium. d. risk premium. 9. According to the liquidity premium theory, a yield curve that is flat means that a. the yield curve has nothing to do with expectations of bond purchasers. b. bond purchasers expect interest rates to stay the same. c. bond purchasers expect interest rates to fall in the future. d. bond purchasers expect interest rates to rise in the future. 10. The term structure of interest rates is a. the relationship among interest rates on bonds with different maturities. b. the relationship among the term to maturity of different bonds. c. the structure of how interest rates move over time. d. the relationship among interest rates of different bonds with the same maturity. 11. The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ U.S. Treasury bonds. a. less speculative than b. less liquid than c. lower-yielding than d. tax-exempt unlike 12. Which of the following statements is true? a. All government issued bonds local, state, and federal are federal income tax exempt. b. State and local governments cannot default on their bonds. c. Bonds issued by state and local governments are called municipal bonds. d. The coupon payment on municipal bonds is usually higher than the coupon payment on Treasury bonds. 13. Which of the following is true? a. Commercial paper is issued by corporations. b. Maturities on commercial paper rarely exceed 9-months. c. Commercial paper makes no regular interest payments, but sells at a discount. d. Commercial paper trades on a secondary market. e. All of the above. 14. A stockholder's ownership of a company's stock gives her the right to a. vote and be the primary claimant of all cash flows. b. vote and be the residual claimant of all cash flows. c. manage and assume responsibility for all liabilities. d. vote and assume responsibility for all liabilities. 15. The value of any investment is found by computing the a. present value of all future sales. b. present value of all future liabilities. c. future value of all future expenses. d. present value of all future cash flows. 16. In the one-period valuation model, an increase in the required 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. 17. 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 18. In the generalized dividend model, a future sales price far in the future does not affect the current stock price because a. the present value cannot be computed. b. the present value is almost zero. c. the sales price does not affect the current price. d. the stock may never be sold. 19. 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. 20. Using the Gordon growth model, a stock's price will increase if a. the dividend growth rate increases. b. the growth rate of dividends falls. c. the required rate of return rises. d. the expected sales price rises. 21. A stock's price will fall if there is a. a decrease in perceived risk. b. an increase in the required rate of return. c. an increase in the future sales price. d. current dividends are high. 22. Terrorist attacks on the United States caused a. a decrease in stock prices due to lower expected growth and greater risk. b. a decrease in stock prices due to lower expected dividend growth and reduced uncertainty. c. an increase in stock prices due to an increased required return. d. an increase in stock prices due to higher expected dividend growth. 23. The view that expectations change relatively slowly over time in response to new information is known in economics as a. rational expectations. b. irrational expectations. c. slow-response expectations. d. adaptive expectations. 24. An expectation may fail to be rational if a. relevant information was not available at the time the forecast is made. b. relevant information is available but ignored at the time the forecast is made. c. information changes after the forecast is made. d. information was available to insiders only. 25. Rational expectations forecast errors will on average be ________ and therefore ________ be predicted ahead of time. a. positive; can b. positive; cannot c. negative; can d. zero; cannot 26. If market participants notice that a variable behaves differently now than in the past, then, a. according to rational expectations theory, we can expect market participants to 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. 27. 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. 28. If the optimal forecast of the return on a security exceeds the equilibrium return, then: a. the market is inefficient. b. no unexploited profit opportunities exist. c. the market is in equilibrium. d. the market is myopic. 29. Financial markets quickly eliminate unexploited profit opportunities through changes in a. dividend payments. b. tax laws. c. asset prices. d. monetary policy. 30. If a mutual fund outperforms the market in one period, evidence suggests that this fund is a. highly likely to consistently outperform the market in subsequent periods due to its superior investment strategy. b. likely to under-perform the market in subsequent periods to average its overall returns. c. not likely to consistently outperform the market in subsequent periods. d. not likely to outperform the market in any subsequent period. 31. Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is a. clearly inconsistent with the efficient markets hypothesis. b. consistent with the efficient markets hypothesis if the earnings were not as high as anticipated. c. consistent with the efficient markets hypothesis if the earnings were not as low as anticipated. d. consistent with the efficient markets hypothesis if the favorable earnings were expected. 32. The efficient markets hypothesis predicts that stock prices follow a "random walk." The implication of this hypothesis for investing in stocks is a. a "churning strategy" of buying and selling often to catch market swings. b. turning over your stock portfolio each month, selecting stocks by throwing darts at the stock page. c. a "buy and hold strategy" of holding stocks to avoid brokerage commissions. d. following the advice of technical analysts. 33. The small-firm effect refers to the a. negative returns earned by small firms. b. returns equal to large firms earned by small firms. c. abnormally high returns earned by small firms. d. low returns after adjusting for risk earned by small firms. 34. 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. 35. 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%. 36. The advantage of a "buy-and-hold strategy" is that a. net profits will tend to be higher because there will be fewer brokerage commissions. b. losses will eventually be eliminated. c. the longer a stock is held, the higher will be its price. d. profits are guaranteed. 37. A situation when an asset price differs from its fundamental value is a. a random walk. b. an inflation. c. a deflation. d. a bubble. 38. A decrease in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant. a. left; depreciate b. left; appreciate c. right; depreciate d. right; appreciate 39. The Economist regularly publishes an interesting application of the PPP. The ________ index calculates the exchange rate based on the theory of PPP. a. Coca-cola b. Tall Late c. Big Mac d. Whopper 40. The theory of PPP suggests that if one country's price level falls relative to another's, its currency should a. appreciate in the short run. b. depreciate in the long run. c. appreciate in the long run. d. depreciate in the short run. 41. In a world with few impediments to capital mobility, the domestic interest rate equals the sum of the foreign interest rate and the expected depreciation of the domestic currency, a situation known as the a. foreign asset parity condition. b. purchasing power parity condition. c. exchange rate parity condition. d. interest parity condition. 42. If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollar- denominated assets, and if the dollar is expected to appreciate at a 4 percent rate, the expected return on ________-denominated assets in ________ percent. a. dollar; euros is 3 b. euro; dollars is 1 c. euro; dollars is 3 d. dollar; euros is 1 43. A decrease in the expected future domestic exchange rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant. a. left; appreciate b. left; depreciate c. right; appreciate d. right; depreciate 44. On April 7, 2006, one U.S. dollar traded on the foreign exchange market for about 1.30 Swiss francs. Therefore, one Swiss franc would have purchased about ________ U.S. dollars. a. 0.30 b. 0.77 c. 1.30 d. 3.10 45. When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per pound, then, holding everything else constant, the pound has ________ and ________ expensive. a. depreciated; American wheat sold in Britain becomes more b. depreciated; American wheat sold in Britain becomes less c. appreciated; British cars sold in the United States become more d. appreciated; British cars sold in the United States become less 46. Assume that the following are the predicted inflation rates in these countries for the year: 2% for the United States, 3% for Canada; 4% for Mexico, and 5% for Brazil. According to the purchasing power parity and everything else held constant, which of the following would we expect to happen? a. The Mexican peso will depreciate against the Brazilian real. b. The Brazilian real will depreciate against the U.S. dollar. c. The U.S. dollar will depreciate against the Canadian dollar. d. The Canadian dollar will depreciate against the Mexican peso. 47. If the U.S. Congress imposes a quota on imports of Japanese cars due to claims of "unfair" trade practices, and Japanese demand for American exports increases at the same time, then, in the long run ________, everything else held constant. a. there will be no effect on the Japanese yen relative to the U.S. dollar b. the Japanese yen will appreciate relative to the U.S. dollar c. the Japanese yen will either appreciate, depreciate or remain constant against the U.S. dollar d. the Japanese yen will depreciate relative to the U.S. dollar 48. An increase in productivity in a country will cause its currency to ________ because it can produce goods at a ________ price, everything else constant. a. depreciate; lower b. appreciate; lower c. depreciate; higher d. appreciate; higher 49. The ________ states that exchange rate between any two currencies will adjust to reflect changes in the price levels of the two countries. a. theory of money neutrality b. quantity theory of money c. theory of purchasing power parity d. the law of one price 50. Suppose the Federal Reserve releases a policy statement today which leads people to believe that the Fed will be enacting expansionary monetary policy in the near future. Everything else held constant, the release of this statement would immediately cause the demand for U.S. assets to ________ and the U.S. dollar to ________. a. increase; appreciate b. decrease; appreciate c. increase; depreciate d. decrease; depreciate ...
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