Name: __________________________ Date: _____________



1.
Other things equal, an increase in the government budget deficit
A.
drives the interest rate down.
B.
drives the interest rate up.
C.
might not have any effect on interest rates.
D.
increases business prospects.
E.
none of the above.


2.
Over the past year you earned a nominal rate of interest of 10 percent on your money. The inflation rate was 5 percent over the same period. The exact actual growth rate of your purchasing power was
A.
15.5%.
B.
10.0%.
C.
5.0%.
D.
4.8%.
E.
15.0%


3.
A year ago, you invested $12,000 in an investment that produced a return of 16%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?
A.
18%.
B.
2%.
C.
16%.
D.
14%.
E.
none of the above.


4.
You purchase a share of Yestel stock for $90. One year later, after receiving a dividend of $3, you sell the stock for $92. What was your holding period return?
A.
5.56%
B.
2.22%
C.
3.33%
D.
1.11%
E.
40%


5.
Wine Cellars, Inc. has the following probability distribution of holding period returns on its stock.


Assuming that the expected return on Wine Cellar's stock is 14.35%, what is the standard deviation of these returns?
A.
4.27%
B.
5.74%
C.
12.83%
D.
20.42%
E.
32.93%


6.
A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 7%. What is your approximate annual real rate of return if the rate of inflation was 3% over the year?
A.
4%.
B.
10%.
C.
7%.
D.
3%.
E.
none of the above.


7.
You purchased a share of stock for $12. One year later you received $0.25 as dividend and sold the share for $12.92. What was your holding period return?
A.
11%
B.
8.65%
C.
9.75%
D.
11.25%
E.
none of the above


8.
A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 2.5%. What is your approximate annual real rate of return if the rate of inflation was 1.6% over the year?
A.
4.1%.
B.
2.5%.
C.
0.9%.
D.
1.6%.
E.
none of the above.


9.
If the annual real rate of interest is 5% and the expected inflation rate is 4%, the nominal rate of interest would be approximately
A.
1%.
B.
9%.
C.
20%.
D.
15%.
E.
none of the above.


10.
Which of the following determine(s) the level of real interest rates?

I) the supply of savings by households and business firms
II) the demand for investment funds
III) the government's net supply and/or demand for funds
A.
I only
B.
II only
C.
I and II only
D.
I, II, and III (all of the above)
E.
none of the above


11.
If the nominal return is constant, the after-tax real rate of return
A.
declines as the inflation rate increases.
B.
increases as the inflation rate increases.
C.
declines as the inflation rate declines.
D.
increases as the inflation rate decreases.
E.
A and D.


12.
Discuss some reasons why an investor with a long time horizon might choose to invest in common stocks, even though they have historically been riskier than government bonds or T-bills.

Answer:


13.
The risk premium for common stocks
A.
cannot be zero, for investors would be unwilling to invest in common stocks.
B.
must always be positive, in theory.
C.
is negative, as common stocks are risky.
D.
A and B.
E.
A and C.


14.
You purchased a share of stock for $65. One year later you received $2.37 as dividend and sold the share for $63. What was your holding period return?
A.
-4.5%
B.
-0.2550%
C.
0.89%
D.
0.57%
E.
none of the above


15.
Which of the following measures of risk best highlights the potential loss from extreme negative returns?
A.
Standard deviation
B.
Variance
C.
Upper partial standard deviation
D.
Value at Risk (VaR)
E.
None of the above


16.
In words, the real rate of interest is approximately equal to
A.
the nominal rate minus the inflation rate.
B.
the inflation rate minus the nominal rate.
C.
the nominal rate times the inflation rate.
D.
the inflation rate divided by the nominal rate.
E.
the nominal rate plus the inflation rate.


17.
Discuss the law of one price and how this concept relates to the possibility of earning arbitrage profits?

Answer:


18.
Over the past year you earned a nominal rate of interest of 12.5 percent on your money. The inflation rate was 2.6 percent over the same period. The exact actual growth rate of your purchasing power was
A.
9.65%.
B.
9.90%.
C.
15.10%.
D.
10.52%.
E.
8.67%.


19.
Toyco stock has the following probability distribution of expected prices one year from now:


If you buy Toyco today for $55 and it will pay a dividend during the year of $4 per share, what is your expected holding period return on Toyco?
A.
7.27%
B.
18.18%
C.
10.91%
D.
16.36%
E.
9.09%


20.
If both the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation:
A.
borrowers gain and savers lose.
B.
savers gain and borrowers lose.
C.
both borrowers and savers lose.
D.
neither borrowers nor savers gain or lose.
E.
both borrowers and savers gain.


21.
Over the past year you earned a nominal rate of interest of 14 percent on your money. The inflation rate was 2 percent over the same period. The exact actual growth rate of your purchasing power was
A.
12.00%.
B.
16.00%.
C.
15.02%.
D.
14.32%.
E.
11.76%


22.
"Bracket Creep" happens when
A.
tax liabilities are based on real income and there is a negative inflation rate.
B.
tax liabilities are based on real income and there is a positive inflation rate.
C.
tax liabilities are based on nominal income and there is a negative inflation rate.
D.
tax liabilities are based on nominal income and there is a positive inflation rate.
E.
too many peculiar people make their way into the highest tax bracket.


23.
What is the expected variance for the stock?
A.
142.07%
B.
189.96%
C.
177.04%
D.
148.04%
E.
128.17%


24.
The holding-period return (HPR) for a stock is equal to
A.
the real yield minus the inflation rate.
B.
the nominal yield minus the real yield.
C.
the capital gains yield minus the tax rate.
D.
the capital gains yield minus the dividend yield.
E.
the dividend yield plus the capital gains yield.


25.
If the annual real rate of interest is 4% and the expected inflation rate is 3%, the nominal rate of interest would be approximately
A.
4%.
B.
3%.
C.
1%.
D.
7%.
E.
none of the above.


26.
You purchased a share of stock for $120. One year later you received $1.82 as dividend and sold the share for $136. What was your holding period return?
A.
14.85%
B.
22.12%
C.
15.67%
D.
13.24%
E.
none of the above


You have been given this probability distribution for the holding period return for a stock:

Reference: 5-2

27.
What is the expected holding period return for the stock?
A.
11.67%
B.
8.33%
C.
10.4%
D.
12.4%
E.
7.88%


28.
Discuss why common stocks must earn a risk premium.

Answer:


29.
A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 4%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year?
A.
4%.
B.
2%.
C.
6%.
D.
3%.
E.
none of the above.


30.
Ceteris paribus, a decrease in the demand for loanable funds
A.
drives the interest rate down.
B.
drives the interest rate up.
C.
might not have any effect on interest rate.
D.
results from an increase in business prospects and a decrease in the level of savings.
E.
none of the above.


You have been given this probability distribution for the holding period return for a stock:

Reference: 5-2

31.
What is the expected standard deviation for the stock?
A.
2.07%
B.
9.96%
C.
7.04%
D.
1.44%
E.
12.17%


32.
The holding period return (HPR) on a share of stock is equal to
A.
the capital gain yield over the period, plus the inflation rate.
B.
the capital gain yield over the period, plus the dividend yield.
C.
the current yield, plus the dividend yield.
D.
the dividend yield, plus the risk premium.
E.
the change in stock price.


You have been given this probability distribution for the holding period return for XYZ stock:

Reference: 5-1

33.
What is the expected variance for XYZ stock?
A.
72.07%
B.
69.96%
C.
77.04%
D.
66.04%
E.
68.13%


34.
An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding period return on his investment?
A.
1.52%
B.
0.50%
C.
1.02%
D.
0.01%
E.
0.01%


35.
A risk-free intermediate or long-term investment
A.
is free of all types of risk.
B.
does not guarantee the future purchasing power of its cash flows.
C.
does guarantee the future purchasing power of its cash flows as it is insured by the U. S. Treasury.
D.
A and B.
E.
B and C.


36.
If the annual real rate of interest is 2.5% and the expected inflation rate is 3.4%, the nominal rate of interest would be approximately
A.
5.9%.
B.
0.9%.
C.
-0.9%.
D.
7%.
E.
none of the above.


37.
What has been the relationship between T-Bill rates and inflation rates since the 1980s?
A.
The T-Bill rate was sometimes higher than and sometimes lower than the inflation rate.
B.
The T-Bill rate has equaled the inflation rate plus a constant percentage.
C.
The inflation rate has equaled the T-Bill rate plus a constant percentage.
D.
The T-Bill rate has been higher than the inflation rate almost the entire period.
E.
The T-Bill rate has been lower than the inflation rate almost the entire period.


38.
Which of the following statements is true:
A.
Inflation has no effect on the nominal rate of interest.
B.
The realized nominal rate of interest is always positive.
C.
The realized nominal rate of interest is always greater than the real rate of interest.
D.
Certificates of deposit offer a guaranteed real rate of interest.
E.
None of the above is true.


39.
Discuss the relationships between interest rates (both real and nominal), expected inflation rates, and tax rates on investment returns.

Answer:


40.
Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2002 show that
A.
stocks offered investors greater rates of return than bonds and bills.
B.
stock returns were less volatile than those of bonds and bills.
C.
bonds offered investors greater rates of return than stocks and bills.
D.
bills outperformed stocks and bonds.
E.
treasury bills always offered a rate of return greater than inflation.



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