True/False
Indicate whether the statement is true or
false.
|
|
|
1.
|
Compounding refers to the accumulation of a sum of money in, say, a bank
account, where the interest earned remains in the account to earn additional interest in the
future.
|
|
|
2.
|
Idiosyncratic risk refers to risk that affects all economic actions.
|
|
|
3.
|
Aggregate risk refers to risk that affects only a single economic actor.
|
|
|
4.
|
Dividends are cash payments that a company makes to its shareholders.
|
|
|
5.
|
The efficient markets hypothesis implies that stock prices should follow a
random walk, that is, the path where changes are impossible to predict from available
information.
|
|
|
6.
|
The concept of a random walk is similar to throwing darts at the stock page in
your newspaper to choose your portfolio.
|
|
|
7.
|
Regardless of irrational behavior in the market, stocks always trade at the
calculated value of that company.
|
Multiple Choice
Identify the choice that best completes the statement or
answers the question.
|
|
|
1.
|
The higher the rate of interest,
a. | the lower will be the future value of a given sum of money deposited in the bank
today, ceteris paribus | b. | the greater will be the future value of a given
sum of money deposited in the bank today, ceteris paribus | c. | Changes in the
interest rate will not affect the future value of money deposited in the bank | d. | The amount of money
will only have a present value |
|
|
|
2.
|
Finance is
a. | the field that studies how people make decisions regarding the allocation of
resources over time and the handling of risk | b. | the field that studies how human behaviour
affects economic behaviour | c. | the field that studies how people decide what
goods and services to trade | d. | the field that looks at the behaviour of
non-participants in the market |
|
|
|
3.
|
Compounding
a. | will decrease the amount of money deposited in the bank | b. | will not change the
amount of money deposited in the bank | c. | means that future value of the money will be
less than the present value | d. | is the accumulation of a sum of money deposited
in a bank where the interest earned remains to earn interest in the
future |
|
|
|
4.
|
Present value is
a. | the amount of money today that would be needed to produce, using prevailing interest
rates, a given future amount of money | b. | the amount of money in the future that an
amount of money today will yield, given prevailing interest rates | c. | the value of a
capital asset as determined by the owner of the asset | d. | the value of a capital asset as determined by
the person who wants to buy the asset |
|
|
|
5.
|
A risk-averse individual will
a. | will take no risk at all | b. | will take many risks | c. | will show a dislike
of uncertainty | d. | displays no marginal utility |
|
|
|
6.
|
Economists have developed a model of risk aversion using the
a. | concept of productivity | b. | concept of efficiency | c. | concept of
avoidance | d. | concept of utility |
|
|
|
7.
|
The market for insurance cannot easily spread risks because of
a. | adverse selection and moral hazard | b. | problems with demand and
supply | c. | government intervention | d. | consumers being too
rational |
|
|
|
8.
|
If you put $100 in the bank today, how much will it be worth in 10 years at a
compound annual interest rate of 5 percent?
|
|
|
9.
|
If you are going to be paid $400 in 10 years, and the prevailing interest rate
is 5 percent, what is the present value of this future payment?
a. | $450.00 | b. | $245.57 | c. | $651.52 | d. | $250.25 |
|
|
|
10.
|
When people use their savings to buy financial assets, they can reduce their
risk
a. | by buying all of the same stocks | b. | by buying only bonds | c. | by buying only
Canadian stocks | d. | through diversification |
|
|
|
11.
|
Mr. Akins is interested in purchasing a business. In order to evaluate how much
he is going to spend he would analyze the business based on
a. | profits and losses | b. | the present value of dividend
payments | c. | only the value of the assets (land, capital and equipment) | d. | all of the
above |
|
|
|
12.
|
By diversifying one’s portfolio,
a. | you substantially eliminate all risk | b. | you eliminate the idiosyncratic risk but still
have aggregate risk | c. | you eliminate the aggregate risk but not the
idiosyncratic risk | d. | you have no effect on either the idiosyncratic
risk or the aggregate risk |
|
|
|
13.
|
Which would you prefer?
a. | $500 today | b. | the present value of $900 if interest is 12%
over 5 years | c. | the present value of $700 if interest is 10% over 5 years | d. | $100 compounded
monthly at 3% for 30 years |
|
Short Answer
|
|
|
1.
|
Distinguish between present value and future value.
|
|
|
2.
|
If you put $20,000 in a bank account today, who much will it be worth in 5
years, if the annual compounded interest rate is 8 percent?
|
|
|
3.
|
If you have to pay out $6,000 in 5 years, what lump sum should you deposit today
at 8 percent compounded annually?
|
|
|
4.
|
What problems do markets for insurance suffer from that impede their ability to
spread risk?
|
|
|
5.
|
What is diversification? Explain.
|