tesfatsi@iastate.edu
ANSWER OUTLINE
ECON 353 (SECTION 2) L. Tesfatsion
SECOND MIDTERM EXAM: 40 POINTS TOTAL April 1, 2004
Q1. Recurrent fluctuations that occur in time series data for real GDP and
other key macro variables are referred to as
A A. the business cycle.
B. variable trends.
C. standard deviations.
D. measurement errors.
E. recessions.
Q2. Which of the following statements is/are TRUE:
A. The average price of goods and services in an economy is called the
aggregate price level.
B. The inflation rate is measured as the rate of change in the aggregate
price level.
C. The only measure used in the U.S. for the aggregate price level
is the GDP Deflator.
D. All of the above.
E E. Only A and B.
Q3. Auction markets and over-the-counter (OTC) markets are DISTINGUISHED
by the following characteristic:
A. Auction markets only handle trades in financial assets whereas OTC
markets handle trades in both real and financial assets.
B B. Trades in auction markets are conducted through a centralized facility
whereas trades in OTC markets are not.
C. Trades in auction markets are generally handled by dealers whereas
trades in OTC markets are generally handled by brokers.
D. Auction markets are secondary markets whereas OTC markets are primary
markets.
Q4. A key DISTINCTION between a broker and a dealer is:
A. The broker buys low and sells high whereas the dealer sells low
and buys high.
B. The broker "makes the market" by posting bid and ask prices.
C C. The dealer maintains an inventory of the assets he or she trades in.
D. The dealer earns his/her profits by commissions.
Q5. Which of the following statements is TRUE?
A. Corporations are obliged to pay their stockholders a percentage of
their profits in the form of dividends.
B B. Common stock shares are considered to be a "long term" security because
they have no maturity date.
C. Stock holders do not have voting rights with regard to corporate
management issues except when bankruptcy occurs.
D. Stock holders have first claim on corporate assets in case of bankruptcy.
E. All of the above.
Q6. ___________ in financial markets leads to adverse selection and moral
hazard problems that interfere with the functioning of these markets.
A. Noncollateralized risk
B. Free-riding
C. Costly state verification
D D. Asymmetric information
Q7 Whatever a society uses as money, the defining characteristic is that
A. it must be indexed to inflation so it holds its value.
B B. it must be generally acceptable as payment for goods and services
and repayment of debts, as a matter of social custom.
C. it must contain at least some amount of a precious metal.
D. it must be produced by government.
E. both B and D
Q8 Which of the following statements best explains why the use of money in
an economy increases economic efficiency relative to barter exchange:
A. Money provides a highly stable store of value.
B. Only money can provide a unit of account.
C. Money reduces the need for specialization and the division of labor.
D D. Money reduces the number of prices needed to carry out trades.
Q9 The observed tendency for the form of money to evolve from commodity
money to fiat money increases the fragility of money because
A. fiat money has to be collateralized by a fixed amount of some precious
commodity, which leads to inflexibility in the exchange system.
B. fiat money can lose much of its value if people lose confidence in its
general acceptability as a means of payment for goods and services.
C. fiat money can lose much of its value in hyperinflations.
D. All of the above.
E E. Only B and C.
Q10. Under the terms of a coupon bond, the borrower agrees to pay the lender
A. a periodic fixed coupon payment until a specified maturity date, where
the fixed coupon payment includes both principal and interest.
B. the face value of the bond plus principal, both at the maturity date.
C C. a periodic fixed coupon payment until a specified maturity date, plus
the face value of the bond at the maturity date.
D. only one payment, the face value of the bond at the maturity date.
Q11. "Present value" is considered to be one of the most important concepts
ever articulated in financial economics because
A. it measures the implicit discount rate used by the market to price assets.
B B. it permits payment streams on different financial assets to be compared
with each other in terms of a common unit of account (current dollars).
C. it corrects for changes in real purchasing power due to price effects.
D. it provides an accurate assessment for future return rates.
E. it provides a simple way to measure the value of a financial asset solely
in terms of its current (present) payments, ignoring future payments.
Q12. Suppose a two-year security selling for $200 pays $110 at the end of the
first year and $121 at maturity (the end of the second year). Then, letting *
denote multiplication, its YIELD TO MATURITY is the solution i to
A. $200 = $110*(1+i) + $121*(1+i)^2
B B. $200 = $110/(1+i) + $121/(1+i)^2
C. $200 = [$110 + $121]/(1+i)^2
D. $110 + $121 = $200/(1+i)^2
Q13. Suppose the current nominal interest rate on bank deposit accounts is
2 percent, and the inflation rate over the coming year is expected to be 1
percent. Suppose you receive $1000 today, and your intention is to store
this $1000 in a hole in your back yard for the entire next year. Then the
NOMINAL return rate you should expect to earn on this $1000 over the coming
year is ____ and the REAL return rate that you should expect to earn on this
$1000 over the coming year is _____.
A. 1 percent; 0 percent
B. 0 percent; 1 percent
C C. 0 percent; -1 percent
D. 2 percent; -1 percent
E. 2 percent; 1 percent
Q14. In primary bond markets the bond demand curve slopes DOWNWARD because,
at a LOWER bond price, the yield to maturity is _______ which is an
incentive to ______ to demand more bonds.
A. lower; borrowers
B. higher; borrowers
C. lower; lenders
D D. higher; lenders
Q15. A bond market is said to be in EQUILIBRIUM when
A. the price of each bond equals the present value of its payment stream.
B B. the demand for bonds equals the supply of bonds at the current bond
market price
C. the Fed has attained its Federal funds rate target level at its
current level of open market operations (bond purchases or sales).
D. the Treasury is neither buying nor selling bonds at the current price
level for bonds
Q16. Key factors that are likely to cause the DEMAND curve for bonds to
shift RIGHT (more bonds DEMANDED for each bond price P) include
A. higher government deficits.
B B. a decrease in the expected inflation rate.
C. an increase in the expected future return on physical capital investment.
D. all of the above
E. only A and B
Q17. Key factors that are likely to cause the SUPPLY curve for bonds to
shift RIGHT (more bonds SUPPLIED for each bond price P) include:
A. an increase in the expected future return on physical capital investment.
B. an increase in the expected inflation rate.
C. higher government deficits.
D D. all of the above
E. only A and B
Q18. If there is a sudden INCREASE today in the inflation rate that
borrowers and lenders expect to occur over the next year, then (all else
equal) this will tend to encourage an INCREASE in the supply of bonds today
because _______ will now foresee a ______.
A. lenders; increase in their real future interest earnings
B B. borrowers; decrease in their real future interest payment costs
C. lenders; decrease in their real future interest payment costs
D. borrowers; increase in their real future interest earnings
Q19. Suppose the bond market is currently in equilibrium. However, new
data convinces people to revise DOWNWARD their expectations regarding their
future wealth and income levels due to decreased likelihood for continued
business cycle expansion. Then the theory in Mishkin Chapter 5 predicts that
(all else equal) the effect on the bond market today will be ________ in the
equilibrium PRICE of bonds and _________ in the equilibrium QUANTITY of bonds
sold.
A. a definite increase; a definite decrease
B. a definite increase; either an increase or decrease
C. a definite decrease; either an increase or decrease
D D. either an increase or decrease; a definite decrease
Q20. An ARBITRAGE OPPORTUNITY is said to exist if
A. a conflict arising between traders can be resolved by an arbitration
process.
B. regulators are able to increase social welfare by suitably applied
rules and regulations.
C. traders have a chance to increase their profits by investing in
projects with high expected returns.
D D. traders have an opportunity to make profits for sure (i.e., without any
risk of loss) by engaging in a particular sequence of trades.
Q21. A basic principle underlying the fundamental view of stock market
pricing is
A. Stock prices are strongly affected by market psychology.
B B. The current market value of a security equals the present value of its
future cash flow.
C. Stock bubbles always ultimately break.
D. Dividend payments are always proportional to corporate earnings.
E. It is essential to pay close attention to the buy and sell advice
published by seasoned stock brokers.
Q22. In the one-period stock valuation model presented in Mishkin, Chapter 7,
the current price of a stock share is set equal to
A. the disounted value of the next-period sales price
B. the discounted value of the next-period dividend payment
C C. the discounted value of the sum of the next-period sales price and the
next-period dividend payment.
D. the discounted value of all future interest payments.
E. the discounted value of all future corporate earnings.
Q23. The Gordon Growth Model presented in Mishkin Chapter 7 simplifies the
general dividend stock valuation model by assuming
A A. a constant dividend growth rate g.
B. earnings E are a constant proportion of corporate revenues R.
C. all dividends are paid out at maturity.
D. the same per share dividend D is paid out in every time period.
E. the price P of the stock share is constant over time.
Q24. The Gordon Growth Model predicts that the increased uncertainty over
quality of accounting information resulting from the Enron scandal
should result in LOWER stock prices due to
A. a smaller required return on equity investment
B B. a lower expected dividend growth rate.
C. increased government regulation.
D. expected lowering of next-period's sales prices.
E. price bubbles.
Q25. Dividend payouts by U.S. corporations have been undergoing a long-term
decline despite a long-term rise in the average price of U.S. stock shares.
This empirical evidence
A. refutes the validity of stock valuation models that assume stock
prices are entirely determined by fundamental (intrinsic) value.
B. refutes the validity of stock valuation models that assume behavioral
factors (fads, irrational exuberance,...) have significant effects on
stock prices.
C C. is consistent with the fundamentalist view that the price of a stock
share is equal to the present value of its expected dividend payment
stream as long as the full payment stream is taken into account.
D. can be explained by the favorable tax treatment accorded to dividends
relative to capital gains in the U.S. tax code.
Q26. If expectations of the future inflation rate are formed solely on the
basis of a weighted average of past inflation rates, then economists would say
that this expectation formation is
A. irrational.
B. rational.
C C. adaptive.
D. fundamental.
E. behavioral.
Q27. In rational expectations theory, when a person is said to have formed
an "optimal price forecast" for a stock share, this means
A. the price forecast is correct (without any error).
B. the price forecast equals the present value of the dividend stream.
C. the price forecast is an optimally weighted average of all past
observed prices for this stock share.
D D. the person has made the best possible use of their available
information in determining this price forecast.
E. the price forecast coincides with the market clearing price.
Q28. The key way in which "strong-form" rational expectations DIFFERS from
"weak-form" rational expectations is that strong-form rational expectations
A. assumes that people make optimal use of their information.
B B. assumes that people have access to all available information about the
structure of the world in which they live.
C. are free of any error.
D. are self-fulfilling.
E. are optimal forecasts.
Q29. As presented by Mishkin in Chapter 7, the Efficient Market Hypothesis
in its STRONGEST form implies
A. investors have strong-form rational expectations.
B. stock prices adjust until all unexploited profit opportunities are
eliminated.
C. stock prices reflect fundamental (intrinsic) value only, hence there
are no "price bubbles" on stock prices.
D D. all of the above.
E. only A and B.
Q30. Some empirical evidence that does NOT support the Efficient Market
Hypothesis includes the following:
A. On average, financial analysts are not able to outperform the overall
market (e.g., do better than the return on the S&P 500 stock index).
B. Announcements that concern information that is already publicly
available do not appear to affect stock prices.
C C. Fluctuations in stock prices appear to be greater than warranted by
the fluctuations in their fundamental (intrinsic) values.
D. future changes in stock prices do not appear to be predictable.
Q31. The Black Monday Crash of 1987 is said by some to provide evidence
_____ the Efficient Market Hypothesis in its strongest form because _____
A. in support of; it showed how quickly investors can react.
B B. against; economists cannot identify any fundamental change in the
economy that occurred at that time to trigger the crash.
C. in support of; it was not anticipated.
D. against; it is clear that investors did not optimally make use of all
available information.
Q32. If the euro-U.S.$ exchange rate changes from 1 euro per U.S.$ to 0.87
euros per U.S.$, then
A. the euro has appreciated and the U.S.$ has appreciated
B. the euro has depreciated and the U.S.$ has appreciated
C C. the euro has appreciated and the U.S.$ has depreciated
D. the euro has depreciated and the U.S.$ has depreciated
Q33. It is important for the U.S. to keep track of its exchange rates with
its trading partners because
A. these exchange rates keep track of the net exchange (trade) volumes
between the U.S. and its trading partners.
B B. these exchange rates measure the cost to U.S. citizens of imports from
these trading partners.
C. these exchange rates keep track of the differences in inflation rates
between the U.S. and its trading partners.
D. these exchange rates keep track of borrowing and lending flows between
the U.S. and its trading partners.
Q34. In a world divided between HC and ROW, multiplying any amount V measured
in HC currency units by the HC exchange rate E ________
A. corrects V for changes in the HC price level.
B. transforms V into pure quantity terms.
C C. transforms V into an amount measured in ROW currency units.
D. corrects V for changes in the ROW price level.
Q35. Given a world divided between HC and ROW, the PURCHASING POWER PARITY
condition in level form asserts that
A. the HC real interest rate does not change over time
B. the HC nominal exchange rate is always equal to 1
C. the HC inflation rate is always equal to the ROW inflation rate
D D. the HC real exchange rate is always equal to 1
E. none of the above
Q36. Given a world divided between HC and ROW, in order for the PURCHASING
POWER PARITY condition to reduce to a straightforward application of the "law
of one price," the following condition(s) need(s) to hold:
A. the HC and ROW must have the same inflation rates.
B. information about the availability and price of goods and services in
the HC and ROW must be freely available to everyone, and there must be
no barriers to trade.
C. the HC and ROW must produce the same bundles of goods and services.
D. all of the above
E E. only B and C above.
Q37. If the inflation rate in Canada during 2003 was 4 percent, and the
inflation rate in Mexico during 2003 was 2 percent, then the PURCHASING POWER
PARITY (PPP) condition (in rates of change form) predicts that, during 2003,
the nominal exchange rate E giving the value of the Canadian dollar in terms
of Mexican pesos (i.e., the number of pesos per Canadian dollar) should have
A A. fallen by 2 percent
B. fallen by 6 percent
C. risen by 2 percent
D. risen by 6 percent
Q38. Given a world divided between HC and ROW, some of the key assumptions
underlying the Interest Parity Condition include
A. Bank deposit accounts in the HC and ROW carry the same risk.
B. Faced with equally risky options, savers always attempt to maximize
expected return.
C. The HC real exchange rate stays constant over time.
D. All of the above
E E. Only A and B
Q39. If the average nominal interest rate on ROW bank deposit accounts is 6
percent, and if the average nominal interest rate on HC bank deposit accounts
is 9 percent, and both deposit accounts are equally risky, then the Interest
Parity condition predicts that the HC nominal exchange rate E with respect to
ROW is expected to ______________
A. depreciate by 1.5 percent.
B. appreciate by 1.5 percent.
C C. depreciate by 3 percent.
D. appreciate by 3 percent.
E. none of the above.
Q40. Potential DISADVANTAGES to being a member country of the European
Monetary Union with the euro as the common currency unit include
A A. the need to surrender domestic monetary policy authority.
B. possible chaos as member countries pursue separate monetary policies
within the Monetary Union.
C. the possible emergence of the euro as a reserve currency held around
the world.
D. the possibility that, under its current mandate, the European Central
Bank will put too much stress on economic growth and not enough stress
on inflation control.