BEEM119: Homework Assignment
Answer ALL 25 questions for 4 marks each by clearly indicating the letter for each question
on a separate sheet of paper. There is one correct answer for each question; incorrect answers
score zero.
1. Which of the following regarding inflation is true?
(a) If CPI changes from 100 to 105 in a year and then changes from 105 to 100 in the
following year, then the initial rate of price increase is greater than the following
rate of price decrease.
(b) If CPI doubles in one year and then remains at that high level for five years, it
means that the country suffers high inflation for five years.
(c) If CPI is cut by half in one year, it means that the deflation rate of that year is
0.5%.
(d) Increasing CPI means that money is getting more and more valuable.
(e) None of the above.
2. If the realised inflation rate turns out much higher than people expected, who in the
following will be a “winner” of a long-term contract?
(a) A landlord who entered a two-year letting contract with \$700 monthly rent.
(b) An employer who entered a two-year wage contract with \$4000 monthly salary.
(c) A lender who entered a two-year debt contract with \$10,000 lendings.
(d) A mobile phone company who entered a two-year mobile phone contract with \$40
monthly payment with its new customer.
3. What is the yield to maturity of a one-year discount bond with no coupons and face
value \$500 that it is sold for \$400,
(a) 100%,
(b) 80%,
(c) 25%,
(d) 20%,
(e) 15%.
4. Suppose that the yield of bonds issued by firm XYZ decreased. Which of the following
scenarios is the LEAST likely one to have caused this decrease?
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(a) The firm’s credit rating went up.
(b) The firm’s collateral value went up.
(c) Investors’ demand for assets went up.
(d) A lot of other firms started to issue bonds.
5. How much will you have to repay if you borrow \$1000 for 3 years at an interest rate of
10%?
(a) \$1210
(b) \$1333
(c) \$1313.13
(d) \$1331
(e) \$1220
6. Financial intermediaries
(a) provide a channel for linking those who want to save with those who want to invest.
(b) produce nothing of value and are therefore a drain on society’s resources.
(c) hurt the performance of the economy.
(d) hold very little of the average American’s wealth.
7. Stockholders are residual claimants, meaning that they
(a) have the first priority claim on all of a company’s assets.
(b) are liable for all of a company’s debts.
(c) will never share in a company’s profits.
(d) receive the remaining cash flow after all other claims are paid.
8. Which one of the following is NOT a correct definition of Gross Domestic Product
(GDP)?
(a) GDP is the value of the final goods and services produced in the economy during
a given period.
(b) GDP is the sum of value added in the economy during a given period.
(c) GDP is the sum of labor incomes in the economy during a given period.
(d) All of the above are correct definitions of GDP.
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9. You read a story in the newspaper announcing the proposed merger of Dell Computer
and Gateway. The merger is expected to greatly increase Gateway’s profitability. If you
decide to invest in Gateway stock, you can expect to earn
(a) above average returns since you will share in the higher profits.
(b) above average returns since your stock price will definitely appreciate as higher
profits are earned.
(c) below average returns since computer makers have low profit rates.
(d) a normal return since stock prices adjust to reflect expected changes in profitability
almost immediately.
10. According to rational expectations theory, forecast errors of expectations
(a) are more likely to be negative than positive.
(b) are more likely to be positive than negative.
(c) tend to be persistently high or low.
(d) are unpredictable.
11. Which of the following would count as valid evidence against the efficient markets hy-
pothesis?
(a) Some investors make huge profits betting on specific stocks on the stock market.
(b) Financial crises still occur.
(c) Stock prices always rise two days after good news are released.
(d) Stock prices are very volatile.
(e) A company’s stock price does not always rise with good news about that company.
12. If bad credit risks are the ones who most actively seek loans, then financial intermediaries
face
(a) a moral hazard problem.
(c) a free-riding problem.
(d) no problem at all.
13. Consider a stock that pays a year-end dividend of \$2.00 and has an expected sales price
of \$103. Suppose you require a rate of return of ke = 5%. How would you calculate the
current price of the stock (you’d be ready to pay)?
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(a) Using the Gordon Growth model;
(b) Using the one-period valuation model;
(c) Using the Generalized Dividend Valuation Model;
(d) Using non of the above.
14. Consider a stock that pays a year-end dividend of \$2.00 and has an expected sales price
of \$103. Suppose you require a rate of return of ke = 5%. Which formula would you
use to calculate the current price of the stock (you’d be ready to pay)?
(a) P0 =
∑∞
t=0
Dt
(1+ke)t .
(b) P0 = D0(1+g)ke−g .
(c) P0 = D11+ke +
P1
1+ke .
(d) Any one of the above.
15. Consider a stock that pays a year-end dividend of \$2.00 and has an expected sales price
of \$103. Suppose you require a rate of return of ke = 5%. What is the current price of
the stock (you’d be ready to pay)?
(a) 98.
(b) 99.75.
(c) 100.
(d) 101.
(e) 102.25.
16. You believe that a corporation’s dividends will grow 5% on average into the foreseeable
future. The company’s last dividend payment was \$5. You require a rate of return of
ke = 12%. How would you calculate the current price of the stock?
(a) Using the Gordon Growth model;
(b) Using the one-period valuation model;
(c) Using the Generalized Dividend Valuation Model;
(d) Using non of the above.
17. You believe that a corporation’s dividends will grow 5% on average into the foreseeable
future. The company’s last dividend payment was \$5. You require a rate of return of
ke = 12%. Which formula would you use to calculate the current price of the stock?
(a) P0 =
∑∞
t=0
Dt
(1+ke)t .
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(b) P0 = D0(1+g)ke−g .
(c) P0 = D11+ke +
P1
1+ke .
(d) Any one of the above.
18. You believe that a corporation’s dividends will grow 5% on average into the foreseeable
future. The company’s last dividend payment was \$5. You require a rate of return of
ke = 12%. What is the current price of the stock?
(a) 65.
(b) 69.5.
(c) 73.5.
(d) 75.
(e) 81.25.
19. The present value is
(a) the sum of capital gains and the current yield.
(b) the expected change in the price as a fraction of the current price.
(c) the sum of discounted future cash flow payments.
(d) Non of the above.
20. Given the interest rate i, the present value of an asset that promises payments of \$100
in 4, 5, and 6 years from now can be calculated as
(a) 100(1+i)15 ;
(b) 300(1+i)4 ;
(c) 100(1+i)5 +
100
(1+i)6 +
100
(1+i)7 ;
(d) non of the above.
21. If the interest rate is 10%, which of these three investment opportunities has the highest
present value?
(a) It pays 110 next year.
(b) It pays 95 this year.
(c) It pays 105 in two years.
(d) All the above have the same present value.
22. The “yield to maturity” is
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(a) the interest rate that equates the value of a debt instrument’s cash flow payments
discounted to today with its value today.
(b) the interest rate that equates the present value of cash flow payments from a debt
instrument with its value today.
(c) the interest rate that equates the present value of cash flow payments from a debt
instrument with its price today.
(d) All of the above.
23. Which of the following bonds has a highest yield to maturity?
(a) A 1-year bond with a face value of \$110, a coupon of \$20 and current price \$100.
(b) A bond that pays a fixed coupon of \$10 forever (perpetuity) and current price \$100.
(c) A 1-year zero coupon bond (also called Discount Bond) with a face value of \$120
and current price \$100.
(d) A 1-year bond with a face value of 100, a coupon rate of 10% and a current price
of \$100.
24. Consider two bonds x and y, both with face value 100, coupon rate 10%, and maturity
of 1 year. Assume that the interest rate is 10%. Assume that bond y will go into
default on both the principal and interest payments with probability 50%. Suppose
that prices equal the expected discounted payments. What is the difference in the
yields to maturity?
(a) The yields to maturity are the same.
(b) 110.
(c) 120.
(d) 10.
(e) 12.
25. According to the expectation theory of the yield curve, relatively high long-term yields
mean
(a) that current short term yields are perceived to be above a “normal” level.
(b) that future short term yields are expected to decrease.
(c) that current long term yields are perceived to be above a “normal” level.
(d) that future short term yields are expected to increase.
END.
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