Question 1

Some people argue that there are two advantages to holding mutual funds. The first is that mutual funds provide an inexpensive way to hold a diversified portfolio. The second is that because of their expertise mutual fund managers should be able to consistently beat the market. Which of the following does the evidence show?
A)Diversification does reduce risk and mutual funds typically outperform the market.
B)Diversification does reduce risk, but mutual funds do not typically outperform the market.
C)Diversification does not reduce risk but mutual funds typically outperform the market.
D)Diversification does not reduce risk and mutual funds do not typically outperform the market.

Accepted Answer

The evidence shows that diversification does reduce risk, but mutual funds do not typically outperform the market. Many studies have shown that only a handful of mutual fund managers are able to consistently beat the market, and it can be difficult to predict which managers will do so in advance. Additionally, mutual funds often charge fees, which can eat into returns over time. So while mutual funds can provide a cheap and convenient way to hold a diversified portfolio, investors should not expect them to consistently outperform the market.

Question 2

For a risk averse person,
A)the pleasure of winning $1,000 on a bet exceeds the pain of losing $1,000 on a bet.
B)the pain of losing $1,000 on a bet exceeds the pleasure of winning $1,000 on a bet.
C)the utility function exhibits the property of increasing marginal utility.
D)the utility function gets steeper as wealth increases.

Accepted Answer

A risk averse person typically values avoiding loss more than potential gains, so the pain of losing $1,000 on a bet would exceed the pleasure of winning $1,000 on a bet.

Question 3

A previously well-respected and trusted president of a corporation is accused of fraud. At the same time interest rates unexpectedly fall. Which of the above would tend to make the price of the stock rise?
A)the announcement and the fall in interest rates
B)the announcement but not the fall in interest rates
C)the fall in interest rates, but not the announcement
D)neither the announcement nor the fall in interest rates

Accepted Answer

The fall in interest rates would tend to make the price of the stock rise because lower interest rates generally reduce the cost of borrowing and can increase investment and spending, which can positively affect stock prices. The announcement of fraud would likely have a negative impact on the stock price.

Question 4

Risk aversion helps to explain various things we observe in the economy, including
A)adherence to the old adage, "Don't put all your eggs in one basket."
B)insurance.
C)the risk-return trade-off.
D)All of the above are correct.

Accepted Answer

Risk aversion leads people to adhere to the old adage of not putting all their eggs in one basket, which helps to reduce their overall risk. This also leads to the purchase of insurance, which mitigates the financial impact of adverse events. Additionally, the risk-return trade-off arises due to risk aversion, as individuals require higher returns to compensate for taking on more risk.

Question 5

Which of the following approaches to investing does not rely on fundamental analysis to choose the stocks in your portfolio?​
A)​Choosing stocks based on research and analysis you do yourself
B)​Relying on advice from Wall Street analysts
C)​Buying shares of an actively managed mutual fund
D)​Buying shares of an index fund that purchases all stocks in a particular stock index

Accepted Answer

Buying shares of an index fund that purchases all stocks in a particular stock index does not rely on fundamental analysis as it simply tracks the performance of an overall market index rather than selecting individual stocks based on their financial performance.

Question 6

Ron decides which stocks to purchase by throwing darts at the stock pages of The Wall Street Journal. Ron probably believes that
A)stock prices follow a random walk.
B)the stock market is informationally efficient.
C)it is better to own stock in 20 companies than it is to own stock in 2 companies.
D)All of the above are correct.

Accepted Answer

The answer of Ron decides which stocks to purchase by...

Question 7

A company unexpectedly announces a product recall due to safety concerns about its product. According to the efficient markets hypothesis, this news should
A)raise the price of the company's stock.
B)not affect the price of the company's stock.
C)reduce the price of the company's stock.
D)More information is needed to answer the question.

Accepted Answer

According to the efficient markets hypothesis, all publicly available information (including news about a product recall due to safety concerns) is already reflected in the current market price of a company's stock. Therefore, the news of a recall would be expected to reduce the price of the company's stock.

Question 8

Diminishing marginal utility of wealth implies that the utility function
A)has increasing slope and a person is risk averse.
B)has increasing slope and a person is not risk averse.
C)has decreasing slope and a person is risk averse
D)has decreasing slope and a person is not risk averse.

Accepted Answer

Diminishing marginal utility of wealth means that as a person's wealth increases, the additional utility gained from each additional dollar of wealth decreases. This implies a decreasing slope in the utility function. Additionally, a person who experiences diminishing marginal utility of wealth is more likely to be risk averse as they will be less willing to take on additional risk to gain more wealth when the added utility from that wealth is relatively low. Therefore, choice C is the best answer.

Question 9

Economists have developed models of risk aversion using the concept of
A)utility and the associated assumption of diminishing marginal utility.
B)utility and the associated assumption of increasing marginal utility.
C)income and the associated assumption of diminishing marginal wealth.
D)income and the associated assumption of increasing marginal wealth.

Accepted Answer

Economists have traditionally used the concept of utility to model risk aversion. When individuals face uncertainty or risk, they may be willing to pay a premium or accept lower returns in order to avoid a potential loss. This is the basis of risk aversion. The concept of diminishing marginal utility implies that each additional unit of wealth or income provides less additional utility than the previous unit. As a result, individuals may be more risk averse when they have low levels of wealth or income, since the loss of a dollar at that point represents a greater loss of utility than the loss of a dollar when they have higher levels of wealth or income.

Question 10

David's Utility Function  If David's current wealth is $61,000, then
A)his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. David is risk averse.
B)his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. David is not risk averse.
C)his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. David is risk averse.
D)his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. David is not risk averse.

Accepted Answer

The answer of David's Utility Function  If David's current...

Question 11

Fundamental analysis shows that stock in "Night and Day" fitness centers has a price below its present value.
A)This stock is undervalued; you should consider adding it to your portfolio.
B)This stock is undervalued; you shouldn't consider adding it to your portfolio.
C)This stock is overvalued; you should consider adding it to your portfolio.
D)This stock is overvalued; you shouldn't consider adding it to your portfolio.

Accepted Answer

Fundamental analysis shows that the stock is undervalued, meaning it is a good investment opportunity as it is priced below its true value. Therefore, it is recommended to consider adding it to one's portfolio.

Question 12

Risk aversion helps to explain various things we observe in the economy, including
A)adherence to the old adage, "Don't put all your eggs in one basket."
B)insurance.
C)the risk-return trade-off.
D)All of the above are correct.

Accepted Answer

Risk aversion is a fundamental concept in economics and finance that explains why individuals tend to prefer less risky choices over more risky ones. Adherence to the old adage of not putting all your eggs in one basket is a form of risk aversion. Insurance is another example of risk aversion, as people are willing to pay a premium to protect themselves from potential losses. The risk-return trade-off is also a result of risk aversion, as individuals demand higher returns for taking on higher levels of risk. Therefore, all the options provided are correct explanations of how risk aversion helps to explain various things we observe in the economy.

Question 13

If Joanna is risk averse, then
A)her utility function exhibits the property of decreasing utility.
B)her utility function exhibits the property of increasing marginal utility.
C)she dislikes bad things more than she likes comparable good things.
D)she is unlike most people, because most people are not risk averse.

Accepted Answer

Being risk averse means that an individual dislikes bad things (negative outcomes) more than they like comparable good things (positive outcomes). This is because the negative outcome is perceived as more painful compared to the pleasure received from the positive outcome.  Thus, choice C is the best answer.

Question 14

Figure 27-1. The figure shows a utility function. 
-Refer to Figure 27-1. What is measured along the vertical axis?
A)risk aversion
B)marginal utility
C)utility
D)the number of units of a good that can be purchased

Accepted Answer

The vertical axis measures utility, which represents the satisfaction or happiness a consumer derives from consuming a certain amount of a good or service. Therefore, the best choice(s) will be determined by the level of utility that the consumer wants to achieve, represented by the highest point on the utility function.

Question 15

After much anticipation a company releases a new smartphone. The smartphone doesn't work as well as expected and lacks many of the features buyers had been expecting. The unexpectedly negative reaction to the smartphone would
A)raise the present value and the price of the corporation's stock.
B)raise the present value and reduce the price of the corporation's stock.
C)reduce the present value and the price of the corporation's stock.
D)reduce the present value and raise the price of the corporation's stock.

Accepted Answer

The negative reaction to the smartphone would decrease the corporation's future cash flows, leading to a decrease in the present value of the corporation's stock. Additionally, the negative reaction would likely lead to a decrease in demand and sales of the smartphone, further reducing the corporation's future cash flows and causing a decrease in the stock price.

Question 16

According to the efficient markets hypothesis, which of the following would decrease the price of stock in Veblen's Leisure Company?
A)Veblen announces, just as everyone had expected, that it has fired its CEO who has been accused of ethics violations.
B)Veblen announces, as the market had expected, that its profits were low.
C)Fundamental analysis published by KM Financial shows that Veblen's stock is undervalued.
D)A highly anticipated book is published by a Veblen insider which details Veblen's innovative technology in plain English, information that was previously unavailable to the public and which will now be used by Veblen's competitors.

Accepted Answer

The efficient markets hypothesis suggests that stock prices reflect all available information. If new information, such as the details of Veblen's innovative technology becoming available to competitors, is released, it could negatively impact the company's competitive advantage and thus decrease the stock price.

Question 17

No particular stock is a better buy than any other stock if
A)stock prices are driven by investors' "animal spirits."
B)the random-walk theory of stock prices is incorrect.
C)the efficient markets hypothesis is correct.
D)actively managed mutual funds always outperform index funds.

Accepted Answer

The efficient markets hypothesis suggests that all available information is already reflected in stock prices, meaning that no single stock is a better buy than any other stock. Therefore, choice C is the most appropriate answer.

Question 18

Diversification
A)increases the likely fluctuation in a portfolio's return, but reduces market risk.
B)increases the likely fluctuation in a portfolio's return, but reduces firm-specific risk..
C)reduces the likely fluctuation in a portfolio's return and reduces market risk.
D)reduces the likely fluctuation in a portfolio's return and reduces firm-specific risk.

Accepted Answer

Diversification reduces the likely fluctuation in a portfolio's return by spreading investments across various assets, which reduces firm-specific risk but not market risk.

Question 19

Matt's Utility Function
Wealth
Utility
$50,000
7000
51,000
7250
52,000
7499
53,000
7746
If Matt's current wealth is $51,000, then
A)his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. Matt is risk averse.
B)his gain in utility from gaining $1,000 is greater than his loss in utility from losing $1,000. Matt is not risk averse.
C)his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is risk averse.
D)his gain in utility from gaining $1,000 is less than his loss in utility from losing $1,000. Matt is not risk averse.

Accepted Answer

The answer of Matt's Utility Function
Wealth
Utility
$50,000
7000
51,000
7250
52,000
7499
53,000
7746
If Matt's current wealth is...

Question 20

Writing in The Wall Street Journal in 2009, economist Jeremy Siegel pointed out that the efficient markets hypothesis
A)was responsible for the financial crisis of 2008-2009.
B)was responsible for the Great Depression of the 1930s.
C)claims that prices observed in financial markets are always "right."
D)claims that prices observed in financial markets are mostly "wrong."

Accepted Answer

The answer of Writing in The Wall Street Journal in...

Quiz 27: Tools of Finance

For a risk averse person,

A previously well-respected and trusted president of a corporation is accused of fraud. At the same time interest rates unexpectedly fall. Which of the above would tend to make the price of the stock rise?

Risk aversion helps to explain various things we observe in the economy, including

Which of the following approaches to investing does not rely on fundamental analysis to choose the stocks in your portfolio?​

Ron decides which stocks to purchase by throwing darts at the stock pages of The Wall Street Journal. Ron probably believes that

A company unexpectedly announces a product recall due to safety concerns about its product. According to the efficient markets hypothesis, this news should

Diminishing marginal utility of wealth implies that the utility function

Economists have developed models of risk aversion using the concept of

David's Utility Function If David's current wealth is $61,000, then

Fundamental analysis shows that stock in "Night and Day" fitness centers has a price below its present value.

Risk aversion helps to explain various things we observe in the economy, including

If Joanna is risk averse, then

Figure 27-1. The figure shows a utility function. -Refer to Figure 27-1. What is measured along the vertical axis?

After much anticipation a company releases a new smartphone. The smartphone doesn't work as well as expected and lacks many of the features buyers had been expecting. The unexpectedly negative reaction to the smartphone would

According to the efficient markets hypothesis, which of the following would decrease the price of stock in Veblen's Leisure Company?

No particular stock is a better buy than any other stock if

Diversification

Matt's Utility Function Wealth Utility $50,000 7000 51,000 7250 52,000 7499 53,000 7746 If Matt's current wealth is $51,000, then

Writing in The Wall Street Journal in 2009, economist Jeremy Siegel pointed out that the efficient markets hypothesis

Which of the following approaches to investing does not rely on fundamental analysis to choose the stocks in your portfolio?