978-1259723223 Test Bank TBChap037 Part 7

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Difficulty : 02 Medium

Learning Objective: 37-08 Explain how the Security Market Line illustrates the compensation

that investors receive for time preference and nondiversifiable risk and why arbitrage will tend

to move all assets onto the Security Market Line.

Test Bank: II

To pi c: The Security Market Line

Type: Graph

293.

In the accompanying graph, bracket B represents the

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Type: Graph

294.

In the accompanying graph, point Y represents the

295.

Refer to the graph. The average expected rate of return for an asset with a beta equal to X would

be

296.

Refer to the graph. The risk premium for an asset with a beta equal to X would be

297.

If the Federal Reserve uses open-market operations to lower the interest rate on short-term

U.S. government bonds, then, as a consequence, asset prices

298.

If the Federal Reserve conducts an open-market purchase, then the SML will

299.

If the Fed raises the interest rates on short-term U.S. government bonds, then the Security

Market Line shifts

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To pi c: The Security Market Line

300.

During the financial crisis of 2007–2008, investors demanded much higher risk premiums

in their investments. This caused the SML to

301.

If investors started to prefer investing in more ethical companies, then it would be expected

that the stock prices for those companies would

302.

If investors showed less of a preference for investing in war-related companies, then it

would be expected that the stock prices for those companies would

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D.

decrease, and the rates of return would decrease relative to other companies.

303.

Before taking management and trading costs into account, arbitrage activities in the market

ensure that the returns of actively managed funds are

304.

A key reason that actively managed funds have lower returns than index funds with a

similar level of risk is that

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to move all assets onto the Security Market Line.

Test Bank: II

To pi c: The Security Market Line

True / False Questions

305.

The terms “economic investment” and “financial investment” can be used synonymously.

306.

The “time value” of money is based on the fact that prices may increase over time.

307.

The compound interest formula states that if X dollars are invested today at an interest rate i

and allowed to grow for t years, it will become X(1 + i)(t) dollars in t years.

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Test Bank: II

To pi c: Present Value

308.

You deposit $5,000 into a 10-year bank CD that pays a 6.5 percent annual compound

interest rate. When the CD matures in 10 years, you will get more than $9,000 from it.

309.

After 4 years, a $5,000 investment earning a 6 percent annual interest rate will be worth

more than a $6,000 investment earning 1 percent annual interest.

310.

You believe that a certain asset, such as a business or shop, is going to be worth $100

million in five years. If the interest rate is 5 percent, then that asset will be worth $75 million

today.

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To pi c: Present Value

311.

Other factors constant, if the interest rate is higher, the present value of a certain future

amount will be smaller.

with a present value of $150,000 or one in downtown with a future value of $200,000. If the

current market interest rate is 5 percent and he wants to buy the home with the highest future

value in 5 years, he should

buy the condo in downtown.

313.

The current price of an asset is equal to the future value of its expected returns or income

streams.

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To pi c: Present Value

314.

Stockholders of a company can benefit from either capital gains or dividends when the

company is profitable.

315.

Bonds issued by the Federal government are riskier than bonds issued by corporations.

316.

The key difference between bonds and stocks is that stocks’ income streams are more

predictable than those of bonds.

317.

Stocks represent a debt, and buyers of stock expect to earn interest.

318.

Mutual funds allow individuals to own corporate stocks or bonds indirectly.

319.

Mutual fund managers tend to focus on the long-term performance of the corporations in

whose securities they are invested, rather than their short-term quarterly performance.

320.

An investment’s rate of return is positively related to the price paid for it.

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A c c e s s i b i l i t y : Keyboard Navigation

Blooms: Understand

Difficulty : 02 Medium

Learning Objective: 37–04 Relate how percentage rates of return provide a common

framework for comparing assets and explain why asset prices and rates of return are inversely

related.

Test Bank: II

To pi c: Calculating Investment Returns

321.

Stock investors can earn a return from stocks only in the form of dividends.

322.

Arbitrage refers to the buying and selling activities that cause an equalization of the rates of

return on assets that have substantially different characteristics.

323.

If investors have two identical assets that have different rates of return, the investors will

sell the asset with the higher rate of return to buy the asset with the lower rate of return.

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D i f f i c u l t y : 01 Easy

Learning Objective: 37-05 Define and utilize the concept of arbitrage.

Test Bank: II

To pi c: Arbitrage

324.

Arbitrage activities will make the price of the asset with the higher initial return increase,

while the price of the asset with the lower return will decrease.

325.

Risk in financial economics refers mainly to the chance that an investment could lose value.

326.

Diversification is an investment strategy that seeks to reduce the overall risk in an

investment portfolio by selecting a group of assets whose risks differ from one another.

327.

A recession in an economy would be an example of a diversifiable risk.

328.

If an asset has a beta of 1.5, it has 50 percent more nondiversifiable risk than the market

portfolio.

329.

The compensation for bearing more risk in owning an asset is a higher rate of return for the

asset.

330.

The so-called risk-free rate in financial markets is indicated by the rate of return on short-

term U.S. government bonds.

331.

The risk-free market rate is essentially the rate of return that compensates solely for time

preference.

332.

The average expected rate of return on an asset can be fully understood as the rate that

compensates for risk.

333.

The Security Market Line is a straight line that plots how the average expected rates of

return on assets and portfolios in an economy vary with their respective levels of

334.

When the Security Market Line shifts up, the average expected rate of return on investment

assets with given risk levels is increasing.

335.

The decision of the Federal Reserve to reduce the short-term interest rate will shift the

Security Market Line upward.

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Test Bank: II

To pi c: The Security Market Line