Chapter 17 – Financial Economics
90. If the Federal Reserve uses open-market operations to lower the interest rates on short-
term U.S. government bonds, then as a consequence asset prices:
91. If the Federal Reserve conducts an open-market purchase, then the SML will:
92. If the Fed raises the interest rates on short-term U.S. government bonds, then the Security
Market Line shifts:
Chapter 17 – Financial Economics
93. During the Financial Crisis of 2007-2008, investors demanded much higher risk premiums
in their investments. This caused the SML to:
94. If investors started to prefer investing in more ethical companies, then it would be
expected that the stock prices for those companies would:
95. 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:
Chapter 17 – Financial Economics
96. A Ponzi scheme can only succeed if the investors in the scheme believe that something is
preventing:
97. A key reason that actively managed funds have lower returns than index funds with a
similar level of risk is that:
98. The terms “economic investment” and “financial investment” can be used synonymously.
Chapter 17 – Financial Economics
99. Compound interest allows a certain amount to grow much faster than simple interest.
100. The compound interest formula states that if X dollars is invested today at interest rate i
and allowed to grow for t years, it will become X(1 + i)(t) dollars in t years.
101. You deposit $5,000 into a 10-year bank CD that pays 6% annual compound interest rate.
When the CD matures in 10 years, you will get more than $9,000 from it.
102. After 4 years, $5,000 earning 6% annual interest rate will be worth more than $6,000
earning 1% annual interest.
Chapter 17 – Financial Economics
103. You believe that a certain asset, like a business or shop, is going to be worth $100
million in five years. If the interest rate is 5%, then that asset will be worth $75 million today.
104. Other factors constant, if the interest rate is higher, the present value of a certain future
amount will be smaller.
105. Joseph is considering purchasing a condo. He has the option of buying one in Midtown
with a present value of $150,000 or one in downtown with a future value of $200,000. If the
current market 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.
106. The current price of an asset is equal to the future value of its expected returns or income
streams.
Chapter 17 – Financial Economics
107. Investors can benefit from either capital gains or dividends when a firm is profitable.
108. Bonds from the Federal government are riskier than bonds from corporations.
109. The key difference between bonds and stocks is that stocks’ income streams are more
predictable.
110. Stocks represent a debt, and buyers of stock expect to earn interest.
Chapter 17 – Financial Economics
111. An investment’s rate of return is positively related to the price paid for it.
112. Stock investors can earn a return from stocks only in the form of dividends.
113. Arbitrage refers to the buying and selling that occurs to equalize the rates of return on
assets that have substantially different characteristics.
114. 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.
Chapter 17 – Financial Economics
115. Arbitrage 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.
116. Risk in financial economics refers mainly to the chance that an investment could lose
value.
117. Diversification is an investment strategy that seeks to reduce the overall risk facing an
investment portfolio by selecting a group of assets whose risks differ from one another.
118. A recession in an economy would be an example of a diversifiable risk.
Chapter 17 – Financial Economics
119. If an asset has a beta of 1.5, it has 50 percent more nondiversifiable risk than the market
portfolio.
120. The compensation for bearing more risk in owning an asset is a higher rate of return for
the asset.
121. The rate of return that compensates for time preference is assumed to be equal to the rate
of return earned by the Standard and Poor’s 500 stock index.
122. The risk-free market rate is essentially the rate of return that compensates for time
preference.
Chapter 17 – Financial Economics
123. The Security Market Line is a straight line that plots how the average expected rates of
return on assets and portfolios in an economy must vary with their respective levels of
124. When the Securities Market Line shifts up, the average expected rate of return on assets
will increase.
125. The decision of the Federal Reserve to reduce the short-term interest rate will shift the
Security Market Line upward.