Chapter 08
Stocks, Stock Markets and Market Efficiency
Multiple-Choice Questions
1. A share of common stock represents a(n):
a. claim from a lender against a borrower.
b. share in the company’s debts.
c. share of ownership of the company.
d. unlimited liability to the owner of the stock.
2. Two characteristics that make owning stock attractive are:
a. unlimited liability and first claim on assets.
b. share prices are relatively inexpensive and are transferable.
c. each share represents a large percentage of ownership and dividends are fixed.
d. dividends are paid before any other distributions are made and stocks are transferable.
3. Voting rights in a corporation are held by the:
a. board of directors.
b. preferred stockholders.
c. corporate bondholders.
d. common stockholders.
4. The fact that common stockholders are residual claimants means the stockholders:
a. have a claim against the revenue that remains after everyone else is paid.
b. receive their dividends before any other residuals are paid.
c. are paid any past due dividends before other claims are paid.
d. are paid before the bondholders but after any taxes are paid.
5. If a public corporation goes bankrupt and does not have enough assets to pay off all creditors:
a. the stockholders are personally liable for the balance.
b. the fact that stockholders are residual claimants means they may have to pay in additional
capital to cover the obligations.
c. the stockholders receive any dividends due before the other creditors are paid.
d. the stockholders cannot lose more than their investment.
6. The concept of limited liability says a stockholder of a corporation:
a. is liable for the corporation’s liabilities, but nothing more.
b. cannot receive dividends that exceed his/her investment.
c. cannot lose more than his/her investment.
d. is only responsible for any taxes that the corporation may owe but not its other debts.
7. Which of the following statements is most correct?
a. Stockholders have limited liability and have no control over corporate leadership.
b. Stockholders can dislodge the managers of the corporation but not the board of directors.
c. Stockholders have unlimited liability and can dislodge members of the board of directors.
d. Stockholders can dislodge members of the board and have limited liability.
8. Which of the following is not a feature of common s
toc
k
?
a
. Stockholders receive regular fixed payments on their shares.
b. Stockholders have limited liability.
c. Stock holders are residual
claimants. d. Stockholders have voting
9. What do bondholders and stockholders have in common?
a. Both are claimants.
b. Both have voting rights.
c. Both are shareholders in the company.
d. Both receive fixed payments on their securities each year.
10. Which of the following statements is most correct?
a. Managers, directors, and stockholders almost always share the same interest.
b. Managers’ and directors’ interests often conflict with stockholders’ interest.
c. Managers and stockholders have the same interests, but this usually conflicts with the interests
of directors.
d. Directors and stockholders have the same interests, but this usually conflicts with the interests
of managers.
11. Which of the following stock price indexes is a price–weighted index?
a. Dow Jones Industrial Average
b. Standard & Poor’s 500
Inde
x
c
. Nasdaq
d. Wilshire 5000
12. An index number is valuable because:
a. the level of every index number itself provides critical information.
b. it is more stable than the data it reflects.
c. it provides a meaningful measurement scale to calculate percentage changes.
d. it does not require any calculations to compute percentage changes.
13. The Dow Jones Industrial Average is:
a. an index made up of the stock prices of the 100 largest corporations in the U.S.
b.an index that measures the value of purchasing 100 shares in each of the corporations that
make up the index.
c. the average price of stock in 30 of the largest companies in the U.S.
d. the broadest measure of stock market performance.
14. The Dow Jones Industrial Average is a:
a. simple average.
b. price–weighted index.
c. value-weighted index.
d. total-value index.
15. The Dow Jones Industrial Average:
a. gives equal weight to a change in the price of the stock of any company in the index.
b. reflects that a 10% increase in a share of stock selling for $30 will have the same effect on the
index as a 10% increase in the price of a stock selling for $60.
c. is a value-weighted index.
d. gives greater weight to shares with higher prices.
16. If the Dow Jones Industrial Average is currently at 10,000 and the price of one stock
included in the index increases by $10, the Dow Jones Industrial Average will:
a. not change; it is a value–weighted index.
b. increase by 10.0%.
c. increase by 1.0%.
d. increase by 0.1%.
17. If the Dow Jones Industrial Average is at 10,205 and it is up 4% from the previous day, what
was the index at the close of the market the previous day?
a. 10,201.0
b. 9,805.0
c. 9,812.5
d. 9800. 0
18. The stocks that make up the Dow Jones Industrial Average:
a. are dominated by the automobile industry.
b. are the same ones that were originally used to construct the index.
c. are not a broad measure of the market since they do not include any technology companies.
d. have changed as the structure of the economy has changed.
19. If each company that made up the Dow Jones Industrial Average increased the number of
their shares outstanding by 10%, but the share prices did not change, the value of the index
would:
a. not change.
b. increase by 10%.
c. increase, but by less than 10%.
d. decrease since there are more shares outstanding.
20. The Standard & Poor’s 500 Index differs from the Dow Jones Industrial Index because:
a. it takes into account the stock prices of 500 of the largest firms, which is less than the DJIA.
b. it is a price–weighted index, where the DJIA is a value-weighted index.
c. larger firms are less important in the S&P 500 than in the DJIA.
d. it takes into account the prices of more stocks and it uses a different weighting scheme.
21. The Standard & Poor’s 500 Index:
a. gives more weight to large companies than small companies.
b. actually includes more than 500 of the largest corporations in the U.S.
c. is a price-weighted index.
d. assigns equal weight to all the prices of all the stocks in the index.
22. Considering the S&P 500 Index, if each company’s stock price increased by 10%:
a. the weights in the index would remain the same.
b. the companies with the most shares outstanding would have even greater weight after the
increase.
c. the companies with fewer shares would gain more weight at the expense of the companies
with greater shares.
d. the weights in the index would change to reflect the percentage changes in the prices of the
various stocks.
23. Which of the following statements is not true?
a. A value-weighted index is a better index to use to reflect changes in the economy‘s overall
wealth.
b. A price–weighted index is a better index to use to reflect the average change in the price of a
typical share of stock.
c. The Dow Jones Industrial Average is a price–weighted index.
d. The S&P 500 is a price–weighted index.
24. The Nasdaq Composite Index is:
a. a value-weighted index.
b. a price–weighted index.
c. made up of over 5000 companies traded on the NYSE.
d. made of mainly older firms and is heavily weighted by manufacturing.
25. The Nasdaq Composite Index is:
a. made up of over 50,000 firms traded on the Over-the-Counter market.
b. a price–weighted index.
c. made up of mainly newer firms, and heavily influenced by technology and internet
companies.
d. the most broadly based index in use.
26. The most broadly based stock index in use is the:
a. Nasdaq Composite Index.
b. Wilshire 5000.
c. Dow Jones Industrial Average.
d. Standard and Poor’s 500 Index.
27. When studying world stock indexes, we observe that:
a. the S&P 500 is largest in terms of index value.
b. most of the world’s indexes are price–weighted.
c. the indexes are very comparable.
d. the indexes are comparable but only in percentage terms.
28. When comparing stock indexes around the world we:
a. find that a given percentage change across all indexes has the same value.
b. observe that they always move together.
c. can see that the numeric change in indices allows investors to make easy comparisons of value.
d. can examine their respective movements if we look at them as percentage changes.
29. People differ on the method by which stock should be valued. Some people are chartists,
others behavioralists. The basic difference between these groups is:
a. chartists rely on astrological charts to predict stock values, behavioralists rely on psychology.
b. behavioralists are finance based, chartists study charts of investor psychology.
c. chartists study charts of stock prices; behavioralists focus on investor psychology and behavior.
d. chartists and behavioralists are the same in their approach; essentially there aren’t any differences.
30. The dividends that stockholders receive are:
a. fixed by contract and paid annually.
b. distributions from profits.
c. paid before all other obligations of the company are met.
d. always equal to the average amount of interest paid to a bond holder, adjusting for the
value of the holdings.
31. You start with a $1,000 portfolio; it loses 50% over the next year, the following year it gains
50% in value. At the end of two years your portfolio is worth:
a. $1,000.
b. $500.
c. $750.
d. $950.
32. You start with a portfolio valued at $500. Over the next twelve months it loses 40%; the
following year it has a gain of 30%. At the end of two years your portfolio is worth:
a. $390.
b. $450.
c. $300.
d. $410.
33. You have a portfolio valued at $1,000. Over the next twelve months it loses 75% of its value.
What return does the portfolio need to earn over the following twelve months to restore the
portfolio to its original value?
a. 75%
b. 200%
c. 300%
d. 25%
34. You have a portfolio valued at $10,000. Over the next twelve months it loses 50% of its
value. What return does the portfolio need to earn over the following twelve months to be
restored to its original value?
a. 100%
b. 50%
c. 200%
d. 25%
35. The dividend-discount model of stock valuation:
a. is an application of the net present value formula.
b. takes the net present value of expected dividends and add it to the future sale price of the
stock.
c. takes the net present value of the expected future price of the stock and adds the annual
dividend.
d. takes the annual dividend, adds it to the expected future selling price and divides by the
number of years to get the current price.
36. A stock has an annual dividend of $10.00 and it is expected not to grow. It is believed the
stock will sell for $100 one year from now, and an investor has a discount (interest) rate of 6%
(0.06). The dividend discount model predicts the stock’s current price should be:
a. $94.67
b. $116.00
c. $103.77
d. $106.60
37. A stock has a current annual dividend of $6.00 per year and it is expected to grow by 3%
(0.03) a year. It is expected that two years from now the stock will sell for $90.00 a share. If the
interest rate is 5% (0.05), the dividend-discount model predicts the stock’s current price should
be:
a. $94.90
b. $93.29
c. $101.30
d. $94.30
38. A stock currently does not pay an annual dividend. An investor expects this policy to remain
in force. She believes, however, the stock of this company will sell for $110.00 per share four
years from now. If she has an interest (discount) rate of 7% (0.07), the dividend discount model
predicts the current price of this stock should be:
a. you cannot apply the model to this example since it requires a dividend be offered.
b. $82.00
c. $83.92
d. $86.35
39. Next year, the price of a stock is expected to be $2,200 and the stock will pay a $55 dividend.
The interest rate is 10%. Based on the dividend-discount model, what is the current price of this
stock?
a. $1,980
b. $2,000
c. $2,050
d. $2,035
40. The price of a stock is currently $750 and the stock will pay a $43 dividend. The interest rate
is 7.5%. Based on the dividend-discount model, what is the expected price of this stock for next
year?
a. $651.17
b. $657.67
c. $691.17
d. $763.25
41. A company currently pays a dividend of $4.00 per share. It expects the growth rate of the
dividend to be 3% (0.03) annually. If the interest rate is 6% (0.06) what does the dividend-
discount model predict the current price of the stock should be?
a. $103.33
b. it doesn’t, you need an expected future selling price to use the model.
c. $ 137.33
d. $66.67
42. A company currently pays an annual dividend of $6.50 per share. It expects the growth rate
of the dividend will be 2.5% (0.025) annually. If the interest (discount) rate is 5% (0.05) what
does the dividend-discount model predict the current price of the stock should be?
a. It doesn’t, you need an expected future price to use the model
b. $257.50
c. $130.00
d. $266.50
43. The dividend-discount model predicts that stock prices:
a. should be high when dividends are high.
b. will be high when interest rates are high.
c. will be higher when the growth rate of dividends is low.
d. should be high when dividends are low.
44. Suppose that the current dividend for a stock is Dtoday, the expected dividend growth rate is r,
and the interest rate is i. If we ignore risk, which of the following represents the dividend-
discount model formula for the fundamental price of a stock?
a. Dtoday / (i + g)
b. (i + g) / Dtoday
c. Dtoday (1 + g) / (i – g)
d. Dtoday / (i – g)
45. A share of stock resembles a consol in all of the following ways except that the:
a. share of stock does not have a maturity date.
b. annual dividend the stock pays resembles the coupon on a consol.
c. prices of both can be computed using a variation of the net present value formula.
d. are both residual claims.
46. As the corporation uses more debt financing, which of the following holds true for the
stockholders?
a. The expected return to the stockholders decreases and the standard deviation of that return
decreases.
b. The expected return to the stockholders increases and the standard deviation of the return
decreases.
c. The expected return to the stockholders increases and the standard deviation of the return
increases.
d. The expected return to the stockholders decreases and the standard deviation of the return
increases.
47. The fact that many corporations use debt financing as well as equity financing creates all of
the following except:
a. the opportunity for a greater expected return for the stockholders.
b. greater risk for the stockholders.
c. leverage for the stockholders.
d. consistently lower debt-to-equity ratios.
48. Without the stockholders’ limited liability, the risk from the use of leverage would:
a. be significantly less.
b. be significantly greater.
c. still be the same.
d. be irrelevant.
49. Consider the effect of business cycles on bondholders versus stockholders. We expect that
business cycles will affect:
a. bondholders and stockholders about the same.
b. bondholders more since the amount they receive depends on profits.
c. stockholders more since they are residual claimants.
d. bondholders more since they do not have any claim to property.
50. In the event of bankruptcy, stockholders:
a. are paid before bondholders.
b. receive at least their initial investment due to limited liability.
c. could lose more than their initial investment.
d. are the last to be paid and could end up losing what they have invested.
51. As a company issues more debt:
a. its leverage decreases.
b. the share of financing from equity increases.
c. the expected return to equity holders falls.
d. risk increases
52. All other things equal, a decrease in the equity risk premium leads to a(n):
a. increase in the required return on stock.
b. decrease in the present value of s
toc
k.
c
. increase in the price of equity shares.
d. decrease in dividend growth.
53. The basic dividend-discount model is a bit of an oversimplification for valuing stocks
because it:
a. ignores expected dividend growth.
b. ignores the value of future dividends.
c. ignores the risk involved in holding stocks.
d. cannot handle stocks that do not pay dividends.
54. The required stock return an investor seeks can best be represented by which of the
following?
a. Risk Premium – Risk-free Return
b. Risk-free Return × Risk Premium
c. (Risk-free Return + Risk Premium)/(1 + i)
d. Risk-free Return + Risk Premium
55. Which of the following will cause an increase in the current price of a stock?
a. A decrease in the risk-free return
b. A decrease in the current dividend
c. A decrease in the dividend growth rate
d. Both an increase in the risk-free return or an increase in the current dividend
56. If a company reports that it is going to have a difficult time meeting its debt obligations,
you would expect the Ptoday:
a. to fall since the risk-free return will rise.
b. to rise since the Dtoday will likely fall.
c. to fall since the risk premium will likely rise.
d. to remain about the same until the Dtoday actually changes.
19
57. Suppose there is a reduction of the return provided on U.S. Treasury bonds. We should
expect the current price of stocks to:
a. increase since the risk-free return is now lower.
b. decrease since U.S. Treasury bonds are safer.
c. increase since the risk premium on the stocks will increase.
d. stay the same; there is no effect on stock prices from this reduction.
58. The impact from rapid dividend growth on a stock’s current price will be:
a. negative, since the company is paying out profits to stockholders.
b. positive since rapid dividend growth causes stockholders to expect higher future dividends.
c. zero; only current dividends are used to determine the current price of a stock.
d. positive, but only if the corporation does not have any debt.
59. The theory of efficient markets assumes that:
a. prices of bonds, but not stocks, reflect all available information.
b. the prices of all financial instruments reflect all available information.
c. stock prices are relatively rigid because it takes a while for information to efficiently move
through the market.
d. the best approach to determining stock prices is to follow the chartists.
60. The theory of efficient markets implies:
a. stock prices should be highly unpredictable.
b. the price at which stocks currently trade only reflect past information.
c. expectations do not play a role in stock prices because this isn’t real information.
d. the chartists are in fact correct that there are patterns in stock prices.
61. The theory of efficient markets means
a. professional fund managers should be able to consistently beat the market average.
b. a professional fund manager should really not expect to beat the market average consistently.
c. a professional fund manager who beats the market average one year should be expected to beat
the market average the next year.
d. a professional fund manager who beats the market average one year should be expected to not
beat the market average the next year.
62. The theory of efficient markets:
a. rules out high returns due to chance.
b. says insider information makes markets less efficient.
c. allows for higher than average returns if the investor takes higher than average risk.
d. assumes people have equal luck.