6th Assignment

6th Assignment (CH.7)

Review of attempt 2

Started on Tuesday, February 22, 2011, 11:08 AM

Completed on Tuesday, February 22, 2011, 01:20 PM

Time taken 2 hours 11 mins

Marks 31/50

Grade 3.1 out of a maximum of 5 (62%)

Question1Marks: 1

If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement?

Choose one answer.

a. A stock that has done poorly in the past is more likely to do well in the future.

b. A security's price reflects all available information about the intrinsic value of the security.

c. One investment is as good as any other because the securities' prices are correct.

d. Security prices can be used by managers to assess their cost of capital accurately.

CorrectMarks for this submission: 1/1.

Question2Marks: 1

According to the Gordon-Growth model, what will be the percentage change in the value of the stock of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% per year but now are expected to grow by 1% per year?

Choose one answer.

a. -4.0%

b. -66.0%

c. -31.1%

d. -23.7%

IncorrectMarks for this submission: 0/1.

Question3Marks: 1

If expectations of the future inflation rate are formed solely on the basis of a weighted average of past inflation rates, then economics would say that expectation formation is

Choose one answer.

a. irrational.

b. rational.

c. reasonable.

d. adaptive.


Question4Marks: 1

According to the efficient markets hypothesis, purchasing the reports of financial analysts

Choose one answer.

a. is not likely to be an effective strategy for increasing financial returns.

b. is likely to increase one's returns by an average of 10%.

c. is likely to increase one's returns by about 3 to 5%.

d. is likely to increase one's returns by an average of about 2 to 3%.


Question5Marks: 1

In the Gordon Growth Model, the growth rate is assumed to be ________ the required return on equity.

Choose one answer.

a. less than

b. equal to

c. greater than

d. proportional to


Question6Marks: 1

If a market participant believes that a stock price is irrationally high, they may try to borrow stock from brokers to sell in the market and then make a profit by buying the stock back again after the stock falls in price. This practice is called

Choose one answer.

a. undermining.

b. short selling.

c. long marketing.

d. double dealing.


Question7Marks: 1

In the one-period valuation model, the current stock price increases if

Choose one answer.

a. dividends are cut.

b. the expected sales price falls.

c. the required return increases.

d. the expected sales price increases.


Question8Marks: 1

Using the Gordon growth model, a stock's price will increase if

Choose one answer.

a. the expected sales price rises.

b. the dividend growth rate increases.

c. the required rate of return on equity rises.

d. the growth rate of dividends falls.


Question9Marks: 1

A stock's price will fall if there is

Choose one answer.

a. an increase in the future sales price.

b. current dividends are high.

c. an increase in the required rate of return.

d. a decrease in perceived risk.


Question10Marks: 1

According to the Gordon-Growth model, what is the value of a stock with a dividend of $1, required return on equity of 10% and expected growth rate of dividends of 5%?

Choose one answer.

a. $21

b. $20

c. $2

d. $10


Question11Marks: 1

If a forecast is made using all available information, then economists say that the expectation formation is

Choose one answer.

a. irrational.

b. adaptive.

c. reasonable.

d. rational.


Question12Marks: 1

Suppose Apple announces that its earnings for the fourth quarter of 2011 rose to $2 billion. As a result of this announcement the price of Apple's stock does not change. The best explanation of this is

Choose one answer.

a. market participants expected Apple's earnings to be less than $2 billion.

b. market participants expected Apple's earnings to be $2 billion.

c. market participants were expecting Apple's earnings to be greater than $2 billion.

d. market participants have adaptive expectations.


Question13Marks: 1

According to rational expectations theory, forecast errors of expectations

Choose one answer.

a. are more likely to be positive than negative.

b. tend to be persistently high or low.

c. are unpredictable.

d. are more likely to be negative than positive.


Question14Marks: 1

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

Choose one answer.

a. above average returns since you will share in the higher profits.

b. a normal return since stock prices adjust to reflect expected changes in profitability almost immediately.

c. below average returns since computer makers have low profit rates.

d. above average returns since your stock price will definitely appreciate as higher profits are earned.


Question15Marks: 1

The efficient markets hypothesis predicts that an investor

Choose one answer.

a. will be able consistently to earn above-normal profits from buying or selling stocks so long as he or she makes use of rational expectations.

b. will be able consistently to earn above-normal profits so long as stock prices in general are rising.

c. will be able consistently to earn above-normal profits from buying or selling stocks so long as he makes us of adaptive expectations.

d. will not be able consistently to earn above-normal profits from buying or selling stocks.


Question16Marks: 1

In comparing actively managed mutual funds with those funds that simply buy and hold a large market portfolio (index funds), we would expect that

Choose one answer.

a. the index funds provide a higher return after expenses than the actively managed funds.

b. actively managed funds and index funds provide the same returns.

c. index funds provide a lower return than actively managed funds only if taxes are taken into consideration.

d. the actively managed funds provide a higher return than the index funds.


Question17Marks: 1

Which of the following expressions gives the present value of future dividends for a company whose current dividend is $5.00 and whose future dividends are expected to grow at rate g?

Choose one answer.

a. [$5.00(1 - g)]/(i - g)

b. [$5.00(1 + g)]/(i + g)

c. [$5.00(1 + g)]/(i - g)

d. [$5.00(1 - g)]/(i + g)


Question18Marks: 1

Tests used to rate the performance of rules developed in technical analysis conclude that technical analysis

Choose one answer.

a. does not outperform the overall market, suggesting that stockbrokers do not provide services of any value.

b. does not outperform the overall market.

c. outperforms the overall market.

d. far outperforms the overall market, suggesting that stockbrokers provide valuable services.


Question19Marks: 1

If major traders believe the price of a stock should be higher than its current market price,

Choose one answer.

a. they should petition the Securities and Exchange Commission to authorize an adjustment in the price of the stock.

b. their actions will result in the information they possess being incorporated into the price of the stock.

c. there is little they can do because government regulation precludes their acting on what they know.

d. they have an incentive to sell the stock.


Question20Marks: 1

Rules used to predict movements in stock prices based on past patterns are, according to the efficient markets hypothesis,

Choose one answer.

a. profitably employed by all financial analysts.

b. a waste of time.

c. consistent with the random walk hypothesis.

d. the most efficient rules to employ.


Question21Marks: 1

The rate of return of a stock held for one year equals

Choose one answer.

a. the dividend yield minus the rate of capital gain.

b. the dividend yield plus the rate of capital gain.

c. the rate of capital gain minus the dividend yield.

d. the change in the price of the stock.


Question22Marks: 10

What is the difference between adaptive expectations and rational expectations in terms of stock valuation? write your answer concisely.

Answer:

Adaptive Expectations: agents form expectations about the future values of variables using the previous, or lagged, values of the same variable i.e., regardless of new information available, agents rely on past information, updating their beliefs in a form of moving average. The adaptive-expectations approach dominated work on inflation and macroeconomics in the 1960s. It was intuitively plausible, tractable both mathematically and empirically, and successful in terms of yielding sensible parametric estimates of models. In the 1970s, however, this hypothesis fell into disfavor following the work of John Muth , who demonstrated that the optimality of using adaptive expectations (in the sense of delivering unbiased and efficient estimates of a variable) was confined to a limited class of variables.

Rational Expectations: John Muth introduced and applied the concept of rational expectations. Economic variables are often influenced by the behavior of actors acting on their expectations of these variables. The stock market is a prominent example, where expectations of an increase in the value of equities will lead to buying, which in turn increases the price of equities. Rational expectations require that actors take all of these interactions into account, so that their actions are based on an expectation that is, in turn, realized as a result of their actions. The rational expectations model assumes that economic agents know the structure of the economy and that they can compute optimal forecasts that represent their expectations, much like econometricians making use of all available and relevant information. In the extreme, when information is complete and there is no uncertainty, the rational-expectations hypothesis becomes a model of perfect foresight. Indeed, in games of strategic interaction, it is often the case that there is only one rational-expectations equilibrium, so that applying a rational-expectation assumption to agents' behavior produces a unique prediction.The most basic criticism of rational-expectation models is that they make implausible demands on the computing abilities of economic agents. Moreover, forecasting is a costly activity. The structure of the economy constantly changes; agents may not be able to deal with these changes in statistical terms; and changes may occur faster than the speed at which people assess the economy. In all cases, their forecasts will diverge from optimal forecasts. Even if it were plausible that agents “learn” to form rational expectations, such learning would proceed very slowly given the complexity of the economy and the large amounts of data that they need to sift through. This criticism is perhaps more valid for rational-expectations models in the macro economy, where interactions are highly complex. For interaction among a few firms or individuals, it is more plausible that actions can be predicted.

Question23Marks: 1

The efficient markets hypothesis suggests that investors

Choose one answer.

a. act on all "hot tips" they hear.

b. can use the advice of technical analysts to outperform the market.

c. let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy.

d. should purchase no-load mutual funds which have low management fees.


Question24Marks: 1

The major criticism of the view that expectations are formed adaptively is that

Choose one answer.

a. adaptive expectations models have no predictive power.

b. people are irrational and therefore never learn from past mistakes.

c. it is easier to model adaptive expectations than it is to model rational expectations.

d. this view ignores that people use more information than just past data to form their expectations.


Question25Marks: 1

In the generalized dividend model, the current stock price is the sum of

Choose one answer.

a. the actual value of the future dividend stream.

b. the present value of the future dividend stream plus the actual future sales price.

c. the present value of the future sales price.

d. the present value of the future dividend stream.


Question26Marks: 1

In the one-period valuation model, an increase in the required return on investments in equity

Choose one answer.

a. reduces the current price of a stock.

b. increases the expected sales price of a stock.

c. reduces the expected sales price of a stock.

d. increases the current price of a stock.


Question27Marks: 1

To say that stock prices follow a "random walk" is to argue that stock prices

Choose one answer.

a. tend to follow trends.

b. rise, then fall in a predictable fashion.

c. cannot be predicted based on past trends.

d. rise, then fall, then rise again.


Question28Marks: 1

A key point made by the Gordon-Growth model is that the

Choose one answer.

a. past trends in a stock's behavior indicate future price trends.

b. dividends have little to do with a stock's value.

c. value of a stock depends on investor's expectations about the future profitability of a firm.

d. risk has little effect on a stock's value.


Question29Marks: 1

According to the efficient markets hypothesis, the difference between today's price for a share of stock and tomorrow's price is

Choose one answer.

a. predictable given currently available information.

b. zero.

c. equal to today's price minus yesterday's price.

d. unforecastable.


Question30Marks: 1

Which of the following types of information most likely allows the exploitation of a profit opportunity?

Choose one answer.

a. Insider information

b. Technical analysis

c. Financial analysts' published recommendations

d. Hot tips from a stockbroker


Question31Marks: 1

Which of the following statements is true of rational expectations?

Choose one answer.

a. If traders have rational expectations, any announcement by a company will have an effect on its stock price, even if the market was already aware of the facts being announced.

b. For a trader with rational expectations, the expectation of an asset's price equals the optimal price forecast.

c. Rational expectations forecasts are always correct.

d. If a trader really has rational expectations, he or she was always earn a greater than normal return on his or her financial portfolio.


Question32Marks: 1

Excessive volatility refers to the fact that

Choose one answer.

a. stock prices fluctuate more than is justified by dividend fluctuations.

b. stock returns display mean reversion.

c. stock prices can be slow to react to new information.

d. stock price tend to rise in the month of January.


Question33Marks: 1

Increased uncertainty resulting from the subprime crisis ________ the required return on investment in equity.

Choose one answer.

a. decreased

b. lowered

c. had no impact on

d. raised


Question34Marks: 1

According to the Gordon-Growth model, what is the value of a stock with a dividend of $2, required return on equity of 8% and expected growth rate of dividends of 4%?

Choose one answer.

a. $50

b. $25

c. $52

d. $26


Question35Marks: 1

You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor

Choose one answer.

a. will definitely be worse in the future. What goes up must come down.

b. will always be the best of the group.

c. may or may not be better than the other forecasts. Past performance is no guarantee of the future.

d. will be worse in the near future, but improve over time.


Question36Marks: 1

Psychologists have found that people tend to be ________ in their own judgments.

Choose one answer.

a. underconfident

b. insecure

c. indecisive

d. overconfident


Question37Marks: 1

If market participants rely only past stock prices to forecast future stock prices,

Choose one answer.

a. they have rational expectations.

b. they will be better able to forecast future price increases than future price decreases.

c. they will be better able to forecast future price decreases than future price increases.

d. they have adaptive expectations.


Question38Marks: 1

Which of the following accurately summarize the empirical evidence about technical analysis?

Choose one answer.

a. Technical analysts tend to outperform other financial analysis, but on average they nevertheless under-perform the market.

b. Technical analysts fare no better than other financial analysis, and like other financial analysts they under-perform the market.

c. Technical analysts fare no better than other financial analysisnot outperform the market.

d. Technical analysts fare no better than other financial analysis, and like other financial analysts they outperform the market.


Question39Marks: 1

An implication of the efficient markets hypothesis is that

Choose one answer.

a. unless he or she acts recklessly, the average investor should be able to make above-normal profits.

b. above-normal profits are available only to major traders.

c. only sophisticated investors will be able to earn above-normal profits from financial investments.

d. above-normal profits will be eliminated in the trading process.


Question40Marks: 1

Another way to state the efficient markets condition is: in an efficient market,

Choose one answer.

a. unexploited profit opportunities will be quickly eliminated.

b. unexploited profit opportunities will never exist.

c. every financial market participant must be well informed about securities.

d. arbitragers guarantee that unexploited profit opportunities never exist.


Question41Marks: 1

Suppose that Google announces that its profits for the third quarter of 2011 were $1.6 billion. As a result of this announcement the price of Google's stock declines. The best explanation of this is

Choose one answer.

a. market participants have adaptive expectations.

b. market participants expected Google's profits to be less than $1.6 billion for the third quarter.

c. market participants expected Google's profits to be greater than $1.6 billion for the third quarter.

d. the stock market is not an efficient market.


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6th Assignment