CHAPTER 17
The Stock Market
1. A(n) _______________________ is an irrational increase in prices accompanied by euphoric
expectations.
a. irrational exuberance
b . financial crisis
c. speculative bubble
d. circuit breaker
ANSWER: c
2. Which of the following contributed to the record stock market boom of the late 1990s?
a. structural changes that facilitated the flow of funds into equity investments around the world
b. some sharp sell-offs of stocks during the late 1990s despite the record boom
c. declining opportunities to make investments other than stocks
d. increased volatility in the stock market
ANSWER: a
3. Which of the following is false?
a. The Fed is concerned about minimizing inflation in output markets.
b. The Fed is concerned about the destabilizing effects of extremely volatile stock prices.
c. Volatile stock prices can affect the health and safety of the financial system.
d. Although drops in stock prices can be devastating to individual investors, they generally do
not affect employment and output prices.
ANSWER: d
4. Common stockholders
a. are paid a variable dividend after preferred stock holders have been paid a fixed dividend.
b. do not have voting rights in the corporation.
c. must be paid a dividend before retained earnings can be set aside.
d. rely on capital appreciation for their return to owning stock.
ANSWER: a
5. Who regulates the marketing of newly issued shares of stock?
a. The investment banker who is responsible for underwriting the new issue
b. The Fed, as primary regulator of the financial system
c. The Securities and Exchange Commission (SEC)
d. The Initial Public Offering (IPO)
ANSWER: c
6. Preferred stockholders
a. are paid a fixed dividend before common stock holders have been paid a dividend.
b. have voting rights in the corporation.
c. must be paid a dividend even if the corporation does not earn a profit.
d. rely on capital appreciation for their return to owning stock.
ANSWER: a
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7. Common stockholders
a. are paid a variable dividend after preferred stock holders have been paid a fixed dividend.
b. have voting rights in the corporation.
c. may or may not be paid a dividend even if the firm has retained earnings.
d. All of the above.
ANSWER: d
8. Preferred stockholders
a. are paid a fixed dividend before common stock holders have been paid a dividend.
b. do not have voting rights in the corporation.
c. must be paid a dividend only if the corporation earns a profit.
d. All of the above.
ANSWER: d
9. The ____________________________ designs and markets a new securities offering.
a. investment banker
b. securities and Exchange Commission (SEC)
c. preferred stock holder
d. institutional investor
ANSWER: a
10. What makes stocks liquid?
a. The reputation and financial strength of the corporations that issue them
b. The fact that a secondary market exists for publicly traded stocks
c. The fact that they are generally short term financial assets
d. The Securities and Exchange Commission’s provision that they must be liquid
ANSWER: b
11. An offering of newly issued shares of stock by a firm that already has outstanding publicly held
shares is
a. an initial public offering (IPO)
b. the result of a shelf registration.
c. a secondary stock offering.
d. always more profitable than the previous offering.
ANSWER: c
12. Which of the following is false?
a. A secondary stock offering is an offering of newly issued shares by a firm that already has
outstanding publicly held shares.
b. To bring new shares to the market, a corporation must register the new issue with the
Securities and Exchange Commission (SEC).
c. Since 1982, the SEC has allowed corporations to register securities without immediately
issuing them through a procedure called shelf registration.
d. Shelf registration permits a company to register a quantity of securities and sell them over a
twenty-year period rather than at the time the shares are registered.
ANSWER: d
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13. ____________________________________ permits a company to register a quantity of
securities and sell them over a two-year period rather than at the time the shares are registered.
a. A secondary offering
b. A primary offering
c. Shelf registration
d. The Fed
ANSWER: c
14. Which of the following is not an advantage of shelf registration?
a. Shelf registration avoids the costs in money of several registration processes
b. Shelf registration allows the firm to respond quickly to advantageous market conditions.
c. Shelf registration raises the most funds for a firm at the least costly way despite the
cumbersome approval process with the Securities and Exchange Commission (SEC).
d. Shelf registration avoids the costs in time of several registration processes.
ANSWER: c
15. Which of the following is false?
a. Program trading is the pre-programming of computers to buy or sell a large number (basket)
of stocks.
b. Program trading is used extensively by all market participants in the stock market.
c. Program trading is used primarily by institutional investors.
d. The expanded use of computers has facilitated the increase in program trading.
ANSWER: b
16. ______________________ is the pre-programming of computers to buy or sell a large basket of
stocks.
a. The circuit breaker
b. Program trading
c. The NASDAQ
d. The over-the-counter market
ANSWER: b
17. The
is the world’s largest secondary market for trading stocks.
a. American Stock Exchange (AMEX)
b. Designated Order Turnaround (DOT) System
c. Over-the-Counter Market
d. New York Stock Exchange (NYSE)
ANSWER: d
18. The
is a network of thousands of securities dealers all over the country that
trade the stocks of more than 30,000 companies over the telephone or computer.
a. American Stock Exchange (AMEX)
b. Designated Order Turnaround (DOT) System
c. Over-the-Counter Market
d. New York Stock Exchange (NYSE)
ANSWER: c
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19. The
is a computer system that sends buy and sell orders to a market
specialist’s post where the transaction is automatically executed.
a. American Stock Exchange (AMEX)
b. Designated Order Turnaround (DOT) System
c. Over-the-Counter Market
d. New York Stock Exchange (NYSE)
ANSWER: b
20. The
is an association whose members trade stocks over an advanced
computer system that provides immediate information about prices and the number of shares
being traded.
a. American Stock Exchange (AMEX)
b. National Association of Securities Dealers Automated Quotation System (NASDAQ)
c. Over-the-Counter Market d. New York Stock Exchange (NYSE)
ANSWER: b
21. An investment-type financial intermediary that pools the funds of many investors to invest in
several hundred or even thousands of stocks and/or bonds is called a/an
a. mutual fund.
b. no-load fund.
c. load fund.
d. open-end fund.
ANSWER: a
22. The ______________________________ is the minimum amount of equity the investor needs in
her account relative to the market value of her stock.
a. margin requirement
b. circuit breaker
c. maintenance margin requirement
d. market risk premium
ANSWER: c
23. The primary advantage gained by purchasing a mutual fund rather than an individual stock is
a. deposit insurance.
b. increased risk and return.
c. diversification.
d. uniformly lower brokerage fees.
ANSWER: c
24. Equity claims representing ownership of the net income and assets of a corporation that receive a
variable dividend after preferred stockholders have been paid and retained earning have been put
aside are called
a. mutual funds.
b. preferred stock.
c. common stock.
d. corporate bonds.
ANSWER: c
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25. Equity claims representing ownership of the net income and assets of a corporation that receive a
fixed dividend before common stockholders are entitled to anything are called
a. mutual funds.
b. preferred stock.
c. common stock.
d. corporate bonds.
ANSWER: b
26. Preferred stockholders
a. are paid before retained earnings are set aside.
b. are paid after common stock holders are paid.
c. receive a variable dividend.
d. All of the above
ANSWER: a
27. The
is an index that measures stock price movements of 30 of the largest
companies traded on the NYSE.
a. S&P 500
b. Dow Jones Industrial Average (DJIA or the Dow)
c. Russell 2000
d. GNMA 30
ANSWER: b
28. Which of the following stock market indices is the broadest measure of stock market activity that
includes virtually all U.S. headquartered companies?
a. The New York Composite Index
b. The Wilshire Equity Index Value
c. The NASDAQ Composite Index
d. Standard and Poor’s 500
ANSWER: b
29. Falling capital asset prices can have which of the following effects on a country’s economy?
a. Decreased capital asset prices decrease wealth and with it consumption, borrowing, output,
and employment.
b. Decreased capital asset prices can adversely affect financial institutions by decreasing the
value of their assets while leaving their liabilities largely unchanged.
c. Decreased stock, bond, and real estate prices can cause bankruptcies of financial and nonfinancial firms on such a large scale that the financial system and real sectors of an affected
economy collapse.
d. All of the above
ANSWER: d
30. Which of the following statements is false regarding The Wall Street Journal’s stock listings?
a. Stock prices are currently reported using fractions.
b. Beginning in January 2001, decimals were used to report stock prices rather than fractions.
c. The “High” and “Lo” columns give the high and low prices of the stock on this particular
day.
d. The higher the earnings per share of the company (given the price of the stock), the lower the
Price-to-Earnings ratio.
ANSWER: a
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31. Circuit breakers
a. were in place, but failed to work effectively when the Dow fell 508 points on October 19,
1987.
b. temporarily halt market trading if prices fall by some specified percentage.
c. do not place a limit on program trading.
d. have not been “tripped” since they were instituted.
ANSWER: b
32. Which of the following statements about mutual funds is false?
a. Mutual funds provide diversification at a minimum cost.
b. Mutual funds have experienced tremendous growth in recent years.
c. Mutual funds offer greater safety and less diversification than investment in one or more
stocks.
d. Mutual funds pool the funds of many investors and then invest in several hundred or even
thousands of stocks.
ANSWER: c
33. One disadvantage of program trading is that
a. during a market crash, computers tend to automatically execute huge numbers of buy orders
as prices fall. This accelerates and strengthens the market decline.
b. investors program their computers to buy or sell particular stocks when the stock hits a
particular price.
c. during a market crash, computers tend to automatically execute huge numbers of sell orders
as prices rise. This accelerates and strengthens the market decline.
d. during a market crash, computers tend to automatically execute huge numbers of sell orders
as prices fall. This accelerates and deepens the market decline.
ANSWER: d
34. If a share of stock pays a dividend of $3 and closes today at $42, what is its current yield (or
return)?
a. 14 percent
b. 9.3 percent
c. 7.7 percent
d. 7.1 percent
ANSWER: d
35. If the current yield on a share of stock is 8 percent when its price is $50, what is the dividend?
a. $4
b. $8
c. $5
d. It is impossible to tell with the information given.
ANSWER: a
36. The margin requirement is
a. currently 50 percent and is set by the Securities and Exchange Commission (SEC).
b. currently 50 percent and is set by the Fed.
c. set by either the exchange or the broker.
d. applies to secondary market offerings only.
ANSWER: b
37. Which of the following is false?
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a. The margin requirement is the percentage of a stock purchase that can be borrowed as
opposed to being paid in readily available funds.
b. The margin requirement is always equal to the maintenance margin requirement.
c. The maintenance margin requirement is the minimum amount of equiaty the investor needs
in his account relative to the market value of his stocks.
d. In a declining market, margin buying magnifies losses.
ANSWER: b
38. Which of the following is false?
a. In a rising stock market, buying on the margin makes
investment more profitable than it otherwise would be.
b. When an investor uses borrowed funds to purchase stock, the
lender may put in a margin call that requires the investor to
put up more funds at any time.
c. If the investor fails to meet a margin call, the stock is sold
for the lender to recoup part or all of its losses.
d. The selling of the stock to recoup losses when a borrower
fails to meet a margin call puts additional downward pressure
on the flagging stock price.
ANSWER: b
39. Which of the following is true?
a. In late 1999 and early 2000, margin credit grew much faster
than the overall appreciation of the stock market.
b. By early 2000, margin credit relative to the total value of
stocks traded in the market was extremely high.
c. Raising margin requirements has been proposed as a monetary
policy tool to reduce speculative behavior that could fuel a
stock market bubble.
d. All of the above
ANSWER: d
40. Which of the following is false?
a. Buying stocks on the margin refers to putting up only a
fraction of the stock’s selling price and borrowing the rest.
b. Currently, the margin requirement to purchase stock is set by
the Fed and is equal to 50 percent.
c. Stocks may be traded in organized markets such as the NYSE,
the American Stock Exchange, or other regional stock
exchanges.
d. Stock exchanges are the only secondary markets for stocks.
ANSWER: d
41. Who directly regulates the participants in the over-the-counter market?
a. The Securities and Exchange Commission (SEC)
b. The Fed
c. The National Association of Securities Dealers Automated Quotation System (NASDAQ)
d. The National Association of Securities Dealers (NASD).
ANSWER: d
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42. The Dow Jones Industrial Average (the Dow) is
a. an unweighted average of the sum of the daily closing prices of the stocks of 30 blue chip
companies in the country.
b. is a weighted average of the market value of all stocks traded on the New York Stock
Exchange
c. is a weighted average of prices of 500 broad-based companies in the economy.
d. the broadest stock market index available.
ANSWER: a
43. Which of the following is true?
a. Once stock is issued, it is illegal for a company to buy back its own stock.
b. Most common stock holders exercise their voting rights in a corporation even if they own a
very few shares of the stock.
c. Initial Public Offerings (IPOs) of new stock are done only on organized exchanges.
d. Previously issued shares of stock are traded either on organized exchanges or over-thecounter.
ANSWER:d
44. The ________________________________, founded in 1971, is the world’s first electronic
stock market.
a. National Association of Securities Dealers Automated Quotation System (NASDAQ)
b. National Association of Securities Dealers (NASD)
c. Designated Order Turnaround (DOT) System
d. American Stock Exchange (AMEX)
ANSWER: a
45. Which of the following is false?
a. The National Association of Securities Dealers (NASD)
regulates the market participants in the other-the-counter
market under the supervision of the SEC.
b. More than 4,800 of the larger 30,000 companies whose stocks
are traded over-the-counter are also members of the National
Association of Securities Dealers Automated Quotation System
(NASDAQ). Stocks of NASDAQ members are traded on an advanced
computer system that provides immediate information about
prices and the number of shares being traded.
c. Trading in the pre-market and after market hours offers much
more liquidity, less volatility, and superior prices than
trading during regular hours.
d. Over 1,000 brokers and dealers participate in the NASDAQ
market and trading information is broadcast over 350,000
computer terminals world wide.
ANSWER: c
46. Which of the following is true?
a. Being a member of the New York Stock Exchange is referred to as having a seat on the
exchange.
b. The New York Stock Exchange is basically an auction type of market.
c. The New York Stock Exchange is about 200 years old and an original seat sold for $400.
d. All of the above.
ANSWER: d
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47. The current price of a stock
a. should be the present value of the expected cash flows that the stock will generate.
b. is always equal to the value of the assets that the corporation owns divided by the number of
shares outstanding.
c. always falls when interest rates go down.
d. is unrelated to interest rates.
ANSWER: a
48. The _________________________ develops a model of the return needed to
own a share of stock based on the risk free return, and the
market and firm specific risks.
a. Capital Asset Pricing Model
b. Stock Valuation Model
c. Beta Model
d. Market and Firm Specific Risk Model
ANSWER: a
49. A measure of the overall sensitivity or variability of the
stock’s return relative to changes in the entire stock market is
which of the following?
a. Beta
b. The market risk premium
c. The firm specific risk premium
d. The risk free return
ANSWER: a
50 .Assuming a constant cash flow of $100 and a discount factor of 10
percent, the current value of a share of stock will be
a. $10
b. $100
c. $1,000
d. $10,000
ANSWER: c
51. If the current price of a stock is $200 and the discount factor
is 10 percent, what is the constant cash flow?
a. $100
b. $200
c. $20
d. $10
ANSWER: c
52. Which of the following is false?
a. If we expect the firm to earn a constant cash flow, C, then
the stock’s price (P) will be equal to C/d where d is the
discount factor.
b. There are often divergent opinions about the future expected
cash flows of a stock.
c. Assuming we can estimate the expected cash flow (C) and the
discount factor (d), we can solve for the current value of a
share of the stock.
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d. The stock’s price will always converge to a value based on a
universally held expected value.
ANSWER: d
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53. What happens if a stock is trading at a lower price than what a
savvy investor expects?
a. The investor will quickly recognize his error and move on.
b. The investor will buy the stock.
c. The investor will sell the stock.
d. The investor will hold the stock.
ANSWER: b
54. Which of the following is true?
a. The equilibrium return on a stock is based solely on a risk
premium associated with owning the stock.
b. The equilibrium return on a stock is based on the firm
specific risk, as measured by beta, only.
c. The equilibrium return on a stock should be based on the risk
free return, and a market and firm specific risk.
d. At any time, more people are usually trying to buy stock than
to sell stock.
ANSWER: c
55. The market risk premium is
a. based on historical data that shows how much on average the
ownership of stocks pays over the risk free return.
b. based on the risk free and firm specific risk premium.
c. measured by beta.
d. All of the above.
ANSWER: a
56. Which of the following is the formula for finding the price, P,
of a stock with an original cash flow of C, a discount factor of
d, and a constant growth rate of cash flows equal to g?
a. P = C x d x g
b. P = C/(d – g)
c. P = C/(d + g)
d. P = C + d + g
ANSWER: b
57. Beta is
a. a market risk premium based on historical data that shows how
much on average the ownership of stocks pays over the risk
free return.
b. a firm specific risk premium
c. a measure of the overall sensitivity or variability of the
stock’s return relative to changes in the entire stock market.
d. always negative.
ANSWER: c
58. Assume that d is the discount factor, Rf is the risk free return,
b is beta for a particular stock, and Rm is the market risk
premium. According to the capital asset pricing model, the
formula for finding the discount factor is
a. d = Rf + b(Rm)
b. d = Rf/b(Rm)
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c. d = Rf x Rm
d. not enough information is given to find the discount factor.
ANSWER: a
59. Assume that the discount factor of a stock is 12 percent and that
cash flows are expected to grow 2 percent. What is the price of
the stock if the original cash flow is $100?
a. $1,400
b. $1,200
c. $800
d. $1,000
ANSWER: d
60. What is the price of a stock with an initial cash flow of $100, a
discount factor of 13.5 percent, and where cash flows are
expected to grow 5 percent?
a. $1,176.50
b. $1,000
c. $740.70
d. impossible to determine from the information given
ANSWER: a
61. Which of the following is false?
a. The market risk premium and the risk free return are the same
for all firms.
b. Beta is the same for all firms.
c. According to the capital asset pricing model, the return
needed for owning a share of stock is equal to the risk free
return plus beta multiplied by the market risk premium.
d. The discount factor takes into account the risk free return,
the market risk premium, and the firm specific variance of the
return.
ANSWER: b
62. If the risk free return is 4.5 percent, the market risk factor
based on historical data is 4 percent, and beta for this firm is
3, then which of the following is the discount factor equal to?
a. 16.5 percent
b. 11.5 percent
c. 5.5 percent
d. 3.5 percent
ANSWER: a
63. If the discount factor is 14.5, the risk-free return is 5.5, the
market risk factor based on historical data is 4.5 percent, what
is beta?
a. 5.5
b. 2
c. 3
d. 4.5
ANSWER: b
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64. Which of the following is true?
a. The prices of stocks and bonds adjust until the average
investor is indifferent between stocks or bonds--in other
words, until the risk adjusted returns to owning stocks or
bonds are equalized.
b. The equilibrium return to owning stocks consists of a risk
free return, a risk premium for owning stock, and a firm
specific premium.
c. If the Fed takes action that causes interest rates to change,
this changes the risk free return of government bonds, and
financial prices of stocks and bonds adjust until the investor
is again indifferent between stocks and bonds.
d. All of the above.
ANSWER: d
65. Which of the following is false?
a. Future cash flows are unknown.
b. It is the discounted value of expected cash flows that is used
in stock valuation.
c. If earnings reports are what were expected, sharp price
movements can occur immediately as investors take advantage of
buying and selling opportunities.
d. According to the capital asset pricing model, the return
needed to purchase stock is equal to the risk free return plus
beta multiplied by the market risk premium.
ANSWER: c
66. Which of the following best summarizes how changes in interest rates influence stock prices?
a. A fall in interest rates increases the quantity demanded of bonds and decreases stock prices.
b. A fall in interest rates will be expected to increase the demand for goods and services, to
increase the earnings of firms, and in turn to increase their stock prices.
c. A fall in interest rates makes the expected return on stocks greater than the expected return
on bonds.
d. Both b and c
ANSWER: d
67. ____________________________ is the spending of money balances on hand
or the liquidation of financial or real assets owned by firm to
finance the excess.
a. Retained earnings
b. External financing
c. Internal financing
d. Borrowing
ANSWER: c
68. ______________________is the largest source of funds for
business firms.
a. Retained earnings
b. External financing
c. Internal financing
d. Borrowing
ANSWER: c
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69 ._________________is financing by issuing new debt or new equity.
a. Retained earnings
b. Internal financing
c. External financing
d. Borrowing
ANSWER: c
70. Which of the following is true?
a. There are two types of internal financing: expanding equity
or expanding debt.
b. External financing includes using cash on hand.
c. External financing via equity involves issuing shares of
common stock, thereby expanding the ownership in the firm and
deciding whether the equity will be long term or short term.
d. If the firm chooses external financing through borrowing, it
faces the decision of whether to issue long-term or short-term
debt; a firm will choose the option that minimizes the cost of
funds.
ANSWER: d
71. The particular financing decision that a firm makes will be based
on which of the following?
a. The particular type of expenditures being financed
b. The current financial environment and expectations about the
future environment
c. The firm’s financial structure, and the tax laws
d. All of the above
ANSWER: d
72. The leverage ratio is
a. the ratio of the firm’s equity to debt
b. the ratio of the stock’s price to dividends
c. the ratio of a stock’s price to the interest rate
d. the ratio of a firm’s debt to equity
ANSWER: d
73. Circuit breakers were
a. first introduced after the stock market crash of 1987.
b. temporarily halt market trading if stock prices change by a specific amount.
c. are intended to prevent wild swings in stock prices.
d. All of the above.
ANSWER: d
74. In equilibrium, investors should
a. prefer stocks to bonds since stocks pay a higher return over the long run.
b. prefer bonds to stocks since stocks are more risky.
c. be indifferent between owning stocks or bonds.
d. prefer both stocks and bonds over lower interest bank deposits.
ANSWER: c
75. If stocks pay a higher risk-adjusted return than bonds, then
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a. investors will sell stocks
b. investors will buy bonds
c. there will be a tendency for stock prices to rise and bond prices to fall
d. stock prices will fall and bond prices will rise
ANSWER: c
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76. Which of the following with regards to circuit breakers is false?
a. If the Dow declines 10 percent from the threshold before 2:00
P.M., the market will close for one hour; between 2:00 and
2:30 P.M., the market will close for 30 minutes; after 2:30
P.M., the 10 percent threshold is removed and the market will
continue trading.
b. If the Dow declines 20 percent from the threshold before 1
P.M., the market will close for the day.
c. If the Dow declines 30 percent at any time, the market will
close for the day.
d. The point movement that triggers limitations on program
trading is 180 points.
ANSWER: b
77. Which of the following is true?
a. Most individual investors use program trading today.
b. Most trading at the New York Stock Exchange is program
trading.
c. Circuit breakers that halt program trading apply to both price
advances and price declines.
d. According to the authors, circuit breakers are universally
considered to be a success.
ANSWER: c