D 22. Your Certificate of Deposit will mature in one week and you are considering
how to invest the proceeds. If you invest in a 30-day CD the bank will pay you 4%. If you invest in a 2-year CD the bank will pay you 6% interest. Which option would you choose?
A) the 30-day CD, no matter what you expect interest rates to do in the future B) the 2-year CD, no matter what you expect interest rates to do in the future C) the 30-day CD if you expect that interest rates will fall in the future D) the 2-year CD if you expect that interest rates will fall in the future E) You would be indifferent between the 30-day and the 2-year CDs. Rationale: You would prefer to lock in the higher rate on the 2-year CD rather
than subject yourself to reinvestment rate risk. If you expected interest rates to rise in the future the opposite choice would be better.
A 23. In words, the real rate of interest is approximately equal to A) the nominal rate minus the inflation rate. B) the inflation rate minus the nominal rate. C) the nominal rate times the inflation rate. D) the inflation rate divided by the nominal rate. E) the nominal rate plus the inflation rate. Rationale: The actual relationship is (1 + real rate) = (1 + nominal rate) / (1 +
inflation rate). This can be approximated by the equation: real rate = nominal rate - inflation rate.
B 24. If the Federal Reserve lowers the discount rate, ceteris paribus, the
equilibrium levels of funds lent will __________ and the equilibrium level of real interest rates will ___________
A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease E) reverse direction from their previous trends Rationale: A lower discount rate would encourage banks to make more loans,
which would increase the money supply. The supply curve would shift to the right and the equilibrium level of funds would increase while the equilibrium interest rate would fall.
D 25. What has been the relationship between T-Bill rates and inflation rates since
the 1980s?
A) The T-Bill rate was sometimes higher than and sometimes lower than the
inflation rate.
B) The T-Bill rate has equaled the inflation rate plus a constant percentage. C) The inflation rate has equaled the T-Bill rate plus a constant percentage. D) The T-Bill rate has been higher than the inflation rate almost the entire
period.
E) The T-Bill rate has been lower than the inflation rate almost the entire
period.
Rationale: The T-Bill rate was higher than the inflation rate for over two
D 26.
E 27.
D 28.
Use the following to answer question 29:
You have been given this probability distribution for the holding period return for Cheese, Inc stock:
decades.
“Bracket Creep” happens when
A) tax liabilities are based on real income and there is a negative inflation
rate.
B) tax liabilities are based on real income and there is a positive inflation rate. C) tax liabilities are based on nominal income and there is a negative inflation
rate.
D) tax liabilities are based on nominal income and there is a positive inflation
rate.
E) too many peculiar people make their way into the highest tax bracket. Rationale: A positive inflation rate typically leads to higher nominal income. Higher nominal income means people will have higher tax liabilities and in some cases will put them in higher tax brackets. This can happen even when real income has declined.
The holding-period return (HPR) for a stock is equal to A) the real yield minus the inflation rate. B) the nominal yield minus the real yield. C) the capital gains yield minus the tax rate.
D) the capital gains yield minus the dividend yield. E) the dividend yield plus the capital gains yield.
Rationale: HPR consists of an income component and a price change
component. The income component on a stock is the dividend yield. The price change component is the capital gains yield.
The historical arithmetic rate of return on small stocks over the 1926-2005 period has been _______. The standard deviation of small stocks' returns has been ________ than the standard deviation of large stocks' returns. A) 12.43%, lower B) 13.11%, lower C) 16.24%, higher D) 17.95%, higher E) 21.53%, higher
D 29. Assuming that the expected return on Cheese's stock is 14.35%, what is the
standard deviation of these returns?
A) 4.72% B) 6.30% C) 4.38%
E 30.
B 31.
A 32.
C 33.
B 34.
D) 5.74%
E) None of the above
Rationale: Variance = .20*(24-14.35)2 + .45*(15-14.35)2 + .35*(8-14.35)2 = 32.9275. Standard deviation = 32.9275.1/2 = 5.74.
An investor purchased a bond 45 days ago for $985. He received $15 in interest and sold the bond for $980. What is the holding period return on his investment? A) 1.52% B) 0.50% C) 1.92% D) 0.01%
E) None of the above
Rationale: HPR = ($15+980-985)/$985 = .010152284 = approximately 1.02%. Over the past year you earned a nominal rate of interest of 8 percent on your money. The inflation rate was 3.5 percent over the same period. The exact actual growth rate of your purchasing power was A) 15.55%. B) 4.35%. C) 5.02%. D) 4.81%. E) 15.04%
Rationale: r = (1+R) / (1+I) - 1; 1.08 / 1.035 - 1 = 4.35%.
Over the past year you earned a nominal rate of interest of 14 percent on your money. The inflation rate was 2 percent over the same period. The exact actual growth rate of your purchasing power was A) 11.76%. B) 16.00%. C) 15.02%. D) 14.32%.
E) none of the above.
Rationale: r = (1+R) / (1+I) - 1; 1.14 / 1.02 - 1 = 11.76%.
Over the past year you earned a nominal rate of interest of 12.5 percent on your money. The inflation rate was 2.6 percent over the same period. The exact actual growth rate of your purchasing power was A) 9.15%. B) 9.90%. C) 9.65%. D) 10.52%.
E) none of the above.
Rationale: r = (1+R) / (1+I) - 1; 1.125 / 1.026 - 1 = 9.65%.
A year ago, you invested $1,000 in a savings account that pays an annual interest rate of 4%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year? A) 4%.
E 35.
E 36.
E 37. E 38. E 39.
B) 2%. C) 6%. D) 3%.
E) none of the above. Rationale: 4% - 2% = 2%.
A year ago, you invested $2,500 in a savings account that pays an annual interest rate of 2.5%. What is your approximate annual real rate of return if the rate of inflation was 1.6% over the year? A) 4.1%. B) 2.5%. C) 2.9%. D) 1.6%.
E) none of the above.
Rationale: 2.5% - 1.6% = 0.9%.
A year ago, you invested $12,000 in an investment that produced a return of 16%. What is your approximate annual real rate of return if the rate of inflation was 2% over the year? A) 18%. B) 2%. C) 16%. D) 15%.
E) none of the above. Rationale: 16% - 2% = 14%.
If the annual real rate of interest is 3.5% and the expected inflation rate is 2.5%, the nominal rate of interest would be approximately A) 3.5%. B) 2.5%. C) 1%. D) 6.8%.
E) none of the above.
Rationale: 3.5% + 2.5% = 6%.
If the annual real rate of interest is 2.5% and the expected inflation rate is 3.4%, the nominal rate of interest would be approximately A) 4.9%. B) 0.9%. C) -0.9%. D) 7%.
E) none of the above.
Rationale: 2.5% + 3.4% = 5.9%.
If the annual real rate of interest is 4% and the expected inflation rate is 3%, the nominal rate of interest would be approximately A) 4%. B) 3%. C) 1%.
A 40.
E 41.
A 42.
Use the following to answer questions 43-45:
You have been given this probability distribution for the holding period return for a stock:
D) 5%.
E) none of the above. Rationale: 4% + 3% = 7%.
You purchased a share of stock for $12. One year later you received $0.25 as dividend and sold the share for $12.92. What was your holding period return? A) 9.75% B) 10.65% C) 11.75% D) 11.25%
E) none of the above
Rationale: ($0.25 + $12.92 - $12)/$12 = 0.975, or 9.75%.
You purchased a share of stock for $120. One year later you received $1.82 as dividend and sold the share for $136. What was your holding period return? A) 15.67% B) 22.12% C) 15.67% D) 13.24%
E) none of the above
Rationale: ($1.82 + $136 - $120)/$120 = 0.1485, or 14.85%.
You purchased a share of stock for $65. One year later you received $2.37 as dividend and sold the share for $63. What was your holding period return? A) 0.57% B) -0.2550% C) -0.89% D) 1.63%
E) none of the above
Rationale: ($2.37 + $63 - $65)/$65 = 0.0056, or 0.57%.
E 43.
What is the expected holding period return for the stock? A) 11.67% B) 8.33% C) 9.56% D) 12.4%