Economics of Money, Banking, and Financial Markets, 11e, Global Edition (Mishkin) Chapter 7 The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis
7.1 Computing the Price of Common Stock
1) A stockholder's ownership of a company's stock gives her the right to A) vote and be the primary claimant of all cash flows. B) vote and be the residual claimant of all cash flows. C) manage and assume responsibility for all liabilities. D) vote and assume responsibility for all liabilities. Answer: B
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2) Stockholders are residual claimants, meaning that they A) have the first priority claim on all of a company's assets. B) are liable for all of a company's debts. C) will never share in a company's profits.
D) receive the remaining cash flow after all other claims are paid. Answer: D
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3) Periodic payments of net earnings to shareholders are known as A) capital gains. B) dividends. C) profits. D) interest. Answer: B
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4) The value of any investment is found by computing the A) present value of all future sales. B) present value of all future liabilities. C) future value of all future expenses. D) present value of all future cash flows. Answer: D
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5) In the one-period valuation model, the value of a share of stock today depends upon A) the present value of both the dividends and the expected sales price. B) only the present value of the future dividends.
C) the actual value of the dividends and expected sales price received in one year. D) the future value of dividends and the actual sales price. Answer: A
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6) In the one-period valuation model, the current stock price increases if A) the expected sales price increases. B) the expected sales price falls. C) the required return increases. D) dividends are cut. Answer: A
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7) In the one-period valuation model, an increase in the required return on investments in equity A) increases the expected sales price of a stock. B) increases the current price of a stock.
C) reduces the expected sales price of a stock. D) reduces the current price of a stock. Answer: D
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8) In a one-period valuation model, a decrease in the required return on investments in equity causes a(n) ________ in the ________ price of a stock. A) increase; current B) increase; expected sales C) decrease; current
D) decrease; expected sales Answer: A
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9) Using the one-period valuation model, assuming a year-end dividend of $0.11, an expected sales price of $110, and a required rate of return of 10%, the current price of the stock would be A) $110.11. B) $121.12. C) $100.10. D) $100.11 Answer: C
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10) Using the one-period valuation model, assuming a year-end dividend of $1.00, an expected sales price of $100, and a required rate of return of 5%, the current price of the stock would be A) $110.00. B) $101.00. C) $100.00. D) $96.19. Answer: D
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11) In the generalized dividend model, if the expected sales price is in the distant future A) it does not affect the current stock price.
B) it is more important than dividends in determining the current stock price. C) it is equally important with dividends in determining the current stock price. D) it is less important than dividends but still affects the current stock price. Answer: A
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12) In the generalized dividend model, a future sales price far in the future does not affect the current stock price because
A) the present value cannot be computed. B) the present value is almost zero.
C) the sales price does not affect the current price. D) the stock may never be sold. Answer: B
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13) In the generalized dividend model, the current stock price is the sum of A) the actual value of the future dividend stream. B) the present value of the future dividend stream.
C) the present value of the future dividend stream plus the actual future sales price. D) the present value of the future sales price. Answer: B
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14) Using the Gordon growth model, a stock's current price will increase if A) the dividend growth rate increases. B) the growth rate of dividends falls.
C) the required rate of return on equity rises. D) the expected sales price rises. Answer: A
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15) Using the Gordon growth model, a stock's current price decreases when A) the dividend growth rate increases. B) the required return on equity decreases. C) the expected dividend payment increases. D) the growth rate of dividends decreases. Answer: D
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16) In the Gordon growth model, a decrease in the required rate of return on equity A) increases the current stock price. B) increases the future stock price. C) reduces the future stock price. D) reduces the current stock price. Answer: A
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17) Using the Gordon growth formula, if D1 is $2.00, ke is 12% or 0.12, and g is 10% or 0.10, then the current stock price is A) $20. B) $50. C) $100. D) $150. Answer: C
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18) Using the Gordon growth formula, if D1 is $1.00, ke is 10% or 0.10, and g is 5% or 0.05, then the current stock price is A) $10. B) $20. C) $30. D) $40. Answer: B
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19) Using the Gordon growth model, if D1 is $.50, ke is 7%, and g is 5%, then the present value of the stock is A) $2.50. B) $25. C) $50. D) $46.73. Answer: B
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20) One of the assumptions of the Gordon Growth Model is that dividends will continue growing at ________ rate. A) an increasing B) a fast C) a constant D) an escalating Answer: C
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21) In the Gordon Growth Model, the growth rate is assumed to be ________ the required return on equity.
A) greater than B) equal to C) less than
D) proportional to Answer: C
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22) You believe that a corporation's dividends will grow 5% on average into the foreseeable future. If the company's last dividend payment was $5 what should be the current price of the stock assuming a 12% required return? Answer: Use the Gordon Growth Model. $5(1 + .05)/(.12 - .05) = $75 AACSB: Analytical Thinking
23) What rights does ownership interest give stockholders?
Answer: Stockholders have the right to vote on issues brought before the stockholders, be the residual claimant, that is, receive a portion of any net earnings of the corporation, and the right to sell the stock.
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7.2 How the Market Sets Stock Prices
1) In asset markets, an asset's price is
A) set equal to the highest price a seller will accept.
B) set equal to the highest price a buyer is willing to pay. C) set equal to the lowest price a seller is willing to accept. D) set by the buyer willing to pay the highest price. Answer: D
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2) Information plays an important role in asset pricing because it allows the buyer to more accurately judge A) liquidity. B) risk. C) capital. D) policy. Answer: B
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