Chapter 26

Saving, Investment, and the Financial System

TRUE/FALSE1.

The financial system coordinates investment and saving, which are important determinants of long-run real GDP.ANS: T DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment | Saving MSC: Definitional

2. When economists refer to investment, they mean the purchasing of stocks and bonds and other types of saving.ANS: F DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment | Saving MSC: Definitional

3. Banks and mutual funds are examples of financial markets.ANS: F DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial intermediaries | Financial markets MSC: Definitional

4.

When a firm wants to borrow directly from the public to finance the purchase of new equipment, it does so by

selling shares of stock.ANS: F DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Stock MSC: Definitional

5. Most entrepreneurs finance their purchases of real capital using their past saving.ANS: F DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment MSC: Definitional

6.

Other things the same, the higher the rate of saving and investment in a country, the higher will be the

standard of living.ANS: T DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Saving | Investment MSC: Interpretive

7. Lenders sell bonds and borrowers buy them.ANS: F DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds MSC: Definitional

8.

When a firm wants to borrow directly from the public to finance the purchase of new equipment, it does so by

selling bonds.ANS: T DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Stock MSC: Definitional

9. Other things the same, corporate bonds generally feature higher interest rates than U.S. government bonds.ANS: T DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds MSC: Definitional

10. The sale of either stocks or bonds to raise money is known as equity finance.ANS: F DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Stock MSC: Definitional

1742

Chapter 26/Saving, Investment, and the Financial System ? 1743

11. When a corporation experiences financial problems, bondholders are paid before stockholders.

ANS: T DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Stock MSC: Definitional

12. Corporations receive no proceeds from the resale of their stock.ANS: T DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock MSC: Definitional

13. Generally, if people begin to expect a company to have higher future profits, the price of the company’s stock

will begin to decrease.ANS: F DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock MSC: Interpretive

14. If a share of stock in Skylight Chili sells for $75, the retained earnings per share are $5, and the divided per

share is $2, then the price-earnings ratio is 15.ANS: F DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock MSC: Applicative

15. If people become less optimistic about the future earnings of Hyde Park Jazz Studio, then the price of the

company’s stock will fall.ANS: T DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock. MSC: Interpretive

16. Mutual funds are a type of financial intermediary.ANS: T DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Mutual funds | Financial intermediaries MSC: Definitional

17. Index funds are usually outperformed by mutual funds that are actively managed by professional money

managers.ANS: F DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Mutual funds MSC: Definitional

18. To state that national saving is equal to investment, for a closed economy, is to state an accounting identity.ANS: T DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Identities MSC: Interpretive

19. National saving is equal to Y - T - C.ANS: F DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Interpretive

20. Public saving is T - G, while private saving is Y - T - C.ANS: T DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving | Public saving MSC: Interpretive

21. Public saving is equal to national saving minus private saving.ANS: T DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Definitional

1744 ? Chapter 26/Saving, Investment, and the Financial System

22. To state that public saving is equal to investment, for a closed economy, is to state an accounting identity.ANS: F DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Identities MSC: Interpretive

23. In a closed economy, investment must be equal to private saving.ANS: F DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving | Investment MSC: Definitional

24. If, for an imaginary closed economy, investment amounts to $10,000 and the government is running a $2,500

deficit, then private saving must amount to $12,500.ANS: T DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Identities | Private saving | Investment MSC: Applicative

25. If, for an imaginary closed economy, investment amounts to $12,000 and the government is running a $2,000

deficit, then private saving must amount to $10,000.ANS: F DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Identities | Private saving | Investment MSC: Applicative

26. Suppose a small closed economy has GDP of $5 billion, consumption of $3 billion, and government

expenditures of $1 billion. Then investment and national saving are both $1 billion.ANS: T DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving | Investment MSC: Applicative

27. Joan uses some of her income to buy mutual fund shares. A macroeconomist refers to Joan's purchase as

investment.ANS: F DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Saving | Investment MSC: Interpretive

28. Alberta buys a paint sprayer and a lift for her car customizing shop. A macroeconomist would refer to these

purchases as investment.ANS: T DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment MSC: Interpretive

29. The demand for loanable funds comes from saving and the supply of loanable funds comes from investment.ANS: F DIF: 1 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Market for loanable funds MSC: Definitional

30. A decrease in taxes on interest income would increase the interest rate.ANS: F DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Saving | Market for loanable funds MSC: Applicative

31. If Congress instituted an investment tax credit, the demand for loanable funds would shift rightward.ANS: T DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment MSC: Applicative

32. When the government budget deficit rises, national saving is reduced, interest rates rise, and investment falls.ANS: T DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Budget deficits MSC: Applicative

Chapter 26/Saving, Investment, and the Financial System ? 1745

33. The term crowding out refers to decreases in the interest rate caused by government budget surpluses.

ANS: F DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Crowding out MSC: Definitional

34. When the U.S. government is in debt during a given year, it follows that its budget is in deficit for that year.ANS: F DIF: 1 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Government debt | Budget deficits MSC: Interpretive

35. The ratio of government debt to GDP was higher during the Reagan presidency than at any previous time in

U.S. history.ANS: F DIF: 1 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Government debt MSC: Definitional

36. An increase in the demand for loanable funds increases the equilibrium interest rate and increases the

equilibrium level of saving.ANS: T DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and applying economic models TOP: Market for loanable funds MSC: Applicative

37. An increase in the demand for loanable funds increases the equilibrium interest rate and decreases the

equilibrium level of saving.ANS: F DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and applying economic models TOP: Market for loanable funds MSC: Applicative

38. The term loanable funds refers to all income that is not used for consumption.ANS: F DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Market for loanable funds MSC: Definitional

39. The term loanable funds refers to all income that is not used for consumption or government expenditures.ANS: T DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Market for loanable funds MSC: Definitional

40. We interpret the term loanable funds to mean the flow of resources available to fund private investment.ANS: T DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Market for loanable funds MSC: Interpretive

41. An increase in the budget deficit shifts the demand for loanable funds to the right.ANS: F DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Budget deficits MSC: Applicative

42. A government may use deficit financing to smooth tax rates over time.ANS: T DIF: 2 REF: 26-3 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Budget deficits MSC: Analytic

1746 ? Chapter 26/Saving, Investment, and the Financial System

SHORT ANSWER

1. What are the basic differences between bonds and stocks?ANS:

A bond is a certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond, while stock represents a share of ownership in a firm and is, therefore, a claim on the profits that the firm makes. The sale of bonds to raise money is called debt finance, while the sale of stock is called equity finance. Whereas the owner of shares of stock in a company share in the profits of a company, the owner of bonds receives a fixed interest rate. Compared to bonds, stocks offer the holder both higher risk and a potentially higher return.

DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics MSC: Interpretive

TOP: Stock | Bonds

2.

Which of the two bonds in each example would you expect to generally pay the higher interest rate? Explain why.

a. a U.S. government bond or a Brazilian government bond

b. a U.S. government bond or a municipal bond with the same term and issued by a creditworthy

municipality.

c. a 6-month Treasury bill or a 20-year Treasury bond

d. a Microsoft bond or a bond issued by a new recording company

ANS:

a. The Brazilian government bond would likely pay a higher interest rate because the market perceives a

higher level of risk for the Brazilian bond relative to the U.S. bond.

b. Because of the tax advantages of municipal bonds, the U.S. government bond would likely pay the

higher interest rate.

c. The 20-year bond would likely pay a higher interest rate than would the 6-month bill. The future is

uncertain and therefore more risky for a 20-year bond than for a 6-month bill.

d. Since Microsoft is less likely to default than a new and unknown company, the interest on the bond of

the new company is likely to be higher.

DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics MSC: Applicative

TOP: Bonds

3.

Suppose that you are a broker and people tell you the following about themselves. What sort of bond would you recommend to each? Defend your choices.

a. \ b. \

c. \

ANS:

a. A municipal bond. Municipal bonds generally have low credit risk and are not subject to federal income

tax.

b. A junk bond. Junks bonds have a high return because they have high risk.

c. A corporate bond that isn't a junk bond. Corporate bonds have more risk than government bonds but

have no special tax treatment, so they pay moderate rates of return.

DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics MSC: Analytical

TOP: Bonds

Chapter 26/Saving, Investment, and the Financial System ? 1747

4.

Your brother-in-law wants to buy either stock or bonds in Cedar Valley Furniture, which manufactures

wooden furniture. He wants your advice on whether to buy stock or bonds. Explain how each of his quotes below should affect his choice between the stock and the bond.

a. \ b. \ c. \

ANS:

a. Presumably, when this happens, unless everyone else has anticipated it, dividends, the price of the stock,

or both will increase. The interest rate on bonds will not change as profits increase, so this quote suggests buying stock would better suit your brother-in law's purposes.

b. Bondholders are simply creditors, while stockholders are part owners. So this quote indicates your

brother-in-law would prefer to buy stock.

c. In case of financial difficulties stockholders get paid after bondholders, so the stock is somewhat more

risky. So, your brother-in-law may prefer the bond.

DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics MSC: Interpretive

TOP: Stock | Bonds

5.

Suppose the Move It! exercise chain has revenues of $45 million, accounting costs of $15 million, and currently has issued 10 million shares of stocks selling at $90 each. Compute the price-earning ratio. Show your work. Is this ratio relatively high or low? What might an increase in the price-earnings ratio indicate?ANS:

The earnings per share is ($45 million - $15 million)/10 million = $3. So, the price-earnings ratio is $90/$3 = 30. This is a high P/E ratio, as the historical average for the market is about 15. An increase in the PE ratio may indicate the people expect the firm to have higher earnings in the future or that the stock has become overvalued.

DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics MSC: Analytical

TOP: Stock

6.

In the national income accounting identity showing the equality between national saving and investment, what are the algebraic expressions for private saving and public saving?ANS:

Private saving is Y - C - T, Public Saving is T - G

DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving | Public saving MSC: Interpretive7.

Identify each of the following acts as representing either saving or investment.

a. Fred uses some of his income to buy government bonds. b. Julie takes some of her income and buys mutual funds.

c. Alex purchases a new truck for his delivery business using borrowed funds. d. Elaine uses some of her income to buy stock in a major corporation. e. Henrietta hires a builder to construct a new building for her bicycle shop.

Fred is saving. Julie is saving. Alex is investing. Elaine is saving.

Henrietta is investing.

TOP: Saving | Investment

ANS:

a. b. c. d. e.

DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics MSC: Interpretive

1748 ? Chapter 26/Saving, Investment, and the Financial System

8. Draw and label a graph showing equilibrium in the market for loanable funds.ANS:

Market for Loanable Funds

DIF: 1 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: MSC: Interpretive

Market for loanable funds

9.

Explain why the demand for loanable funds slopes downward and why the supply of loanable funds slopes upward.ANS:

When the interest rate rises investment spending becomes more expensive, so people invest less. As the interest rate rises saving becomes more rewarding, so people want to save more. The inverse relation between interest and

borrowing is reflected in the downward slope of the demand for loanable funds curve. The positive relation between interest and saving is reflected in the upward slope of the supply of loanable funds curve.

DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: MSC: Interpretive

Market for loanable funds

10. The model of the market for loanable funds shows that an investment tax credit will cause interest rates to rise

and investment to rise. Yet we also suppose that higher interest rates lead to lower investment. How can these two conclusions be reconciled?ANS:

The claim that an increase in the interest rate decreases investment supposes that only the interest rate changes and everything else is constant. The investment tax credit causes investment to rise at each interest rate. As firms want to borrow more the interest rate will rise. The rise in interest rates does make investment less than it would otherwise be, but unless the supply of loanable funds is vertical, the increase in investment demand from the tax credit is larger than the decrease in investment demand from the rising interest rate.

DIF: 3 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: MSC: Analytical

Investment

Chapter 26/Saving, Investment, and the Financial System ? 1749

11. Using a graph representing the market for loanable funds, show and explain what happens to interest rates and

investment if the government budget goes from a deficit to a surplus.ANS:

As shown in the graph below, the economy starts in equilibrium at point E0 with interest rate r0 and equilibrium quantity of saving and investment at q0. If the government succeeds in obtaining a surplus, there will be more public saving in the economy and so more national saving at each interest rate, and the supply of loanable funds curve will shift from S0 to S1. The new equilibrium will be at E1, with a lower interest rate, r1 and a higher quantity of saving and investment, q1. Hence, if the federal government succeeds in having a surplus, interest rates will fall and investment will increase.

Market for Loanable Funds

DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Budget deficits | Budget surpluses MSC: Applicative

Sec00 - Saving, Investment, and the Financial System

MULTIPLE CHOICE1.

When opening a print shop you need to buy printers, computers, furniture, and similar items. Economists call

these expenditures a. capital investment.

b. investment in human capital.

c. business consumption expenditures. d. personal saving.

DIF: 1 REF: 26-0

LOC: The Study of economics, and definitions of economics MSC: Definitional

ANS: A

NAT: Analytic TOP: Investment 2.

If you were to start a business delivering documents, you might need to purchase cell phones, bicycles, desks, and chairs.

a. These purchases are called capital investment. If you raise the funds from others to purchase them

you are a saver.

b. These purchases are called capital investment. If you raise the funds from others to purchase them

you are a borrower.

c. These purchases are called consumption. If you raise the funds from others to purchase them you

are a saver.

d. These purchases are called consumption. If you raise the funds from others to purchase them you

are a borrower.

DIF: 2 REF: 26-0

LOC: The study of economics, and definitions of economics MSC: Interpretive

ANS: B

NAT: Analytic TOP: Investment

1750 ? Chapter 26/Saving, Investment, and the Financial System

3.

When a country saves a larger portion of its GDP than it did before, it will have

a. more capital and higher productivity. b. more capital and lower productivity. c. less capital and higher productivity. d. less capital and lower productivity.

ANS: A DIF: 1 REF: 26-0 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Saving | Investment MSC: Interpretive

4.

Institutions that help to match one person's saving with another person's investment are collectively called the

a. Federal Reserve system. b. banking system. c. monetary system. d. financial system.

ANS: D DIF: 1 REF: 26-0 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial system MSC: Definitional

5.

The primary economic function of the financial system is to

a. keep interest rates low.

b. provide expert advice to savers and investors.

c. match one person’s consumption expenditures with another person’s capital expenditures. d. match one person’s saving with another person’s investment.

ANS: D DIF: 2 REF: 26-0 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial system MSC: Interpretive

6.

Given that Lekeisha's income exceeds her expenditures, Lekeisha is best described as a

a. saver or as a supplier of funds. b. saver or as a demander of funds. c. borrower or as a supplier of funds. d. borrower or as a demander of funds.

DIF: 1 REF: 26-0

LOC: The Study of economics, and definitions of economics MSC: Interpretive

ANS: A

NAT: Analytic TOP: Saving 7.

Alyssa is opening a bicycle shop, and her monthly expenditures to get the shop up and running exceed her monthly income. Alyssa is best described as a a. saver or as a supplier of funds. b. saver or as a demander of funds. c. borrower or as a supplier of funds. d. borrower or as a demander of funds.

DIF: 1 REF: 26-0

LOC: The Study of economics, and definitions of economics MSC: Interpretive

ANS: D

NAT: Analytic TOP: Investment 8.

Most entrepreneurs do not have enough money of their own to start their businesses. When they acquire the necessary funds from someone else,

a. their consumption expenditures are being financed by someone else’s saving. b. their consumption expenditures are being financed by someone else’s investment. c. their investments are being financed by someone else’s saving. d. their saving is being financed by someone else’s investment.

ANS: C DIF: 2 REF: 26-0 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment | Saving MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1751

Sec01 - Saving, Investment, and the Financial System - Financial Institutions in the

U.S. Economy

MULTIPLE CHOICE1.

At the broadest level, the financial system moves the economy’s scarce resources from a. the rich to the poor.

b. financial institutions to business firms and government. c. households to financial institutions. d. savers to borrowers.

ANS: D DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial system MSC: Interpretive

2.

The fact that borrowers sometimes default on their loans by declaring bankruptcy is directly related to the

characteristic of a bond called a. credit risk. b. interest risk. c. term risk. d. private risk.

DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

ANS: A

NAT: Analytic TOP: Bonds 3.

When a large, well-known corporation wishes to borrow directly from the public, it can a. sell bonds.

b. sell shares of stock. c. go to a bank for a loan. d. All of the above are correct.

DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

ANS: A

NAT: Analytic TOP: Bonds 4.

Which of the following statements about the term of a bond is correct?

a. Term refers to the various characteristics of a bond, including its interest rate and tax treatment. b. The term of a bond is determined entirely by its credit risk.

c. The term of a bond is determined entirely by how much sales charge the buyer of the bond pays

when he or she purchases the bond.

d. Interest rates on long-term bonds are usually higher than interest rates on short-term bonds.

DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

ANS: D

NAT: Analytic TOP: Bonds 5.

We would expect the interest rate on Bond A to be higher than the interest rate on Bond B if the two bonds have identical characteristics except that

a. the credit risk associated with Bond A is lower than the credit risk associated with Bond B. b. Bond A was issued by the state of New York and Bond B was issued by the Exxon Mobil

Corporation.

c. Bond A has a term of 20 years and Bond B has a term of 2 years. d. All of the above are correct.

DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

ANS: C

NAT: Analytic TOP: Bonds

1752 ? Chapter 26/Saving, Investment, and the Financial System

6.

We would expect the interest rate on Bond A to be higher than the interest rate on Bond B if the two bonds

have identical characteristics except that

a. Bond A was issued by a financially weak corporation and Bond B was issued by a financially

strong corporation.

b. Bond A was issued by the General Electric Corporation and Bond B was issued by the state of

California.

c. Bond A has a term of 20 years and Bond B has a term of 1 year. d. All of the above are correct.

DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

ANS: D

NAT: Analytic TOP: Bonds 7.

As an alternative to selling shares of stock as a means of raising funds, a large company could, instead, a. invest in physical capital. b. use equity finance. c. sell bonds. d. purchase bonds.

ANS: C DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock | Bonds MSC: Interpretive

8.

Which of the following statements is correct?

a. The expected future profitability of a corporation influences the demand for that corporation’s

stock.

b. When a corporation sells stock as a means of raising funds it is engaging in debt finance. c. The owners of bonds sold by the Microsoft Corporation are part owners of that corporation. d. All bonds are, by definition, perpetuities.

ANS: A DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock | Bonds MSC: Interpretive

9.

Which of the following statements is correct?

a. A corporation receives a monetary payment every time its shares of stock are traded by

stockholders on organized stock exchanges.

b. When a corporation sells bonds as a means of raising funds it is engaging in debt finance. c. A share of stock is an IOU.

d. The two most important financial markets in the economy are the stock market and financial

intermediaries.

ANS: B DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock | Bonds MSC: Interpretive

10. The economy’s two most important financial markets are

a. the investment market and the saving market. b. the bond market and the stock market. c. banks and the stock market.

d. financial markets and financial institutions.

ANS: B DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial markets MSC: Interpretive

11. Two of the economy’s most important financial intermediaries are

a. suppliers of funds and demanders of funds. b. banks and the bond market.

c. the stock market and the bond market. d. banks and mutual funds.

ANS: D DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial intermediaries MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1753

12. We associate the term debt finance with

a. the bond market, and we associate the term equity finance with the stock market. b. the stock market, and we associate the term equity finance with the bond market.

c. financial intermediaries, and we associate the term equity finance with financial markets. d. financial markets, and we associate the term equity finance with financial intermediaries.

ANS: A DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial markets | Financial intermediaries MSC: Interpretive13. A bond is a

a. financial intermediary. b. certificate of indebtedness.

c. certificate of partial ownership in an enterprise. d. None of the above is correct.

ANS: B

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

14. Which of the following is a financial-market transaction?

a. A saver buys shares in a mutual fund.

b. A saver deposits money into a credit union.

c. A saver buys a bond a corporation has just issued so it can purchase capital. d. None of the above is correct.

ANS: C DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial markets | Bonds MSC: Interpretive

15. A certificate of indebtedness that specifies the obligations of the borrower to the holder is called a

a. bond. b. stock.

c. mutual fund.

d. All of the above are correct.

ANS: A

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

16. Long-term bonds are

a. riskier than short-term bonds, and so interest rates on long-term bonds are usually lower than

interest rates on short-term bonds.

b. riskier than short-term bonds, and so interest rates on long-term bonds are usually higher than

interest rates on short-term bonds.

c. less risky than short-term bonds, and so interest rates on long-term bonds are usually lower than

interest rates on short-term bonds.

d. less risky than short-term bonds, and so interest rates on long-term bonds are usually higher than

interest rates on short-term bonds.

ANS: B

NAT: Analytic TOP: Bonds DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

17. If the government's expenditures exceeded its receipts, it would likely

a. lend money to a bank or other financial intermediary.

b. borrow money from a bank or other financial intermediary. c. buy bonds directly from the public. d. sell bonds directly to the public.

ANS: D DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Financial system MSC: Interpretive

1754 ? Chapter 26/Saving, Investment, and the Financial System

18. A national chain of grocery stores wants to finance the construction of several new stores. The firm has

limited internal funds, so it likely will

a. demand the required funds by buying bonds. b. demand the required funds by selling bonds. c. supply the required funds by buying bonds. d. supply the required funds by selling bonds.

ANS: B DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment | Bonds MSC: Interpretive

19. Skyline Chili wants to finance the purchase of new equipment for its restaurants. The firm has limited

internal funds, so Skyline likely will

a. demand funds from the financial system by buying bonds. b. demand funds from the financial system by selling bonds. c. supply funds to the financial system by buying bonds. d. supply funds to the financial system by selling bonds.

ANS: B DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment | Bonds MSC: Interpretive

20. If Proctor and Gamble sells a bond it is

a. borrowing directly from the public. b. borrowing indirectly from the public. c. lending directly to the public. d. lending indirectly to the public.

ANS: A DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Financial markets MSC: Interpretive

21. Which of the following is correct?

a. The maturity of a bond refers to the amount to be paid back. b. The principal of the bond refers to the person selling the bond. c. A bond buyer cannot sell a bond before it matures. d. None of the above is correct.

ANS: D

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

22. Which of the following is not correct?

a. By saving a larger portion of its GDP, a country can raise its output per worker.

b. Savers supply their money to the financial system with the expectation that they will get it back

with interest at a later date.

c. Financial intermediaries are the only type of financial institution.

d. The financial system helps match people’s saving with other people’s borrowing.

ANS: C DIF: 1 REF: 26-1 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Financial system MSC: Interpretive

23. Which of the following is not a nonsensical headline?

a. British perpetuities about to mature.

b. Disney issues new bonds with term of $1,000 each.

c. Government bonds currently pay less interest than corporate bonds. d. Standard and Poor's judges new junk bond to have very low credit risk.

ANS: C

NAT: Analytic TOP: Bonds DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1755

24. The length of time until a bond matures is called the

a. perpetuity. b. term. c. maturity.

d. intermediation.

ANS: B

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

25. A perpetuity is distinguished from other bonds in that it

a. pays continuously compounded interest. b. pays interest only when it matures. c. never matures.

d. will be used to purchase another bond when it matures unless the owner specifies otherwise.

ANS: C

NAT: Analytic TOP: Perpetuities DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

26. Which of the following is correct?

a. Some bonds have terms as short as a few months.

b. Because they are so risky, junk bonds pay a low rate of interest. c. Corporations buy bonds to raise funds. d. All of the above are correct.

ANS: A

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

27. Which of the following is not correct?

a. If you buy a bond from a corporation, you can sell the bond to someone else before it matures. b. Term refers to the scheduling of periodic interest rate payments on a bond. c. A bond is an IOU.

d. There are millions of different bonds in the U.S. economy.

ANS: B

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

28. A bond that never matures is known as a

a. perpetuity.

b. an intermediary bond. c. an indexed bond. d. a junk bond.

ANS: A

NAT: Analytic TOP: Perpetuities DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

29. A bond buyer is a

a. saver. Bond buyers must hold their bonds until maturity. b. saver. Bond buyers may sell their bonds prior to maturity. c. borrower. Bond buyers must hold their bonds until maturity. d. borrower. Bond buyers may sell their bonds prior to maturity.

ANS: B

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The study of economics, and definitions of economics MSC: Definitional

1756 ? Chapter 26/Saving, Investment, and the Financial System

30. Which of the following is correct?

a. Lenders sell bonds and borrowers buy them.

b. Long-term bonds usually pay a lower interest rate than do short-term bonds because long-term

bonds are riskier.

c. The term junk bonds refers to bonds that have been resold many times. d. None of the above is correct.

ANS: D

NAT: Analytic TOP: Bonds DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

31. Short-term bonds are generally

a. less risky than long-term bonds and so they feature higher interest rates. b. less risky than long-term bonds and so they feature lower interest rates. c. more risky than long-term bonds and so they feature higher interest rates. d. more risky than long-term bonds and so they feature lower interest rates.

ANS: B

NAT: Analytic TOP: Bonds | Risk DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

32. Compared to short-term bonds, other things the same, long-term bonds generally have

a. more risk and so they pay higher interest rates. b. less risk and so they pay lower interest rates. c. less risk and so they pay higher interest rates.

d. about the same risk and so they pay about the same interest rate.

ANS: A

NAT: Analytic TOP: Bonds | Risk DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

33. Two bonds have the same term to maturity. The first was issued by a state government and the probability of

default is believed to be low. The other was issued by a corporation and the probability of default is believed to be high. Which of the following is correct?

a. Because they have the same term to maturity the interest rates should be the same.

b. Because of the differences in tax treatment and credit risk, the state bond should have the higher

interest rate.

c. Because of the differences in tax treatment and credit risk, the corporate bond should have the

higher interest rate.

d. It is not possible to say if one bond has a higher interest rate than the other.

ANS: C DIF: 3 REF: 26-1 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Bonds | Interest rates MSC: Applicative

34. On which of these bonds is the prospect of default most likely?

a. a junk bond

b. a municipal bond

c. a U.S. government bond

d. a corporate bond issued by General Electric Corporation

ANS: A

NAT: Analytic TOP: Bonds | Risk DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

35. On which of these bonds is the prospect of default least likely?

a. a junk bond

b. a bond issued by the state of Texas

c. a bond issued by the federal government d. a bond issued by Exxon Mobil Corporation

ANS: C

NAT: Analytic TOP: Bonds | Risk DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1757

36. Assume the bonds below have the same term and principal and that the state or local government that issues

the municipal bond has a good credit rating. Which list has bonds correctly ordered from the one that pays the highest interest rate to the one that pays the lowest interest rate? a. corporate bond, municipal bond, U.S. government bond b. corporate bond, U.S. government bond, municipal bond c. municipal bond, U.S. government bond, corporate bond d. U.S. government bond, municipal bond, corporate bond

ANS: B

NAT: Analytic TOP: Bonds | Risk DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

37. Other things the same, as the maturity of a bond becomes longer, the bond will pay

a. a lower interest rate because it has less risk. b. a lower interest rate because it has more risk. c. a higher interest rate because it has more risk.

d. the same interest rate, because there is no relationship between term and risk.

ANS: C

NAT: Analytic TOP: Bonds | Risk DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

38. Suppose the issuer of a bond fails to pay some of the interest or principal that was promised to the bondholders.

This failure is referred to as a a. breach. b. default. c. risk.

d. term failure.

ANS: B

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

39. Suppose the city of Springfield has a high credit rating, and so when Springfield borrows funds by selling

bonds,

a. the city’s high credit rating and the tax status of municipal bonds both contribute to a lower interest

rate than would otherwise apply.

b. the city’s high credit rating and the tax status of municipal bonds both contribute to a higher interest

rate than would otherwise apply.

c. the city’s high credit rating contributes to a lower interest rate than would otherwise apply, while

the tax status of municipal bonds contributes to a higher interest rate than would otherwise apply. d. the city’s high credit rating contributes to a higher interest rate than would otherwise apply, while

the tax status of municipal bonds contributes to a lower interest rate than would otherwise apply.

ANS: A DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Interest rates MSC: Applicative

40. Municipal bonds pay a relatively

a. low rate of interest because of their high default risk and because the interest they pay is subject to

federal income tax.

b. low rate of interest because of their low default risk and because the interest they pay is not subject

to federal income tax.

c. high rate of interest because of their high default risk and because federal taxes must be paid on the

interest they pay.

d. high rate of interest because of their low default risk and because the interest they pay is not subject

to federal income tax.

ANS: B DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Interest rates MSC: Interpretive

1758 ? Chapter 26/Saving, Investment, and the Financial System

41. Which of the following bond buyers did not buy the bond that best met his or her objective?

a. Mia wanted a bond with a high interest rate and was willing to take a lot of risk. She purchased a

junk bond.

b. Anna wanted a bond that would let her best avoid federal income taxes. She purchased a municipal

bond.

c. Bill wanted to purchase a bond whose seller was unlikely to default. He purchased a bond that

Standards and Poor's rated a low credit risk.

d. Toby held long-term bonds rather than short-term ones to avoid risk.

ANS: D

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

42. You hold bonds issued by the state of Ohio. The interest you earn each year on these bonds

a. is not subject to federal income tax and so these bonds pay a higher interest rate than otherwise

comparable bonds issued by the U.S. government.

b. is not subject to federal income tax and so these bonds pay a lower interest rate than otherwise

comparable bonds issued by the U.S. government.

c. is subject to federal income tax and so these bonds pay a higher interest rate than otherwise

comparable bonds issued by the U.S. government.

d. is subject to federal income tax and so these bonds pay a lower interest rate than otherwise

comparable bonds issued by the U.S. government.

ANS: B DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Interest rates MSC: Interpretive

43. Other things the same, bonds are likely to have higher interest rates if they have

a. tax exemptions and short terms. b. tax exemptions and long terms. c. no tax exemptions and short terms. d. no tax exemptions and long terms.

ANS: D DIF: TOP: Interest on bonds 1 REF: 26-1

MSC: Definitional

44. Other things the same, which bond would you expect to pay the highest interest rate?

a. a bond issued by the U.S. government b. a bond issued by IBM

c. a bond issued by New York State

d. a bond issued by a new restaurant chain

ANS: D DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Interest rates MSC: Applicative

45. Other things the same, which bond would you expect to pay the lowest interest rate?

a. a bond issued by a state with a very good credit rating b. a bond issued by the U.S. government

c. a bond issued by a fairly new company doing genetic research d. a bond issued by Nabisco

ANS: A DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Interest rates MSC: Applicative

Chapter 26/Saving, Investment, and the Financial System ? 1759

46. You are thinking of buying a bond from Knight Corporation. You know that this bond is long term and you

know that Knight’s business ventures are risky and uncertain. You then consider another bond with a shorter term to maturity issued by a company with good prospects and an established reputation. Which of the following is correct?

a. The longer term would tend to make the interest rate on the bond issued by Knight higher, while the

higher risk would tend to make the interest rate lower.

b. The longer term would tend to make the interest rate on the bond issued by Knight lower, while the

higher risk would tend to make the interest rate higher.

c. Both the longer term and the higher risk would tend to make the interest rate lower on the bond

issued by Knight.

d. Both the longer term and the higher risk would tend to make the interest rate higher on the bond

issued by Knight.

ANS: D DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Interest rates | Risk MSC: Applicative

47. Jerry has the choice of two bonds, one that pays 3 percent interest and one that pays 6 percent interest. Which

of the following is most likely?

a. The 6 percent bond is less risky than the 3 percent bond.

b. The 6 percent bond is a U.S. government bond, and the 3 percent bond is a junk bond. c. The 6 percent bond has a longer term than the 3 percent bond.

d. The 6 percent bond is a municipal bond, and the 3 percent bond is a U.S. government bond.

ANS: C

NAT: Analytic TOP: Bonds | Risk DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

48. Lacey, a financial advisor, has told her clients the following things. Which of her statements is not correct?

a. \ b. \ c. \ d. \

ANS: D

NAT: Analytic TOP: Bonds DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

49. The sale of stocks

a. and bonds to raise money is called debt finance. b. and bonds to raise money is called equity finance.

c. to raise money is called debt finance, while the sale of bonds to raise funds is called equity finance. d. to raise money is called equity finance, while the sale of bonds to raise funds is called debt finance.

ANS: D DIF: TOP: Bonds | Stock 1 REF: 26-1

MSC: Definitional

50. ABC Co. sells newly issued bonds. JLG Co. sells newly issued stocks. Which company is raising funds in

financial markets? a. only ABC b. only JLG

c. both ABC and JLG d. neither ABC nor JLG

ANS: C DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Stock MSC: Definitional

1760 ? Chapter 26/Saving, Investment, and the Financial System

51. Papa Mario's Pizza Company sells common stock. The company is using

a. equity financing and the return shareholders earn is fixed.

b. equity financing and the return shareholders earn depends on how profitable the company is. c. debt financing and the return shareholders earn is fixed.

d. debt financing and the return shareholders earn depends on how profitable the company is.

ANS: B

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

52. Stock represents

a. a claim to a share of the profits of a firm. b. ownership in a firm. c. equity finance.

d. All of the above are correct

ANS: D

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

53. The bond market

a. is a financial market, whereas the stock market is a financial intermediary. b. is a financial intermediary, whereas the stock market is a financial market. c. is a financial market, as is the stock market.

d. is a financial intermediary, as is the stock market.

ANS: C DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bond market, stock market MSC: Definitional

54. Which of the following would likely make the interest rate on a bond higher than otherwise?

a. both high credit risk and a long term b. high credit risk but not a long term c. a long term but not a high credit risk d. neither high credit risk nor a long term

ANS: A DIF: 1 REF: 26-1 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Bonds | Interest rates MSC: Definitional

55. People who buy newly issued stock in a corporation such as Crate and Barrel provide

a. debt finance and so become part owners of Crate and Barrel. b. debt finance and so become creditors of Crate and Barrel. c. equity finance and so become part owners of Crate and Barrel. d. equity finance and so become creditors of Crate and Barrel.

ANS: C

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

56. People who buy stock in a corporation such as General Electric become

a. creditors of General Electric, so the benefits of holding the stock depend on General Electric's

profits.

b. creditors of General Electric, but the benefits of holding the stock do not depend on General

Electric's profits.

c. part owners of General Electric, so the benefits of holding the stock depend on General Electric's

profits.

d. part owners of General Electric, but the benefits of holding the stock do not depend on General

Electric's profits.

ANS: C

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1761

57. If Huedepool Beer runs into financial difficulty, the stockholders as

a. part owners of Huedepool are paid before bondholders get paid anything at all. b. part owners of Huedepool are paid after bondholders get paid.

c. creditors of Huedepool are paid before bondholders get paid anything at all. d. creditors of Huedepool are paid after bondholders get paid.

ANS: B

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

58. As chief financial officer you sell newly issued bonds on behalf of your firm. Your firm is

a. borrowing directly. b. borrowing indirectly. c. lending directly. d. lending indirectly.

ANS: A

NAT: Analytic TOP: Bonds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

59. Which of the following people purchased the correct asset to meet his or her objective?

a. Michelle wanted to be a part owner of Mamma Rosa's Pizza, so she purchased a bond issued by

Mamma Rosa's Pizza.

b. Tim wanted a high return, even if it meant taking some risk, so he purchased stock issued by

Specific Electric instead of bonds issued by Specific Electric.

c. Jennifer wanted to buy equity in Honda, so she purchased bonds sold by Honda. d. All of the above are correct.

ANS: B DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Bonds | Stock MSC: Interpretive

60. If a firm sells a total of 100 shares of stock, then

a. each share represents 1 percent of the firm’s indebtedness. b. each share represents ownership of 1 percent of the firm. c. the firm is engaging in debt finance. d. the firm is engaging in term finance.

ANS: B

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

61. The prices of stock traded on exchanges are determined by

a. the Corporate Stock Administration. b. the administrators of NASDAQ.

c. the supply of, and demand for, the stock. d. All of the above are correct.

ANS: C

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

62. Which of the following is not an important stock exchange in the United States?

a. New York Stock Exchange b. American Stock Exchange c. Chicago Mercantile Exchange d. NASDAQ

ANS: C

NAT: Analytic TOP: Stock market DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

1762 ? Chapter 26/Saving, Investment, and the Financial System

63. All else equal, when people become more optimistic about a company's future, the

a. supply of the stock and the price will both rise. b. supply of the stock and the price will both fall. c. demand for the stock and the price will both rise. d. demand for the stock and the price will both fall.

ANS: C

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

64. Suppose the government finds a major defect in one of a company's products and demands that the product be

taken off the market. We would expect that the

a. supply of existing shares of the stock and the price will both rise. b. supply of existing shares of the stock and the price will both fall. c. demand for existing shares of the stock and the price will both rise. d. demand for existing shares of the stock and the price will both fall.

ANS: D

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

65. World Wide Delivery Service Corporation develops a way to speed up its deliveries and reduce its costs. We

would expect that this would

a. raise the demand for existing shares of the stock, causing the price to rise. b. decrease the demand for existing shares of the stock, causing the price to fall. c. raise the supply of the existing shares of stock, causing the price to rise. d. raise the supply of the existing shares of stock, causing the price to fall.

ANS: A

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

66. In the late summer of 2005 some regions of the country were suffering from drought. What effect would we

expect this to have on the stock of companies such as John Deere that manufacture farm equipment? a. raise the demand for existing shares of the stock, causing the price to rise b. decrease the demand for existing shares of the stock, causing the price to fall c. raise the supply of the existing shares of stock, causing the price to rise d. raise the supply of the existing shares of stock, causing the price to fall

ANS: B

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

67. In the Coen Brothers’ movie The Hudsucker Proxy the board of directors picks someone to run the company

who they believe will make poor decisions. If things turn out as they plan,

a. the price of a share of stock in the Hudsucker corporation should decline as the demand for shares

falls.

b. the price of a share of stock in the Hudsucker corporation should rise as the demand for shares

rises.

c. the price of a share of stock in the Hudsucker corporation should decline as the supply of existing

shares falls.

d. the price of a share of stock in the Hudsucker corporation should rise as the supply of existing

shares rises.

ANS: A

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

Chapter 26/Saving, Investment, and the Financial System ? 1763

68. Suppose that the tires of a certain tire manufacturer are discovered to be defective. Other things the same, this

news would cause

a. the demand for this company’s stock to decrease, so the price would rise. b. the demand for this company’s stock to decrease, so the price would fall. c. the supply of this company’s stock to decrease, so the price would fall. d. the supply of this company’s stock to decrease, so the price would rise.

ANS: B

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

69. Nastech Pharmaceuticals announced it has developed a nasal spray that would reduce hunger cravings. Other

things the same we would expect

a. the demand for existing shares of stock in this company to decrease, so the price would fall. b. the demand for existing shares of stock in this company to increase, so the price would rise. c. the supply of existing shares of stock in this company to decrease, so the price would fall. d. the supply of existing shares of stock in this company to increase, so the price would rise.

ANS: B

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

70. Other things being constant, when a firm sells new shares of stock, the

a. supply of the stock increases and the price decreases as a result. b. supply of the stock decreases and the price increases as a result. c. demand for the stock increases and the price increases as a result. d. demand for the stock decreases and the price decreases as a result.

ANS: A

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

71. Which of the following is a certificate of indebtedness?

a. stocks and bonds b. stocks but not bonds c. bonds but not stocks d. neither stocks nor bonds

ANS: C DIF: 1 REF: 26-1 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Bonds | Stocks MSC: Definitional

72. Compared to stocks, bonds offer the holder

a. lower risk and lower potential return. b. lower risk and higher potential return. c. higher risk and lower potential return. d. higher risk and higher potential return.

ANS: A

NAT: Analytic TOP: Bonds, Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

73. Which of the following statements is correct?

a. A general, persistent decline in stock prices may signal that the economy is about to enter a boom

period because people will be able to buy stock for less money.

b. A general, persistent decline in stock prices may signal that the economy is about to enter a

recession because low stock prices may mean that people are expecting low corporate profits. c. A general, persistent decline in stock prices may signal that the economy is about to enter a

recession because low stock prices mean that corporations have had low profits in the past. d. Expectations about the business cycle have no impact on stock prices.

ANS: B

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

1764 ? Chapter 26/Saving, Investment, and the Financial System

74. A stock index is

a. an average of a group of stock prices. b. an average of a group of stock yields.

c. a measure of the risk relative to the profitability of corporations.

d. a report in a newspaper or other media outlet on the price of the stock and earnings of the

corporation that issued the stock.

ANS: A DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock indexes MSC: Definitional

75. The Dow Jones Industrial Average has been computed regularly since

a. 1976. b. 1948. c. 1913. d. 1896.

ANS: D DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock indexes MSC: Definitional

76. The Dow Jones Industrial Average is now based on the prices of the stocks of

a. 30 major U.S. corporations. b. 100 major U.S. corporations.

c. 500 representative U.S. corporations. d. 1,000 representative U.S. corporations.

ANS: A DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock indexes MSC: Definitional

77. The single most important piece of information about a stock is its

a. term. b. dividend. c. daily volume. d. price.

ANS: D

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

78. Potential buyers of ABC Corporation bonds are not concerned about ABC Corporation declaring bankruptcy.

Potential buyers of XYZ Corporation bonds are concerned that XYZ Corporation may declare bankruptcy. Which of the following statements is correct?

a. Other things equal, the interest rate on XYZ Corporation bonds will be high relative to the interest

rate on ABC Corporation bonds.

b. An ABC Corporation bond is a perpetuity, whereas an XYZ Corporation bond is not a perpetuity. c. XYZ Corporation bonds carry more interest-rate risk than do ABC Corporation bonds. d. All of the above are correct.

ANS: A

NAT: Analytic TOP: Bonds DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

79. Compared to bondholders, stockholders

a. face higher risk and have the potential for higher returns. b. face higher risk but receive a fixed payment.

c. face lower risk and have the potential for higher returns. d. face lower risk but receive a fixed payment.

ANS: A DIF: 1 REF: 26-1 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Bonds | Stock MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1765

80. After a corporation issues stock, the stock

a. can not be resold.

b. can be resold only if the corporation wants to buy it back.

c. can be resold on exchanges; the resale will raise additional funds for the corporation. d. None of the above are correct.

ANS: D

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The study of economics, and definitions of economics MSC: Definitional

81. A high demand for a company’s stock is an indication that

a. the company is in need of funds.

b. the company has recently sold a large quantity of bonds. c. people are optimistic about the company’s future. d. people are pessimistic about the company’s future.

ANS: C

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

82. The price of a stock will rise if

a. the managers of a stock exchange decide the price should be higher. b. the demand for the stock rises. c. the supply of the stock rises. d. None of the above are correct.

ANS: B

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The study of economics, and definitions of economics MSC: Interpretive

83. Volume, as reported in stock tables, refers to the

a. number of shares traded.

b. percentage of shares outstanding traded.

c. number of shares traded times the price they sold at.

d. number of shares of a company traded divided by the shares of all companies traded.

ANS: A

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

84. A corporation’s earnings are the amount of revenue it receives for the sale of its products

a. minus its cost of production as measured by its accountants. Earnings must be paid out as

dividends.

b. minus its cost of production as measured by its accountants. Earnings may be paid out as dividends

or retained by the corporation.

c. minus its direct and indirect costs as measured by its economists. Earnings must be paid out as

dividends.

d. minus its direct and indirect cost as measure by its economists. Earnings may be paid out as

dividends or retained by the corporation.

ANS: B DIF: 2 REF: 26-2 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Dividends | Stock MSC: Definitional

85. All or part of a firm’s profits may be paid out to the firm’s stockholders in the form of

a. retained earnings. b. dividends.

c. interest payments. d. capital accounts.

ANS: B

NAT: Analytic TOP: Dividends DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

1766 ? Chapter 26/Saving, Investment, and the Financial System

86. Profits not paid out to stockholders are

a. retained earnings. b. known as dividends.

c. the denominator in the price-earnings ratio. d. All of the above are correct.

ANS: A

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

87. A stock’s dividend yield is the

a. dividend as a percentage of the price per share. b. stock price as a percentage of the dividend.

c. dividend as a percentage of the retained earnings per share. d. retained earnings per share as the percentage of the dividend.

ANS: A

NAT: Analytic TOP: Dividends DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

88. A particular stock pays an annual dividend of $2 per share and the annual dividend yield is 4 percent. The

price of a share of this stock is a. $2.08. b. $5.00. c. $8.00 d. $50.00.

ANS: D

NAT: Analytic TOP: Dividends DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

89. In 2008, XYZ Corporation had total earnings of $200 million and 50 million shares of the corporation’s stock

were outstanding. If the price-earnings ratio for XYZ is 20, then what is the price of a share of its stock? a. $5 b. $10 c. $80 d. $500

ANS: C

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

90. In 2008, CDZ Corporation had total earnings of $500 million and CDZ retained 30 percent of its earnings for

future investments. If the price of a share of CDZ stock is $70 and if 80 million shares of its stock were outstanding, then what is the price-earnings ratio? a. 0.14 b. 11.2 c. 16.0 d. 37.3

ANS: B

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

91. The number of shares of Biggie Corporation stock outstanding in 2007 was 100 million. In 2007, Biggie

stock paid a dividend of $2.40 per share and its dividend yield was 4 percent. If the price-earnings ratio is 16, then Biggie’s total earnings in 2007 amounted to a. $1.92 million. b. $87.50 million. c. $375.00 million. d. $960.00 million.

ANS: C

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

Chapter 26/Saving, Investment, and the Financial System ? 1767

92. Camp Company had total earnings of $600 million in 2008, out of which it retained $150 million for future

investments. In 2008, its stock featured a dividend yield of 3 percent and 200 million shares were outstanding. The price-earnings ratio for Camp Company stock was a. 8.33. b. 12.00. c. 16.67. d. 25.00.

ANS: D

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

93. Fortunade Corporation stock has a price of $100 per share, a dividend of $1.60 per share, and retained

earnings of $2.00 per share. The dividend yield on this stock is a. 2.8 percent. b. 2.0 percent. c. 1.6 percent. d. 0.4 percent.

ANS: C

NAT: Analytic TOP: Dividends DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

94. Queen City Sausage stock is selling at $40 per share, it has retained earnings of $2.00 per share and dividends

of $.50 per share. What is the price-earnings ratio and what is the dividend yield? a. 20, 1.25 percent b. 20, 6.25 percent c. 16, 1.25 percent

d. None of the above is correct.

ANS: C

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

95. Stock in Creole Cuisine Restaurants is selling at $25 per share. Creole Cuisine had earnings of $5 a share and

a dividend yield of 5 percent. The dividend is a. $0.25 and the price-earnings ratio is 5. b. $.25 and the price-earnings ratio is 6.7. c. $1.25 and the price-earnings ratio is 5. d. $1.25 and the price-earnings ratio is 6.7.

ANS: C

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

96. Stock in Tasty Greens Restaurants is selling at $80 per share with 1 million shares outstanding. Last year,

Tasty Greens earned $5 million, of which it retained $1 million for future investments. The dividend yield on the stock is a. 1 percent. b. 2 percent. c. 4 percent. d. 5 percent.

ANS: D DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock | Dividends MSC: Applicative

1768 ? Chapter 26/Saving, Investment, and the Financial System

97. Buskin’s Corporation has issued 2 million shares of stock. Its earnings were $10 million, of which it retained

$6 million. What was the dividend per share? a. $2. b. $3. c. $5

d. None of the above is correct.

ANS: A

NAT: Analytic TOP: Dividends DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

98. Over-the-Rhine Cheese Corporation had a P/E ratio of 20, retained earnings of $1.50 per share and a dividend

of $.50. What was its dividend yield? a. 1.25% b. 1.67% c. 3.33% d. 7.50%

ANS: A

NAT: Analytic TOP: Dividends DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

99. Dependable Appliances had a P/E ratio of 25, earnings per share of $4, and retained earnings per share of $3.

What was its dividend yield? a. 4% b. 3% c. 1%

d. None of the above is correct.

ANS: C

NAT: Analytic TOP: Dividends DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

100. XDF Corp. had a price-earnings ratio of 15, paid a dividend of $1, and retained earnings of $2 a share. What

was the price of a share of XDF stock? a. $15 b. $30 c. $45

d. None of the above is correct.

ANS: C

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

101. Thomas Publishing has a share price of $28, retained earnings of $0.60 per share, and a dividend yield of 5

percent. What is its price-earnings ratio? a. 24 b. 16 c. 14 d. 12

ANS: C

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

Chapter 26/Saving, Investment, and the Financial System ? 1769

102. A corporation's earnings are

a. the amount of revenue it receives for the sale of its products minus its costs of production as

measured by its accountants minus the dividends paid out.

b. the amount of revenue it receives for the sale of its products minus its direct and indirect costs of

production as measured by its economists minus the dividends paid out.

c. the amount of revenue it receives for the sale of its products minus its costs of production as

measured by its accountants.

d. the amount of revenue it receives for the sale of its products minus its direct and indirect costs of

production as measured by its economists.

ANS: C

NAT: Analytic TOP: Profits DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

103. Retained earnings are

a. earnings of a company that are not paid out to stockholders.

b. the amount of revenue a corporation receives for the sale of its products minus its costs of

production as measured by its accountants.

c. the single most important piece of information about a stock.

d. computed by multiplying the dividend yield by the price of the stock.

ANS: A

NAT: Analytic TOP: Profits DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

104. The amount of revenue a firm receives for the sale of its products minus its costs of production as measured by

its accountants is the firm's a. earnings.

b. retained earnings.

c. economic, or real, profit. d. dividend.

ANS: A

NAT: Analytic TOP: Profits DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

105. Historically, the typical price-earnings ratio for stocks is about

a. 3 b. 8 c. 15 d. 26

ANS: C

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

106. A high price-earnings ratio for a stock indicates that either the stock is

a. undervalued or people are relatively optimistic about the corporation's prospects. b. overvalued or people are relatively optimistic about the corporation's prospects. c. overvalued or people are relatively pessimistic about the corporation's prospects. d. undervalued or people are relatively pessimistic about the corporation's prospects.

ANS: B

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

107. A low price-earnings ratio indicates that either the stock is

a. undervalued or people are relatively optimistic about the corporation's prospects. b. overvalued or people are relatively optimistic about the corporation's prospects. c. overvalued or people are relatively pessimistic about the corporation's prospects. d. undervalued or people are relatively pessimistic about the corporation's prospects.

ANS: D

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

1770 ? Chapter 26/Saving, Investment, and the Financial System

108. PacknCamp Corporation has a stock price of $50, has issued 2,000,000 shares of stock, has retained earnings

of $4 million dollars, and a dividend yield of 4 percent. The price-earnings ratio of PacknCamp is a. 25, which is high compared to historical standards of the market. b. 25, which is low compared to historical standards of the market. c. 12.5, which is low compared to historical standards of the market. d. 12.5, which is high compared to historical standards of the market.

ANS: C

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

109. Metals, Inc. has a price of $20 a share, outstanding shares of 2.5 million, retained earnings of $1 million

dollars, and a dividend yield of 2 percent. It has a price-earnings ratio of a. 50, which is high by historical standards. b. 50, which is low by historical standards. c. 25, which is high by historical standards. d. 25, which is low by historical standards.

ANS: C

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

110. Zeta Corporation has a price of $20 a share, outstanding shares of 2.5 million, retained earnings of $1 million

dollars, and a dividend yield of 1 percent. It has a price-earnings ratio which is a. high, perhaps indicating that people expect future earnings to rise. b. high, perhaps indicating that people expect future earnings to fall. c. low, perhaps indicating that people expect future earnings to rise. d. low, perhaps indicating that people expect future earnings to fall.

ANS: A

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Analytical

111. A low P/E for a stock indicates that

a. people may expect earnings to fall in the future, perhaps because the firm will be faced with

increased competition.

b. its dividends have been low so that no one is willing to pay very much for it. c. the corporation is possibly overvalued. d. All of the above are correct.

ANS: A

NAT: Analytic TOP: Stock DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

112. Suppose Sarah Lee Corporation stock has a P/E ratio of 8. This P/E ratio is relatively

a. low, indicating that buyers may expect earnings to rise. b. low, indicating that buyers may expect earnings to fall. c. high, indicating that buyers may expect earnings to rise. d. high, indicating that buyers may expect earnings to fall.

ANS: B

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

113. Which of the following is correct?

a. Joan takes some of her income and buys mutual fund shares. Joan’s purchase will be included in the

investment category of GDP.

b. If a share of stock in Virtual Pizza Corporation sells for $77, the earnings per share are $5, and the

dividend per share is $2, then the P/E ratio is 11.

c. In order to use equity finance, a firm must sell about equal values of stocks and bonds. d. None of the above is correct.

ANS: D

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

Chapter 26/Saving, Investment, and the Financial System ? 1771

Use the following table to answer the following questions. Table 26-1 Stock GenMills Gillette Graco Hershey Sym GIS G GGG HSY Yld % 2.5 2.2 1.2 2.1 P/E 35 31 16 38 Vol 100s 13758 30428 705 5418 Hi 44.3 31.1 24.2 63.4 Lo 43.5 29.7 23.1 61.7 Close 43.97 30 23.95 62.45 Net Chg. –0.63 0.17 –0.53 0.72 114. Refer to Table 26-1. In dollar terms, which company paid the highest dividend per share?

a. GenMills b. Gillette c. Graco d. Hershey

ANS: D

NAT: Analytic TOP: Dividends DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

115. Refer to Table 26-1. What was Hershey's earnings per share?

a. $38 b. $1.64 c. $1.31 d. $0.61

ANS: B

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

116. Refer to Table 26-1. Assume that the closing price was also the average price at which each stock transaction

took place. What was the total dollar volume of Gillette stock traded that day? a. $912,840,000 b. $91,284,000 c. $9,128,400 d. $912,840

ANS: B

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

117. Refer to Table 26-1. Which firm had the P/E ratio that was closest to the historically typical P/E ratio?

a. GenMills b. Gillette c. Graco d. Hershey

ANS: C

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

1772 ? Chapter 26/Saving, Investment, and the Financial System

Use the following table to answer the following questions. Table 26-2 Stock Boeing Co. Eli Lily and Co. H. J. Heniz and Co. Kellog Co. Sym BA LLY HNZ K Yld % P/E 1.55 2.60 3.30 2.22 30.48 29.71 15.33 20.50 Vol 100s 4,531,600 3,765,700 1,350,200 1,990,600 Hi 64.78 58.98 36.55 45.72 Lo 63.70 58.21 36.26 45.20 Close 64.62 58.52 36.33 45.50 Net Chg. +.93 +.16 +.21 +.24 118. Refer to Table 26-2. Which company had the highest dollar dividend?

a. Boeing Co. b. Eli Lilly and Co. c. H. J. Heinz and Co. d. Kellog Co.

ANS: B

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

119. Refer to Table 26-2. Which company had the lowest dollar dividend?

a. Boeing Co. b. Eli Lilly and Co. c. H. J. Heinz and Co. d. Kellog Co.

ANS: A

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

120. Refer to Table 26-2. Which company had the highest earnings per share?

a. Boeing Co. b. Eli Lilly and Co. c. H. J. Heinz and Co. d. Kellog Co.

ANS: C

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

121. Refer to Table 26-2. Which company had the lowest earnings per share?

a. Boeing Co. b. Eli Lilly and Co. c. H. J. Heinz and Co. d. Kellog Co.

ANS: B

NAT: Analytic TOP: Stock DIF: 3 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

122. Refer to Table 26-2. For which company’s stock is the P/E ratio closest to what is historically typical?

a. Boeing Co. b. Eli Lilly and Co. c. H. J. Heinz and Co. d. Kellog Co.

ANS: C

NAT: Analytic TOP: Stock DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Applicative

Chapter 26/Saving, Investment, and the Financial System ? 1773

123. Financial intermediaries are

a. the same as financial markets.

b. individuals who make profits by buying a stock low and selling it high.

c. a more general name for financial assets such as stocks, bonds, and checking accounts. d. financial institutions through which savers can indirectly provide funds to borrowers.

ANS: D DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial intermediaries MSC: Definitional

124. Which of the following is both a financial institution and a financial intermediary?

a. banks

b. stock exchanges c. the bond market

d. All of the above are correct.

ANS: A DIF: 1 REF: 26-1 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Financial intermediaries | Financial institutions MSC: Definitional

125. Which of the following statements is correct?

a. Stocks, bonds, and deposits are all similar in that each provides a common medium of exchange. b. Most buyers of stocks and bonds prefer those issued by large and familiar companies. c. Banks charge borrowers a slightly lower interest rate than they pay to depositors. d. None of the above is correct.

ANS: B DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Stock | Bonds | Banks MSC: Interpretive

126. Which of the following is a financial intermediary?

a. a mutual fund b. the stock market

c. a U.S. government bond

d. a wealthy individual who regularly buys and holds large quantities of government bonds

ANS: A DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial intermediaries MSC: Definitional

127. Which of the following are financial intermediaries?

a. both banks and mutual funds b. banks but not mutual funds c. mutual funds but not banks d. neither banks or mutual funds

ANS: A DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial intermediaries MSC: Definitional

128. Which of the following is an example of financial intermediation?

a. Susan buys shares of stock issued by a fast food company. b. A foreign government buys bonds issued by the U.S. Treasury.

c. John makes a deposit at a bank and the bank uses this money to make an auto loan to Luke. d. None of the above is correct.

ANS: C DIF: 1 REF: 26-1 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Financial intermediaries MSC: Interpretive

1774 ? Chapter 26/Saving, Investment, and the Financial System

129. Which of the following statements is correct?

a. A large, well-known corporation such as Proctor and Gamble would generally use financial

intermediation to finance expansion of its factories. b. On average, indexed funds outperform managed funds.

c. Unlike corporate bonds and stocks, checking accounts are a store of value.

d. Financial intermediaries are institutions through which savers can directly provide funds to

borrowers.

ANS: B DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Financial intermediaries MSC: Interpretive

130. Which of the following statements is correct?

a. A large, well-known corporation such as Intel generally would use financial intermediation to

finance expansion of its facilities.

b. On average, managed funds outperform indexed funds.

c. Unlike corporate bonds and stocks, checking accounts are a medium of exchange. d. A mutual fund is a financial market.

ANS: C DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Medium of exchange MSC: Interpretive

131. Which of the following is both a store of value and a common medium of exchange?

a. corporate bonds b. mutual funds

c. checking account balances d. All of the above are correct.

ANS: C DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Store of value | Medium of exchange MSC: Interpretive132. A checking deposit functions as

a. a medium of exchange and as a store of value. b. a medium of exchange, but not as a store of value. c. a store of value, but not as a medium of exchange. d. neither a medium of exchange nor as a store of value.

ANS: A DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Store of value | Medium of exchange MSC: Interpretive

133. In addition to

a. performing financial intermediation, banks are important in that they help create a medium of

exchange.

b. serving as financial markets, mutual funds are important in that they help create a store of value. c. serving as stores of value, stocks and bonds also serve as media of exchange. d. All of the above are correct.

ANS: A DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Medium of exchange MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1775

134. Stocks and bonds

a. and checking accounts are all stores of value and commonly function as mediums of exchange. b. and checking accounts are all stores of value, but only stocks and bonds commonly function as

mediums of exchange.

c. and checking accounts are all stores of value, but only checking accounts commonly function as

mediums of exchange.

d. and checking accounts all commonly function as mediums of exchange, but only stocks and bonds

are a store of value.

ANS: C DIF: 2 REF: 26-1 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Bonds | Medium of exchange | Stocks | Store of value MSC: Interpretive135. A U.S. Treasury bond is a

a. store of value and common medium of exchange.

b. store of value, but not a common medium of exchange. c. a common medium of exchange, but not a store of value. d. neither a store of value nor a common medium of exchange.

ANS: B DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Store of value | Medium of exchange MSC: Interpretive

136. A mutual fund

a. is a financial market where small firms mutually agree to sell stocks and bonds to raise funds.

b. is funds set aside by local governments to lend to small firms who want to invest in projects that are

mutually beneficial to the firm and community.

c. sells stocks and bonds on behalf of small and less known firms who would otherwise have to pay

high interest to obtain credit.

d. is an institution that sells shares to the public and uses the proceeds to buy a selection of various

types of stocks, bonds, or both stocks and bonds.

ANS: D

NAT: Analytic TOP: Mutual funds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

137. It is claimed that mutual funds have two advantages. The first is that mutual funds allow people with small

amounts of money to diversify. The second is that mutual funds provide the skills of professional money managers who buy stocks they believe will be the most profitable and thereby increase the return that mutual fund depositors earn on their savings.

a. Economists strongly agree with both claims. b. Economists are skeptical of both claims.

c. Economists are skeptical of the first claim, but strongly agree with the second. d. Economists strongly agree with the first claim, but are skeptical of the second.

ANS: D

NAT: Analytic TOP: Mutual funds DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

138. The primary advantage of mutual funds is that they

a. always make a return that \

b. allow people with small amounts of money to diversify. c. provide customers with a medium of exchange. d. All of the above are correct.

ANS: B DIF: 2 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Mutual funds | Diversification MSC: Definitional

1776 ? Chapter 26/Saving, Investment, and the Financial System

139. The old adage, “Don’t put all your eggs in one basket,” is very similar to a modern bit of advice concerning

financial matters:

a. “Buy low-risk bonds.”

b. “Use a medium of exchange.” c. “Diversify.” d. “Intermediate.”

ANS: C DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Diversification MSC: Interpretive

140. As a money management fee, mutual funds usually charge their customers

a. between 0.5 and 2.0 percent of assets each year. b. between 1.5 and 3.0 percent of assets each year.

c. nothing, because they receive commissions from the firms whose stock they buy. d. a flat fee of about $50.

ANS: A

NAT: Analytic TOP: Mutual funds DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

141. It is claimed that a secondary advantage of mutual funds is that

a. an investor can avoid investment charges and fees.

b. they give ordinary people access to loanable funds for investing. c. they usually outperform stock market indexes.

d. they give ordinary people access to the skills of professional money managers.

ANS: D

NAT: Analytic TOP: Mutual funds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

142. Index funds

a. typically have a higher rate of return and higher costs than managed mutual funds. b. typically have a higher rate of return and lower costs than managed mutual funds. c. typically have a lower rate of return and higher costs than managed mutual funds. d. typically have a lower rate of return and lower costs than managed mutual funds.

ANS: B DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Mutual funds | Index funds MSC: Interpretive

143. Index funds

a. buy all the stocks in a given stock index.

b. promise to beat the market by a certain percentage known as an index. c. provide a return that is adjusted for changes in the consumer price index.

d. buy industries within a particular category of the North American Industry Classification System.

ANS: A

NAT: Analytic TOP: Index funds DIF: 1 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Definitional

144. Managed funds

a. typically have a higher rate of return and higher costs than index funds. b. typically have a higher rate of return and lower costs than index funds. c. typically have a lower rate of return and higher costs than index funds. d. typically have a lower rate of return and lower costs than index funds.

ANS: C DIF: 1 REF: 26-1 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Mutual funds | Index funds MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1777

145. Which of the following statements about mutual funds is correct?

a. A mutual fund is a financial intermediary.

b. A mutual fund acquires its funds primarily by selling shares to the public.

c. People who buy shares from a mutual fund accept all of the risk and return associated with the

mutual fund’s portfolio. d. All of the above are correct.

ANS: D

NAT: Analytic TOP: Mutual funds DIF: 2 REF: 26-1

LOC: The Study of economics, and definitions of economics MSC: Interpretive

146. Which advantage(s) do mutual funds claim to provide?

a. diversification and access to the skills of professional money managers b. diversification but not access to the skills of professional money managers c. access to the skills of professional money managers but not diversification d. neither diversification nor access to the skills of professional money managers.

ANS: A

NAT: Analytic TOP: Mutual funds DIF: 1 REF: 26-1

LOC: The study of economics, and definitions of economics MSC: Interpretive

Sec02 - Saving, Investment, and the Financial System - Saving and Investment in the

National Income Accounts

MULTIPLE CHOICE1.

Which of the following is not correct?

a. Gross domestic product is both total income in an economy and total expenditures on the

economy’s output of goods and services. b. In a closed economy net exports are zero.

c. National saving is the sum of private saving and public saving. d. Purchases of capital goods are excluded from GDP.

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Investment | Gross domestic product MSC: Definitional2.

You observe a closed economy that has a government deficit and positive investment. Which of the following

is correct?

a. Private and public saving are both positive.

b. Private saving is positive; public saving is negative. c. Private saving is negative; public saving is positive. d. Both private saving and public saving are negative.

ANS: B DIF: 2 REF: 26-2 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Private saving | Public saving MSC: Analytic

3.

If national saving in a closed economy is greater than zero, which of the following must be true?

a. Either public saving or private saving must be greater than zero. b. Investment is positive. c. Y - C - G > 0

d. All of the above are correct.

ANS: D DIF: 2 REF: 26-2 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: National saving MSC: Analytic

1778 ? Chapter 26/Saving, Investment, and the Financial System

4.

Which of the following is correct?

a. In the national income accounts, investment and private saving refer to the same thing. b. In a closed economy if national saving is greater than zero, then everyone must be saving. c. The financial system channels funds from savers to borrowers. d. People whose consumption exceeds their income are savers.

ANS: C DIF: 1 REF: 26-2 NAT: Analytic LOC: The study of economics, and definitions of economics TOP: Financial system | Saving MSC: Definitional

5.

A closed economy does not

a. trade with other economies. b. have free markets.

c. allow financial intermediation. d. All of the above are correct.

ANS: A DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Closed economies MSC: Definitional

6.

The assumption of a closed economy

a. applies to the world economy.

b. applies to most national economies.

c. requires us to assume that the government’s budget is always balanced. d. All of the above are correct.

ANS: A DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Closed economies MSC: Interpretive

7.

In a closed economy, what does (T - G) represent?

a. national saving b. investment c. private saving d. public saving

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Public saving MSC: Definitional

8.

In a closed economy, what remains after paying for consumption and government purchases is

a. national disposable income. b. national saving. c. public saving. d. private saving.

ANS: B DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Interpretive

9.

In a closed economy, what does (Y - T - C) represent?

a. national saving

b. government tax revenue c. public saving d. private saving

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving MSC: Definitional

Chapter 26/Saving, Investment, and the Financial System ? 1779

10. In which of the following cases would it necessarily be true that national saving and private saving are equal

for a closed economy?

a. Private saving is equal to government expenditures. b. Public saving is equal to investment.

c. After paying their taxes and paying for their consumption, households have nothing left. d. The government’s tax revenue is equal to its expenditures.

ANS: D DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving | Private saving MSC: Applicative

11. Which of the following statements is correct?

a. The total income in the economy that remains after paying for consumption and government

purchases is called private saving.

b. The sum of private saving and national saving is called public saving.

c. For a closed economy, the sum of private saving and public saving must equal investment. d. For a closed economy, the sum of consumption, national saving, and taxes must equal GDP.

ANS: C

NAT: Analytic TOP: Identities DIF: 2 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Interpretive

12. Net exports must equal zero for any economy

a. that is closed.

b. for which Y = C + I + G. c. for which S = Y - C - G. d. All of the above are correct.

ANS: D DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Closed economies MSC: Applicative

13. In national income accounting, we use which of the following pairs of terms interchangeably?

a. “investment” and “private saving”

b. “investment” and “purchases of stocks and bonds” c. “saving” and “national saving”

d. “public saving” and “government tax revenue minus government spending”

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Definitional

14. The purchase of a new house is the one form of

a. investment that is financed by private saving rather than public saving.

b. household spending that is not counted as part of investment in the national income accounts. c. household spending that is investment rather than consumption. d. household spending that does not contribute to GDP.

ANS: C

NAT: Analytic TOP: Investment DIF: 1 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Definitional

15. The identity that shows that total income and total expenditure are equal is

a. GDP = Y.

b. Y = DI + T + NX. c. GDP = GNP - NX. d. Y = C + I + G + NX.

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Gross domestic product MSC: Interpretive

1780 ? Chapter 26/Saving, Investment, and the Financial System

16. Which of the following lists correctly identifies the four expenditure categories of GDP?

a. consumption, government purchases, investment, net-exports b. consumption, investment, depreciation, net-exports c. consumption, saving, investment, depreciation,

d. consumption, government purchases, investment, savings

ANS: A DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Gross domestic product MSC: Definitional

17. Y = C + I + G + NX is an identity because

a. each symbol identifies a macroeconomic variable.

b. the right-hand and left-hand sides are equal when an equilibrium is reached. c. the equality holds due to the way the variables are defined. d. None of the above is correct.

ANS: C DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Identities | Gross domestic product MSC: Interpretive

18. Which of the following equations will always represent GDP in an open economy?

a. S = I - G b. I = Y - C + G c. Y = C + I + G

d. Y = C + I + G + NX

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Gross domestic product MSC: Interpretive

19. Which of the following equations represents GDP for a closed economy?

a. Y = C + I + G + T b. S = I - G c. I = Y - C + G d. Y = C + I + G

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Gross domestic product | Closed economies MSC: Interpretive20. Which of the following equations represents GDP for an open economy?

a. Y = C + I + G + NX b. NX = I - G

c. I = Y - C + G + NX d. Y = C + I + G

ANS: A DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Gross domestic product | Open economies MSC: Interpretive

21. Which of the following expressions must be equal to national saving for a closed economy?

a. Y - I - G - NX b. Y - C - G c. Y - I - C d. G + C - Y

ANS: B DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1781

22. In a closed economy, national saving equals

a. investment.

b. income minus the sum of consumption and government purchases. c. private saving plus public saving. d. All of the above are correct.

ANS: D DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Interpretive

23. In a closed economy, national saving is

a. usually greater than investment. b. equal to investment.

c. usually less than investment because of the leakage of taxes. d. always less than investment.

ANS: B DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Definitional

24. In a small closed economy investment is $20 billion and private saving is $22 billion. What are public saving

and national saving?

a. $24 billion and $2 billion b. $20 billion and -$2 billion c. $2 billion and $24 billion d. -$2 billion and $20 billion

ANS: D DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving | Public saving MSC: Applicative

25. Suppose a closed economy had public saving of $3 trillion and private saving of $2 trillion. What are national

saving and investment for this country? a. $5 trillion, $5 trillion b. $5 trillion, $2 trillion c. $1 trillion, $5 trillion d. $1 trillion, $2 trillion

ANS: A DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving | Investment MSC: Applicative

26. Consider the expressions T - G and Y - T - C. Which of the following statements is correct?

a. Each one of these is equal to national saving. b. Each one of these is equal to public saving.

c. The first of these is private saving; the second one is public saving. d. The first of these is public saving; the second one is private saving.

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Public saving | Private saving MSC: Definitional

27. According to the definitions of private and public saving, if Y, C, and G remained the same, an increase in

taxes would

a. raise both private and public saving.

b. raise private saving and lower public saving. c. lower private saving and raise public saving. d. lower private and public saving.

ANS: C DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving | Public saving MSC: Interpretive

1782 ? Chapter 26/Saving, Investment, and the Financial System

28. According to the definitions of national saving and private saving, if Y, C, and G remained the same, an

increase in taxes would

a. raise both national saving and private saving. b. raise national saving and reduce private saving. c. leave national saving and private saving unchanged.

d. leave national saving unchanged and reduce private saving.

ANS: D DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving | Private saving MSC: Interpretive

29. According to the definitions of national saving and public saving, if Y, C, and G remained the same, an

increase in taxes would

a. raise national saving and public saving. b. raise national saving and raise public saving.

c. leave national saving and public saving unchanged. d. leave national saving unchanged and raise public saving.

ANS: D DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving | Public saving MSC: Interpretive

30. Suppose that in a closed economy GDP is equal to 11,000, taxes are equal to 1,500, consumption equals 7,500,

and government purchases equal 2,000. What is national saving? a. -500 b. 0 c. 1,500

d. None of the above is correct.

ANS: C DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Applicative

31. Suppose that in a closed economy GDP is equal to 11,000, taxes are equal to 2,500, consumption equals 7,000,

and government purchases equal 3,000. What are private saving and public saving? a. 1,500 and -500, respectively b. 1,500 and 500, respectively c. 1,000 and -500, respectively d. 1,000 and 500, respectively

ANS: A DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Public saving | Private saving MSC: Applicative

32. Suppose that in a closed economy GDP is equal to 11,000, taxes are equal to 2,500 consumption equals 7,500

and government purchases equal 2,000. What are private saving, public saving, and national saving? a. 1,500, 1,000, and 500, respectively b. 1,000, 500, and 1,500, respectively c. 500, 1,500, and 1,000, respectively d. None of the above is correct.

ANS: B DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving | Public saving | National saving MSC: Applicative

Chapter 26/Saving, Investment, and the Financial System ? 1783

33. Suppose that in a closed economy GDP is 11,000, consumption is 7,500, and taxes are 2,000. What value of

government purchases would make national savings equal to 1,000 and at that value would the government have a deficit or surplus? a. 2,500, deficit b. 2,500, surplus c. 1,000, deficit d. 1,000, surplus

ANS: A DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving | Budget deficits MSC: Applicative

34. Suppose the economy is closed with national saving of $2 trillion, consumption of $7 trillion, and government

purchases of $1 trillion. What is GDP? a. $8 trillion b. $9 trillion c. $10 trillion d. $11 trillion

ANS: C DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Gross domestic product MSC: Applicative

35. Suppose the economy is closed and consumption is 6,500, taxes are 1,500, and government purchases are

2,000. If national saving amounts to 1,000, then what is GDP? a. 9,500 b. 10,000 c. 10,500

d. None of the above is correct.

ANS: A DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Gross domestic product MSC: Applicative

36. For a closed economy, GDP is $11 trillion, consumption is $7 trillion, taxes are $2 trillion and the government

runs a deficit of $1 trillion. What are private saving and national saving? a. $4 trillion and $1 trillion, respectively b. $4 trillion and $-1 trillion, respectively c. $2 trillion and $1 trillion, respectively d. $2 trillion and $-1 trillion, respectively

ANS: C DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving | National saving MSC: Applicative

37. For a closed economy, GDP is $11 trillion, consumption is $7 trillion, taxes are $3 trillion and the government

runs a surplus of $1 trillion. What are private saving and national saving? a. $4 trillion and $1 trillion, respectively b. $4 trillion and $5 trillion, respectively c. $1 trillion and $2 trillion, respectively d. $1 trillion and $1 trillion, respectively

ANS: C DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving | National saving MSC: Applicative

1784 ? Chapter 26/Saving, Investment, and the Financial System

38. If in a closed economy Y = $11 trillion, which of the following combinations would be consistent with national

saving of $2.5 trillion?

a. C = $8 trillion, G = $.5 trillion b. C = $6.5 trillion, G = $3 trillion c. C = $8.5 trillion, G = $2 trillion d. C = $9 trillion, G = $.5 trillion

ANS: A DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: National saving MSC: Interpretive

39. For an imaginary closed economy, T = $5,000; S = $11,000; C = $50,000; and the government is running a

budget deficit of $1,000. Then

a. private saving = $10,000 and GDP = $54,000. b. private saving = $10,000 and GDP = $58,000. c. private saving = $12,000 and GDP = $67,000. d. private saving = $12,000 and GDP = $72,000.

ANS: C DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving | Gross domestic product MSC: Applicative

Scenario 26-1. Assume the following information for an imaginary, closed economy.

GDP = $110,000; consumption = $70,000; private saving = $8,000; national saving = $12,000.

40. Refer to Scenario 26-1. For this economy, investment amounts to

a. $4,000. b. $8,000. c. $12,000. d. $16,000.

ANS: C

NAT: Analytic TOP: Investment DIF: 2 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Applicative

41. Refer to Scenario 26-1. This economy’s government is running a

a. budget surplus of $4,000. b. budget surplus of $8,000. c. budget deficit of $4,000. d. budget deficit of $8,000.

ANS: A DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Government purchases MSC: Applicative

42. Refer to Scenario 26-1. For this economy, government purchases amount to

a. $12,000. b. $18,000. c. $28,000. d. $40,000.

ANS: C DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Government purchases MSC: Applicative

43. Refer to Scenario 26-1. For this economy, taxes amount to

a. $16,000. b. $24,000. c. $28,000. d. $32,000.

ANS: D

NAT: Analytic TOP: Taxes DIF: 2 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Applicative

Chapter 26/Saving, Investment, and the Financial System ? 1785

44. In the small closed economy of San Lucretia, the currency is the denar. Statistics for last year show that

private saving was 60 billion denars, taxes were 70 billion denars, government purchases of goods and

services were 80 billion denars, there were no transfer payments by the government, and GDP was 400 billion denars. What were consumption and investment in San Lucretia? a. 270 billion denars, 50 billion denars b. 260 billion denars, 60 billion denars c. 250 billion denars, 70 billion denars d. None of the above is correct.

ANS: A DIF: 2 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Consumption | Investment MSC: Analytical

45. The country of Meditor uses the merit as its currency. Recent national income statistics showed that it had

GDP of $700 million merits, no government transfer payments, taxes of $210 million merits, a budget surplus of $60 billion merits, and investment of $100 billion merits. What were its consumption and government expenditures on goods and services?

a. 450 million merits and $150 million merits b. 410 million merits and $150 million merits c. 330 million merits and $270 million merits d. 290 million merits and $270 million merits

ANS: A DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Consumption | Government purchases MSC: Analytical

46. Consider three different closed economies with the following national income statistics. Country A has taxes

of $40 billion, transfers of $20 billion, and government expenditures on goods and services of $30 billion. County B has private savings of $60 billion, and investment expenditures of $50 billion. Country C has GDP of $300 billion, investment of $70, consumption of $180 billion, taxes of $60 billion and transfers of $20 billion. From this information we know that there is a $10 billion government budget deficit for a. only country A. b. only country B. c. only country C. d. all three countries.

ANS: D DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Budget deficits MSC: Analytical

47. In examining the national income accounts of the closed economy of Nepotocracy you see that this year it had

taxes of $100 billion, transfers of $40 billion, and government purchases of goods and services of $80 billion. You also notice that last year it had private saving of $50 billion and investment of $70 billion. In which year did Nepotocracy have a budget deficit of $20 billion? a. this year and last year b. this year but not last year c. last year but not this year d. neither this year nor last year

ANS: B DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Budget deficits MSC: Applicative

1786 ? Chapter 26/Saving, Investment, and the Financial System

48. You have some estimates of national accounts numbers for a closed economy for the coming year. Under one

set of expectations, government purchases will be $30 billion, transfer payments will be $10 billion, and taxes will be $45 billion. Under another set of expectations, GDP will be $200 billion, taxes will be $50 billion, transfer payments will be $20 billion, consumption will be $120 million, and investment will be $40 billion. Based on these numbers in the first case there should be a

a. $15 billion surplus, and in the second case a $10 billion surplus. b. $15 billion surplus, and in the second case a $10 billion deficit. c. $5 billion surplus, and in the second case a $10 billion surplus. d. $5 billion surplus, and in the second case a $10 billion deficit.

ANS: D DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Budget deficits | Budget surpluses MSC: Analytical

49. The country of Cedarland does not trade with any other country. Its GDP is $20 billion. Its government

purchases $3 billion worth of goods and services each year, collects $6 billion in taxes, and provides $2 billion in transfer payments to households. Private saving in Cedarland is $4 billion. What is investment in Cedarland? a. $5 billion b. $4 billion c. $3 billion d. $2 billion

ANS: A

NAT: Analytic TOP: Investment DIF: 3 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Applicative

50. The country of Growpaw does not trade with any other country. Its GDP is $17 billion. Its government

purchases $4 billion worth of goods and services each year, collects $6 billion in taxes, and provides $1 billion in transfer payments to households. Private saving in Growpaw is $4 billion. For Growpaw, a. investment is $6 billion and consumption is $9 billion. b. investment is $6 billion and consumption is $8 billion. c. investment is $5 billion and consumption is $8 billion. d. investment is $5 billion and consumption is $7 billion.

ANS: C DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Investment | Consumption MSC: Applicative

51. The country of Hykenia does not trade with any other country. Its GDP is $20 billion. Its government collects

$4 billion in taxes and pays out $3 billion to households in the form of transfer payments. Consumption equals $15 billion and investment equals $2 billion. What is public saving in Hykenia, and what is the value of the goods and services purchased by the government of Hykenia? a. -$2 billion and $3 billion b. $1 billion and $3 billion c. -$1 billion and $4 billion

d. There is not enough information to answer the question.

ANS: A DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Public saving | Government purchases MSC: Analytical

52. The country of Yokovia does not trade with any other country. Its GDP is $30 billion. Its government

purchases $5 billion worth of goods and services each year, collects $7 billion in taxes, and provides $3 billion in transfer payments to households. Private saving in Yokovia amounts to $5 billion. What are consumption and investment in Yokovia?

a. $18 billion and $5 billion, respectively b. $21 billion and $4 billion, respectively c. $13 billion and $7 billion, respectively

d. There is not enough information to answer the question.

ANS: B DIF: 3 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Consumption | Investment MSC: Analytical

Chapter 26/Saving, Investment, and the Financial System ? 1787

53. In a closed economy, private saving is

a. the amount of income that households have left after paying for their taxes and consumption. b. the amount of income that businesses have left after paying for the factors of production. c. the amount of tax revenue that the government has left after paying for its spending. d. always equal to investment.

ANS: A DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Private saving MSC: Definitional

54. In a closed economy, public saving is the

a. amount of income that households have left after paying for taxes and consumption. b. amount of income that businesses have left after paying for the factors of production. c. amount of tax revenue that the government has left after paying for its spending. d. sum of A, B, and C.

ANS: C DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Public saving MSC: Definitional

55. Which of the following is not always correct for a closed economy?

a. National saving equals private saving plus public saving. b. Net exports equal zero.

c. Real GDP measures both income and expenditures. d. Private saving equals investment.

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Closed economies MSC: Interpretive

56. If the tax revenue of the federal government exceeds spending, then the government necessarily

a. runs a budget deficit. b. runs a budget surplus. c. runs a national debt. d. will increase taxes.

ANS: B DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Budget deficits MSC: Interpretive

57. A budget surplus is created if

a. the government sells more bonds than it buys back.

b. the government spends more than it receives in tax revenue. c. private saving is greater than zero. d. None of the above is correct.

ANS: D DIF: 1 REF: 26-2 NAT: Analytic LOC: The Study of economics, and definitions of economics TOP: Budget surpluses MSC: Definitional

58. In the language of macroeconomics, investment refers to

a. saving.

b. the purchase of new capital.

c. the purchase of stocks, bonds, or mutual funds. d. All of the above are correct.

ANS: B

NAT: Analytic TOP: Investment DIF: 1 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Definitional

1788 ? Chapter 26/Saving, Investment, and the Financial System

59. Larry buys stock in A to Z Express Company. Curly Corporation builds a new factory. Whose transaction

would be an act of investment in the language of macroeconomics? a. only Larry’s

b. only Curly Corporation’s

c. Larry’s and Curly Corporation’s

d. neither Larry’s nor Curly Corporation’s

ANS: B

NAT: Analytic TOP: Investment DIF: 1 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Interpretive

60. Which of the following would be included as investment in the GDP accounts?

a. the government buys goods from another country b. someone buys stock in an American company c. a firm increases its capital stock d. All of the above are correct.

ANS: C

NAT: Analytic TOP: Investment DIF: 2 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Interpretive

61. Which of the following would a macroeconomist consider as investment?

a. Charlie purchases a bond issued by Proctor and Gamble Corp. b. Karlee purchases stock issued by Texas Instruments, Inc. c. Mariah builds a new coffee shop. d. All of the above are correct.

ANS: C

NAT: Analytic TOP: Investment DIF: 1 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Interpretive

62. Fran buys 1,000 shares of stock issued by Miller Brewing. In turn, Miller uses the funds to buy new

machinery for one of its breweries. a. Fran and Miller are both investing. b. Fran and Miller are both saving. c. Fran is investing; Miller is saving. d. Fran is saving; Miller is investing.

ANS: D

NAT: Analytic TOP: Investment DIF: 2 REF: 26-2

LOC: The Study of economics, and definitions of economics MSC: Interpretive

Sec03 - Saving, Investment, and the Financial System - The Market for Loanable Funds

MULTIPLE CHOICE1.

The source of the supply of loanable funds

a. is saving and the source of demand for loanable funds is investment. b. is investment and the source of demand for loanable funds is saving. c. and the demand for loanable funds is saving. d. and the demand for loanable funds is investment.

ANS: A DIF: 1 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Definitional

Chapter 26/Saving, Investment, and the Financial System ? 1789

2.

Assuming the market for loanable funds is in equilibrium, use the following numbers to determine the quantity

of loanable funds supplied.

GDP Consumption Spending Taxes Net of Transfers Government Purchases

$8.7 trillion $3.5 trillion $2.7 trillion $3.0 trillion

a. b. c. d. $2.2 trillion $2.5 trillion $3.9 trillion $5.2 trillion

ANS: A DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Applicative

3.

Suppose the market for loanable funds is in equilibrium. Given the numbers below, determine the quantity of

loanable funds demanded.

GDP Consumption Taxes Net of Transfers Government Spending $100 billion $65 billion $15 billion $20 billion

a. b. c. d. $25 billion $20 billion $15 billion $10 billion

ANS: C DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Applicative

4.

The slope of the demand for loanable funds curve represents the

a. positive relation between the real interest rate and investment. b. negative relation between the real interest rate and investment. c. positive relation between the real interest rate and saving. d. negative relation between the real interest rate and saving.

ANS: B DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

5.

The Eye of Horus incense company has $10 million in cash which it has accumulated from retained earnings.

It was planning to use the money to build a new factory. Recently, the rate of interest has increased. The increase in the rate of interest should

a. not influence the decision to build the factory because The Eye of Horus doesn't have to borrow any

money.

b. not influence the decision to build the factory because its stockholders are expecting a new factory. c. make it more likely that The Eye of Horus will build the factory because a higher interest rate will

make the factory more valuable.

d. make it less likely that The Eye of Horus will build the factory because the opportunity cost of the

$10 million is now higher.

ANS: D DIF: 3 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Investment | Market for loanable funds MSC: Applicative

1790 ? Chapter 26/Saving, Investment, and the Financial System

6.

Other things the same, when the interest rate rises,

a. people would want to lend more, making the supply of loanable funds increase. b. people would want to lend less, making the supply of loanable funds decrease.

c. people would want to lend more, making the quantity of loanable funds supplied increase. d. people would want to lend less, making the quantity of loanable funds supplied decrease.

ANS: C DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

7.

Fred is considering expanding his dress shop. If interest rates rise he is

a. less likely to expand. This illustrates why the supply of loanable funds slopes downward. b. more likely to expand. This illustrates why the supply of loanable funds slopes upward. c. less likely to expand. This illustrates why the demand for loanable funds slopes downward. d. more likely to expand. This illustrates why the demand for loanable funds slopes upward.

ANS: C DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Investment | Market for loanable funds MSC: Interpretive8.

The slope of the supply of loanable funds curve represents the

a. positive relation between the real interest rate and investment. b. positive relation between the real interest rate and saving. c. negative relation between the real interest rate and investment. d. negative relation between the real interest rate and saving.

ANS: B DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

9.

Other things the same, a higher interest rate induces people to

a. save more, so the supply of loanable funds slopes upward. b. save less, so the supply of loanable funds slopes downward. c. invest more, so the supply of loanable funds slopes upward. d. invest less, so the supply of loanable funds slopes downward.

ANS: A DIF: 1 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

10. The supply of loanable funds slopes

a. upward because an increase in the interest rate induces people to save more. b. downward because an increase in the interest rate induces people to save less. c. downward because an increase in the interest rate induces people to invest less. d. upward because an increase in the interest rate induces people to invest more.

ANS: A DIF: 1 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

11. Other things the same, an increase in the interest rate

a. would shift the demand for loanable funds to the right. b. would shift the demand for loanable funds to the left. c. would increase the quantity of loanable funds demanded. d. would decrease the quantity of loanable funds demanded.

ANS: D DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

Chapter 26/Saving, Investment, and the Financial System ? 1791

12. If the quantity of loanable funds demanded exceeds the quantity of loanable funds supplied,

a. there is a surplus and the interest rate is above the equilibrium level. b. there is a surplus and the interest rate is below the equilibrium level. c. there is a shortage and the interest rate is above the equilibrium level. d. there is a shortage and the interest rate is below the equilibrium level.

ANS: D DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

13. If the quantity of loanable funds supplied exceeds the quantity of loanable funds demanded,

a. there is a surplus and the interest rate is above the equilibrium level. b. there is a surplus and the interest rate is below the equilibrium level. c. there is a shortage and the interest rate is above the equilibrium level. d. there is a shortage and the interest rate is below the equilibrium level.

ANS: A DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

14. If there is a surplus of loanable funds, then

a. the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and

the interest rate is above equilibrium.

b. the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and

the interest rate is below equilibrium.

c. the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and

the interest rate is above equilibrium.

d. the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and

the interest rate is below equilibrium.

ANS: C DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

15. If there is a shortage of loanable funds, then

a. the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and

the interest rate is above equilibrium.

b. the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and

the interest rate is below equilibrium.

c. the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and

the interest rate is above equilibrium.

d. the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and

the interest rate is below equilibrium.

ANS: B DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive

16. If there is a surplus of loanable funds, then

a. the quantity demanded is greater than the quantity supplied and the interest rate will rise. b. the quantity demanded is greater than the quantity supplied and the interest rate will fall. c. the quantity supplied is greater than the quantity demanded and the interest rate will rise. d. the quantity supplied is greater than the quantity demanded and the interest rate will fall.

ANS: D DIF: 2 REF: 26-3 NAT: Analytic LOC: Understanding and Applying Economic Models TOP: Market for loanable funds MSC: Interpretive