1. Under dividend-discount model stock prices:

A) Are inversely related to dividends

B) Are inversely related to interest rates

C) Are inversely related to dividend growth

D) Are directly related to the risk premium

2. Consider a 5% coupon bond that is selling at par. Suppose interest rates rise. We can conclude that

A) The bond is now selling at a discount.

B) The yield to maturity is now below 5%.

C) The bond is now selling at a premium.

D) Both b and c.

3. The difference in the price of a zero coupon bond and a coupon bond with the same face value and maturity are simply:

A) Nothing, since they are the same.

B) The present value of the final payment.

C) The present value of the coupon payments.

D) The future value of the coupon payments.

4. A sluggish economy and tax revenues mean that the U.S. government continues to run a budget deficit and increase its borrowing. In the bond market this leads to

A) Falling interest rates as bond supply shifts right.

B) Falling interest rates as bond demand shifts left.

C) Rising interest rates as bond supply shifts right.

D) Rising interest rates as bond demand shifts right.

5. For a bond, the holding period return will equal the yield to maturity

A) For all zero coupon bonds.

B) When the bond is held until maturity.

C) When the price of the bond is less than its face value.

D) When the coupon rate is greater than the yield to maturity.

6. To reduce overall portfolio risk through diversification,

A) The assets in the portfolio must move predictably in opposite directions.

B) Investors must hold a risk free asset in their portfolio.

C) The assets in the portfolio must have returns that are NOT perfectly positively correlated.

D) Investors must accept a lower expected return.

7. Using a demand and supply diagram, EXPLAIN how a falling U.S. real interest rate, relative to the Euro interest rate, would affect the US$/Euro exchange rate.

8. Explain why an assets risk is inversely related to its price, but directly relative to its expected return. Explain why.

9. Explain what is wrong with the following statement: A risk averse investor always chooses the investment option with the lowest risk.