Ch. 7

Question 1

Stockholders

Answer 1

Those who hold stock in a corporation - own an interest in the corporation equal to the % of outstanding shares they own.

Question 2

Residual Claimant

Answer 2

Stockholders hold claim of all funds flowing into the firm (cash flow), meaning they get whatever remains after all other claims against the firm’s assets have been satisfied.

Question 3

Dividends

Answer 3

Payments made periodically to stockholders, from net earnings of the corporation.

Question 4

Generalized dividend model

Answer 4

States the price of a stock is determined only by the present value of the dividends and that nothing else matters.

Question 5

Gordon Growth Model used with what two conditions?

Answer 5

1. Dividends are assumed to continue growing at a constant rate forever.
2. The growth rate is assumed to be less Thant the required return on equity.

Question 6

The theory of rational expectations

Answer 6

Pop

Question 7

Adaptive expectations

Answer 7

Suggest the changes in expectations will occur slowly over time , as data for a variable evolves. Simply using an average.

Question 8

Rational expectations

Answer 8

States that expectations will be identical to optimal forecasts(best guess of the future) using all available information.

Question 9

Even though a rational expectation equals the optimal __________ using all available information, a prediction based on it may not always be perfectly accurate.

Answer 9

Forecast

Question 10

Implications of the Rational Expectations Theory

Answer 10

1. If there is a change in the way a variable moves, the way in which expectations of this variable are formed will change as well.
2. The forecast errors of expectation will , on average, be zero and cannot be predicted ahead of time.

Question 11

Application of the rational expectations theory in financial markets is called the:

Answer 11

Efficient Market Hypothesis

Question 12

Efficient Market Hypothesis

Answer 12

Expectations in financial markets are equal to optimal forecasts using all available information.

Question 13

Current prices in a financial market will be set so that the __________ ____________ of a security’s return using all available information equals the security’s equilibrium return.

Answer 13

Optimal Forecast

Question 14

Two types of Arbitrage

Answer 14

Pure Arbitrage is Elimination of unexploited profit opportunities involves no risk, and second type of arbitrage where they take on sone risk when eliminating the unexploited profit opportunities

Question 15

In an efficient market, all unexplored profit opportunities will be _____________,

Answer 15

Eliminated

Question 16

Random walk

Answer 16

Describes the movement of a variable whose future values cannot be predicted (are random) because , given today’s value, the value of the variable is just as likely to fall as it is to rise.

Question 17

The efficient Market Hypothesis should follow a __________ _______; future changes in stock prices should, for all practical purposes, be unpredictable.

Answer 17

Random walk

Question 18

Behavioral Finance

Answer 18

Applies concepts from other social sciences, such as anthropology, sociology, and particularly psychology, to explain the behavior of securities prices.