Unit 4: Capital Markets and Investments

Answer: D — Correct answer: D) Because capital markets enable companies to raise capital by issuing stocks, bonds, and other securities. Incorrect answers: A) Commodities are traded in commodity markets, not capital markets. B) The exchange of goods and services occurs in product markets. C) Regulating the money supply is a function of monetary policy, not capital markets.

Answer: A — The correct answer is A) Increased cost of debt due to higher default risk. As a company increases its debt-to-equity ratio, it takes on more debt and increases its financial leverage. This can increase the risk of default, which may lead to higher interest rates on new debt issuance. The other options are incorrect because increasing the debt-to-equity ratio does not necessarily lead to decreased cost of equity (B), increased stock price due to higher dividend payments (C), or decreased interest rates due to lower inflation (D).

Answer: C — The correct answer, C, is the best explanation because it describes a scenario in which investors are driven by momentum, rather than fundamental analysis. This can lead to prices deviating from their intrinsic value. A is incorrect because the market may still be efficient, even if prices are deviating from their fundamental value in the short term. B is incorrect because there is no evidence of management manipulating the stock price. D is incorrect because, while the surprise earnings announcement may have increased the company's intrinsic value, the subsequent price increases are not solely due to this increase in value.

Answer: A — The correct answer is A, because in an efficient capital market, all publicly available information is already reflected in the stock's price. The well-known investor's announcement is public information, and therefore, the market has already incorporated this information into the stock's price. The other options are incorrect because if the market is efficient, the price of the stock should not change in response to the announcement, as the information is already reflected in the price. Option B is incorrect because the investor's announcement will not cause the price to increase, as the information is already reflected in the price. Option C is incorrect because the announcement will not cause the price to decrease, as the information is already reflected in the price. Option D is incorrect because the price will not fluctuate randomly in response to the announcement, as the market has already incorporated the information into the stock's price.

Answer: B — The correct answer is B because, according to the efficient market hypothesis, stock prices reflect all publicly available information. Since the merger has already been announced, the stock price has likely adjusted to reflect this new information, and no abnormal returns can be expected. Option A is incorrect because the stock price has already adjusted to the new information, and further increases are not guaranteed. Option C is incorrect because the completion of the merger does not necessarily mean the stock price will decrease. Option D is incorrect because the stock price can change at any time in response to new information, not just at quarterly earnings reports.