Due to asymmetric information, the market fears that afirm issuing securities wi

Question

Due to asymmetric information, the market fears that afirm issuing securities will do so when the stock is_________.

A.

caught up in a bear market

B.

undervalued

C.

overvalued

D.

being sold by insiders

Which of these investments would you expect to have thehighest rate of return for the next 20 years?

A.

long-term corporate bonds

B.

intermediate-term U.S. government bonds

C.

anybody’s guess

D.

U.S. Treasury bills

Dimensions of risk include__________.

A.

the certainty of a negative outcome

B.

the impossibility of the same return

C.

uncertainty about yesterday’s outcome

D.

uncertainty about the future outcome

Due to asymmetric information, the market fears that afirm issuing securities will do so when the stock is_________.

A.

caught up in a bear market

B.

undervalued

C.

overvalued

D.

being sold by insiders

Explanation / Answer

1. (C) as management knows much more aboutexpected future return of the company they would prefer to sellstock only if it is overpriced and they do not expect stellarperformance, otherwise they would borrow (issue debt or take bankloans) 2. (A) long term corporate debt pays interestwith is calculated as a sum of risk free return on government bonds+ credit spread + liquidity spread, so well diversified portfolioof corp. bonds should outperform any government securities ona quite long term horizont (like 20 years when business cycles aresmoothed) 3. (D) risk is, by definition, theuncertainty of the future outcome. (A) and (C) are obviouslywrong, as we know that the outcome is not negative (otherwiseinvestor should not invest first of all), and yesterday'soutcome is certain. (B) is wrong as return easily maybe thesame in any periods.

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