# Understanding Financial Markets Coursera Quiz Answers

### Understanding Financial Markets Coursera Quiz Answers

#### Week 1: Understanding Financial Markets

Q1. Suppose the aggregate earnings of the companies that are part of an index fall more than the price of the index (which is an aggregation of the stock prices of these same companies). Which of the following statements is/are true?

• The index is now “more expensive” because its Price/Earnings ratio is higher.
• The index is now “cheaper” because its Price/Earnings ratio is lower.
• The index is now “more expensive” because its Price/Earnings ratio is lower.
• The index is now “cheaper” because its Price/Earnings ratio is higher.

Q2. Which of the following statements about market valuation is/are true?

• Market valuation can be assessed by just looking at the aggregate earnings of the companies that constitute a stock index
• Market valuation can be assessed by just looking at the price of a stock index
• An “expensive” market can always become “more expensive”
• A “cheap” market can always become “cheaper”

Q3. A stock has a price of 100. Over the following two months, its monthly returns are 20% and 10% respectively. Among the following expressions, which is/are equal to the price of the stock after these two months?

• Stock price after two months = 100 * (1 + 20%) * (1 + 10%)
• Stock price after two months = 100 * (1.2) * (1.1)
• Stock price after two months = 100 * (0.02) * (0.01)
• Stock price after two months = 100 * (1 + 15%) * (1 + 15%)
• Stock price after two months = 100 * (20%) * (10%)

Q4. When talking about an histogram, what does “skewness” refer to?

• The scale, i.e. whether the histogram is very spread out (say between -50% and +50%) or very narrow (say between -10% and +10%)
• The thickness of the tails, i.e. whether extreme events (good or bad) are likely or not.
• The asymmetry of the histogram, i.e. whether one tail (the left one or the right one) is “longer” than the other.
• The interval of returns (say between 0% and 5%) that has the highest bar, i.e. the one that contains the most observations.

Q5. Who are the main participants in financial markets?

• Financial intermediaries
• Firms
• Tax collectors
• The government
• Investors
• Journalists

Q6. You hold some shares of company XYZ and you would like to sell them to pay a speeding ticket you just received. Which of the following markets will you turn to?

The secondary market

The primary market

Q7. Which of these examples best illustrates “insider trading”?

• Some investors benefiting from privileged information about a company and illegally taking advantage of it by trading shares of the company.
• Some intermediaries that are supposed to execute trades for their clients but actually take advantage of the situation to execute trades for themselves before doing it for their clients.
• Some powerful investors colluding with each other to manipulate the price of an asset.
• Some investors using very modern and sophisticated computer-intensive systems to execute orders on exchanges right before “normal” investors.

Q8. You have gathered the following information about the performance of the American and Brazilian stock indices:

Which of the following statements is/are true?

• Based on this data alone and using the return/risk ratio as the decision tool, one should invest in the American index rather than the Brazilian index.
• Based on this data alone and using the return/risk ratio as the decision tool, one should invest in the Brazilian index rather than the American index.
• The return/risk ratio is higher for Brazil than the USA.
• There is not enough information to compute the return/risk ratios for both countries.
• With no access to additional data, an investment opportunity with a higher return/risk ratio should be preferred to another investment opportunity with a lower return/risk ratio.

Q9. Based on the data you gathered, you were able to plot the following histogram:

• Over this time period, there was a 80% chance of observing a monthly return between -10% and 10%.
• Over this time period, there was a greater chance of observing extremely bad monthly returns (more negative than -20%) than extremely good monthly returns (more positive than 20%).
• The distribution is skewed to the right (i.e. the right tail is “longer”).
• Over this time period, there was a 30% chance of observing a monthly return between 0% and 10%.

Q10. What are the 3 advantages that private investors enjoy over their professional counterparts?

• The fact that they don’t have expenses, the ability to take a much longer
term view than professional investors and the fact that they do not have to track or try to beat a particular benchmark.
• The ability to deal with illiquidity, the ability to take a much longer
term view than professional investors and an access to a greater set of information.
• The ability to deal with illiquidity, a better reactivity when faced with short term moves in the market and the fact that they do not have to track or try to beat a particular benchmark.
• The ability to deal with illiquidity, the ability to take a much longer term view than professional investors and the fact that they do not have to track or try to beat a particular benchmark.

#### Week 2: Understanding Financial Markets

Q1. In this assignment, you will apply the concepts of company valuation that you have just learned to determine whether company XYZ is overvalued.

We are currently at the end of year “t”. You performed a thorough financial analysis of XYZ and forecast the following Free Cash Flows (FCF):

``````Year t+1: 352 million USD

Year t+2: 385 million USD

Year t+3: 407 million USD

From year t+3 onward, you expect the FCFs to grow at a constant yearly rate of 4%.``````

Through your analysis, you also determined that the appropriate Weighted Average Cost of Capital (WACC) for XYZ was 11%.

Finally, you know that XYZ has 1000 million USD in debt and 100 million shares outstanding.

• Let’s start!

Q2. What is the terminal value (in Year t+3)?

For example, if your answer is 3088 million USD, then type in “3088”.

`Enter answer here`

Q3. Suppose the correct Terminal Value is 6000 million USD (i.e. discard your answer to the previous question), what is the price of 1 share of XYZ using the Discounted Cash Flow (DCF) valuation method?

For example, if your answer is 17 USD, then type in “17”.

`Enter answer here`

Q4. Suppose you observe that a share of XYZ is traded at a price of 35 USD on an exchange.
Based on your own estimate of the price of a share of XYZ, would you
say that the company is overvalued or undervalued by the market (use the price for one
share that you found in the previous question to answer this question)?

• The company is overvalued by the market.
• The company is undervalued by the market.

Q5. You are now contemplating the following project: buying 1 share of XYZ today at 35 USD on the exchange.

What is the Net Present Value (NPV) of this project?

For example, if your answer is 17 USD, then type in “17”.

(Hint: think about what the costs and benefits are for this project. For the benefits, use the price of 1 share of XYZ that you found in Question 3.)

`Enter answer here`

• It is not a project worth pursuing because its Net Present Value is positive.
• It is a project worth pursuing because its Net Present Value (NPV) is positive.
• It is not a project worth pursuing because its Net Present Value is negative.
• It is a project worth pursuing because its Net Present Value is negative.

Q7. Of course, you also know about the multiples-based valuation
method. You would like to use this method to verify if your conclusion
regarding the overvaluation or undervaluation of XYZ is correct.

On
the stock exchange, companies that are comparable to XYZ (including in terms of financing structure (i.e. relative debt level)) currently have a
Price/Earnings ratio of 9. XYZ’s current earnings are 400 million USD and it (still) has 100 million shares outstanding.

Based only on the information provided in this question, what is your estimate of the price of a share of XYZ in USD?

For example, if your answer is 17 USD, then type in “17”.

`Enter answer here`

Q8. Does this new price estimate (i.e. the one you got in the previous question) change your conclusion regarding the undervaluation or overvaluation of XYZ by the market (i.e. does it change your answer to Question 4)?

• Yes
• No

Q9. Suppose you have found a lower value for the price of a share of XYZ using the multiples-based method than the DCF method. Given this discrepancy, you are looking for errors you could have made in your forecasts using the DCF method.

Which of the following possible estimation errors could explain the discrepancy between the share prices you found using the DCF and multiples-based valuation methods?

(When evaluating each of the following statements, assume all other variables are held constant.)

• You underestimated the constant yearly growth rate of Free Cash Flows (FCFs) from Year t+3 onward.
• You overestimated the constant yearly growth rate of Free Cash Flows (FCFs) from Year t+3 onward.
• You underestimated the Weighted Average Cost of Capital (WACC).
• You overestimated the Weighted Average Cost of Capital (WACC).
• You underestimated the Free Cash Flow (FCF) in Year t+3.

#### Week 3:Understanding Financial Markets

Q1. On April 16, 2012, the President of Argentina introduced a bill for the re-nationalization of the country’s largest energy company, YPF. In more concrete terms, Argentina expropriated the shares that a foreign investor (Repsol) held in the company.

Into which of the following (explicit and implicit) barriers for investing in emerging market equity would you classify such an event?

• Withholding taxes
• Foreign ownership limits
• Lack of transparency
• Lack of familiarity
• Governance issues
• Information asymmetry

Q2. You observe the following yields on the market:

10-year Indian bond issued in local currency: 8%

8-year Indian bond issued in US dollar: 6%

10-year US bond issued in US dollar: 4%

8-year US bond issued in US dollar: 3%

Which of the following statement is/are true?

• The 8-year Indian-US yield spread stands at 3% and suggests that 8-year Indian bonds are riskier than 8-year US bonds.
• You do not have enough information at your disposal to adequately compute the 10-year Indian-US yield spread.
• You have enough information to adequately compute the 8-year Indian-US yield spread.
• The 10-year Indian-US yield spread stands at 40 basis points.

Q3. This picture was taken in Germany in 1923 and shows children playing with stacks of banknotes.

Which of the following statements are true?

• This picture illustrates the effects of hyperinflation (i.e. when a country experiences very high and accelerating inflation rates that erode the real value of money).
• In this kind of scenario, holding gold should be avoided at all costs.
• Gold can serve as a hedge in times of hyperinflation because its supply cannot be increased as easily as banknotes. In other words, it is very unlikely that we will one day see children play with bars of gold.
• The fact that the real value of money was very low could explain why these children were allowed to play with stacks of banknotes.

In cases of hyperinflation, people tend to wait for the last moment to use their wage to buy goods.

Q4. Which of the following statements about real estate assets are true?

• Real estate assets have a high unit value.
• Real estate assets are not very liquid (i.e. it takes time to sell them) and lack transparency (i.e. it is hard to gain access to transaction prices).
• The value of real estate assets is easy to estimate.
• There are no pronounced cycles in the aggregate price of real estate assets.
• Real estate assets are homogeneous (i.e. the characteristics of two real estate assets are generally the same).

When investing in real estate assets, local knowledge is important.

Q5. Which of the following statements about real estate investments is true?

• Indirect investments in real estate encompasses non-listed funds (i.e. private real estate) and securitized investments (i.e. public real estate).
• Direct investments in real estate assets have a trait in common with shares of companies traded on stock exchanges: both have a high unit value.
• The shares of non-listed real estate funds are traded on stock exchanges.
• Direct investments in real estate assets are fairly liquid (i.e. they can be sold quite quickly).

Q6. Which of the following statements regarding hedge funds are true?

• Hedge fund managers usually charge fees on both the the assets they manage but also on the performance they deliver.
• They have to be permanently invested.
• Hedge fund managers are asked by their clients to invest a significant part of their own wealth in the fund they manage to make sure that they will not pursue some silly strategy.
• Leverage has the advantage of boosting positive gains while not affecting losses.
• Their fundamental objective is to achieve positive performance irrespective of market conditions.
• The first “long-short” equity fund was created by Alfred Winslow Jones because he wanted to bet on the over-performance of some firms and the under-performance of other firms while having a neutral view on the direction of the stock market as a whole.

Q7. You meet the following 4 investors and each have their own beliefs:

• Pete thinks that both company ABC and XYZ will perform equally well.
• Mary thinks that company XYZ will perform badly but has neutral views on the performance of company ABC.
• Roger thinks that company XYZ will perform badly while company ABC will perform very well.
• Lucy thinks that company ABC will perform well but has neutral views on the performance of company XYZ.
• Given their views, which of the following sets of strategies are the one they are most likely to pursue?
• Pete will have two long positions of equal size in the stocks of ABC and XYZ.
• Mary will have a short position in the stock of XYZ.
• Roger will have a short position in the stock of XYZ and a long position in the stock of ABC.
• Lucy will have a long position in the stock of ABC.
• Pete will have two long positions of equal size in the stocks of ABC and XYZ.
• Mary will have a short position in the stock of XYZ.
• Roger will have a short position in the stock of ABC and a long position in the stock of XYZ.
• Lucy will have a long position in the stock of ABC.
• Pete will have two long positions of equal size in the stocks of ABC and XYZ.
• Mary will have a short position in the stock of ABC.
• Roger will have a short position in the stock of XYZ and a long position in the stock of ABC.
• Lucy will have a long position in the stock of XYZ.
• Pete will have a short position in the stock of XYZ.
• Mary will have two long positions of equal size in the stocks of ABC and XYZ.
• Roger will have a long position in the stock of ABC.
• Lucy will have a short position in the stock of XYZ and a long position in the stock of ABC.
• Roger will have two long positions of equal size in the stocks of ABC and XYZ.
• Mary will have a short position in the stock of XYZ.
• Pete will have a short position in the stock of XYZ and a long position in the stock of ABC.
• Lucy will have a long position in the stock of ABC.

Q8. Which of the following statements about Private Markets are true?

• Private companies tend to be smaller companies that cannot access financial markets.
• Public companies are traded on stock exchanges and are not required to disclose financial accounts and earnings.
• “Unicorns” are private companies that have reached a valuation in excess of \$1 billion.
• Professional private equity investor tend to take an active role in running the companies in which they hold equity.
• Private companies tend to be at an earlier stage of development and hence it is relatively easy to pick exceptionally successful companies among these.
• An advantage that private investments have over public investments is their lack of liquidity.

#### Week 4: Understanding Financial Markets

Q1. Which of these goals is/are typically part of a central bank’s mandate?

• Maintaining price or currency stability
• Guaranteeing gender equality in terms of wages
• Maintaining healthy public finances
• Providing financial aid to developing countries

Q2. Which of the following statements is/are true?

• Central banks can “kill two birds with one stone”.
• A rise in interest rates typically causes the economy to slow down.
• A central bank can promote growth and reduce inflation at the same time by manipulating interest rates alone.
• Inflation is typically passed from producers to consumers because the
higher cost of production inputs cause the price of final products to
increase.

Q3. Which of the following steps of the traditional boom / bust cycle have been replaced by the numbers 1, 2 and 3 in this picture?

• Increased demand for employment and raw materials
• Staff wages and raw materials prices rise
• Interest rates rise
• Increased demand for employment and raw materials
• Interest rates rise
• Staff wages and raw materials prices rise
• Staff wages and raw materials prices rise
• Interest rates rise
• Increased demand for employment and raw materials
• Interest rates rise
• Staff wages and raw materials prices rise
• Increased demand for employment and raw materials
• Staff wages and raw materials prices rise
• Increased demand for employment and raw materials
• Interest rates rise
• Interest rates rise
• Increased demand for employment and raw materials
• Staff wages and raw materials prices rise

Q4. Which of these statements characterize(s) a “normal” yield curve?

• The yield of bonds with a shorter maturity are lower than that of bonds with a longer maturity.
• It is indicative of a restrictive monetary policy being conducted by the central bank.
• It is indicative of an easy monetary policy being conducted by the central bank.
• The yield of bonds with a shorter maturity are higher than that of bonds with a longer maturity.
• The yield of bonds of all maturity are the same.

Q5. Which of the following statements is/are true?

• You should not increase the share of bonds in your portfolio when you
expect high inflation in the future because the revenue you get from
them does not increase with inflation.
• High inflation is generally good for equities and bonds.
• High inflation is generally bad for equities and bonds.
• You should increase the share of bonds in your portfolio when you expect
high inflation in the future because the revenue you get from them
increases with inflation.

Q6. Which of the following statements correspond(s) to a flattening of a “normal” yield curve?

• Short term rates decrease more than long term rates.
• Short term rates increase more than long term rates.
• Short term rates increase less than long term rates.
• Short term rates decrease less than long term rates.

Q7. Suppose the yield curve is upward sloping. Then, short term rates decrease and long term rates increase. Which of the following statements is/are true?

• The yield curve is still upward sloping.
• The yield curve has flattened.
• The yield curve is now downward sloping.
• The yield curve has steepened.

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