Module 2 Honors Quiz :Honors Assignments (Financial Markets) Answers 2025

Question 1

A limited liability corporation you invested in has gone bankrupt. You will be called on to pay:

❌ A proportion of the total debt decided by the judge.
❌ A proportional share of all creditor claims.
✅ Nothing.
❌ An amount equal to what you paid for the shares.

Explanation:
With limited liability, shareholders are not responsible for corporate debts beyond their investment. Once shares are worthless, you owe nothing.

Question 2

The inflation risk that inflation indexation aims to mitigate (check all that apply):

❌ Risk that nominal return exceeds inflation.
✅ Risk that inflation fluctuates significantly over time.
✅ Risk associated with investments involving cash flows over time.
✅ Risk that future cash flows lose purchasing power due to inflation.

Explanation:
Inflation risk is about uncertainty and erosion of real value, especially for long-term cash flows.

Question 3

Human capital risk (check all that apply):

✅ Risk associated with the present value of future wages.
❌ Not correlated with professional competency.
❌ Not correlated with the stock market.
✅ Can be considered a protection against inflation.

Explanation:
Human capital (future earnings) is a major asset, often linked to skills and can rise with inflation (via wages).

Question 4

The random walk hypothesis posits that:

❌ Historical stock prices follow a random walk.
❌ Stock price volatility follows a random walk.
❌ Historical stock returns follow a random walk.
✅ Short-term investment returns are inherently unpredictable.

Explanation:
Random walk implies past information cannot predict short-term returns.

Question 5

If a market is inefficient, as new information arrives:

✅ There will be a lag in the stock price adjustment.
❌ Volatility must increase.
❌ Investors will short the stock.
❌ Nothing will happen.

Explanation:
In inefficient markets, prices do not adjust instantly to new information.

Question 6

Investors mainly use the P/E ratio to:

❌ Decide future profits precisely.
❌ Determine product prices.
❌ Determine optimal risk-return ratio.
✅ Decide whether shares are overpriced or underpriced.

Explanation:
The P/E ratio compares price relative to earnings to assess valuation.

Question 7

Shape of the value function in prospect theory:

❌ Gains: concave up; Losses: concave up
❌ Gains: concave up; Losses: concave down
✅ Gains: concave down; Losses: concave up
❌ Gains: concave down; Losses: concave down

Explanation:
People are risk-averse over gains and risk-seeking over losses (loss aversion).

Question 8

Evidence of cognitive dissonance:

❌ Investors trade very rapidly.
❌ Investors choose popular investments.
✅ Investors do not remember negative performance of their investments.
❌ Investors hold onto poorly performing funds.

Explanation:
Cognitive dissonance leads investors to ignore or forget bad outcomes to protect self-image.

Question 9

Examples of the framing effect (check all that apply):

✅ Elevator lists 2000 lbs though it can safely carry 5000 lbs.
✅ $1000 mattress advertised as $4000 with “75% off”.
❌ Gold coin sold far above value.
❌ Stock split from $60 to $30 with double shares.

Explanation:
Framing changes perception without changing reality, influencing decisions.

Question 10

Which applies to doctors but generally not to financial advisors?

❌ Patients can research medicine but not finance.
❌ Doctors use data and intuition; advisors must use one.
✅ Doctors have an oath of loyalty; financial advisors generally do not.
❌ Patients can seek second opinions only from doctors.

Explanation:
Doctors have a formal fiduciary oath, unlike most financial advisors.

Question 11

Concept of social contagion:

❌ Diseases spread socially.
✅ Models of disease spread can be applied to the spread of ideas.
❌ Ideas evolve like genes (memetics).
❌ Cultural momentum alone defines spread.

Explanation:
Social contagion studies how ideas, behaviors, and beliefs spread using epidemic-style models.

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