Applied Finance & Economics Flashcards

Which concept explains why a monopolist produces at a lower output and charges a higher price than a perfectly competitive firm in equilibrium?

Answer: Monopolist equates MR = MC where MR < P

A monopolist faces a downward-sloping demand curve, so MR < P at every output level, leading to higher prices and lower output than competitive markets.

An investor uses a zero-cost collar strategy on a stock position. This strategy involves:

Answer: Buying a put and selling a call at equal premiums

A zero-cost collar involves buying a protective put and selling a covered call such that the premiums offset, creating downside protection at no net cost.

In the context of fixed income, 'negative convexity' is most commonly associated with:

Answer: Mortgage-backed securities

MBS exhibit negative convexity because prepayments accelerate when rates fall, limiting price appreciation—similar to callable bonds.

The Fisher Effect states that the nominal interest rate equals approximately:

Answer: Real interest rate plus expected inflation

The Fisher Effect: nominal rate ≈ real rate + expected inflation, meaning nominal rates adjust to compensate for anticipated inflation.

GDP measured by the expenditure approach equals the sum of:

Answer: C + I + G + (X – M)

The expenditure approach sums Consumption, Investment, Government spending, and Net Exports (Exports minus Imports).

Which measure of risk captures only the downside deviations below a target return?

Answer: Semi-variance (semi-deviation)

Semi-variance (or semi-deviation) measures volatility only for returns falling below a target or mean, focusing exclusively on downside risk.

A company's WACC is 10%. A new project has an IRR of 8%. Which statement best describes the investment decision?

Answer: Reject the project since IRR < WACC

When IRR < WACC, the project destroys value because financing costs exceed the return generated; the NPV will be negative.