Refer to the Following Figure When Answering the Following Questions

question 93

Multiple Choice

Refer to the following figure when answering the following questions.
Figure 17.2: Dow Jones Industrial Average: 2000-2012 (Source: Federal Reserve Economic Data, St. Louis Federal Reserve)
-Your grandmother is a follower of the financial press and decides to quiz you about your knowledge of financial markets. She asks you to explain the price of stock prices based on the financial capital arbitrage equation. She shows you the graph shown in Figure 17.2. She asks you to explain the cause in the rise of stock prices for the years 2008-2012. What do you tell her?

• A) "The graph suggests there are capital losses in financial markets, so to cover these losses, stock prices have to rise."
• B) "Grandma, I was an art major and didn't have to take finance or economics classes."
• C) "Ironically, falling capital gains have no impact on stock prices."
• D) "A falling DJI leads to negative capital gains in financial assets. This, in turn, drives stock prices down."
• E) "Because, in equilibrium, the real interest rate, capital gains, and dividends move in tandem, the decline in stock prices is due to 'irrational exuberance.'"

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