File: ch01: Understanding Investments
Multiple Choice
1.
Which of the following is the best definition of wealth?
a.
b.
c.
d.
the sum of all current and future income
the total of all assets and all income
the total of assets and income less any liabilities.
the sum of current income and the present value of future income.
Ans: d
Difficulty: Moderate
Ref: Establishing a Framework for Investors
2.
Gold coins would be classified as:
a.
b.
c.
d.
real assets
indirect assets
personal assets
financial assets
Ans: a
Difficulty: Easy
Ref: Establishing a Framework for Investors
3.
Technically, investments include:
a.
b.
c.
d.
only financial assets.
only marketable assets.
financial and real assets that are marketable or non-marketable.
only financial and real assets that are marketable.
Ans: c
Difficulty: Easy
Ref: Establishing a Framework for Investors
4.
The retirement plans that guarantee retirees a set amount of money each
are known as:
a.
b.
c.
d.
401(k) plans
self-directed plans
defined-benefit plans
defined-contribution plans
Ans: c
Difficulty: Moderate
Chapter One
Understanding Investments
1
month
Ref: Establishing a Framework for Investors
5.
The investment professionals that arrange the sale of new securities are
called:
a.
b.
c.
d.
arbitragers
traders
investment bankers
specialists
Ans: c
Difficulty: Moderate
Ref: The Importance of Studying Investments
6.
Another name for stockbrokers is:
a.
b.
c.
d.
specialists
financial advisors
security analysts
portfolio managers
Ans: b
Difficulty: Moderate
Ref: The Importance of Studying Investments
7.
Investment professionals who take companies public, arrange mergers and
acquisitions, and participate in municipal bond issues are :
a.
b.
c.
d.
registered representatives
security analysts
investment bankers
portfolio managers
Ans: c
Difficulty: Moderate
Ref: The Importance of Studying Investments
8.
One reason for the declining importance of pension funds is the:
a.
b.
c.
d.
decrease in pension benefits for workers.
downsizing of U.S. companies
large number of conversions into self-directed plans.
increasing number of federal regulations that restrict pension fund portfolios.
Ans: c
Difficulty: Difficult
Ref: The Importance of Studying Investments
Chapter One
Understanding Investments
2
9.
Most financial advisors are registered with the Securities and Exchange
Commission as:
a.
b.
c.
d.
registered representatives.
registered investment advisors.
registered financial planners.
registered securities consultants.
Ans: b
Difficulty: Moderate
Ref: The Importance of Studying Investments
10.
A Chartered Financial Analyst designation is a (an)
a.
b.
c.
SEC-approved and awarded designation.
certification of a successful investing record.
professional designation awarded for meeting recognized standards of conduct
and competency.
professional designation awarded by the brokerage industry.
d.
Ans: c
Difficulty: Easy
Ref: The Importance of Studying Investments
11.
Underlying all investments is the tradeoff between:
a.
b.
c.
d.
expected return and actual return
low risk and high risk
actual return and high risk
expected return and risk
Ans: d
Difficulty: Moderate
Ref: Understanding the Investment Decision Process
12.
Which of the following investment areas is heavily tied to work using
mathematical and statistical models?
a.
b.
c.
d.
Security analysis
Portfolio management
Institutional investing
Retirement planning
Ans: b
Difficulty: Moderate
Ref: Understanding the Investment Decision Process
Chapter One
Understanding Investments
3
13.
Most investors are risk averse which means:
a.
they will assume more risk only if they are compensated by higher expected
return.
they will always invest in the investment with the lowest possible risk.
they actively seek to minimize their risks.
they avoid the stock market due to the high degree of risk.
b.
c.
d.
Ans: a
Difficulty: Moderate
Ref: Understanding the Investment Decision Process
14.
Which of the following would be considered a risk-free investment?
a.
b.
c.
d.
gold
equity in a house
high-grade corporate bonds
U.S. Treasury bills
Ans: d
Difficulty: Easy
Ref: Understanding the Investment Decision Process
15.
Security analysis is most concerned with:
a.
b.
c.
d.
analysis of the overall securities market and its direction.
valuation and analysis of individual securities.
purchasing securities at the best price.
determination of the investor’s required return.
Ans: b
Difficulty: Moderate
Ref: Understanding the Investment Decision Process
16.
In general, the ex ante risk-return tradeoff
a.
b.
c.
d.
slopes upward.
slopes downward
is flat
is impossible to determine.
Ans: a
Difficulty: Moderate
Ref: Understanding the Investment Decision Process
17.
International investing:
a.
is only practical for institutional investors.
Chapter One
Understanding Investments
4
b.
c.
d.
increases the overall risk of a stock portfolio.
always leads to higher returns than a domestic portfolio.
can reduce risk due to increased diversification.
Ans: d
Difficulty: Moderate
Ref: Understanding the Investment Decision Process
18.
Investment decision making traditionally consists of two steps:
a.
b.
c.
d.
investment banking and security analysis
buying and selling
risk and expected return.
security analysis and portfolio management.
Ans: d
Difficulty: difficult
Ref: Understanding the Investment Decision Process
19.
Which of the following statements concerning global stock market capitalization
is true?
a.
b.
c.
d.
The United States accounts for roughly 85 percent of stock market capitalization
worldwide.
The United States accounts for roughly 50 percent of stock market capitalization
worldwide.
The United States accounts for roughly 25 percent of stock market capitalization.
It is expected that the United States will increase its percentage of stock market
capitalization in the world over time.
Ans: b
Difficulty: Moderate
Ref: Important Considerations in the Investment Decision Process for Today's Investor
20.
Regulation FD applies to disclosure between:
a.
b.
c.
d.
private companies and public officials
public companies and investment professionals
public companies and public officials
private companies and investment professionals
Ans: b
Difficulty: Moderate
Ref: Important Considerations in the Investment Decision Process for Today's Investor
21.
Which of the following statements is true regarding multi-national corporations?
a.
Both Exxon Mobil and Hewlett Packard earn roughly 70% of their profits from
their overseas operations.
Chapter One
Understanding Investments
5
b.
c.
d.
Google currently derives about 95% of its earnings from the U.S.
Wal-Mart earns nearly 50% of its profits outside the U.S.
Coca-Cola has no overseas operations and no earnings outside the U.S. at all
Ans: a
Difficulty: difficult
Ref: Important Considerations in the Investment Decision Process for Today's Investor
22.
The rise of the Internet has:
a.
b.
c.
d.
greatly increased the cost of security trading.
significantly democratized the flow of investment information.
led to fewer number of discount brokers
led to large amounts of security fraud.
Ans: b
Difficulty: Moderate
Ref: Important Considerations in the Investment Decision Process for Today's Investor
23.
Which of the following professionals would be considered an institutional
investor?
a.
b.
c.
d.
Investment Banker
Security Analyst
Stockbroker
Portfolio Manager
Ans: d
Difficulty: difficult
Ref: Important Considerations in the Investment Decision Process for Today's Investor
24.
The risk-free rate of return (RFR) equals:
a. 3.5%
b. the return on long-term Treasury bonds
c. the average of the last 3 years’ inflation rate
d. the return on short-term Treasury bills
Ans: d
Difficulty: difficult
Ref: Important Considerations in the Investment Decision Process for Today's Investor
25.
All of the following are benefits of geographic diversification in investment
portfolios EXCEPT:
a.
b.
c.
d.
Gaining exposure to currencies other than the U.S. dollar.
Some global markets have growth rates higher than the U.S., offering potentially
higher returns.
Global markets behave completely independently of U.S. markets.
Many global markets are not highly correlated with U.S. markets.
Chapter One
Understanding Investments
6
Ans: c
Difficulty: difficult
Ref: Important Considerations in the Investment Decision Process for Today's Investor
True-False Questions
1.
A 401(k) plan is an example of a defined benefit retirement plan.
Ans: False
Difficulty: Moderate
Ref: The Importance of Studying Investments
2.
Investors always seek to minimize their risk of investing.
Ans: False
Difficulty: Moderate
Ref: Understanding the Investment Decision Process
3.
Both 401(k) plans and IRAs are self-directed retirement plans.
Ans: True
Difficulty: Easy
Ref: Understanding the Investment Decision Process
4.
The two major considerations in investing are return and timing.
Ans: F
Difficulty: Easy
Ref: Understanding the Investment Decision Process
5.
Risk is defined as the possibility of loss.
Ans: False
Difficulty: difficult
Ref: Understanding the Investment Decision Process
6.
The minimum actual return necessary to induce investors to invest is known as
the expected return.
Answer: False
Difficulty: difficult
Ref: Understanding the Investment Decision Process
7.
Investors enjoyed the best 5 consecutive years in the stock market history over
the period 1996-2000.
Answer: False
Chapter One
Understanding Investments
7
Difficulty: Moderate
Ref: Understanding the Investment Decision Process
8.
Investors unwilling to assume risk should be satisfied with the rate of
inflation as their investment return.
Answer: False
Difficulty: difficult
Ref: Understanding the Investment Decision Process
9.
Security analysts are typically employed only at brokerage houses.
Answer: False
Difficulty: Moderate
Ref: Importance of Studying Investments
10.
Financial planners must pass a standardized test and possess certain
credentials.
Ans: False
Difficulty: Easy
Ref: Importance of Studying Investments
11.
Many Wall Street jobs tend to be cyclical in nature..
Ans: True
Difficulty: Easy
Ref: Importance of Studying Investments
12.
Due to the Internet, institutional investors have gained in importance.
Ans: F
Difficulty: difficult
Ref: Important Considerations in the Investment Decision Process for Today's Investor
Short-Answer Questions
1.
Briefly explain the difference between expected returns and realized returns and
between ex ante returns an ex post returns.
Answer:
Difficulty:
2.
Expected returns are mean returns based on probability distributions
dealing with the future. Realized returns are the returns that actually
occurred in the past. Ex ante returns are in the future. Ex post returns are
in the past.
Moderate
What are some of the career opportunities in the investment industry?
Chapter One
Understanding Investments
8
Answer:
Difficulty:
3.
Define risk in the context of investments?
Answer:
Difficulty:
4.
Investment banker, merger and acquisition specialist, security traders,
sales people, security analyst, portfolio manager, registered investment
advisor and financial planner.
Moderate
Risk is the chance that the actual return on an investment will differ from
its expected return.
Moderate
Will risk-averse investors ever include commodity futures or options in their
portfolios? Explain.
Answer:
Difficulty:
They may include these items in their portfolios since risk-averse is not
the same thing as risk avoidance. Risk-averse investors would expect a
higher return from these assets as they are riskier than many other assets.
Moderate
Martha Stewart was banned from serving as an officer of a public corporation, sentenced
to 5 months in prison, and fined $30,000. Why?
5.
Answer:
Contrary to popular belief, she was not charged with insider
trading but obstruction of justice as a result of her efforts to hide her alleged
insider trading.
Difficulty:
Moderate
6.
A 25-year old college graduate is participating in a 401(k) retirement plan and
wishes to minimize risk by eliminating stock-based mutual funds and other
equities from his investment portfolio. What will this probably do to his ending
retirement funds in 40 years?
Answer:
Difficulty:
If he minimizes risk, then he will also minimize return. His retirement
fund will likely be much smaller than if he chose to take more risk over
the long run.
Moderate
Critical Thinking/Essay Questions
1.
What are some of the steps involved in valuing a company’s common stock?
Answer:
Difficulty:
The investor must evaluate the overall economy, industry and individual
company, since all have an impact on the value of the stock.
In
addition, the expected return and appropriate risk must be estimated, based
upon the expected future cash flows of the company. And lastly, the
efficiency of stock markets must be considered and whether the current
market value of the stock is greater or less than its perceived economic
value.
difficult
Chapter One
Understanding Investments
9
2.
What are some of the reasons driving so many individual investors to manage
their own investments today, versus the conventional route of investing through a
financial advisor, or stockbroker?
Answer:
Difficulty:
The emergence of the Internet has produced a host of online, discount
brokers offering ultra low-cost commissions, sometimes free trades, and
real-time quotes on stocks and bonds. There is also now a preponderance
of websites offering information on corporate news and SEC filings,
which helps investors become more self-sufficient if they so choose.
Also, extreme levels of market volatility seen in the last decade have
eroded the wealth of many investors, including whatever portion was
being professionally managed by mutual funds or through financial
advisors. That begs the question of whether professional management or
advice is worth the cost in the face of such tremendous wealth erosion.
Many investors have decided to go out on their own, using a discount
broker.
Moderate
Chapter One
Understanding Investments
10
Files: ch02, Chapter 2: Investment Alternatives
Multiple Choice Questions
1.
The largest single institutional owner of common stocks is:
a.
b.
c.
d.
mutual funds.
insurance companies.
pension funds.
commercial banks.
Ans: c
Difficulty: Moderate
Ref: Organizing Financial Assets
2.
Which of the following is not a characteristic of the primary nonmarketable
financial asset owned by most individuals?
a.
b.
c.
d.
High liquidity
High return
Often issued by the U.S. government
Low risk
Ans: b
Difficulty: Moderate
Ref: Nonmarketable Financial Assets
3.
Savings accounts are:
a.
b.
c.
d.
negotiable but are not liquid.
marketable but are not liquid.
liquid but are not personal.
liquid but are not marketable.
Ans: d
Difficulty: Difficult
Ref: Nonmarketable Financial Assets
4.
Nonmarketable financial assets that protect against inflation include:
a.
b.
c.
d.
nonnegotiable certificates of deposit (CDs).
money market deposit accounts (MMDAs).
Series EE US government savings bonds.
US government savings bonds, I bonds.
Chapter Two
Investment Alternatives
10
Ans: d
Difficulty: Moderate
Ref: Nonmarketable Financial Assets
5.
Treasury bills are traded in the:
a.
b.
c.
d.
money market.
capital market.
government market.
regulated market.
Ans: a
Difficulty: Easy
Ref: Money Market Securities
6.
a.
b.
c.
d.
Which of the U.S. Treasury securities is always sold at a discount?
Treasury bills
Treasury notes
Treasury bonds
Treasury inflation protected securities (TIPS)
Ans: a
Difficulty: Moderate
Ref: Money Market Securities
7.
Which of the following statements regarding money market instruments is
not true?
a.
b.
c.
d.
They tend to be highly marketable.
They have maturities from 1 to 3 years.
They tend to have a low probability of default.
Their rates tend to move together.
Ans: b
Difficulty: Moderate
Ref: Money Market Securities
8.
Which of the following would not be considered a capital market security?
a.
b.
c.
d.
A 20-year corporate bond
A common stock
A 6-month Treasury bill
A mutual fund share
Ans: c
Difficulty: Moderate
Ref: Capital Market Securities
Chapter Two
Investment Alternatives
11
9.
The coupon rate is another name for the:
a.
b.
c.
d.
market interest rate.
current yield.
stated interest rate.
yield to maturity.
Ans: c
Difficulty: Easy
Ref: Fixed-Income Securities
10.
Zero-coupon bonds are similar to Treasury bills in that both:
a.
b.
c.
d.
are issued exclusively by the U.S. Treasury.
are money-market securities.
are capital-market securities.
are sold at less than par.
Ans: d
Difficulty: Moderate
Ref: Fixed-Income Securities
11.
Each point on a corporate bond quote represents:
a.
b.
c.
d.
$100.
1 percent of $100.
1 percent of $1000.
$1000.
Ans: c
Difficulty: Difficult
Ref: Fixed-Income Securities
12.
Treasury STRIPS are most similar to which type of corporate security?
a.
b.
c.
d.
Preferred stock
Premium bond
High-yield bond
Zero-coupon bond
Ans: d
Difficulty: Moderate
Ref: Fixed-Income Securities
Chapter Two
Investment Alternatives
12
13.
Bonds trade on an accrual interest basis. This means an investor:
a.
b.
can sell a bond at any time without losing the interest that has accrued.
can buy a bond at any time and gain the interest accrued from the time of the last
payment.
can sell a bond at any time and retain the interest portion of the bond.
can buy a bond at any time and receive an immediate interest check.
c.
d.
Ans: a
Difficulty: Moderate
Ref: Fixed-Income Securities
14.
Bonds called in are likely to be:
a.
b.
c.
d.
bonds already in default.
replaced with new bonds that have a lower interest rate.
replaced with new bonds that have a higher interest rate.
junk bonds.
Ans: b
Difficulty: Moderate
Ref: Fixed-Income Securities
15.
What will a bond be worth on the day it matures?
a.
b.
c.
d.
$0
$100
Its face value (plus remaining coupon, if applicable)
Its remaining coupon, if applicable
Ans: c
Difficulty: Moderate
Ref: Fixed-Income Securities
16.
Which of the following statements is true regarding an investment in mortgagebacked securities?
a.
b.
c.
d.
There is little default risk.
The stated maturity is generally 10 years.
They receive a fixed payment per month.
They are not subject to prepayment.
Ans: a
Difficulty: Moderate
Ref: Fixed-Income Securities
Chapter Two
Investment Alternatives
13
17.
A municipal bond issued to finance a toll bridge would most likely be a:
a.
b.
c.
d.
general obligation bond.
revenue bond.
special assessment bond.
zero-coupon bond.
Ans: b
Difficulty: Easy
Ref: Fixed-Income Securities
18.
What is the major difference between municipal bonds and other types of bonds?
a.
b.
c.
d.
Municipal bonds are always insured; other bonds are not.
Unlike other bonds, municipal bonds sell at a discount.
Municipal bond interest is tax-exempt; interest on other bonds is not.
There is no brokerage commission on municipal bonds unlike other bonds.
Ans: c
Difficulty: Moderate
Ref: Fixed-Income Securities
19.
For an investor with a 28% marginal tax rate, what return would a corporate bond
have to pay to provide the same after-tax return as a municipal bond paying 5%?
a.
b.
c.
d.
1.40%
2.50%
5.00%
6.94%
Ans: d
Difficulty: Moderate
Ref: Fixed-Income Securities
20.
Interest on bonds is typically paid:
a.
b.
c.
d.
monthly.
quarterly.
semi-annually.
annually.
Ans: c
Difficulty: Moderate
Ref: Fixed-Income Securities
Chapter Two
Investment Alternatives
14
21.
Treasury bonds generally have maturities of:
a.
b.
c.
d.
5 to 15 years.
5 to 30 years.
10 to 20 years.
10 to 30 years.
Ans: d
Difficulty: Easy
Ref: Fixed-Income Securities
22.
A corporate bond with a rating of BBB- is considered to be which of the
following?
a.
b.
c.
d.
Non-investment grade
Investment grade
Speculative grade
Junk or high-yield
Ans: b
Difficulty: Difficult
Ref: Fixed-Income Securities
23.
An unsecured bond is known as a(n):
a.
b.
c.
d.
debenture.
indenture.
mortgage bond.
junk bond.
Ans: a
Difficulty: Moderate
Ref: Fixed-Income Securities
24.
Which of the following 10-year bonds would have the lowest yield?
a.
b.
c.
d.
AAA-rated corporate bond
AAA-rated insured municipal bond
U.S. Treasury bond
AAA-rated mortgage-backed bond
Ans: b
Difficulty: Difficult
Ref: Fixed-Income Securities
Chapter Two
Investment Alternatives
15
25.
For U.S. companies, dividends are typically paid:
a.
b.
c.
d.
monthly.
quarterly.
semi-annually.
yearly.
Ans: b
Difficulty: Easy
Ref: Equity Securities
26.
If an investor states that Intel is overvalued at 65 times, he is referring to Intel’s:
a.
b.
c.
d.
earnings per share.
dividend yield.
book value.
P/E ratio.
Ans: d
Difficulty: Difficult
Ref: Equity Securities
27.
Which of the following is a security that represents shares of a foreign company,
which are held in a bank?
a.
b.
c.
d.
Convertible bond
American Depository Receipt (ADR)
Asset-backed security
LEAPS
Ans: b
Difficulty: Easy
Ref: Equity Securities
28.
Which of the following statements regarding common stocks is true?
a.
b.
c.
d.
The par value of common stock is usually $100.
The market value of common stock is equal to its book value.
Dividends on common stock are at the discretion of the company.
Common stock has a senior claim on company assets.
Ans: c
Difficulty: Moderate
Ref: Equity Securities
Chapter Two
Investment Alternatives
16
29.
If a preferred stock issue is cumulative, this means:
a.
b.
c.
unpaid preferred stock dividends are paid at the end of the year.
unpaid preferred stock dividends are legally binding on the corporation.
unpaid preferred stock dividends must be paid in the future before common stock
dividends can be paid.
unpaid preferred stock dividends are never repaid.
d.
Ans: c
Difficulty: Moderate
Ref: Equity Securities
30.
Which of the following statements is true regarding asset-backed securities?
a.
b.
c.
d.
They offer relatively high yields.
They have relatively long maturities.
They generally have low credit ratings.
Each traunche has the same risk.
Ans: a
Difficulty: Moderate
Ref: Asset Backed Securities
31.
What is the biggest difference between an option and a futures contract?
a.
b.
c.
Options are traded on exchanges, whereas futures are not.
Options give investors a way to manage portfolio risk, while futures do not.
Options can be used by speculators to profit from price fluctuations, while futures
cannot.
Options give their holders the right to buy or sell, whereas futures contracts are
obligations to buy or sell.
d.
Ans: d
Difficulty: Difficult
Ref: Derivative Securities
32.
The premium on an option is the:
a.
b.
c.
d.
par value of the option.
price of the option.
book value of the option.
price at which a security may be bought or sold using the option.
Ans: b
Difficulty: Moderate
Ref: Derivative Securities
Chapter Two
Investment Alternatives
17
33.
If a call option has a $10 strike price, and the underlying stock is trading at $11,
then the option is considered:
a.
b.
c.
d.
in the money.
at the money.
out of the money.
worthless.
Ans: a
Difficulty: Easy
Ref: Derivative Securities
True-False Questions
1.
Direct investing involves trades made by directly purchasing shares of a financial
intermediary.
Ans: False
Difficulty: Moderate
Ref: Organizing Financial Assets
2.
An example of indirect investing would be buying shares in a mutual fund.
Ans: True
Difficulty: Easy
Ref: Organizing Financial Assets
3.
Nonmarketable investments would include savings accounts at banks and
Treasury bills.
Ans: False
Difficulty: Moderate
Ref: Nonmarketable Financial Assets
4.
Marketable securities all fall into the category of capital market securities.
Ans: False
Difficulty: Moderate
Ref: Nonmarketable Financial Assets
5.
All U. S. government securities are considered marketable securities.
Ans: False
Difficulty: Easy
Ref: Money Market Securities
Chapter Two
Investment Alternatives
18
6.
Money market securities generally carry a low chance of default.
Ans: True
Difficulty: Moderate
Ref: Money Market Securities
7.
The money market rate most often used as a benchmark for the risk-free rate is
the money market deposit account rate.
Ans: False
Difficulty: Easy
Ref: Money Market Securities
8.
The rate spreads between the different money market securities of the same term
tend to be quite large.
Ans: False
Difficulty: Difficult
Ref: Money Market Securities
9.
Treasury notes represent the nontraded debt of the U.S. government.
Ans: False
Difficulty: Moderate
Ref: Fixed-Income Securities
10.
The capital market includes both fixed-income and equity securities.
Ans: True
Difficulty: Easy
Ref: Fixed-Income Securities
11.
Term bonds have a single maturity.
Ans: True
Difficulty: Easy
Ref: Fixed-Income Securities
12.
The return on a zero-coupon bond is derived from the difference between
the purchase price of the bond and its par value.
Ans: True
Difficulty: Difficult
Ref: Fixed-Income Securities
Chapter Two
Investment Alternatives
19
13.
The deeper the discount on a zero-coupon bond, the lower the effective return.
Ans: False
Difficulty: Moderate
Ref: Fixed-Income Securities
14.
If a bond has a coupon greater than the current market yield, it should be
selling at a premium.
Ans: True
Difficulty: Difficult
Ref: Fixed-Income Securities
15.
Callable bonds attract investors because they can be redeemed early.
Ans: False
Difficulty: Moderate
Ref: Fixed-Income Securities
16.
TIPS adjust for inflation by adjusting the rate of interest paid on the bond.
Ans: False
Difficulty: Difficult
Ref: Fixed-Income Securities
17.
The major attraction of municipal bonds is their extremely low risk.
Ans: False
Difficulty: Moderate
Ref: Fixed-Income Securities
18.
Investors in high tax brackets would be unlikely to invest in municipal bonds.
Ans: False
Difficulty: Moderate
Ref: Fixed-Income Securities
19.
In the case of a corporate bankruptcy, bondholders are paid before any
distributions are paid to preferred or common stockholders.
Ans: True
Difficulty: Moderate
Ref: Fixed-Income Securities
20.
Bond ratings are primarily used to assess interest rate risk.
Ans: False
Difficulty: Moderate
Ref: Fixed-Income Securities
Chapter Two
Investment Alternatives
20
21.
The major bond rating service is Dun & Bradstreet.
Ans: False
Difficulty: Easy
Ref: Fixed-Income Securities
22.
The earnings retention rate is calculated as 1 – dividend yield.
Ans: False
Difficulty: Easy
Ref: Equity Securities
23.
The par value on common stock sets the value that stockholders will receive in
case of bankruptcy.
Ans: False
Difficulty: Easy
Ref: Equity Securities
24.
LEAPS have maturity dates up to 10 years.
Ans: False
Difficulty: Easy
Ref: Equity Securities
25.
Most futures contracts are not exercised.
Ans: T
Difficulty: Moderate
Ref: Equity Securities
26.
Convertible bonds give their investors the right to convert the bond into common
stock at their discretion.
Ans: True
Difficulty: Easy
Ref: Fixed-Income Securities
Short-Answer Questions
1.
Distinguish between direct and indirect investing.
Answer:
Difficulty:
Ref:
Direct investing – buy bonds and stocks; Indirect investing – buy mutual
funds, contribute to pension plans, buy life insurance policies.
Easy
Organizing Financial Assets
Chapter Two
Investment Alternatives
21
2.
Compare the cash flows an investor expects from coupon bonds, zero-coupon
bonds, and preferred stock.
Answer:
Difficulty:
Ref:
3.
How is the earnings retention rate related to the dividend payout rate?
Answer:
Difficulty:
Ref:
4.
Difficulty:
Ref:
Difficulty:
Ref:
If a stock is trading at 12 times earnings, it is cheaper than the one trading
at 20 times earnings in the sense investors get $1 of earnings for only a
$12 investment in buying the stock.
Moderate
Equity Securities
What are two direct and one indirect method for individuals to invest in foreign
stocks?
Answer:
Difficulty:
Ref:
7.
Stock splits do not affect total value of equity or the individual
accounts, other than the number of shares outstanding and the par value.
Moderate
Equity Securities
In what sense is a stock selling for 12 times earnings “cheaper” than a stock with
a P/E ratio of 20?
Answer:
6.
Earnings retention rate = 1 - dividend payout rate
Moderate
Equity Securities
How is the total book value of equity affected by stock splits?
Answer:
5.
Coupon bonds – annuity of interest payments plus lump sum of
principal at maturity
Zero-coupon bonds – principal at maturity
Preferred stock – annuity ad infinitum (perpetuity)
Moderate
Fixed-Income Securities
Buy securities directly through exchanges or as American depository
receipts and indirectly through mutual funds.
Moderate
Organizing Financial Assets, Equity Securities
Explain how writing option contracts (both puts and calls) can generate income
for owners of the underlying stock.
Answer:
Difficulty:
Ref:
The writer keeps the option premium regardless of whether or not the
option is exercised.
Moderate
Derivative Securities
Chapter Two
Investment Alternatives
22
8.
Rank (lowest to highest) the following securities in terms of the risk-expected
return tradeoff from the investors’ viewpoint: common stock, corporate bonds,
U.S. Treasury bonds, preferred stock.
Answer:
Difficulty:
Ref:
9.
What are some advantages of asset-backed securities to investors?
Answer:
Difficulty:
Ref:
10.
U.S. Treasury bonds, corporate bonds, preferred stock, common stock
Moderate
Fixed-Income Securities, Equity Securities
High yields with manageable risk.
Moderate
Fixed-Income Securities
Who benefits from a futures contract, a call contract, and a put contract, if prices
fall?
Answer:
Difficult:
Ref:
The seller of the futures contract, the writer of the call contract, and the
buyer of the put contract.
Moderate
Derivative Securities
Essay Questions
1.
Does the options market help stabilize or destabilize the stock market? Explain.
Answer:
Difficulty:
Ref:
2.
Options should be a stabilizing force if options are used to hedge stock
positions. Options might be destabilizing if used for speculation.
Difficult
Equity Securities, Derivative Securities
How do asset-backed securities improve the flow of funds from savers to
borrowers?
Answer:
Difficulty:
Ref:
Asset-backed securities can be sold to a broader market of investors than
the underlying securities.
Moderate
Fixed-Income Securities
Problems
1.
What rate would a taxable corporate bond have to pay to be comparable to a
municipal bond with a coupon rate of 7 percent if the investor is in the 28 percent
tax bracket?
Answer:
Difficulty:
Ref:
Taxable equivalent yield is 0.07/(1-0.28) = 9.72%
Easy
Fixed-Income Securities
Chapter Two
Investment Alternatives
23
2.
A corporate investor in the 34% marginal income tax bracket can buy bonds
issued by a petroleum exploration company yielding 10.606%. The investor
should be willing to buy tax-exempt municipal bonds of similar quality yielding
what percent or higher?
Answer:
Difficulty:
Ref:
3.
The par value of Blaze, Inc. common stock is $0.50, the earnings per share is $4,
the stock price is $60, and the dividend per share is $1. Calculate the dividend
yield.
Answer:
Difficulty:
Ref:
4.
Dividend yield = $1/$60 = 0.0167 = 1.67%
Moderate
Equity Securities
The par value of Blaze, Inc. common stock is $0.50, the earnings per share is $4,
the stock price is $60, and the dividend per share is $1. Calculate the payout
ratio.
Answer:
Difficulty:
Ref:
5.
10.606 x (1.0-0.34) = 7.00 percent
Easy
Fixed-Income Securities
Payout rate = $1/$4 = 0.25 = 25%
Moderate
Equity Securities
The par value of Inferno, Inc. common stock is $0.50, the earnings per share is $6,
and it trades at a P/E of 15. What is Inferno, Inc.’s stock price?
Answer:
Difficulty:
Ref:
Stock price is EPS x P/E = $6 x 15 = $90
Moderate
Equity Securities
Chapter Two
Investment Alternatives
24