Fundamentals Of Investing 13th Edition by Scott B. Smart – Test Bank

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Fundamentals Of Investing 13th Edition by Scott B. Smart – Test Bank

Fundamentals of Investing, 13e (Smart)

Chapter 2   Securities Markets and Transactions

 

2.1   Learning Goal 1

 

1) Stocks, bonds and mutual fund shares are bought and sold in the capital market.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

2) Capital markets deal exclusively in stock.  Money markets deal exclusively in debt instruments.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

3) Primary markets deal in the stocks of larger, well-known companies; secondary markets deal in the stocks of smaller, less well-known companies.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

4) Short-term securities are bought and sold in the

  1. A) capital market.
  2. B) primary market.
  3. C) money market.
  4. D) stock market.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

5) The governmental agency that oversees the capital markets is the

  1. A) Federal Trade Commission.
  2. B) Federal Reserve.
  3. C) Securities and Exchange Commission.
  4. D) Fair Trade and Banking Agency.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

6) Stocks purchased in the secondary market are purchased

  1. A) directly from the issuing corporation.
  2. B) from other investors.
  3. C) from small, little-known brokerages.
  4. D) indirectly through financial institutions.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

7) Stocks and bonds are traded in

  1. A) securities and exchange commissions.
  2. B) money markets.
  3. C) federal trade commissions.
  4. D) capital markets.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

 

8) The primary market tends to be more active when

  1. A) the economy is slowing and stock prices are falling.
  2. B) the economy is expanding and stock prices are rising.
  3. C) interest rates are rising.
  4. D) early in the calendar year.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 1

2.2   Learning Goal 2

 

1) Underwriters are responsible for promoting and facilitating the sale of securities.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

2) The preliminary version of a prospectus is called a red herring.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

3) The purpose of the “quiet period” a company must observe from the time it files a registration statement with the SEC until after an IPO is complete is to assure that all investors receive the same information.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

 

4) IPOs are typically underpriced so that the price rises during the first few days of trading.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

5) IPOs are relatively safe investments.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

6) The price of stock sold in an IPO is set by bids submitted in the month before trading begins.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 2

7) Which one of the following statements concerning the primary market is correct?

  1. A) A transaction in the primary market is between two private stockholders.
  2. B) The first public sale of a company’s stock in the primary market is called a seasoned new issue.
  3. C) The first public sale of a company’s stock is called an IPO.
  4. D) A rights offering is a direct sale of stock to an institution that participates in the primary market.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

 

8) A rights offering is the

  1. A) initial offering of securities to the public.
  2. B) offering of new securities to current shareholders on a pro-rata basis.
  3. C) sale of newly issued shares of stock to the general public.
  4. D) sale of securities directly to a select group of investors.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

9) IPO activity tends to peak when stock prices

  1. A) have fallen sharply.
  2. B) have risen sharply.
  3. C) are volatile and unstable.
  4. D) Stock prices have relatively little influence on IPO activity.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

10) The document that describes the issuer of a security’s management and financial position is known as a

  1. A) balance sheet.
  2. B) 10-K report.
  3. C) prospectus.
  4. D) red herring.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

11) Companies offering their stock to the public for the first time usually seek the assistance of

  1. A) investment bankers.
  2. B) the Securities and Exchange Commission.
  3. C) the Federal Reserve Bank.
  4. D) prospectors.

Answer:  A

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

12) The financial crisis of 2008 resulted in

  1. A) a steep increase in the price of newly issued stock because supply was limited.
  2. B) new regulations affecting initial public offerings.
  3. C) a sharp reduction in the number of initial public offerings.
  4. D) B and C, but not A.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

13) Investment bankers who join together to share the financial risk associated with buying an entire issue of new securities and reselling them to the public is called a(n)

  1. A) selling group.
  2. B) tombstone group.
  3. C) underwriting syndicate.
  4. D) primary market group.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

 

14) Describe the initial public offering (IPO) process and explain the role of the underwriter, the Securities and Exchange Commission (SEC), and the red herring.

Answer:  The underwriter is responsible for promoting the stock and facilitating the sale of the company’s IPO shares. The SEC approves the registration statement including the prospectus. This statement includes the key aspects of the issue, the issuer, the company management, and the financial position of the company. The SEC does NOT recommend the investment nor offer an opinion on the value of the stock. The red herring is the preliminary prospectus issued on tentative offerings. The prospectus has red lettering on the front cover.

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

15) Explain the role of investment bankers and brokerage firms in the issuance of new securities.

Answer:  An investment banker assumes the role of the underwriter and bears the risk of reselling the securities purchased from an issuing corporation. The investment banker earns a profit by reselling at a price higher than the price paid to the issuer. Brokerage firms form a selling group with each firm accepting responsibility for selling a portion of the newly issued securities. The brokerage firms also earn a profit if they can resell the shares at a price higher than their purchase price.

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

 

2.3   Learning Goal 3

 

1) The NYSE and AMEX are examples of dealer markets.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

2)  Only U.S. corporations can list their stocks on the NYSE.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

3) Firms that list their stock on an exchange can be delisted for failing to meet the requirements of the exchange.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

4) The NYSE is part of the world’s largest international trading network known as NYSE Euronext.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

5) Exchange traded funds (ETFs) perform like a broad market index but are bought and sold like individual stocks.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

6) Most commodity futures are traded on the NYSE Amex.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

7) Securities that trade in the over-the-counter market are called unlisted securities.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

8) A market maker brings together buyers and sellers in an auction market.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

9) The income paid to a market maker is referred to as the spread.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

10) Federal laws that control the sale of securities are called blue sky laws.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

11) Federal securities laws are designed to protect financial institutions.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

12) Stocks of many large foreign companies such as Toyota trade on the NYSE as well as on exchanges in their own country.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

13) The majority of bonds trade in the OTC market.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

14) Market makers in dealer markets

  1. A) bring sellers and buyers together by matching offers.
  2. B) earn commissions paid by the sellers of securities.
  3. C) buy securities at a bid price and hope to resell them at a higher offer price.
  4. D) all of the above.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

15) Which one of the following statements about the NYSE is correct?

  1. A) Each member of the exchange owns a trading post.
  2. B) Any listed stock may be traded at any of 20 trading posts.
  3. C) Brokerage firms are only permitted to have one individual trading on the floor of the exchange.
  4. D) Buy orders are filled at the lowest price and sell orders are filled at the highest price.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

16) In recent years, trading in secondary markets has increasingly become a function of

  1. A) securities exchanges.
  2. B) dealer markets.
  3. C) technology that by-passes both brokers and dealers.
  4. D) broker-dealer markets using consolidated venues and technologies.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

17) The great majority of transactions on the NYSE are executed

  1. A) automatically through electronic technology.
  2. B) on the trading floor by brokers known as specialists.
  3. C) by dealers known as market makers.
  4. D) by auction in trading areas known as pits.

Answer:  A

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

18) Which of the following are correct statements concerning the NYSE?

 

  1. Each stock has a designated location, called a post, at which its shares are traded.
  2. The NYSE is a dealer market.

III. Supply and demand determines the price of each security.

  1. A specialist buys and sells to maintain a market for a particular security.

 

  1. A) I and II only
  2. B) I and III only
  3. C) I, III and IV only
  4. D) I, II, III and IV

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

19) A market where securities are are bought from or sold to a market maker is known as a

  1. A) broker market.
  2. B) dealer market.
  3. C) exchange floor.
  4. D) board of exchange.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

20) Large technology companies such as IBM and Microsoft trade

  1. A) exclusively on the NASDAQ.
  2. B) exclusively on the NYSE.
  3. C) on either the NASDAQ or the NYSE.
  4. D) exclusively on alternative trading systems.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

21) Which of the following is currently a requirement for a stock to be listed on the NYSE?

  1. A) A price of at least $10 per share.
  2. B) Three consecutive years of profitable operations.
  3. C) Gross revenue of at least $15,000,000.
  4. D) Total value of shares available for public trading (float) of $15,000,000.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 3

 

22) The dominant exchange for trading options contracts is the ________.  The dominant player in the trading of futures contracts is ________.

  1. A) NYSE; Nasdaq OMX BX
  2. B) PHLX; CBOE
  3. C) CBOE; CME Group
  4. D) ISE; CBOT

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 3

 

 

23) Exchange traded funds are

  1. A) mutual funds that trade on the Big Board.
  2. B) baskets of securities that trade like a single stock.
  3. C) index funds that trade on the NYSE.
  4. D) groups of securities that trade only on regional exchanges.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

24) The dominant options exchange is the

  1. A) Chicago Board Options Exchange.
  2. B) American Stock Exchange.
  3. C) Pacific Stock Exchange.
  4. D) Philadelphia Options Exchange.

Answer:  A

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

25) The NYSE Euronext includes exchanges in all of the following cities EXCEPT

  1. A) Amsterdam.
  2. B) Brussels.
  3. C) Paris.
  4. D) Tokyo.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

26) The purpose of the Intermarket Trading System is to link major exchanges and dealer markets to

  1. A) eliminate competition between brokers and dealers.
  2. B) allow brokers and dealers to make transactions at the best price.
  3. C) allow individual to compare the prices offered by various dealers and brokers.
  4. D) allow individual investors to traded directly with each other.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

27) Options contracts on stocks may

  1. A) grant the owner the right to buy the stock at a specified price over a specified period of time.
  2. B) grant the owner the right to sell the stock at a specified price over a specified period of time.
  3. C) depending on the type of contract, grant the owner the right to either buy or sell the stock at a specified price over a specified period of time.
  4. D) legally oblige the owner to buy the stock at a specified price over a specified period of time.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 3

28) The automated system for trading highly active OTC securities is the

  1. A) Big Board.
  2. B) Kansas City Board.
  3. C) Chicago Board of Trade.
  4. D) NASDAQ.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

29) The over-the-counter (OTC) market is a

  1. A) centrally located auction market.
  2. B) telecommunications network connecting dealers.
  3. C) market solely for institutional traders.
  4. D) geographically dispersed auction market.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

30) ECNs are

  1. A) publicly owned auction markets for listed stocks.
  2. B) privately owned networks that transact trades between institutional investors.
  3. C) facilities used by market makers for trading unlisted securities.
  4. D) part of the third market which trades listed securities between individual investors.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

31) The price an individual investor will pay to purchase a stock in the OTC market is the

  1. A) spread.
  2. B) ask price.
  3. C) bid price.
  4. D) broker price.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

32) Which of the following are associated with bull markets?

 

  1. investor pessimism
  2. government stimulus

III. economic recovery

  1. low inflation

 

  1. A) I and II only
  2. B) II and III only
  3. C) I, II and III only
  4. D) II, III and IV only

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

33) Which of the following are associated with bear markets?

 

  1. investor pessimism
  2. rising profits

III. economic slowdown

  1. rising security prices

 

  1. A) I and III only
  2. B) II and III only
  3. C) I, II and III only
  4. D) II, III and IV only

Answer:  A

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

34) There are many differences between broker markets and dealer markets. These differences include such things as membership, location, regulation, and several other characteristics. Discuss at least five key differences between these two markets.

Answer:  BROKER MARKETS—listing requirements, central physical location, members own seats, transactions occur through an auction process, specialists maintain fair and orderly markets, limited securities traded, limited number of securities traded, brokers charge commission to execute trades; largest in terms of dollar volume.

DEALER MARKETS—unlisted securities, most bonds traded here, primary and secondary market, decentralized locations, NASD membership required to trade; dealers make profit from bid/ask spread; largest in terms of number of companies.

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

2.4   Learning Goal 4

 

1) Diversification is the inclusion of a number of different investments in a portfolio with the goal of increasing returns or reducing risk.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

2) The financial markets are becoming more globally integrated.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

3) Participation in foreign stock markets is complicated and expensive for American investors.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

4) The U.S. stock markets tend to produce the highest rate of return each year.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

5) Including foreign investments in a portfolio

  1. A) increases the overall risk of the portfolio.
  2. B) reduces the potential rate of return.
  3. C) provides potential benefits from changes in currency values.
  4. D) limits the diversification amongst industries.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

6) Which one of the following statements about foreign investments is true?

  1. A) In general, major foreign markets always tend to underperform the U.S. market.
  2. B) Investing in foreign markets may involve specific risks not encountered with domestic securities.
  3. C) Investing in foreign markets will always produce higher returns because of exchange rate fluctuations.
  4. D) Foreign markets include equity securities only.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

 

7) Functioning securities exchanges are located in

 

  1. Brazil
  2. China

III. Russia

  1. South Korea

 

  1. A) I, II, III and IV
  2. B) I, II and IV only
  3. C) I and IV only
  4. D) II, III, and IV only

Answer:  A

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 4

 

8) Dollar-denominated debt securities issued by foreign corporations and traded in U.S. markets are called

  1. A) ADRs.
  2. B) Yankee bonds.
  3. C) ETFs.
  4. D) global bonds.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

9) Which of the following can be encountered when investing in foreign markets?

 

  1. foreign taxation of dividends
  2. different accounting standards for financial disclosure

III. restrictions on types of investments

  1. illiquid markets

 

  1. A) II and III only
  2. B) II and IV only
  3. C) I, II and IV only
  4. D) I, II, III and IV

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

10) American Depositary Receipts represent

  1. A) receipts for dollar deposits in foreign banks.
  2. B) receipts from foreign broker-dealers establishing ownership of foreign stocks.
  3. C) receipts for the stocks of foreign companies held by banks in the companies’ home country.
  4. D) receipts for shares of foreign companies held by U.S. broker-dealers.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

11) Assume the foreign exchange rate for the euro was U.S. $1.00 = .91 euro last month. This month, the exchange rate is U.S. $1.00 = .88 euro. This information indicates that over the past month the

  1. A) U.S. dollar remained unchanged relative to the euro.
  2. B) U.S. dollar appreciated relative to all foreign currencies.
  3. C) euro appreciated relative to the dollar.
  4. D) euro depreciated relative to the dollar.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

 

12) Assume the foreign exchange rate for the euro was U.S. $1.00 = .91 euro last month. This month, the exchange rate is U.S. $1.00 = .88 euro.  All things equal, the dollar value of European stocks

  1. A) decreased.
  2. B) increased.
  3. C) stayed the same.
  4. D) would vary depending on the country.

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

 

13) American investors can participate in international stock markets by

  1. A) purchasing shares in a mutual fund that invests in foreign companies.
  2. B) purchasing shares of a U.S. based company such as Coca Cola or McDonald’s with extensive international operations.
  3. C) purchasing ADSs (American Depositary shares).
  4. D) all of the above.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

14) The effects of fluctuating foreign exchange rates may

 

  1. increase a U. S. investor’s rate of return.
  2. decrease a U. S. investor’s rate of return.

III. can be avoided by investing in ADRs.

  1. can be avoided by investing in mutual funds that specialize in foreign stocks.

 

  1. A) I and II only
  2. B) I and III only
  3. C) III and IV only
  4. D) I, II, III and IV

Answer:  A

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

15) Kayla invested $3,000 and purchased shares of a German corporation when the exchange rate was $1.00 = .91 euro. After six months, she sold all of the shares for 3,180 euros, when the exchange rate was $1.00 = .88 euro. No dividends were paid during the time Heidi owned the shares of stock. What is the amount of Kayla’s gain or loss on this investment?

  1. A) $613.64 loss
  2. B) $613.64 gain
  3. C) $497.60 loss
  4. D) $497.60 gain

Answer:  B

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

 

2.5   Learning Goal 5

 

1) After hours markets tend to be less volatile and more liquid than the regular trading sessions.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

2) SEC regulations strictly prohibit trading outside the normal hours of 9:30 A.m. to 4:00 P.M. EST.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

3) The Securities Act of 1933 deals mostly with primary markets.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

 

4) Research indicates that investors are more likely to overreact to news when trading after hours.

Answer:  FALSE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 5

5) Insider trading is the use of nonpublic information about a security to gain a profit.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

6) The Sarbanes-Oxley Act of 2002 strengthens accounting disclosure requirements and ethical guidelines for financial officers.

Answer:  TRUE

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

 

7) Which of the following characteristics apply to trading before and after regular hours?

 

  1. Most after hours trades match a bid price to a corresponding offer price.
  2. Most brokerage firms require individual investors to place only market orders for after-hours trades.

III. Electronic Communications Networks (ECNs) play a key role in after hours trading.

  1. After-hours trading begins at 4:00 P.M. and ends at 9:30 A.M. eastern time.

 

  1. A) II and IV only
  2. B) I, II and III only
  3. C) I and IV only
  4. D) I, III and IV only

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Revised

Learning Goal:  Learning Goal 5

 

8) The Sarbanes-Oxley Act of 2002 focuses on

  1. A) insider trading.
  2. B) IPOs.
  3. C) accounting and other public disclosures of information.
  4. D) regulation of the OTC markets.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

9) Which of the following acts abolished fixed commission schedules?

  1. A) Investment Advisers Act of 1940
  2. B) Investment Company Act of 1940
  3. C) Securities Acts Amendments of 1975
  4. D) Insider Trading and Fraud Act of 1988

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

 

10) An act explicitly defining and prohibiting insider trading was passed in

  1. A) 1934.
  2. B) 1975.
  3. C) 1988.
  4. D) 2002.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Revised

Learning Goal:  Learning Goal 5

 

11) Which of the following are provisions of the Sarbanes-Oxley Act of 2002?

 

  1. an oversight board to monitor the accounting industry
  2. tougher penalties for executives who commit corporate fraud

III. stricter prohibitions against insider trading

  1. guidelines for analysts conflicts of interest

 

  1. A) II and IV only
  2. B) I, II and III only
  3. C) I and IV only
  4. D) I, II and IV only

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

12) The Consumer Financial Protection Agency was established by

  1. A) Investment Company Act of 1940.
  2. B) The Securities Acts Amendments of 1975.
  3. C) The Sarbanes-Oxley Act of 2002.
  4. D) The Dodd-Frank Act of 2010.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

13) Which of the following practices is prohibited by the Insider Trading and Fraud Act of 1988?

  1. A) the use of nonpublic information to make profitable stock transactions
  2. B) selling of stock by officers of the company
  3. C) the granting of stock options to corporate executives in lieu of salaries
  4. D) private sales of stock between executives of the company

Answer:  A

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

14) Crossing markets are those that

  1. A) trade foreign securities.
  2. B) conduct transactions between institutional and individual traders.
  3. C) fill only the orders which have opposing orders at identical prices.
  4. D) conduct business at locations in varying time zones.

Answer:  C

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

15) The Securities Exchange Act of 1934

  1. A) requires full disclosure of information on all new security issues.
  2. B) authorized the SEC to regulate mutual funds.
  3. C) established trade associations such as the NASD.
  4. D) created the SEC as the regulator of the securities exchanges.

Answer:  D

Learning Outcome:  F-01 Describe the different financial markets and the role of the financial managers

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

 

2.6   Learning Goal 6

 

1) Margin trading requires the borrowing of securities.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

2) Margin trading will magnify losses on a percentage basis.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

3) Short selling requires the borrowing of securities.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

4) Short selling involves the sale of depreciated stock at a price below the amount borrowed on margin.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

5) When a person sells a common stock short, she or he is betting that the price of the stock will fall.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

6) Losses on a stock purchase are limited to the price of the stock, but losses on a short sale are potentially unlimited.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

7) The minimum initial margin requirement for both long and short positions is set by the Federal Reserve Board and currently is 50%.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

8) A brokerage firm may set a higher margin requirement than that set by the Federal Reserve Board.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

9) The purchase of stock with cash in the hope of earning a capital gain is known as taking a

  1. A) long position in the stock.
  2. B) short position in the stock.
  3. C) long, margined position in the stock.
  4. D) short, margined position in the stock.

Answer:  A

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

10) Which one of the following statements about margin trading is correct?

  1. A) The Federal Reserve sets the minimum margin requirement for margin trading.
  2. B) If Fred buys $1,000 worth of stock using 60% margin, he will need to pay $400 in cash to make the purchase.
  3. C) Purchasing stocks on margin is less risky than purchasing stocks by paying cash for the entire purchase.
  4. D) Margin trading increases the potential profits while lowering the potential losses on a percentage basis.

Answer:  A

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

11) Which one of the following statements about margin trading is correct?

  1. A) The Securities Exchange Commission sets the minimum margin requirement for margin trading.
  2. B) If Fred buys $1,000 worth of stock using 60% margin, he will need to pay $600 in cash to make the purchase.
  3. C) Margin traders are willing to accept lower return to reduce their risk.
  4. D) Margin traders are pessimistic about the future price of the stock.

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

12) Megan bought 200 shares of stock at a price of $10 a share. She used her 70% margin account to make the purchase. Megan sold her stock after a year for $12 a share. Ignoring margin interest and trading costs, what is Megan’s return on investor’s equity for this investment?

  1. A) 67%
  2. B) 29%
  3. C) 14%
  4. D) 10%

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

13) Joseph bought 100 shares of stock at a price of $24 a share. He used his 70% margin account to make the purchase. Joseph sold his stock after a year for $20 a share. Ignoring margin interest and trading costs, what is Joseph’s return on investor’s equity for this investment?

  1. A) -17%
  2. B) -24%
  3. C) 24%
  4. D) -56%

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

14) Michael purchased 1000 shares of stock at a price of $16 a share. He utilized his 50% margin account to make the purchase. What is Michael’s initial equity in this investment?

  1. A) -$16,000
  2. B) $16,000
  3. C) $8,000
  4. D) -$8,000

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

15) Jessica purchased 200 shares of stock at $38 using her 70% margin account. Her maintenance margin is 40%.  Jessica has no other securities in her account. At what price will she receive a margin call?

  1. A) $26.60
  2. B) $19.00
  3. C) $11.40
  4. D) $7.60

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

16) A restricted account is defined as a margin account wherein the equity is

  1. A) less than the initial margin amount.
  2. B) greater than the initial margin amount.
  3. C) less than the maintenance margin amount.
  4. D) greater than the maintenance margin amount.

Answer:  A

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

17) Emily bought 200 shares of ABC Co. stock for $29.00 per share on 60% margin. Assume she holds the stock for one year and that her interest costs will be $80 over the holding period. Ignoring commissions, what is her percentage return (loss) on invested capital if the stock price went down 10%?

  1. A) -32%
  2. B) -19%
  3. C) -16%
  4. D) -10%

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 6

 

18) Gerry bought 100 shares of stock for $30.00 per share on 70% margin. Assume Gerry holds the stock for one year and that his interest costs will be $45 over the holding period. Gerry also received dividends amounting to $0.30 per share. Ignoring commissions, what is his percentage return on invested capital if he sells the stock for $34 a share?

  1. A) 106.17%
  2. B) 20.48%
  3. C) 18.33
  4. D) 9.16%

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

19) Justin just made a margin purchase of 100 shares of DEF Corp. for $22.50 per share. The initial margin is 70%. The maintenance margin is 30%. How low can the price of each share of DEF be before Justin will have to add equity to his account?

  1. A) $4.73
  2. B) $5.25
  3. C) $6.75
  4. D) $9.64

Answer:  D

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

20) Maintenance margin is the

  1. A) minimum amount of loan that can be used for margin trading.
  2. B) initial amount of equity required for a margin purchase.
  3. C) minimum amount of equity that an investor can have to avoid a margin call.
  4. D) amount of additional funds that need to be added to an account to meet minimal equity requirements.

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

21) If an investor does not respond to a margin call, the broker will

  1. A) sell enough of the investor’s holdings that the margin account can be closed.
  2. B) sell some of the investor’s holdings to cover the margin call.
  3. C) notify the Federal Reserve so they can cover the call.
  4. D) sell all of the investor’s holdings and close their brokerage account.

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

22) Which one of the following is a major advantage of margin trading?

  1. A) increase in potential diversification
  2. B) increase in potential profits on a percentage basis
  3. C) possibility of increased gains on a dollar basis
  4. D) interest free loans

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

23) Which of the following are characteristics of short selling?

 

  1. borrowing shares of stock from a brokerage firm or other investors
  2. selling shares of stock you do not own

III. betting the stock price will increase

  1. limiting losses per share to the price at which the stock was sold

 

  1. A) I and II only
  2. B) III and IV only
  3. C) I, II and IV only
  4. D) I, II, III only

Answer:  A

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

24) Jocelyn sells short 1000 shares of JKLO stock at $31.25 per share and six months later purchases the shares at $29.00 each. Ignoring margin interest and brokerage fees, Nancy will

  1. A) earn a total profit of $3,125.
  2. B) lose a total of $2,900.
  3. C) earn a total profit of $2,250.
  4. D) Lose a total of $2,250.

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

25) Which of the following statements about short selling is (are) true?

 

  1. Short selling requires an initial margin deposit.
  2. Short sellers begin a transaction with a sale and end it with a purchase.

III. Short sellers profit when the stock prices rises.

  1. Short selling can be a risky strategy.

 

  1. A) IV only
  2. B) I and II only
  3. C) I, II and IV only
  4. D) I, II, III and IV

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

26) Last week, Seward Company stock was selling at $66 a share when Ryan sold 300 shares of the stock short. Today Ryan bought 300 shares of the same stock at a price of $70.00 share to cover his position. Ignoring trading costs, what is the dollar return on Ryan’s investment?

  1. A) $1,200
  2. B) -$400
  3. C) $400
  4. D) $-1,200

Answer:  D

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

27) Aria has heard a rumor that a major food company will be forced to recall millions of jars of peanut butter. due to contamination  If the rumors are true, the company’s stock price will decline sharply. Which one of the following strategies would allow Jennifer to earn a profit if the rumor proves to be true?

  1. A) Take a long position in the stock today.
  2. B) Sell the stock short today.
  3. C) Buy the stock on margin today.
  4. D) Take a long position in the stock one month from today.

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 6

 

Fundamentals of Investing, 13e (Smart)

Chapter 4   Return and Risk

 

4.1   Learning Goal 1

 

1) Investors can be confidently predict future returns on an investment by studying its past performance.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

2) An investment that has earned a high rate of return over the last 5 years will not necessarily continue to perform well in the future.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

3) Meaningful measures of an investment’s return must consider both income and capital gains.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

4) In response to the same external force, the return on one investment may increase while the return on another investment may decrease.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

5) In the short term, stock prices tend to rise as inflation rises.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

 

6) When investors expect higher inflation, they will generally require higher rates of return.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

7) A capital loss is computed by

  1. A) subtracting the original cost of an investment from the proceeds received from the sale of that investment minus any income from the investment.
  2. B) subtracting the original cost of an investment from the proceeds received from the sale of that investment plus any income from the investment.
  3. C) subtracting the proceeds received from the sale of an investment from the original cost of the investment.
  4. D) subtracting the original cost of an investment from the proceeds received from the sale of that investment.

Answer:  D

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

8) Rational investor’s are motivated to purchase an asset because of its

  1. A) expected returns.
  2. B) past returns.
  3. C) emotional benefits.
  4. D) all of the above.

Answer:  A

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 1

 

9) The most predictable component of stock returns is

  1. A) capital gains.
  2. B) capital losses.
  3. C) inflation adjusted return.
  4. D) dividend income.

Answer:  D

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

 

10) Kelly bought a stock at a price of $22.50. She received a $1.75 dividend and sold the stock for $24.75. What is Kelly’s capital gain on this investment?

  1. A) $4.00
  2. B) $3.75
  3. C) $2.25
  4. D) $1.75

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

11) Ashley purchased a stock at a price of $27 a share. She received quarterly dividends of $0.75 per share. After one year, Ashley sold the stock at a price of $29.25 a share. What is her percentage holding period return on this investment?

  1. A) 10.3%
  2. B) 11.1%
  3. C) 17.9%
  4. D) 19.4%

Answer:  D

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

12) Inflation tends to have a particularly negative impact on the price of

  1. A) real estate.
  2. B) bonds.
  3. C) gold.
  4. D) crude oil.

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

 

 

13) Historically, what is the correct ranking of the following securities from lowest rate of return to the

highest?

  1. A) Short-term government bills, long-term government bonds, stocks.
  2. B) Long-term government bonds, short-term government bills, stocks.
  3. C) Stocks, short-term government bills,long-term government bonds.
  4. D) Historical returns do not exhibit a consistent pattern.

Answer:  A

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 1

 

14) Which of the following internal characteristics should cause investors to expect the highest rate of return?

  1. A) a steady record of past dividends
  2. B) interest and principal guaranteed by the U.S. government
  3. C) a record of excellent management and consistent dividend payments
  4. D) poor management and excessive use of debt financing

Answer:  D

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 1

15) Which of the following investments may be impacted by government actions?

  1. A) stocks
  2. B) corporate bonds
  3. C) government bonds
  4. D) all of the above

Answer:  D

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 1

 

16) Over the long term, which one of the following has historically had the lowest risk and lowest average annual rate of return?

  1. A) common stock
  2. B) long-term government bonds
  3. C) real-estate
  4. D) corporate bonds

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 1

 

4.2   Learning Goal 2

 

1) The financial concept of time value of money is dependent upon the opportunity to earn interest over time.

Answer:  TRUE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

2) Compound interest is interest paid not only on the initial investment but also on any interest earned after the initial investment.

Answer:  TRUE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

3) An investor who requires a 7% rate of return should be willing to pay $934.58 now to receive $1,000 at the end of one year.

Answer:  TRUE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

4) The holding period return includes the time value of money.

Answer:  FALSE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

5) If the discount rate is appropriate for the level of risk, a satisfactory investment will have a present value of benefits equal to or greater than than the present value of costs.

Answer:  TRUE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

6) An investment’s internal rate of return does not depend on the rate at which income from the investment is reinvested.

Answer:  FALSE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

7) The time value of money concept best supports the idea of

  1. A) the sooner the better.
  2. B) better late than never.
  3. C) a bird in hand is worth two in the bush.
  4. D) good things come to those who wait.

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

8) The present value of $10,000 discounted at 5% per year and received at the end of 5 years is

  1. A) $10,000/1.25.
  2. B) $10,000(1.05)5.
  3. C) $10,000/(1.05)5.
  4. D) $10,000 (1.05)1/5.

Answer:  C

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

9) Bob’s house has doubled in value since he bought it 30 years ago. The house’s value has increased by an annual rate of

  1. A) 2.34%.
  2. B) 3.33%.
  3. C) 6.67%.
  4. D) 100%.

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

 

10) Which one of the following statements is correct concerning the time value of money?

  1. A) The future value of $1 at the end of two years is equal to $1 plus the first year’s interest times 1 plus the annual interest rate.
  2. B) As the interest rate increases for any given year, the future value interest factor will decrease.
  3. C) The future value of $1 decreases with the passage of time.
  4. D) The future value interest factor is equal to zero if the interest rate is zero.

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

11) Christopher invests $400 today at a 4% rate of return which is compounded annually. What is the future value of this investment after four years?

  1. A) $342
  2. B) $416
  3. C) $464
  4. D) $468

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

12) Roy is going to receive a payment of $5,000 one year from today. He earns an average of 6% on his investments. What is the present value of this payment?

  1. A) $4,717
  2. B) $4,821
  3. C) $5,000
  4. D) $5,300

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

13) Which of the following statements are correct concerning the present value of $1.00 five years from today discounted at 5%?

 

  1. The present value is equal to $1.00 divided by 1.05 to the 5th power.
  2. If the discount rate were less than 5%, the present value would be smaller.

III. If the discount rate were more than 5%, the present value would be smaller.

  1. If the $1.00 were to be received 6 years from today, the present value would be larger.

 

  1. A) I and II only
  2. B) I and III only
  3. C) II and III only
  4. D) I, III and IV only

Answer:  B

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

14) Camille purchased a bond 5 years ago for $1,050.  The bond paid $50 in annual interest and returned the $1,000 principal at the end of the fifth year.  Camille used the interest payment to pay for college textbooks.

  1. A) Her internal rate of return was exactly than 5%.
  2. B) Her internal rate of return was greater than 5%.
  3. C) Her internal rate of return was less than 5%.
  4. D) Her internal rate of return cannot be determined.

Answer:  C

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

15) When calculating the present value of either a future single sum or a future annuity, the applicable interest rate is usually called the

  1. A) yield to maturity.
  2. B) compound interest rate.
  3. C) internal rate of return.
  4. D) discount rate.

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

16) When the rate of return is equal to the discount rate

  1. A) the present value of an investment’s benefits must be greater than its cost.
  2. B) the cost of an investment equals the sum of its benefits.
  3. C) the cost of an investment equals the future value of its benefits.
  4. D) the cost of an investment equals the present value of its benefits.

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

17) If the present value of an investment’s benefits equals the present value of the investment’s costs, then the investor would earn a

  1. A) return equal to the discount rate.
  2. B) negative rate of return.
  3. C) 0% rate of return.
  4. D) return greater than the discount rate.

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

18) The present value of $1,000 discounted at the rate of 5% per year, to be received at the end of 3 years is equal to

  1. A) $1,000/(1.03)5.
  2. B) $1,000/(1.05)3.
  3. C) $1,000 × (1.05)3.
  4. D) $1,000 – ($1,000) × .03 × 5.

Answer:  B

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

 

19) Zachary has purchased an investment that he expects to produce income of $3,000 at the end of the first year and $4,000 at the end of the second year.  If he requires an 8% rate of return compounded annually, what is the maximum amount that he can pay and still earn the required rate of return?

Answer:  $3,000/(1.08)1 + $4,000/(1.08)2 = $6,207.13

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

20) Zachary has purchased an investment that he expects to produce income of $3,000 at the end of the first year and $4,000 at the end of the second year.  If he pays $5,800 for this investment, what is the internal rate of return?

Answer:  $3,000/1.128 + $4,000/1.1282 = $5,800 Answer is approximately 12.8%.  A more exact answer found with Excel is 12.8414%

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

4.3   Learning Goal 3

 

1) The return that fully compensates for the risk of an investment is called the risk-free rate of return.

Answer:  FALSE

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

2) The required return on a risky investment includes a real rate of return, an inflation premium and a risk premium.

Answer:  TRUE

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

3) If the risk-free rate of return is less than the inflation rate, the real rate of return is negative.

Answer:  TRUE

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

4) It is not possible for the nominal risk-free rate of return to be lower than the rate of inflation.

Answer:  FALSE

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

5) Short-term U. S. Treasury bills are yielding 0.5%.  The expected inflation rate is 2%.  Therefore, the real rate of interest must be negative 1.5%.

Answer:  TRUE

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 3

 

6) One reason that the holding period return should not be used to compare long-term investments is that it does not consider the time value of money.

Answer:  TRUE

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

7) The holding period return is especially useful comparing investments with unequal holding periods.

Answer:  FALSE

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

8) The closest approximation to the real, risk-free rate of interest is

  1. A) the short-term Treasury bill rate plus the inflation rate.
  2. B) the short-term Treasury bill rate minus the inflation rate.
  3. C) the 10 year Treasury bond rate minus the inflation rate.
  4. D) the 10 year Treasury bond rate minus the 1 year Treasury bill rate.

Answer:  B

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

9) The risk-free rate is equal to the real rate of return plus

  1. A) an expected inflation premium.
  2. B) a risk premium.
  3. C) both an inflation and a risk premium.
  4. D) the prevailing prime rate.

Answer:  A

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

10) The markets in general are paying a 2% real rate of return. Inflation is expected to be 3%. ABC stock commands a 6% risk premium. What is the expected rate of return on ABC stock?

  1. A) 2%
  2. B) 5%
  3. C) 8%
  4. D) 11%

Answer:  D

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

11) The required rate of return on the Cosmos Corporation’s common stock is 10%, the current real rate of return in the market is 1%, and the inflation rate is 3%. In this case, the risk premium associated with Cosmos stock is

  1. A) 5%.
  2. B) 6%.
  3. C) 7%.
  4. D) 8%.

Answer:  B

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

12) Which one following will lower required rates of return?

  1. A) higher rates of inflation
  2. B) higher risk premiums
  3. C) lower rates of inflation
  4. D) lower dividend yields

Answer:  C

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

13) The required return on Beta stock is 14%. The risk-free rate of return is 4% and the real rate of return is 2%. How much are investors requiring as compensation for risk?

  1. A) 8%
  2. B) 10%
  3. C) 12%
  4. D) 14%

Answer:  B

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

14) Which of the following is(are) issue characteristics of an investment?

 

  1. type of investment such as stocks or bonds
  2. financial condition of the issuer

III. coupon or dividend payments

  1. time to maturity

 

  1. A) I and II only
  2. B) III only
  3. C) I, III and IV only
  4. D) I, II, III and IV

Answer:  C

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  6 Diverse and multicultural work environments.

Question Status:  Revised

Learning Goal:  Learning Goal 3

 

15) A holding period return is calculated by adding the current income to the capital gains and dividing this sum by the

  1. A) average investment value.
  2. B) beginning investment value.
  3. C) total income received.
  4. D) selling price of the investment.

Answer:  B

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

16) Lauren purchased a stock for $28 a share and sold it six months later for $31. While she owned the stock, Lauren received two quarterly dividends of $0.35 per share. Brittany’s holding period return on this stock is

  1. A) 13.2%.
  2. B) 10.7%.
  3. C) 11.9%.
  4. D) 26.4%.

Answer:  A

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

17) In which of the following circumstances would it be most appropriate to use the holding period return?

  1. A) to compare the capital gains on a house held for 8 years and a mutual fund held for 6 years
  2. B) to compare the calendar year performance of stocks purchased in March to stocks purchased in September
  3. C) to compare the dividend yield of stocks to the interest rate on bonds
  4. D) to compare the performance of several stocks, each of which was held throughout an entire year

Answer:  D

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

18) Christopher purchased 200 shares of ABC stock at $21.25 per share. After nine months, he sold all of his shares at a price of $19.88 a share. Christopher received a total of $0.55 per share in dividends during the time he owned the shares. Jake’s holding period return is

  1. A) -6.4%.
  2. B) -3.9%.
  3. C) 2.6%.
  4. D) 9.7%.

Answer:  A

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

19) The holding period return (HPR) can appropriately be used to

  1. A) compare the yield on investments held for any time period.
  2. B) compare returns among investments that are held for the same period of time.
  3. C) isolate realized capital gains.
  4. D) determine the required reinvestment rate for long-term investments.

Answer:  B

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

20) Jason purchased ABC stock at $40 per share and DEF stock at $35 per share on the same day in 2015.  Exactly 6 months later, the ABC stock is worth $42.00 per share and has not paid a dividend while the DEF stock is worth $36 per share and has paid 2 quarterly dividends of $0.50 each.  The holding period returns are

  1. A) ABC, $2.00 and DEF $2.00.
  2. B) ABC 5% and DEF 2.9%.
  3. C) ABC 5% and DEF 5.7%.
  4. D) The holding period return cannot be determined because we do not know the discount rate.

Answer:  C

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 3

 

21) Briefly explain the holding period return (HPR) and give several characteristics of this measure.

Answer:  HPR is the total return earned from holding an investment for a specified period of time.

HPR =

(a)  HPR takes into account both current income and capital gains.

(b)  HPR should be used for holding periods of one year or less.

(c)  HPR does not take into account the time value of money.

(d) HPR offers a relative comparison of investments of different sizes.

(e)  HPR indicates the return per invested dollar.

(f)  HPR can have a positive, a zero, or a negative value.

Learning Outcome:  F-05 Explain what determines interest rates and how changes in rates influence investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 3

 

 

4.4   Learning Goal 4

 

1) The internal rate of return is the rate of return that causes a project to have a zero net present value.

Answer:  TRUE

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

 

2) The internal rate of return on an investment is the discount rate that produces a present value of benefits greater than the cost of the investment.

Answer:  FALSE

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

3) The internal rate of return is a less meaningful measure of an investment’s performance than holding period return if the holding period is other than 1 year.

Answer:  FALSE

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

 

4) The present value of an investment must be computed by discounting cash flows at the internal rate of return.

Answer:  FALSE

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

 

5) When using a financial calculator or electronic spreadsheet to calculate an investment’s yield, the amount invested is expressed as a negative number.

Answer:  TRUE

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

6) The internal rate of return is the correct method to use when an investor wants to determine an investment’s average annual yield.

Answer:  TRUE

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

7) If you own an investment providing periodic returns, your actual yield on the investment will depend on the reinvestment rate you are able to obtain.

Answer:  TRUE

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

8) A suitable investment should have an internal rate of return equal to or greater than its required rate of return.

Answer:  TRUE

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 4

9) When computing an investment’s internal rate of return using a financial calculator or spreadsheet such as Excel, which of the following should be entered as a negative number?

  1. A) the number of time periods
  2. B) dividend or interest payments
  3. C) the price at which the investment is sold
  4. D) the initial cost of the investment

Answer:  D

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 


Table 1

  A B
  1 Year Cash Flow
2 1 $(5,000)
3 2 $4,000
4 3 $3,000

 

10) Given a spreadsheet similar to the one shown in Table 1, the command to compute the internal rate of return would be

  1. A) =RATE(3,B3,B4,B2).
  2. B) =IRR(B2:B4).
  3. C) =IRR(B3:B4)-B2.
  4. D) =TVM(A2:B4).

Answer:  B

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 4

 

11) Six years ago, Miguel invested $3,500. Today his investment is worth $5659. The internal rate of return on this investment is

  1. A) -7.69%.
  2. B) error 5.
  3. C) 8.34%.
  4. D) 10.28%.

Answer:  C

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

12) Alexis bought a stock for $34 a share two years ago. The stock does not pay any dividends. Today she sold the stock for $28.50 a share. What was her internal rate of return on this investment?

  1. A) 9.22%
  2. B) -9.22%
  3. C) 19.30%
  4. D) -8.44%

Answer:  D

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

13) An investment costs $3,500 today. This investment is expected to produce annual cash flows of $1,200, $1,400, $1,300 and $1,100, respectively, over the next four years. What is the internal rate of return on this investment?

  1. A) 8.1%
  2. B) 9.33%
  3. C) 14.6%
  4. D) 16.2%

Answer:  D

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

14) The following investment cash flows have been entered into cells B5 through B9 of an EXCEL spreadsheet. B5 $(5,200 ), B6 $2,100, B7 $1,300, B8 $1,800, B9 $1,200, where $(5,200) is the cost of the investment and the following amounts are cash flows at the end of years one through four.  The correct function for computing the yield on this investment is

  1. A) =irr(B6:B9)+B5.
  2. B) =irr(B5:B9).
  3. C) =rate(4,0,-5200, 1200).
  4. D) =ytm(B5, B6:B9).

Answer:  B

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

15) The Sorka Corp. has paid annual dividends of $0.60, $0.63, $0.65, $0.68 and $0.72, respectively, over the past five years. What is the dividend growth rate?

  1. A) 4.7%
  2. B) 5.2%
  3. C) 5.4%
  4. D) 5.9%

Answer:  A

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

 

16) If a stock is purchased at the beginning of a year, a single dividend is paid at the end of the year and the stock is sold immediately after the dividend has been received.  In this case

  1. A) the internal rate of return is lower than the holding period return.
  2. B) the holding period return. is lower than the internal rate of return.
  3. C) it is not possible to calculate the internal rate of return.
  4. D) the internal rate of return equals the holding period return.

Answer:  D

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

17) Ryan purchased a bond for $980 at the beginning of 2011.  He received annual interest payments of $55 at the end of each year through 2016 when the bond was redeemed at its face value of $1,000.  Compute the yield (internal rate of return) Ryan earned on his bond purchase.

  1. A) 5.50%
  2. B) 5.61%
  3. C) 5.91%
  4. D) .34%

Answer:  C

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

18) Josh purchased 100 shares of XOM at the beginning of 2011.  He received dividends per share of $1.37 (2011), $1.55 (2012), $1.66 (2013), $1.74 (2014), $1.85 (2015).  At the end of 2015, just after receiving the last dividend, he sold the stock for $84.76.  At what rate did the dividends grow from the end of 2011 to the end of 2015?  Assume that all dividends were received at the end of the year.

  1. A) 7.8%
  2. B) 6.2%
  3. C) 13.1%
  4. D) 35%

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

 

 

19) Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2011.  He received dividends per share of $1.37 (2011), $1.55 (2012), $1.66 (2013), $1.74 (2014), $1.85 (2015).  At the end of 2015 just after receiving the last dividend, he sold the stock for $84.76.  What was his average annual rate of return form both dividends and capital gains? (Hint: compute the IRR, assume that all dividends were received at the end of the year.)

  1. A) 9.831%
  2. B) 3.774%
  3. C) 3.423%
  4. D) 4.94%

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Revised

Learning Goal:  Learning Goal 4

 

20) Samantha bought a stock one year ago for $66 a share. She received a total of $2.00 in dividends. Today she sold the stock for $70 a share. Which one of the following statements is correct concerning this investment?

  1. A) Samantha has current income of $6.00.
  2. B) Samantha has a capital gain of $2.00.
  3. C) Samantha has a total return of 9.1%.
  4. D) Samantha has unrealized income of $4 a share.

Answer:  C

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

21) Explain the similarities and differences between the holding period return and the internal rate of return.

Answer:  Both measures take into account total return from both income and capital gains.  The holding period of return does not adjust returns for the length of time that an investment is held.  The internal rate of return computes an average compound annual rate of return and is suitable for comparing investments held for different periods of time.

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

 

22) Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2007.  He received dividends per share of $1.37 (2007), $1.55 (2008), $1.66 (2009), $1.74 (2010), $1.85 (2011).  At the end of 2011, just after receiving the last dividend, he sold the stock for $84.76.  What was his average annual rate of return form both dividends and capital gains? (Hint: compute the IRR, assume that all dividends were received at the end of the year.)

Answer:  Josh’s cash flows on a per share basis were as follows:

 

PV at 4.076%

2007 (beginning)         -$76.63                  -76.63

2007 (end)                   1.37                       1.32

2008 (end)                   1.55                       1.43

2009 (end)                   1.66                       1.47

2010 (end)                   1.74                       1.48

2011 (end)                   1.85 + 84.76          70.93

Total                                                          00.00

 

Josh has earned 4.076% on his investment in XOM.  The solution involves finding the internal rate of return for all cash flows.  The discount rate of 4.076%, which equates the present value of dividends and the 2011 price to the 2007 price can be found by trial and error or more efficiently using a financial calculator. Because the internal rate of return is a percentage, it does not matter whether you use the cash flows for 100 shares or a single share.

Learning Outcome:  F-07 Describe how and when to apply the NPV Rule and alternative decision rules such as IRR and Payback

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 4

 

4.5   Learning Goal 5

 

1) Risk can be defined as uncertainty concerning the actual return that an investment will generate.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

2) Business risk resulting from uncertainty over a firm’s earnings is a concern for stockholders, but not for debt holders.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

3) Lower risk investments are associated with lower expected rates of return.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

4) The reluctance of Congress to tinker with tax rates and deductions has virtually eliminated tax risk for U.S. businesses.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

5) Business risk is the risk associated with the amount of debt financing used by a firm.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

6) Investing in short-term debt decreases exposure to interest rate risk.

Answer:  TRUE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 5

 

7) Investors who limit themselves to risk free and low risk investments can avoid purchasing power risk.

Answer:  FALSE

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

8) Liquidity risk is defined as the risk of

  1. A) having to trade a security in a broad market.
  2. B) not being able to sell an investment conveniently and at a reasonable price.
  3. C) having inflation erode the purchasing power of your investment.
  4. D) having declining price levels affect the reinvestment rate of your current income stream.

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

9) In some markets it may take many months to sell a residential property.  This is an example of

  1. A) business risk.
  2. B) credit risk.
  3. C) market risk.
  4. D) liquidity risk.

Answer:  D

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

10) The stock of Plomb Co. falls sharply on news that its CEO has drowned in a boating accident while on vacation.  This is an example of

  1. A) liquidity risk.
  2. B) event risk.
  3. C) accidental risk.
  4. D) flotation risk.

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

 

11) As gasoline prices fell in 2015, sales of hybrid and electric vehicles dropped sharply.  This is an example of

  1. A) liquidity risk.
  2. B) event risk.
  3. C) business risk.
  4. D) purchasing power risk.

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 5

12) A petroleum refinery in the Gulf region is forced to shut down for several months because of hurricane damage.  This is an example of

  1. A) market risk.
  2. B) speculation.
  3. C) event risk.
  4. D) business risk.

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

13) A business has strong sales and profits, but its stock price falls anyway because stock prices in general are declining.  This is an example of

  1. A) business risk.
  2. B) financial risk.
  3. C) market risk.
  4. D) liquidity risk.

Answer:  C

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 5

 

 

14) Congress considers a bill that would eliminate the mortgage interest deduction for individuals.  For the housing industry, this is an example of

  1. A) tax risk.
  2. B) interest rate risk.
  3. C) business risk.
  4. D) event risk.

Answer:  A

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

15) Which of the following will lower the rate of return on a stock whose price has doubled since you bought it?

  1. A) an increase in the capital gains tax from 15% to 20%
  2. B) an increase in the tax rate on dividend income from 15% to 20%
  3. C) persistently low inflation rates
  4. D) the Federal Reserve acts to lower interest rates

Answer:  A

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  New Question

Learning Goal:  Learning Goal 5

16) Which of the following factors will increase the risk level of an investment?

 

  1. a firm’s decision to use a high percentage of debt financing
  2. an economic situation in which consumer prices are rising at a rapid rate

III. the ability to trade the investment in a broad market rather than in a thin market

  1. unstable currency values

 

  1. A) I and II only
  2. B) I, II and IV only
  3. C) II and IV only
  4. D) I, III and IV only

Answer:  B

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

 

17) Identify and discuss five sources of risk.

Answer:  Students can select five from the following risk sources.

 

 

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

18) Which types of risk can not be avoided by carefully researching a company’s business prospects and financial statements?

Answer:  Market risk is the risk that market forces can affect the return of an individual investment.  Event risk is the risk that an unforeseeable event may have an immediate, significant effect on an investment’s returns.  Tax risk is the possibility that tax laws affecting an investment could change.  All of these risks are caused by factors external to the company, so they cannot be avoided by researching internal factors.  Although not firm related, we could also mention purchasing power risk tied to unanticipated changes in inflation and interest rate risk which could affect stock values.

Learning Outcome:  F-11 Explain the relationship between risk and return in capital markets

AACSB:  8 Application of knowledge (Able to translate knowledge of business and management into practice)

Question Status:  Previous Edition

Learning Goal:  Learning Goal 5

 

 

4.6   Learning Goal 6

 

1) The standard deviation is computed by dividing the sum of the squared deviations by the number of observations.

Answer:  FALSE

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

2) Historical returns are of no use in estimating the risk of an investment.

Answer:  FALSE

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

3) The greater the dispersion around an asset’s expected return, the greater the risk.

Answer:  TRUE

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

4) Investments with lower standard deviations can be expected to produce higher rates of return.

Answer:  FALSE

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

5) Historically speaking, the standard deviation of returns on U.S. Treasury Bills is zero.

Answer:  FALSE

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

6) Most investors are risk averse, meaning they will always be willing to sacrifice higher return if they can avoid risk.

Answer:  FALSE

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

7) Each of the following investments produces the same rate of return. Which one has the greatest amount of risk?

  1. A) investment A with a standard deviation of 4%
  2. B) investment B with a standard deviation of 12%
  3. C) investment C with a standard deviation of 8%
  4. D) investment D with a standard deviation of 19%

Answer:  D

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

8) An investment produced annual rates of return of 5%, 12%, 8% and 11% respectively over the past four years. What is the (sample) standard deviation of these returns?

  1. A) 2.7%
  2. B) 3.2%
  3. C) 3.6%
  4. D) 3.8%

Answer:  B

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

9) An investment produced annual rates of return of 7%, -14%, 20% and 4% respectively over the past four years. What is the standard deviation of these returns?

  1. A) 12.1%
  2. B) 14.0%
  3. C) 1.5%
  4. D) 7.0%

Answer:  B

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 6

 

10) Which of the following choices is in the correct order from less risk to more risk?

  1. A) corporate bonds, certificates of deposit, mutual funds that invest in stock, common stock
  2. B) certificates of deposit, corporate bonds, common stock, mutual funds that invest in stock
  3. C) certificates of deposit, mutual funds that invest in stock, common stock, corporate bonds
  4. D) certificates of deposit, corporate bonds, mutual funds that invest in stock, common stock

Answer:  D

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

11) An investment produced annual rates of return of 4%, 8%, 14% and 6%, respectively, over the past four years. What is the standard deviation of these returns?

  1. A) 3.7%
  2. B) 4.1%
  3. C) 4.3%
  4. D) 4.6%

Answer:  C

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

12) Which of the following statements about the standard deviation are correct?

 

  1. The standard deviation is a measure of relative dispersion.
  2. Standard deviations should be in conjunction with expected returns to compare investments.

III. The standard deviation is calculated by taking the square root of the variance.

  1. The higher the standard deviation of an investment, the lower its risk.

 

  1. A) I and IV only
  2. B) II and III only
  3. C) I, III and IV only
  4. D) I, II and III only

Answer:  D

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

13) The expected rate of return and standard deviations, respectively for four stocks are given below:

 

ABC    9%, 3%

CDE    11%, 9%

FGH    12%, 8%

IJK      14%, 10%

 

Which stock is clearly least desirable?

  1. A) ABC
  2. B) CDE
  3. C) FGH
  4. D) IJK

Answer:  B

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

14) The expected rate of return and standard deviations, respectively for four stocks are given below:

 

OPQ    11%, 8%

RST     11%, 9%

UVW   12%, 10%

XYZ    12%, 8%

 

Which stock is clearly most desirable?

  1. A) OPQ
  2. B) RST
  3. C) UVW
  4. D) XYZ

Answer:  D

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

15) Most investors are risk-averse, which means they

  1. A) refuse to accept any financial risk.
  2. B) invest only in government insured securities.
  3. C) require an increase in return for any increase in risk.
  4. D) gain satisfaction from the excitement of risk.

Answer:  C

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

16) Which of the following should be considered when deciding among alternative investments?

 

  1. time value of money
  2. risks associated with each investment

III. risk free rate of return

  1. personal risk tolerance level

 

  1. A) I and II only
  2. B) III and IV only
  3. C) I, II and IV only
  4. D) I, II, III and IV

Answer:  C

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

17) Explain the relationship between risk, the expected rate of return and the actual rate of return.

Answer:  The higher the risk, real or perceived, of an investment the higher the expected rate of return. The higher the actual risk of an investment, the greater the probability that the actual rate of return will vary significantly from the expected rate of return.

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

 

18) Over the past 4 years, the annual rates of return on stock of Brown & Warren Inc. have been -2%, 4%, 14% and 6%, respectively, over the past four years. Compute the standard deviation of these returns.

Answer:

    rt (rt-avg)2
    -2.00% 0.56%
    4.00% 0.02%
    14.00% 0.72%
    6.00% 0.00%
  sum 22.00% 1.31%
  avg. 5.50%  
   variance   0.44%
  st. dev.   6.61%

 

Learning Outcome:  F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 6

 

4.7   Appendix 4A The Time Value of Money

 

1) Sydney invested $10,000 for an indefinite period at 5% per year.  At the end of each year, she receives a $500 check for interest earned.  This type of account pays simple interest.

Answer:  TRUE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

2) For a given stated rate of interest, a sum compounded monthly will earn more interest than a sum compounded annually.

Answer:  TRUE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

3) An ordinary annuity is defined as an annuity for which the cash flows occur at the beginning of each year or payment period.

Answer:  FALSE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

4) To calculate the interest rate or growth rate using a spreadsheet or financial calculator, the present value and the future value most have opposite signs.

Answer:  TRUE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

5) There is no limit to the increase in the true rate of interest as compounding becomes more frequent.

Answer:  FALSE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

6) When using a financial calculator to compute the present value of a lump sum, the future value is entered as PMT.

Answer:  FALSE

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

 

7) Justin invests $4,000 in a savings account for two years. The account pays 2% interest compounded annually.  How much interest income will Justin earn on this investment?

  1. A) $80.00
  2. B) $81.60
  3. C) $160.00
  4. D) $161.60

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

8) Justin invests $4,000 in a savings account for two years. The account pays 2% interest compounded annually.  How much money will be in the account at the end of the second year?

  1. A) $4,161.60
  2. B) $4,160.00
  3. C) $4,080.00
  4. D) $1,161.60

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

9) Which one of the following is an example of an annuity?

  1. A) the receipt of $50 in January, March, April, June, August, September and December
  2. B) the payment of $259 a month for three consecutive years
  3. C) the payment of $389 in January, $200 in February, and $200 in March
  4. D) the receipt of $100 a month for three months and then $150 a month for two months

Answer:  B

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

 

10) Which is most true of an annual rate of 4% compounded quarterly?

  1. A) It is equivalent to 4.4% paid annually.
  2. B) It is equivalent to 16.99% paid annually.
  3. C) It is equivalent to 1% simple interest paid quarterly
  4. D) It is equivalent to 4.06% paid annually.

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

11) The maximum rate of return that can be earned for a given rate of interest occurs when interest is compounded

  1. A) annually.
  2. B) daily.
  3. C) monthly.
  4. D) continuously.

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

12) If you invest $2,000 at the end of each year for five years and you earn 7% interest compounded annually, how much will you have accumulated at the end of the fifth year?

  1. A) $10,700
  2. B) $11,501
  3. C) $12,307
  4. D) $14,026

Answer:  B

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

 

13) Taylor has saved $400 at the end of every month for the last 4 years with the intention of paying cash for a new car.  She has earned a fixed annual rate of 4% over the 4 year period; interest is compounded monthly.  How much can she pay for her new car at the end of the fourth year?

  1. A) $20,784
  2. B) $55,705
  3. C) $17,716
  4. D) $22,272

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

14) Assume that $100 is deposited at the end of each year for five years at 10% compound interest and that no withdrawals are made over the five-year period. Based on this data, which one of the following statements is correct?

  1. A) The future value will be $550.
  2. B) The present value can be determined by computing the present value of $500 in five years at 10%.
  3. C) The present value can be determined by computing the present value of a $100 ordinary annuity for five years at 10%.
  4. D) The present value will be $500.

Answer:  C

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

15) David has purchased an investment that he expects to produce an annual cash flow of $3,000 for five years. He requires an 8% rate of return compounded annually. What is the maximum amount that David can pay and still earn the required rate of return?

  1. A) $19,008
  2. B) $15,000
  3. C) $14,764
  4. D) $11,978

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

 

16) Jeremy purchased 100 shares of FB for $19 per share in September 2012 and sold them 3 years later at $91 per share.  At what annual rate did the value of his investment grow?

  1. A) about 95%
  2. B) about 48%
  3. C) about 69%
  4. D) about 12%

Answer:  C

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  New Question

Learning Goal:  Learning Goal 2

 

17) To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, you should enter the following variables into a financial calculator.

  1. A) N=3, i=5, PMT=1000
  2. B) N=3, i=5, FV=3000
  3. C) N=3, i=15, PMT=1000
  4. D) N=1, i=5, PMT=3000

Answer:  A

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

18) To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, you should use which of the following EXCEL commands?

  1. A) ANN
  2. B) TVM
  3. C) RATE
  4. D) PV

Answer:  D

Learning Outcome:  F-03 Explain the process of valuing costs and benefits and show the relationship between interest rates and the time value of money

AACSB:  3 Analytical thinking

Question Status:  Previous Edition

Learning Goal:  Learning Goal 2

 

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