Module 6: Investment Basics and Strategies

systematic risk

A general risk component representing the variability of a stock's total return as it directly relates to overall movements in the general economy is known as

making an initial public offering (IPO).

A privately held company may go public through A) a venture capitalist investing in the company. B) passing control of the company to another family member. C) selling the company. D) making an initial public offering (IPO).

high annual expenses (Most, but not all, ETFs have low annual expense ratios.)

All of these are advantages of investing in exchange-traded funds (ETFs) except A) diversification. B) marketable. C) tax efficient. D) high annual expenses.

guarantee the portfolio will achieve a positive rate of return. (An investment policy statement is a written document that sets forth a client's objectives and certain limitations on the investment manager, and provides a means for evaluating investment performance. This statement cannot guarantee the portfolio will achieve a positive rate of return.)

An effective investment policy statement should accomplish all of these except A) place limitations on the investment manager. B) provides a mean for evaluating investment performance. C) guarantee the portfolio will achieve a positive rate of return. D) set forth the client's objectives.

unsystematic risk that includes the firm's ability to make a profit.

Business risk is a type of

high portfolio turnover.

Each of these is an advantage of investing in mutual funds except A) professional management. B) high portfolio turnover. C) pooling of funds. D) diversification.

Jack and Krissy, ages 65 and 63, conservative risk tolerance, need for liquidity and safety of principal (Investors seeking diversification, liquidity, and safety of principal are the best candidates for U.S. Treasury bills. In this case, the best choice is Jack and Krissy.)

For which of the following investors would U.S. Treasury bills be most appropriate? A) Lucy, age 54, divorced, moderate to aggressive risk tolerance, need for retirement funding in 11 years, provides some financial support for her 78-year-old mother B) Alisha and Sergei, ages 43 and 41, moderate risk takers, need for college funding in eight years for their 10-year-old daughter, Megan C) Jack and Krissy, ages 65 and 63, conservative risk tolerance, need for liquidity and safety of principal D) Rashaan, age 25, single, no dependents, aggressive risk tolerance, need for growth and speculation

Fund W because it has a higher risk-adjusted return. (The risk-adjusted return is calculated by taking the average return and dividing by beta. Fund T 7.5 / 1.1 = 6.82%, Fund W 6.8 / 0.9 = 7.56%. The best choice is the fund with the highest risk-adjusted return, which is Fund W.)

Fund T has an average return of 7.5% and a beta of 1.1. Fund W has an average return of 6.8% and a beta of 0.9. Which fund should you purchase and why?

650,000 (Fred has $200,000 of coverage on his individual savings account, $250,000 of coverage on the traditional IRA, and $200,000 of coverage on the joint account, for a total of $650,000.)

How much FDIC insurance coverage does Fred have for his accounts at the bank? Savings $200,000 Traditional IRA $300,000 CDJoint w/spouse $400,000

BBB (An investment-grade bond is a bond rated BBB- or higher by the Standard & Poor's rating service. Generally, this type of bond is of high quality with limited risk of default by the issuer.)

Jason wants to purchase a bond that will provide him a steady income with low default risk. As a result, he wishes to purchase an investment-grade bond through his stockbroker. Among these choices, what would be the lowest bond rating by Standard & Poor's that would still be considered investment grade?

Real Estate Investment Trust (REIT)

Jordan and Pat, ages 45 and 43 respectively, would like to diversify their portfolio. They are considering real estate as a possible alternative. Which of these investments would offer the couple the opportunity to participate indirectly in the real estate market?

4.32% (Set calculator for 2 P/YR, END mode, C ALL PV = −1,035 FV = 1,000 PMT = 23.75 (4.75% × 1,000 / 2) 10, DOWNSHIFT, N (20 compounding periods) Solve for I/YR = 4.3154, or 4.32%)

Leslie purchased a 10-year bond with an annual coupon rate of 4.75% paid semiannually. The bond has a current market price of $1,035. What is the bond's yield to maturity (YTM)?

2040 target date fund (A target date fund is a fund of funds that is made up of other mutual funds. This type of fund would be diversified and have both stock and bond funds, and would enable Lorenzo to have just one fund to accomplish his objective.)

Lorenzo, age 42, has a 401(k) plan and is unsure of where to invest. He wants a diversified portfolio of both stocks and bonds but has no idea about which funds to choose and how much to put into each fund. He plans to retire in about 19 years and only wants to choose one fund. Given Lorenzo's situation, which of these funds available in his 401(k) would be the best choice?

The current yield is 3.53% ($35 / $992).

Mike owns a corporate bond that is currently trading at $992. The annual interest (coupon) payment is $35 per year. What is the current yield of the bond?

4.25%. (Do the tax-adjusted return first and then the inflation-adjusted return. Tax-adjusted return: 0.09 × (1 - 0.25) = 0.0675 = 6.75%; tax- and inflation-adjusted return: [(0.0675 + 1) / 1.024] - 1 = (1.0675 / 1.024) - 1 = 1.0425 - 1 = 0.0425, or 4.25%.)

Nefeli has earned 9% on her five-year investment to buy a car. She is in a 22% federal and a 3% state marginal income tax bracket. The inflation rate has averaged 2.4% over the past five years. What is her tax- and inflation-adjusted return?

dividends and capital appreciation

Returns from common stock can be in the form of

Money market mutual funds are considered a liquid asset. (Corporate bonds, REITs, and jewelry are not easily sold and may be subject to a loss in principal; thus, they are not considered liquid.)

Which of the following assets is considered liquid? A) Corporate bonds B) REITs C) Jewelry D) Money market mutual funds

Event (Exchange rate, interest rate, and purchasing power risks are all types of systematic risk. Event risk, a type of unsystematic risk, is the possibility that a security will be affected by an unanticipated and damaging event.)

Which of the following is NOT a type of systematic risk? A) Interest rate B) Event C) Exchange rate D) Purchasing power

Asset allocation (The three main possible objectives for a mutual fund are striving for income, capital appreciation, or capital preservation. Asset allocation refers to how assets are invested and is relevant regardless of a mutual fund's objective.)

Which of the following is NOT one of the three main investment mutual fund objectives? A) Capital preservation B) Asset allocation C) Capital appreciation D) Income

Risk tolerance (The constraints are liquidity needs, time horizon, taxes, legal and regulatory factors, and unique needs and preferences. Risk tolerance is included in the investment objectives of the policy statement, not in the constraints.)

Which of the following is least likely to be considered a constraint when preparing an investment policy statement? A) Tax concerns B) Liquidity needs C) Legal and regulatory factors D) Risk tolerance

1,2, and 3

Which of the following rights do owners of common stock normally have? 1. Voting rights 2. Dividend rights 3. Preemptive rights

If a bond is issued when interest rates are at 8%, and interest rates decrease to 7%, the bond would then be selling at a premium. (There is an inverse relationship between bond prices and interest rates. If interest rates go down, the bond price goes up, and the bond would sell at a premium, not a discount. A zero-coupon bond usually trades at a discount.)

Which of the following statements about bond pricing is CORRECT? A) A zero-coupon bond always trades at a premium. B) If a bond is issued when interest rates are at 7%, and interest rates decrease to 6%, the bond would then be selling at a discount. C) If a bond is issued when interest rates are at 8%, and interest rates decrease to 7%, the bond would then be selling at a premium. D) If a bond is issued when interest rates are at 5%, and interest rates increase to 6%, the bond would then be selling at a premium.

Standard deviation is a measure of the dispersion of returns around the mean.

Which of the following statements concerning standard deviation is CORRECT? A) The greater the standard deviation, the greater the possibility for small future gains. B) The narrower the standard deviation, the greater the risk. C) Standard deviation is a measure of the dispersion of returns around the mean. D) Standard deviation is a measure of central tendency.

This strategy of buying and holding investments minimizes transaction costs in the buying and selling of securities.

Which of the following statements concerning the buy-and-hold investment strategy is CORRECT? A) This strategy of buying and holding investments minimizes transaction costs in the buying and selling of securities. B) This strategy guarantees the investor will have positive returns over the long term. C) An investor using the buy-and-hold strategy would likely miss out on upswings in the market. D) The buy-and-hold strategy is considered an active investment strategy.

Revenue Bond (Revenue bonds are issued by municipalities and backed by a specific project, such as a toll road or hospital. CDs are issued by banks and credit unions. Mortgage-backed securities are issued by federal agencies, not state municipalities. Savings bonds are issued by the federal government.)

Which of the following types of debt is issued by municipalities? A) Savings bonds B) CDs C) Mortgage-backed securities D) Revenue bonds

Illiquidity

Which of these is a disadvantage of investing in real estate? A) Illiquidity B) Tax advantages C) Leverage D) Inflation hedge

Unsystematic risk

Which of these is the risk that can be eliminated with a well-diversified portfolio? A) Purchasing power risk B) Interest rate risk C) Systematic risk D) Unsystematic risk

Pools of mortgages are put together to create an MBS.

Which of these statements about mortgage-backed securities (MBSs) is CORRECT? A) The holder of the MBS will receive only return of principal each month. B) Pools of mortgages are put together to create an MBS. C) The holder will receive the same payment amount every month. D) The holder of the MBS will receive only interest each month.

There are numerous no-load funds with various investment styles and objectives. (There are numerous types of no-load mutual funds with various investment styles and objectives. A no-load mutual fund is one that does not have any sales charges applied when it is purchased. All mutual funds have operating expenses. No-load funds may charge a redemption fee to discourage short-term trading in the fund's shares. No-load funds are not always the best choice for investors.)

Which of these statements about no-load mutual funds is CORRECT? A) No-load funds are always the best choice for investors. B) There are numerous no-load funds with various investment styles and objectives. C) All no-load funds charge a redemption fee. D) No-load means the fund does not have any operating expenses.

Inflation may be increasing in the coming years. (Rising inflation would be considered a threat to a client's financial plan. Unrealistic goals for the amount of saving and investing would be considered a weakness. Lower housing prices make purchasing an affordable home more likely would be considered an opportunity. Your client's net worth being reasonable for their age would be considered a strength.)

Which one of these would be identified as a threat when developing a SWOT analysis for a client? A) Inflation may be increasing in the coming years. B) Lower housing prices make purchasing an affordable home more likely. C) Unrealistic goals for the amount of saving and investing. D) The client's net worth is reasonable for her age.