Basic Tax Rules: Market Analysis

The Standard and Poor's Composite Average is most affected by price changes in: A technology stocks B utility stocks C energy stocks D industrial stocks

A. The S&P 500 Index was "recategorized" about 15 years ago into different sectors to allow the creation of "Sector SPDRs" - index funds based on these sectors. The new breakdown, by approximate size, is: Technology24%Financials15%Healthcare14%Consumer Discretionary12%Industrials10%Consumer Staples9%Energy6%Utilities3%Materials3%Real Estate3%Telecoms2% By far the largest weighting in the revised sector breakdown is technology stocks.

All of the following statements are true about the interbank market EXCEPT: A the market is centralized B trading is unregulated C foreign policy actions affect values in the market D foreign currency values are determined in this market

A. The Interbank market is a free wheeling, unregulated, worldwide currency trading market open 24 hours a day. It is completely unregulated, but is influenced by central bank trading. Central bank trading actions are directed by each country's government.

Which action would NOT help a client diversify his or her portfolio? A Buying bonds in a portfolio that have different credit ratings B Buying stocks in a portfolio in accounts held at different broker-dealers C Buying an index fund that invests solely in domestic securities and another index fund that invests solely in foreign securities D Buying a target date mutual fund based on the customer's investment objectives and investment time horizon

B. Diversification takes many forms to offset investment risks - one can diversify into different asset classes, can diversify by geographic regions, can diversify bond holdings by maturity and/or credit quality, etc. Buying holdings at different broker-dealers does nothing to diversify a portfolio. A target date fund allows the customer to set up a target date when the money will be needed, and the fund manager will then allocate investments in early years to growth equities, shifting to a safer mix (stocks/bonds) as the years progress, and finally shifting the asset mix to mainly money market instruments as the cash is needed. Thus, it gives both diversification and portfolio reallocation as the years progress to fulfill the customer's investment objective.

NYSE MARKET DIARYYesterdayPrev. DayAdvanced577827Declined19631757Unchanged455388Total Issues29952972New Highs1013New Lows9178 Based on the information presented for both days, a technical analyst would conclude that the market: A is in a consolidation phase B breadth indicates a strong bullish trend C breadth indicates a strong bearish trend D is peaking and will soon enter a downturn

C. Declines sharply outnumbered advances on both days, with many new low prices being set. Thus, the breadth of the market indicates a strong bearish (downward) trend.

Trading in the Interbank market will DIRECTLY affect all of the following EXCEPT: A American Depositary Receiptprices in terms of U.S. dollars B Foreign currency prices in terms of U.S. dollars C Future trade deficit or surplus figures D Future economic growth

A. Foreign currencies trade in the "Interbank" market. If the dollar declines against foreign currencies, U.S. goods become cheaper to foreigners. This will stimulate exports and domestic economic growth. If the dollar rises against foreign currencies, foreign goods become cheaper in the U.S. This will stimulate imports, and shift production out of the U.S. to other countries. American Depositary Receipts are vehicles for foreign securities to be traded in the United States. ADRs are only traded in the United States, and are denominated in U.S. dollars, so there is no direct effect of foreign currency price movements on ADR prices (though an argument can be made that the foreign stock held in trust pays dividends in the foreign currency; and that these dividends are converted to U.S. dollars to be paid to ADR holders; that currency price movements have some impact on ADR values).

Which index broadly measures activity in New York Stock Exchange, NYSE American (American Stock Exchange) and NASDAQ Stock Market? A Value Line Index B Dow Jones Averages C Standard and Poor's 500 D Major Market Index

A. The Value Line Index covers 1,700 stocks that are listed on the NYSE, NYSE American(AMEX) and NASDAQ. The Dow Jones Industrial Average consists principally of NYSE listed issues - but only includes 30 stocks. The Standard and Poor's 500 Average includes 500 issues, most of which are NYSE listed. The Major Market index only includes 20 NYSE listed issues

An investor has purchased shares of an international bond fund. Which statement is TRUE? A The fund will have superior performance if the value of the foreign currency increases B Performance will be unaffected by currency swings since the investor is U.S.-based C The fund will have superior performance if the dollar strengthens D Performance will be unaffected by currency swings since the investment is Dollar-based

A. An international bond fund will have securities that are denominated in foreign currencies. If the foreign currency value rises against the dollar, then when the fund's NAV is converted into dollars, proportionately more dollars will be created, since each unit of foreign currency buys more dollars. This would result in superior performance from the U.S. investor's point of view. Remember, just because an investment is dollar- denominated, investors can't assume the holding is immune from currency swings.

If the U.S. economy runs balance of trade surpluses, which statement is TRUE? A U.S. currency values will increase relative to that of foreign countries and U.S. exports should become more expensive to foreign countries B U.S. currency values will increase relative to that of foreign countries and U.S. exports should become less expensive to foreign countries C U.S. currency values will decrease relative to that of foreign countries and U.S. exports should become more expensive to foreign countries D U.S. currency values will decrease relative to that of foreign countries and U.S. exports should become less expensive to foreign countries

A. If our economy consistently runs balance of trade surpluses, then the country is becoming "richer" and its currency value increases relative to that of foreign countries. As the currency value increases, exports become more expensive to foreign countries, so exports decline and the surplus should dissipate over time.

A U.S. balance of payments deficit would be widened by all of the following EXCEPT: A increased levels of U.S. imports B increased levels of foreign tourists visiting the United States C increased dividends paid to foreign holders of U.S. securities D decreased sales of U.S. securities to foreign holders

B. If the balance of payments is running a deficit, then more U.S. Dollars are being spent abroad for foreign goods and services than are being spent in the United States by foreigners for domestic goods and services. Increased levels of U.S. imports will cause more dollars to leave the U.S., widening the deficit. Increased levels of foreign tourists visiting the U.S. will narrow the deficit, since dollars are being spent in the U.S. by more foreigners. Increased dividends paid to foreign holders of U.S. securities will cause dollars to leave the U.S., widening the deficit. Decreased sales of U.S. securities to foreign holders will reduce the inflow of dollars resulting from these purchases, widening the balance of payments deficit.

The U.S. balance of payments deficit would widen for all of the following reasons EXCEPT: A dividend payments by U.S. issuers to foreign holders of those securities increase B purchases of U.S. securities by foreigners increase C exports of domestic goods to foreign countries decrease D imports of foreign goods into the United States increase

B. Increased purchases of U.S. securities by foreigners brings funds into the U.S., narrowing the balance of payments deficit. Increased dividends paid to foreigners means that more funds are taken out of the U.S.; decreased exports of U.S. goods means that less funds are coming into the U.S.; and increased imports means that more funds are leaving the U.S. All would increase the balance of payments deficit.

Which of the following economic events would have a positive long term impact on common stock prices? A Rising interest rates B Falling capital gains tax rates C Rising unemployment rates D Rising inflation rates

B. Rising interest rates are bad for stock prices. More investors will switch from investments in stocks to bond investments. A falling capital gains tax rate makes stocks more attractive to investors since any potential profits would be taxed at a lesser rate. Rising unemployment indicates that the economy is contracting. This is bearish for corporate profits and hence, stock prices. High inflation means that interest rates are likely moving higher which means investors may shift assets from stocks to bonds to capture the more attractive coupons.

The largest component of the Standard and Poor's 500 Average is the: A utilities. B technology C consumer staples D industrials

B. The S&P 500 Index was "recategorized" about 15 years ago into different sectors to allow the creation of "Sector SPDRs" - index funds based on these sectors. The new breakdown, by approximate size, is: Technology24%Financials15%Healthcare14%Consumer Discretionary12%Industrials10%Consumer Staples9%Energy6%Utilities3%Materials3%Real Estate3%Telecoms2% By far the largest weighting in the revised sector breakdown is technology stocks.

A customer is 100% invested in an S&P 500 Index Fund. This portfolio has: A no risk B systematic risk C nonsystematic risk D credit risk

B. The basic idea of diversification of a portfolio is that it reduces risk. If a portfolio consists of only a few positions, an adverse event affecting one of the positions can result in a big loss. If the portfolio consists of a broad range of positions, an adverse event affecting only a single position will not have as big a negative impact. A portfolio that is fully diversified still has risk. It is said to only have "systematic" risk, which is the same as market risk. If the overall market drops, the portfolio will likely drop by a similar percentage. A portfolio that is not fully diversified is said to have both "systematic" and "nonsystematic" risk. As more and more positions are added to the portfolio, the "nonsystematic risk" is diversified away, leaving the portfolio only with "systematic" risk.

The beta coefficient of a single stock measures that stock's price volatility as compared to the volatility of: A other stocks within its industry B the market as measured by the S&P 500 Index C interest rates as measured by the LIBOR index D 10 year benchmark Treasury notes

B. Beta measures the volatility of a single stock's price movements relative to a benchmark market index (the S&P 500 index). If a stock has a beta of 1, it moves exactly with the market index. If a stock has a beta of 2, it moves twice as fast as the benchmark index (an example might be a rapidly growing tech company). If a stock has a beta of .5, it moves ½ as fast as the benchmark index (an example is a utility stock).

The Federal Reserve Bank has made a policy decision to try to strengthen the U.S. Dollar versus the Japanese Yen. Which of the following intervention actions would increase the U.S. Dollar's exchange value? A Buy U.S. Dollars and Buy Japanese Yen B Buy U.S. Dollars and Sell Japanese Yen C Sell U.S. Dollars and Buy Japanese Yen D Sell U.S. Dollars and Sell Japanese Yen

B. If the Federal Reserve wishes to strengthen the U.S. Dollar against the Japanese Yen (which would make our goods more expensive to the Japanese and would decrease exports), it would buy U.S. Dollars and sell Japanese Yen. To decrease the value of the U.S. Dollar, it would do just the opposite - sell the U.S. Dollar and buy the Japanese Yen.

An investor has purchased shares of an international bond fund. The fund will have inferior performance if the value of the: A U.S. Dollar increases and foreign currency increases B U.S. Dollar increases and foreign currency decreases C U.S. Dollar decreases and foreign currency increases D U.S. Dollar decreases and foreign currency decreases

B. Remember, currency pricing is always relative so by definition an increasing Dollar is a decreasing foreign currency. An international bond fund will have securities that are denominated in foreign currencies. If the foreign currency value falls against the dollar, then when the fund's NAV is converted into dollars, proportionately fewer dollars will be created, since each unit of foreign currency buys less dollars. This would result in inferior performance from the U.S. investor's point of view.

Settlement of spot contracts which have been traded in the Interbank market takes place: A on the same day as the trade B one or two business days after trade date C five business days after trade date D seven business days after trade date

B. Settlement of "spot" trades in the Interbank market takes place either one or two business days after trade date (the more actively traded currencies settle next day; less actively traded currencies settle in 2 business days).

Which action would NOT help a client diversify his or her portfolio? A Buying stocks of companies located in different geographic region B Buying stocks of companies in different industries C Buying stocks of companies on different exchanges D Buying stocks of companies with different customer profiles

C. Diversification takes many forms to offset investment risks. When investing in stocks, buying companies in different geographic regions helps diversification, because they each region has different economic growth characteristics. Of course, buying companies in different industries helps diversification, and buying companies that have different customers helps diversification (for example, one company might be a government contractor, another might be a seller of retail items, another might build high end real estate - and the customers for all of these are different). The same company can trade on different exchanges (it might trade on both the NYSE and NASDAQ, as an example). Making the purchase in a specific market does nothing to affect diversification.

All of the following economic events would have a positive long term impact on common stock prices EXCEPT: A Falling interest rates B Falling capital gains tax rates C Rising inflation rates D Rising employment rates

C. Falling interest rates are good for stock prices. More investors will switch from low yielding bonds to stock investments. A falling capital gains tax rate also makes stocks attractive to investors. Rising employment indicates that the economy is expanding. This is bullish for corporate profits and hence, stock prices. Rising inflation means that interest rates are likely to rise. This makes long term debt unattractive due to their greater price volatility in response to market interest rate changes and also makes stocks unattractive since corporations are not able to increase prices in line with rising costs, hurting profits. In inflationary times, investors switch from stocks and long term bonds to money market instruments which are paying current high rates of interest; and "hard" assets such as gold and real estate that tend to keep up with inflation.

Which statement is TRUE? A Trades of listed equity options take place in theinterbank market B Trades of listed foreign currency options take place in the interbank market C Trades of foreign currencies take place in the interbank market D Trades of bankers acceptances take place in the interbank market

C. Foreign currencies trade in the "Interbank Market." Trading of foreign currency option contracts takes place on the Philadelphia Stock Exchange. Trading of listed equity options takes place on the CBOE, AMEX, PHLX, PAC, and ISE. Trading of bankers acceptances takes place in the "over-the-counter" market.

Speculators in foreign currencies would be subject to all of the following risks EXCEPT: A political risk B market risk C reinvestment risk D exchange rate risk

C. Reinvestment risk only affects securities that pay an income stream. If interest rates fall over the time period that an investment is held; any dividends or interest payments received over this time period are reinvested at lower rates, lowering the overall rate of return. This risk would not affect foreign currencies, which do not give investors an income stream. Speculators in foreign currencies are simply placing bets on the future value of that currency. They assume political risk, exchange rate risk, and market risk. Market risk in this case is simply the risk of being on the wrong "side" of the market - e.g., being long the currency only to have its value fall; or short the currency only to have its value rise.

All of the following economic events would have a negative long term impact on common stock prices EXCEPT: A Rising interest rates B Rising capital gains tax rates C Rising employment rates D Rising inflation rates

C. Rising interest rates are bad for stock prices. More investors will switch from investments in stocks to bond investments. A rising capital gains tax rate also makes stocks less attractive to investors (why would an investor want to invest in stocks if the capital gains tax is so high?) Rising employment indicates that the economy is expanding. This is bullish (not bearish) for corporate profits and hence, stock prices. Rising inflation means that interest rates are likely to rise. This makes long term debt unattractive due to their greater price volatility in response to market interest rate changes and also makes stocks unattractive since corporations are not able to increase prices in line with rising costs, hurting profits. In inflationary times, investors switch from stocks and long term bonds to money market instruments which are paying current high rates of interest; and "hard" assets such as gold and real estate that tend to keep up with inflation.

Which stock market index is made up of 30 large capitalization companies? A Russell Index B Value Line Index C Dow Jones Industrial Average D Standard and Poor's Index

C. The Dow Jones Industrial Average only consists of 30 large cap companies. The Standard and Poor's Index that is most widely quoted is the "500" index - the 500 largest companies by market capitalization headquartered in the United States. The Value Line Index consists of 1700 widely-followed companies, spread between NYSE, AMEX, and NASDAQ. The Russell Index consists of 2000 small capitalization companies.

A customer is 100% invested in an S&P 500 Index Fund. This portfolio has: A no market risk B diversifiable risk C systematic risk D credit risk

C. The basic idea of diversification of a portfolio is that it reduces risk. If a portfolio consists of only a few positions, an adverse event affecting one of the positions can result in a big loss. If the portfolio consists of a broad range of positions, an adverse event affecting only a single position will not have as big a negative impact.

A customer has the following portfolio: 20% DEFF Common Stock30% XYZZ Preferred Stock30% Safety Money Market Fund20% S&P 500 Index Fund This portfolio has: A no risk B systematic risk C nonsystematic risk D credit risk

C. The basic idea of diversification of a portfolio is that it reduces risk. If a portfolio consists of only a few positions, an adverse event affecting one of the positions can result in a big loss. If the portfolio consists of a broad range of positions, an adverse event affecting only a single position will not have as big a negative impact. A portfolio that is fully diversified still has risk. It is said to only have "systematic" risk, which is the same as market risk. If the overall market drops, the portfolio will likely drop by a similar percentage. A portfolio that is not fully diversified is said to have both "systematic" and "nonsystematic" risk. As more and more positions are added to the portfolio, the "nonsystematic risk" is diversified away, leaving the portfolio only with "systematic" risk. This portfolio only consists of 4 positions, and, even though 30% is invested in a very safe money fund and 20% is invested in a broad-based, ETF, the other 50% is concentrated in 2 stock holdings, so it is not fully diversified.

If the dollar falls against foreign currencies, all of the following statements are true EXCEPT: A U.S. goods are cheaper to foreign countries B U.S. exports are likely to rise C foreign currencies buy fewer dollars D foreign imports are likely to fall

C. If the dollar falls, U.S. goods become cheaper to foreigners and foreign goods become more expensive in the U.S. Thus, exports are likely to rise and imports are likely to fall. Since the dollar is cheaper, foreign currencies buy more dollars and/or goods.

NYSE MARKET DIARYYesterdayPrev. DayAdvanced577827Declined19631757Unchanged455388Total Issues29952972New Highs1013New Lows9178 This exhibit consists of: A only issues included in the Dow Jones Averages B only issues included in the Standard and Poor's 500 Average C all NYSE listed issues D all issues traded on all exchanges

C. The NYSE Market Diary shows the number of issues advancing in price; versus the number of issues declining in price; for all NYSE listed issues, each day.

Which of the following actions is likely to cause the value of the U.S. Dollar to rise? A The Federal Reserve lowers the discount rate B The Federal Reserve becomes more accommodating C United States investors purchase foreign securities D Foreign investors purchase U.S. securities

D. If the Federal Reserve lowers the discount rate, then interest rates would fall in the U.S. As interest rates fall, so does the U.S. Dollar's value, since dollar denominated investments are less attractive to foreign purchasers. So a dovish (accommodating) stance by the Federal Reserve would devalue the U.S. Dollar. Conversely, if foreign investors make large purchases of U.S. securities, then they must sell their foreign currency to buy the U.S. dollars needed to pay for that security. As dollars are bought, the value will rise. Conversely, if U.S. investors make large purchases of foreign securities, then they must sell their dollars to buy the foreign currency needed to pay for that foreign security. As dollars are sold, the value will drop.

Based solely upon fluctuations in foreign currency exchange rates, the net asset value per share, valued in U.S. dollars, of an "international" bond mutual fund, would increase if: A the value of the U.S. dollar increases and interest rates increase in the United States B the value of the U.S. dollar increases and interest rates increase in foreign countries C the value of the U.S. dollar decreases and interest rates increase in the United States D the value of the U.S. dollar decreases and interest rates increase in foreign countries

D. The fund shares are valued, based on the value of the foreign currency in which the securities are denominated. When the net asset value is reported in the United States, it must be converted to its value in U.S. dollars. For example, assume that a bond has a market value of 1,000 Euros. Also assume that the dollar is valued at 2 Euros. Upon conversion, this bond is worth $500 dollars. If the dollar weakens to the point where it is valued at 1 Euro per dollar (the Euro is strengthening, therefore the dollar is weakening), then upon conversion, this bond would be worth $1,000 dollars. Conversely, if the dollar were to strengthen, then the conversion would result in a decrease in NAV per share. Interest rates increasing in foreign countries would cause those currencies to strengthen against the dollar, thus the dollar is weakening. This would cause the NAV to rise upon conversion into U.S. dollars. Interest rates increasing in the United States would cause the dollar to strengthen, resulting in a decrease in NAV upon conversion.

he value of both the Dow Jones and Standard and Poor's Averages would be most affected by a change in the: A transportation stocks B financial stocks C utility stocks D industrial stocks

D. The industrial stocks are the largest component of both the Dow Jones Averages (30 out of 65 stocks) and the Standard and Poor's 500 Average (approximately 400 out of 500 stocks). Note that this question is based on the "old" breakdown of the S&P 500 Index, which was simply composed of industrial stocks, transportations stocks, utility stocks and financial stocks. The S&P 500 Index was "recategorized" about 15 years ago into different sectors to allow the creation of "Sector SPDRs" - index funds based on these sectors. The new breakdown, by approximate size, is: Technology24%Financials15%Healthcare14%Consumer Discretionary12%Industrials10%Consumer Staples9%Energy6%Utilities3%Materials3%Real Estate3%Telecoms2%

When a security has a "high beta," this means that it moves more: A slowly in price as compared to market interest rate changes B rapidly in price as compared to market interest rate changes C slowly in price as compared to overall market price changes D rapidly in price as compared to overall market price changes

D. Beta measures the volatility of a single stock's price movements relative to a benchmark market index (the S&P 500 index). If a stock has a beta of 1, it moves exactly with the market index. If a stock has a beta of 2, it moves twice as fast as the benchmark index (an example might be a rapidly growing tech company). If a stock has a beta of .5, it moves ½ as fast as the benchmark index (an example is a utility stock).

If the U.S. economy runs a balance of trade deficit, which statement is TRUE? A U.S. currency values will increase relative to that of foreign countries and U.S. exports should become more expensive to foreign countries B U.S. currency values will increase relative to that of foreign countries and U.S. exports should become less expensive to foreign countries C U.S. currency values will decrease relative to that of foreign countries and U.S. exports should become more expensive to foreign countries D U.S. currency values will decrease relative to that of foreign countries and U.S. exports should become less expensive to foreign countries

D. If our economy consistently runs balance of trade deficits, then the country is becoming "poorer" and its currency value decreases relative to that of foreign countries. As the currency value decreases, exports become less expensive to foreign countries, so exports increase and the deficit should dissipate over time.

If the U.S. dollar appreciates against foreign currencies, which statement is TRUE? A U.S. exports should increase and any trade deficit should narrow B U.S. exports should increase and any trade deficit should widen C U.S. exports should decrease and any trade deficit should narrow D U.S. exports should decrease and any trade deficit should widen

D. If the U.S. dollar appreciates against foreign currencies, then U.S. goods become more expensive to foreigners, while foreign goods become cheaper in the U.S. This should cause exports to decrease, and imports to increase. If the U.S. is running a trade deficit, the increase in net imports will widen the deficit.