Claritas quizzes ch. 1-20

If investments underperform expectations in a defined benefit pension plan, additional contributions may be required from the: a. plan sponsor. b. plan beneficiaries. c. investment manager.

A is correct. A defined benefit pension plan promises a specified annual benefit to its retired members, typically based on age, years of service with the firm, and average compensation prior to retirement. The employer bears the risk associated with the performance of the pension plan portfolio. If the investments fail to perform as expected, the employer may be required to make additional contributions to the fund based on regulatory requirements. B is incorrect because the plan beneficiaries would not be required to make additional contributions to a defined benefit pension plan as a result of poor performance. C is incorrect because the investment manager is hired to manage the pension plan assets and does not guarantee investment performance results. Chapter 16

A private equity fund is most likely: a. funded by investors who are limited partners. b. operated by a fund manager who is a limited partner. c. set up by a private equity firm who is a limited partner.

A is correct. A private equity fund is typically funded by investors who are limited partners; these investors face limited liability, which means that they cannot lose more than the amount of capital they contributed to the private equity fund. B is incorrect because a private equity fund is typically operated by a fund manager but the fund manager is not a limited partner. C is incorrect because a private equity fund is set up by a private equity firm but the private equity firm is a general rather than limited partner. Chapter 12

Active investment management is most likely to be favoured over passive management: a. for real estate investments. b. when markets are informationally efficient. c. when transaction costs are high.

A is correct. Active management may be preferred in less efficient markets and also for unique assets in which trading occurs in private transactions. Real estate assets are generally unique and are traded in private transactions, thereby increasing the need for and opportunities from active management. B is incorrect because if markets are efficient, there is little point to actively managing investments; asset prices already reflect available information and the potential of the underlying investments. C is incorrect because when transaction costs are high, active management is less likely to identify opportunities with excess return sufficient to cover the transaction costs. Chapter 17

Active investment managers are more likely than passive investment managers to: a. try to time a market. b. use strategic asset allocation. c. seek to minimise tracking error.

A is correct. Active managers may try to time a market (buying when they believe a market is undervalued and selling when they believe a market is overvalued). B is incorrect because passive investment managers, rather than active managers, tend to use strategic asset allocation. C is incorrect because passive investment managers, rather than active managers, attempt to minimise tracking error. Chapter 17

Compared with exchanges, alternative trading systems: a. may be less transparent. b. require the use of brokers. c. exercise regulatory authority over their subscribers.

A is correct. Alternative trading systems may be less transparent than exchanges. Many alternative trading systems are known as dark pools because of a lack of transparency; they do not display the orders that their clients send to them. Large investment managers especially like these systems because market prices often move to their disadvantage when other traders know about their large orders. B is incorrect because alternative trading systems do not require the use of brokers. Most of them allow institutional traders to trade directly with each other without the intermediation of dealers or brokers, which makes them lower-cost trading venues. C is incorrect because alternative trading systems are trading venues that function like exchanges but do not exercise regulatory authority over their subscribers whereas exchanges do. Chapter 15

The step in the regulatory process at which regulators weigh the costs and benefits of a proposed regulation is the: a. analysis. b. identification of perceived need. c. dispute resolution process.

A is correct. Analysis is the step in the regulatory process at which regulators weigh the costs and benefits of a proposed regulation. B is incorrect because the identification of perceived need is the step at which a future need or a previous problem is perceived to exist and leads to regulation. C is incorrect because the dispute resolution process is the step that identifies how disputes may be handled. Chapter 3

Active managers that focus on sentiment to identify investment opportunities most likely use: a. behavioural analysis. b. quantitative analysis. c. fundamental analysis.

A is correct. Behavioural analysis studies indicators of market sentiment, such as manufacturing new orders or indices of consumer expectations, to identify investment opportunities. B is incorrect because quantitative analysis is based on creating statistical models to identify investment opportunities. C is incorrect because fundamental analysis is based on a thorough analysis of a company, its prospects, and its financial situation to identify investment opportunities. Chapter 17

Which of the following services is most likely provided by brokers? a. Finding counterparties for their clients' trades b. Collecting interest and dividends for clients' securities c. Eliminating settlement risk by acting as a settlement intermediary

A is correct. Brokers are agents who arrange trades for their clients by finding counterparties to take the other side of their clients' trades. B is incorrect because collecting interest and dividends for clients' securities is a function most likely provided by custodians. C is incorrect because eliminating settlement risk by acting as a settlement intermediary is a role that is performed by a clearing house, not a broker. Chapter 13

Which of the following parties most likely arranges trades on behalf of clients who want to trade large blocks of securities? a. Block brokers b. Prime brokers c. Primary dealers

A is correct. Brokers who help arrange trades of large blocks of securities for clients by finding counterparties willing to buy or sell a large number of securities are referred to as block brokers. B is incorrect because prime brokers usually offer brokerage services to investment professionals, as well as a bundle of other services, including financing clients' investment positions. C is incorrect because primary dealers do not typically trade for clients on a brokerage basis. Their role is to facilitate monetary policy transactions that are initiated by central banks. Chapter 13

The investment most likely to be purchased by an investor with a preference for direct investments is a share in: a. a company. b. a mutual fund. c. an exchange-traded fund (ETF).

A is correct. Buying a share in a company is a direct investment. B and C are incorrect because an investor buying shares in a mutual fund or in an ETF is making an indirect investment. Chapter 14

Consequences are most severe for market participants who violate which of the following? a. Regulations b. Ethical principles c. Professional standards

A is correct. Consequences are most severe for violations of regulations. B and C are incorrect because violations of ethical principles and professional standards have consequences, but those consequences may not be as severe as those for violations of regulations, which carry the force of law. Chapter 3

Which of the following parties most likely acts as a custodian and as a monitor? a. Depositories b. Clearing houses c. Primary dealers

A is correct. Depositories usually act as a custodian and a monitor. They tend to be regulated and monitor counterparties to prevent fraud, monitor securities pledges, and monitor security settlement, among other activities. B and C are incorrect because clearing houses and primary dealers do not monitor counterparties or take custody of assets. Clearing houses arrange for the final settlement of trades. Primary dealers trade with clients and facilitate monetary policy transactions that are initiated by central banks. Chapter 13

Exchange-traded funds (ETFs) most likely: a. trade continuously. b. are actively managed. c. have relatively management fees.

A is correct. ETFs usually trade continuously. B is incorrect because ETFs are primarily passively managed. C is incorrect because, as a result of being primarily passively managed, ETFs do not trade frequently. Thus, they have relatively low trading costs and management fees. Chapter 14

Increasing the hurdle rate for a hedge fund manager will usually lead to total fees that are: a. lower. b. unchanged. c. higher.

A is correct. Hedge fund managers generally receive an annual management fee plus a performance fee that is often specified as a percentage of the returns that they produce in excess of a hurdle rate. Therefore, if the hurdle rate is increased, the performance fee is decreased (lower) and total fees are decreased. Chapter 14

A high-water mark is incorporated in a hedge fund fee structure to benefit: a. investors. b. fund managers. c. both investors and fund managers.

A is correct. Hedge fund managers usually earn the performance fee only if the fund is above its high-water mark. Therefore, the existence of the high-water mark is a benefit to investors. If the net asset value of the fund is below the high-water mark, no performance fee is payable. Chapter 14

In establishing a merit-based rule, regulators are most likely to: a. restrict access to specific products deemed to be risky. b. mandate disclosure of information relevant to decision making. c. establish broad principles within which the industry is expected to operate.

A is correct. In a merit-based regulatory system, regulators attempt to protect consumers by limiting the products sold to them. B is incorrect because disclosure-based, not merit-based, regulatory systems mandate disclosure of information relevant to decision making. In a disclosure-based system, regulators do not decide whether a product is good or bad for consumers, but merely ensure that consumers have sufficient information to make their own decisions. C is incorrect because principles-based, not merit-based, regulatory systems establish broad principles within which the industry is expected to operate. In fact, most regulatory systems are hybrids that draw on each of the four approaches: rules-based, principles-based, merit-based, and disclosure-based. As a result, some regulations will be very detailed, some will establish broad principles, some will attempt to protect consumers by limiting access to products considered risky or harmful, and some will focus on ensuring that appropriate information is provided. Chapter 3

In the regulatory process, regulators must assess whether firms and individuals are complying with regulations. This step in the regulatory process is best described as: a. monitoring. b. enforcement. c. implementation.

A is correct. In a typical regulatory process, the step that involves monitoring firms and individuals for compliance, including such things as examinations and investigations, is the monitoring step. B is incorrect because the enforcement step of the regulatory process involves regulators identifying and punishing compliance violations. C is incorrect because the implementation step of the regulatory process is when a new regulation goes into effect and may include informing firms and individuals about the new regulations. Chapter 3

From the perspective of an investor, index funds are popular because they are generally: a. broadly diversified. b. tax-free investments. c. not subject to management fees.

A is correct. Index funds are diversified. They are also transparent and tax efficient with very low management and trading costs. B is incorrect because index funds are tax-efficient investments but not tax-free investments. C is incorrect because index funds represent investments with very low, but not zero, management fees. Chapter 14

Investment managers that determine the proportion of a client's money that should be invested in cash, equities, and fixed income are performing which of the following activities? a. Asset allocation b. Investment analysis c. Portfolio construction

A is correct. Investment managers are performing asset allocation when they determine the proportion of a client's money to invest in various asset classes, such as cash, equity securities, and debt securities. B is incorrect because investment analysis is when investment managers determine the value of potential investments and identify attractive securities. C is incorrect because portfolio construction is the process of trading, holding, and managing the assets according to the client's asset allocation requirements. Chapter 13

An investor's loss is limited to the amount of the initial investment in a: a. long position b. short position c. leveraged position

A is correct. Investors have long positions when they own assets or securities, such as stocks, bonds, currencies, commodities, or real assets. The potential gain in a long position generally is unlimited. But the potential loss on a long position is limited to no more than 100%—a complete loss of the initial investment—for a long position with no associated liabilities (debt). B is incorrect because the potential gains and losses in a short position are mirror images of the potential losses and gains in a long position. Thus, the potential gain on a short position is limited to no more than 100%, but the potential loss is unlimited. C is incorrect because a leveraged position involves buying securities on margin—that is, by borrowing some of the purchase price. Buying securities on margin increases the potential gains or losses for a given amount of equity in a position because the buyer can buy more securities on margin than otherwise. The buyer thus earns greater profits when prices rise. But the buyer suffers greater losses when prices fall—losses that potentially could exceed the amount of the initial investment. Chapter 15

An investor with a long time horizon will most likely have a: a. higher tolerance for risk. b. reduced investment return expectation. c. lower ability to invest in illiquid investments.

A is correct. Investors with longer time horizons can take on more risk because they have more time to adapt to their circumstances. B is incorrect because investors with long time horizons, and consequently a greater ability to take on risk, are likely to have higher return requirements given their higher level of assumed risk. C is incorrect because investors with long time horizons have a greater ability to invest in illiquid investments. Chapter 16

Hedge funds are most likely to: a. impose capital lock-up periods. b. raise capital from retail investors. c. have relatively low management and performance fees.

A is correct. Most hedge funds impose capital lock-up periods, the lengths of which depend on how much time the hedge fund managers expect that they will need to successfully implement their strategies. B is incorrect because retail investors are not typically eligible to invest in hedge funds. C is incorrect because hedge funds have relatively high management and performance fees. Chapter 14

Markets that can absorb large orders without substantial price impacts are classified as: a. operationally efficient. b. allocationally efficient. c. informationally efficient.

A is correct. Operationally efficient markets have relatively low transaction costs, and they can absorb large orders without substantial price impacts. B is incorrect because allocationally efficient is used to describe economies that use resources where they are most valuable. C is incorrect because informationally efficient markets are markets in which prices reflect all available information about fundamental values. Chapter 15

The price concessions that occur as large-trade buyers push prices up and large-trade sellers push prices down are called: a. price impact. b. bid-ask spreads. c. opportunity costs.

A is correct. Price impact is the price concessions that occur as large-trade buyers push prices up and large-trade sellers push prices down. B is incorrect because the bid-ask spread is the difference between the bid price and the ask price and is not the price concession associated with large-trade buys or sells. C is incorrect because opportunity costs are the costs of not trading and not the price concessions associated with large-trade buys and sells. Chapter 15

Real-time data about companies and market conditions are usually supplied by: a. data vendors. b. credit rating agencies. c. investment research providers.

A is correct. Real-time data about companies and market conditions are usually supplied by data vendors. B and C are incorrect because credit rating agencies and investment research providers do not supply real-time data about companies and market conditions. Credit rating agencies supply opinions about the credit quality of bonds and their issuers. Investment research providers supply research reports about companies. Chapter 13

Regulations intended to increase the national savings rate and encourage home ownership most likely have: a. a social objective. b. a fairness objective. c. an economic stability objective.

A is correct. Regulations intended to increase the national savings rate and encourage home ownership have a social objective. B is incorrect because the fairness objective of regulation seeks to promote fair and orderly markets in which no participant has an unfair advantage. C is incorrect because economic stability objectives seek to ensure that companies in the financial services industry do not engage in practices that could disrupt the economy. Chapter 3

Regulations that attempt to prevent market manipulation are examples of: a. trading rules. b. operational rules. c. sales practice rules.

A is correct. Regulations that attempt to prevent market manipulation are examples of trading rules. Trading rules focus on trading practices in the market and trading activity of financial participants to ensure fair, organised, and efficient markets. Market manipulation involves investors taking actions intended to move the price of a stock to generate a short-term profit. B is incorrect because operational rules are related to how a company operates; operation rules include rules with respect to financial leverage and how customer accounts are handled. C is incorrect because sales practice rules are intended to ensure that industry professionals treat clients appropriately with regard to the products recommended and fees charged. Furthermore, such rules are intended to reduce potential conflicts of interest an industry professional might face in the sale and recommendation of a financial product. Chapter 3

With respect to corporate policies and procedures, when should supervision of employees begin? a. Before an employee is hired b. During an employee's orientation c. During an employee's job training

A is correct. Supervision begins before employees are hired; the company should conduct background checks to ascertain the competence and character of prospective employees. B and C are incorrect because initial orientation and training should emphasise the importance and role of corporate policies and procures as well as regulatory compliance, but those occur after the employee has been hired. Chapter 3

Analysts who review share price and trading volume trends in an effort to identify shares that might outperform are most likely: a. technical analysts. b. fundamental analysts. c. quantitative analysts.

A is correct. Technical analysts use price and trading volume trends within the stock market to identify stocks that may outperform or underperform. For example, managers might look for imbalances between the potential buyers and sellers of a stock as a sign of which direction the share may move. B is incorrect because fundamental analysts conduct a detailed and thorough analysis of a company's business model, its prospects, and its financial situation to identify shares that will outperform or underperform. C is incorrect because quantitative analysts build statistical models to identify shares that are likely to outperform or underperform. Chapter 17

The costs associated with orders failing to execute are best described as: a. opportunity costs. b. price impact costs. c. brokerage commissions.

A is correct. The costs associated with orders failing to execute are called opportunity costs. Traders lose the opportunity to profit if their buy orders fail to execute when prices are rising, and they lose the opportunity to avoid losses if their sell orders fail to execute when prices are falling. Thus, opportunity costs represent the costs of not trading. B and C are incorrect because price impact costs and brokerage commissions are only incurred if orders execute—that is, if trading happens. Price impact costs are price concessions that often occur over time as large-trade buyers push prices up and large-trade sellers push them down in multiple transactions. For large institutions, the price impact of trading large orders generally is the biggest component of their transaction costs. Brokerage commissions are the commissions that market participants pay their brokers to arrange their trades. These commissions usually are a fixed percentage of the principal value of the transaction or a fixed price per security or contract. Chapter 15

From the investor's perspective, the main drawback to using a limit order to buy shares is that it may: a. not execute. b. execute immediately. c. execute at an unacceptable price.

A is correct. The main drawback with a limit order is that it may not execute. Limit orders do not execute if the limit price on a buy order is too low or if the limit price on a sell order is too high. B is incorrect because a limit order will only execute immediately if the limit price matches the bid or ask price of other traders. C is incorrect because by placing a limit order, the investor ensures that the buy order is executed at an acceptable price. Chapter 15

The proportional ownership of shareholders who fail to exercise their options under a rights offering will: a. decrease. b. remain the same. c. increase.

A is correct. The proportional ownership of existing shareholders who do not exercise their option in a rights offering will decrease. They will hold the same number of shares of the company but the total number of shares outstanding has increased. Chapter 15

Which of the following best describes a broad objective of regulation in the context of the financial services industry? a. To protect consumers b. To eliminate financial risk c. To enforce corporate policies and procedures

A is correct. The protection of consumers is a broad objective of regulation in the context of the financial services industry. B is incorrect because the reduction of risk may be an objective of regulation, but the elimination of risk in the financial services industry is not possible. C is incorrect because corporate policies and procedures are set by companies and are intended to ensure good business practices and compliance with regulation; however, the enforcement of internal company policies is not an objective of regulation. Chapter 3

The benefits of risk reduction are most likely to be greater by combining securities whose expected returns have a: a. low correlation. b. perfectly positive correlation. c. high, but less than perfect, correlation.

A is correct. When securities with different characteristics are combined in a portfolio, the overall level of risk is typically reduced as a result of diversification. The risk reduction benefits resulting from diversification are greatest when the securities have returns that exhibit a low correlation with each other. B is incorrect because there will not be any diversification benefit when the securities in the portfolio have returns that exhibit a perfectly positive correlation. C is incorrect because a less than perfect correlation will reduce risk but not as significantly as a low correlation. Chapter 17

Which of the following titles best describes the person responsible for leading the legal department and interpreting regulations? a. Chief risk officer b. General counsel c. Chief compliance officer

B is correct. A firm's general counsel is usually the head of the legal department, which is responsible for arranging contracts, interpreting regulations, and handling lawsuits. A is incorrect because the chief risk officer is responsible for identifying and managing potential risks to clients and the firm. C is incorrect because the chief compliance officer is usually the person responsible for ensuring that the firm follows internal policies and regulations or constraints placed on the firm by laws, regulations, and clients. Chapter 13

An investor currently owns a portfolio of five securities. If the investor adds another security to the portfolio that is less than perfectly positively correlated with the other five securities, the portfolio's: a. total risk will likely increase. b. specific risk will likely decrease. c. systematic risk will likely decrease.

B is correct. Adding securities that are less than perfectly positively correlated with the other securities in the portfolio will likely decrease the specific risk and, therefore, the total risk. A is incorrect because the total risk of the portfolio will likely decrease, not increase, as a result of the decrease in specific risk. C is incorrect because the portfolio's systematic risk is independent of the number of securities in the portfolio. Chapter 17

An economy that uses resources where they are most valuable can be described as being: a. operationally efficient. b. allocationally efficient. c. informationally efficient.

B is correct. Allocationally efficient economies are economies that use resources where they are most valuable. A is incorrect because markets in which trades are easy to arrange and have low transaction costs are operationally efficient. C is incorrect because informationally efficient prices reflect all available information about fundamental values. Informationally efficient prices are crucial to an economy's welfare because they help ensure that the resources available to the economy, such as labour, capital, material, and ideas, are used wisely. Chapter 15

An index that gives each security's weight according to the proportion of its market capitalisation is: a. a price-weighted index. b. a value-weighted index. c. an equal-weighted index.

B is correct. An index that gives each security's weight according the proportion of its market capitalisation is a value-weighted index, also known as a capitalisation-weighted, cap-weighted, or market-weighted index. The market capitalisation of a security is the market price of the security multiplied by the number of units outstanding of the security. A is incorrect because a price-weighted index assigns weights in the proportion of market price rather than market capitalisation. C is incorrect because an equal-weighted index gives the same weight to all the securities included in the index. Chapter 14

An objective of establishing corporate policies and procedures is to: a. promote economic growth and stability. b. ensure compliance with laws and regulations by employees. c. set standards for employee conduct that carry the force of law.

B is correct. An objective of establishing corporate policies and procedures is to ensure compliance with laws and regulations by employees. A is incorrect because promoting economic growth and stability are broad objectives of regulation. C is incorrect because corporate policies and procedures do not carry the force of law. Chapter 3

Which of the following statements is most accurate? Brokers trade: a. with clients by buying and selling the traded securities. b. on behalf of clients in exchange for a commission that typically depends on the value or quantity traded. c. on behalf of clients in exchange for a fee that is usually based on assets under management.

B is correct. Brokerage services primarily include placing trade orders for securities on behalf of clients, otherwise described as acting as an agent to execute trade orders. Clients pay commissions to brokers for finding buyers or sellers for their securities, and these commissions typically depends on the value or quantity traded. A is incorrect because trading with a client by buying and selling the traded security, also described as "making a market" in a security, describes the function of an investment dealer, not a broker. C is incorrect because neither brokers nor dealers are usually compensated by collecting a fee based on assets under management, which would describe how investment (or asset) managers are typically compensated. Chapter 13

If the price of a security falls, the loss experienced by an investor who bought the security on margin relative to the loss experienced by an investor who did not use leverage will most likely be: a. lower. b. higher. c. the same.

B is correct. Buying securities on margin is risky, because leverage (debt) magnifies gains and losses. Thus, if the price of a security falls, the loss experienced by an investor who bought the security on margin (leveraged position) will be higher than the loss experienced by an investor who did not use leverage (debt-free position). Chapter 15

Credit rating agencies provide: a. historical accounting data. b. opinions about an issuer's credit quality. c. real-time news about companies and markets.

B is correct. Credit rating agencies provide opinions about an issuer's credit quality. A and C are incorrect because data vendors, not credit rating agencies, provide historical accounting data and real-time news about companies and markets. Chapter 13

The ability to defer taxes in tax-advantaged accounts will be most beneficial for investors who expect their tax rates in the future to: a. increase. b. decrease. c. remain unchanged.

B is correct. Deferral is advantageous if future tax rates are expected to be lower than current tax rates. In this case, investors will be better off if they pay taxes at the lower future tax rate rather than at the higher current tax rate. Chapter 14

Rebalancing is most likely to be associated with an index that is: a. price weighted. b. equal weighted. c. capitalisation weighted.

B is correct. Equal-weighted indices represent returns based on an equal value invested in each security included in the index. The prices of these securities change continuously. Thus, to maintain the equal weights between securities, regular index rebalancing is necessary. A and C are incorrect because price-weighted and capitalisation-weighted indices do not require rebalancing. Chapter 14

Investment professionals who create savings and investment plans appropriate for their clients' needs are most likely: a. dealers. b. financial planners. c. investment research providers.

B is correct. Financial planners are investment professionals who create savings and investment plans appropriate for their clients' needs. In particular, they help their clients set their financial goals and determine how much money they should save for future expenses and/or how much money they can spend on current expenses while still preserving their capital. A is incorrect because dealers are agents who provide trading services for their clients by participating directly in each trade. C is incorrect because investment research providers research and compile data about industries, companies, and technologies and document the results in investment reports. They provide information services and do not interact with clients regarding their investment planning needs. Chapter 13

Asset allocation and investment decisions in a defined contribution pension plan are made by the: a. plan sponsor. b. plan member. c. investment manager.

B is correct. In a defined contribution pension plan, asset allocation and investment decisions are made by the plan member. A is incorrect because the plan sponsor is not responsible for investment decisions within a defined contribution pension plan. C is incorrect because the investment manager is not responsible for the asset allocation decisions within a defined contribution plan. Chapter 16

An index fund will sell securities if: a. the value of the benchmark index falls. b. withdrawal requests are greater than new receipts from investors. c. dividends, interest, and investor contributions are greater than withdrawals.

B is correct. Index funds may have to sell securities if withdrawal requests from investors exceed additional investment from investors. A is incorrect because an index fund uses a passive investment strategy. C is incorrect because an index fund will purchase securities if net cash inflows (Dividends + Interest + Investor contributions) are greater than withdrawal requests. Chapter 14

Insider trading is best defined as: a. trading for internal company accounts before placing a customer's order. b. trading based on material, non-public information that is likely to affect prices. c. taking actions intended to move the price of a security to generate a short-term profit.

B is correct. Insider trading is trading based on material, non-public information. A is incorrect because trading for internal company accounts before placing a customer's order is front running. C is incorrect because taking actions intended to move the price of a stock to generate a short-term profit is market manipulation. Chapter 3

Relative to indirect investments, direct investments: a. are less expensive to trade. b. offer more control to investors. c. allow small investors to share in the purchase of large assets.

B is correct. Investors who hold direct investments can exercise more control over their investments than investors who hold indirect investments. Investors who hold indirect investments generally must accept all the decisions made by the investment managers, and they can rarely provide input into those decisions. A is incorrect because indirect investments are often substantially less expensive to trade than their underlying assets. C is incorrect because indirect investments, not direct investments, allow investors to share in the purchase and ownership of large assets. This advantage is especially important to small investors who cannot afford to buy large assets themselves. Chapter 14

Stock exchanges most likely use trading systems that are: a. price-driven. b. order-driven. c. quote-driven.

B is correct. Many shares trade on exchanges that use order-driven trading systems. Order-driven markets arrange trades by using rules to match buy orders with sell orders. A and C are incorrect because price-driven and quote-driven markets are the same thing; they are also called over-the-counter markets. They are markets in which investors trade with dealers at the prices quoted by the dealers. Almost all bonds and currencies and most commodities for immediate delivery (spot commodities) trade in price-driven/quote-driven markets. Chapter 15

An unfavourable feature of hedge funds for most investors is the: a. hurdle rate. b. lock-up period. c. high-water mark.

B is correct. Most hedge funds lock up their investors' capital for various periods of time, which will restrict investors' access to their invested capital. A and C are incorrect because a hurdle rate and a high-water mark benefit investors participating in hedge funds and would thus be viewed as favourable features. Chapter 14

Practitioners most likely use the term buy side to refer to: a. dealers who provide investment products and services. b. investors who purchase investment products and services from the sell side. c. firms that only provide investment data, research, and consulting services.

B is correct. Practitioners typically use the term buy side to refer to investors who purchase investment products and services from the sell side. A is incorrect because it is sell-side, not buy-side, firms that provide investment products and services. C is incorrect because the classifications of buy side and sell side are not usually applied to independent firms, such as the ones that provide investment data, research, and consulting services. Chapter 13

A company sells new shares to the public in the: a. call market. b. primary market. c. secondary market.

B is correct. Primary markets are the markets in which issuers sell their securities to investors. If the company is selling shares in a public market for the first time, it is an initial public offering (IPO). If the company has previously sold shares in a public market, the sale of new shares is a seasoned offering. A is incorrect because a call market is where participants can arrange trades only once per day and is not the sale of newly issued shares to the public. C is incorrect because secondary markets are the markets in which securities trade between investors. Chapter 15

Relative to public offerings, private placements provide: a. slower access to capital and less regulatory oversight. b. quicker access to capital and less regulatory oversight. c. quicker access to capital and higher regulatory compliance costs.

B is correct. Private placements allow for quicker access to capital with less regulatory oversight and lower cost of regulatory compliance than public offerings. A is incorrect because access to capital is quicker. C is incorrect because the cost of regulatory compliance is lower. Chapter 15

Dealers arrange all trades in: a. a brokered market. b. a quote-driven market. c. an order-driven market.

B is correct. Quote-driven markets (also called dealer markets), price-driven markets, or over-the-counter markets are markets in which investors trade with dealers at the price quoted by the dealers. A is incorrect because brokered markets are markets in which brokers arrange trades between their clients. Assets traded in brokered markets are usually unique and of interest to only a limited number of people or institutions; they are also infrequently traded and expensive to carry in inventory. C is incorrect because order-driven markets are markets in which a broker, an exchange, or an alternative trading system arranges trades using rules to match buy orders and sell orders. Chapter 15

In working toward ensuring fairness in the markets, regulators most likely attempt to: a. increase information asymmetries. b. maintain fair and orderly markets. c. prevent public release of insider information.

B is correct. Regulations seek to maintain fair and orderly markets by promoting rules that eliminate unfair advantages to select participants. A is incorrect because information asymmetries refers to some market participants having more information relevant to an investment than other participants. Regulations seek to reduce information asymmetries, not to increase them. C is incorrect because regulations seek to prevent participants from trading on inside information to the detriment of other market participants. Public release, or dissemination, reduces the unfair advantage of insider information. Chapter 3

Systematic risk is the portion of total risk that: a. is related to a certain company or security. b. is created by general economic conditions. c. results from a lack of portfolio diversification.

B is correct. Systematic risk (also known as market risk) is the risk created by general economic conditions. A is incorrect because the risk that is related to a certain company or security is known as specific, idiosyncratic, non-systematic, or unsystematic risk. C is incorrect because specific risk, not systematic risk, is the result of a lack of diversification. Chapter 17

The act of an investment manager adjusting his or her portfolio to take advantage of short-term fluctuations in asset class returns most likely describes: a. rebalancing. b. tactical asset allocation. c. strategic asset allocation.

B is correct. Tactical asset allocation refers to portfolio adjustments to the strategic asset allocation in an effort to take advantage of short-term fluctuations in asset class returns. Although the chosen strategic asset allocation is expected to meet the investor's objectives over the longer term, there may be times when shorter-term fluctuations in asset class returns may be exploited to potentially increase returns. A is incorrect because rebalancing refers to resetting a portfolio to its initial strategic weights. Rebalancing involves selling some of the holdings that have increased as a proportion of the portfolio and investing the proceeds into the holdings that have decreased as a proportion of the portfolio. C is incorrect because strategic asset allocation is the long-term mix of assets that is expected to meet the investor's objectives. Chapter 17

If the investment returns of a defined benefit pension plan exceed projections, pension benefits will most likely: a. decrease. b. remain the same. c. increase.

B is correct. The benefits associated with a defined benefit pension plan are established independent of specified investment targets. If the performance of the fund exceeds projections, a pension surplus may be created that improves the funding status of the plan but does not alter the benefit payments made to plan members. Chapter 16

The consequences of failure to comply with regulations and corporate policies and procedures: a. include costs to only the firm and employees. b. range from individual costs to damage to the global economy. c. are borne by the employee who failed to comply and not by the employee's supervisor or employer.

B is correct. The consequences of failure to comply with regulations and corporate policies and procedures can have far-reaching consequences. A is incorrect because these failures affect more than just the company and its employees. C is incorrect because supervisors and the employer may be assigned some responsibility for the failure. Chapter 3

The consistent outperformance of an investment fund compared with its benchmark is best described as: a. beta. b. alpha. c. tracking error.

B is correct. The consistent outperformance of an investment fund compared with its benchmark is generally referred to as alpha. Alpha reflects the investment skill of the fund manager. A is incorrect because beta reflects the market performance, over which the fund manager has no control. C is incorrect because the tracking error reflects how much the performance of the investment fund deviates from the performance of its benchmark. Chapter 19

The factor most likely to contribute to the success of active management is the: a. existence of trading costs. b. existence of inefficient markets. c. inability for active managers to consistently access better information than other investors.

B is correct. The existence of inefficient markets creates an environment in which security mispricing may occur, and active management may prove beneficial in exploiting such mispricing. If markets are efficient, there is little point to actively managing investments because asset prices already reflect the available information and the potential of the underlying investments. A is incorrect because trading costs reduce the expected benefit of active management and may limit the success of active management. For active management to be successful, any mispricing of investments has to be substantial enough to cover the costs of exploiting the mispricing. C is incorrect because the success of active management will be limited if active managers cannot consistently access better information than other investors. Active managers may also be able to use the same information faster than other investors or have better models to process the information. Chapter 17

Which of the following titles best describes the person in a firm responsible for providing independent assessments of the firm's operational systems? a. Chief risk officer b. Chief audit executive c. Chief operating officer

B is correct. The firm's chief auditor, or chief audit executive, is responsible for leading the firm's auditing department, assessing the firm's operational systems, and suggesting ways for the firm to improve them. A is incorrect because the chief risk officer is responsible for identifying and managing potential risks to clients and the firm. C is incorrect because the firm's chief operating officer is responsible for the day-to-day management of the firm. Chapter 13

The return requirement for an investor should be: a. specified in nominal terms. b. achievable within the relevant constraints. c. higher for investors with low risk tolerances.

B is correct. The investment manager or adviser has to be comfortable that the investor's desired rate of return is achievable within the related constraints. A is incorrect because the return requirement, particularly for a long-term horizon, should be specified in real terms, which means adjusting for the effect of inflation. Adjusting for the effect of inflation is important because it focuses on what the accumulated portfolio will be able to purchase rather than just the nominal monetary value. C is incorrect because for investors with lower risk tolerances, the return requirement will be lower because of the low level of risk in the portfolio. Chapter 16

The market where an investor sells shares of a publicly traded company she bought in an initial public offering (IPO) three years ago is known as the: a. primary market. b. secondary market. c. private placement.

B is correct. The investor will sell the shares to another investor, and trading of securities between investors takes place in the secondary market. A is incorrect because the purchase of the shares in the IPO three years ago took place in the primary market—that is, the market in which the company sold shares to investors for the first time. C is incorrect because a private placement is a primary market transaction in which a company sells shares to a small group of qualified investors. Chapter 15

Which activity is a clearing activity? a. Exchanging cash for securities b. Confirming the terms of the trade c. Reporting the trade to the company's transfer agent

B is correct. The most important clearing activity is confirming the terms of the trade. A and C are incorrect because exchanging cash for securities and reporting the trade to the company's transfer agent are activities that occur after clearing activities and are settlement activities. Chapter 15

Unique assets, such as real estate, are most likely traded in: a. a dealer market. b. a brokered market. c. an order-driven market.

B is correct. Unique assets, such as real estate, are likely to be traded in a brokered market. Brokers organise markets for assets that are unique and thus of interest to only a limited number of buyers and sellers. Successful brokers spend most of their time building their client networks. A is incorrect because dealer markets are markets in which investors trade with dealers at the prices quoted by the dealers. Dealers are not likely to make markets in real estate because real estate is infrequently traded and expensive to carry in inventory. C is incorrect because unique assets, such as real estate, are not likely to be traded in order-driven markets because too few traders would participate. Chapter 15

Which of the following orders will most likely be executed immediately? a. Stop order b. Limit order c. Market order

C is correct. A market order instructs the broker or exchange to obtain the best price immediately available when filling an order. B is incorrect because a limit order also instructs the broker or exchange to obtain the best price immediately available, but it sets conditions on price. The price to be paid on a purchase cannot be higher than the specified limit price, or the price to be accepted on a sale cannot be lower than the specified limit price. Thus, the order may not execute. A is incorrect because a stop order is an order for which the trader has specified a stop condition. The order may not be filled until the stop condition has been satisfied. Chapter 15

Compared with a regular public offering, in a shelf registration, a company: a. sells the shares in a single transaction. b. faces lower public disclosure requirements. c. can sell shares over a longer period of time.

C is correct. A shelf registration allows a company to sell the shares directly into the secondary market over time when it needs additional capital. A shelf registration gives a company more flexibility with the timing of selling the shares. A is incorrect because in a shelf registration, unlike in a regular public offering, a company that issues shares does not have to sell the shares in a single transaction. The sale of additional shares can be timed over several months or even years. B is incorrect because in a shelf registration, the company makes the same public disclosures that it would for a regular offering. Companies face lower public disclosure requirements when they issue shares via a private placement. Chapter 15

Which of the following is most likely a regulatory failure? a. Only inadequate regulation b. Only failure to enforce regulation c. Both inadequate regulation and failure to enforce regulation

C is correct. Both inadequate regulation and failure to properly enforce regulations are examples of regulatory failure, potentially resulting in harm to market participants and the industry as a whole. Chapter 3

Credit rating agencies are best described as providing: a. custodial services. b. financial planning services. c. investment information services.

C is correct. Credit rating agencies are investment information services providers that specialise in providing opinions about the credit quality of bonds and of their issuers. A is incorrect because custodians, not credit rating agencies, are firms that hold money and securities on behalf of their clients for safekeeping. B is incorrect because credit rating agencies do not provide financial planning services. Chapter 13

Which of the following statements is most accurate? Dealers: a. match buyers and sellers. b. serve as trade negotiators. c. provide liquidity in securities markets.

C is correct. Dealers provide liquidity in securities markets by trading on demand; they buy when their clients want to sell and sell when their clients want to buy. A and B are incorrect because matching buyers and sellers and serving as trade negotiators are services provided by brokers, not by dealers. Chapter 13

Direct investments allow retail investors to: a. own diversified pools of risk. b. use the services of professional managers. c. choose when to buy or sell to minimise tax liabilities.

C is correct. Direct investments provide an investor with the ability to choose the securities and assets they invest in, time their trades to minimise their tax liabilities, and exercise control over their investments. A and B are incorrect because indirect investments allow retail investors to own diversified pools of risk and to use the services of professional managers, which they otherwise might not be able to do. Chapter 14

Regulatory sanctions against firms include: a. only financial penalties. b. only financial penalties and loss of licences. c. financial penalties, loss of licences, and forced closure.

C is correct. Failure to comply with regulations and internal policies may result in regulatory sanctions, including fines, loss of licences, and forced closure. A and B are incorrect because sanctions can include fines, loss of licences, and forced closure. Chapter 3

Front office activities within a sell-side firm most likely include: a. core activities of the firm. b. administrative and support activities. c. client-facing, revenue-producing activities.

C is correct. Front office activities in a sell-side firm include activities that directly produce revenue and typically have direct client contact. Examples include sales and customer services. A is incorrect because core activities of the firm are performed by the middle office. B is incorrect because the back office of a firm is responsible for support and administrative functions. Chapter 13

Which of the following types of investors is most likely to be identified as an individual investor? a. Insurance company b. Sovereign wealth fund c. Ultra-high-net-worth investor

C is correct. High-net-worth and ultra-high-net-worth investors are individual investors with the largest amounts of investable assets. A and B are incorrect because insurance companies and sovereign wealth funds are institutional investors. Chapter 16

Which of the following is most likely the first step in a typical regulatory process? a. Public consultation b. Compliance monitoring c. Perceived need identification

C is correct. In a typical regulatory process, the first step is identification of a perceived need. Perceived need for regulation may be proactive in anticipation of need or in response to a current situation. A is incorrect because public consultation is part of the regulatory step, but it comes after the identification of a need, identification of legal authority, and analysis. B is incorrect because compliance monitoring occurs after the regulation is in place. Chapter 3

An investment bank is exposed to the greatest risk with: a. a rights offering. b. a best efforts offering. c. an underwritten offering.

C is correct. In an underwritten offering, the investment bank buys the securities from the issuer at an offering price that is negotiated with the issuer. The objective of the investment bank is to set a price at which it can sell all of the securities and not become a long-term shareholder. If all the shares are not sold, the investment bank risks its own capital in the residual shareholding. A is incorrect because a rights offering allows existing shareholders to buy shares at a fixed price and does not involve the investment bank's capital. B is incorrect because with a best efforts offering, the investment bank acts only as a broker and thus does not expose its own capital to buy the securities. Chapter 15

The investment needs of individual investors are most likely: a. the same among investors of similar ages and wealth. b. similar in many respects to those of institutional investors. c. unique to each individual's circumstances and requirements.

C is correct. Investment needs are directly affected by personal situations, such as age, wealth level, family obligations, and investment horizon, which are generally unique among individual investors. A is incorrect because the investment needs of individual investors tend to vary among individuals based on factors in addition to wealth and age, such as family obligations, investment horizon, and so on. B is incorrect because the characteristics that define individual investors are usually different from those that define institutional investors. Consequently, investor needs are likely to be different for individual investors compared with institutional investors. Chapter 16

An investor takes a short position in a security by: a. buying the security. b. lending the security to another trader. c. borrowing the security and then selling it to another trader.

C is correct. Investors take short positions when they sell securities that they do not own, a process that involves borrowing securities, selling them, and repurchasing them later to return them to their owner. If the security falls in price, the investor profits because she can repurchase the security at a lower price than the price at which she sold it. If the security rises in price, she loses. A is incorrect because if the investor buys the security, she takes a long, not short, position in the security. B is incorrect because if the investor lends the security to another trader, she becomes the security lender. Chapter 15

Which of the following statements best describes passive management? Passive investment managers: a. attempt to outperform the benchmark. b. tend to earn higher returns than the benchmark. c. seek to match the risk and return of the benchmark.

C is correct. Passive investment managers seek to match the risk and return of an appropriate benchmark. A is incorrect because passive investment managers do not try to outperform the benchmark. B is incorrect because although the costs of passive management are lower than the costs of active management, the return earned by the passive investor will typically be less than the benchmark return because of these costs. Chapter 17

Passive managers will most likely: a. sell securities that are expected to outperform. b. sell securities that are expected to underperform. c. match the return and risk of a broad market index.

C is correct. Passive managers seek to match the return and risk of an appropriate benchmark, such as a broad market index. A and B are incorrect because it is active, not passive, managers who trade securities to beat the benchmark. Note that active managers will buy securities that are expected to outperform and sell securities that are expected to underperform. Chapter 13

A difference in investment policy statements for institutional investors and individual investors most likely relates to the inclusion of: a. client constraints. b. investment objectives. c. procedural and governance issues.

C is correct. Procedural and governance issues are constraints specific to many institutional investors. A and B are incorrect because the investment policy statement for both institutional investors and individual investors will include client constraints and investment objectives. Chapter 16

Which of the following types of institutional investors is most likely to have the shortest investment time horizon? a. Life insurer b. Endowment fund c. Property and casualty insurer

C is correct. Property and casualty insurers have short-term horizons and relatively unpredictable payouts. A is incorrect because life insurers have longer-term time horizons and relatively predictable payouts. B is incorrect because endowments are usually intended to exist in perpetuity and, as such, can be regarded as very long-term investors. Chapter 16

Regulations that affect the financial services industry are most likely needed because: a. power is equally distributed among industry participants. b. the same information is available to all industry participants. c. a high number of interconnections exists among industry participants.

C is correct. Regulations that affect the financial services industry are needed because a high number of interconnections exist among industry participants. The interconnections between industry participants create the risk of a systemic failure. A and B are incorrect because there are differences in the relative power and access to information among industry participants, which creates a need for regulation. Chapter 3

Regulations that require large financial firms to create virtual and physical barriers between investment banking activities and research activities are examples of: a. trading rules. b. gatekeeping rules. c. sales practice rules.

C is correct. Regulations that require large financial firms to create virtual and physical barriers between investment banking activities and research activities are examples of sales practice rules. Sales practice rules attempt to address potential conflicts of interest when financial service providers have a financial stake in the decisions that their clients make. Such regulation also includes controls on advertising and pricing. A is incorrect because trading rules focus on trading practices in the market and trading activity of financial participants to ensure fair, organised, and efficient markets. B is incorrect because gatekeeping rules are intended to ensure that industry personnel meet standards for competency and integrity and that financial products offered meet certain standards. Chapter 3

Regulations to ensure that companies in the financial services industry do not engage in practices that could cause failures in the financial markets most likely have: a. a social objective. b. an efficiency objective. c. an economic stability objective.

C is correct. Regulations to ensure that companies in the financial services industry do not engage in practices that could cause failures in the financial market have an economic stability objective. A is incorrect because social objectives of regulation include increasing the availability of credit to a specific group, encouraging home ownership, increasing national savings rates, and preventing criminal activity. B is incorrect because efficiency objectives of regulation are intended to reduce costs and increase economic efficiency. For example, the adoption of rules to standardise documentation or how to transport information. Chapter 3

An example of a middle office activity is: a. sales. b. accounting. c. risk management.

C is correct. Risk management is classified as a middle office activity. A is incorrect because sales is classified as a front office activity. B is incorrect because accounting is classified as a back office activity. Chapter 13

Sell-side firms are best described as firms that: a. sell insurance products to retail clients. b. sell investment data, research, and consulting services. c. provide investment products and services.

C is correct. Sell-side firms provide investment products and services. Brokers, dealers, and investment banks are considered sell-side firms. A is incorrect because insurance companies typically sell insurance products and buy investment products and services. B is incorrect because firms that provide only investment data, research, and consulting services are neither buy- or sell-side firms. These firms are investment information services providers. Chapter 13

The long-term mix of assets that is expected to meet an investor's objectives best describes: a. diversification. b. tactical asset allocation. c. strategic asset allocation.

C is correct. Strategic asset allocation is the long-term mix of assets that is expected to meet the investor's objectives. The desired overall risk and return profile of the portfolio is a factor in determining the strategic asset allocation. A is incorrect because diversification is the process of combining assets with different characteristics in a portfolio for the purpose of reducing risk. B is incorrect because tactical asset allocation refers to short-term adjustments among asset classes. Although the chosen strategic asset allocation is expected to meet the investor's objectives over the longer term, there may be times when shorter-term fluctuations in asset class returns may be exploited to potentially increase returns. Chapter 17

An investor's investment policy statement: a. ensures that investment plan objectives are met. b. should be reviewed only when the client's circumstances change. c. outlines what is required of and acceptable in the investment portfolio.

C is correct. The investment policy statement serves as a guide for the investor and investment manager regarding what is required and what is acceptable in the investment portfolio. A is incorrect because the investment policy statement outlines the investment plan objectives and serves as a guide to achieving the objectives but it cannot ensure that investment plan objectives will be met. B is incorrect because the investor and manager/adviser should agree on the investment policy statement and review it on a regular basis, typically at least once a year. If the client experiences a change in circumstances, the investment policy statement may be reviewed more frequently. Chapter 16

The process of adding and removing securities included in a security market index is called: a. churning. b. rebalancing. c. reconstitution.

C is correct. The process of adding and removing securities included in a security market index is called index reconstitution. A is incorrect because churning is excessive trading to increase commissions. B is incorrect because rebalancing is the process of adjusting the weights of the securities in an index. Chapter 14

Which of the following statements about the settlement cycle is correct? a. The settlement cycle is the same across markets. b. A long settlement cycle reduces counterparty risk. c. The settlement cycle refers to the timing of the procedures used to settle trades.

C is correct. The settlement cycle refers to the timing of the procedures used to settle trades. Settlement may occur in real time (instantaneously), or it may take up to three trading days. A is incorrect because settlement cycles vary across markets. B is incorrect because a short, not long, settlement cycle reduces counterparty risk. Chapter 15

Compared with shares of closed-end funds, shares of open-end mutual funds: a. are not redeemable. b. are exchange traded. c. trade at net asset value.

C is correct. The shares of open-end mutual funds are bought and redeemed at net asset value. Shares of closed-end funds generally trade at prices different from their net asset value. A is incorrect because it is the shares of closed-end, not open-end, mutual funds that are not redeemable. B is incorrect because it is the shares of closed-end, not open-end, mutual funds that are exchange traded. Chapter 14

When an investor's willingness and ability to take risk differ, the investment adviser should counsel the investor to use a risk level based on the: a. ability to take risk only. b. willingness to take risk only. c. lesser of the two risk levels.

C is correct. There may be situations in which an investor's willingness to take risk and his or her ability to take risk are different. In such situations, the investment adviser should counsel the investor about risk and determine the appropriate level of risk to take in the portfolio, taking into account both the investor's ability and willingness to take risk. The lesser of the two risk levels should be the risk level assumed. A and B are incorrect because both the ability and willingness to take risk must be considered. Chapter 16

When investment managers identify attractive securities based on fundamental values, the investment managers are performing which of the following activities? a. Asset allocation b. Investment analysis c. Portfolio construction

Chapter 13

Which of the following options would be described as being in the money? a. A put option in which the underlying's price is lower than the exercise price. b. A call option in which the underlying's price is lower than the exercise price. c. A put option in which the underlying's price is higher than the exercise price.

a. A put option in which the underlying's price is lower than the exercise price. A put option is in the money when the underlying's price is lower than the exercise price. The put buyer has the right to sell the underlying at the exercise price, which is higher than the current market price of the underlying. B is incorrect because a call option in which the underlying's price is lower than the exercise price is out of the money. C is incorrect because a put option in which the underlying's price is higher than the exercise price is out of the money. Chapter 11

Assuming a discount rate of 10%, which of the following projects will have the highest present value? a. A €10,000 lump-sum payment received today. b. A €10,000 lump-sum payment received in one year. c. A €5,000 payment received today plus €5,000 to be received in one year.

a. A €10,000 lump-sum payment received today. A lump-sum payment received today has a higher present value than the same amount received in the future or in instalments. Chapter 8

Which of the following most likely represents potential violation of ethical principles due to a conflict of interest? a. an analyst writes a research report about a company for which he owns a significant number of shares. b. a financial salesperson, who sells specific investment products, recommends an investment product to a client and is paid a commission on the sale. c. an employee sells her own shares of a company after placing a client's order to sell shares of the same company.

a. An analyst writes a research report about a company for which he owns a significant number of shares. The analyst preparing a research report about a company when there is an ownership interest, unless the interest is clearly insignificant, has a conflict of interest. The analyst's personal interests might affect his or her ability to write an unbiased, objective report, which is contrary to the interests of his or her employer and the employer's clients. B is incorrect because there is a different level of responsibility associated with a financial salesperson, who is committed to selling specific investment products, and an investment adviser, who is helping clients to plan and achieve their personal financial goals. C is incorrect because although acting prior to executing a client's order (front running) represents a violation of an ethical principle due to a conflict of interest, it may be appropriate for an employee to act after executing the client's order. Chapter 2

Which of the following alternative investments is the least liquid?: a. An investment in a private equity fund b. An investment in a real estate investment trust c. An investment in a commodity futures contract

a. An investment in a private equity fund. Investments in private equity funds are private market investments. Thus, they are illiquid investments. B and C are incorrect because real estate investment trusts and commodity futures contracts are both traded on public exchanges. Thus, they are more liquid investments. Chapter 12

Which type of private equity strategy is most likely used to restructure and facilitate a change of ownership? a. Buyout. b. Growth equity. c. Venture capital.

a. Buyout. Buyouts are investments in established companies that require money to restructure and facilitate a change of ownership. B is incorrect because the growth equity strategy usually invests in existing companies with proven business models, good customer bases, and positive cash flow or profits. C is incorrect because the venture capital strategy invests in start-up companies that exist merely as an idea or a business plan. The company may have only a few employees, have little to no revenue, and may still be developing its product or business model. Chapter 12

Which of the following entities raises external capital to finance their operations by issuing a combination of equity and debt securities? a. Companies b. Governments c. Both companies and governments

a. Companies Companies raise external capital to finance their operations by issuing a combination of debt and equity securities. B and C are incorrect because governments raise external capital by issuing debt securities but they do not issue equity securities. Chapter 9

Which of the following is most likely an example of external documentation? a. Contract between the buyer and seller of an asset b. Process flow diagram that guides employees when they receive gifts from clients c. Policy document that states the organisation will not engage in insider trading

a. Contract between the buyer and seller of an asset A policy document describes principles of action adopted by a company. They are typically driven from the top down, with rules cascading down through the various business units and functional areas of the company. B is incorrect because a process document describes the individual steps the company must take, from start to finish, to achieve a desired outcome. C is incorrect because a procedure document broadly identifies what the company must do to achieve a desired outcome. It often provides a bridge between the activities that are allowed at the policy level and what needs to happen at the process level. Policies broadly state the rules, procedures help apply policies, and processes divide procedures into manageable actions. Chapter 20

A company imports goods and pays for them in a foreign currency. Which of the following exchange rate systems would eliminate currency risk for the company? a. Fixed b. Pure floating c. Managed floating

a. Fixed The advantage of a fixed exchange rate system is that it eliminates currency risk (or foreign exchange risk), which is the risk associated with the fluctuation of foreign exchange rates. Under a fixed exchange rate system, the company will know with certainty the amount it will pay for the imported goods. B and C are incorrect because under pure or managed floating exchange rate systems, the company faces currency risk. Chapter 6

Which type of private equity strategy is most likely used to invest in existing companies with proven business models, good customer bases, and positive cash flow or profits? a. Growth equity. b. Buyout. c. Venture capital.

a. Growth equity. The growth equity strategy usually invests in existing companies with proven business models, good customer bases, and positive cash flow or profits. B is incorrect because buyouts are investments in established companies that require money to restructure and facilitate a change of ownership. C is incorrect because the venture capital strategy invests in start-up companies that exist merely as an idea or a business plan. The company may have only a few employees, have little to no revenue, and may still be developing its product or business model. Chapter 12

Which of the following best shows the accounting equation? a. Total assets = Total liabilities + Total shareholders' equity b. Total assets + Total liabilities = Total shareholders' equity c. Total shareholders' equity - Total assets = Total liabilities

a. Total assets = Total liabilities + Total shareholders' equity. The fundamental relationship of a company's financial position, as represented by the balance sheet, is known as the accounting equation and is noted as: Total assets = Total liabilities + Shareholders' equity. B and C are incorrect because they represent incorrect algebraic rearrangements of the equation. Chapter 7

Which of the following situations most likely increases an organisation's compliance risk? a. Using agents and third parties b. Separating the front and back offices c. Monitoring and controlling business processes

a. Using agents and third parties Using agents and third parties increases compliance risk. It is more difficult to monitor and control these agents and third parties than internal staff, but the company may still be responsible for the actions of these agents and third parties. B and C are incorrect because separating the front and back offices and monitoring and controlling business processes decrease compliance risk. Chapter 18

A fund manager who uses analytical and trading skills to try to beat a benchmark is best described as a(n): a. active manager. b. index replicator. c.passive manager.

a. active manager. Active fund managers use analytical and trading skills to try to beat a benchmark. They seek out investments that meet the investment mandate, and their portfolios look different from the benchmark. B and C re incorrect because passive fund managers, including index replicators, try to match the performance of the benchmark. Chapter 19

The Sharpe ratio is used in the performance evaluation process to: a. adjust return for risk. b. attribute performance. c. measure absolute returns.

a. adjust return for risk. The Sharpe ratio evaluates the reward for each unit of risk. B and C are incorrect because the Sharpe ratio is not used in the attribution of performance or in the measurement of absolute performance. Chapter 19

A broker will act as a(n): a. agent. b. principal. c. proprietary trader.

a. agent. Brokers act as agents and do not trade directly with investors. B and C are incorrect because brokers do not use their own accounts to trade as principals with buyers/sellers nor do they use their own capital as proprietary traders. Chapter 1

If all other factors remain the same, which of the following changes would most likely cause an increase in the growth rate of a country's GDP? a. an increase in productivity. b. an increase in unemployment. c. a decrease in the availability of capital.

a. an increase in productivity. An increase in productivity will lead to an increase in GDP, all other factors remaining the same. B is incorrect because an increase in unemployment (a decrease in the employed labour force) will lead to a decrease in GDP, all other factors being unchanged. C is incorrect because a decrease in the availability of capital will lead to a decrease in GDP, all other factors being unchanged. Chapter 5

The monthly fact sheet of a mutual fund is available electronically on the mutual fund's external website. The fact sheet is: a. an official record. b. not an official record because it is in electronic format. c. not an official record because it conveys only information and not evidence.

a. an official record. Fact sheets are documents that provide short summaries of investments and typically detail historical performance—in this case, the monthly performance of the mutual fund. Fact sheets represent an official record. B and C are incorrect because official records can be in electronic or printed format and can provide information or evidence. Chapter 20

The last step in an ethical decision-making process should be to: a. assess how a decision turned out and learn from it. b. assess how others might view a possible course of action. c. determine whether the decision is affected by outside factors.

a. assess how a decision turned out and learn from it. The last step in an ethical decision-making process should be to assess how a decision turned out and to learn from it. B and C are incorrect because assessing how others might view a possible course of action and determining whether the decision is affected by outside factors occur earlier in the decision-making process. Chapter 2

The process of decomposing a fund manager's performance to identify the source(s) of that performance is best described as: a. attribution analysis. b.risk-adjusted analysis. c.relative performance analysis.

a. attribution analysis. Attribution analysis is used to identify the source(s) of a fund's or fund manager's performance—that is, how much of the return was attributable to the manager's asset allocation, sector selection, security selection, or currency exposure. B is incorrect because risk-adjusted analysis, such as calculating reward-to-risk ratios, is used to determine how much return was generated per unit of risk. C is incorrect because relative performance analysis is the comparison of the fund manager's holding-period return with the return on an appropriate benchmark. Chapter 19

The financial statement that provides information about a company's financial position at a specific point in time is the: a. balance sheet. b. income statement. c. cash flow statement.

a. balance sheet. The balance sheet provides information about a company's financial position at a specific point in time. It shows the resources the company controls (assets), its obligations to lenders and other creditors (liabilities or debt), and its owner-supplied capital (shareholders' equity, stockholders' equity, or owners' equity) at a specific point in time. B is incorrect because the income statement shows the company's financial performance over a given time period. It identifies the profit or loss generated by a company over the period. C is incorrect because the cash flow statement identifies the sources and uses of cash over a given time period. It explains the change in the company's cash balance reported on the balance sheet over the period. Chapter 7

The private equity firm receives management fees: a. based on committed capital. b. only if the private equity fund is profitable. c. based on profits generated by the private equity fund's investments.

a. based on committed capital. The private equity firm receives management fees based on the amount of committed capital. B is incorrect because the private equity firm receives management fees even if the private equity fund is not profitable. C is incorrect because carried interest is the fee that the private equity firm receives based on profits generated by the private equity fund's investments. Chapter 12

In fulfilling obligations to their employer, employees should: a. be careful in carrying out their responsibilities. b. accept and diligently complete any assigned task. c. balance their personal interests with their employer's interests.

a. be careful in carrying out their responsibilities. Being careful in carrying out their responsibilities is an obligation of all employees. The efficient operations of a company can be compromised if employees do not act competently and carefully. B is incorrect because employees should not accept a task if they lack the appropriate level of knowledge or skill to carry it out, if they have a conflict of interest, or if they are concerned about an ethical issue. C is incorrect because loyalty, an obligation owed to employers, includes an expectation that employees act in their employer's interests when fulfilling their work obligations. Chapter 2

The return on equity for a company and the industry in which it operates are 10.3% and 9.6%, respectively. The company is most likely performing: a. better than the industry. b. the same as the industry. c. worse than the industry.

a. better than the industry. The return on equity is higher for the company than for the industry, indicating that the company is performing better. An analyst should conduct further analysis to identify the source(s) of this apparently superior performance. Chapter 7

A currency dealer makes more money when the: a. bid-offer spread is wide. b. bid-offer spread is narrow. c. bid rate is equal to the offer rate.

a. bid-offer spread is wide. The bid exchange rate (or bid rate) is the exchange rate at which the currency dealer will buy the foreign currency, and the offer exchange rate (or offer rate) is the exchange rate at which the currency dealer will sell the foreign currency. The currency dealer makes a profit by buying a unit of currency more cheaply than it sells it. Thus, the wider the bid-offer spread, the more money the currency dealer makes. Chapter 6

Which of the following is most likely to facilitate trading and help reduce transaction costs? a. brokers. b. analysts. c. asset managers.

a. brokers. Brokers are trading service providers who facilitate trading between investors. B and C are incorrect because analysts and asset managers are not trading services providers. Analysts are primarily engaged in collecting and analysing information about companies and their competitors and preparing detailed reports (sell-side analysts) or reviewing potential investments (buy-side analysts). Asset managers are professionals who help their clients with investment decisions to achieve their investment goals. Chapter 1

According to fundamental ethical and professional principles applicable to the investment industry, which group should have their interests ranked first? a. clients. b. employers. c. co-workers.

a. clients. Individuals working in the investment industry have the obligation to place client interests ahead of personal interests or the interests of employers. B and C are incorrect because although individuals in the investment industry have an obligation to employers and co-workers, the clients' interests come first. Chapter 2

Which of the following securities most likely provides voting rights to investors? a. common shares. b. preferred shares. c. depositary receipts.

a. common shares. Common shareholders usually have the right to vote on certain matters. B is incorrect because preferred shareholders are not generally entitled to voting rights. C is incorrect because depositary receipts are securities that represent an economic interest in a foreign company, are issued by a custodian financial institution, and trade like common stock on a local stock exchange. Although they essentially represent common stock ownership, they typically do not offer their owners any voting rights because the custodian financial institution usually retains the voting rights associated with the stock. Chapter 10

Ratio analysis is used to: a. compare companies of different sizes. b. identify the uses of cash during the period. c. determine profit or loss associated with operations.

a. compare companies of different sizes. Ratio analysis is used to compare companies of different sizes. When companies are different sizes, it is critical to standardise the financial information. B is incorrect because the cash flow statement is used to identify the sources and uses of cash over a period of time. C is incorrect because the income statement is used to identify the profit or loss associated with operations over a period of time. Chapter 7

The final step in a risk management process most likely includes: a. controlling and monitoring activities. b. using a risk matrix to prioritise risks. c. hedging unwanted risk by using derivative instruments.

a. controlling and monitoring activities. A risk management process generally includes five steps: set objectives, detect and identify events, assess and prioritise risks, select a risk response, and control and monitor activities. Controlling and monitoring activities are typically the final step of a risk management process. C is incorrect because hedging unwanted risks by using derivative instruments is a response, which relates to the fourth step of a risk management process. B is incorrect because using a risk matrix to prioritise risks is associated with the third step of a risk management process, assess and prioritise risks. Chapter 18

Payments from a computer company in the United Kingdom to a company in India that operates a call centre to answer questions from the computer company's customers are most likely included in the United Kingdom's: a. current account. b. capital account. c. financial account.

a. current account. Answering questions at a call centre in India to service a computer company's customers in the United Kingdom is an export of service from India and an import of service for the United Kingdom. The flow of money for service is included in the current account in the balance of payments. Chapter 6

Holding all other factors constant, an increase in imports would most likely cause total GDP to: a. decrease. b. remain the same. c. increase.

a. decrease. Imports involve domestic residents spending money on foreign goods. Higher imports would cause GDP to decrease as defined by the following equation: GDP = C + I + G + (X - M), where C is consumer spending, I is gross investment, G is government spending, X is exports, and M is imports. Chapter 5

In a mortgage transaction, the amount of each fixed payment made by the borrower that represents interest: a. decreases over time. b. remains the same over time. c. increases over time.

a. decreases over time. Although the payment amount is fixed, the portion of each payment that is interest is based on the remaining principal at the beginning of each period. As the principal declines, so does the amount of the fixed payment that constitutes interest. B is incorrect because the payment remains fixed, but the portion allocated to interest decreases over time while the portion allocated to principal increases over time. C is incorrect because the portion of the fixed payment allocated to principal increases over time. Chapter 8

Ratings assigned to debt securities by credit rating agencies help investors assess: a. default risk. b. inflation risk. c. interest rate risk.

a. default risk. Credit rating agencies assess the credit quality of particular bonds and issue credit ratings, which help bond investors to assess the bond's default risk (or credit risk). B and C are incorrect because although rating agencies assess inflation and interest rate risk when they analyse the credit quality of a particular bond, their ratings help investors assess the default risk of the debt issue. Chapter 9

If a country has a current account surplus, it most likely has a capital and financial account: a. deficit. b. surplus. c. in balance.

a. deficit. If a country has a current account surplus, it will have a capital and financial account deficit—the country is a net saver and ends up being a net lender to the rest of the world. Chapter 6

An economy experiencing deflation is most likely characterised by: a. delayed consumption. b. increased production. c. reduced unemployment.

a. delayed consumption. In a deflationary environment, consumers may expect prices to continue falling and delay purchases (consumption). B and C are incorrect because companies, as a result of reduced consumer spending, are likely to reduce production, which leads to increased unemployment. Chapter 5

If consumers demand more of a good than sellers find profitable to produce, then sellers' inventories will tend to: a. deplete. b. pile up. c. remain unchanged.

a. deplete. When the price of a good is below the equilibrium price, consumers will demand more of the good than producers will find profitable to sell and inventories will be depleted. B is incorrect because inventories pile up when companies are willing to supply more of a good than consumers are willing to buy. C is incorrect because sellers' inventories are affected by consumer demand and will not remain unchanged. Chapter 4

The interest rate used to determine the present value of future cash flows is called the: a. discount rate. b. effective annual rate. c. annual percentage rate.

a. discount rate. The present value of future cash flows is obtained by discounting the future cash flows by the interest rate. The interest rate in this context is called the discount rate. C is incorrect because the annual percentage rate is a quoted simple interest rate. B is incorrect because the effective annual rate is used to annualise a rate that is paid more than once a year. Chapter 8

Greater integrity by participants in financial markets is most likely achieved by: a. effective laws and regulations b. lower prices c. competition

a. effective laws and regulations Greater integrity is achieved by effective laws and regulations and not through competition. Chapter 1

If revenues decrease when the price of a good increases, the price elasticity of this good is most likely: a. elastic. b. inelastic. c. unit elastic.

a. elastic. For elastic goods, an increase in price will lead to a greater percentage decrease in quantity and a decrease in revenues. B is incorrect because for inelastic goods, a decrease in price will lead to a decrease in revenues. C is incorrect because price changes do not affect total revenue for goods that are unit elastic. Chapter 4

Which of the following costs is most likely a variable cost for a manufacturing plant? a. energy costs. b. interest expense. c. insurance expense.

a. energy costs. Energy costs are variable costs that are sensitive to the level of production. B is incorrect because interest expense is often a fixed cost and does not vary with the level of production. C is incorrect because insurance expense is often a fixed cost and does not vary with the level of production. Chapter 4

A private market investment vehicle holding hundreds of commercial properties that are diversified by geography, property type, and vintage year is best described as a real estate: a. equity fund. b. investment trust. c. limited partnership.

a. equity fund. A real estate equity fund is a private market investment vehicle that holds hundreds of commercial properties that are diversified by geography, property type, and vintage year (year the purchase was made). B is incorrect because a real estate investment trust (REIT) is an investment through public rather than private markets. A REIT is a company that mainly owns, and in most cases operates, income-producing real estate. C is incorrect because a real estate limited partnership is a private market investment vehicle that typically focuses on a smaller number of commercial properties, such as the construction of a housing subdivision or an apartment complex. Chapter 12

The discounted cash flow approach to valuation of a company's common shares most likely considers the: a. expected dividends on the shares. b. current value of the company's assets. c. price-to-earnings ratios of comparable companies.

a. expected dividends on the shares. The discounted cash flow approach to valuation estimates the value of a security as the present value of all future cash flows that the investor expects to receive from the security. Common shareholders expect to receive two types of cash flows: dividends and the proceeds from selling their shares. Thus, the expected dividends on the shares are an important component of the discounted cash flow valuation approach. B is incorrect because the valuation approach that considers the current value of the company's assets is the asset-based valuation approach. C is incorrect because the valuation approach that considers the price-to-earnings ratios of comparable companies is the relative valuation approach. In such a valuation approach, the value of a common share is estimated by using multiples based on market prices and some other measure for comparable, publicly traded companies. Chapter 10

The country of Australia classifies products departing from the port of Melbourne to other countries as: a. exports. b. imports. c. net exports.

a. exports. Exports are products and services that are produced within a country's borders and then transported to another country. B is incorrect because imports are products and services that are produced outside a country's borders and then brought into the country. C is incorrect because net exports represent the difference between exports and imports of products and services. Chapter 6

Interest is paid by the borrower to compensate the lender: a. for opportunity cost and risk. b. for forgoing future consumption. c. for increases in future purchasing power.

a. for opportunity cost and risk. Interest is a payment paid by the borrower and earned by the lender that compensates for opportunity cost and risk. B is incorrect because the lender is forgoing current, not future, consumption. C is incorrect because interest is paid by the borrower to compensate the lender for potential decreases in future purchasing power. Chapter 8

Tools of fiscal policy include: a. government spending. b. open market operations. c. changes in the central bank lending rate.

a. government spending. Government spending and tax policies are tools of fiscal policy. B and C are incorrect because open market operations and changes in the central bank lending rate are tools of monetary policy. Chapter 5

International trade most likely: a. helps keep prices down. b. reduces competition. c. reduces demand for domestic products and services.

a. helps keep prices down. International trade promotes greater efficiency, which helps keep prices down. B and C are incorrect because international trade tends to increase competition and increase demand for domestic products and services. Chapter 6

Maintaining high ethical standards in the investment industry will most likely: a. increase the fairness of financial markets. b. decrease the stability of the financial system. c. decrease the complexity of financial markets.

a. increase the fairness of financial markets. By maintaining high ethical standards, investors' trust in the investment industry will increase as will trust in the fairness of financial markets. B is incorrect because high ethical standards help prevent financial crises and increase the stability of the financial system. C is incorrect because high ethical standards do not affect the complexity of financial markets. The increasing complexity of global financial markets increases the need for high ethical standards to deal with the resulting increase in ethical dilemmas. Chapter 2

Holding all other factors constant, if the demand for printers increases, the demand for ink cartridges is most likely to: a. increase. b. decrease. c. remain unchanged.

a. increase. Printers and ink cartridges are complementary products. Thus, if the demand for printers increases, the demand for ink cartridges increases as well. B is incorrect because the demand for ink cartridges would decrease if the demand for printers increased if printers and ink cartridges were substitute products, not complementary products. C is incorrect because printers and ink cartridges are complementary products. Thus, an increase in demand for printers will increase the demand for ink cartridges. Chapter 4

Holding all other factors constant, if the price of a product increases, the demand for a substitute product is most likely to: a. increase. b. decrease. c. remain unchanged.

a. increase. When the price of a product increases, the demand for substitute products also increases. B is incorrect because the demand for a complementary product, not a substitute product, will decrease if the price of the product increases. C is incorrect because the demand for a substitute product will increase if the price of a product increases. Chapter 4

ABC Company issued a 10-year bond at a price of $1,000. A month after issuance, the market price of the bond had dropped to $980. Over the month, the yield to maturity on the bond: a. increased. b. decreased. c. stayed the same.

a. increased. Bond prices and bond yields to maturity are inversely related. As the price of a bond falls, its yield to maturity increases. Chapter 9

Globally, regulation of the investment industry has: a. increased. b. decreased. c. remained stable.

a. increased. Globally, there has been a growing trend toward greater regulation of the investment industry. Chapter 1

If the price of a company's common shares increases significantly, the conversion value of a convertible bond issued by that company most likely: a. increases. b. decreases. c. remains unchanged.

a. increases. If the price of a company's common shares increases significantly, the conversion value of a convertible bond issued by that company increases. Chapter 10

The criterion that a benchmark should be made up of assets that can be bought or sold by the fund manager is known as: a. investability. b. compatibility. c. pre-specification.

a. investability. The ability to buy and sell the assets in a benchmark means it is investable. B is incorrect because compatibility means that the benchmark's composition and level of risk should be in line with the investor's objectives, including desired level of risk. C is incorrect because pre-specification means that the benchmark should be specified in advance so that the manager is clear about the client's objectives. Chapter 19

A company that mainly owns, and in most cases operates, income-producing real estate through public rather than private markets is best described as a real estate: a. investment trust. b. equity fund. c. limited partnership.

a. investment trust. A real estate investment trust (REIT) is an investment through public rather than private markets. A REIT is a company that mainly owns, and in most cases operates, income-producing real estate. B is incorrect because a real estate equity fund is a private market investment vehicle that holds hundreds of commercial properties that are diversified by geography, property type, and vintage year (year the purchase was made). C is incorrect because a real estate limited partnership is a private market investment vehicle that typically focuses on a smaller number of commercial properties, such as the construction of a housing subdivision or an apartment complex. Chapter 12

For individuals working in the investment industry, ethical standards are most needed when: a. legal obligations are ambiguous. b. market innovations are infrequent. c. different jurisdictions have unambiguous and similar laws.

a. legal obligations are ambiguous. Ethical standards are most needed when legal obligations are ambiguous. The need for ethical standards is particularly apparent in situations in which vague or ambiguous legal rules provide opportunities for unethical behaviour. B is incorrect because laws and regulations are often slow to catch up with market innovations. So, in the case of frequent market innovations, the need for ethical standards would be great. But in an environment with infrequent market innovations, the need is not so apparent. C is incorrect because activities that occur in different jurisdictions can be complicated by inconsistencies in legal obligations, which would make the need for ethical standards important. But in different jurisdictions where legal obligations are unambiguous and similar, the need for ethical standards is not as great. Chapter 2

Compared with common shares, an investment in preferred shares is most likely to be: a. less risky. b. more risky. c. equally risky.

a. less risky. Preferred shares are less risky than common shares because they rank higher than common shares with respect to the payment of dividends and distribution of net assets upon liquidation. The risk of preferred shares is also reduced to some degree by the expectation of a fixed dividend each year. Chapter 10

The present value of €100 that will be received two years from today is: a. less than €100. b. equal to €100. c. more than €100.

a. less than €100. The present value of any amount is less than the same amount received in the future. How much less depends on the discount rate used to determine the present value. B and C are incorrect because any amount received in the future is worth less than the same amount received today. Chapter 8

A private market investment vehicle that typically focuses on a smaller number of commercial properties, such as the construction of a housing subdivision or an apartment complex, is best described as a real estate: a. limited partnership. b. investment trust. c. equity fund.

a. limited partnership. A real estate limited partnership is a private market investment vehicle that typically focuses on a smaller number of commercial properties, such as the construction of a housing subdivision or an apartment complex. B is incorrect because a real estate investment trust (REIT) is an investment through public rather than private markets. A REIT is a company that mainly owns, and in most cases operates, income-producing real estate. C is incorrect because a real estate equity fund is a private market investment vehicle that holds hundreds of commercial properties that are diversified by geography, property type, and vintage year (year the purchase was made). Chapter 12

Tracking error for a passive investment fund is most likely: a. lower than the tracking error for an active investment fund. b. equal to the tracking error for an active investment fund. c. higher than tracking error for an active investment fund.

a. lower than the tracking error for an active investment fund. The tracking error reflects how the performance of the investment fund deviates from the performance of its benchmark. Because a passive investment fund is seeking to replicate a benchmark, the tracking error should be very low. Active investment funds attempt to select assets in a benchmark that will outperform the benchmark, and as a result the tracking error is typically higher than the passive fund. B and C are incorrect because the tracking error for the passive investment fund is most likely lower than the tracking error for active investment funds. Chapter 19

If $1,000 is deposited to an account with an annual interest rate of 3% and is left on deposit for three years, the amount of money in the account at the end of three years will be: a. lower using simple interest compared with using compound interest. b. the same using either simple interest or compound interest. c. greater using simple interest compared with using compound interest.

a. lower using simple interest compared with using compound interest. The amount of money in the account at the end of three years will be lower using simple interest compared with compound interest. Compound interest will result in interest being earned on the original deposit as well as interest on interest. Chapter 8

All else being equal, the fixed coupon rate on a convertible bond compared with a straight bond is most likely: a. lower. b. the same. c. higher.

a. lower. Because the conversion feature represents a benefit to the bondholder, a convertible bond typically offers the bondholder a lower fixed annual coupon rate than that of a comparable bond without a conversion feature (a straight bond). Chapter 10

Which of the following is a measure of central tendency? a. mean. b. range. c. standard deviation.

a. mean. Mean is a measure of central tendency. B and C are incorrect because both the range and standard deviation are measures of dispersion. Chapter 8

Which of the following investments is unacceptable? An investment with a net present value of: a. negative $5. b. $0. c. positive $5.

a. negative $5. A net present value of negative $5 means that the cost of the investment is $5 more than the present value of the future cash flows from the investment and the investment should not be made. B and C are incorrect because a net present value of zero or greater means that the investment is earning at least the discount rate and is acceptable. Chapter 8

Income that is available to reinvest in the company or distribute to owners is: a. net income. b. operating income. c. earnings before taxes.

a. net income. Net income is calculated as revenues minus all expenses and represents income that a company has available to retain or reinvest in the company or to distribute to owners in the form of dividends. B is incorrect because interest and tax expenses must be subtracted from operating income to arrive at the amount that is available to reinvest in the company or distribute to owners. C is incorrect because taxes must be subtracted from earnings before taxes to arrive at the amount that is available to reinvest in the company or distribute to owners. Chapter 7

According to fundamental ethical and professional principles for the investment industry, trading on insider information on behalf of clients is: a. not allowed. b. allowed only if the trade benefits the client. c. allowed only if the trade is disclosed as a conflict of interest.

a. not allowed. Trading on insider information is not allowed because it will harm all investors by eroding investor confidence in the trading markets. B is incorrect because trading on insider information is a case in which the duty to maintain the integrity of financial markets takes precedence over the client's interests. Therefore, even if the trade would benefit the client, it is a violation of fundamental ethical and professional principles. C is incorrect because trading on insider information is not allowed whether or not it is disclosed. A conflict of interest may not be present and is not the issue. Chapter 2

The type of risk characterised by failed internal policies and procedures is classified as: a. operational. b. compliance. c. investment.

a. operational. Operational risk refers to the risk of losses from inadequate or failed people, systems, and internal policies and procedures, as well as from external events that are beyond the control of the organisation but that affect its operations. B is incorrect because compliance risk relates to the risk that an organisation fails to follow all applicable rules, laws, and regulations and faces sanctions as a result. C is incorrect because investment risk is the risk associated with investing that arises from the fluctuation in the value of investments. Chapter 18

Gross domestic product (GDP) is best defined as the total: a. output of a country. b. output of a country per person. c. changes in real output of a country.

a. output of a country. GDP is the total output of a country. It is the total value of final goods and services produced within a country over a period of time. B is incorrect because the total output of a country per person measures GDP per capita. C is incorrect because total changes in real output of a country is a measure of economic growth. Chapter 5

A document describing principles of action adopted by a company is best described as a: a. policy document. b. process document. c. procedure document.

a. policy document. A policy document describes principles of action adopted by a company. They are typically driven from the top down, with rules cascading down through the various business units and functional areas of the company. B is incorrect because a process document describes the individual steps the company must take, from start to finish, to achieve a desired outcome. C is incorrect because a procedure document broadly identifies what the company must do to achieve a desired outcome. It often provides a bridge between the activities that are allowed at the policy level and what needs to happen at the process level. Policies broadly state the rules, procedures help apply policies, and processes divide procedures into manageable actions. Chapter 20

The value of a derivatives contract is most likely to be directly affected by the: a. price of the underlying. b. supply of the underlying. c. demand for the underlying.

a. price of the underlying. Derivatives are contracts that derive their value from the performance, such as price, of an underlying. B and C are incorrect because although the supply of and demand for the underlying will affect the price of the underlying, they will indirectly rather than directly affect the value of the derivatives. Chapter 11

Which of the following factors is most likely to affect the pricing of a service? a. production costs. b. average age of the workforce. c. availability of complementary products.

a. production costs. Production costs are considered when pricing the service. B is incorrect because the average age of the workforce does not affect pricing. C is incorrect because the availability of substitute products will affect pricing, not the availability of complementary products. Chapter 4

Which of the following parties to an option contract on a company's shares is obligated to buy shares at the option strike price if the option is exercised? a. put seller. b. put buyer. c. call seller.

a. put seller. The seller of a put option has an obligation to buy shares at the strike or exercise price if the put buyer exercises the option. B is incorrect because a put buyer has the right to sell shares at the exercise price. C is incorrect because a call seller has an obligation to sell shares at the exercise price if the call buyer exercises the option. Chapter 11

The most likely objective of an exporter using the forward market in currencies is to: a. reduce risk. b. increase profit. c. increase currency exposure.

a. reduce risk. An exporter is most likely to use the forward market in currencies to reduce the currency risk associated with a future cash flow in a foreign currency. Using the forward market allows the exporter to gain predictability about future cash flows exposed to currency risk. Thus, the exporter can focus on its core business activities rather than worry about currency risk. B is incorrect because the exporter does not use the forward market in currencies to increase profits but to reduce currency risk. C is incorrect because by using the forward market, the exporter is trying to decrease, rather than increase, currency exposure. Chapter 6

If the required structural and procedural controls have not been established, then an employee should: a. refrain from assuming supervisory duties. b. notify the appropriate regulatory authorities. c. perform their supervisory duties with utmost care.

a. refrain from assuming supervisory duties. Supervisory duties should only be assumed when the work environment provides the requisite structural and procedural controls to prevent and detect violations. Supervisors are expected to execute supervisory duties responsibly, which includes ensuring compliance with ethical, legal, professional, and organisational standards. B and C are incorrect because if deficiencies are detected, the employee should document all issues and refrain from assuming supervisory duties until controls have been established. The employee does not necessarily have an obligation to notify the appropriate regulatory authorities. Chapter 2

Country A can produce 1 electric turbine using 10 units of labour and 4 refrigerators using 10 units of labour. Country B can produce 1 electric turbine using 7 units of labour and 4 refrigerators using 12 units of labour. According to the theory of comparative advantage, Country A should produce: a. refrigerators and trade with Country B for electric turbines. b. electric turbines and trade with Country B for refrigerators. c. electric turbines and refrigerators and not trade with Country B.

a. refrigerators and trade with Country B for electric turbines. Country A has both an absolute and a comparative advantage in the production of refrigerators. It only takes 2.5 units of labour (10 units of labour divided by 4 refrigerators) to produce a refrigerator in Country A compared with 3.0 units of labour (12 units of labour divided by 4 refrigerators) in Country B. By contrast, Country B has both an absolute and a comparative advantage in the production of electric turbines. It only takes 7 units of labour to produce an electric turbine in Country B compared with 10 units of labour in Country A. Thus, according to the theory of comparative advantage, both countries will be better off if Country A makes refrigerators, Country B makes electric turbines, and they trade with each other. Chapter 6

Which of the following forces that drive the investment industry promotes transparency of financial markets? a. regulation. b. competition. c. computerization.

a. regulation. Regulation promotes transparency. B is incorrect because competition, although one of the four forces that drive the investment industry, does not promote transparency. C is incorrect because computerisation, although also one of the four forces, does not promote transparency. Regulation is the only one of the four forces that promotes transparency. Chapter 1

Standard deviation is a measure of the variability of a fund's return: a. relative to its average return. b. relative to a benchmark return. c. below its average return.

a. relative to its average return. The standard deviation is a measure of the variability of returns relative to the fund's average return. B and C are incorrect because the fund's return relative to the benchmark is the tracking error and a measure that considers a fund's returns that are less than the average return is the downside deviation. Chapter 19

The approach to valuing common shares that uses price multiples of other comparable, publicly traded companies best describes: a. relative valuation. b. asset-based valuation. c. discounted cash flow valuation.

a. relative valuation. The relative valuation approach estimates the value of a common share by using multiples based on prices and some other measure for comparable, publicly traded companies. One multiple commonly used is the price-to-earnings ratio, which is the ratio of a company's share price to its earnings per share. B is incorrect because the asset-based valuation approach estimates the value of common shares by calculating the company's net asset value—that is, the difference between a company's total assets and its outstanding liabilities. C is incorrect because the discounted cash flow valuation approach estimates the value of a common share as the present value of all future cash flows that the investor expects to receive from the common share. Chapter 10

Which of the following classifications of debt securities is backed by collateral? a. secured debt. b. subordinated debt. c. senior unsecured debt.

a. secured debt. Secured debt securities are backed by collateral. Collateral is generally a tangible asset, such as property, plant, or equipment, that the borrower pledges to the lender to secure the loan. B and C are incorrect because subordinated debt and senior unsecured debt are not backed by collateral. Chapter 9

Which of the following classes of debt securities has the highest ranking in the priority of claims? a. secured debt. b. subordinated debt. c. senior unsecured debt.

a. secured debt. The priority of claims, from highest to lowest of the choices given, is secured debt, senior unsecured debt, subordinated debt. Chapter 9

Which of the following corporate actions would decrease a company's number of outstanding shares? a. share repurchase. b. exercise of warrants. c. seasoned equity offering.

a. share repurchase. In a share repurchase, the company buys back (or repurchases) shares from existing shareholders, which decreases the number of shares outstanding. B and C are incorrect because the exercise of warrants and seasoned equity offerings increase the number of shares outstanding. Chapter 10

The process of a company creating a new company from an existing subsidiary best describes a: a. spinoff. b. stock split. c. reverse stock split.

a. spinoff. The process of a company creating a new company from an existing subsidiary is called a spinoff. Shares of the new entity are distributed to the parent company's existing shareholders. B is incorrect because a stock split simply replaces one existing common share with a specified number of common shares, which increases the number of shares outstanding. C is incorrect because a reverse stock split reduces the number of shares outstanding. Stock splits and reverse stock splits do not change any single shareholder's proportion of ownership. Chapter 10

The measure that best reflects the variability of returns around the mean return is the: a. standard deviation. b. reward-to-risk ratio. c. downside deviation.

a. standard deviation. The standard deviation reflects the variability (or volatility) of returns around the mean (or average) return. B is incorrect because the reward-to-risk ratio is a measure of risk-adjusted performance, which indicates how much return was generated per unit of risk. C is incorrect because the downside deviation is calculated by using only deviations that are negative; the downside deviation considers only the outcomes that are less than the mean return. Chapter 19

A characteristic of a normal distribution is that the distribution of data is: a. symmetrical. b. positively skewed. c. negatively skewed.

a. symmetrical. A normal distribution is a distribution in which 50% of the distribution lies to the left of the mean and 50% of the distribution lies to the right of the mean; the shape of the distribution is symmetrical. B and C are incorrect because if the distribution is skewed, more than 50% of the distribution lies to either the left (negatively skewed) or right (positively skewed) of the mean. Chapter 8

Market manipulation is best defined as: a. taking actions intended to move the price of a security to generate a short-term profit. b. trading for internal company accounts before placing a customer's order. c. trading based on material, non-public information that is likely to affect prices.

a. taking actions intended to move the price of a security to generate a short-term profit. Taking actions intended to move the price of a security to generate a short-term profit is called market manipulation. B is incorrect because trading for internal company accounts before placing a customer's order is front running. C is incorrect because trading based on material, non-public information is called insider trading.

Fiscal policy that is intended to stimulate the economy includes decreases in: a. tax rates. b. interest rates. c. public spending.

a. tax rates. A decrease in tax rates is a fiscal policy intended to stimulate an economy by increasing spending and aggregate demand. B is incorrect because a decrease in interest rates is an example of monetary policy intended to stimulate the economy. C is incorrect because a decrease in public spending is an example of a fiscal policy intended to slow an economy. Chapter 5

The ratio that best measures a company's ability to meet its short-term obligations is: a. the quick ratio. b. the asset turnover ratio. c. the debt-to-equity ratio.

a. the quick ratio. The quick ratio is a liquidity ratio used to assess a company's ability to pay its outstanding obligations in the short term. B is incorrect because the asset turnover ratio measures asset utilisation, which indicates the volume of revenues being generated by the assets used in the business. C is incorrect because the debt-to-equity ratio, a leverage ratio, measures how much debt is used in the financing of the business. Chapter 7

Which of the following characteristics most likely represents a normal distribution? a. the values of the mean and median are identical. b. there are more observations to the right of the mean than to the left. c. there are more observations to the left of the mean than to the right.

a. the values of the mean and median are identical. The mean and median are identical in a normal distribution. B and C are incorrect because in a normal distribution, like any symmetrical distribution, there are the same number of observations to the left and to the right of the mean. Chapter 8

Front running is best defined as: a. trading for internal company accounts before placing a customer's order. b. trading based on material, non-public information that is likely to affect prices. c. taking actions intended to move the price of a security to generate a short-term profit.

a. trading for internal company accounts before placing a customer's order. Trading for internal company accounts before placing a customer's order is front running. B is incorrect because trading based on material, non-public information is called insider trading. C is incorrect because taking actions intended to move the price of a stock to generate a short-term profit is market manipulation.

Compared with a preferred shareholder, a common shareholder most likely has: a. voting rights. b. limited liability. c. cash flow rights.

a. voting rights. Except in rare circumstances, preferred shareholders do not possess voting rights. By contrast, common shareholders receive voting rights. B and C are incorrect because both preferred and common shareholders have limited liability and possess cash flow rights to declared dividends and in liquidation. Chapter 10

Stock options issued by a company to its employees as a form of compensation are an example of: a. warrants. b. convertible bonds. c. depositary receipts.

a. warrants. Stock options issued by a company to its employees as a form of compensation are an example of warrants. A warrant is an equity-like security that entitles the holder to buy a pre-specified amount of common stock of the issuing company at a pre-specified share price prior to a pre-specified expiration date. By issuing stock options to its employees, the company's goal is to align the objectives of the employees (such as senior management) with those of the shareholders. B is incorrect because a convertible bond is a bond issued by a company that offers the bondholder the right to convert the bond into a pre-specified number of common shares. C is incorrect because a global depository receipt is a security representing an economic interest in a foreign company that trades like a common share on a local stock exchange. Chapter 10

The term structure of interest rates on government bonds presented in graphical form is referred to as the: a. yield curve. b. current yield. c. credit spread.

a. yield curve. The term structure of interest rates shows how interest rates on government bonds vary with maturity. The term structure presented in graphical form is referred to as the yield curve. B is incorrect because the bond's current yield is calculated as the bond's annual coupon payment divided by its current market price. C is incorrect because the credit spread is the difference between a risky bond's yield to maturity and the yield to maturity on a government bond with the same maturity. Chapter 9

If there is no relationship between two variables, the correlation coefficient is closest to: a. +1. b. 0. c. -1.

b. 0. Correlation measures the strength of a relationship between two variables. A correlation close to 0 indicates that there is no relationship between the variables. A is incorrect because a correlation of +1 indicates that the two variables are perfectly positively correlated. C is incorrect because a correlation of -1 indicates that the two variables are perfectly negatively correlated. Chapter 8

Which of the following statements relating to document management is correct? a. Document retention rules tend to apply only to physical documents. b. Companies should dispose of documentation after the retention period. c. Documents should be moderately difficult to access by authorised staff.

b. Companies should dispose of documentation after the retention period. Documents cannot simply be archived and forgotten. Specific destruction or disposal instructions should be applied to all archived information. Companies have a responsibility to discard or destroy documentation after the retention period. A is incorrect because document retention rules tend to apply to both physical and electronic documentation. C is incorrect because documents that need to be available to authorised staff should be easily retrievable. Chapter 20

Which of the following best measures the relative wealth of citizens of different countries? a. real GDP. b. GDP per capita. c. nominal GDP.

b. GDP per capita. GDP per capita is defined as a country's total GDP divided by population and describes the average wealth of each citizen of a country. A and C are incorrect because GDP—real and nominal—is a measure of total wealth of a country, which can be highly dependent on total population. Chapter 5

Which of the following would most likely be reduced if India imposed a tariff on goods from Japan? a. India's exports b. India's imports c. Japan's imports

b. India's imports A tariff tends to make imported goods more expensive. Goods imported from Japan would likely be more expensive, which would reduce India's imports (and Japan's exports). Chapter 6

Which objective of documentation is fulfilled when documents ensure thoroughness and consistency of action, thus allowing a company to function more efficiently and effectively? a. Educating b. Organizing c. Formalizing

b. Organizing Organizing is the objective of documentation that is fulfilled when documents ensure thoroughness and consistency of action, thus allowing a company to function more efficiently and effectively. A is incorrect because educating is achieved when documents inform or provide instruction. C is incorrect because formalising is achieved when documents establish roles, deliverables, and obligations. Chapter 20

Which of the following best describes an internal factor that could affect judgment in ethical decisions? a. Incentives b. Overconfidence & rationalization c. Authority figures

b. Overconfidence & rationalization. Internal factors that may affect judgment include overconfidence and rationalization. A and C are incorrect because they are both external factors, not internal. External factors that affect a person's judgment include authority figures, vocal groups, and incentives. Chapter 2

Zero-coupon bonds are typically issued at: a. par value. b. a discount to par value. c. a premium to par value.

b. a discount to par value. Zero-coupon bonds are typically issued at a discount to the bond's par value. The difference between the issue price and the par value received at maturity represents the investment return earned by the bondholder over the life of the bond. Chapter 9

Monetary policy is similar to fiscal policy in that: a. legislation is required to implement policy decisions. b. a time lag may occur before it affects economic growth. c. commercial banks tend to react immediately by changing their lending terms.

b. a time lag may occur before it affects economic growth. There can be a time lag before the effects of monetary and fiscal policies are realised. A is incorrect because fiscal policy is set by lawmakers whereas monetary policy is usually set by a central bank, which is often independent from other government branches and may not require legislative action. C is incorrect because commercial banks tend to respond quickly to monetary policy but not to fiscal policy. Chapter 5

Dividends: a. increase shareholders' equity. b. are a distribution of net income. c. are an expense on the income statement.

b. are a distribution of net income. Dividends represent the amount of net income distributed to shareholders. A is incorrect because dividends decrease shareholders' equity; dividends reduce retained earnings, a component of shareholders' equity. C is incorrect because dividends are not reported as an expense on the income statement. Chapter 7

The chief risk officer working at an investment management firm typically reports directly to the: a. shareholders. b. board of directors. c. chief investment officer.

b. board of directors. It is typical for companies in the investment industry to have a stand-alone risk management function with a chief risk officer who is capable of independent judgment and action and who often reports directly to the board of directors. Chapter 18

Compared with compound interest, simple interest assumes that interest is: a. paid annually. b. calculated using only the original amount invested. c. reinvested and added to the original amount invested.

b. calculated using only the original amount invested. Simple interest assumes that interest is not reinvested; consequently, simple interest is only calculated on the original principal amount, or the original amount invested. C is incorrect because compound interest (not simple interest) assumes that, over time, interest is earned on the original amount invested as well as on the interest earned. A is incorrect because both simple and compound interest may be paid annually or more frequently. Chapter 8

Which of the following provisions in a debt security is a right of the issuer? a. put. b. call. c. conversion.

b. call. The call provision provides bond issuers with the right to buy back the bonds prior to maturity at a prespecified price. A is incorrect because a put provision provides bondholders with the right to sell their bonds to the issuer prior to maturity at a pre-specified price. C is incorrect because a conversion provision provides bondholders with the right to convert the bonds into a pre-specified number of common shares of the issuing company. Chapter 9

Which financial statement is not prepared on an accrual basis? a. income statement. b. cash flow statement. c. profit and loss statement.

b. cash flow statement. The cash flow statement is prepared on a cash, not accrual, basis. A and C are incorrect because the income statement (also called the profit and loss statement) is prepared on an accrual basis. The accrual basis requires revenues to be recorded when the revenues are earned rather than when they are received in cash. Recognition of related expenses on the income statement does not necessarily coincide with when they are paid in cash. Expenses may be recognised before, at the same time, or after they are paid for. Chapter 7

Sovereign bonds are issued by: a. companies. b. central governments. c. all levels of government.

b. central governments. Bonds issued by central governments are called sovereign bonds. A is incorrect because bonds issued by companies are called corporate bonds. C is incorrect because bonds issued by different levels of government take different names; there is no standard name that covers bonds issued by all levels of government. Chapter 9

Economics is the study of: a. an economy as a whole. b. choices in the presence of limited or scarce resources. c. how individuals and companies make decisions to allocate limited resources.

b. choices in the presence of limited or scarce resources. Economics is the study of choices in the presence of limited or scarce resources (labour, real assets, financial capital, etc.). Macroeconomics is the study of an economy as a whole. Microeconomics is the study of how individuals and companies make decisions to allocate limited resources. Chapter 4

The right to elect members of the board of directors of a company belongs to that company's: a. senior management. b. common shareholders. c. preferred shareholders.

b. common shareholders. Common shareholders collectively elect members of the board of directors, whose job it is to monitor the company's business activities on behalf of its shareholders. A is incorrect because senior management is appointed/hired by the board of directors, not the other way around. C is incorrect because preferred shareholders are usually not entitled to voting rights. Chapter 10

Shareholders' equity, as reported on the balance sheet, includes: a. cash. b. common stock. c. long-term debt.

b. common stock. Common stock is a component of shareholders' equity. Shareholders' equity includes the amount received from selling stock to common shareholders and retained earnings (retained income). A is incorrect because cash is an asset. C is incorrect because long-term debt is a liability. Chapter 7

Which of the following is associated with the concept of interest on interest? a. simple interest. b. compound interest. c. annual percentage rate.

b. compound interest. Compound interest is based on the assumption that interest earned is added to the original amount invested. Over time, interest is earned on the original amount invested as well as on the interest earned. As a result, compound interest is often referred to as interest on interest. A is incorrect because simple interest assumes that interest is always calculated based on the original amount invested. C is incorrect because the annual percentage rate is a simple interest rate and does not involve compounding. Chapter 8

A company that needs to raise capital in a public market for the first time would most likely: a. repurchase shares. b. conduct an initial public offering. c. conduct a seasoned equity offering.

b. conduct an initial public offering. An initial public offering (IPO) is a way for a company to raise capital in a public market for the first time. In the process, the company becomes a publicly traded company. A is incorrect because share repurchases require the company to use capital to buy back (or repurchase) shares from existing shareholders. C is incorrect because publicly traded companies may raise additional capital by selling additional shares in a seasoned (or secondary) equity offering subsequent to the IPO. Chapter 10

A company obtains a loan from a local bank for $50 million. From the company's perspective, interest is best defined as the: a. risk of default. b. cost of borrowing. c. value of the next best alternative.

b. cost of borrowing. From the company's perspective, interest is defined as payment for the use of borrowed money or the cost of borrowing. A and C are incorrect because from the lender's perspective, interest is earned to compensate for opportunity cost (value of the next best alternative) and risk, including default. Chapter 8

Gross profit represents revenue minus: a. all expenses. b. cost of sales. c. operating expenses.

b. cost of sales. Gross profit is calculated as revenues minus the cost of sales. It represents the cost of producing or acquiring the goods or services provided or sold by the company. A is incorrect because revenue minus all expenses represents net income, not gross profit. C is incorrect because revenue minus operating expenses represents operating income (or profit), not gross profit. Chapter 7

Which of the following characteristics most likely remains unchanged during the life of an inflation-linked bond? a. par value. b. coupon rate. c. coupon payments.

b. coupon rate. The coupon rate usually remains unchanged. The par value of the bond, not the coupon rate, is adjusted at each payment date to reflect changes in inflation, usually measured by a consumer price index. A is incorrect because the par value is adjusted to reflect changes in inflation. C is incorrect because the bond's coupon payments are adjusted for inflation and the fixed coupon rate is multiplied by the inflation-adjusted par value. Chapter 9

The risk of loss as a result of the bond issuer failing to make timely payments of interest and/or principal is referred to as: a. call risk. b. credit risk. c. interest rate risk.

b. credit risk. Credit risk, or default risk, is the risk of loss as a result of the bond issuer failing to make full and timely payments of interest and/or principal. A is incorrect because call risk describes the risk to the bondholder that the issuer will buy back (call) a bond prior to maturity through the exercise of a call provision. C is incorrect because interest rate risk is the risk that interest rates will increase, resulting in a decrease in the price of a bond. Chapter 9

Which of the following is used to evaluate how a company is financing its assets? a. current ratio b. debt-to-equity ratio c. return on assets

b. debt-to-equity ratio Ratios used in determining how a company is financing its assets often look at the amount of debt that is used by the company. Ratios that can help provide this information include the debt-to-equity ratio and financial leverage (or the equity multiplier) ratios. A is incorrect because the current ratio is used to assess liquidity. C is incorrect because return on assets is used to evaluate a company's profitability. Chapter 7

If the discount rate increases, the value of a zero-coupon bond will: a. increase. b. decrease. c. remain unchanged.

b. decrease. A bond's price and the discount rate are inversely related. If the discount rate increases, the bond's value, represented by the present value of the bond's expected cash flows, will decrease. Chapter 9

A net loss during an accounting period will cause shareholders' equity to: a. increase. b. decrease. c. remain unchanged.

b. decrease. A net loss during an accounting period decreases a company's retained earnings and will thus cause shareholders' equity to decrease. Chapter 7

Assume the correlation between the unemployment rate and the inflation rate is close to -1. Based on this information, if the unemployment rate is expected to increase, then the inflation rate will most likely: a. increase. b. decrease. c. remain unchanged.

b. decrease. Because the unemployment rate and the inflation rate are negatively correlated, if unemployment is expected to increase, then the inflation rate is likely to decrease Chapter 8

When evaluating an investment, if the discount rate increases while holding all other factors constant, the present value will: a. increase. b. decrease. c. remain unchanged.

b. decrease. The higher the discount rate, the lower the present value. Chapter 8

If the price of chocolate increases, the quantity of chocolate demanded will most likely: a. increase. b. decrease. c. remain unchanged.

b. decrease. The law of demand states that the quantity demanded and the price of a product are inversely related. If the price of chocolate increases, then the quantity of chocolate demanded should decrease. A and C are incorrect because the law of demand suggests that as the price of a product increases, the quantity demanded will decrease, not increase or remain unchanged. Chapter 4

Which of the following is most likely a potential effect of unethical behaviour by people in the investment industry? a. increased employment. b. decreased economic output. c. decreased regulatory scrutiny.

b. decreased economic output. Unethical behaviour in the investment industry may lead to a loss of investor confidence, which may reduce the availability of capital to companies and lead to decreased economic output. A is incorrect because decreased rather than increased employment is a potential result of unethical behaviour in the investment industry. C is incorrect because unethical behaviour typically results in an increase in regulatory scrutiny. Chapter 2

Client on-boarding documentation refers to: a. wire transfer documentation. b. documentation required to accept a new client. c. marketing documentation sent to an existing client.

b. documentation required to accept a new client. Client on-boarding is the process by which a company accepts a new client and inputs the client's details into its records to enable the company to conduct transactions with and on behalf of the client. Thus, it refers to documentation required to accept a new client. A is incorrect because wire transfer documentation is best described as funding documentation. C is incorrect because marketing documentation promotes and positions the organisation's products and services to attract and retain clients. Chapter 20

A company's first line of defence to manage risk is its: a. internal auditors. b. employees and managers. c. risk and compliance officers.

b. employees and managers. Employees and managers, through their daily responsibilities, form the first line of defence against risk. A is incorrect because internal auditors form the third line of defence against risk. C is incorrect because risk and compliance officers form the second line of defence against risk. Chapter 18

Accounting standard setters help ensure the consistency of reported financial information by: a. recognising and enforcing financial reporting standards. b. establishing how financial reports should be prepared and presented. c. expressing an opinion on the application of financial reporting standards.

b. establishing how financial reports should be prepared and presented. Standard setters help ensure the consistency of reported financial information by detailing the "rules" of financial reporting. They establish how financial reports should be prepared and presented. A is incorrect because regulators recognise and enforce financial reporting standards. C is incorrect because auditors express an opinion on a company's application of financial reporting standards. Chapter 7

Alternative investments most likely: a. are highly liquid. b. exhibit low correlations with equity and debt securities. c. offer greater transparency than investments in equity and debt securities.

b. exhibit low correlations with equity and debt securities. There is a relatively low correlation between alternative investments and equity and debt securities. Thus, alternative investments provide diversification benefits. A is incorrect because most alternative investments are illiquid—that is, it is difficult to sell them quickly without accepting a lower price. C is incorrect because many alternative investments are less transparent than investments in equity and debt securities. Chapter 12

Which stage of the business cycle is most often characterised by rising interest rates and higher wages? a. recession. b. expansion. c. contraction.

b. expansion. During an economic expansion, production, inflation, interest rates, employment, and investment spending all tend to rise. Employees have more bargaining power in demanding higher wages. A and C are incorrect because inflation and interest rates tend to decline and unemployment tends to increase during a contraction. A recession is a significant economic contraction. Chapter 5

Depositary receipts are issued by: a. governments. b. financial institutions. c. the company whose shares are represented by the depositary receipts.

b. financial institutions. Depositary receipts are securities representing an economic interest in a foreign company that trade like common stock on a local stock exchange. They are issued by a custodian financial institution that is located in the domestic country. The financial institution buys the shares in the foreign country, holds them in custody, issues depositary receipts against the shares held, and sells the depositary receipts to domestic investors who can trade them on the local stock exchange. A and C are incorrect because governments and the company whose shares are represented by the depositary receipts do not issue depositary receipts. Chapter 10

Which of the following would most likely assist individuals in defining their investment goals? a. dealers. b. financial planners. c. investment bankers.

b. financial planners. Financial planners typically help individuals understand their future financial needs and define their investment goals. A is incorrect because dealers facilitate trading between investors. C is incorrect because investment bankers help companies and governments raise capital. Chapter 1

Bonds with coupon rates linked to a reference rate are best described as: a. fixed-rate bonds. b. floating-rate bonds. c. zero-coupon bonds.

b. floating-rate bonds. The coupon rate of a floating-rate bond is usually linked to a reference rate. The floating rate is equal to the reference rate plus a spread that depends on the borrower's creditworthiness and the bond's features. A is incorrect because the coupon rate of a fixed-rate bond does not change during the life of the bond. C is incorrect because the only payment offered by a zero-coupon bond is a single payment equal to the bond's par value that is paid on the bond's maturity date. Chapter 9

Counterparty risk is most likely lowest for: a. swap contracts. b. futures contracts. c. forward contracts.

b. futures contracts. Futures contracts are exchange traded. Margin requirements and daily marking to market reduce counterparty risk for investors in futures contracts. A and C are incorrect because forward contracts and swap contracts are traded in private, over-the-counter markets. Consequently, counterparty risk is higher in forward contracts and swap contracts than in futures contracts. Chapter 11

A country's currency will most likely depreciate when the country experiences high: a. interest rates. b. government debt. c. economic growth.

b. government debt. High government debt tends to lead to a depreciation of a country's currency. A and C are incorrect because high interest rates and high economic growth tend to lead to an appreciation of the country's currency. Chapter 6

Swap contracts: a. are mostly traded on exchanges. b. have an initial net value of zero. c. are not susceptible to counterparty risk.

b. have an initial net value of zero. The initial net value of a swap contract is zero. Over time, the swap changes in value as the underlying changes in value. One side of the swap contract loses while the other side gains. A and C are incorrect because swap contracts mostly trade in private, over-the-counter (OTC) markets and not on exchanges; consequently, the parties to swap contracts are susceptible to counterparty risk. Chapter 11

The profit or loss generated by a company over a year is presented in the: a. balance sheet. b. income statement. c. cash flow statement.

b. income statement. The income statement identifies the profit or loss generated by a company over a given time period, such as a year. A is incorrect because the balance sheet provides information about a company's financial position at a specific point in time. C is incorrect because the cash flow statement identifies the sources and uses of cash over a given time period. Chapter 7

The greater the risk associated with a borrower's ability to repay a loan, the greater the: a. opportunity cost for the borrower. b. interest rate demanded by the lender. c. risk of purchasing power increasing over the life of the loan.

b. interest rate demanded by the lender. The lower the certainty a borrower will make the promised payments on the loan in a timely manner, the higher the level of interest required by the lender to compensate for the increased risk of default. A is incorrect because the opportunity cost for the lender, not the borrower, is unrelated to the risk of the borrower. C is incorrect because the lender bears the risk that purchasing power will decrease not increase. Chapter 8

Which of the following accounts is most likely classified as a current asset? a. goodwill. b. inventory. c. property, plant, and equipment.

b. inventory. Inventory is generally classified as a current asset. Current assets are expected to be converted into cash, used, or sold within the current operating period. A is incorrect because goodwill is generally a non-current (long-term) asset. Goodwill is recognised and reported if a company purchased another company but paid more than the fair value of the net assets (assets minus liabilities) of the company it purchased. C is incorrect because property, plant, and equipment is generally a non-current asset that is used over a number of years to generate revenue for the company. Chapter 7

A manufacturing company recently sold one of its buildings. The proceeds from the sale are classified as a cash flow from: a. financing activities. b. investing activities. c. operating activities.

b. investing activities. The proceeds of a sale by a manufacturing company of a building are classified as a cash inflow from investing activities. Investing activities typically relate to purchases or sales of long-term assets, such as equipment or buildings. Chapter 7

A sell-side analyst typically works for a(n): a. pension plan. b. investment bank. c. endowment fund.

b. investment bank. Investment (merchant) bank analysts are called sell-side analysts because they work for the organisation selling securities. A and C are incorrect because analysts who work for pension plans and endowment funds are buy-side analysts. Chapter 1

An analyst is comparing the returns of two investment portfolios. The two portfolios have the same mean return. The portfolio with the higher standard deviation most likely: a. is less risky. b. is more risky. c. has a smaller range.

b. is more risky. Higher standard deviation indicates higher variability and risk. A and C are incorrect because the portfolio with the higher standard deviation is more dispersed, has a larger range, and is more risky. Chapter 8

Which of the following indicators is most appropriate to use in forcasting future economic activity? a. lagging economic indicators. b. leading economic indicators. c. coincident economic indicators.

b. leading economic indicators. Leading indicators usually signal changes in the economy in the future and, therefore, are considered useful for economic prediction and policy formulation. A is incorrect because lagging indicators signal a change in economic activity after it has already changed. C is incorrect because coincident indicators reveal current economic conditions but do not have predictive value. Chapter 5

Which of the following statements best describes price inelasticity? A small change in price produces a: a. proportional change in demand. b. less than proportional change in demand. c. disproportionally larger change in demand.

b. less than proportional change in demand. If price elasticity is low or inelastic, changes in price are accompanied by less than proportional changes in the quantity demanded. This means demand is not very price sensitive. A is incorrect because a small change in prices would produce a proportional change in demand for a good exhibiting unit elasticity. C is incorrect because a small change in price would produce a disproportionally larger change in demand for a good exhibiting high price elasticity. Chapter 4

Accounts payable are classified as: a. assets. b. liabilities. c. shareholders' equity.

b. liabilities. Accounts payable (credit extended by suppliers) are current liabilities—obligations that must be repaid in the next year. A is incorrect because assets are what the company owns. C is incorrect because shareholders' equity represents the owners' investment in the company. Chapter 7

The risk of being unable to sell a bond prior to the maturity date without having to accept a significant discount to market value best describes: a. credit risk. b. liquidity risk. c. interest rate risk.

b. liquidity risk. Liquidity risk refers to the risk of being unable to sell a bond prior to the maturity date without having to accept a significant discount to market value. A is incorrect because credit risk is the risk of loss as a result of the borrower (the bond issuer) failing to make full and timely payments of interest and/or principal. C is incorrect because interest rate risk refers to the risk associated with decreases in bond prices as a result of increases in interest rates. Chapter 9

A major benefit of competition in financial markets for the individual investor is: a. risk transfer. b. lower prices. c. greater integrity.

b. lower prices. Competition in financial markets promotes higher efficiency and helps keep prices of investment products and services down. A is incorrect because risk transfer does not deal with competition, although it is a benefit for the individual investor. C is incorrect because greater integrity is achieved by effective laws and regulations and not through competition. Chapter 1

Compared with preferred shareholders, the ranking of common shareholders in the priority of claims on the company's net assets upon liquidation is: a. equal. b. lower. c. higher.

b. lower. Common shareholders are last in line if the company is liquidated; they are the residual claimants in a company. Thus, common shareholders have a lower claim on the company's net assets (that is, the difference between a company's total assets and its outstanding liabilities) upon liquidation than preferred shareholders. Chapter 10

In the document management process, ease of data retrieval is best accomplished by: a. retaining information after its initial use. b. maintaining a centralized repository. c. using sound practices for safekeeping documentation.

b. maintaining a centralized repository. Maintaining a centralised repository, with appropriate access rights, helps data retrieval. This repository is often electronic. A and C are incorrect because retaining information after its initial use and using sound practices for safekeeping documentation do not imply that data will be easy to retrieve. Chapter 20

Which of the following sentences is most accurate? a. the income statement and cash flow statement are unrelated. b. net income is often the starting point for the cash flow statement. c. the income statement presents information for a period of time, whereas the cash flow statement presents information at a point in time.

b. net income is often the starting point for the cash flow statement. When preparing a cash flow statement, many companies use an indirect method and begin with the net income reported on the income statement and make adjustments to arrive at cash flows from operations. A is incorrect because the income statement and cash flow statement are related. C is incorrect because both the income statement and cash flow statements present information for a period of time. It is the balance sheet that presents information at a point in time. Chapter 7

When choosing among investments that have different initial costs and future cash flows, the best choice is the investment with the highest: a. discount rate. b. net present value. c. present value of future cash flows.

b. net present value. Net present value is the difference between the present value of future cash inflows and the cost of that investment. The investment with the highest positive net present value is the best choice if only one investment will be chosen. A is incorrect because the investment with the largest discount rate is the one with the most risk. It may or may not have the highest net present value, depending on expected cash flows and their timing and initial cost. C is incorrect because the present value of future cash flows must be compared with the cost before a choice can be made. Chapter 8

Credit risk is best described as the risk: a. caused by changes in market conditions affecting prices. b. of failing to receive timely payments of interest and principal from borrowers. c. that an asset cannot be bought and sold quickly without a significant concession in price.

b. of failing to receive timely payments of interest and principal from borrowers. Credit risk is the risk` for a lender that a borrower fails to honour a contract and make timely payments of interest and principal. A is incorrect because the risk caused by changes in market conditions affecting prices describes market risk. C is incorrect because the risk that an asset cannot be bought and sold quickly without a significant concession in price describes liquidity risk. Chapter 18

A document is best described as an: a. official record for internal use only. b. official record for internal or external use. c. unofficial record for internal or external use.

b. official record for internal or external use. A document serves as an official record that may be for internal or external use. Chapter 20

An industry dominated by a small number of large companies is most likely a(n): a. monopoly. b. oligopoly. c. perfect competition.

b. oligopoly. Oligopolies are dominated by a small number of large companies because the barriers to entry are high. A is incorrect because a monopoly is a market with a single company that produces a product for which there are no close substitutes and with significant barriers to entry. C is incorrect because in perfect competition there are many buyers and sellers trading in a uniform commodity and there are no major barriers to entry. Chapter 4

Which of the following is a monetary policy tool? a. changes in tax rates. b. open market operations. c. decreases in government spending.

b. open market operations. Monetary policies are typically carried out by central banks and include such tools as open market operations, changes in central bank lending rates, and changes in reserve requirements for commercial banks. A and C are incorrect because both are examples of fiscal policy tools. Chapter 5

Rogue trading is best described as an example of: a. investment risk. b. operational risk. c. compliance risk.

b. operational risk. Rogue trading, which refers to situations in which traders bypass management controls and place unauthorised trades that can cause large losses for the companies they work for, is an example of operational risk. Operational risk is the risk of losses from inadequate or failed people, systems, and internal policies and procedures, as well as from external events that are beyond the control of the company but affect its operations. A is incorrect because investment risk is the risk associated with investing that arises from the fluctuation in the value of investments. C is incorrect because compliance risk relates to the risk that an organisation fails to follow all applicable rules, laws, and regulations and faces sanctions as a result. Chapter 18

Forward contracts and futures contracts, with otherwise identical terms, are similar with respect to: a. counterparty risk. b. payoffs at maturity. c. customisation of contracts.

b. payoffs at maturity. If a forward contract and a futures contract with identical terms are held to maturity, the final outcome is the same. For a forward contract, the entire effect of changing prices is taken into account at maturity, whereas for a futures contract, the effect of changing prices is taken into account on an ongoing basis. A is incorrect because counterparty risk is much higher for investors in forward contracts. C is incorrect because forward contracts are customised contracts, whereas futures contracts are standardised contracts. Chapter 11

The most effective way to compare investments with the same initial outflow that have different cash flows at different points in time is to determine each investment's: a. discount rate. b. present value. c. future cash flows.

b. present value. Present value considers the three elements that should be used when comparing investments; the amount of the future cash flows, the timing of the future cash flows, and the risk associated with each investment as reflected by the discount rate. A and C are incorrect because they are elements needed to determine present value. Chapter 8

The external document that is most likely provided during the marketing stage of the client investment cycle is a: a. share certificate. b. prospectus or term sheet. c. monthly statement.

b. prospectus or term sheet. An external document, such as a prospectus or a term sheet, is usually provided during the marketing stage of the client investment cycle.

Which of the following is a measure of dispersion? a. mode. b. range. c. median.

b. range. Measures of dispersion are used to measure the spread associated with a dataset or its variation around a central value. The range is a measure of dispersion that is calculated by taking the difference between the highest and lowest values of the dataset. A and C are incorrect because the mode and the median are measures of central tendency. Chapter 8

A breach of ethical standards most likely results in: a. higher public trust. b. reduced financial market efficiency. c. fulfilment of clients' investment goals.

b. reduced financial market efficiency. A breach of ethical standards can undermine the factors, such as market efficiency, affected by ethical standards. A and C are incorrect because both higher public trust and fulfilment of clients' investment goals are supported by high ethical standards. Chapter 2

A farmer will harvest his corn crop in six months but wants to lock in a price today. The farmer will most likely: a. buy a corn futures contract. b. sell a corn futures contract. c. buy a corn forward contract.

b. sell a corn futures contract. The seller of a forward or futures contract is obligated to make delivery of the underlying. By selling a corn futures contract, the farmer is agreeing to sell corn in six months at the contract price locked in today. A and C are incorrect because buying (taking a long position in) a corn futures contract or a corn forward contract, respectively, would require the farmer to buy, not sell, corn in the future, which is not the farmer's objective. Chapter 11

The statement of cash flows presents: a. revenues and expenses over a period of time. b. sources and uses of cash over a period of time. c. assets, liabilities, and owners' equity at a point in time.

b. sources and uses of cash over a period of time. The statement of cash flows presents the sources and uses of cash over a period of time. A is incorrect because revenues and expenses over a period of time are presented on the income statement. C is incorrect because assets, liabilities, and shareholders' equity at a point in time are presented on the balance sheet or statement of financial position. Chapter 7

Countries with exports greater than imports most likely have a current account: a. deficit. b. surplus. c. in balance.

b. surplus. A country with exports greater than imports has positive net exports, or a trade surplus. The trade balance tends to dominate the current account balance, so this country most likely has a current account surplus. Chapter 6

A force driving the investment industry that has led to decreased trade processing costs is: a. regulation. b. technology. c. globalisation.

b. technology. Technology, and computerisation in particular, is a force driving the investment industry that has dramatically decreased trade processing costs. A and C are incorrect because regulation and globalisation are both forces affecting the evolution of the investment industry that have not reduced trade processing costs. Chapter 1

The measurement of relative returns involves comparing the fund manager's holding-period return with: a. a measure of risk. b. the return on a benchmark. c. the fund manager's past performance.

b. the return on a benchmark. The measurement of relative returns involves comparing the fund manager's holding-period return with the return on an appropriate benchmark. A is incorrect because measures of risk, such as the standard deviation, are used to calculate risk-adjusted returns (the second step of the performance evaluation process) rather than relative returns (the third step of the performance evaluation process). C is incorrect because the fund manager's past performance is not an appropriate benchmark. Chapter 19

If interest is paid and compounded annually, the compound interest rate is most likely to be: a. higher than the simple interest rate. b. the same as the simple interest rate. c. lower than the simple interest rate.

b. the same as the simple interest rate. The number of compounding periods is one. Therefore, the simple and compound interest rates are the same. More frequent compounding leads to a higher compound interest rate than the simple interest rate. Chapter 8

The key difference between cumulative preferred stock and non-cumulative preferred stock relates to: a. voting rights. b. the treatment of missed dividends. c. the company's ability to buy back the preferred shares.

b. the treatment of missed dividends. Cumulative preferred stock requires that the company pay in full any missed dividends (dividends promised but not paid in prior years) before paying dividends to common shareholders. By comparison, non-cumulative (or straight) preferred stock does not require that missed dividends from prior years be paid before dividends are paid to common shareholders. A is incorrect because preferred shareholders are usually not entitled to voting rights, irrespective of whether the preferred stock is cumulative or non-cumulative. C is incorrect because the redemption feature (that is, the company's ability to buy back the preferred shares) is unrelated to the distinction between cumulative and non-cumulative preferred stock. Chapter 10

Which of the following real estate segments represents the most speculative investment? a. Offices b. Undeveloped land c. Land with utilities and building permits

b. undeveloped land. Undeveloped (raw) land can be highly speculative. It has no cash flow streams from tenants or occupants and instead has only cash outflows in the form of real estate taxes and other costs of holding the land. The success of the investment depends on developing the land at a profit or on the land appreciating in value. A is incorrect because offices are less speculative than land. Offices are typically leased, and office rents provide a stream of future cash flows. C is incorrect because land with utilities and building permits approaches something having a commercial value based on a projected stream of future cash flows. Chapter 12

Which of the following will most likely decrease when an economy is in the expansion phase of the business cycle? a. production. b. unemployment rate. c. consumer spending.

b. unemployment rate. Unemployment tends to fall when an economy is in the expansion phase of the business cycle. A and C are incorrect because production and consumer spending tend to increase during the expansion phase of the business cycle. Chapter 5

Which debt security promises its investors only one payment over the life of the bond? a. fixed-rate bond. b. zero-coupon bond. c. floating-rate bond.

b. zero-coupon bond. A zero-coupon bond does not pay periodic interest payments (coupon payments) to its investors during its life. The only payment received by an investor in a zero-coupon bond is a single payment of the par value at the maturity date. A and C are incorrect because fixed-rate and floating-rate bonds promise periodic coupon payments over the life of the bond in addition to a final payment of the par value at maturity. The periodic coupon payment does not change during the life of a fixed-rate bond, but changes over time for a floating-rate bond. Chapter 9

Beta measures the portion of the investment fund's return attributable to: a. randomness. b.broad market movements. c.the fund manager's judgment.

b.broad market movements. Beta measures the portion of the investment fund's return attributable to broad market movements, over which the fund manager has no control. A is incorrect because randomness is the portion of the investment fund's return attributable to luck. C is incorrect because the portion of the investment fund's return attributable to the fund manager's judgment (or skill) is referred to as alpha, not beta. Chapter 19

Which of the following values of a company's quick ratio indicates the best liquidity? a. 0.50 b. 1.00 c. 1.50

c. 1.50 The quick ratio, a liquidity ratio, measures a company's ability to meet its short-term obligations. When analysing a liquidity ratio, the higher the number, the higher the company's liquidity. Thus, 1.50 represents the best liquidity ratio. A and B are incorrect because both values are lower than 1.50 and when analysing liquidity, a higher ratio is preferable. Chapter 7

Which of the following is a foreign exchange transaction involving the forward market? a. A company writes a cheque in foreign currency. b. A tourist converts US$1,000 into euros at an airport. c. A company agrees to buy US$100,000 for ¥7,500,000 in 60 days.

c. A company agrees to buy US$100,000 for ¥7,500,000 in 60 days. An agreement to convert one currency into another in the future is a foreign exchange transaction that involves the forward market. A and B are incorrect because writing a cheque in a foreign currency and converting US dollars into euros at the airport are foreign exchange transactions conducted in the spot market. Chapter 6

Which of the following situations best represents a compliance risk? a. Failure of an IT network paralyses business operations. b. A counterparty does not complete its side of a deal as agreed. c. An organisation fails to follow all applicable rules, laws, and regulations.

c. An organisation fails to follow all applicable rules, laws, and regulations. Compliance risk is the risk that an organisation fails to follow all applicable rules, laws, and regulations and faces sanctions as a result. B is incorrect because the risk that a counterparty does not complete its side of a deal as agreed describes settlement risk (also called counterparty risk). A is incorrect because failure of an IT network that paralyses business operations is an example of operational risk. Chapter 18

A broker receives a purchase order by e-mail from a client and a printed memorandum with some policy updates from the human resources department. Which of the following statements is most likely correct? a. The client e-mail is considered a document, but not the memorandum. b. The memorandum is considered a document, but not the client e-mail. c. Both the client e-mail and the memorandum are considered documents.

c. Both the client e-mail and the memorandum are considered documents. Any document serves as an official record. Some documents, such as the memorandum, are for internal use only. They are generally administrative and reflect a company's philosophy, approach, and activities. Other documents, such as the client e-mail, are for external use. They convey information to and from the public domain and often help limit the risks that this interaction with the public creates. Chapter 20

Which of the following would most likely promote international trade? a. Increased tariffs b. Higher transportation costs c. Faster transport of products and services

c. Faster transport of products and services. Improvements in transportation, including faster transport, help international trade. A is incorrect because tariffs are trade barriers; they are effectively taxes (duties) levied on imported goods and services. Increased trade barriers limit international trade. B is incorrect because higher transportation costs increase the cost of importing and exporting goods, which limits international trade. Chapter 6

Which of the following outcomes of acting with high ethical standards will most likely directly benefit both clients and investment professionals? a. Enhanced employment security b. Reduced risk of adverse legal consequences c. Increased trust in the fairness of financial markets

c. Increased trust in the fairness of financial markets. Acting with high ethical standards increases clients' trust in the fairness of financial markets, thus promoting market efficiency, which, in turn, helps clients achieve their investment goals. This outcome also benefits investment professionals because increased trust from clients increases the likelihood that clients will seek their advice, thus enhancing the security of their employment. A and B are incorrect because enhanced employment security and the reduced risk of adverse legal consequences benefit investment professionals directly and only indirectly may benefit clients. Chapter 2

Which of the following best describes a limitation of monetary policy? a. crowding out of private borrowers. b. long time lags until implementation. c. unexpected responses from consumers.

c. Unexpected responses from consumers. Monetary policies are intended to change the behaviour of businesses and consumers to stimulate or slow the economy. One of the drawbacks is that consumers and businesses may not respond as expected, leading to ineffective policies. A and B are incorrect because both are limitations of fiscal policy. Increased government borrowing and spending may crowd out private borrowers. Unlike fiscal policy, monetary policy can be implemented quickly. Chapter 5

Which type of private equity strategy is most likely used to finance a start-up company? a. Buyout. b. Growth equity. c. Venture capital.

c. Venture capital The venture capital strategy invests in start-up companies that exist merely as an idea or a business plan. The company may have only a few employees, have little to no revenue, and may still be developing its product or business model. A is incorrect because buyouts are investments in established companies that require money to restructure and facilitate a change of ownership. B is incorrect because the growth equity strategy usually invests in existing companies with proven business models, good customer bases, and positive cash flow or profits. Chapter 12

Which of the following is most likely to cause a country's currency to appreciate? a. High inflation b. Political instability c. A current account surplus

c. a current account surplus. A current account surplus tends to lead to an appreciation of a country's currency. A and B are incorrect because high inflation and political instability tend to lead to a depreciation of a country's currency. Chapter 6

The corporate action most likely taken to mitigate the effects of exercised warrants is: a. a stock dividend. b. an issuance of new shares. c. a share repurchase program.

c. a share repurchase program. Whenever warrants are exercised, there is an increase in the total number of shares outstanding of a company. To mitigate the dilution effect on existing shareholders, companies typically buy back or repurchase shares in the open market to offset the shares issued when warrants are exercised. A is incorrect because issuing a stock dividend increases the number of shares outstanding but does not change any single shareholder's proportional ownership. A stock dividend does nothing to mitigate the dilution effect created by the exercise of warrants. B is incorrect because issuing new shares compounds the effect of the exercised warrants, increasing the dilution effect on existing shareholders. Chapter 10

An employee handbook that outlines travel reimbursement guidelines is best classified as a(n): a. ad hoc document. b. derived document. c. associated document.

c. associated document. An employee handbook that outlines travel reimbursement guidelines is an associated document that employees would refer to in order to determine which travel expenses may or may not be reimbursed. A is incorrect because an ad hoc document is typically informal. Because an employee handbook usually describes policies and procedures, it is more likely to be a standardised document rather than an ad hoc document. B is incorrect because a derived document comes into existence because of other documents. In this context, an expense claim form would be a better example of a derived document. Chapter 20

Documentation that protects a company is best described as providing: a. a benchmark for measurement and audit. b. the basis, and often the authority, for action. c. assurance of a system to safeguard interests and manage risks.

c. assurance of a system to safeguard interests and manage risks. Documentation that protects a company provides assurance of a system to safeguard interests and manage risks. B is incorrect because documentation that provides the basis, and often the authority, for action more appropriately describes the objective of documentation related to authorising. A is incorrect because documentation that provides a benchmark for measurement and audit more appropriately describes the objective of documentation related to measuring. Chapter 20

The values of assets on the balance sheet are reported: a. only at historical cost. b. only at fair market value. c. at a mix of historical cost and fair market value.

c. at a mix of historical cost and fair market value. Most balance sheet items are reported at historical cost, but some assets, such as financial instruments, may be reported at fair market value. A and B are incorrect because the values of assets on the balance sheet are reported at a mix of historical cost or fair market value. Chapter 7

The financial services industry benefits the economy by providing a link between providers of capital and: a. savers. b. lenders. c. borrowers.

c. borrowers. The financial services industry exists to provide a link between providers of capital (also called savers, lenders, or investors) that have funds to invest and users of capital (also called spenders or borrowers) that need funds. A and B are incorrect because savers and lenders are providers, not users, of capital. Chapter 1

Time lags until policies affect the economy are most likely associated with: a. only fiscal policy. b. only monetary policy. c. both fiscal policy and monetary policy.

c. both fiscal policy and monetary policy. Both monetary policies and fiscal policies can have a significant time lag between a change in policy and when actions based on policy changes affect the economy. Chapter 5

Which of the following parties to an option contract on a company's shares has the right to buy shares at the exercise price? a. put seller. b. call seller. c. call buyer.

c. call buyer. The buyer of a call option has the right to buy shares at the exercise price. A is incorrect because the seller of a put option has an obligation to buy shares at the exercise price. B is incorrect because the seller of a call option has an obligation to sell shares at the exercise price if the call buyer exercises the option. Chapter 11

If a company is profitable, then its cash flow from operating activities: a. is positive. b. is negative. c. can be positive or negative.

c. can be positive or negative. If a company is profitable, its cash flow from operating activities can be positive or negative. Profit and net cash flow from operating activities may differ in sign because profits are measured on an accrual basis. For example, revenues may be included on the income statement before the cash is collected. Chapter 7

Which of the following is best described as an investing activity on the cash flow statement? a. cash inflow from the issuance of new shares of equity. b. cash outflow from the payment of dividends to stockholders. c. cash outflow from the purchase of property, plant, and equipment.

c. cash outflow from the purchase of property, plant, and equipment. The statement of cash flows identifies the purchase of property, plant, and equipment as a cash outflow in investing activities. A and B are incorrect because issuing new shares and paying dividends are financing activities. Chapter 7

According to fundamental ethical and professional principles for the investment industry, conflicts of interest with: a. clients should be avoided. b. clients and employers should be avoided. c. clients and employers should be avoided or disclosed.

c. clients and employers should be avoided or disclosed. Conflicts of interests with clients and employers may arise in the course of business. Conflicts should be avoided or managed through disclosure so that all relevant stakeholders are aware of these conflicts and their potential effects on the relationship. A and B are incorrect because, although it is preferable to avoid conflicts of interest, it is not always possible to avoid or eliminate them. In situations lacking that ability, an employee should prominently disclose the conflicts in plain language to effectively communicate the information. Chapter 2

Current economic conditions are best shown by: a. leading economic indicators. b. lagging economic indicators. c. coincident economic indicators.

c. coincident economic indicators. Coincident indicators reveal current economic conditions but do not have predictive value. A is incorrect because lagging indicators signal a change in economic activity after it has already changed. B is incorrect because leading indicators usually signal changes in the economy in the future. Chapter 5

The largest component of total GDP is most likely to be: a. gross investment. b. government spending. c. consumer or household spending.

c. consumer or household spending. Consumer or household spending is the largest component of total spending, and may be as high as 70% of total GDP. Chapter 5

Which of the following phases of the business cycle most likely follows the peak phase? a. trough. b. recovery. c. contraction.

c. contraction. The business cycle can vary, but it typically follows a pattern of expansion, peak, contraction, trough, recovery, and back to expansion. Therefore, an economic peak is most likely followed by a contraction phase. A and B are incorrect because the trough and recovery phases typically occur following the contraction cycle. Chapter 5

Unethical behaviour by investment professionals may lead to higher: a. employment. b. long-term growth expectations for the economy. c. cost of capital for those companies requiring capital.

c. cost of capital for those companies requiring capital. Unethical behaviour by investment professionals may lead to companies finding it difficult to raise capital in financial markets, thereby leading to a higher cost of capital. If high ethical standards are maintained, access to equity and debt funding will likely increase and the cost of capital for companies requiring capital will decrease. A and B are incorrect because unethical behaviour by investment professionals may result in lower economic output, lower employment, and reduced long-term growth expectations for the economy. Chapter 2

A bond's current yield is calculated as the annual coupon payment divided by its: a. par value. b. yield to maturity. c. current market price.

c. current market price. A bond's current yield is calculated as the annual coupon payment divided by its current market price. A is incorrect because a bond's coupon rate is calculated as the annual coupon payment divided by its par value. B is incorrect because the discount rate that equates the present value of a bond's promised cash flows with its market price is the bond's yield to maturity. Chapter 9

A security representing an economic interest in a foreign company that trades like a common stock on a local stock exchange is most likely a: a. warrant. b. convertible bond. c. depositary receipt.

c. depositary receipt. A depositary receipt is a security representing an economic interest in a foreign company that trades like a common stock on a local stock exchange. A is incorrect because a warrant is an equity-like security that entitles the holder to buy a pre-specified amount of common stock of the issuing company at a pre-specified share price prior to a pre-specified expiration date. B is incorrect because a convertible bond is a type of debt security issued by a company that offers the holder the right to convert the bond into a pre-specified number of common shares. Chapter 10

Which of the following is an example of an operating expense? a. dividends paid to shareholders. b. interest payments made on a bank loan. c. depreciation expenses for plant and equipment.

c. depreciation expenses for plant and equipment. Operating expenses report expenses incurred by the regular operations of a business and include such items as cost of sales, administrative expenses, and depreciation expenses. A is incorrect because dividend payments are not expenses and are not incurred in the operations of the company. Dividend payments are reported as a financing activity on the cash flow statement. B is incorrect because interest payments are reported on the income statement as a financing expense, not as an operating expense. Chapter 7

Net cash flow is most likely: a. equal to net income over a reporting period. b. equal to operating income over a reporting period. c. different from profit depending on the timing of the cash flows.

c. different from profit depending on the timing of the cash flows. Net cash flow most likely differs from profit because revenues and expenses, which are used to calculate profit, are accounted for on an accrual basis (when the revenue is earned or the expense incurred). Cash flows for revenues and expenses are accounted for when cash is actually exchanged. Thus, profit and cash flow generally differ in the timing of recognition of revenues and expenses. A and B are incorrect because revenue, expenses, and measures of income such as net and operating income are accounted for on an accrual basis. There are non-cash expenses, such as amortisation and depreciation, included when calculating income. The related cash flows were reported when they were made to acquire the long-term assets. Chapter 7

Compared with external documentation, internal documentation is more likely to: a. legally bind. b. inform the public. c. document policies, procedures, and processes.

c. document policies, procedures, and processes. Internal documentation typically documents an organisation's policies, procedures, and processes. A and B are incorrect because external documentation is more likely to be legally binding and to inform the public or other external parties. Chapter 20

The measure that is best suited for investors who dislike losses more than they like equivalent gains is the: a. Sharpe ratio. b. standard deviation. c. downside deviation.

c. downside deviation. The downside deviation focuses only on the negative deviations—that is, the returns that are less than the mean return. Thus, it is an appropriate measure of risk for investors who dislike losses (negative outcomes) more than they like equivalent gains (positive outcomes). A is incorrect because the Sharpe ratio is a measure of risk-adjusted performance that reflects the excess return on a portfolio per unit of risk. B is incorrect because the standard deviation considers all outcomes, both above and below the mean return. It is a better measure for investors who like gains as much as they dislike equivalent losses. Chapter 19

Financial panics are most likely: a. limited to specific countries. b. limited to specific securities markets. c. easily spread throughout the global economy.

c. easily spread throughout the global economy. As financial markets are increasingly global, financial panics are easily spread throughout the global economy. A and B are incorrect because financial panics generally do not remain contained to specific markets or countries, but spread globally as experienced from 2007 to 2009. Chapter 5

To maintain purchasing power, lenders demand an interest rate that reflects the: a. likelihood of default. b. current rate of inflation. c. expected rate of inflation.

c. expected rate of inflation. To maintain purchasing power, lenders demand an interest rate that takes into account expected inflation. As a result of inflation, the money received from a loan may not be worth as much as expected even if the loan is repaid as promised. To compensate for the risk of inflation and a decline in purchasing power, the interest rate demanded by the lender includes expected inflation over the life of the loan. The higher the expected inflation, the higher the interest rate demanded. A is incorrect because even if the loan is repaid as promised, purchasing power will decline if inflation is greater than expected over the life of the loan. B is incorrect because the expected rate of inflation is reflected in the interest rate, not in the current rate of inflation. Chapter 8

The preferred measure of central tendency for investment returns is the: a. mode. b. arithmetic mean. c. geometric mean.

c. geometric mean. The investment industry prefers the geometric mean because the geometric mean is the average return earned each year to get the total accumulation assuming that returns are compounding. A is incorrect because investment returns are continuous data; the mode is not a useful measure of central tendency when data are continuous. B is incorrect because the arithmetic mean does not assume compounding. Chapter 8

When valuing debt securities by using the discounted cash flow approach, the expected cash flows of bonds with: a. lower credit risk should be discounted by using higher discount rates. b. higher credit risk should be discounted by using lower discount rates. c. higher credit risk should be discounted by using higher discount rates.

c. higher credit risk should be discounted by using higher discount rates. When estimating the value of a debt security using the discounted cash flow approach, an analyst or investor must estimate and use an appropriate discount rate that reflects the riskiness of the bond's cash flows. The expected cash flows of bonds with higher credit risk should be discounted at relatively higher discount rates. This approach will result in lower estimates of value. A is incorrect because the expected cash flows of bonds with lower credit risk should be discounted at relatively lower discount rates. B is incorrect because the credit risk associated with the expected cash flows of bonds and the discount rate have a positive, as opposed to inverse, relationship. Thus, the expected cash flows of bonds with higher credit risk should be discounted at relatively higher, not lower, discount rates. Chapter 9

For a particular period, a golf course generated revenues of $10,000,000 and incurred costs of $5,000,000. In addition, the implicit costs were $1,000,000. The accounting profit is most likely: a. lower than the economic profit. b. the same as the economic profit. c. higher than the economic profit.

c. higher than the economic profit. Accounting profit considers only explicit costs and would be derived from the difference between revenues and direct costs ($10,000,000 − $5,000,000 = $5,000,000). A is incorrect because economic profit deducts implicit costs from accounting profit ($10,000,000 − $5,000,000 − $1,000,000 = $4,000,000). B is incorrect because accounting profit and economic profit are not the same when there are implicit costs. Chapter 4

Compared with the expected return on an investment in preferred shares, the expected return on an investment in common shares is most likely to be: a. equal. b. lower. c. higher.

c. higher. Common shares are considered riskier than preferred shares, but they offer a higher expected return. If a company does very well, common shareholders stand to benefit greatly whereas preferred shareholders only receive the fixed dividend. Chapter 10

If a corporate bond's default risk increases, its credit spread will most likely: a. decrease. b. remain unchanged. c. increase.

c. increase. The difference between a risky bond's yield to maturity and the yield to maturity on a government bond with the same maturity is the risky bond's credit spread. If the corporate bond's default risk increases, its credit spread will also increase to compensate investors for the increased risk of default. Chapter 9

Maintaining high ethical standards in the investment industry will most likely result in: a. decreased market efficiency. b. fewer conflicts of interest. c. increased market participation.

c. increased market participation. By maintaining high ethical standards, trust in the fairness of financial markets will increase, thereby increasing market participation. A is incorrect because the end result of maintaining high ethical standards should be increased market efficiency. B is incorrect because high ethical standards help individuals deal with potential conflicts of interest but do not affect the quantity of those inherent conflicts. Chapter 2

In a given year, if a country's GDP per capita decreases while total GDP is unchanged, then the population of the country has: a. decreased. b. remained the same. c. increased.

c. increased. GDP per capita is calculated as total GDP divided by the population. A lower GDP per capita with an unchanged total GDP implies that the population has increased. Chapter 5

The investment industry benefits the economy by: a. increasing risk. b. decreasing liquidity. c. increasing efficiency.

c. increasing efficiency. The investment industry helps savers invest their money and borrowers get the funds they require. In doing so, it reduces the resources that would be expended on the search rather than on productive uses, thus increasing efficiency. A is incorrect because the investment industry helps transform and transfer risk, not increase it. B is incorrect because the investment industry increases rather than decreases liquidity. Chapter 1

If consumers anticipate an inflationary environment, it may lead to consumer spending: a. decreasing. b. remaining unchanged. c. increasing.

c. increasing. Consumers may change the timing of their purchases in response to expected price changes. If they expect prices to increase (inflation), they may buy now rather than save (a lower savings rate). Chapter 5

More closely aligned movements in the business cycles between countries is best explained by: a. reduced international trade. b. decreased mobility of labour. c. increasingly connected financial markets.

c. increasingly connected financial markets. Movements in the business cycles of countries have become more closely aligned as a result of increasingly connected financial markets. A and B are incorrect because increased mobility of labour and growth in international trade result in economies becoming more closely aligned. Chapter 5

Ratio analysis provides analysts: a. information about only the past financial performance of a company. b. information about only the valuation of a company based on the market price of its shares. c. information about both the past financial performance of a company and the valuation of a company based on the market price of its shares.

c. information about both the past financial performance of a company and the valuation of a company based on the market price of its shares.

When valuing a fixed-rate bond by using the discounted cash flow approach, the discount rate used in the valuation is typically the: a. bond's coupon rate. b. London Interbank Offered Rate (Libor). c. investor's required rate of return for the bond.

c. investor's required rate of return for the bond. The discount rate used in the valuation is the investor's required rate of return on the bond given its riskiness. The expected cash flows of bonds with higher credit risk should be discounted at relatively higher discount rates, which results in lower estimates of value. A is incorrect because the coupon rate is used in determining the bond's future cash flows. B is incorrect because Libor is a widely used reference rate to determine the coupon rate for floating-rate bonds. Libor is not necessarily the discount rate used to value a fixed-rate bond. Chapter 9

A prescribed format for marketing materials used by a company relates to documenting: a. origin. b. direction. c. level of standardization.

c. level of standardization. A prescribed format for marketing materials used by an organisation describes the level of standardisation, a characteristic used to classify documentation. The level of standardisation determines whether a document is standardised or ad hoc. Standardised documents have pre-established formats, whereas ad hoc documents are free form. A is incorrect because origin refers to the source of the document—that is, whether it is an original, derived, or associated document. B is incorrect because direction refers to the flow of documentation—that is, whether the information flows down, for example documents associated with policies and procedures, or up, for example documents associated with reporting. Chapter 20

Which of the following is most likely an advantage of owning common stock? a. low risk b. finite life c. limited liability

c. limited liability. By legally separating the shareholders from the company, an individual shareholder's liability is limited to the amount he or she invested. A is incorrect because investing in common stock carries relatively high risk. B is incorrect because common stock is issued without maturity dates. Thus, it has an infinite life. Chapter 10

A central bank's intervention aimed at stabilizing the value of its currency within a certain range best describes a: a. fixed exchange rate system. b. pure floating exchange rate system. c. managed floating exchange rate system.

c. managed floating exchange rate system. Under a managed floating exchange rate system, a country's central bank intervenes to stabilise its currency within a certain range. To do so, it buys its domestic currency using its foreign currency reserves to strengthen its domestic currency or buys foreign currency using its domestic currency to weaken its domestic currency. Chapter 6

The first step of performance evaluation is: a. attributing performance. b. measuring relative returns. c. measuring absolute returns.

c. measuring absolute returns. The performance evaluation process begins with the measurement of absolute returns. Absolute returns are the holding-period returns. They measure the total gain or loss that an investor owning a security achieved over the holding period compared with the investment at the beginning of the period. Holding-period returns usually come from the changes in the price of the security between the beginning and the end of the period, as well as the income received over the period (dividend, interest). B and A are incorrect because measuring relative returns and attributing performance are the third and fourth steps of the performance evaluation process, respectively. Chapter 19

If the data in a set are continuous and skewed, which of the following gives the best measure of central tendency? a. mean. b. mode. c. median.

c. median. The median is the middle value in a data set when the items in that data set are ordered from smallest to largest. Thus, the median is not affected by outliers (extremely high or low value items in the data set). A is incorrect because the mean is affected by outliers. B is incorrect because with continuous data, it is less likely that any observation will appear more than once; thus, the mode may not be identifiable. Chapter 8

The external document that is most likely used during the reporting stage of the client investment cycle is a: a. prospectus. b. share certificate. c. monthly statement.

c. monthly statement. In the reporting stage of the client investment cycle, the external document usually takes the form of a statement, often provided by a third-party custodian or administrator. A is incorrect because an external document, such as a prospectus or a term sheet, is usually provided during the marketing stage of the client investment cycle. B is incorrect because a share certificate is an external document associated with an investment transaction, which occurs during the funding stage of the client investment cycle. Chapter 20

Integrated global financial markets have most likely caused business cycles between countries to be: a. less aligned. b. unrelated. c. more aligned.

c. more aligned. Integrated global financial markets have caused business cycles of various countries to become more closely aligned. Chapter 5

Compared with its underlying securities, an asset-backed security provides: a. less diversification, but more liquidity. b. less liquidity, but more diversification. c. more diversification and more liquidity.

c. more diversification and more liquidity. An asset-backed security pools a large number of related underlying securities, such as mortgages, which creates both more diversification and more liquidity relative to the underlying securities. A and B are incorrect because asset-backed securities provide both more diversification and more liquidity that their underlying securities. Chapter 9

A company's return on equity (ROE) can be broken down into which of the following components? a. Asset turnover, liquidity, and financial leverage b. Net profit margin, liquidity, and financial leverage c. Net profit margin, asset turnover, and financial leverage

c. net profit margin, asset turnover, and financial leverage. The basic ratio for return on equity (ROE) is calculated as Net income/Equity. Analysts often break this down into component parts to determine what is affecting the return on equity. ROE can be calculated as follows: ROE = (Net income/Revenues) × (Revenues/Total assets) × (Revenues/Equity) or, put another way, ROE = Net profit margin × Asset turnover × Financial leverage. A and B are incorrect because liquidity is not used in the calculation of ROE. Chapter 7

Net property, plant, and equipment is included in: a. shareholders' equity. b. long-term debt. c. non-current assets.

c. non-current assets. Net property, plant, and equipment is included in non-current assets. It is used over a number of years to generate revenue for the company. A is incorrect because shareholders' equity represents the owners' investment in the company and includes common stock and retained earnings. B is incorrect because long-term debt is money borrowed from banks and other lenders to be paid back over periods of longer than a year. Chapter 7

Cash paid for salaries would be included as a component of cash flows from: a. financing activities. b. investing activities. c. operating activities.

c. operating activities. Cash paid for salaries is an operating cash outflow. Operating activities relate to the company's profit-making activities and occur on an ongoing basis. Any salaries paid would be considered an integral component of such activities. A is incorrect because financing activities relate to raising new capital (an increase in borrowing and/or issuance of shares) and paying dividends, repaying debt, or repurchasing of shares. B is incorrect because investing activities typically relate to purchases or sales of long-term assets, such as equipment or buildings. Chapter 7

Operating income and cash flow from operating activities are reported, respectively, on the: a. income statement and the balance sheet. b. balance sheet and the cash flow statement. c. profit and loss statement and the cash flow statement.

c. profit and loss statement and the cash flow statement. Operating income is reported on the income statement, or profit and loss statement. Cash flow from operating activities is reported on the cash flow statement. A and B are incorrect because the balance sheet does not report either operating income or cash flow from operating activities. The balance sheet reports the value of a company's assets, liabilities, and shareholders' equity at a specific point in time. Chapter 7

Value at risk: a. often overestimates the frequency of losses. b. assumes that the distribution of returns is random. c. provides an estimate of the minimum loss of value that can be expected.

c. provides an estimate of the minimum loss of value that can be expected. Value at risk gives an estimate of the minimum, but not the maximum, loss of value that can be expected for a given period of time with a specified level of probability. A is incorrect because value at risk often underestimates, not overestimates, the frequency of losses. B is incorrect because value at risk makes an assumption regarding the distribution of returns. For example, it is often assumed that returns are normally distributed. Chapter 18

If an individual makes an initial payment to an insurance company in exchange for a fixed number of future payments of a certain amount from the insurance company, the individual has: a. received a loan. b. obtained a mortgage. c. purchased an annuity.

c. purchased an annuity. The time value of money application described is an annuity. After the initial payment, the insurance company will make payments to the individual which can also be considered withdrawals by the individual. These withdrawals reduce the balance of the annuity over time. A is incorrect because a simple loan requires interest payments and the repayment of the loan amount when the loan matures. B is incorrect because the individual obtaining the mortgage must make the fixed payments of a certain amount to the lender. Chapter 8

Market equilibrium is a state in the market when, at a particular price and with all other factors remaining unchanged, no buyer or seller has any incentive or desire to change the: a. quality of a product that is demanded or supplied. b. market for a product that is demanded or supplied. c. quantity of a product that is demanded or supplied.

c. quantity of a product that is demanded or supplied. Market equilibrium is a state in the market when at a particular price, no buyer or seller has any incentive or desire to change the quantity of a product that is demanded or supplied, all other factors remaining unchanged. A is incorrect because market equilibrium is a price at which there is no excess supply or demand and it does not consider the quality of the product. B is incorrect because market equilibrium relates to the quantity of a product that is demanded or supplied at a particular price, not the market for the product. Chapter 4

When a client wants to sell an investment, the documentation needed from the client relates to: a. funding. b. reporting. c. redemption.

c. redemption. Redemption documentation is required when a client wants to redeem or sell an investment. After verifying the authenticity of the client's instruction, the firm arranges for the investment to be sold. A is incorrect because funding documentation refers to the cash transfer and the investment of the money. B is incorrect because reporting documentation refers to the regular communication between the firm and its client. Chapter 20

After a company conducts a stock split, a common shareholder's proportional ownership will most likely: a. increase. b. decrease. c. remain unchanged.

c. remain unchanged. A stock split replaces one existing common share with a specified number of common shares. It increases the number of shares outstanding but does not change any single shareholder's proportion of ownership. Chapter 10

The Sharpe ratio is a measure of: a. historical volatility. b. downside deviation. c. risk-adjusted performance.

c. risk-adjusted performance. The Sharpe ratio is a commonly used reward-to-risk ratio that is a measure of risk-adjusted performance; the higher the value of the Sharpe ratio, the better the risk-adjusted performance. A is incorrect because the measure of historical volatility is the standard deviation. B is incorrect because the downside deviation is a measure of risk that focuses only on the negative deviations—that is, the returns that are less than the mean return. Chapter 19

The process of a publicly traded company raising additional capital by selling new shares to the public best describes a: a. stock dividend. b. share repurchase. c. seasoned equity offering.

c. seasoned equity offering. The selling of new shares to the public by a publicly traded company to raise additional capital is referred to as a seasoned (or secondary) equity offering. A and B are incorrect because stock dividends and share repurchases do not raise additional capital for the company. In a stock dividend, the company distributes new shares at no cost to existing shareholders. In a share repurchase, the company buys back (or repurchases) shares from existing shareholders. Chapter 10

An external document associated with an investment transaction during the funding stage of the client investment cycle mostly is a: a. prospectus. b. monthly statement. c. share certificate.

c. share certificate A share certificate is an external document associated with an investment transaction, which occurs during the funding stage of the client investment cycle.

An intangible cost of risk management is: a. hiring risk managers. putting b. compliance procedures in place. c. slowing down the decision-making process.

c. slowing down the decision-making process. The intangible costs of risk management are slower decision making and missed opportunities. A and B are incorrect because hiring risk managers and putting compliance procedures in place are tangible, not intangible, costs of risk management. Chapter 18

An institutional investor that invests a government's surpluses is a(n): a. foundation. b. endowment fund. c. sovereign wealth fund.

c. sovereign wealth fund. Sovereign wealth funds invest a government's surpluses. A is incorrect because a foundation is a grant-making institution funded by financial gifts and investment income. B is incorrect because an endowment fund is a long-term fund of a not-for-profit institution, such as a university. Chapter 1

The Sharpe ratio is a measure of the excess return on a portfolio compared with the: a. beta of portfolio returns. b. portfolio's tracking error. c. standard deviation of portfolio returns.

c. standard deviation of portfolio returns. The Sharpe ratio is calculated as reward per unit of risk, where reward is excess return on the portfolio and risk is the standard deviation of portfolio returns. A is incorrect because the Treynor ratio is calculated as the excess return on the portfolio relative to the beta, a measure of systematic risk, of portfolio returns. B is incorrect because the information ratio is calculated as the difference between average return of the portfolio and the benchmark relative to the fund's tracking error. Chapter 19

For a normal distribution, the height and width of the distribution is determined by the distribution's: a. mean. b. median. c. standard deviation.

c. standard deviation. The height and width of a normal distribution is determined by the standard deviation. If the standard deviation is large, the curve is short and wide; if the standard deviation is small, the curve is tall and narrow. A and B are incorrect because the mean and median are the same in a normal distribution; they determine the centre of the curve in a normal distribution. Chapter 8

Which of the following is a measure of dispersion used to assess the risk of an investment? a. arithmetic mean. b. geometric mean. c. standard deviation.

c. standard deviation. The standard deviation is a measure of dispersion in a dataset. The higher the standard deviation, the greater the risk associated with an investment. A and B are incorrect because they are measures of central tendency. Chapter 8

Relative to a futures contract, an advantage of a forward contract is: a. greater liquidity. b. lower counterparty risk. c. the ability to customise the contract.

c. the ability to customise the contract. An advantage of forward contracts is the ability of the investor to create customised contracts that meet his or her needs. Futures contracts are standardised contracts with contract terms established by the exchange and are not customisable. A is incorrect because futures contracts have greater liquidity. It is easier to exit a position prior to the settlement date with futures than with forwards. B is incorrect because futures contracts have lower counterparty risk. Chapter 11

A risk matrix classifies risks according to: a. market, credit, and liquidity risk exposures. b. operational, compliance, and investment risk exposures. c. the expected level of frequency of the event and the expected severity of its consequences.

c. the expected level of frequency of the event and the expected severity of its consequences. A risk matrix is used to assess and prioritise the risks an organisation faces. It classifies risks according to the expected level of frequency of the event (e.g., highly unlikely, unlikely, possible, likely, or highly likely) and the expected severity of its consequences (e.g., negligible, slightly harmful, harmful, extremely harmful, or catastrophic). A and B are incorrect because they are not related to risk matrices. Market, credit, and liquidity risks refer to types of investment risks. Operational, compliance, and investment risks are risk classifications. Chapter 18

Decreased cost of capital may lead to the growth of: a. only the investment industry. b. only companies seeking capital in financial markets. c. the investment industry, companies seeking capital in financial markets, and the overall economy.

c. the investment industry, companies seeking capital in financial markets, and the overall economy. Decreased cost of capital may positively influence the growth of the companies requiring capital as well as growth in the investment industry and the overall economy. A and B are incorrect because the benefits of lower cost of funds is not limited to only the companies raising funds and the investment industry. Chapter 2

Cash flow from financing activities is most likely related to: a. the payment for inventory. b. the purchase of a machine. c. the issuance of long-term debt.

c. the issuance of long-term debt. When a company issues long-term debt, it is a cash inflow from financing activities. A is incorrect because the payment for inventory is a cash outflow for an operating activity related to the company's recurring profit-making activities. B is incorrect because the purchase of a machine is a cash outflow related to investing activities. Chapter 7

A significant benefit of implementing a risk management process is most likely: a. the elimination of risk. b. less accountability. c. the more efficient allocation of capital.

c. the more efficient allocation of capital. One of the benefits of implementing a risk management process is bringing greater discipline to the organisation's operations, which leads to more effective business processes, better controls, and the more efficient allocation of capital. A is incorrect because implementing a risk management process can serve to incorporate risk considerations in all business decisions to ensure that the organisation's risk profile is aligned with its risk tolerance, but it does not lead to the elimination of risk. Some risks should be eliminated, but others may be exploited—for example, the risks the organisation has expertise in dealing with and can benefit from. B is incorrect because implementing a risk management process leads to more rather than less accountability. Chapter 18

Which of the following would most likely cause a steel manufacturer to increase the quantity supplied? An increase in: a. input costs. b. corporate taxes. c. the price of steel.

c. the price of steel. The law of supply states that when prices increase, the quantity supplied by companies will increase. Movements along the supply curve occur when only the price changes. A is incorrect because an increase in input costs would cause the supply curve to shift to the left and the manufacturer to offer the same quantities of steel at higher prices or smaller quantities at the same prices. B is incorrect because an increase in corporate taxes would cause the supply curve to shift to the left and the manufacturer to offer the same quantities of steel at higher prices or smaller quantities at the same prices. Chapter 4

All else being equal, given a choice of when to pay for a purchase, an individual would most likely prefer to pay £100: a. today. b. one year from today. c. two years from today.

c. two years from today. For any given amount of money, most individuals would prefer to pay the amount later compared with paying the same amount of money today because money has a time value. The present value of the payment of £100 is lower the further in the future that amount is paid. A and B are incorrect because if the individual postpones payment, the £100 could be invested for two years rather than for one year or not at all. Chapter 8

Which of the following statements best describes the effect of lower production on a manufacturing plant's costs per unit? Average: a. total cost will decrease. b. fixed cost will decrease. c. variable cost will remain fairly constant.

c. variable cost will remain fairly constant. Average variable cost or variable cost per unit of output is generally constant as production changes. A is incorrect because average total cost should increase as output decreases. B is incorrect because average fixed cost will increase. The fixed costs are being spread over fewer units of production. Chapter 4

The fundamental ethical principle to act with independence and objectivity is best upheld when: a. client confidentiality is maintained. b. personal education and professional development are undertaken. c. work and opinions are unaffected by any potential conflict of interest.

c. work and opinions are unaffected by any potential conflict of interest. Conflicts of interest can adversely affect objectivity and independence by creating a bias that may affect judgment. A is incorrect because maintaining client confidentiality is related to the fundamental ethical principle of protecting confidential information. B is incorrect because undertaking personal education and professional development is related to the fundamental ethical principle of acting with diligence and reasonable care. Chapter 2

The rate that equates the present value of a bond's promised cash flows to its market price is a bond's: a. coupon rate. b. current yield. c. yield to maturity.

c. yield to maturity. The yield to maturity for a bond is the discount rate that equates the present value of a bond's promised cash flows with its market price. Many investors use a bond's yield to maturity to approximate the annualized return from buying a bond at the market price and holding it until maturity. A is incorrect because the coupon rate determines the periodic coupon payments but does not measure the overall return from or reflect the risk of investing in a bond. B is incorrect because the current yield measures the current year return calculated as the total annual coupon payment divided by the current market price of the bond. Chapter 9

A put option on shares of Company B has an exercise price of £40. The option is out of the money when the share price of Company B is: a. £35. b. £40. c. £45.

c. £45. A put option contract is out of the money when the underlying's price is higher than the exercise price. A is incorrect because the put option contract is in the money when the underlying's price is less than the exercise price. B is incorrect because the put option contract is at the money when the underlying's price equals the exercise price. Chapter 11

Given an interest rate of 10% and assuming that interest is reinvested, which of the following will have the highest future value? a. €10,000 invested today for 5 years. b. €10,000 invested today for 10 years. c. €10,000 invested today for 15 years.

c. €10,000 invested today for 15 years. The longer the compounding period, the greater the future value. Chapter 8

A call option contract on shares of Company A has an exercise price of €50. The option is in the money when the share price of Company A is: a. €45. b. €50. c. €55.

c. €55. A call option is in the money when the underlying's price exceeds the exercise price. A is incorrect because the call option is out of the money when the underlying's price is less than the exercise price. B is incorrect because the call option is at the money when the underlying's price equals the exercise price. Chapter 11