FP513 Practice questions
Your client has learned of a private placement offering. Which of the following is NOT a characteristic of a private placement?
An investor with a net worth of $1 million, including the value of their primary residence, can participate in a private placement offering.
Which of the following statements regarding hedge funds is CORRECT?
C) Hedge funds are usually structured as a partnership
Which of the following would least likely be included as a constraint in an investment policy statement (IPS)?
How funds are spent after being withdrawn from the portfolio
Based on the following information, which of the following is the expected rate of return for Softco Corporation? Stock's beta0.80 Forecasted market rate of return15% Risk-free rate of return6.5%
The answer is 13.30%. Using the capital asset pricing model, the expected rate of return is 13.30% [6.5% + (15% - 6.5%)0.80].
Rex, Ltd., has assets of $400 million and liabilities of $200 million. Last year, the company earned $45 million and paid out $15 million in dividends. Using the formula g = return on equity × retention rate, what is the growth rate for Rex, Ltd.?
The answer is 15.0%. $400,000,000 - $200,000,000 = $200,000,000 of equity; $45,000,000 earnings ÷ $200,000,000 equity = 0.225, or 22.50% ROE $45,000,000 earnings - $15,000,000 paid out in dividends = $30,000,000 of retained earnings; $30,000,000 ÷ $45,000,000 = 0.6667 retention rate g = ROE × RR g = 0.2250 × 0.6667 = 0.15, or 15%
Your client has just experienced an unanticipated financial emergency resulting in an immediate need of $25,000. Which of your client's assets would you advise be sold to cover this expense? A) Short-Term U.S. Treasury ETF B) Collection of gold coins C) BioTech Mutual Fund D) S&P 500 Index ETF
The answer is Short-Term U.S. Treasury ETF. The other three choices may exhibit either liquidity risk or marketability risk or both. The U.S. Treasury ETF would be the least susceptible to these risks and highly liquid and accessible.
The Pratts are concerned that ABC stock may substantially decline in price in the near future. Which of the following option strategies would best protect the Pratts' position in ABC stock? (Assume they own 100 shares currently valued at $130 per share, and all options will expire within 60 days.)
The answer is buy one put option with an exercise price of $120 for $3.00 per share. If the Pratts are bearish, they will either sell a call or buy a put. In this particular case, the Pratts should purchase one put option with an exercise price of $120 for $3.00 per share. The total cost of the put option, excluding transaction costs, is $300 ($3 × 100). Each put option contract gives the holder the right to sell 100 shares of the underlying stock at the exercise price within a specified time frame.
Advantages of investing in exchange-traded funds (ETFs) include all of the following except A) daily pricing. B) tax efficiency. C) ability to sell short. D) low expense ratios.
The answer is daily pricing. ETFs are continually priced during a trading day, just like stocks.
Which of the following financial intermediaries would a business look to for startup capital? A) Credit unions B) Investment bankers C) Unit investment trusts D) Mutual funds
The answer is investment bankers. Startup capital is typically available at commercial banks and from investment bankers. LO 1.1.1
Reham Corporation has declared a record date of Friday, August 1, for its next quarterly dividend. Which of the following is the last day an investor can purchase the stock and still qualify for the dividend?
Wednesday, July 30
Which of the following is the primary difference between the underlying assumptions of technical analysis and those of fundamental analysis? A) Technical analysts believe the trend in security prices is determined solely by the interaction of economic supply and demand. B) Technical analysts argue that the market only weighs irrational factors, and therefore, the psychology of investors will produce a herd effect. C) Technical analysts maintain that stock prices adjust quickly to the dissemination of public information. D) Technical analysts hold that the price of a security is established by the expected investor return and a combination of risk factors.
A) Technical analysts believe the trend in security prices is determined solely by the interaction of economic supply and demand.
Which of these statements regarding unit investment trusts (UITs) is CORRECT? A) UITs are actively managed, as portfolio managers typically attempt to match the return of a stated index. B) At the maturity date of the portfolio, the securities are generally liquidated, and the proceeds are distributed to the investors or trust beneficiaries. C) The majority of UIT offerings are listed on the major stock exchanges. D) Units in a UIT are priced in the secondary market at a premium or discount to NAV.
B) At the maturity date of the portfolio, the securities are generally liquidated, and the proceeds are distributed to the investors or trust beneficiaries.
Which of the following statements regarding fundamental and technical analysis is CORRECT?
B) Technical analysis is not considered valid under the efficient market hypothesis because this type of analysis is attempting to predict future prices based on past price movement.
Mimi, a client of Osborne Capital, Inc., believes her portfolio should be adjusted. She supports her claim by stating that she just won the lottery and wants to retire 10 years earlier than originally planned. Does she have a valid claim?
C) Yes, her wealth and time horizon have changed.
Which of the following statements describing tangible assets and natural resources is CORRECT? A) The share value of a mutual fund that invests primarily in companies that develop natural resources is positively correlated with the value of the bond market. B) Gold prices and stock prices have traditionally had an inverse relationship. C) Oil and gas investments are typically offered to the public as general partnerships. D) Collectibles offer the investor personal enjoyment and a highly liquid investment.
Gold prices and stock prices have traditionally had an inverse relationship.
Which of the following combinations of risks is associated with art and other collectibles? A) Liquidity risk and market risk B) Reinvestment rate risk and purchasing power risk C) Regulation risk and interest rate risk D) Market risk and business risk
Liquidity risk and market risk
Yadira owns 20 stocks across several sectors of the economy that are part of the S&P 500 index, typically known as "blue chip" stocks. Her investments are exposed to which of the following risks?
Market risk
Connie, 45, has an extensive amount of assets in a separately managed account. The account is mostly compromised of small-cap growth companies. What is the best benchmark to analyze the performance of her account?
Russell 2000 Index
Brian and Kellie purchased savings bonds for their children's future college education expenses. What series of bonds did they choose if the savings bonds are inflation-indexed and may be used to pay for higher education costs on a tax-favored basis?
Series I
A call option with an exercise price of $105 is selling in the open market for $4.25 when the market price of the underlying stock is $102. What is the intrinsic value of this option?
The answer is $0. This call option is out-of-the-money; thus, its intrinsic value is zero.
ABC Corporation issued bonds with a 10-year maturity, $1,000 par value, and 7% coupon rate (paid semiannually). Two years after issue, interest rates on similar bonds fell to 5.75%. What price should ABC Corporation bonds sell for in the secondary market?
The answer is $1,079.26. This answer is calculated using the following factors: FV = $1,000 PMT = 7% x 1000 ÷ 2 = $35 N = 16 semiannual periods (8 years x 2 periods per year) I/YR = 5.75% Solve for PV = -1,079.26, or $1,079.26
CCC stock paid a dividend this year of $3, and this dividend is expected to grow at a rate of 10% for the next two years and at a rate of 5% thereafter. Assuming Jackie expects to sell the stock in three years, and her required rate of return is 12%, what is the price she should be willing to pay for CCC stock?
The answer is $49.25. Use the multistage growth dividend discount model to calculate the stock's intrinsic value. Step 1: Compute the value of each future dividend until the growth rate stabilizes (Years 1-2). D1 = $3.00 × 1.10 = $3.30 D2 = $3.30 × 1.10 = $3.63 Step 2: Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 3). D3 = $3.63 × 1.05 = $3.81 V = $3.81 ÷ (0.12 - 0.05) = $54.45 Step 3: Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 = $0 CF1 = $3.30 CF2 = $3.63 + $54.45 = $58.08 I/YR = 12% Solve for NPV = $49.25 The intrinsic value of the stock is $49.25.
Last year, Patrice began investing in the Apex Fund. She is investing $500 every quarter and wants to know what her average cost per share (basis) has been. These are the prices of the Apex Fund at the end of each quarter when she made her purchases: $35.50, $38.90, $65.70, $72.50, and $89.00. What is her average cost per share?
The answer is $53.12. Calculated as follows: TOTAL. 47.063 shares $2,500 ÷ 47.063 shares = $53.12
ABC Corporation pays a current annual dividend of $0.75 per share. This dividend is expected to grow at a 30% rate per year during Years 1 and 2. After Year 2, the company's dividend is expected to grow at a constant rate of 8%. What is the value of the stock today, assuming a required rate of return of 10%?
The answer is $58.50. Using the multistage growth dividend discount model, the value of the stock equals $58.50. Compute the value of each future dividend until the growth rate stabilizes (Years 1-2). D1 = $0.75 × 1.30 = $0.9750 D2 = $0.9750 × 1.30 = $1.2675 Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 3). D3 = $1.2675 × 1.08 = $1.3689 V = $1.3689 ÷ (0.10 - 0.08) = $68.4450 Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 = $0 CF1 = $0.9750 CF2 = $1.2675 + $68.4450 = $69.7125 I/YR = 10% Solve for NPV = $58.50 LO 4.3.1
The Pratts are considering purchasing JKL stock based on a stock tip from their neighbor, Alicia. Alicia has provided them with the following information: Current dividend: $2.50 Expected dividend growth rate for years 1 and 2: 8% Expected dividend growth rate for years 3+: 10% Based on this information, what is the intrinsic value of JKL stock if the Pratts have a required rate of return for this investment of 14%?
The answer is $66.37. Using the multistage growth dividend discount model, calculate JKL stock's intrinsic value: Step 1: Compute the value of each future dividend until the growth rate stabilizes (Years 1-2). D1 = $2.50 × 1.08 = $2.70 D2 = $2.70 × 1.08 = $2.92 Step 2: Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 3). D3 = $2.92 × 1.10 = $3.21 V = $3.21 ÷ (0.14 - 0.10) = $80.25 Step 3: Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0= $0 CF1= $2.70 CF2 = $2.92 + $80.25 I/YR= 14% Solve for NPV = $66.37
Norma Smith owns ABC Corporation bonds of AA rated quality that mature in seven years, pay semiannual interest, and have a coupon of 8%. Similar bonds (AA rated, seven years to maturity) yield 9%. The ABC Corporation bonds are convertible into common stock at $26 per share, and the current market price of ABC common stock is $23. What is the conversion value of an ABC Corporation bond?
The answer is $884.61. Conversion value = conversion ratio × market price of common stock, or ($1,000 ÷ $26) × $23 = $884.61.
Wayne owns shares in the Big Value mutual fund. Last year, Big Value had a return of 18%, the S&P 500 Index had a return of 21%, and six-month Treasury bills averaged a return of 5%. Big Value's standard deviation was 14, the standard deviation of the S&P 500 index was 12, and Big Value's beta was 0.9. Which of the following is the Treynor ratio for Big Value last year?
The answer is +14.44. The Treynor ratio for Big Value: (18 - 5) ÷ 0.9 = 14.44
Juan has an investment portfolio consisting of 30% MIJ stock with a beta of 1.76, 40% ABC stock with a beta of 0.98, and 30% LFM stock with a beta of 2.09. What is the weighted beta for Juan's portfolio?
The answer is 1.547. The portfolio's weighted beta is calculated as follows: (0.30 × 1.76) + (0.40 × 0.98) + (0.30 × 2.09) = (0.528 + 0.392 + 0.627) = 1.547 With a beta higher than 1.0, the portfolio is much more volatile than the overall market.
Assume an investor has purchased a bond with these characteristics: Seven years to maturity $1,000 face value 6% annual coupon (paid semiannually) 8.43% current yield $711.74 current market price Which of the following is the bond's yield to maturity?
The answer is 12.25%. The bond's yield to maturity is calculated using the following inputs: PV = -$711.74 FV = $1,000 PMT = 6% × 1,000 ÷ 2 = $30 N = 14 (7 x 2 periods per year) I/YR = 12.2508, or 12.25%
Nancy bought 50 shares of ABC stock for $50 per share. She made additional purchases at the end of each of the following years: Year 1: 10 shares at $52 per share Year 2: 10 shares at $53 per share Year 3: 10 shares at $45 per share ABC stock has not paid any dividends during her holding period. At the end of Year 4, the stock is trading for $55 per share. Which of the following is Nancy's return over the past four years on ABC stock (assume she sells the stock for the current trading price)?
The answer is 2.95%. The dollar-weighted return is calculated as follows: CF0 (2,500) [50 × $50] CF1 (520) [10 × $52] CF2 (530) [10 × $53] CF3 (450) [10 × $45] CF4 4,400 [80 × $55] Solve for IRR/YR = 2.95%
Javier has just been informed that his XYZ stock will be incurring a 2-for-1 stock split. How many additional shares will Javier acquire if he already owns 200 shares of XYZ?
The answer is 200. Javier will acquire 200 additional shares, and therefore, will own a total of 400 shares of XYZ stock. In a stock split, the par value of each share of stock is reduced, and the number of shares is increased proportionately.
During the past year, the stock market had a return of 8%, while the risk-free rate of return was 3%. Fund B had a realized return of 12%, a standard deviation of 15, and a beta of 1.20. Jensen's alpha for the fund is
The answer is 3.00%. Alpha = 12% - [3% + (8% - 3%)1.20] = 12% - 9% = 3%
A wash sale for tax purposes occurs when a person sells a security and repurchases it within ___ days before or after the sale.
The answer is 30. A wash sale occurs if the taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities. If this event occurs, the basis of the new stock or securities will include the unrecovered portion of the basis of the formerly held stock or securities.
Assume the nominal return on 30-year U.S. T-bonds is 6.5%, and the inflation rate is 1.75%. Which of the following is the real rate of return on the T-bonds?
The answer is 4.67%. The real rate of return is 4.67%, calculated as follows: {[(1 + 0.065) ÷ (1 + 0.0175)] -1} × 100 = 0.0467, or 4.67%.
Angela purchased a corporate bond currently selling for $925 in the secondary market. The bond has a coupon rate of 7.75% and matures in 12 years. Which of these is the yield to maturity on this bond?
The answer is 8.77%. The yield to maturity on this bond is calculated using the following inputs: PV = -$925 PMT = 7.75% × 1,000 ÷ 2 = $38.75 FV = $1,000 N = 24 (12 x 2 periods per year) Solve for I/YR = 8.77%
DIV Corporation's current market value is $50 million, with 2 million shares outstanding. The board of directors votes to pay a stock dividend of 10%. Which of the following statements is correct? A) DIV Corporation will have 2 million shares outstanding following the stock dividend. B) DIV Corporation's per-share stock price will be $22.73 following the stock dividend. C) DIV Corporation's overall market value will be $55 million following the stock dividend. D) DIV Corporation's per-share stock price will be adjusted upward following the stock dividend.
The answer is DIV Corporation's per-share stock price will be $22.73 following the stock dividend. DIV Corporation's overall market value will remain unchanged at $50 million, with 2.2 million shares outstanding. The stock price per share will be adjusted downward to $22.73 ($50,000,000 ÷ 2,200,000).
Mysterious Company stock has a mean return of 9% and a standard deviation of 3%. Based on this information, which of the following statements is CORRECT? A) Five percent of Mysterious Company's returns will be greater than 15%. B) Approximately 68% of Mysterious Company's returns will fall between 3% and 15%. C) Half of Mysterious Company's returns will fall below 6%. D) Mysterious Company is unlikely to experience a negative return.
The answer is Mysterious Company is unlikely to experience a negative return. With a normal probability distribution, 68% of the returns fall within one standard deviation of the mean, 95% within two standard deviations, and 99% within three standard deviations. Therefore, Mysterious Company has less than a 0.5% chance of experiencing a negative return.
Sinowe purchased a Treasury-issued security for its par value of $1,000. The security has a coupon rate of 6%, and the last semiannual interest payment he received was $36. The security recently matured, and Sinowe received $1,200. What type of Treasury security did he own?
The answer is Treasury Inflation-Protected Securities (TIPS). Sinowe owned a TIPS. The security was issued at par with a 6% coupon. The principal value is inflation-adjusted every six months, and one-half of the stated coupon rate is paid semiannually on the inflation-adjusted principal. The last interest payment of $36 and the paid maturity value of $1,200 reflect the inflation-adjusted principal.
Greg and Elizabeth are discussing their retirement plan with Jack, a financial advisor with an investment advisory firm. They would like Jack to reposition a portion of their assets into an investment that would provide them a monthly income with minimal risk. Which of the following choices would be the best for Jack to recommend to his clients?
The answer is U.S. government bond fund. Of the available choices, only the U.S. government bond fund would offer the client monthly income.
Which of the following statements regarding futures contracts is correct? A) Hedging involves purchasing a futures contract in the same position of that which is currently held. B) A futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset at a future time, place, and unit price. C) Futures contracts do not trade on an exchange. D) To complete a futures contract, delivery of the asset or commodity must be made.
The answer is a futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset at a future time, place, and unit price. To complete a futures contract, delivery of the commodity or asset may be made. But more often, the buyer (or holder) simply purchases an offsetting contract and cancels the original position. Hedging involves purchasing a futures contract in the opposite position of that which is currently held. Futures contracts are traded on an exchange such as the Chicago Mercantile Exchange.
Which of the following statements regarding modern portfolio theory is correct? A) A portfolio that lies below the efficient frontier is superior to the one that has the same risk but lies on the efficient frontier. B) A portfolio that lies below the security market line (SML) is undervalued. C) A portfolio that lies below the efficient frontier is unattainable. D) A portfolio that lies at the point where the indifference curve is tangent to the efficient frontier is the optimal portfolio.
The answer is a portfolio that lies at the point where the indifference curve is tangent to the efficient frontier is the optimal portfolio. Statements III and IV are not correct. A portfolio that lies below the SML is overvalued because its expected return is lower than the required return plotted on the SML. A portfolio that lies below the efficient frontier is inferior to one that lies on the efficient frontier. Each portfolio on the efficient frontier offers the highest possible return for a particular level of risk.
Which type of hedge should a wheat farmer select?
The answer is a short hedge—sell wheat futures contracts as a hedge against a decline in the price of wheat. Because the wheat farmer is long wheat, he would be interested in a short hedge to protect against a decline in the price of wheat.
Which of these is a risk associated with corporate bonds? A) Default risk B) Reinvestment rate risk C) All of these D) Interest rate risk
The answer is all of these. All bonds are subject to systematic risks. However, government bonds are not subject to default risk.
Which of the following is a risk involved in an investment in undeveloped land? A) Access to the investor's land may be restricted by adjacent landowners. B) The land may be adversely rezoned. C) All of these. D) The investor may not be able to obtain permits to build on the land.
The answer is all of these. An investment in undeveloped land may be subject to all of these risks.
Which of these statements describing the primary market is correct? A) A syndicate is a group of investment banks that collectively underwrite an issue. B) One goal of underwriting is to evaluate a firm's financial needs. C) All of these. D) The purpose of the primary market is to facilitate the initial sale of securities to the public.
The answer is all of these. In the primary market, underwriters assist with the sale of the issue, evaluate the firm's financial needs, and determine the best investment vehicle to achieve the capital goal.
Which of the following is a disadvantage of investing in convertible bonds? A) They are doubly cursed in times of high interest rates and low stock prices. B) All of these. C) The holder may be forced into conversion if the bond is callable. D) The yield is less than that of a nonconvertible bond with similar risk and maturity.
The answer is all of these. These bonds are doubly cursed during times of high interest rates and low stock prices because convertibles typically have lower coupon rates than comparable nonconvertibles. Thus, they experience greater price volatility.
Larry's 401(k) plan has experienced returns over the past five years of -10%, 15.55%, -5.87%, 12.75%, and 14.85%. What are both the arithmetic and geometric means for this series of returns?
The answer is arithmetic mean = 5.45%; geometric mean = 4.85%. Arithmetic mean: [(-0.10 + 0.155 - 0.0587 + 0.1275 + 0.1485) ÷ 5] = 0.0545, or 5.45%. Geometric mean: PV = -1; FV = (1 - 0.10)(1 + 0.155)(1 - 0.0587)(1 + 0.1275)(1 + 0.1485) = 1.2671; N = 5; solve for I/YR = 4.8485, or 4.85%.
Jack has $50,000 to invest in a portfolio of bonds. He decides to invest $25,000 into bonds with a two-year maturity and $25,000 into bonds with a 10-year maturity. His portfolio illustrates what type of bond strategy?
The answer is bond barbells. Bond barbells is a strategy for investing in both short-term and long-term bond issues.
You currently own 100 shares of a stock that has increased in value from $15 to $35 per share. You do not want to sell the stock but want to protect yourself against a large downturn in the market. Which of the following is an effective action on your part?
The answer is buy a $30 put option on the stock. The purchase of a put option on the stock will provide downside protection without limiting the investor's upside.
The duration of a bond is inversely related to its
The answer is coupon rate. Duration is directly related to term to maturity and inversely related to coupon rate and yield to maturity.
Which of the following are attributes of an economy that is coming out of recession? A) Cyclical stocks will begin to move up in price. B) Interest rates are falling. C) Personal incomes are in decline. D) Unemployment is increasing.
The answer is cyclical stocks will begin to move up in price. Once the economy starts to recover, the unemployment rate will decline, interest rates will fall, and personal income will grow. Then cyclical stocks will begin to move up in price.
Which of these is an example of a defensive stock? A) Airline stock B) Grocery store stock C) Restaurant stock D) Computer stock
The answer is grocery store stock. Companies that provide non-cyclical consumer products (i.e., food, consumer staples, pharmaceuticals, and tobacco) typically do well despite general economic downturns. A computer stock, an airline stock, and a restaurant stock are types of companies that sell luxury products and services, purchases of which may be reduced during an economic downturn.
Which of the following is a characteristic of American depositary receipts (ADRs)? A) They are not relatively liquid and marketable investments. B) Information regarding the foreign company is often more easily attainable with ADRs because the entity holding the security generally has access to that information. C) Dividends are declared in the foreign currency, so exchange-rate risk is completely eliminated. D) ADRs are denominated and pay dividends in foreign currencies.
The answer is information regarding the foreign company is often more easily attainable with ADRs because the entity holding the security generally has access to that information. ADRs are trust receipts issued by a U.S. bank for shares of a foreign company purchased and held by a foreign branch of the bank. They are an alternative to investing directly in foreign companies or foreign mutual funds. Dividends are declared in the local currency, so exchange-rate risk is not completely eliminated.
Which of the following correctly describes a disadvantage of cash and cash equivalents?A) investments in money market mutual funds are insured or guaranteed by the U.S. government. B) the rate of return on passbook savings accounts is relatively high when compared to higher risk alternatives such as government bonds. C) investors choosing to redeem their CDs prior to maturity may be subject to a substantial penalty. D) an investor may quickly convert a money market deposit account to cash to meet short-term needs.
The answer is investors choosing to redeem their CDs prior to maturity may be subject to a substantial penalty. One of the advantages of money market deposit accounts is their liquidity. They may be used by investors as a source of funds to meet emergencies and other short-term obligations. Investments in money market mutual funds are not insured or guaranteed by the U.S. government. The rate of return on passbook savings accounts is relatively low when compared to higher risk alternatives such as government bonds.
Which of the following combinations will result in a bond with the greatest price volatility? A) High coupon and long maturity B) Low coupon and short maturity C) High coupon and short maturity D) Low coupon and long maturity
The answer is low coupon and long maturity. Price volatility is measured by duration. Duration is inversely related to the bond's coupon rate and directly related to the bond's term to maturity.
Rossalyn is researching GFD stock to determine if she should add it to her extensive equity portfolio. This stock has a beta of 1.40 and a standard deviation of 6.85%. Assuming the market rate of return is 10%, and the current 90-day T-bill rate is 2%, what is the market and stock risk premiums for GFD stock?
The answer is market = 8.00%; stock = 11.20%. The market risk premium is calculated as follows: rm - rf = (10% - 2%). The stock risk premium is 11.20%, calculated as follows: (rm - rf)βi = (10% - 2%)1.40.
Jim, 32, and Caren, 30, have been married for seven years. Both Jim and Caren work and have no children, so they have a large amount of disposable income. They live in the suburbs and are planning to purchase a condominium downtown as a weekend getaway. They would like to invest their money in a safe place for the down payment during the six months they spend searching for the perfect location and amenities. Which of the following investments would you recommend to Jim and Caren to accomplish this goal? A) Stock index fund B) U.S. government income fund C) Money market fund D) Investment-grade bond fund
The answer is money market fund. Jim and Caren are preparing to make a significant purchase within a relatively short period of time. They will require a highly liquid investment to keep their money safe. Therefore, the money market fund best matches their investment objective.
Which of the following correctly explains a disadvantage of investing in money market instruments? A) certificates of deposit (CDs) generally pay a higher rate of interest than long-term corporate bonds and are FDIC insured. B) money market mutual funds pay a low rate of interest. C) money market instruments are not subject to purchasing power (inflation) risk. D) certificates of deposit are not subject to penalties for withdrawals made prior to maturity.
The answer is money market mutual funds pay a low rate of interest. An investor in CDs is willing to accept a lower return to maintain a high degree of safety. Certificates of deposit are subject to penalties for withdrawals made prior to maturity. However, by accepting a low rate of return, the investor is subject to purchasing power (inflation) risk. Money market instruments are subject to purchasing power (inflation) risk.
Francis and William would like to place $5,000 into an account that would be used primarily for emergencies. Which of the following investment choices should be recommended for an emergency fund?
The answer is money market mutual funds. Money market mutual funds are used by many investors as their emergency fund because the funds are extremely liquid.
Which of the following stock market anomaly descriptions is CORRECT? A) BVMV: buy stocks with high market value relative to book value B) Size effect: big-company stocks outperform small-company stocks over time C) Neglected firm effect: buy stocks followed by few analysts D) January effect: buy stocks in January
The answer is neglected firm effect: buy stocks followed by few analysts. Buying stocks in December and selling them in January is the January effect. Buying stocks with high book value to market value is BVMV. Small-company stocks outperforming large-company stocks over time is the size effect.
Which of the following is a characteristic of preferred stock? A) is issued for a fixed period of time B) represents equity ownership C) offers guaranteed income D) pays interest based on current market interest rates
The answer is offers guaranteed income. Preferred stocks possess features of both stocks and bonds. However, they represent equity ownership with no maturity date and pay dividends, though payment may be suspended if earnings are poor. Preferred stocks trade on the exchanges.
As a result of a market correction, your client's portfolio mix has changed substantially from the desired allocation. What portfolio management technique could be used to bring the allocation back to the desired mix?
The answer is portfolio rebalancing. Rebalancing refers to adjusting the weights of securities in a portfolio to their target weights after price changes have affected the weights.
Which of the following statements concerning preferred stock is correct? A) Preferred stock resembles bonds, in that dividend income continues forever unless the stock issue is called or otherwise retired. B) If the issuer of a cumulative preferred stock fails to pay the dividend in any year, the unpaid dividend(s) will not have to be paid in the future. C) Preferred stock dividends are not legally binding but must be voted on each period by the corporation's board of directors. D) Preferred stockholders are paid before bondholders in terms of priority of payment of income and in case of corporate liquidation.
The answer is preferred stock dividends are not legally binding but must be voted on each period by the corporation's board of directors. Preferred stockholders are paid after bondholders in terms of priority of payment of income and in case of corporate liquidation. If the issuer of a cumulative preferred stock fails to pay the dividend in any year, the unpaid dividend(s) will have to be paid in the future before common stock dividends can be paid.
Xavier is concerned that his investment portfolio is too concentrated in only a few stocks. He meets with his financial advisor for advice. The advisor recommends that Xavier diversify his portfolio among many different types of issues. Which of the following is the primary goal of this strategy?
The answer is reduce portfolio risk. Diversification aims to reduce unsystematic risk, not necessarily increase portfolio returns.
Which of the following statements correctly explains separately managed accounts and their relation to mutual funds? A) in a mutual fund, the investor owns the underlying securities directly, while in a separately managed account, the investor owns shares of the fund. B) the key difference between mutual funds and separate accounts is that in a separate account, the money manager is purchasing the securities in the portfolio on behalf of the fund, not on behalf of the investor. C) they are similar to mutual funds, in that a money manager develops a model index specializing in a particular aspect of the market. D) separately managed accounts are individual investment accounts offered by financial consultants who provide advisory services and are managed by independent money managers using an asset-based fee structure.
The answer is separately managed accounts are individual investment accounts offered by financial consultants who provide advisory services and are managed by independent money managers using an asset-based fee structure.
All of the following correctly explain advantages of investing in real estate investment trusts (REITs) except
The answer is tax deferral. Tax deferral is not an advantage of investing in REITs. REITs are professionally managed assets investing in a diversified portfolio of real estate holdings. Many REITs trade on the exchanges and over the counter, thereby providing investors with liquidity.
Which of the following correctly identifies an issue with the Dow Jones Industrial Average (DJIA)? the S&P 500 Index and the DJIA have a correlation coefficient of only 95%, indicating that the DJIA is not a fair representation of the overall market. B) the DJIA considers stock dividends of less than 10%. C) the DJIA fails to account for the number of shares outstanding. D) the DJIA reflects the payment of cash dividends.
The answer is the DJIA fails to account for the number of shares outstanding. Although the DJIA has fundamental problems, it is highly correlated with other broader market indexes such as the S&P 500 Index. A high correlation indicates that the DJIA is an adequate representation of the market in spite of its fundamental weaknesses. The DJIA ignores stock dividends of less than 10% and fails to reflect the payment of cash dividends.
Wendy traveled to France and converted U.S. dollars into euros when the exchange rate was USD 1.42 for each euro. When Wendy returned from France, she had some euros left over and converted them back into U.S. dollars. At that time, one dollar was worth .77 euros. Wendy wants to know if she made or lost money on the euros she exchanged back into U.S. dollars. You inform her that
The answer is the dollar has strengthened, and she lost money. When she returned, she would have preferred the euro to strengthen against the dollar; that way, she could have received more dollars.
Which of the following is NOT considered when calculating a mutual fund operating expense? A) Shareholder recordkeeping B) Transaction costs related to the portfolio securities C) 12b-1 fees D) Management fees
The answer is transaction costs related to the portfolio securities. A fund's operating expenses include management fees, 12b-1 fees, and administrative fees. Funds do incur transaction costs and those costs do impact performance but transaction costs are not captured in the expense calculation.
Which of the following forms of the efficient market hypothesis suggests that fundamental analysis and insider information may produce above-market returns? A) All of these B) Weak C) Semistrong D) Strong
The answer is weak. The weak form holds that current stock prices reflect all historical market data and that historical price trends are, therefore, of no value in predicting future prices. However, this form holds that credible fundamental analysis and insider information may produce above-market returns.
CAL stock has a current annual dividend of $1.25 that has been growing at a constant rate of 4.5% per year. Assuming the stock is currently selling for $40, and your required rate of return is 7.5%, should you buy the stock at today's price?
The answer is yes, because the stock is undervalued. On the basis of the constant growth dividend discount model, the intrinsic value of CAL stock is $43.54, calculated as follows: V = [$1.25 × (1 + 0.045)] ÷ (0.075 - 0.045) V = $1.30625 ÷ 0.03 V = $43.54 Because CAL stock is currently selling for $40 per share, it is undervalued in the secondary market and worthy of a purchase.
When a taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities, this transaction is classified as
a wash sale.
The basic purposes of the investment policy statement include all of the following except
determining the specific assets to include.
According to Markowitz, an investor's optimal portfolio is determined when the investor's
highest indifference curve is tangent to the efficient frontier.
