Chapter 12

Which of the following statements is incorrect with respect to the structure of the SEC? ​ a. It is composed of seven commissioners appointed by the president of the United States. ​b. The president selects one commissioner to chair the commission. ​c. Each commissioner serves a five-year term. ​d. Commissioners' terms are staggered. ​e. Commissioners meet to assess whether existing regulations are successfully preventing abuses and to revise the regulations as needed

a. It is composed of seven commissioners appointed by the president of the United States.

A margin call from a broker means that the investor is required to provide more collateral (cash or stocks) or sell the stock. a. True b. False

a. True

A market order is an order to buy or sell a stock at the best possible price. a. True b. False

a. True

A stop-loss order is a particular type of limit order whereby the investor specifies a selling price that is below the current market price of the stock. a. True b. False

a. True

Many high frequency traders are willing to serve as intermediaries (similar to market makers) by accommodating orders that they believe will ultimately result in profits. a. True b. False

a. True

Trading halts are intended to ensure that the market has complete information before trading on news. a. True b. False

a. True

When the ratio of the number of shares of a stock sold short divided by the total number of shares outstanding is 3 percent or higher, this suggests a large amount of short positions in the market, which implies that a relatively large number of investors expect the stock's price to decline. a. True b. False

a. True

Dark pools a. are computerized platforms used by institutional investors that operate like private stock markets. b. are stocks issued by firms that have disclosed very limited financial information. c. are stock option contracts that cover positions in stocks. d. are contracts used to bet against the default of a debt instrument.

a. are computerized platforms used by institutional investors that operate like private stock markets.

____ offer advice to customers on stocks to buy or sell. a. ​Full-service brokers b. ​Discount brokers c. ​Floor brokers d. ​Specialistse. ​Market makers

a. ​Full-service brokers

______________ represents the use of electronic platforms to execute orders based on an algorithm with programmed instructions. a. ​High frequency trading b. ​Mechanical analysis c. ​Liquidity trading d. ​Technical analysis

a. ​High frequency trading

High frequency traders set up their own _________ that specify the conditions under which a specific stock should be purchased or sold, the size of the transaction, and the price that should be paid. a. ​algorithms b. ​inverse programs c. ​circuit breakers d. ​nextron networks

a. ​algorithms

A ____ is a trading platform on a computer website that allows investors to trade stocks without the use of a broker. a. ​direct access broker b. ​program trader c. ​market maker d. ​communication network

a. ​direct access broker

Investors can reduce their risk by purchasing a stock on margin instead of using all cash to buy the stock. a. True b. False

b. False

It is not illegal for investors to take positions in a stock based on inside information that they received from an insider at the company, although it would be illegal for the insider to take a position based on that information. a. True b. False

b. False

Regulation Fair Disclosure (FD) requires firms to disclose relevant information first to their most important clients. a. True b. False

b. False

The SEC's Division of Trading and Markets assesses possible violations of the SEC's regulations and can take action against individuals or firms. a. True b. False

b. False

The initial margin is the minimum amount of margin that investors must maintain as a percentage of the stock's value without receiving a margin call. a. True b. False

b. False

The maintenance margin is the minimum amount of the margin that investors must maintain as a percentage of the stock's initial purchase price. a. True b. False

b. False

The short interest ratio is commonly measured as the number of shares sold short divided by the number of shares that the firm has repurchased in the last quarter. a. True b. False

b. False

The short interest represents the amount of interest that borrowers owe on loans used to purchase stock. a. True b. False

b. False

Under the SEC's uptick rule, speculators are prohibited from taking a short position in stocks that have experienced a decline of at least 10 percent for the day, unless the most recent trade resulted in a decrease in the stock price. a. True b. False

b. False

When investors place a limit order, they can place it for the day only. a. True b. False

b. False

When investors sell short, they are essentially lending the stock to another investor and will ultimately receive that stock back from the investor to whom they lent it. a. True b. False

b. False

Which of the following statements is incorrect? a. In a short sale, investors place an order to sell a stock that they do not own. b. Investors sell a stock short when they anticipate that its price will rise. c. When investors sell short, they will ultimately have to provide the stock back to the investor from whom they borrowed it. d. Short-sellers must make payments to the investor from whom the stock was borrowed to cover the dividend payments that the investor would have received if the stock had not been borrowed.

b. Investors sell a stock short when they anticipate that its price will rise.

While an investor's ability to simultaneously consider multiple markets to accommodate orders was perceived to allow for more competitive pricing (lower transactions costs), it also led to a form of "_______________" whereby traders with relatively faster access to specific markets can use another trader's planned orders and move ahead of that order. a. randomized algo b. front running c. circuit breaking d. specialist surfing

b. front running

The ____ the trading volume of a stock, the ____ the spread. a. larger; wider b. larger; narrower c. lower; narrower d. None of these are correct.

b. larger; narrower

You purchase a stock with cash, and you earn a negative return on the stock. If you had purchased the stock with 60 percent cash and 40 percent borrowed funds, your return on your investment would have been a. positive. b. more negative than if you had covered the entire investment with cash. c. negative, but more favorable than if you had covered the entire investment with cash. d. zero.

b. more negative than if you had covered the entire investment with cash.

​____ are enforced to restrict the amount of credit extended to customers by stockbrokers. a. Limit orders​ b. ​Margin requirements c. ​Maintenance margins d. ​Initial margins

b. ​Margin requirements

When investors buy stock with borrowed funds, this is sometimes referred to as a. ​use of proxy. b. ​purchasing stock on margin. c. ​a margin call. d. ​a margin residual claim.

b. ​purchasing stock on margin.

Karen purchased a stock priced at $33 on margin, paying $23 and borrowing the remainder from a brokerage firm at 15 percent annual interest. The stock pays an annual dividend of $2. If Karen sells the stock after one year at a price of $50, what is her return on the stock? a. 27.60 percent b. 82.61 percent c. 76.09 percent d. 58.70 percent e. None of these are correct.

c. 76.09 percent

____ may execute transactions on a stock exchange for their clients. a. Board members b. Capstone members c. Floor brokers d. None of these are correct.

c. Floor brokers

____ may facilitate stock transactions by taking positions in specific stocks. a. Board members b. Capstone members c. Market makers d. None of these are correct.

c. Market makers

____ is defined as a computerized response by institutional investors to either buy or sell a large basket of stocks in response to movements in a particular stock index. a. Direct access brokering b. Electronic communication networking c. Program trading d. High-volume stock trading

c. Program trading

Which of the following is incorrect in regard to short selling? a. Naked short selling involves selling a stock short without first borrowing the stock. b. During the credit crisis, the SEC temporarily protected more than 800 firms from short selling. c. The SEC's uptick rule prevents speculators from taking a short position in stocks that have declined at least 30 percent for the day, except when the most recent trade resulted in an increase in the stock price. d. During the credit crisis, some short-sellers focused particularly on the stocks of financial institutions. e. None of these are correct.

c. The SEC's uptick rule prevents speculators from taking a short position in stocks that have declined at least 30 percent for the day, except when the most recent trade resulted in an increase in the stock price.

Which of the following is incorrect with regard to taxes imposed on stock transactions? ​a. Stock transactions are subject to dividend and capital gains tax at the federal level and may be subject to state income tax as well. ​b. Stocks have to be held for at least one year to qualify for the long-term capital gains tax. ​c. The maximum federal tax on dividends and long-term capital gains is 14 percent. ​d. Higher tax rates are imposed on the dividends and capital gains of individuals in high tax brackets.

c. The maximum federal tax on dividends and long-term capital gains is 14 percent.

A short-seller a. anticipates that the price of the stock sold short will increase. b. earns the difference between what was initially paid for the stock versus what the stock is later sold for. c. makes a profit equal to the difference between the original selling price and the price paid for the stock, after subtracting any dividend payments made. d. is essentially lending the stock to another investor and will ultimately receive that stock back from that investor. e. None of these are correct

c. makes a profit equal to the difference between the original selling price and the price paid for the stock, after subtracting any dividend payments made.

The risk of a short sale is that the stock price a. may decrease over time. b. will remain the same. c. may increase over time. d. None of these are correct.

c. may increase over time.

The strategy of combining the use of futures or options contracts on a stock index with program trading is known as a. trading with algorithms b. downside insurance. c. portfolio insurance. d. spread the risk trading.

c. portfolio insurance.

When the price of a company's stock increases or decreases significantly in advance of a public announcement of an event affecting the company, there are suspicions that __________ may have occurred. a. ​bid rigging b. ​default inversion c. ​insider trading d. ​an increase in margin requirements

c. ​insider trading

A(n) ____ from a broker requires the investor to put up additional collateral. a. ​maintenance margin b. ​initial margin c. ​margin call d. ​trading halt

c. ​margin call

Trading halts are imposed by a. ​the SEC. b. ​brokers. c. ​stock exchanges. d. ​the Treasury.

c. ​stock exchanges.

Under the present margin requirements, at least ____ percent of an investor's invested funds must be paid in cash. a. 20 b. 30 c. 40 d. 50 e. None of these are correct.

d. 50

The transaction costs associated with international trading of stocks have been reduced by a. the consolidation of stock exchanges. b. extensive computerization of stock exchanges. c. the Eurolist system. d. All of these are correct.

d. All of these are correct.

Which of the following statements about program trading is incorrect? a. It represents a computerized response by institutional investors to either buy or sell a large basket of stocks in response to movements in a particular stock index. b. It may involve the purchase of stocks that have become "underpriced." c. It may involve the sale of stocks that have become "overpriced." d. It is designed to capitalize on Federal Reserve monetary policy announcements. e. None of these are correct.

d. It is designed to capitalize on Federal Reserve monetary policy announcements.

The Division of ____ of the SEC requires the orderly disclosure of securities trades by various organizations that facilitate the trading of securities. a. Corporation Finance b. Enforcement c. Administration d. Trading and Markets

d. Trading and Markets

Expert networks consisting of managers or executives of a publicly traded company who are hired as consultants ("experts") by a hedge fund to provide insight about the company a. are illegal under Regulation FD. b. are legitimate if the consultants divulge only information that is already public. c. have raised concerns that the consultants provide inside information. d. are legitimate if the consultants divulge only information that is already public AND have raised concerns that the consultants provide inside information.

d. are legitimate if the consultants divulge only information that is already public AND have raised concerns that the consultants provide inside information.

With a ____ order, the investor specifies a purchase price that is above the current market price. a. ​market b. ​limit c. ​stop-loss d. ​stop-buy

d. ​stop-buy

Short selling a stock refers to a. ​poor performance from purchasing an overvalued stock. b. ​the new issuance of low-priced stocks by firms. c. ​the new issuance of stocks by financially weak firms. d. ​the borrowing of stock owned by someone else and selling it in the market.

d. ​the borrowing of stock owned by someone else and selling it in the market.

Which of the following statements is incorrect with respect to Regulation Fair Disclosure (FD)? a. It requires firms to disclose relevant information broadly to investors at the same time. b. It requires firms to file all relevant information with the SEC before disclosing it to analysts. c. Some critics suggest that the regulation has caused firms to disclose less information than before to ensure that they do not violate the regulation. d. It prohibits firms from communicating with analysts after a news announcement is made to all investors. e. It requires firms to file all relevant information with the SEC before disclosing it to analysts AND it prohibits firms from communicating with analysts after a news announcement is made to all investors.

e. It requires firms to file all relevant information with the SEC before disclosing it to analysts AND it prohibits firms from communicating with analysts after a news announcement is made to all investors.

Assume that a stock is priced at $50 and pays an annual dividend of $2 per share. An investor purchases the stock on margin, paying $25 per share and borrowing the remainder from the brokerage firm at 9 percent annual interest. If, after one year, the stock is sold at a price of $65.25 per share, the return on the stock is a. 60 percent. b. 44 percent. c. 30 percent. d. 69 percent.

a. 60 percent.

The SEC's ____ reviews the registration statement filed when a firm goes public, corporate filings for annual and quarterly reports, and proxy statements that involve voting for board members or other corporate issues. a. Division of Corporation Finance b. Division of Trading and Markets c. Division of Enforcement d. None of these are correct.

a. Division of Corporation Finance

Traders that engage in high frequency trading commonly close out their positions in a. one day. b. one month. c. three months. d. one year.

a. one day.

A criticism of dark pools is that they a. reduce transparency. b. are more expensive than the public stock exchanges. c. are not accessible to institutional investors. d. cannot be used to trade large blocks of stock.

a. reduce transparency.

When a brokerage firm demands more collateral from investors who have borrowed from the brokerage firm to buy stocks, it is making a a. ​margin call. b. ​short sale. c. ​proxy fight. d. ​hedge.

a. ​margin call.

​A ____ order to buy or sell a stock means to execute the transaction at the best possible price. a. ​market b. ​limit c. ​stop-loss d. ​stop-buy

a. ​market

The Division of ____ of the SEC assesses possible violations of SEC regulations and can take action against individuals or firms. a. Corporation Finance b. Enforcement c. Administration d. Trading and Markets

b. Enforcement

A trading halt prevents a stock from experiencing a loss in response to news. a. True b. False

b. False

Electronic communications networks are primarily intended to prevent executives from using inside information when trading stocks. a. True b. False

b. False

In naked short selling, short-sellers sell a stock short that they currently own. a. True b. False

b. False

Trading halts are intended to prevent insider trading. a. True b. False

b. False

Mark purchases a stock priced at $70. The stock is not expected to pay any dividends in the coming year. Mark thinks he can sell the stock for $100 after one year. If Mark uses his own funds for half of the investment amount and borrows the remainder from his brokerage firm at an annual interest rate of 12 percent, his estimated return on the stock would be ____ percent. a. 42.86 b. 85.71 c. 73.71 d. 30.00

c. 73.71

To prosecute defendants connected with the Galleon Fund for __________, the government effectively used wiretap evidence. a. ​dark pool trading b. ​naked short selling c. ​insider trading d. ​accounting fraud

c. ​insider trading

Kayla would like to purchase a stock priced at $30. The stock is not expected to pay any dividends in the coming year. She thinks she can sell the stock for $36 after one year. Her estimated return on the stock would be ____ percent. a. 6 b. 10 c. 15 d. 20

d. 20

Mark uses his own funds to purchase a stock priced at $70. He thinks he can sell the stock for $100 after one year. What is Mark's estimated return on the stock? a. 30.00 percent b. -42.86 percent c. -30.00 percent d. 42.86 percent e. None of these are correct.

d. 42.86 percent

A short interest ratio of 20 or higher indicates that many investors a. believe that the stock price is currently overvalued. b. believe that the stock price is currently undervalued. c. are selling the stock short. d. believe that the stock price is currently overvalued AND are selling the stock short.

d. believe that the stock price is currently overvalued AND are selling the stock short.

On May 6, 2010, the "__________" occurred, when stocks on the New York Stock Exchange declined by more than 9 percent on average before reversing and recovering most of those losses on that same day. Much of the trading occurred within a half hour. a. credit default crisis b. swap crisis c. specialist crash d. flash crash

d. flash crash

The bid-ask spread is negatively related to a. order costs b. inventory costs c. risk d. trading volume

d. trading volume

International trading of stocks has been facilitated by reductions in a. transaction costs. b. information costs. c. exchange rate risk. d. transaction costs AND information costs.

d. transaction costs AND information costs.

​Assume a stock is initially priced at $50, and pays an annual $2 dividend. An investor uses cash to pay $25 a share and borrows the remaining funds at a 12 percent annual interest. What is the return if the investor sells the stock for $55 at the end of one year? a. ​50 percent b. ​30 percent c. ​10 percent d. ​16 percent e. ​8 percent

d. ​16 percent

Assume that a stock is priced at $50 and pays an annual dividend of $2 per share. An investor purchases the stock, using only personal funds and not borrowing from the brokerage firm. If, after one year, the stock is sold at a price of $65.25 per share, the return on the stock is a. ​26.5 percent. b. ​28.5 percent. c. ​30.5 percent. d. ​34.5 percent.

d. ​34.5 percent.