Chapters 14, 15, and 16.
Dale is considering the purchase of a rental property with several units. The property rents for $12,300 a month when all units are occupied. The units are expected to be rented 80% of the year. Additional expenses associated with the property include real estate taxes of $11,800 a year, liability insurance of $4,000 a year, advertising expense of $1,200 a year, maintenance costs of $11,200 a year, depreciation of $32,700 a year, and interest expense on the property loan of $25,000 a year. If Dale's required rate of return on the property is 10%, what is the intrinsic value of the property? A)$321,800. B)$648,800. C)$898,800. D)$1,180,800.
)$898,800. Rationale $147,600 Gross potential rental receipts ($12,300 x 12) + 0 Other income = $147,600 Gross potential income - 29,520 Vacancy losses (20% x $147,600 = $29,520) = $118,080 Gross income before expenses - 28,200 Operating expenses (excluding interest & depreciation) = $89,880 Net Operating Income (NOI)
A cash flow evaluation of income-producing real estate takes into account which of the following variables?1. Taxes2. Projected rental income3. Depreciation A)1 only. B)1 and 2. C)2 and 3. D)1, 2, and 3.
1, 2, and 3.
Jack owns a convertible bond with a $1,000 face value that can be exchanged for 25 shares of WUF stock, which is trading at $50 per share. The conversion ratio equals: A)20. B)25. C)40. D)1.25.
25.
A put option is available on the stock of Rally Corporation. The exercise price is $65. The put option price is $1. Rally stock is currently selling for $70 per share. What is the "intrinsic value" of the put option? A)$0. B)$4. C)$5. D)$9.
A)$0. Rationale The intrinsic value is the minimum value an option will trade for and equals the strike price minus the FMV of the stock for a put option. In this case, the intrinsic value equals $0 ($65 - $70) - it cannot be less than zero. The intrinsic value is not influenced/impacted by the option price.
The intrinsic value of an apartment complex with the following details is closest to:Gross potential receipts $440,027 Gross potential income $460,829Gross income before expenses $437,909Net operating income $227,930Capitalization rate 11.9% A)$1,915,378. B)$3,679,907. C)$3,872,512. D)$3,697,705.
A)$1,915,378. Rationale Intrinsic Value = NOI ÷ capitalization rate = 227,930 ÷ 0.119 = 1,915,378
Writing a call option on the S&P 500 Index results in: A)A gain if the S&P 500 Index falls. B)A loss if the S&P 500 Index falls. C)A gain if the S&P 500 Index rises. D)Neither a gain nor loss, no matter what happens to the S&P 500 Index.
A)A gain if the S&P 500 Index falls.
An investor buys 1 ZZZ Dec 95 call at $5. When ZZZ increases to 99, the call is exercised and the stock is immediately sold. What is the result? A)A loss of $100. B)A profit of $400. C)A loss of $400. D)A profit of $100.
A)A loss of $100.
The risk of unexpected change in the difference between currency futures prices and currency spot prices is called: A)Basis risk. B)Foreign currency risk. C)Exchange rate risk. D)Interest rate variation risk.
A)Basis risk.
What is the investor's strategy for profit if he buys 1,000 shares of LMT stock at $71 and also 10 LMT July puts at $2? A)Bullish. B)Bearish. C)Stability. D)Volatility.
A)Bullish. RationaleThe put is to protect the downsides risk. He is bullish because he is long the stock.
Which position produces a loss when the price of the underlying asset rises? A)Buying a put option on a share of stock. B)Buying a call option on an equity index. C)Taking the long position in an energy futures contract. D)Entering a swap contract to pay fixed dividend and receive floating return on equity index.
A)Buying a put option on a share of stock.
U.S. federal and state governments are most likely to impose regulatory price controls on: A)Dairy products. B)Lumber. C)Textiles. D)Orange juice.
A)Dairy products. Rationale
A private equity firm has a wealthy individual shareholder who has recently declared personal bankruptcy. The likelihood the investor will be limited in her ability to make additional required contributions to the firm is known as: A)Funding risk. B)Liquidity risk. C)Market risk. D)Exit risk.
A)Funding risk.
An "at the money call": A)Has intrinsic value = 0. B)Is where the stock price > strike price. C)Is where the stock price < strike price. D)Has a time value = 0.
A)Has intrinsic value = 0. Rationale An "at the money call" is strike price equal to the market value, which is an intrinsic value of zero.
A watch worn by Christopher Columbus during his global sea travels will least likely: A)Have a long price history. B)Contain some emotional attachment by its owner. C)Be subject to the risk of forgery. D)Have a limited secondary market.
A)Have a long price history. Rationale
The futures price of an asset is increased by: A)Higher cost of carrying. B)Lower risk-free interest rate. C)Higher expected spot price. D)Higher margin requirements.
A)Higher cost of carrying.
Rascal has entered into a contract to buy 100 shares of Rally stock for $40 per share anytime over the next six months. He has a: A)Long position in a call option. B)Short position in a call option. C)Long position in a futures contract. D)Short position in a put option.
A)Long position in a call option. Rationale
Primary commodities most likely include: A)Oil extracted from wells. B)Refined gasoline. C)Steel produced from iron ore. D)'2 by 4s' made in a lumber yard.
A)Oil extracted from wells.
Which of the following is an advantage of interest rate swaps? A)The ability to manage interest rate risk. B)The ability to exchange taxable interest income for tax free income. C)The ability to manage default risk. D)The ability to exchange interest income for capital gain income.
A)The ability to manage interest rate risk. Rationale
The use of futures contracts for a farmer who grows a variety of fruits and grains is most likely to be limited by: A)The lack of availability of fruit contracts on the exchanges. B)The standardization of all contracts. C)Federal regulations of the futures markets. D)The daily settlement requirement for futures trading.
A)The lack of availability of fruit contracts on the exchanges. Rationale
The net gain on buying a call option for $10 when the stock price is $28, the exercise price is $20, and the expiration date stock price is $40 is closest to: A)$0. B)$10. C)$20. D)$40.
B)$10.
Which of the following is marked-to-market daily? A)A fixed-rate loan. B)A futures contract. C)An option contract. D)A forward contract.
B)A futures contract.
The financial institution that guarantees both sides of a futures contract is called the: A)Futures exchange. B)Clearing house. C)Selective exchange. D)Futures contract regulator.
B)Clearing house. Rationale The clearing house is the institution that guarantees both sides of a futures contract.
For a call option contract, the price at which the option holder can buy the underlying security is called? A)Premium. B)Exercise price. C)Intrinsic value. D)Time value.
B)Exercise price.
An individual buyer and seller of lumber may enter into a customizable sales transaction that will occur nine months from today. This type of contract is typically called a: A)Buy/Sell agreement. B)Forward contract. C)Lumber contract. D)Sales contract.
B)Forward contract.
Mike believes that XYZ stock will increase in value. He buys 20 XYZ March 60 call options for $4 when the price of XYZ is $61. If XYZ falls to $55 and stays there through March, what will be Mike's gain or loss? A)Gain $8,000. B)Loss $8,000. C)Gain $122,000. D)Loss $5,500.
B)Loss $8,000. Rationale Mike paid $8,000 (2,000 options x $4). $8,000 is the premium paid and is the maximum loss if the contract expires.
A futures contract price is adjusted daily during the term of the contract, depending on current market conditions. This adjustment is called: A)SEC requirements for futures contracts. B)Mark-to-market. C)The "cheapest to deliver" option on a futures contract. D)Initial margin requirements changing on a daily basis.
B)Mark-to-market. Rationale
The best hedge against inflation is most likely: A)Buying call options on gold mining stocks. B)Owning cases of vintage wine. C)Investing in a hedge fund that uses interest rate swaps. D)A private equity investment in farming equipment suppliers.
B)Owning cases of vintage wine. Rationale
A hedge fund manager believes the price of oil will fall over the next three months. The position most likely to result in a profit if the manager is accurate is: A)Purchase a call option on a barrel of oil. B)Purchase a put option on a barrel of oil. C)Take the long position in an oil futures contract. D)Write a put option on a barrel of oil.
B)Purchase a put option on a barrel of oil.
A corn farmer who wants to hedge the price of corn should enter into what type of contract? A)Buy a corn futures contract. B)Sell a corn futures contract. C)Long position in a corn call option contract. D)Long position in a commodity put option index.
B)Sell a corn futures contract. Rationale
A writer of a call option: A)Bought a "long" position in a futures contract. B)Sold a call option. C)Bought a call option. D)Exercised a call option.
B)Sold a call option. RationaleThe writer of a call option is the seller of the option and receiver of the option premium.
Josh Dolan collects Russian string instruments as part of his investment portfolio. Dolan owns several violins and cellos and purchases a rare Saint Petersburg grand piano made in the 1880s. His total collectible investment now exceeds $10 million. Dolan made the investment during an international auction in which he outbid ten other collectors. The least likely result of this investment for Dolan is: A)A more diversified collection. B)Substantial liquidity issues. C)High storage costs. D)Potential loss due to theft.
B)Substantial liquidity issues.
The conversion ratio of a convertible bond equals: A)The market value of the bond divided by the conversion price. B)The number of shares of common stock that the bondholder will receive if the bond is converted. C)The value of the common stock times the conversion price. D)None of the above.
B)The number of shares of common stock that the bondholder will receive if the bond is converted.
Hedge funds are least likely known for: A)Complex fee structures. B)Unlimited redemptions. C)Heavy reliance on leverage. D)The use of short and long positions.
B)Unlimited redemptions.
Jack owns a convertible bond with a $1,000 face value that can be exchanged for 25 shares of WUF stock, which is trading at $50 per share. The conversion price equals: A)$20. B)$25. C)$40. D)$50.
C)$40. Rationale The conversion price equals the par value of the bond ($1,000) divided by the conversion ratio (25), which equals $40.
JBL Equity (JBL) invested in FLUB, a technology company with $6 million of EBITDA. JBL paid $40 million with 35% financed at a rate of 5% over three years. Assume FLUB's EBITDA grows by 20% each year and JBL exits after three years at a multiple of 14 times EBITDA. What answer is the closest to the IRR for the investment, without regard to any tax benefits attributable to interest or amortization. A)50%. B)62%. C)85%. D)98%.
C)85%. RationalePeriodEBITDACash FlowBuy/SellEBITDADebtNet CF 0$6.00 0-$26.00 -$26.001$7.20 1 $7.20($5.04)$2.16 2 $8.642 $8.64($5.04)$3.60 3$10.373$145.18$10.37($5.04)$150.51
Clarissa holds a concentrated position in XYZ stock, which she purchased 15 years ago for $6 per share. The price of XYZ stock is currently at $100 per share, and Clarissa is happy with the gain that she has achieved. She realizes that it is a good idea to diversify her portfolio, but selling all of the stock in the current year will result in a large tax burden. Which of the following strategies would allow Clarissa to sell some of the shares this year, and delay selling some of the shares until next year to help ease the tax burden, but will lock in her sale price within a reasonable range of the current price? A)A straddle. B)A spread. C)A collar. D)A short sale.
C)A collar.
Which of the following regarding basis is least accurate? A)The basis is the difference between the spot price and the futures price. B)The hedger bears the basis risk. C)A short hedger suffers losses when the basis decreases. D)The basis increases when the futures price increases by more than the spot price.
C)A short hedger suffers losses when the basis decreases.
Bank 1 promises to pay Bank 2 a fixed rate of interest on a $20 million dollar principal amount. In exchange for this, Bank 2 promises to Bank 1 a floating rate of interest on the same $20 million dollar principal. What is this called? A)A call options contract. B)A put option contract. C)An interest rate swap. D)A futures market transaction.
C)An interest rate swap. Rationale
The U.S. federal government imposes rules and regulations in the corn and dairy markets as a means of helping farmers in an attempt to stabilize the agricultural markets. Which of the following accurately describes the means by which this is accomplished? A)By imposing price controls. B)By acting as a buyer of last resort. C)Both a and b. D)Neither a nor b.
C)Both a and b.
Which of the following best describes the means by which private equity managers are compensated? A)They are compensated through carried interest. B)If investments are held in the fund a minimum of 3 years, they will receive long-term capital gain tax treatment on their compensation. C)Both a and b. D)Neither a nor b.
C)Both a and b.
Which of the following regarding futures contracts is least accurate? A)Futures contracts are traded on a regulated exchange. B)Futures contracts are marked-to-market. C)Futures contracts allow fewer delivery options then forward contracts. D)Futures contracts are available for stock indexes.
C)Futures contracts allow fewer delivery options then forward contracts. Rationale
Stone entered into a "forward contract" to sell 100 shares of MMN stock at a price of $9 per share in exactly 9 months. Now, the nine-month period has expired. MMN stock is trading at $12 per share. What are the economic consequences for Stone? A)He has lost $900. B)He has gained $1,200. C)He has lost $300. D)He has gained $300.
C)He has lost $300. Rationale Stone has lost $300 [($9 - $12) x 100 shares].
Which of the following statements regarding hedge funds is NOT correct? A)Hedge fund managers act as general partners in managing capital for the fund's limited partners. B)Hedge fund managers are compensated via carried interest. C)Hedge fund managers have leeway to pursue investment opportunities that is equivalent to that of mutual fund managers. D)Hedge fund investors may be subject to lock-out periods in which they have little access to their capital.
C)Hedge fund managers have leeway to pursue investment opportunities that is equivalent to that of mutual fund managers.
In order for Kylie to buy a coffee futures contract, she is required to deposit a certain amount of money. What are these funds called? A)Mark-to-market. B)Cheapest to deliver. C)Initial margin. D)Open interest.
C)Initial margin. Rationale
The futures exchange specifies which of the following contract terms for futures contracts on commodities? OptionQualityQuantityDelivery DatePrice a √ √ √ √ b √ x √ x c √ √ √ x d x √ √ √ A)Option a. B)Option b. C)Option c. D)Option d.
C)Option c. Rationale
Swaps and forward contracts are negotiated directly by the counterparties to the agreement and are: A)Spot contracts. B)Without default risk. C)Over-the-counter contracts. D)Standardized agreements offered by an exchange.
C)Over-the-counter contracts.
If the S&P 500 index futures price is undervalued relative to the spot S&P 500 index price, an arbitrage exists if the investor were to: A)Buy the S&P 500 futures. B)Sell short all the stocks in the S&P 500 and buy call options on the S&P 500 index. C)Sell short all the stocks in the S&P 500 and buy the S&P 500 index futures. D)Sell the S&P 500 index futures and buy all the stocks in the S&P 500.
C)Sell short all the stocks in the S&P 500 and buy the S&P 500 index futures. Rationale
Futures trading in the U.S. is regulated by: A)The Securities and Exchange Commission (SEC). B)The Federal Reserve (FED). C)The Commodity Futures Trading Commission (CFTC). D)The U.S. Trade and Tariff Board (UTTB).
C)The Commodity Futures Trading Commission (CFTC).
Which of the following regarding margin requirements for futures contracts is least accurate? A)Margin requirements for futures contracts are generally significantly lower than requirements for equities. B)The maintenance margin is always smaller than the initial margin. C)The maintenance margin is only required for sellers of futures contracts. D)The initial margin is the money placed with the clearing house when the trade is initially executed.
C)The maintenance margin is only required for sellers of futures contracts. Rationale
Regarding a short straddle A)The investor is bullish. B)The gain potential is unlimited. C)The maximum loss is unlimited. D)Volatility is expected.
C)The maximum loss is unlimited.
An investor buys 100 shares of XYZ stock for $40 and simultaneously writes 1 XYZ November 40 call at $3. If the investor closes both positions three months later when the XYZ is trading at $45 and the November calls are at $6, what is the result? A)$500 profit. B)$400 profit. C)$300 profit. D)$200 profit.
D)$200 profit. RationaleStock position 100 x ($45-$40) = $500Option position ($6-$3) x 100 = ($300)$500 - $300 = $200
Gerry expects the market to rise. Which of the following option strategies should he follow:1. Long call.2. Long put.3. Short call.4. Short put. A)2 and 3. B)1 and 2. C)3 and 4. D)1 and 4.
D)1 and 4. RationaleLong a call (buy), short a put (sell).
A contract that gives its owner the right to sell a specified asset at any time prior to expiration is called: A)A futures contract. B)A forward contract. C)A spot contract. D)A put option contract.
D)A put option contract.
Which of the following option positions represents the most risk to an investor? A)A long put. B)A long straddle. C)A long call. D)A short straddle.
D)A short straddle.
Which of the following best describes a futures contract? A)The right to buy or sell a specified quantity of a particular asset during a given period at the spot price. B)A standardized obligation to buy or sell a specified quantity of a particular asset during a given period for a given price. C)An option to buy or sell a specified quantity of a particular asset during a given period for a given price. D)A standardized obligation to buy or sell a particular asset in a specified quality at a future time, place, and unit price.
D)A standardized obligation to buy or sell a particular asset in a specified quality at a future time, place, and unit price.
Which of the following factors are important when selecting a futures contract to trade? A)Volatility. B)Contract size (dollar value of the contract). C)Liquidity. D)All of the above.
D)All of the above.
The venture capitalist return on their investment is most likely realized during the: A)Seed stage. B)Emerging stage. C)Expansion stage. D)Bridge stage.
D)Bridge stage.
Liquidity can be defined as the ability to transact quickly and efficiently without a substantial impact to the price of the underlying asset. Which of the following transactions is the LEAST liquid? A)Buying or selling an exchange-traded fund (ETF). B)Buying or selling an E-mini S&P 500 futures contract. C)Buying or selling a car. D)Buying or selling a house.
D)Buying or selling a house.
Which of the following types of contracts are traded on exchanges in the United States? A)Swap contracts. B)Forward contracts. C)Spot contracts. D)Futures contracts.
D)Futures contracts. Rationale Swap contacts are over the counter agreements. Forward contracts are negotiated agreements between two parties. Spot contracts are agreements to buy or sell at current prices. None of these contracts are traded on exchanges. Futures contracts are standardized agreements that are traded on exchanges.
Beau buys 10 DEF 65 call options for $7 when the price of DEF is $61. Beau sells the call options for $16. What is his gain or loss? A)Loss of $900. B)Gain of $900. C)Loss of $9,000. D)Gain of $9,000.
D)Gain of $9,000. Rationale Beau bought the calls for $7,000. Remember, 1 option contract represents 100 shares of stock. He sold the calls for $16,000. Therefore, his gain equals $9,000.
Beau entered into a "forward contract" to buy 100 shares of ABC stock at a price of $8 per share in exactly 9 months. Now, the nine-month period has expired. ABC stock is trading at $11 per share. What are the economic consequences for Beau? A)He has lost $800. B)He has gained $1,100. C)He has lost $300. D)He has gained $300.
D)He has gained $300. Rationale Beau has gained $300 [($11 - $8) x 100 shares].
Which of the following lists of characteristics best describe alternative investments? A)Illiquid, high fees, high returns, high risks, use leverage, high correlation with stocks, passive management. B)Passive management, illiquid, high fees, low research costs, not for conservative investors. C)Low fees, little principal risk, active management, inflation hedge. D)Illiquid, high fees and risk, low correlation with equities and bonds, high research costs, not recommended for conservative investors.
D)Illiquid, high fees and risk, low correlation with equities and bonds, high research costs, not recommended for conservative investors. Rationale
Harris buys 20 call options on XYZ March 60 for $5 when the price of XYZ is 61. XYZ falls to $40 and remains there through March. What is Harris's gain or loss? A)Gain 30,000. B)Gain 29,000. C)Loss 9,000. D)Loss 10,000.
D)Loss 10,000. Rationale The options will expire worthless and Harris will lose the premium paid for the options.5 x 2 options x 100 shares = 10,000 Loss
Which of the following is most accurate? A)Speculators always take the "other" side of trades made by hedgers. B)Limit orders can only be used to exit a market position. C)Price move limits remain the same regardless of market conditions. D)Mark-to-market settlement of futures positions is based on end of trading day or trading session prices.
D)Mark-to-market settlement of futures positions is based on end of trading day or trading session prices.
Which of the following is NOT correct regarding derivative securities? A)Derivatives can be used for speculation and hedging. B)The use of leverage is both an advantage and a disadvantage of derivatives. C)The value of a derivative is tied to the value of an underlying security or asset. D)Most types of derivatives are suitable investments for unsophisticated investors.
D)Most types of derivatives are suitable investments for unsophisticated investors. Rationale
A hedge fund manager believes the correlation coefficient between two large financial institutions is going to fall. Using advanced statistical techniques, the manager shorts the higher price stock and buys the lower priced stock. The least likely risk facing the manager is: A)Correlations remain high. B)One of the institutions makes a major announcement. C)The economy enters a recession. D)Options exchanges experience a sudden drop in volume.
D)Options exchanges experience a sudden drop in volume.
The least likely reason a significant investment in an ancient European coin collection would have high research costs is because of: A)An illiquid secondary market. B)The threat of forgery is high. C)Information on ancient coins is not readily and completely available. D)Protection from inflation is uncertain.
D)Protection from inflation is uncertain. Rationale
Which of the following is the most suitable addition to the retirement income portfolio for a moderate risk tolerance, moderate net worth investor seeking diversification and current income? A)Private equity. B)Collectibles. C)Venture capital. D)Publicly traded mortgage REIT.
D)Publicly traded mortgage REIT. Rationale
Motives for including alternative investments in a portfolio most likely include: A)Leverage-free investments. B)Protection against inflation during times of market stress. C)High correlations with traditional securities. D)Reduction in the number of publicly held stocks.
D)Reduction in the number of publicly held stocks.
Which of the following positions has the greater risk for investors? A)Long call. B)Selling a covered call. C)Selling a covered put. D)Shorting a stock.
D)Shorting a stock.
Which of the following regarding futures contracts is least accurate? A)A futures contract is essentially a standardized and marketable forward contract. B)Futures markets use a clearing house to mitigate default risk. C)Futures contracts can be used to lock in the future selling price of a commodity regardless of future changes in spot market prices. D)The basis in futures is similar to a basis point in bonds.
D)The basis in futures is similar to a basis point in bonds. Rationale
If a farmer buys a wheat put option on futures: A)The farmer must deliver the wheat at the specified price. B)The farmer must deliver the wheat at the market price. C)The farmer must accept delivery on the wheat but will only do so if the price is favorable. D)The farmer has the right to assume a short position in the underlying wheat futures at the option strike price.
D)The farmer has the right to assume a short position in the underlying wheat futures at the option strike price.
What is the investor's strategy for profit if he buys one ABC July 60 call at $3 and buys one ABC July 50 put at $1? A)Bullish. B)Bearish. C)Stability. D)Volatility.
D)Volatility.
When someone "writes" a call option, he has: A)Taken a "long" position in a futures contract. B)"Marked-to-market" a futures contract. C)Sold a call option. D)Bought a call option.
Sold a call option.
