Investments review

Two years ago, Isabella purchased 100 shares of CVC, Inc., for $15,000. Unfortunately, the value of the shares has dropped to $10,000. Isabella's daughter, Shea, was heading off to college, and Isabella was tired of waiting for a return on the stock. Isabella gave the stock to Shea when it was worth $10,000 to help fund Shea's education. If Shea sells the shares for $12,000 three months after the transfer, what is the amount and character of her gain or loss?

$0 Isabella gave loss property to her daughter. When a taxpayer transfers property with a loss to someone else, and the recipient sells the property for an amount between the donor's adjusted basis and the fair market value of the stock on the date of the gift, no gain or loss is recognized. In this example, the no-gain, no-loss corridor is from $10,000 (the fair market value of the stock on the date of the gift) to $15,000 (the adjusted basis in the hands of the donor). If Shea sold the stock for any amount between $10 and $15 thousand dollars, she is not required to recognize any gain, and she is prohibited from recognizing any loss on the transaction. Since there is no gain or loss, there is no need to categorize the tax result as either long or short term.

Ingrid owns a bond that pays a semi-annual coupon. The last coupon was $20 and was paid 3 months ago. The current list price for the bond is $1,100. If Ingrid sells the bond, how much will she receive (ignoring any trading fees and taxes)?

$1110 Ingrid will receive the list price plus half of the accrued interest.

Cody purchased 400 shares of NAY stock six years ago when it was trading at $65 per share. Unfortunately, NAY has been steadily declining. Cody sold his shares this year for $18 per share. This year Cody also sold 800 shares of a mutual fund that he purchased 6 months ago. His average cost per share was $15 and he sold the shares for $32. Assuming Cody had no other capital transactions this year, what is Cody's tax consequence from these transactions?

$3,000 ordinary loss this year with a $2,200 loss carried forward indefinitely The NAY stock sale resulted in a long-term loss of $18,800 ($47 loss per share × 400 shares). The mutual fund sale resulted in a short-term gain of $13,600 ($17 gain × 800 shares). The entire $13,600 gain is offset by the loss, leaving a net long-term loss of $5,200. Cody can take $3,000 of the loss against ordinary income this year, and the remaining loss is carried forward indefinitely (until death).

Billie originally purchased display cases for her business at $15,000. They were fully depreciated by the time Billie retired. Billie died last month, and the display cases were valued in her estate at $8,000. If Billie's daughter, Kelly, inherits the display cases and sells them for $8,500 2 months after Billie's death, what is the income tax treatment on the sale?

$500 long-term capital gain Even though the display cases were Section 1231 assets in Billie's hands and were subject to depreciation recapture, once they ran through Billie's estate, they qualified for a Section 1014 step-to fair market value in basis, which eliminates the recapture potential. If Kelly sells the cases for $8,500 2 months after Billie's death, her gain is $500 due to the step-up in basis. Since all assets passing through an estate and receiving a step-up in basis qualify for long-term capital-gains treatment, the gain will be characterized as a long-term gain.

Joe is a 24% federal income taxpayer. His capital-gains rate and qualified dividend rate is 15%. Joe bought 100 shares of ING for $12 per share 10 months ago. ING paid a dividend of $80 during Joe's holding period. Joe just sold all the stock for $20 per share. What are Joe's tax consequences for the year?

$80 taxed at the LTCG rate, $800 taxed at the ordinary income rate The dividend is a qualified dividend taxed at the LTCG rate. The gain is a short-term capital gain and is taxed at ordinary income tax rates.

An investor is close to retirement and is worried about the possibility of his stock portfolio suddenly losing value. He has heard that certain options strategies can limit his downside risk, but he is hesitant to pay premiums each month. Which options strategy, if structured appropriately, could limit his downside risk without costing him anything out of pocket?

A collar combines a protective put and a covered call. A zero-cost collar is created when the premiums received from the short call offset the premiums paid for the long put.

A corn farmer who wants to hedge the price of corn should enter into what type of contract?

A corn farmer would enter into a short (sell) futures contract, because he wants to sell his corn.

Devon Baines is a board member with DDO, Inc., a large pharmaceutical firm. At a recent meeting, the board votes to take over a smaller competitor whose shares trade in the OTC market and are priced at $50 per share. DDO will offer $75 per share, and the offer will become public 10 hours after the meeting. Baines decides to purchase shares in the target firm immediately after the meeting, but when he calls his broker to place the order, he is informed that the price of the target firm is $75. The market is most likely in a(n)

A market in which prices reflect all relevant information, including private information, is a strong-form market. In this case, Baines was hoping to purchase at $50 but was only able to place the order when the price had risen to $75 per share, indicating that the price already reflected the new private information about the takeover. This can only occur in a strong-form market.

Juan bought XYZ Company stock at $40 per share. Today, the stock sells for $52 per share. Juan likes the long-term prospects for XYZ stock but wants some protection against price decreases. Which of the following orders is the best way for Juan to both participate in future price increases and ensure a minimum profit of $6 per share? A)A limit order to sell at $46 B)A stop-limit order, stop price = $47, limit price = $46 C)A limit order to buy at $40 D)A stop-sell order, stop price = $46

A stop-limit order, stop price = $47, limit price = $46 A limit order will not work as it is a sell order at or above $46 that would be executed today. It does not provide the downside protection Juan is looking for. The stop-limit order will place a limit order with a price of $46 once the stock reaches $47. The stop-sell order results in a market order once the stock price reaches $46, which likely will result in the order being filled below $46.

Brooks has been following Amazon stock for years. All forms of analysis leads him to firmly believe the stock is overpriced. Based on this conclusion, he shorts 1,000 shares of Amazon. Which of the following positions would help hedge his short? A)Buy 10 Amazon call options. B)Sell 10 Amazon call options. C)Buy 10 Amazon put options. D)Sell 10 Amazon put options.

A. Buy 10 Amazon Call options Brooks has a short stock position, which means he borrowed the shares that he sold short. If the stock price increases, his loss potential is unlimited. The long call allows the Amazon stock to be bought at a fixed price, limiting his risk.

Mutual fund 12b-1 fees cover

Advertising and marketing fees

According to the Black-Scholes option pricing model, the value of a call option will decrease under which of the following conditions, all other things equal?

As the exercise price increases The higher the exercise price, the less likely the option will ever be in the money. Therefore, higher exercise prices will lead to decreased call option prices.

Weak Form Efficiency

Asset prices reflect historical pricing and volume information. Investors cannot use this information set (past prices and volume) to generate a return that exceeds its risk-adjusted expected value. This form suggests technical analysis is useless. Investors can, however, beat the market with fundamental analysis and insider trading.

Portfolio A has a weighted beta coefficient of 1.5, and Portfolio B has a weighted beta coefficient of 0.9. With these assumptions, which of the following statements is correct?Assuming the market were to drop by 5 percent, Portfolio __ should drop less than Portfolio ___.

B A

Which type of mutual fund share generally converts to an "A share" after a period of time?

Both B and C shares

Which of the following types of income generally is subject to long-term capital-gains rates? A)Municipal bond coupon payments B)Corporate bond coupon payments C)Stock qualified dividends D)Savings account interest

C)Stock qualified dividends Generally, qualified dividends are subject to long-term capital-gains rates.

____ are bonds created by private investment firms and are secured by a pool of mortgages. Since they are mortgage-backed securities, they are subject to ______ risk. The advantage of a CMO is?

CMOs prepayment the ability to select the tranche that best meets the investor's risk-return needs.

Andrea believes that the economic cycle is at its peak and that a severe downturn is likely in the near future. She would like to invest in a stock that will remain relatively stable if the expected downturn does take place. Which of the following is the most suitable investment to meet her goal?

Defensive stocks are firms that provide products that are necessary for everyday life and are relatively unaffected by general fluctuations in the economy. They typically have betas of less than one.

__________contracts are more liquid than _________contracts, because they are traded on organized exchanges and are standardized. _________ contracts are customized to the parties involved in the transaction.

Futures forward forward

Investors may benefit from adding alternative investments to their portfolio because I their higher expected return tends to increase portfolio returns. II their low correlation with traditional asset classes can reduce portfolio risk.

II only The major benefit of alternative investments is their low correlation with stocks and bonds. This low correlation makes them especially desirable for diversifying a portfolio.

Which of the following statements is/are correct? I. Longer maturity bonds are less volatile than shorter term bonds when interest rates fluctuate. II. Higher coupon bonds are less volatile than lower coupon bonds when interest rates fluctuate.

II only When interest rates change, bonds with higher coupon payments and shorter maturities are less volatile

___________is a measure of how heavy- or light-tailed data is relative to a normal distribution.

Kurtosis

Which of the following is an index designed to track the performance of large- and mid-cap securities from 21 developed countries?

MSCI EAFE foreign asset managers

Which of the following is (are) correct with respect to bond portfolio strategies? I. A portfolio that has 40% invested in bonds with a 2-year maturity and the other 60% invested in bonds with a 10-year maturity is known as a bullet portfolio. II. If the portfolio's duration statistic matches the intended holding period, then the portfolio is always referred to as a laddered portfolio.

Neither I or II The portfolio in Statement I is an example of a barbell portfolio. The portfolio in Statement II is an example of an immunized portfolio.

Samantha and Jordan decide to open a sports equipment store together because of their love of the outdoors. They each own 50% in SportsCrazy, LLC, which is taxed as a partnership. Jordan manages the business. Samantha has a thriving tax practice and therefore does not participate in the operation of the business. Is any of this passive income?

Only the income distributed to Samantha is considered passive income.

Jack is considering purchasing a 6-year bond that is selling for $1,150. The bond can be called in 3 years at $1,040. What is the YTC for this bond if it has a 9% coupon, paid semiannually?

P/YR = 2 PV = -$1,150.00 N = 6 FV = $1,040.00 PMT = $45 I/YR = 4.82

Items specified in a commodity futures contract:

Quality, quantity, delivery date and a daily price limit

On September 20 of Year 1, Rene purchased 1,000 shares of Carter, Inc., common stock for $40,000. He sold the shares for $50,000 on September 20 of Year 2. What are tax consequences?

Rene will recognize a $10,000 short-term capital gain on the sale.

____________savings bonds offer inflation protection and are default-risk-free.

Series I

Beverly engaged in several capital transactions this year. She had a short-term capital gain of $400, a short-term capital loss of $600, a long-term capital gain of $800, and a long-term capital loss of $500. How will Beverly report these items on her income tax return?

Short-term capital losses can be netted against short-term capital gains, and long-term capital losses can be netted against long-term capital gains. Since there is a short-term loss of $200 and a long-term gain of $300, the short- and long-term summary results can be netted together. In this case, since the long-term capital gain was larger on an absolute basis, the character of the resulting net gain is a long-term capital gain.

Maggie considers four potential securities with identical expected returns but different correlations with her existing portfolio as part of her asset-selection decision. Which security would provide Maggie with the greatest diversification benefit?

Since the returns of the four potential securities are the same, the primary consideration is the risk element. The best security is the one with the lowest correlation

________________ is a measure of the lack of symmetry for a data set.

Skewness

An investment manager is suspected of insider trading. Trying to avoid prison time, she claims that she could not have been making insider trades because she did not outperform her benchmark portfolio. If she did in fact commit insider trading, it is likely that the market she invests in is

Strong-form efficient

A small-cap fund manager invests in a technology company that grows and eventually becomes part of the S&P 500. What problem does the fund manager face by not selling shares of this company?

Style shift

______________are a low-risk, low-reward investment that only pays well in periods of high inflation. Young people are less exposed to inflation risk because their incomes and higher-risk investments will help keep pace with inflation. Older people into retirement, on the other hand, are very exposed to inflation risk

TIPS

Which of the following technique or strategy would take advantage of a perceived undervaluation in the energy sector of the economy? What type of allocation?

Tactical asset allocation is in response to short-term market conditions.

An investment manager routinely uses technical analysis to outperform his benchmark portfolio. He also finds that fundamental analysis and a little bit of insider trading (which is illegal) provide improved returns. Based on this information, he is investing in a market that is

Technical analysis should not provide improved returns in any type of efficient market. This market is inefficient.

The act that regulates investment advisers and requires registration with the SEC for firms or any individual advisers with assets under management exceeding $100 million.

The Investment Advisers Act of 1940

The act that forms the backbone of financial regulation and established the foundation for mutual funds and hedge funds.

The Investment Company Act of 1940

An investor owns a well-diversified portfolio that contains the equity securities of large U.S. corporations. The beta of the portfolio is 1.0. The most appropriate benchmark for this portfolio is

The S&P 500 Index is comprised of the largest 500 US stocks, so it makes perfect sense to use this index as the benchmark, especially since the beta of the portfolio matches the beta of the index.

Which securities law regulates the offering and sale of securities in the primary market and ensures more transparency in financial statements?

The Securities Act of 1933

Act that focuses on the trading of securities in the secondary market.

The Securities Exchange Act of 1934

According to the Black-Scholes option pricing model, what will happen to the average cost of call options if interest rates increase?

The average cost will increase. According to the Black-Scholes option pricing model, interest rate increases will increase the average cost of all call options. Higher interest rates mean investors make relatively higher returns in stable, less risky investments. Call options allow these investors exposure to price increases in the riskier stock market without committing to large up-front investments. The greater demand for call options, in turn, increases their price.

What is the primary risk to investors when hedging with futures contracts?

The investor has insufficient funds to meet margin requirements.

1. If an investor owns a single share of a stock with a beta of 0.75, what can you conclude about his investment risk relative to the market?

The investor's systematic risk is ³⁄₄ of the risk of the market. Beta only measures systematic risk relative to 1, the market's beta. Beta assumes a stock is added to an already diversified portfolio. Because a single stock has both diversifiable as well as systematic risk, an investor who purchases only a single stock may have a total risk greater than the market's risk.

What is the maximum possible federal tax rate applied to capital gains from the sale of common stock?

The maximum possible capital-gains rate is the base 20% maximum plus the 3.8% net investment income tax for a total of 23.8%.

An investor writes a put option with a $4 premium. The option has a strike price of $25 on a stock currently trading for $35. At the option's expiration, the stock trades for $26. What is this investor's profit or loss per share?

The option has expired out of the money and will not be exercised. The investor will keep the $4 premium as profit.

An investor receives a premium of $5 for writing a put option with a strike price of $105 on a stock currently trading for $115. At the option's expiration, the stock trades for $95. What is this investor's profit or loss per share?

The option will be exercised, requiring the investor to purchase the stock for $105 even though it is only worth $95. This $10 loss is offset by the $5 premium received, leading to a loss of $5 per share.

An "in the money put"

The stock price is less than the strike price.

Assume that the 1-, 2-, 3-, 5-, 10-, 20-, and 30-year rates were 7 percent, 6.5 percent, 6 percent, 5.4 percent, 5.2 percent, 5.0 percent, and 4.8 percent, respectively. What type of yield curve is this?

The yield curve is downward sloping, which is known as inverted.

Tax consequences for the writer of a put or call

There are no tax consequences when an option is initially written. Tax consequences only arise when the option is exercised, when the option expires, or when the option position is closed with an offsetting trade.

You buy a call option on a stock for $3 per share. The strike price is $75, and the current price of the stock is $65. If on the expiration date the stock's price is $74, your net profit per share (excluding commission and taxes) is

This option expired out of the money, so you will lose the $3 premium.

____________ are the most difficult for an investor to assess, partly because the other fees and expenses are disclosed to investors in the prospectus, but also because some trading costs are implicit.

Trading costs

___________ risk is reduced by diversification

Unsystematic

Which of the following is (are) included in a mutual fund's expense ratio? 12b-1 fees Front-end loads

While 12b-1 fees are included in a fund's expense ratio, front-end loads are not.

A hybrid mutual fund is one that includes

a mix of asset classes, such as stocks and bonds.

A covered call is the most appropriate strategy for investors looking for

additional income from a stock they already own.

Semi-Strong Efficiency: Asset prices reflect

all publicly available information. Investors cannot use publicly available information to generate an excess return. That information is already reflected in security prices. Examples of information reflected in asset prices: Firm related — dividends, executive leadership skills, operating cash flows, cost of capital, merger activity, SEC filings, and analyst reports. Market related — economic information, changes in gross domestic product, inflation rates, relative currency values, energy prices, and global uncertainty. Suggests both technical analysis and fundamental analysis are useless. Investors can only beat the market with insider trading.

Strong Form Efficiency: Asset prices reflect

all relevant information, including private information. The implication is that investors cannot use any information, including private information, to generate an excess return. Suggests all attempts to beat the market are pointless - even with insider trading.

In a futures contract, the futures price is the price of the asset when? as the futures contract nears its expiration date, the spot price and futures price __________. A contract's futures price is ______once it is purchased. A spot price and futures price apply to both forward and futures contracts.

at some time in the future converge fixed

A ________________ may be charged when an investor redeems shares of a mutual fund shortly after buying them.

back end load

UIT's generally consist of ___________. UIT's are generally better for __________. Are UIT's passive or actively managed?

bonds generating income: older clients passive (non-managed)

In futures contracts, who is required to have a maintenance margin?

buyers and sellers

An asset-allocation strategy that periodically purchases assets that have fallen in value and sells assets that have risen in value is

constant weighting

A ________ involves writing a put for a stock that has been sold short. The put premium offsets some of the downside risk.

covered put

National Fund is a closed-end fund with a cash balance of $80 million. American Fund is an open-end fund with a cash balance of $300 million. Both National and American have $2 billion in market value of assets. National has less cash most likely because it A)invests in less liquid assets than American. B)does not permit investors to redeem shares at any time. C)has greater management fees than American. D)has less access to capital than American.

does not permit investors to redeem shares at any time.

Responsibilities of FINRA:

educate investors foster market transparency write and enforce rules gov activities of all registered investment advisers

For a call option contract, the price at which the option holder can buy the underlying security is called the

exercise or strike price

investment bankers most commonly use a _____________ to facilitate a primary offering.

firm commitment

The goals of regulatory oversight are

fostering transparency, integrity, and accuracy.

Private equity is regularly characterized by __________risk.

high liquidity risk.

The buyer of a put option will profit when?

if the stock's price drops by a larger amount than the option's premium.

A bond is ______________ if its duration is matched to the timing of the investor's cash flow needs. The portfolio has less exposure to both ________and __________risks.

immunized interest rate reinvestment rate

The general rule is that one should place securities with _____________ in qualified accounts and securities with good prospects for ___________in nonqualified accounts.

interest income capital gains

There is an _________ relationship between interest rate risk and reinvestment rate risk. If interest rates increase, bond prices will ____, while reinvest coupons will experience what?

inverse fall increased returns.

Where do investors buy mutual fund shares?

investors directly buy shares from the investment manager; shares are never available in the secondary market.

A distribution that is more peaked than normal is ___________.

leptokurtic

Options are a zero sum game. If the buyer profits, the seller?

loses money (and vice versa).

What type of risk are stock investors subject to?

market risk, idiosyncratic risk, and the risk that the firm will declare bankruptcy.

A real estate investor is subject to what kind of risks?

market risk, liquidity risk and political risk

Mutual fund shares can be redeemed for ______________value while ETFs can be sold at _________ value, which will be very close to __________ value if the shares are highly liquid. ETFs generally are more tax efficient because?

net-asset market net-asset they tend to have lower stock turnover, and on average, have lower expenses

Hedge funds often invest in

options and futures contracts and also try to benefit when one industry leader outperforms its main rival.

The process of mark-to-market does what?

posts gains or losses to each account daily and may result in margin calls.

What is the loss for a long call? What is the risk for a covered call?

premium paid to lose the stock, which is loss of upside potential

Colin purchased Apple stock earlier this year. The stock has increased significantly. While Colin likes the company's long-term prospects, he is concerned about a rapid price drop. Which of the following strategies would be protect him from such a price drop?

put option protects against drops in Apple stock price.

With the _____________ approach, it is often difficult to identify acceptable peer groups for a given company. Analysts must balance firm size, capital structure, and location.

relative valuation

The ______________ method uses price multiples to determine the relative value of each individual stock. The price-to-sales ratio is commonly used for firms that do not have what?

relative valuation a long history of positive earnings.

The value-style box refers to mutual funds that invest in firms that have

relatively low P/E ratios, suggesting they provide a good value for their earnings.

The intersection of the security market line (SML) and the y axis occurs at the

risk-free rate of return

A long position in a futures contract expiring in November can be offset by

selling a futures contract expiring in November. An offsetting contract is one that is in the opposite position (buy versus sell) and has the same characteristics, such as expiration date.

Why is the short the riskiest position?

since the short seller must repurchase the stock in the open market if the stock price increases.

A venture capitalist provides EUR 25 million to a business that has developed an innovative fishing product. Distribution channels have not yet been identified, although some revenues have been generated. The VC has most likely entered the process at the

start up phase The startup stage is characterized by businesses that have a product to sell but need help with marketing, packaging, and distribution. The VC frequently acts as an expert in this stage by providing advice and consulting services. The startup stage can produce some revenues, but the business lacks mass production capabilities.

Insider selling decreases a stock price just before an important public announcement of quarterly losses. This finding conflicts with which form of the efficient market hypothesis?

strong

A high-income investor owns a portfolio of bonds. Interest rates abruptly and sharply increased. Which of the following strategies would be most helpful in order to take advantage of the decrease in the value of this investor's fixed-income securities?

tax swap As interest rates increase, the price of bonds decreases. This drop in value may create an opportunity to recognize the capital loss for tax purposes, which is the purpose of the tax swap.

The total price of a bond is

the asked price plus accrued interest.

A bond priced at par will have a YTM equal to

the current yield and coupon rate.

A financial analyst computes the present value of a firm's operating cash flows to calculate an intrinsic value of the shares. The analyst is most likely using

the discounted cash-flow technique.

The return from the CAPM is the ____________.

the expected return

Re the CML portfolios on the new efficient frontier are some combination of

the risk-free asset and the market portfolio.

Based on a normal distribution, 95% of all outcomes for investment returns should fall within

two standard deviations from the mean.