FIN 2303 Chapter 2 Review

You recently sold 100 shares of Facebook stock to your uncle. You had the certificates and gave them to him. In exchange, he wrote you a check. Which of the following best describes this transaction? (a) This is an example of a money market transaction. (b) This is an example of a primary market transaction. (c) This is an example of a derivative market transaction. (d) This is an example of an exchange of physical assets. (e) This is an example of a direct transfer of capital.

(a) This is an example of a direct transfer of capital. (if one person transfers an asset to another without the involvement of a financial intermediary, then a direct transfer of capital has occurred)

Three years ago you purchased 500 shares in the Kellogg Company, but yesterday you sold 200 those shares through your broker. This is: (a) A primary market transaction. (b) A secondary market transaction. (c) A money market transaction. (d) A futures market transaction.term-25 (e) An over-the-counter market transaction.

(b) A Secondary market transaction. (Secondary markets involve securities and other financial assets traded among investors after they have been issued by corporations.)

Which of the following statements about hedge funds is CORRECT? (a) Hedge funds are extremely popular in Europe and Asia, but they are rarely used or made available in the United States. (b) Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. (c) Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks. (d) Hedge funds have more in common with investment banks than with any other type of financial institution. (e) Hedge funds have more in common with commercial banks than with any other type of financial institution.

(c) Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks.

Which of the following is an example of a capital market instrument? (a) Money market mutual funds. (b) Commercial paper. (c) Banker's acceptances. (d) Preferred stock. (e) U.S. Treasury bills.

(d) Preferred stock. (capital markets are markets for stocks and for intermediate or long term debt)

There are some important distinctions among mutual funds. _______ funds use a manager's expertise to outperform the overall markets. _______ funds are designed to simply replicate the performance of a specific basket of stocks like the S&P 500. Both types of funds provide investors with valuable ________.

Actively-managed , Indexed, diversification.

Data from the Dow Jones Industrial Average, the S&P 500 Index, and the NASDAQ Composite Index give information about past stock returns. True False

True

The most active secondary market, and the most important one to financial managers, is the stock market where the prices of firms' stocks are established. There are a number of different stock markets; however, the two leaders are the New York Stock Exchange, which is a(n) ____________ exchange, and the Nasdaq, which is an ___________ market. The New York Stock Exchange is a tangible entity that conducts auction markets in listed securities.

physical location, electronic dealer-based

Which of the following statements about financial markets is CORRECT? (a) While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. (b) The New York Stock Exchange is an auction market, and it has a physical location. (c) Capital markets deal only with common stocks and other equity securities. (d) Home mortgage loans are traded in the money market. (e) If an investor sells shares of stock through a broker, then it would be a primary market transaction.

(b) The New York Stock Exchange is an auction market, and it has a physical location.

Thinking about the financial markets, which of the following statements is CORRECT? (a) Money market transactions only involve securities denominated in U.S. dollars. (b) The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. (c) Spot market transactions involve securities that have maturities of less than one year, whereas futures markets transactions involve securities with maturities greater than one year. (c) Both NASDAQ dealers and specialists on the NYSE hold inventories of stocks. (d) Capital market transactions involve only preferred stock or common stock. (e) If General Electric were to issue new stock this year, this would be considered a secondary market transaction as the company already has stock outstanding.

(c) Both NASDAQ dealers and specialists on the NYSE hold inventories of stocks.

Of the following statements, which is CORRECT? (a) If you purchase 100 shares of Facebook stock from your friend Sam, this is an example of a primary market transaction. (b) If H&R Block issues additional shares of common stock through an investment banker, this would be a secondary market transaction. (c) Only institutions, and not individuals, can engage in derivative market transactions. (d) As they are generally defined, money market transactions involve debt securities with maturities of less than one year. (e) The NYSE is an example of an over-the-counter market.

(d) As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

One of the following statements about issuing and owning securities is incorrect. Which statement is NOT CORRECT? (a) The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC. (b) When a corporation's shares are owned by a few individuals, we say that the firm is closely, or privately, held. (c) It is possible for a firm to go public and yet not raise any additional new capital for the firm itself. (d) Going public establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares. (e) When stock in a closely held corporation is offered to the public for the first time, the transaction is called going public, or an IPO, and the market for such stock is called the new issue, or IPO, market.

(d) Going public establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Which of the following statements about IPOs is CORRECT? (a) The term "IPO" stands for Individual Purchase Order, and it is the price at which individual shares of a new company are offered for purchase. (b) Sometimes, a company is forced to issue more shares than it wants to sell in an IPO because the share price is so low and demand is high. (c) IPO prices are generally established by the market, and buyers of the new stock must pay the price that prevails at the close of trading on the day that the stock is offered to the public. (d) In a Dutch auction, investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay. (e) It is possible that the price set in an IPO is so high that investors will refuse to buy the number of shares that the company wants to sell. In this situation, the IPO is said to be oversubscribed.

(d) In a Dutch auction, investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay.

Which of the following statements describes a primary market transaction? (a) One financial institution buys 200,000 shares of BP stock from another institution. An investment banker arranges the transaction. (b) You sell 200 shares of Kroger stock on the NYSE through your broker. (c) Microsoft sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years. (d) You buy 200 shares of Honda stock from your brother. The trade is not made through a broker; you just give him cash and he gives you the stock. (e) Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

(e) Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

Which of the following is an example of securities traded in money markets? (a) Consumer automobile loans. (b) Common stocks. (c) Foreign currencies. (d) Long-term bonds. (e) Short-term debt securities such as Treasury bills and commercial paper.

(e) Short-term debt securities such as Treasury bills and commercial paper.

Which of the following statements about financial institutions and securities is CORRECT? (a) While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. (b) Money markets are markets for long-term debt and common stocks. (c) A liquid security is a security whose value is derived from the price of some other "underlying" asset. (d) Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks. (e) The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market.

(e) The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market.

Many believe that insufficient supervision of the financial sector was partly responsible for the recent financial crisis. Consequently, Congress passed the ________ Act. The legislation's main goals are to create a new agency for consumer protection, increase the transparency of derivative transactions, and force financial institutions to take steps to limit excessive risk-taking and to hold more capital.

Dodd-Frank

The acronym IPO stands for "independent public offering." True False

False (IPO = initial public offering, the process for introducing a company to the public markets)

Retirement plans funded by corporations or government agencies for their workers and administered primarily by the trust departments of commercial banks are known as...

Pension funds

A corporation is said to be publicly owned if its shares are held by the investing public, which may include individuals, other corporations, and institutional investors. True False

True

Financial institutions are more diversified today than they were in the past, when federal separated investment banks, commercial banks, insurance companies, and other financial companies. Today, large financial services corporations offer services that they could not in the past. True False

True

Hedge funds are similar to mutual funds except that they are less regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions. True False

True (hedge funds are largely unrelated and are marketed primarily to institutions & individuals w high net worths)

The traditional department stores of finance serving a variety of savers and borrowers are known as...

commercial banks

Cooperative associations whose members are supposed to have a common bond are known as...

credit unions

Businesses, individuals, and governments often need to raise capital, while others have surplus funds. In a well-functioning economy, capital flows efficiently from those with surplus capital to those who need it. Transfers can take place in 3 ways: ________ transfers without going through any type of financial institution, _________ transfers through investment banks that underwrite the securities, and indirect transfers through financial _________ that create new forms of capital.

direct, indirect, intermediaries

The _____________ remains one of the cornerstones of modern finance theory. It implies that, on average, asset prices are approximately _______ their intrinsic values. Many events in the real world seem inconsistent with the hypothesis, which has spurred a growing field called _______________, that borrows insights from psychology to better understand how irrational actions can be sustained over time. This theory considers two key points. First, it is often difficult or risky for traders to take advantage of mispriced assets. Second, it considers why mispricing occurs. Investors and managers behave differently in down markets than they do in up markets and individuals tend to ___________ their true abilities.

efficient markets hypothesis (EMH), equal to, behavioral finance, overestimate

If the stock market is ________, it's a waste of time for most people to seek bargains by analyzing published data on stocks. Stock prices will already reflect all publicly available information and these stocks will be ________ priced. However, an investor should still be careful when selecting stocks for his or her portfolio. Most importantly, the portfolio should be ____________.

efficient, fairly, diversified

Large conglomerates that combine many different financial institutions within a single corporation are known as...

financial service corporations

Stock prices are determined in the financial markets. Management's primary goal is to maximize the firm's stock price, so financial managers need to understand how these markets operate in order to make good decisions. In addition, individuals make personal investment decisions so they too must understand how the financial markets operate and have some knowledge of the institutions that operate in these markets. In a global context, economic development is __________ correlated with the level and efficiency of financial markets and institutions.

highly

Organizations that underwrite and distribute new investment securities and help businesses obtain financing are known as...

investment banks

______ asset markets exist for wheat, autos, and real estate, while____ asset markets deal with stocks, bonds, and mortgages. ______ markets are where assets are sold for almost immediate delivery, while _____ markets are markets in which participants agree today to buy or sell an asset months from now. ______ markets are the markets for intermediate- or long-term debt and corporate stocks, ______ markets are the markets for short-term, highly liquid debt securities. ______ markets are markets in which existing, already outstanding securities are traded among investors, while ______ markets are the markets in which corporations raise new capital. In _______ markets transactions are negotiated directly between two parties, while _______ markets are markets where standardized contracts are traded on organized exchanges.

physical, financial, spot, future, capital, money, secondary, primary, private, public

Stock market transactions can be classified into three distinct categories: (1) outstanding shares of established publicly owned companies that are traded in the _______ market, (2) additional shares sold by established publicly owned companies in the ______ market, and (3) initial public offerings made by privately held firms in the ______ market.

secondary, primary, IPO

A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. One example is a commercial bank, which takes in demand deposits and then uses that money to make long-term mortgage loans. True False

true

A stock is considered to be closely held if the corporation's shares are owned by a few individuals who are associated with the firm's management. True False

true

The equation used to find the annual rate of return on any given stock is the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price. When applied to a large portfolio of stocks, like those in the S&P 500, the average of the returns on each stock can be used to find stock market returns for the year in question. True False

true

To find the annual rate of return on any given stock, add the stock's dividend for the year plus the change in the stock's price during the year, then divide by its beginning-of-year price. True False

true

A stock's return can be broken out into its dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). These returns can be calculated for all of the stocks in the S&P 500. You can find an indicator of the "return on the market" by calculating the weighted average of those returns, using each stock's total market value. True False

true (the returns on stock and on an index are calculated the same way)