Investments CH 1-5

Why would a closed ended fund trade at a premium?

A close ended fund typically trades at a premium when investors are convinced that the future performance of the fund will be so strong that paying a premium for the shares is warranted. For example, a closed ended fund might concentrate on a single country expected to perform very strongly over the future, and other readily available alternatives for participating in this particular country are not available.

Why might investors prefer a hybrid fund to either a stock fund or a bond fund?

A hybrid fund holds both bonds and stocks, therby offering a combination to investors in one fund. Typically, such funds should have higher returns, on average, than bond funds while offering lower risk than stock funds.

Municipal bond yields are stated on an after tax basis while corporate bond yields are stated on a before tax basis. Agree of disagree, state your reasoning.

Agree. municipal bond yields must be adjusted to a before tax basis to make them comparable to corporate bond yields. This is done by calculating the TEY.

What does it mean to say the losses from short selling are infinite while the gains are finite?

Because there is no theoretical limit to how hight a stock price can rise, the theoretical losses from short selling are said to be infinite. In practice, of course, the majority of all stocks don't rise in price to thousands of dollars a share. In contrast, the most a stock price can drop to is zero, so the gains from short selling are finite.

Why is it necessary for brokerage accounts to be market to the market every day

Brokerage firms must calculate the actual margin in their customer's accounts daily to determine if a margin call is required.

Why might a company opt to have its shares traded on NASDAQ rather than NYSE? What about the reverse?

Companies may have to disclose less information on NASDAQ, or may prefer having multiple market makers for their stock. Not he other hand, companies may prefer to have their shares traded on the NYSE, long considered to be the premier secondary market for the trading of equities.

Distinguish between the DP, the D/E, and the P/E?

D/P is the dividend yield, dividend divided by current price; D/E is the payout ration, dividends divided by earnings. The P/E is price divided by earnings and indicates the multiple of earnings that investors pay for stocks.

The Securities Act of 1933 ensures investors that every new issue of stock has met its quality standards and is likely to be a good investment.

DISAGREE. The securities act of 1933 ensures investors only that the issuer has complied with all regulations, particularly those involving disclosure of information. The company may still be a weak company without good prospects for success.

Rational investors always attempt to minimize their risks. Agree or disagree, and explain your reasoning

Disagree. If rational investors always minimized their investment risk, they would likely own nothing but Treasury bills. The correct statement is that rational investors assume risk if they expect to be compensated adequately for doing so.

Investors should always seek to minimize their returns from investing. Agree or disagree.

Disagree. In this case investors would seek the assets expected to return the most regardless of their risk. The correct statement is that investors should seek to maximize their returns for a given level risk.

ETFs are closed end funds both trade on exchanges. Why, then, are ETFs having a big negative impact on closed end funds?

ETFs have largely eliminated the issue of discounts and premiums which plague closed ended funds. They typically offer targeted diversification while closed ends often resemble mutual funds.

Given the wide availability of no load funds, why do many investors choose to buy load funds and pay sales charge?

Investors may choose to buy load funds and pay sales charges because of ignorance about the alternatives available, or carelessness in seeking out the lower cost alternative of no load funds. Of course, if investors believe that a particular fund/manager offers better opportunities than the alternatives, and such a fund charges a sales charge, they will be willing to pay the load fees.

Historically, stocks on average have outperformed other asset classes such as bonds. Should all intelligent investors own stocks?

Investors should select assets consistent with their risk tolerance. Some investors may not be able to deal with the risk of common stocks. Therefore, it is not correct to argue that all intelligent investors should own common stocks.

Why is it reasonable to expect growth funds and value funds to perform well over different periods of time?

Investors tend to favor value stocks for certain periods of time, and growth stocks at other times based on perceived economic conditions. Therefore, growth funds and value funds will reflect these verifying expectations.

When resolving investor disputes with brokers, what is the major difference between mediation and arbitration?

Mediation is voluntary, mediation decisions are non binding Arbitration is a binding process that can determine damages.

Why are money market funds the safest type of mutual fund an investor can hold?

Money market fund by definition hold money market assets, the safest financial assets because of their high credit quality and very short maturity. Therefore, they are simply a reflection of the type of assets they hold.

Why are money market securities referred to as impersonal assets, while the non marketable financial assets are not?

Money mart securities can be sold in financial markets, where neither the buyer or seller is identified to each other. Non marketable financial assets must be handled by the owner of the asset.

Why do you think mutual funds are by far the most popular type of investment company with investors as measured by assets under management?

Mutual funds are by far the most popular type of investment company because they have existed for many years, as have closed ended funds, but the latter fell out of favor with investors a long time ago. ETFs are relatively new and while growing rapidly, have a way way to go to catch up with mutual funds. Very heavy promotion and publicity also accounts for the popularity of mutual funds.

Distingish between NASDAQ and the over the counter market.

NASDAQ is a marketpalce distinguishable by its trading mechanisms and processes. The term over the counter market has traditionally referred to the trading of securities not listed on the organized exchanges.

Consider a corporate bond rated AAA vs another corporate bond rated only BBB. Could you say with confidence that the first bond will not default while for the second bond there is some reasonable probability of default?

No, because bond ratings are a measure of the relative probability of default. There is some absolute probability, although it is extremely small, that an AAA bond will default.

Assume you wish to take advantage of an expected change in exchange rates. Would ADRs be an effective way for you to do this?

No. ADRS do not involve foreign currencies, but rather are stated on a dollar basis.

Why might investors opt to hold preferred stocks rather than bonds in their portfolios?

Preferred stocks could have higher expected returns and have no maturity date. Also, preferred stocks can be much easier to buy and sell than individual stocks.

Why sell short instead of using puts?

Puts are only available on a limited number of stocks. Therefore, to profit from an expected decline in price, short selling is often the only alternative. Also, there is no time limit on short selling, while puts have a very shot life of several months at most.

Should risk adverse investors avoid junk bonds.

Risk averse investors can buy junk bonds, or any financial asset, if they expect to be adequately compensated for the risk. The greater the risk, the greater the expected return should be.

What is the rationale for buying class B shares? Class C shares?

Some investors simply wish to avoid paying an upfront sales charge, which can be avoided by buying class B or C class shares. Of course, what really matters is what an investor pays in total in fees during the period the shares are owned; therefore, investors in mutual funds with share classes should do some calculations to try to determine which class of shares will be least expensive during the time period the shares are owned.

What is the major presumed deficiency of the DJIA?

The DIJA is a price weighted index, while almost all others are market value weighted. Also, it consists of only 30 stocks

What are some important differences between NYSE and NASDAQ?

The NYSE is the oldest stock exchange in the US. NASDAQ only recently became an exchange. The NYSE trades many large, very well known companies, while NASDAQ trades some smaller companies that are not well known, as well as some of the most important technology companies in the world. NASDAQ is based on dealers or market makers. The merger between the NYSE and ArcaEx marked a significant change in the way the NYSE operates

Is the S&P 500 Index affected by the size of the companies in the index?

The S&P 500 Index is affected by the size of the companies in the index because it is a market value weighted index. Therefore, each stocks weight in the index is proportionate to its market value.

A chance for larger returns than those available domestically is the primary reason US investors should hold foreign securities. Agree or disagree and explain your reasoning.

The primary reason for holding foreign securities is to diversify ones portfolio. Diversification is a major tenet of portfolio management.

In a typical underwriting, the procedure is referred to as a firm commitment. What do you think this means?

The term underwriting technically involves a firm commitment, eaminging the investment bankers have agreed to prate the securities outright from the issuer. This is different, for example, from a best effort, where the risk of selling the issue is shared by the the issuer and the underwriters

The following is a correct statement : "the tradeoff between return and risk can be, and has been, both upward-sloping and downward sloping" how is this possible?

The tradeoff between return and risk can be, and has been, both upward sloping and downward sloping. This is possible because the tradeoff is always upward sloping for rational investors before one invests- that is, ex ante. However, for various periods that have occurred, the tradeoff can be downward sloping, because the retunes on the risk free asset are positive when stocks may be lower, or even negative. A vivid example is 2000-2002, when stocks dropped sharply, and most investors holding stocks lost money- in many cases, a lot of money. Another example of a very sharp market drop is 2008.

Why does the Treasury bill serve as a benchmark security?

The treasury bill is the benchmark security for the economy because bills are auctioned off every week, and the rates offered on them reflect current demand and supply conditions for short term funds without credit risk. Other interest rates are scaled up from this short term, riskless rate by adding time and risk premiums.

It is said that IPOs are often underpriced relative to the price at which they could be marketed. What are some possible reasons for this?

The underwriters have an incentive to quickly sell an issue, thereby reducing their risk as well as enhancing their reputation as successful investment bankers.

Assume you bought a stock for $50 and it has now increased to $75. You think it might go higher, but you want to protect most of your current profit, realizing a minimum gain for about $23 a share. What type of order?

To realize a minimum gain of approx $23 a share, you place a stop loss order (to sell) at $73. If the price declined below $73, your order would become a market order and be executed close to $73, thereby giving you a profit of approx $23, since you bought the stock for $50

Individual investors make investing decisions under conditions of uncertainty, while professional investors make such decisions under conditions of controlled risk taking, thereby eliminating the uncertainty. Agree of disagree and explain your reasoning.

Uncertainty cannot be eliminated, only reduced. For example, no one, whether professional investor or not, can know what the stock market will do with certainty next year, next month, or even tomorrow.

Holding maturity constant, would you expect the yields on money market securities to be within a few tenths of a percent of each other?

You should expect the yields on the money market securities to be within a few tenths of a pecent of each other because they are very short term, very high quality assets with little risk of default.

State 2 reasons why an investor establishing a brokerage account might prefer a wrap account to the more traditional asset management account.

a wrap account means that all costs are included in the wraps fee, which some investors prefer. Also, some investors want to have a constant in the form of a money manager for their account, a wrap account can provide for this.