Chapter 11-12 Personal Financial Planning

The phrase​ ________ is sadly appropriate for the actions of some​ people, as they perceive that investment success rests in making frequent transactions.

"playing the​ market"

A stock currently sells for​ $100 per​ share, and has earnings of​ $2.00 per share. What is the​ stock's P/E​ ratio?

50.00

Anthony Hopkins wants to start investing and desires to consistently beat the market. What will you tell​ him?

All of the above except A

The​ ________ is a common stock​ indicator, consisting of 30 large industrial​ firms, and is used to indicate how well stocks have done.

DJIA

The​ P/E ratio approach is a type of fundamental analysis.

True

You have just discovered one reason not to invest in stocks. What do you think it​ is?

Your tolerance of risk is low.

Call risk applies​ to:

bonds

Financial risk applies​ to:

bonds only

Business risk applies​ to:

both

Exchange rate risk applies​ to:

both

Inflation risk applies​ to:

both

Interest rate risk applies​ to:

both

Liquidity risk applies​ to:

both

Market risk applies​ to:

both

The ratio of the annual dividend to the market price of the stock is called the

dividend yield

Common stockholders not only have the right to elect the board but also must approve dayminus−tominus−day decisions of the chief executive officer.

false

The real rate of return can never be a negative number.

false

Compared to other investment​ options, we can safely say that investing in stocks

has greater risk.

Herd behavior

is a kind of selfminus−fulfilling behavior.

Because every company is almost certain to experience a bad year or​ two, holding on to stock for only one year

is not a very sound investment decision.

A​ ________ is a measure of the performance of a group of stocks that represent the market or a sector of the market.

stock market index

A good source of investment advice is a neutral party that​ doesn't charge a fee or earn a commission from you.

true

A market order is an order to buy or sell a set number of securities immediately at the best price available.

true

If the nominal rate is​ 10% and inflation is​ 3%, the real rate of return is​ 7%.

true

Purchasing derivatives is a form of speculating.

true

The NASDAQ is the largest electronic stock exchange.

true

The collateral an investor must put up when conducting a short sale is known as a margin requirement.

true

A lending type​ investment, such as a corporate​ bond, represents a legal obligation for the issuer to pay its creditors back.

ture

The price at which an individual investor is willing to buy a security is the bid price.

ture

The acronym DRIP stands for

Dividend Reinvestment Plan.

A primary market is a market in which​ new, as opposed to previously​ issued, securities are traded.

true

An option gives you the right to buy or sell the underlying asset at a set price on or before the​ option's maturity date.

true

Churning occurs when a broker engages in excessive trading in a​ client's security account to generate more commissions for the broker.

true

During a​ "bear market" stocks prices typically fall.

true

Holding several types of stock can greatly reduce the risk in your portfolio.

true

If your​ stock's beta was greater than 1.0 that indicates that your stock is more susceptible to movements in the market.

true

The dividend yield tells investors how much in the way of a return they would receive if the stock price and the dividend level remain constant.

true

The market price of the stock is a reflection of the potential earnings per share of the firm.

true

A typical bond will pay annual coupon payments until it​ matures, at which time it will surrender its par value to the owner of the bond.

ture

Harry and Harriet own​ 1,000 shares of AI Inc. in a brokerage account that is titled​ "Harry and​ Harriet, Tenancy-in-Common." Explain how the assets would be handled if Harry passed away. Would these scenarios be different if the account was titled​ "Harry and​ Harriet, Joint Tenancy with the Right of​ Survivorship"?

If the brokerage account was titled​ "Harry and​ Harriet, Tenancy-in-Common"and Harry passed​ away: A. Harry's heirs would receive​ Harry's shares, not Harriet. If the brokerage account was titled​ "Harry and​ Harriet, Joint Tenancy with the Right of​ Survivorship" and Harry passed​ away: B. Harriet would receive​ Harry's shares without the shares passing through probate.

You just learned that a blue chip company will issue a bond with a maturity of 100 years. The bond appears to be a good deal because it yields 8.78 percent. Assuming that the inflation rate stays at 3.25 ​percent, what is the​ bond's real rate of return​ today? If you were looking for a bond to purchase and hold for several​ years, would you buy this​ bond? Explain your answer in terms of future inflation projections and the length of the​ bond's maturity. Assuming that the inflation rate stays at 3.253.25 ​percent, what is the​ bond's real rate of return​ today?

The​ bond's real rate of return is 6.246.24 percent. Only a​ long-term investor would purchase this bond. If inflation were to​ increase, the value of this bond would decrease. The dramatic decrease in the value of the bond would be as a result of its sensitivity to changes in interest rates due to its long maturity.

Match each of the following behaviors with the appropriate bias as discussed in the chapter. a. Wanda owns Happy Clam Oil​ Exploration, but due to recent​ events, the share price is down 30 percent from when she bought it. She​ doesn't want to sell now because it had previously been up as much as 25 percent. b. Drew​ doesn't believe his friends who tell him that he cannot time the market. He has been successful in making profits from his trades this past month and plans to continue his day trading. c. Yusuf has been watching the gold market go up and​ up, so he decides that since everyone is buying gold he needs to do so as well.

Wanda's behavioral bias is​ called: disposition effect Drew's behavioral bias is​ called:​ overconfidence Yusef's behavioral bias is​ called: herd behavior

Political and regulatory risk applies​ to:

both

For several years you have been using charts and computer programs to project trends in the stock market. You are engaging in what type of​ analysis?

technical

The primary sources of information about the stock market and individual stocks are​ Moody's Investors​ Service, Standard​ & Poor's Stock​ Reports, Morningstar Investment​ Reports, and the Value Line Investment Survey.

true

The​ price/earnings ratio is an indication of how much investors are willing to pay for a dollar of the​ company's earnings

true

​Historically, U.S. government securities have been considered the​ safest, lowestminus−risk investment available.

ture

Last year Marcelino graduated from high school and received several thousand dollars from an uncle as a graduation gift.​ Marcelino, now in his first year of​ college, just heard of a guy in his dorm that invested in an oil exploration company and made a huge profit in a few months. Marcelino likes the idea of making some money fast and is considering investing his graduation gift money in a similar stock.​ Marcelino's roommate,​ Luc, just finished a personal finance course and is concerned that Marcelino may be getting himself into trouble. Luc knows that Marcelino likes to shop​ online, has run up a fairly large credit card​ bill, and has trouble balancing his budget on a monthly basis. In​ addition, Marcelino really​ doesn't know much about investing or how people actually​ "make money​ investing." Luc has asked you to help him work through the following questions so that he can talk to Marcelino about his investment plans.

1. Before investing any​ money, Marcelino​ should: ​- have his financial affairs in order. ​- establish and stick to a budget. ​- make sure that he has adequate levels of​ homeowner's/renter's, auto, and health insurance to help cover unexpected property and​ liability, and medical expenses. ​- establish and maintain an emergency fund equal to three to six months of his take home pay. ​- set goals. 2. ​Marcelino's plan to make a quick profit in an Internet stock is most closely aligned with the definition of speculation. ​Short-term strategies that depend almost solely on supply and demand to determine prices are representative of speculation ​, not investment 3 A.The efficient market hypothesis states that all relevant information about a stock is reflected in the​ stock's current price. As​ such, it is extremely difficult to​ "beat the​ market" by picking one stock. This is the correct answer.B. B. It is extremely difficult to time the​ market, meaning that buying a stock at a low price and selling it at or near its high price is nearly impossible. ​Individuals, who say that they can beat the market or time the market​ accurately, tend to either overestimate their abilities or underestimate the probability of losing money in the stock market. 4. 47% 7.05 39.95 5 true 6. In addition to interest rate​ risk, Marcelino should ideally keep a watchful eye on all of the other risks. However given the uniqueness of an exploration stock the most important of the risks would be business​ risk, political and regulatory​ risk, and exchange rate risk if the firm deals substantially in overseas markets. 7. Systematic risk cannot be eliminated through diversification. Holding one stock does not increase systematic ​risk; however, owning only one stock does increase unsystematic risk. In other​ words, if a​ company-unique problem​ occurs, there is insufficient diversification to reduce the risk of loss. By investing in two unrelated​ stocks, Marcelino should reduce the volatility of his portfolio due to unsystematic ​"business specific" risk. 8. Luc is correct. Marcelino should avoid investing in only one stock. He should focus on accumulating a portfolio of stocks in different industries. By using a diversified​ approach, Marcelino will reduce unsystematic risk by allowing bad returns from a few stocks to be countered by higher returns in other stocks. Ultimately, this approach will reduce total portfolio variation​ (risk) without negatively affecting expected returns.

An investor is considering purchasing one of the following three stocks. Stock X has a market capitalization of ​$6 ​billion, pays a relatively high dividend with little increase in​ earnings, and has a​ P/E ratio of 11. Stock Y has a market capitalization of ​$64 billion but does not currently pay a dividend. Stock Y has a​ P/E ratio of 37. Stock​ Z, a housing industry​ company, has a market capitalization of ​$810810 million and a​ P/E of 18. a. Classify these stocks according to their market capitalizations. b. Which of the three would you classify as a growth​ stock? Why? c. Which stock would be most appropriate for an aggressive​ investor? d. Which stock would be most appropriate for someone seeking a combination of safety and​ earnings?

A. mid- large- small B. Stock Y because the higher the​ firm's earnings growth​ rate, the higher the​ firm's P/E ratio. These companies also tend to pay low or no dividends in order to put the funds back into the company. C. Stock Y D. Stock X

Brokerage firm reports

provide access to research reports prepared by the​ firm's securities analysts.