Unit 3&4 Review (Part 2)

An investor has the following tax picture in 2021: Tax loss carryover from 2020: $9,000 Capital gains realized in 2021: $15,000 Capital losses realized in 2021: $2,000 What is the investor's reportable gain or loss for 2021? A) $4,000 net capital gains B) $13,000 net capital gains C) $13,000 net capital gains and a $4,000 loss carryover into 2022 D) $6,000 net capital gains

A) $4,000 net capital gains The first thing to remember is that there is no limitation on the amount of capital loss that may be carried over to use against capital gain. The $3,000 limitation is against income. In determining an investor's capital gain or loss for the tax year, all gains and losses must be aggregated and offset against each other. In this situation, all of the prior year's loss carryover of $9,000 is added to the current year's loss of $2,000. The total loss of $11,000 is offset against the total capital gains of $15,000, for a net capital gain of $4,000. LO 3.i

Which of the following expressions describes the current yield of a bond? A) Annual interest payment divided by current market price B) Yield to maturity divided by current market price C) Yield to maturity divided by par value D) Annual interest payment divided by par value

A) Annual interest payment divided by current market price The current yield on a bond is calculated by dividing the annual interest payment by the current market price of the bond. LO 4.e

Characteristics common to penny stocks would include which of the following? I. Market price less than $5 per share II. Market price greater than or equal to $5 per share III. Nasdaq over-the-counter (OTC) stock IV. Non-Nasdaq OTC stock

A) I and IV Penny stocks are generally defined as those with a market price below $5 per share that are not traded on any exchange or Nasdaq. LO 3.d

Which of the following terms are associated with over-the-counter (OTC) trading? I. Market maker II. Specialist III. Auction market IV. Negotiated market

A) I and IV The OTC market is a negotiated market. Within it, market makers are broker-dealer firms that provide a source for stock that customers wish to buy and a repository for stock that customers wish to sell. LO 3.h

Which of the following statements regarding warrants are true? I. They pay dividends. II. They represent ownership in the issuing corporation. III. They allow for the purchase of common stock at a fixed price. IV. They do not give holders voting rights.

A) III and IV Holders of warrants have the right to buy stock from the issuer at a stated price for a specific time period. They do not pay dividends that are only paid to stockholders or give holders voting rights. The owner of the warrant does not own the stock until the warrant is exercised. LO 3.f

The over-the-counter (OTC) market is A) a negotiated market. B) an auction market. C) the first market. D) all of these.

A) a negotiated market. The OTC market is a negotiated market. Registered market makers compete among themselves to post the best bid and ask prices. LO 3.h

An investor is looking to add some fixed-income securities to their portfolio. A registered representative suggests either the ABC 6s of 2050, or the XYZ 6s of 2043. Should there be an increase to market interest rates, A) the ABC bonds will suffer a price decline greater than the XYZ bonds. B) the XYZ bonds will enjoy a price increase greater than the ABC bonds. C) the XYZ bonds will suffer a price decline greater than the ABC bonds. D) the ABC bonds will enjoy a price increase greater than the XYZ bonds.

A) the ABC bonds will suffer a price decline greater than the XYZ bonds. This is a basic duration problem. When interest rates change, the bond with the longest duration will have the greatest price change. When there are two bonds with the same coupon rate (6%), the bond maturing latest has the longest duration. That tells us that the ABC bonds will fluctuate more than the XYZ bonds. Then, we need to remember that when interest rates increase, bond prices fall. That means that while both bonds will decline in price, the decline of the ABC bonds will be greater. LO 4.e

A similarity between common and preferred stock is A) the dividend must be declared by the board of directors. B) they have an equal vote. C) the dividend is fixed. D) both are evidence of corporate indebtedness.

A) the dividend must be declared by the board of directors. LO 3.e

Which of the following is the act that extended the regulation of securities to the secondary market or exchanges? A) The Investment Company Act of 1940 B) The Securities Act of 1934 C) The Investment Advisors Act of 1940 D) The Securities Act of 1933

B) The Securities Act of 1934 The answer is the Securities Act of 1934. In addition, this act also established the SEC (Securities and Exchange Commission) as the primary regulatory body overseeing the sale and purchase of securities by a potential investor. The 1934 act deals with the people involved in the subsequent sale and purchase of previously registered securities.

The 5% markup policy would apply to all of the following equity transactions except A) a riskless principal transaction. B) a primary market transaction. C) a proceeds transaction. D) an agency trade done on an exchange.

B) a primary market transaction. The 5% markup policy applies to secondary market transactions in nonexempt securities. LO 3.j

If interest rates increase, the interest payable on outstanding corporate bonds will A) change according to the inverse payout theory. B) remain unchanged. C) decrease. D) increase.

B) remain unchanged. The interest payable is the nominal yield, which is stated on the face of the bond. It is the percentage of face value the bond will pay each year, regardless of the prevailing interest rates in the market. It is the market price of bonds—not the interest payable—that responds inversely to changes in interest rates. LO 4.e

An investor purchased 200 shares of DCAST common stock at $200 per share. What is the adjusted cost basis per share of this position after the company pays a 100% stock dividend? A) $200 B) $50 C) $100 D) $400

C) $100 The total value of the initial position is unchanged, remaining at $40,000 (200 times $200). After the stock dividend, the investor owns 400 shares (200 times 100% = 200 + 200 = 400). Therefore, the adjusted cost basis is $100.00 per share ($40,000 divided by 400 = $100). Perhaps you recognized that a 100% stock dividend has the same effect as a 2:1 split. That is, the stock's cost basis is cut in half. It is important to remember that anytime there is a distribution resulting in additional shares (stock split, stock dividend), the cost basis per share is reduced while the total account value remains the same. LO 3.b

An investor had a $20,000 capital loss, a $15,000 capital gain, and $50,000 in income for the year. How much of the income is taxable? A) $50,000 B) $30,000 C) $47,000 D) $20,000

C) $47,000 Capital losses may be used to reduce taxable income. The first step is to net the gains and the losses. This investor has a net loss of $5,000. Of that net loss, a maximum of $3,000 can be written off against the income for the year. That reduces the investor's taxable income to $47,000. The unused $2,000 of the net loss is carried forward to subsequent tax years until utilized. LO 3.i

Which of the following customer accounts requires the sending of monthly customer statements? A) A margin account B) A discretionary account C) An account containing penny stocks D) An options account

C) An account containing penny stocks

Which of the following debt instruments would likely be suitable for sophisticated investors only? A) Debentures B) First mortgage bonds C) Equity-linked notes D) Jumbo CDs

C) Equity-linked notes Despite the misleading name, ELNs are debt instruments. When traded on an exchange, they are exchange-traded notes (ETNs). In either case, these are considered alternative products with unique risks, and therefore, not suitable for most investors. Although debentures are corporate debt without any pledged collateral, some of the financially strongest companies in the country issue them and receive high ratings. Even though Jumbo CDs require a minimum of $100,000, it does not require any sophistication to understand the product. LO 4.g

A 2-for-1 split does which of the following? I. Increases the number of outstanding shares II. Decreases the number of outstanding shares III. Decreases par value per share IV. Decreases retained earnings

C) I and III

If the dollar price of a municipal bond is 101 and, at that price, the basis is 6.10, the nominal yield is A) exactly 6.10%. B) less than the coupon rate. C) greater than 6.10%. D) less than 6.10%.

C) greater than 6.10%. Basis is a common synonym for yield to maturity, especially for municipal bonds. For any bonds trading at a premium, the nominal yield (or coupon) is higher than the basis (YTM). For bonds at a premium, yields from lowest to highest are as follows: yield to call, yield to maturity, current yield, and nominal yield. LO 4.e

Which of the following securities cannot pay a dividend? A) Convertible preferred stock B) Class B common stock C) American depositary receipt D) Warrant

D) Warrant

All of the following would be included in a penny stock risk disclosure statement except A) investors' legal rights. B) the risks of investing in penny stock. C) the definition of penny stock. D) the broker-dealer's statement of guarantee.

D) the broker-dealer's statement of guarantee. LO 3.j

Cement Mixer Corporation has 1 million shares of convertible preferred stock and 2 million shares of common outstanding. Each share of preferred can be converted into half a share of common. The preferred stock is selling at $17.50, and the common stock is selling at $35.75. If all preferred shares were converted, how many shares of common stock would be outstanding after conversion? A) 2,500,000 B) 2,000,000 C) 3,000,000 D) 500,000

A) 2,500,000 One million shares of preferred, each converted to half a share of common, is 500,000 common shares, and 500,000 shares after conversion, added to 2 million shares of common previously outstanding, equals 2.5 million common shares. LO 3.e

An investor owns 300 shares of XYZ common stock, currently selling for $50 per share. The investor also owns 100 shares of XYZ's 5% $100 par preferred stock currently trading at $90 per share. A 2:1 stock split is declared. After the payment date, the investor will own A) 600 shares of common at $25 per share and 100 shares of the preferred at $90 per share. B) 300 shares of common at $50 per share and 200 shares of the preferred at $45 per share. C) 600 shares of common at $25 per share and 200 shares of the preferred at $45 per share. D) 150 shares of common at $100 per share and 100 shares of the preferred at $90 per share.

A) 600 shares of common at $25 per share and 100 shares of the preferred at $90 per share. A stock split is always of common stock. In a 2:1 split, the number of shares doubles, and the price is 50% of the presplit price, which means 600 shares at $25 per share. The stock split has no effect on the preferred stock. LO 3.b

Many investors, especially institutions, diversify their fixed-income portfolios by purchasing bonds issued outside of the United States. When a French corporation issues a bond denominated in Swiss francs, it is known as A) a eurobond. B) sovereign debt. C) a euroswiss bond. D) a eurodollar bond.

A) a eurobond. The term eurobond is the generic name given to a long-term debt instrument issued and sold outside the country of the currency in which it is denominated. An example would be eurosterling bonds where a non-U.K. entity issues a debt denominated in British pounds. In our question, the French company is borrowing in Swiss francs instead of the domestic currency (the euro). Sovereign is issued by the sovereign government, e.g., U.S. Treasury bonds. LO 4.d

A corporation must have stockholder approval to A) issue convertible bonds. B) repurchase 100,000 shares of stock for its Treasury. C) declare a 15% stock dividend. D) declare a cash dividend.

A) issue convertible bonds. Stockholders are entitled to vote on the issuance of additional securities that would dilute shareholders' equity (the shareholders' proportionate interest). Conversion of the bonds would cause more shares to be outstanding, thus reducing the proportionate interest of current stockholders. Decisions that are made by the board of directors and do not require a stockholder vote include the repurchase of stock for its Treasury, declaration of a stock dividend, and declaration of a cash dividend. LO 3.c

In which of the following will a change in interest rates lead to the greatest fluctuations in the market price? A) 7% AA-rated one-year municipal note B) 7% 30-year U.S. Treasury bond C) Series EE bond D) 7% AAA-rated corporate bond with eight years until maturity

B) 7% 30-year U.S. Treasury bond Price fluctuations are the greatest in bonds with the longest duration. All other things being equal (all the bonds have the same 7% coupon), the bond with the longest time to maturity, regardless of the nature of the issuer, is going to have the longest duration. Series EE (savings) bonds are nonmarketable and never fluctuate in price. LO 4.e

A 10-year bond, callable in five years at par, is sold at a discount. Rank the following yields from lowest to highest. I. Nominal yield II. Current yield III. Yield to call IV. Yield to maturity

B) I, II, IV, III The lowest of all yields for a discount bond is the nominal yield (coupon rate), which is a fixed percentage of par. The highest possible return to the owner of a bond purchased at a discount would occur if the bond were called before maturity because less time must elapse for the investor to receive the discount. LO 4.e

Which of the following are characteristics of commercial paper? I. It is registered with the SEC. II. It is a short-term debt instrument. III. It is issued by commercial banks. IV. It is unsecured debt.

B) II and IV Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Because commercial paper is issued with maturities of less than 270 days, it is exempt from SEC registration under the Securities Act of 1933. LO 4.c

Which of the following is not an advantage of purchasing American depositary receipts (ADRs)? A) Foreign taxes withheld can be claimed as a credit to offset income taxes on dividends received. B) They eliminate exchange rate risk. C) They allow U.S. investors to buy foreign country stock denominated in dollars. D) Transactions are done on an organized exchange in the U.S.

B) They eliminate exchange rate risk. ADRs are priced in U.S. dollars and therefore have exchange rate risk. That is, if the value of the currency in the home country of the company underlying the ADR should decline in relationship to the U.S. dollar, the investor could actually lose money even if the stock's price rises. For example, the foreign company's stock is selling for $50 per share Canadian. At the time of purchase, the Canadian dollar is worth $0.80 U.S. That would make the ADR value approximately $40 per share U.S. If the client decides to sell that ADR when the company stock is selling for $52 per share on its domestic exchange, but the Canadian dollar is now worth $0.70 U.S., the ADR's value will be approximately $36.40. Therefore, we've seen the price of the stock go up while the value of the ADR to the U.S. investor has declined. LO 3.g

Corporations issue equity securities. One category of equity is preferred stock. A number of different adjectives can apply to preferred stock issues. All of the following are types of preferred stock except A) cumulative preferred. B) straight cumulative preferred. C) participating preferred. D) convertible preferred.

B) straight cumulative preferred. Preferred stock can be noncumulative (straight) or it can be cumulative. It cannot be both. Cumulative preferred has the right to receive skipped dividends before any dividend can be paid to common shareholders. Those skipped dividends are known as dividends in arrears, or arrearage. Straight preferred does not have the right to receive skipped dividends; there is no arrearage. Once the dividend is not paid, the holder of straight preferred has no claim on it. LO 3.e

Five years ago, a corporation issued a portion of its authorized shares. Those shares currently trade on the New York Stock Exchange. In an effort to reduce the number of shares outstanding, the issuer purchases 30 million shares from existing shareholders. The shares purchased by the issuer in the secondary market are now known as A) authorized stock. B) treasury stock. C) issued stock. D) unissued stock.

B) treasury stock. LO 3.a

An investor holds 3,000 shares of a stock with a current market value of $12 per share. After a 1:6 stock split, the investor's position will be A) 500 shares with a market value of $2.40 per share. B) 15,000 shares with a market value of $2.40 per share. C) 500 shares with a market value of $72 per share. D) 15,000 shares with a market value of $12 per share.

C) 500 shares with a market value of $72 per share. This is an example of a reverse split. For each share owned, the investor will now have 1/6 of a share. That turns 3,000 shares into 500. At the same time, the market price per share will increase approximately by a factor of six. The key to any stock split question is that the total value of the account remains the same. Presplit, it was 3,000 × $12 = $36,000 and postsplit it is 500 × $72 = $36,000. LO 3.b

Aenical Corporation issued $100 million of $100 par value preferred stock a number of years ago. The stock pays quarterly dividends of $1.25. Recent issues of comparable preferred stock carry a dividend yield of 10%. One could expect the market price of the Aenical preferred stock to be closest to A) $25. B) $100. C) $75. D) $50.

D) $50. As with other fixed-income securities, as market yields increase, the price of previously issued securities declines. The logic is that investors will purchase fixed income securities only if they can receive a return comparable to the current market rate. This stock is paying an annual dividend of $5 ($1.25 per quarter times four). Investors will be most interested in this stock if their return will be approximately 10%, the current rate being paid in the market. The math here needs to first answer "$5 is 10% of what number?" Divide $5 by 10% and the answer is $50. At $50 per share, Aenical stock paying a $5 annual dividend is offering a 10% return on investment. LO 3.e

ABC Corporation offers statutory voting. At the upcoming annual meeting, it is announced that six people are running for the four available open seats on the board. An investor with 100 shares would be able to cast A) 600 votes on one of the individuals. B) 400 votes on one of the individuals. C) 100 votes for each of six individuals. D) 100 votes for each of four individuals.

D) 100 votes for each of four individuals. With statutory voting, the shareholder has one vote for each share and can use those votes for each open seat on the board. It is cumulative voting where the shareholder can lump votes to place on a single seat. Any of the other choices could be correct for cumulative voting. LO 3.c

A stockholder owns 200 shares of common stock in a corporation that features statutory voting. If an election is being held in which six candidates are running for three seats on the board, the stockholder could cast the votes in which of the following ways? A) 100 votes for each of six directors. B) 600 votes for any one director C) 300 votes for each of two directors. D) 200 votes for each of three directors

D) 200 votes for each of three directors A stockholder has one vote per seat for each share of stock he owns. Thus, in this case, the stockholder has a total of 600 votes. Under the statutory voting method, he must allocate an equal number to each seat, or 200 for each of three seats. LO 3.c

Investors in all of the following securities could receive dividend payments at an increased rate over time except A) common stock. B) adjustable-rate preferred stock. C) participating preferred stock. D) cumulative preferred stock.

D) cumulative preferred stock. The dividend rate on cumulative preferred stock is fixed. It is never more than the stated rate. The cumulative feature simply means that if there are skipped dividend payments, those must be made up before dividends may be paid on common stock. That is not considered an increase in the dividend rate. Adjustable-rate preferred stock has a dividend that adjusts based on market interest rates. In a period of increasing interest rates, the dividends will increase. Participating preferred stock has a tie-in to the common stock dividend. As companies become more profitable or the need for retaining earnings decreases, the common stock dividend tends to increase, and that increases the payout to the participating preferred shareholders. LO 3.e

Investing in ADRs presents certain risks that do not apply to investing in domestic stocks. One specific risk that applies only to ADRs is A) business risk. B) financial risk. C) market risk. D) currency risk.

D) currency risk. Because the ultimate value of the ADR is based on the underlying stock's value in its local currency, ADRs have currency risk. Both have market risk. You may not know business or financial risk, but you should know that currency risk is part of investing in ADRs. LO 3.g

A share of common stock in the hands of a stockholder carries with it certain rights. Among those rights is A) entitlement to receive profits through dividends when distributed but not the right to vote for who will serve on the board of directors. B) entitlement to receive profits through dividends when distributed and the right to vote for the amount of that dividend. C) a claim on the assets of the corporation second only to that of the company's secured creditors. D) entitlement to receive profits through dividends when distributed and the right to vote for who will serve on the board of directors.

D) entitlement to receive profits through dividends when distributed and the right to vote for who will serve on the board of directors. Each share of common stock entitles its owner to a portion of the company's earnings through dividends when distributed and a proportionate vote in major management decisions such as electing individuals to the board of directors (BOD). It is the board that determines the amount and frequency of dividend payments. The common stockholders' claim is behind everyone—they are last in line. LO 3.b

Many investors diversify by adding foreign securities to their portfolios. Those who do so by purchasing foreign stock mutual funds are least likely to be concerned with A) market risk. B) political risk. C) currency risk. D) liquidity risk.

D) liquidity risk. Because federal law requires mutual funds to offer redemption at net asset value within seven days of the request (in the real world, it is much quicker), liquidity risk is not a concern to this investor. Although the fund is trading in dollars and all distributions in the U.S. currency, the income to the fund comes through the foreign currency. That makes investors in the fund subject to the same currency risk as if they bought the stock directly. The foreign securities in the portfolio of the fund are subject to market risk and that directly affects the value of the fund shares. Political risk is always a concern when making foreign investments. Certainly, it is of less concern in the major developed countries, but we cannot compare that with the absence of liquidity risk. LO 3.g