Module 5 - FP513 | Alternative Investments & Derivatives

Two months ago, an investor purchased a call option trading for $3 with an exercise price of $30. The stock's market price was $32. What was the time value of the call option? A) $1 B) $2 C) $6 D) $3

A) $1 time value = option premium − intrinsic value = option premium − (stock's market price − exercise price) = $3 − ($32 − $30) = $1

Options with expiration dates more than two years out are categorized as A) LEAPS. B) REMICs. C) CMOs. D) GICs.

A) LEAPS. Long-term equity anticipation securities (LEAPS) are options with expiration dates extending beyond two years.

Select the INCORRECT statement regarding futures contracts. A) To complete a futures contract, the delivery of the commodity is required. B) Purchasing a contract for future delivery is considered taking a long position. C) Futures contracts may be written on financial assets or commodities. D) A short position will increase in value if the underlying commodity or asset declines in value.

A) To complete a futures contract, the delivery of the commodity is required. To complete the futures contract, delivery of the commodity may be made, but usually the holder will purchase an offsetting contract and cancel the original position.

John is traveling to Europe and has $2,000 that he wants to convert to euros. The current exchange rate is 0.68 euros = $1. How many euros will John receive in this exchange? A. 1,360 B. 1,500 C. 2,000 D. 3,360

A. 1,360 Determine the cost in U.S. dollars to purchase one euro. HP 10bII+: 0.68, gold, 1/x = $1.4706 Then, $2,000 ÷ $1.4706 = 1,360 euros, or $2,000 × 0.68 = 1,360 euros.

Mary is traveling to Europe and has $1,000 (U.S.) that she wants to convert to euros. The current exchange rate is 0.90 euros = $1 (U.S.). How many euros will she receive in this exchange? A) 1,800 B) 900 C) 1,111 D) 2,000

B) 900 Determine the cost in U.S. dollars to purchase one euro: 1 / 0.90 = $1.1111 Then, $1,000 ÷ $1.1111 = 900 euros or $1,000 × 0.90 = 900 euros

Your client is considering the purchase of an apartment complex with the following anticipated financial characteristics: Mortgage = 8% for 30 years, amortized monthly, with financing available for 70% of value Cost recovery period = 27.5 years (residential rental) Potential gross income (PGI) (year 1) = $1,500,000 Vacancy rate = 8% of PGI Operating expenses = 30% of PGI Capitalization rate = 9% Based on this information, what is the maximum price you would advise your client to pay? A) $16,666,667 B) $11,666,667 C) $10,333,333 D) $9,400,000

C) $10,333,333 The calculation is as follows: Potential gross income (PGI) of $1,500,000 less vacancy losses of $120,000 equals effective gross income of $1,380,000. Subtract operating expenses of $450,000, resulting in net operating income (NOI) of $930,000. Value = $930,000 ÷ 0.09 = $10,333,333

Interest in gold as an investment increases during periods of which of these? A) Economic growth B) Deflation C) Economic or political uncertainty D) Recession

C) Economic or political uncertainty Economic or political uncertainty causes the demand for gold to grow.

All of these positions are used to create a zero-cost collar except A) purchasing a put option on the stock. B) writing a call option on the stock. C) purchasing a call option on the stock. D) a long position in the stock.

C) purchasing a call option on the stock. To create a zero-cost collar, the investor will not purchase a call option on the stock. Rather, the investor will use the premium received from writing the call option to subsequently purchase the put option on the underlying stock, thereby creating a cashless collar and protection from downside risk.

What is the intrinsic value of a put option with an exercise price of $45, when the stock is selling for $40? A) $4 B) $50 C) $1 D) $5

D) $5 intrinsic value of a put option = (exercise price − market price) = ($45 − $40) = $5

Gold mining stocks are approximately how volatile in comparison to U.S. large-cap stocks? A) Cannot be determined B) Twice as volatile C) Equally volatile D) Half as volatile

B) Twice as volatile Gold mining stocks are roughly twice as volatile as large-cap U.S. stocks.

Which of the following statements describing the difference between a RELP and a REIT is CORRECT? A. A RELP is actively traded on a stock exchange. B. A REIT is a portfolio investment and generates investment income. C. A RELP is not subject to the passive income taxation rules. D. A REIT is managed by a general partner.

B. A REIT is a portfolio investment and generates investment income. In contrast, distributions from a RELP are subject to the passive income taxation rules. A RELP is managed by a general partner, whereas a REIT is managed by a board of directors. Some REITs are actively traded on the exchanges.

Which of the following risks would be of greatest concern to a holder of ADRs? I. Currency II. Liquidity III. Market IV. Purchasing power A. I and II B. I and III C. II and IV D. III and IV

B. I and III ADRs represent ownership in a foreign security that subjects the holder to currency risk. Since most ADRs are traded on the exchanges, they are subject to little liquidity risk, and, because they represent equity, they are usually a good hedge against inflation.

Trey is considering the purchase of American depositary receipts (ADRs). He is looking to further diversify his portfolio. Which of these is NOT a feature of this type of investment vehicle? A) ADRs are both liquid and marketable. B) Information regarding the foreign company is easily attainable. C) They are not subject to exchange rate, or currency, risk. D) ADRs are denominated and pay dividends in U.S. dollars.

C) They are not subject to exchange rate, or currency, risk. The answer is they are not subject to exchange rate, or currency, risk. Even though ADRs are denominated in U.S. dollars, they are subject to exchange rate, or currency, risk.

Baylor stock is currently selling for $63 per share. A call option for this stock with an exercise price of $65 per share may be purchased for a premium of $4. The option expires in three months. Which of the following terms best describes this option? A. In the money B. At the money C. Out of the money D. By the money

C. Out of the money The option is currently out of the money because the exercise price of the option ($65 per share) is currently greater than the current market price of the stock ($63 per share). Therefore, the option will not be exercised unless the market price increases to more than $65 per share within the three-month period.

Choose the statement that best describes a real estate investment trust (REIT). A) A REIT is an agreement between two parties to make or take delivery of a specified amount of a financial asset at a future time, place, and unit price. B) A REIT is a self-liquidating, flow-through entity that invests exclusively in real estate mortgages or mortgage-backed securities. C) Similar to open-end investment companies, REITs are redeemed directly by the issuer at a price determined by the investment company minus a sales commission. D) A REIT is a closed-end investment company investing in real estate, short-term construction loans, or mortgages.

D) A REIT is a closed-end investment company investing in real estate, short-term construction loans, or mortgages. Similar to closed-end investment companies, some REITs are publicly traded on the exchanges and can sell at premiums or discounts to net asset value. Also, REIT investors achieve diversification and marketability that is generally lacking with real estate limited partnerships (RELPs).

Select the CORRECT statement regarding foreign investments. A) Investing directly in a foreign company's shares is a convenient way for the individual investor to diversify a portfolio. B) Eurobonds are commonly used by U.S. companies to finance imports and exports. C) Global mutual funds invest exclusively in foreign securities. D) American depositary receipts (ADRs) pay dividends in U.S. currency.

D) American depositary receipts (ADRs) pay dividends in U.S. currency. Global mutual funds invest in both U.S. and foreign securities. Direct investment in foreign companies is inconvenient. Banker's acceptances are used to finance imports and exports.

Which of the following are characteristics of collectibles investments that distinguish them from financial investments? I. The market is relatively inefficient. II. The capital gain is taxed at a maximum rate of 20%. III. There are large spreads between bid and ask prices. IV. There is little liquidity risk. A) I, II, and III B) II, III, and IV C) I, II, III, and IV D) I and III

D) I and III Collectibles are taxed at a maximum capital gain rate of 28%, compared to the 20% maximum rate on financial assets. Liquidity is a major risk in collectibles, since there is no active market for the assets.

If the intrinsic value of a call option is $3, which of these statements is CORRECT? A) The option is at-the-money. B) The option is out-of-the-money. C) The option is covered. D) The option is in-the-money.

D) The option is in-the-money. When the intrinsic value of an option is positive, the option is in-the-money.

Which of these best describes a futures contract? A) A futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset at a future time, place, and unit price. B) A futures contract is a derivative characterized by low risk and the potential for high return. C) A futures contract seeks to invest in an industry sector or index that is undervalued, but is expected to rise in value in the future. D) A futures contract is a self-liquidating, flow-through entity that invests exclusively in mortgage-backed securities.

A) A futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset at a future time, place, and unit price. To complete the futures contract, delivery of the commodity or asset may be made, but more often, the buyer (or holder) simply purchases an offsetting contract and cancels the original position.

Which of these statements regarding a real estate mortgage investment conduit (REMIC) is CORRECT? I. A REMIC is a self-liquidating, flow-through entity that invests exclusively in real estate mortgages or mortgage-backed securities. II. A REMIC terminates when the mortgages that constitute the investment of the REMIC are repaid. A) Both I and II B) II only C) I only D) Neither I nor II

A) Both I and II REMICs are often structured to offer classes of bonds that mature over a period of 3-30 years. Accordingly, investors may invest in bond classes that match their investment time horizon and avoid the uncertainty of bond principal repayment.

Which of these strategies is considered a protective strategy? A) Buying a put option on a stock already owned B) Buying stock index futures C) Purchasing a hedge fund D) Purchasing a call option on a stock already owned

A) Buying a put option on a stock already owned A protective strategy limits downside risk. The purchase of a put option on a stock that is already owned reduces downside risk. If the price of a stock declines, the value of the put option increases and protects an investor holding a long position in the underlying stock.

Which of the following are advantages of investing internationally? I. Some international markets are less efficient than U.S. markets. II. International mutual funds do not have the exchange rate risks of individual foreign stocks. III. Due to lower correlations with U.S. stocks, foreign stocks can lower total portfolio risk. IV. Investors in foreign securities avoid U.S. tax on realized capital gains. A) I and III B) I, III, and IV C) I and II D) II and IV

A) I and III Portfolio standard deviation is highly dependent on the covariance of returns. The covariance of foreign stocks with U.S. stocks is relatively low, serving to lower the standard deviation of the portfolio into which such stocks are placed. Exchange rate risk is a constant threat to a foreign stock or bond investment in any form, including mutual funds. Foreign security income is taxed first in the country of origin and then again in the United States. U.S. taxpayers can take a foreign tax credit on their U.S. return for the taxes paid to other countries.

Which of these are characteristics of foreign currency exchange? I. When a strong foreign currency is converted into U.S. dollars, more dollars are received than if the foreign currency had stayed stable or declined. II. An increase in the supply of a currency results in its devaluation. III. A U.S. investor in foreign assets would want the U.S. dollar to strengthen against foreign currencies after the assets are purchased. IV. When the U.S. dollar weakens against a foreign currency, the total return increases to a U.S. investor holding stocks denominated in that currency. A) I, II, and IV B) II, III, and IV C) II and IV D) I and III

A) I, II, and IV When an investor has money invested in a foreign stock, the investor should want the dollar to decline relative to the foreign currency so that a currency gain occurs in addition to the security gain. Currencies are subject to the same supply/demand rules that apply to goods and services and to the money supply. Increasing supply results in decreasing price of the currency.

Which of the following statements assessing derivative securities is CORRECT? I. A call option is at the money when the exercise price is less than the market price of the stock. II. A put option is at the money when the exercise price is greater than the market price of the stock. III. Buyers of calls are betting that the price of the underlying common stock will rise, making the call option more valuable. IV. Put buyers are betting that the price of the underlying common stock will decline, making the put option more valuable. A) III and IV B) I and II C) I, II, and IV D) II and III

A) III and IV Statements I and II are incorrect because both call and put options are at the money when the exercise price equals the market price of the stock.

A major source of systematic risk when investing in foreign securities is exchange rate risk. To minimize the effect of exchange rate risk, an investor can hedge with currency futures. Which of the following illustrate appropriate times for an investor who owns a foreign security to hedge? I. The foreign security is expected to rise in price and the dollar is expected to fall relative to the foreign currency. II. The foreign security is expected to remain relatively stable in price and the dollar is expected to fall relative to the foreign currency. III. The foreign security is expected to fall in price and the dollar is expected to rise relative to the foreign security. IV. The foreign security is expected to fall in price and the dollar is expected to remain relatively stable relative to the foreign security. A) III only B) II only C) I and IV D) I and III

A) III only A hedge should be initiated if the U.S. dollar is expected to rise; it is not needed if the dollar is expected to fall or remain relatively stable.

Which of these statements regarding basic option positions is CORRECT? A) If an investor sells a put, the maximum loss is the exercise price less the amount of premium received. B) If an investor buys a call, the maximum loss is unlimited. C) If an investor buys a put, the maximum gain is unlimited. D) If an investor sells a call, the maximum loss is the amount of the premium received.

A) If an investor sells a put, the maximum loss is the exercise price less the amount of premium received. If an investor buys a put, the maximum gain is the exercise price less the premium paid. If an investor sells a naked call, the maximum loss is unlimited. If an investor buys a call, the maximum loss is the premium paid.

Which of these is a disadvantage of a REIT investment? A) No flow-through of tax benefits B) Double taxation of REIT income C) No limited liability for the REIT shareholder D) A lack of knowledgeable professionals as managers

A) No flow-through of tax benefits Tax losses cannot be passed on to REIT investors.

George owns 1,000 shares of XYZ stock. Based on recent analyst projections and George's own research, he believes XYZ's price will remain flat over the next few months. Accordingly, which strategy would George likely employ if one of his objectives was to increase his portfolio's income stream? A) Sell 10 XYZ call option contracts B) Buy an index future C) Buy a warrant D) Buy 10 XYZ put option contracts

A) Sell 10 XYZ call option contracts This is known as the covered call strategy and is used to increase the income of the portfolio when the price of the underlying stock is expected to remain flat for a period of time. Assuming the price of the underlying stock continues to remain flat, there is little chance of the option being exercised and the stock being called away.

Mary owns a put option with an exercise price of $20 per share. The option is currently trading for $0.53 and the underlying stock is currently trading for $19.67 per share in the secondary market. Based on this information, select the INCORRECT statement. A) The option is out-of-the-money. B) The option has a time value of $0.20. C) The option has an intrinsic value of $0.33. D) The put option allows Mary to sell the underlying stock for a specified price within a specified period.

A) The option is out-of-the-money. The option is in-the-money because the option has a positive intrinsic value. The option has an intrinsic value of $0.33 ($20.00 - $19.67) and a time value of $0.20 ($0.53 - $0.33).

An investment, such as an option, whose value is based on that of another security is classified as A) a derivative. B) an equity. C) a collectible. D) a tangible asset.

A) a derivative. An investment whose value is based on that of another security is a derivative. Examples of derivatives include options, futures, and warrants.

One of the characteristics of real estate investment trusts (REITs) is that they generally A) have a high degree of marketability. B) offer new shares continually to investors. C) pay federal income tax on their earnings. D) reinvest most of their income.

A) have a high degree of marketability. Therefore, an investor in real estate can generally expect some difficulty in converting a property to cash if cash is needed quickly. However, a REIT securitizes real estate properties, thereby allowing REIT investors to easily sell REIT shares in the open market. REITs must flow through at least 90% their income to investors; therefore the investors and not the REITs pay tax on these distributions.

An investor who creates a long straddle most likely expects the underlying security to A) increase in volatility. B) decrease in volatility. C) increase in price. D) remain near its current price.

A) increase in volatility. Long straddle profits if the volatility of the underlying security increases more than is reflected in current option prices, which would increase the value of both the call option and the put option. Either a significant increase or a significant decrease in the underlying price would benefit the holder of a long straddle. If the investor was expecting only an increase in price, long call would be a better choice of investment (as the premium paid on the long put would be a waste).

The minimum price at which an option will trade on an exchange is identified as the A) intrinsic value. B) future value. C) premium. D) exercise price.

A) intrinsic value. The minimum price at which an option will trade on an exchange is known as the intrinsic value.

Lisa is considering investing in timberland. She owns a portfolio of stocks, bonds and money market securities. Relative to her existing portfolio, the primary benefit of the timberland investment is most likely A) low correlation between traditional asset returns and timberland returns. B) timber values are tied to cyclical industries. C) the investment horizon is longer than that of stocks and bonds, balancing the duration of the portfolio. D) timber is a renewable resource so Lisa can profit from the land for many years.

A) low correlation between traditional asset returns and timberland returns. Timberland returns exhibit low correlation with stock and bond returns. This is generally cited as the key advantage to investing in timber. However, it is difficult to measure the returns to illiquid assets such as timber so the low correlation may be more a function of poor measurement of returns and less a function of true uncorrelated or negatively correlated returns. Cyclicality and a long investment horizon are disadvantages of timberland investments. Timber is a renewable resource but that would not be the key advantage in a traditional asset portfolio.

ADM needs large quantities of soybeans in the future for use in manufacturing products. Which of the following investment strategies should ADM employ to hedge its risk? A. ADM should buy soybean futures to hedge against higher soybean prices. B. ADM should sell soybean futures to hedge against lower soybean prices. C. ADM should sell soybean futures to hedge against higher soybean prices. D. ADM should buy soybean futures to hedge against lower soybean prices.

A. ADM should buy soybean futures to hedge against higher soybean prices. ADM needs, or is short, soybeans. Therefore, the company should buy soybean futures (take an opposite position) to hedge against higher soybean prices. This is referred to as a long hedge.

Which of the following subjects the investor to the greatest possible loss? A. Selling a naked call option B. Selling a covered call C. Buying a put option D. Buying a call option

A. Selling a naked call option The most risky transaction is selling a naked call option. The loss when purchasing any type of option (call or put) is limited to the option premium paid. However, selling a naked call option exposes the investor to an unlimited loss because there is no limit to how much the underlying stock price can increase in the secondary market.

Alex owns a put option with an exercise price of $51. The underlying stock is currently trading at $48 in the secondary market. Assuming the put option is currently trading at $6 and has three months until expiration, calculate the intrinsic value of the put option. A) $100 B) $300 C) -$400 D) -$600

B) $300 The price the put option is currently trading at in the secondary market and the premium paid for the put option are both ignored when determining the intrinsic value of the put option. The two factors that matter are the exercise price of the put option and the price that the underlying stock is currently trading at in the secondary market. Therefore, the intrinsic value of this put option is $300 ($51 − $48 × 100 shares), which is the exercise price of the put option minus the price the underlying stock is currently trading at in the secondary market multiplied by 100 shares. Each option contract represents 100 shares of the underlying stock.

Larry is looking to add a real estate investment to his portfolio that is publicly traded on the exchanges, thereby offering him diversification and marketability. He has decided that a real estate investment trust (REIT) is the best choice and asks his financial planner for information about the REITs available for purchase. Based on Larry's request, the financial planner explained the various investment choices. Which of these was incorrectly stated by his financial planner? A) Equity REITs acquire real estate for the purpose of renting the space to other companies, thereby generating income. B) For the shareholders, income received is considered passive income. C) Hybrid REITs are a combination of equity REITs and mortgage REITs. D) Mortgage REITs finance real estate ventures by making loans to develop property or finance construction.

B) For the shareholders, income received is considered passive income. For REIT shareholders, income received is considered investment (not passive) income. Similar to a closed-end investment company, a REIT invests in real estate, short-term construction loans, and mortgages. Some REITs are publicly traded on the exchanges and may sell at a premium or discount to net asset value. As a result, the REIT investor achieves diversification and marketability.

Your clients have invested in a variety of mutual funds, including foreign country funds. You expect the U.S. dollar to strengthen against the Japanese yen over the next year. Which of these actions would be most appropriate? A) Hedge by taking a long position in yen futures. B) Hedge by taking a short position in yen futures. C) Sell the Japanese mutual funds. D) Purchase additional Japanese mutual funds.

B) Hedge by taking a short position in yen futures. Fluctuating currency rates alone are not good reason to sell or purchase country funds. The performance of the funds might exceed the currency loss by a substantial amount.

Which of the following statements regarding a straddle is CORRECT? I. An investor who writes a short straddle expects that the underlying stock's price will not change or change very little. II. A straddle is an options strategy combining the use of a call option and a put option with different exercise prices and expiration dates. A) Neither I nor II B) I only C) II only D) Both I and II

B) I only A straddle is an options strategy combining the use of a call option and a put option with the same exercise price and expiration date.

Which of these statements regarding option pricing models is CORRECT? I. The binomial option pricing model assumes that the price of the option will change constantly because the market price of the underlying security also changes constantly. II. The Black-Scholes option valuation model is designed to determine the price of an American call option. III. The Black-Scholes option valuation model assumes that the price of the option will change in discrete increments on the basis of movements (up or down) in the price of the underlying stock. IV. The binomial model assumes the call option being valued has an exercise price of $100. A) I, II, and III B) IV only C) I and IV D) II, III, and IV

B) IV only The Black-Scholes option valuation model assumes that the price of the option will change constantly because the market price of the underlying security also changes constantly and is designed to determine the price of a European call option. The binomial option pricing model assumes that the price of the option will change in discrete increments on the basis of movements (up or down) in the price of the underlying stock.

Which of these statements describing real estate limited partnerships (RELPs) is CORRECT? A) Interests in RELPs are generally traded in the secondary market. B) Income attributed to limited partners is considered passive income for income tax purposes. C) An individual may be the sole owner of a RELP. D) Limited partners have limited management responsibilities.

B) Income attributed to limited partners is considered passive income for income tax purposes. Real estate limited partnerships (RELPs) are composed of at least two partners. Limited partners do not have any management responsibilities, and income attributed to them is treated as passive income by the IRS. RELPs are not publicly traded.

Which of the following are reasons an investor might buy a stock index call option instead of an individual stock call option? A) The investor is more confident about the performance of an individual stock than the market as a whole. B) It is the best way to be fully diversified against unsystematic risk. C) It reduces the level of systematic risk. D) The investor wants to hedge his existing stock portfolio against a market decline.

B) It is the best way to be fully diversified against unsystematic risk. Buying an index option means the risk associated with any one company (business risk) is avoided. An index option can be used to participate in a broad market advance, but still has systematic risk. One would buy a put to hedge against a market decline.

Which of these combinations of events is likely to cause the largest loss on a transaction for a German investor who invests in a Japanese stock? Gain/Loss on Japanese Stock | Gain/Loss on Euro vs. Yen A. 5% gain | 10% devaluation of euro vs. yen B. 5% loss | 10% revaluation of euro vs. yen C. 5% gain | 10% revaluation of euro vs. yen D. 5% loss | 10% devaluation of euro vs. yen A) Option D B) Option B C) Option C D) Option A

B) Option B One of the options with the 5% loss on the stock is likely to provide the largest loss if there also is a loss on the currency translation. When a German investor buys a Japanese stock, he or she wants the euro to depreciate against the yen; therefore, a revaluation of the euro vs. the yen will cause a currency loss in addition to the stock loss, providing the greatest overall loss.

An investor who is interested in developing a portfolio of collectibles should probably do which one of these? A) Buy relatively inexpensive collectibles B) Specialize in a type of collectibles C) Avoid buying through knowledgeable dealers D) Diversify over a variety of types of collectibles

B) Specialize in a type of collectibles Specializing in a type of collectible would give an investor a better knowledge of that collectible and its market direction and worth.

On January 1, one U.S. dollar could buy 105 Japanese yen; on December 31 in the same year, one U.S. dollar could buy 121 Japanese yen. Which one of these statements best illustrates what happened to the U.S. dollar during the year? A) The U.S. dollar was above parity. B) The U.S. dollar was revalued. C) The U.S. dollar was devalued. D) The U.S. dollar was hedged.

B) The U.S. dollar was revalued. A revaluation occurs to a U.S. investor when the U.S. dollar can buy more of a foreign currency today than it could buy last year. A devaluation occurs when the U.S. dollar can buy less of a foreign currency today than it could buy last year.

You are about to invest in foreign mutual funds and have decided to invest in country funds as opposed to a single diversified international mutual fund. Your single biggest concern is the fact that the U.S. dollar has been rising dramatically against the currency of this country. Which of the following points is most important? A) The correlation between the foreign market and the U.S. market should be as low as possible. B) The foreign currency should be fully hedged. C) If the U.S. mutual funds hold only large-cap stocks, the foreign funds should include only small-cap stocks. D) The correlation between the foreign market and the U.S. market should be as high as possible

B) The foreign currency should be fully hedged. To achieve the greatest diversification benefits of investing in foreign securities, or any securities for that matter, the correlation coefficients between the two markets should be as low as possible—generally close to zero or negative, but hedging the foreign currency will eliminate exchange rate risk and allow the investor to focus only on the fundamentals of investing in that country's stock market. Diversifying with different investment styles and market caps is important, but not as critical to addressing his primary concern of the rising dollar.

The exercise price of a put is $25 and the market price of the stock is $18. Which of the following statements is true? A) The put is out of the money. B) The put is in the money. C) The put is a covered put. D) The put is a naked put.

B) The put is in the money. An investor who purchases a put option makes a profit only if the market price of the stock is lower than the exercise (strike) price of the option. Until the market price drops below the strike price, the option is said to be out of the money. It is in the money when the market price drops below the strike price. This put is in the money by $7.

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) Transactions are done on an organized exchange in the United States. D) They allow U.S. investors to buy foreign country stock denominated in dollars.

B) They eliminate exchange rate risk. ADRs are priced in U.S. dollars and therefore have exchange rate risk.

All of these statements describing real estate mortgage investment conduits (REMICs) are correct except A) REMICs commonly issue bonds backed by a pool of mortgages. B) investors receive a variable cash flow from the underlying real estate mortgages. C) REMICs are self-liquidating flow-through entities. D) Tranche A of a collateralized mortgage obligation (CMO) has the least amount of interest rate risk of all CMO tranches.

B) investors receive a variable cash flow from the underlying real estate mortgages. Investors who own REMICs receive a specified cash flow from the underlying pool of mortgages. REMICs are self-liquidating pass-through entities that invest exclusively in mortgages and mortgage-backed securities. REMICs frequently issue bonds in the form of collateralized mortgage obligations, which divide payment streams into tranches. Investors in Tranche A receive principal payments first, which reduces their interest rate risk, when compared to other tranche investors.

Reasons for investing in real estate include all of these except A) potential tax shelter. B) liquidity. C) potential long-term appreciation. D) relatively constant cash flow.

B) liquidity. Real estate is an illiquid investment. Real estate offers the ability to shelter an investment's cash flow. Income real estate provides a relatively dependable source of cash flow. Real estate offers investors an excellent source of long-term capital appreciation.

Dale is concerned about a decline in the stock market. He has many holdings in growth stock mutual funds and would like to diversify his portfolio into an investment that offers a hedge against a bearish market. Which of the following investments would be the most appropriate for Dale? A. Fine art and paintings B. Gold coins C. Oil and gas futures D. Savings bonds

B. Gold coins Precious metals derive their value from factors that are external to the financial markets. As a result, the price of precious metals often moves inversely (i.e., has a negative correlation) with the market prices of stocks. Therefore, investing in gold coins may be used as a hedge against a declining, or bearish, stock market.

Which of these best describes a real estate mortgage conduit (REMIC)? A) None of these describes a REMIC. B) Like other open-end companies, a REMIC issues shares that are redeemed directly by the issuer. C) A REMIC is a self-liquidating, flow-through entity that invests exclusively in real estate mortgages or mortgage-backed securities. D) A REMIC is an agreement between two parties to make or take delivery of a specified amount of a financial asset at a future time, place, and unit price.

C) A REMIC is a self-liquidating, flow-through entity that invests exclusively in real estate mortgages or mortgage-backed securities. Typically, a REMIC issues debt securities to investors in the form of publicly traded REMIC bonds. A futures contract is an agreement between two parties to make or take delivery of a specified amount of a commodity or financial asset at a future time, place, and unit price.

Jim is a paper maker who purchases lumber from tree farmers around his state. Which of these hedge positions should Jim consider if he is concerned with rising lumber prices? A) A short hedge; Jim should buy lumber futures contracts to protect against rising lumber prices. B) A short hedge; Jim should sell lumber futures contracts to protect against rising lumber prices. C) A long hedge; Jim should buy lumber futures contracts to protect against rising lumber prices. D) A long hedge; Jim should sell lumber futures contracts to protect against rising lumber prices.

C) A long hedge; Jim should buy lumber futures contracts to protect against rising lumber prices. The answer is a long hedge; Jim should buy lumber futures contracts to protect against rising lumber prices. A long hedge uses a long futures position to hedge a short position (purchasing lumber).

The portfolio manager of XYZ Insurance Co. is considering the use of Treasury bond futures to hedge the portfolio of the company. XYZ has a Treasury bond portfolio worth over $500 million. Into what type of hedge position should XYZ enter, and why? A) A short hedge: The company should sell Treasury bond futures contracts because it is hedging against lower interest rates. B) A long hedge: The company should buy Treasury bond futures contracts because it is hedging against lower interest rates. C) A short hedge: The company should sell Treasury bond futures contracts because it is hedging against higher interest rates. D) A long hedge: The company should buy Treasury bond futures contracts because it is hedging against higher interest rates.

C) A short hedge: The company should sell Treasury bond futures contracts because it is hedging against higher interest rates. If interest rates rise, there is a loss on the cash side (i.e., bond prices drop); however, there is a gain on the futures side because the short position can be covered at a lower price. When you own something and want to hedge, you must short; when you are short something and want to hedge, you must buy.

Mike expects a certain stock to significantly rise in value in the near future. He is expecting a bond to mature in two months and does not want to miss out on any appreciation on the stock while waiting for the funds to become available. Which of these option strategies should be recommended to Mike? A) Buy a put option B) Sell a call option C) Buy a call option D) Sell a put option

C) Buy a call option Mike can lock in the price of the stock by purchasing a call option with an expiration date exceeding two months.

Jay has recently learned that foreign investments are a good way to diversify a portfolio. Select which of these statements regarding the risks and benefits of foreign investments, specifically American depositary receipts (ADRs), is CORRECT. A) Because ADRs are only available through private placements, they are relatively illiquid and nonmarketable investments. B) ADRs are receipts for investments placed with foreign mutual funds. C) Foreign taxes paid on income earned from an ADR are eligible for the foreign tax credit. D) ADRs are free of exchange rate risk but are subject to market risk.

C) Foreign taxes paid on income earned from an ADR are eligible for the foreign tax credit. Although ADRs are dollar denominated, they are still subject to exchange rate risk because the dividends are declared in the local currency and converted to U.S. dollars. ADRs are receipts for shares of a foreign company, not shares of a mutual fund. Because ADRs are traded in the secondary market, they are relatively liquid and marketable investments. Foreign taxes paid are eligible for the foreign income tax credit.

You are about to recommend international mutual funds to your clients. Which of the following are characteristics of investing internationally? I. International markets are less efficient than U.S. markets. II. International mutual funds have the exchange rate risks of individual foreign stocks. III. Due to lower correlations with U.S. stocks, foreign stocks can lower total portfolio risk. IV. Investors in foreign securities avoid U.S. tax on realized capital gains. A) I and II B) II, III, and IV C) I, II, and III D) I and III

C) I, II, and III Foreign markets have fewer analysts following stocks than do U.S. markets, and the information available from many foreign companies is minimal, making these markets less efficient than U.S. markets. The covariance of foreign stocks, especially small-cap and emerging market stocks, with U.S. stocks is relatively low, serving to lower the standard deviation of the portfolio in which such stocks are placed. Exchange rate risk is a systematic risk with foreign investments. Foreign income is taxed first in the country of origin and then again in the United States; U.S. taxpayers can take a foreign tax credit for taxes paid to other countries.

Which of these statements concerning the principles of real estate investing is CORRECT? I. Investors in undeveloped land are seeking returns primarily from capital appreciation. II. Effective real estate investing almost always involves a careful but extensive use of leverage. III. Investors in real estate are usually seeking tax benefits for mortgage interest, property taxes, and depreciation. IV. Generally, investors in developed land experience significant taxable income in the early years of ownership. A) I, III, and IV B) IV only C) I, II, and III D) II and III

C) I, II, and III Only Statement IV is incorrect. Investors in real estate experience little taxable income in the early years due to depreciation.

American Depositary Receipts (ADRs) are used to I. finance foreign exports. II. eliminate currency risk. III. sell U.S. securities in overseas markets. IV. trade foreign securities in U.S. markets. A) I and IV B) I, II, and III C) IV only D) II and IV

C) IV only ADRs are used to trade foreign securities in the United States. ADRs are trust receipts issued by a U.S. bank for shares of a foreign company that are held by a foreign branch of the bank. ADRs are legal claims against the equity interest that the bank holds. ADRs do not eliminate currency risk.

Baylor stock is currently selling for $63 per share. A put option for this security with an exercise price of $65 per share can be purchased for $4 per share. The option expires in three months. Which of these statements best describes this option? A) By-the-money B) At-the-money C) In-the-money D) Out-of-the-money

C) In-the-money A put option is in-the-money when the exercise price is greater than the market price of the underlying security. A put option is out-of-the-money when the market price is greater than the exercise price.

Identify the CORRECT statement concerning international investing. A) The rates of return on foreign securities have always been less than those available from U.S. markets. B) Foreign markets are usually mature and offer no growth advantages. C) Information is not as readily available on foreign investments. D) The addition of foreign securities to a portfolio may result in increased portfolio risk due to the different movements of foreign markets and U.S. markets.

C) Information is not as readily available on foreign investments. Foreign markets offer economies of scale and growth opportunities. Investors may earn higher returns in foreign markets, particularly if they are less efficient than U.S. markets. Including foreign securities in an investment portfolio may lower risk through greater diversification.

Which of these statements regarding index options is NOT correct? A) Investors can profit from a decline in the stock market by purchasing a put index option. B) When exercised, index options result only in cash settlement. C) Investors often buy call index options to hedge against the risk of a decline in the value of their long positions in stocks. D) Index options allow investors to earn a return associated with the movements in the market.

C) Investors often buy call index options to hedge against the risk of a decline in the value of their long positions in stocks. Investors purchase put index options to hedge their long positions in stocks. A decline in stock prices causes the value of their long portfolios to decline. This loss is offset by the gain in the value of the option.

Which of these represents the best reason to include real estate as part of an investment portfolio? A) High liquidity B) Low potential for capital appreciation C) Low correlation between real estate and equity investments D) Low management costs

C) Low correlation between real estate and equity investments Real estate's low correlation with equities provides investors with an additional way to diversify a portfolio. Real estate ownership may present an opportunity for capital appreciation. Investment in real estate generally requires substantial management costs and is not liquid.

Which of these is a reason why tangible assets are an excellent addition to an investment portfolio? A) High liquidity of the investments B) Low cost of buying tangible assets C) Low correlations with financial assets D) Tax benefits

C) Low correlations with financial assets Tangible assets have low correlations with financial assets.

Choose the REITs that are used to finance real estate ventures that develop property or finance construction. A) Equity REITs B) Hybrid REITs C) Mortgage REITs D) Government REITs

C) Mortgage REITs Mortgage REITs are in the business of financing real estate ventures. They make loans to develop property or finance construction.

Which of the following best illustrates characteristics of mortgage and equity real estate investment trusts (REITs)? Mortgage REITs | Equity REITs A. Generates capital gains | Generates interest income B. Generates rental income | Generates capital gains C. Similar to a bond fund | Similar to a stock fund D. Also known as a FREIT | Also known as a hybrid REIT A) Option D B) Option A C) Option C D) Option B

C) Option C Equity REITs own property and receive all income from the property rentals, making them more like a stock fund; they also are more volatile than mortgage REITs, and they provide more capital gain opportunity then do mortgage REITs. Mortgage REITs own the mortgages used to finance real estate properties, making them more like a bond fund.

Assume an option writer buys a stock for $75 and immediately sells a call option on the stock for a premium of $5 at a strike price of $75. What is the maximum gain to the call writer and the maximum loss to the call buyer? Maximum Gain to Call Writer | Maximum Loss to Call Buyer A. $5 | $80 B. $80 | $5 C. $80 | $80 D. $5 | $5 A) Option C B) Option B C) Option D D) Option A

C) Option D The maximum gain for the option writer is the call premium received; the maximum loss for the option buyer is the call premium paid.

Which statement regarding single-country, closed-end funds is NOT correct? A) After the initial public offering, the fund will generally not issue additional shares. B) Capital appreciation is the primary objective of single-country funds. C) Single-country funds trade at the fund's NAV. D) Professional management of the fund and portfolio diversification within the selected market are available with single-country funds.

C) Single-country funds trade at the fund's NAV. Single-country funds are closed-end funds and, like other closed-end funds, generally trade at a discount to NAV.

Currently it costs $1.47 in U.S. dollars to purchase one Eurodollar. If a U.S. investor purchases euros, what would be the result for this investor if the exchange rate were to be 0.70 euros per U.S. dollar when the euros were converted back into U.S. dollars? A) The U.S. investor would have lost money, because the U.S. dollar has been devalued. B) The U.S. investor would have made money, because the U.S. dollar has been revalued. C) The U.S. investor would have lost money, because the U.S. dollar has been revalued. D) The U.S. investor would have made money, because the U.S. dollar has been devalued

C) The U.S. investor would have lost money, because the U.S. dollar has been revalued. The key here is to compare apples to apples and state the currency rate from the same perspective. You are given how many U.S. dollars are needed to purchase a euro ($1.47), so calculate how many euros you would receive for one U.S. dollar: 1/ $1.47 = 0.6803 euros per U.S. dollar You are told the rate has changed to 0.70 euros per U.S. dollar, and before it was 0.68 euros per U.S. dollar. This means the investor needs to spend more euros for one U.S. dollar—so the euro is worth less (devaluation), and the U.S. dollar is worth more (revaluation). In order to make money on a currency transaction, the home currency (the U.S. dollar in this case) needs to go down (devaluation), and the foreign currency needs to go up (revaluation). The opposite has happened in this case, so the U.S. investor has lost money because the U.S. dollar has gone up in value (revalued).

A Japanese bank has decided to use some of its U.S. dollar reserves, resulting from the U.S. merchandise trade deficit with Japan, to invest in U.S. Treasury bonds. The U.S. Treasury securities pay approximately 6% interest, compared to 2% interest paid on Japanese bonds. For the Japanese bank to retain at least this differential in interest income, which of these situations in the foreign exchange market would have to occur? A) The yen would have to appreciate relative to the dollar and interest rates in the United States would have to fall. B) The yen would have to appreciate relative to the dollar during the holding period of the bond. C) The yen would have to depreciate or remain steady relative to the dollar during the holding period of the bond. D) The yen would have to depreciate relative to the dollar and interest rates in the United States would have to rise

C) The yen would have to depreciate or remain steady relative to the dollar during the holding period of the bond. When an investor in Country A invests in a security in Country B, the investor benefits if Country A's currency depreciates relative to Country B (or Country B's currency appreciates relative to Country A). Because rising interest rates cause bond prices to decline, the best possible scenario would be for the yen to depreciate and for U.S. interest rates to fall. This would give both a capital gain and a currency gain.

All of these statements correctly describe international investing except A) an international investor faces the additional risks of foreign currency risk and country risk. B) international investing offers diversification and potentially higher returns. C) an emerging market is a market in a highly developed foreign economy with stable political and social institutions. D) one method to engage in international investing is through American depositary receipts.

C) an emerging market is a market in a highly developed foreign economy with stable political and social institutions. Emerging markets are markets in lesser developed countries.

The daily limit of a commodity futures contract is the maximum A) amount by which the maintenance margin can change per day. B) number of contracts allowed to be traded that day. C) price increase or decrease relative to the settlement price the previous day. D) percentage by which the futures price can increase from the previous day.

C) price increase or decrease relative to the settlement price the previous day. This is the definition of the daily limit.

A wheat farmer would hedge by _____________ wheat futures; a bread manufacturer would hedge by ________________ wheat futures; a speculator would _________ a wheat futures contract if he believes the price of wheat may rise; and a speculator would __________ a wheat futures contract if he believes the price of wheat may fall. A) buying; shorting; buy; short B) buying; shorting; short; buy C) shorting; buying; buy; short D) shorting; buying; short; buy

C) shorting; buying; buy; short A wheat farmer would hedge by shorting wheat futures; a bread manufacturer would hedge by buying wheat futures; a speculator would buy a wheat futures contract if he believes the price of wheat may rise; and a speculator would short a wheat futures contract if he believes the price of wheat may fall.

A collateralized mortgage obligation (CMO) differs from other mortgage-backed securities in that the cash flows associated with the CMO's pool of underlying mortgages are divided into repayment periods known as A) conversion privileges. B) pre-retirement provisions. C) tranches. D) guaranteed remittance provisions.

C) tranches. A CMO differs from mortgage-backed securities in that the cash flows associated with the CMO's pool of underlying mortgages are divided into repayment periods known as tranches.

An investor might use a stock index option instead of an individual stock option if the investor A) wants to reduce the level of systematic risk. B) wants to reduce the level of market risk. C) wants to avoid business risk. D) is proficient at stock selection. Explanation

C) wants to avoid business risk. Buying an index option means the risk associated with any one company (business risk) is avoided. An index option can be used to protect against market or sector swings, and the investor need not be concerned with individual companies.

Roger is interested in purchasing a commercial real property investment currently offered for $2 million. He will finance the investment by taking out a $1.5 million loan, on which the debt service will be $9,000 per month. The real property will be depreciated using the straight-line depreciation method at $6,000 per month. Roger has determined that the gross rental receipts from the property will be $25,000 per month and that the vacancy and collection losses will be estimated at 5% of potential gross income (PGI). Operating expenses will be $12,000 per month. What is the monthly NOI of Roger's potential investment? A. $2,750 B. $8,750 C. $11,750 D. $13,000

C. $11,750 The monthly NOI of Roger's potential commercial real property investment is $11,750, computed as follows: Gross rental receipts: $25,000 − vacancy and collection losses (5% of PGI, or $1,250) = effective gross income: $23,750 − operating expenses (*$12,000) = NOI of $11,750 *Operating expenses do not include debt service or depreciation expense.

An investor sells (writes) a call option with an exercise price of $45 on KRF stock for $2.50. The option expires when the stock is trading at $44.50. What is the investor's gain or loss? A. $50 gain B. $50 loss C. $250 gain D. $250 loss

C. $250 gain This option was allowed to expire because it was out of the money. When the option expires, the investor's gain is the amount of premium received, or $250 ($2.50 × 100 shares). Recall each option contract represents 100 shares of underlying stock.

All of the following are factors used in determining the price of a call option under the Black-Scholes option valuation model except A. time to expiration. B. risk-free rate. C. call money rate. D. exercise price.

C. call money rate. The call money rate is a rate of interest charged by broker-dealers on borrowed money and is not a factor used in determining the price of a call option under Black-Scholes.

Which of the following statements are true regarding risk and return for tangible investments? I. Unsystematic risk tends to be high with most forms of tangible assets. II. High cash flows from collectibles create annual taxable events. III. The illiquid nature of the investments makes them suitable for income-seeking investors. IV. The capital gains rate on collectibles is greater than that of other investments. A) II and III B) I only C) I and II D) I and IV

D) I and IV Generally, collectibles do not provide an investor with predictable cash flows. Therefore, they would not be suitable for an income-seeking investor.

Why would financial planners recommend their clients purchase natural resources for their investment portfolios? I. Diversification II. Low degree of risk III. Positive correlation with other financial assets IV. Pass through of certain tax benefits including depletion A) II and III B) II, III, and IV C) I, II, III, and IV D) I and IV

D) I and IV Statements II and III are incorrect. Investments in natural resources offer investors a high degree of risk and a negative correlation with other financial assets.

Fred Smith, your client, has consulted you regarding increasing the overall yield on his portfolio while simultaneously reducing his risk exposure to the stock market. You have suggested real estate investment trusts (REITs) and explain that there are several different kinds of REITs. Which of the following accurately describe the characteristics of equity REITs? I. Earn rental income from leasing properties they own II. Earn interest income from mortgages on real estate properties III. Are designed to be liquidated in a specific future year IV. Are similar to open-end mutual funds A) I, III, and IV B) II only C) I and II D) I only

D) I only Mortgage REITs receive interest income from mortgages they own. Finite life REITs liquidate in a future year. REITs are closed-end funds.

Which of the following factors should be considered when investing in antiques? I. Supply II. Marketability III. Inflation IV. Dealer reputation A) III and IV B) I, III, and IV C) I and II D) I, II, III and IV

D) I, II, III and IV The antique/collectibles markets are inefficient, where supply is frequently limited, making supply an important consideration. Some rare and famous antiques may be in great demand and be marketable; for many, however, no, or a limited, market and demand may exist. Rising inflation generally encourages investors to purchase tangibles. Dealer reputation is important in the collectibles market to minimize fraud.

Which of the following are risks associated with tangible assets? I. Price fluctuations II. Higher front-end costs III. Loss from fraud and theft IV. Lack of liquidity and marketability A) III and IV B) I and IV C) I and II D) I, II, III, and IV

D) I, II, III, and IV All of these are potential risks from investing in nonfinancial assets.

Which of the following statements correctly explain real estate investing? I. Real estate allows investors to use substantial leverage when acquiring property. II. Real estate may be used as a hedge against inflation. III. Real estate offers high liquidity to investors. IV. Real estate owned can be used as collateral for loans and offers investors tax write-offs. A) I and II B) III only C) II, III, and IV D) I, II, and IV

D) I, II, and IV Real estate is an illiquid investment and involves high transaction costs.

Which of the following statements regarding the variables in the Black/Scholes European call option pricing model is CORRECT? I. An increase in the price of the underlying stock decreases the value of the European call option. II. An increase in the variability of the price of the underlying stock decreases the value of the European call option. III. An increase in the risk-free rate increases the value of the European call option. IV. An increase in the time to expiration decreases the value of the European call option. A) II and III B) I, II, and IV C) III and IV D) III only

D) III only An increase in the time to expiry also increases the value of the European call option.

Which of these statements correctly illustrates basic option positions? A) If an investor buys a put, the maximum gain is unlimited. B) If an investor writes a call, the maximum loss is the amount of premium paid. C) If an investor buys a call, the maximum loss is unlimited. D) If an investor writes a put, the maximum loss is the exercise price less the amount of premium received.

D) If an investor writes a put, the maximum loss is the exercise price less the amount of premium received. If an investor buys a put, the maximum gain is the exercise price less the amount of premium paid. If an investor writes a call, the maximum loss is unlimited. If an investor buys a call, the maximum loss is the premium paid.

John sells a naked call option for a $3 premium. The call option has an exercise price of $20. Which of these statements is CORRECT? A) The call will likely not be exercised while the stock is trading at $23. B) John's loss is limited to $20. C) The option will not be exercised until the market price is $17. D) John's maximum gain is $3.

D) John's maximum gain is $3. John's maximum loss is unlimited. Because the call option was written as a naked call option, the seller (John) will have to buy the stock at the prevailing market price if the call option is exercised by the buyer. The buyer would exercise the call option when the stock price exceeds $20. Any price level over $20 begins to reduce the call option buyer's potential loss, and at $23 the seller and buyer break even.

Due to an inheritance, Danielle now owns a large position in XYZ stock. She is concerned that the stock may decline in the upcoming months while she is deciding what to do with the investment. What type of investment strategy could her financial planner propose to protect the stock from substantial downside risk? A) Write a call option B) Zero-cost collar C) Purchase an index future D) Purchase a put option

D) Purchase a put option Danielle should purchase a put option (referred to as protective put or portfolio insurance) to protect herself from possible loss. Thereby, the portfolio is protected and the investor's loss on the option is limited to the amount of the premium paid for the put.

If a U.S. resident buys a Japanese auto stock that subsequently rises in price while the Japanese currency weakens relative to the U.S. currency, which one of these situations is most likely to occur when the investor sells the stock at a gain? A) None of these. B) The net gain will be increased due to the currency change. C) The net gain will be the same regardless of the currency change. D) The net gain will be decreased due to the currency change.

D) The net gain will be decreased due to the currency change. A strong U.S. currency decreases the gain from a sale of a foreign stock.

If a U.S. resident buys a Japanese bank stock that subsequently rises in price, while the Japanese currency strengthens relative to the U.S. currency, which of these situations is most likely to occur when the investor sells the stock at a gain? A) The net gain will be the same regardless of the currency change. B) None of these. C) The net gain will be decreased due to the currency change. D) The net gain will be increased due to the currency change.

D) The net gain will be increased due to the currency change. Strong Japanese currency means a weak U.S. currency, which increases the net gain on the transaction.

Which of the following is CORRECT with regard to the purchasers of gold futures contracts? A) They are considered to be unleveraged positions. B) They have less speculative positions. C) They do not have to meet margin requirements. D) They run the risk of government intervention altering the supply and demand for gold.

D) They run the risk of government intervention altering the supply and demand for gold. Government intervention has always been an issue for gold. The price was fixed for years and Americans were forbidden from owning gold. Although this has changed, the possibility of government intervention does exist. These positions are very speculative and are highly leveraged and risky.

Select the repayment period that subjects the investor to least amount of interest rate risk. A) Tranche B B) Tranche Z C) Tranche C D) Tranche A

D) Tranche A Once all of the obligations of Tranche A are satisfied, all principal payments are made to the second tranche (Tranche B) and so on until all of the tranches are repaid. As a result, the holders of Tranche A have less interest rate risk than do the holders of all the other tranches, because the maturity date (or repayment period) of the mortgage principal obligation is the shortest.

All of these correctly express risks associated with an investment in undeveloped land except A) the investor may not be able to obtain permits to build on the land. B) access to the land may be restricted. C) the land may be adversely rezoned. D) an investment in undeveloped land always guarantees a short-term profit.

D) an investment in undeveloped land always guarantees a short-term profit. An investment in undeveloped land is made with the expectation that the land will eventually provide a significant, future capital return over the long run.

An investor fearing a bear market would hedge his or her position by A) buying a call. B) writing a put. C) selling a put. D) buying a put.

D) buying a put. Buying a put is bearish. All the other choices are bullish.

All of these are disadvantages of investing in foreign securities except A) lack of complete information about foreign companies. B) fluctuations in the value of currencies. C) changes in foreign government or government policies. D) strong correlation with U.S. securities.

D) strong correlation with U.S. securities. Foreign securities are not highly correlated with U.S. securities and thus offer opportunities to further reduce the portfolio volatility. Changes in the value of a foreign currency can increase or reduce the return from a securities portfolio.

Open interest is A) the rate of interest charged on the difference between the market value of a commodity contract and the amount of margin on deposit in a customer's account. B) the number of unexecuted buy and sell orders for a particular commodity pending at the end of trading each day on a commodity exchange. C) a technical indicator, used only with financial futures, that indicates the dollar amount of bonds expected to be delivered at contract expiration. D) the number of futures contracts outstanding for a commodity on any given trading day.

D) the number of futures contracts outstanding for a commodity on any given trading day. The answer is the number of futures contracts outstanding for a commodity on any given trading day. Open interest is reported daily in the financial press. Traders like to be in the most active months of a contract for liquidity purposes.

Brandon is considering selling a piece of residential real estate that he has owned for 12 years. The apartment complex consists of 100 units with an average rental rate of $400 per month. Laundry and parking gross potential income is $20,000 per year. The vacancy rate is 7%, and operating expenses are 30% of potential gross income (PGI). Brandon takes $40,000 of depreciation each year, and his mortgage costs $6,000 per month. If the capitalization rate for comparable properties is 9%, what should be the selling price for Brandon's property? A. $2,256,000 B. $3,056,000 C. $3,472,000 D. $3,500,000

D. $3,500,000 PGI = $400 per month × 100 units × 12 months + $20,000 (laundry and parking) = $500,000. Net income after vacancy and expenses = $500,000 × [1 − (0.07 + 0.30)] = $500,000 × 0.63 = $315,000. Sales price = $315,000 ÷ 0.09 = $3,500,000. Depreciation and financing expenses are not considered.

Which tranche of a collateralized mortgage obligation (CMO) carries the greatest amount of interest rate risk? A. Tranche A B. Tranche B C. Tranche C D. Tranche Z

D. Tranche Z Tranche Z has the longest repayment period and receives no payments until the other tranches are repaid. Thus, Tranche Z carries the greatest amount of interest rate risk.

A 35-unit apartment complex has 20 one-bedroom and 15 two-bedroom apartments renting for $450 and $600 per month, respectively. Laundry income: $2,000 per year Vacancy and collection losses: 9% of potential gross income (PGI) Operating expenses: $55,000 No major repairs are expected over the next five years. Cost of the project is $1.7 million. Land is valued at $300,000 and improvements at $1.4 million. Improvements will be depreciated using the straight-line method over 27.5 years. Assume the property is purchased on January 1 of the year so that a full year's depreciation is allowed in year 1. A mortgage of $1.2 million is available at 9% for 30 years (annual payments), fully amortized. The investor's marginal tax bracket is 24%. Calculate the net operating income (NOI) for the apartment complex for the next year. A) $92,471 B) ($15,529) C) $143,380 D) $141,560

The key to this problem is to recognize that interest expense and depreciation are not included in expenses when calculating NOI. The calculation is as follows: Gross rental income of $216,000 plus other income of $2,000 equals potential gross income (PGI) of $218,000. Subtract vacancy and collection losses (9%) of $19,620 to arrive at effective gross income of $198,380. Subtract operating expenses of $55,000, resulting in net operating income (NOI) of $143,380.