Chapter 1 UNDERSTANDING INVESTMENTS Multiple Choice Questions

Establishing a Framework for Investors 1. a. b. c. d. Which of the following is the best definition of wealth? the sum of all current and future income the total of all assets and all income the total of assets and income less any liabilities. the sum of current income and the present value of future income.

(d, moderate) 2. a. b. c. d. Stocks and bonds would be classified as: real assets indirect assets personal assets financial assets

(d, easy) 3. a. b. c. d. Technically, investments include: only financial assets. only marketable assets. financial and real assets that are marketable or non-marketable. only financial and real assets that are marketable.

(c, easy) 4. a. b. c. d. The retirement plans that guarantee retirees a set amount of money each month are known as: 401(k) plans self-directed plans defined-benefit plans defined-contribution plans

(c, moderate)

Chapter One Understanding Investments

The Importance of Studying Investments 5. a. b. c. d. The investment professionals that arrange the sale of new securities are called: arbitragers traders investment bankers specialists

(c, moderate) 6. a. b. c. d. Another name for stockbrokers is: specialists registered representatives security analysts portfolio managers

(b, moderate) 7. a. b. c. d. Investment professionals whose jobs may depend on their performance relative to the market are the: registered representatives security analysts investment bankers portfolio managers

(d, moderate) 8. a. b. c. d. One reason for the declining importance of pension funds is the: decrease in pension benefits for workers. downsizing of U.S. companies large number of conversions into self-directed plans. increasing number of federal regulations that restrict pension fund portfolios.

(c, difficult)

Chapter One Understanding Investments

9. a. b. c. d.

Most financial advisors are registered with the Securities and Exchange Commission as: registered representatives. registered investor advisors. registered financial planners. registered securities consultants.

(b, moderate) 10. a. b. c. d. A Chartered Financial Analyst designation is a (an) SEC-approved and awarded designation. certification of a successful investing record. professional designation awarded for meeting recognized standards of conduct and competency. professional designation awarded by the brokerage industry.

(c, easy) Understanding the Investment Decision Process 11. a. b. c. d. Underlying all investments is the tradeoff between: expected return and actual return low risk and high risk actual return and high risk expected return and risk

(d, moderate) 12. a. b. c. d. Which of the following investment areas is heavily tied to work using mathematical and statistical models? Security analysis Portfolio management Institutional investing Retirement planning

(b, moderate)

Chapter One Understanding Investments

13.
a.

Most investors are risk averse which means: they will assume more risk only if they are compensated by higher expected return. they will always invest in the investment with the lowest possible risk. they actively seek to minimize their risks. they avoid the stock market due to the high degree of risk.

b. c. d.

(a, moderate) 14. a. b. c. d. Which of the following would be considered a risk-free investment? gold equity in a house high-grade corporate bonds U.S. Treasury bills

(d, easy) 15. a. b. c. d. Security analysis is most concerned with: analysis of the overall securities market and its direction. valuation and analysis of individual securities. purchasing securities at the best price. determination of the investors required return.

(b, moderate) 16. a. b. c. d. In general, the ex ante risk-return tradeoff slopes upward. slopes downward is flat is impossible to determine.

(a, moderate) 17. a. b. c. d. International investing: is only practical for institutional investors. increases the overall risk of a stock portfolio. always leads to higher returns than a domestic portfolio. can reduce risk due to increased diversification.

(d, moderate)

Chapter One Understanding Investments

18. a. b. c. d.

Investment decision making traditionally consists of two steps: investment banking and security analysis buying and selling risk and expected return. security analysis and portfolio management.

(d, moderate) Important Considerations in the Investment Decision Process for Today's Investor 19. a. b. c. d. Which of the following statements concerning global stock market capitalization is true? The United States accounts for roughly 85 percent of stock market capitalization worldwide. The United States accounts for roughly 50 percent of stock market capitalization worldwide. The United States accounts for roughly 25 percent of stock market capitalization. It is expected that the United States will increase its percentage of stock market capitalization in the world over time.

(b, moderate) 20. a. b. c. d. Regulation FD applies to disclosure between: private companies and public officials public companies and investment professionals public companies and public officials private companies and investment professionals

(b, moderate) 21. a. b. c. d. In 2003, The SEC charged Martha Stewart with: insider trading. securities conspiracy. obstruction of justice. all of the above

(c, difficult)

Chapter One Understanding Investments

22. a. b. c. d.

The rise of the Internet has: greatly increased the cost of security trading. significantly democratized the flow of investment information. led to fewer number of discount brokers led to large amounts of security fraud.

(b, moderate) 23. a. b. c. d. Which is not an advantage institutional investors enjoy over individual investors ? They can trade in the aftermarket. They can exploit spinoffs better than individual investors. They may receive information from public companies prior to individual investors. Al l of the above are advantages.

(b, moderate) 24. Which of the following regulations prohibits companies from disclosing material, nonpublic information to investment professionals unless the company simultaneously publicly discloses the information? Regulation FD Regulation PD Regulation SD Regulation TD

a. b. c. d.

(a, moderate) 25. a.

b.

Investors should be concerned with international investing for all of the following reasons except: Large amount of capital flows from abroad into domestic markets. Rates of return on foreign securities may be larger than on domestic securities. Foreign companies are taking over many domestic industries, such as banking. U.S. companies derive a large percentage of their revenues from abroad.

c. d.

(c, difficult)

Chapter One Understanding Investments

True-False Questions
The Importance of Studying Investments 1. A 401(k) plan is an example of a defined benefit retirement plan.

(F, moderate) Understanding the Investment Decision Process 2. Investors always seek to minimize their risk of investing.

(F, moderate) 3. Both 401(k) plans and IRAs are self-directed retirement plan.

(T, easy) 4. The two major considerations in investing are return and timing.

(F, easy) 5. Risk is defined as the possibility of loss.

(F, moderate) 6. The minimum actual return necessary to induce investors to invest is known as the expected return.

(F, easy) 7. Investors enjoyed the best 5 consecutive years in the stock market history over the period 1996-2000.

(F, moderate) 8. Investors unwilling to assume risk should be satisfied with the rate of inflation as their investment return.

(F, difficult) Importance of Studying Investments 9. Security analysts are typically employed only at brokerage houses.

(F, moderate)

Chapter One Understanding Investments

10.

Financial planners must pass a standardized test and possess certain credentials.

(F, easy) 11. Many Wall Street jobs tend to be cyclical in nature..

(T, easy) Important Considerations in the Investment Decision Process for Today's Investor 12. Due to the Internet, institutional investors have gained in importance.

(F, difficult)

Short-Answer Questions
1. Briefly explain the difference between expected returns and realized returns and between ex ante returns an ex post returns. Expected returns are mean returns based on probability distributions dealing with the future. Realized returns are the returns that actually occurred in the past. Ex ante returns are in the future. Ex post returns are in the past.

Answer:

(moderate) 2. What are some of the career opportunities in the investment industry? Investment banker, merger and acquisition specialist, security traders, sales people, security analyst, portfolio manager, registered investment advisor and chartered financial analyst.

Answer:

(easy) 3. Define risk in the context of investments? Risk is the chance that the actual return on an investment will differ from its expected return.

Answer: (moderate) 4.

Will risk-averse investors ever include commodity futures or options in their portfolios? Explain. They may include these items in their portfolios since risk-averse is not the same thing as risk avoidance. Risk-averse investors
8

Answer:

Chapter One Understanding Investments

would expect a higher return from these assets as they are riskier than many other assets. (moderate) 5. Security analysis takes place before portfolio management. Why? Consideration of information generated by security analysts is a necessary component in portfolio construction.

Answer: (moderate) 6.

A 25-year old college graduate is participating in a 401(k) retirement plan and wishes to minimize risk. What will this probably do to his ending retirement funds in 40 years? If he minimizes risk, then he will also minimize return. His retirement fund will likely be much smaller than if he chose to take more risk over the long run.

Answer:

(moderate)

Critical Thinking/Essay Questions

1. What are some of the difficulty in valuing common stock? The investor must evaluate the overall economy, industry and individual company as all have an impact on the value of the stock. In addition, the expected return and appropriate risk must be estimated. And lastly, the efficiency of stock markets must be considered and if the market value of the stock is the same as the economic value.

Answer:

(difficult) 2. Why are investors and their brokers sometimes on different sides of the fence when it comes to trading decisions? Investors are generally looking for long-term returns and must consider the overall cost of trading. Investors may often do well with a buy and hold strategy. Brokers, on the other hand, make their living by commissions which means they have a vested interest in having customers trade more often.

Answer:

(moderate)

Chapter One Understanding Investments