Investment Management. Review Questions for Midterm Exam 1

FIN352 Review questions for midterm exam 1 1. The nominal risk-free rate of interest is a function of a) The real risk-free rate plus the investment's variance. b) The prime rate and the rate of inflation. c) The T-bill rate plus the inflation rate. d) The real risk-free rate and the expected rate of inflation.* 2. At the beginning of the year an investor purchased 100 shares of common stock from ABC Corporation at $10 per share. During the year, the firm paid dividends of $1 per share. At the end of the year, the investor sold the 100 shares at $11 per share. What is the period return? a) b) c) d) 1.20% 5.50% 12.00% 20.00% * 7. The member of the New York Stock Exchange who acts as a dealer on assigned stocks is known as a a) b) c) d) Registered trader. Commission broker. Registered dealer. Specialist. * 9. An order placed specifying the buy or sell price a) b) c) d) is a Limit order. * Short sale. Market order. Priced order. 10. A pure auction market is one in which a) b) c) d) Dealers provide liquidity by buying and selling shares of stock for themselves. Dealers compete against each other to provide the highest bid and lowest asking prices. Buyers submit bid prices to sellers. Buyers and sellers submit bid and ask prices to a central location to be matched. * USE THE FOLLOWING INFORMATION FOR THE NEXT THREE PROBLEMS Jack has a margin account and deposits $25,000. If the margin requirement is 40 percent, commissions are ignored, and Irish Industries is currently selling at $45 per share: 11. What is the value of stock that Jack can acquire? a) b) c) d) $41,667 $62,500 * $75,000 $87,500 12. What is Jack's profit if the price of Irish Industries rises to $55? a) b) c) d) $ 5,555 $ 9,259 $13,895 * $23,598 13. If the maintenance margin is 20 percent, to what price can Irish Industries fall before Jack receives a margin call? a) b) c) d) 14. > $21.75 $23.75 $33.75 * $35.75 Portfolio theory tells us that diversification has the potential to: a. b. c. d. increase anticipated risk for a given expected return. reduce expected return for a given anticipated risk. reduce anticipated risk for a given expected return. reduce transaction costs. 15. A stock broker may improperly buy and sell the securities in a customer’s account to generate commissions. This is known as ____________ . > 17. > 18 a. a. b. c. d. enhancement insider trading indexing churning Annual accounting information is filed with the SEC on the: a. 10K report. b. 10Q report. c. 13D report. d. Form 144. The largest single institutional owner of common stocks is:\ mutual funds. b. c. d. insurance companies. pension funds * commercial banks 19. Finance professionals who work with individual investors and institutions in executing orders for individual common stocks or bonds are called: > a. b. c. d. 22. brokers. portfolio managers. analysts. certified financial planners. Treasury bills are traded in the --------------------- . a. b. c. d. money market. * capital market. government market. regulated market. 23. Bonds trade on an accrual interest basis. This means an investor: a. b. can sell a bond at any time without losing the interest that has accrued. * can buy a bond at any time and gain the interest accrued from the time of the last payment. can sell a bond at any time and retain the interest portion of the bond. buy a bond at any time and receive an immediate interest check. c. d. 24. A corporate bond with a rating of BBB- is considered to be which of the following? a. b. c. d. non-investment grade investment grade * speculative grade junk, or high-yield 26. The New York Stock Exchange is the: > a) b) c) d) sole trading forum for all companies listed on the NYSE. home of securities with a total market capitalization of roughly $50 trillion. second largest equities marketplace in the world. largest U.S. securities market in terms of the value of companies listed and the dollar value of trading activity. 27. The National Association of Securities Dealers (NASD) is a: > a) b) self-regulatory organization with particular responsibility for the regulation of options markets. self-regulatory organization with particular responsibility for the regulation of OTC markets. c) d) regulatory arm of the SEC. self-regulatory organization with particular responsibility for the regulation of futures markets. 28. Nasdaq is a negotiated market in which investors deal directly with: > a) b) c) d) 29. The S&P 500: > a) b) c) d) market maker dealers. exchange specialists. floor brokers. other investors in a trading pit. dates from 1896. is comprised mainly of Nasdaq stocks.. accounts for roughly 30% of the market capitalization of the overall stock market. a market cap weighted index. 30. Which stock index is a good benchmark for determining the performance of small companies? > a. Whilshire 4500 b. Nikkei 225 Index c. Russell 2000 a. NASDAQ 100 31. Investment a. b. c. d. companies must register with the SEC under the provisions of the: Securities Act of 1933 Securities Exchange Act of 1934 Maloney Act of 1938 Investment Company Act of 1940 * 32. Short sales with 50% initial margin trigger a 30% maintenance margin call following a: > a. b. c. d. 50% rise in price. 15.4% rise in price. 20% rise in price. 22.9% fall in price. Solution: consider that the investor shorts one share of a $100 with $50 of borrowed money. To trigger a 30% margin call, the price would have to change to 0.3 = (100+50-P) / P, solving for P = $115.38, which represents a 15.4% increase in price. 33. If the initial margin requirement is 40%, an investor buying 100 shares at $100 per share must furnish equity of: > a) b) c) d) $4,000. $6,000. $10,000. $100. Solution: equity = 40% × 100 × $100 = $4,000 34.Limit orders: > 35. a. b. c. d. specify a certain price at which a market order takes effect. specify a particular price to be met or bettered. are executed at the best price available. are orders entered for a particular day. Primary markets: a. b. c. involve the organized trading of outstanding securities on exchanges. involve the organized trading of outstanding securities in the over-the-counter market. involve the organized trading of outstanding securities on exchanges and over-the-counter markets. are where new issues (IPOs) are sold by corporations to raise new capital. > d. 36. The role of investment banker does not include: > a. b. c. d. giving companies advice on the price, amount and timing of an IPO. a commitment to maintain a continuous primary market for listed issues. managing a syndicate for distribution on a firm-price (dealer) or best-efforts (broker) basis. helping maintain an after market for OTC issues. 37. An investor buys $10,000 worth of stock using 50% margin. If the stock price increases by 20%, what return does the investor earn? (ignore transaction costs and interest fees) > a. b. c. d. 10% 20% 30% 40% Solution: return = 20%×$10,000 / (50% × $10,000) = 0.4 or 40% 38. If an investor would like to sell short shares originally valued at $20,000 in which his/her cash contribution is $10,000, what is the stock value when the investor receives a margin call if the maintenance margin 30%? > a) The current stock value decreases to $24,615 b) The current stock value decreases to $14,000 c) The current stock value increases to $24,615 d) The current stock value increases to $26,000 0.30 = Solution: $20, 000 + $18, 000 − Current Stock Value Current Stock Value Current stock value = $24,615 39. Net asset value takes into account: a. b. c. d. both realized and unrealized capital gains. * only realized capital gains. only unrealized capital gains. neither realized or unrealized capital gains. 40. Index a. b. c. d. funds provide low-cost, passive investment exposure in a similar fashion to: hybrid mutual funds money market mutual funds exchange-traded funds * equity income funds 41. A loading fee is a: a. b. c. d. type of income tax. management fee. origination fee. sales charge. * 42. The ___________ summarizes information about a new security issue. a. b. c. d. syndicate offer IPO prospectus * shelf rule 43. Merrill Lynch and UBS are examples of: a. b. c. d. discount brokers wholesale brokers full-service brokers * blue-chip brokers 44. Ms. Brown sold short 100 shares of common stock at $78 per share. The price has declined to $69. The outlook for the stock is mixed, so she would cover her short position if the stock moves up as much as $1 but hold if it continues down. Ms. Brown should place a a. b. c. d. sell stop order at $70. buy stop order at $70. * sell limit order at $70. buy limit order at $70. 43. Total return is equal to: a. b. c. d. capital gain + price change. yield + income. capital gain - loss. yield + price change. * 44.. At the beginning of the year an investor purchased 100 shares of common stock from ABC Corporation at $10 per share. During the year, the firm paid dividends of $1 per share. At the end of the year, the investor sold the 100 shares at $11 per share. What is the period return? e) f) g) h) 1.20% 5.50% 12.00% 20.00% * 45. Given the following returns and return relatives over the past four years, compute the arithmetic mean (AM) and geometric mean (GM) rates of return. Period t1 t2 t3 t4 a) b) c) d) 1.05 0.90 1.11 0.98 Return Relative Return Relative 0.05 -0.10 0.11 -0.02 AM = 4.000%, GM = 1.010% AM = 1.000%, GM = 0.692% * AM = 0.692%, GM = 4.000% AM = 1.000%, GM = 1.0692% 46. If a U.S. investor buys foreign stock, his dollar-denominated return will increase if the dollar: a. b. c. d. appreciates in value. depreciates in value. * remains unchanged. moves to a net gain position. 47. The equity risk premium is: a. b. c. d. the difference between stocks and bonds the difference between high-grade stocks and low-grade stocks. the difference between stocks and the risk-free rate. * the difference between a stock market index and the inflation rate. 48. The standard deviation measures: a. b. c. d. systematic risk of a security. unsystematic risk of a security. total risk of a security. * the equity risk premium. 49. John Crossborder buys 1 share of Telmex at 140 pesos when the value of the peso is stated in dollars at $0.35. One year later, Telmex is selling for 155 pesos and paid a dividend of 5 pesos during the year. If after 1 year the value of the pesos is $0.29, what will John's rate of return be in U. S. dollars? Solution: Return Relative in pesos = [(155 - 140 + 5)/140] + 1.0 = 1.1429 Domestic TR = percent 1.1429[0.29/0.35] - 1 = -0.0531 or -5.31 50. Portfolio theory tells us that diversification has the potential to: a. b. c. d. increase anticipated risk for a given expected return. reduce expected return for a given anticipated risk. reduce anticipated risk for a given expected return. * reduce transaction costs. 51. The expected value is the: a. b. c. d. inverse of the standard deviation correlation between a security’s risk and return. weighted average of all possible outcomes. * same as the discrete probability distribution. 52. Given the following probability distribution, calculate the expected return of security XYZ. Security XYZ's Potential return 20% 30% -40% 50% 10% a. b. c. d. 16 percent 22 percent 25 percent 18 percent 0.3 0.2 0.1 0.1 0.3 Probability Solution: E(R) = ΣRipri = (20)(0.3) + (30)(0.2) + (- 40)(0.1) + (50)(0.1) + = (10)(0.3) = 22 percent 53. Two stocks with perfect negative correlation will have a correlation coefficient of: a. b. c. d. +1.0 +2.0 0 –1.0 *