Chapter 1 The Investment Environment: Fundamentals of Investing, 13e, Global Edition (Smart)

Fundamentals of Investing, 13e, Global Edition (Smart)
Chapter 1 The Investment Environment
1.1 Learning Goal 1
1) A non-interest bearing checking account is still considered an investment. FALSE
2) Land and buildings are examples of real property investments. TRUE
3) Since 1900, the average return on stocks has exceeded the average return on savings
accounts by more than 6 percentage points. TRUE
4) A United States Savings Bond is an example of an investment as defined in the text. TRUE
5) Most sources of investment information are in print format, expensive, and difficult to
access. FALSE
6) Which of the following is NOT an investment as defined in the text?

A) a certificate of deposit issued by a bank
B) a new automobile
C) a United States Saving Bond
D) a mutual fund held in a retirement account
7) Stocks are a(n) ________ investment representing ________ of a business.

A) direct; ownership
B) direct; debt
C) indirect; ownership
D) indirect; debt
8) An exchange traded fund that invests in the stocks of large corporations is an example of
A) direct investment.
B) indirect investment.
C) derivative investment.
D) tangible investment.
9) Which of the following has declined in recent years?

A) direct ownership of stock by individual investors
B) the percentage of foreign stocks held in typical portfolios
C) institutional ownership of common stocks
D) the timeliness of information available to investors
10) Debt represents funds loaned in exchange for

A) dividend income and the repayment of the loan principal.
B) dividend income and an ownership interest in the firm.
C) interest income and a partial ownership interest in the firm.
D) interest income and the repayment of the loan principal.
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1.2 Learning Goal 2
1) Institutional investors manage money for businesses and nonprofit organizations, but not for
individuals. FALSE
2) Institutional investors are individuals who invest indirectly through financial institutions.
FALSE
3) Banks and insurance companies are examples of institutional investors. TRUE
4) In the financial markets, individuals are net demanders of funds. TRUE
5) The government is generally

A) not involved in the financial markets.
B) the owner of the financial market.
C) a supplier of funds to the financial market.
D) a demander of funds in the financial market.
6) On a net basis, funds in the financial markets are generally supplied by

A) individuals.
B) both individuals and business firms.
C) business firms.
D) the government.
7) A forum in which suppliers and demanders of funds make financial transactions is called a
financial
A) institution.
B) bank.
C) instrument.
D) market.
8) Which of the following are true concerning institutional investors?
I. Institutional investors are professionals who manage money for other people.
II. Banks, insurance companies and mutual funds are all institutional investors.
III. Institutional investors are individuals who invest indirectly through financial institutions.
IV. Institutional investors invest large sums of money.
A) I and II only
B) I, II and IV only
C) II, III and IV only
D) I, II, III and IV
9) Which of the following is NOT traded in the securities markets?

A) stocks
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B) bonds
C) derivatives
D) real estate
10) Describe the major differences between individual and institutional investors.
1.3 Learning Goal 3
1) Bond investors lend their money for a fixed period of time and receive interest. TRUE
2) A collection of securities designed to meet an investment goal is called a portfolio. TRUE
3) If the value of a common stock increases the value of an option to buy that stock should also
increase. TRUE
4) An option to purchase common stock is a type of derivative security. TRUE
5) Bonds represent a lower level of risk than do stocks in the same company. TRUE
6) Exchange traded funds are similar to mutual funds, but are traded like stocks. TRUE
7) Mutual funds invest in diversified portfolios of securities. TRUE
8) Bond prices rise as interest rates decline. TRUE
9) Bond interest and stock dividends are different ways of distributing a corporation's earnings
to its owners. FALSE
10) Which of the following is an example of a tangible asset?

A) bonds
B) mutual funds
C) real estate
D) stocks
11) Which one of the following would be the most liquid investment?
A) stock
B) Series EE bond
C) money market mutual fund
D) real estate
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12) Which of the following investments represents partial ownership of a corporation?
A) bonds
B) mutual funds
C) commercial paper
D) common stock
13) Investors seeking a diversified, professionally managed portfolio of securities can purchase
shares of
A) preferred stock.
B) convertible securities.
C) insurance policies.
D) mutual funds.
14) One feature that mutual funds and exchange traded funds have in common is
A) they trade continuously throughout the trading day.
B) their portfolios are always based on one of the major market indexes.
C) they invest in broadly diversified portfolios of securities.
D) investors purchase share from the funds managers rather than from other investors.
15) Briefly describe three advantages of investing in mutual funds or exchange traded funds.
1.4 Learning Goal 4
1) Earning a high rate of return with little or no risk is a realistic investment goal. FALSE
2) Under current tax laws, most taxpayers will pay a lower tax rate on capital gains than on
dividends. FALSE
3) Under current tax laws, most taxpayers will pay a lower tax rate on capital gains than on
income from wages. TRUE
4) Investors can postpone or avoid income taxes by investing through Individual Retirement
Accounts. TRUE
5) Short-term capital gains are taxed at the taxpayer's marginal tax rate. TRUE
6) To qualify for long-term capital gains rates, a stock must be held for at least 12 months.
TRUE
7) Retirement plans, such as a 401(k), allow employees to defer taxes on the plan contributions
until such time as the funds are withdrawn from the retirement plan. TRUE
8) You should spend money on housing, clothing and basic insurance before investing. TRUE
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9) Which of the following represent investment goals?
I. saving for major expenditures such as a house or education

II. sheltering income from taxes
III. increasing current income
IV. saving funds for retirement
A) I and IV only
B) III and IV only
C) I, III and IV only
D) I,,II, III and IV
10) In selecting investments consistent with your goals, you should consider
A) rates of return and taxes only.
B) the pre-tax rate of return only.
C) annual dividends and taxes only.
D) risks, returns, and taxes.
11) Sarah purchased a stock one year ago at a price of $32 a share. In the past year, she has
received four quarterly dividends of $0.75 each. Today she sold the stock for $38 a share. Her
capital gain per share is
A) $3.00.
B) $6.00.
C) $(6.00).
D) $9.00.
12) A well-conceived investment policy statement will specify

A) the investor's current age and economic situation.
B) the investor's preference for frequent or infrequent trading.
C) the types of investments the investor is willing to consider.
D) all of the above.
13) Beginning investors with small amounts to invest should

A) avoid stock investments completely.
B) invest all of their money in one high quality stock.
C) buy mutual funds or exchange traded funds (ETFs).
D) buy a portfolio of very low priced stocks (penny stocks).
14) Research indicates that investors who closely monitor their portfolios and trade quickly in
response to minor fluctuations in price
A) outperform those who hold investments for the long-term and trade infrequently.
B) underperform those who hold investments for the long-term and trade infrequently.
C) earn rates of return similar to those who hold investments for the long-term and trade
infrequently.
D) be more highly educated and in higher income brackets than those who hold investments for
the long term and trade infrequently.
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Table 1.2
Use the following tax rates and income brackets for 2015 to answer the following question(s).
15) In 2015, John and Nicole earned a combined taxable income of $148,800 from employment
plus $1,000 in long term capital gains and they file a joint tax return. What is their total federal
income tax? Round to the nearest dollar.
A) $37,150
B) $29,063
C) $29,593
D) $28,963
16) Josh earned $82,500 in taxable income, all from wages and interest, and files an individual
tax return. What is the amount of Josh's taxes for the year 2015? Round to the nearest dollar.
A) $13,750
B) $16,481
C) $18,425
D) $12,285
17) For a taxpayer in the 25% marginal tax bracket, a long-term capital gain realized in 2015
will be taxed at
A) 5%.
B) 10%.
C) 15%.
D) 25%.
18) Andrew and Jennifer are in the 25% marginal tax bracket. Three years ago they purchased
100 shares of stock at $20 a share. In 2015, they sold the 100 shares for $29 a share. What is
the amount of federal income tax they owe as a result of this sale?
A) $135
B) $165
C) $225
D) $435
19) Michelle and Patrick are in the 28% marginal tax bracket. They bought 100 shares of DJN
stock at $45 per share and sold them 4 years later in 2015 at $22 per share? By how much did
their loss reduce their taxes in the year when they sold the stock?
A) $0
B) $644
C) $345
D) $1,260
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20) Under current tax law, dividend income is taxed at the same rate as
A) ordinary income.
B) short-term capital gains.
C) long-term capital gains.
D) interest income.
21) Both the holding period to qualify and the tax rate on long-term capital gains
A) are subject to political pressure and occasionally change.
B) are very stable and have not changed since the 1960s.
C) are phased out on incomes over $388,351.
D) are adjusted for inflation every year.
22) Tax planning

A) guides investment activities to maximize after-tax returns over the long term for an
acceptable level of risk.
B) ignores the source of income and concentrates solely on the amount of income.
C) is primarily done by individuals with incomes below $200,000.
D) is limited to reviewing income for the current year and determining how to minimize current
taxes.
23) Speculative and growth oriented investments are least appropriate for
A) young investors.
B) middle-aged investors.
C) retired investors.
D) high income investors.
24) Investors seeking to increase their wealth as quickly as possible would invest in
A) corporate bonds and preferred stock.
B) large company stocks with high dividends.
C) smaller companies pursuing rapid growth.
D) government bonds and low-risk income stocks.
25) Discuss the relationship between stock prices and investors' beliefs about the business
cycle.
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26) What are some of the important prerequisites to investing?
27) Discuss the general investment philosophy and the types of investments preferred by
investors in each phase of the life cycle.
1.5 Learning Goal 5
1) U.S. Treasury Bills mature in 1 year or less. TRUE
2) Liquidity is the ability to convert an investment into cash quickly with little or no loss of
value. TRUE
3) Short-term investments generally provide liquidity, safety, and a high rate of return. FALSE
4) Money market accounts, certificates of deposit, bonds and commercial paper are all forms of
short-term investment vehicles. FALSE
5) The primary risk associated with a short-term investment is

A) purchasing power risk.
B) default risk.
C) interest rate risk.
D) economic risk.
6) Short-term investments
I. provide liquidity.
II. fill an important part of most investment programs.
III. provide a high rate of return with low risk.
IV. provide resources for emergencies.
A) I and IV only
B) II and IV only
C) I, II and IV only
7) Federal insurance protects passbook savings accounts and money market deposit accounts
(MMDAs) up to
A) $100,000.
B) $150,000.
C) $250,000.
D) $1,000,000.
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8) Beginning in 2010, the amount protected by the Federal Deposit Insurance Corporation in
non-interest bearing checking accounts is
A) zero.
B) $100,000.
C) unlimited.
D) $250,000.
9) Since 2010, the interest rate on passbook accounts and certificates of deposit has
A) been less than the rate of inflation.
B) has closely tracked the rate of inflation.
C) exceeded the rate of inflation by 1.5% on average.
D) fluctuated widely.
10) Which one of the following has the lowest level of risk?
A) commercial paper
B) money market mutual fund account
C) banker's acceptance
D) U.S. Treasury bill
1.6 Learning Goal 6
1) Certified Financial Planners typically manage institutional portfolios. FALSE
2) A major goal of corporate financial management is to increase the value of the firm to
investors. TRUE
3) Stringent regulations and vigorous enforcement have all but eliminated unethical behavior
by financial professionals in recent years. FALSE
4) Insurance companies invest the premiums and fees collected from customers in order to
neutralize the risks assumed from their clients. TRUE
5) Chartered Financial Analyst (CFA) is a degree offered by several prestigious business

schools. FALSE
6) Typical responsibilities of financial professionals in a corporate setting include
I. managing cash and short-term investments.

II. evaluating investment opportunities.
III. working one on one with individuals to formulate plans for reaching their financial goals.
IV. interacting with financial markets to find sources of external financing such as debt and
equity.
A) I and IV only
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7) Jobs in which of the following fields require an understanding of the investment
environment?
I. commercial banking
II. corporate finance
III. financial planning
IV. insurance
A) I and IV only
8) A major function of investment banking firms is

A) providing loans to investors.
B) providing financial planning services to wealthy individuals.
C) assisting businesses when they issue stocks and bonds.
D) developing investment strategies to neutralize risk.
9) Which of the following has set an outstanding example of ethical behavior in the financial
professions?
A) Bernard Madoff of Madoff Securities
B) Hank Greenberg of AIG
C) Ramalinga Raju of Satyam Computers
D) none of the above
10) In the U.S., the most prestigious designation for financial planners is
A) CFP.
B) CPA.
C) ING.
D) SIPC.
11) Briefly describe three different career paths that require a strong background in securities,
and advising individuals as personal bankers.
Corporate financial managers must investments.
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Chapter 2 Securities Markets and Transactions
2.1 Learning Goal 1
1) Stocks, bonds and mutual fund shares are bought and sold in the capital market. TRUE
2) Capital markets deal exclusively in stock. Money markets deal exclusively in debt
instruments. FALSE
3) Primary markets deal in the stocks of larger, well-known companies; secondary markets deal
in the stocks of smaller, less well-known companies. FALSE
4) Short-term securities are bought and sold in the

A) capital market.
B) primary market.
C) money market.
D) stock market.
5) The governmental agency that oversees the capital markets is the

A) Federal Trade Commission.
B) Federal Reserve.
C) Securities and Exchange Commission.
D) Fair Trade and Banking Agency.
6) Stocks purchased in the secondary market are purchased

A) directly from the issuing corporation.
B) from other investors.
C) from small, little-known brokerages.
D) indirectly through financial institutions.
7) Stocks and bonds are traded in

A) securities and exchange commissions.
B) money markets.
C) federal trade commissions.
D) capital markets.
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8) The primary market tends to be more active when
A) the economy is slowing and stock prices are falling.
B) the economy is expanding and stock prices are rising.
C) interest rates are rising.
D) early in the calendar year.
2.2 Learning Goal 2
1) Underwriters are responsible for promoting and facilitating the sale of securities. TRUE
2) The preliminary version of a prospectus is called a red herring. TRUE
3) The purpose of the "quiet period" a company must observe from the time it files a
registration statement with the SEC until after an IPO is complete is to assure that all investors
receive the same information. TRUE
4) IPOs are typically underpriced so that the price rises during the first few days of trading.
TRUE
5) IPOs are relatively safe investments. FALSE
6) The price of stock sold in an IPO is set by bids submitted in the month before trading begins.
FALSE
7) Which one of the following statements concerning the primary market is correct?
A) A transaction in the primary market is between two private stockholders.
B) The first public sale of a company's stock in the primary market is called a seasoned new
issue.
C) The first public sale of a company's stock is called an IPO.
D) A rights offering is a direct sale of stock to an institution that participates in the primary
market.
8) A rights offering is the

A) initial offering of securities to the public.
B) offering of new securities to current shareholders on a pro-rata basis.
C) sale of newly issued shares of stock to the general public.
D) sale of securities directly to a select group of investors.
9) IPO activity tends to peak when stock prices

A) have fallen sharply.
B) have risen sharply.
C) are volatile and unstable.
D) Stock prices have relatively little influence on IPO activity.
10) The document that describes the issuer of a security's management and financial position is
known as a
A) balance sheet.
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B) 10-K report.
C) prospectus.
D) red herring.
11) Companies offering their stock to the public for the first time usually seek the assistance of
A) investment bankers.
B) the Securities and Exchange Commission.
C) the Federal Reserve Bank.
D) prospectors.
12) The financial crisis of 2008 resulted in

A) a steep increase in the price of newly issued stock because supply was limited.
B) new regulations affecting initial public offerings.
C) a sharp reduction in the number of initial public offerings.
D) B and C, but not A.
13) Investment bankers who join together to share the financial risk associated with buying an
entire issue of new securities and reselling them to the public is called a(n)
A) selling group.
B) tombstone group.
C) underwriting syndicate.
D) primary market group.
14) Describe the initial public offering (IPO) process and explain the role of the underwriter,
the Securities and Exchange Commission (SEC), and the red herring.
15) Explain the role of investment bankers and brokerage firms in the issuance of new
securities.
2.3 Learning Goal 3
1) The NYSE and AMEX are examples of dealer markets. FALSE
2) Only U.S. corporations can list their stocks on the NYSE. FALSE
3) Firms that list their stock on an exchange can be delisted for failing to meet the requirements
of the exchange. TRUE
4) The NYSE is part of the world's largest international trading network known as NYSE
Euronext. TRUE
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5) Exchange traded funds (ETFs) perform like a broad market index but are bought and sold
like individual stocks. TRUE
6) Most commodity futures are traded on the NYSE Amex. FALSE
7) Securities that trade in the over-the-counter market are called unlisted securities. TRUE
8) A market maker brings together buyers and sellers in an auction market. FALSE
9) The income paid to a market maker is referred to as the spread. TRUE
10) Federal laws that control the sale of securities are called blue sky laws. FALSE
11) Federal securities laws are designed to protect financial institutions. FALSE
12) Stocks of many large foreign companies such as Toyota trade on the NYSE as well as on
exchanges in their own country. TRUE
13) The majority of bonds trade in the OTC market. TRUE
14) Market makers in dealer markets

A) bring sellers and buyers together by matching offers.
B) earn commissions paid by the sellers of securities.
C) buy securities at a bid price and hope to resell them at a higher offer price.
15) Which one of the following statements about the NYSE is correct?
A) Each member of the exchange owns a trading post.
B) Any listed stock may be traded at any of 20 trading posts.
C) Brokerage firms are only permitted to have one individual trading on the floor of the
exchange.
D) Buy orders are filled at the lowest price and sell orders are filled at the highest price.
16) In recent years, trading in secondary markets has increasingly become a function of
A) securities exchanges.
B) dealer markets.
C) technology that by-passes both brokers and dealers.
D) broker-dealer markets using consolidated venues and technologies.
17) The great majority of transactions on the NYSE are executed

A) automatically through electronic technology.
B) on the trading floor by brokers known as specialists.
C) by dealers known as market makers.
D) by auction in trading areas known as pits.
18) Which of the following are correct statements concerning the NYSE?
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I. Each stock has a designated location, called a post, at which its shares are traded.
II. The NYSE is a dealer market.
III. Supply and demand determines the price of each security.
IV. A specialist buys and sells to maintain a market for a particular security.
A) I and II only
B) I and III only
19) A market where securities are are bought from or sold to a market maker is known as a
A) broker market.
B) dealer market.
C) exchange floor.
D) board of exchange.
20) Large technology companies such as IBM and Microsoft trade

A) exclusively on the NASDAQ.
B) exclusively on the NYSE.
C) on either the NASDAQ or the NYSE.
D) exclusively on alternative trading systems.
21) Which of the following is currently a requirement for a stock to be listed on the NYSE?
A) A price of at least $10 per share.
B) Three consecutive years of profitable operations.
C) Gross revenue of at least $15,000,000.
D) Total value of shares available for public trading (float) of $15,000,000.
22) The dominant exchange for trading options contracts is the ________. The dominant
player in the trading of futures contracts is ________.
A) NYSE; Nasdaq OMX BX
B) PHLX; CBOE
C) CBOE; CME Group
D) ISE; CBOT
23) Exchange traded funds are

A) mutual funds that trade on the Big Board.
B) baskets of securities that trade like a single stock.
C) index funds that trade on the NYSE.
D) groups of securities that trade only on regional exchanges.
24) The dominant options exchange is the

A) Chicago Board Options Exchange.
B) American Stock Exchange.
C) Pacific Stock Exchange.
D) Philadelphia Options Exchange.
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25) The NYSE Euronext includes exchanges in all of the following cities EXCEPT
A) Amsterdam.
B) Brussels.
C) Paris.
D) Tokyo.
26) The purpose of the Intermarket Trading System is to link major exchanges and dealer
markets to
A) eliminate competition between brokers and dealers.
B) allow brokers and dealers to make transactions at the best price.
C) allow individual to compare the prices offered by various dealers and brokers.
D) allow individual investors to traded directly with each other.
27) Options contracts on stocks may

A) grant the owner the right to buy the stock at a specified price over a specified period of time.
B) grant the owner the right to sell the stock at a specified price over a specified period of time.
C) depending on the type of contract, grant the owner the right to either buy or sell the stock at
a specified price over a specified period of time.
D) legally oblige the owner to buy the stock at a specified price over a specified period of time.
28) The automated system for trading highly active OTC securities is the
A) Big Board.
B) Kansas City Board.
C) Chicago Board of Trade.
D) NASDAQ.
29) The over-the-counter (OTC) market is a

A) centrally located auction market.
B) telecommunications network connecting dealers.
C) market solely for institutional traders.
D) geographically dispersed auction market.
30) ECNs are

A) publicly owned auction markets for listed stocks.
B) privately owned networks that transact trades between institutional investors.
C) facilities used by market makers for trading unlisted securities.
D) part of the third market which trades listed securities between individual investors.
31) The price an individual investor will pay to purchase a stock in the OTC market is the
A) spread.
B) ask price.
C) bid price.
D) broker price.
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32) Which of the following are associated with bull markets?
I. investor pessimism
II. government stimulus
III. economic recovery
IV. low inflation
A) I and II only
B) II and III only
C) I, II and III only
D) II, III and IV only
33) Which of the following are associated with bear markets?
I. investor pessimism
II. rising profits
III. economic slowdown
IV. rising security prices
A) I and III only

B) II and III only
34) There are many differences between broker markets and dealer markets. These differences
include such things as membership, location, regulation, and several other characteristics.
Discuss at least five key differences between these two markets.
2.4 Learning Goal 4
1) Diversification is the inclusion of a number of different investments in a portfolio with the

goal of increasing returns or reducing risk. TRUE
2) The financial markets are becoming more globally integrated. TRUE
3) Participation in foreign stock markets is complicated and expensive for American investors.
FALSE
4) The U.S. stock markets tend to produce the highest rate of return each year. FALSE
5) Including foreign investments in a portfolio

A) increases the overall risk of the portfolio.
B) reduces the potential rate of return.
C) provides potential benefits from changes in currency values.
D) limits the diversification amongst industries.
6) Which one of the following statements about foreign investments is true?

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A) In general, major foreign markets always tend to underperform the U.S. market.
B) Investing in foreign markets may involve specific risks not encountered with domestic
securities.
C) Investing in foreign markets will always produce higher returns because of exchange rate
fluctuations.
D) Foreign markets include equity securities only.
7) Functioning securities exchanges are located in
I. Brazil
II. China
III. Russia
IV. South Korea
A) I, II, III and IV

C) I and IV only
D) II, III, and IV only
8) Dollar-denominated debt securities issued by foreign corporations and traded in U.S.

markets are called
A) ADRs.
B) Yankee bonds.
C) ETFs.
D) global bonds.
9) Which of the following can be encountered when investing in foreign markets?
I. foreign taxation of dividends

II. different accounting standards for financial disclosure
III. restrictions on types of investments
IV. illiquid markets
A) II and III only

B) II and IV only
10) American Depositary Receipts represent

A) receipts for dollar deposits in foreign banks.
B) receipts from foreign broker-dealers establishing ownership of foreign stocks.
C) receipts for the stocks of foreign companies held by banks in the companies' home country.
D) receipts for shares of foreign companies held by U.S. broker-dealers.
11) Assume the foreign exchange rate for the euro was U.S. $1.00 = .91 euro last month. This
month, the exchange rate is U.S. $1.00 = .88 euro. This information indicates that over the past
month the
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A) U.S. dollar remained unchanged relative to the euro.
B) U.S. dollar appreciated relative to all foreign currencies.
C) euro appreciated relative to the dollar.
D) euro depreciated relative to the dollar.
12) Assume the foreign exchange rate for the euro was U.S. $1.00 = .91 euro last month. This
month, the exchange rate is U.S. $1.00 = .88 euro. All things equal, the dollar value of
European stocks
A) decreased.
B) increased.
C) stayed the same.
D) would vary depending on the country.
13) American investors can participate in international stock markets by

A) purchasing shares in a mutual fund that invests in foreign companies.
B) purchasing shares of a U.S. based company such as Coca Cola or McDonald's with
extensive international operations.
C) purchasing ADSs (American Depositary shares).
14) The effects of fluctuating foreign exchange rates may
I. increase a U. S. investor's rate of return.

II. decrease a U. S. investor's rate of return.
III. can be avoided by investing in ADRs.
IV. can be avoided by investing in mutual funds that specialize in foreign stocks.
A) I and II only
B) I and III only
C) III and IV only
15) Kayla invested $3,000 and purchased shares of a German corporation when the exchange
rate was $1.00 = .91 euro. After six months, she sold all of the shares for 3,180 euros, when the
exchange rate was $1.00 = .88 euro. No dividends were paid during the time Heidi owned the
shares of stock. What is the amount of Kayla's gain or loss on this investment?
A) $613.64 loss
B) $613.64 gain
C) $497.60 loss
D) $497.60 gain
2.5 Learning Goal 5
1) After hours markets tend to be less volatile and more liquid than the regular trading sessions.
FALSE
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2) SEC regulations strictly prohibit trading outside the normal hours of 9:30 A.m. to 4:00 P.M.
EST. FALSE
3) The Securities Act of 1933 deals mostly with primary markets. TRUE
4) Research indicates that investors are more likely to overreact to news when trading after
hours. FALSE
5) Insider trading is the use of nonpublic information about a security to gain a profit. TRUE
6) The Sarbanes-Oxley Act of 2002 strengthens accounting disclosure requirements and ethical
guidelines for financial officers. TRUE
7) Which of the following characteristics apply to trading before and after regular hours?
I. Most after hours trades match a bid price to a corresponding offer price.
II. Most brokerage firms require individual investors to place only market orders for after-
hours trades.
III. Electronic Communications Networks (ECNs) play a key role in after hours trading.
IV. After-hours trading begins at 4:00 P.M. and ends at 9:30 A.M. eastern time.
A) II and IV only
B) I, II and III only
C) I and IV only
D) I, III and IV only
8) The Sarbanes-Oxley Act of 2002 focuses on

A) insider trading.
B) IPOs.
C) accounting and other public disclosures of information.
D) regulation of the OTC markets.
9) Which of the following acts abolished fixed commission schedules?

A) Investment Advisers Act of 1940
B) Investment Company Act of 1940
C) Securities Acts Amendments of 1975
D) Insider Trading and Fraud Act of 1988
10) An act explicitly defining and prohibiting insider trading was passed in
A) 1934.
B) 1975.
C) 1988.
D) 2002.
11) Which of the following are provisions of the Sarbanes-Oxley Act of 2002?
I. an oversight board to monitor the accounting industry

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II. tougher penalties for executives who commit corporate fraud
III. stricter prohibitions against insider trading
IV. guidelines for analysts conflicts of interest
A) II and IV only
C) I and IV only
D) I, II and IV only
12) The Consumer Financial Protection Agency was established by

A) Investment Company Act of 1940.
B) The Securities Acts Amendments of 1975.
C) The Sarbanes-Oxley Act of 2002.
D) The Dodd-Frank Act of 2010.
13) Which of the following practices is prohibited by the Insider Trading and Fraud Act of
1988?
A) the use of nonpublic information to make profitable stock transactions
B) selling of stock by officers of the company
C) the granting of stock options to corporate executives in lieu of salaries
D) private sales of stock between executives of the company
14) Crossing markets are those that

A) trade foreign securities.
B) conduct transactions between institutional and individual traders.
C) fill only the orders which have opposing orders at identical prices.
D) conduct business at locations in varying time zones.
15) The Securities Exchange Act of 1934

A) requires full disclosure of information on all new security issues.
B) authorized the SEC to regulate mutual funds.
C) established trade associations such as the NASD.
D) created the SEC as the regulator of the securities exchanges.
2.6 Learning Goal 6
1) Margin trading requires the borrowing of securities. FALSE
2) Margin trading will magnify losses on a percentage basis. TRUE
3) Short selling requires the borrowing of securities.TRUE
4) Short selling involves the sale of depreciated stock at a price below the amount borrowed on
margin. FALSE
5) When a person sells a common stock short, she or he is betting that the price of the stock will
fall. TRUE
21
6) Losses on a stock purchase are limited to the price of the stock, but losses on a short sale are
potentially unlimited. TRUE
7) The minimum initial margin requirement for both long and short positions is set by the
Federal Reserve Board and currently is 50%. TRUE
8) A brokerage firm may set a higher margin requirement than that set by the Federal Reserve
Board. TRUE
9) The purchase of stock with cash in the hope of earning a capital gain is known as taking a
A) long position in the stock.
B) short position in the stock.
C) long, margined position in the stock.
D) short, margined position in the stock.
10) Which one of the following statements about margin trading is correct?
A) The Federal Reserve sets the minimum margin requirement for margin trading.
B) If Fred buys $1,000 worth of stock using 60% margin, he will need to pay $400 in cash to
make the purchase.
C) Purchasing stocks on margin is less risky than purchasing stocks by paying cash for the
entire purchase.
D) Margin trading increases the potential profits while lowering the potential losses on a
percentage basis.
11) Which one of the following statements about margin trading is correct?
A) The Securities Exchange Commission sets the minimum margin requirement for margin
trading.
B) If Fred buys $1,000 worth of stock using 60% margin, he will need to pay $600 in cash to
make the purchase.
C) Margin traders are willing to accept lower return to reduce their risk.
D) Margin traders are pessimistic about the future price of the stock.
12) Megan bought 200 shares of stock at a price of $10 a share. She used her 70% margin
account to make the purchase. Megan sold her stock after a year for $12 a share. Ignoring
margin interest and trading costs, what is Megan's return on investor's equity for this
investment?
A) 67%
B) 29%
C) 14%
D) 10%
13) Joseph bought 100 shares of stock at a price of $24 a share. He used his 70% margin
account to make the purchase. Joseph sold his stock after a year for $20 a share. Ignoring
margin interest and trading costs, what is Joseph's return on investor's equity for this
investment?
A) -17%
22
B) -24%
C) 24%
D) -56%
14) Michael purchased 1000 shares of stock at a price of $16 a share. He utilized his 50%
margin account to make the purchase. What is Michael's initial equity in this investment?
A) -$16,000
B) $16,000
C) $8,000
D) -$8,000
15) Jessica purchased 200 shares of stock at $38 using her 70% margin account. Her
maintenance margin is 40%. Jessica has no other securities in her account. At what price will
she receive a margin call?
A) $26.60
B) $19.00
C) $11.40
D) $7.60
16) A restricted account is defined as a margin account wherein the equity is

A) less than the initial margin amount.
B) greater than the initial margin amount.
C) less than the maintenance margin amount.
D) greater than the maintenance margin amount.
17) Emily bought 200 shares of ABC Co. stock for $29.00 per share on 60% margin. Assume
she holds the stock for one year and that her interest costs will be $80 over the holding period.
Ignoring commissions, what is her percentage return (loss) on invested capital if the stock price
went down 10%?
A) -32%
B) -19%
C) -16%
D) -10%
18) Gerry bought 100 shares of stock for $30.00 per share on 70% margin. Assume Gerry holds
the stock for one year and that his interest costs will be $45 over the holding period. Gerry also
received dividends amounting to $0.30 per share. Ignoring commissions, what is his percentage
return on invested capital if he sells the stock for $34 a share?
A) 106.17%
B) 20.48%
C) 18.33
D) 9.16%
19) Justin just made a margin purchase of 100 shares of DEF Corp. for $22.50 per share. The
initial margin is 70%. The maintenance margin is 30%. How low can the price of each share of
DEF be before Justin will have to add equity to his account?
A) $4.73
23
B) $5.25
C) $6.75
D) $9.64
20) Maintenance margin is the

A) minimum amount of loan that can be used for margin trading.
B) initial amount of equity required for a margin purchase.
C) minimum amount of equity that an investor can have to avoid a margin call.
D) amount of additional funds that need to be added to an account to meet minimal equity
requirements.
21) If an investor does not respond to a margin call, the broker will
A) sell enough of the investor's holdings that the margin account can be closed.
B) sell some of the investor's holdings to cover the margin call.
C) notify the Federal Reserve so they can cover the call.
D) sell all of the investor's holdings and close their brokerage account.
22) Which one of the following is a major advantage of margin trading?

A) increase in potential diversification
B) increase in potential profits on a percentage basis
C) possibility of increased gains on a dollar basis
D) interest free loans
23) Which of the following are characteristics of short selling?
I. borrowing shares of stock from a brokerage firm or other investors

II. selling shares of stock you do not own
III. betting the stock price will increase
IV. limiting losses per share to the price at which the stock was sold
A) I and II only
B) III and IV only
D) I, II, III only
24) Jocelyn sells short 1000 shares of JKLO stock at $31.25 per share and six months later
purchases the shares at $29.00 each. Ignoring margin interest and brokerage fees, Nancy will
A) earn a total profit of $3,125.
B) lose a total of $2,900.
C) earn a total profit of $2,250.
D) Lose a total of $2,250.
25) Which of the following statements about short selling is (are) true?
I. Short selling requires an initial margin deposit.

II. Short sellers begin a transaction with a sale and end it with a purchase.
III. Short sellers profit when the stock prices rises.
24
IV. Short selling can be a risky strategy.
A) IV only
B) I and II only
26) Last week, Seward Company stock was selling at $66 a share when Ryan sold 300 shares
of the stock short. Today Ryan bought 300 shares of the same stock at a price of $70.00 share
to cover his position. Ignoring trading costs, what is the dollar return on Ryan's investment?
A) $1,200
B) -$400
C) $400
D) $-1,200
27) Aria has heard a rumor that a major food company will be forced to recall millions of jars
of peanut butter. due to contamination If the rumors are true, the company's stock price will
decline sharply. Which one of the following strategies would allow Jennifer to earn a profit if
the rumor proves to be true?
A) Take a long position in the stock today.
B) Sell the stock short today.
C) Buy the stock on margin today.
D) Take a long position in the stock one month from today.
25
Chapter 3 Investment Information and Securities Transactions
3.1 Learning Goal 1
1) Most brokers charge higher commissions for on-line trades than for telephone transactions.
FALSE
2) On-line trading has greatly lowered the cost of buying and selling stock as well as greatly
increasing the speed of transactions. TRUE
3) For most stocks, charts and tables of historical prices are only available through subscription
services. FALSE
4) You can utilize the Internet to develop financial plans and goals, analyze and select
individual investments and organize your portfolio. TRUE
5) An investor who mistakenly buys the wrong stock because the symbols are similar has 24
hours to undo the trade. FALSE
6) The tools and calculators available on the FINRA website are useful, but quite expensive to
use. FALSE
7) Investing online is usually less expensive than traditional methods. TRUE
8) The Internet provides
I. educational sites for financial investing.

II. the ability to trade securities on-line.
III. current information on stocks and bonds.
IV. analysts reports on individual stocks.
A) II and III only

B) III and IV only
9) Individuals can use the Internet to
I. analyze individual securities.

II. search for stocks that meet specific investment criteria.
III. organize their financial information.
IV. track the performance of their portfolio.
A) I and IV only
B) II and III only
1
10) Individuals can now use the Internet to buy and sell
I. stocks.
II. bonds.
III. mutual funds.
IV. stock options.
A) I and IV only
B) II and III only
11) Information that can be found on the Internet at no cost includes
I. P/E ratios.
II. recent news about a company.
III. financial statements.
IV. future earnings and stock prices.
A) I and IV only
B) II and III only
12) Which one of the following can be considered a pitfall for investors new to on-line
trading?
A) On-line trading is fast and efficient.
B) On-line investors tend to trade too frequently.
C) On-line trading is available to the average investor.
D) On-line investors pay lower costs per trade than investors using a broker.
13) What are some of the tools available to investors on the internet (name at least 4)?
Price histories, plot charts that track the performance of investments over time, screening for
various attributes such as dividends, calculators, stock quotes and portfolio trackers all are
available on the internet, often at no cost.
2
3.2 Learning Goal 2
1) Analytical information would include such information as estimates of growth in sales and
future earnings. TRUE
2) Reviewing industry and company information may provide guidance on the future outlook of
a particular firm. TRUE
3) A listing of a firm's major product lines and projections of future sales would both be
considered descriptive information. FALSE
4) Descriptive information might include the company's lines of business, a list of major
competitors, and recent changes in management. TRUE
5) Current price information on shares of a company's stock is often accompanied by statistics

on the recent price behavior of that stock. TRUE
6) Investors who are aware of current economic, political, and market events tend to make
better investment decisions. TRUE
7) Chemical Week and the Oil and Gas Journal are considered to be general business
periodicals. FALSE
8) Investors can usually find the financial statements of a firm on the firm's website. TRUE
9) A "pump and dump" scheme involves buying shares of stock, hyping that stock via the
Internet and then quickly selling the shares at a profit. TRUE
10) Charting is the technique of

A) plotting the performance of a security over time.
B) sorting through databases of securities to select one based on certain parameters.
C) monitoring a stock based on the underlying economic conditions.
D) determining the amount of money that must be saved based on a given financial goal.
11) Which of the following types of information will NOT be found in major urban
newspapers?
A) price quotations for stocks of local interest
B) stories concerning local business leaders
C) interest rates offered by local and national banks
D) real time price quotes for widely held stocks and exchange traded funds
12) Which of the following is a general rather a financial newspaper?

A) The New York Times
B) Investor's Business Daily
C) The Wall Street Journal
D) Barron's
3
13) Which one of the following is NOT published by the U.S. Government?
A) Federal Reserve Bulletin
B) Survey of Current Business
C) Kiplinger Washington Letter
D) Economic Report of the President
14) Regulation FD requires simultaneous disclosure of critical information simultaneously

to investment professionals and the general public with the exception of
A) brokerage firms.
B) hedge funds.
C) securities rating service such as Moody's Investor Services and Standard & Poor's.
D) mutual fund managers.
15) Which one of the following web sites should you utilize to review the financial
information in a company's 10-K report?
A) freeedgar.com
B) valueline.com
C) wsj.com
D) finance.yahoo.com
16) Which of the following is usually available on a companies website?

A) brokerage reports
B) annual reports
C) back-office reports
D) red herrings
17) The published analysis and recommendations of an individual brokerage firm is

called a
A) prospectus.
B) comparative data source.
C) back-office research report.
D) broker's subscription report.
18) Assume you wanted to find the most current price for Home Depot's stock. Your most
likely source would be
A) Yahoo Finance.
B) Investor's Business Daily.
C) The Granville Market Letter.
D) The Wall Street Journal.
19) Which one of the following statements about back-office research reports is FALSE?
A) They frequently include buy or sell recommendations.
B) They include analyses of current and future prospects for the securities markets.
C) They look at specific companies as well as industries.
D) They are only available to high-profile clients who maintain large accounts with the
brokerage firm.
4
20) The Value Line Investment Survey includes which of the following reports?
I. Selection and Opinion

II. The Outlook
III. Ratings and Reports
IV. Summary and Index
A) I and II only
21) Subscription letters are

A) sometimes geared to specific industries and companies.
B) available free on the Internet.
C) published on an annual basis.
D) descriptive in nature but do not offer investment advice.
22) Which of the following sites is especially valuable for information concerning mutual
funds?
A) www.investopedia.com
B) www.morningstar.com
C) www.moody's.com
D) www.bondsonline.com
23) Current price information is found in which of the following?
I. Dow Theory Letters

II. Yahoo!Finance
III. CNBC TV website
IV. Hulbert Financial Digest
A) II and III only

24) MSN Money, Yahoo! Finance, and the Motley Fool are all classified as
A) subscription services.
B) comparative data sources.
C) financial portals.
D) institutional news sites.
25) Which one of the following services provides bond ratings?

A) Standard & Poor's
B) Yahoo Finance
C) Value Line
5
D) Bureau of the Public Debt Online
3.3 Learning Goal 3
1) An index measures the current value of a group of stocks in relation to a base value
established previously. TRUE
2) All the Standard & Poor's indexes are based on the total market values of the companies
rather than on the price of a single share. TRUE
3) Both the Dow Jones Industrial Average and the Standard & Poor's 500 Index are constructed
to reflect the value of shares in large, mid-size and smaller companies. FALSE
4) Standard & Poor's and Mergent both publish extensive data on bonds. TRUE
5) In addition to the Dow Jones Industrial Average, the Standard & Poors 500 and NASDAQ
indexes are widely quoted measures of market performance. TRUE
6) The Value Line Index is a value weighted index based on a small sample of the 1700 stocks
covered by the Value Line investment reports. FALSE
7) Stock market averages and indexes are commonly used to measure the
A) specific behavior of companies.
B) general behavior of stock prices.
C) specific behavior of alternative investments.
D) specific behavior of the economy.
8) Stock market averages reflect the arithmetic average price behavior of a group of
stocks
A) at a given point in time.
B) relative to a base value set at an earlier point in time.
C) relative to other indexes.
D) relative to a base price of 100.
9) Averages and indexes differ from one another in that an index

A) is the arithmetic average price behavior of a group of stocks at a given point in time.
B) measures the current price behavior of a group of stocks in relation to a base value set at an
earlier point in time.
C) is of value in-and-of itself, whereas an average must be compared to a historical figure to
have any meaning.
D) always moves up before a corresponding average moves up, and always moves down before
a corresponding average moves down.
10) The Dow Jones Industrial Average (DJIA) consists of 30 stocks whose price behavior
A) typically has little correlation with the rest of the stock market.
B) broadly reflects the overall price behavior of the stock market.
C) reflects the changes in value of manufacturing stocks only.
6
D) leads the movements in the general economy by one to two weeks.
11) Both General Electric and Goldman Sachs are part of the Dow-Jones Industrial
Average. If on a given day Goldman Sachs closes at $175 and General Electric at $25
A) the difference in price will not affect the Average.
B) the Average will include 7 shares of General Electric for each share of Goldman Sachs.
C) the effect of each stock on the Average cannot be determined without knowing the number
of shares outstanding for each company.
D) the effect of changes in the price of Goldman Sachs shares will have 7 times the effect on
the Average as changes in the price of General Electric.
12) The Dow Jones Industrial Average (DJIA) is based on the prices of
A) 30 stocks.
B) 100 stocks.
C) 500 stocks.
D) 200 stocks.
13) Which of the following statements about the Dow Jones Industrial Average are
correct?
I. Higher-priced stocks tend to affect the average more than lower-priced stocks.
II. A one-point change in the DJIA correlates to a $1 change in average share value.
III. Changes in the DJIA are made to reflect company mergers and acquisitions.
IV. The DJIA divisor was determined when the average was created and remains constant.
A) I and III only

B) II and IV only
14) Which one of the following statements is correct?

A) The S&P 500 Index is based on 500 large companies that trade on U.S. exchanges.
B) Because of mergers and bankruptcies, the S&P 500 Index no longer contains 500 stocks.
C) The S&P 500 Index is carefully constructed to reflect the values of large, medium and small
capitalization companies.
D) The S&P 500 is based on the 500 largest U.S. companies as measured by market value.
15) Assume that the S&P 500 composite stock index closes at 2,000. This means that
A) the average stock in the index is selling for $20.00.
B) an investor would have to pay $2,000 to purchase one share of each of the stocks
represented in the index.
C) The average value of a company reflected in the Index has doubled from when the Index
was at 1000.
D) the share prices of the stocks in the index have risen 20 times since the 1941-1943 base
period.
16) Over-the-counter market activity is reflected in the

7
A) Standard & Poor's composite index.
B) NASDAQ index.
C) AMEX composite index.
D) financials index.
17) The value of a Standard & Poor's Index is computed by

A) dividing the sum of the closing share prices by an adjusted divisor.
B) dividing the sum of the closing share prices by a divisor and then multiplying the quotient
by 100.
C) dividing the sum of the current market value of all the stocks in the index by a divisor
adjusted for changes in the companies composing the Index.
D) dividing the sum of the current market value of all the stocks in the index by a divisor that
adjusts for stock splits and scales the Index figure to a manageable size.
18) EAFE stands for

A) Europe, Asia, Far East.
B) Europe, Australia, Far East.
C) England, America, Far East.
D) England, America, France, European Community.
19) Which one of the following statements is true concerning bonds?

A) A bond yield represents only the interest earned on a bond.
B) Bond yield data is more useful to an investor when compared over time.
C) A bond's yield remains constant even when a bond is sold prior to maturity.
D) Bonds with similar characteristics generally have widely disparate bond yields.
20) Which of the following indexes would best reflect the performance of a large,
diversified portfolio with equal amounts of money invested in each company.
A) the S&P 500 Index
B) the Russell 3000
C) the NASDAQ 100
D) the Value Line Composite Index
21) Which one of the following indexes reflects a large sample of small, medium sized and
large companies?
A) NYSE composite
B) DJIA
C) Russell 3000
D) Value Line composite
22) Which one of the following is a measure of the performance of small companies?
A) Russell 2000
B) Russell 1000
C) Russell 3000
D) Value Line 1700
23) The Dow Jones Corporate Bond Indexes is based

8
A) the yield to maturity of bonds in the index.
B) annual rates of return and assume the bonds were purchased one year ago and sold today.
C) the interest rates offered on a sample of newly issued bonds.
D) the closing prices of bonds in the index.
24) The Dow Jones Industrial Average and the Standard & Poor's Industrial Index have a
number of similarities and differences. Discuss at least two major similarities and major
differences between these two market indicators.
Similarities: they have the same purpose: to provide a big-picture view of whether stock prices
are generally moving up, down, or sideways from moment to moment, and by how much.
Both indexes arrive at a number by tracking the price movements of a representative list of
stocks.
Difference: The DJIA and the S&P Industrial Index are constructed very differently. The DJIA
is a price average of only 30 stocks and is widely quoted by newspapers and market
commentators; while the S&P is a market-weighted index of 500 stocks and is more highly
regarded by securities industry professionals because of its broader sampling.
25) Why are market averages and indexes useful to investors?
They help determine the performance of the stocks compared to the rest of the stock market and
assess the market's relative strength or weakness. Averages and indexes are also convenient
benchmarks to assess the performance of individual portfolios and mutual funds against the
broader markets.
3.4 Learning Goal 4
1) The basic function of stockbrokers is to execute client orders at the best possible price.
TRUE
2) Shares of stock owned by an individual but held in a brokerage firm's name for ease of
trading are said to be held in street name. TRUE
3) Trading stocks is much faster and less complicated if an individual investor has possession
of the actual stock certificates. FALSE
4) Regulation FD requires that brokerage firms disclose material information such as earnings
forecasts with all clients simultaneously. TRUE
5) Stocks held in street name can be quickly sold online or by telephone. TRUE
6) Brokerage firms are not allowed to make specific buy or sell recommendations to their
clients. FALSE
7) Dividends earned on securities held in street name by the brokerage are not reported to the
Internal Revenue Service. FALSE
9
8) Which one of the following statements about stockbrokers is correct?
A) Stockbrokers act as dealers in the securities they trade.
B) Stockbrokers must be licensed by the Securities and Exchange Commission.
C) Stockbrokers are regulated by financial consultants.
D) Stockbrokers execute trades on the floor of the New York Stock Exchange on behalf of
account executives.
9) Which one of the following statements concerning stock trades is correct?

A) Brokerage firms send customer orders to a market maker on the floor of the NYSE.
B) Confirmation of a trade is transmitted directly from the NYSE to the customer who placed
the order.
C) A broker transmits OTC orders from a customer directly to a floor broker in the OTC
market.
D) Brokerage firms generally hold securities in street name so they can be transferred without
the customer's signature.
10) Unless the investor has requested another arrangement, cash from dividends and the
sale of stock is normally
A) deposited in a Money Market Account offered by the brokerage.
B) automatically reinvested in more stock.
C) direct deposited to the investor's bank account.
D) held in escrow by the brokerage until it is be reinvested.
11) Which of the following services would not be available through premium discount
brokerages?
A) fast execution of trades
B) lower commissions on most trades
C) phone conversations and advice from a broker
D) the ability to place limit and stop-loss orders
12) Which is the correct order of events when an individual buys a stock through a
brokerage firm?
I. The order is transmitted to the main office of the brokerage firm.

II. The customer places the order with their local stockbroker.
III. The confirmation of the order is sent to the broker placing the order.
IV. The order is sent to the floor of the exchange.
A) I, II, III, IV
B) II, I, III, IV
C) II, IV, I, III
D) II, I, IV, III
13) Holding securities in street name

A) makes the trading of securities easier and more efficient for individual investors.
B) allows the brokerage firm to sell securities without the customers approval.
10
C) enables the brokerage firm to collect the stock dividends as compensation for their services.
D) means that the brokerage firm actually owns the securities.
14) A report describing the transactions in an account, listing the dividend and interest
payments received, and detailing the current holdings is called a
A) prospectus.
B) red herring.
C) statement.
D) street certificate.
15) A brokerage firm which provides analyst reports, investment advice and information
as well as online brokerage services is called a(n)
A) premium discount broker.
B) full-service broker.
C) basic discount broker.
D) electronic broker.
16) When deciding between a discount or full service brokerage, the investor should
consider
A) trading costs.
B) her comfort level making unassisted investment decisions.
C) her awareness of potential investment opportunities.
17) Which one of the following is the LEAST important when selecting a stockbroker?
A) knowing the stockbroker personally
B) selecting a stockbroker who best understands your investment goals
C) considering the services offered and the related costs
D) getting referrals from personal acquaintances with similar investment objectives
3.5 Learning Goal 5
1) A limit order is an order to buy at the limit price or less. TRUE
2) A limit order is an order to sell at the limit price or less. FALSE
3) A stop-loss order is activated once the stock reaches the specified price. TRUE
4) When placing an order on-line, an individual investor should always double check the ticker
symbol prior to submitting the order. TRUE
5) Many day traders are also margin traders. TRUE
6) Stop orders are used only when selling a stock. FALSE
7) Most day traders avoid holding stocks overnight because they fear large price changes while
the markets are closed. TRUE
11
8) It is generally a good idea to use limit orders when trading after hours. TRUE
9) Traders who hold stocks for less than a full day can reduce the tax burden on their profits.
FALSE
10) Commission structures vary with the type of security being traded, the type of broker
involved and the size of the order. TRUE
11) Small investors normally have a negotiated commission schedule while large investors
benefit from a fixed-commission schedule. FALSE
12) Commissions for on-line trades are considerable lower than for orders placed with a full-
service broker. TRUE
13) SIPC insurance is offered by some full-service brokers to protect investors from large
losses. FALSE
14) Many brokerage firms require that disputes between individual investors and brokers be
settled through arbitration. TRUE
15) The Securities Investors Protection Corporation protects investors from brokers who offer
incompetent advice. FALSE
16) Excessively trading a customers account to increase a stockbrokers commission

income is
A) an acceptable method of timing the market to increase rates of return.
B) called churning which is an illegal practice.
C) probably unethical but yet is acceptable by the securities industry.
D) permitted provided that the customer does not object.
17) Which of the following practices is NOT recommended for on-line traders?
A) Double check stock symbols to be sure you are ordering the right stock.
B) Use limit orders rather than market orders, especially when trading after hours.
C) Trade as often as possible to maintain a strong relationship with the brokerage.
D) Double check your order to be sure the quantity of shares and the price is what you
intended.
18) When an investor places a ________ order, he agrees to buy or sell at the best
available price when the trade is executed.
A) market
B) limit
C) stop
D) stop-limit
19) An individual investor who wishes to borrow money to buy stocks must open a
A) signature account.
12
B) margin account.
C) joint account.
D) custodial account.
20) The current price of XUM stock is $35. Jason places a limit order for 100 shares at
$30, GTC. The price fall so $30.05 and the rises over the course of a month to $42.
A) Jason has a gain of $1,200.
B) Jason has a gain of $1,195.
C) Jason does not own the stock, but will if his trade can ever be executed at $30.00 or better.
D) Jason has a loss of $1,195.
21) A margin account

A) can be opened by any investor who wants to purchase securities by charging them to his/her
credit card.
B) allows an investor to borrow one hundred percent of the cost of the securities purchased.
C) allows an investor to borrow a portion of the purchase price at a reasonable rate of interest.
D) is permitted only in wrap accounts.
22) Which of the following are characteristics of a wrap account?
I. a flat amount of commission per transaction

II. an increased probability of account churning
III. a money manager
IV. detailed performance reports
A) I and II only
B) III and IV only
23) An odd-lot trade involves a trade

A) of only 100 shares.
B) that is generally priced at a discount to the market price.
C) of 100,000 shares or more.
D) consisting of any number of shares that is not a multiple of 100.
24) Heather places an order to buy 525 shares of stock. This is an order for
A) five round lots and one odd lot.
B) 21 round lots of 25.
C) one odd lot.
D) five hundred round lots and twenty-five odd lots.
25) An order to sell 300 shares of ABC stock at the best available price is called a
A) limit order.
B) market order.
C) stop loss order.
D) fill-or-kill order.
13
26) Market orders are usually executed
A) only after all limit orders have been executed.
B) at the average price during the previous trading session.
C) at the closing price for the day's trading.
D) before the price can change significantly if the order is placed while the markets are in
session.
27) McDonald's stock is now selling for $92 per share. Kim wants to buy 100 shares but
only if she can do so at $90 or less. She should place a(n)
A) stop order.
B) market order.
C) limit order.
D) odd-lot order.
28) Which one of the following statements about limit orders is correct?
A) The execution of the trade will occur prior to the close of trading on the day the trade is
placed.
B) The execution will occur at the regular open on the day following the day the trade is placed.
C) The trade may be executed only at the limit price or better at any time prior to expiration or
cancellation of the order.
D) The trade will be executed at the market price at the end of the third business day, if not
executed previously at the limit price.
29) A fill-or-kill order will be

A) executed immediately upon order arrival on the floor of the exchange.
B) will be cancelled if not immediately executed at the stated price or better.
C) will be cancelled at the end of the trading day if not executed by that time.
D) in effect until cancelled by the customer who placed the order.
30) Ryan places a good-'til-canceled limit order to sell 300 shares of KM at $18 a share.
When his order reaches the trading floor, KM is trading at $18.20. Which of the following
statements is true concerning Roy's order?
A) The trade will not be executed and will be immediately cancelled.
B) The specialist will record the order in the order book and execute the trade as soon as the
price hits $18.00.
C) The brokerage firm will sell the 300 shares at $18.20 and keep the additional $0.20 as a
commission.
D) The order will be executed at $18.20 with the proceeds credited to Roy's account.
31) Which of the following statements concerning market, stop loss and limit orders are
correct?
I. Market orders guarantee both a price and an execution.

II. Market orders guarantee an execution but not a price.
III. Limit orders guarantee a price but not an execution.
IV. Stop-loss orders may never be executed.
14
A) I and III only
B) II, III and IV only
C) I and IV only
D) II and IV only
32) On March 15, Marcos placed a good-'til-canceled order to buy 200 shares of ABC at
$10 a share. ABC sold between $10.50 and $11.00 on that day. Over the following two
months the stock price continued to rise and Marcos forgot about the order. After the
markets closed on June 6, some bad news concerning ABC was released. The stock
opened on June 7 at a price of $8.00 a share. Which one of the following statements is
correct concerning Marcos' order?
A) The order was cancelled on May 15 because it had not been executed within the allowable
two-month time period.
B) The order was executed on March 15 at $10.50 a share since that was the best available
price of the day.
C) The order was executed on June 7 at a price of $10.00 a share.
D) The order was executed on June 7 at a price of $8.00 a share.
33) Which one of the following statements is correct about a good-'til-cancelled order?
A) The order generally expires after six weeks.
B) The order will automatically renew unless cancelled by the customer.
C) The order helps customers obtain a specific price without watching the market continuously.
D) The order will be cancelled at the end of the trading day if not executed.
34) On October 12, Kevin placed a day order to purchase 100 shares of ABC stock at $21
a share. During the day, the stock sold at prices ranging from $21.01 to $22.49. Over the
following month the stock sold in a range of $21.60 to $23.05. On December 2, the market
declined radically and the price of ABC stock dropped to $19.94. Which one of the
following statements is correct concerning Allen's order?
A) The order was never executed.
B) The order was executed at $21.01 per share.
C) The order was executed at $22.49.
D) The order was executed at $19.94.
35) Ryan bought a stock three years ago for $6 a share. Today, June 22, the stock is selling
for $72 a share. Ryan is afraid that the price will fall and does not want to lose his profits
so he places a stop-loss order to sell at $70. The stock sells between $71 and $75
throughout the remainder of the day on June 22. On the morning of June 23, the stock
opens at $9 a share based on rumors of a possible bankruptcy due to inappropriate
accounting procedures. Which one of the following statements is true concerning this
situation?
A) Ryan was able to sell his stock for $70 a share thereby protecting his profits.
B) Ryan's stock was sold for $9 a share causing him to lose most of his profits.
C) Ryan still owns his shares of stock since his order was never executed at the $70 price.
D) Ryan received a call from the specialist asking him what he wanted to do about his order.
15
36) Three years ago, Emily bought 200 shares of HQ at $27.00 per share. HQ shares have
risen to $57.50 per share. If the stock continues to rise, she wants to hold it, but she fears
that the price could fall quickly and she will lose most of her profit. Which of the
following decisions would be best?
A) Place a limit order to sell at $60.00.
B) Place a stop-limit order at $55.00.
C) Place a stop-loss order at $27.00.
D) Place a stop-loss order at $55.00.
37) Mike bought 200 shares of EG stock two years ago at $16 per share. The stock has
traded in a range of $21 to $44 a share over the past year. EG is now selling for $43.60 a
share. EG announces its earnings today and Mike feels the stock could go to $60 on good
news or fall to $30 on bad. To protect his profits, the most appropriate order for him to
place is
A) market order to sell immediately.
B) a limit sell order at $60.00.
C) a stop loss order at $42.
D) a stop-limit order to sell at $45.
38) Angela placed a stop-limit order to sell 100 shares of RST stock at $28 when the
market price of RST was $31. Shortly after Angela placed her order, trading on RST was
halted due to a pending news announcement. When trading re-opens RST is priced at $24
a share. Within minutes the price of RST began to drop further until it reached $19 a
share. Which one of the following statements is correct concerning Angela's stop-limit
order to sell?
A) Angela's stock was sold for $28 a share.
B) Angela's stock was sold for $24 a share.
C) Angela's stock was sold at a price between $19 and $24 a share.
D) Angela still owns her 100 shares of stock.
39) At 10:45 a.m., Ashley placed a stop-loss order to sell 200 shares of Alpha stock at $43
a share. At 2:15 p.m., the price of Alpha fell to $42.90 and then rose to $43.40 a share by
the end of the trading day. Ashley order was executed that day. Ashley would have
received a price
A) of $42.90 a share for her stock since her order was already recorded in the specialist's book.
B) of $43.40 a share for her stock since that was the closing price on the day of execution.
C) between $42.90 and $43.40 a share depending upon when her trade executed.
D) equal to the average prices paid by the specialist during that trading day.
40) Which of the following statements concerning day traders are correct?
I. Day traders generally do not hold securities over night.

II. Day trading is a relatively low risk approach to investing.
III. Some day traders sell stocks short.
IV. Day trading was declared illegal by the Market Stabilization Act of 2002.
A) I and II only
16
B) I and III only
41) The Securities Investor Protection Corporation insures individual investors against
A) the loss of up to $500,000 in securities or $100,000 in cash held by a broker.
B) market losses of $500,000 total or $100,000 per transaction.
C) losses of up to $100,000 incurred due to innocent online trading errors.
D) losses incurred up to $500,000 due to churning by a broker.
42) In which of the following cases might an investor receive help from The Securities
Investor Protection Corporation?
A) The investor purchased a stock at $40 per share because his broker recommended it. Over
the next six months, it fell to $20 per share.
B) The investor purchases stock in a company that shortly later was forced into bankruptcy
because of accounting fraud.
C) The investor holds $100,000 worth of stock in certificate form. The certificates are
destroyed in a fire.
D) A broker took money sent by investors to cover stock purchases, but never invested it and
sent falsified statements to cover the fraud.
43) An informal, voluntary agreement to solve disputes between an investor and his/her
broker by utilizing a person to facilitate negotiations between the two parties is called
A) voluntary arbitration.
B) binding arbitration.
C) mediation.
D) litigation.
44) Describe several appropriate uses of stop-loss orders.
The most important benefit of a stop-loss order is that it costs nothing to implement. Stop-loss
orders are traditionally thought of as a way to prevent losses. Stop loss orders are appropriate
when an investor who cannot continuously monitor her investments daily wants to limit
potential losses on a newly purchased stock. They are also used to protect profits or limit
additional losses on stocks that the investor has held for a period of time.
45) When is it appropriate to use limit orders?
It is especially appropriate to use limit orders when buying or selling outside of normal trading
hours. The limit order protects the investor from large, unanticipated price changes when the
markets open. Limit orders are also useful when an investor has decided to sell but wants to
profit a little longer from rising prices or wants to catch what he hopes is a temporary dip in the
price before he buys. And when you’re trading a high number of shares.
3.6 Learning Goal 6
1) Chartered Financial Analysts and Certified Financial Planners must pass a rigorous series of
17
exams, as well as meet educational and experience requirements. TRUE
2) A person can become a Certified Financial Planner merely by filling out an application and
paying an annual fee. FALSE
3) Investment clubs are legal partnerships. TRUE
4) Investment clubs may only operate under the guidance of a registered investment advisor.
FALSE
5) Investment advisors are legally responsible for losses incurred by their clients. FALSE
6) Which of the following designations does NOT have formal education and testing
requirements?
A) Chartered Financial Analyst
B) Certified Financial Planner
C) Registered Investment Adviser
D) Certified Public Accountant
7) Recent studies suggest that, on average, investments clubs

A) outperform broad market indexes by several percentage points.
B) underperform broad market indexes by a several percentage points.
C) earn average rates of return.
D) no data is available on investment club performance.
8) Which of the following is required by the Investment Advisers Act to disclose their
background and any conflicts of interest?
A) professional investment advisers
B) accountants and lawyers
C) stockbrokers
D) all of the above
9) Which of the following are advantages of investment clubs?
I. Small investors can pool their money to build a portfolio.

II. Members can share research responsibilities.
III. Individual members may have different goals and tolerance levels for risk.
IV. Investment clubs typically buy stocks for the long term rather than short term profits.
A) I and III only.

B) III and IV only.
18
Chapter 4 Return and Risk
4.1 Learning Goal 1
1) Investors can be confidently predict future returns on an investment by studying its past
performance. FALSE
2) An investment that has earned a high rate of return over the last 5 years will not necessarily
continue to perform well in the future. FALSE
3) Meaningful measures of an investment's return must consider both income and capital gains.
TRUE
4) In response to the same external force, the return on one investment may increase while the
return on another investment may decrease. TRUE
5) In the short term, stock prices tend to rise as inflation rises. FALSE
6) When investors expect higher inflation, they will generally require higher rates of return.
TRUE
7) A capital loss is computed by

A) subtracting the original cost of an investment from the proceeds received from the sale of
that investment minus any income from the investment.
B) subtracting the original cost of an investment from the proceeds received from the sale of
that investment plus any income from the investment.
C) subtracting the proceeds received from the sale of an investment from the original cost of
the investment.
D) subtracting the original cost of an investment from the proceeds received from the sale of
that investment.
8) Rational investor's are motivated to purchase an asset because of its

A) expected returns.
B) past returns.
C) emotional benefits.
9) The most predictable component of stock returns is

A) capital gains.
B) capital losses.
C) inflation adjusted return.
D) dividend income.
10) Kelly bought a stock at a price of $22.50. She received a $1.75 dividend and sold the
19
stock for $24.75. What is Kelly's capital gain on this investment?
A) $4.00
B) $3.75
C) $2.25
D) $1.75
11) Ashley purchased a stock at a price of $27 a share. She received quarterly dividends of
$0.75 per share. After one year, Ashley sold the stock at a price of $29.25 a share. What is
her percentage holding period return on this investment?
A) 10.3%
B) 11.1%
C) 17.9%
D) 19.4%
12) Inflation tends to have a particularly negative impact on the price of

A) real estate.
B) bonds.
C) gold.
D) crude oil.
13) Historically, what is the correct ranking of the following securities from lowest rate of
return to the highest?
A) Short-term government bills, long-term government bonds, stocks.
B) Long-term government bonds, short-term government bills, stocks.
C) Stocks, short-term government bills,long-term government bonds.
D) Historical returns do not exhibit a consistent pattern.
14) Which of the following internal characteristics should cause investors to expect the
highest rate of return?
A) a steady record of past dividends
B) interest and principal guaranteed by the U.S. government
C) a record of excellent management and consistent dividend payments
D) poor management and excessive use of debt financing
15) Which of the following investments may be impacted by government actions?

A) stocks
B) corporate bonds
C) government bonds
D) all of the above
16) Over the long term, which one of the following has historically had the lowest risk and
lowest average annual rate of return?
A) common stock
B) long-term government bonds
C) real-estate
D) corporate bonds
20
4.2 Learning Goal 2
1) The financial concept of time value of money is dependent upon the opportunity to earn
interest over time. TRUE
2) Compound interest is interest paid not only on the initial investment but also on any interest
earned after the initial investment. TRUE
3) An investor who requires a 7% rate of return should be willing to pay $934.58 now to
receive $1,000 at the end of one year. TRUE
4) The holding period return includes the time value of money. FALSE
5) If the discount rate is appropriate for the level of risk, a satisfactory investment will have a
present value of benefits equal to or greater than than the present value of costs. TRUE
6) An investment's internal rate of return does not depend on the rate at which income from the
investment is reinvested. FALSE
7) The time value of money concept best supports the idea of

A) the sooner the better.
B) better late than never.
C) a bird in hand is worth two in the bush.
D) good things come to those who wait.
8) The present value of $10,000 discounted at 5% per year and received at the end of 5
years is
A) $10,000/1.25.
B) $10,000(1.05)5.
C) $10,000/(1.05)5.
D) $10,000 (1.05)1/5.
9) Bob's house has doubled in value since he bought it 30 years ago. The house's value has
increased by an annual rate of
A) 2.34%.
B) 3.33%.
C) 6.67%.
D) 100%.
10) Which one of the following statements is correct concerning the time value of money?
A) The future value of $1 at the end of two years is equal to $1 plus the first year's interest
times 1 plus the annual interest rate.
B) As the interest rate increases for any given year, the future value interest factor will
decrease.
C) The future value of $1 decreases with the passage of time.
D) The future value interest factor is equal to zero if the interest rate is zero.
21
11) Christopher invests $400 today at a 4% rate of return which is compounded annually.
What is the future value of this investment after four years?
A) $342
B) $416
C) $464
D) $468
12) Roy is going to receive a payment of $5,000 one year from today. He earns an average
of 6% on his investments. What is the present value of this payment?
A) $4,717
B) $4,821
C) $5,000
D) $5,300
13) Which of the following statements are correct concerning the present value of $1.00
five years from today discounted at 5%?
I. The present value is equal to $1.00 divided by 1.05 to the 5th power.
II. If the discount rate were less than 5%, the present value would be smaller.
III. If the discount rate were more than 5%, the present value would be smaller.
IV. If the $1.00 were to be received 6 years from today, the present value would be larger.
A) I and II only
B) I and III only
C) II and III only
14) Camille purchased a bond 5 years ago for $1,050. The bond paid $50 in annual
interest and returned the $1,000 principal at the end of the fifth year. Camille used the
interest payment to pay for college textbooks.
A) Her internal rate of return was exactly than 5%.
B) Her internal rate of return was greater than 5%.
C) Her internal rate of return was less than 5%.
D) Her internal rate of return cannot be determined.
15) When calculating the present value of either a future single sum or a future annuity,
the applicable interest rate is usually called the
A) yield to maturity.
B) compound interest rate.
C) internal rate of return.
D) discount rate.
16) When the rate of return is equal to the discount rate

A) the present value of an investment's benefits must be greater than its cost.
B) the cost of an investment equals the sum of its benefits.
C) the cost of an investment equals the future value of its benefits.
D) the cost of an investment equals the present value of its benefits.
22
17) If the present value of an investment's benefits equals the present value of the
investment's costs, then the investor would earn a
A) return equal to the discount rate.
B) negative rate of return.
C) 0% rate of return.
D) return greater than the discount rate.
18) The present value of $1,000 discounted at the rate of 5% per year, to be received at
the end of 3 years is equal to
A) $1,000/(1.03)5.
B) $1,000/(1.05)3.
C) $1,000 × (1.05)3.
D) $1,000 - ($1,000) × .03 × 5.
19) Zachary has purchased an investment that he expects to produce income of $3,000 at
the end of the first year and $4,000 at the end of the second year. If he requires an 8%
rate of return compounded annually, what is the maximum amount that he can pay and
still earn the required rate of return?
$3,000/(1.08)1 + $4,000/(1.08)2 = $6,207.13
20) Zachary has purchased an investment that he expects to produce income of $3,000 at
the end of the first year and $4,000 at the end of the second year. If he pays $5,800 for
this investment, what is the internal rate of return?
$3,000/1.128 + $4,000/1.1282 = $5,800 Answer is approximately 12.8%.
4.3 Learning Goal 3
1) The return that fully compensates for the risk of an investment is called the risk-free rate of
return. FALSE
2) The required return on a risky investment includes a real rate of return, an inflation premium
and a risk premium. TRUE
3) If the risk-free rate of return is less than the inflation rate, the real rate of return is negative.
TRUE
4) It is not possible for the nominal risk-free rate of return to be lower than the rate of inflation.
FALSE
5) Short-term U. S. Treasury bills are yielding 0.5%. The expected inflation rate is 2%.
Therefore, the real rate of interest must be negative 1.5%. TRUE
6) One reason that the holding period return should not be used to compare long-term
investments is that it does not consider the time value of money. TRUE
23
7) The holding period return is especially useful comparing investments with unequal holding
periods. FALSE
8) The closest approximation to the real, risk-free rate of interest is

A) the short-term Treasury bill rate plus the inflation rate.
B) the short-term Treasury bill rate minus the inflation rate.
C) the 10 year Treasury bond rate minus the inflation rate.
D) the 10 year Treasury bond rate minus the 1 year Treasury bill rate.
9) The risk-free rate is equal to the real rate of return plus

A) an expected inflation premium.
B) a risk premium.
C) both an inflation and a risk premium.
D) the prevailing prime rate.
10) The markets in general are paying a 2% real rate of return. Inflation is expected to be
3%. ABC stock commands a 6% risk premium. What is the expected rate of return on
ABC stock?
A) 2%
B) 5%
C) 8%
D) 11%
11) The required rate of return on the Cosmos Corporation's common stock is 10%, the
current real rate of return in the market is 1%, and the inflation rate is 3%. In this case,
the risk premium associated with Cosmos stock is
A) 5%.
B) 6%.
C) 7%.
D) 8%.
12) Which one following will lower required rates of return?

A) higher rates of inflation
B) higher risk premiums
C) lower rates of inflation
D) lower dividend yields
13) The required return on Beta stock is 14%. The risk-free rate of return is 4% and the
real rate of return is 2%. How much are investors requiring as compensation for risk?
A) 8%
B) 10%
C) 12%
D) 14%
24
14) Which of the following is(are) issue characteristics of an investment?
I. type of investment such as stocks or bonds

II. financial condition of the issuer
III. coupon or dividend payments
IV. time to maturity
A) I and II only
B) III only
15) A holding period return is calculated by adding the current income to the capital
gains and dividing this sum by the
A) average investment value.
B) beginning investment value.
C) total income received.
D) selling price of the investment.
16) Lauren purchased a stock for $28 a share and sold it six months later for $31. While
she owned the stock, Lauren received two quarterly dividends of $0.35 per share.
Brittany's holding period return on this stock is
A) 13.2%.
B) 10.7%.
C) 11.9%.
D) 26.4%.
17) In which of the following circumstances would it be most appropriate to use the
holding period return?
A) to compare the capital gains on a house held for 8 years and a mutual fund held for 6 years
B) to compare the calendar year performance of stocks purchased in March to stocks purchased
in September
C) to compare the dividend yield of stocks to the interest rate on bonds
D) to compare the performance of several stocks, each of which was held throughout an entire
year
18) Christopher purchased 200 shares of ABC stock at $21.25 per share. After nine
months, he sold all of his shares at a price of $19.88 a share. Christopher received a total
of $0.55 per share in dividends during the time he owned the shares. Jake's holding
period return is
A) -6.4%.
B) -3.9%.
C) 2.6%.
D) 9.7%.
19) The holding period return (HPR) can appropriately be used to

A) compare the yield on investments held for any time period.
25
B) compare returns among investments that are held for the same period of time.
C) isolate realized capital gains.
D) determine the required reinvestment rate for long-term investments.
20) Jason purchased ABC stock at $40 per share and DEF stock at $35 per share on the
same day in 2015. Exactly 6 months later, the ABC stock is worth $42.00 per share and
has not paid a dividend while the DEF stock is worth $36 per share and has paid 2
quarterly dividends of $0.50 each. The holding period returns are
A) ABC, $2.00 and DEF $2.00.
B) ABC 5% and DEF 2.9%.
C) ABC 5% and DEF 5.7%.
D) The holding period return cannot be determined because we do not know the discount rate.
21) Briefly explain the holding period return (HPR) and give several characteristics of
this measure.
Holding period return is the total return received from holding an asset or portfolio of assets over
a period of time, generally expressed as a percentage. It is particularly useful for comparing
returns between investments held for different periods of time.
4.4 Learning Goal 4
1) The internal rate of return is the rate of return that causes a project to have a zero net present
value. TRUE
2) The internal rate of return on an investment is the discount rate that produces a present value
of benefits greater than the cost of the investment. FALSE
3) The internal rate of return is a less meaningful measure of an investment's performance than
holding period return if the holding period is other than 1 year. FALSE
4) The present value of an investment must be computed by discounting cash flows at the
internal rate of return. FALSE
5) When using a financial calculator or electronic spreadsheet to calculate an investment's

yield, the amount invested is expressed as a negative number. TRUE
6) The internal rate of return is the correct method to use when an investor wants to determine
an investment's average annual yield. TRUE
7) If you own an investment providing periodic returns, your actual yield on the investment will
depend on the reinvestment rate you are able to obtain. TRUE
8) A suitable investment should have an internal rate of return equal to or greater than its
required rate of return. TRUE
9) When computing an investment's internal rate of return using a financial calculator or

26
spreadsheet such as Excel, which of the following should be entered as a negative
number?
A) the number of time periods
B) dividend or interest payments
C) the price at which the investment is sold
D) the initial cost of the investment
Table 1
A B
1 Year Cash Flow
2 1 $(5,000)
3 2 $4,000
4 3 $3,000
10) Given a spreadsheet similar to the one shown in Table 1, the command to compute the
internal rate of return would be
A) =RATE(3,B3,B4,B2).
B) =IRR(B2:B4).
C) =IRR(B3:B4)-B2.
D) =TVM(A2:B4).
11) Six years ago, Miguel invested $3,500. Today his investment is worth $5659. The
internal rate of return on this investment is
A) -7.69%.
B) error 5.
C) 8.34%.
D) 10.28%.
12) Alexis bought a stock for $34 a share two years ago. The stock does not pay any
dividends. Today she sold the stock for $28.50 a share. What was her internal rate of
return on this investment?
A) 9.22%
B) -9.22%
C) 19.30%
D) -8.44%
13) An investment costs $3,500 today. This investment is expected to produce annual cash
flows of $1,200, $1,400, $1,300 and $1,100, respectively, over the next four years. What is
the internal rate of return on this investment?
A) 8.1%
B) 9.33%
C) 14.6%
D) 16.2%
14) The following investment cash flows have been entered into cells B5 through B9 of an
EXCEL spreadsheet. B5 $(5,200 ), B6 $2,100, B7 $1,300, B8 $1,800, B9 $1,200, where
$(5,200) is the cost of the investment and the following amounts are cash flows at the end
27
of years one through four. The correct function for computing the yield on this
investment is
A) =irr(B6:B9)+B5.
B) =irr(B5:B9).
C) =rate(4,0,-5200, 1200).
D) =ytm(B5, B6:B9).
15) The Sorka Corp. has paid annual dividends of $0.60, $0.63, $0.65, $0.68 and $0.72,
respectively, over the past five years. What is the dividend growth rate?
A) 4.7%
B) 5.2%
C) 5.4%
D) 5.9%
16) If a stock is purchased at the beginning of a year, a single dividend is paid at the end
of the year and the stock is sold immediately after the dividend has been received. In this
case
A) the internal rate of return is lower than the holding period return.
B) the holding period return. is lower than the internal rate of return.
C) it is not possible to calculate the internal rate of return.
D) the internal rate of return equals the holding period return.
17) Ryan purchased a bond for $980 at the beginning of 2011. He received annual
interest payments of $55 at the end of each year through 2016 when the bond was
redeemed at its face value of $1,000. Compute the yield (internal rate of return) Ryan
earned on his bond purchase.
A) 5.50%
B) 5.61%
C) 5.91%
D) .34%
18) Josh purchased 100 shares of XOM at the beginning of 2011. He received dividends
per share of $1.37 (2011), $1.55 (2012), $1.66 (2013), $1.74 (2014), $1.85 (2015). At the end
of 2015, just after receiving the last dividend, he sold the stock for $84.76. At what rate
did the dividends grow from the end of 2011 to the end of 2015? Assume that all
dividends were received at the end of the year.
A) 7.8%
B) 6.2%
C) 13.1%
D) 35%
19) Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2011. He
received dividends per share of $1.37 (2011), $1.55 (2012), $1.66 (2013), $1.74 (2014),
$1.85 (2015). At the end of 2015 just after receiving the last dividend, he sold the stock for
$84.76. What was his average annual rate of return form both dividends and capital
gains? (Hint: compute the IRR, assume that all dividends were received at the end of the
year.)
28
A) 9.831%
B) 3.774%
C) 3.423%
D) 4.94%
20) Samantha bought a stock one year ago for $66 a share. She received a total of $2.00 in
dividends. Today she sold the stock for $70 a share. Which one of the following statements
is correct concerning this investment?
A) Samantha has current income of $6.00.
B) Samantha has a capital gain of $2.00.
C) Samantha has a total return of 9.1%.
D) Samantha has unrealized income of $4 a share.
21) Explain the similarities and differences between the holding period return and the
internal rate of return.
Both measures take into account total return from both income and capital gains. The holding
period of return does not adjust returns for the length of time that an investment is held. The
internal rate of return computes an average compound annual rate of return and is suitable for
comparing investments held for different periods of time.
22) Josh purchased 100 shares of XOM for $76.63 per share at the beginning of 2007. He
received dividends per share of $1.37 (2007), $1.55 (2008), $1.66 (2009), $1.74 (2010),
$1.85 (2011). At the end of 2011, just after receiving the last dividend, he sold the stock
for $84.76. What was his average annual rate of return form both dividends and capital
gains? (Hint: compute the IRR, assume that all dividends were received at the end of the
year.)
Answer: Josh's cash flows on a per share basis were as follows:
PV at 4.076%
2007 (beginning) -$76.63 -76.63
2007 (end) 1.37 1.32
2008 (end) 1.55 1.43
2009 (end) 1.66 1.47
2010 (end) 1.74 1.48
2011 (end) 1.85 + 84.76 70.93
Total 00.00
4.5 Learning Goal 5
1) Risk can be defined as uncertainty concerning the actual return that an investment will
generate. TRUE
2) Business risk resulting from uncertainty over a firm's earnings is a concern for stockholders,
but not for debt holders. FALSE
29
3) Lower risk investments are associated with lower expected rates of return. TRUE
4) The reluctance of Congress to tinker with tax rates and deductions has virtually eliminated
tax risk for U.S. businesses. FALSE
5) Business risk is the risk associated with the amount of debt financing used by a firm.
FALSE
6) Investing in short-term debt decreases exposure to interest rate risk. TRUE
7) Investors who limit themselves to risk free and low risk investments can avoid purchasing
power risk. FALSE
8) Liquidity risk is defined as the risk of

A) having to trade a security in a broad market.
B) not being able to sell an investment conveniently and at a reasonable price.
C) having inflation erode the purchasing power of your investment.
D) having declining price levels affect the reinvestment rate of your current income stream.
9) In some markets it may take many months to sell a residential property. This is an
example of
A) business risk.
B) credit risk.
C) market risk.
D) liquidity risk.
10) The stock of Plomb Co. falls sharply on news that its CEO has drowned in a boating
accident while on vacation. This is an example of
A) liquidity risk.
B) event risk.
C) accidental risk.
D) flotation risk.
11) As gasoline prices fell in 2015, sales of hybrid and electric vehicles dropped sharply.
This is an example of
A) liquidity risk.
B) event risk.
C) business risk.
D) purchasing power risk.
12) A petroleum refinery in the Gulf region is forced to shut down for several months
because of hurricane damage. This is an example of
A) market risk.
B) speculation.
C) event risk.
D) business risk.
30
13) A business has strong sales and profits, but its stock price falls anyway because stock
prices in general are declining. This is an example of
A) business risk.
B) financial risk.
C) market risk.
D) liquidity risk.
14) Congress considers a bill that would eliminate the mortgage interest deduction for
individuals. For the housing industry, this is an example of
A) tax risk.
B) interest rate risk.
C) business risk.
D) event risk.
15) Which of the following will lower the rate of return on a stock whose price has
doubled since you bought it?
A) an increase in the capital gains tax from 15% to 20%
B) an increase in the tax rate on dividend income from 15% to 20%
C) persistently low inflation rates
D) the Federal Reserve acts to lower interest rates
16) Which of the following factors will increase the risk level of an investment?
I. a firm's decision to use a high percentage of debt financing

II. an economic situation in which consumer prices are rising at a rapid rate
III. the ability to trade the investment in a broad market rather than in a thin market
IV. unstable currency values
A) I and II only
C) II and IV only
17) Identify and discuss five sources of risk.

• Business Risk: the degree of uncertainty associated with an investment’s earnings and the
investment’s ability to pay the returns (interest, principal, dividends) that investors expect.
• Financial Risk: the increased uncertainty that results when a firm borrows money.
• Liquidity Risk: the risk of not being able to sell (liquidate) an investment quickly without
reducing its price.
• Tax Risk: The chance that Congress will make unfavorable changes in tax laws, driving
down the after-tax returns and market values of certain investments.
• Event Risk: occurs when an unexpected event has a significant and unusually immediate
effect on the underlying value of an investment.
31
• Market Risk: the risk that investment returns will decline because of factors that affect the
broader market, not just one company or one investment.
• Operational Risk – Uncertainty about a company’s operations, including its supply chain and
the delivery of its products or services.
• Legal Risk – Uncertainty related to lawsuits or the freedom to operate
18) Which types of risk can not be avoided by carefully researching a company's business
prospects and financial statements?
Market risk is the risk that market forces can affect the return of an individual investment.
Event risk is the risk that an unforeseeable event may have an immediate, significant effect on
an investment's returns.
Tax risk is the possibility that tax laws affecting an investment could change. All of these risks
are caused by factors external to the company, so they cannot be avoided by researching
internal factors.
4.6 Learning Goal 6
1) The standard deviation is computed by dividing the sum of the squared deviations by the
number of observations. FALSE
2) Historical returns are of no use in estimating the risk of an investment. FALSE
3) The greater the dispersion around an asset's expected return, the greater the risk. TRUE
4) Investments with lower standard deviations can be expected to produce higher rates of
return. FALSE
5) Historically speaking, the standard deviation of returns on U.S. Treasury Bills is zero.
FALSE
6) Most investors are risk averse, meaning they will always be willing to sacrifice higher return
if they can avoid risk. FALSE
7) Each of the following investments produces the same rate of return. Which one has the
greatest amount of risk?
A) investment A with a standard deviation of 4%
B) investment B with a standard deviation of 12%
C) investment C with a standard deviation of 8%
D) investment D with a standard deviation of 19%
8) An investment produced annual rates of return of 5%, 12%, 8% and 11% respectively
over the past four years. What is the (sample) standard deviation of these returns?
32
A) 2.7%
B) 3.2%
C) 3.6%
D) 3.8%
9) An investment produced annual rates of return of 7%, -14%, 20% and 4% respectively
over the past four years. What is the standard deviation of these returns?
A) 12.1%
B) 14.0%
C) 1.5%
D) 7.0%
10) Which of the following choices is in the correct order from less risk to more risk?
A) corporate bonds, certificates of deposit, mutual funds that invest in stock, common stock
B) certificates of deposit, corporate bonds, common stock, mutual funds that invest in stock
C) certificates of deposit, mutual funds that invest in stock, common stock, corporate bonds
D) certificates of deposit, corporate bonds, mutual funds that invest in stock, common stock
11) An investment produced annual rates of return of 4%, 8%, 14% and 6%,
respectively, over the past four years. What is the standard deviation of these returns?
A) 3.7%
B) 4.1%
C) 4.3%
D) 4.6%
12) Which of the following statements about the standard deviation are correct?
I. The standard deviation is a measure of relative dispersion.

II. Standard deviations should be in conjunction with expected returns to compare investments.
III. The standard deviation is calculated by taking the square root of the variance.
IV. The higher the standard deviation of an investment, the lower its risk.
A) I and IV only
B) II and III only
D) I, II and III only
13) The expected rate of return and standard deviations, respectively for four stocks are
given below:
ABC 9%, 3%
CDE 11%, 9%
FGH 12%, 8%
IJK 14%, 10%
Which stock is clearly least desirable?

A) ABC
33
B) CDE
C) FGH
D) IJK
14) The expected rate of return and standard deviations, respectively for four stocks are
given below:
OPQ 11%, 8%
RST 11%, 9%
UVW 12%, 10%
XYZ 12%, 8%
Which stock is clearly most desirable?

A) OPQ
B) RST
C) UVW
D) XYZ
15) Most investors are risk-averse, which means they

A) refuse to accept any financial risk.
B) invest only in government insured securities.
C) require an increase in return for any increase in risk.
D) gain satisfaction from the excitement of risk.
16) Which of the following should be considered when deciding among alternative
investments?
I. time value of money

II. risks associated with each investment
III. risk free rate of return
IV. personal risk tolerance level
A) I and II only
B) III and IV only
17) Explain the relationship between risk, the expected rate of return and the actual rate
of return.
The relationship between risk and required rate of return is known as the risk-return
relationship. It is a positive relationship because the more risk assumed, the higher the required
rate of return most people will demand.
About the actual rate of return now, which I assume to be the realized return. It basically
depends on how you define / measure risk. If your measure is volatility the empirical
relationship is negative. However, if you chose a different measure of risk, you may find the
reverse relationship.
34
18) Over the past 4 years, the annual rates of return on stock of Brown & Warren Inc.
have been -2%, 4%, 14% and 6%, respectively, over the past four years. Compute the
standard deviation of these returns.
Rt -2.00% 4.00% 14.00% 6.00% T= 22%

(rt-avg)2 0.56% 0.02% 0.72% 0.00% T= 1.31%
variance= 0.44%
standard deviation= 6.61%
4.7 Appendix 4A The Time Value of Money
1) Sydney invested $10,000 for an indefinite period at 5% per year. At the end of each year,
she receives a $500 check for interest earned. This type of account pays simple interest. TRUE
2) For a given stated rate of interest, a sum compounded monthly will earn more interest than a
sum compounded annually. TRUE
3) An ordinary annuity is defined as an annuity for which the cash flows occur at the beginning
of each year or payment period. FALSE
4) To calculate the interest rate or growth rate using a spreadsheet or financial calculator, the
present value and the future value most have opposite signs. TRUE
5) There is no limit to the increase in the true rate of interest as compounding becomes more
frequent. FALSE
6) When using a financial calculator to compute the present value of a lump sum, the future
value is entered as PMT. FALSE
7) Justin invests $4,000 in a savings account for two years. The account pays 2% interest
compounded annually. How much interest income will Justin earn on this investment?
A) $80.00
B) $81.60
C) $160.00
D) $161.60
8) Justin invests $4,000 in a savings account for two years. The account pays 2% interest
compounded annually. How much money will be in the account at the end of the second
year?
A) $4,161.60
B) $4,160.00
C) $4,080.00
D) $1,161.60
9) Which one of the following is an example of an annuity?

35
A) the receipt of $50 in January, March, April, June, August, September and December
B) the payment of $259 a month for three consecutive years
C) the payment of $389 in January, $200 in February, and $200 in March
D) the receipt of $100 a month for three months and then $150 a month for two months
10) Which is most true of an annual rate of 4% compounded quarterly?

A) It is equivalent to 4.4% paid annually.
B) It is equivalent to 16.99% paid annually.
C) It is equivalent to 1% simple interest paid quarterly
D) It is equivalent to 4.06% paid annually.
11) The maximum rate of return that can be earned for a given rate of interest occurs
when interest is compounded
A) annually.
B) daily.
C) monthly.
D) continuously.
12) If you invest $2,000 at the end of each year for five years and you earn 7% interest
compounded annually, how much will you have accumulated at the end of the fifth year?
A) $10,700
B) $11,501
C) $12,307
D) $14,026
13) Taylor has saved $400 at the end of every month for the last 4 years with the intention
of paying cash for a new car. She has earned a fixed annual rate of 4% over the 4 year
period; interest is compounded monthly. How much can she pay for her new car at the
end of the fourth year?
A) $20,784
B) $55,705
C) $17,716
D) $22,272
14) Assume that $100 is deposited at the end of each year for five years at 10% compound
interest and that no withdrawals are made over the five-year period. Based on this data,
which one of the following statements is correct?
A) The future value will be $550.
B) The present value can be determined by computing the present value of $500 in five years at
10%.
C) The present value can be determined by computing the present value of a $100 ordinary
annuity for five years at 10%.
D) The present value will be $500.
15) David has purchased an investment that he expects to produce an annual cash flow of
$3,000 for five years. He requires an 8% rate of return compounded annually. What is the
maximum amount that David can pay and still earn the required rate of return?
36
A) $19,008
B) $15,000
C) $14,764
D) $11,978
16) Jeremy purchased 100 shares of FB for $19 per share in September 2012 and sold
them 3 years later at $91 per share. At what annual rate did the value of his investment
grow?
A) about 95%
B) about 48%
C) about 69%
D) about 12%
17) To compute the present value of $1,000 annuity received at the end of each of the next
three years and discounted at the rate of 5% per year, you should enter the following
variables into a financial calculator.
A) N=3, i=5, PMT=1000
B) N=3, i=5, FV=3000
C) N=3, i=15, PMT=1000
D) N=1, i=5, PMT=3000
18) To compute the present value of $1,000 annuity received at the end of each of the next
three years and discounted at the rate of 5% per year, you should use which of the
following EXCEL commands?
A) ANN
B) TVM
C) RATE
D) PV
37
Chapter 5 Modern Portfolio Concepts
5.1 Learning Goal 1
1) Portfolio objectives should be established before beginning to invest. TRUE
2) A portfolio that offers the lowest risk for a given level of return is known as an efficient
portfolio. TRUE
3) By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all
investors. FALSE
4) Portfolio objectives should be established independently of tax considerations. FALSE
5) If the actual rate of return on an investment portfolio is constant from year to year, the
standard deviation of that portfolio is zero. TRUE
6) An efficient portfolio maximizes the rate of return without consideration of risk. FALSE
7) Melissa owns the following portfolio of stocks. What is the return on her portfolio?
A) 8.0%
B) 9.0%
C) 9.8%
D) 10.9%
8) Marco owns the following portfolio of stocks. What is the expected return on his portfolio?
A) 5.5%
B) 6.6%
C) 4.7%
D) 8.0%
1
9) A portfolio consisting of four stocks is expected to produce returns of -9%, 11%, 13% and
17%, respectively, over the next four years. What is the standard deviation of these expected
returns?
A) 10.05%
B) 11.60%
C) 8.00%
D) 33.42%
10) The stock of a technology company has an expected return of 15% and a standard deviation
of 20% The stock of a pharmaceutical company has an expected return of 13% and a standard
deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected
return of 14 % and a standard deviation
A) less than the average of 20% and 18%.
B) the average of 20% and 18%.
C) greater than the average of 20% and 18%.
D) the answer cannot be determined with the information given.
11) The statement "A portfolio is less than the sum of its parts." means
A) it is less expensive to buy a group of assets than to buy those assets individually.
B) portfolio returns will always be lower than the returns on individual stocks.
C) a diversified group of assets will be less volatile than the individual assets within the group.
D) for reasons that are not well understood, the value of a portfolio is less than the sum of the
values of its components.
5.2 Learning Goal 2
1) Negatively correlated assets reduce risk more than positively correlated assets. TRUE
2) Correlation is a measure of the relationship between two series of numbers. TRUE
3) Most assets show a slight degree of negative correlation. FALSE
4) Investing globally offers better diversification than investing only domestically. TRUE
5) Studies have shown that investing in different industries as well as different countries
reduces portfolio risk. TRUE
6) Coefficients of correlation range from a maximum of +10 to a minimum of -10. FALSE
7) Maximum international diversification can be achieved by investing solely in U.S.

multinational corporations. FALSE
8) In severe market downturns different asset classes become less correlated. FALSE
9) Investing in emerging markets is an effective means of diversifying a U.S. portfolio. TRUE
10) The transaction costs of investing directly in foreign-currency-denominated assets can be

2
reduced by purchasing American Depositary Shares (ADSs). TRUE
11) If there is no relationship between the rates of return of two assets over time, these assets
are
A) positively correlated.
B) negatively correlated.
C) perfectly negatively correlated.
D) uncorrelated.
12) Combining uncorrelated assets will

A) increase the overall risk level of a portfolio.
B) decrease the overall risk level of a portfolio.
C) not change the overall risk level of a portfolio.
D) cause the other assets in the portfolio to become positively related.
13) Two assets have a coefficient of correlation of -.4.

A) Combining these assets will increase risk.
B) Combining these assets will have no effect on risk.
C) Combining these assets may either raise or lower risk.
D) Combining these assets will reduce risk.
14) In the real world, most of the assets available to investors

A) tend to be somewhat positively correlated.
B) tend to be somewhat negatively correlated.
C) tend to be uncorrelated.
D) tend to be either perfectly positively or perfectly negatively correlated.
15) The risk of a portfolio consisting of two uncorrelated assets will be

A) equal to zero.
B) greater than the risk of the least risky asset but less than the risk level of the more risky
asset.
C) greater than zero but less than the risk of the more risky asset.
D) equal to the average of the risk level of the two assets.
16) The returns on the stock of DEF and GHI companies over a 4 year period are shown below:
Year DEF GHI

8% 11%
12% 9%
-5% -9%
6% 13%
From this limited data you should conclude that returns on

A) DEF and GHI are negatively correlated.
B) DEF and GHI are somewhat positively correlated.
C) DEF and GHI are perfectly positively correlated.
D) DEF and GHI are uncorrelated.
3
17) Which one of the following will provide the greatest international diversification?
A) directly purchasing a foreign stock
B) purchasing stock of a U.S. multinational firm
C) purchasing an ADS
D) purchasing shares of an international mutual fund
18) American investors have several alternatives available to diversify their portfolios
internationally. In terms of transaction costs, which of the alternatives below is least attractive?
A) mutual funds with an international focus
B) stocks of U.S. based companies with extensive foreign sales and/or operations
C) direct investment in foreign stocks
D) American Depositary Shares
19) American depositary shares (ADS) are

A) shares of foreign companies traded on the U.S. markets.
B) shares of American companies traded on foreign markets.
C) foreign currency deposits in American banks.
D) American currency deposits in foreign banks.
20) Explain the relationship between correlation, diversification, and risk reduction.
Correlation is a statistic that measures the relationship between returns on assets.

Positively correlated assets move together; negatively correlated opposites move in
opposite directions. Diversification reduces risk most effectively when the assets have
low or negative coefficients of correlation.
21) Returns on the stock of First Boston and Midas Metals for the years 2010-2013 are shown
below.
First
Boston Midas Metals Portfolio
2010 -18.00% 26.00%
2011 32.00% -5.00%
2012 18.00% 3.00%
2013 1.00% 10.00%
a. Compute the average annual return for each stock and a portfolio consisting of 50% First
Boston and 50% Midas.
b. Compute the standard deviation for each stock and the portfolio.
4
c. Are the stocks positively or negatively correlated and what is the effect on risk?
The two stocks are negatively correlated. The return on the 50/50 portfolio is half way
between the returns for each stock, but the standard deviation is much lower than for
either stock, indicating that the portfolio has much less risk than the individual stocks.
5.3 Learning Goal 3
1) Diversifiable risk is also called systematic risk. FALSE
2) Standard deviation is a measure that indicates how the price of an individual security
responds to market forces. FALSE
3) Market return is estimated from the average return on a large sample of stocks such as those
in the Standard & Poor's 500 Stock Composite Index. TRUE
4) Betas for actively traded stocks. are readily available from online sources. TRUE
5) A negative beta means that on average a stock moves in the opposite direction of the market.
TRUE
6) A beta of 0.5 means that a stock is half as risky the overall market. TRUE
7) The index used to represent market returns is always assigned a beta of 1.0. TRUE
8) The betas of most stocks are constant over time. FALSE
9) A stock with a beta of 1.3 is less risky than a stock with a beta of 0.42. FALSE
10) For stocks with positive betas, higher risk stocks will have higher beta values. TRUE
11) Adding stocks with higher standard deviations to a portfolio will necessarily increase the
portfolio's risk. FALSE
12) Beta measures diversifiable risk while standard deviation measures systematic risk. FALSE
13) By design, half of all stocks betas are positive betas and half are negative. FALSE
5
14) Which of the following represent unsystematic risks?
I. the president of a company suddenly resigns

II. the economy goes into a recessionary period
III. a company's product is recalled for defects
IV. the Federal Reserve unexpectedly changes interest rates
A) I, II and IV only
B) II and IV only
C) I and III only
15) Which of the following represent systematic risks?
I. the president of a company suddenly resigns

II. the economy goes into a recessionary period
III. a company's product is recalled for defects
IV. the Federal Reserve unexpectedly changes interest rates
B) II and IV only
C) I and III only
Answer: B
16) Estimates of a stock's beta may vary depending on
I. when the estimate was made.

II. the risk-free rate of interest used.
III. how many months of returns were used to estimate the beta.
IV. the index used to represent market returns.
B) II and IV only
17) Which one of the following conditions can be effectively eliminated through portfolio
diversification?
A) a general price increase nationwide
B) an interest rate reduction by the Federal Reserve
C) increased government regulation of auto emissions
D) change in the political party that controls Congress
18) Which one of the following types of risk cannot be effectively eliminated through portfolio
diversification?
A) inflation risk
6
B) labor problems
C) materials shortages
D) product recalls
19) Which one of the following conditions can be effectively eliminated through portfolio
diversification?
A) a general price increase nationwide
B) an interest rate reduction by the Federal Reserve
C) increased government regulation of auto emissions
D) change in the political party that controls Congress
20) Systematic risks

A) can be eliminated by investing in a variety of economic sectors.
B) are forces that affect all investment categories.
C) result from random firm-specific events.
D) are unique to certain types of investment.
21) A measure of systematic risk is

A) standard deviation.
B) correlation coefficient.
C) beta.
D) variance.
22) Beta can be defined as the slope of the line that explains the relationship between
A) the return on a security and the return on the market.
B) the returns on a security and various points in time.
C) the return on stocks and the returns on bonds.
D) the risk free rate of return versus the market rate of return.
23) In designing a portfolio, relevant risk is

A) total risk.
B) unsystematic risk.
C) event risk.
D) nondiversifiable risk.
24) Which of the following best describes the relationship between a stock's beta and the
standard deviation of the stock's returns?
A) The higher the standard deviation, the higher the beta.
B) The higher the standard deviation, the lower the beta.
C) The relationship depends on the correlation between the stock's returns and the market's
returns.
D) Standard deviation and beta are different ways of measuring the same thing.
25) A stock's beta value is a measure of

A) interest rate risk.
7
B) total risk.
C) systematic risk.
D) diversifiable risk.
26) The beta of the market is

A) -1.0.
B) 0.0.
C) 1.0.
D) undefined.
27) When the stock market has bottomed out and is beginning to recover, the best portfolio to
own is the one with a beta of
A) 0.0.
B) +0.5.
C) +1.5.
D) +2.0.
28) The best stock to own when the stock market is at a peak and is expected to decline in value
is one with a beta of
A) +1.5.
B) +1.0.
C) -1.0.
D) -0.5.
29) Stock of Gould and Silber Inc. has a beta of -1. If the market declines by 10%, Gould and
Silber would be expected to
A) decline by 10%.
B) rise by 10%.
C) not respond to market fluctuations.
D) decline by 1%.
30) Beta is the slope of the best fit line for the points with coordinates representing the
________ and the ________ for each one of several years.
A) rate of return; level of risk for an individual security
B) rate of inflation; rate of return for an individual security
C) risk level of a stock; market rate of return
D) market rate of return; security's rate of return
31) The stock of ABC, Inc. has a beta of .80. The market rate of return is expected to increase
by by 5%. Beta predicts that ABC stock should
A) increase in value by 6.25%.
B) increase in value by 4.0%.
C) decrease in value by 1.0%.
D) increase in value by .8%.
32) Analysts commonly use the ________ to measure market return.

A) the Dow Jones Industrial Average
8
B) the rate of return on 10 year Treasury bonds
C) some large, mainstream company such as General Electric
D) the Standard & Poor's 500 Index
33) The market rate of return increased by 8% while the rate of return on XYZ stock increased
by 4%. The beta of XYZ stock is
A) -2.0.
B) -0.40.
C) 0.50.
D) 2.0.
34) Which of the following statements concerning beta are correct?
I. Stock with high standard deviations of returns will always high betas.
II. The higher the beta, the higher the expected return.
III. A beta can be positive, negative, or equal to zero.
IV. A beta of .35 indicates a lower rate of risk than a beta of -0.50.
A) II and III only

B) I and IV only
35) Explain what beta measures and how investors can use beta.
Students should mention some or all of the following.

∙ Beta measures nondiversifiable (market) or systematic risk.
∙ Beta measures how a security will perform in relation to the market.
∙ The higher the beta, the riskier the security.
∙ The beta for the market is 1; stocks may have positive or negative betas.
∙ Stocks with betas greater than 1 are more responsive to changes in the market than is the
market.
∙ Beta is derived from the slope of the "characteristic line."
5.4 Learning Goal 4
1) The basic theory linking portfolio risk and return is the Capital Asset Pricing Model. TRUE
2) The CAPM estimates the required rate of return on a stock held as part of a well diversified
portfolio. TRUE
3) The Dow Jones Industrial Average of thirty stocks is customarily used to represent market
returns in the CAPM. FALSE
4) In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market
returns. TRUE
9
5) According to the CAPM, the required rate of a return on a stock can be estimated using only
beta and the risk-free rate. FALSE
6) The risk premium to be used in the Capital Asset Pricing Model is calculated as (rrf-rm).
FALSE
7) You have gathered the following information concerning a particular investment and
conditions in the market.
According to the Capital Asset Pricing Model, the required return for this investment is
A) 8.85%.
B) 11.48%.
C) 13.98%.
D) 14.85%.
8) OKAY stock has a beta of 0.8. The market as a whole is expected to decline by 12% thereby
causing OKAY stock to
A) decline by 9.6%.
B) decline by 12.5%.
C) increase by 9.6%.
D) increase by 12%.
9) The Capital Asset Pricing Model (CAPM) is a mathematical model that depicts the
A) positive relationship between risk and return.
B) standard deviation between a risk premium and an investment's expected return.
C) exact price that an investor should be willing to pay for any given investment.
D) difference between a risk-free return and the expected rate of inflation.
10) When the Capital Asset Pricing Model is depicted graphically, the result is the
A) standard deviation line.
B) coefficient of variation line.
C) security market line.
D) alpha-beta line.
11) Which of the following factors comprise the CAPM?
I. dividend yield
II. risk-free rate of return
III. the expected rate of return on the market
IV. risk premium for the firm
A) I and III only

B) II and IV only
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C) III and IV only
12) The Franko Company has a beta of 1.90. By what percent will the required rate of return on
the stock of Franko Company increase if the expected market rate of return rises by 3%?
A) 1.91%
B) 2.75%
C) 3.27%
D) 5.70%
13) What is the expected return on a stock with a beta of 1.09, a market risk premium of 8%,
and a risk-free rate of 4%?
A) 4.36%
B) 8.36%
C) 8.72%
D) 12.72%
14) According to MSN money, the stock of Orange Corporation has a beta of 1.5, but according
to Yahoo Finance it is 1.75. The expected rate of return on the market is 12% and the risk free
rate is 2%. What is the difference between the required rates of return calculated using each of
these betas?
A) 1.50%
B) 1.75%
C) 2.0%
D) 2.5%
15) The Capital Asset Pricing Model (CAPM) includes which of the following in its base
assumptions?
I. Investors should earn a minimum return equal to the risk-free rate.

II. Investors in the market should earn a return greater than the return on the overall market.
III. Investors should be rewarded for the amount of risk they assume.
IV. Investors should earn a return located above the Security Market Line.
A) I and III only

B) II and IV only
16) Small company stocks are yielding 10.7% while the U.S. Treasury bill has a 1.3% yield and
a bank savings account is yielding 0.8%. What is the risk premium on small company stocks?
A) 10.7%
B) 9.4%
C) 12.0%
D) 9.9%
17) The risk-free rate of return is 2% while the market rate of return is 12%. Parson Company
11
has a historical beta of .85. Today, the beta for Delta Company was adjusted to reflect internal
changes in the structure of the company. The new beta is 1.38. What is the amount of the
change in the expected rate of return for Delta Company based on this revision to beta?
A) 8.5%
B) 5.3%
C) 12.2%
D) 14.0%
18) Which of the following statements about the Security Market Line are correct?
I. The intercept point is the risk-free rate of return.

II. The slope of the line is beta.
III. An investor should accept any return located above the SML line.
IV. A beta of 1.0 indicates the risk-free rate of return.
A) I and II only
B) III and IV only
5.5 Learning Goal 5
1) Both the efficient frontier and beta are important aspects of MPT. TRUE
2) Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible
set. TRUE
3) Portfolios C and X each have expected rates of return of 12%. C's beta is .9; X's beta is 1.1,
therefore C dominates X. TRUE
4) Modern portfolio theory seeks to minimize risk and maximize return by combining highly
correlated assets. FALSE
5) Traditional portfolio management

A) concentrates on only the most recent "hot" sectors of the market.
B) typically centers on interindustry diversification.
C) uses portfolio betas and standard deviations to minimize risk.
D) is based on statistical measures to develop the portfolio plan.
6) Traditional portfolio managers prefer well-known companies because
I. stocks of well-known firms tend to be less risky than stocks of lesser-known firms.
II. individuals are more apt to purchase a mutual fund if it contains stocks of well-known firms.
III. window dressing encourages the purchase of well-known stocks.
IV. institutional investors tend to exhibit "herd-like" behavior.
A) I only
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B) I and II only
C) II and III only
D) I, II , III and IV
7) Which of the following measures or concepts are deliberately used by modern portfolio
theory?
I. beta
II. inter industry diversification
III. efficient frontier
IV. correlation
A) II and III only

B) I and IV only
8) Portfolios falling to the left of the efficient frontier

A) have too much risk for the expected return.
B) would be desirable if only they were possible.
C) do not use all of the assets in the portfolio.
D) fall within the set of feasible portfolios.
9) The efficient frontier

A) is represented by the rightmost boundary of the feasible set of portfolios.
B) represents the best attainable tradeoff between risk and return.
C) includes all feasible sets of portfolios based on risk and return characteristics.
D) provides the highest level of risk for the lowest level of return.
10) Investors are rewarded for assuming

A) total risk.
B) diversifiable risk.
C) nondiversifiable risk.
D) any type of risk.
11) Large, professionally managed portfolios tend to

A) lie on or near the efficient frontier.
B) exhibit very little overlap in their stock holdings.
C) hold many of the same large, well-known companies.
D) be constructed to result in array of portfolio betas allowing investors to choose a position on
the efficient frontier.
12) Modern portfolio theory does not consider diversifiable risk relevant because
A) it is easy to eliminate.
B) it is impossible to eliminate.
C) its effects are unpredictable.
D) its effects are too small to make a difference in portfolio returns.
13
13) Explain the differences in how modern and traditional theories of portfolio management
approach the issue of diversification.
The modern approach to portfolio diversification uses computers to analyze a large
number of investment alternatives, mathematically seeking minimum correlation and
maximum return. Ideally these methods identify portfolios on the efficient frontier with
minimum portfolio betas or standard deviations for the expected level of return.
The traditional approach to diversification uses human judgment and experience to
choose a diversified combination of stocks and other securities across industry lines and
possibly national borders. When done well, this approach also reduces risk without
excessively sacrificing return. The traditional approach may lead to overinvestment in
the stocks of large, well-known companies because they most readily come to mind for
the manager, because the manager fears criticism for omitting them, or wants to avoid
blame for less conventional choices (window dressing).
5.6 Learning Goal 6
1) An investment portfolio should be built around the needs of the individual investor. TRUE
2) Beta is more useful in explaining an individual security's return fluctuations than a large
portfolio's return fluctuations. FALSE
3) A portfolio with a beta of 1.5 will be 50% more volatile than the market portfolio. TRUE
4) Both modern portfolio theory and traditional portfolio management result in diversified
portfolios, but they take different approaches to diversification. TRUE
5) Portfolio betas will always be lower than the weighted average betas of the securities in the
portfolio. FALSE
6) Jonathan has the following portfolio of assets.
What is the beta of Jonathan's portfolio?

A) 1.04
B) 1.11
C) 1.13
D) 1.00
7) Amanda has the following portfolio of assets.
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What is the beta of Amanda's portfolio?
A) 0.62
B) 0.733
C) 1.13
D) 2.20
8) A portfolio with a beta of 1.26

A) is 126% more risky than the overall market.
B) has less risk than the lowest risk security held within that portfolio.
C) is 26% more risky than a risk-free asset.
D) is considerably more risky than the overall market.
9) Which of the following will always lower a portfolio's beta?
I. Diversify among different types of securities and across industry and geographic lines.
II. Add investments with low betas to the portfolio.
III. Hold more cash or Treasury Bills in the portfolio.
IV. Reduce the percentage of the portfolio invested in high beta securities.
10) Which of the following guidelines are appropriate for inclusion in a portfolio management
policy?
I. Diversify among different types of securities and across industry and geographic lines.
II. Determine the risk level and financial situation of the individual investor.
III. Utilize beta to help align the portfolio to the risk level of the investor.
IV. Minimize the standard deviation of each security in the portfolio.
11) Alexis has inherited $120,000 from her grandmother's estate. She has decided to invest
$10,000 in each of 12 different industries. Because she has lower than average risk tolerance,
she carefully seeks out stocks so that her portfolio will have a weighted average beta of .80.
A) Alexis is using traditional portfolio management techniques.
B) Alexis is using modern portfolio management techniques.
15
C) Alexis is using a combination of modern and traditional portfolio management techniques.
D) Alexis seems to be unaware of modern portfolio management techniques.
12) Dr. Zweibel's portfolio consists of four stocks: AZMN, 35%, beta 2.4; MKR, 20%, beta
1.6; ABDE, 25%, beta 1.8; and SBUK, 20%, beta 2.1. Compute Dr. Z's portfolio beta. Does
he seem to be a conservative or aggressive investor?
Portfolio beta = (.35 × 2.4) + (.20 × 1.6) + .25 × 1.8) + (.20 × 2.1) = 2.03. A beta higher than 2
would make Dr. Z either a very aggressive investor, or one who is very confidently optimistic
about the future direction of the market.
13) How can individuals who manage their own portfolios reconcile some of the most useful
aspects of traditional portfolio management and modern portfolio theory?
Students should include these key points.

Investors should carefully consider how much risk they are willing to bear when seeking higher
returns.
They should diversify across industry lines, not necessarily limiting themselves to well-known
or U.S. based companies.
While some aspects of modern portfolio theory might require mathematical training and
computing power beyond the reach of most individual investors, they should pay attention to
the betas of assets within their portfolio and their effect on the overall portfolio beta.
They should evaluate alternative portfolios and keep choices in line with their desired level of
risk.

Chapter 6 Common Stocks
6.1 Learning Goal 1
1) Every shareholder is a part owner of the firm and, as such, has a direct claim on a portion of
the firm's assets. FALSE
2) There is a stronger tendency for the stock market to increase in value rather than decrease in
value over time. TRUE
3) Since 1960, returns on the Dow Jones Industrial Average have never been negative for 3
consecutive years. FALSE
4) For most stocks, the returns from dividend income far exceeds the return from capital gains.
FALSE
5) Between 1930 and 2014, the average return on stocks exceeded 10%. TRUE
6) Between 1956 and 2011, approximately 30% of years had positive returns. FALSE
7) In spite of major losses in 2008, by the end of 2014 stock prices, as measured by the S&P
16
500 index, were higher than their peak levels of 2007. TRUE
8) Because common shareholders are entitled to the profits that remain after all of a
corporation's other obligations have been met, common shareholders are known as
A) residual owners.
B) temporary owners.
C) debt owners.
D) owners of last resort.
9) If stocks earn an average rate of return of 12 %, their value doubles every

A) 4 years.
B) 6 years.
C) 8 years.
D) 12 years.
10) Which one of the following statements about common stock is true?
A) Common stock can provide attractive capital appreciation opportunities.
B) Dividends generally provide the greatest rate of return on common stocks.
C) Common stocks generally have a negative rate of return over a ten-year period.
D) The DJIA is the best indicator of the overall performance of common stocks.
11) Which of the following are benefits related to stock ownership?
I. ease of trading
II. attractive inflation-adjusted rates of return
III. guarantee of long-term positive returns
IV. affordability
A) I and II only
B) II and IV only
C) I and III only
6.2 Learning Goal 2
1) A market correction is defined as a stock market decline of 10% or more. TRUE
2) While many stocks increase in value over the long run, most of the return on stocks comes
from dividends. FALSE
3) It is not unusual for bear markets to occur two or more times in any given 10 year period.
TRUE
4) Over the long term, the capital gain on most stocks will exceed the dividend income. TRUE
5) Although bear markets on average occur every 3 to 4 years, the timing of bear markets is
very hard to predict. TRUE
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6) For stocks in the S&P 500 index, returns from dividends exceeded capital gains over the
period 2000-2009. TRUE
7) The period from late 2007 through the end of 2014 is best described as a prolonged bear
market. FALSE
8) For the period 2000 through 2009, the average annual price change for stocks in the S&P
500 index was
A) 16%.
B) 8%.
C) -1%.
D) -50%.
9) The rate of return from dividends has been much higher in recent decades than it was in the
1930s and 40s. FALSE
10) $10,000 invested in the S&P 500 in March 2009 would have grown to more than $20,000
by the end of 2014. TRUE
11) When residential real estate values fell sharply from 2006 to 2009, the stocks of financial
institutions were hardly impacted at all. FALSE
12) Stocks generally have produced positive inflation-adjusted rates of return over the long-
term. TRUE
13) An individual stock generally provides a

A) dividend payment that ensures total protection from purchasing power risk.
B) refuge from event risk.
C) current income that is less predictable than that available from other types of investments.
D) predictable annual rate of return.
14) From October 2007 to March 2009, stock prices as measured by the S&P 500 Index
A) nearly doubled in value.
B) lost more than half their value.
C) declined by nearly 10%.
D) rose by nearly 25%.
15) From March 2009 to January 2012, stock prices as measured by the S&P 500 Index
A) more than doubled in value.
B) lost more than half their value.
C) declined by nearly 10%.
D) rose by nearly 25%.
16) Which of the following periods provided particularly high returns to stock investors?
A) February 1972-October 1974
B) March 2009-December 2014
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C) September 2000-September 2002
D) October 2007-March 2009
17) From 1976 through 2014, the dividend yield on stocks has been ________ the coupon yield
on corporate bonds.
A) sometimes higher and sometimes lower than
B) on average, about the same as
C) consistently lower than
D) consistently higher than
18) The extraordinary run up in stock prices during the late 1990s primarily affected
A) energy stocks.
B) retail stocks.
C) pharmaceutical stocks.
D) technology stocks.
19) Many companies increased their dividends

A) whenever necessary to compensate shareholders for declining stock values.
B) in every year since 1950.
C) during the market decline of 2007-2008.
D) during the market recovery of 2009-2011.
20) Which of the following are true about stock market returns as measured by the S&P 500
index?
I. In 2008 alone stocks in the index lost approximately 36% of their value.
II. $10,000 invested in the index in March 2009 would have been worth more than $20,000 by
the end of 2014.
III. From the beginning of 2000 to the end of 2010, the index more than doubled in value.
IV. Both stock and real estate prices recovered recovered strongly in the period between early
2009 and late 2014.
A) I II and III only

C) I ,II and IV only
D) I, and IV only
21) Describe the bear market of 2008 through early 2009 and the trend of stock prices in
subsequent years.
The bear market from 2007 to 2009 lasted 1.3 years and sent the S&P 500 down by 50.9%. The
U.S. economy had slipped into a recession in 2007, accompanied by a growing crisis in
subprime mortgages, with increasing numbers of borrowers unable to meet their obligations as
scheduled. This eventually snowballed into a general financial crisis by September 2008, with
systemically important financial institutions (SIFIs) across the globe in danger of insolvency.
19
Complete collapses in the global financial system and the global economy were averted in 2008
by unprecedented interventions by central banks around the world. Their massive injections of
liquidity into the financial system, through a process called quantitative easing (QE), propped up
the world economy and the prices of financial assets such as stocks by pushing interest rates
down to record low levels.
20
6.3 Learning Goal 3
1) Shares of publicly traded stock can be issued either through a public offering or a rights
offering. TRUE
2) Companies typically issue new shares through an initial public offering (IPO). TRUE
3) Shareholders must either exercise their rights granted via a rights offering or let them expire
unused. FALSE
4) Corporations often split their stocks when they believe that the price makes them less
attractive to average investors. TRUE
5) The total value of an investor's holdings in a company will increase as a direct result of a
stock split. FALSE
6) Stock held in treasury is a means of increasing the number of shares outstanding. FALSE
7) Firms tend to repurchase shares of their outstanding stock when they view the shares as
undervalued. TRUE
8) Different classes of stock generally have either different voting rights or different dividends.
TRUE
9) Electronic trading systems have increased transaction costs of odd-lot trades. FALSE
10) Since each share of common stock represents ownership in a company, shares of common
stock are often referred to as
A) illiquid investments.
B) equity securities.
C) fixed-income securities.
D) unit-cost securities.
11) Which one of the following statements about common stock is correct?
A) Each share of stock has a specified maturity date.
B) Common stock gives stockholders first title to a share of the company's earnings, prior to
other corporate obligations.
C) Common stock typically provides higher levels of current income than do similar grade
corporate bonds.
D) Each share of common stock of a given class entitles the holder to an equal ownership
position and an equal vote in the corporation.
12) Stocks that are readily available to the general public and that are bought and sold on the
open market are known as
A) initial public offerings.
B) publicly traded issues.
C) treasury stocks.
21
D) blue chip stocks.
13) When a company offers the investing public a certain number of shares of its stock at a
certain price, the company is making what is known as a
A) public offering.
B) rights offering.
C) stock spin-off.
D) treasury offering.
14) In a rights offering, the

A) existing stockholders are given the first opportunity to purchase new shares in proportion to
their current ownership position.
B) underwriter offers the investing public a certain number of shares at a certain price.
C) total equity remains constant while the number of shares of common stock outstanding
increases.
D) amount of debt in the capital structure increases by the amount of the rights offering.
15) Rob owns 300 shares of Blackwood common stock valued at $9 a share. Blackwood has
declared a 3-for-1 stock split effective tomorrow. After the split, Rob will own
A) 100 shares valued at about $27 a share.
B) 100 shares valued at about $3 a share.
C) 900 shares valued at about $27 a share.
D) 900 shares valued at about $3 a share.
16) Engines, Inc. declares a 4-for-10 stock split. The stock currently sells for $3 a share. A
shareholder who owned 1000 shares of stock prior to the split will now own
A) 400 shares valued at about $7.50 a share.
B) 40 shares valued at about $1.20 a share.
C) 250 shares valued at about $7.50 a share.
D) 250 shares valued at about $1.20 a share.
17) When a corporation declares a stock split, it usually does so because

A) the firm's retained earnings are excessive.
B) there are too many shares of stock outstanding.
C) investors sometimes require nontaxable returns.
D) it wants to make its stock more affordable to average investors.
18) Stock which has been issued and subsequently reacquired by the issuing corporation is
called
A) letter stock.
B) treasury stock.
C) classified stock.
D) book stock.
19) Tiffany owned 1000 shares of GIA stock which was selling for $1.50 per share when the
company declared a 1 for 10 reverse split. After the split, Tiffany owned
A) 10,000 shares worth approximately $1.50 per share.
22
B) 10,000 shares worth approximately $0.15 per share.
C) 100 shares worth approximately $15 per share.
D) 100 shares worth approximately $1.50 per share.
20) Which of the following is unlikely to be found in an internet stock quotation?

A) earning per share (EPS)
B) beta
C) previous day's closing price
D) broker's commission per 100 shares
21) What are the effects of a company repurchasing its own stock as Treasury shares?
A) usually negative in the short term but uncertain over the long term
B) usually positive in the short term but uncertain over the long term
C) usually positive in both the short term and the long term
D) no effect in either the short term or the long term
22) One motive for issuing classified stock with different voting rights is to
A) increase the market value of the company.
B) avoid SEC reporting requirements.
C) allow the company's founders to retain control of the company.
D) facilitate the issue of additional shares in the future.
23) Stock quotes on most Internet service providers such as Yahoo Finance include
I. the highest and lowest price over the last 52 weeks.

II. the closing price for the previous trading day.
III. the opening price for the day.
IV. the bid price and ask price.
A) I and III only

B) II and IV only
24) A round lot consists of

A) 1 share.
B) 10 shares.
C) 100 shares.
D) 1,000 shares.
25) Assume the Plum Corporation has two different issues of common stock. One issue carries
voting rights, and the other issue does not. In this situation, Plum is said to have issued
A) buy-back stock.
B) treasury stock.
C) OTC stock.
D) classified stock.
23
26) Why do some companies split their stock?
Stocks are split primarily to attract new investors, by making individual shares more affordable
for the average investor. For example, Microsoft (MSFT) stock has split 9 times: 2-for-1 in
1987, 2-for-1 in 1990, 3-for-2 in 1991, 3-for-2 in 1992, 2-for-1 in 1994, 2-for-1 in 1996, 2-for-1
in 1998, 2-for-1 in 1999, and 2-for-1 in 2003. If the stock had never split, one share today
would be 288 times the current share price. Based on a $187.74 share price (on June 12, 2020),
if no splits had occurred each share would be priced at $54,069.12.
That said, stock splits are not quite as “necessary” as they once were, because many brokers
provide ways to invest in fractional shares, and many small investors opt for index funds and
other types of funds that are priced affordably, but hold high-priced shares of companies. This is
why you still see AMZN, BKNG, and GOOG, for example, at share prices over $2500, $1600,
and $1400, respectively (at the time of this writing). These stocks have not yet split, and might
never split.
6.4 Learning Goal 4
1) A stock's market value would normally be higher than it's book value. TRUE
2) A stock's book value and par value are normally the same or nearly the same. FALSE
3) A stock can have only one market value, but different investment values for different
investors. TRUE
4) A stock's investment value can be much higher than its book value. TRUE
5) The investment value for a publicly traded stock can readily be found in the financial section
of the newspaper or on the Internet. FALSE
6) If a firm has a 2 million shares outstanding and its stock trades at $25 per share, the company
has a market capitalization of $50,000,000. TRUE
7) Another term for the stated value or face value of a stock is its
A) book value.
B) liquidation value.
C) par value.
D) proxy value.
8) The par or stated value of common stock is important for

A) accounting purposes only.
B) helping the investor determine the stock's intrinsic value.
C) helping the board of directors determine the dividend payout.
D) helping the market determine the trading price of the stock.
9) The balance sheet value of a firm's assets minus the balance sheet amount of its liabilities is
known as
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A) par value.
B) book value.
C) liquidation value.
D) market value.
10) If a firm has a 2 million shares outstanding and its stock trades at $25 per share, the
company also has $10,000,000 in debt. The company's market capitalization is
A) $40,000,000.
B) $49,000,000.
C) $50,000,000.
D) $60,000,000.
11) Westlake Industries has total assets of $42.5 million, total debt of $29.3 million, and $2.4
million of 6% preferred stock outstanding. If the company has 250,000 shares of common stock
outstanding, its book value per share would be
A) $32.33.
B) $33.60.
C) $43.20.
D) $52.80.
12) As a general rule, which one of the following statements concerning the various values of
common stock is correct?
A) Market values are usually below book values.
B) Par values are usually above book values.
C) Market values are usually below par values.
D) Book values are usually below market values.
13) Which of the following will tend to increase transaction costs?

A) using a full service broker
B) buying or selling shares through an on-line broker
C) buying or selling more than 1000 shares in a single trade
D) buying or selling at times when volume is high and the exchanges are busy
14) The Charbridge Inc. has 4 million shares of stock outstanding. The stock has a par value of
$1.00 per share and is currently trading at $36 per share. Nicole estimates the investment value
of this stock at $38.50. According to this information, the market capitalization of Charbridge
is
A) $144,000,000.
B) $154,000,000.
C) $4,000,000.
D) $72 million.
15) You are given the following information on a company.
25
Which one of the following statements is correct based on the information provided?
A) The market price is $21.34 per share.
B) The investment value is $2.67 per share.
C) The par value is $2.67 per share.
D) The book value is $21.34 per share.
16) The value that investors place on a stock is called its

A) book value.
B) investment value.
C) liquidation value.
D) par value.
17) What is the relationship between a stock's market value and its investment value?
Market value is the price that is currently offered for an asset in the marketplace. In other
words, the market value is a reasonable estimate of the investment’s value that reflects current
market conditions.
Conversely, investment value is a concept that describes the value that an investor is willing to
pay for the asset or investment based on his or her own objectives and parameters. Essentially,
the investment value is a subjective judgment of an asset’s value.
6.5 Learning Goal 5
1) A company's board of directors must declare a dividend if the firm is profitable. FALSE
2) Shareholders who sell their stock on or after the ex-dividend date, but before the date of
record, will still receive the declared dividend. TRUE
3) High dividend yields are typical of rapidly growing companies. FALSE
4) Dividend payments are usually more stable than capital gains. TRUE
5) Stock dividends do not increase the value of a shareholder's position. TRUE
6) Stock dividends and stock splits both increase the number of shares but add nothing to the
value of the company. TRUE
7) Cash dividends are taxed at the same rate as ordinary income. FALSE
8) The stock listing for a company shows a P/E of 18, a dividend yield of 2.4% and a closing
price of $23.76. What is the amount of dividends per share?
A) $0.03
B) $0.57
C) $1.03
D) $1.32
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9) The decision of how much money to pay out in dividends is made by the
A) board of directors.
B) company shareholders.
C) chief executive officer.
D) chief financial officer.
10) Factors considered in making a decision on a firm's dividend include the
I. cash position of the firm.

II. firm's growth prospects.
III. the expectations of the shareholders.
IV. minimum dividends required by law.
A) II and IV only
11) The date on which an investor must be a registered shareholder of the firm in order to
receive a dividend is called the
A) date of record.
B) ex-dividend date.
C) payment date.
D) purchase date.
12) The Limberger Corporation declared a quarterly dividend of $0.10 per share. The ex-
dividend date was July 15, the date of record was July 18, and the payment date was July 28. If
you had owned 100 shares of the Limberger Corporation and sold them on July 15, then
A) you would collect $10.00 in dividends, and the purchaser would not collect any dividends.
B) the purchaser would collect $10.00 in dividends, and you would not collect any dividends.
C) you would collect $5.00 in dividends, and the purchaser would collect $5.00 in dividends.
D) neither you nor the purchaser would collect any money in dividends.
13) The common shares of the Hiboux Ltd have a book value of $21.60 and a market value of
$28.60. The company pays $0.28 in dividends each quarter. What is the dividend yield?
A) 1.0%
B) 1.3%
C) 3.9%
D) 5.2%
14) Since 2003, most dividends are taxed

A) at a higher rate than capital gains.
B) at a lower rate than capital gains.
C) at the same rate as ordinary income.
D) at the same rate as capital gains.
27
15) Since 2003, dividends have been taxed at the same rate as capital gains. As a result,
A) many companies have reduced the percentage of earnings paid out as dividends.
B) many companies have increased the percentage of earnings paid out as dividends.
C) tax rates have had little or no effect on dividend policies.
D) more companies have replaced dividends with stock repurchase plans.
16) Dividend yield is calculated by dividing

A) the market price of one share of stock by the annual dividend per share.
B) the annual dividend per share by the market price of one share of stock.
C) earnings per share by market price per share.
D) annual dividend per share by earnings per share.
17) If a corporation declares a 10% stock dividend, then

A) the share price of the stock will most likely decline by about 9%.
B) the share price of the stock will most likely increase by about 10%.
C) the share price of the stock will most likely remain unchanged.
D) each shareholder will get a 10% cash rebate off his or her next round lot purchase of the
stock.
18) Gypsum Corp. pays out 25% of its earnings as dividends. Earnings per share are currently
$1.32, book value per share is $16.80, and the market price per share is $22.44. What is the
dividend yield?
A) 1.5%
B) 2.0%
C) 5.9%
D) 7.9%
19) Pilgrim Corp. stock currently sells for $25 per share? The annual dividend payment is
$1.00 per share and earnings per share are $3.00. The dividend yield is ________ and the
dividend payout ratio is ________.
A) 12%; .4%
B) 8.33%; 25%
C) 4%; 33%
D) 33%; 4%.
20) Pilgrim Corp. stock currently sells for $25. The dividend yield is 4% and the dividend
payout ratio is 25%. The dividend is ________ and the earnings per share are ________.
A) $3.00; $1.00
B) $1.00; $4.00
C) $.12; $1.00
D) $.25; $6.25
21) To take advantage of the opportunity to acquire additional shares of a company's stock
without incurring any brokerage commissions, many investors participate in
A) initial public offerings.
B) dividend reinvestment plans.
C) deferred equity securities.
28
D) corporate trusts.
22) Reinvested dividends

A) are taxed when the shares purchased with the reinvested dividend are sold.
B) are taxed at the time the dividend is paid.
C) do not increase the value of an investors holdings.
D) are generally sold at a premium over the market price.
6.6 Learning Goal 6
1) Stocks which perform well in a faltering economy are called defensive stocks. TRUE
2) Mid-cap stocks are generally classified as those with a market capitalization between $2 and
$10 billion. TRUE
3) "Baby blues" is a term used to refer to telecom stocks. FALSE
4) A stock can be both a tech stock and a blue chip stock at the same time. TRUE
5) So-called income stocks pay fixed dividends similar to interest on bonds. FALSE
29
6) American Depositary Receipts (ADRs) are issued against shares of U.S. corporations and are
traded on foreign security exchanges. FALSE
7) American Depositary Receipts (ADRs) are denominated in U.S. dollars and traded on U.S.
security exchanges. but track the performance of a foreign corporation. TRUE
8) Over the period 1900 to 2014, U.S. stocks had the highest rate of return of any country.
FALSE
9) The rate of return on a foreign investment is affected by changes in the exchange rates.
TRUE
10) An increase in the value of the dollar relative to the yen has a positive effect on the returns
of U.S. investors who invest in stocks of Japanese firms. FALSE
11) An increase in the dollar relative to the euro has a negative effect on the returns of U.S.
investors who invest in European firms. TRUE
12) The most common reason for an investor to adopt the quality long-term growth investment
strategy is for long-term accumulation of capital. TRUE
13) The total-return approach concentrates solely on capital gains over the long term. FALSE
14) Which one of the following is a characteristic of blue chip stocks?

A) guaranteed minimum annual dividend of $2 a share
B) annual dividends of more than $5 per share
C) long and stable dividend and earnings records
D) relatively high risk exposure
15) Investors seeking current income that tends to increase over time should purchase
A) corporate bonds.
B) income stocks.
C) growth stocks.
D) speculative stocks.
16) Companies with strong earnings but limited growth opportunities

A) do not generally pay any dividends.
B) are called blue-chip stocks.
C) generally pay high dividends.
D) are speculative stocks.
17) Characteristics of established growth companies include all of the following EXCEPT
A) high operating margins.
B) steady earnings growth.
C) adequate cash flow to service their debt.
D) high dividend payout ratios.
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18) Stocks whose prices are expected to remain stable, or even prosper, when economic activity
is slowing down are known as
A) defensive stocks.
B) cyclical stocks.
C) growth stocks.
D) speculative stocks.
19) Which of the following are typical characteristics of small cap stocks?
I. strong balance sheets

II. market cap less than $2 billion
III. potential for high returns along with high risk
IV. potentially dramatic changes in their earnings
A) III and IV only

B) II and III only
20) Which of the following are characteristics of blue-chip stocks?
I. solid balance sheets

II. generous dividend yields
III. immunity from bear markets
IV. some growth potential
A) III and IV only

B) II and III only
21) Stocks related to computers and the Internet are classified as

A) blue-chip stocks.
B) income stocks.
C) cyclical stocks.
D) tech stocks.
22) Typical characteristics of growth stocks include

A) rapidly growing dividends.
B) high rates of growth in operations and earnings.
C) acquisitions of competing companies.
D) strong performance even in market downturns.
31
23) Which of the following best fits the description "speculative stock"?
A) Sirius XM Radio
B) Facebook
C) Amazon
D) Apple
24) Which of the following best fits the description "defensive stock"?
A) Facebook
B) Walmart
C) Samsung
D) Tesla Motors
25) Which of the following best fits the description "blue chip stock"?
A) Facebook
B) Under Armour
C) General Electric
D) Chipotle Mexican Grill
26) One characteristic of mid-cap stocks is that they

A) are generally new firms with high growth potential.
B) tend to be highly volatile.
C) are fairly good-sized companies that offer attractive return opportunities.
D) are traded primarily through pink sheet bids.
27) Which category of stocks represents the highest level of risk?

A) large-cap
B) mid-cap
C) baby blue
D) small-cap
28) The U.S. stock market

A) currently represents about 66% of the world's equity market.
B) consistently outperforms the foreign markets once exchange rates are considered.
C) is decreasing as a percentage of the world's equity market.
D) lists over 25,000 stocks.
29) Advantages of using American Depositary Receipts to participate in foreign markets

include
I. lower transaction costs than for direct foreign stock purchases.

II. reduced exposure to foreign exchange risk.
III. dividends are paid in U.S. dollars.
IV. quotations are readily available from U.S. sources such as Yahoo Finance or MSN Money.
A) I and II only
B) I and III only
32
D) I, III and IV only.
30) ADRs
I. are shares of U.S. companies traded on foreign exchanges.

II. are shares of foreign companies traded on U.S. exchanges.
III. pay dividends in U.S. dollars if they pay dividends.
IV. are subject to exchange rate risk.
A) I and II only
B) II and III only
C) II. III and IV only
31) Amanda purchased stock in a German firm at a price per share of 35 euros when the U.S.
$/euro exchange rate was $1.20. After six months, Ann sold the stock for 37 euros when the
U.S. $/euro exchange rate was $1.10. The stock does not pay a dividend. What is Ann's rate of
return on this investment?
A) 3.31%
B) -3.10%
C) 5.7%
D) 9.2%
32) Aggressive stock management

A) requires holding speculative stocks for the long term.
B) involves active stock trading in the short-term in the quest for capital gains.
C) concentrates on the long-term growth aspects of a security.
D) concentrates on high dividend yielding stocks.
33) Which of the following are advantages of the buy and hold strategy?
I. rapid accumulation of wealth

II. low transaction costs
III. capital gains taxed at the long-term rate
IV. portfolio requires less time and energy to manage than for most other strategies
A) I and II only
B) II and III only
34) Which one of the following investment strategies would NOT appeal to an investor who is
most concerned with storage of value?
A) buy-and-hold
B) high income
C) quality long-term growth
D) speculation and short-term trading
33
35) The common stock investment strategy that is the most basic strategy and is popular with
conservative, quality-conscious individuals looking for competitive returns over the long run is
the
A) buy-and-hold strategy.
B) current income strategy.
C) growth strategy.
D) speculation and short-term trading strategy.
36) Aggressive stock management focuses on the pursuit of

A) dividend income.
B) short-term capital gains.
C) long-term capital gains.
37) Which of the following strategies appeal to investors who place primary emphasis on the
storage of value aspects of an investment?
I. buy and hold

II. short-term trading
III. quality long-term growth
IV. consistent dividend record
A) I and IV only
B) I and III only
38) Which strategy applies to investors who fund long-term goals with high-quality stocks
which they retain for the entire investment period?
A) quality long-term growth
B) buy and hold
C) speculation
D) current income
39) Income stocks are well suited for retirees because

A) dividend income is tax-free.
B) the capital gains are predictable.
C) dividend yields tend to exceed bond yields.
D) dividends tend to increase over time.
40) Explain why every stock portfolio should include some defensive stocks.
A defensive stock is a stock that can be relied on to provide consistent returns even during an
economic or market downturn. Typically, these companies offer goods or services that people
continue to buy even when the economy isn't doing well.
Defensive stocks function as their name suggests: They defend an investment portfolio against
34
loss. While they don't offer huge growth potential, they perform consistently even during
periods of economic decline, when other equities are tumbling.
Like a bulwark against erosion, defensive stocks can prevent your portfolio from substantially
losing its value during a recession or bear market.
Advantages of defensive stocks

- Stability: Market volatility can scare some consumers away from investing, and the
stability of defensive stocks offers a solution to this. Padding your portfolio with these
predictable performers can act as a defense against sudden swings in the stock market.
- Low-risk: Defensive stocks are often attractive to investors who prioritize protecting
their wealth against loss. These low-risk companies maintain their value, and investors'
capital, value over time.
- Outperform in periods of economic decline: When the economy drops, defensive stocks
tend to outperform their cyclical peers. In theory, this can provide some balance to any
losses experienced by the growth stocks during a recession.
35
Chapter 7 Analyzing Common Stocks
7.1 Learning Goal 1
1) The top down approach to security analysis starts with top management and then examines
production and marketing strategies. FALSE
2) Company analysis is only concerned with how a company has performed in the past. FALSE
3) Advocates of the efficient market hypothesis would argue that it is virtually impossible for
any investor to consistently outperform the market. TRUE
4) Economic analysis is concerned with how the general state of the economy will impact the
performance of a particular company within a particular industry. TRUE
5) Investors who believe that most securities are efficiently priced should not not be concerned
with fundamental analysis. FALSE
6) Fundamental analysis can only be profitable if some securities are at least temporarily
mispriced. TRUE
7) Markets can only be efficient if many competent analysts are performing fundamental
analysis. TRUE
8) One of the basic premises of security analysis, and in particular fundamental analysis, is that
A) a stock's price is based on its past cash flows rather than on anticipated future cash flows.
B) market sectors do not move in concert with business cycles.
C) all securities have an intrinsic value that their market value will approach over time.
D) a security's risk has relatively little effect on the security's return.
9) The intrinsic value of a security is based on the
I. amount of risk.
II. current market value of the security.
III. discount rate applicable to the security.
IV. estimated future cash flows from the security.
A) I and III only

B) III and IV only
1
10) The three steps in determining a stock's intrinsic value are
I. estimating the stock's future cash flows.

II. estimating the risk associated with future cash flows.
III. careful analysis of patterns in the stock's recent price history.
IV. estimating an appropriate discount rate to apply to future cash flows.
A) II, III and IV only

11) The basic motivation of security analysis is to help investors

A) identify the best times to buy and sell securities.
B) contribute to the efficiency of securities markets.
C) identify securities whose intrinsic values are at or near their market values.
D) identify mispriced stocks.
12) Top-down security analysis

A) starts with the fundamental analysis of a firm.
B) includes economic, industry, and fundamental analysis.
C) concentrates on the competency of the senior management of a firm.
D) centers on the past performance of a firm.
13) The normal sequence in performing top down analysis is

A) competition, consumer demand, threat of substitute products.
B) market conditions, risk, company fundamentals.
C) economy, industry, company.
D) profitability, efficiency, liquidity.
14) Fundamental analysis involves the in-depth study of the

A) role of nondiversifiable risk in an investor's portfolio.
B) financial condition and operating results of a given firm.
C) pattern of security prices as revealed in chart formations.
D) role of diversifiable risk in an investor's portfolio.
15) Investment analysts who believe that a thorough investigation of a company's financial
condition, product development, management and other intrinsic factors can discover stocks
that are priced above or below their intrinsic value are advocates of
A) fundamental analysis.
B) behavioral analysis.
C) the efficient market hypothesis.
D) technical analysis.
7.2 Learning Goal 2
1) Most firms tend to be more profitable and have higher stock values when the economy is
strong. TRUE
2
2) The purpose of economic analysis is to gain an insight into the underlying health or vitality
of the economy and to formulate expectations about future security prices. TRUE
3) The business cycle reflects economic changes only in the industrial sectors of the economy.
FALSE
4) The best time to buy stock is at the peak of an economic cycle. FALSE
5) Developing a general economic outlook assists in the identification of industries and firms
that might be good investment opportunities. TRUE
6) Federal budget deficits tend to further depress an already depressed economy. FALSE
7) Changes in stock prices tend to lag changes in level of economic activity by several months.
FALSE
8) Interest rates and stock prices tend to rise and fall together. FALSE
9) Which measure of the business cycle represents the market value of all goods and services
produced in a country over a twelve-month period?
A) industrial production index
B) money supply
C) gross domestic product
D) productivity average
10) Which one of the following is likely to have a negative effect on stock prices?
A) falling interest rates
B) a decrease in the money supply (M2)
C) low inflation
D) a decrease in the unemployment rate
11) The Federal Reserve through monetary policy can help expand the economy by
A) lowering income taxes on individuals.
B) reducing tariffs such that foreign exports can increase.
C) supporting a moderate growth of the money supply.
D) increasing government spending on the national infrastructure.
12) Rising interest rates tend to

A) contract the level of economic activity.
B) increase the level of business investment.
C) indicate governmental expansion of the economy.
D) signal the trough of a recessionary market.
13) The government has an expansionary economic policy when it

A) increases taxes.
B) increases government spending.
3
C) promotes rising interest rates.
D) limits exports of goods and services.
14) Rising corporate profits are likely to have the greatest effect on which of the following
industrial sectors?
A) business equipment
B) defense
C) food and agriculture
D) consumer durables
15) Which of the following businesses will be positively impacted by a weak dollar?
A) retailing
B) imports
C) exports
D) personal services
16) Which of the following businesses will be negatively impacted by a strong dollar?
A) retailing
B) imports
C) exports
D) automotive
17) Which of the following tend to signal that stock prices are likely to rise in the future?
I. Employment increases after several months of recession.

II. Interest rates are low compared to the recent past.
III. Major market indexes have just reached record highs.
IV. Housing starts increase after several months of decline.
A) I and II only
B) II and III only
18) Which of the following are characteristics of an expansionary fiscal policy?
I. Increased government spending on infrastructure projects.

II. Reduction in defense and education budgets.
III. Reduction in employment taxes.
IV. Reduction in government borrowing.
A) I and III only

B) II and III only
4
19) Which of the following is most likely to increase in value as the result of a weakening
dollar?
A) an ADR for a foreign telecommunications company
B) stock in a firm that depends heavily on imported raw materials
C) stock in a firm with many accounts payable in foreign currencies
D) stock in a foreign company that depends heavily on exports to the U.S.

A) Stock prices are independent of the economic cycle.
B) Stock prices change simultaneously with the economy.
C) Stock prices are often start to rise before the end of a recession.
D) Changes in stock prices generally lag changes in the economy.
21) Name at least three economic variables that the affect the stock market and describe their
effects. Supply and demand, company financial performance and broad economic trends.
7.3 Learning Goal 3
1) To predict the demand for an industrial sector, it is essential to understand the economic
forces that affect the industry. TRUE
2) Economic factors such as a weak dollar will have a negative impact on all industrial sectors.
FALSE
3) Industries in the rapid expansion stage will be especially sensitive to a slowing economy.
FALSE
4) In addition to company reports, Value Line also publishes industry analyses. TRUE
5) The economy will expand more slowly if consumers decided to save more and reduce their
debt levels. TRUE
6) Industry analysis focuses on the amount spent on research and development by individual
companies within the industry. FALSE
7) Investors who conduct industry analyses typically favor companies with strong market
positions over companies with less secure market positions because firms with strong market
positions tend to
I. be price leaders.
II. benefit more from economies of scale.
III. have better R&D programs.
IV. have lower production costs.
A) II and IV only
5
8) The consumer electronics industry would be most significantly affected by

A) developments in technology.
B) interest rates and inflation.
C) labor relations.
D) government regulations.
9) Which of the following factors are considered when analyzing an industry?
I. the nature and conditions of governmental regulations

II. the involvement and relations, if any, with labor unions
III. the development of new technologies relevant to the industry
IV. the extent of competition within the industry
10) Which stage of an industry's growth cycle is most influenced by economic events?
A) initial development
B) stability or decline
C) mature growth
D) rapid expansion
11) Which stage of an industry's growth cycle is interesting only for potentially high dividend
payouts?
B) stability or decline
C) mature growth
D) rapid expansion
12) The rapid expansion phase of an industry is characterized by

A) extreme sensitivity to interest rates and other economic factors.
B) high returns and relatively low risks.
C) willingness of investors to buy almost any stock associated with the industry.
D) many decades of sustained above average growth.
13) Well managed companies rarely reach the decline stage because
A) the world's population is growing.
B) they continuously develop new products to meet the needs of changing markets.
C) consumers remain loyal to established brands.
6
14) Which stage of an industry's growth cycle offers the greatest opportunity for an investor
who is seeking capital gains?
B) mature growth
C) stability or decline
D) rapid expansion
15) List and explain the various stages of the growth cycle of an industry. Also discuss the
merit of investing in the industry during each of the various stages. Startup, growth, shakeout,
maturity, and decline
16) Briefly describe and discuss industry analysis and the motivation behind it. Industry
analysis is a tool that facilitates a company's understanding of its position relative to other
companies that produce similar products or services.
7.4 Learning Goal 4
1) Fundamental analysis is based on the presumption that the value of a stock is influenced by
the financial performance of the issuing company. TRUE
2) Fundamental analysis encompasses return, but not risk, in the valuation process. FALSE
3) The statement of cash flows is less influenced than the income statement by choices of
accounting methods. TRUE
4) The income statement indicates how successfully a company has utilized its assets. TRUE
5) Positive cash flow from investing activities is typical of firms experiencing healthy growth.
FALSE
6) A company may appear to be profitable on its income statement, but fail to generate strong
cash flows. TRUE
7) The balance sheet summarizes the company's operations over the last fiscal year. FALSE
8) EBITDA stands for earnings before inflation, taxes, depreciation, and adjustments. FALSE
9) Calculating the times interest earned ratio using EBITDA is more conservative than using
EBIT because it takes the cost of replacing fixed assets into consideration. FALSE
10) Which of the following are considered in the ratio analysis of a firm?
I. profitability
II. market share
III. liquidity
IV. leverage
7
A) I and II only
B) I, III and IV only
C) II and IV only
11) Which of the following accounting practices are potentially misleading or even fraudulent?
I. writing off goodwill as an extraordinary loss

II. using accrual rather than cash basis reporting
III. off-balance sheet liabilities
IV. recognizing revenues prematurely
A) I and II only
C) III and IV only
12) Which one of the following statements concerning accounting reports is correct?
A) The income statement reflects the position of a firm as of a single point in time.
B) The total equity of a firm is equal to the total assets plus the total liabilities.
C) The statement of cash flows identifies both the sources and the uses of cash.
D) The income statement reflects the amount of cash available for investment and financing
activities.
13) Cash flow from operations includes all of the following adjustments to net income
EXCEPT
A) purchases of new equipment.
B) depreciation.
C) increase or decrease in current liabilities.
D) increase or decrease in current inventory.
14) Which of the following would be typical of a Statement of Cash Flows for a healthy firm in
a sustainable business?
A) Cash flow from operations is negative, cash flows from investment activities and financing
activities are positive.
B) Cash flow from operations , investment activities and financing activities must all be
positive.
C) Cash flow from operations is positive, cash flows from investment activities and financing
activities are negative.
D) If the Statement shows a net increase in cash, the source is unimportant.
15) Which of the following measures excludes non-cash charges against income?
A) operating expenses
B) EBIT
C) net income before taxes
D) EBITDA
8
16) Which of the following would be found on a company's income statement?
I. cost of goods sold

II. interest expense
III. cash flow from operations
IV. earnings before taxes
A) I an IV only
17) Which of the following would be found on a company's balance sheet?
I. Accounts receivable
II. Interest expense
III. Property plant and equipment
IV. Total stockholders' equity
A) I an IV only
18) On September 30, the Simpson Company reported the following information on its
financial statements.
What is the amount of the stockholder's equity in the Simpson Company?

A) $243,000
B) $277,000
C) $927,000
D) $3,217,000
19) Briefly describe fundamental analysis and the basic assumption behind it.
Fundamental analysis (FA) is a method of measuring a security's intrinsic value by examining
related economic and financial factors. This method of stock analysis is considered to be in
contrast to technical analysis, which forecasts the direction of prices through an analysis of
historical market data such as price and volume.
7.5 Learning Goal 5
9
1) Ratio analysis is the study of the relationships between various financial statement accounts.
TRUE
2) Financial ratios can reveal a lot about a company's liquidity, activity, and profitability.
TRUE
3) The quick ratio differs from the current current ratio in that accounts receivable are excluded
from current assets. FALSE
4) Return on assets is a very important analytical tool because it measures how effectively
management is using a firm's assets to generate profits. TRUE
5) A firm with a very low debt-equity ratio has a low risk of defaulting on its loans. TRUE
6) A firm with a very low debt-equity ratio might be able to increase return on equity by taking
on additional debt. TRUE
7) The Allied Computer Co. has sales of $300 million, a net profit margin of 9%, and 10
million shares of common stock outstanding. It has no preferred stock outstanding. If Allied
stock trades at $50 per share, it has a price/earnings ratio of 20.9. FALSE
8) Return on equity (ROE) is computed by dividing net income by the market value of equity.
FALSE
9) The PEG ratio divides the stock's current price by the growth rate of earnings over the
preceding 12 months. FALSE
10) In seeking potential stock investments, most analysts look for companies that have PEG
ratios that are equal to or less than one. TRUE
11) Banks can use the times interest earned ratio as a measure of a borrower's ability to repay
their loan. TRUE
12) If a firm has an equity multiplier of 3, this means that the firm has $3 in equity for every $1
in long-term debt. FALSE
13) Return on equity can be expressed mathematically as "(net profit margin)(total asset
turnover)(equity multiplier)." TRUE
14) A high P/E ratio may be an indication that a stock is overpriced. TRUE
15) A high PEG ratio implies a high growth rate in earnings relative to the stock's price.
FALSE
16) When comparing companies in the same industry but of different sizes, net profit margin is
more meaningful than net profit as a dollar amount. TRUE
10
17) Which of the following are measures of liquidity?
I. net working capital

II. accounts receivable turnover
III. current ratio
IV. times interest earned
A) I and III only

18) Financial ratios
I. allow comparisons across firms without concern over firm size.

II. can compare a firm's operating and financial status to industry norms.
III. provide insights into a companies future.
IV. look at the liquidity, activity, leverage, profitability and market measures of a firm.
A) II and IV only
B) I and II only
19) On December 31, the Gold Standard Company reported the following information on its
financial statements.
According to this information, the company's current ratio is approximately

A) 1.39.
B) 1.68.
C) 1.73.
D) 1.90.
20) To determine whether a company is using leverage effectively, an analyst should consider
A) the current ratio and net working capital.
B) inventory, accounts receivable and total asset turnover ratios.
C) the debt to equity and times interest earned ratios.
D) ROA and the net profit margin.
21) A company has sales of $640,000, net profit after taxes of $23,000, and a total asset
turnover of 2.5. What is the return on assets?
A) 3.6%
11
B) 4.5%
C) 8.1%
D) 9.0%
22) A company has sales of $640,000, net profit after taxes of $23,000, a total asset turnover of
4.17 and an equity multiplier of 1.67. What is the return on equity?
A) 24%
B) 9.0%
C) 8.1%
D) 4.5%
23) Substituting EBITDA for EBIT when computing the times interest earned ratio will make
the company appear
A) more leveraged.
B) less leveraged.
C) more profitable.
D) less efficient.
24) For their last fiscal year, the Short Company reported the following information.
What is the accounts receivables turnover rate?

A) 0.8
B) 2.8
C) 4.5
D) 7.3
25) The inventory turnover rate for a firm is 14.5 as compared to the relevant industry rate of
13.2. In this case, the firm is
A) selling its inventory slower than the industry.
B) underperforming the industry.
C) averaging fewer days of sales in inventory than the industry.
D) generating fewer sales per dollar of inventory.
26) A total asset turnover of 3 means that every

A) $1 in sales is supported by $3 of assets.
B) $3 in assets produces $1 in net earnings.
C) $1 in total assets is replaced on average every 3 years.
D) $1 in assets produces $3 in sales.
27) On March 31, Adolpha, Inc. reported the following information on its financial statements.
12
What is the available net working capital for Adolpha, Inc.?
A) -$253,844
B) -$132,366
C) $121,578
D) $1,873,020
28) A company has a net loss for the year of $(10,000,000) and a deficit (negative equity) of
$(1,000,000). ROE will be
A) 1000% indicating an exceptional opportunity.
B) 1000% and meaningless.
C) -1000% indicating that the company is in dire straits.
D) 10.
29) The measure that indicates how efficiently assets are being used to support sales is called
the
A) total asset turnover.
B) current ratio.
C) book value.
D) net profit margin.
30) A lending institution would prefer that a firm have a ________ debt-equity ratio and a
________ times interest earned ratio.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
31) Marco's just reported an EPS of $1.80 on revenues of $440 million. The company has 13
million shares outstanding. Total assets are $380 million, current liabilities equal $78 million,
and long-term debt is $122 million. Net fixed assets are worth $230 million. Given this
information, which one of the following statements is correct?
A) Marco's net working capital is $72 million.
B) Marco's current ratio is 1.75.
C) Marco's total asset turnover is 3.67.
D) .Marco's debt-equity ratio is 0.75.
32) Worcester Corporation has a P/E ratio of 15. Natick Corporation is in the same industry as
Worcester, but has a P/E ratio of 20. Possible interpretations of this discrepancy include
A) Worcester Corporation is overpriced.
B) Natick Corporation has higher earnings per share.
C) Investors expect Natick to grow faster than Worcester.
D) Natick's stock price is higher than Worcester's.
13
33) Nadine Enterprises has total assets of $240,000, a debt-equity ratio of 0.60, and a return on
assets of 9%. What is the return on equity?
A) 5.4%
B) 5.6%
C) 14.4%
D) 15.0%
34) Quick Cement has a return on assets of 8%. If it has $1.5 million in total assets and a total
asset turnover of 2, it follows that the firm must have a net profit margin of
A) 4%.
B) 6%.
C) 8%.
D) 12%.
35) Investors are most interested in which one of the following ratios?
A) return on assets
B) current ratio
C) net profit margin
D) return on equity
36) Which one of the following is a leverage measure?

A) times interest earned
B) net working capital
C) return on equity
D) net profit margin
37) If a company's ROA is high, then an investor can assume that the company
A) is in danger of defaulting on its loans.
B) pays a high dividend.
C) is profitable.
D) has more equity than debt in its capital structure.
38) If a firm has an ROA of 10% and an ROE of 10%, then the
A) operating results of the firm are improving.
B) firm has no financial leverage.
C) firm must have enough cash on hand to pay some extra dividends.
D) firm is losing money.
39) Kim has gathered the following information on a company.
What is the amount of the earnings per share?
14
A) $0.14
B) $0.25
C) $0.28
D) $0.30
40) Over the last 5 years, Spencer Inc.'s earnings have grown at an annual average rate of 9%.
Current EPS are $1.80 and the company's stock recently sold for $36 per share. Spencer's PEG
ratio is
A) .05
B) 20
C) 2.22
D) 222.22
41) JJ Industries has a P/E ratio of 18 and an EPS of $0.93. This means that JJ's stock is
currently selling for
A) $16.74 per share.
B) $17.07 per share.
C) $18.00 per share.
D) $19.35 per share.
42) When dividend payout ratios are higher than ________, investors should investigate
whether or not they are sustainable.
A) 15%
B) 25%.
C) 40%.
D) 75%.
43) Which of the following may be signs of future problems for a company?
I. Inventories growing faster than sales.

II. Rapidly increasing debt to equity ratio.
III. Cash flow from operations is higher than net income.
IV. Current liabilities increasing faster than current assets.
A) I and III only

B) II and IV only
44) The PEG ratio

A) preferred by investors is equal to 2.0 or higher.
B) compares the price/earnings ratio to the rate of growth of the company's earnings.
C) is a measure of a firm's liquidity.
D) measures the ability of a firm's assets to generate growth for the firm.
45) Which of the following directly impact return on equity?
15
I. net profit margin
II. leverage
III. return on assets
IV. cash flow from investment activities
A) I and III only

B) II and IV only
46) ROE = (net profit margin)(total asset turnover)(equity multiplier). What is the advantage of
using this expanded version of the ROE formula versus using the simplified version which is
net income divided by total equity?
This allows an investor to determine what financial activities are contributing the most to the
changes in ROE. An investor can use analysis like this to compare the operational efficiency of
two similar firms.
47) The following information is available for the Oil Creek Corporation.
(a) What is the current ratio? 0.88

(b) What is the net working capital? -$5000
(c) What is the net income? $11,700
(d) What is the return on equity? 20.17
(e) What is the total asset turnover? 1.33
(f) What is the debt-equity ratio? 0.83
(g) What is the accounts receivable turnover? 10.26
(h) What is the earnings per share (EPS)? $0.78
(i) What is the price to earnings (P/E) ratio? 18.50
7.6 Learning Goal 6
1) A company's ratios are more meaningful when compared to other companies in the same
industry. TRUE
2) The debt to equity ratio should be approximately the same across all industrial sectors.
FALSE
16
3) Financial ratios give little indication whether a company is well managed or not. FALSE
4) Investors who want to analyze a company's ratios usually need to compute them from the
financial statements. FALSE
5) Historical comparisons will reveal whether a company's performance is improving or

deteriorating. TRUE
6) Generally, the market price of a stock is

A) below its book value.
B) above its book value.
C) equal to its par value.
D) equal to its book value.
7) To determine whether a pharmaceutical company's profitability ratios indicate strength or

weakness, we should
I. compare them to others in the same industry.

II. compare them to companies in unrelated industries such as energy or banking.
III. compare them to previous years.
IV. compare them to absolute standards established by the CFA Institute.
A) I and II only
B) I and III only
C) III and IV only
D) IV only
8) Which of the following is a readily available source of industry comparisons?
I. Standard & Poor's

II. MSN Money, Yahoo Finance and other financial portals
III. Mergent (Moody's)
IV. The Wall Street Journal
A) I and II only
C) III and IV only
9) A comparison of a firm's current financial ratios to those of prior years allows one to
A) accurately predict the future performance of a firm.
B) see how a firm's performance compares to that of a competitor.
C) see trends that are developing.
D) determine if the firm is performing better than the overall industry.
10) Amgen's debt to equity ratio is .54 while Walmart's is .68. By comparing these ratios we
can conclude
17
A) that Walmart is in danger of bankruptcy.
B) that Amgen uses too little debt financing.
C) that Walmart uses too little equity financing.
D) very little because the firm's are in different industries.
Use the following information for the question(s) that follow.
Company X and Company Y are in the same industry and have the following ratios.
11) Based on the information above, we can conclude that

A) company X is using leverage more aggressively than company Y.
B) company X is more liquid than company Y.
C) company X is using assets more efficiently than company Y.
D) company X is reinvesting a higher percentage of its earnings in the business than company
Y.
12) Based on the information above, we can conclude that

A) company Y is more financially conservative than company X.
B) company Y is more liquid than company X.
C) company Y is reinvesting a higher percentage of its earnings in the business than company
X.
D) company Y is using assets less efficiently than company X.
13) Company X and Company Y are in the same industry and have the following ratios.
Discuss the relative natures of the two companies in terms of risk and return. Identify the more
growth-oriented firm and justify your selection. Support your discussion and conclusions by
referring to the ratios.

Chapter 8 Stock Valuation
18
8.1 Learning Goal 1
1) The most important factors influencing a stock's current price are its past earnings and
dividends. FALSE
2) The key to the future financial success of a company lies in the sales growth and the net
profit margin. TRUE
3) Companies with high P/E ratios tend to also have high dividend payout ratios. FALSE
4) A stock's value depends on future cash flows. TRUE
5) A company's estimated future earnings and its P/E ratio can be used to estimate the stock's
future price. TRUE
6) The estimated price of a stock in the future is important because it includes the projected
capital gain on the stock. TRUE
7) The single most important issue in the stock valuation process is a company's
A) past earnings record.
B) historic dividend growth rate.
C) expected future returns.
D) capital structure.
8) Most analysts would not feel comfortable forecasting a firm's future earnings for more than
A) the next quarter.
B) 1 to 3 years.
C) 4 or 5 years.
D) the next business cycle.
9) The value of a stock is a function of

A) future returns.
B) historic dividend growth rate.
C) most recent earnings per share.
D) past returns.
10) Which of the following variables affect the P/E ratio?
I. capital structure of a firm

II. amount of dividends to be paid
III. inflation rate
IV. earnings rate of growth
A) I, II and III only

19
11) Which of the following will affect the firm's future cash flows?
I. state of the economy

II. state of the industry
III. the firm's recent and current earnings
IV. new products in the firm's pipeline

12) Which of the following contributes to high P/E ratios?

A) high dividend payout ratios
B) high rate of earnings growth
C) periods of high inflation
D) high debt ratios
20
13) High P/E ratios can be expected when investors expect
A) a high rate of growth in earnings.
B) low earnings. relative to market prices.
C) high interest rates.
D) a bear market.
14) Which of the following will most directly influence a company's market value?
A) the state of the economy
B) the book value of its assets
C) the use of financial leverage
D) its future cash flows
15) List the key variables that affect the P/E ratio and explain the relationship between each
variable and the P/E ratio.
(a) growth rate in earnings; higher the growth rate, higher the P/E ratio
(b) general state of the economy; the better the economic outlook, higher the P/E ratio
(c) amount of debt in a company's capital structure; lower the debt ratio, higher the P/E
(d) current and projected rate of inflation; lower the inflation, higher the P/E
(e) level of dividends; lower the dividend payout, higher the P/E
8.2 Learning Goal 2
1) The first step in predicting a stock's future price is to forecast profits. FALSE
2) If net income rises, but the number of shares outstanding remains the same, EPS will rise.
TRUE
3) The common-size income statement expresses every item on the income statement as a
percentage of sales. TRUE
4) A temporary decline in earnings per share usually results in a temporary reduction of

dividends. FALSE
5) A decline in earnings that investors expect to be temporary may actually increase a firm's
P/E ratio. TRUE
6) The sales forecast depends on factors both internal and external to the firm. TRUE
7) The Merry Co. has current annual sales of $350,000 and a net profit margin of 6%. Sales are
expected to increase by 5% annually while the profit margin is expected to remain constant.
What is the projected after-tax earnings for two years from now?
A) $19,294
B) $22,050
C) $23,100
D) $23,153
8) P/E ratios could rise even as earnings fall if

21
A) earnings fall at a faster rate than stock prices.
B) earnings fall at a slower rate than stock prices.
C) investors expect lower stock prices to be permanent.
D) investors expect lower earnings to be permanent.
9) Even if a company does not officially follow a fixed-dividend policy, dividend payments are
A) extremely difficult to predict.
B) very volatile and subject to economic conditions.
C) fairly stable from one time period to another.
D) directly tied to a company's P/E ratio.
10) Columbus Co.'s sales revenue for the most recent quarter was $2.5 million and cost of
goods sold was $1.5 million. If sales grow by 15% in the next quarter and all ratios remain the
same, gross profit will be
A) $2.25 million.
B) $1.725 million.
C) $1.15 million.
D) $1.375 million.
11) If the market multiple is 20.24 and the P/E ratio of a company is 24.5, then the stock's
relative P/E is
A) 0.83.
B) 1.19.
C) 1.21.
D) 4.26.
12) The current annual sales of Flower Bud, Inc. are $178,000. Sales are expected to increase
by 4% next year. The company has a net profit margin of 5% which is expected to remain
constant for the next couple of years. There are 10,000 shares of common stock outstanding.
The market multiple is 16.4 and the relative P/E of the firm is 1.21. What is the expected
market price per share of common stock for next year?
A) $15.18
B) $17.66
C) $18.37
D) $19.29
13) The major forces behind earnings per share are

A) return on assets and total asset value.
B) gross revenue and the stock price.
C) growth and the number of shares outstanding.
D) net income and the number of shares outstanding.
14) GLOO stock's P/E ratio is 45 at a time when the market's P/E ratio is 15. GLOO's relative
P/E ratio is
A) 30.
B) -30.
C) 3.
22
D) .33.
15) Which one of the following is a correct equation to calculate earnings per share?
A) (ROA)(book value per share)
B) (profit margin)(total asset turnover)(equity multiplier)(book value per share)
C) (profit margin)(equity multiplier)(book value per share)
D) (profit margin)(book value per share)
16) Which one of the following is is most likely to increase the price of a stock?
A) rapid growth in sales
B) rapid decrease in the company's debt levels
C) rapid growth in earnings
D) rapid increases in bond interest rates
17) Global Warning's EPS for the current year is $2.75 and its current P/E ratio is 50. You
have forecasted that EPS will grow by 10% but the P/E ratio will fall to 40. What do you
expect the price of a share of GW's stock to be at the end of next year?
A) $110
B) $121
C) $137.50
D) $151.25
18) Over the last year, a firm's earnings per share increased from $1.20 to $1.40, its dividends
per share increased from $0.50 to $0.60, and its share price increased from $21 to $24. The firm
maintained a relative P/E of 1.10 over the entire time period. Given this information, it follows
that the
A) stock experienced an increase in its P/E ratio.
B) company had a decrease in its dividend payout ratio.
C) current P/E of the overall market is 26.4.
D) overall market P/E is declining.
19) Which of the following will lead to an increase in earnings per share?
A) an increase in the P/E ratio.
B) an increase in the dividend payout ratio.
C) an increase in return on equity if book value per share stays the same.
D) a decrease in the number of shares if return on equity stays the same.
20) Markhem Enterprises is expected to earn $1.34 per share this year. The company has a
dividend payout ratio of 40% and a P/E ratio of 18. What should one share of common stock in
Markhem Enterprises be selling for in the market?
A) $9.65
B) $14.47
C) $24.12
D) $33.77
21) The common stock of Rob's Discount Furniture is currently selling at $65.20 a share. The
company adheres to a 60% dividend payout ratio and has a P/E ratio of 19. There are 42,000
23
shares of stock outstanding. What is the amount of the annual net income for the firm?
A) $42,338
B) $36,032
C) $144,126
D) $72,064
8.3 Learning Goal 3
1) The efficient market hypothesis holds that a stock's intrinsic value and market value are
essentially the same. TRUE
2) A stock will be an attractive investment if the required rate of return exceeds the expected
rate of return. FALSE
3) There is no assurance that the actual rate of return on an asset will be similar to the projected
rate of return. TRUE
4) The greater the perceived risk of an asset, the lower the expected rate of return. FALSE
5) Both beta and the expected return on the market portfolio incorporate risk into the Capital
Asset Pricing Model. TRUE
6) The required rate of return denotes the minimum rate of return an investor should expect.
TRUE
7) The intrinsic value of an asset equals the present value of all future cash flows at a given
discount rate. TRUE
8) The intrinsic value of a stock provides a purchase price for the stock
A) that is reasonable given the associated level of risk.
B) which will assuredly yield the anticipated capital gain.
C) which will guarantee the expected rate of return.
D) that is always below the market value but yet yields the expected rate of return.
9) The risk-free rate of return is 2.2 percent, the expected market return is 11 percent, and the
beta for Solstice, Inc. is 1.12. What is Solstice's required rate of return?
A) 8.80%
B) 12.05%
C) 13.20%
D) 14.30%
10) The risk free rate is 2%. The expected rate of return on the market is 12%. Beta and the
expected rate of return for four stocks are as follows.: ABC .8 , 10%; DEF 1, 12%; GHI 1.2 ,
13%, and JKL 2, 22%. Which of these stocks should not be purchased?
A) ABC
B) DEF
C) GHI
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D) JKL
11) Which of the following are key inputs to determining the intrinsic value of an asset?
I. the required rate of return

II. future cash flows
III. current stock price
IV. timing of future cash flows
A) I and II only
B) I and III only
12) In the Capital Asset Pricing Model, which of the following factors are used to determine the
required rate of return?
I. the risk-free interest rate

II. future cash flows
III. expected return on the market portfolio
IV. beta
A) I and II only
13) The most uncertain value used in the Capital Asset Pricing Model is
A) beta.
B) the risk-free rate.
C) expected return on the market.
D) all are equally uncertain.
14) An investor should purchase a stock when

A) the market price exceeds the intrinsic value.
B) the expected rate of return equals or exceeds the required return.
C) the capital gains rate is less than the required return and no dividends are paid.
D) the market price is greater than the justified price.
15) Which of the following variables used in determining a stock's intrinsic value can be known
with the greatest level of confidence?
A) future earnings
B) expected return on the market
C) the risk free rate of return
D) future dividends
16) Heather believes that by carefully examining a company's fundamentals and by applying
25
the best valuation models she can identify stocks whose market prices are lower than their
intrinsic values. In order for this to be true
A) she needs an accurate estimate of future earnings and dividends.
B) some stocks must be incorrectly priced.
C) betas must be stable over time.
D) P/E ratios for both the stock and the market must be stable over time.
17) Explain how the time value of money concept is used in stock valuation.
The time value of money (TVM) is the concept that money you have now is worth more than
the identical sum in the future due to its potential earning capacity. It draws from the idea that
rational investors prefer to receive money today rather than the same amount of money in the
future because of money's potential to grow in value over a given period of time.
8.4 Learning Goal 4
1) The required rate of return estimated by the Capital Asset Pricing Model is not suitable for
use in dividend valuation models. FALSE
2) The approach to stock valuation which holds that the value of a share of stock is a function
of its future dividends is known as the dividend valuation model (DVM). TRUE
3) If the annual dividend on a stock never changes, its price will never change. FALSE
4) The dividend valuation model (DVM) is very sensitive to the growth rate (g) being used,
because it affects both the model's numerator and its denominator. TRUE
5) The dividend valuation model estimates the value of a share of stock as the future value of
all dividends. FALSE
6) The growth rate of dividends cannot be permanently greater than the required rate of return.
TRUE
7) One of the easiest aspects of the dividend valuation model (DVM) is specifying the
appropriate growth rate for a firm's dividends over time. FALSE
8) The intrinsic value of a zero-growth stock can be found simply by dividing the dividend by
the required rate of return. TRUE
9) One method of estimating the dividend growth rate is to calculate the discount rate that
equates today's dividend with the dividend paid several years ago. TRUE
10) The rate of dividend growth can be estimated by multiplying the return on equity rate by
the dividend payout ratio. FALSE
11) The rate of growth can exceed the required return during the variable-growth period
without invalidating the variable growth dividend valuation model. FALSE
26
12) The dividend valuation model (DVM) cannot accommodate which of the following
assumptions?
A) constant dividends
B) a constant growth rate of dividends less than the required rate of return
C) a constant growth rate of dividends greater than the required rate of return
D) dividends growing at a variable rate
13) Lindor Inc.'s $100 par value preferred stock pays a dividend fixed at 8% of par. To earn
12% on an investment in this stock, you need to purchase the shares at a per share price of
A) $9.60.
B) $66.67.
C) $96.00.
D) $150.00.
14) The required rate of return necessary for the dividend valuation model can be estimated
using
A) the Capital Asset Pricing Model.
B) comparisons to the rates of return on stocks of similar risk.
C) a subjective assessment of the return required over and above less risky investments such as
government bonds.
D) any or all of the above.
15) James is willing to settle for a 10% rate of return on EG stock at a time when investors, on
average, are requiring an 11% rate of return on the same stock. Which of the following will
happen?
A) James will be have to pay more for the stock than he was willing to pay.
B) Investors with different required rates of return will pay different prices for the stock.
C) James will not be able to buy the stock unless the price changes.
D) James will be happy to buy the stock for less than he was willing to pay.
16) John requires a 12% rate of return on EG stock at a time when investors, on average, are
requiring an 11% rate of return on the same stock. Which of the following will happen?
A) John will have to pay more for the stock than he was willing to pay.
B) Investors with different required rates of return will pay different prices for the stock.
C) John will not be able to buy the stock unless the price changes.
D) John will buy the stock at a lower price.
17) A company that wants to maintain both a constant growth rate in dividends and a constant
payout ratio will have to
A) grow earnings faster than dividends.
B) increase assets at the same rate as dividends.
C) grow earnings at the same rate as dividends.
D) increase stockholders' equity at the same rate as dividends.
18) Michelak's Maritime Industries has relatively stable earnings and pays an annual dividend
of $3.00 per share. This dividend has remained constant over the past few years and is expected
to remain constant for some time to come. If you want to earn 11% on an investment in the
27
common stock of Michelak's, how much should you pay to purchase each share of stock?
A) $12.50
B) $18.88
C) $20.83
D) $27.27
19) Walpurg, Inc. paid $1.30 as an annual dividend per share last year. The company is
expected to increase their annual dividends by 6% each year. How much should you pay to
purchase one share of this stock if you require a 9% rate of return on this investment?
A) $45.93
B) $11.44
C) $23.39
D) $22.96
20) One stock valuation model holds that the value of a share of stock is a function of its future
dividends, and that the dividends will increase at an annual rate which will remain unchanged
over time. This stock valuation model is known as the
A) approximate yield model.
B) holding period return model.
C) dividend reinvestment model.
D) constant growth dividend valuation model.
21) What is the required rate of return on a common stock that is expected to pay a $0.75
annual dividend next year if dividends are expected to grow at 2 percent annually and the
current stock price is $8.59?
A) 8.73%
B) 8.91%
C) 10.73%
D) 11.38%
22) The constant-growth dividend valuation model is best suited for use with
A) stocks of new or emerging companies.
B) small-cap stocks within growing industries.
C) the stocks of mature, dividend-paying companies.
D) the stocks of cyclical companies.
23) When using the constant-growth dividend valuation model, which of the following will
lower the value of the stock?
A) an increase in the required rate of return
B) a decrease in the required rate of return
C) an increase in the dividend payout ratio
D) an increase in the growth rate of the dividends
24) Newton, Inc. just paid an annual dividend of $0.95. Their dividends are expected to
increase by 4% annually. Newton Company stock is selling for $11.54 a share. What is the
required rate of return on this stock implied by the dividend-growth model?
A) 8.23%
28
B) 12.2%
C) 12.6%
D) 13.9%
25) The Hopkinton Company just paid $2.25 as its annual dividend. The dividends have been
increasing at a rate of 5% annually and this trend is expected to continue. The stock is currently
selling for $63.60 a share. What is the rate of return on this stock?
A) 3.60%
B) 3.70%
C) 8.7%
D) 11.8%
26) ABC Company stock currently has a market value equivalent to its intrinsic value. Marco
perceives that ABC Company is increasing its level of risk and therefore Marco increases his
required rate of return on ABC stock. This change in the required rate of return
A) will reduce the intrinsic value of ABC stock to Marco.
B) will increase the intrinsic value of ABC stock to Marco.
C) will change the intrinsic value but the direction of the change cannot be determined.
D) is a signal to Marco that he should buy more ABC Company stock.
27) In applying the variable-growth dividend valuation model to a company's stock, analysts
frequently define the growth rate, g, as equal to
A) ROE multiplied by the firm's retention rate.
B) ROE divided by the dividend payout ratio.
C) the dividend payout ratio multiplied by the firm's retention rate.
D) P/E multiplied by the dividend payout ratio.
28) A company has an annual dividend growth rate of 5% and a retention rate of 40%. The
company's dividend payout ratio is
A) 35%.
B) 40%.
C) 45%.
D) 60%.
29) Which of the following statements concerning the constant-growth dividend valuation
model is (are) correct?
I. One simple method of estimating the dividend growth rate is to analyze the historical
pattern of dividends.
II. The expected total return equals the return from capital gains plus the return from dividends
paid.
III. The model is applicable to growth firms with initially high growth rates.
IV. The intrinsic value calculated using this method can change from one investor to another if
their risk-return payoffs differ.
A) I and IV only
B) II and III only
29
30) The variable-growth dividend valuation model

A) develops the value of a stock using the future value of dividends minus a rate of capital gain
growth.
B) is valuable because it accounts for the general growth patterns of most companies.
C) is invalid if at any point in time the growth rate exceeds the required rate of return.
D) assumes the rate of dividend growth will vary indefinitely.
31) In general, the higher the retention ratio

A) the higher the future growth rate of the company.
B) the higher the dividends per share of common stock.
C) the higher the future debt-equity ratio.
D) the lower the future book value per share.
32) Martin's Inc. is expected to pay annual dividends of $2.50 a share for the next three years.
After that, dividends are expected to increase by 3% annually. What is the current value of this
stock to you if you require a 9% rate of return on this investment?
A) $39.47
B) $40.11
C) $41.81
D) $42.92
33) MBA Inc. will pay a dividend for the first time at the end of 2016. It projects the following
dividend per share:
2016 $1.50
2017 $2.00
2018 $2.50
Beginning with 2016 dividends will grow at 4% per year. The required rate of return is 12%.
The intrinsic value of MBA shares is
A) $25.37.
B) $27.85.
C) $28.96.
D) $38.50.
34) DMC3 Inc. will pay no dividend for 2016 or 2017. At the end of 2018, it will pay a
dividend of $1.50.
Thereafter dividends will grow at 4% per year. The required rate of return is 10%. The
intrinsic value of DMC3 shares is (assume you are at the beginning of 2016)
A) $34.61.
B) $26.00
C) $24.91.
D) $20.66.
30
35) WaterCo is a manufacturer of boat parts and has been in business only a few years. Its
board of directors decided to start paying a dividend to help boost the attractiveness of its stock.
The dividend will be $0.50 per share next year. After that dividends will increase by 4 percent
per year. The company has a beta of 1.6. The market rate of return is 8% and the T-bill rate is
3%. Should you purchase shares in this firm at the current market price of $6.98 per share?
Required rate of return = 3% + [1.6 (8% - 3%)]= 3% + [1.6 (5%)]= 11.0%The value of a share
using the constant growth dividend valuation model = $0.50/(0.11 - 0.04) = $7.14.
Yes, you should buy the stock as it is currently priced at $6.98 per share while the intrinsic
value is $7.14 per share.
36) The common stock of Peachtree Paper, Inc., is currently selling for $40 a share. A dividend
of $2.00 per share was just paid. You are estimating that this dividend will grow at a constant
rate of 10%.
(a) Using the constant growth DVM model, what is your required rate of return if $40 is a
reasonable trading price? (Show all work.)
(b) If Peachtree Papers is a new company that produces a relatively unknown product, is the
constant growth model a good valuation method for a potential investor to use? Justify your
answer.
(a) Required rate of return = [$2.00(1.10)/$40] + 0.10r = 15.50%
(b) No, it is not. The constant growth DVM is suited only for mature companies with strong
track records. It is unlikely that the firm can continue increasing their dividends by 10%
annually over the long term.
8.5 Learning Goal 5
1) A stock's internal rate of return (IRR) is the discount rate that cause the present value of
future dividends and the price at which a stock is expected to be sold to equal the current price
of the stock. TRUE
2) Neither the P/E approach nor the cash flow to equity approach rely on dividends as the key
input into the valuation of a stock. TRUE
3) The free cash flow to equity approach does not require that a stock pay dividends. TRUE
4) The investor's internal rate of return is always equal to the firm's rate of return on equity.
FALSE
5) The value of a stock using the price to cash flow approach is to multiply the P/E ratio times
operating cash flow divided by the number of shares outstanding. FALSE
6) High price/sales multiples often go with high profit margins. TRUE
7) Stocks trading at high price to book value multiples may be especially attractive to bargain
hunters. FALSE
31
8) Which of the following statements concerning the Price to Cash-Flow approach to stock
valuation are true?
I. The Price to Cash-Flow method works just as well for non-dividend paying stocks as it does
for dividend-paying stocks.
II. The Price to Cash-Flow calculate s the intrinsic value of a stock as the present value of
future cash flows.
III. The Price to Cash-Flow ratio divides the market price of one share of stock by cash flow
per share.
IV. The Price to Cash-Flow method does not directly calculate the intrinsic value of a share.
A) I and II only
B) III and IV only
9) Commonly used multiples for determining a stock's value include
I. price to earnings.
II. price to sales.
III. price to cash flow.
IV. price to dividends.

10) The intrinsic value of a stock is greater than its current market price if
A) The market price is higher than the present value of expected future cash flows.
B) the stock's P/E ratio is higher than the market's average P/E ratio.
C) the stock's IRR exceeds the required rate of return.
D) the stock's P/CF ratio is higher than the market's average P/CF ratio.
11) Zephyr Inc. sells wind based systems for generating electricity. The company pays no
dividends, but you estimate the stock will be worth $50 per share 5 years from now and you
require a 15% rate of return for stock investments of this type. What price should you be
willing to pay for this stock?
A) $12.50
B) $24.86
C) $43.48
D) $57.50
12) Ivonne has bought shares of RIO, Inc. stock for $25.00 per share. She expects a 1.00
dividend at the end of this year. After 2 years, she expects to receive a dividend of $1.25 and to
sell the stock for $28.75. What is Ivonne's required rate of return?
A) 4.0%
32
B) 11.6%
C) 15.2%
D) 24.0%
13) An internal rate of return (IRR) is the discount rate that

A) represents the minimal rate required to create a positive net present value.
B) is the minimal rate of return an investor will accept.
C) provides an investor with their required return.
D) produces a present value of future benefits equal to the market price of a stock.
14) In the price/earnings approach to stock valuation,

A) historical stock prices are utilized.
B) forecasted EPS are typically used.
C) the P/E ratio is computed by multiplying the stock price by the earnings per share.
D) the market P/E ratio, adjusted by beta, is used to value individual stocks.
15) Hallowell Inc. has free cash flow of $2.5 million and 1.25 million shares outstanding. If
you believe the price to cash flow ratio for this company should be 11, what is the highest price
you should pay for the stock?
A) $13.75
B) $22.00
C) $22.72
D) $27.50
16) Equinox Bioengineering began operations in January of 2015. In its first year of operation,
sales were $85 million and the net loss was $(5.1 million). Free cash flow was $(300,000).
Equinox has 10 million shares outstanding. If you think the price to sales ratio for this
company should be 1 or less, what is the most you should pay per share.
A) $85.00
B) $8.50
C) $51.00
D) Such a stock would have no value at all.
17) Early in 2015, Maria bought shares of MBA Inc. at $27.85 per share. She received the
following dividends per share (end of year).
2015 $1.50
2016 $2.00
2017 $2.50
Immediately after receiving the 2017 dividend, she sold the stock for $32.50 per share. Her
internal rate of return on this investment was
A) 9.17%.
B) 10.25%.
C) 11.99%.
D) 13.85%.
33
18) Early in 2015, Mathew is analyzing shares of Janeff Corp. He expects the following
dividends per share (end of year).
2015 $1.00
2016 $1.25
2017 $1.50
He expects 2017 earnings per share to be $4.50 and Janeff's P/E ratio to be 20. His required
rate of return for this stock is 12%. He should pay no more than
A) $43.75 per share.
B) $67.02 per share.
C) $68.75 per share.
D) $93.75 per share.
19) Which of the following approaches to stock valuation is NOT based on a multiple of some
figure from the financial statements?
A) the price-to-cash flow approach
B) the price-to-sales approach
C) the dividends-growth model
D) the price-to-earnings approach
20) The Highlight Company has a book value of $56.50 per share, and is currently trading at a
price of $59.00 per share. You are interested in investing in Highlight, and have just used a
present-value based stock valuation model to calculate a present (intrinsic) value of $55.00 per
share for Highlight's stock. Assuming that your calculations are correct you should
A) buy the stock, because the current market price per share is higher than the present value.
B) buy the stock, because the book value per share is greater than the present value.
C) not buy the stock, because the present value is less than the market price per share.
D) buy the stock, because the book value and the current trading price are very close to one
another in value.
21) Macoun Co.'s most recent EPS were $3.25 and they are expected to grow at a rate of 5%
for the near future. The stock currently sells for $48.75. What is the price to forecasted
earnings ratio?
A) 15.00
B) 14.30
C) 15.75
D) .07
22) How can you determine the current value of a non-dividend paying stock?
There are several methods you can use such as the price to cash flow, price/earnings approach,
price to sales, or the price to book ratio method.
8.6 Learning Goal 6
1) The constant growth dividend valuation model works best for mature companies with a long
record of paying dividends. TRUE
34
2) The free cash flow to equity approach does not require present value calculations. FALSE
3) None of the commonly used valuation approaches can assign a value to a company with no
earnings. FALSE
4) A drawback to the price-to-cash-flow method of valuation is that there is no generally

accepted cash flow measure. TRUE
5) Generally speaking, the higher the price-to-sales ratio, the better. FALSE
6) To use the Price-to-Sales valuation approach you also need to know the after tax profit
margin. FALSE
7) The price-to-cash-flow method of stock valuation generally

A) uses either EBITDA or operating cash flow from the cash flow statement as a measure of
cash flow.
B) relies on historical cash flows.
C) produces a cash flow multiple that is greater than the P/E multiple.
D) applies the P/E multiple to the cash flow per share value.
8) For which one of the following situations will the price-to-sales valuation model work but
the dividend and cash flow models will not?
A) mature firm with minimal growth opportunities
B) water-powered electric utility company
C) newly-formed biotechnology company with negative earnings
D) top-performing firm in a mature industry
9) For which one of the following situations will the dividend-growth models work especially
well?
A) mature firm with a policy of increasing its earnings and dividends at an average rate of 5%
per year
B) a company with highly variable earnings and a policy of maintaining a constant 50% payout
ratio
C) a company that intends to pay out all of its earnings as dividends
D) a company that is widely viewed as an attractive takeover target
10) EBITDA is an acronym for

A) Earnings Based Information, Total Development Approach.
B) Ernst, Bostwick, Davenport, Innes Approach.
C) Earnings Before Interest, Taxes, Depreciation, and Amortization.
D) Earnings Before Interest, Taxes, Dividends, and Asset replacement.
11) A firm with a price to sales ratio of 1 would usually be considered

A) overvalued.
B) correctly valued.
C) near bankruptcy.
35
D) undervalued.
12) Which of the following can be considered discounted cash flow methods of stock
valuation?
I. The constant growth dividend valuation model

II. The variable growth dividend valuation model
III. The price to cash flow method
IV. The cash flow to equity method
A) I, II, and IV only

B) II, III, and IV only
C) I, II, and III only
D) I, II, III, and IV
13) Tureves S.A. is a French biotechnology company that has developed promising therapies
for hair loss, obesity, and wrinkled skin. Sales have doubled in each of the last three years, but
so far, the company has yet to turn a profit. Which common procedures would be most, and
least appropriate to value Tureves' ADRs.
Such a speculative company would be extremely difficult to value, but the price-to- sales ratio
would be the best method, and the price-to-cash-flow ratio might be of some help. Since there
are no dividends or earnings, dividend valuation and price-to-earnings methods would not be
helpful.
36
Chapter 9 Market Efficiency and Behavioral Finance
9.1 Learning Goal 1
1) In an efficient market, the only means of achieving high returns is to invest in high-risk
securities. TRUE
2) The efficient market hypothesis means that trades can be executed quickly, easily, and
inexpensively. FALSE
3) If a company's revenues and earnings are highly predictable, it's stock price will also be
highly predictable. FALSE
4) Historically higher returns on the stocks of small companies can be completely explained by
their higher risk.
FALSE
5) Investors skilled in exploiting behavioral errors and market anomalies can consistently
outperform the market by a wide margin.
FALSE
6) Even if weak form market efficiency is true, it does not mean that studying charts of past
prices and searching for repeating pattern is useless.
FALSE
7) Even if the semi-strong version of the efficient market hypothesis is true, it might be possible
to earn extraordinary returns from private information not available to other investors.
8) An efficient market reflects

A) only historical information.
B) only the information related to events that have already occurred.
C) all publicly known information related to past events and announced future events.
D) all information including predictions about future information.
9) A type of mutual fund with particular appeal to investors who accept the efficient market
hypothesis is
A) index fund.
B) asset allocation fund.
C) growth opportunities fund.
D) emerging markets fund.
10) In an efficient market, prices appear to move randomly because

A) investors do not process new information correctly.
B) only new information affects stock prices.
C) insider trading has an unpredictable effect on stock prices.
D) the number of investors who can forecast prices correctly is too small to have any effect.
11) The efficient market hypothesis rests on which of the following assumptions?
1
I. Information is widely available to all investors almost simultaneously.
II. Investors react quickly to new information.
III. Investors correctly interpret all available information.
IV. Events which affect the market occur randomly.
A) I and II only
12) Which one of the following activities is likely to be useful if the market is only weak form
efficient?
A) attempting to find the best times to buy and sell
B) attempting to find repeating pattern in stock price behavior
C) attempting to determine if stock prices have upward or downward momentum
D) None of the above would be useful.
13) Which of the following activities would be most useful in an efficient market?
A) buying and holding a diversified portfolio
B) searching for patterns in charts based on stock price movements
C) analyzing financial ratios based on accounting data
D) buying only securities that have performed well in the recent past
14) Followers of the efficient market hypothesis believe that

A) very few investors actually analyze or evaluate stocks before they make a purchase decision.
B) the needed information to assess the market is available only to corporate insiders.
C) investors react quickly and accurately to new information.
D) individual traders can have a significant impact on the price of a security.
15) The weak form of the efficient market theory contends that
A) past price performance is useless in predicting future price movements.
B) past performance can help determine the general direction of future price movements.
C) any publicly available information is useless in predicting future price movements.
D) price movements are not random but follow a general trend over a period of time.
16) According to the semi-strong form of the efficient market hypothesis, which of the
following might lead to extraordinary profits?
A) studying charts of a stock's past price behavior
B) thoroughly analyzing the state of the economy, the industry and the company's fundamentals
C) possessing private information not available to other investors
D) carefully timing trades to buy when the price is low and sell when the price is high
17) The strong form of the efficient market hypothesis contends that
A) a select few institutional investors can earn abnormal profits.
B) abnormal profits are randomly distributed.
C) no one can consistently earn a profit.
D) no one can consistently earn abnormal profits.
2
18) Security markets have been described as random walks and efficient markets. What does
each of these terms mean and how do they relate to the stock market? What makes a market
efficient and what are the consequences of efficiency for fundamental and technical analysis?
FALSE
9.2 Learning Goal 2
1) For most companies, the stock price follows the same seasonal pattern as revenues and
earnings. FALSE
2) If stock prices move randomly, charting and technical analysis are useful investment tools.
FALSE
3) The process of buying an underpriced security and selling an equivalent overpriced security
until the prices converge is known as arbitrage.
TRUE
4) Even if the semi-strong form of the efficient market hypothesis is true, trading on illegal
insider information may lead to abnormal profits. TRUE
5) The apparent randomness of stock price movements is powerful evidence against market
efficiency. FALSE
6) Followers of the random walk hypothesis believe that

A) security analysis is the best tool to utilize when investing in the stock market.
B) the price movements of stocks are unpredictable, and therefore security analysis will not
help to predict future market behavior.
C) that traders can earn higher than normal returns by exploiting market anomalies such as the
small-firm effect.
D) support levels and resistance lines, when combined with basic chart formations, yield both
buy and sell signals.
7) Which one of the following statements concerning the random walk hypothesis is correct?
A) Stock price movements are predictable but only over short periods of time.
B) Random price movements support the weak form efficient market hypothesis.
C) Stock prices in general follow repetitive patterns but the actions of individual investors are
random in nature.
D) Random price movements indicate that investors can earn abnormal profits on a routine
basis.
8) The process that quickly eliminates price discrepancies in efficient markets is known as
A) arbitration.
B) market correction.
C) arbitrage.
D) random fluctuation.
9) The random walk hypothesis

A) implies that security analysis is unable to predict future market behavior.
B) suggests that random patterns appear but only over long periods of time.
3
C) has been disproved based on recent computer simulations.
D) accounts for market anomalies such as calendar effects.
10) There is evidence to support the contention that company insiders

A) cannot earn abnormal profits because they are not permitted to trade shares in their
company's stock without a one-month advance notice to the SEC.
B) can profit in a manner that counters the strong form of the efficient market hypothesis.
C) generally earn a profit equal to that of public investors.
D) have no distinct advantage when trading shares of their company's stock.
11) Which of the following is true?

A) Historically, high P/E or growth stocks have outperformed low P/E or value stocks.
B) Historically, low P/E or value stocks have outperformed high P/E or growth stocks.
C) After adjusting for risk, high P/E or growth stocks and low P/E or value stocks have
performed about the same over time.
D) the P/E effect is limited to U.S. stocks.
12) Market anomalies are caused by

A) investors' efforts to avoid or postpone taxes.
B) different levels of risk.
C) statistical quirks.
D) some poorly understood combination of factors.

A) The weekend effect states that security prices tend to rise between Friday afternoon and
Monday morning.
B) The market responds immediately to reflect the information contained in quarterly earnings
reports.
C) Low P/E stocks tend to outperform high P/E stocks on a risk-adjusted basis.
D) The market fully anticipates the information contained in an earnings announcement prior to
the actual announcement.
14) Believers in efficient markets tend to explain away market anomalies as
I. random occurrences that create an illusion of causality.

II. errors resulting from inaccurate measures of risk.
III. the result of illegal price manipulation by corporate insiders.
IV. the effect of normal human emotions such as fear and greed.
A) I and II only
C) I and III only
9.3 Learning Goal 3
1) Behavioral finance suggests that investors react to new information in an efficient manner
4
such that security prices accurately reflect the new information.
FALSE
2) Fund managers tend to have too little confidence in their abilities leading them to be
excessively cautious. FALSE
3) Individuals tend to invest in mutual funds that have recently been performing well.
TRUE
4) Loss aversion is the behavior of excessively conservative investors.
5) Most investors quickly sell their losers and hold on to their winners.
FALSE
6) Most investors are slow to accept evidence that contradicts their strongly held beliefs.
TRUE
7) Self-attribution bias causes investors to attribute their successes to skill and failures to
chance.
TRUE
8) There is strong evidence that investors who trade frequently outperform the market.
FALSE
9) Some behavioral characteristics cause investors to realize lower investment returns.
TRUE
10) Investor overconfidence leads to
A) too little trading.
B) an overestimation of risk.
C) overly optimistic predictions.
D) narrow framing.
11) Four "decision traps " identified by behavioral finance are

A) overconfidence, representativeness, loss aversion, narrow framing.
B) lack of confidence, representativeness, overreaction, narrow framing.
C) overconfidence, representativeness, loss aversion, comprehensive framing.
D) overconfidence, unfamiliarity bias, loss aversion. narrow framing.
12) The tendency of investors to blame others for their failures and take personal credit for their
successes is referred to as
A) loss aversion.
B) representativeness.
C) narrow framing.
D) self-attribution bias.
13) The most important lesson investors can learn from behavioral finance is
A) to understand psychological factors influencing long-term price movement.
B) to have the humility to let professionals manage their investments.
C) how to avoid letting their emotions and biases affect their investment decisions.
D) to have confidence in their instincts and first impressions.
14) Jason has decided to sell his stock in an energy company because gas and oil prices as well
the price of his stock have declined in 5 of the last 6 months. Jason has most likely fallen into
5
the trap known as
A) loss aversion.
B) representativeness.
C) narrow framing.
D) biased self-attribution.
15) Which of the following characteristics are referred to as representativeness?
I. hesitating to sell stocks at a loss

II. basing conclusions on small samples
III. underestimating the effects of random chance
IV. underestimating the level of risk in an investment
A) I and IV only
B) II and III only
D) I, II, III and IV only
16) Which of the following are common but dysfunctional investor behaviors?
I. overinvesting in companies with familiar names

II. dividing their funds equally among available choices, even if several of the choices serve
the same purpose
III. holding on to a stock that has dropped in value because you would be willing to buy it at its
current price
IV. overestimating one's ability to pick successful investments
A) I and IV only
B) II and III only
17) People tend to

A) ignore information that contradicts their current beliefs.
B) overestimate the effects of random chance.
C) be underconfident in their judgment of investments.
D) look at the entire situation when analyzing an individual security.
18) The tendency of investors to take greater risks after a large loss and fewer risks after a large
gain can be attributed to
A) overconfidence.
B) the "house money" effect.
C) loss aversion.
D) representativeness.
6
19) Investors who buy mutual funds that have had large gains over the last few years are
exhibiting a tendency known as
A) overconfidence.
B) narrow framing.
C) loss aversion.
20) Heather has the equivalent of one year's income in an insured savings account. Her 401-K
fund offers a choice of a government bond fund, an S&P 500 Index fund, and a balanced fund
that holds roughly equal amounts of stocks and bonds. If she decided to allocate 1/3 of her
retirement investments to each fund, she may be a victim of
A) overconfidence.
B) narrow framing.
C) loss aversion.
21) Which of the following accurately reflect appropriate investment guidelines?
I. Always invest in last years best performing mutual fund.

II. Trade frequently to increase your investment returns.
III. Sell losing stocks unless you are willing to buy them at the current price.
IV. Take corrective action when so indicated.
A) I and II only
B) III and IV only
22) Which of the following statements correctly present recommendations based on behavioral
finance?
I. Don't hesitate to sell a losing stock.

II. Trade frequently.
III. Chase performance.
IV. Be humble and open-minded.
A) I and II only
B) I and IV only
C) II and III only
D) III and IV only
23) Evidence suggests that the price of a stock continues to move up or down for a period of
A) a decade or more.
B) 3 to 5 years.
C) 1 to 3 years.
D) 6 to 12 months.
7
24) Market bubbles such as the technology bubble of the 1990s and the housing bubble of
2004-2007 are best explained by
A) the efficient market hypothesis.
B) behavioral finance and economics.
C) rational expectations theory.
D) anomaly theory.
25) What are some of the more important disagreements between the efficient market
hypothesis and the findings of behavioral finance? FALSE
9.4 Learning Goal 4
1) Recent academic studies in behavioral finance confirm that markets are even more efficient
than previously believed. FALSE
2) The efficient market hypothesis has some trouble explaining the existence of market
anomalies.
TRUE
3) Evidence suggests that growth stocks tend to outperform value stocks.
FALSE
4) Stocks of small companies have a historical tendency to do especially well in the month of
January.
TRUE
5) One of the calendar effect market anomalies indicates that ________ in value during
January.
A) large cap stocks tend to decline
B) equities in general tend to decline
C) small cap stocks tend to increase
D) equities in general tend to increase
6) The anomaly known as post-earnings announcement drift or momentum describes the

tendency of stock prices to rise or fall for several ________ after unexpectedly good or bad
earnings announcements.
A) months
B) weeks
C) days
D) hours
7) From a behavioral perspective, the anomaly known as post-earnings announcement drift or

momentum is best explained by
A) self attribution bias.
B) loss aversion.
C) representativeness.
D) familiarity bias.
8) Even after adjusting for risk, ________ firms have, over long periods of time, earned higher
returns than ________ firms.
8
A) small; large
B) large; small
C) new; old
D) old; new
9) The tendency of small firms to have higher returns than large firms , even after adjusting for
risk, may be attributable to
A) representativeness.
B) overconfidence.
C) familiarity bias.
D) loss aversion.
10) The tendency of naive investors to buy high (after prices have risen for several periods) and
sell low (after prices have dropped for several periods) can be explained by the behavioral
tendency known as
A) anchoring.
B) overconfidence.
C) familiarity bias.
D) loss aversion.
11) The stock of PHRM, the price declined by 30% when the FDA did not approve a promising
new therapy the company was developing. Patrick holds on to the stock and constantly
searches the internet looking for favorable stories about the company while ignoring a cascade
of negative reports. This is an example of
A) anchoring.
B) overconfidence.
C) belief perseverance.
D) loss aversion
12) Barb and Ken purchased a house for $300,000 in 2005. When they needed to sell because
of a job transfer in 2009, the house was appraised for $250,000 but they put it on the market for
$300,000 anyway. The house is still on the market. Behavioral tendencies at work here may
include
A) representativeness and narrow framing.
B) overconfidence and representativeness.
C) familiarity bias and self attribution bias.
D) loss aversion and anchoring.
9.5 Learning Goal 5
1) A principal objective of technical analysis is trying to determine when to invest.

TRUE
2) Investors should never combine fundamental analysis and technical analysis.
FALSE
3) Resources for technical analysis are readily available on the Internet.
TRUE
4) For technical analysts, the forces of supply and demand have an important effect on the
9
prices of securities.
TRUE
5) The stock market is considered strong when the market volume decreases in a declining
market.
TRUE
6) Market volume is a function of market demand for and supply of stocks.
TRUE
7) The breadth of the market refers to the spread between the number of stocks advancing and
those declining in value.
TRUE
8) A relatively high level of short sales is an indicator of a current bull market.
FALSE
9) The odd-lot theory supports buying into the market when the number of odd-lot trades rises.
FALSE
10) Technical analysis is so called because it relies on sound scientific principles rather than
intuition.
FALSE
11) The new high-new lows measure suggests that buying opportunities occur when new lows
outnumber new highs.
FALSE
12) An oversold market is generally considered to be overvalued.
FALSE
13) Technical analysis primarily monitors shifts in the ________ in the market.
A) level of risk
B) supply and demand forces
C) volume of trading
D) rate of return
14) Which of the following are included in technical analysis?
I. charting price movements

II. tracking trading volume
III. determining the investor's risk tolerance
IV. monitoring odd-lot trading
A) I and II only
B) II and III only
C) I, II and III
D) I, II and IV
15) Technical analysis is used for which of the following purposes?
I. deciding when to enter the market

II. deciding whether to sell a stock
III. deciding which stocks to buy
IV. deciding whether basic economic conditions are favorable for investing
10
A) I and II only
B) II and III only
16) The principal objective of technical analysis is

A) determining the best time to get into or out of the market.
B) maintaining the lowest level of risk possible.
C) avoiding all unpleasant surprises in the market.
D) increasing trading to improve overall profits.
17) Which of the following are used as indicators of a strong market in the future?
I. The advance-decline spread is increasing at a time when the advances outnumber the
declines.
II. The level of short interest is relatively high.
III. The net difference of odd-lot purchases minus odd-lot sales begins increasing.
IV. The trading volume increases in a declining market.
A) I and II only
B) III and IV only
18) The odd-lot trading theory advocates that small investors

A) tend to buy high and sell low.
B) react in a manner which generally forecasts the future direction of the market.
C) are the first to react to market changes.
D) tend to be the first to speculate on a bull market.
19) Which of the following practices are typical of technical analysis?
I. charting
II. computing moving averages
III. computing financial ratios
IV. plotting advance-decline lines
A) I and III only

20) The new highs-new lows measure typically looks at a period of

A) 10 trading days.
B) one month.
C) 100 days.
D) 52 weeks.
11
21) One of the most popular tools of technical analysis is
A) charting.
B) financial statement analysis.
C) investor profiling.
D) investor behavior analysis.
22) Chartists advocate that

A) history repeats itself.
B) patterns appear that are very clear and distinctive.
C) formations are less important than the direction of the latest price movement.
D) a breakout below a support line is a buy signal.
23) Technical analysts believe that some of the key elements of market behavior—called
technical indicators-can provide valuable insights about the condition of the market. Briefly
discuss each of the following indicators.
Confidence Index looks at ratio between yields on high-grade corporate bonds compared to
intermediate-grade corporate bonds
Market Volume is pure supply and demand analysis for common stocks
Breadth of the Market looks at number of stock prices that go up (advances) versus number of
stock prices that go down (declines)
Short Interest looks at number of stocks that have been sold short at any given time
Contrary Opinion and Odd-Lot Trading measures the volume of small traders and assumes that
small traders will do just the opposite of what should be done
• Market volume
• Breadth of the market
• Short-interest
• Odd-lot trading
9.6 Learning Goal 6
1) The relative strength index compares a security's price relative to itself over a period of time.
TRUE
2) The simple moving average is a weighted average.
FALSE
3) The purpose of moving averages is to reduce the effect of random, short-term market
fluctuations.
TRUE
4) The mutual fund cash ratio (MFCR) compares the percentage of an investor's portfolio held
in cash to the percentage held in mutual funds.
FALSE
5) The on-balance volume indicator is used as a means of evaluating the significance of price
movements.
TRUE
6) Charts are used as a means of spotting developing trends.
TRUE
7) The advance/decline line is be used to time both the purchase and the sale of securities.
12
TRUE
8) Which one of the following relative strength values would most indicate that a stock is
oversold?
A) 120
B) 80
C) 20
D) -20
9) Over the last 14 trading days, the average price increase for Quincy Industries stock was
$0.88 and the average drop on down days was $0.44. The relative strength index for Quincy is
A) 2.
B) 66.67.
C) 50.
D) 33.33.
10) The theory behind the mutual fund cash ratio is

A) mutual fund managers hold high levels of cash when they are optimistic about market
conditions.
B) when mutual fund managers hold high levels of cash, they must eventually buy stocks with
it.
C) when mutual fund managers hold low levels of cash they are pessimistic about market
conditions.
D) when market conditions are favorable, shareholders remit more cash than the managers can
invest.
11) On a given trading day, 700 stocks advanced and 1,200 stocks declined. The volume of
declining stocks was 280 million while the volume of advancing stocks was 530 million. What
is the ARMS (a.k.a. TRIN) index value for the day?
A) 0.31
B) 0.91
C) 1.10
D) 3.24
12) A high TRIN value is considered

A) good for the market when the number of advancing stocks is declining.
B) good for the market when the volume of advancing stocks is declining.
C) bad for the market when the trading volume in the declining stocks is rising.
D) bad for the market when the number of declining stocks is stable.
13) The confidence index indicates a strong stock market when the
A) ratio of the average yield on high-grade corporate bonds to the average yield on low-grade
corporate bonds rises.
B) ratio between the average yield on S&P 500 stocks to the average yield on high-grade
corporate bonds rises.
C) consumer confidence index rises above its long-term trend.
D) demand for bonds declines relative to the demand for equity securities.
13
14) The confidence index indicates
A) stock investors ' perceptions of risk in the economy.
B) bond investors ' perceptions of risk in the economy.
C) consumers' perceptions of risk in the economy.
D) investors' trust in financial advisors.
15) Which one of the following combinations best signals a strong market?
I. a greater number of advancing stocks than declining stocks

II. a greater number of declining stocks than advancing stocks
III. a greater volume in rising stocks than in declining stocks
IV. a greater volume in declining stocks than in advancing stocks
A) I and III
B) I and IV
C) II and III
D) II and IV
16) The on balance volume (OBV) indicator

A) considers only the amount of daily trading volume.
B) indicates an up market when heavy volume accompanies price increases.
C) is divergent when the OBV is falling and prices are also falling.
D) rises by 10,000 on a day when the trading volume is 5,000 shares and the price rises by $2.
17) Which one of the following statements is correct concerning the mutual fund cash ratio
(MFCR)?
A) The lower the value of the MFCR, the stronger the market will be in the future.
B) The MFCR is equal to the cash inflows into money market funds divided by the cash flows
out of money market funds.
C) A low MFCR indicates that fund managers might be forced to sell securities should
investors wish to withdraw funds.
D) A MFCR greater than 12% is considered a bearish signal.
18) Which one of the following statements is correct concerning the mutual fund cash ratio
(MFCR)?
A) When mutual funds have a lot of cash it is a bearish signal because managers are not buying
stocks.
B) Low mutual fund cash is bullish because it means managers have been buying stocks.
C) High mutual fund cash indicates that fund managers might be forced to sell securities should
investors wish to withdraw funds, a bearish signal.
D) A high MFCR is like high short interest in that it indicates pent up demand.
19) The on balance volume (OBV) indicator

A) indicates a market bottom when prices and volume are both falling.
B) is optimistic when prices are rising on low volume.
C) is optimistic when prices are rising on high volume.
D) is neutral whenever prices and volume move in opposite directions.
14
20) Technical analysts consider the stock market to be strong when volume ________ in a
rising market and ________ during a declining market.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases
21) Which of the following is a contrary indicator?

A) odd-lot trading
B) breadth of market
C) the advance/decline line
D) the TRIN measure
22) Price and volume of shares traded of Salem Industries on four consecutive days are shown
below.
Monday Tuesday Wednesday Thursday

$27 $26 $28 $30
100,000 80,000 70,000 110,000
Compute Salem's on balance volume at the end of Thursday's trading. Assume last Friday's
closing price was $26.50.
A) 200,000
B) -40,000
C) 180,000
D) 360,000
23) Which of the following is used to identify long-term trends?

A) odd-lot trading
B) breadth of market and market volume
C) 10 moving average
D) 100 day moving average
24) Which of the following signals that a market top or bottom is near?
A) mutual fund cash ratio
B) the relative strength index
C) odd-lot volume
D) on balance volume
25) According to chartists, a breakout below a support level

A) is a sell signal.
B) is a signal that the market is stagnant.
C) is a buy signal but only for value investors.
D) is a buy signal.
26) On a given day, 200 of the S&P 500 stocks were up, 300 were down. Volume for up stocks
15
was 500 million, volume for down stocks was 700 million. The ARMS or TRIN for that day
was
A) 0.48.
B) 0.70.
C) 0.93.
D) 3.50.
27) What is the ten-day simple moving average if the latest daily closing prices are $5, $7, $8,
$5, $4, $6, $7, $8, $9, $10?
A) $6.00
B) $6.90
C) $7.67
D) $10.00
28) Which one of the following statements is correct concerning moving averages?
A) The longer the time period under consideration, the more sensitive the moving average is to
daily price fluctuations.
B) A simple moving average is computed as the arithmetic mode.
C) The shorter the time period under consideration, the easier it is to spot long-term price
trends.
D) A moving average helps remove short-term fluctuations from the analysis.
29) A sell signal is indicated by a security's price

A) rising above the moving average.
B) falling below the moving average.
C) equaling the moving average.
D) running parallel to the moving average.
30) Explain why technical analysts use charts so extensively.

Charts provide a visual picture of numerical data. This visual image allows analysts to see
trends and patterns that cannot be spotted simply by looking at the numbers.
Chapter 10 Fixed-Income Securities
10.1 Learning Goal 1
1) Bondholders can earn income both from interest and from capital gains.
TRUE
2) The primary reasons for owning bonds are the income they provide and also the stability
they bring to an investment portfolio.
TRUE
3) The bond market has occasionally outperformed the stock market for several years at a time.
TRUE
4) As investors approach retirement age, they should hold more bonds and less stock.
TRUE
5) Bondholders usually have capital gains when interest rates are rising. FALSE
16
6) Bond prices are stable over any five- to ten-year period.
FALSE
7) Bonds are typically a good investment choice for an individual who is seeking long-term
preservation of capital.
TRUE
8) Bonds are immune from most of the types of risk that affect stocks.
9) Which of the following are advantages of owning bonds?
I. diversification properties
II. higher long-term returns than equity holdings
III. current income
IV. lower risk than stocks
A) I and II only
10) When bonds are initially added to an all-equity portfolio the

A) level of risk of the portfolio is impacted more than the rate of return.
B) rate of return on the portfolio is impacted more than the level of risk.
C) level of risk and the rate of return are equally impacted.
D) rate of return is not impacted but the level of risk is lowered.
11) the phenomenon known as "flight to quality" causes yields on government bond and
corporate bonds
A) to rise in tandem.
B) to fall in tandem.
C) to move in opposite directions.
D) to become less volatile.
12) Which of the following types of risk affect bonds?
I. call risk
II. business risk
III. purchasing power risk
IV. liquidity risk
A) III and IV only

13) The bond market is considered bearish when

A) market interest rates are low or falling.
B) market interest rates are high or rising.
17
C) the risk-free rate of return exceeds the required rate of return.
D) more bonds are called than issued over a given period of time.
14) Under normal economic conditions, the major source of risk faced by investors who
purchase investment grade bonds is
C) liquidity risk.
D) default risk.
15) In a severe recession, the major source of risk faced by investors who purchase corporate
bonds is
C) liquidity risk.
D) default risk.
16) When interest rates are falling, most of the return on bonds will come from
A) inflation gains.
B) interest income.
C) capital gains.
D) risk premiums.
17) Which type of risk is based on the financial integrity of a bond issuer?
A) liquidity risk
B) call risk
C) default risk
D) interest rate risk
18) Bond investors will experience capital gains when

A) market interest rates are high and falling.
B) market interest rates are high and rising.
C) the required rate of return exceeds the risk-free rate of return.
D) more bonds are called than issued over a given period of time.
19) Discuss at least three differences between investing in stocks and investing in bonds.
1) A coupon rate of 6% means that the bond will pay $60 interest every 6 months if interest is
paid semi-annually. FALSE
2) The interest payment on a 6% coupon, semi-annual bond is $30 every 6 months.

TRUE
3) When a bond is called, the bondholder generally faces a rate of return that is lower than
expected. TRUE
18
4) The holder of a serial bond receives both semi-annual interest and principal payments over
the life of the bond.
FALSE
5) The risk premium component of a bond's market interest rate is related to the characteristics
of the particular bond and its issuer.
TRUE
6) Most bonds pay interest quarterly.
FALSE
7) Debt instruments with maturities of 2 to 10 years are known as notes.
TRUE
8) A bond which is noncallable for a period of time after which it is freely callable is called a
deferred call bond.
TRUE
9) As a bond approaches maturity, the call premium typically rises.
10) A single bond issue with multiple maturity dates is called a

A) callable bond.
B) premium bond.
C) serial bond.
D) term bond.
11) Subordinated debentures

A) have a lower claim on assets than simple debentures.
B) are secured by some physical asset.
C) are financial assets held in trust by a third party.
D) are the safest form of corporate bonds.
12) A note is generally defined as debt with an initial term to maturity of

A) zero to two years.
B) one year or less.
C) two to ten years.
D) ten to thirty years.
13) Under which bond provision is the issuer required to retire portions of the bond issue prior
to maturity?
A) call feature
B) refunding provision
C) subordination clause
D) sinking fund feature
14) Most bonds pay interest

A) annually.
B) semi-annually.
C) quarterly.
D) monthly.
15) A bond which has a deferred call

19
A) does not have to be redeemed when it reaches maturity.
B) can be retired at any time prior to maturity provided six months notice is given.
C) cannot be retired for a specific period of time after which it can be retired at any time.
D) can be retired at any time during the initial call period but after that time can not be
redeemed prior to maturity.
20
16) A bond's sinking fund provisions specifies
A) which assets are available to secure the bond.
B) how the issuer will pay off the bond over time.
C) which bond issues have a higher claim on the firm's assets in case the firm goes under.
D) a diminishing series of interest payments as the bond approaches maturity.
17) When a bond's rating improves from A to AA

A) the coupon rate will fall and the price will rise.
B) both the coupon rate and the price will rise.
C) both the coupon rate will stay the same and the price will fall.
D) the coupon rate will stay the same, but the price will rise.
18) Which of the following statements about bond rating agencies is true?
A) Bonds are rated by an agency of the federal government.
B) Bonds rated AAA are guaranteed by the company that issues the rating.
C) During the financial crisis of 2007-2009 it became clear that rating agencies severely
underestimated the risks of some issues.
D) Bond rating agencies are paid by investors and receive no compensation from the bonds'
issuer.
19) Lee is considering buying one of two newly-issued bonds. Bond A is a twenty-year, 7.5%
coupon bond that is non-callable. Bond B is a twenty-year, 8.25% bond that is callable after
two years. Both bonds are comparable in all other aspects. Lee plans on holding his bond to
maturity. What should Lee do if he feels that interest rates are going to decline by 2% in the
near future and then remain relatively stable thereafter?
A) purchase Bond A
B) purchase Bond B
C) purchase neither A nor B at this time
D) negotiate a higher rate on Bond A
20) Which of the following are true concerning bond ratings?
I. They have a greater impact on the price and yield of junk bonds than on investment grade
bonds.
II. They provide investors with a convenient way to assess the relative risk of various bond
issues.
III. They are provided by an independent government agency.
IV. They have a significant effect on a bond's price and yield.
A) I and II only
B) II and IV only
C) III only
21) Which one of the following is the most junior in terms of its claim on earnings and assets?
A) subordinated debenture
B) mortgage bond
21
C) collateral trust bond
D) equipment trust certificate
22) Bonds are least likely to be called if

A) they are selling at a substantial premium.
B) they are selling at a substantial discount.
C) the price is close to par value.
D) if they do not mature for at least 5 years.
23) Which of the following bond features is least desirable to investors ?

A) serial maturity dates
B) a nonrefundable provision
C) a call provision
D) sinking fund
24) Bonds with one of the top four ratings (Aaa through Baa, or AAA through BBB) are
designated as
A) split bonds.
B) investment grade bonds.
C) illiquid bonds.
D) high-yield bonds.
25) When the economy is moving toward a recession, the yield on riskier bonds will tend to
A) rise.
B) fall.
C) stagnate.
D) become volatile.
26) If a bond rating moves from a BB to a BBB rating

A) the bond will still be classified as junk.
B) it must also move from a Ba to a Baa rating.
C) the market yield on the bond will rise.
D) the market price of the bond will rise.
27) Which of the following factors are included in the rating analysis of a corporate bond?
I. the issue's indenture provisions

II. the liquidity position of the issuing company
III. the issuing company's relative debt burden
IV. the stability of the company's earnings
A) I and II only
22
28) Bond ratings are an important element of the bond market. Explain what bond ratings are,
who issues the ratings, and what the ratings mean to the average investor.
Bond ratings are letter grades that designate a bond's investment quality. They are issued by
agencies such as Moody's, Standard & Poor's, Fitch Investor Services and Duff & Phelps. Bond
analysts study each bond issue for factors such as the bond's provisions and the issuing
company's financial stability and then issue the rating. "A" ratings are highest, then "B" ratings,
followed by "C" ratings for bonds that are at or near default and finally "D" ratings for bonds that
are in default. For investors, ratings measure an issue's default risk. Other things being equal, the
higher the rating, the higher the bond price and the lower the yield.
29) Every bond is issued with a call feature. Explain what it means for a bond to be "called,"
then briefly describe the three most common types of call features. Also explain why investors
suffer when bonds are called.
If a bond is called, it is retired before its maturity date.
The 3 types of call features are
1. freely callable (the bond can be retired at any time)
2. noncallable (the bond cannot be called)
3. deferred call (can be called, but only after a certain specified period).
Investors suffer because high-yielding bonds are called and replaced with low-yielding bonds.
Thus the investor is left with a lower rate of return than anticipated.
1) When interest rates change, the prices of short-term bonds will change more than those of
long-term bonds.
FALSE
2) Interest rates and bond prices are positively related.
FALSE
3) An increase in the market rate of interest can cause a bondholder to realize a capital loss on
the sale of their bonds.
TRUE
4) When the market rate of interest drops below a bond's coupon rate, the bond will sell at a
premium.
5) Issuers must redeem outstanding bonds for at least their par value.
FALSE
6) If you want to reduce the price volatility of your bond portfolio, you should shorten the time-
to-maturity of your portfolio.
TRUE
7) If you feel interest rates are going to drop significantly, you could potentially realize large
capital gains by purchasing long-term zero coupon bonds prior to the rates decreasing.
TRUE
8) Junk bond prices are more sensitive to ratings changes than investment grade bonds.
9) Which one of the following variables has the greatest effect on bond prices?
A) economic growth
B) interest rates
C) inflation
D) stock market returns
23
10) An increase in the market rate of return on an outstanding bond will
A) increase the coupon rate.
B) decrease the coupon rate.
C) increase the bond price.
D) decrease the bond price.
11) The Franklin Company issued a 6% bond three years ago at par value. The market interest
rate on comparable bonds today is 5%. The Franklin Company bond currently pays ________ a
year in interest and the bond sells at a ________.
A) $60; discount
B) $60; premium
C) $50; discount
D) $50; premium
12) Solstice Corporation issued a 3% bond four years ago at par value. The market interest rate
on comparable bonds today is 4%.
A) This bond sells at a discount and the coupon rate is higher than the yield.
B) This bond sells at a premium and the coupon rate is lower than the yield.
C) This bond sells at a discount and the coupon rate is lower than the yield.
D) This bond sells at a premium and the coupon rate is higher than the yield.
13) Two years ago, Mathew purchased a 10 year government bond with a yield of 4.75%.
Today, the interest rate on government bonds with 8 years to maturity is 3.5%. If Mathew sells
his bond today, he most likely will
A) realize a capital gain.
B) realize a capital loss.
C) sell the bond at face value.
D) sell the bond at par value.
14) At the time you purchase a bond, you know the exact holding period return you will earn if
A) the bond is called at any time prior to maturity.
B) you resell the bond in exactly one year from the date of purchase.
C) the market rate of interest declines within the next year.
D) you hold the bond to maturity.
15) When the market rate of return exceeds the coupon rate, a bond will sell at
A) par.
B) face value.
C) a premium.
D) a discount.
16) Which one of the following combination of features causes bond prices to be the most
volatile?
A) low coupon, short maturity
B) high coupon, short maturity
C) low coupon, long maturity
24
D) high coupon, long maturity
17) Bob expects to retire in a few years and his primary goal is to avoid major losses in his 401-
K account. Which of the following bond characteristics should he be seeking?
I. long maturities
II. high ratings
III high yields
IV. short maturities
A) I and III only

B) I, III and III only
C) II and IV only
18) If you expect market interest rates to rise, you should purchase
A) short term, low coupon bonds.
B) short term, high coupon bonds.
C) long term, low coupon bonds.
D) long term, high coupon bonds.
19) A bond quoted at a price of 101.2

A) is a deep discount bond.
B) yields 10.12%.
C) yields 12%.
D) has a coupon rate that exceeds the market rate.
20) As bonds approach their maturity dates

A) premiums or discounts will increase.
B) the risk of a call will increase.
C) the bonds prices will become more sensitive to changes in interest rates.
D) prices will approach their par values.
1) A debenture is secured only by the issuer's promise to repay the debt.

TRUE
2) The par value of a Treasury inflation-indexed obligation is established as $1,000 over the life
of the bond.
FALSE
3) In an inflationary environment, the interest payments on Treasury inflation-indexed
obligations increase over time.
TRUE
4) If the inflation rate is 2%, the principal of a Treasury inflation protection security will from
$1,000 to $1,020.
TRUE
5) If you hold a zero-coupon bond to maturity, the fully compounded rate of return is virtually
25
guaranteed to be equal to the rate stated at the time the bond was purchased.
TRUE
6) Zero coupon bonds have very limited price volatility.
FALSE
7) Municipal bonds are most attractive to residents of states with high income tax rates.
TRUE
8) Mortgage-backed bonds are issued primarily by state governments and are secured by home
mortgages.
FALSE
9) Securitization is the process of creating marketable securities from various types of loans.
10) Collateralized mortgage obligations are relatively low risk investments. FALSE
11) Junk bond appeal to some investors because of higher yields and potentially higher capital
gains than those offered by investment grade bonds.
TRUE
12) The various CMO tranches can have significantly different degrees of prepayment risk.
TRUE
13) CMO tranches are structured to create long, intermediate and short-term securities.
TRUE
14) Which one of the following statements concerning Treasury bonds is correct?
A) The par values of all Treasury bonds are adjusted periodically in response to changes in the
rate of inflation.
B) Treasury bonds have maturity dates ranging from two to ten years.
C) Interest earned on Treasury bonds is tax-exempt at the federal level.
D) All Treasury securities are backed by the "full faith and credit" of the U.S. government.
15) Which of the following statements about U.S. Agency bonds are true?
I. They are backed by the "full faith and credit" of the U.S. government.
II. Their risk is almost as low as government notes and bonds.
III. Their yields are slightly higher than those of government securities.
IV. They are exempt from state and federal taxes.
C) II and III only
D) I and IV only
16) Debt securities issued by the Federal Home Loan Bank, the Student Loan Marketing
Association and the Government National Mortgage Association are known as
A) agency bonds.
B) organizational bonds.
C) municipal bonds.
D) Treasury bonds.
17) Which of the following statements concerning mortgage backed securities are correct?
26
I. They are secured by a pool of residential mortgages.
II. A portion of the income stream is a non-taxable return of capital.
III. They are backed by the full faith and credit of the U.S. government.
IV. Their maturity depends on prepayments of the mortgages in the pool.
A) I and III only

B) I and IV only
18) Municipal bonds can be either general obligation bonds or revenue bonds. Of these two
types of municipal bonds, only general obligation bonds
A) are specifically serviced by the income generated from particular projects.
B) are backed by the full faith and credit of the issuer.
C) repay the principal only if a sufficient level of revenue is generated.
D) have the principal and interest guaranteed by a third party.
19) Which of the following statements are correct concerning municipal bonds?
I. Yields on municipal bonds are usually lower than yields on Treasury bonds.
II. Municipal bonds are most appealing to individuals with high incomes.
III. Interest on a municipal bond is exempt from federal income tax.
IV. Municipal bonds are less risky than Treasury bonds.
A) I, II, III and IV

D) II and III only
20) Kayla is in the 28% federal income tax bracket and the 5% state income tax bracket. If she
purchases a municipal bond yielding 4.25%, what is the equivalent yield on a taxable bond if
the municipal bond income is exempt from both federal and state taxes?
A) 4.47%
B) 5.90%
C) 6.34%
D) 6.21%
21) What is the tax-equivalent yield of a double tax-free 4% municipal bond if the investor is in
the 33% federal and 6% state tax brackets?
A) 6.35%
B) 5.97%
C) 6.56%
D) 4.26%
22) Which one of the following statements concerning the tax treatment of municipal bonds is
correct?
27
A) The interest income on municipal bonds is subject to federal income tax.
B) The capital gain realized on the sale of a municipal bond is tax-free income.
C) Interest income on a municipal bond is usually exempt from state and local income taxes if
the bond is issued by the state or locality in which the investor resides.
D) Municipal bonds receive no special income tax treatment.
23) Martin is trying to decide which one of the following bonds he should purchase. All the
bonds have the same maturity date and all have approximately the same level of risk. The
general level of interest rates is declining. Martin is in the 33 percent federal income tax bracket
and the 6 percent state income tax bracket. The municipal bonds are from his home state.
Which bond should Martin purchase if he wishes to hold it for the long term?
A) bond A because it has the highest yield and is unlikely to be called when rates are declining
B) bond B because it has the highest after tax yield and is unlikely to be called when rates are
declining
C) bond C because bond D is likely to be called
D) bond D because it has the highest after tax yield and is unlikely to be called when rates are
declining
24) The denomination of most corporate bonds is ________ and the maturities generally range
from ________.
A) $1,000; 5 to 10 years
B) $1,000; 20 to 30 years
C) $100,000; 5 to 10 years
D) $100,000; 25 to 40 years
25) Which of the following statements concerning equipment trust certificates are correct?
I. Equipment trust certificates are typically used to raise funds for purchasing airplanes and
railroad engines.
II. Equipment trust certificates are usually issued with a single maturity date.
III. Equipment trust certificates normally mature in 20 to 30 years.
IV. Equipment trust certificates generally offer above-average yields.
A) I and IV only
B) II and IV only
C) I and III only
26) Which one of the following statements correctly describes the unique feature of GNMA
pass-through securities?
A) The interest income on a GNMA is exempt from state and federal tax.
28
B) GNMAs consistently have lives of 25-30 years.
C) GNMAs are backed by the full faith and credit of the issuing state.
D) GNMAs pay income to holders on a monthly basis.
27) Which one of the following statements correctly describes the major drawback of a zero-
coupon bond?
A) Unless the bond is held in a tax-sheltered account, the investor must pay taxes on the annual
accrued interest even though no interest is actually received.
B) The conversion feature found on most zero-coupon bonds generally requires the investor to
switch to a coupon-bearing bond after a period of 5 years.
C) The lack of an annual coupon basically prohibits the investor from locking in a high rate of
return.
D) Because there is no reinvestment of a coupon payment, large capital losses accrue when
interest rates decline.
28) Which of the following characteristics apply to collateralized mortgage obligations?
I. All bondholders receive a pro-rata share of all interest payments.

II. CMOs are derivative securities created from mortgage-backed bonds.
III. All principal payments are paid to the shortest remaining tranche.
IV. CMOs have definite maturity dates for each tranche.
A) I and II only
B) I and III only
29) The practice of bundling mortgages or other types of loans into pools and selling pieces of
the pool as bond-like instruments to investors is known as
A) securitization.
B) privatization.
C) collateralization.
D) fractionalization.
30) Asset backed securities (ABS)are relatively safe investments because

A) they are collateralized only with the highest quality loans.
B) because the debt pools are highly diversified.
C) because the pool of assets backing the securities is often much larger than the bond issue.
D) because the loans in the pool are collateralized with valuable assets such as cars and trucks.
31) Pass-through securities backed by pools of auto loans, credit card bills, and computer leases
are known as
A) PIK bonds.
B) REIMCs.
C) ABSs.
D) Fannie Maes.
29
32) Securitization is the practice of
A) bundling loans into large pools and dividing them into bond-like securities.
B) selling government debt in the private sector.
C) increasing the safety of asset backed securities by insuring them.
D) protecting the privacy of borrowers whose loans have been sold to a third party.
33) The first tranche of a collateralized mortgage obligation has

A) the greatest default risk and the least prepayment risk.
B) the greatest prepayment risk and default risk.
C) the greatest prepayment risk and the least default risk.
D) the least prepayment risk and default risk.
34) Which of the following statements are correct in respect to high-yield bonds?
I. They are junk bonds with highly unpredictable rates of return.

II. The issuing corporation usually has an excessive amount of debt.
III. They possess a high level of default and market risk.
IV. They are often subordinated debentures.

C) I and III only
35) PIK-bonds
A) are relatively safe investments.
B) initially pay interest payments in the form of additional debt.
C) are collateralized by home mortgages.
D) pay monthly interest payments.
36) Describe some of the relatively new investment instruments derived from securitized debt.
1) The biggest risk with foreign pay bonds issued by the German government is the risk of
default.
FALSE
2) Foreign companies sometimes issue bonds which pay interest and principal in U. S. dollars.
TRUE
3) After the U. S. dollar, bonds denominated in euros are the largest segment of the global bond
market.
FALSE
4) Yankee bonds are issued by the U.S. government, but sold only to foreign investors.
FALSE
5) An American investor who holds euro-denominated bonds will profit if the euro weakens
against the dollar.
FALSE
6) One type of foreign bond that carries no currency exchange rate risk for a U.S. investor is a
30
A) Eurodollar bond.
B) foreign-pay bond.
C) PIK bond.
D) Yankee bond.
7) Which one of the following statements concerning a global view of the bond market is
correct?
A) The United States today accounts for about seventy-five percent of the available fixed-
income securities worldwide.
B) U.S. pay bonds distribute both interest and principal payments in euros.
C) Foreign bonds, like junk bonds, have high default risk.
D) Exchange rate fluctuations influence the returns earned on foreign-pay bond holdings.
8) A type of bond that is issued and traded outside the United States and which is denominated
in U.S. dollars but is not registered with the SEC is
A) a Yankee bond.
B) an issue of the World Bank.
C) an issue of the InterAmerican Bank.
D) a Eurodollar bond.
9) Annika bought euro denominated bonds when the exchange rate was .909 euro to the dollar.
She paid $11,881 for the bonds. At the end of the year, the bonds were worth 10,600 euro; she
received 400 euro in interest and the exchange rate was .921 euro to the dollar. What was her
holding period return in U.S. dollars?
A) -0.74%
B) 1.85%
C) 0.53%
D) 5.30%
10) Eurodollar bonds are

A) purchased with dollars but redeemed in euros.
B) purchased with euros but redeemed in dollars.
C) purchased with dollars, but redeemable in either euros or dollars.
D) purchased and redeemed in dollars but issued by entities outside the U.S.
11) In general, foreign-pay bonds provide ________ rates of return and ________
diversification effects for U.S. investors.
A) non-competitive; positive
B) competitive; positive
C) non-competitive; negative
D) competitive; negative
12) From the viewpoint of a U.S. resident, describe the merits of investing in foreign bonds.
1) When the call price of a convertible bond stock exceeds the conversion value of the bond,
31
the issuing company is likely to force conversion by calling the bonds.
FALSE
2) The coupon rate on convertible bonds is usually higher than the coupon rate on equivalent
bonds that are not convertible.
FALSE
3) The conversion ratio denotes the number of shares for which a convertible bond can be
exchanged.
TRUE
4) Convertible bonds will retain their value as bonds even if stock prices are falling.
TRUE
5) LYON's or liquid yield option notes are a type of convertible security. TRUE
6) When convertible bonds are first issued
I. the conversion price of the stock is higher than the market price.
II. the market price of the stock is higher than the conversion price.
III. the coupon rate is higher than if the bond were not convertible.
IV. the coupon rate is lower than if the bond were not convertible.
A) I and III only

B) II and IV only
C) I and IV only
D) II and III only
7) Which of the following is most likely to happen with a convertible bond when the market
price of the stock exceeds the conversion price? The stock does not pay a dividend.
A) The bondholders will immediately convert their bonds to stock.
B) The issuing company will call the bonds and the bondholders will redeem them for the call
price.
C) The issuing company will call the bonds and bondholders will convert them to common
shares.
D) Both the issuing company and the bondholders will wait for the bonds to reach their
maturity date.
8) Bonhomme Co. issued $1,000 par value bonds with a 6% coupon rate, convertible into 25
share of Bonhomme common stock. When the bonds were issued the stock traded at $25 per
share. The stock is now at $42 per share and pays a $0.10 per share annual dividend. In the
near future
A) the bondholders will voluntarily convert their bonds to stock.
B) The issuing company will call the bonds and the bondholders will redeem them for the call
price (par).
C) The issuing company will call the bonds and bondholders will convert them to common
shares.
D) Both the issuing company and the bondholders will wait for the bonds to reach their
maturity date.
9) Liquid yield option notes or LYONS have which of the following characteristics?
32
I. convertibility at a fixed conversion ratio
II. high coupon rates
III. a put feature that guarantees the right to redeem the bonds at a prespecified price
IV. convertibility at a fixed conversion price
A) I and III only

B) II and IV only
C) I and IV only
D) II and III only
10) Which of the following is a good reason to invest in convertible bonds?

A) They often have higher than normal coupon rates.
B) They offer protection against rising interest rates.
C) They tend to be issued by stable, low-risk companies.
D) They offer predictable income and a chance to profit from an increase in the stock price.
11) The major attraction of convertible bonds is

A) the option to convert subordinated debentures into senior securities.
B) the option to convert the bond into shares of the company's stock.
C) the option to convert the bonds into longer term securities when they mature.
D) the absence of a call provision allows the value of the bonds to increase at the same rate as
the company's stock while the owner still collects interest.
12) Kandy Korn Co. issued convertible bonds with a conversion ratio of 50. The most likely
price of the stock at the time the bonds were issued was
A) $50.
B) $25.
C) $20.
D) $15.
13) What are the major factors that affect the price of convertible bonds?
When the stock's market price is at or above its conversion price, the value of a convertible is
driven by the price behavior of the underlying common stock. When the stock's price is well
below the conversion price, convertibles behave more like conventional bonds and the price is
driven by market interest rates.
33

Chapter 1 The Investment Environment: Fundamentals of Investing, 13e, Global Edition (Smart)

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Chapter 1 The Investment Environment: Fundamentals of Investing, 13e, Global Edition (Smart)

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Fundamentals of Investing, 13e, Global Edition (Smart)

Chapter 1 The Investment Environment

1.1 Learning Goal 1

1) A non-interest bearing checking account is still considered an investment. FALSE

2) Land and buildings are examples of real property investments. TRUE

6) Which of the following is NOT an investment as defined in the text?

7) Stocks are a(n) ________ investment representing ________ of a business.

9) Which of the following has declined in recent years?

10) Debt represents funds loaned in exchange for

3) Banks and insurance companies are examples of institutional investors. TRUE

4) In the financial markets, individuals are net demanders of funds. TRUE

5) The government is generally

6) On a net basis, funds in the financial markets are generally supplied by

8) Which of the following are true concerning institutional investors?

9) Which of the following is NOT traded in the securities markets?

1.3 Learning Goal 3

2) A collection of securities designed to meet an investment goal is called a portfolio. TRUE

4) An option to purchase common stock is a type of derivative security. TRUE

7) Mutual funds invest in diversified portfolios of securities. TRUE

8) Bond prices rise as interest rates decline. TRUE

10) Which of the following is an example of a tangible asset?

1.4 Learning Goal 4

I. saving for major expenditures such as a house or education

12) A well-conceived investment policy statement will specify

13) Beginning investors with small amounts to invest should

22) Tax planning

1.5 Learning Goal 5

1) U.S. Treasury Bills mature in 1 year or less. TRUE

5) The primary risk associated with a short-term investment is

1.6 Learning Goal 6

1) Certified Financial Planners typically manage institutional portfolios. FALSE

5) Chartered Financial Analyst (CFA) is a degree offered by several prestigious business

6) Typical responsibilities of financial professionals in a corporate setting include

I. managing cash and short-term investments.

8) A major function of investment banking firms is

2.1 Learning Goal 1

4) Short-term securities are bought and sold in the

5) The governmental agency that oversees the capital markets is the

6) Stocks purchased in the secondary market are purchased

7) Stocks and bonds are traded in

2.2 Learning Goal 2

2) The preliminary version of a prospectus is called a red herring. TRUE

5) IPOs are relatively safe investments. FALSE

8) A rights offering is the

9) IPO activity tends to peak when stock prices

12) The financial crisis of 2008 resulted in

2.3 Learning Goal 3

1) The NYSE and AMEX are examples of dealer markets. FALSE

6) Most commodity futures are traded on the NYSE Amex. FALSE

9) The income paid to a market maker is referred to as the spread. TRUE

13) The majority of bonds trade in the OTC market. TRUE

14) Market makers in dealer markets

17) The great majority of transactions on the NYSE are executed

20) Large technology companies such as IBM and Microsoft trade

23) Exchange traded funds are

24) The dominant options exchange is the

27) Options contracts on stocks may

29) The over-the-counter (OTC) market is a

30) ECNs are

33) Which of the following are associated with bear markets?

A) I and III only

2.4 Learning Goal 4

1) Diversification is the inclusion of a number of different investments in a portfolio with the

7) Stocks are a(n) investment representing of a business.