Chapter 2 - Investment Alternatives
Chapter 2 - Investment Alternatives
Chapter 2 - Investment Alternatives
2. Which of the following is not one of the characteristics of the primary nonmarketable
financial assets owned by most individuals?
A) high liquidity
B) high return
C) often issued by the U.S. government
D) low risk
Ans: B
4. Series EE bonds must be held at least ______ years in order to receive the guaranteed
minimum rate.
A) 3
B) 5
C) 8
D) 10
Ans: B
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6. Which of the U.S. Treasury securities is always sold at a discount?
A) Treasury bills
B) Treasury notes
C) Treasury bonds
D) All of the Treasury securities are sold at a discount.
Ans: A
7. Which of the following statements regarding money market instruments is not true?
A) They tend to be highly marketable.
B) They tend to require a small dollar investment.
C) They tend to have a low probability of default.
D) Their rates tend to move together.
Ans: B
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11. Each point on a bond quote represents:
A) $100
B) 1 percent of $100
C) 1 percent of $1000
D) $1000
Ans: C
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16. Which of the following statements is true regarding an investment in mortgage-backed
securities?
A) There is little default risk.
B) The stated maturity is generally 10 years.
C) They receive a fixed payment per month.
D) All of the above are true.
Ans: A
17. A municipal bond issue that was sold to finance a toll bridge would most likely be a:
A) general obligation bond.
B) revenue bond.
C) special assessment bond.
D) zero-coupon bond.
Ans: B
18. What is the major difference between municipal bonds and other types of bonds?
A) Municipal bonds are always insured; other bonds are not.
B) Unlike other bonds, municipal bonds sell at a discount.
C) Municipal bond interest is tax-exempt; interest on other bonds is not.
D) There is no brokerage commission on municipal bonds unlike other bonds.
Ans: C
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21. Treasury bonds generally have maturities of:
A) 5 to 15 years
B) 5 to 30 years
C) 10 to 20 years
D) 10 to 30 years
Ans: D
22. Which of the following types of municipal bonds is generally considered the riskiest?
A) General obligation bonds
B) Revenue bonds
C) Serial bonds
D) Term bonds
Ans: B
24. The first four categories of bond ratings are known as _______.
A) risk-free securities.
B) high-yield securities.
C) investment grade securities.
D) top drawer securities.
Ans: D
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26. If an investor states that Intel is overvalued at 65 times, he is referring to:
A) earnings per share.
B) dividend yield.
C) book value.
D) P/E ratio.
Ans: D
30. Which of the following statements is true regarding asset-backed securities (ASB)?
A) They offer relatively high yields.
B) They have relatively long maturities.
C) They generally have low credit ratings.
D) All of the above are true.
Ans: A
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31. What is the biggest difference between an option and a futures contract?
A) Options are traded on exchanges while futures are not.
B) Options give investors a way to manage portfolio risk while futures do not.
C) Options can be used by speculators to profit from price fluctuations while futures
cannot.
D) Options is the right to buy or sell while a futures contract is an obligation to buy
or sell.
Ans: D
33. Which of the following is not one of the factors that influence the value of an option?
A) the current premium
B) current interest rates
C) volatility of the stock
D) time remaining to maturity
Ans: A
34. Direct investing involves trades made by directly purchasing shares of a financial
intermediary.
A) True
B) False
Ans: B
36. Nonmarketable investments would include savings accounts at banks and Treasury bills.
A) True
B) False
Ans: B
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37. Marketable securities all fall into the category of capital market securities.
A) True
B) False
Ans: B
40. The money market security most often used a benchmark for the risk-free rate is money
market deposit account rate.
A) True
B) False
Ans: B
41. The rate spreads between the different money market securities of the same term tend to
be quite large.
A) True
B) False
Ans: B
42. Treasury notes represent the nontraded debt of the U.S. government.
A) True
B) False
Ans: B
43. The capital market includes both fixed-income and equity securities.
A) True
B) False
Ans: A
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44. Term bonds have a single maturity.
A) True
B) False
Ans: A
45. The return on a zero-coupon bond is derived from the difference between the price paid
and par value.
A) True
B) False
Ans: A
46. The deeper the discount on a zero-coupon bond, the lower the effective return.
A) True
B) False
Ans: B
47. If a bond has a coupon greater than the current market yield, it is selling at a premium.
A) True
B) False
Ans: A
48. Callable bonds attract investors because they can be redeemed early.
A) True
B) False
Ans: B
49. TIPS adjust for inflation by adjusting the rate of interest paid on the bond.
A) True
B) False
Ans: B
50. The major attraction of municipal bonds is their extremely low risk.
A) True
B) False
Ans: B
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51. Investors in high tax brackets would be unlikely to invest in municipal bonds.
A) True
B) False
Ans: B
52. In the case of a corporate bankruptcy, bondholders are paid before any distributions are
paid to preferred or common stockholders.
A) True
B) False
Ans: A
53. Bond ratings are primarily used to assess interest rate risk.
A) True
B) False
Ans: B
56. The par value on common stock sets the value that stockholders will receive in case of
bankruptcy.
A) True
B) False
Ans: B
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58. Most futures contracts are not exercised.
A) True
B) False
Ans: A
60. Compare the cash flows an investor expects from coupon bonds, zero-coupon bonds,
and preferred stock.
Ans: Coupon bonds – annuity of interest payments plus lump sum of principal at
maturity.
Zero-coupon bonds – principal at maturity.
Preferred stock – annuity ad infinitum (perpetuity)
61. How is the earnings retention rate related to the dividend payout rate?
Ans: Earnings retention rate = 1 - dividend payout rate
63. How is the total book value of equity affected by stock splits
Ans: Stock splits do not affect total value of equity or the individual accounts, other
than the number of shares outstanding and the par value.
64. In what sense is a stock selling for 12 times earnings “cheaper” than a stock with a P/E
ratio of 20?
Ans: In that investors are willing to pay only 12 times above earnings for one stock but
are willing to pay the higher “price” of 20 times above earnings for the other.
65. What are two direct and one indirect method for individuals to invest in foreign stocks?
Ans: Buy securities directly through exchanges or as American depository receipts and
indirectly through mutual funds.
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66. Explain how writing option contracts (both puts and calls) can generate income for
owners of the underlying stock.
Ans: The writer keeps the option premium regardless of whether or not the option is
exercised.
67. Rank (lowest to highest) the following securities in terms of the risk-expected return
tradeoff from the investors' viewpoint: common stock, corporate bonds, U. S. Treasury
bonds, options, preferred stock..
Ans: U. S. Treasury bonds, corporate bonds, preferred stock, common stock, options
69. Do the stock options markets help stabilize or destabilize the stock markets? Explain.
Ans: Options should be a stabilizing force if options are used to hedge stock positions.
Options might be destabilizing if used for speculation.
70. How do asset-backed securities improve the flow of funds from savers to borrowers?
Ans: Asset-backed securities can be sold to a broader market of investors than the
underlying securities.
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71. What stated coupon rate would a taxable corporate bond have to have to be comparable
to a municipal bond with a coupon rate of 7 percent if the investor is in the 28 percent
tax bracket?
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72. A corporate investor in a 34 percent marginal income tax bracket can buy bonds issued
by a petroleum exploration company yielding 10.606 percent. The investor should be
willing to buy tax-exempt municipal bonds of similar quality yielding what percent or
higher?
Ans: 10.606(1 - .34) = 7.00 percent
73. The par value of Blaze, Inc. common stock is $0.50, the earnings per share is $4, the
market price is $60, the dividend per share is $1. Calculate the dividend yield.
Ans: Dividend yield = $1/$60 = 0.0167 = 1.67%
74. The par value of Blaze, Inc. common stock is $0.50, the earnings per share is $4, the
market price is $60, the dividend per share is $1. Calculate the payout ratio.
Ans: Payout rate = $1/$4 = 0.25 = 25%
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