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Risks in business

1-MULTIPLE CHOICE
1-Risk is
A: Variability in expected return
B: The potential for loss
C: The possibility returns may be positive, zero, or negative
D: Uncertainty of a future outcome
E: All of the above are acceptable definitions

2- Strategies to help manage investment risk include:
A: Asset allocation
B: Professional management
C: Diversification
D: All of the above are potential strategies to reduce investment risk
E: None of the above will have any impact on investment risk

3- Changes in financial risk affects a company’s
A: Stock price
B: Availability of credit lines
C: Cost to borrow
D: All of the above are affect by changes in financial risk
E: B and C are affected, but A is not

4- If interest rates increase, prices of previously issued bonds will
A: Decrease
B: Increase
C: Bond prices are not affected by changes in interest rates

5- The standard deviation:
A: Is always positive or zero
B: Is the square-root of the covariance
C: Is a measure of the total risk of the asset
D: All of the above are true
E: A and C are true, but B is false

6- The degree to which two variables move in a systematic or predictable way is the
A: Beta
B: Covariance
C: Variance
D: Skewness
E: R-Square

7- Two securities that are perfectly positively correlated
A: Are considered to be independent securities
B: Have a correlation of 0
C: Provide no diversification benefits
D: Have a negative covariance
E: Are a benefit to the portfolio

8- Investing overseas induces all of the following potential risks EXCEPT:
A: Political risk
B: Currency risk
C: Agency risk
D: Foreign taxation risk
E: Liquidity risk

9- U.S. investors in U.S. Treasury securities need to be most concerned about which of the following risk factors:
A: Liquidity risk
B: Event risk
C: Currency risk
D: Inflation risk
E: Default risk

10- The best guess of the anticipated return for some future period is the
A: Actual return
B: Expected return
C: Realized return
D: Unexpected return
E: None of the above

11- A probability distribution
A: Consists of all possible outcomes and the probability of each outcome occurring
B: May have an infinite number of possible outcomes
C: Must have probabilities that sum to 1.0
D: All of the above are true
E: A and C are true, but B is false

12- Standard deviation
A: Measures return
B: Is the same as skewness
C: Measures the average amount values differ from the mean
D: Measures the relationship between observations
E: All of the above are true

13- Betty has saved $60,000 for a down payment on a home. She is now actively looking for her dream house and anticipates making an offer on a home within the next two months. If the offer is accepted, it will take up to three additional months to close on the house. Betty will need to deposit about $1,000 in an escrow account as “good faith” money when she makes the offer. The rest of the down payment is made at closing. The best place for Betty to deposit her funds now is
A: the stock market.
B: a municipal bond.
C: a six-month certificate of deposit (CD).
D: $1,000 in a two month certificate of deposit (CD) and the remainder
in a six-month CD.
E: a money market mutual fund.
14- Bonds A, B and C are all zero-coupon bonds. Bond A matures in 3 years; Bond B matures in 7 years, and Bond C matures in 10 years. Paul is uncertain as to the direction of interest rates over the next several years, so he wants to lock-in his return over his 7 year time horizon. Which bond is best for Paul?
A: Bond A because it matures in 3 years, and Paul can then roll-over the funds to a 4 year bond.
B: Bond B because it matches Paul’s time horizon.
C: Bond C because it has a longer maturity, it will probably have a higher yield.
D: Since these are zero-coupon bonds, it does not matter which bond Paul
chooses.
E: Bonds are too risky for Paul to be investing.
15- A firm has $10 million to invest in safe securities. The time horizon is five years, and interest rates are anticipated to decrease over this period. The best investment for this firm is
A: Six-month CDs
B: Nonparticipating GICs
C: Treasury bills
D: Participating GICs
E: Two-year corporate bonds

16- Luke is 35 years old, has a good job, a wife and two small children, and is financially conservative. He has heard about the large returns that may be achieved by investing in the oil and gas field. Luke is interested, but he has no expertise to provide day-to-day management. Which of the following investments would be best for Luke?
A: direct investment through a working interest
B: general partner
C: limited partner
D: all of these options would be a reasonable investment for Frank
E: either B or C (partnership) would be a reasonable investment for Frank, but a direct investment (A) is not reasonable

17- Round lots are
A: 10 shares
B: 100 shares
C: 1,000 shares
D: 10,000 shares
E: 100,000 shares
18- Factors that should be considered in taking a stock option position include:
A: The dividend paid on the underlying stock
B: The volatility of the underlying stock
C: The time to expiration
D: The anticipated direction of market movement
E: All of the above are relevant factors in the option decision

19- Advantages of investing in tax-exempt bond funds include all of the following EXCEPT:
A: Diversification
B: Provides additional benefits to tax-deferred retirement plans
C: Automatic reinvesting
D: Fund maintains individual investor’s tax reports and records
E: Low initial deposit

20- Zack needs a $100,000 loan to start his new business. Due to his age and inexperience, he is unable to obtain a bank loan. Possible alternatives to raise the funds include all of the following EXCEPT
A: promissory note from his mother.
B: having his mother co-sign a bank loan.
C: selling personal assets.
D: issuing debt in the market.
E: all of the above are possible sources of funds for Zack.

21- A portfolio of Treasury bonds with coupon payment dates of February 15 and August 15 that matures in 10 years may be stripped into how many zero-coupon bonds?
A: 0 since Treasury securities and not eligible for stripping
B: 1
C: 10
D: 11
E: 21

22- XYZ Corporation has a cumulative preferred stock that pays $1 per share per quarter. The firm did not declare a dividend the last two quarters. To be able to pay dividends to common shareholders, the preferred stock dividend this coming quarter must be
A: XYZ does not need to pay preferred stock dividends to be able to pay common stock dividends
B: $1
C: $2
D: $3
E: $4

23- Preferred stock with cumulative fixed dividends
A: Are required to pay dividends each quarter
B: Must pay the missed dividend before common shareholders can receive dividends
C: Are taxed on the accumulated dividends
D: Are considered to be bankrupted if one year of dividends is missed
E: All of the above are true

24- Diane has $85,000 to invest. She wants to invest in relatively safe securities. Diane believes interest rates will decrease and stabilize at a lower level over the next 5-10 years. She should invest in
A: Treasury bills
B: Long-term Treasury notes or bonds
C: Equity
D: B-rated corporate bonds
E: Commercial paper

25- 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.

26- 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.

27- Which of the following is an example of a tangible asset.
A) Bonds
B) mutual funds
C) real estate
D) stocks

28- 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.

29- 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.

30- 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.
MULTIPLE CHOICE (part b-problem solution)- Answer any 12 of the following- 36 points (3 points each)
You must show the steps/explanation to arrive at the correct answer- If you ONLY circle the correct answer, you will get 1 point instead of 3points

1- Jason is in the 28% Federal income tax bracket and 7% New York state income tax. He has invested in New York State bonds that yields a 6% return. The taxable equivalent yield on this bond is
A: 6.45%
B: 7.32%
C: 8.54%
D: 9.23%
E: 10.61%

2- Angie deposits $250 in an account that earns 12% per year. If no other deposits or withdrawals are made, how much will Angie have in her account at the end of 15 years?
A: $ 280
B: $ 700
C: $1,368
D: $3,450
E: $4,200

3- XYZ Corporation has a cumulative preferred stock that pays $1 per share per quarter. The firm did not declare a dividend the last two quarters. To be able to pay dividends to common shareholders, the preferred stock dividend this coming quarter must be
A: XYZ does not need to pay preferred stock dividends to be able to pay common stock dividends
B: $1
C: $2
D: $3
E: $4

4- A 6.4% preferred stock has a par value of $30 and is currently selling in the market at $40. The quarterly dividend for this stock is
A: $0.16.
B: $0.48.
C: $0.64.
D: $1.92.
E: $2.56.

5- One of the most successful collection programs is the 50 State Quarters program developed by the U.S. Mint. This program began in 1999 and permitted each state to put a design on the back of the U.S. quarter. There are 5 state quarters issued each year over the 10-year program. According to CoinWorld.com, in 1999 4.43 billion quarters were minted across the first five states issued. In 2000, the U.S. Mint increased the mintage by 46%. What was the number of state quarters minted in 2000?
A: 2.04 billion
B: 4.43 billion
C: 4.63 billion
D: 6.47 billion
E: 6.65 billion

6- Wendy’s broker has recommended she purchase 500 shares of a mutual fund that is currently priced at $25 a share. The commission on the purchase price is 3%, and the fund charges a 1% annual management fee and a $10 annual administrative charge. What is the total cost over the first year to invest in this fund?
A: $12,500
B: $12,875
C: $13,000
D: $13,010
E: $13,014

7- Last month when IBM was selling for $86, Dan purchased a call option on IBM with an exercise price of $90 for $2 per option or $200 total. Yesterday IBM closed at $95. Based on the minimum value of the contract, if Dan sells his call at yesterday’s close, what would his return be?
A: 4%
B: 6%
C: 50%
D: 150%
E: 250%

8- Stella pays 15% in dividend and capital gains taxes and 35% in ordinary income taxes. In 1990, she paid $1,000 for three American Eagle $50 gold coins (1 oz gold) and $340 for one coin in December 2003. In July 2004, she sold all four coins to net $460 each. What is the after-tax cash flow from this investment?
A: $150
B: $247
C: $401
D: $425
E: $500
9- A 6.4% preferred stock has a par value of $30 and is currently selling in the market at $40. The quarterly dividend for this stock is
A: $0.16.
B: $0.48.
C: $0.64.
D: $1.92.
E: $2.56.

10- A $1,000 par 1.4% coupon convertible bond with a stock purchase warrant for 1 share of stock at $35 per share is purchased for $900. The common stock has a current market price of $38 per share and the warrant’s market price is $4. If the market price of the stock increases to $41.80, the minimum percentage increase in the value of the warrant is
A: 10.0%
B: 17.8%
C: 19.4%
D: 70.0%
E: 119.4%

11- What is the standard deviation of returns given returns of 10%, -5%, 8%, 3%?
A: 3.7%
B: 4.0%
C: 5.8%
D: 6.7%
E: 7.1%

12- Claire has 200 shares of stock in a firm that just issued 1 right per share. The right gives the holder the opportunity to purchase 0.125 shares of stock. If Claire exercises all her rights, how many addition shares of stock will she be able to obtain?
A: 8
B: 25
C: 125
D: 200
E: 1,600

13- Before the new tax law enacted in 2003, dividends were taxed as ordinary income. Now the maximum tax rate on dividends paid to individuals is 15%. As a result of the law, an investor in the 25% tax bracket who received $70,000 in qualifying dividends had a tax savings of
A: $ 0.
B: $ 7,000.
C: $ 9,000.
D: $10,500.
E: $17,500.

14- Abby buys a position in a closed-end mutual fund that is selling at an 8% discount. The fund earns 12%, but the discount decreases to 5%. What is Abby’s return on this investment?
A: 8.5%
B: 12.0%
C: 12.4%
D: 14.2%
E: 15.7%

15- Corey pays 15% in dividend and capital gains taxes and 35% in ordinary income taxes. Four years ago, she invested $500,000 in a private placement offering with some friends. The initial price was $50 a share. The investment group is now discussing the possibility of publicly selling their shares. One of the members of the group believes they could get at least $75 a share. If this is correct, what are Corey’s taxes when she sells her shares (ignoring commissions and fees)?
A: $0 because the group is not allowed to sell their private placement shares to the public
B: $37,500
C: $54,000
D: $70,000
E: $87,500

16- Assume that the futures price of gold is $390 a troy ounce, and the contract is for 100 troy ounces. The initial margin is $2,000. If the future price increases by 5.0%, what is the return to the investor?
A: 1.0%
B: 2.5%
C: 5.0%
D: 19.5%
E: 97.5%

17- Iris pays 15% in dividends and capital gains taxes and 35% in ordinary income taxes. Several years ago, she purchased a Mortgage-Backed Security (MBS) for $20,000 which was the par value of the underlying assets. At the end of this year, she received a statement stating she had received $700 in scheduled amortization of principal, $1,200 in interest, and $500 in unscheduled collection of principal. What is Iris’s after-tax cash flow this year from this investment?
A: $1,560
B: $1,695
C: $1,980
D: $2,040
E: $2,400

18- Three years ago, Charles purchased a $1,000 face value 10-year Treasury note for par. The market value of this bond is now $950. If Charles sells the bond today, the tax implications of sale are
A: $50 loss against ordinary income
B: $50 capital gain
C: $50 capital loss
D: $50 gain against ordinary income
E: No tax effects since Treasury securities are exempt from taxes

19- Two years ago, an investor purchased a $1,000 par 6% coupon bond that pays interest semiannually. Inflation over the last two years has been 2% per year. The inflation-adjusted value of the next interest payment is
A: $28.84
B: $30.00
C: $31.21
D: $57.67
E: $60.00

20- Cameron pays 15% in dividend and capital gains taxes and 35% in ordinary income taxes. Ten years ago, Cameron purchased a position in a limited partnership for $10,000. Three years later, she was required to contribute $2,000 more to the partnership. Two years ago, she was required to contribute an additional $2,000. If Cameron sells her limited partnership investment today for $20,000, what are the taxes?
A: $ 900
B: $1,500
C: $2,100
D: $2,700
E: $3,500
B- TRUE/FALSE- Answer any 11 out of the following (11 points-1 point each)
1-In the financial markets, individuals are net demanders of funds.

2-Under current tax laws, most taxpayers will pay a lower tax rate on capital gains than on income from wages.

3-Capital markets deal exclusively in stock. Money markets deal exclusively in debt instruments.

4-Securities that trade in the over-the-counter market are called unlisted securities.

5- Diversification is the inclusion of a number of different investments in a portfolio with the goal of increasing returns or reducing risk.

6-On-line trading has greatly lowered greatly lowered the cost of buying and selling stock as well as greatly increasing the speed of transactions.

7- Descriptive information might include the company’s lines of business, a list of major competitors, and recent changes in management.

8- 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.

9- Sydney invested $10,000 for an indefinite period at 5% per year. At the end of each year, she receives a a $500 check for interest earned. This type of account pays simple interest.

10-$10,000 invested in the NASDAQ Composite at the beginning of 1995 would have increased in value to over $50,000 by the end of 1999.

11- High dividend payout ratios are more of a concern to analysts than low payout ratios.

12-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.

13- Advocates of the weak-form efficient market hypothesis claim that past price movements are the best predictors of future price movements.

14- For technical analysts, the forces of supply and demand have an important effect on the prices of securities.

15- Bonds are typically a good investment choice for an individual who is seeking long-term preservation of capital.

16-The risk premium component of a bond’s market interest rate is related to the characteristics of the particular bond and its issuer.

17- According to the expectations hypothesis, if investors anticipate higher rates of inflation in the future, the yield curve will be down sloping.

18- If a bond’s yield to maturity is lower than its coupon rate, the bond will sell at a discount.

19- When developing an asset allocation scheme, it is best to weight each type of asset equally.

20- Investors need to monitor economic and market activity to assess the potential impact these factors can have on their investment portfolios.

C- QUESTIONS/ANSWERS- Answer any 4 of the following ( 28 points- 7 points each)
1) Discuss the relationship between stock prices and investors’ beliefs about the business cycle.

2) What is the advantage of charting the price of a security over a period of time?

3) 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?

4) 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.

5) 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?

6) Why do some companies split their stock?

7) 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?

8) Explain the concept of bond immunization and the benefits derived from using this technique.

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