Investment Section 1-3

Question 1

Jessica owns 10 shares of ACME Tools stock at $50 per share. The stock splits 2 for 1. What would be the number of shares Jessica owns after the split and the total value of her investment?

Answer 1

20 shares; $500 value.

Share amount will double due to the split. However, since share price is halved, total stock value will not change after the split.

Question 2

Which of the following firm ratios will change after a stock split?

1. Price to earnings ratio
2. Return on equity ratio
3. Earnings per share ratio
4. Gross margin ratio

Answer 2

3. Earnings per share ratio

Earning will not change after a split, but shares outstanding will double

Question 3

Common stocks have voting rights that give shareholders the power to do which of the following EXCEPT:

1. Vote by proxy
2. Elect board of directors
3. Vote of major company issues
4. Vote on everyday management decisions

Answer 3

4. Vote on everyday management decisions

Question 4

Carl ended the year with a total investment in McDonald’s stock of $7,000. (100 shares at $70) McDonald’s just announced a 3-for-2 stock split, payable May 30th. If the market price of the stock does not change (except for the split effect), what is his total investment, price per share, and total share amount?

Answer 4

Total investment: $7,000 (150 shares at $46.67)

Question 5

Solve for the PV of a Bond:

If a $1,000 par 5-year bond has an annual coupon rate of 6% and pays semi-annually, what would its present value be if interest is 8%, 6%, or 4%?

Answer 5

8% = $919 (discount)
6% = $1,000 (par)
4% = $1,090 (premium)

Because the coupon rate is 6%

Question 6

If there was a money market instrument with a $1,000,000 denomination quoted with a discount rate of 1.5%, how much would the investor pay for the security and what would the investor’s real interest rate be?

Answer 6

Purchase price: $985,000

The bank discount basis, which is the investor’s real interest rate = 1.52% or $15,000/$985,000

Question 7

What is the TEY equation?

on the formula sheet

Answer 7

Tax equivalent yield

= tax-free rate / (1- tax bracket)

Question 8

Bonnie a resident of Ohio, has an effective tax rate of 36%. If risk was not an issue for Bonnie, which of the following choices would provide her the highest yield?

1. 30-year T-Bond paying 6%
2. Disney 30-year bond paying 7%
3. Ohio 30-year GO muni bond paying 5%
4. Ohio 30-year revenue muni bond paying 5.5%

Answer 8

4. Ohio 30-year revenue muni bond paying 5.5%

TEY equation to solve

Question 9

Joesph would like to invest in a government bond that will mature in three years. Which of the following should he purchase?

1. Treasury bond
2. Treasury bill
3. Treasury note
4. Either a T bill or T bond

Answer 9

3. Treasury note

T-notes mature in 1-10 years

Question 10

When do T-bills mature?

Answer 10

less than one year

Question 11

When do T-notes mature?

Answer 11

1-10 years

Question 12

When do T-bonds mature?

Answer 12

10+ years

Question 13

Which investments below would yield tax-exempt interest on the client’s federal return if the proceeds were used to finance education?

1. GNMA funds
2. EE bonds
3. Zero coupon T-bonds
4. T-bills

Answer 13

2. EE bonds only

Question 14

Which of the following will likely increase the chance that a corporation will exercise the right to call a callable bond?

1. An increase in the general level of interest rates
2. Rumors of a corporate buyout
3. A favorable change in the rating assigned to the issuing corp by a credit rating org
4. A decrease in the general level of interest rates

Answer 14

3. & 4.
   Lower interest rates and an increase in the rating of a bond will increase the likelihood that the bond will be called to then be issued at a lower rate

Question 15

A bond that has a discount rate greater than its coupon interest rate will sell for a price that is:

1. at par
2. above par
3. below par
4. equal to the face value of the bond plus the PV of all interest payments

Answer 15

3. below par

if a bond has a discount rate or required return that exceeds its coupon rate, the bond must sell at a discount to attract investors

Question 16

A taxpayer who is in the marginal 28% tax bracket and is considering a 4% muni bond should also consider a corporate bond earning:

1. 3.7%
2. 6.8%
3. 5.6%
4. 11.2%

Answer 16

3. 5.6%

4% is looked at as the tax free rate - use TEY to find answer

Question 17

What is the NAV equation?

Answer 17

NAV = assets - liabilities / shares outstanding

Question 18

Assume that, as of yesterday’s trading day, the Orion Fund held $11,700,000 worth of common stock, $3,000,000 of cash, and $700,000 of liabilities. If the fund had 1,000,000 shares outstanding, then yesterday’s NAV would be what?

Answer 18

(11.7M + 3,000,000 - 700,000) / 1,000,000 = $14

Question 19

What is the net asset value of an investment company with $28,000,000 in assets, $2,300,000 in liabilities, $25,700,000 in owner’s equity and 1,800,000 shares outstanding?

Answer 19

$14.28

($28 - $2.3) / 1.8

Question 20

Which of the following fixed income funds typically has the highest dividend yield?

1. Treasury Inflation Protected Bond Fund
2. Money Market Fund
3. Investment Grade Corporate Bond Fund
4. Junk Bond Fund

Answer 20

4. Junk Bond Fund

aka as high-yield bond funds - they invest in corporate bonds with lower ratings and give higher income payments than higher rated bonds.