Module 1 Flashcards
Securities Markets & Money Market Instruments (132 cards)
1
Q
Most investors purchase deposit and investment instruments through ?
A
financial intermediaries
2
Q
What are investment banks or bankers?
A
financial institutions that assist corporations and municipal governments in raising capital by underwriting new securities and/or acting as the issuer’s agent in the issuance of securities.
3
Q
What is an initial public offering (IPO)?
A
the process by which a private company offers its shares to the public for the first time on a stock exchange. This transition from a private to a publicly traded company allows the business to raise capital from public investors.
4
Q
What are the two different types of underwriting agreements for IPOs?
A
firm commitment & best efforts.
5
Q
What is the difference between firm commitment and best efforts?
A
best efforts: no guarantees from investment bankers to the company going public - they will sell as many shares as possible.
firm commitment: investment bankers guarantee the company going public that the entire issue will be purchased; investment bankers absorb loss if they fail to sell the entire issue to investors.
6
Q
If a company has already issued shares but wants to raise additional capital through the sale of more stock, it does so by what is called a ?
A
secondary or seasoned offering
7
Q
What is dilution of shares?
A
occurs when a company issues additional shares, reducing the ownership percentage of existing shareholders. this typically happens when a company raises more capital through new stock issuance, converts stock options, or issues convertible securities.
for this reason, a company typically issues new shares only if its capital structure of debt and equity needs rebalancing to comply with debt covenants.
8
Q
What is a red herring?
A
refers to a preliminary prospectus filed with the Securities and Exchange Commission (SEC) during an Initial Public Offering (IPO) process. it provides details about the company’s business, financials, and intended use of proceeds but does not include the final share price or the number of shares to be issued.
9
Q
What is a prospectus?
A
the offering document for the sale of securities.
10
Q
With regard to a prospectus, what is registration?
A
the process of filing the prospectus with the SEC.
11
Q
What does the term “green shoes” refer to?
A
the right to increase the size of an offering.
12
Q
What is a managing underwriter, lead underwriter, or originating house?
A
the investment banker that takes the lead role in an underwriting group.
13
Q
What is a syndicate?
A
the investment banking companies that participate with the managing underwriter to assist in the distribution of the new issue.
14
Q
What is the selling group?
A
brokerage firms that help distribute securities in an offering but that are not members of the syndicate.
15
Q
What is a broker-dealer?
A
refers to many securities firms acting as both brokers (agents of sellers of securities who receive a commission for executing a transaction) and dealers (principals who buy and sell securities for their own accounts).
16
Q
After a new issue comes to market, typically there is a lockup period, often ? days, during which early investors and employees may not sell their shares.
A
180
this period is instituted to keep shares attractive to new investors by delaying the price pressure that might occur if the early investors and employees sell their shares before the lockup ends.
17
Q
The dealer quotes prices on a ? basis, with the ? price being the price at which the dealer will buy and the ? price being the price at which the dealer will sell.
A
bid and ask; bid; ask
18
Q
What is venture capital?
A
financing for privately held companies (e.g., start-ups) typically in the form of convertible preferred stock and is characterized by high risk with the potential for high return.
19
Q
The ? makes investments in the selected companies in exchange for a large percentage interest in the firm’s equity capital.
A
venture capitalist firm
20
Q
What kind of investment does the below statement refer to?
These investments are characterized by high risk, high return, lack of liquidity, and a low correlation with equities.
A
venture capital
21
Q
What is seed capital?
A
a stage of venture capital. seed capital is for new companies without any products - provides them cash for product development and market research. this is sometimes referred to as seed financing.
22
Q
What is start-up capital?
A
a stage of venture capital. cash is provided for initial marketing activities but not for sales activities.
23
Q
What is first-stage financing?
A
a stage of venture capital. cash is provided for manufacturing and sales activities.
24
Q
What is second-stage financing?
A
a stage of venture capital. cash is provided for working capital.
25
What is mezzanine financing?
a stage of venture capital. cash is provided for expansion and new products.
26
What is bridge financing?
a stage of venture capital. capital is provided for an expected IPO.
27
What is acquisition financing?
a stage of venture capital. capital, including high-yield bonds, is provided to acquire other companies.
28
What is leveraged buyout (LBO) financing?
a stage of venture capital. capital is provided to allow management to buy all or part of a business; it is often used when a public company divests a division that it feels is no longer part of its long-term plans.
29
What are private placements?
the sale of securities (most commonly bonds) directly to a select group of investors rather than through a public offering. these investors are typically institutional investors, high-net-worth individuals, or private equity firms.
30
? avoid the SEC registration requirements of an IPO, and the company’s information is not accessible by the general public. In addition, the selling costs associated with a public offering are eliminated, and the issue can be tailored to meet both the issuer’s and investor’s needs.
private placements
31
Private placements are limited to ? unaccredited investors but are available to an unlimited number of accredited investors.
35
32
What is an accredited investor?
an individual or entity that meets certain financial criteria set by the Securities and Exchange Commission (SEC), allowing them to invest in private securities offerings, such as private equity, hedge funds, and venture capital deals. The SEC sets these requirements to ensure that investors have the financial sophistication and capacity to handle the risks of private investments.
33
Frequent investors in private placements include ? and ?
insurance companies; pension funds
34
What are limited partnerships?
characterized by a partnership entity that consists of a general partner and limited partners.
the general partner controls the business activities of the partnership, determines when distributions are made to the limited partners, and has unlimited liability. the limited partners do not participate in the management of the partnership and have limited liability.
35
What do the below statements refer to?
These programs offer investors a share in the income, gains, losses, deductions, and tax credits of the business entity. Investors should purchase ? that are economically viable and offer the potential of cash distributions and capital gains.
limited partnerships
36
? investments tend to be relatively risky and generally unsuitable for the average investor. Mutual funds or exchange-traded funds (ETFs) offer investors many of the same advantages of ?, including diversification and professional management, but without as much marketability or liquidity risk.
limited partnership
37
What is the primary market?
facilitates the initial sale of securities issued to the public. with primary market transactions, funds from a new issue would flow from investors to the issuing company (less any underwriting costs).
38
What is the secondary market?
provides investors with a method of buying and selling previously issued securities.
39
The secondary market consists of ? distinct markets.
four
40
The major security exchange in the world is the ?
NYSE
41
For listing on the NYSE, there must be at least ? round-lot holders and ? public shares outstanding (and other financial standards for listing, such as certain earnings or valuation/revenue tests, that must be met).
400; 1.1 million
42
What is a public float?
indicates the number of shares that are available for trading by investors; the remaining shares of those outstanding generally are held by insiders and often have restrictions on disposition.
43
What is a market order?
an order to buy or sell at the current price. the order would be executed at the best price available at that time.
44
What is a limit order?
an order to buy or sell at a specific price. the price acts as a ceiling for purchases and a floor for sales. for example, an order to buy at $50 per share means that the buyer does not want to pay more than $50 per share for the stock. note that “or better” is inferred with limit orders, meaning the order may be executed at a better price if available. for example, with an order to buy at $50, if shares are available at $49.90, the order may be executed at this lower (better) price.
45
What is a day order?
an order that is good just for the day and expires at the end of the day (if not executed).
46
What is a good-til-canceled (GTC) order?
an order that will remain in effect until either it is executed or canceled. sometimes broker-dealers will put a time limit on GTC orders, such as 90 days, after which they will automatically be canceled.
47
What is a stop order?
an order to buy or sell if the price of the stock trades at or through the stop price. a buy stop would be placed higher than the current market price of the stock, and a sell stop would be placed lower than the current market price of the stock. if the stock trades at or through the stock price, the order then becomes a market order.
48
What is a stop-limit order?
similar to a stop order, with the difference being that if the stock trades at or through the stop price, it then becomes a limit order rather than a market order.
49
When investors decide to buy or sell securities, they would place an order to trade the securities. A ? is considered the general unit of trading, which is usually 100 shares. An ? would be less than 100 shares.
round lot; odd lot
50
The ? order is used to protect investors from large losses. Likewise, this order is used to limit losses in connection with short sales.
stop
51
Most often, investors will leave their securities with a ? rather than taking physical delivery of a stock certificate.
brokerage firm
52
What is the Securities Investor Protection Corporation (SIPC)?
oversees the liquidation of brokerage firms and insures investors’ accounts up to a maximum value of $500,000 ($250,000 for cash balances) in the case of bankruptcy of a brokerage firm. while the SIPC insures brokerage accounts in the event of a brokerage firm’s financial difficulties, it does not cover market losses suffered while waiting to get securities from a bankrupt brokerage firm.
53
What is short selling?
a trading strategy where an investor borrows shares of a stock and sells them, hoping to buy them back later at a lower price to make a profit. It is used to bet against a stock, profit from declining prices, or hedge risks.
54
Selling a stock short involves ? steps.
four
55
Lauren short sells 200 shares of XYZ at $32 with a 50% initial margin. XYZ pays a dividend of $1 per share before she covers the short sale. She then buys back the stock for $30. What is her percentage profit or loss?
Lauren’s investment: 200 × $32 × 0.5 = $3,200
$6,400 Proceeds from short sale
(6,000) Cost to repurchase shares
$400 Gain
(200) Dividend payment
$200 Net profit
net profit ÷ investment = % gain/loss
$200 ÷ $3,200 = 6.25% gain
56
What is leveraging?
the use of borrowed money to achieve an individual’s investment objectives.
57
What is maintenance margin?
a minimum percentage of cash equity in the position. usually set at 35%. the maintenance margin is set by the broker-dealer, not the Federal Reserve, but Rule 431(b) of the NYSE requires a minimum maintenance requirement of at least 25%.
58
What is margin?
when an investment is purchased on margin, 50% of the funds are deposited by the investor (known as the initial margin percentage, as established by Federal Reserve Regulation T), and the 50% may be borrowed from the broker-dealer. however, some broker-dealers may require a higher initial margin percentage. once a margin account position has been established, the investor must maintain a maintenance margin, which is usually set at 35%.
59
What is a margin call?
if the equity in an investor’s position drops below the maintenance margin percentage, then the investor will receive a margin call (i.e., a demand by the broker to add cash to the margin account). if the investor does not add cash promptly, a portion of the investor’s position will be sold by the broker to cover the margin call.
60
What is a debit balance?
the amount owed to the broker-dealer is known as the debit balance and includes the original amount borrowed by the investor plus any accrued interest.
61
Harry pays $20,000 to purchase shares of XYZ Company, currently trading at $25 per share, using his margin account. Therefore, $20,000 is also borrowed from the broker-dealer. Harry can buy a total of 1,600 shares. At what point should Harry be concerned about receiving a margin call from the broker-dealer?
margin call = ($25x 0.50) / (1 - 0.35) = $12.50 / 0.65 = $19.2308 (rounded to $19.23)
the answer is when the stock price declines to $19.23.
62
Harry pays $20,000 to purchase shares of XYZ Company, currently trading at $25 per share, using his margin account. Therefore, $20,000 is also borrowed from the broker-dealer.
Assume that XYZ stock has dropped to $15 per share. How much money (dollar amount) is Harry now required to deposit to meet the margin call?
required equity = stock x equity % = $15 x 0.35 = $5.25
actual equity = stock - loan amount = $15 - 12.50 = $2.50
The answer is $2.75 per share, or a total of $4,400 ($2.75 × 1,600 shares). The required equity ($5.25) less the actual equity ($2.50) equals $2.75 per share.
63
Darrin bought 100 shares of XYZ stock at $100 per share on margin (a 50% initial margin percentage). The margin interest was 8% annually. After one year, Darrin sold all of his shares for $130 per share. XYZ stock paid no dividends during the one-year period. What was Darrin’s HPR using margin?
The answer is 52%, in the following manner:
1. Ending value = 100 shares × $130 per share = $13,000
2. Beginning value = 100 shares × $100 per share = $10,000
3. Cash flows: – Positive? No (no dividends) – Negative? Yes (margin interest = 8% × 50% × $10,000 = $400)
4. Darrin’s investment = 50% × $10,000 = $5,000
Therefore, his HPR can be calculated as follows:
HPR = ($13,000 - $10,000 - $400) / $5,000 = $2,600 / $5,000 = 0.52 x 100 = 52%
In contrast, the HPR would have been only 30%, rather than 52%, if Darrin had not purchased this stock on margin:
HPR = ($13,000 - $10,000) / $10,000 = $3,000 / $10,000 = 0.30 x 100 = 30%
Therefore, Darrin has indeed leveraged, or increased, his percentage HPR through the use of margin. However, what if the value of XYZ stock had declined over the course of the year? In that case, the use of margin would have also increased the potential percentage loss or downside risk that Darrin experienced.
64
What is marketability?
the ability to sell an investment quickly in a readily identifiable market.
65
Indeed, the financial planner should remember that one of the biggest risks to a senior’s income is not the loss of an investment’s principal but, rather, the loss of an investment’s ?
purchasing power
66
What are certificates of deposit (CDs)?
deposits made with a bank or savings and loan for a specified period, commonly one month to five years. CDs have traditionally been used to provide an income stream to retirees. Interest is subject to ordinary income tax in the year earned. The financial institution usually pays a fixed rate of interest for the term of the certificate, with rates increasing as the term gets longer.
67
CDs are FDIC insured up to ? per ownership category, which is often a reason for investors’ interest in purchasing CDs.
$250,000
68
What are negotiable CDs?
deposits of $100,000 or more placed with commercial banks at a specified interest rate for a term of up to one year.
69
Unlike regular CDs, which are redeemable by the issuing bank, negotiable CDs are bought and sold in the ? market at a market-determined price (i.e., an amount that is potentially different from the original principal invested).
secondary
70
What are money market deposit accounts (MMDAs)?
a type of interest-bearing bank account that typically offers a higher interest rate than a regular savings account while still providing some liquidity. MMDAs are insured by the FDIC (up to $250,000 per depositor, per bank), making them a safe place to store cash.
71
Typically, ? transfers or withdrawals are permitted from the MMDA each month.
six
72
What are money market mutual funds?
a type of mutual fund that invests in high-quality, short-term, low-risk debt securities, such as U.S. Treasury bills, commercial paper, and certificates of deposit. These funds aim to provide investors with stability, liquidity, and modest returns, making them a popular choice for parking cash while earning a slightly higher yield than traditional savings accounts.
73
What kind of investment does the below blurb refer to?
The investments within the fund usually mature within one year and have an overall weighted average maturity of less than 60 days. The typical minimum investment is $1,000, and funds may be withdrawn from the account at any time without penalty by writing a check on the account (usually for a minimum amount). The rate of return on the fund is highly sensitive to changes in short-term interest rates, particularly the federal funds rate or the overnight lending rate between banks that are members of the Federal Reserve System.
money market mutual funds
74
Money market mutual funds are used by investors as part of their ? because the funds are extremely liquid. In addition, such funds serve as a short-term depository for investors in a managed (wrap) account who are waiting for a more appropriate time to invest in other securities.
emergency fund
75
The three major categories of money market mutual funds are as follows:
Taxable money market funds.
Tax-exempt money market funds—national.
Tax-exempt money market funds—state.
76
What are taxable money market funds?
a type of money market mutual fund (MMMF) that invests in short-term, high-quality, taxable debt securities, such as U.S. Treasury bills, corporate commercial paper, and certificates of deposit (CDs). the interest earned on these funds is subject to federal and sometimes state income taxes.
77
What are tax-exempt money market funds - national?
these funds invest in municipal securities from around the country, and the income is free from federal income tax. if some of the income comes from the individual’s home state, then that portion can also be free from state income taxes. if private activity bonds are in the fund, then the income from these bonds would be subject to AMT (alternative minimum tax).
78
What are tax-exempt money market funds - state?
these funds also offer tax-exempt income and are normally purchased by residents of the state so that any income is also free from state income taxes. as with the national tax-exempt funds, AMT may be an issue.
79
What are U.S. Treasury bills (T-bills)?
short-term government securities. the U.S. Treasury regularly issues, by way of weekly auction (52-week T-bills are auctioned every 4 weeks), 4-, 13-, 26-, and 52-week T-bills in $100 increments with a $100 minimum purchase.
80
Because of their lack of default risk and high degree of marketability, ? are often used as the proxy for a risk-free investment (an asset having the lowest level of risk among all available assets) in modern portfolio management theory.
T-bills
81
What is commercial paper?
a negotiable, short-term, unsecured promissory note issued by a large corporation to finance accounts receivable and inventories. this type of debt is usually issued in denominations of $100,000 or more and is a substitute for short-term bank financing. money market mutual funds are the primary purchasers of commercial paper.
82
? is normally sold at a discount and is rated by a rating service (such as Standard & Poor’s) as to quality. the term to maturity is no more than 270 days and is often backed by lines of credit from banks. compared to T-bills, ? is slightly less liquid and has a higher risk of default; therefore, it has a nominally higher yield.
commercial paper
83
What are repurchase agreements (repos)?
a short-term borrowing arrangement in which one party sells securities (usually government bonds) to another party with an agreement to buy them back later at a slightly higher price. the difference between the selling price and the repurchase price represents the interest (or repo rate) paid for the loan.
84
What are reverse repurchase agreements (reverse repos)?
the dealer buys government securities from another dealer and then sells them back later at a higher price.
85
What are bankers' acceptances?
short-term drafts drawn by a private company on a major bank used to finance imports and exports. they are typically traded at a discount from their face value in the secondary market. companies that are too small to issue commercial paper sometimes use banker’s acceptances to finance their short-term debt needs.
86
When using a ?, the bank usually acts as an intermediary between the American company and the foreign company (i.e., the company furnishing or receiving the goods).
banker’s acceptance
87
What are eurodollars?
U.S. dollar–denominated deposits at banks outside the United States used to settle international transactions. the average deposit is very large (in the millions) and has a maturity of less than six months. interest income is taxable to the owner as ordinary income when earned.
88
What is a eurodollar CD (euro CD)?
a U.S. dollar-denominated certificate of deposit (CD) issued by banks outside the United States, typically in Europe or offshore financial centers. these CDs function similarly to domestic CDs but are not subject to U.S. banking regulations, often leading to higher interest rates for investors.
89
There is a special rate for collectibles, which are taxed at a maximum ? rate.
28%
90
Natasha has the following gains and losses from the previous year:
$20,000 long-term capital gain
$12,000 long-term capital loss
$15,000 short-term capital gain
$30,000 short-term capital loss
What are the income tax ramifications?
first, net the long-term gains and losses and the short-term gains and losses. So, a $20,000 long-term capital gain with a $12,000 long-term capital loss equals a net long-term capital gain of $8,000. for short-term capital gains and losses, net the $15,000 short-term capital gain with the $30,000 short-term capital loss, which comes to a $15,000 short-term capital loss. then, take the $8,000 long-term capital gain and offset it against the $15,000 short-term capital loss for a net short-term capital loss of $7,000. when Natasha files her tax return, she will be able to deduct $3,000 of the $7,000 loss and will carry forward to the next tax year the remaining $4,000 loss.
91
Net capital losses are deductible against earned income to a maximum of ? per year. Any capital losses not deducted in a taxable year may be carried forward indefinitely to be used in future years.
$3,000
92
What is net investment income?
investment income reduced by certain deductible investment expenses—for example, the penalty on the early withdrawal of savings and investment interest expense, as computed for regular tax purposes.
93
Paul and Tina are married taxpayers filing a joint tax return. This year, their AGI is $350,000, and their net investment income (included in the AGI) is $80,000. They will pay the 3.8% tax on $80,000. This is the lesser of the net investment income ($80,000) or the AGI in excess of the threshold amount ($350,000 – $250,000, or $100,000). In this situation, all $80,000 of the net investment income is subject to the tax. Paul and Tina will pay a ? tax.
$3,040 (3.8% on $80,000)
94
Tim and Jennifer are married taxpayers filing a joint tax return. This year, their AGI is $275,000, and their net investment income is $80,000. They will pay the 3.8% tax on $25,000. This is the lesser of the net investment income ($80,000) or the AGI in excess of the threshold amount ($275,000 – $250,000, or $25,000). In this situation, only $25,000 of the investment income is subject to the tax. Tim and Jennifer will pay a ? tax.
$950 (3.8% on $25,000)
95
What is a wash sale?
occurs if the taxpayer sells or exchanges stock or securities for a loss and, within 30 days before or after the date of the sale or exchange, acquires similar securities.
96
Which of the following statements regarding venture capital are CORRECT?
I. Venture capitalists have a high risk tolerance.
II. They offer investors the potential for high rates of return.
III. Investors are willing to lose their entire principal.
IV. Venture capital investments exhibit a high level of liquidity.
A. I and II
B. III and IV
C. I, II, and III
D. I, II, III, and IV
C. I, II, and III
Explanation: The answer is I, II, and III. Only statement IV is incorrect. Venture capital investments exhibit a lack of liquidity.
97
John, age 47, is considering diversifying his large investment portfolio. He has contacted his financial advisor to discuss the merits of investing in a private placement. He meets the definition of an accredited investor. Which of the following are considerations to determine the suitability of a private placement for John?
I. How much information regarding the company is available to John?
II. How and when might he be able to liquidate the investment?
III. What are the risk factors?
IV. How does this investment mix with his current holdings?
A. I only
B. III and IV
C. II, III, and IV
D. I, II, III, and IV
D. I, II, III, and IV
Explanation: The answer is I, II, III, and IV. All of these are considerations for an investor when deciding on the purchase of a private placement.
98
Kim owns a Marina Limited Partnership worth $25,000. She is interested in selling her interest in order to raise money for a down payment on a new rental property. Which of the following are NOT characteristics of her investment in the limited partnership?
A. Kim’s investment is managed by someone other than herself.
B. Tax-free income is provided by the partnership to Kim.
C. Her interest may be subject to liquidity and marketability risk.
D. The sale of her interest may be restricted.
B. Tax-free income is provided by the partnership to Kim.
Explanation: The answer is tax-free income is provided by the partnership to Kim. The income from limited partnerships is not tax exempt. An investor, however, may use a tax loss from a partnership to offset the income from another passive investment.
99
Which of the following types of orders does NOT restrict the price at which an order is executed?
A. Limit
B. Stop
C. Market
D. Stop limit
C. Market
Explanation: The answer is market. A market order does not reflect or restrict the price at which a security is executed. A limit order limits the amount to be paid or received for securities. A limit order becomes a market order if the stock reaches or goes through the stop price. A stop-limit order becomes a limit order if the stock hits or goes through the trigger price.
100
Myron, age 68, enjoys participating in an investment club. The club actively trades securities for its members, with the goal of modest capital appreciation. In which market do the club’s trades take place?
A. Primary
B. Secondary
C. Futures
D. Currency
B. Secondary
Explanation: The answer is secondary. The purpose of the secondary market is to provide investors with a method of buying and selling previously issued securities. The purpose of the primary market is to facilitate the initial sale of securities issued to the public.
101
Robert wishes to short ABC stock. He places a market order to sell short 100 shares of ABC stock, and the order is filled at a price of $45 per share. If Robert later buys 100 shares of ABC stock at $40 per share, what is his gross profit, if any?
A. $0
B. $350
C. $450
D. $500
D. $500
Explanation: The answer is $500. Robert will make $500 on the shares of ABC stock that he sells short, calculated as follows: $45 proceeds – $40 cost = $5 gain × 100 shares = $500.
102
Your client purchased 100 shares of FAQ stock at $60 per share with a 50% initial margin percentage and a 35% maintenance margin requirement. If the stock drops to $40 per share, how much money does your client need to deposit to meet the required equity amount in the margin account?
A. $400
B. $600
C. $615
D. $800
A. $400
Explanation: The answer is $400. Calculate as follows:
- Value: $40 × 100 shares = $4,000
- Loan amount: $6,000 × 0.50 = ($3,000)
- Actual equity: $1,000
- Required equity: $4,000 × 0.35 = ($1,400)
- Cash deposit needed: $400
103
Abigail uses her margin account to purchase 300 shares of Monroe stock at $85 per share. The initial margin is 50% and the maintenance margin is 35%. Abigail’s margin account charges 6% annual interest. Monroe stock pays the following dividends at the end of the first two years: $2.50 (Year 1) and $3.60 (Year 2). At the end of Year 2, Abigail sells all of her stock for $100 per share. What is Abigail’s holding period return?
A. 18.83%
B. 24.85%
C. 37.65%
D. 49.67%
C. 37.65%
Explanation: The answer is 37.65%. For HPR, we sum the cash flows and divide by the initial investment.
Profit on sale: $100 – $85 = $15
Dividends: $2.50 + $3.60 = $6.10
Margin account interest: 6% × 50% × $85 × 2 (years) = $5.10
HPR = ($15 + $6.10 – $5.10) ÷ (50% × $85) = 37.65% or ($30,000 – $25,500 + $750 + $1,080 – $1,530) ÷ $12,750 $4,800 ÷ $12,750 = 37.65%
104
Which of the following assets are liquid but NOT marketable?
A. Personal residence
B. Personal checking account
C. U.S. Treasury bills
D. Stock in a privately owned corporation
B. Personal checking account
Explanation: The answer is personal checking account. A personal checking account cannot be traded or sold and, therefore, is not marketable. The account can be turned into cash quickly without penalty. A personal residence and stock in a privately owned corporation are illiquid but marketable. U.S. Treasury bills are both liquid and marketable.
105
Which of the following is a primary purchaser of negotiable CDs?
A. Institutional investor
B. Individual of modest means
C. Hedge fund
D. Highly risk-tolerant investor
A. Institutional investor
Explanation: The answer is institutional investor. A large institutional investor is likely the primary purchaser of a negotiable CD. With a minimum denomination of $100,000, an individual of modest means probably could not afford its purchase, and a highly risk-tolerant investor or hedge fund is more interested in growth and a greater return on investment than that afforded by a negotiable CD.
106
Which of the following statements best describes money market mutual funds?
A. They allow up to six withdrawals per month and are insured by the FDIC.
B. They are an asset that provides a modest rate of return, diversification, and liquidity.
C. They are used primarily to finance imports and exports.
D. The average maturity date of the investments within these types of funds is 270 days.
B. They are an asset that provides a modest rate of return, diversification, and liquidity.
Explanation: The answer is they are an asset that provides a modest rate of return, diversification, and liquidity. Unlike an MMDA, the fund is not insured by the FDIC. The average maturity date of the investments in the fund is usually less than 60 days. Banker’s acceptances are used primarily to finance imports and exports.
107
U.S. Treasury bills would be most appropriate for which of the following investors?
A. John, age 25, single, no dependents, aggressive risk tolerance, need for growth and speculation
B. Mary and Ed, ages 43 and 41, moderate risk takers, need for college funding in 8 years for their 10-year-old daughter, Megan
C. Jack and Krissy, ages 65 and 63, conservative risk tolerance, need for liquidity and safety of principal
D. Lucy, age 54, divorced, moderate to aggressive risk tolerance, need for retirement funding in 11 years, provides some financial support for her 78-year-old mother
C. Jack and Krissy, ages 65 and 63, conservative risk tolerance, need for liquidity and safety of principal
Explanation: The answer is Jack and Krissy, ages 65 and 63, conservative risk tolerance, need for liquidity and safety of principal. Investors seeking diversification, liquidity, and safety of principal are the best candidates for U.S. Treasury bills. In this case, the best choice is Jack and Krissy.
108
Why would an institutional investor choose to purchase commercial paper for a portfolio?
A. Commercial paper provides higher yields than U.S. Treasury bills.
B. Commercial paper offers tax-free interest payments.
C. Commercial paper is generally not rated as to quality.
D. Commercial paper is usually offered in denominations below $50,000.
A. Commercial paper provides higher yields than U.S. Treasury bills.
Explanation: The answer is commercial paper provides higher yields than U.S. Treasury bills. Compared to U.S. Treasury bills, commercial paper is slightly less liquid and has a higher risk of default; therefore, it has a nominally higher yield. The interest paid on commercial paper is subject to income tax in the year earned. Commercial paper is rated by independent rating services as to quality and is offered in denominations generally in excess of $100,000.
109
In a repurchase agreement, the percentage difference between the repurchase price and the amount borrowed is most accurately described as:
A. the haircut.
B. the repo rate.
C. the repo margin.
D. the federal funds rate.
B. the repo rate.
Explanation: The answer is the repo rate. The repo rate is the percentage difference between the repurchase price and the amount borrowed. The repo margin, or haircut, is the percentage difference between the amount borrowed and the value of the collateral.
110
Which of the following is the best reason for an import company to use banker’s acceptances?
A. The company is seeking the use of a secured line of credit.
B. The company is looking to raise long-term capital for a new product line.
C. The company needs to finance international purchases.
D. The company needs to provide collateral for a bond issue.
C. The company needs to finance international purchases.
Explanation: The answer is the company needs to finance international purchases. Banker’s acceptances are similar to unsecured lines of credit and are not used as collateral for other loans or new product development.
111
Which of the following is NOT a characteristic of Eurodollars?
A. They are used to settle international transactions.
B. The average deposit is in the millions.
C. They have a maturity of greater than one year.
D. Interest income is taxable as ordinary income when earned.
C. They have a maturity of greater than one year.
Explanation: The answer is they have a maturity of greater than one year. Eurodollars have a maturity of less than six months.
112
On December 17 of last year Henry sells XYZ stock for a loss at $25 a share that he originally purchased for $42 per share. On January 4 of this year he repurchases the shares for $26 per share. What is his cost basis on the repurchased shares?
A. $1
B. $16
C. $25
D. $43
D. $43
Explanation: The answer is $43. This is a wash sale because the shares were repurchased within 30 days of their sale. The loss is then disallowed for tax purposes, and the disallowed loss is added to the repurchase price to determine the new cost basis ($42 – $25 = $17 disallowed loss, so $17 + $26 = $43 new cost basis).
113
Greg calls his broker and tells her to sell his XYZ stock if it falls to $20, but he does not want less than $19.50 for his shares. What type of order should his broker recommend to sell the stock?
A) Good-till-canceled order
B) Market order
C) Limit order
D) Stop limit order
D) Stop limit order
The stop limit order turns into a limit order when triggered (both the stop order price and the limit order price are specified). However, this type of order will not guarantee execution if the stock leapfrogs below the $19.50 mark.
114
Choose the risk that is attributable to cash and cash equivalents.
A) Purchasing power risk
B) None of these because cash and cash equivalents are considered risk-free
C) Liquidity risk
D) Marketability risk
A) Purchasing power risk
Cash and cash equivalents are subject to purchasing power (inflation) risk because they offer limited potential for growth.
115
All of the following correctly identify features of limited partnerships except
A) the general partner determines when distributions are made to the limited partners.
B) the limited partners may participate in the management of the partnership.
C) the limited partners have limited liability.
D) the general partner controls the business activities of the partnership
B) the limited partners may participate in the management of the partnership.
The answer is the limited partners may participate in the management of the partnership. Disadvantages of limited partnerships include the following: (1) they are generally riskier than bonds or exchange-traded equities; (2) they are generally illiquid; (3) limited partners cannot participate in the management; and (4) the sale of partnership interest may be restricted. In addition, the general partner has unlimited liability.
116
If an investor has a net short-term capital loss of $1,200 and a net long-term capital gain of $2,500, which of the following statements is true?
A) The client pays tax on a net long-term capital gain of $1,300.
B) The client pays tax on a long-term capital gain of $2,500 and carries over the net short-term capital loss to future years until it can offset a short-term capital gain.
C) None of these statements are true.
D) The client has an ordinary loss deduction of $1,200 and pays tax on a long-term capital gain of $2,500.
A) The client pays tax on a net long-term capital gain of $1,300.
Short-term gains and losses are netted with each other, then long-term gains and losses are netted with each other. Short-term losses are then netted with long-term gains, with ultimate tax treatment being determined by the result of the final netting. In this case, the final net is $1,300 and is treated as a net long-term capital gain for tax purposes.
117
The use of borrowed money to attain an individual's investment objectives is described as:
A) indexing.
B) hedging.
C) laddering.
D) leveraging.
D) leveraging.
Using borrowed money to attain one's investment objectives is known as leveraging. The advantage of leveraging is that the investor can control property that has greater value than the amount of cash invested.
118
What are the advantages of a private placement to the issuing firm?
I. Avoidance of disclosure requirements
II. Reduction in the time needed to raise the capital
III. Avoidance of some costs associated with publicly selling securities
IV. Limited to 25 unaccredited investors, but is available to an unlimited number of accredited investors
A) I, III, and IV
B) II and IV
C) I, II, and III
D) I and II
C) I, II, and III
The answer is I, II, and III. A private placement is limited to 35 unaccredited investors but is available to an unlimited number of accredited investors and eliminates the need for full disclosure and SEC registration. In addition, costs associated with the sale of securities to the public are avoided. Because there is no need for SEC registration, the company can quickly raise the needed capital. However, a private placement usually means a higher, not lower, cost of capital to the issuing firm.
119
Which of the following best describes the term marketability?
A) The ability to sell an investment quickly at a specific price.
B) The ability to sell an investment with a significant loss in principal.
C) The ability to sell an investment quickly in a readily identifiable market.
D) The ability to sell an investment quickly without transaction costs.
C) The ability to sell an investment quickly in a readily identifiable market.
The answer is the ability to sell an investment quickly in a readily identifiable market. Liquidity is the ability to sell or redeem an investment quickly and at a known price, without a significant loss of principal.
120
Select the arrangement that is commonly used by dealers in government securities to satisfy short-term liquidity needs.
A) Negotiable CDs
B) Commercial paper
C) Banker's acceptance
D) Repurchase agreement
D) Repurchase agreement
Dealers in government securities use repurchase agreements, or repos, to satisfy short-term liquidity needs.
121
All of the following correctly identify advantages of U.S. Treasury bills except
A) interest income is not subject to federal income tax.
B) investors can tailor purchases to meet short-term goals and obligations.
C) investors are provided a high degree of safety.
D) they are not subject to default risk.
A) interest income is not subject to federal income tax.
Interest income from U.S. Treasury bills is taxed at ordinary federal income tax rates but is not subject to state income tax.
122
Which of these statements pertaining to the various types of money market investments is CORRECT?
I. Commercial paper offers higher yields than T-bills.
II. Eurodollars are U.S. dollar-denominated deposits at banks outside of the United States.
III. Banker's acceptances are short-term drafts drawn by a private company on a major bank to finance imports and exports.
IV. T-bills are subject to default risk and a lack of marketability.
A) I, II, and III
B) II, III, and IV
C) IV only
D) II and IV
A) I, II, and III
Only statement IV is incorrect. T-bills are not subject to default risk and exhibit a high degree of marketability. As a result, the 90-day T-bill is often used as a proxy for the risk-free investment.
123
All of the following statements correctly describe certificates of deposit (CDs) except
A) CDs typically pay a variable interest rate.
B) redemption prior to maturity typically results in an early withdrawal penalty.
C) CDs are eligible for FDIC coverage.
D) CDs are commonly referred to as time deposits.
A) CDs typically pay a variable interest rate.
The answer is CDs typically pay a variable interest rate based on the term of the certificate. CDs typically pay a fixed interest rate, with higher interest rates offered for longer-term certificates.
124
Which of the following accurately describes the certificate of deposit investment strategy known as laddering?
A) Purchasing certificates in progressively increasing deposit amounts
B) Immediately purchasing another certificate as one certificate matures
C) Redeeming a certificate of deposit and reinvesting in a new certificate when interest rates increase
D) Purchasing multiple certificates, rather than just one, with differing terms of maturity
D) Purchasing multiple certificates, rather than just one, with differing terms of maturity
Laddering is the procedure of purchasing multiple CDs with differing terms of maturity.
125
Lloyd is a dealer in government securities. He has purchased government securities from another dealer, Fred, and has agreed to sell them back at a later date. From Lloyd's perspective, which transaction has been executed?
A) Repurchase agreement
B) Promissory note
C) Commercial paper investment
D) Reverse repurchase agreement
D) Reverse repurchase agreement
Lloyd, as the buyer, has entered into a reverse repurchase agreement, and Fred, as the seller, has entered into a repurchase agreement.
126
A money market mutual fund manager recently purchased negotiable, short-term, unsecured promissory notes issued by a number of large corporations for the portfolio. Select the type of investment the money manager purchased.
A) Repurchase agreements
B) Reverse repurchase agreements
C) Banker’s acceptances
D) Commercial paper
D) Commercial paper
Commercial paper is usually issued in denominations of $100,000 or more and is a substitute for short-term bank financing. Commercial paper is normally sold at a discount and is rated for quality by a rating service.
127
Which of the following types of federal income tax treatment generally apply to municipal bonds?
I. Ordinary income
II. Tax-free income
III. Capital gains or losses
IV. Tax-deferred income
A) II and III
B) II and IV
C) I and III
D) I and IV
A) II and III
The answer is II and III. Municipal bond interest is received federal income tax free by the bondholder. In addition, when a municipal bond is sold by the investor, the net proceeds above/below basis may be subject to capital gain/loss.
128
When investment bankers absorb the loss on an initial public offering, which one of the following terms represents this type of offering?
A) Green shoes
B) Best efforts
C) Firm commitment
D) Secondary offering
C) Firm commitment
The answer is firm commitment. Firm commitment underwriting occurs when investment bankers purchase all shares from a company and resell them to the public at their own risk.
129
Alice uses a stockbroker to borrow shares of stock from another investor's account and then sells the borrowed stock in the open market. She later repurchases the stock in the open market and replaces, or covers, the borrowed stock. Identify the type of transaction that she used in her account.
A) Protective put
B) Zero-cost collar
C) Short sale
D) Wash sale
C) Short sale
This type of transaction is known as a short sale. A short sale allows an investor to take advantage of falling stock prices.
130
A strategy where investors with relatively large amounts of money to invest purchase multiple certificates with varying terms to maturity is
A) staging.
B) laddering.
C) swapping.
D) bulleting.
B) laddering.
Laddering is the process of purchasing multiple CDs with staggered maturities, that are equally spaced, and with varying interest rates. As each CD matures, a CD is purchased with a maturity equal to the longest in the ladder. This strategy is used to manage interest rate risk.
131
Which of the following is both liquid and marketable?
A) Passbook savings accounts
B) U.S. Treasury bills
C) Blue chip stocks
D) Antique jewelry
B) U.S. Treasury bills
The answer is U.S. Treasury bills. U.S. Treasury bills are both liquid and marketable. Passbook savings accounts are liquid but not marketable. Neither blue chip stocks nor antique jewelry is assured of being both liquid and marketable.
132
Mike places a market order to sell short 200 shares of ABC stock. The order is filled at $23.45 per share. Assuming he can cover the short by purchasing the shares at $20 per share, calculate his gain or loss.
A) Gain of $690
B) Loss of $345
C) Gain of $850
D) Loss of $690
A) Gain of $690
Mike will have a gain of $690 on the shares of XYZ stock.
$23.45 proceeds
– $20.00 cost
$3.45 gain × 200 shares = $690
