Deck 17: Markets for Common Stock: The Basic Characteristics

Question 1

________ may be sent to the broker-dealer's floor broker, and ________ orders may be transacted with another broker-dealer or internalized at a competitive bid or offer.

A) Exchange orders; OTC
B) Exchange orders; NYSE
C) Floor orders; AMEX
D) Floor orders; OTC

Answer 1

A

Question 2

For common stock investors, the return realized by holding this investment comes from ________.

A) dividend payments
B) decrease in the price of the common stock
C) decrease in the price of the common stock
D) All of these

Answer 2

D

Question 3

In a ________ stop order, the designated price is ________ than the current market price of the stock, while in a ________ limit order, the designated price is ________ than the current market price of the stock.

A) buy; lower; buy; higher
B) sell; lower; buy; lower
C) sell; higher; buy; lower
D) sell; lower; sell; lower

Answer 3

B

Question 4

Which of the below statements is TRUE?

A) Dividends (which are typically in the form of stock) are are distributions made by a corporation to its owners that represent a return on their investment.
B) Dividends paid to common stockholders are not legal obligations of a corporation and some corporations do not pay cash dividends.
C) At one time, dividend payments were taxed solely as ordinary income. Ordinary income means that the tax rate applicable is based on the investor's average tax bracket.
D) Depending on the individual's income tax rate, preferential dividends are taxed at either 5% or 15%.

Question 5

________ are the direct costs of trading, such as broker commissions, fees, and taxes.

A) Embedded costs
B) Operation costs
C) Implicit costs
D) Explicit costs

Question 6

Investors often choose their ________ based on who will give them the best execution at the ________ on a specific transaction, and also based on who will provide ________ over a period of time.

A) customers; highest transaction cost; required services
B) broker/dealer; highest transaction cost; required services
C) broker/dealer; lowest transaction cost; complementary services
D) customers; lowest transaction cost; complementary services

Question 7

A transaction in which an investor borrows to buy shares using the shares themselves as collateral is called ________.

A) buying on margin.
B) selling on margin.
C) buying on loan.
D) selling on loan.

Question 8

________ involves the sale of a security not owned by the investor at the time of sale.

A) Short buying
B) Long selling
C) Short selling
D) Long buying

Question 9

________ are orders requiring the execution of trades in a large number of different stocks at as near the same time as possible.

A) Retail trades
B) Program trades
C) Mutual fund trades
D) Block trades

Question 10

________ is the minimum proportion of (1) the equity in the investor's margin account to (2) the total market value.

A) preservation margin requirement
B) maintenance boundary requirement
C) maintenance margin condition
D) maintenance margin requirement

Question 11

Which of the below statements is TRUE?

A) Stock prices often exhibit abrupt price changes, so the direction of a change in a stock price may be quite permanent, resulting in the premature trading of a stock.
B) A stop-limit order, a hybrid of a stop order and a limit order, is a stop order that designates a price limit.
C) The stop-limit order cannot be used to cushion the market impact of a stop order.
D) We can think of the stop order as an order designed to get out of an existing position at an acceptable price (by specifying the exact price), and the market if touched order as an order designed to get into a position at an acceptable price (also by specifying the exact price).

Question 12

The ________ is a conditional order and is executed only if the limit price or a better price can be obtained. Another type of conditional order is the ________, which specifies that the order is not to be executed until the market moves to a designated price, at which time it becomes a ________.

A) limit order; stop order; market order
B) stop order; limit order; market order
C) limit order; market order; stop order
D) market order; stop order; limit order

Question 13

If the price at a future date ________ the purchase price, then there is a ________.

A) less than; capital gain
B) less than; a taxable gain
C) exceeds; capital loss
D) exceeds; capital gain

Question 14

Which of the below statements is FALSE?

A) Trades are executed by individuals (wholesale investors) and institutions.
B) Institutions typically transact much larger orders than individuals.
C) Consistent with their larger size, institutions typically pay lower commissions than individuals.
D) Although both an individual and an institution can trade through a broker-dealer, the ways in which their orders are entered and executed may be considerably different, even if the trades are through the same broker-dealer.

Question 15

During the past 50 years, common stock holdings in the United States have become increasingly institutionalized. The major institutional holders include ________.

A) pension funds and asset management companies.
B) life insurance companies and bank trusts.
C) endowments and foundations.
D) All of these

Question 16

In regards to types of order, which of the below statements is FALSE?

A) The simplest type of order is the market order, an order to be executed at the best price available in the market.
B) The danger of a market order is that an adverse move may take place between the time the investor places the order and the time the order is executed.
C) A buy limit order indicates that the stock may be purchased only at the designated price or lower, while a sell limit order indicates that the stock may be sold at the designated price or higher.
D) The key advantage of a limit order is that there is no guarantee that it will be executed at all; the designated price may simply not be obtainable.

Question 17

Equity securities represent ________ interest in a corporation. Holders of equity securities are entitled to the earnings of the corporation when those earnings are distributed in the form of ________. The key distinction between common stock and preferred stock lies in the degree to which they may participate in any distribution of earnings and the priority given to each in the ________.

A) an ownership; dividends; retainment of earnings
B) an ownership; interest; distribution of earnings
C) an ownership; dividends; distribution of earnings
D) a potential; interest; retainment of earnings

Question 18

Implicit trading costs include ________.

A) influence costs, timing costs, and sunk costs.
B) impact costs, time period costs, and sunk costs.
C) influence costs, time period costs, and opportunity costs.
D) impact costs, timing costs, and opportunity costs.

Question 19

________ is the "cost" of securities not traded.

A) The sunk cost
B) The impact cost
C) The timing cost
D) The opportunity cost

Question 20

An investor preferentially routes their order to the broker/dealer specified in the soft dollar relationship and does not have to pay real money, for the research or other services. This practice is called paying "________" (i.e., directing their order flow) for the ancillary research.

A) "hard dollars"
B) "soft dollars"
C) "ancillary dollars"
D) "real money dollars"

Question 21

Which of the below statements is FALSE?

A) The growth of mutual fund sales and massive equity investments by pension funds and insurance companies during the 1990s have all given an impetus to such methods to trade baskets or bundles of stocks efficiently.
B) Program trading is used for a strategy called index arbitrage.
C) Several commission arrangements are available to an institution for a program trade, and each arrangement has numerous variants.
D) From a dealer's perspective, program trades can be conducted in only one way and this on a principal basis.

Question 22

________ important because of the interrelationship between the stock market, stock index futures market, and stock index options markets.

A) Trading restrictions are
B) Ineptness across markets is
C) Awkwardness across markets is
D) Coordination across markets is

Question 23

________ means that the price of the security reflects the past price and trading history of the security.

A) Weak-form efficiency
B) Semistrong-form efficiency
C) Strong-form efficiency
D) All of these

Question 24

Which of the below statements is FALSE?

A) Common stock investment strategies can be classified into two general categories: active strategies and passive strategies.
B) Investors who believe that the market prices stocks efficiently should accept the implication that any attempts to outperform the market cannot be systematically successful, except by luck.
C) The decision to pursue a passive strategy must be based on the belief that there is some type of gain from such costly efforts, but gains are possible only if pricing inefficiencies exist.
D) Market capitalization-weighted indexes have a growth tilt and fundamental indexes have a value tilt.

Question 25

The ________ is the electronic service that provides last sale and trade data for issues listed on the NYSE, Amex, and U.S. regional stock exchanges and was introduced in April 1976.

A) Consolidated Tape System (CTS)
B) Consolidated Quotation System (CQS)
C) National Best Bid and Offer (NBBO)
D) Self-Regulating Organizations (SROs)

Question 26

Which of the below statements is TRUE?

A) The basis for the federal government regulation of the stock market resides with the CQS.
B) The SEC of the NYSE has been responsible for the member regulation, enforcement, and arbitration functions of the NYSE.
C) All clearance and settlement services for U.S equities market (as well as corporate bonds, municipal bonds, exchange-traded funds, and unit investment trusts trades) are provided by the Consolidated Quotation System (CQS).
D) After a stock trade is completed, the delivery of the shares by the seller and the payment of cash by the buyer must occur quickly and efficiently.

Question 27

The Consolidated Tape Association (CTA) ________.

A) oversees the dissemination of real-time trade and quote information (market data) from the NYSE and Amex listed securities (stocks and bonds).
B) manages two systems to govern the collection, processing and dissemination of trade and quote data: the Consolidated Tape System (CTS) and the Consolidate Quotation System (CQS).
C) conducts price reporting in the U.S. stock markets.
D) All of these

Question 28

Which of the below statements is FALSE?

A) In practice, capitalization weighting continues to be the dominant practice, but fundamentally weighted mutual funds and ETFs have been introduced.
B) Fundamentally weighted portfolios do not necessarily clear the market and require rebalancing as stock price change.
C) Indexing is an example of an active strategy.
D) According to modern portfolio theory, the market portfolio offers the highest level of return per unit of risk in a market that is price efficient.

Question 29

The NYSE and Nasdaq reduced the tick size to pennies 2001. This reduction in the tick size narrowed the bid-offer spread considerably, which ________.

A) increased the costs to market makers and the profits of the customers.
B) reduced the costs to market makers and the profits of the customers.
C) reduced the costs to customers and the profits of the market makers.
D) increased the costs to customers and the profits of the market makers.

Question 30

Participants in the upstairs market play a key role ________.

A) by providing liquidity to the market so that institutional trades can be executed.
B) through arbitrage activities that help to integrate the mended institutional market.
C) by providing liquidity to the market so as to integrate the fragmented stock market.
D) by providing arbitrage opportunities to the market so that institutional trades can be executed.

Question 31

What type of trades requires require the execution of a trade of a large number of shares of a given stock?

A) Program trades
B) Pension fund trades
C) Block trades
D) Execution trades

Question 32

________ exists in a market where the price of a security reflects all information, whether it is publicly available or known only to insiders such as the firm's managers or directors.

A) Weak-form efficiency
B) Weak efficiency
C) Semistrong-form efficiency
D) Strong-form efficiency

Question 33

With the exception of the ________, all of the most widely used indexes are market-value weighted.

A) Wilshire 5000
B) S&P 500
C) Dow Jones averages (such as the DJIA)
D) Russell 3000

Question 34

________ means that the price of the security fully reflects all public information (which includes but is not limited to historical price and trading patterns).

A) Weak-form efficiency
B) Semistrong-weak efficiency
C) Semistrong-form efficiency
D) Strong-form efficiency

Question 35

A ________ is a temporary halting of trading during a severe market decline.

A) price limit
B) circuit breaker
C) collar
D) block trade

Question 36

The preponderance of empirical evidence supports the claim that the common stock market is efficient in ________.

A) the weak form.
B) semistrongweak form.
C) ultrastrong form.
D) strong form.

Question 37

Which of the below statements is FALSE?

A) The NYSE defines block as trades of either at least 10,000 shares of a given stock or trades of shares with a market value of at least $200,000.
B) When sales traders find enough institutions to take an entire block, then the balance of the block trade order is given to the brokerage firm's market maker.
C) Program trades involve the buying and/or selling of a large number of names simultaneously.
D) The two major applications of program trades are asset allocation and index arbitrage.

Question 38

Stock market ________.

A) indexes rise and fall in difference patterns.
B) indexes are constructed by using a few stocks represented by the sample underlying the index.
C) indicators can be classified into a group produced by stock exchanges based on some stocks traded on the exchange.
D) indicators can be classified into a group produced by organizations that subjectively select the stocks to be included in indexes.

Question 39

Stock market indicators ________.

A) have come to perform a variety of functions, from serving as benchmarks for evaluating the performance of professional money managers to answering the question "How did the market do today?"
B) have not yet become a part of everyday life.
C) are used interchangeably because each indicator applies to, and measures, the same facet of the stock market.
D) are inaccurate assessments of how the markets are performing.

Question 40

Empirical evidence on insider trading argues against the notion that the market is efficient in the ________ sense.

A) weak form
B) true form
C) strong-form
D) None of these

Question 41

The Internal Revenue Code defines short-term as a holding period of one year or less. If a capital gain is classified as a short-term capital gain, it is taxed as ordinary income at the investor's regular income tax rate.

Question 42

What do equity securities represent? Describe the two types of equity securities distinguishing between them.

Question 43

There are two major components of transaction costs: explicit costs and implicit costs.

Question 44

The optimal strategy to pursue when the stock market is perceived to be price inefficient is indexing because it allows the investor to capture the efficiency of the market.

Question 45

The key to instituting circuit breakers is coordination and infrequency.

Question 46

Active investment strategies, consisting of efforts to time purchases and select stocks, are pursued by investors who believe that securities are mispriced enough that it is possible to capitalize on strategies that are designed to exploit the perceived inefficiency.

Question 47

Short selling involves the sale of a security not owned by the investor at the time of sale. Investors can arrange to have their broker borrow the stock from someone else, and the borrowed stock is delivered to implement the sale. To cover their short position, investors must subsequently purchase the stock and return it to the party that lent the stock. Give an example of how this short selling is done.

Question 48

An investor shorts (borrows and sells) 100 shares of a stock at $50 for a total stock value of $5,000. With an initial margin of 50%, the investor must deposit $2,500 (in addition to leaving the $5,000 from the sale in the account). This leaves the investor with a credit balance of $7,000 (which does not change with the stock price since it is in cash).

Question 49

Discount brokers have been particularly ineffective in inducing retail investors to participate in the market for individual stocks.

Question 50

The Wilshire 4500 includes all stocks in the Wilshire 5000 except for those in the Dow Jones 500.

Question 51

Describe a "soft dollar" arrangement and how it differs from a "hard dollar" arrangement.

Question 52

From a dealer's perspective, program trades can be conducted in two ways. Name and describe these two ways.

Question 53

The brokerage firm can also choose to execute the trade on an agency basis. In this case, the dealer would commit its own capital to buy or sell the portfolio and complete the investor's transaction immediately.

Question 54

Explicit trading costs include impact costs, timing costs, and opportunity costs.

Question 55

Implicit transaction costs are commissions, custodial fees, and transfer fees.

Question 56

Some indexes represent a broad segment of the stock market while on a particular sector such as technology, oil and gas, and financial.

Question 57

To the investor, the disadvantage of the agency program trade is that, while commissions may be the lowest, the execution price may not be the best because of impact costs and the potential frontrunning by the brokerage firms that were solicited to submit a commission bid.

Question 58

The institutional arrangement that has evolved to accommodate these needs is the upstairs market, which is a network of trading desks of the major securities firms and institutional investors that communicate with each other by means of electronic display systems and telephones.

Question 59

When an investor is calculating the return from holding common stock from the date of purchase to a given point in time and has sold the common stock, the return reflects an unrealized capital gain or unrealized capital loss.

Question 60

Assume an investor buys 100 shares of a stock at $80 per share for $8,000 of stock on 50% margin and the maintenance margin is 30%. By purchasing $8,000 of a stock on 50% margin, the investor must put up $4,000 of cash (or other equity) and, thus, borrows $4,000 (referred to as the "debit balance").

Question 61

Stock market indicators can be classified into three groups. Describe these two of these three groups.

Question 62

Name and describe the three different forms of pricing efficiency.

Question 63

A large single-day decline in the stock market occurred on Monday, October 19, 1987, popularly referred to as "Black Monday." On this day,the Dow Jones Industrial Average (DJIA), declined by 23%, and other market indexes declined by roughly the same amount. While several potential reasons for the crash were identified, no unambiguous conclusions resulted. One clear dynamic for the price decline, however, did exist. Describe this dynamic and what stock market policy resulted.

Question 64

Comment on the following statement: "institutions can use program trade arrangements to minimize frontrunning."