Deck 1: The Investment Setting

Question 1

In general, inflation results in a loss of purchasing power to the investor.

Answer 1

True
Explanation: Inflation erodes the value of money, resulting in a loss of purchasing power. Inflation is too many dollars chasing too few goods. As inflation rises, dollars buy less, since the prices of goods are rising.

Question 2

The only compensation anticipated from an investment is for inflation protection.

Answer 2

False
Explanation: Three components make up the required return for an investment (the compensation anticipated): the real rate of return, the anticipated inflation factor, also called the inflation premium, and the risk premium.

Question 3

Diamonds represent a form of real assets, but cattle do not.

Answer 3

False

Question 4

Pension funds are a form of indirect equity claims.

Question 5

It is generally thought that young, upwardly mobile people should take less risk than elderly people living on a fixed income.

Question 6

Warrants are a form of direct equity claims.

Question 7

Rare paintings and baseball cards may be considered as forms of investment.

Question 8

In an efficient and informed capital market environment, those investments with the greatest return tend to have the greatest risk.

Question 9

The age and economic circumstances of an investor are important variables in determining an appropriate level of risk.

Question 10

Common stock represents a direct equity claim.

Question 11

An investor can totally eliminate time-consuming investment management activities by participating in a mutual fund or limited partnership.

Question 12

The riskiness of an investment is measured by the dispersion of possible outcomes.

Question 13

To achieve maximum diversification benefits, an investor should invest in projects which are highly correlated.

Question 14

The Tax Act of 2003 offers greater potential for wealth accumulation.

Question 15

Investment is the commitment of current funds in anticipation of receiving a larger flow of funds in the future.

Question 16

The Ibbotson study showed that high-risk investments generate high returns.

Question 17

Mutual funds are a form of direct equity claims.

Question 18

Commodity futures are a form of financial asset.

Question 19

Diversification is the process of determining the risk premium.

Question 20

Unlike the risk-free rate, the level of the risk premium varies by investment.

Question 21

Silver is an example of a financial asset.

Question 22

Real assets tend to be more liquid than financial assets.

Question 23

A public utility is likely to appeal to an income-oriented, conservative investor.

Question 24

Retirement questions should be asked 5-10 years before retirement.

Question 25

Real estate is a good example of an investment that lacks liquidity.

Question 26

A lack of immediate liquidity cannot be justified even if there is an opportunity for large gains.

Question 27

In the financial world, risk is defined as variability of returns.

Question 28

Most financial assets provide a high degree of liquidity.

Question 29

Finding high income (yield) and growth in the same investment is a relatively standard practice.

Question 30

Investors desiring to assume low risks would probably invest in short-term securities.

Question 31

A share in a money market fund is an indirect equity claim.

Question 32

Real estate may be favored by investors in high tax brackets.

Question 33

The Stocks, Bonds, Bills and Inflation Yearbook is an annual reference book that publishes return data on a variety of securities. The data shows that the large company category had a negative return in only one decade, and that was the 1930s.

Question 34

Common stock investments that do not pay dividends are likely to provide relatively low total returns.

Question 35

Dividends and long-term capital gains are now taxed at the same maximum rate.

Question 36

Common stock is a good example of an investment that lacks liquidity.

Question 37

Risk is not correlated with return in the capital markets.

Question 38

Those who engage in short-term market tactics are considered traders.

Question 39

An aggressive portfolio might include real assets.

Question 40

Liquidity refers to how little the sales price of an asset has decreased from its cost.

Question 41

A(n) _____ is a legally documented claim on an asset, while a(n) _____ is an actual, tangible asset which may be seen, felt, held, or collected.

A)Real asset; financial asset
B)Financial asset; real asset
C)Indirect equity claim; direct equity claim
D)Direct equity claim; indirect equity claim
E)None of the above

Question 42

One of the problems that investors face in determining required rates of return is forecasting errors involving interest rates and inflation.

Question 43

In managing a personal portfolio, an investor should consider opportunity costs.

Question 44

Which of the following statements is the most accurate concerning security returns over the eight decades since the 1920s?

A)Returns on large common stocks were very stable.
B)Returns on long-term corporate bonds were very stable.
C)Returns on long-term government bonds were very stable.
D)Returns on treasury bills were very consistent from period to perioD.
E)All securities exhibited very unstable returns over the eight decades in question.

Question 45

The commitment of current funds in anticipation of receiving a larger future flow of funds is called:

A)a financial asset.
B)a real asset.
C)an investment.
D)gambling.
E)None of the above

Question 46

The Tax Act of 2001 lowered the capital gains tax rate.

Question 47

The Tax Relief Act of 2003 has made stocks that pay high dividends more attractive than they previously were.

Question 48

Real assets, because of increasing replacement value and scarcity, tend to perform better than financial assets during periods of high inflation.

Question 49

Investment in a mutual fund results in:

A)an indirect equity claim.
B)a direct equity claim.
C)a creditor claim.
D)None of the above

Question 50

What factors must be considered in choosing between investment alternatives?

A)Risk and liquidity
B)Interest or dividends versus capital gains
C)Time frame for managing funds and evaluating performance and tax effects
D)Safety of principal
E)All of the above

Question 51

Prior to the Taxpayer Relief Act of 1997, long-term capital gains were taxed at ordinary income tax rates.

Question 52

Every investment requires a total return comprised of a real rate of return, compensation for inflationary expectations, and a risk premium.

Question 53

Research has shown that it is not that difficult to beat the market on a risk-adjusted basis.

Question 54

Those who attempt to engage in short-term market tactics are termed traders.

Question 55

Beta measures a security's return relative to the market.

Question 56

When ranking the riskiness of securities using the standard deviation, the highest risk security to the lowest risk security is as follows:

A)Small stocks, large stocks, long-term government bonds, U.S. treasury bills.
B)Long-term government bonds, small stocks, large stocks, U.S. treasury bills.
C)Large stocks, small stocks, long-term government bonds, U.S. treasury bills.
D)Small stocks, long-term government bonds, large stocks, U.S. treasury bills.
E)U.S. treasury bills, long-term government bonds, large stocks, small stocks.

Question 57

Liquidity can be measured by the ability of the investor to convert an investment into cash within a relatively long period of time, at its fair book value.

Question 58

When comparing returns by decade, the Ibbotson study shows that small company stocks outperformed large company stocks in every decade since the 1920s.

Question 59

A direct equity claim arises through investment in:

A)bonds and other debt instruments.
B)common stocks, warrants, and options.
C)preferred stock and commodity futures.
D)mutual funds.
E)None of the above

Question 60

When ranking security returns, the data shows that the annualized returns are as follows (ranked from highest return to lowest return):

A)Large stocks, small stocks, long-term corporate bonds, long-term government bonds, treasury bills.
B)Small stocks, large stocks, long-term corporate bonds, long-term government bonds, treasury bills.
C)Small stocks, large stocks, treasury bills, long-term government bonds, long-term corporate bonds.
D)Treasury bills, long-term government bonds, long-term corporate bonds, large stocks, small stocks.
E)Large stocks, small stocks, long-term government bonds, long-term corporate bonds, treasury bills.

Question 61

An investment requires a total return that comprises:

A)a real rate of return and compensation for inflation.
B)a real rate of return, compensation for inflation, and a risk premium.
C)compensation for inflation and a risk premium.
D)a real rate of return, compensation for inflation, a risk premium, and compensation for time and effort devoted to researching alternative investments.
E)None of the above

Question 62

The two components that make up the risk-free rate are:

A)real rate of return and capital gains.
B)risk-free assets and capital gains.
C)real rate of return and the inflation factor.
D)real assets and the inflation factor.
E)capital gains and the inflation factor.

Question 63

Because most investors are risk averse,

A)the riskier the investment, the more the investor will pay for it.
B)the riskier the investment, the less compensation the investor requires.
C)only financial institutions invest in risky assets.
D)they will require a higher rate of return for a riskier investment.

Question 64

What would be the rate of return for a stock that increased in value from $60 per share to $63 per share and paid a $3 dividend?

A)12%
B)11%
C)10%
D)1.5%
E)5%

Question 65

Which of the following investments would theoretically always carry the highest risk premium?

A)U.S. treasury bill
B)Common stock
C)Preferred stock
D)Corporate bond
E)Any one of the above

Question 66

One of the reasons a short-term trader has difficulty in beating the market is because of:

A)risk.
B)lack of information.
C)large institutional investors.
D)commissions.

Question 67

What is the risk-free rate in an environment where the real rate is 3% and inflation is running at 3%? Use either method found in chapter one.

A)14.5% or just 14%
B)10.21% or just 10%
C)6.09% or just 6%
D)9.09% or just 9%
E)0%

Question 68

Wealthy investors may prefer the favorable tax treatment of investments such as:

A)corporate bonds.
B)municipal bonds.
C)common stock.
D)preferred stock.

Question 69

Which of the following is not one of the considerations in setting investment objectives?

A)Risk versus safety of principal
B)Maximize wealth versus minimize expenses
C)Current income versus capital appreciation
D)Short-term versus long-term orientation
E)Taxes

Question 70

Stocks and bonds are preferred during periods of:

A)higher inflation.
B)lower inflation.
C)rising stock prices.
D)higher risk premiums.
E)None of the above

Question 71

An investment in common stock carries a higher return than a bank certificate of deposit. The difference in returns is called:

A)the risk-free rate.
B)the real rate of return.
C)the risk premium.
D)the beta.
E)None of the above

Question 72

A stock that pays low or no cash dividends is:

A)eBay.
B)Duke Power.
C)AT&T.
D)All of the above

Question 73

What are the components in determining the real rate of return?

A)The risk premium
B)The inflation factor
C)The required rate of return
D)Both a) and b) above
E)None of the above

Question 74

An investor in Duke Energy can expect:

A)low dividends.
B)high dividends.
C)low inflation.
D)fast stock price growth.
E)None of the above

Question 75

Deposits in an IRA are:

A)allowed to grow tax free until withdrawal.
B)deducted from current income tax due.
C)deducted from current income to reduce income tax due.
D)A and C

Question 76

Common stock dividends are now taxed at a maximum rate of:

A)10%.
B)15%.
C)20%.
D)30%.
E)38.8%.

Question 77

____, because of increasing replacement value and scarcity, perform(s) best in periods of high inflation.

A)Real assets
B)Common stock
C)Preferred stock
D)Financial assets
E)More than one of the above

Question 78

What is the rate of return on a share of common stock that increased in value from $40 to $50?

A)5%
B)10%
C)20%
D)25%
E)None of the above

Question 79

The ability of the investor to convert an investment into cash in a short period of time is called:

A)short-term orientation.
B)low investment risk.
C)liquidity.
D)capital appreciation.
E)None of the above

Question 80

The holding period to qualify for long-term capital gains is:

A)at least 6 months.
B)at least 9 months.
C)at least 18 months.
D)at least 2 years.
E)more than one year.