Question 1

A client has $100,000 to invest. They are considering a short-term investment that is unsecured but think it may be a good idea to have the issuer to be a large corporation. What investment vehicle should a financial planner suggest?

Accepted Answer

A client considering a short-term investment at $100,000 issued by a large corporation and is unsecured should be offered commercial paper. Commercial paper are considered promissory notes, they are unsecured documents signed by the borrower promising to repay a loan under specified conditions are not backed by the specific asset as security. The issuers are large corporations and finance companies with strong credit ratings. Investments must be $100,000 or more and matures in 2-3 days to 270 days. The marketability of commercial paper is the weak secondary market.

Question 2

What type of financial investment is guaranteed by a commercial bank?

Accepted Answer

Banker's acceptances are financial investments that are guaranteed by commercial banks. These investments are short-term debt instrument issued by a firm as part of a commercial transaction and then backed by commercial banks. The bank takes full and complete responsibility for repaying these loans to the holder. The acceptances are sold on a discounted basis and are common with international trade.

Question 3

In 1985, the Treasury introduced a zero coupon bond called STRIPS; they are direct obligations of the federal government. Your client is interested in investing a sum of funds that can grow tax-free and is concerned about bond volatility, what should you inform your client about STRIPS?

Accepted Answer

A client wanting to invest in STRIPS should be informed that STRIPS can be volatile, but do not grow tax-free. However, the client should also be informed that STRIPS can be purchased through retirement accounts. STRIPS bought in this fashion are recommended since the taxed interest is taxed during the retirement years when tax brackets are lower. These bonds are more volatile than other government bonds during periods changing interest rates; therefore it is best to purchase them when interest rates are expected to fall.

Question 4

Assume you have a client that is willing to take a moderate level of risk when investing. They are interested in government coupons and want to take advantage the highs and lows of inflation, what should be recommended?

Accepted Answer

A client willing to take a moderate level of risk, is interested in government coupons, and wishes to take advantage of highs and lows of inflation should be geared towards Treasury Inflation Protected Securities (TIPS). TIPS are securities issued by the federal government that have coupon payments that periodically adjust to changes in the inflation rate. The changes in inflation are represented in the principal and not the coupon. The inflation-adjusted principal is multiplied by the real rate to get the appropriate coupon payment.

Question 5

The U.S. Government's Series E bond was replaced by what bond?

Accepted Answer

The U.S. Government's Series E bond was replaced by the EE bond. The original bond was designed to encourage more people to save money. It was sold in denominations of $25 - $10,000 and were sold at a discount and paid no interest. The Treasury issued the new Series EE bond to replace the Series E bond. The rate of interest is a variable that allows investors to benefit from increasing interest rates. Neither of these bonds is taxable until the bonds are redeemed or reach maturity. However, they do permit recognition of the income in earlier years with a valid election. Recognizing the income from the bonds may be a tax planning strategy for young children who have no other taxable income and will thereby create basis in the bonds. Once the Series EE bonds reach maturity, taxes can further be deferred by exchanging them for HH bonds.

Question 6

What type of investment vehicle is issued by federal agencies, are not debt of the federal government, provide higher yields than the U.S. Treasury debt, and are extremely safe for investors?

Accepted Answer

Mortgaged-backed securities are issued by federal agencies, but are not debt of the federal government, they provide higher yield than the U.S. Treasury debt. These securities are extremely safe for investors since they are backed by the federal government. However, this backing in most cases is only moral backing, which, in the case of default, the federal government is not obligated to support the debt. N Treasury debt is legally bound to assume any obligation contained in the debt's indenture.

Question 7

Some bonds are issued to purchase specific fixed assets, some are promissory notes, still others are sold with no coupon at a discount; what type of bonds are debt obligations issued by state and local government?

Accepted Answer

Municipal bonds are issued by state and local governments. These are general obligation bonds that are backed by the full faith and credit of the government unit. The revenue gained is by the specific project financed by the bond issue.

Question 8

Some bonds are debt obligations issued by state and local governments, others are sold with no coupon at a discount, still others are promissory notes; what type of bond are issued to purchase specific fixed assets that are pledged to secure debt?

Accepted Answer

Corporate bonds are issued to purchase specific fixed assets that are pledged to secure debt. These bonds are mainly issued through utility companies which use the proceeds to build power plants. As the asset generates revenue, the revenue generated goes toward retiring the debt and servicing the interest.

Question 9

A shareholder owns 100 shares and there are three positions on the board of directors. How many votes does this shareholder have and what is the proper term for this voting right?

Accepted Answer

A board of directors with three members and a shareholder with 100 shares would have 300 votes, thus using cumulative voting rights. Cumulative voting rights permits a shareholder to cast votes equal to the number of positions on the board of directors times the number of shares owned, allocated in any way the shareholder sees fit. Cumulative voting helps to protect minority shareholders' right to management.

Question 10

By what means can current stockholders use to maintain their proportionate ownership in a firm?

Accepted Answer

Current stockholders use pre-emptive rights to maintain their proportionate ownership in a firm. Firms that have given pre-emptive rights present a rights offering when they issue new stock. This offering allows existing shareholders to purchase new shares before they are offered to the general public. This right prevents dilution of an investor's ownership percentage when new shares are issued. The right is defined as an option given to stockholders to buy additional shares a specified price during a specified time period. The distribution affects the shareholder's proportionate interest in the corporation.

Question 11

Your client has an investment bond paying a coupon rate of 5 percent, but inflation increased to 5.5 percent. What type of risk does the scenario represent?

Accepted Answer

A client with an investment bond paying a coupon rate of 5 percent with inflation increased 5.5 percent is experiencing a purchasing power risk. Purchasing power risk is often called inflation risk; it arises from variations in cash flows from a security because of inflation, which reduces the purchasing power of money. The difference between the client's 5 percent and inflation's 5.5 percent is declined the money's value.

Question 12

Interest rates have an inverse relationship with what type of investments?

Accepted Answer

Interest rates have an inverse relationship with both bonds and stocks. This is to say, when the market interest rates increase, the prices of bonds and stock go down. When market interest rates droop, the prices go up. The inverse relationship between market yields and bond process is extended to a bond's coupon. It market yields fall below a bond's coupon, the price of the bond will always exceed its par value. The bond is said to trade at a premium. In contrast, when market yield rises above coupons, the price of a bond is always less than its par value and said to be trading at a discount.

Question 13

You have invested $10,000 of your client's money in the exchange market of Spain. You have introduced your client's money to what?

Accepted Answer

When investing a client's money in Spain or any other foreign market, you are introducing your client's money to exchange rate risk. Exchange rate risk, or currency risk, occurs when interest and dividend payment are denominated in a foreign currency and the value of the currency fluctuates relative to the value of the home currency. If the foreign currency increases against the home currency, each unit, or dollar, will be worth less; if a foreign currency decreases against the home currency, each unit will be worth more.

Question 14

Systematic risk includes risks that affect the entire market; the risk cannot be eliminated through diversification because it affects the entire market. For an investor to determine total financial risk, what must also be determined?

Accepted Answer

For an investor to determine total financial risk, a nonmarket risk must also be combined with systematic risk. Nonmarket risk is also known as unsystematic risk. It is risk associated with individual events that affect a particular security. It implies the ease with which a security can be bought or sold. These risks include business risk and financial risk. Unlike systematic risk, unsystematic risk can be eliminated through diversification.

Question 15

What concept states that the larger a sample population the more accurate the prediction acquired by the testing of the sample?

Accepted Answer

The law of large number states that the larger a sample population the more accurate the prediction acquired by the testing of the sample. There is a deviation in comparison outcomes are expected to be smaller than if using a small population sample. It is assumed the

Question 16

What would have to be completed to compare the benefits of a project to the cost of a project?

Accepted Answer

A cost-benefit analysis would have to be completed to compare the benefits of a project to the cost of a project. The benefit and cost is expressed in terms of money.

Question 17

What term is defined as the variability or uncertainly in a firm's operating income or earnings before interest and taxes?

Accepted Answer

Business risk is defined as the variability or uncertainly in a firm's operating income or earnings before interest and taxes. It is evident from the income statement that variability in earnings per share is affected by business risk. This is the risk inherent in the business, or the risk resulting from the asset side of the balance sheet. Business risks are unique to a single business or industry, such as operations and methods of financing. Investment risk equals total risk equals standard deviation equals systematic risk plus unsystematic risk.

Question 18

A firm takes out a loan for investments; this introduces the firm to what type of risk?

Accepted Answer

A firm taking out a loan for investments become introduced to financial risks. Financial risk is the uncertainty introduced through ho a firm finances its investments. If a firm uses common stock only to finance investments, it incurs only business risk. If a firm borrows money to fiancé investments, it must pay fixed financing charges in the form of interest to creditors prior to providing income to the common stockholder. This causes the uncertainty of returns to equity investors to increase. This increase in uncertainty because of fixed-cost financing is called financial risk and causes an increase in the stock's risk premium.

Question 19

What improves when more participants are engaged in trading a security?

Accepted Answer

Liquidity risk improves when more participants are engaged in trading a security. Liquidity risk represents the ease with which a security can be sold at a fair price without risk of loss. Securities can be marketable but not necessarily liquid. The primary measure of liquidity is the size of the spread between the bid and ask. A larger spread signals an illiquid market. Investors want liquid markets so as to sell their securities quickly at a fair price.

Question 20

What do normal distribution and "skewness" have in common?

Accepted Answer

Normal distribution and "skewness" have the bell curve in common. Normal distribution measures the results of a bell curve. "Skewness" measures the symmetry of the bell curve. The "skewness" occurs wherever the tail is larger. "Skewness" to the right represents positive and to the left represents negative.

Quiz 4: Investment Planning