Question 1

Define investment derivatives. Also, present examples of some of the key derivatives.

Accepted Answer

Derivatives are financial instruments that, like futures, are derived from an underlying transaction in goods (stocks, bonds, or money itself). Originally invented for commodities providers as a hedge against price fluctuations, futures and options also give speculators the chance to make a fortune or lose everything.
Examples:
Option Spreads: A call option gives the holder the right to buy the underlying asset on or before a certain date, and at a certain price. A put option gives the holder the right to sell the underlying asset on or before a certain date, and at a certain price. An infinite variety of option spreads exist today. These include yield curve spreads, money-market spreads, spreads on London Inter Bank Offered Rate (LIBOR), T-bills, and Euro-dollar futures, and spreads on mortgage swap, commodities currency, and hybrid equity and bond markets.
Straddles and Strips: These are combination option trading strategies which involve taking a position in both calls and puts on the same stock. Of these, the straddles are the most common strategy. It involves buying equal amounts of puts and calls with the same strike price, the same underlying asset index or currency, and the same expiration date.

Question 2

What are junk bonds? Are they worthless?

Accepted Answer

In Wall Street terminology, corporate bonds rated below BAA by Moody's or below BBB by Standard & Poor's (S&P's) are characterized as junk bonds, whereas bonds with higher ratings are identified as investment quality bonds. The connotation junk comes from the investment community's belief that, under unfavorable economic conditions, market prices of such bonds will significantly drop, producing at least a paper loss. Most junk bonds are not worthless. As a matter of fact, depending upon the risk tolerance level, junk bonds may very well be an appropriate investment in the portfolios of some investors.

Question 3

Describe index funds. What are the key advantages they enjoy over managed funds?

Accepted Answer

Traditionally, index funds were used by institutional investors who wanted to diversify and earn returns close to the market return. At first blush, index funds do not appear to be glamorous. They are designed not to do better or worse than the market they reflect. But in the long run, these funds may prove that slow and steady wins the race. Academic studies show that index funds offer better returns than many actively managed funds.
Index funds have two other advantages over managed funds. First, transactions and sales costs of these funds are minimal: The average expense ratio of these funds could be as low as 0.18 percent versus 1.40 percent for managed funds. Second, because there is little turnover, index funds do not generate as much taxable capital gains as most managed mutual funds do.

Question 4

What are fixed-income securities? List the major types of fixed-income securities available today.

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Question 5

What are preferred stocks? Are there different types of preferred stocks?

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Question 6

Describe the various types of mutual funds classified according to their investment objectives.

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Question 7

Explain the nature of Treasury Inflation-Protection Securities or TIPS.

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Question 8

Compare and contrast no-load and load funds.

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Question 9

Comment on the following statement: "Mutual funds charge so many fees that it is impossible to make any money by investing through them."

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Question 10

What are the three popular nonmarketable government issues?

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Question 11

Compare and contrast warrants and rights.

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Question 12

Explain what is meant by fund alphabet soup.

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Question 13

Distinguish between various types of stocks classified according to their investment grades.

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Question 14

Compare closed-end companies with mutual funds.

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Question 15

Jane Bryant, a widow, bought a AAA-rated, long-term bond issued by Ford because it was safe and guaranteed. However, she is upset because in yesterday's paper it was reported that the price of her bond dropped by 1/4 ($2.50). Can you calm her down?

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Question 16

Describe the various types of municipal bonds that represent an integral part of the fixed-income securities market.

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Question 17

Comment on the following statement: "A mutual fund prospectus is full of legalese and provides little useful information."

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Question 18

Discuss various types of marketable government issues available to investors.

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Question 19

Describe the nature of short selling as a part of an investment strategy.

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Question 20

Distinguish between various types of corporate bonds. Which is the best type of bond from an investor's point of view?

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Quiz 8: Investment Products and Markets: an Introduction