Chapter 1 The Investment Environment: Fundamentals of Investing

Fundamentals of Investing,
Chapter 1 The Investment Environment
1.1 Learning Goal 1
1) A non-interest bearing checking account is still considered an investment.

Answer: TRUE or FALSE
*Page: 31
2) Land and buildings are examples of real property investments.

*Page: 33
3) Since 1900, the average return on stocks has exceeded the average return on savings
accounts by more than 6 percentage points.
*Page: 39
4) A United States Savings Bond is an example of an investment as defined in the text.

*Page: 35
5) Most sources of investment information are in print format, expensive, and difficult to
access.
*Page: 23
6) Which of the following is NOT an investment as defined in the text?

A) a certificate of deposit issued by a bank
B) a new automobile
C) a United States Saving Bond
D) a mutual fund held in a retirement account
*Page: 37
7) Stocks are a(n) ________ investment representing ________ of a business.

A) direct; ownership
B) direct; debt
C) indirect; ownership
D) indirect; debt *Page: 34
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Copyright © 2017 Pearson Education, Inc.
8) An exchange traded fund that invests in the stocks of large corporations is an example of
A) direct investment.
B) indirect investment.
C) derivative investment.
D) tangible investment.
*Page: 33
9) Which of the following has declined in recent years?

A) direct ownership of stock by individual investors
B) the percentage of foreign stocks held in typical portfolios
C) institutional ownership of common stocks
D) the timeliness of information available to investors
10) Debt represents funds loaned in exchange for
A) dividend income and the repayment of the loan principal.
B) dividend income and an ownership interest in the firm.
C) interest income and a partial ownership interest in the firm.
D) interest income and the repayment of the loan principal.
*Page: 33
1.2 Learning Goal 2
1) Institutional investors manage money for businesses and nonprofit organizations, but not for
individuals.
Answer: TRUE or FALSE *Page:34
2) Institutional investors are individuals who invest indirectly through financial institutions.
Answer: TRUE or FALSE *Page: 36
3) Banks and insurance companies are examples of institutional investors.

4) In the financial markets, individuals are net demanders of funds.

5) The government is generally

A) not involved in the financial markets.
B) the owner of the financial market.
C) a supplier of funds to the financial market.
D) a demander of funds in the financial market. *Page: 35
6) On a net basis, funds in the financial markets are generally supplied by

A) individuals.
B) both individuals and business firms.
C) business firms.
D) the government. *Page: 36
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7) A forum in which suppliers and demanders of funds make financial transactions is called a
financial
A) institution.
B) bank.
C) instrument.
D) market.
*Page: 35
8) Which of the following are true concerning institutional investors?
I. Institutional investors are professionals who manage money for other people.
II. Banks, insurance companies and mutual funds are all institutional investors.
III. Institutional investors are individuals who invest indirectly through financial institutions.
IV. Institutional investors invest large sums of money.
A) I and II only
B) I, II and IV only
C) II, III and IV only
D) I, II, III and IV
*Page:35
9) Which of the following is NOT traded in the securities markets?

A) stocks
B) bonds
C) derivatives
D) real estate *Page: 35
10) Describe the major differences between individual and institutional investors.
Answer: Individual investors manage their own funds to achieve individual goals such as
increasing financial security or financing a comfortable retirement. Institutional investors such
as mutual funds and insurance companies manage funds for individuals who lack the time or
expertise to invest individually and for other institutions such as universities or charities.
*Page: 36
1.3 Learning Goal 3
1) Bond investors lend their money for a fixed period of time and receive interest.
2) A collection of securities designed to meet an investment goal is called a portfolio.

3) If the value of a common stock increases the value of an option to buy that stock should also
increase.
3
4) An option to purchase common stock is a type of derivative security.

5) Bonds represent a lower level of risk than do stocks in the same company.
6) Exchange traded funds are similar to mutual funds, but are traded like stocks.
7) Mutual funds invest in diversified portfolios of securities.

8) Bond prices rise as interest rates decline.

9) Bond interest and stock dividends are different ways of distributing a corporation's earnings
to its owners.
10) Which of the following is an example of a tangible asset?

A) bonds
B) mutual funds
C) real estate
D) stocks
*Page: 33
11) Which one of the following would be the most liquid investment?
A) stock
B) Series EE bond
C) money market mutual fund
D) real estate
*Page: 38
12) Which of the following investments represents partial ownership of a corporation?

A) bonds
B) mutual funds
C) commercial paper
D) common stock
*Page: 41
13) Investors seeking a diversified, professionally managed portfolio of securities can purchase
shares of
4
A) preferred stock.
B) convertible securities.
C) insurance policies.
D) mutual funds.
*Page: 41
14) One feature that mutual funds and exchange traded funds have in common is
A) they trade continuously throughout the trading day.
B) their portfolios are always based on one of the major market indexes.
C) they invest in broadly diversified portfolios of securities.
D) investors purchase share from the funds managers rather than from other investors.
*Page: 41
15) Briefly describe three advantages of investing in mutual funds or exchange traded funds.
Answer: The investor does not need to spend a great deal of time researching individual
securities. Small investors easily achieve diversification by investing indirectly in a broad
portfolio of securities. The funds are managed by professionals who presumably have expertise
in making investment decisions.
*Page: 42
1.4 Learning Goal 4
1) Earning a high rate of return with little or no risk is a realistic investment goal.
*Page: 53
2) Under current tax laws, most taxpayers will pay a lower tax rate on capital gains than on
dividends.
*Page: 49
3) Under current tax laws, most taxpayers will pay a lower tax rate on capital gains than on
income from wages.
*Page: 46
4) Investors can postpone or avoid income taxes by investing through Individual Retirement
Accounts.
*Page: 46
5
5) Short-term capital gains are taxed at the taxpayer's marginal tax rate.
*Page: 49
6) To qualify for long-term capital gains rates, a stock must be held for at least 12 months.
*Page: 48
7) Retirement plans, such as a 401(k), allow employees to defer taxes on the plan contributions
until such time as the funds are withdrawn from the retirement plan.
*Page: 49
8) You should spend money on housing, clothing and basic insurance before investing.
*Page: 53-54
9) Which of the following represent investment goals?
I. saving for major expenditures such as a house or education

II. sheltering income from taxes
III. increasing current income
IV. saving funds for retirement
A) I and IV only
B) III and IV only
C) I, III and IV only
D) I,,II, III and IV
*Page: 51
10) In selecting investments consistent with your goals, you should consider
A) rates of return and taxes only.
B) the pre-tax rate of return only.
C) annual dividends and taxes only.
D) risks, returns, and taxes.
*Page: 52
11) Sarah purchased a stock one year ago at a price of $32 a share. In the past year, she has
received four quarterly dividends of $0.75 each. Today she sold the stock for $38 a share. Her
capital gain per share is
6
A) $3.00.
B) $6.00.
C) $(6.00).
D) $9.00.
*Page: 40
12) A well-conceived investment policy statement will specify

A) the investor's current age and economic situation.
B) the investor's preference for frequent or infrequent trading.
C) the types of investments the investor is willing to consider.
D) all of the above.
*Page: 51
13) Beginning investors with small amounts to invest should

A) avoid stock investments completely.
B) invest all of their money in one high quality stock.
C) buy mutual funds or exchange traded funds (ETFs).
D) buy a portfolio of very low priced stocks (penny stocks).
*Page: 47
14) Research indicates that investors who closely monitor their portfolios and trade quickly in
response to minor fluctuations in price
A) outperform those who hold investments for the long-term and trade infrequently.
B) underperform those who hold investments for the long-term and trade infrequently.
C) earn rates of return similar to those who hold investments for the long-term and trade
infrequently.
D) be more highly educated and in higher income brackets than those who hold investments for
the long term and trade infrequently.
*Page: 39
Table 1.2
Use the following tax rates and income brackets for 2015 to answer the following question(s).
15) In 2015, John and Nicole earned a combined taxable income of $148,800 from employment
plus $1,000 in long term capital gains and they file a joint tax return. What is their total federal
income tax? Round to the nearest dollar.
7
A) $37,150
B) $29,063
C) $29,593
D) $28,963
*Page: 54
16) Josh earned $82,500 in taxable income, all from wages and interest, and files an individual
tax return. What is the amount of Josh's taxes for the year 2015? Round to the nearest dollar.
A) $13,750
B) $16,481
C) $18,425
D) $12,285
*Page: 44
17) For a taxpayer in the 25% marginal tax bracket, a long-term capital gain realized in 2015
will be taxed at
A) 5%.
B) 10%.
C) 15%.
D) 25%.
*Page: 48
18) Andrew and Jennifer are in the 25% marginal tax bracket. Three years ago they purchased
100 shares of stock at $20 a share. In 2015, they sold the 100 shares for $29 a share. What is
the amount of federal income tax they owe as a result of this sale?
A) $135
B) $165
C) $225
D) $435
*Page: 43
19) Michelle and Patrick are in the 28% marginal tax bracket. They bought 100 shares of DJN
stock at $45 per share and sold them 4 years later in 2015 at $22 per share? By how much did
their loss reduce their taxes in the year when they sold the stock?
A) $0
B) $644
C) $345
D) $1,260
*Page: 42
20) Under current tax law, dividend income is taxed at the same rate as
8
A) ordinary income.
B) short-term capital gains.
C) long-term capital gains.
D) interest income.
*Page: 56
21) Both the holding period to qualify and the tax rate on long-term capital gains
A) are subject to political pressure and occasionally change.
B) are very stable and have not changed since the 1960s.
C) are phased out on incomes over $388,351.
D) are adjusted for inflation every year.
*Page: 56
22) Tax planning

A) guides investment activities to maximize after-tax returns over the long term for an
acceptable level of risk.
B) ignores the source of income and concentrates solely on the amount of income.
C) is primarily done by individuals with incomes below $200,000.
D) is limited to reviewing income for the current year and determining how to minimize current
taxes.
*Page: 49
23) Speculative and growth oriented investments are least appropriate for
A) young investors.
B) middle-aged investors.
C) retired investors.
D) high income investors.
*Page: 49-50
24) Investors seeking to increase their wealth as quickly as possible would invest in
A) corporate bonds and preferred stock.
B) large company stocks with high dividends.
C) smaller companies pursuing rapid growth.
D) government bonds and low-risk income stocks.
*Page: 50
25) Discuss the relationship between stock prices and investors' beliefs about the business
cycle.
Answer: Stock prices tend to anticipate the economic conditions that investors expect in the
future. When they believe that economic conditions will deteriorate and profits will decline,
stock prices fall. When they expect an improving economy and higher corporate profits, stock
prices rise.
9
*Page: 50
26) What are some of the important prerequisites to investing?

Answer: Before entering into risky investments, individuals need to provide for the necessities
of life such as housing, transportation, and taxes. They should have liquid assets available to
meet unforeseen emergencies such as job loss, auto repairs or dental treatments. They should
also have insurance for catastrophic events involving health or property.
*Page: 50
27) Discuss the general investment philosophy and the types of investments preferred by
investors in each phase of the life cycle.
Answer:
1.5 Learning Goal 5
1) U.S. Treasury Bills mature in 1 year or less.

*Page: 53
2) Liquidity is the ability to convert an investment into cash quickly with little or no loss of
value.
*Page: 52
3) Short-term investments generally provide liquidity, safety, and a high rate of return.
*Page:52
4) Money market accounts, certificates of deposit, bonds and commercial paper are all forms of
short-term investment vehicles.
*Page: 53
5) The primary risk associated with a short-term investment is

10
A) purchasing power risk.
B) default risk.
C) interest rate risk.
D) economic risk.
*Page: 53
6) Short-term investments
I. provide liquidity.
II. fill an important part of most investment programs.
III. provide a high rate of return with low risk.
IV. provide resources for emergencies.
A) I and IV only
B) II and IV only
C) I, II and IV only
*Page: 53
7) Federal insurance protects passbook savings accounts and money market deposit accounts
(MMDAs) up to
A) $100,000.
B) $150,000.
C) $250,000.
D) $1,000,000.
*Page: 52
8) Beginning in 2010, the amount protected by the Federal Deposit Insurance Corporation in
non-interest bearing checking accounts is
A) zero.
B) $100,000.
C) unlimited.
D) $250,000.
*Page: 52
9) Since 2010, the interest rate on passbook accounts and certificates of deposit has
A) been less than the rate of inflation.
B) has closely tracked the rate of inflation.
C) exceeded the rate of inflation by 1.5% on average.
D) fluctuated widely.
*Page: 53
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10) Which one of the following has the lowest level of risk?
A) commercial paper
B) money market mutual fund account
C) banker's acceptance
D) U.S. Treasury bill
*Page: 53
1.6 Learning Goal 6
1) Certified Financial Planners typically manage institutional portfolios.

*Page: 57
2) A major goal of corporate financial management is to increase the value of the firm to
investors.
*Page: 57
3) Stringent regulations and vigorous enforcement have all but eliminated unethical behavior
by financial professionals in recent years.
*Page: 58
4) Insurance companies invest the premiums and fees collected from customers in order to
neutralize the risks assumed from their clients.
*Page: 58
5) Chartered Financial Analyst (CFA) is a degree offered by several prestigious business

schools.
*Page: 58
6) Typical responsibilities of financial professionals in a corporate setting include
I. managing cash and short-term investments.

II. evaluating investment opportunities.
III. working one on one with individuals to formulate plans for reaching their financial goals.
IV. interacting with financial markets to find sources of external financing such as debt and
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equity.
A) I and IV only
*Page: 59
7) Jobs in which of the following fields require an understanding of the investment

environment?
I. commercial banking
II. corporate finance
III. financial planning
IV. insurance
A) I and IV only
*Page: 58
8) A major function of investment banking firms is

A) providing loans to investors.
B) providing financial planning services to wealthy individuals.
C) assisting businesses when they issue stocks and bonds.
D) developing investment strategies to neutralize risk.
*Page: 59
9) Which of the following has set an outstanding example of ethical behavior in the financial
professions?
A) Bernard Madoff of Madoff Securities
B) Hank Greenberg of AIG
C) Ramalinga Raju of Satyam Computers
D) none of the above
*Page: 59
10) In the U.S., the most prestigious designation for financial planners is
A) CFP.
B) CPA.
C) ING.
D) SIPC.
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*Page: 58
11) Briefly describe three different career paths that require a strong background in
investments.
Answer: Students may discuss any of the following career paths. Answers will vary.
Responsibilities of commercial bankers may include portfolio management, managing short-
term securities, and advising individuals as personal bankers.
Corporate financial managers must raise external fuds through the debt and equity markets,
manage short-term investments, and understand investor expectations for their business.
Financial planners assist individuals in choosing the investments that will help them meet their
short and long term goals.
The insurance industry employs professionals to invest and manage the large sums collected
from premiums.
Within the investment management industry, professionals may work as securities analysts,
fund managers, or retail brokers.
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Chapter 1 The Investment Environment: Fundamentals of Investing

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Fundamentals of Investing,

Chapter 1 The Investment Environment

1.1 Learning Goal 1

1) A non-interest bearing checking account is still considered an investment.

2) Land and buildings are examples of real property investments.

4) A United States Savings Bond is an example of an investment as defined in the text.

6) Which of the following is NOT an investment as defined in the text?

7) Stocks are a(n) ________ investment representing ________ of a business.

9) Which of the following has declined in recent years?

1.2 Learning Goal 2

3) Banks and insurance companies are examples of institutional investors.

4) In the financial markets, individuals are net demanders of funds.

5) The government is generally

6) On a net basis, funds in the financial markets are generally supplied by

8) Which of the following are true concerning institutional investors?

9) Which of the following is NOT traded in the securities markets?

1.3 Learning Goal 3

2) A collection of securities designed to meet an investment goal is called a portfolio.

4) An option to purchase common stock is a type of derivative security.

7) Mutual funds invest in diversified portfolios of securities.

8) Bond prices rise as interest rates decline.

10) Which of the following is an example of a tangible asset?

12) Which of the following investments represents partial ownership of a corporation?

1.4 Learning Goal 4

9) Which of the following represent investment goals?

I. saving for major expenditures such as a house or education

12) A well-conceived investment policy statement will specify

13) Beginning investors with small amounts to invest should

22) Tax planning

26) What are some of the important prerequisites to investing?

1.5 Learning Goal 5

1) U.S. Treasury Bills mature in 1 year or less.

5) The primary risk associated with a short-term investment is

1.6 Learning Goal 6

1) Certified Financial Planners typically manage institutional portfolios.

5) Chartered Financial Analyst (CFA) is a degree offered by several prestigious business

6) Typical responsibilities of financial professionals in a corporate setting include

I. managing cash and short-term investments.

7) Jobs in which of the following fields require an understanding of the investment

8) A major function of investment banking firms is

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7) Stocks are a(n) investment representing of a business.