File: ch04, Chapter 4: Securities Markets and Market Indexes

Multiple Choice Questions

1. The sale of a new issue of common stock of which there are already shares
publicly held is known as:

a. an IPO.
b. a secondary market issue.
c. an EPO.
d. a seasoned new issue.

Ans: d
Difficulty: Easy
Ref: The Primary Markets

2. In a firm commitment underwriting arrangement, the risk of placing the

security is typically assumed by the:

a. issuer of the security

b. investment bankers
c. commercial bankers
d. institutional investors

Ans: b
Difficulty: Easy
Ref: The Primary Markets

3. The ___________ summarizes information about a new security issue.

a. syndicate offer
b. IPO
c. prospectus
d. shelf rule

Ans: c
Difficulty: Easy
Ref: The Primary Markets

4. Investment bankers are compensated by:

a. the underwriting spread

b. commissions paid by the buyers of the security
c. commission paid by the sellers of the security

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d. guaranteed investment contracts

Ans: a
Difficulty: Moderate
Ref: The Primary Markets

5. A major appeal for U.S. firms selling bonds in private placements is potential:

a. lower interest expense

b. greater regulatory protection
c. savings from not registering with the SEC or incurring an underwriting spread
d. fewer restrictions on subsequent borrowing activities

Ans: c
Difficulty: Moderate
Ref: The Primary Markets

6. Automatic Shelf Registration refers to the practice of allowing:

a. well-seasoned issuers to file shelf registration statements with the SEC that become
effective immediately, or the filing of a “base prospectus,” enabling efficient stock
issue
b. well-seasoned issuers to file shelf registration statements with the SEC that become
effective immediately, or the filing of a “base prospectus,” enabling efficient debt
issue
c. well-seasoned issuers to file shelf registration statements with the SEC that become
effective immediately, or the filing of a “base prospectus,” enabling efficient stock or
debt issue
d. well-seasoned issuers to file shelf registration statements with the SEC that become
effective immediately upon filing of a “red herring prospectus,” enabling efficient
stock or bond issue

Ans: c
Difficulty: Difficult
Ref: The Primary Markets

7. Investment bankers operate in the:

a. primary market
b. secondary market
c. tertiary market
d. fourth market

Ans: a
Difficulty: Easy

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Ref: The Primary Markets

8. NASDAQ stocks:

a. are generally foreign stocks.

b. trade via the Blue Sheets.
c. are not generally listed on organized exchanges.
d. represent less than 1,000 companies.

Ans: c
Difficulty: Easy
Ref: The Secondary Markets

9. Which exchange member is assigned to a specific trading post?

a. Commission broker
b. Floor trader
c. Specialist
d. Dealer

Ans: c
Difficulty: Easy
Ref: The Secondary Markets

10. According to its website, NYSE Euronext accounts for nearly what percent of
the world’s publicly traded equity securities?

a. nearly 25%
b. nearly 33%
c. nearly 40%
d. nearly 50%

Ans: c
Difficulty: Easy
Ref: The Secondary Markets

11. The NYSE is now part of a:

a. not-for-profit corporation.
b. a quasi-federal agency.
c. a publicly-owned company.
d. a multinational company.

Ans: c
Difficulty: Moderate

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Ref: The Secondary Markets

12. A block trade is defined as a transaction involving at least:

a. 1,000 shares
b. 5,000 shares
c. 10,000 shares
d. 1 million share

Ans: c
Difficulty: Moderate
Ref: The Secondary Markets

13. A type of trading involving a basket of 15 stocks or more and often used in
conjunction with arbitrage strategies is called:

a. swapping
b. program trading
c. day trading
d. insider trading

Ans: b
Difficulty: Moderate
Ref: The Secondary Markets

14. Which of the following is not true regarding the NYSE Amex?

a. It specializes in technology and biotech stocks

b. It trades only ETFs
c. It specializes in small- and mid-cap stocks
d. It is an Over-the-Counter (OTC) market

Ans: c
Difficulty: Moderate
Ref: The Secondary Markets

15. Which of the following statements regarding the Nasdaq Stock Market is not
true?

a. It was less affected by the 2000-2002 market decline than the NYSE
b. NASDAQ dealers make a market by standing ready to buy and sell
securities
c. Stocks listed on the NYSE may also trade on NASDAQ

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d. NASDAQ’s electronic trading system provides instantaneous
transactions

Ans: a
Difficulty: Difficult
Ref: The Secondary Markets

16. A computerized trading network that matches buy and sell orders
electronically entered by customers is a:

a. National Markets System

b. Electronic Communications Network
c. Internet Investment Service
d. Global Investment Network

Ans: b
Difficulty: Moderate
Ref: The Secondary Markets

17. The original electronic network, started in 1969 for brokers, dealers, exchange
specialists and institutional investors only is known as:

a. ReadiMarket
b. National Market System
c. OTC Worldwide
d. lnstinet

Ans: d
Difficulty: Moderate
Ref: The Secondary Market

18. NASDAQ tends to list stocks concentrated in this industry: to be concentrated

in these two industries:

a. aerospace.
b. energy.
c. technology.
d. telecommunications.

Ans: c
Difficulty: Moderate
Ref: The Secondary Markets

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19. Some OTC stocks are traded through the:

a. Blue Sheets.
b. Red Sheets.
c. Pink Sheets
d. Green Sheets.

Ans: c
Difficulty: Easy
Ref: The Secondary Markets

20. The fastest growing region in the world is:

a. Western Europe.
b. Latin America.
c. Eastern Europe.
d. the Far East.

Ans: d
Difficulty: Easy
Ref: The Secondary Markets

21. Which of the following statements about NYSE is true?

a. The NYSE is the oldest and most prominent primary market in the U.S.
b. Specialists account for over 50 percent of the seats on the NYSE.
c. The NYSE is the oldest and most prominent secondary market in the
U.S.
d. Institutional investors do not trade on the NYSE

Ans: c
Difficulty: Difficult
Ref: The Secondary Markets

22. Europe's leading cross border exchange is:

a. Deutsche Boerse
b. Euromarket
c. London Stock Exchange
d. NYSE Euronext

Ans: d
Difficulty: Moderate
Ref: The Secondary Markets

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23. In-house trading refers to:

a. trades made only on the floor of the exchanges

b. direct trades made between OTC dealers
c. trades by fund managers without the use of brokers or exchanges
d. trades made between specialists on the NYSE

Ans: c
Difficulty: Moderate
Ref: The Secondary Markets

24. The price that some seller is trying to sell a stock for is known at the:

a. the bid quote

b. the ask quote
c. the closing price
d. the specialist price

Ans: b
Difficulty: Moderate
Ref: The Secondary Markets

25. The difference between the bid and the ask price is known as the:

a. commission
b. premium
c. quote
d. spread

Ans: d
Difficulty: Moderate
Ref: The Secondary Markets

26. The largest electronic screen-based equity securities market in the U.S. is
known as:

a. Pink Sheets
b. Instinet
c. Amex
d. NASDAQ

Ans: d
Difficulty: Moderate

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Ref: The Secondary Markets

27. The Dow-Jones Industrial Average has historically consisted of high quality
stocks that were considered to be:

a. OTC stocks
b. cyclical stock
c. blue-chip stocks
d. defensive stocks

Ans: c
Difficulty: Easy
Ref: Stock Market Indexes

28. A criticism of the Dow-Jones Industrial Average (DJIA) is:

a. it has too few stocks in the average

b. it is a value weighted method
c. it adjusts for even small stock dividends
d. it includes too many risky stocks

Ans: a
Difficulty: Moderate
Ref: Stock Market Indexes

29. A major difference between the Standard & Poor’s 500 Index (S&P) and the
Dow-Jones Industrial Average (DJIA) is that:

a. the S&P 500 is more dominated by OTC stocks than the DJIA
b. the S&P 500 is more difficult to calculate than the DJIA
c. the DJIA is a price-weighted rather than value-weighted index like the S&P
500 d. the S&P 500 is more stable than the DJIA

Ans: c
Difficulty: Difficult
Ref: Stock Market Indexes

30. Which of the following limits the usefulness of the S&P 500 Index as
a market benchmark?

a. It is too weighted with NYSE stocks to be representative.

b. It is too difficult to calculate for the average investor.
c. Its use of a base year in its calculations affects its performance.
d. Its performance can be greatly affected by a small number of stocks.

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Ans: d
Difficulty: Difficult
Ref: Stock Market Indexes

31. A market capitalization-weighted index obtains the current market value of

each stock by:

a. using the closing market price.

b. multiplying price times shares outstanding.
c. multiplying price times daily volume.
d. dividing earnings by shares outstanding.

Ans: b
Difficulty: Moderate
Ref: Stock Market Indexes

32. Most secondary bond trading takes place on:

a. the NYSE
b. the American Stock Exchange
c. the OTC
d. the Philadelphia Exchange

Ans: c
Difficulty: Difficult
Ref: Bond Markets

33. The yields on corporate bonds issued in the primary market should
be___________the yields on similar corporate bonds trading in the secondary
market.

a. much less than

b. exactly the same as
c. slightly higher than
d. similar to

Ans: d
Difficulty: Moderate
Ref: Bond Markets

34. The type of bonds with the thinnest secondary market is:

a. agency bonds

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b. corporate bonds
c. Treasury bonds
d. municipal bonds

Ans: d
Difficulty: Moderate
Ref: Bond Markets

36. The open-outcry system for trading securities is utilized in the:

a. futures market
b. municipal bond market
c. Treasury bond market
d. options market

Ans: a
Difficulty: Easy
Ref: Derivatives Markets

True-False Questions

1. A large public offering is often handled by a syndicate of investment banking

firms, with one lead managing underwriter.

Ans: T
Difficulty: Easy
Ref: The Primary Markets

2. In private placements, new securities issues are sold directly to financial

institutions.

Ans: T
Difficulty: Easy
Ref: The Primary Markets

3. Stocks traded on NASDAQ are bought and sold from specialists, who are
often affiliated with brokerage firms.

Ans: F
Difficulty: Difficult
Ref: The Primary Markets

5. The NASDAQ 100 Composite Index is a value-weighted index.

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Ans: T
Difficulty: Moderate
Ref: The Secondary Markets

6. Smaller companies with fewer publicly held shares are more likely to meet the
listing requirements of the NYSE.

Ans: F
Difficulty: Easy
Ref: The Secondary Markets

7. Prices of stocks traded on the NYSE are determined through supply and
demand.

Ans: T
Difficulty: Moderate
Ref: The Secondary Markets

8. Orders on Nasdaq come from market makers, ECNs and on-line brokers.

Ans: T
Difficulty: Moderate
Ref: The Secondary Markets

9. All OTC stocks are included in the Nasdaq.

Ans: F
Difficulty: Moderate
Ref: The Secondary Markets

10. By 2005, program trading accounted for over 70 percent of total NYSE
volume.

Ans: F
Difficulty: Difficult
Ref: The Secondary Markets

11. ECNs offer the advantages of automation, lower costs and anonymity to its
members.

Ans: T
Difficulty: Moderate
Ref: The Secondary Markets

12. Normal stock exchange hours in the U.S. are 9:30 a.m. to 4 p.m.

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Ans: T
Difficulty: Easy
Ref: The Secondary Markets

13. The Dow Jones averages handle stock splits by adjusting the market value of
the stocks.

Ans: F
Difficulty: Moderate
Ref: Stock Market Indexes

Fill-in-the-Blank Questions

1. The S&P 500 comprises approximately ________________ percent of the

market capitalization of all U.S. publicly traded companies.

Ans: 75
Difficulty: Moderate
Ref: Stock Market Indexes

2. The DJIA is a ______________-weighted index.

Ans: price
Difficulty: Easy
Ref: Stock Market Indexes

Short-Answer Questions

1. What is the difference between a seasoned new issue and an initial public
offering?

Ans: A seasoned new issue is the sale of a publicly traded company while an IPO
represents the first time an issuer has sold securities.
Difficulty: Moderate

2. What are the major advantages of a private placement for the issuer of
securities?

Ans: The issuer avoids SEC registration, which saves time. In addition, investment
banking fees are normally avoided, since they are not typically incurred in
private placements.
Difficulty: Moderate

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3. What are the major similarities and differences between a specialist and a
dealer?

Ans: Both have their own inventory of selected securities and both can make a
profit (or loss) from the trades made from their own inventory. However, the
specialist does not set the security’s price as the dealer does. In addition, the specialist
operates on the exchanges while the dealer operates on the OTC market.
Difficulty: Difficult

4. What factors does the NYSE consider important in determining if a company

should be listed on the exchange?

Answer: The exchange pays close attention to the degree of national interest in the
company, its relative position and stability in the industry, and its prospects for
maintaining that relative position.
Difficulty: Moderate

5. What is the Nasdaq National Market System?

Answer: The Nasdaq/NMS, which is a component of the Nasdaq market, is a

combination of the competing market makers in OTC stocks and the up- to-
the-minute reporting of trades.
Difficulty: Moderate

6. What is the difference between a price-weighted index and a market-value

index?

Answer: A price-weighted series gives more weight to higher priced stocks

whereas under a market value approach, each stock’s importance is
based on relative total market value, not price per share.
Difficulty: Moderate

7. Why do the DJIA and the S&P 500 have a high correlation?

Answer: Because both are calculated primarily using NYSE stocks.

Difficulty: Easy

8. What is Instinet and what does it offer for investors?

Answer: It is the original electronic trading network and offers anonymous trading
and access to more than 40 equity markets worldwide.
Difficulty: Moderate

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Critical Thinking/Essay Questions

1. How do you think the globalization of the securities markets will impact the
NYSE and the Nasdaq? What specific developments do you foresee
happening soon for the global marketplace?

Answer: There will be a higher correlation between international markets and

international developments, such as the Asian crisis. Such events will
have a greater impact on the NYSE and the Nasdaq than in times past.
Soon, investors will have greater access to the global marketplace and
will be able to trade foreign securities much easier. This will increase
the overall volume of securities trading.
Difficulty: Moderate

2. What impact does the increasing amount of institutional investing have on

securities markets today and what role do you think institutional investors will
play in the future?

Answer: Institutional investors definitely increase the volume of trading and

volatility of the markets. Since most institutional investors, especially
the fund managers, are judged on short-term performance, they are
more likely to trade in and out of positions in order to bolster their
return. They provide a great deal of information to individual
investors, often free. They are likely to continue to dominate certain
sectors of the market, such as IPOs.
Difficulty: Difficult

3. An NYSE Euronext market maker awaits news of a major merger involving

one of the stocks he/she makes a market in. Why does he/she set the bid-ask spread
higher?

Ans: Insiders who have knowledge about the outcome of the merger may trade on
superior knowledge.
Difficulty: Difficult
Ref: The Secondary Markets

Problems

1. Global Stock Index is a value weighted index with just 2 stocks in the index:
ABC stock and XYZ stock.

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 ABC ended 2005 at a price of $55 and had 1 million shares outstanding. XYZ
stock ended 2005 at a price of $32 and had 4 million shares outstanding.

ABC ended 2006 at a price of $29 (after a 2-for-1 split). XYZ stock closed at
$35 for 2006.

Calculate the new value of the index.

Solution: 2005 stock price X #shares Market value

ABC $55 1 million = $55,000,000
XYZ $32 4 million = 128,000,000
183,000,000

2006 stock price X #shares Market value

ABC $29 2 million = $58,000,000
XYZ $35 4 million = 140,000,000

198,000,000

New value of index: 198,000,000

183,000,000 X 100 = 1.082 X 100 = 108.2

Difficulty: Difficult

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