Download File: ch01, Chapter 1: The Nature of Investments

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Multiple Choice
1. Chapter 1 defines the nature of investments. Which of the following is NOT
considered an investment?
a) The commitment of funds to an asset held for the future.
b) Gold coins
c) Treasury notes
d) Renting an apartment
Ans: D
EASY
Response: Investments can be real (gold), or financial (Treasury notes), marketable or
non-marketable, but all are expected to have some value in the future. Section:
Establishing a Framework for Investing.
2. Which of the following is NOT a common reason why many people invest in financial
assets?
a) Save for retirement.
b) Save to buy a house or condominium.
c) Save for children’s education.
d) Help their stockbroker make commissions.
Ans: D
EASY
Response: Although many financial companies do encourage us to invest with them, the
rational reason that people invest is to increase their wealth and their ability to buy goods
and services, like a home, an education, or to fund one’s retirement. Section:
Establishing a Framework for Investing.
3.
a)
b)
c)
d)
Which of the following best describes 401K investment plans?
401Ks are defined benefit plans offered by many employers.
401Ks allow the worker to make his own investment choices.
401Ks are guaranteed by an agency of the US government.
401Ks can only be invested in very safe investments, like government bonds.
Ans: B
MEDIUM
Response: 401K plans are defined contribution plans offered by many private employers,
where the employee chooses where to invest his contributions, and any matching
contribution that the employer may provide. Section: The Importance of Studying
Investments.
4. Which of the following is NOT a career field using an understanding of Investments?
a) Investment bankers
b) Bond salespeople
c) Chemical engineers
d) Registered representatives
Ans: C
EASY
Response: The study of investments prepares people for careers as investment bankers,
bond traders and salespeople, security analysts, portfolio managers, registered
representatives, and financial planners, but not chemical engineers. Section: The
Importance of Studying Investments.
5.
a)
b)
c)
d)
Which of the following is the foundation for making investment decisions?
Buying the right investment products.
The trade-off between expected return and risk.
Making the most money.
Minimizing taxes, commissions and storage costs.
Ans: B
HARD
Response: Maximizing expected return is important, but only once we have considered
risk. We can only know which investment products are “right” after defining our goals –
maximize expected return for a specified level of risk. Taxes, commissions, and similar
transaction costs can be significant, but must be considered part of expected return.
Section: Understanding the Investment Decision Process.
6. Refer to the table in Example 1-1. Which factor causes the greatest increase in the
Final Dollar Wealth?
a) The amount invested per year.
b) The number of years invested.
c) The interest rate.
d) The final dollar wealth does not change.
Ans: B
EASY
Response: The discussion in the example highlights the benefits of higher rates, but the
longer investment period has an even stronger effect. Section: The Importance of
Studying Investments.
7. Which of the following is a financial product NOT normally available to smaller
investors?
a) Individual Retirement Accounts (IRAs).
b) Self-directed retirement plans (including 401Ks)
c) Hedge funds
d) Mutual funds
Ans: C
MEDIUM
Reponse: 401Ks, mutual funds and IRAs are available to most individual investors, but
hedge funds are only available to institutional investors and certain high net worth
individuals. Section: The Importance of Studying Investments
8. Which of the following is considered an “investment,” but not a “marketable
security”?
a) Common stocks
b) An apartment building
c) Treasury bonds
d) Exchange Traded Funds
Ans: B
EASY
Response: An investment in an apartment building is considered an investment in a “real”
asset, not a “financial” asset. Stocks, bonds and funds are considered “financial assets”,
making them liquid, tradable investments, i.e. marketable securities. Section:
Establishing a Framework for Investing.
9. Which of the following investment professionals is responsible for selling mutual
funds and other investment products to individual investors?
a) Portfolio Manager
b) Investment Banker
c) Security Analyst
d) Stockbroker
Ans: D
MEDIUM
Response: Portfolio managers are responsible for making the buy/sell decisions in a
portfolio of securities. Investment bankers assist with mergers and acquisitions, as well
as arranging the sale of new securities to institutional investors. A security analyst, or
investment analyst, may assist investment bankers or portfolio managers by providing a
valuation of a company and its securities. Stockbrokers, or financial advisors, primarily
sell stocks, bonds and funds to individual investors, for a commission. Section: The
Importance of Studying Investments.
10. Which of the following is a reason that studying Investments is more important now
than in previous generations?
a) More college business programs require students to take one or more courses in
Investments.
b) Workers are increasingly responsible for managing their own retirement funds in
401K’s.
c) The Securities and Exchange Commission now requires would-be investors to pass a
test on investment basics.
d) The stock market crash in 2000-2002 highlights the risks inherent in investing.
Ans: B
EASY
Response: Section: The Importance of Studying Investments.
11. What is meant by the statement “investors are risk averse”?
a) Investors never invest in assets with even the smallest risk.
b) Investors invest in risky assets only if they expect a greater return.
c) All investors choose risky assets.
d) All investors will choose to invest in the same assets.
Ans: B
HARD
Response: Investors are considered risk-averse because they will only accept an
increased level of risk if they feel that the expected return of the investment will
adequately compensate them for that risk. In other words, a risk-averse investor will not
take risk without reward. Response: Understanding the Investment Decision Process.
12. Which of the following is a defined benefit retirement account sponsored by an
employer?
a) 401K plan
b) IRA (Individual Retirement Account)
c) Pension plan
d) Mutual fund
Ans: C
HARD
Response: A 401K plan is a defined contribution retirement account sponsored by an
employer, where the employee chooses investments and the employer often matches the
employee’s contributions. An IRA is a self-directed retirement account, not typically
sponsored by an employer. A mutual fund refers to the underlying investments which are
typically owned in a 401K or IRA retirement account. Section: The Importance of
Studying Investments.
13. If investors are risk-averse, then what is meant by the term “risk tolerance”?
a) Risk tolerance is the opposite of risk-averse.
b) Risk tolerance refers to the degree of risk an investor is willing to accept with their
investments.
c) Risk tolerance is the same as risk-averse.
d) Risk tolerance is the same for all investors.
Ans: B
HARD
Response: Risk tolerance reflects the degree to which an investor is willing to accept risk
in their investment portfolio, based on their own particular set of circumstances. A 27year old professional with no dependents and a six-figure income may have a higher risk
tolerance than a 75-year old retiree who needs stable investment income to pay monthly
bills. Section: Understanding the Investment Decision Process.
14. Consider Figure 1-1, page 1-18. Why is the line from RF to B upward sloping?
a) The definition of “risk averse” implies that people will accept more risk (horizontal
axis) only if they get more expected return (vertical axis).
b) The line has to slope upward because B is above and to the right of RF.
c) All investments on the line will return the risk-free rate.
d) Nearly all assets will fall on or near a straight line connecting RF and B.
Ans: A
MEDIUM
Response: The line is upward sloping because as risk increases, expected return must
increase. Otherwise, no risk-averse investor would accept any risk greater than the riskfree rate. Section: Some Practical Advice.
15. Among the following assets, which is the most risky?
a) Corporate bonds
b) Treasury bonds
c) Speculative puts & calls
d) Corporate equities
Ans: C
EASY
Response: Treasury bonds, corporate bonds and corporate equities have less risk, i.e.
variability in returns, than stock options like puts and calls. Options are derivative
securities that carry a great deal of price volatility, and therefore risk. Section: Some
Practical Advice.
16. Why did investors invest in risky tech stocks which had negative returns for 20002002?
a) The stocks were supposed to be risk-free.
b) The investors had very low risk tolerance.
c) The investors had high risk tolerance, because they expected to be adequately
compensated through higher returns.
d) Tech stocks had done poorly in the later 1990’s and were due for a rebound.
Ans: C
MEDIUM
Response: The late 1990’s saw investors bid up even the most speculative of technology
stocks, a period of time in the stock markets now commonly referred to as the “Tech
Bubble”, or “Internet Bubble”. With record returns in stocks during that period, many
investors increased their risk tolerance to continue chasing returns in technology stocks in
particular. Unfortunately the bubble popped in 2000, and those expected returns turned
into devastating losses for most. Section: Some Practical Advice.
17. Which of the following is NOT part of security analysis?
a) Determining the factors that affect the value of the specific security.
b) Determining the expected future returns for the specific security.
c) Performing an asset-allocation matrix.
d) Determining the risk-return profile of the specific security as it relates to other
securities
Ans: C
MEDIUM
Response: Security analysis involves a comprehensive approach to analyzing the
attractiveness of a particular company’s stock or bonds. A common approach considers
the impact of the overall economy, the company’s industry and competitors, and the
company itself. Asset allocation is used in financial planning, not security analysis.
Section: Understanding the Investment Decision Process.
18. Which of the following statements best describes the current situation in global
investing?
a) All U.S. stocks are also traded on foreign stock exchanges.
b) U.S. stocks account for 95% of the world’s stock market value.
c) All foreign stocks are traded in US dollars.
d) Approximately two-thirds of US investors now own the securities of foreign
companies.
Ans: D
MEDIUM
Response: A global marketplace of round-the-clock investing opportunities has emerged
and many global companies now list their stocks on multiple foreign stock exchanges in
local currencies. Geographic diversification is now the norm, as most investors own the
stocks of companies from around the world. Section: Important Considerations in the
Investment Decision Process for Today's Investors.
19. Which of the following is NOT a contribution the Internet has made to the field of
Investments?
a) Investors can access information on companies and markets very easily.
b) Investors can place stock market orders quickly and inexpensively.
c) Individual investors now have access to information previously available only to
institutional investors.
d) Investors have much higher returns today because of the Internet.
Ans: D
EASY
Response: The Internet has truly revolutionized the world of global investing, particularly
for individual investors. Online brokers offer cheap commissions, corporate information
is widely accessible, and securities can be bought and sold with a mouse click. Although
more individuals do invest directly today because of the Internet, there is no correlation
between the Internet and better returns. Section: Important Considerations in the
Investment Decision Process for Today's Investors.
20. Which of the following best describes the relationship between individual and
institutional investors?
a) Although individual investors have relatively small accounts, the combined value of all
their accounts is about two-thirds of the total value of the NYSE.
b) Institutional investors have much better access to the managers of major public
companies.
c) Individual investors sometimes invest directly, and sometimes indirectly through
mutual funds and pension funds managed by large institutional investors.
d) Individual investors can never compete successfully with institutional investors.
Ans: C
EASY
Response: Although the Internet has largely driven the emergence of the individual
investor, institutional investors still hold the vast majority of the value of NYSE stocks,
largely through the mutual funds and pension funds that they manage on behalf of
individual investors. Section: Important Considerations in the Investment Decision
Process for Today's Investors.
True False
1. The trade-off between risk and reward is one of the most important topics in
investments.
Ans: True
Response: Some Practical Advice
2. The field of Investments covers only marketable securities, not non-marketable assets.
Ans: False
Response: Establishing a Framework for Investing
3. Wealth should be evaluated and managed within the context of a portfolio, which
consists of the asset holdings of an investor.
Ans: True
Response: Establishing a Framework for Investing
4. Investment bankers need security analysts to assist in the sale of new securities and in
the valuation of firms as possible merger or acquisition candidates.
Ans: True
Response: The Importance of Studying Investments
5. All investors should invest in stocks, because historically stocks have provided the
highest return of all financial assets.
Ans: False
Response: Some Practical Advice
6. The first issue to understand in the study of Investments is the trade-off between risk
and return.
Ans: True
Response: Some Practical Advice
7. All investors have the same degree of risk aversion.
Ans: False
Response: Some Practical Advice
8. Investments are made on the basis of future (ex ante) returns, rather than past (ex post)
returns.
Ans: True
Response: Some Practical Advice
9. Even the best investors make mistakes.
Ans: True
Response: Important Considerations in the Investment Decision Process for Today's
Investors
10. New regulations have completely eliminated the possibility of unethical market
behavior, such as seen in the Martha Stewart case.
Ans: False
Response: Ethics in Investing