File: ch01, Chapter 1: The Nature of Investments

File: ch01Multiple 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 apartmentAns: DEASY

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 childrens education.

d) Help their stockbroker make commissions.Ans: DEASY

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 ones retirement. Section: Establishing a Framework for Investing.3. Which of the following best describes 401K investment plans?

a) 401Ks are defined benefit plans offered by many employers.

b) 401Ks allow the worker to make his own investment choices.

c) 401Ks are guaranteed by an agency of the US government.

d) 401Ks can only be invested in very safe investments, like government bonds.

Ans: BMEDIUM

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: CEASY

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. Which of the following is the foundation for making investment decisions?a) Buying the right investment products.b) The trade-off between expected return and risk.c) Making the most money.d) Minimizing taxes, commissions and storage costs.Ans: BHARD

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: BEASY

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: CMEDIUM

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: BEASY

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: DMEDIUM

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 401Ks.

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: BHARD

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 planb) IRA (Individual Retirement Account)c) Pension pland) Mutual fund

Ans: CHARD

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 employees 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: BHARD

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 27-year 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: AMEDIUM

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 risk-free 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: CEASY

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 2000-2002?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 1990s and were due for a rebound.Ans: CMEDIUM

Response: The late 1990s 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 securitiesAns: CMEDIUM

Response: Security analysis involves a comprehensive approach to analyzing the attractiveness of a particular companys stock or bonds. A common approach considers the impact of the overall economy, the companys 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 worlds 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: DMEDIUM

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: DEASY

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: CEASY

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 Investing3. Wealth should be evaluated and managed within the context of a portfolio, which consists of the asset holdings of an investor.

Ans: TrueResponse: Establishing a Framework for Investing4. 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: TrueResponse: 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: FalseResponse: 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 Advice7. All investors have the same degree of risk aversion.

Ans: False

Response: Some Practical Advice8. Investments are made on the basis of future (ex ante) returns, rather than past (ex post) returns.

Ans: True

Response: Some Practical Advice9. Even the best investors make mistakes.

Ans: True

Response: Important Considerations in the Investment Decision Process for Today's Investors10. New regulations have completely eliminated the possibility of unethical market behavior, such as seen in the Martha Stewart case.

Ans: False

Response: Ethics in InvestingNo mention of hedge funds in chapter 1

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