Analysis 300 part B

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Ch.s 4 & 5 Portfolio Analysis & Technical Analysis

Which of the following is NOT considered to be a cyclical stock?

A. Home appliance manufacturer
B. Automobile manufacturer
C. Natural gas producer
D. Home builder

C. Natural gas producer
Natural gas production and consumption in homes and factories is fairly constant and is not cyclical. Durable goods manufacturers and home builders are in notoriously cyclical industries - these are deferrable purchases in bad times.

A "defensive company" is one whose fortunes are _________ (affected / unaffected) by the economic cycle.

Examples of "defensive companies" are pharmaceutical and beer and tobacco companies.
When the economy is bad people still _____________________ USE PRESCRIPS, SMOKE, DRINK and UTILITIES (power usage does not vary that much with the economic cycle.)

A "defensive company" is one whose fortunes are UNAFFECTED by the economic cycle.

Examples of "defensive companies" are pharmaceutical and beer and tobacco companies. When the economy is bad: PEOPLE STILL USE PRESCRIPS, SMOKE, DRINK and UTILITIES (power usage does not vary that much with the economic cycle.)

Which of the following stocks would be considered defensive?

A. Automobile manufacturer
B. Pharmaceutical manufacturer
C. Gold mining company
D. Computer software developer

The best answer is B. Defensive stocks are unaffected by the business cycle. Pharmaceutical companies are defensive and are not affected by the business cycle; in good times or bad, people must take prescribed drugs. The performance of cyclical stocks follows the business cycle. In times of GDP expansion, they do well; in times of recession, they do poorly. The classic cyclical stocks are home building, automobile manufacturers and durable goods producers. All of these purchases are deferrable in hard times. Gold mining stocks are counter-cyclical. In bad economic times, people "flee to safety" and buy gold stocks. Computer software companies are growth companies.

The best answer is B. Defensive stocks are unaffected by the business cycle. Pharmaceutical companies are defensive and are not affected by the business cycle; in good times or bad, people must take prescribed drugs. The performance of cyclical stocks follows the business cycle. In times of GDP expansion, they do well; in times of recession, they do poorly. The classic cyclical stocks are home building, automobile manufacturers and durable goods producers. All of these purchases are deferrable in hard times. Gold mining stocks are counter-cyclical. In bad economic times, people "flee to safety" and buy gold stocks. Computer software companies are growth companies..

INTEREST RATE SENSITIVITY

An interest rate sensitive company is one whose fortunes are tied to ______ ____ levels.

Examples =
UTILITIES, which have a very large proportion of their capitalization in long term debt, and rising interest rates will disproportionately increase such a company's financing costs;

BANKING - rising interest rates means a rise in a bank's cost of funds; and a slackening demand for loans from banks

FIXED INCOME SECURITIES - of any company are interest rate sensitive

INTEREST RATE SENSITIVITY

An interest rate sensitive company is one whose fortunes are tied to INTEREST RATE levels.

Examples =
UTILITIES, which have a very large proportion of their capitalization in long term debt, and rising interest rates will disproportionately increase such a company's financing costs;

BANKING - rising interest rates means a rise in a bank's cost of funds; and a slackening demand for loans from banks

FIXED INCOME SECURITIES - of any company are interest rate sensitive

A sharp rise in interest rates would have the greatest effect on the market price of:

A. pharmaceutical stocks
B. public utility stocks
C. electronics stocks
D. forest products stocks

B. public utility stocks
. Utility company revenue streams are very stable, allowing the company to support a large percentage of their capitalization as debt. Since earnings do not vary much with the business cycle, bondholders are not worried about a bad year resulting in insufficient earnings to meet debt service costs. However, as interest rates rise, utility stocks are hit hard precisely because of their high leverage. Each time the utility goes out to refinance its debt as interest rates rise, it will be more expensive, reducing earnings, and hence the stock price. Other types of companies do not have as stable an income stream and are not as highly leveraged.

"RISK PREMIUM" is the excess return that can be achieved by investing in specific securities, as compared to a benchmark portfolio.
The risk premium is the excess return achieved for investing in a specific class of assets as compared to the risk free return.
WHICH OF THE FOLLOWING OFFERS A "RISK FREE RETURN" ?

A) bonds are yielding 15%
B) corporate bonds are yielding 10%
C) 1-Year Treasury issues are yielding 5%

C) 1-Year Treasury issues are yielding 5%

If high yield bonds are yielding 15%, corporate bonds are yielding 10%, and 1-Year Treasury issues are yielding 5%, the risk premium for investing in high yield bonds is:

A. 15%
B. 10%
C. 5%
D. 0%

B. 10%
The risk premium is the excess return achieved for investing in a specific class of assets as compared to the risk free return. The high yield bonds are yielding 15% when the risk-free return is 5%, therefore the excess return for investing in high yield bonds is 10%.

YESS !!!!

Historically, which of the following investments has provided the highest return over time?

A. Treasury Bills
B. Treasury Bonds
C. Listed common stocks
D. Listed corporate bonds

C. Listed common stocks
Historically, common stocks have provided a superior return over time compared to that provided by Corporate Bonds and Treasury securities. This has occurred because common stock investments have provided both capital gains over time, in addition to the dividend yield. Long term investments in other securities do not provide capital gains; these securities mature at par value. The investment return consists solely of interest paid.
Please note that the risk/reward relationship holds true for these securities. Common stocks have given the highest return, but have the highest risk. Investment grade Corporate Bonds give a lower return, with lower risk. Treasury Bills give the lowest return with the lowest risk.

Growth fund =

Growth fund = a management company (one of the 3 types of investment companies defined under the Investment Company Act of 1940) that buys common stocks (and equivalent securities such as convertibles) that have above average growth potential with the principal objective of achieving capital gains..

Income fund =

Income fund = a management company (one of the 3 types of investment companies defined under the Investment Company Act of 1940) with the investment objective of achieving high levels of income by purchasing bonds, preferred stocks and high dividend paying common stocks. To enhance returns, these funds also employ covered call writing and repurchase agreements..

Balanced fund =

Balanced fund = a management company that invests in common stocks for growth; and preferred stocks and bonds for income: to achieve a "balance" of both..

Specialty fund =

Specialty fund = an investment company that invests in one industry or geographic area.

YES !!!!

Which of the following would be least important in determining the level of diversification in a corporate bond portfolio?

A. Bond ratings
B. Industries represented in portfolio
C. Domicile of issuers
D. Maturities of the bonds in the portfolio

C. Domicile of issuers
The "domicile" of an issuer is the state where the issuer legally resides. It has no bearing on the quality of the issuer's securities. Bond rating, type of industry, and maturity would all be considered when examining the diversification of a bond portfolio.

Passive asset management =

Passive asset management = the pursuit of investment returns to match, but not exceed, the specific benchmark return. Passive asset managers believe that undervalued stocks do not exist in the marketplace, and that they can only match the performance of a similar index fund.

Active asset management =

Active asset management = the pursuit of investment returns in excess of the specific benchmark return. Active asset managers believe that undervalued stocks exist in the marketplace, and that by investing in them, they can surpass the performance of a similar index fund.

Strategic asset allocation =

Strategic asset allocation = the determination of the percentage of assets to be placed in each asset class under an asset allocation scheme..

Tactical asset allocation =

Tactical asset allocation = the permitted variation from the fixed percentage of assets to be placed in each asset class given to the asset manager under an asset allocation scheme.

Passive asset managers select investments into a portfolio to match the return provided by a "b_______" p______ (such as a comparable index fund)

"Passive asset managers" believe that the market is _______ in pricing securities and that undervalued investments cannot be f____ / do not e______ EXIST.

Passive asset managers select investments into a portfolio to match the return provided by a BENCHMARK PORTFOLIO (such as a comparable index fund)

"Passive asset managers" believe that the market is EFFICIENT in pricing securities and that undervalued investments cannot be FOUND / do not EXIST..

Passive asset management is:

A. buying securities positions and holding them to the liquidation date of the portfolio
B. buying securities positions and holding them until pre-established prices are reached
C. selecting securities to be purchased for each asset class based upon fundamental analysis
D. using index funds as the investments for each asset class

D. using index funds as the investments for each asset class
Passive asset management does not mean that there is no management. Passive asset management is the use of index funds (which are managed to mirror a chosen index benchmark) as the security selections within an asset class. Thus, the actual specific security selection and management is embedded within the index fund chosen for investment.
.

The portfolio management technique that uses a market index as a performance benchmark that the asset manager must exceed is called:

A. Passive asset management
B. Active asset management
C. Strategic asset management
D. Tactical asset management

B. Active asset management
Active asset management is the management of a portfolio to exceed a benchmark return (say the return of a comparable index fund). The manager's "active" return is any incremental return achieved over the benchmark return. In contrast, passive asset management is simply the management of a portfolio to match the benchmark return (the "passive return"). Active managers believe that underpriced securities can be found in the market and that performance of the benchmark can be exceeded. Passive managers believe that the market is efficient at pricing securities and that one cannot do any better than the "market" return as measured by a relevant index.

The setting of specific goals for an investment plan to be created for a customer is known as:

A. Strategic asset management
B. Tactical asset management
C. Dollar cost averaging
D. Portfolio rebalancing

A. Strategic asset management

Which statements are true?

I Strategic portfolio management is the determination of the asset allocation percentages among different asset classes in the portfolio

II Strategic portfolio management is the determination of the permitted variance within each asset allocation percentage assigned to a specific asset class

III Tactical portfolio management is the determination of the asset allocation percentages among different asset classes in the portfolio

IV Tactical portfolio management is the determination of the permitted variance within each asset allocation percentage assigned to a specific asset class

A. I and III
B. I and IV
C. II and III
D. II and IV

B. I and IV
Strategic portfolio management is the determination of the percentage allocation to be given to each asset class - for example a portfolio might be strategically allocated as follows:
Money Market Instruments 10%
Corporate Bonds 30%
Large Cap Equities 50%
Small Cap Equities 10%
Tactical asset management is the permitted variance within each allocation percentage. For example, Large Cap equities are allocated 50%, but the manager may be tactically allowed to lower this percentage to, say, 40% or raise it to 60%. Thus, if the manager believes that Large Cap equities will under-perform the market, he or she can lower the allocation to 40%; and if the manager believes that they will outperform the market, he or she can raise the allocation to 60%. This gives the manager some ability to "time the market" when conditions are overbought or oversold.

Tactical portfolio management is the selection of the:

A. securities in which to invest
B. asset classes in which to invest
C. target asset allocation for each asset class selected for investment
D. variation permitted in target asset allocation for each asset class selected for investment

D. variation permitted in target asset allocation for each asset class selected for investment

. Strategic asset allocation is the determination of the target percentage to be allocated to each asset class (e.g., 25% Treasuries; 25% Corp. Debt; 50% Equities). Tactical asset allocation is the permitted variation around each of the chosen percentages - for example, even though Equities are targeted at 50%, this might be allowed to be dropped to as low as 40%, or as high as 60%, depending on market conditions.

Which statements are TRUE about asset classes and investment time horizons?
I Equity investments are the better choice for short term time horizons
II Interest bearing investments are the better choice for short term time horizons
III Equity investments are the better choice for long term time horizons
IV Interest bearing investments are the better choice for long term time horizons

A. I and III
B. I and IV
C. II and III
D. II and IV

C. II and III

The best answer is C. Equity investments typically produce a higher rate of return with higher volatility - thus a long time horizon is needed to achieve consistent results with equity investments. Interest bearing investments produce a lower rate of return with lower volatility - thus they are suitable for portfolios with short time horizons.

What is a VALUE INVESTOR?

A Value Investor invests in ___________ companies - as measured by _____ (low or high) Price/Earnings ratios and _____ (low or high) Price/Book Value ratios - that have good market prospects.

They also consider product _____ , market _____, management, etc.

A Value Investor invests in UNDERVALUED companies - as measured by LOW Price/Earnings ratios and LOW Price/Book Value ratios - that have good market prospects.

They also consider product LINE, market share, management, etc.

What is GROWTH INVESTOR?

Growth investors select investments based simply on growth in _______ or growth in _____ _____; on the assumption that these will always be the _____ performing investments.

Growth investors select investments based simply on growth in EARNINGS or growth in MARKET PRICE; on the assumption that these will always be the BEST performing investments.

A value investor would consider all of the following EXCEPT a company's:

A. Price / Earnings ratio
B. Price / Book Value ratio
C. Stock price growth rate
D. Market share

C. Stock price growth rate

Value investors invest in undervalued companies - as measured by low Price/Earnings ratios and low Price/Book Value ratios - that have good market prospects. Thus, they also consider product line, market share, management, etc. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments.

Value investors:

A. seek to find investments that are undervalued by the market
B. determine the value of a security through fundamental analysis
C. invest in securities included in the Value Line Index
D. make their investment decision based upon the market performance of the security

A. seek to find investments that are undervalued by the market

Value investors believe that the market is not completely efficient at pricing securities and that undervalued securities can be found in the marketplace. Once the market realizes the true worth of these undervalued companies, their prices should rise at a greater rate than the general market...

Growth investors:

A. seek to find investments that are undervalued by the market
B. determine the value of a security through fundamental analysis
C. invest in securities included in growth funds
D. make their investment decision based upon the market performance of the securit

D. make their investment decision based upon the market performance of the security
Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments.

When a manager liquidates securities out of one asset class and invests the proceeds in another asset class to maintain the desired asset allocation percentages as market prices move, the manager is:

A. strategically managing the portfolio
B. tactically managing the portfolio
C. rebalancing the portfolio
D. optimizing the portfolio.

C. rebalancing the portfolio

Customers A, B, C and D have their portfolio assets allocated as follows:

.................................A B C D....
Money Markets 15% 5% 5% 0%
Treasury Bonds 40% 10% 20% 20%
Speculative Bonds 10% 30% 10% 30%
Blue Chip Equities 15% 15% 20% 10%
Small Cap. Equities 10% 10% 30% 5%
Emerging Markets 10% 20% 10% 30%
REITs.......................0% 10% 5% 5%

Which asset allocation is MOST appropriate for a risk-intolerant older customer with a short investment time horizon?

A. Customer A
B. Customer B
C. Customer C
D. Customer D

A. Customer A

For an older, risk-intolerant customer, safe fixed income securities are the best recommendation. Customer A's portfolio has the highest allocation of safe Treasury Bonds, which have the highest credit rating and give an assured income stream.

A customer, age 69, has never invested in securities. She is retired with no dependents, living on a fixed pension of $35,000 per year. She has a savings account with $160,000 and her home is fully paid. She desires to supplement her retirement income, assuming minimal risk. The best recommendation would be for the customer to invest $100,000 of her cash savings into a(n):

A. variable annuity contract
B. CMO planned amortization class tranch
C. SPDR
D. income (adjustment) bond

B. CMO planned amortization class tranch
CMO planned amortization classes give a good yield that is 50 or so basis points higher than equivalent maturity Treasuries and are extremely safe. These meet the customer's objective of additional income with low risk. Since this customer is only earning $35,000 per year, she is in a low tax bracket - making tax-deferred variable annuities unattractive. SPDRs - Standard and Poor's 500 Depository Receipts are an exchange traded fund that consists of equities - which don't provide much income. Income bonds only pay interest if the corporation has enough "income" - so these are not appropriate either.

SIMPLY READ FOR REVIEW

Portfolio allocations must be matched to the customer's
investment objective,
financial needs
investment time horizon, and
risk tolerance level.

For example, customers that are looking for "growth" should not be over-allocated to extremely safe investments - since they provide little growth (and little income) in return for safety.

For example, customers that are looking to reduce their taxes as part of their objectives should be recommended securities whose income is taxed at lower brackets (e.g. stocks that pay cash dividends taxed at a maximum of 15%) or municipal bonds where the interest is not federally taxable.

For example, customers that are looking for retirement income must be placed in "safe" investments, and should consider annuity purchases if they do not have adequate pension plan assets or pension coverage.

...

Customer Q, age 40, is married with 3 young children. He earns $120,000 per year and has $10,000 of liquid assets to invest. The customer has no current portfolio, but does own his home, worth $400,000 against which there is a $200,000 mortgage. The customer informs you that his father just died, leaving him an inheritance of $150,000. He wishes to invest the money so that he can retire in 20 years, using the investment's income. The best recommendation to the customer is to invest the $150,000 in:

A. a large cap stock mutual fund
B. CMO companion tranches with a 20 year average life
C. TIPs with a 20 year maturity
D. a low-load variable annuity separate account with a growth objective

D. a low-load variable annuity separate account with a growth objective

This customer wishes to fund his retirement 20 years from now. Large capitalization stock mutual funds don't provide a lot of income, and are subject to a greater degree of market risk unless the investment time horizon is very long (which it isn't in this case) - so these are not the best retirement investment for this customer. CMO companion tranches are very risky - not the best idea. Remember, these are the "buffer" tranches that absorb prepayment and extension risk. TIPs provide inflation protection, but the real rate of return is quite low (the price of "safety"), so if the customer lives a long time, the income will not be sufficient for retirement. A variable annuity will pay until the customer dies. Low sales charge variable annuities provide assured retirement income - best meeting the customer's objective.

Client A's portfolio consists of the following:
Equities: 85%
Fixed Income: 10%
Cash: 5%
The breakdown of these holdings is:

Equities
35% DEFF Total Market Index Fund
30% 2,100 shares of ABCD
25% 3,100 shares of XYZZ
10% PDQQ International Small Cap Growth Fund
Fixed Income:
75% Investment Grade
25% Speculative
Cash:
100% Money Market Fund
Client A is 55 years old, single with no children. He is beginning to think about retirement and wishes to modify his portfolio so that he can start receiving an assured income stream starting at age 65. Which recommendation would be the best choice to meet the customer's changed investment objective?


A. The ABCD and XYZZ stock holdings should be liquidated in full immediately, with the proceeds invested in 10 year income bonds of companies in special situations
B. The DEFF Total Market Index Fund holding should be liquidated in full immediately, with the proceeds invested in 10-30 year Treasury bonds
C. The customer should set minimum and maximum threshold prices at which the ABCD and XYZZ stock positions are to be liquidated; and if this occurs, the proceeds should be invested in 10-30 year maturity Treasuries
D. The customer should liquidate the ABCD and XYZZ stock holding to purchase 10, 15 and 20 years STRIPs that will mature in even installments

C. The customer should set minimum and maximum threshold prices at which the ABCD and XYZZ stock positions are to be liquidated; and if this occurs, the proceeds should be invested in 10-30 year maturity Treasuries

This customer's portfolio is 85% invested in stocks and only 15% invested in bonds and cash. Since he is looking for income 10 years from now, more of the portfolio mix must be allocated to bond investments. Immediate liquidation of some of the stock investments might cause the customer to sell at a loss; or to miss out on potential stock gains that he or she anticipates. Setting minimum and maximum threshold prices to begin liquidating the stock investments, and reallocating the proceeds to safe income generating bond investments, is the best way to meet the customer's income objective.

Customer Jane Jennings' suitability information is presented below:
Age: 39
Marital Status: Single
Dependents: 1 Child - Age 10
Annual Income: $80,000
Tax Bracket: 28%
Net Worth: $510,000 excluding home
Home: $350,000 fully paid
Investment Portfolio: $422,000

60% equities;
20% long bonds
20% money market

The customer wants to start a college fund for her child. The anticipated tuition, starting 8 years from now, is $50,000 per year ($200,000 total tuition).

Which of the following recommendations is most appropriate for this customer?

A. liquidate $200,000 of common stock in the client's portfolio and invest the entire proceeds in 8-year Treasury Notes
B. take out a second mortgage on the customer's residence in the amount of $200,000 and invest the proceeds in a tax-deferred annuity funded by an income separate account
C. liquidate $160,000 of the common stock and invest the proceeds in laddered Treasury Notes of $40,000 amounts maturing 8, 9, 10 and 11 years from now
D. liquidate $100,000 of the bonds in the customer's portfolio and $100,000 of common stock in the customer's portfolio and invest the entire proceeds in 8-year Adjustment Bonds

C. liquidate $160,000 of the common stock and invest the proceeds in laddered Treasury Notes of $40,000 amounts maturing 8, 9, 10 and 11 years from now

To fund this child's college education, payments of $50,000 per year are needed over a period of 4 years, starting 8 years from now. There is no reason to fund the entire $200,000 right now, since this amount will grow over the next 8 years - making Choices A, B and D incorrect. Also, please note that this customer is only 39 years old - a fairly young age. She should keep as much of her portfolio in growth stocks as possible.

A customer is in the highest tax bracket and will possibly be subject to the AMT. Which of the following is the best investment recommendation?

A. 5.40% Municipal bond that is not subject to the AMT
B. 5.60% Municipal bond that is subject to the AMT
C. 6.00% Treasury bond with a long expiration
D. 6.00% Corporate bond mutual fund

A. 5.40% Municipal bond that is not subject to the AMT
Since this customer is in the highest Federal tax bracket (currently 35%), 35% of the return offered by taxable Treasury Bonds or Corporate Bonds would go to tax, and only 65% of the 6% return (3.90%) offered by these would be kept after-tax. Thus, the 5.40% or 5.60% tax-free municipal bonds are the best choices. Since this customer is possibly subject to the AMT (Alternative Minimum Tax), which adds back "tax preferences" to reported income and taxes the adjusted-up figure at a flat 26-28%, buying the bond that is NOT subject to the AMT is the way to go!

In a cyclical economic downturn, the hardest hit asset group is ______ .

Also hard hit are speculative grade _____ , which can default.

In a cyclical economic downturn, the hardest hit asset group is STOCKS.

Also hard hit are speculative grade BONDS, which can default. .

Assessing risk levels and different types of securities susceptibility.

1) Long term bonds are most susceptible to _________ rate risk.

2) Growth equity investments are most susceptible to _____ risk (a risk of a market decline).
3) Emerging markets investments are most susceptible to ______ risk.

Assessing risk levels and different types of securities susceptibility.

1) Long term bonds are most susceptible to INTEREST rate risk.

2) Growth equity investments are most susceptible to MARKET risk (a risk of a market decline).

3) Emerging markets investments are most susceptible to POLITICAL risk..

...................

SMALL CAP or NASDAQ Capital Market
(both new and old names should be known for the exam)

NASDAQ-listed issues are placed in 1 of 2 tiers:

The "upper tier" of larger NASDAQ issues is the NASDAQ Global Market, previously called the NASDAQ National Market (or "NMS" - National Market System).

The "lower tier" of smaller NASDAQ issues is the NASDAQ Capital Market, previously called the Small Cap Market.

...................

SMALL CAP or NASDAQ Capital Market
(both new and old names should be known for the exam)

NASDAQ-listed issues are placed in 1 of 2 tiers:

The "upper tier" of larger NASDAQ issues is the NASDAQ Global Market, previously called the NASDAQ National Market (or "NMS" - National Market System).

The "lower tier" of smaller NASDAQ issues is the NASDAQ Capital Market, previously called the Small Cap Market.

MEMORIZE THE FOLLOWING
CARDS AND EACH RISK

Business risk =

Business risk
the risk that an issuer's business declines, often due to technological change; bad business decision making; and law changes
in turn, the value of the issuer's securities declines

Call risk

Call risk
if interest rates fall, it becomes attractive for issuers to call in outstanding bonds and refinance at lower current rates
the bonds most likely to be called are those with high interest rates and low call premiums
the bonds least likely to be called are those with low interest rates and high call premiums.

Business risk =

Business risk = the risk that an issuer's business declines, often due to technological change; bad business decision making; and law changes
in turn, the value of the issuer's securities declines
.

Call risk =

Call risk = if interest rates fall, it becomes attractive for issuers to call in outstanding bonds and refinance at lower current rates
the bonds most likely to be called are those with high interest rates and low call premiums
the bonds least likely to be called are those with low interest rates and high call premiums
.

Capital risk (also known as ______ risk) =

Capital risk (Market risk) = the risk that the amount invested may not fully be recovered

Credit risk =

Credit risk = the risk that the issuer cannot make interest and principal payments as due.

Credit risk =

Credit risk = the risk that the issuer cannot make interest and principal payments as due

Currency Exchange risk =

Currency Exchange risk
the risk associated with the exchange of one foreign currency to another.

Inflationary risk (see Purchasing Power risk)

Interest Rate risk (Market risk) =

Inflationary risk (see Purchasing Power risk)

Interest Rate risk (Market risk) = as interest rates go up, bond prices fall - this is interest rate risk.
The bonds that are most susceptible to interest rate risk are:
- longer maturity issues
- low coupon issues

Legislative risk =

Example: Legislative risk for holders of municipal issues is the risk that the Federal Government will tax the _______ income on the bonds

Legislative risk = the risk of new law changes which could impact the tax treatment of certain investments

Example: Legislative risk for holders of municipal issues is the risk that the Federal Government will tax the INTEREST income on the bonds

Liquidity risk =

Liquidity risk = the risk that selling a position will result in higher than normal transaction costs (commissions). This is typical for smaller, thinly traded issues

Market risk =

Market risk (see Capital risk; Interest Rate risk; Systematic risk)

Capital risk (Market risk) = the risk that the amount invested may not fully be recovered

Interest Rate risk (Market risk) = as interest rates go up, bond prices fall - this is interest rate risk.

Marketability risk =

Marketability risk =
the risk that a security will be difficult to sell. Smaller, thinly traded issues are most subject to marketability risk

Political risk =

Political risk =
for holders of foreign securities and for issuers that have operations in politically unstable foreign countries, the risk that the foreign government reneges on its obligations or seizes assets held by foreigners

Purchasing Power risk (Inflationary risk) =

Purchasing Power risk (Inflationary risk) =
if inflation rates increase, interest rates increase as well. If interest rates increase, bond prices fall - this is purchasing power risk

Reinvestment risk =

Reinvestment risk = the risk that interest rates drop after the issuance of a bond, and the semi-annual interest payments received from a bond are now reinvested at lower current market rates. Thus, the overall rate of return on the investment is reduced. Zero-coupon bonds do not make periodic interest payments, and hence, do not have reinvestment risk

Systematic risk (Market risk) =

Systematic risk (Market risk) = undiversifiable risk is Systematic risk, also known as Market risk. This is the risk that general economic conditions (i.e. due to bad economic conditions, war, rising interest rates, inflation, etc.) will affect a portfolio negatively.

Timing risk =

Timing risk = the risk that buying and selling occur at disadvantageous price levels due to poor market timing.

LIQUIDITY RISK - CARD 2
(fill in the blanks)

Liquidity risk is the risk that a security can only be sold by incurring large transaction costs. The easiest securities to sell (meaning the most liquid) are large capitalization issues listed on the NYSE. Small cap stocks that are inactively traded have a high level of liquidity risk. Market risk (also known as systematic risk) is the risk that the market as a whole will drop. This risk affects small cap issues more acutely than large cap issues, but liquidity risk is still the best of the choices offered. Interest rate risk is the risk of price volatility for fixed income securities due to interest rate movements and does not apply to common stocks. Business risk is the risk that an issuer's business declines and, in turn, the value of the issuer's securities declines. This is a consideration, but once again, liquidity risk is the most important of the choices offered.

...

CONTANT RATIO PLAN

A constant ratio investment plan is one which:

A. invests a fixed percentage amount periodically in equity securities
B. invests a fixed percentage amount periodically in debt securities
C. maintains a fixed percentage amount of a portfolio's assets in equities
D. maintains a dollar amount of a portfolio's assets in debt

The best answer is C. Under a constant ratio plan, a portfolio manager sets a fixed percentage level (say 70% of total asset value) to be maintained in equity securities. If the value rises above 70%, the excess is invested in debt securities. Conversely, if the equity market value drops below 70% of the portfolio, bonds are liquidated and invested in equities to bring the equity balance to the constant 70%.

...

The EFFICIENT MARKET THEORY is the theory that all i________ INFORMATION about an issuer is available to all p_______ PARTICIPANTS in the market at the s____ SAME t____ TIME, and that the prices of securities directly reflect investor expectations based on this information.

Therefore, attempting to profit from buying under_____ VALUED stocks or selling short over_____ VALUED stocks is futile.

Most accepted is the "semi-strong" version of this theory, which states that market valuations reflect a___ ALL "publicly known" information about an issuer; but do not reflect information known only by "i_______" INSIDERS - the officers and directors of that company.

There are 3 versions of this theory:
• W____ WEAK Form: States that securities prices only reflect "old" information. Thus, attempting to predict future market movements based on historical data is impossible, because what has happened in the past is not necessarily a predictor of the future.
• S____-____ SEMI-STRONG Form: States that securities prices fully reflect all publicly available information. Thus, the use of publicly reported information to select stocks cannot result in a better return, since their prices already reflect this information.
• S_____ STRONG Form: States that securities prices fully reflect all information, whether publicly available or not.

Efficient market theory holds that securities prices instantaneously and fully reflect all a_______ AVAILABLE information. Because of this, r_____ RANDOM selection of a portfolio should provide a return that is as good as selection by any other analytical method. In essence, the theory says that there is n__ w____ NO WAY to improve on the return that the market is giving.

The EFFICIENT MARKET THEORY is the theory that all i________ INFORMATION about an issuer is available to all p_______ PARTICIPANTS in the market at the s____ SAME t____ TIME, and that the prices of securities directly reflect investor expectations based on this information.

Therefore, attempting to profit from buying under_____ VALUED stocks or selling short over_____ VALUED stocks is futile.

Most accepted is the "semi-strong" version of this theory, which states that market valuations reflect a___ ALL "publicly known" information about an issuer; but do not reflect information known only by "i_______" INSIDERS - the officers and directors of that company.

There are 3 versions of this theory:
• W____ WEAK Form: States that securities prices only reflect "old" information. Thus, attempting to predict future market movements based on historical data is impossible, because what has happened in the past is not necessarily a predictor of the future.
• S____-____ SEMI-STRONG Form: States that securities prices fully reflect all publicly available information. Thus, the use of publicly reported information to select stocks cannot result in a better return, since their prices already reflect this information.
• S_____ STRONG Form: States that securities prices fully reflect all information, whether publicly available or not.

Efficient market theory holds that securities prices instantaneously and fully reflect all a_______ AVAILABLE information. Because of this, r_____ RANDOM selection of a portfolio should provide a return that is as good as selection by any other analytical method. In essence, the theory says that there is n__ w____ NO WAY to improve on the return that the market is giving.

The "Efficient Market Theory" states that:
I undervalued securities should exist
II undervalued securities should not exist
III overvalued securities should exist
IV overvalued securities should not exist

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is D. The "Efficient Market" Theory holds that prices of securities in the market fully reflect all publicly available information, so that undervalued or overvalued securities should not exist. Thus, securities selection based on any type of analytical method is irrelevant. In reality, most individuals believe that the market is only "partly" efficient in pricing securities - so that undervalued and overvalued securities will always exist. These could be identified by both fundamental and/or technical analysis.

The "Efficient Market Theory" states that:
I undervalued securities should exist
II undervalued securities should not exist
III overvalued securities should exist
IV overvalued securities should not exist

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is D. The "Efficient Market" Theory holds that prices of securities in the market fully reflect all publicly available information, so that undervalued or overvalued securities should not exist. Thus, securities selection based on any type of analytical method is irrelevant. In reality, most individuals believe that the market is only "partly" efficient in pricing securities - so that undervalued and overvalued securities will always exist. These could be identified by both fundamental and/or technical analysis.

The "Efficient Market Theory" states that:

A. practitioners of fundamental analysis should realize superior investment returns as compared to technical analysts
B. practitioners of technical analysis should realize superior investment returns as compared to fundamental analysts
C. securities selection based on technical or fundamental factors is irrelevant since prices reflect all available information
D. securities selection based on both fundamental and technical analysis will result in superior returns

C. securities selection based on technical or fundamental factors is irrelevant since prices reflect all available information

The "Efficient Market" Theory holds that prices of securities in the market fully reflect all publicly available information, so that undervalued or overvalued securities should not exist. Thus, securities selection based on any type of analytical method is irrelevant. In reality, most individuals believe that the market is only "partly" efficient in pricing securities - so that undervalued and overvalued securities will always exist. These could be identified by both fundamental and/or technical analysis.

Analysis: Portfolio Analysis: Capital Asset Pricing Model: Definition

"CAPM" stands for ______ ______ ______ ______ CAPITAL ASSET PRICING MODEL.

This is a methodology for finding the most e______ EFFICIENT investments - those that give the g______ GREATEST return for the amount of r______ RISK assumed.

Analysis: Portfolio Analysis: Capital Asset Pricing Model: Definition

"CAPM" stands for ______ ______ ______ ______ CAPITAL ASSET PRICING MODEL.

This is a methodology for finding the most e______ EFFICIENT investments - those that give the g______ GREATEST return for the amount of r______ RISK assumed.

Capital Asset Pricing Theory is used to identify investments that give the:

A. lowest expected level of return for the level of risk assumed
B. highest expected level of return for the level of risk assumed
C. lowest beta coefficient as companies are added to the portfolio
D. highest beta coefficient as companies are added to the portfolio

The best answer is B. The Capital Asset Pricing Model is a methodology for finding the most efficient investments - those that give the greatest return for the amount of risk assumed. The model identifies the most efficient investments as those that give a rate of return equal to the "risk-free" rate of return (the rate of return for investments only having systematic risk) plus a premium for any non-systematic risk inherent in the investment.

Capital Asset Pricing Theory is used to identify investments that give the:

A. lowest expected level of return for the level of risk assumed
B. highest expected level of return for the level of risk assumed
C. lowest beta coefficient as companies are added to the portfolio
D. highest beta coefficient as companies are added to the portfolio

The best answer is B. The Capital Asset Pricing Model is a methodology for finding the most efficient investments - those that give the greatest return for the amount of risk assumed. The model identifies the most efficient investments as those that give a rate of return equal to the "risk-free" rate of return (the rate of return for investments only having systematic risk) plus a premium for any non-systematic risk inherent in the investment.

The Capital Asset Pricing Model (CAPM) would identify the most efficient investments as those with the:
I lowest rate of return
II highest rate of return
III lowest level of risk
IV highest level of risk

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is C. CAPM is a methodology for finding the most efficient investments - those that give the greatest return for the amount of risk assumed. The model identifies the most efficient investments as those that give a rate of return equal to the "risk-free" rate of return (the rate of return for investments only having systematic risk) plus a premium for any non-systematic risk inherent in the investment.

The Capital Asset Pricing Model (CAPM) would identify the most efficient investments as those with the:
I lowest rate of return
II highest rate of return
III lowest level of risk
IV highest level of risk

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is C. CAPM is a methodology for finding the most efficient investments - those that give the greatest return for the amount of risk assumed. The model identifies the most efficient investments as those that give a rate of return equal to the "risk-free" rate of return (the rate of return for investments only having systematic risk) plus a premium for any non-systematic risk inherent in the investment.

Systematic risk = the risk of a general market decline affecting the portfolio; called _______ _______ and cannot be diversified away.

Non-systematic risk = the risk of a single investment going sour, also known as _______ _______ . By diversifying the portfolio, this risk is minimized.

Systematic risk = the risk of a general market decline affecting the portfolio; called Market Risk and cannot be diversified away.

Non-systematic risk = the risk of a single investment going sour, also known as Selection Risk. By diversifying the portfolio, this risk is minimized.

Market risk is the same as:

A. systematic risk
B. non-systematic risk
C. credit risk
D. selection risk

The best answer is A. Market risk is the same as systematic risk. It is the risk of the market moving adversely, and one's securities positions moving with the market. This risk cannot be diversified away; but it can be hedged against.

Market risk is the same as:

A. systematic risk
B. non-systematic risk
C. credit risk
D. selection risk

The best answer is A. Market risk is the same as systematic risk. It is the risk of the market moving adversely, and one's securities positions moving with the market. This risk cannot be diversified away; but it can be hedged against.

The risk inherent in a portfolio that can be diversified away is known as:

A. systematic risk
B. non-systematic risk
C. credit risk
D. marketability risk

The best answer is B. Market risk is the same as systematic risk. It is the risk of the market moving adversely, and one's securities positions moving with the market. This risk cannot be diversified away; but it can be hedged against. Non-systematic risk is the portion of risk in a portfolio that is "stock specific." Also known as selection risk, this can be diversified away by adding more and more stocks to the portfolio, until the portfolio becomes reflective of the "market" as a whole.

The risk inherent in a portfolio that can be diversified away is known as:

A. systematic risk
B. non-systematic risk
C. credit risk
D. marketability risk

The best answer is B. Market risk is the same as systematic risk. It is the risk of the market moving adversely, and one's securities positions moving with the market. This risk cannot be diversified away; but it can be hedged against. Non-systematic risk is the portion of risk in a portfolio that is "stock specific." Also known as selection risk, this can be diversified away by adding more and more stocks to the portfolio, until the portfolio becomes reflective of the "market" as a whole.

An investor has a broadly diversified portfolio of blue chip stocks. The use of index options to hedge the portfolio reduces:

A. systematic risk
B. non-systematic risk
C. interest rate risk
D. timing risk

The best answer is A. Index options can be used to hedge a portfolio. If index puts are bought, then a drop in the market lowering the portfolio's value will be offset by a gain in the value of the index puts. This strategy hedges against market risk, also known as systematic risk. Non systematic risk is the risk that any one security will perform poorly. The larger the portfolio, the lower the effect of non-systematic risk.

Timing risk is the risk that trades will not be performed at the best market prices;

interest rate risk is the risk that interest rates rise, forcing bond prices and stock prices down.

An investor has a broadly diversified portfolio of blue chip stocks. The use of index options to hedge the portfolio reduces:

A. systematic risk
B. non-systematic risk
C. interest rate risk
D. timing risk

The best answer is A. Index options can be used to hedge a portfolio. If index puts are bought, then a drop in the market lowering the portfolio's value will be offset by a gain in the value of the index puts. This strategy hedges against market risk, also known as systematic risk. Non systematic risk is the risk that any one security will perform poorly. The larger the portfolio, the lower the effect of non-systematic risk.

Timing risk is the risk that trades will not be performed at the best market prices

interest rate risk is the risk that interest rates rise, forcing bond prices and stock prices down.

UNDERSTAND T-BILLS

Market risk is the risk the securities prices, as a whole, will fall, dragging down both good and bad investments. To minimize market risk, common stocks should be avoided, as should long term fixed income securities, such as preferred stock and long bonds. To minimize this risk, investors "flee to safety" in the form of Treasury Bills. These are the safest type of credit - backed by the U.S. Government; and the price cannot drop that much because of their short term maturities. Since they will redeemed shortly at par, the price cannot fall much below par, no matter what happens to the market as a whole.

...

Which of the investments listed below offers the greatest protection against market risk?

A. Common Stocks
B. Treasury Bills
C. Preferred Stocks
D. Treasury Bonds

The best answer is B. Market risk is the risk the securities prices, as a whole, will fall, dragging down both good and bad investments. To minimize market risk, common stocks should be avoided, as should long term fixed income securities, such as preferred stock and long bonds. To minimize this risk, investors "flee to safety" in the form of Treasury Bills. These are the safest type of credit - backed by the U.S. Government; and the price cannot drop that much because of their short term maturities. Since they will redeemed shortly at par, the price cannot fall much below par, no matter what happens to the market as a whole.

Which of the investments listed below offers the greatest protection against market risk?

A. Common Stocks
B. Treasury Bills
C. Preferred Stocks
D. Treasury Bonds

The best answer is B. Market risk is the risk the securities prices, as a whole, will fall, dragging down both good and bad investments. To minimize market risk, common stocks should be avoided, as should long term fixed income securities, such as preferred stock and long bonds. To minimize this risk, investors "flee to safety" in the form of Treasury Bills. These are the safest type of credit - backed by the U.S. Government; and the price cannot drop that much because of their short term maturities. Since they will redeemed shortly at par, the price cannot fall much below par, no matter what happens to the market as a whole.

Beta
also called the Beta coefficient, the relative volatility of a particular stock relative to the overall market as measured by the Standard & Poor's 500 index. If a stock's Beta coefficient is +1, this means that its price rises and falls in direct relationship to the movement of the index. A Beta that is less than +1 indicates a stock is less volatile than the overall market; while a Beta of greater than +1 indicates that a stock is more volatile. A - Beta indicates that the stock's price moves in the opposite direction to the market as a whole

Beta
also called the Beta coefficient, the relative volatility of a particular stock relative to the overall market as measured by the Standard & Poor's 500 index. If a stock's Beta coefficient is +1, this means that its price rises and falls in direct relationship to the movement of the index. A Beta that is less than +1 indicates a stock is less volatile than the overall market; while a Beta of greater than +1 indicates that a stock is more volatile. A - Beta indicates that the stock's price moves in the opposite direction to the market as a whole

Which statement is TRUE about a stock's Beta Coefficient?

A. Beta measures price movement of a stock relative to its industry
B. Beta measures price movement of a stock relative to the market
C. Beta measures the credit rating of a stock relative to its industry
D. Beta measures the credit rating of a stock relative to the market

The best answer is B. The "Beta" coefficient is a measure of price volatility of a stock (or a portfolio) relative to the market. A Beta of +1 indicates that a particular security moves as fast, and in the same direction, as the market. A Beta of +1/2 indicates that the stock's price moves half as fast, and in the same direction, as the overall market.

Which statement is TRUE about a stock's Beta Coefficient?

A. Beta measures price movement of a stock relative to its industry
B. Beta measures price movement of a stock relative to the market
C. Beta measures the credit rating of a stock relative to its industry
D. Beta measures the credit rating of a stock relative to the market

The best answer is B. The "Beta" coefficient is a measure of price volatility of a stock (or a portfolio) relative to the market. A Beta of +1 indicates that a particular security moves as fast, and in the same direction, as the market. A Beta of +1/2 indicates that the stock's price moves half as fast, and in the same direction, as the overall market.

A portfolio of securities that moves in both the same direction and same velocity as the market as a whole would have a Beta equal to:

A. +0
B. -0
C. +1
D. -1

The best answer is C. A portfolio with a "beta" coefficient of +1 is one that moves in both the same direction and same velocity as the market as a whole. A portfolio with a "beta" coefficient of +2 is one that moves in the same direction as the market as a whole, but which moves twice as fast as the market. A portfolio with a "beta" coefficient on -1 is one that moves at the same velocity as the market as a whole, but it moves in the opposite direction to the market.

A portfolio of securities that moves in both the same direction and same velocity as the market as a whole would have a Beta equal to:

A. +0
B. -0
C. +1
D. -1

The best answer is C. A portfolio with a "beta" coefficient of +1 is one that moves in both the same direction and same velocity as the market as a whole. A portfolio with a "beta" coefficient of +2 is one that moves in the same direction as the market as a whole, but which moves twice as fast as the market. A portfolio with a "beta" coefficient on -1 is one that moves at the same velocity as the market as a whole, but it moves in the opposite direction to the market.

Securities that rise in price, when the market, as measured by the Standard and Poor's Index, falls, are said to have a:

A. positive beta
B. negative beta
C. positive delta
D. negative delta

B. negative beta
Securities that have a positive beta move in the same direction to the market as a whole. Securities that have a negative beta move in the opposite direction to the market as a whole - e.g., they are counter-cyclical stocks. For example, when industrial stocks move up due to improving economic conditions, this is an indicator that interest rates are likely to start rising. As a result, interest rate sensitive stocks, such as utilities, tend to decline in value. Thus, this stock is said to have a negative beta.

Common shares of which of the following issuers are likely to have a Beta coefficient much higher than +1?

A. Semi-conductor manufacturer
B. Pharmaceutical manufacturer
C. Public utility
D. Food processor

The best answer is A. The "Beta" coefficient is a measure of market volatility. A Beta of "+1" indicates that a particular security moves as fast as the market. A Beta higher than one means that the security moves faster than the market - for example a Beta of +2 means that the security moves twice as fast as the overall market. A Beta of less than 1, say 1/2, indicates that the stock's prices moves half as fast as the overall market. Thus, a stock with a low beta is one that is strongly defensive - that is one that is not affected by business cycles. Food and pharmaceutical companies have beta coefficients that average around 1. Electric and gas utilities, and railroads have the lowest beta factors - around .7. These companies' betas are the lowest because their rates of return are regulated. Therefore, these firms' profits are generated independently of the business cycle and stay relatively constant - no matter how good or bad business conditions are. High technology companies typically have very high betas relative to the market - these are growth companies.

Common shares of which of the following issuers are likely to have a Beta coefficient much higher than +1?

A. Semi-conductor manufacturer
B. Pharmaceutical manufacturer
C. Public utility
D. Food processor

The best answer is A. The "Beta" coefficient is a measure of market volatility. A Beta of "+1" indicates that a particular security moves as fast as the market. A Beta higher than one means that the security moves faster than the market - for example a Beta of +2 means that the security moves twice as fast as the overall market. A Beta of less than 1, say 1/2, indicates that the stock's prices moves half as fast as the overall market. Thus, a stock with a low beta is one that is strongly defensive - that is one that is not affected by business cycles. Food and pharmaceutical companies have beta coefficients that average around 1. Electric and gas utilities, and railroads have the lowest beta factors - around .7. These companies' betas are the lowest because their rates of return are regulated. Therefore, these firms' profits are generated independently of the business cycle and stay relatively constant - no matter how good or bad business conditions are. High technology companies typically have very high betas relative to the market - these are growth companies.

A company's common stock has a Beta of +2.0. The market has declined over the last 3 years. During this period, the price of the stock would have:

A. declined at the same rate as the market
B. increased at the same rate as the market
C. declined at a faster rate than the market
D. increased at a faster rate than the market

The best answer is C. If a stock has a "beta" of 1, the stock's price moves in the same direction and velocity as the market. If a stock has a "beta" of more than 1, then the stock's price moves in the same direction, but at a faster velocity, than the market. A stock with a beta of +2.0 moves 2 times as fast as the market.

C. declined at a faster rate than the market

If a stock has a "beta" of 1, the stock's price moves in the same direction and velocity as the market. If a stock has a "beta" of more than 1, then the stock's price moves in the same direction, but at a faster velocity, than the market. A stock with a beta of +2.0 moves 2 times as fast as the market.

Alpha Is A Measure Of Uncorrelated Stock-Specific Price Movement
While "beta" measures how correlated a stock's price movements are to the overall market, another measure, called "alpha," calculates the uncorrelated price movements of the stock. It is a measure of the stock price volatility based on the specific characteristics of that company. The higher the Alpha, the higher the "stock specific" risk and, hopefully, return.
This is an "older" definition of Alpha that is covered on the Series 7 exam. A newer version of "alpha" takes the basic concept of stock-specific risk and return and applies it to portfolio returns as opposed to market price movement.

...

The measure of "stock specific" risk is:

A. alpha
B. beta
C. delta
D. sigma

The best answer is A. Alpha measures the risk peculiar to an individual security. Beta measures a security's volatility relative to the market.

...

All of the following investments would be considered to be "defensive" during deflationary periods EXCEPT:

A. Common Stock
B. Preferred Stock
C. 10-Year Bonds
D. 30-Year Bonds

The best answer is A. In a deflationary period, interest rates will fall, raising the prices of fixed income securities. Thus, fixed income securities are defensive securities in times of deflation. Equity securities' price movements will depend on the state of the economy at the time deflation occurs, and thus would not be defensive.

All of the following investments would be considered to be "defensive" during deflationary periods EXCEPT:

A. Common Stock
B. Preferred Stock
C. 10-Year Bonds
D. 30-Year Bonds

The best answer is A. In a deflationary period, interest rates will fall, raising the prices of fixed income securities. Thus, fixed income securities are defensive securities in times of deflation. Equity securities' price movements will depend on the state of the economy at the time deflation occurs, and thus would not be defensive.

A counter-cyclical stock would be characterized by which of the following?
I Earnings variability due to changes in economic growth
II No earnings variability due to changes in economic growth
III A stock price that tends to move in the same direction of the market as a whole
IV A stock price that tends to move in the opposite direction of the market as a whole

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is B. Counter-cyclical stocks are those whose performance runs counter to the economic cycle. In good economic times, these stocks don't do as well; in poor economic times, these stocks do very well. An example of a counter-cyclical stock is a basic food producer - in good times, people eat out more and do less cooking at home; in bad times, people eat out less and do more cooking at home. Thus, in bad times, the earnings of a basic food producer would improve, and its stock price would rise. In good times, the earnings of a basic food producer would deteriorate, and its stock price would fall.

Which of the following stocks would be considered counter-cyclical?

A. Automobile manufacturer
B. Pharmaceutical manufacturer
C. Gold mining company
D. Computer software developer

The best answer is C. The performance of counter-cyclical stocks moves opposite to the economic cycle. Gold mining stocks are counter-cyclical. In bad economic times, people "flee to safety," selling stocks that are adversely affected in bad times and buying gold stocks - since gold tends to hold its value in good times or bad. In contrast, the performance of cyclical stocks follows the business cycle. In times of GDP expansion, they do well; in times of recession, they do poorly. The classic cyclical stocks are home building, automobile manufacturers and durable goods producers. All of these purchases are deferrable in hard times. Pharmaceutical companies are defensive and are not affected by the business cycle; in good times or bad, people must take prescribed drugs. Computer software companies are growth companies.

Equity securities of which issuer are the LEAST defensive?

A. Defense
B. Pharmaceuticals
C. Grocers
D. Utilities

The best answer is A. A defensive industry is one which is not greatly affected by economic downturns. Pharmaceuticals, grocers, and utilities are all defensive. If the economy sours, people still buy drugs, food, and use electricity. The defense industry is the least defensive of the choices offered. In periods of economic slowdowns, the government collects less taxes, and tends to reduce arms and expensive defense systems orders.

.All of the following are defensive stocks EXCEPT:

A. Beer Manufacturer
B. Supermarket Chain
C. Home Builder
D. Public Utility

The best answer is C. Defensive stocks are not much affected by economic downturns. During economic downturns, people still buy beer, food, and electricity. These are all defensive stocks. Home building is highly cyclical and is severely affected by economic downturns.

Which of the following securities are directly interest rate sensitive?
I Utility Stocks
II Growth Stocks
III Preferred Stocks
IV Common Stocks

A. I and II
B. III and IV
C. I and III
D. II and IV

The best answer is C. Utility stocks are directly interest rate sensitive since utilities have an extremely large portion of their capitalization as debt. If interest rates rise, as the utilities refund maturing debt, their interest costs increase, depressing earnings and therefore the stock price. Preferred stocks are directly interest rate sensitive because they pay a fixed dividend rate. If interest rates rise, their prices must fall to provide comparable market yields; and vice-versa. Common stocks and growth stocks are priced primarily on future expectations of earnings for these companies. Their prices are not directly interest rate sensitive.

If high yield bonds are yielding 15%, corporate bonds are yielding 10%, and 1-Year Treasury issues are yielding 5%, the risk premium for investing in high yield bonds is:

A. 15%
B. 10%
C. 5%
D. 0%

The best answer is B. The risk premium is the excess return achieved for investing in a specific class of assets as compared to the risk free return. The high yield bonds are yielding 15% when the risk-free return is 5%, therefore the excess return for investing in high yield bonds is 10%.

. The portfolio management technique that uses a market index as a performance benchmark that the asset manager must meet is called:

A. Passive asset management
B. Active asset management
C. Strategic asset management
D. Tactical asset management

The best answer is A. Active asset management is the management of a portfolio to exceed a benchmark return (say the return of a comparable index fund). The manager's "active" return is any incremental return achieved over the benchmark return. In contrast, passive asset management is simply the management of a portfolio to match the benchmark return (the "passive return"). Active managers believe that underpriced securities can be found in the market and that performance of the benchmark can be exceeded. Passive managers believe that the market is efficient at pricing securities and that one cannot do any better than the "market" return as measured by a relevant index.

Passive portfolio management is:

A. buying and holding the investments chosen by the Registered Representative
B. determining the securities to be bought or sold based on investment research performed by the Registered Representative
C. managing a portfolio to meet the performance of a benchmark portfolio
D. managing a portfolio to exceed the performance of a benchmark portfolio

The best answer is C. Passive portfolio management is the management of a portfolio to meet the performance of a benchmark, such as a designated index. Active portfolio management attempts to beat the performance of the benchmark portfolio through better security section and better investment timing.

.Which statements are true?
I Strategic portfolio management is the determination of the asset allocation percentages among different asset classes in the portfolio
II Strategic portfolio management is the determination of the permitted variance within each asset allocation percentage assigned to a specific asset class
III Tactical portfolio management is the determination of the asset allocation percentages among different asset classes in the portfolio
IV Tactical portfolio management is the determination of the permitted variance within each asset allocation percentage assigned to a specific asset class

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is B. Strategic portfolio management is the determination of the percentage allocation to be given to each asset class - for example a portfolio might be strategically allocated as follows:

Money Market Instruments 10%
Corporate Bonds 30%
Large Cap Equities 50%
Small Cap Equities 10%

Tactical asset management is the permitted variance within each allocation percentage. For example, Large Cap equities are allocated 50%, but the manager may be tactically allowed to lower this percentage to, say, 40% or raise it to 60%. Thus, if the manager believes that Large Cap equities will under-perform the market, he or she can lower the allocation to 40%; and if the manager believes that they will outperform the market, he or she can raise the allocation to 60%. This gives the manager some ability to "time the market" when conditions are overbought or oversold.

A value investor would consider all of the following EXCEPT a company's:

A. Price / Earnings ratio
B. Price / Book Value ratio
C. Stock price growth rate
D. Market share

The best answer is C. Value investors invest in undervalued companies - as measured by low Price/Earnings ratios and low Price/Book Value ratios - that have good market prospects. Thus, they also consider product line, market share, management, etc. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments.

Customers A, B, C and D have their portfolio assets allocated as follows:
......................................A...........B...........C...........D
Money Markets............15%......5%.......5%........0%
Treasury Bonds...........40% 10% 20% 20%
Speculative Bonds......10% 30% 10% 30%
Blue Chip Equities......15% 15% 20% 10%
Small Cap. Equities.....10% 10% 30% 5%
Emerging Markets.......10% 20% 10% 30%
REITs............................. 0% 10% 5% 5%

Which asset allocation is MOST appropriate for a risk-intolerant older customer with a short investment time horizon?

A. Customer A
B. Customer B
C. Customer C
D. Customer D

The best answer is A. For an older, risk-intolerant customer, safe fixed income securities are the best recommendation. Customer A's portfolio has the highest allocation of safe Treasury Bonds, which have the highest credit rating and give an assured income stream.
.

Customer Z is a single 26-year-old man who earns $125,000 annually. He informs you that he is getting married and that his new wife's income of $75,000 per year will put them into the highest federal tax bracket. The couple will have investable income of $25,000 per year. The couple wishes to buy a house in 5 years that will be substantially more expensive than the condominium in which they currently reside. To meet the customer's needs for the large cash down payment in 5 years and to reduce taxable income, the best recommendation is to:

A. open a margin account and invest in income bonds
B. open an Individual Retirement Account and invest in tax-deferred variable annuities
C. open a cash account and invest in mutual funds holding high yielding common and preferred stocks
D. open a trust account and invest in Treasury STRIPs

The best answer is C. Income bonds are not a reliable source of income or principal repayment (since payment depends on earnings of the issuer), and the interest is 100% taxable. Tax-advantaged investments like variable annuities should never be purchased in tax-deferred accounts. The annual accretion on Treasury STRIPs is taxable, unless the bonds are held in a tax-deferred account. Only Choice C makes sense - since cash dividends are taxed at a maximum rate of 15% (reducing taxable income), and the mutual fund shares can be easily liquidated in 5 years to make the house down payment.

Customer Q, age 40, is married with 3 young children. He earns $120,000 per year and has $10,000 of liquid assets to invest. The customer has no current portfolio, but does own his home, worth $400,000 against which there is a $200,000 mortgage. The customer informs you that his father just died, leaving him an inheritance of $150,000. He wishes to invest the money so that he can retire in 20 years, using the investment's income. The best recommendation to the customer is to invest the $150,000 in:

A. a large cap stock mutual fund
B. CMO companion tranches with a 20 year average life
C. TIPs with a 20 year maturity
D. a low-load variable annuity separate account with a growth objective

The best answer is D. This customer wishes to fund his retirement 20 years from now. Large capitalization stock mutual funds don't provide a lot of income, and are subject to a greater degree of market risk unless the investment time horizon is very long (which it isn't in this case) - so these are not the best retirement investment for this customer. CMO companion tranches are very risky - not the best idea. Remember, these are the "buffer" tranches that absorb prepayment and extension risk. TIPs provide inflation protection, but the real rate of return is quite low (the price of "safety"), so if the customer lives a long time, the income will not be sufficient for retirement. A variable annuity will pay until the customer dies. Low sales charge variable annuities provide assured retirement income - best meeting the customer's objective..

A retired customer has an existing stock portfolio held in a cash account. He has heard that "leveraging" his portfolio can increase his return. The portfolio holds blue chip stocks that pay current dividends. He wants to transfer the positions to a margin account and use them as collateral to buy more stocks of the same blue chip companies. Which statement is TRUE?

A. This is an appropriate strategy that will increase the customer's income
B. This is not an appropriate strategy because the customer's tax liability will increase if the securities appreciate and are sold
C. This is not an appropriate strategy because the customer's income will decline
D. This is an appropriate strategy because the customer has the potential for larger capital gains

The best answer is C. This customer needs income. If he margins the blue chip stock positions to "double up" on the amount of stock owned (since Regulation T margin is 50%), this does not come for free! He is borrowing the extra money to buy the new shareholding, using his existing stock as collateral, and he must pay interest on the loan. The interest charge will eat up any dividends that the stocks pay - so there goes his income!.

A 60-year old man seeks an investment that gives liquidity and income. The best recommendation would be:

A. Short-term Treasury Note
B. Blue Chip Stock
C. Bank CD
D. Zero-Coupon Bond

The best answer is A. This customer seeks liquidity and income. Liquidity means that the customer can easily cash-out the investment. A zero-coupon bond gives no income, so we can rule that one out. A bank CD gives income but is not liquid, in the sense that it cannot be sold in the market. Of course, it can be redeemed with the bank issuer, but there typically is an interest penalty to do so. A blue chip stock is liquid, but the dividend income is not as great as that provided by a fixed income security. A Treasury note gives a fixed rate of income and also is highly liquid. It is the best choice, (though a good argument could also be made for a bank CD!).

A 79-year old customer in the highest tax bracket with $1,000,000 to invest is risk averse. Which investment recommendation would be appropriate?

A. Money market funds
B. Municipal bonds
C. A Dow Jones Industrial Average index fund
D. Certificates of deposit

The best answer is B. Since this customer is in the highest tax bracket, and appears to be wealthy (with $1,000,000 to invest), tax-free municipal bonds are the best recommendation.

A customer has a $1,000,000 portfolio that is invested in the following:
$250,000 Large Cap Growth Stocks
$250,000 Large Cap Defensive Stocks
$250,000 U.S. Government Bonds
$250,000 Investment Grade Corporate Bonds
During a period of economic recession, the securities which will depreciate the least are likely to be the:
I Large Cap Growth Stocks
II Large Cap Defensive Stocks
III U.S. Government Bonds
IV Investment Grade Corporate Bonds

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is C. In a period of economic recession, defensive companies (which are those that are unaffected by the general economy, such as drug companies) remain profitable and their stock prices usually do not decline. In contrast, growth company profits can be hard hit by a recession, so their stock prices fall. In times of recession, investors "flee to safety." They sell their corporate bonds and use the proceeds to buy safe U.S. Government issues. This pushes corporate bond prices down, and U.S. Government bond prices up.

Customers A, B, C and D have their portfolio assets allocated as follows:
.........................................A.........B.........C.........D...
Money Markets..............15%....5%.......5%......0%
Treasury Bonds..............40%...10%.....20%...20%
Speculative Bonds........10%....30%....10%....30%
Blue Chip Equities........15%....15%....20%....10%
Small Cap. Equities......10%....10%....30%....5%
Emerging Markets........10%.....20%....10%...30%
REITs..............................0%.......10%....5%......5%

Which customer's portfolio is MOST susceptible to interest rate risk?

A. Customer A
B. Customer B
C. Customer C
D. Customer D

The best answer is A. Interest rate risk is the risk that rising market interest rates will force bond values to fall. Long term and low coupon bonds are most susceptible to this risk. Thus, Customer A, who has the greatest percentage of assets in Treasury Bonds - which are long term fixed income securities - is most exposed to this risk..

Customers A, B, C and D have their portfolio assets allocated as follows:
...................................A..........B..............C............ D
Money Markets.......15%.........0%........5%..........0%
Treasury Bonds.......40%.......30%.......20%.......30%
Speculative Bonds..10%.......20%.......10%.......20%
Blue Chip Equities...15%.......10%.......20%......10%
Small Cap. Equities.10%.......10%.......30%.......5%
Emerging Markets....10%.......20%.......10%......30%
REITs...........................0%........10%........5%.......5%

Which customer's portfolio is MOST susceptible to a cyclical economic downturn?

A. Customer A
B. Customer B
C. Customer C
D. Customer D

The best answer is C. In a cyclical economic downturn, the hardest hit asset group is stocks. Since earnings fall greatly in a downturn, so do stock prices. Also hard hit are speculative grade bonds, which can default. Portfolio C is the one that is most heavily invested in equities, so it would suffer the most in an economic downturn...

When making a recommendation of corporate commercial paper to a customer, which risk is the MOST important consideration?

A. Inflation (purchasing power) risk
B. Call risk
C. Market risk
D. Credit risk

The best answer is D. Credit risk is the risk that the issuer cannot make interest and principal payments as due. Since Commercial Paper is unsecured, investors are buying a security backed only by "faith and credit" - so credit quality is the major consideration. Because commercial paper is short term, there is minimal purchasing power risk and market risk. Over a short term time horizon, short term interest rates cannot rise much. Commercial Paper, like all money market instruments, is non-callable so this risk is not a factor.

The "Efficient Market Theory" states that:
I undervalued securities should exist
II undervalued securities should not exist
III overvalued securities should exist
IV overvalued securities should not exist

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is D. The "Efficient Market" Theory holds that prices of securities in the market fully reflect all publicly available information, so that undervalued or overvalued securities should not exist. Thus, securities selection based on any type of analytical method is irrelevant. In reality, most individuals believe that the market is only "partly" efficient in pricing securities - so that undervalued and overvalued securities will always exist. These could be identified by both fundamental and/or technical analysis.

The Capital Asset Pricing Model (CAPM) would identify the most efficient investments as those with the:
I lowest rate of return
II highest rate of return
III lowest level of risk
IV highest level of risk

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is C. CAPM is a methodology for finding the most efficient investments - those that give the greatest return for the amount of risk assumed. The model identifies the most efficient investments as those that give a rate of return equal to the "risk-free" rate of return (the rate of return for investments only having systematic risk) plus a premium for any non-systematic risk inherent in the investment.

An investor has a broadly diversified portfolio of blue chip stocks. The use of index options to hedge the portfolio reduces:

A. systematic risk
B. non-systematic risk
C. interest rate risk
D. timing risk

The best answer is A. Index options can be used to hedge a portfolio. If index puts are bought, then a drop in the market lowering the portfolio's value will be offset by a gain in the value of the index puts. This strategy hedges against market risk, also known as systematic risk. Non systematic risk is the risk that any one security will perform poorly. The larger the portfolio, the lower the effect of non-systematic risk. Timing risk is the risk that trades will not be performed at the best market prices; interest rate risk is the risk that interest rates rise, forcing bond prices and stock prices down.

Which of the investments listed below offers the greatest protection against market risk?

A. Common Stocks
B. Treasury Bills
C. Preferred Stocks
D. Treasury Bonds

The best answer is B. Market risk is the risk the securities prices, as a whole, will fall, dragging down both good and bad investments. To minimize market risk, common stocks should be avoided, as should long term fixed income securities, such as preferred stock and long bonds. To minimize this risk, investors "flee to safety" in the form of Treasury Bills. These are the safest type of credit - backed by the U.S. Government; and the price cannot drop that much because of their short term maturities. Since they will redeemed shortly at par, the price cannot fall much below par, no matter what happens to the market as a whole.

Customer Name: Charlie Customer
Age: 69
Marital Status: Single - Widowed
Dependents: None
Occupation: Retired
Household Income: $31,000 (Social Security and Pension)
Net Worth: $130,000 (excluding residence)
Own Home: Yes $220,000 Value, No Mortgage
Investment Objective: Current Income
Risk Tolerance: Low
Investment Time Horizon: 20 years
Investment Experience: 0 years
Current Portfolio Composition: Cash in Bank: $130,000
After reviewing this customer's profile sheet, which recommendation would be most appropriate?


A. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20 year TIPs to meet the customer's desire for current income and his low risk tolerance requirements
B. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20 year STRIPs to meet the customer's desire for current income and his low risk tolerance requirements
C. The customer should mortgage his house for $100,000 at current market interest rates and use the proceeds to buy 20 year income bonds to provide current income
D. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20 year Treasury Bonds to meet the customer's desire for current income and his low risk tolerance requirements

The best answer is D. This customer is age 69, with no current investments or investment experience. The customer has a fairly low retirement income and needs additional current income to live comfortably. This customer really only has 2 assets to tap for potential current income. He owns a fully paid house worth $220,000; and has $130,000 of cash in the bank. One way to supplement income is for the customer to get a reverse mortgage on the house, but this is not a banking exam, so we will not go near that possibility! The other way to supplement income is to invest the cash in the bank in an investment that is safe and that gives current income. Treasury Bonds pay interest semi-annually at a higher rate than that earned on bank deposits, and are really safe, so these would be the best recommendation. STRIPs do not provide current income since they are a zero-coupon Treasury obligation so these will not work. TIPs give a lower current interest rate than regular Treasury bonds, in return for protecting the investor against inflation - however the inflation protection is not "paid" until maturity, so again, these will not give the greatest additional current income.

Customer Name: Jane Doe
Age: 41
Marital Status: Married
Dependents: 1 Child, Age 13
Occupation: Homemaker
Household Income: $140,000
Net Worth: $240,000 (excluding residence)
Own Home: Yes
Investment Objectives: Total Return / Tax Advantaged
Investment Experience: 12 years
Current Portfolio Composition: 8% Common Stocks
62% Corporate Bonds
30% Money Market Fund
In order to make an appropriate recommendation to this customer, the registered representative should be concerned about the customer's:

I investment time horizon, with specific emphasis on whether the 13 year old child will go to college and how this expense will be funded
II strategic asset allocation needs with specific emphasis on the fact that the customer's portfolio mix might be overly conservative for a person that is only 41 years old
III retirement needs, with specific emphasis on whether the customer's spouse is covered by a pension plan or if the customer must fund her retirement on her own
IV life insurance coverage, with specific emphasis on the fact that this non-working wife and child must be supported if the husband dies

A. I and III only
B. II and IV only
C. I, II, III
D. I, II, III, IV

D. I, II, III, IV

The best answer is D. All of the choices are important and they are not addressed in the client profile provided. The registered representative should be concerned about whether the customer has been planning to pay for the 13 year old child's college education (if this is relevant). The current asset mix of 92% of the portfolio in bonds and money market instruments appears to be very conservative for a 41 year old, and will lower overall investment returns over the long haul. A reallocation of some of these funds to long term common stock investments may be appropriate. The profile does not address the customer's retirement needs and coverage; nor does it address the customer's insurance needs and coverage. All of these are relevant items.

Customer Name: Joey Jones
Age: 30
Marital Status: Single
Dependents: None
Occupation: VP - Marketing - ACCO Corp.
Household Income: $250,000
Net Worth: $60,000 (excluding residence)
Own Home: No - Rents
Investment Objectives: Aggressive Growth / Early Retirement at age 50
Investment Time Horizon: 20 years
Investment Experience: 0 years
Current Portfolio Composition: 401k: $30,000
Cash in Bank: $30,000
When reviewing this customer's profile sheet, the most immediate question that should be considered is:

A. "Does the customer intend to buy a home?"
B. "Does the customer intend to get married?"
C. "Since the customer earns $250,000 per year, how come he only has $60,000 in his portfolio?"
D. "Since this customer is age 30, why does he want to retire by age 50?"

C. "Since the customer earns $250,000 per year, how come he only has $60,000 in his portfolio?"
This customer, age 30, is a high earner, yet he only has $60,000 put away in his 401k and in cash. It sure looks like he is a big spender! Beginning a systematic plan of putting away money for retirement is critical when formulating an investment plan for a customer - especially one that wants to retire in 20 years. The customer must be made aware of the fact that, probably, his current spending pattern needs to be curtailed. This customer needs to start socking away money now to meet his early retirement goal!

Customer Name: Joey Jones
Age: 30
Marital Status: Single
Dependents: None
Occupation: VP - Marketing - ACCO Corp.
Household Income: $250,000
Net Worth: $110,000 (excluding residence)
Own Home: No - Rents
Investment Objectives: Aggressive Growth / Early Retirement
Investment Time Horizon: 20 years
Investment Experience: 0 years
Current Portfolio Composition: 401k: $70,000
Cash in Bank: $40,000
The customer informs you that he just got married and that his wife intends to work for the next 5 years before they think about children. In order to make recommendations to the client due to these changed circumstances, the registered representative should:


A. ask the customer if he wishes to open a joint account with his wife
B. update the account profile to include the wife's financial information
C. obtain the wife's social security number and perform a credit check
D. update the account file with a copy of the customer's marriage certificate

The best answer is B. Getting married is a life-changing event, both from a personal standpoint and a financial planning standpoint. Since the new wife will be working for 5 years, there will be additional income that can be invested. The financial goals and investment time horizon are likely to change as well. The first step is to update the financial profile based on the new circumstances.

A customer has a $1,000,000 portfolio that is invested in the following:
$250,000 Large Cap Growth Stocks
$250,000 Large Cap Defensive Stocks
$250,000 U.S. Government Bonds
$250,000 Investment Grade Corporate Bonds
During a period of economic recession, the securities which will depreciate the least are likely to be the:
I Large Cap Growth Stocks
II Large Cap Defensive Stocks
III U.S. Government Bonds
IV Investment Grade Corporate Bonds

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is C. In a period of economic recession, defensive companies (which are those that are unaffected by the general economy, such as drug companies) remain profitable and their stock prices usually do not decline. In contrast, growth company profits can be hard hit by a recession, so their stock prices fall. In times of recession, investors "flee to safety." They sell their corporate bonds and use the proceeds to buy safe U.S. Government issues. This pushes corporate bond prices down, and U.S. Government bond prices up.

Customers A, B, C and D have their portfolio assets allocated as follows:
A B C D
Money Markets 15% 5% 5% 0%
Treasury Bonds 40% 10% 20% 20%
Speculative Bonds 10% 30% 10% 30%
Blue Chip Equities 15% 15% 20% 10%
Small Cap. Equities 10% 10% 30% 5%
Emerging Markets 10% 20% 10% 30%
REITs 0% 10% 5% 5%
Which customer's portfolio is MOST susceptible to interest rate risk?


A. Customer A
B. Customer B
C. Customer C
D. Customer D

The best answer is A. Interest rate risk is the risk that rising market interest rates will force bond values to fall. Long term and low coupon bonds are most susceptible to this risk. Thus, Customer A, who has the greatest percentage of assets in Treasury Bonds - which are long term fixed income securities - is most exposed to this risk.

Customers A, B, C and D have their portfolio assets allocated as follows:
A B C D
Money Markets 15% 5% 5% 0%
Treasury Bonds 40% 10% 20% 20%
Speculative Bonds 10% 30% 10% 30%
Blue Chip Equities 15% 15% 20% 10%
Small Cap. Equities 10% 10% 30% 5%
Emerging Markets 10% 20% 10% 30%
REITs 0% 10% 5% 5%
Which customer's portfolio is MOST susceptible to political risk?


A. Customer A
B. Customer B
C. Customer C
D. Customer D

The best answer is D. Political risk is only associated with making foreign investments in developing Third World countries where the political and legal systems are not strong. These weak governments can be overthrown, and the new governments can "nationalize" private industry, giving the shareholders essentially "nothing" for their investment. Since Customer D has the greatest percentage of assets invested in Emerging Markets stocks, this investor is most susceptible to political risk.

Customers A, B, C and D have their portfolio assets allocated as follows:
A B C D
Money Markets 15% 0% 5% 0%
Treasury Bonds 40% 30% 20% 30%
Speculative Bonds 10% 20% 10% 20%
Blue Chip Equities 15% 10% 20% 10%
Small Cap. Equities 10% 10% 30% 5%
Emerging Markets 10% 20% 10% 30%
REITs 0% 10% 5% 5%
Which customer's portfolio is MOST susceptible to a cyclical economic downturn?


A. Customer A
B. Customer B
C. Customer C
D. Customer D

The best answer is C. In a cyclical economic downturn, the hardest hit asset group is stocks. Since earnings fall greatly in a downturn, so do stock prices. Also hard hit are speculative grade bonds, which can default. Portfolio C is the one that is most heavily invested in equities, so it would suffer the most in an economic downturn.

When making a recommendation of corporate commercial paper to a customer, which risk is the MOST important consideration?

A. Inflation (purchasing power) risk
B. Call risk
C. Market risk
D. Credit risk

The best answer is D. Credit risk is the risk that the issuer cannot make interest and principal payments as due. Since Commercial Paper is unsecured, investors are buying a security backed only by "faith and credit" - so credit quality is the major consideration. Because commercial paper is short term, there is minimal purchasing power risk and market risk. Over a short term time horizon, short term interest rates cannot rise much. Commercial Paper, like all money market instruments, is non-callable so this risk is not a factor.

The "Efficient Market Theory" states that:
I undervalued securities should exist
II undervalued securities should not exist
III overvalued securities should exist
IV overvalued securities should not exist

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is D. The "Efficient Market" Theory holds that prices of securities in the market fully reflect all publicly available information, so that undervalued or overvalued securities should not exist. Thus, securities selection based on any type of analytical method is irrelevant. In reality, most individuals believe that the market is only "partly" efficient in pricing securities - so that undervalued and overvalued securities will always exist. These could be identified by both fundamental and/or technical analysis.

The Capital Asset Pricing Model (CAPM) would identify the most efficient investments as those with the:
I lowest rate of return
II highest rate of return
III lowest level of risk
IV highest level of risk

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is C. CAPM is a methodology for finding the most efficient investments - those that give the greatest return for the amount of risk assumed. The model identifies the most efficient investments as those that give a rate of return equal to the "risk-free" rate of return (the rate of return for investments only having systematic risk) plus a premium for any non-systematic risk inherent in the investment.

An investor has a broadly diversified portfolio of blue chip stocks. The use of index options to hedge the portfolio reduces:

A. systematic risk
B. non-systematic risk
C. interest rate risk
D. timing risk

The best answer is A. Index options can be used to hedge a portfolio. If index puts are bought, then a drop in the market lowering the portfolio's value will be offset by a gain in the value of the index puts. This strategy hedges against market risk, also known as systematic risk. Non systematic risk is the risk that any one security will perform poorly. The larger the portfolio, the lower the effect of non-systematic risk. Timing risk is the risk that trades will not be performed at the best market prices; interest rate risk is the risk that interest rates rise, forcing bond prices and stock prices down.

Which of the investments listed below offers the greatest protection against market risk?

A. Common Stocks
B. Treasury Bills
C. Preferred Stocks
D. Treasury Bonds

The best answer is B. Market risk is the risk the securities prices, as a whole, will fall, dragging down both good and bad investments. To minimize market risk, common stocks should be avoided, as should long term fixed income securities, such as preferred stock and long bonds. To minimize this risk, investors "flee to safety" in the form of Treasury Bills. These are the safest type of credit - backed by the U.S. Government; and the price cannot drop that much because of their short term maturities. Since they will redeemed shortly at par, the price cannot fall much below par, no matter what happens to the market as a whole.

A "saucer" formation is:
I bullish
II bearish
III a reverse upward trend
IV a reverse downward trend

A. I and III
B. I and IV
C. II and III
D. II and IV

The best answer is B. A saucer formation is bullish since the market has bottomed out and is now moving back upwards. It is a downtrend that has reversed itself.

If the market is consolidating, it is said to be moving "s______" .

It is moving within a very n______ price range, with no clear u____ or d_____ .

If the market is consolidating, it is said to be moving " SIDEWAYS".

It is moving within a very NARROW price range, with no clear UPWARD or DOWNWARD.

The NASDAQ Market Diary shows the following:
Market Diary
Total Issues 4,037
Advanced 1,002
Declined 2,103
Unchanged 332

New Highs 103
New Lows 55
Total Vol 3,503,889,000
The Advance/Decline Ratio is:


A. 1:2
B. 2:1
C. 1:4
D. 4:1

The best answer is A. On this day, 1,002 issues advanced; while 2m103 issues declined; for an advance/decline ratio of 1,002/2,103 = 1:2.

Which of the following is an indicator of "market sentiment"?

A. Daily trading volume
B. Daily trading price range
C. Number of bullish investors versus number of bearish investors
D. Number of new listings on the New York Stock Exchange versus number of delistings

The best answer is C. The principal "Market Sentiment" (that is, market direction) indicators are the advance / decline ratio and the put / call ratio. Both of these indicators measure the relative number of bullish investors (as indicated by advancing prices or call purchases) relative to the number of bearish investors (as indicated by declining prices or put purchases). Trading volumes and price ranges do not indicate market direction; nor do the number of new listings versus the number of delistings.

Which of the following are an indicators of "market sentiment"?
I Put / Call Ratio
II Trading volume
III Advance / Decline Ratio
IV Price range

A. I and III only
B. II and IV only
C. I, III, IV
D. I, II, III, IV

The best answer is A. The principal "Market Sentiment" (that is, market direction) indicators are the advance / decline ratio and the put / call ratio. Both of these indicators measure the relative number of bullish investors (as indicated by advancing prices or call purchases) relative to the number of bearish investors (as indicated by declining prices or put purchases). Trading volumes (as a whole) and price ranges do not indicate market direction.

A technical analyst would be least concerned with the:

A. Short interest
B. Standard and Poor's 500 Index
C. Advance / Decline Line
D. Book Value per share

The best answer is D. A technical analyst makes buy and sell decisions on "technical" market factors such as trading volumes, breadth of market movement (advance / decline line), and the movement of market averages, and short interest figures. The "short interest" is the aggregate outstanding short position in a security. Technical analysts are not concerned with fundamentals such as earnings per share, balance sheet ratios etc.

The "Monetary Environment" is a reflection of which of the following?
I Stock trading volumes
II Stock price levels
III Monetary policy
IV Fiscal policy

A. I and II only
B. III and IV only
C. I and IV only
D. II and III only

The best answer is B.
The "Monetary Environment" is a reflection of
--- whether credit is easy or tight, as shown by
------ interest rate levels,
------ money supply levels, and
------ current economic policies of Gov"t -
----------->>> that is, fiscal policy.

The "Monetary Environment" is:

A. the spending and taxation policies in current use by the U.S. Government
B. the dollar level of imports entering the United States versus the dollar level of exports leaving the United States
C. current money supply levels, interest rate levels, and economic policies
D. current rate of exchange of the U.S. Dollar against major foreign currencies

The best answer is C. The "Monetary Environment" is a reflection of whether credit is easy or tight, as shown by interest rate levels, money supply levels, and current economic policies of the Government (for example, is the government using moral suasion to encourage lending or to discourage lending?)

A technical analyst who monitors stock advances against declines subscribes to the:

A. Odd Lot Theory
B. Breadth of Market Theory
C. Dow Theory
D. Efficient Market Theory

B. Breadth of Market Theory
An analyst who charts advances relative to declines is measuring the "breadth" of the market movement as an indicator of future market direction.

A fundamental analyst is likely to use technical analysis to determine:

A. transaction timing
B. investment selection
C. portfolio diversification
D. market volatility

A. transaction timing
Technical analysis is valid for fathoming short term price trends and is very useful in determining the specific time to buy or sell. However, the actual buy or sell decision is best made through fundamental analysis.

All of the following technical indicators would be considered to be bullish EXCEPT:

A. a breakout through a resistance level
B. a head and shoulders bottom formation
C. a saucer formation
D. odd lot purchases

The best answer is D. A breakout through a resistance level is bullish, since this is a market "breakout" to the upside. A head and shoulders bottom formation shows that the market has bottomed and is heading upward; a saucer formation shows the same - that the market has bottomed and is heading upward. The Odd Lot theory states that the small investor tends to trade odd lots and that the small investor is always wrong. Thus, the knowledgeable investor should do the opposite of what the small investor does. In this case, the small investor is buying, so, one should sell (a bearish indicator).

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