Investments : Analysis And Management, Third Canadian Edition Test Bank

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank1Chapter 1CHAPTER 1Understanding InvestmentsMULTIPLE CHOICE1.A Chartered Financial Analyst designation is a(an):a.OSC-approved and awarded designation.b.certification of a successful investing record.c.professional designation awarded for meeting recognized standards of conduct andcompetency.d.professional designation awarded by the brokerage industry.Answer: cTopic: Investments as a ProfessionLevel of Difficulty: EasyType: Factual2.Gold, gems, art and real estate would be classified as:a.real assets.b.indirect assets.c.personal assets.d.financial assets.Answer: aTopic: The Nature of InvestmentsLevel of Difficulty: EasyType: Factual3.Another name for stockbrokers is:a.specialists.b.registered representatives.c.security analysts.d.portfolio managers.Answer: bTopic: Investments as a ProfessionLevel of Difficulty: ModerateType: Factual4.A portfolio:a.is made of the asset holdings of an investor.b.cannot include real assets.c.is not evaluated after initially purchased.d.is unimportant in overall financial planning.Answer: aTopic: Structuring the Decision Process: Portfolio ManagementLevel of Difficulty: ModerateType: Factual5.Underlying the evaluation of an investment is the trade-off between:a.expected return and actual return.b.low risk and high risk.c.actual return and high risk.d.expected return and risk.Answer: dTopic: The Expected Return-Risk TradeoffLevel of Difficulty: ModerateType: Factual6.Most investors exhibit risk averse behaviour which means:a.they will not assume more risk only unless they are compensated by higher expected returns.b.they will always invest in investments providing the lowest possible risk.

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank2Chapter 1c.they actively seek to maximize their risks.d.they invest only in money market securities to avoid the risk inherent in the stock market.Answer: aTopic: The Basis on Investment Decisions: RiskLevel of Difficulty: ModerateType: Factual7.The discipline of security analysis concerns as its primary criterion to provide a(n):a.analysis of the overall securities market and its direction.b.valuation and analysis of individual securities.c.purchasing securities at the best price.d.determination of the investor’s required return.Answer: bTopic: Structuring the Decision Process: Security AnalysisLevel of Difficulty: ModerateType: Factual8.The ex ante risk-return trade-off as its basic principle suggests:a.a higher expected return for investors who take on higher expected risk.b.a lower expected return for investors who take on higher expected risk.c.the same expected return for investors who take on higher expected risk.d.the amount of expected return for investors is not directly related to the amount of expectedrisk.Answer: aTopic: The Expected Return-Risk TradeoffLevel of Difficulty: EasyType: Factual9.The expected return from an investment is:a.contingent upon the historical return from that investment.b.inversely related to the risk associated with that investment.c.always equal to required return.d.the anticipated return for some future period on that investment.Answer: dTopic: The Expected Return-Risk TradeoffLevel of Difficulty: ModerateType: Factual10.An emerging market is one that is characterized by:a.the continual introduction of new products and technologies.b.the issuance of financially engineered securities.c.a high participation rate in Internet trading.d.a low per capita economy.Answer: dTopic: The Global Investments Arena: Emerging MarketsLevel of Difficulty: ModerateType: Factual11.Global events have a significant impact on the Canadian economy because:a.Canada derives a small percentage of its economic wealth from international trade.b.Canada’s economy has a relatively large proportion of commodity-based industries.c.Canada’s manufacturing base has increased substantially in the last two decadesd.almost all of the Government of Canada debt is held by domestic investors.Answer: bTopic: The Global Investments ArenaLevel of Difficulty: ModerateType: Conceptual12.Which of the following isnotan institutional investor?a.chartered banksb.insurance companiesc.pension fundsd.high net worth investors

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank3Chapter 1Answer: dTopic: Institutional InvestorsLevel of Difficulty: EasyType: Factual13.Which of the following would be considered a risk-free investment by a Canadian investor?a.goldb.equity in a housec.high-grade corporate bondsd.Bank of Canada Treasury billsAnswer: dTopic: The Expected Return-Risk TradeoffLevel of Difficulty: EasyType: Factual14.International investing:a.is only practical for institutional investors.b.increases the overall risk of a stock portfolio.c.always leads to higher returns than a domestic portfolio.d.can reduce risk due to increased diversification.Answer: dTopic: The Global Investments ArenaLevel of Difficulty: ModerateType: Factual15.Investment decision-making traditionally consists of two steps:a.investment banking and security analysis.b.buying and selling.c.risk and expected return.d.security analysis and portfolio management.Answer: dTopic: The Expected Return-Risk TradeoffLevel of Difficulty: ModerateType: Factual16.Which of the following groups of investments is incorrectly ordered from lowest to highest risk?a.government bonds, preferred stock, warrantsb.T-bills, corporate bonds, optionsc.government bonds, financial futures, common stockd.T-bills, common stock, options.Answer: aTopic: The Expected Return-Risk TradeoffLevel of Difficulty: DifficultType: Factual17.Investors should be concerned with international investing for all of the following reasons except:a.Large amount of capital flows from abroad into domestic markets.b.Rates of return on foreign securities have often been larger than on domestic securities.c.Foreign companies are taking over many domestic industries, such as banking.d.Canadian companies derive a large percentage of their revenues from abroad.Answer: cTopic: The Global Investment ArenaLevel of Difficulty: DifficultType: Factual18.The __________ Act was implemented in 2002 in the U.S. in response to the collapse in publicconfidence surrounding the debacles of Enron and WorldCom.a.Canadian Business Incorporationb.Sarbanes-Oxleyc.Shermand.Trading with the EnemyAnswer: bTopic: Corporate Governance: Sarbanes Oxley Act

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank4Chapter 1Level of Difficulty: EasyType: Factual19.Emerging markets are often characterized as:a.low risk, low return markets.b.low risk, high return markets.c.high risk, low return markets.d.high risk, high return markets.Answer: dTopic: The Global Investment ArenaLevel of Difficulty: ModerateType: Factual20.Markets that have prices adjusting quickly to new information to reflect the impact of thatinformation on the security is known as:a.risk-free.b.liquid.c.self-fulfilling.d.efficient.Answer: dTopic: The Issue of Market EfficiencyLevel of Difficulty: EasyType: Factual21.Investment professionals whose jobs may depend on their performance relative to the market arethe:a.registered representatives.b.security analysts.c.investment bankers.d.portfolio managers.Answer: dTopic: Investments as a ProfessionLevel of Difficulty: ModerateType: Factual22.Institutional investors often avoid investing in spinoffs because:a.they often pay no dividends and may be too small.b.they tend to be too risky for most institutional investors.c.they generally have lower than average returns.d.they require too great a commitment of funds.Answer: aTopic: Institutional InvestorsLevel of Difficulty: DifficultType: Conceptual23.Technically, investments include:a.only financial assets.b.only marketable assets.c.financial and real assets that are marketable or non-marketable.d.only financial and real assets that are marketable.Answer: cTopic: The Nature of InvestmentsLevel of Difficulty: EasyType: Factual24.Portfolio management is most concerned with:a.generating the highest expected return regardless of risk.b.the income tax planning for security returns.c.the retirement planning process.d.the selection, revision, and evaluation of a group of assets.Answer: dTopic: Structuring the Decision Process: Portfolio ManagementLevel of Difficulty: ModerateType: Conceptual

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank5Chapter 125.In order to become licensed to sell securities in Canada, individuals must pass the followingcourses:1.CSC3. IFIC2.CPH4. CFAa.1 and 2b.1, 2, and 3c.1 onlyd.1 and 4Answer: aTopic: Investments as a Profession/CSI Appendix 1BLevel of Difficulty: ModerateType: FactualTRUE-FALSE1.A risk-averse investor will avoid all risk when investing.Answer: FalseTopic: The Basis of Investment DecisionsLevel of Difficulty: EasyType: Factual2.Investors always seek to maximize the return from their investments regardless of the risk ofinvesting.Answer: FalseTopic: The Basis of Investment DecisionsLevel of Difficulty: ModerateType: Factual3.All investors should allocate the majority of their portfolio in T-bills to minimize the risk of theportfolio.Answer: FalseTopic: The Expected Return–Risk Trade-OffLevel of Difficulty: Easy Type: Factual4.The two major considerations in investing are timing and risk.Answer: FalseTopic: Understanding the Investment Decision ProcessLevel of Difficulty: EasyType: Factual5.Common stock analysis is a two-step process of analyzing the industry and analyzing the individualcompany.Answer: FalseTopic: Structuring the Decision ProcessLevel of Difficulty: ModerateType: Factual6.Investors that do not strongly believe in the Efficient Market Hypothesis tend to follow a passiveinvestment strategy.Answer: FalseTopic: The Issue of Market EfficiencyLevel of Difficulty: DifficultType: Factual7.Financial planners must pass a standardized test and possess certain credentials.Answer: FalseTopic: Appendix 1A – The Chartered Financial Analyst ProgramLevel of Difficulty: Easy Type: Factual8.Risk is defined as the chance that the actual return on an investment will outperform the stockmarket in a given year.Answer: FalseTopic: The Basis of Investment DecisionsLevel of Difficulty: ModerateType: Factual

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank6Chapter 19.Institutional investors have gained in importance at the expense of individual investors.Answer: TrueTopic: Institutional InvestorsLevel of Difficulty: DifficultType: Factual10.Financial planners, on average, earn much more than security analysts.Answer: FalseTopic: Investments as a ProfessionLevel of Difficulty: DifficultType: Factual11.The minimum actual return necessary to induce investors to invest is known as the expected return.Answer: FalseTopic: The Basis of Investment DecisionsLevel of Difficulty: Easy Type: Factual12.According to the Efficient Market Hypothesis, prices of securities reflect their underlying economicvalue.Answer: TrueTopic: The Issue of Market EfficiencyLevel of Difficulty: ModerateType: Conceptual13.Real assets include stocks, bonds and financial futures.Answer: FalseTopic: The Nature of InvestmentsLevel of Difficulty: ModerateType: Factual14.The CSI has the exclusive right to grant the Certified Financial Planner (CFP) designation inCanada.Answer: FalseTopic: Appendix 1B – The Canadian Securities Institute (CSI)Level of Difficulty: Easy Type: Factual15.The CFA program is offered by the CFA Institute.Answer: TrueTopic: Appendix 1A – The Chartered Financial Analyst ProgramLevel of Difficulty: Easy Type: FactualSHORT ANSWER1.Briefly explain the difference between expected returns and realized returns and between ex antereturns and ex post returns.Answer: Expected returns are mean returns based on probability distributions dealing with the future.Realized returns are the returns that actually occurred in the past. Ex ante returns are in the future. Expost returns are in the past.2.What are some of the career opportunities in the investment industry?Answer: Merger and acquisition specialist, security traders, salespeople, security analyst, portfoliomanager, registered representative, and financial analyst.3.What is the major difference separating the Chartered Financial Analyst from the other financialplanners?Answer: The CFA is oriented toward institutional portfolio management, whereas the others(Certified Financial Planner, Chartered Financial Consultant, and Personal Financial Specialist) areoriented toward personal financial planning.4.Define risk in the context of investments.

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank7Chapter 1Answer: Risk is the chance that the actual return on an investment will deviate from its expectedreturn.5.Will risk-averse investors ever include commodity futures or options in their portfolios? Explain.Answer: They may include these items in their portfolios since risk-averse is not the same thing asrisk avoidance. Risk-averse investors would expect a higher return from these assets as they areriskier than many other assets.6.Explain why T-bills are not totally risk-free.Answer: T-bills are assumed free of default risk since the Canadian government has always paid itsdebts. But T-bills are still subject to interest rate and inflation risk since their prices may fluctuate ifinterest rates or inflation changes.7.What are the components of security analysis and why does it take place before portfolioconstruction?Answer: The valuation of securities is a time-consuming and difficult task wherein the analyst isrequired to understand the various factors that affect the value of securities and to then be able toincorporate these factors into a valuation model. Once these factors on individual securities have beenidentified and valued, then the analyst can incorporate them into the construction of a portfolio, whichwill need to reflect the risk-return components of the individual securities.8.A 25-year old college graduate is participating in an RRSP. His primary investment criterion is tominimize risk. What will this decision probably do to his ending retirement funds in 40 years? Whattypes of investments would be in that RRSP that the graduate has chosen to provide minimum risk?Answer: If he minimizes risk, then he will also minimize return. His retirement fund will likely bemuch smaller than if he chose to take on additional risk over the long run. The types of investorswould be money market instruments, such as T-bills, GIC, commercial paper, as well as very securegovernment bonds.9.Considering the Efficient Market Hypothesis, how does new economic information affect securities’prices?Answer: The price adjusts quickly to new economic information.CRITICAL THINKING/ESSAY1.What are the steps required to value common stock?Answer: The investor must evaluate the overall economy, industry and individual company as allhave an impact on the value of the stock to estimate the expected return and risk for the company.And while the investor is attempting to identify undervalued stocks, the efficiency of the stockmarkets must be considered to ascertain whether the observed market price of the stock is the same asthe economic value.2.According to the Efficient Market Hypothesis, stocks in the market are assumed to be fairly priced.Does this mean that security analysis is a waste of time?Answer: No, security analysis helps investors to identify the underlying economic strengths andweaknesses associated with the investment. Also, the possibility of a short-term market lag, and hencea potentially slow speed of adjustment of the price to that information, means that the more informedinvestor can take advantage of temporarily undervalued securities.3.When it comes to decisions about the amount of trades taken by an investor explain why someinvestors and their brokers may want to take different approaches to trading decisions?

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank8Chapter 1Answer: Investors are generally looking for long-term returns and must consider the overall cost oftrading. Investors may often do well with a buy-and-hold strategy attempting passive techniques thatindex the market. Brokers, on the other hand, make their living by commissions which means theyhave a vested interest in having customers trade more often and may be more predisposed towardsactive techniques which attempt to time the market or are based on a belief that they are able to pickbetter performing assets. Excessive trading in an investor’s account is known as churning an account.

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank1Chapter 2CHAPTER 2Investment AlternativesMULTIPLE CHOICE1.Which of the following isnota usual characteristic of money market securities?a.They are issued by large credit worthy corporations in large denominations.b.They are very liquid instrument that trade without a significant liquidity premium.c.They are of an intermediate to long term maturity.d.They include T-bills, commercial paper, and bankers’ acceptances.Answer: cTopic: Money Market SecuritiesLevel of Difficulty: ModerateType: Factual2.The coupon rate is another name for the:a.market interest rate.b.current yield.c.stated interest rate.d.yield to maturity.Answer: cTopic: Capital Market Securities: BondsLevel of Difficulty: EasyType: Factual3.T-bills are sold:a.on an auction basis every two weeks by the Bank of Canada.b.in denominations ranging from $1,000 to $1,000,000.c.for only 91 days maturity.d.both a. and b.Answer: dTopic: Money Market SecuritiesLevel of Difficulty: ModerateType: Factual4.Which of the following is true concerning corporate bonds?a.Mortgage bonds are secured obligations whereas debentures are unsecured.b.Bonds have a subordinated debenture which functions as a contract between the bondholderand the issuing company.c.Bonds have superior voting rights to common shareholders.d.One can buy a bond at any time and receive an immediate interest cheque.Answer: aTopic: Capital Market Securities: BondsLevel of Difficulty: ModerateType: Factual5.Bonds with a call provision can be:a.exchanged for common shares at the option of the bondholder.b.redeemed prior to maturity at option of the issuing company.c.exchanged for common shares at the option of the issuing company.d.redeemed prior to maturity at the option of the bondholder.Answer: bTopic: Capital Market Securities: BondsLevel of Difficulty: ModerateType: Factual6.Which of the following statements regarding dividend dates is true?a.The ex-dividend date is prior to the date of record.b.The date of record is prior to the declaration date.c.The ex-dividend date is prior to the declaration date.

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank2Chapter 2d.The date of record is prior to the ex-dividend date.Answer: dTopic: Equity Securities: Common StockLevel of Difficulty: ModerateType: Factual7.A major difference between a warrant and a call option is that:a.warrants have less value.b.warrants allow investors to buy bonds; calls allow investors to buy stock.c.warrants generally have a longer term.d.options have a greater leverage effect.Answer: cTopic: Derivative SecuritiesLevel of Difficulty: DifficultType: Factual8.Dividends on common stock are typically declared and paid:a.monthly.b.quarterly.c.semi-annually.d.yearly.Answer: bTopic: Equity Securities: Common StockLevel of Difficulty: EasyType: Factual9.If an investor states that Commercial Bank is undervalued at 15 times, he is referring to the:a.EPS.b.dividend yield.c.market to book ratio.d.earning multiple.Answer: dTopic: Common Stock: P/E Ratio or Earnings MultipleLevel of Difficulty: DifficultType: Factual10.Retractable bonds:a.give the bondholder the right to sell the bonds back to the issuer prior to maturity.b.give the issuer the right to buy the bonds back from the issuer prior to maturity.c.give the bondholder the right to buy additional bonds from the issuer.d.give the issuer the right to sell additional bonds to the bondholder..Answer: aTopic: Capital Market Securities: BondsLevel of Difficulty: ModerateType: Factual11.Which of the following statements regarding money market instruments isnottrue?a.They tend to be highly marketable.b.They tend to require a large dollar investment.c.They tend to have a high probability of default.d.Their rates tend to move together.Answer: cTopic: Money Market SecuritiesLevel of Difficulty: ModerateType: Factual12.Which of the following is a capital market instrument?a.Repurchase agreementsb.Negotiable CDsc.Preferred stockd.Commercial paperAnswer: cTopic: Capital Market SecuritiesLevel of Difficulty: ModerateType: Factual

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank3Chapter 213.Which of the following money market instruments is normally used in international trade?a.Negotiable CDsb.Commercial paperc.Repurchase agreementsd.Bankers’ acceptancesAnswer: dTopic: Money Market SecuritiesLevel of Difficulty: DifficultType: Factual14.Coupon interest on corporate bonds is typically paid:a.monthly.b.quarterly.c.semi-annually.d.annually.Answer: cTopic: Capital Market Securities: BondsLevel of Difficulty: ModerateType: Factual15.The price a bond buyer must pay that includes accrued interest is known as the:a.call price.b.coupon rate.c.premium price.d.invoice price.Answer: dTopic: Capital Market Securities: BondsLevel of Difficulty: DifficultType: Factual16.Derivative securities include all of the following except:a.options.b.forwards.c.futures.d.corporate bonds.Answer: dTopic: Derivative SecuritiesLevel of Difficulty: ModerateType: Factual17.An unsecured bond that has a claim that is after all other debt holders is known as a(an):a.debenture.b.indenture.c.mortgage bond.d.subordinated debentureAnswer: dTopic: Capital Market Securities: BondsLevel of Difficulty: ModerateType: Factual18.Which of the following is not a reason investors are attracted to asset-backed securities?a.Investors are often protected by a bond insurer.b.These securities often have investment-grade credit ratings.c.These securities have relatively high yields.d.These securities are generally long-term, stable investments.Answer: dTopic: Capital Market Securities: ASBLevel of Difficulty: DifficultType:Factual19.A three-for-one stock split results in which of the following, compared to before the split?a.Three times as many shares; the same total book value of equity; one-third the market price pershare.

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank4Chapter 2b.Three times as many shares; three times the total book value of equity; three times the marketprice per share.c. One-third as many shares; the same total book value of equity; one-third the market price pershare.d.One-third as many shares; one-third the total book value of equity; one-third the market priceper share.Answer: aTopic: Capital Market Securities: Common StockLevel of Difficulty: DifficultType: Conceptual20.The CDIC provides deposit insurance for the following institutions:1. Chartered banks2. Credit Unions and Caisses Populaires3. Trust companies4. Insurance companiesa.1 onlyb.1 and 2c.1 and 3d.1 and 4Answer: cTopic: Real-World Returns 2-1 Level of Difficulty: ModerateType: Factual21.Which of the following is true for bond rating companies?a.bond ratings are issued exclusively by Moody’sb.bond ratings are of interest only at the time the bond is issuedc.bond ratings can be changed by the rating agency as the issuer’s circumstances changed.the higher the bond rating the greater the interest paid.Answer: cTopic: Fixed-Income SecuritiesLevel of Difficulty: ModerateType: FactualTRUE-FALSE1.Indirect investing means that the investor buys shares on the stock exchange as opposed to directlyfrom the company.Answer: FalseTopic: Organizing Financial AssetsLevel of Difficulty: ModerateType: Factual2.An example of direct investing would be buying shares in a mutual fund.Answer: FalseTopic: Organizing Financial AssetsLevel of Difficulty: EasyType: Factual3.Nonmarketable investments would include savings accounts at banks and Canada Savings Bonds.Answer: TrueTopic: Organizing Financial AssetsLevel of Difficulty: ModerateType: Factual4.The purchase of any marketable security would constitute a capital market transaction.Answer: FalseTopic: Organizing Financial AssetsLevel of Difficulty: EasyType: Factual5.The Canadian government does not issue non-marketable securities.Answer: FalseTopic: Non-Marketable Financial AssetsLevel of Difficulty: EasyType: Factual

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank5Chapter 26.Money market instruments are generally highly liquid.Answer: TrueTopic: Non-Marketable Financial AssetsLevel of Difficulty: ModerateType: Factual7.The money market security most often used as a benchmark for the risk-free rate is the average ratepaid on bankers’ acceptance.Answer: FalseTopic: Money Market SecuritiesLevel of Difficulty: EasyType: Factual8.The rate spreads between the different money market securities of the same term tend to be quitesmall.Answer: TrueTopic: Money Market SecuritiesLevel of Difficulty: DifficultType: Factual9.The non-traded debt of the Canadian government are Canada Savings Bonds.Answer: TrueTopic: Fixed-Income Securities Level of Difficulty: ModerateType: Factual10.Commercial paper is sold in both the capital and money markets.Answer: FalseTopic: Money Market SecuritiesLevel of Difficulty: EasyType: Factual11.Term bonds have a single maturity while serial bonds have several maturity dates.Answer: TrueTopic: Fixed-Income SecuritiesLevel of Difficulty: ModerateType: Factual12.The return on a stripped bond is derived from the difference between the price paid and the facevalue.Answer: TrueTopic: Fixed-Income SecuritiesLevel of Difficulty: DifficultyType: Factual13.The smaller the discount on a zero-coupon bond, the higher the effective return.Answer: FalseTopic: Fixed-Income SecuritiesLevel of Difficulty: ModerateType: Factual14.If a bond has a coupon rate less than the prevailing market yield, it is selling at a discount.Answer: TrueTopic: Capital Market SecuritiesLevel of Difficulty: DifficultType: Factual15.Callable bonds attract investors because they can be redeemed early.Answer: FalseTopic: Fixed-Income SecuritiesLevel of Difficulty: ModerateType: Factual16.Companies would be more likely to exercise the call features on bonds when interest rates rise.Answer: FalseTopic: Fixed-Income SecuritiesLevel of Difficulty: ModerateType: Factual17.The call provision on callable bonds is usually not exercisable immediately but is deferred for aperiod of time as specified in the bond indenture.Answer: TrueTopic: Fixed-Income SecuritiesLevel of Difficulty: DifficultType: Factual

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank6Chapter 218.In the case of a corporate bankruptcy, both bondholders and debenture holders are paid before anydistributions are paid to preferred or common stockholders.Answer: TrueTopic: Fixed-Income SecuritiesLevel of Difficulty: ModerateType: Factual19.Bond ratings are primarily used to assess price risk for the bond.Answer: FalseTopic: Fixed-Income SecuritiesLevel of Difficulty: ModerateType: Factual20.A major Canadian bond rating service is Dominion Bond Rating Service.Answer: TrueTopic: Fixed-Income SecuritiesLevel of Difficulty: EasyType: Factual21.The earnings retention rate is calculated as dividends paid/net income.Answer: FalseTopic Equity Securities: Common StockLevel of Difficulty: EasyType: Factual22.The par value of preferred stock sets the maximum value that these stockholders would receive incase of bankruptcy.Answer: TrueTopic: Fixed-Income SecuritiesLevel of Difficulty: EasyType: FactualSHORT ANSWER1.Distinguish between direct and indirect investing.Answer:Direct investing—buy bonds and stocks.Indirect investing—buy mutual funds, contribute to pension plans, buy life insurance policies.2.Compare the cash flows that an investor expects from any pure discount instruments, couponbonds, zero-coupon bonds, preferred stock and common stock.Answer:Pure discounts instruments arise when an investor has only two cash flows which are atthe beginning when the instrument is purchased for a discount (T-bills, zero coupon bonds) andthen redeemed for the face value (principal) at maturity.Coupon bonds provide two types of cash flows being an annuity of interest payments with aballoon payment of principal at maturity..Preferred stock pays a perpetuity of dividends. To receive an additional cash flow the investorwould need to sell the instrument in the market at the prevailing market price. Some preferredissues are redeemable.Common stock does not guarantee any cash flow from holding the security as any dividendswill need to be declared. The other way of have a cash flow is to sell the investment.3.How are the earnings retention ratio and the dividend payout ratio determined?Answer:The dividend payout ratio and the earnings retention ratio (plowback ratio) are both basedon net income and are complements. The dividend payout ratio is the percentage of the netincome distributed to shareholders (dividends/net income) with the earnings retention ratio beingthe percentage of net income reinvested in the firm (retained earnings/net income). Alternativelythe earnings retention ratio = 1 – dividend payout ratio.4.Why is the ex-dividend date before the holder-of-record date?Answer:So that paperwork can be completed to show correct owners.

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Cleary/JonesInvestments: Analysis and Management, Third Canadian EditionTest Bank7Chapter 25.How is the total book value of equity affected by stock splits? Stock dividends?Are the bookvalues of common stock, capital in excess of par, or retained earnings affected by either?Answer:Stock splits do not affect total value of equity or the individual accounts, other than thenumber of shares outstanding and the par value. Stock dividends do not affect the total value ofequity, but retained earnings are transferred to common stock and capital in excess of par.Thenumber of shares outstanding is affected.6.Why might one say that a stock trading at 10 times earnings could potentially provide a lessexpensive investment opportunity than a stock with a P/E ratio of 20?Answer:The P/E or price-to earnings ratio and the earnings multiple are one indication that ashare may be undervalued. The ratio is defined as the current price of the share divided by thelatest EPS. The higher the P/E ratio means that investors are willing to pay higher amounts topurchase with a lower ratio implying that the stocks may be undervalued and are better buyingopportunities for investors.7.What are one direct and one indirect method for individuals to invest in foreign stocks?Answer:Buy securities directly through exchanges and indirectly through mutual funds.8.Explain how writing option contracts (both puts and calls) can generate income for owners of theunderlying stock.Answer:The writer receives the option premium as a cash flow at the beginning regardless ofwhether or not the option is subsequently exercised.9.Rank (lowest to highest) the following securities in terms of the risk-expected return trade-off fromthe investors’ viewpoint:common stock, corporate bonds, Government of Canada bonds, options,preferred stock.Answer:Government of Canada bonds, corporate bonds, preferred stock, common stock, options.10.What are some advantages of asset-backed securities to investors?Answer:High yields with manageable risk.CRITICAL THINKING/ESSAY1.Do the stock options markets help stabilize or destabilize the stock markets? Explain.Answer:Options should be a stabilizing force if options are used to hedge stock positions, eitherthrough writing calls against common shares owned to generate a covered call position orpurchasing calls to cover a short stock transaction.Options might be destabilizing if used forspeculation.2.How do asset-backed securities improve the flow of funds from savers to borrowers?Answer:Asset-backed securities can be sold to a broader market of investors than the underlyingsecurities.PROBLEMS1.Based on the following partial balance sheet, calculate the book value per share of common equity.Current liabilities$ 20,000Long-term debt90,000Common stock ($1 par)20,000Capital in excess of par60,000

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