Investment Strategies and Market Indices Quiz
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Questions and Answers

What is the main advantage of using an ADR for an investor?

  • It offers greater liquidity than directly investing in the foreign company's shares.
  • It provides a way to invest in foreign companies without having to deal with currency exchange risks.
  • It simplifies the process of investing in foreign companies by meeting US security registration requirements. (correct)
  • It allows investors to purchase fractional shares of a foreign company.

Which of the following is NOT a characteristic of the Dow Jones Industrial Average (DJIA)?

  • It is a price-weighted average of 30 large blue-chip corporations.
  • It has been computed since 1896.
  • It is a broad-based index that reflects the performance of the entire stock market. (correct)
  • The investment in each company within the index is proportional to that company's share price.

What does the price-earnings ratio (P/E ratio) of a stock tell us?

  • The total market value of a company's outstanding shares.
  • The amount of profit a company makes per share.
  • The amount of dividends a company distributes per share.
  • How much investors are willing to pay for each dollar of earnings generated by the company. (correct)

Which of the following types of indexes is NOT a market value index?

<p>Equally weighted indexes (A)</p> Signup and view all the answers

Which of these options correctly describes a put option?

<p>It gives the holder the right to sell an asset for a specified price on or before a specified date. (C)</p> Signup and view all the answers

What is the key difference between a future contract and a forward contract?

<p>Future contracts are standardized and traded on exchanges, while forward contracts are customized and traded over-the-counter. (C)</p> Signup and view all the answers

Which of the following is NOT considered a derivative asset?

<p>Stock shares (B)</p> Signup and view all the answers

What is the main difference between a long position and a short position in a futures contract?

<p>A long position is held by a trader who commits to buying the asset on the delivery date, while a short position is held by a trader who commits to selling the asset on the delivery date. (B)</p> Signup and view all the answers

What happens when the market price of an asset exceeds the exercise price of a call option?

<p>The option holder has the right to purchase the asset at the exercise price and potentially profit from the difference between the market price and exercise price. (D)</p> Signup and view all the answers

What is the main purpose of an index fund?

<p>To provide a yield of return that is equal to that of the index, offering a low-cost passive investment strategy. (A)</p> Signup and view all the answers

What distinguishes a Yankee bond from other types of bonds?

<p>It is dollar denominated and sold in the US by a non-US issuer. (B)</p> Signup and view all the answers

Which type of municipal bond is backed by the general taxing power of the issuer?

<p>General obligation bond (A)</p> Signup and view all the answers

What is the main feature of corporate secured bonds?

<p>They are backed by specified collateral. (B)</p> Signup and view all the answers

Which statement accurately describes subordinated debentures?

<p>They are lower priority than other debentures. (A)</p> Signup and view all the answers

What is the primary purpose of a proxy in corporate governance?

<p>To vote on behalf of a shareholder. (C)</p> Signup and view all the answers

What characteristic of common stock provides limited liability to shareholders?

<p>The maximum loss is limited to the original investment. (A)</p> Signup and view all the answers

What do subprime mortgages entail compared to conforming mortgages?

<p>They are issued to financially weaker borrowers. (B)</p> Signup and view all the answers

What is dividend yield expressed as?

<p>Annual dividend payment as a percentage of the stock price. (D)</p> Signup and view all the answers

What is the primary characteristic of money market securities?

<p>Short-term and low-risk (B)</p> Signup and view all the answers

Which of the following best describes Treasury Bills (T-bills)?

<p>Short-term government-issued debt (D)</p> Signup and view all the answers

What does the bid-ask spread represent in the context of T-bills?

<p>The profit margin for the dealer (D)</p> Signup and view all the answers

What is the role of commercial paper in money markets?

<p>Short-term unsecured debt notes issued by wealthy companies (D)</p> Signup and view all the answers

Which security is characterized as an order to a bank to pay a specific amount at a future date?

<p>Banker's acceptance (D)</p> Signup and view all the answers

What distinguishes Eurodollars from other money market instruments?

<p>They are deposits denominated in dollars outside the U.S. (D)</p> Signup and view all the answers

Which type of yield is primarily associated with money market instruments?

<p>Low risk but not risk-free yield (A)</p> Signup and view all the answers

What type of bonds provide a hedge against inflation risk?

<p>Treasury Inflation-Protected Securities (TIPS) (B)</p> Signup and view all the answers

What is the primary distinction between Treasury notes and Treasury bonds?

<p>Notes have maturities of up to 10 years, while bonds range from 10 to 30 years. (A)</p> Signup and view all the answers

What was the primary reason for replacing LIBOR with SOFR?

<p>LIBOR was based on bank surveys and not actual transactions. (D)</p> Signup and view all the answers

What is the purpose of federal agency debt instruments?

<p>To channel credit to sectors lacking sufficient private funding. (C)</p> Signup and view all the answers

Which type of money market security can be sold before maturity if needed?

<p>Certificates of deposit (CDs) (A)</p> Signup and view all the answers

What unique feature do repos offer in money market transactions?

<p>They involve sales of securities with an agreement to repurchase. (B)</p> Signup and view all the answers

What aspect defines the federal funds rate?

<p>The interest charged for very short-term loans between financial institutions. (D)</p> Signup and view all the answers

Flashcards

Money Markets

Short-term, marketable, liquid, and low-risk debt securities. A subsector of the fixed income market accessible to small investors.

Capital Markets

Longer-term and riskier securities including bonds, equity, options, and futures.

Treasury Bills (T-bills)

Debt securities issued by the US government to raise money. They are highly liquid, marketable, and exempt from state and local taxes.

Ask Price

The price at which you can buy a T-bill from a dealer.

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Bid Price

The price at which you can sell a T-bill to a dealer.

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Bid-Ask Spread

The difference between the ask price and the bid price. It's the dealer's profit margin.

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Certificates of Deposit (CDs)

Time deposits with a fixed interest rate and maturity date. They can be sold before maturity but may incur penalties.

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Commercial Paper

Short-term unsecured debt notes issued by large, well-known companies. Backed by a bank line of credit and maturing in under 270 days.

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Banker's Acceptance

An order to a bank by a customer to pay a sum of money at a future date. This is backed by the bank's credit and traded at a discount.

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Eurodollars

Dollar-denominated deposits held at foreign banks or foreign branches of American banks.

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Repurchase Agreements (Repos)

Short-term sales of securities with an agreement to repurchase them later at a higher price. This is essentially a loan with the security as collateral.

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Federal Funds

Loans arranged at the federal funds rate by banks to maintain their reserve account balances with the Federal Reserve.

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Brokers' Calls

Loans made by brokers to investors who buy stocks on margin. The rate on these loans tends to be higher than the rate on short-term T-bills.

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London Interbank Offer Rate (LIBOR)

The benchmark interest rate at which large banks in London lend to each other. It's currently being replaced by SOFR.

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Secured Overnight Financing Rate (SOFR)

A benchmark interest rate based on overnight repurchase agreements collateralized by Treasury securities, replacing LIBOR in the US.

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Money Market Funds

Mutual funds that invest in money market instruments. They offer a stable return with low risk.

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Yankee bond

Dollar-denominated bonds issued in the US, but by a non-US issuer.

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Municipal Bonds

Bonds issued by state or local governments, offering interest income exempt from federal taxes.

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General Obligation Municipal Bonds

Backed by the issuer's general taxing power, making it a more secure investment than revenue bonds.

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Revenue Municipal Bonds

Backed by the revenue generated from the specific project they finance, like a toll road or airport.

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Corporate bonds

Private companies borrow directly from the public, offering a potential for higher return with higher risk.

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Secured Corporate Bonds

These bonds are backed by specific assets, like real estate, offering more security to investors.

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Unsecured Corporate Bonds (Debentures)

Unsecured bonds with no specific underlying collateral, carrying a higher risk than secured bonds.

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Subordinated Debentures

A type of unsecured bond with even lower priority in bankruptcy than regular debentures, making them riskier but potentially offering a higher return.

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Capital Gains

The amount by which the sale price of a security exceeds (or falls short of) the purchase price. It represents the profit or loss made from buying and selling a security.

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Price-Earnings Ratio

The ratio of a stock's price to its earnings per share. It tells us how much investors are willing to pay for each dollar of earnings generated by the company.

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American Depository Receipts (ADRs)

Certificates traded on US markets that represent ownership in shares of a foreign company. They make it easier for foreign companies to satisfy US security registration requirements.

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Dow Jones Industrial Average (DJIA)

The best-known measure of the performance of the US stock market, consisting of 30 large, well-established companies. It's a price-weighted average, meaning the larger the share price, the greater its influence.

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Standard & Poor's 500 (S&P 500)

A broad-based index of 500 of the largest US companies, calculated based on their market value. It's seen as a more comprehensive representation of the US stock market.

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Index Fund

A fund that mirrors the composition of a specific market index, offering passive investment in a diversified portfolio.

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Exchange-Traded Fund (ETF)

A type of investment fund that trades like a stock on an exchange. It allows investors to trade a basket of securities in a single transaction.

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Derivative Asset

A financial contract whose value is directly dependent on the value of an underlying asset. These contracts are used to hedge against risk or speculate on price movements.

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Call Option

A right, but not an obligation, to purchase an asset at a specified price (the exercise or strike price) on or before a specific date.

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Put Option

A right, but not an obligation, to sell an asset at a specified price (the exercise or strike price) on or before a specific date.

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Study Notes

Asset Classes and Financial Instruments

  • Asset allocation involves dividing investments among different asset classes.
  • Securities selection is choosing specific investments within each asset class.

Financial Markets

  • Money markets are short-term, liquid, low-risk markets for debt securities.
    • Subset of fixed income market
    • Accessible to small investors
  • Capital markets are longer-term, higher-risk markets.
    • Divided into four segments: longer-term bonds, equities, options, and futures.

Money Market Securities

  • Treasury Bills (T-bills)

    • Government-issued debt sold to the public.
    • Highly marketable
    • Exempt from state and local taxes
    • Easily converted to cash
    • Low transaction costs
    • Ask price is the purchase price
    • Bid price is the selling price
    • Bid-ask spread is the difference between ask and bid prices.

  • Certificates of Deposit (CDs)

    • Bank pays interest and principal to the depositor at maturity.

Money Market Securities (Continued)

  • Commercial Paper
    • Short-term unsecured debt notes issued by large, well-known companies.
    • Backed by a bank line of credit
    • Mature in up to 270 days.
    • Considered a fairly safe asset.
  • Banker's Acceptance
    • An order by a customer to a bank to pay a sum of money at a future date.
    • Safe because the bank's credit standing is substituted for the customer's.
  • Eurodollars
    • Dollar-denominated deposits at foreign banks or foreign branches of American banks.
    • Banks avoid Federal Reserve regulation.
  • Repurchase Agreements (Repos)
    • Short-term sales of securities with an agreement to repurchase them the next day at a higher price.
    • The implicit loan can last 30 days or more.

Money Market Securities (Continued)

  • Reverse Repos
    • Dealers buy securities from investors and agree to sell them back later.
    • This is a very safe investment.
  • Federal Funds
    • Funds in a bank's reserve account at the Federal Reserve.

Bond Market

  • The bond market deals with longer-term borrowing or debt instruments.
  • Debt Instruments: examples are treasury notes/bonds, corporate bonds, municipal bonds, mortgage securities, and federal agency debt.
    • Treasury bonds/notes: government securities
    • Corporate bonds: issued by corporations to raise capital
    • Municipal bonds: issued by state and local governments
    • Mortgage-backed securities: bonds backed by mortgage loans.
  • Inflation-protected treasury bonds: linked to the cost of living index.

Equity Securities

  • Common Stock represents ownership in a company.
    • Each share entitles the owner to one vote on corporate governance issues.
    • Stockholders have residual claims on the company’s assets and income, but are last in line.
    • Stockholders have limited liability: they can lose only their invested amount in bankruptcy.

Equity Securities (continued)

  • Depository Receipts (ADRs): certificates traded in US markets representing foreign company shares.
  • Dow Jones Industrial Average (DJIA): a widely known stock market index.

Derivatives Markets

  • Derivative assets: claims whose values are dependent on the value of underlying assets.
    • Options: give the right, but not the obligation, to buy or sell an asset at a set price by a specific date.
    • Call options: the right to buy
    • Put options: the right to sell.
  • Futures contracts: oblige the buyer or seller to make/take delivery of an asset at a specified price on a specific date.
  • Future contracts are entered into without cost.

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Chapter 2: Asset Classes and Financial Instruments PDF

Description

Test your knowledge on investment strategies and market indices with this quiz. Explore key concepts such as ADRs, P/E ratios, and options to deepen your understanding of the financial landscape. Challenge yourself with questions on derivatives and futures contracts.

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