True/False Questions

multiple Choice Questions stock markets

16.You buy a stock for $14 per share and sell it for $18 after you collect a $1.00 per share dividend. Your pre-tax capital gain yield is _____ and your pre-tax dividend yield is _____.

A)28.57%; 7.14%

B)35.71%; 0.00%

C)21.42%; 5.55%

D)22.22%; 5.55%

E)27.78%; 6.32% Answer: A Page: 246-247 Level: Medium

17.Common stocks typically have which of the following that bonds do not have:I. Voting rightsII. Fixed cash flowsIII. Set maturity dateIV. Tax deductibility of cash flows to investors

A)I only

B)I, II and IV only

C)II, III and IV only

D)IV only

E)I, II, III and IV Answer: A Page: 247 Level: Easy

18.You buy a stock for $10 per share and sell it for $12 after holding it for slightly over a year and collecting a $0.50 per share dividend. Your ordinary income tax rate is 28% and your capital gains tax rate is 20%. Your after-tax rate of return is _______.

A)18.1%

B)19.6%

C)25.0%

D)20.2%

E)17.4% Answer: B Page: 247 Level: Medium

Rationale: [(($12-$10)x(1-0.20)) + ($0.50x(1-0.28))] / $10 = $1.96 / $10 = 19.6%

19.An investor has a 38% ordinary income tax rate and a 20% long term capital gains tax rate. The investor holds stock in a firm that could pay its usual $1 per share dividend or reinvest the cash in the firm. The stock price is currently $25 per share. If the firm does not pay the dividend the share price will rise. If it pays the dividend the share price will stay the same. By how much must the share price rise if the dividend is not paid in order to make the investor indifferent between receiving the dividend or not?

A)$2.00

B)$0.59

C)$1.55

D)$1.97

E)$2.50 Answer: C Page: 247-248 Level: Difficult

Rationale: 2 * (1- 0.38) = Change in share price * (1- 0.20)

20.With _________ voting, all directors up for election are voted on by the shareholders at the same time in one general election.

A)Straight

B)Participating

C)Nonparticipating

D)Proxy

E)Cumulative Answer: E Page: 249 Level: Medium

21.If all preferred dividend payments that have been missed must be paid before any common stock dividend can be paid the preferred stock is called _____ preferred stock.

A)Cumulative

B)Participating

C)Nonparticipating

D)Voting

E)Dual class Answer: A Page: 251 Level: Easy

22.In 2004 about 20% of the shares of the top one hundred non-U.S. companies (ranked by sales) were owned by U.S. residents. Most of these stocks were held in the form of _________________.

A)Foreign direct investment

B)ADRs

C)Proxies

D)GRDs

E)Brady bonds Answer: B Page: 280 Level: Medium

23.If the net proceeds are greater than the gross proceeds in an underwritten offering

A)The investment banker made a profit on the spread

B)The issuing company underpriced its securities

C)The issue fails to occur

D)The SEC rescinds the issue

E)None of the above Answer: E Page: 253 Level: Difficult

24.The preemptive right is designed to

A)Allow management to diffuse stock ownership any voting power

B)Allow managers to preempt a stock offering if they do not like the terms of the deal

C)Allow existing shareholders the right to sell their existing shares before the new offer

D)Allow existing shareholders to buy shares of the new offering if they desire

E)None of the above Answer: D Page: 255 Level: Medium

25.The NASDAQ automatic order execution system for individual traders placing buy or sell orders of 1000 or fewer shares is called the

A)ECN Network

B)SOE System

C)NASDAQ/AMEX Joint Program

D)Instinet Network

E)E*Trade Online Program Answer: B Page: 265 Level: Easy

26.The preliminary version of a security offer that is circulated to potential buyers before SEC approval (registration) is obtained is called a

A)Final prospectus

B)Shelf registration statement

C)Due diligence draft

D)Waiting period offer

E)Red herring prospectus Answer: E Page: 256 Level: Easy

27.A shelf registration allows firms the opportunity to avoid the normal _____ day waiting period by allowing preregistration of securities for up to _____ years.

A)20 day; 2 years

B)10 day; 1 year

C)15 day; 3 years

D)20 day; 1 year

E)30 day; 2 year Answer: A Page: 257 Level: Medium

28.Which of the following is/are true about specialists?I. Investment banks generally cannot be specialistsII. Specialists are used by the NASDAQ systemIII. Market and limit orders are transacted at specialist posts, but the specialist's 'own account' orders are executed elsewhereIV. Specialists help maintain continuous trading

A)I, II and III only

B)I and IV only

C)II, III and IV only

D)I only

E)III only Answer: B Page: 259 Level: Medium

29.When all the directors up for election are voted on at the same time the procedure is called

A)Dual class voting

B)Straight voting

C)Limited liability voting

D)Proxy voting

E)Cumulative voting Answer: E Page: 249 Level: Easy

30.A stock has a P/E ratio of 95. If earnings don't grow the investor must wait how long to recover their investment?

A)20 years

B)45 years

C)60 years

D)95 years

E)None of the above Answer: D Page: 263-264 Level: Medium

31.In terms of volume of trading and market value of firms traded the ________ is the largest U.S. stock market. In terms of number of firms traded the ___________ is the largest in the U.S.

A)NYSE; NYSE

B)NASDAQ; NYSE

C)NYSE; AMEX

D)NYSE; NASDAQ

E)NASDAQ; AMEX Answer: D Page: 266 Level: Medium

32.On the NASDAQ system, the inside quotes are the

A)Lowest ask and lowest bid

B)Lowest bid and highest ask

C)Highest bid and highest ask

D)Highest bid and lowest ask

E)None of the above Answer: D Page: 265 Level: Medium

33.NYSE listing has traditionally benefited a firm by

A)Improving the stock's price

B)Generating increased publicity for the firm

C)Providing easier access to primary market capital

D)B and C only

E)A, B and C Answer: E Page: 266 Level: Medium

34.Which of the following indices are value-weighted?I. NYSE CompositeII. S&P500III. NASDAQ CompositeIV. Dow Jones Industrial Average

A)I, II, III and IV

B)I only

C)II only

D)II, III and IV only

E)I, II and III only Answer: E Page: 269-270 Level: Easy

35.The largest single type of holder of common stock ($) is

A)Pension funds

B)Households

C)Mutual funds

D)Brokers and dealers

E)Life insurance firms Answer: B Page: 272 Level: Easy

36.A firm is using cumulative voting and five director spots are up for election. There are 2.4 million shares outstanding. How many shares must a minority owner own or control to ensure that he or she can gain control of one seat on the board of directors?

A)400,001

B)1,200,001

C)555,001

D)650,001

E)None of the above Answer: A Page: 250,267-271 Level: Medium

Rationale: ((1/(5+1))*2.4 million + 1

37.If no information (publicly available or not) can be consistently used to predict stock price changes then the market is

A)weak form efficient

B)semi-strong form efficient

C)semi-strong form inefficient

D)strong form efficient

E)strong form inefficient Answer: D Page: 275 Level: Medium

38.Suppose that over the last ten to fifteen years significantly large numbers of investors have been able to earn abnormal returns from using the firm's publicly available financial information to forecast growth in earnings and dividends. This would be evidence that the markets are not I. weak form efficientII. semi-strong form efficientIII. strong form efficient

A)I only

B)I and II only

C)III only

D)II and III only

E)I, II and III Answer: B Page: 275 Level: Difficult

39.In a ___________ offering the firm preregisters with SEC any securities it wishes to sell over the next two years.

A)Rights

B)Full underwritten

C)General cash

D)Shelf

E)Best efforts Answer: D Page: 257 Level: Easy

40.The stamp on a prospectus accompanying a new issue that indicates the issue has not yet been approved for sale by the SEC is called the

A)green hornet

B)seal of approval

C)red herring

D)eagle stamp

E)Reg FD Answer: C Page: 256 Level: Easy

41.The NYSE specialists are charged with I. trading for their own accountII. ensuring public limit orders are executedIII. facilitating processing public market orders

A)I only

B)I and II only

C)II and III only

D)I and III only

E)I, II and III Answer: E Page: 260-261 Level: Medium

42.The age group that holds the most stock is the ____________ group.

A)Under 35

B)35-44

C)45-64

D)65 and older Answer: C Page: 272 Level: Easy

43.The electronic based market for less actively traded U.S. securities is the

A)ADR market

B)OTC Bulletin Board

C)Pink Sheet stocks

D)NYSE Low Volume Market

E)ECN Market Answer: B Page: 265 Level: Easy

44.Computerized markets that automatically match buyers and sellers orders and are used primarily by institutions traders are called

A)OTC bulletin boards

B)SPIDRS

C)Index Markets

D)ECNs

E)Specialists Answer: D Page: 266 Level: Easy

45.The process of allocating shares in an IPO to certain customers in exchange for additional business or other perks is called

A)Spinning

B)Laddering

C)Biased analyst reporting (BAR)

D)Front running

E)Short dealing Answer: A Page: 253,277 Level: Easy

Rationale: The term 'spinning' is not used in the text.Short Answer Questions

46.Data shows that only 11 of 27 recessions prior to 1990 were preceded by a decline in stock prices. Although stocks are a leading economic indicator, what are some reasons why a stock price decline might not indicate an upcoming recession? Answer: Stock prices might drop because equity risk premiums temporarily rise, depressing stock prices without foreshadowing lower growth. It may also be that current stock prices are overly optimistic about future growth, when the over optimism is corrected, stock prices fall, sometimes sharply. This may occur even if no change in underlying economic growth takes place. One might also observe slower growth than expected that does not result in a recession. More succinctly, expectations may change more rapidly than actual economic growth rates. Page: 273 Level: Medium

47.What are weak form, semi-strong form and strong form efficiency? Does one form of efficiency imply another? Answer: Weak form efficiency implies that past price and trading information is contained in today's stock price and is of no value to an investor. Semi-strong efficiency implies that an investor cannot use any publicly available information to predict tomorrow's price change. Strong form efficiency implies that public and inside information is of no value in predicting tomorrow's price change. Strong form efficiency implies that the markets are also weak and semi-strong form efficient. Likewise, semi-strong from efficiency implies that the markets are also weak form efficient. Page: 274-278 Level: Medium

48.Answer the following questions concerning the given stock quote:

What was the dividend yield? What was the most recent four quarters of earnings per share? Valued at the closing price, what was the total dollar volume of shares traded? What was the stock price at the beginning of the year? Answer: The dividend yield = 1.72%The most recent four quarters of earnings per share = $23.30 / EPS = 35 ; EPS = $0.67

Valued at the close, the total $ volume of shares traded = $23.30 * 4123 * 100 = $9,606,590

The stock price at the beginning of the year was ($23.30 - Pbegin) / Pbegin = -0.153 ;

Pbegin = $23.30 / (1 - 0.153) = $27.51 Page: 263-264 Level: Difficult

49.Investment bankers have recently engaged in unethical practices related to IPOs and stock research. Describe what has been happening and discuss why these practices hurt the overall economy. Answer: Bankers have engaged in spinning and laddering. Spinning (a term not used in the text) is allocating shares of a hot IPO to favored customers in exchange for receiving investment banking business from the customer's firm later on. (Laddering (also not in the text) is allocating IPO shares to firms who agree to buy more in the aftermarket in an attempt to increase the price over the short run, increasing gains to original purchasers.) Investment banking firms have also publicly disseminated overly optimistic research reports in order to facilitate gaining and assisting underwriting business. These practices reduce investor confidence in purchasing IPOs (and in secondary market purchases of securities). Reduced investment results in lower share prices and higher cost of capital for firms. With higher capital costs, corporate investment and economic growth is reduced. Page: 253, 277 Level: Medium

50.What are the advantages and disadvantages of foreign investing? How does an ADR help overcome the disadvantages? Answer: International investing can reduce risk by generating additional diversification benefits. These benefits have been small lately because the U.S. has dominated the rest of the world in economic performance, but this is not likely to continue indefinitely. International investing also introduces foreign exchange risk, information risk and sovereign risk, as well as trading and tax complexities. The ADRs limit foreign exchange risk and other trading complexities. Foreign firms are also required to meet U.S. disclosure requirements when ADRs are issued. Page: 280 Level: Medium

51.As a small (minority) stockholder would you prefer to have cumulative voting or straight voting shares? As a majority shareholder? Answer: Cumulative voting gives a small shareholder a better chance of electing a given board member because they don't have to own (or control by proxy) a majority of shares. As a controlling stockholder you can ensure that you will always be able to elect the entire board of your choice if you have straight voting. Page: 248-250 Level: Medium

52.When would preferred stock be a better investment choice than common stock or bonds? Answer: Preferred stocks have higher yields than bonds and much higher dividend yields than stocks. One will not get capital gains with preferred stock however. Thus if steady high pretax yields are desired, with little or no chance of capital gains, and a tax sheltered investment vehicle such as an IRA is available, preferred may be an ideal choice. Page: 251-252 Level: Medium

53.What are ECNs? How are they changing trading in the traditional markets? Answer: ECNs are electronic communication networks. These computerized trading systems automatically match buy and sell orders. Since they are electronic, ECNs allow for extended trading hours. As fewer humans and physical overhead are required, ECNs provide a potentially cheaper trading platform than the exchanges. Institutions use ECNs to solicit trading interest on large blocks of shares. The rule changes requiring publishing all quotes form different markets mean that ECN market share is likely to grow at the expense of the NYSE and NASDAQ (hence a rationale for the mergers between NYSE and Archipelago and NASDAQ and Instinet). Page: 266 Level: Medium

54.In what major ways do stocks differ from bonds? Answer: Stocks have the following characteristics:1. Discretionary cash flows (dividend payments). The board of directors may choose to pay or not to pay a dividend. 2. Residual claim in the event of bankruptcy3. No maturity date, thus there is no guarantee of a return of your principle.4. Voting rights. As a stockholder you are part owner of the company and have a voice in company decisions.5. Stock markets are deeper and more actively traded than bond markets. Page: 247 Level: Difficult

55.A firm desires to sell stock to the public. The underwriter charges $0.4 million in fees and offers to buy 6 million shares from the firm at a price of $19 per share. In addition, registration and audit fees total $145,000, and marketing and miscellaneous fees add up to another $65,000. The underwriter expects to earn gross proceeds per share of $21. What is the issuing firm's out of pocket dollar transaction cost to issue the stock? Immediately after the stock was issued, the stock price rose to $23. What is the issuing firm's opportunity cost? What is the total issuance cost, including opportunity costs, as a percentage of the total funds available to the issuing firm? Answer: Out of pocket cost = $400,000 + $145,000 + $65,000 = $610,000Opportunity cost = 6 million shares * ($23 - $19) = $24,000,000Actual funds available to firm: 6 million * $19 = $114 million - $610,000 = $113,390,000Percentage cost = ($24,000,000 + $610,000) / $113,390,000 = 21.7% Page: 252-255 Level: Difficult

56.What are the major effects of the Sarbanes-Oxley Act (SO) of 2002 on the stock markets? What else has the NYSE done to improve corporate governance? Answer: The SO Act * Created an independent auditing oversight board under the SEC Increased penalties for corporate wrongdoing Required more extensive accounting disclosure Increased ability of aggrieved shareholders to seek recourse from managementThe NYSE changed listing requirements to ensure Listed firms have a majority of independent directors Boards institute and implement codes of ethics for the board and top management Require shareholder approval of equity based compensation plans Require CEOs to annually certify the information given to stockholders. Page: 277 Level: Difficult

57.Describe recent ethical breaches at the NYSE involving specialists. Why do you think these have occurred? Answer: NYSE specialists have allegedly routinely executed their own orders ahead of orders from the public, a process called 'front running' (the term is not in the text). The NYSE was apparently either unable or unwilling to stop these and other practices. One or more specialists have also engaged in market manipulation, procuring information from corporate executives before the information was made public. These violations have occurred more frequently as specialists' profit margins have declined due to increasing competition and automation. Page: 278 Level: Medium

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