Q.1. What are the distinguishing features of a money market instrument?

Answer: The two distinguishing characteristics are: (1) all money market
instruments are debt instruments and (2) all have less than 12 months to maturity
when originally issued.

Q.2. Why is preferred stock “preferred”?

Answer: Preferred stockholders have a dividend preference and a liquidation

preference. The dividend preference requires that preferred stockholders be paid
before common stockholders. The liquidation preference means that, in the event
of liquidation, the preferred stockholders will receive a fixed face value per share
before the common stockholders receive anything.

Q.3. What is the distinction between a real asset and a financial asset? What are
the two basic types of financial assets, and what does each represent?

Answer: A real asset is a tangible asset such as a land, buildings, precious metals,
knowledge, etc. A financial asset is a legal claim on a real asset. The two basic
types of financial assets are primary assets and derivative assets. A primary asset
is a direct claim on a real asset. A derivative asset is basically a claim (or potential
claim) on a primary asset or even another derivative asset.

A real asset is a tangible asset such as a land, buildings etc. A financial asset is a
legal claim on a real asset. The two basic types of financial assets are primary
assets and derivative assets. A primary asset is a direct claim on a real asset. A
derivative asset is potential a claim on a primary asset or even another derivative
asset.

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Q.4. What is the difference between arithmetic and geometric returns? Suppose
you have invested in a stock for the last 10 years. Which number is more
important to you, the arithmetic or geometric return?

Answer: To calculate an arithmetic return, you simply sum the returns and divide
by the number of returns. As such, arithmetic returns do not account for the
effects of compounding. Geometric returns do account for the effects of
compounding. As an investor, the more important return of an asset is the
geometric return.

Q.5. What does it mean to purchase a security on margin? Why might you do it?

Answer: Purchasing on margin means borrowing some of the money used to buy
securities. You do it because you desire a larger position than you can afford to
pay for, recognizing that using margin is a form of financial leverage. As such, your
gains and losses will be Larger. Of course, you hope to take the gains.

Q.6. What does it mean to sell a security short? Why might you do it?

Answer: Shorting a security means borrowing it and selling it, with the
understanding that at some future date you will buy the security and return it,
thereby “covering” the short. You do it because you believe the security’s value
will decline, so you hope to sell high now, then buy low later.

Q.7. What is the reason margin requirements existing?

Answer: Margin requirements amount to security deposits. They exist to protect

your broker from losses.

Q.8. What is the difference between asset allocation and security selection?

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Answer: Asset allocation means choosing among broad categories such as stocks
and bonds. Security selection means picking individual assets within a particular
category, such as shares of stock in particular companies.

Q.9. Suppose your broker tips you on a hot stock. You invest heavily, but, to your
considerable dismay, the stock plummets in value. What recourse do you have
against your broker?

Answer: A broker simply conducts trades on your behalf, and in return he

receives a commission. An advisor is typically a fee-based relationship, where you
pay an annual percentage of assets, which covers the cost of all advice and
trades? With an advisory relationship, the interests of the advisor and investor
may be better aligned, as the incentive to “churn” is eliminated.

Probably none. The advice you receive is unconditionally not guaranteed. If the
recommendation was grossly unsuitable or improper, then arbitration is probably
your only possible means of recovery. Of course, you can close your account, or at
least what’s left of it.

Q.10. An important difference between a long position in stock and a short

position concerns the potential gains and losses. Suppose a stock sells for $18 per
share, and you buy 500 shares. What are your potential gains and losses?

Answer: If you buy (go long) 500 shares at $18, you have a total of $9,000
invested. This is the most you can lose because the worst that could happen is
that the company could go bankrupt, leaving you with worthless shares. There is
no limit to what you can make because there is no maximum value for your
shares – they can increase in value without limit.

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Q.11. The liquidity of an asset directly affects the risk of buying or selling that
asset during adverse market conditions. Describe the liquidity risk you face with a
short stock position during a market rally, and a long stock position during a
market decline.

Answer: If the asset is illiquid, it may be difficult to quickly sell it during market
declines, or to purchase it during market rallies. Hence, special care should always
be given to investment positions in illiquid assets, especially in times of market
turmoil.

Q.12. If you were to visit your local Chevrolet retailer, there is both a primary and
a secondary market in action. Explain. Is the Chevy retailer a dealer or a broker?

Answer: The new car lot is a primary market; every new car sold is an IPO. The
used car lot is a secondary market. The Chevy retailer is a dealer, buying and
selling out of inventory.

Q.13. What is the difference between a market order and a limit order? What is
the potential downside to each type of order?

Answer: A market order is an order to execute the trade at the current market
price. A limit order specifies the highest (lowest) price at which you are willing to
purchase (sell) the stock. The downside of a market order is that in a volatile
market, the market price could change dramatically before your order is
executed. The downside of a limit order is that the stock may never hit the limit
price, meaning your trade will not be executed.

Multiple Choice Questions

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1. A stock pays a SAR1.50 dividend and falls in price from SAR56.25 to SAR52.75.
What is the stockholder’s total dollar return?
a. -SAR1.50
b. -SAR2.00
c. -SAR2.50
d. -SAR3.00

2. A stock pays a SAR1 dividend and rises in price from SAR50 to SAR53. What is
the stockholder’s total percentage return?
a. 8%
b. 4%
c. 5%
d. -2%

3.. Over a one-year period, a bond pays 7 percent interest and its price falls from
SAR100 to SAR98. What is the bondholder’s total realized one-year return?
a. 9%
b. 7%
c. 5%
d. -2%

4. The total dollar return on an investment is conventionally said to have two

components. What are these two components?
a. a cash payment and a capital gain or loss
b. a dollar return and a percentage return
c. a taxable component and a tax-exempt component
d. principal and interest

5. Suppose the value of an investment doubles in a one-year period. In this case,

the rate of return on this investment over that one-year period is what amount?
a. 100 percent even if the gain is not actually realized
b. 200 percent even if the gain is not actually realized
c. 100 percent only if the gain is actually realized

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d. 200 percent only if the gain is actually realized

6.. Suppose the value of an investment decreases by half in a one-year period. In

this case, the rate of return on this investment over that one-year period is what
amount?
a. -100 percent even if the loss is not actually realized
b. -50 percent even if the loss is not actually realized
c. -100 percent only if the loss is actually realized
d. -50 percent only if the loss is actually realized

7. Which of the following asset categories has an annual returns history most
closely linked to historical annual rates of inflation?
a. U,S. Treasury Bills
b. Corporate bonds
c. Large company stocks
d. Small company stocks

8. Based on the annual returns history since 1926, which asset category on
average has yielded the highest risk premium?
a. U.S. government Bonds
b. Corporate bonds
c. Large company stocks
d. Small company stocks

9. The first lesson of financial markets history is

a. don’t put all your eggs in one basket
b. put all your eggs in one basket and watch that basket
c. buy low and sell high
d. risky assets on average earn a risk premium

10. Which of the following is not a common characteristic of money market

securities?
a. sold on a discount basis
b. mature in less than one year

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c. most important risk is default risk
d. all of the above are characteristics

11. Which of the following money market securities is the most liquid?
a. U.S. Treasury bills
b. bank Certificates of Deposit
c. corporate money market debt
d. municipality money market debt
12. On what basis do we normally distinguish money market securities from fixed-
income securities?
a. issuer
b. interest rate
c. maturity
d. tax status

13. A corporation with common stock issued to the public pays dividends
a. at the discretion of management, who are elected by the shareholders
b. at the discretion of shareholders, since they own the corporation
c. at the discretion of the company’s board of directors, who are elected by
shareholders
d. at the discretion of the company’s board of directors, who are appointed by
management
14. A dividend payment on preferred stock
a. can never be omitted if the company is earning a profit
b. is automatically omitted if the company realizes a loss from operations
c. can be omitted at the discretion of the board of directors
d. cannot be omitted at the discretion of the board of directors

Answers to Multiple Choice Questions

1. B
2. A
3. C
4. A
5. A
6. B

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7. A
8. D
9. D
10. D
11. A
12. C
13. C
14. C
Multiple Choice Questions

1. Which of the following is not a standard provision of a hypothecation

agreement?
a. right of a broker to lend shares held in street name for a beneficial owner
b. right of a broker to pledge shares held in street name as collateral for margin
loans
c. right of a broker to short sell shares held in street name for a beneficial owner
d. all of the above are standard provisions of a hypothecation agreement

2. You deposit SAR100,000 cash in a brokerage account and purchase SAR200,000

of stocks on margin by borrowing SAR100,000 from your broker. Later, the value
of your stock holdings fall to SAR150,000 whereupon you get nervous and close
out your account. What is the percent return on your investment?
a. 0 percent
b. -25 percent
c. -50 percent
d. -75 percent

3. You deposit SAR100,000 cash in a brokerage account and purchase SAR200,000

of stocks on margin by borrowing SAR100,000 from your broker. Later, the value
of your stock holdings falls to SAR175,000. What is your account margin in riyals?
a. SAR50,000
b. SAR75,000
c. SAR100,000
d. SAR150,000
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4. You deposit SAR100,000 cash in a brokerage account and purchase SAR200,000
of stocks on margin by borrowing SAR100,000 from your broker. Later, the value
of your stock holdings falls to SAR150,000. What is your account margin in
percent?
a. 25 percent
b. 33 percent
c. 50 percent
d. 75 percent

5. You deposit SAR100,000 cash in a brokerage account and short sell SAR200,000
of stocks on margin. Later, the value of the stocks held short rises to SAR225,000.
What is your account margin in riyals?
a. SAR50,000
b. SAR75,000
c. SAR100,000
d. SAR150,000

6. You deposit SAR100,000 cash in a brokerage account and short sell SAR200,000
of stocks on margin. Later, the value of the stocks held short rises to SAR250,000.
What is your account margin in percent?
a. 20 percent
b. 25 percent
c. 33 percent
d. 50 percent

7. You deposit SAR100,000 cash in a brokerage account and purchase SAR200,000

of stocks on margin by borrowing SAR100,000 from your broker, who requires
maintenance margin of 30 percent. Which of the following is the largest value for
your stock holdings for which you will still receive a margin call?
a. SAR200,000
b. SAR160,000

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c. SAR140,000
d. SAR120,000

8. You deposit SAR100,000 cash in a brokerage account and short sell SAR200,000
of stocks. Your broker requires maintenance margin of 30 percent. Which of the
following is the lowest value for the stocks you are holding short for which you
will still receive a margin call?
a. SAR260,000
b. SAR240,000
c. SAR220,000
d. SAR200,000
9. What is a securities market characterized by dealers who buy and sell securities
for their own inventories called?
a. a primary market
b. a secondary market
c. an over-the-counter market
d. an institutional market

10. What is the over-the-counter market for exchange-listed securities called?

a. third market
b. fourth market
c. after-market
d. block market

11. An institutional investor wishing to sell a very large block of stock, say, 10,000
shares or more, is most likely to get the best price in which market?
a. the primary market
b. the secondary market
c. the third market
d. the fourth market
12. Short-term securities are bought and sold in the
a. capital market.
b. primary market.

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 c. money market.
d. stock market.

13. The governmental agency that oversees the capital markets is the
a. Federal Trade Commission.
b. Federal Reserve.
c. Securities and Exchange Commission.
d. Fair Trade and Banking Agency.

14. Stocks purchased in the secondary market are purchased

a. directly from the issuing corporation.
b. from other investors.
c. from small, little-known brokerages.
d. indirectly through financial institutions.

15. Stocks and bonds are traded in

a. securities and exchange commissions.
b. money markets.
c. federal trade commissions.
d. capital markets.

16. The primary market tends to be more active when

a. the economy is slowing and stock prices are falling.
b. the economy is expanding and stock prices are rising.
c. interest rates are rising.
d. early in the calendar year.

17. Which one of the following statements concerning the primary market is
correct?
a. A transaction in the primary market is between two private stockholders.
b. The first public sale of a company's stock in the primary market is called a
seasoned new issue.
c. The first public sale of a company's stock is called an IPO.
d. A rights offering is a direct sale of stock to an institution that participates in the
primary market.

18. A rights offering is the

a. initial offering of securities to the public.
b. offering of new securities to current shareholders on a pro-rata basis.

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c. sale of newly issued shares of stock to the general public.
d. sale of securities directly to a select group of investors.

19. IPO activity tends to peak when stock prices

a. have fallen sharply.
b. have risen sharply.
c. are volatile and unstable.
d. Stock prices have relatively little influence on IPO activity.

20. The document that describes the issuer of a security's management and
financial position is known as a
a. balance sheet.
b. 10-K report.
c. prospectus.
d. red herring.

21. Companies offering their stock to the public for the first time usually seek the
assistance of
a. investment bankers.
b. the Securities and Exchange Commission.
c. the Federal Reserve Bank.
d. prospectors.

22. Investment bankers who join together to share the financial risk associated
with buying an entire issue of new securities and reselling them to the public is
called a(n)
a. selling group.
b. tombstone group.
c. underwriting syndicate.
d. primary market group.

23. A market where securities are are bought from or sold to a market maker is
known as a
a. broker market.
b. dealer market.
c. exchange floor.
d. board of exchange.

24. The over-the-counter (OTC) market is a

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a. centrally located auction market.
b. telecommunications network connecting dealers.
c. market solely for institutional traders.
d. geographically dispersed auction market.

25. The purchase of stock with cash in the hope of earning a capital gain is known
as taking a
a. long position in the stock.
b. short position in the stock.
c. long, margined position in the stock.
d. short, margined position in the stock.

26. If an investor does not respond to a margin call, the broker will
a. sell enough of the investor's holdings that the margin account can be closed.
b. sell some of the investor's holdings to cover the margin call.
c. notify the Federal Reserve so they can cover the call.
d. sell all of the investor's holdings and close their brokerage account.

27. Which one of the following is a major advantage of margin trading?

a. increase in potential diversification
b. increase in potential profits on a percentage basis
c. possibility of increased gains on a dollar basis
d. interest free loans

Answers to Multiple Choice Questions

1. C
2. C
3. B
4. B
5. B
6. A
7. C
8. B
9. C
10. A
11. D
12. C
13. C
14. B
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15. D
16. B
17. C
18. B
19. B
20. C
21. A
22. C
23. B
24. B
25. A
26. B
27. B

True / False Questions

1) Stocks, bonds and mutual fund shares are bought and sold in the capital
market.
Answer: TRUE
2) Capital markets deal exclusively in stock. Money markets deal exclusively in
debt instruments.
Answer: FALSE
3) Primary markets deal in the stocks of larger, well-known companies; secondary
markets deal in the stocks of smaller, less well-known companies.
Answer: FALSE
4) Underwriters are responsible for promoting and facilitating the sale of
securities.
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Answer: TRUE
5) IPOs are typically underpriced so that the price rises during the first few days of
trading.
Answer: TRUE
6) IPOs are relatively safe investments.
Answer: FALSE
7) The price of stock sold in an IPO is set by bids submitted in the month before
trading begins.
Answer: FALSE
8) A market maker brings together buyers and sellers in an auction market.
Answer: FALSE
9) The income paid to a market maker is referred to as the spread.
Answer: TRUE
10) The financial markets are becoming more globally integrated.
Answer: TRUE
11) Margin trading requires the borrowing of securities.
Answer: FALSE
12) Margin trading will magnify losses on a percentage basis.
Answer: TRUE
13) Short selling requires the borrowing of securities.
Answer: TRUE
14) Short selling involves the sale of depreciated stock at a price below the
amount borrowed on margin.
Answer: FALSE

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15) When a person sells a common stock short, she or he is betting that the price
of the stock will fall.
Answer: TRUE

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