Investment Analysis and Portfolio Management 10th Edition Frank K. Reilly Test Bank

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Investment Analysis and Portfolio Management 10th Edition Frank K. Reilly Test Bank

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CHAPTER 4ORGANIZATION AND FUNCTIONING OF SECURITIES MARKETS

TRUE/FALSE

1. A market is a means through which buyers and sellers are brought together to aid in the transfer of goods and/or services.

ANS: T PTS: 1

2. It is required by law that a stock market must have a physical location.

ANS: F PTS: 1

3. If transaction prices are volatile, but long-term prices are stable, this is referred to as price continuity.

ANS: F PTS: 1

4. A continuous market that has price continuity requires depth of buyers and sellers.

ANS: T PTS: 1

5. A market where prices adjust rapidly to new information is considered to be internally efficient.

ANS: F PTS: 1

6. Informational efficiency is where the cost of acquiring information is very cheap.

ANS: F PTS: 1

7. The primary market is where issues are traded between current and potential owners.

ANS: F PTS: 1

8. Negotiation, competitive bids, and best efforts are three forms of underwriting arrangements.

ANS: T PTS: 1

9. A corporation wishing to raise funds will normally want the investment banker to use a best efforts arrangement rather than a negotiated basis.

ANS: F PTS: 1

10. Rule 415, shelf registration, allows large firms to register ten years worth of financing needs all at one time.

ANS: F PTS: 1

11. Only the stocks of large companies are traded in the primary market.

ANS: F PTS: 1

12. A good secondary market is important to the efficiency of the primary market.

ANS: T PTS: 1

13. The NYSE has dominated the other U.S. exchanges in trading volume.

ANS: T PTS: 1

14. In recent years there has been a trend toward the consolidation of existing exchanges in developed markets, such as London, Frankfurt and Paris.

ANS: T PTS: 1

15. Listed stocks traded on the over-the-counter market are being traded in the third market.

ANS: T PTS: 1

16. The over-the-counter market includes all stocks not listed on one of the major exchanges but constitutes a lesser of a dollar value than the New York and American Exchanges combined.

ANS: T PTS: 1

17. The over-the-counter market lists more stocks than the New York Stock Exchange and the American Stock Exchange combined.

ANS: T PTS: 1

18. The value of the stocks traded in the over-the-counter market is greater than the combined values of the stocks traded on the New York Stock Exchange and the American Stock Exchange combined.

ANS: F PTS: 1

19. The Nasdaq National Market System is an order driven market.

ANS: F PTS: 1

20. Margin transaction involves borrowing part of the cost of an investment.

ANS: T PTS: 1

21. Short selling is practiced when an investor borrows part of the cost of the investment, e.g., they are short on cash.

ANS: F PTS: 1

22. The NYSE is a dealer market.

ANS: F PTS: 1

23. A block house is a brokerage firm that buys and sells blocks of stock for institutions.

ANS: T PTS: 1

24. Super DOT is an electronic order-routing system through which member firms can transmit market and limit orders directly to the posts where the securities are traded.

ANS: T PTS: 1

25. Global trading has eroded the NYSEs share of the market for NYSE-listed stocks.

ANS: T PTS: 1

26. Rule 415 allows corporations to place securities privately with large, sophisticated institutional investors without extensive registration documents.

ANS: F PTS: 1

27. Secondary equity issues are new shares offered by firms that already have stock outstanding.

ANS: F PTS: 1

28. In a pure auction market buyers and sellers submit bid-and-ask prices for a given stock to a central location.

ANS: T PTS: 1

29. In a dealer market trading system shares of stock are sold to the investor with the highest bid price and bought from the seller with the lowest offering price.

ANS: F PTS: 1

30. Specialists provide added liquidity in the Nasdaq market.

ANS: F PTS: 1

31. Initial public offerings (IPOs) involve selling of bonds to the public for the first time.

ANS: F PTS: 1

32. Rule 144A reduced registration documentation requirements for placing securities privately with large institutional investors.

ANS: T PTS: 1

33. A pure auction market is also referred to as a quote-driven market.

ANS: F PTS: 1

MULTIPLE CHOICE

1. Which of the following statements about a market is true?
a. It is not necessary for the market to have a physical location.
b. The market does not necessarily own the goods or services involved.
c. A market can deal in any variety of goods and services.
d. All of the above
e. None of the above

ANS: D PTS: 1 OBJ: Multiple Choice

2. Which of the following is not a characteristic of a good market for goods and services?
a. Timely and accurate information
b. Liquidity
c. Low transaction costs
d. External efficiency
e. All of the above are characteristics of a good market.

ANS: E PTS: 1 OBJ: Multiple Choice

3. Which of the following is not a secondary equity market?
a. Treasury market
b. National exchanges
c. Regional exchanges
d. Over-the-counter market
e. All of the above are secondary equity markets.

ANS: A PTS: 1 OBJ: Multiple Choice

4. Regional exchanges exist because
a. They provide trading facilities for local companies
b. They allow local brokers to trade dual listed stocks
c. They allow for trading of local bonds
d. a and b.
e. b and c.

ANS: D PTS: 1 OBJ: Multiple Choice

5. An order that specifies the highest buy or lowest sell price is a
a. Limit order.
b. Short sale.
c. Market order.
d. Margin call.
e. Stop loss.

ANS: A PTS: 1 OBJ: Multiple Choice

6. When an investor borrows part of the investment cost it is known as
a. A short sale.
b. A fill or kill order.
c. A margin transaction.
d. A limit order.
e. Going long.

ANS: C PTS: 1 OBJ: Multiple Choice

7. Which of the following is not a function of the specialist?
a. Assists the Federal Reserve in controlling the money supply
b. Acts as a broker who handles the limit orders or special orders placed with member brokers
c. Buys and sells securities in order to stabilize the market
d. Acts as a dealer in assigned stocks to maintain a fair and orderly market
e. All of the above are functions of a specialist

ANS: A PTS: 1 OBJ: Multiple Choice

8. The member of the New York Stock Exchange who acts as a dealer on assigned stocks is known as a
a. Registered trader.
b. Commission broker.
c. Registered broker.
d. Floor broker.
e. Specialist.

ANS: E PTS: 1 OBJ: Multiple Choice

9. Floor brokers on the New York Stock Exchange
a. Use their membership to buy and sell for their own account.
b. Are employees of a member firm and buy and sell for customers of the firm.
c. Handle limit and other orders placed by other brokers.
d. Act as brokers for other members.
e. Maintain a fair and orderly market.

ANS: D PTS: 1 OBJ: Multiple Choice

10. A block trade is one which involves a minimum of
a. 1,000 shares.
b. 5,000 shares.
c. 10,000 shares.
d. 100,000 shares.
e. 1,000,000 shares.

ANS: C PTS: 1 OBJ: Multiple Choice

11. In a call market, trading for individual stocks
a. Occurs anytime the market is open.
b. Takes place at specific times.
c. Takes place at the open and close of the trading day.
d. All of the above.
e. None of the above.

ANS: B PTS: 1 OBJ: Multiple Choice

12. A pure auction market is one in which
a. Dealers provide liquidity by buying and selling shares of stock for themselves.
b. Dealers compete against each other to provide the highest bid and lowest asking prices.
c. Buyers submit bid prices to sellers.
d. Sellers submit ask prices to buyers.
e. Buyers and sellers submit bid and ask prices to a central location to be matched.

ANS: E PTS: 1 OBJ: Multiple Choice

13. In a negotiated bid, the underwriter carries out the following service(s)
a. Origination, risk-bearing, and distribution.
b. Origination and risk-bearing.
c. Risk-bearing and distribution.
d. Origination and distribution.
e. Risk-bearing and distribution.

ANS: A PTS: 1 OBJ: Multiple Choice

14. Municipal bonds are sold using the following method or methods:
a. Competitive bid
b. Negotiated sale
c. Private placement
d. All of the above
e. None of the above

ANS: D PTS: 1 OBJ: Multiple Choice

15. When a market is externally efficient, it means that
a. Timely and accurate information is available
b. The market is liquid
c. Transaction costs are low
d. Prices adjust rapidly to new information
e. The number of buyers and sellers are the same

ANS: D PTS: 1 OBJ: Multiple Choice

16. When a market is internally efficient, it means that
a. The market has price continuity.
b. The market has minimal transactions costs
c. The market has good depth
d. The market has more buyers than sellers
e. The market has more sellers than buyers

ANS: B PTS: 1 OBJ: Multiple Choice

17. Trading in the secondary markets for U.S. Government and municipal bonds
a. Takes place through a network of primary dealers
b. Takes place over the counter by dealers who buy and sell on their own account
c. Takes place on the NYSE bond annex
d. All of the above
e. None of the above

ANS: A PTS: 1 OBJ: Multiple Choice

18. Which of the following is an underwriting function?
a. Origination
b. Risk-bearing
c. Distribution
d. Choices b and c
e. All of the above

ANS: E PTS: 1 OBJ: Multiple Choice

19. With a best effort offering, the investment banker performs all of the following roles except:
a. determines the fee paid to themselves for handling the issue.
b. manages the selling group for the new issue.
c. evaluates market conditions and determines the characteristics of the security.
d. guarantees the selling price for the entire issue to the firm issuing the securities.
e. All of the above are true.

ANS: D PTS: 1 OBJ: Multiple Choice

20. The basic distinction between a primary and a secondary market is
a. proceeds from sales in the primary market go to the current owner of a security; proceeds in secondary market go to the original owner.
b. primary markets involve direct dealings within regional exchanges.
c. only new securities are sold in the primary market; only outstanding securities are bought and sold in the secondary market.
d. primary markets deal exclusively in bonds; secondary markets deal primarily in common stock.
e. None of the above.

ANS: C PTS: 1 OBJ: Multiple Choice

21. Trading in the secondary markets for Corporate bonds
a. Takes place through a network of primary dealers
b. Takes place over the counter by dealers who buy and sell on their own account
c. Takes place on the NYSE bond annex
d. All of the above
e. None of the above

ANS: B PTS: 1 OBJ: Multiple Choice

22. Secondary markets are important because
a. The prevailing market price of securities is determined in the secondary market
b. It has an impact on price stability
c. It has an impact on price continuity
d. All of the above
e. None of the above

ANS: A PTS: 1 OBJ: Multiple Choice

23. Which of the following is not a characteristic of shelf registrations? Shelf registrations:
a. Were introduced by Rule 415.
b. Allow large firms to register security issues and sell them piecemeal during the following six years.
c. Provide flexibility and reduce registration fees and expenses.
d. Are typically used for the sale of straight debentures rather than common stock or convertible issues.
e. All of the above are characteristics of shelf registrations.

ANS: B PTS: 1 OBJ: Multiple Choice

24. All of the following are advantages of secondary markets except
a. Provide liquidity to individuals holding the securities.
b. Support the primary market by reducing the required rate of return due to the lower liquidity risk for securities.
c. Provide price discovery for corporations selling seasoned securities.
d. Impact market efficiency and price volatility.
e. All of the above are advantages of secondary markets.

ANS: E PTS: 1 OBJ: Multiple Choice

25. Which of the following is not a major category of membership in stock exchanges?
a. Specialist
b. Commission broker
c. Floor broker
d. Financial analyst
e. Registered trader

ANS: D PTS: 1 OBJ: Multiple Choice

26. Investors can leverage their stock transactions with the use of
a. Margin orders
b. Stop loss orders
c. Limit orders
d. Market orders
e. Specialists

ANS: A PTS: 1 OBJ: Multiple Choice

27. All of the following are characteristics of a dealer market except:
a. Also referred to as a quote-driven market
b. NASDAQ market is a dealer market
c. Individual dealers buy and sell shares for themselves
d. Centralized trading location
e. All of the above are characteristics of a dealer market

ANS: D PTS: 1 OBJ: Multiple Choice

28. The US secondary market with the largest number of issues traded is the:
a. AMEX
b. NASDAQ
c. NYSE
d. LSE
e. Both a and c

ANS: B PTS: 1 OBJ: Multiple Choice

29. A 1994 study concluded dealers were colluding to maintain wide bid/ask spreads by concentrating market quotes in quarters instead of eighths. This study eventually led to new order handling rules that required quotes to be available to the public through:
a. NASDAQ market
b. Electronic communications networks (ECN)
c. High frequency trading (HFT)
d. Algorithmic trading (AT)
e. Intermarket trading system (ITS)

ANS: B PTS: 1 OBJ: Multiple Choice

Exhibit 4.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Jackie has a margin account with a balance of $150,000. The initial margin deposit is 60 percent and Turtle Industries is currently selling at $50 per share.

30. Refer to Exhibit 4.1. How many shares of Turtle can Jackie purchase?
a. 5,000
b. 3,000
c. 1,800
d. 1,200
e. None of the above

ANS: A
Letting X = total investment, Jackies share will represent 60 percent.
Thus .60X = $150,000 and X = $150,000 .60 = $250,000.
At $50 per share, she can purchase ($250,000 $50) = 5000 shares.

PTS: 1 OBJ: Multiple Choice Problem

31. Refer to Exhibit 4.1. What is Jackies profit/loss if Turtles price after one year is $40?
a. $50,000
b. $50,000
c. $100,000
d. $100,000
e. None of the above

ANS: B
Profit = (40 50)(5000) = $50,000

PTS: 1 OBJ: Multiple Choice Problem

32. Refer to Exhibit 4.1. If the maintenance margin is 25 percent, to what price can Turtle Industries fall before Jackie receives a margin call?
a. $14.56
b. $23.17
c. $32.42
d. $26.67
e. None of the above

ANS: D
Margin = (Market Value Debit Balance) Market Value, where
Debit Balance = initial loan value = ($250,000 $150,000) = $100,000
Market Value = Price Number of Shares = 5000P

Thus 0.30 = (5000P $100,000) (5000P)
P = $26.67

PTS: 1 OBJ: Multiple Choice Problem

Exhibit 4.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Heidi Talbott has a margin account with a balance of $50,000. The initial margin deposit is 50 percent, and RC Industries is currently selling at $50 per share.

33. Refer to Exhibit 4.2. How many shares of RC can Heidi buy?
a. 2,500
b. 2,000
c. 1,000
d. 500
e. None of the above

ANS: B
Letting P = price and Q = quantity of shares,
Heidis share of the investment will = 50% of PQ.

Thus 0.50PQ = $50,000 and PQ = $50,000/0.50 = $100,000
At $50 per share, she can purchase ($100,000 $50) = 2000 shares.

PTS: 1 OBJ: Multiple Choice Problem

34. Refer to Exhibit 4.2. What is Heidis profit if RCs price rises to $80?
a. $55,000
b. $50,000
c. $60,000
d. $68,270
e. $28,570

ANS: C
Profit = (80 50)(2000) = $60,000

PTS: 1 OBJ: Multiple Choice Problem

35. Refer to Exhibit 4.2. If the maintenance margin is 25 percent, to what price can RC Industries stock price fall before Heidi receives a margin call?
a. $21.75
b. $23.33
c. $32.00
d. $33.33
e. None of the above

ANS: D
Margin = (Market Value Debit Balance) Market Value, where
Debit Balance = initial loan value = ($100,000 $50,000) = $50,000
Market Value = Price Number of Shares = 2000P

Thus 0.25 = (2000P $60,000) (2000P)
P = $33.33

PTS: 1 OBJ: Multiple Choice Problem

Exhibit 4.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Kathy Smith has a margin account with a balance of $60,000. Initial margin requirements are 80 percent, and Jackson Industries is currently selling at $40 per share.

36. Refer to Exhibit 4.3. How many shares of Jackson can Kathy buy?
a. 1875
b. 1500
c. 1750
d. 1200
e. None of the above

ANS: A
Letting P = price and Q = quantity of shares,
Kathys share will represent 80% of PQ.

Thus 0.80X = $60,000 and X = $60,000 .80 = $75,000.
At $40 per share, she can purchase ($75,000 $40) = 1875 shares.

PTS: 1 OBJ: Multiple Choice Problem

37. Refer to Exhibit 4.3. What is Kathys profit if Jacksons price rises to $50?
a. $18,750
b. $15,750
c. $55,000
d. $37,750
e. $28,570

ANS: A
Profit = (50 40)(1875) = $18,750

PTS: 1 OBJ: Multiple Choice Problem

38. Refer to Exhibit 4.3. If the maintenance margin is 25 percent, to what price can Jackson Industries fall before Kathy receives a margin call?
a. $21.75
b. $23.00
c. $10.67
d. $15.93
e. None of the above

ANS: C
Margin = (Market Value Debit Balance) Market Value, where
Debit Balance = initial loan value = ($75,000 $60,000) = $15,000
Market Value = Price Number of Shares = 1875P

Thus 0.25 = (1875P $15,000) 1875P
P = $10.67

PTS: 1 OBJ: Multiple Choice Problem

Exhibit 4.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

You decide to sell 100 shares of Davis Industries short when it is selling at its yearly high of $35. Your broker tells you that your margin requirement is 55 percent and that the commission on the sale is $15. While you are short, Davis pays a $0.75 per share dividend. At the end of one year you buy your Davis shares (cover your short sale) at $30 and are charged a commission of $15 and a 6 percent interest rate.

39. Refer to Exhibit 4.4. What is your dollar return on the investment?
a. $130.50
b. $300.50
c. $100.00
d. $1,773.75
e. $3,500.00

ANS: B
Profit = $3500 $3000 $75 $15 $15 (1 0.55)(3500)(0.06) = $300.50

PTS: 1 OBJ: Multiple Choice Problem

40. Refer to Exhibit 4.4. What is your rate of return on the investment?
a. 10.48%
b. 12.87%
c. 13.98%
d. 15.49%
e. 18.87%

ANS: D
Rate of Return = Profit Initial Investment
Initial investment = (.55 $3500) + $15 = $1,940

Rate of Return = $300.50/$1,940 = 15.49%

PTS: 1 OBJ: Multiple Choice Problem

Exhibit 4.5
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

You decide to sell 100 shares of Topgun Enterprises Inc. short when it is selling at its yearly high of $42.25. Your broker tells you that your margin requirement is 60 percent and that the commission on the sale is $20. While you are short, Topgun pays a $0.85 per share dividend. At the end of one year you buy your Topgun shares (cover your short sale) at $44 and are charged a commission of $20 and a 5 percent interest rate.

41. Refer to Exhibit 4.5. What is your dollar return on the investment?
a. $384.50
b. $432.88
c. $432.88
d. $384.50
e. $950.55

ANS: D
Profit = $4225 $4400 $85 $20 $20 (1 0.60)(4225)(0.05) = $384.50

PTS: 1 OBJ: Multiple Choice Problem

42. Refer to Exhibit 4.5. What is your rate of return on the investment?
a. 10.48%
b. 12.87%
c. 13.98%
d. 24.49%
e. 15.05%

ANS: E
Rate of Return = Profit Initial investment
Initial investment = (0.60 $4225) + 20 = $2,555

Rate of Return = $384.50/$2,555.00 = 15.05%

PTS: 1 OBJ: Multiple Choice Problem

43. Suppose you buy a round lot of DG Solutions stock on 60% margin when it is selling at $55 a share. The broker charges a 10 percent annual interest rate and commissions are 3 percent of the total stock value on both the purchase and the sale. If at year end you receive a $1.10 per share dividend and sell the stock for 55 5/8, what is your rate of return on the investment?
a. 10.38%
b. 12.84%
c. 10.95%
d. 21.84%
e. 28.38%

ANS: C
Rate of Return = Profit Initial investment

Profit = Total Return Initial Stock Value Transaction Costs Interest
Total Return = Ending Market Value + Dividend Value
= $5,562.50 + $110.00 = $5,672.50
Initial Stock Value = 100($55) = $5,500.00
Transaction Costs = (0.03)(5,500) + (0.03)(5,562.50) = $331.86
Interest = (0.10)(0.40)($5,500) = $220.00

Profit = $5,672.50 $5,500.00 $331.86 $220.00 = $379.36

Initial investment = Margin deposit + Commission
= (0.60)($5,500.00) + (0.03)($5,500.00) = $3,465

Rate of Return = $379.36/$3,465 = .10948 = 10.95%

PTS: 1 OBJ: Multiple Choice Problem

44. Suppose you buy a round lot of HS Inc. stock on 55% margin when it is selling at $40 a share. The broker charges a 10 percent annual interest rate and commissions are 4 percent of the total stock value on both the purchase and the sale. If at year end you receive a $0.90 per share dividend and sell the stock for 35 5/8, what is your rate of return on the investment?
a. 35.17%
b. 21.84%
c. 14.74%
d. 21.84%
e. 35.17%

ANS: A
Rate of Return = Profit Initial investment

Profit = Total Return Initial Stock Value Transaction Costs Interest
Total Return = Ending Market Value + Dividend Value
= $3562.50 + $90= $3652.50
Initial Stock Value = 100($40) = $4000
Transaction Costs = (0.04)(4000) + (0.04)(3562.50) = $302.50
Interest = (0.10)(0.45)($4000) = $180.00

Profit = $3652.50 $4000 $302.50 $180.00 = $830.00

Initial investment = Margin deposit + Commission
= (0.55)($4,000) + (0.04)($4,000) = $2,360

Rate of Return = $830.00/$2360 = 0.3517 = 35.17%

PTS: 1 OBJ: Multiple Choice Problem

45. Suppose you buy a round lot of Altman Industries stock on 50% margin when it is selling at $35 a share. The broker charges a 10 percent annual interest rate and commissions are 5 percent of the total stock value on both the purchase and the sale. If at year end you receive a $1.00 per share dividend and sell the stock for $42.63, what is your rate of return on the investment?
a. 15.58%
b. 11.84%
c. 14.74%
d. 21.84%
e. 28.38%

ANS: A
Rate of Return = Profit Initial Investment

Profit = Total Return Initial Stock Value Transaction Costs Interest
Total Return = Ending Market Value + Dividend
= $4263 + $100 = $4363
Initial Stock Value = 35(100) = $3,500.00
Transaction Costs = .05 3,500 + (0.05)(4,263) = $388.15
Interest = (0.10)(0.50)($3,500) = $175.00
Profit = $4,363 $3,500 $175.00 $388.15 = $299.85

Initial investment = Margin deposit + Initial investment
= .50 $3,500 + .05 $3,500 = $1,925

Rate of Return = $299.85/$1,925 = 15.58%

PTS: 1 OBJ: Multiple Choice Problem

Exhibit 4.6
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

You decide to sell short 200 shares of XCorp stock at a price of $75. Your margin deposit is 65 percent. Commission on the sale is 1.25%. While you are short, the stock pays a $1.75 per share dividend. Interest on margin debt is 5.25% per year.

46. Refer to Exhibit 4.6. At the end of one year you close out your short position by purchasing share of XCorp at $45 per share. The commission is 1.25%. What is your rate of return on the investment?
a. 55.92%
b. 10.31%
c. 51.06%
d. 23.1%
e. 33.05%

ANS: C
Rate of return =
[75 45 0.9375 0.5625 1.75 (1 .65)(75)(.0525)]/[(.65)(75) + 0.9375] = 51.06%

PTS: 1 OBJ: Multiple Choice Problem

47. Refer to Exhibit 4.6. Suppose at the end of one year XCorp is selling at $90 per share and you cover your short position at this price. What is your rate of return on the investment? (Assume a 1.25% commission on the purchase.)
a. 40.64%
b. 25.53%
c. 5.21%
d. 72.7%
e. 71.2%

ANS: A
Rate of return =
[75 90 0.9375 1.125 1.75 (1 .65)(75)(.0525)]/[(.65)(75) + 0.9375] = 40.64%

PTS: 1 OBJ: Multiple Choice Problem

Exhibit 4.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Shares of RossCorp stock are selling for $45 per share. Brokerage commissions are 2% for purchases and 2% for sales. The interest rate on margin debt is 6.25% per year. The maintenance margin is 30%.

48. Refer to Exhibit 4.7. At the end of one year shares of RossCorp stock are selling for $55 per share and the company paid dividends of $0.85 per share. Assuming that you paid the full cost of the purchase, what is your rate of return if you sell RossCorp stock?
a. 18.08%
b. 23.51%
c. 22.32%
d. 14.96%
e. 19.28%

ANS: E
Rate of return = [55 45 + 0.85 1.10 0.90]/[45 + 0.90] = 19.28%

PTS: 1 OBJ: Multiple Choice Problem

49. Refer to Exhibit 4.7. At the end of one year shares of RossCorp stock are selling for $35 per share and the company paid dividends of $0.85 per share. Assuming that you paid the full cost of the purchase, what is your rate of return if you sell RossCorp stock?
a. 33.05%
b. 23.42%
c. 23.42%
d. 33.05%
e. 25.35%

ANS: B
Rate of return = [35 45 + 0.85 0.70 0.90]/[45 + 0.90] = 23.42%

PTS: 1 OBJ: Multiple Choice Problem

50. Refer to Exhibit 4.7. At the end of one year shares of RossCorp stock are selling for $55 per share and the company paid dividends of $0.85 per share. Assuming that you borrowed 25% of cost of the purchase, what is your rate of return?
a. 23.51%
b. 29.35%
c. 23.51%
d. 5.21%
e. 10.06%

ANS: C
Rate of return =
[55 45 + 0.85 1.10 0.90 (1 .75)(45)(.0625)]/[(0.75)(45) + 0.90] = 23.51%

PTS: 1 OBJ: Multiple Choice Problem

51. Refer to Exhibit 4.7. At the end of one year shares of RossCorp stock are selling for $35 per share and the company paid dividends of $0.85 per share. Assuming that you borrowed 25% of cost of the purchase, what is your rate of return?
a. 33.05%
b. 33.05%
c. 23.51%
d. 25.35%
e. 40.64%

ANS: B
Rate of return =
[35 45 + 0.85 0.70 0.90 (1 .75)(45)(.0625)]/[(0.75)(45) + 0.90] = 33.05%

PTS: 1 OBJ: Multiple Choice Problem

52. Refer to Exhibit 4.7. Assume that you purchase 150 shares of RossCorp stock at $45 each by making a margin deposit of 55%. At what price would you receive a margin call?
a. $29.39
b. $26.48
c. $50.39
d. $28.93
e. $50.10

ANS: D
0.30 = [(150)(P) (0.45)(150)(45)]/[(150)(P)]
0.30 = [(150)(P) 3,037.50]/[(150)(P)]
45P = 150P 3037.50
105P = 3037.50
P = $28.93

PTS: 1 OBJ: Multiple Choice Problem

53. You own 50 shares of Auto Corporation that you purchased for $30 a share. The stock is currently selling for $50 a share and you placed a stop loss order at $45. If the stock price drops to $35 a share what is your return on this investment?
a. 30.0%
b. 16.7%
c. 50.0%
d. 66.7%
e. 150.0%

ANS: C
($45 $30)/$30 = $15/$30 = 0.50 or 50%

PTS: 1 OBJ: Multiple Choice Problem

54. You purchased 100 shares of Highlight Company for $20 a share one year ago with a margin of 50%. The stock is currently selling for $28 a share and no dividends were ever paid. The broker charges an annual interest rate of 8% and a $100 commission on both the purchase and sale of these shares. What is your annual rate of return on this investment?
a. 21%
b. 47%
c. 52%
d. 60%
e. 72%

ANS: B
Annual Rate of Return = Profit/Initial Investment
Profit = Ending Market Value Initial Stock Value Commissions Interest
= (100*$28) (100*$20) (2*$100) (0.08*0.5*100*$20)
= $2,800 $2,000 $200 $80 = $520
Annual Rate of Return = $520/(.50*100*$20) = 520/(1,000 + 100) = 0.47 or 47%

PTS: 1 OBJ: Multiple Choice Problem

Exhibit 4.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

You sell 100 shares short of AMF Corporation when it is selling at $45 per share. Your margin requirement is 60% and the commission on the sale is $50 and the broker charges 10% annual interest. AMF Corporation paid a $0.50 per share dividend while you were short the stock. After one year you cover your short sale at $35 per share with a $50 commission for the purchase.

55. Refer to Exhibit 4.8. What is your total dollar return on this investment?
a. $1,000
b. $900
c. $850
d. $670
e. $520

ANS: D
Profit = $4,500 short sale $3,500 cover $50 for dividends $100 for commissions (1 .60)($4,500)(0.10) interest expense = $850 $180 = $670

PTS: 1 OBJ: Multiple Choice Problem

56. Refer to Exhibit 4.8. What is your annual rate of return on this investment?
a. 18%
b. 24%
c. 25%
d. 36%
e. 37%

ANS: B
Return = Profit/Initial Investment = $670/(.6*$4,500 + $50) = $670/$2750 = 0.244

PTS: 1 OBJ: Multiple Choice Problem

57. Suppose you purchase 200 shares of Best Hat Corporation at $52 a share by making a margin deposit of 50%. If the maintenance margin is 30%, at what price will you receive a margin call?
a. $37.14
b. $37.95
c. $38.23
d. $38.76
e. $39.42

ANS: A
0.30 = [(200)(P) (0.50)(200)(52)]/[(200)(P)]
0.30 = [(200)(P) 5,200]/[(200)(P)]
60P = 200P 5,200
140P = 5,200
P = $37.14

PTS: 1 OBJ: Multiple Choice Problem

58. You purchased 75 shares of Basket Company for $42 a share. One share of the stock is currently trading between $52 and $53 and you placed a stop loss order at $47. If the stock price drops to $40 a share, what is your return on this investment?
a. 8.7%
b. 9.2%
c. 10.3%
d. 11.9%
e. 12.8%

ANS: D
($47 $42)/$42 = $5/$42 = 0.11905 or 11.9%

PTS: 1 OBJ: Multiple Choice Problem

59. You sell short 100 shares of Hi-Light Corporation when it is trading at $70. Your margin requirement is 50%. Assuming there was no commission and the maintenance margin is 25%, at what stock price would you receive a margin call?
a. $76
b. $80
c. $84
d. $88
e. $92

ANS: C
(your equity)/(value of stock owned) = 0.25
[(100)($70) + (0.50)(100)($70) 100P]/100P = 0.25
[$7,000 + $3,500 100P]/100P = 0.25
$10,500 100P = 25P
$10,500 = 125P
P = $84

PTS: 1 OBJ: Multiple Choice Problem

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