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Multiple Choice Questions
1. A purchase of a new issue of stock takes place
A) in the secondary market.
B) in the primary market.
C) usually with the assistance of an investment banker.
D) A and B.
E) B and C.
Answer: E Difficulty: Easy
Rationale: Funds from the sale of new issues flow to the issuing corporation, making this a primary market transaction. Investment bankers usually assist by pricing the issue and finding buyers.
2. The following statements regarding the specialist are true:
A) Specialists maintain a book listing outstanding unexecuted limit orders.
B) Specialists earn income from commissions and spreads in stock prices.
C) Specialists stand ready to trade at quoted bid and ask prices.
D) Specialists cannot trade in their own accounts.
E) A, B, and C are all true.
Answer: E Difficulty: Moderate
Rationale: The specialists' functions are all of the items listed in A, B, and C. In addition, specialists trade in their own accounts.
3. Investment bankers
A) act as intermediaries between issuers of stocks and investors.
B) act as advisors to companies in helping them analyze their financial needs and find buyers for newly issued securities.
C) accept deposits from savers and lend them out to companies.
D) A and B.
E) A, B, and C.
Answer: D Difficulty: Moderate
Rationale: The role of the investment banker is to assist the firm in issuing new securities, both in advisory and marketing capacities. The investment banker does not have a role comparable to a commercial bank, as indicated in C.
4. In a "firm commitment"
A) the investment banker buys the stock from the company and resells the issue to the public.
B) the investment banker agrees to help the firm sell the stock at a favorable price.
C) the investment banker finds the best marketing arrangement for the investment banking firm.
D) B and C.
E) A and B.
Answer: A Difficulty: Moderate
5. The secondary market consists of
A) transactions on the AMEX.
B) transactions in the OTC market.
C) transactions through the investment banker.
D) A and B.
E) A, B, and C.
Answer: D Difficulty: Moderate
Rationale: The secondary market consists of transactions on the organized exchanges and in the OTC market. The investment banker is involved in the placement of new issues in the primary market.
6. The use of the Internet to trade and underwrite securities
A) is illegal under SEC regulations.
B) is regulated by the New York Stock Exchange.
C) decreases underwriting costs for a new security issue.
D) increases underwriting costs for a new security issue.
E) is regulated by the National Association of Securities Dealers.
Answer: C Difficulty: Moderate
Rationale: The SEC permits trading and underwriting of securities over the Internet, but has required firms participating in this activity to take steps to safeguard investment funds. This form of underwriting is expected to grow quickly due to its lower cost.
7. Initial margin requirements are determined by
A) the Securities and Exchange Commission.
B) the Federal Reserve System.
C) the New York Stock Exchange.
D) B and C.
E) A and B
Answer: B Difficulty: Moderate
Rationale: The Board of Governors of the Federal Reserve System determines initial margin requirements. The New York Stock Exchange determines maintenance margin requirements on NYSE-listed stocks; however, brokers usually set maintenance margin requirements above those established by the NYSE.
8. You purchased XYZ stock at $50 per share. The stock is currently selling at $65. Your gains may be protected by placing a __________
A) stop-buy order
B) limit-buy order
C) market order
D) limit-sell order
E) none of the above.
Answer: D Difficulty: Moderate
Rationale: With a limit-sell order, your stock will be sold only at a specified price, or better. Thus, such an order would protect your gains. None of the other orders are applicable to this situation.
9. You sold ABC stock short at $80 per share. Your losses could be minimized by placing a __________:
A) limit-sell order
B) limit-buy order
C) stop-buy order
D) day-order
E) none of the above.
Answer: C Difficulty: Moderate
Rationale: With a stop-buy order, the stock would be purchased if the price increased to a specified level, thus limiting your loss. None of the other orders are applicable to this situation.
10. Which one of the following statements regarding orders is false?
A) A market order is simply an order to buy or sell a stock immediately at the prevailing market price.
B) A limit sell order is where investors specify prices at which they are willing to sell a security.
C) If stock ABC is selling at $50, a limit-buy order may instruct the broker to buy the stock if and when the share price falls below $45.
D) A day order expires at the close of the trading day.
E) None of the above.
Answer: E Difficulty: Moderate
Rationale: All of the order descriptions above are correct.
11. Restrictions on trading involving insider information apply to the following except
A) corporate officers and directors.
B) relatives of corporate directors and officers.
C) major stockholders.
D) All of the above are subject to insider trading restrictions.
E) None of the above is subject to insider trading restrictions.
Answer: D Difficulty: Moderate
Rationale: A, B, and C are corporate insiders and are subject to restrictions on trading on inside information. Further, the Supreme Court held that traders may not trade on nonpublic information even if they are not insiders.
12. The cost of buying and selling a stock consists of __________.
A) broker's commissions
B) dealer's bid-asked spread
C) a price concession an investor may be forced to make.
D) A and B.
E) A, B, and C.
Answer: E Difficulty: Moderate
Rationale: All of the above are possible costs of buying and selling a stock.
13. Assume you purchased 200 shares of XYZ common stock on margin at $70 per share from your broker. If the initial margin is 55%, how much did you borrow from the broker?
A) $6,000
B) $4,000
C) $7,700
D) $7,000
E) $6,300
Answer: E Difficulty: Moderate
Rationale: 200 shares * $70/share * (1-0.55) = $14,000 * (0.45) = $6,300.
14. You sold short 200 shares of common stock at $60 per share. The initial margin is 60%. Your initial investment was
A) $4,800.
B) $12,000.
C) $5,600.
D) $7,200.
E) none of the above.
Answer: D Difficulty: Moderate
Rationale: 200 shares * $60/share * 0.60 = $12,000 * 0.60 = $7,200
15. You purchased 100 shares of ABC common stock on margin at $70 per share. Assume the initial margin is 50% and the maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore interest on margin.
A) $21
B) $50
C) $49
D) $80
E) none of the above
Answer: B Difficulty: Difficult
Rationale: 100 shares * $70 * .5 = $7,000 * 0.5 = $3,500 (loan amount); 0.30 = (100P - $3,500)/100P; 30P = 100P - $3,500; -70P = -$3,500; P = $50.
16. You purchased 100 shares of common stock on margin at $45 per share. Assume the initial margin is 50% and the stock pays no dividend. What would the maintenance margin be if a margin call is made at a stock price of $30? Ignore interest on margin.
A) 0.33
B) 0.55
C) 0.43
D) 0.23
E) 0.25
Answer: E Difficulty: Difficult
Rationale: 100 shares * $45/share * 0.5 = $4,500 * 0.5 = $2,250 (loan amount); X = [100($30) - $2,250]/100($30); X = 0.25.
17. You purchased 300 shares of common stock on margin for $60 per share. The initial margin is 60% and the stock pays no dividend. What would your rate of return be if you sell the stock at $45 per share? Ignore interest on margin.
A) 25%
B) -33%
C) 44%
D) -42%
E) –54%
Answer: D Difficulty: Difficult
Rationale: 300($60)(0.60) = $10,800 investment; 300($60) = $18,000 X (0.40) = $7,200 loan; Proceeds after selling stock and repaying loan: $13,500 - $7,200 = $6,300; Return = ($6,300 - $10,800)/$10,800 = - 41.67%.
18. Assume you sell short 100 shares of common stock at $45 per share, with initial margin at 50%. What would be your rate of return if you repurchase the stock at $40/share? The stock paid no dividends during the period, and you did not remove any money from the account before making the offsetting transaction.
A) 20%
B) 25%
C) 22%
D) 77%
E) none of the above
Answer: C Difficulty: Moderate
Rationale: Profit on stock = ($45 - $40) * 100 = $500, $500/$2,250 (initial investment) = 22.22%.
19. You sold short 300 shares of common stock at $55 per share. The initial margin is 60%. At what stock price would you receive a margin call if the maintenance margin is 35%?
A) $51
B) $65
C) $35
D) $40
E) none of the above
Answer: B Difficulty: Difficult
Rationale: Equity = 300($55) * 1.6 = $26,400; 0.35 = ($26,400 - 300P)/300P; 105P = 26,400 - 300P; 405P = 26,400; P = $65.18
20. Assume you sold short 100 shares of common stock at $50 per share. The initial margin is 60%. What would be the maintenance margin if a margin call is made at a stock price of $60?
A) 40%
B) 33%
C) 35%
D) 25%
E) none of the above
Answer: B Difficulty: Difficult
Rationale: $5,000 X 1.6 = $8,000; [$8,000 - 100($60)]/100($60) = 33%.
21. Specialists on stock exchanges perform the following functions
A) Act as dealers in their own accounts.
B) Analyze the securities in which they specialize.
C) Provide liquidity to the market.
D) A and B.
E) A and C.
Answer: E Difficulty: Moderate
Rationale: Specialists are both brokers and dealers and provide liquidity to the market; they are not analysts.
22. Shares for short transactions
A) are usually borrowed from other brokers.
B) are typically shares held by the short seller's broker in street name.
C) are borrowed from commercial banks.
D) B and C.
E) none of the above.
Answer: B Difficulty: Moderate
Rationale: Typically, the only source of shares for short transactions is those held by the short seller's broker in street name; often these are margined shares.
23. Which of the following orders is most useful to short sellers who want to limit their potential losses?
A) Limit order
B) Discretionary order
C) Limit-loss order
D) Stop-buy order
E) None of the above
Answer: D Difficulty: Moderate
Rationale: By issuing a stop-buy order, the short seller can limit potential losses by assuring that the stock will be purchased (and the short position closed) if the price increases to a certain level.
24. Shelf registration
A) is a way of placing issues in the primary market.
B) allows firms to register securities for sale over a two-year period.
C) increases transaction costs to the issuing firm.
D) A and B.
E) A and C.
Answer: D Difficulty: Easy
Rationale: Shelf registration lowers transactions costs to the firm as the firm may register issues for a longer period than in the past, and thus requires the services of the investment banker less frequently.
25. NASDAQ subscriber levels
A) permit those with the highest level, 3, to "make a market" in the security.
B) permit those with a level 2 subscription to receive all bid and ask quotes, but not to enter their own quotes.
C) permit level 1 subscribers to receive general information about prices.
D) include all OTC stocks.
E) A, B, and C.
Answer: E Difficulty: Easy
Rationale: NASDAQ links dealers in a loosely organized network with different levels of access to meet different needs.
26. You want to buy 100 shares of Hotstock Inc. at the best possible price as quickly as possible. You would most likely place a
A) stop-loss order
B) stop-buy order
C) market order
D) limit-sell order
E) limit-buy order
Answer: C Difficulty: Easy
Rationale: A market order is for immediate execution at the best possible price.
27. You want to purchase XYZ stock at $60 from your broker using as little of your own money as possible. If initial margin is 50% and you have $3000 to invest, how many shares can you buy?
A) 100 shares
B) 200 shares
C) 50 shares
D) 500 shares
E) 25 shares
Answer: A Difficulty: Moderate
Rationale: .5 = [(Q * $60)-$3,000] / (Q * $60); $30Q = $60Q-$3,000; $30Q = $3,000; Q=100.
28. A sale by IBM of new stock to the public would be a(n)
A) short sale.
B) seasoned new issue offering.
C) private placement.
D) secondary market transaction.
E) initial public offering.
Answer: B Difficulty: Easy
Rationale: When a firm whose stock already trades in the secondary market issues new shares to the public this is referred to as a seasoned new issue.
29. The finalized registration statement for new securities approved by the SEC is called
A) a red herring
B) the preliminary statement
C) the prospectus
D) a best-efforts agreement
E) a firm commitment
Answer: C Difficulty: Moderate
Rationale: The prospectus is the finalized registration statement approved by the SEC.
30. The minimum market value required for an initial listing on the New York Stock Exchange is
A) $2,000,000
B) $2,500,000
C) $1,100,000
D) $60,000,000
E) 100,000,000
Answer: E Difficulty: Moderate
Rationale: See Table 3.3.
31. In 2005, the price of a seat on the NYSE reached a high of
A) $1,000,000
B) $4,000,000
C) $1,750,000
D) $2,225,000
E) $3,000,000
Answer: B Difficulty: Moderate
Rationale: See Table 3.2.
32. The floor broker is best described as
A) an independent member of the exchange who owns a seat and handles overload work for commission brokers.
B) someone who makes a market in one or more securities.
C) a representative of a brokerage firm who is on the floor of the exchange to execute trade.
D) a frequent trader who performs no public function but executes trades for himself.
E) any counter party to a trade executed on the floor of the exchange.
Answer: A Difficulty: Easy
Rationale: The floor broker is an independent member of the exchange who handles work for commission brokers when they have too many orders to handle.
33. You sell short 100 shares of Loser Co. at a market price of $45 per share. Your maximum possible loss is
A) $4500
B) unlimited
C) zero
D) $9000
E) cannot tell from the information given
Answer: B Difficulty: Moderate
Rationale: A short seller loses money when the stock price
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