1. You see an advertisement for a book which claims to show how you can make $1,000,000 in investment profits in a year, with no initial investment required and no risk of any loss. The book costs $500. Would you buy it? Why or why not?
I personally would not buy this book because of such an outrageous claim. No such program exists that would not require an initial investment in which to gain compound interest. This sounds like a swindle to me, so no, I would not buy the book. I would rather earn my $1 million the old-fashioned way, through hard work and smart investing.
2. The Dow Jones Industrial Average, the Standard and Poor’s 500, and the Wilshire 5000 are three different market indices which represent the performance of the stock market. Which of the three is the best measure of the overall market? Explain why this is true.
I believe that the S;P 500 is the best measure of the overall market because it is larger and contains more a diverse index than the Dow Jones and the Wilshire 500. The S;P is comprised of 500 of the most widely traded stocks in the United States, and it represents about 70% of the total value of U.S. stock markets. Since the S;P is market rated, or capitalization weighted, every stock in the index is represented in proportion to its total market capitalization. Lastly, the S;P is comprised of a wide array of sectors such as energy, industrials, technology, healthcare, and consumer products.
3. Municipal bonds are issued by state and local governments and government agencies. Corporate bonds are issued by private companies. As an investor, which would you prefer and why? Make sure to discuss the key differences between the two as part of your answer.
The question of investing between Municipal Bonds and Corporate Bonds is often debated in the financial markets. The answer lies with the individual’s preferences and ability to accept a certain amount of risk. Municipal bonds are issued by state and local governments and are essentially risk-free, whereas a corporate bond is issued by private firms, and come with risk based on the returns of the bonds. Because of this, an investor would feel that their money would be more secure in a municipal bond because they are typically backed by the financial strength of the government agency that issued them. A corporate bond would have a higher rate of return due to the inherent risk taken by the company based on their market performance.
4. You are interested in investing in the stock of XYZ company. The stock currently sells for $40 per share and pays a yearly dividend of $1.50 per share. You have $10,000 to invest. How many shares could you buy, ignoring brokerage commissions and other costs? If you keep the stock for two years, what is the total amount of dividends you will receive?
Initial investment = $10,000 / $40 per share = No. of shares = 250
(250 x $1.50)2 = $750.00
5. Margin on a stock investment refers to borrowing part of the purchase price. Would you want to do this? Why or why not? In your answer, make sure you discuss how investing on margin affects the potential risk and return on the investment.
For me personally, I would not purchase stock using a margin. There are rewards that are to be obtained if the stock performs above average, but the inherent risk is something that would drive me away from the purchase. Purchasing stock with a margin requires a specific portion of your money to be invested that is borrowed instead of paying in cash. This can increase your return, but can also increase the risk involved.
6. If you are purchasing stock through a broker, you can place either a market order or some type of limit order. Which would you prefer to use and why? Make sure to explain the differences in the orders as part of your answer.
A market order is an order to buy or sell a stock immediately at the best price. These are good when an investor wants to buy or sell without a delay. Since it is hard to determine the exact price at which the stock will be bought or sold, I would elect to go with a limit order. A limit order places a minimum or maximum price that I would be willing to buy or sell a stock. Being on a strict budget, this would help me meet my financial goals by knowing exactly how much I would earn or lose. In addition, another factor to consider when choosing between the two are the commission fees. Although cheaper on a market order than a limit order, I would be okay with paying them knowing I was getting the best available price per stock.
7. If you want to invest in a mutual fund, you have a choice between open-end and closed-end funds. Which would you prefer and why? Make sure to explain the differences between the two as part of your answer.
The choice of investing in open-end and closed-end mutual funds can be confusing for a new investor. To decide which one to choose, it is important to know the differences and similarities of each. They both have some basic characteristics in common. They are both managed by professional funds that achieve diversification by investing in equities or other assets. The largest difference however, is the number of shares that the fund company sells to investors. An open-end sells as many shares as an investor is willing to buy, whereas a closed-end has a fixed amount of shares through an initial public offering, (IPO). Pricing is another distinct difference between the two. An open-end fund’s prices are fixed once per day at their net asset value. Closed-end funds trade throughout the day like stocks, and can be bought or sold at market value. Closed-end funds price levels are set by market demand. Personally, I do not handle risk very well, so I would invest in open-end mutual funds only.
8. The ABC open-end mutual fund has a total of $200,000,000 in assets invested in a portfolio of stocks and bonds. There are currently 8,000,000 fund shares outstanding. What is the fund’s Net Asset Value per share? If you invest $10,000 in the fund, how many shares would you be buying?
Total Assets = $200,000,000
Total Shares Outstanding = 8,000,000
Net Asset Value (NAV) of fund. $200,000 / 8,000,000 = $25.00 per share
Initial investment = $10,000 / $25.00 per share = 400 shares total
9. Most observers of the financial markets consider it very likely that overall interest rates will rise in the near future due to actions by the Federal Reserve. Assuming that rates do go up, what will happen to the price of existing bonds of all types? Explain why this must be true based on the present value model of bond prices.
There is an inverse relationship between interest rates and bond prices. If interest rates rise, the price of all different types of bonds will fall. This is due to bond prices becoming available at a higher coupon rate when the interest rate goes up. This gives investors more incentive to buy bonds that would pay a higher interest rate with the same funds they had before the interest rates rose.
10. You want to invest in a corporate bond with a face value of $1,000, a coupon rate of 8% per year, and 10 years to maturity. The current annual yield to maturity of this bond is 6%. What is the current value of the bond, assuming interest is paid once per year? What would the value be if the interest is paid twice per year rather than once per year?