Investment Basics – Practice Questions II


Basic Knowledge of Investment – Bond and Mutual Fund yield, Stocks, and more






1. Which of the following indexes gives the broadest measure of the movement and activities of the entire stock market?

A. S&P 500
B. Dow Jones Industrial Average (DJIA)
C. Lehman Aggregate Bond Index
D. Wilshire 5000

2. An investor owns a bond with a 7% yield and 20 years maturity term. The investor wonders how an increase in interest rates would affect his bond. If asked, the best response from the registered rep should be:

A. The investor need not worry as the bond is a long term investment
B. The investor should dispose of the bond and buy another with an even longer maturity
C. The bond will very likely lose value as long term bonds are at higher interest rate risk
D. The value of the bond can be expected to rise due to positive forecasts of the economy



3. Select from the following options those that can be referred to as non-diversifiable risks?

I. Interest Rate Risk
II. Market Risk;
III. Unsystematic Risk;
IV. Exchange Rate Risk;

A. II and III only
B. I, II, and IV
C. I, II, and III
D. I and II only

4. Mr. David bought 100 shares of a company’s stock at $50 a share. He sold the 100 shares after a year at $60 a share. During the year he owned the shares, he received dividends of $1.50 per share. Calculate the Holding Period Return for Mr. David’s investment.

A. 26%
B. 23%
C. 24%
D. 29%

5. Which of the statements below best describes the Real Rate of Return also known as the Inflation-Adjusted Return?

A. The present interest rate minus inflation rate
B. Inflation rate added to the annual return on investment
C. The present T-bill rate minus inflation rate
D. The CPI figure of the month adjusted to the annual return

6. Bella bought 50 shares of a company’s stock at $80 per share on the 1st of January, 2014. He earned a dividend of $1.40 per share in the first year. On the 2nd of January, 2015, Bella sold all 50 shares at $85 per share. If Bella was to ask the registered rep what was her total return for the period, the right answer should be:

A. 11%
B. 7%
C. 5%
D. 9 %


7. What will be the value of a mutual fund investment of $1,000 if the fund earned 25% interest in year one and lost 10% in the second year?

A. $1,125
B. $1,450
C. $1,050
D. $1,345

8. Lucy who resides in New York purchased a U.S Treasury Bond that offers an annual interest rate of 7% (coupon rate). What would be her after-tax yield if the tax rate for the State of New York her is 6% and her federal income tax is 30%?

A. 7.2%
B. 5.9%
C. 4.9%
D. 5.5%



9. A bond’s price of $1,000 par dropped to $800. Which of the following best explains why this may have happened?

A. The bond is getting close to its maturing date
B. The bond was affected by inflation rates
C. Interest rates have decreased
D. Interest rates have increased

10. If a bond worth $1,000 par (7% coupon) sells at a discount for $900, which of the statements below would be true?

A. Current yield is less that yield-to-call
B. The nominal yield will equal the current yield
C. The bond cannot be called
D. Nominal yield exceeds current yield




Answer Key

1. D
The S&P 500 indicator is used to measure the largest trade issues on NYSE.
The Lehman Aggregate Bond Index is used to measure the activity of over 5,000 bond types.
The Dow Jones Industrial Average is the most used indicator containing 20 industrial stocks, but it offers the narrowest measure of the stock market.
The Wilshire 5000 consists of over 7,000 issues on trade on the AMEX, NYSE and OTC markets. It is a value weighted index considered to offer the broadest measurements of movement and activity in the entire stock market.

2. C
Interest rates and bond prices are inversely related. Bond prices would drop when interest rates go up. Long term bonds are most affected by fluctuations in interest rates. When interest rates increase, the investor should lower the maturities on their bond investments.

3. B
No matter the level of diversification, non-diversifiable risks cannot be avoided. Systematic risk is also referred to as non-diversifiable risks and it includes interest rate, exchange rare risks, reinvestment rate and purchasing power.

4. B
The HPR (Holding Period Return) is calculated as the total return on investment (income, capital appreciation and dividends less margin interest) during the entire investment period divided by the cost of the investment.

For the above example, $150 (dividend) + $1000 (capital appreciation) = $1150 divided by $5000 (cost of investment) = 23%

5. A
The Inflation Adjusted Rate refers to the current or present interest rate less inflation rate. If the returns expected on an investment is lower than inflation rate then investment would not be favorable.

6. D
Bella invested 50 x $80 = $4000
She made a profit of $85 x 50 = $4250 – $4000 = $250
Her return on capital appreciation was 250/4000 = 6.25%
She received a total dividend of $1.40 x 50 = $70
Her return on dividend was 70/4000 = 1.75
Her total return on investment was 6.25 + 1.75 = 8%

7. A
At the end of the first year, the mutual fund would be worth $1,250 (25% of 1000 = 250).

At year two, the mutual fund is worth $1250 less 10% (10% 0f 1250 = 125. $1250 – $125 =$1,125.) The mutual fund is worth $1,125 at the end of the second year.

8. C
Investments in U.S treasury bonds are exempted from local and state taxes. They are however subject to federal taxes. Investors need to first calculate the tax exempt yield when making decisions to invest in a non-taxable or taxable bond.

To calculate tax-exempt yield, multiply the taxable equivalent with 1 – (marginal tax rate)  0.07 x (1- 0.30) = .049 or 4.9%

A tax exempt investment such as investments in U.S Treasury Bonds are only deemed to be attractive when they exceed 4.9%

9. D
Interest rates have an inverse relationship with the price of bonds. When interest rates go up, bond prices would go down and a decrease in interest rates would increase the price of bonds. The market price of the bond would get closer to par as the maturity date of the bond approaches.

10. A
The nominal yield is the stated yield or rate of interest on the bond, which is also known as the coupon rate. In this instance the nominal yield is 7%. The current yield of the $1,000 par bond which sells at $900 discount is 7.78% (the annual interest in dollars divided by the bond’s market price).
A financial calculator is used to calculate the yield-to-call rate. It is important to note that discounted bonds have a current yield that is less than their yield-to-call and vice versa. Premium bonds on the other hand have a yield to call that is lesser that their current yield.

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