Module 5

Chapter 11: Investment Planning

Ample insurance and liquidity (cash and savings) that are sufficient to meet life’s emergencies
are important prerequisites for an investment program. See 11-1: The Objectives and Rewards
of Investing.

Bonds are liabilities of the issuer. They are IOU (I owe you) documents of the issuer. See 11-1:
The Objectives and Rewards of Investing.

James purchased five bonds with a face value of $1,000 that paid 5% annual interest rate. The
total annual interest income of James for each year is:
a. $50.
b. $175.
c. $250.
d. $100.
e. $500.
ANSWER: C
RATIONALE: James will receive an interest income of $250. It is calculated as 5% of $1,000
for five bonds. See 11-1: The Objectives and Rewards of Investing.

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Megan invested in 10 bonds with a total face value of $5,000, issued by Zen Corporation. The
bonds paid 10% semiannual interest till the maturity date. Which of the following is the value
of interest earned in the first installment payment?
a. $50
b. $100
c. $500
d. $250
e. $75
ANSWER: D
RATIONALE: Interest received by Megan on the first installment = $5,000 × 10% × 6/12 =
$250. See 11-1: The Objectives and Rewards of Investing.

A bull market is a market condition normally associated with investor optimism, economic
recovery, and expansion; characterized by generally rising securities prices. See 11-2: Securities
Markets.

A bear market is a condition typically associated with investor pessimism, economic slowdown,
and generally falling securities prices. See 11-2: Securities Markets.

Diversification is the process of choosing securities with dissimilar risk–return characteristics in

order to create a portfolio that provides an acceptable level of return and an acceptable exposure
to risk. See 11-6: Managing Your Investment Holdings.

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Mathew purchased 100 shares of Blue Corporation for $100 per share. Currently, the stocks of
Blue Corporation are trading at $150. Which of the following is the return on Mathew’s
investment in one share?
a. 65%
b. 50%
c. 75%
d. 80%
e. 40%
ANSWER: B
RATIONALE: Return on Mathew’s Investment = ($150 – $100) ÷ $100 = 0.5 = 50% See 11-3:
Making Transactions in the Securities Markets.

Clara’s portfolio is worth $200,000, and her portfolio consists of common stocks worth
$56,000. Therefore, equity constitutes _____ of Clara’s portfolio.
a. 10%
b. 33%
c. 28%
d. 56%
e. 61%
ANSWER: C
RATIONALE: Percentage of Equity in Clara’s Portfolio = $56,000 ÷ $200,000 = 28% See 11-6:
Managing Your Investment Holdings.

The Dow Jones Industrial Average is based on 30 stocks. See 11-4: Becoming an Informed
Investor.

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Chapter 12: Investing in Stocks and Bonds

To be liquid, an investment not only must be easy to sell, but also be so at a reasonable price.
Investments such as mutual funds, common stocks, and U.S. Treasury securities are generally
highly liquid; others, such as raw land, are not. See 12-1: The Risks and Rewards of Investing.

Any investment—whether it’s a share of stock, a bond, real estate, or a mutual fund—has two
basic sources of return: current income and capital gains. See 12-1: The Risks and Rewards of
Investing.

The Smith family owns 200 shares of Elta stock. The company declared a 5% stock dividend.
The Smiths now own:
a. 200 shares.
b. 205 shares.
c. 210 shares.
d. 420 shares.
e. 410 shares.
ANSWER: C
RATIONALE: Number of shares owned by the Smiths = 200 shares × 1.05 = 210 shares. See
12-2: Investing in Common Stock.

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Suppose the earnings per share of a stock is $2 and the current price/earnings (P/E) ratio is 10.
What is the current price of the stock?
a. $5
b. $8
c. $20
d. $40
e. $35
ANSWER: C
RATIONALE: When the prevailing market price of a share of common stock is divided by the
annual earnings per share, the result is the price/earnings (P/E) ratio.
P/E ratio = Share price / earnings per share
10 = ? / 2
Current Price of Stock = EPS × Current Price/Earnings Ratio
Current Price = $2 × 10 = $20 See 12-2: Investing in Common Stock.

The net income of Sunrise Corporation is $5 million, and shareholders’ equity is $50 million.
The return on equity is:
a. 5%.
b. 10%.
c. 20%.
d. 15%.
e. 25%.
ANSWER: B
RATIONALE: Return on Equity = Net Income ÷ Shareholders’ Equity = $5 million ÷ $50
million = 10% See 12-2: Investing in Common Stock.

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The current net profit of Sigma Inc. is $8 million, the market price of the stock is $65, and sales
is $50 million. The net profit margin of Sigma Inc. is:
a. 10%.
b. 28%.
c. 16%.
d. 8%.
e. 22%.
ANSWER: C
RATIONALE: Net Profit Margin of Sigma Inc. = Net Profit ÷ Sales = $8,000,000 ÷
$50,000,000 = 16% See 12-2: Investing in Common Stock.

A Puppy Pet Services $1,000 bond has a 7.5% coupon rate, matures in 2020, and is currently
quoted at $820. The current yield is:
a. 6.15%.
b. 7.50%.
c. 9.15%.
d. 10.27%.
e. 11.43%.
ANSWER: C
RATIONALE: Current Yield = Annual Interest Income ÷ Market Price of Bond =
$1,000 × .075 = $75 annual interest income
$75 ÷ $820 (market price of bond) = 9.15% current yield
See 12-3: Investing in Bonds.

When a bond is sold between coupon payment dates, the buyer pays the seller for the accrued
interest, which is the prorated share of the upcoming coupon payment. See 12-3: Investing in
Bonds.

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Chapter 13: Investing in Mutual Funds, ETFs, and Real Estate

The ability to diversify allows investors to reduce their exposure to risk sharply by indirectly
investing in many different securities and companies rather than just one or two. See 13-1:
Mutual Funds and Exchange Traded Funds: Some Basics.

ETFs can be bought or sold like any other stock on listed exchanges. See 13-1: Mutual Funds
and Exchange Traded Funds: Some Basics.

All mutual funds always charge a management fee. See 13-1: Mutual Funds and Exchange
Traded Funds: Some Basics.

A type of fund that buys and holds a portfolio of stocks equivalent to those in a market index
such as the S&P 500 is known as an index fund. See 13-2: Types of Funds and Fund Services.

Aggressive growth funds are highly speculative investments that seek large profits from capital
gains. See 13-2: Types of Funds and Fund Services.

The automatic reinvestment plan gives shareholders the option of electing to have dividends
and capital gains distributions reinvested in additional fund shares. See 13-2: Types of Funds
and Fund Services.

The automatic investment plan allows fund shareholders to funnel fixed amounts of money
from their paychecks or bank accounts automatically into a mutual fund. See 13-2: Types of
Funds and Fund Services.

Life-cycle or target-date funds are balanced funds that automatically change the asset
allocation from more to less equity exposure as an investor ages. See 13-2: Types of Funds and
Fund Services.
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Jenny’s adjusted gross income is $120,000 a year and she owns real estate property that
generates a rental income of $10,000 annually. If she pays mortgage interest of $4,000 on her
property per year, she can write off up to _____ in depreciation.
a. $4,000
b. $10,000
c. $6,000
d. $14,000
e. $8,000
ANSWER: C
RATIONALE: Depreciation = $10,000 – $4,000 = $6,000 See 13-4: Investing in Real Estate.
Page 368 in book – bottom right.
For tax purposes, real estate is considered a passive investment. Therefore, the
amount of expenses, including depreciation, that can be written off is generally
limited to the amount of income generated by this and any other passive
investments owned by the investor.

Mike has decided to purchase a real estate property that is expected to generate a net operating
income (NOI) of $63,000 per year. With a 9% cap rate, the property would have an estimated
value of:
a. $630,000.
b. $187,000.
c. $700,000.
d. $965,000.
e. $235,000.
ANSWER: C
RATIONALE: Value of a Property = Net Operating Income per Year ÷ Cap Rate =
$63,000 ÷ 0.09 = $700,000 See 13-4: Investing in Real Estate. Bottom of page
369 and top of page 370 in book.
Cap rate is the most popular measure through which real estate investments are assessed for
their profitability and return potential. The cap rate simply represents the yield of a property
over a one year time horizon assuming the property is purchased on cash and not on loan. The
capitalization rate indicates the property’s intrinsic, natural, and un-leveraged rate of return.

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