26 Investment Fundamentals

Question 1

What is asset allocation?

Answer 1

Form of diversification in which the investor decides on the proportions of an investment portfolio that will be devoted to various categories of assets.

Question 2

How is average share cost calculated?

Answer 2

By dividing the total amount invested by the total shares purchased.

Question 3

What does average share price represent?

Answer 3

Calculated by dividing the share price total by the number of investment periods.

Question 4

Define bear market.

Answer 4

Market in which securities prices have declined in value by 20 percent or more from previous highs.

Question 5

What are below-average costs?

Answer 5

Average costs of an investment if more shares are purchased when the price is down and fewer shares are purchased when the price is high.

Question 6

What are bonds?

Answer 6

A debt instrument issued by an organization that promises repayment at a specific time and the right to receive regular interest payments during the life of the bond.

Question 7

Define bull market.

Answer 7

Market in which securities prices have risen 20 percent or more over time.

Question 8

What is business-cycle risk?

Answer 8

The fact that economic growth usually does not occur in a smooth and steady manner and that this impacts profits as well as investment returns.

Question 9

What is the buy-and-hold investment strategy?

Answer 9

Investment strategy in which investors buy a widely diversified mix of stocks and/or mutual funds, reinvest the dividends, and hold onto those investments almost indefinitely.

Question 10

What is a capital gain?

Answer 10

Increase in the value of an initial investment, realized upon the sale of the investment.

Question 11

What is a capital loss?

Answer 11

Decrease in paper value of an initial investment.

Question 12

What are commissions?

Answer 12

Fees or percentages of the selling price paid to salespeople, agents, and companies for their services in buying or selling an investment.

Question 13

What is current income?

Answer 13

Money received while you owe an investment.

Question 14

Define debts in the context of investments.

Answer 14

Lending investments that typically offer both a fixed maturity and a fixed income.

Question 15

What is diversification?

Answer 15

Process of reducing risk by spreading investment money among several different investment opportunities.

Question 16

What is dollar-cost averaging?

Answer 16

Systematic program of investing equal sums of money at regular intervals, regardless of the price of the investment.

Question 17

What are equities?

Answer 17

Ownership equities such as common or preferred stocks, equity mutual funds, real estate, and so on that focus on capital gains more than on income.

Question 18

Define financial risk.

Answer 18

Possibility that an investment will fail to pay a return to the investor.

Question 19

What does fixed income refer to?

Answer 19

Specific rate of return that a borrower agrees to pay the investor for use of the principal.

Question 20

What is fixed maturity?

Answer 20

Specific date on which a borrower agrees to repay the principal to the investor.

Question 21

What is herd behavior in investing?

Answer 21

When emotion rules investing decisions and investors decide to copy the observed decisions of other investors or movements in the markets rather than follow their own beliefs and information.

Question 22

What does interest refer to?

Answer 22

Charge for borrowing money.

Question 23

Define investing.

Answer 23

Putting saved money to work so that it makes you even more money.

Question 24

What is an investment philosophy?

Answer 24

Investor’s general approach to tolerance for risk in investments, whether it is conservative, moderate, or aggressive, given the investor’s financial goals.

Question 25

What is an investment plan?

Answer 25

An explanation of your investment philosophy and your logic on investing to reach specific goals.

Question 26

What is investment risk?

Answer 26

The possibility that the yield on an investment will deviate from its expected return.

Question 27

What does leverage mean in investing?

Answer 27

Using borrowed funds to invest with the goal of earning a rate of return in excess of the after-tax costs of borrowing.

Question 28

What is a limited managed account?

Answer 28

An account at an investment firm whereby they sell and buy mutual fund assets on the client’s behalf to automatically rebalance the portfolio back to the client’s specific standard.

Question 29

Define liquidity.

Answer 29

The speed and ease with which an asset can be converted to cash.

Question 30

What is liquidity risk?

Answer 30

The risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss.

Question 31

What is a market correction?

Answer 31

A short-term price decline in the stock markets of at least 10 percent in a stock, bond, commodity or index to adjust for recent price increases.

Question 32

What is market efficiency?

Answer 32

The speed at which new information is reflected in investment prices suggesting that security prices are reflective of their true value at all times.

Question 33

Who are market timers?

Answer 33

Investors who attempt to predict the short-term movements of various markets and move capital based on those predictions.

Question 34

What is market volatility?

Answer 34

The likelihood of large price swings in securities due to a company’s success and various market conditions.

Question 35

What is market-volatility risk?

Answer 35

The fact that all investments are subject to occasional sharp changes in price as a result of events affecting a particular company or the overall market.

Question 36

What is Monte Carlo analysis?

Answer 36

Technique that performs a large number of trial runs of a particular portfolio mix of investments to find an optimal allocation for a particular investor’s goals and risk tolerance.

Question 37

Define portfolio.

Answer 37

Collection of investments assembled to meet investment goals.

Question 38

What is portfolio diversification?

Answer 38

Practice of selecting a collection of different asset classes of investments chosen for their potential returns and dissimilar risk-return characteristics.

Question 39

How is the rate of return (yield) expressed?

Answer 39

Total return of an investment expressed as a percentage of its price.

Question 40

What is the real rate of return?

Answer 40

Return on an investment after subtracting the effects of inflation and income taxes.

Question 41

What does risk averse mean?

Answer 41

One who tends to dislike risk and is unable to put money into investments that seem risky.

Question 42

Define risk indifferent.

Answer 42

Investors who accept some risk as they seek capital gains through slow and steady growth in investment value along with current income.

Question 43

What is a risk premium?

Answer 43

The difference between a riskier investment’s expected return and the totally safe return on the T-bill.

Question 44

What does risk seeking mean?

Answer 44

Investors who primarily seek capital gains, often with a short time horizon.

Question 45

What is risk tolerance?

Answer 45

An investor’s willingness to weather changes in the value of investments.

Question 46

What are securities?

Answer 46

Assets suitable for investment.

Question 47

What are securities markets?

Answer 47

Places where stocks and bonds are traded.

Question 48

What is speculative risk?

Answer 48

Involves the potential for either gain or loss.

Question 49

What are stocks?

Answer 49

Shares of ownership in a business corporation’s assets and earnings.

Question 50

Define systematic (market or undiversifiable) risk.

Answer 50

The possibility for an investor to experience losses due to unknown factors that affect the overall performance of the financial markets.

Question 51

What is total return?

Answer 51

Income an investment generates from current income and capital gains.

Question 52

What is unsystematic (random) risk?

Answer 52

Risk associated with owning only one investment of a particular type.