Exam 1 - Homework Questions [IMPORTANT] Flashcards
How do security dealers earn their profits? (LO 3-3)
The primary source of income for a securities dealer is the bid-ask spread. This is the difference
between the price at which the dealer is willing to purchase a security and the price at which they are
willing to sell the same security.
What are the differences between a limit order and a market order? (LO 3-3)
A stop order is a trade is not to be executed unless stock hits a price limit. The stop-loss is used to limit
losses when prices are falling. An order specifying a price at which an investor is willing to buy or sell a
security is a limit order, while a market order directs the broker to buy or sell at whatever price is
available in the market.
What is the role of an underwriter? A prospectus? (LO 3-1)
Underwriters purchase securities from the issuing company and resell them. A prospectus is a
description of the firm and the security it is issuing
Are the following statements true or false? If false, correct them. (LO 3-4)
An investor who wishes to sell shares immediately should ask his or her broker to enter a limit order.
False, if the investor wants to sell the stock immediately he should sell at the current market price only
Are the following statements true or false? If false, correct them. (LO 3-4)
The ask price is less than the bid price.
False,
Generally, the ask price is higher than bid price
Are the following statements true or false? If false, correct them. (LO 3-4)
An issue of additional shares of stock to the public by Microsoft would be called an IPO.
False (i think)
Are the following statements true or false? If false, correct them. (LO 3-4)
An ECN (Electronic Communications Network) is a computer link used by security dealers primarily to advertise prices at which they are willing to buy or sell shares.
True, Electronic Communication Network is the system which connects a large number of buyer and sellers at a point. It is an automated system on the stock exchange where buyer and sellers can directly contact each other to buy and sell securities. This system eliminates the need for a middleman.
What are the differences between real and financial assets? (LO 1-2)
Real assets are assets used to produce goods and services. Financial assets are claims on real assets or
the income generated by them.
How does investment banking differ from commercial banking? (LO 1-5)
Investment bankers are firms specializing in the sale of new securities to the public, typically by
underwriting the issue. Commercial banks accept deposits and lend the money to other borrowers. After
the Glass-Steagall Act was repealed in 1999, some commercial banks started transforming to “universal
banks” which provide the services of both commercial banks and investment banks. With the passage of
the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010, Glass-Steagall was partially
restored via the Volker Rule.
For each transaction, identify the real and/or financial assets that trade hands. Are any financial assets created or destroyed in the transaction? (LO 1-2)
Toyota takes out a bank loan to finance the construction of a new factory.
Toyota creates a real asset—the factory. The loan is a financial asset that is created in the transaction.
For each transaction, identify the real and/or financial assets that trade hands. Are any financial assets created or destroyed in the transaction? (LO 1-2)
Toyota pays off its loan.
nsaction.
7b.
For each transaction, identify the real and/or financial assets that trade hands. Are any financial assets created or destroyed in the transaction? (LO 1-2)
Toyota uses $10 million of cash on hand to purchase additional inventory of spare auto parts.
.The cash is a financial asset that is traded in exchange for a real asset, inventory
What reforms to the financial system might reduce its exposure to systemic risk? (LO 1-6)
Passed in 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act proposes several
mechanisms to mitigate systemic risk. The act attempts to limit the risky activities in which the banks
can engage and calls for stricter rules for bank capital, liquidity, and risk management practices,
especially as banks become larger and their potential failure becomes more threatening to other
institutions. The act seeks to unify and clarify the lines of regulatory authority and responsibility in
government agencies and to address the incentive issue by forcing employee compensation to reflect
longer-term performance. It also mandates increased transparency, especially in derivatives markets.
What features of money market securities distinguish them from other fixed-income securities? (LO 2-1)
3Money market securities are short-term, relatively low risk, and highly liquid.
Why are high-tax-bracket investors more inclined to invest in municipal bonds than are low-bracket investors? (LO 2-1)
The coupons paid by municipal bonds are exempt from federal income tax and from state tax in many
states. Therefore, the higher the tax bracket that the investor is in, the more valuable the tax-exempt
feature to the investor.
