Module 3 Equity Investments and Managed Assets

Question 1

Can corporations deduct dividend payments to shareholders?

Answer 1

No dividend payments are made from after-tax profits and are not deductible, leading to double taxation. The corporation pays taxes on profits and shareholders pay taxes on received dividends.

Question 2

Our interest payments on corporate bonds, tax deductible for the issuer?

Answer 2

Yes, interest payments on corporate debt are generally deductible as business expenses, reducing taxable income. However, there are limitations, especially for related party transactions or excessive interest payments.

Question 3

How do tax treatments of dividends and interest influenced corporate financing decisions?

Answer 3

The deductibility of interest payments makes debt financing more attractive due to tax benefits, while the non deductibility of dividends can lead to double taxation, influencing corporations to prefer debt over equity financing.

Question 4

True or false?

Historically, stock returns tend to have low positive correlation with bond returns.

Answer 4

True.

That is, what is good for the stock market is not so good for the bond market because they both compete for investor money. Conversely, as bond yields improve (i.e., the price of bonds declines), money may shift into bonds and out of stocks.

Remember, in the case where rates go up in the fixed income market. Those current bondholders, their prices will go down because their bonds are paying less in interest than the market currently.

This then would encourage stockholders to maybe get out of stocks and buy these cheaper bonds or even go for the bonds at the higher interest rate.

Question 5

Question 6

are stocks issued by highly regarded, usually well capitalized companies that have historically paid dividends regardless of the condition of the broader economy. These companies are generally leaders in their respective industries (i.e., the components of the Dow Jones Industrial Average)

Answer 6

Blue chip stocks.

Question 7

are stocks issued by companies that tend to prosper in a growing economy and tend to do poorly during declining economic conditions (e.g., automobile manufacturers, consumer discretionary companies, and restaurants).

Answer 7

Cyclical stocks.

Question 8

are stocks issued by companies that are relatively unaffected by the business cycle (e.g., grocery chains). These companies tend to have steady (although slow) growth, become popular during economic recessions, and lose popularity during economic booms.

Answer 8

Defensive stocks.

Question 9

Healthcare, utilities, consumer staples and telecommunications are examples of what type of sector？

Answer 9

Defensive.

Question 10

What is a Defensive Stock?

Answer 10

Question 11

sometimes referred to as subscription rights, are issued by a corporation that plans to raise funds by issuing new stock to the public.

• Provides the shareholder the opportunity to keep their proportionate share of ownership in the company.
• Are quoted below the current market price.
• Are short-term, typically a few weeks.
• valued separately from the stock and trade in the secondary market

Answer 11

Rights.

Shareholders may execute their rights, sell their rights. Or let them expire.

Question 12

unlike a call option, for which the owner has only the right to purchase a round lot of common shares (1.e., 100 shares), _____ generally do not give the owner the right to purchase 100 shares.

Answer 12

Warrants.

Question 13

Answer 13

If the price of the warrant is below the specified price when the warrant expires, the warrant is worthless. However, because little money has been expended for the warrant (in this example, only $50), and because it has a longer right to exercise than a regular option, warrants are actively traded in the secondary market.

Question 14

True or false? Warrants are actively traded on the secondary exchange.

Answer 14

True.

Warrants are often able to be exercised for several years, typically five years. Or even greater.

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Question 19

What is inferred by the term dividend growth stock ？

Answer 19

This infers that the company’s earnings continue to grow, And therefore, their per dollar dividend payment along with it.

Question 20

Assume a company’s earnings per share is $2.00 and the company has decided to pay approximately 30% of its earnings as a dividend. Therefore, the company would pay 30% of $2.00, or $0.60, per share to common stockholders. This percentage is called the

Answer 20

Dividend payout ratio.

Investors should look at the dividend payout ratioIf it is changing throughout time, this may mean the dividend payments are less predictable.

Question 21

• A track record of raising dividends for many consecutive years.
• Strong financial health, and growing profits.
• A commitment to rewarding shareholders through increasing dividend payments.

Answer 21

Dividend Growth stocks.

Some of these can be seen through the
S&P 500 Dividend Aristocrats Index.

Question 22

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Question 23

John is considering buying shares of Microsoft. He wants to buy it before the upcoming dividend payment. John knows that the ex dividend date is on December 5th, a Wednesday. If John were to buy shares of Microsoft on Monday, the 3rd. How long would he need to hold the stock to get qualified dividend tax treatment?

Answer 23

John will need to hold the stock for an additional 60 days. This is because the trade would have settled on Tuesday the 4th. And would have counted as 1 day prior to the ex dividend date. A holding period of 61 days It is required.

Question 24

True or false?

Dilution occurs when a company issues a stock dividend in place of a cash dividend.

Answer 24

True.

When a company pays a stock dividend, each shareholder’s proportionate ownership remains unchanged, but the share price decreases proportionally, leaving the company’s overall market value unaffected.

Think about it. They’re issuing more stock. But only to existing shareholders.

Question 25

Question 26

True or False

After a stock split, an investor owns a larger percentage of the company.

Answer 26

False.

An investor’s percentage ownership of the company remains the same after a stock split.

Question 27

True or False

Stock splits are taxable as income to shareholders.

Answer 27

False. Stock splits are not income taxable to shareholders.

note that the investor still owns exactly the same total percentage of the company as before, but each share now represents a correspondingly smaller percentage. As a result, stock splits are never income taxable to the shareholders.

Question 28

Answer 28

For every 4 shares, John now has 1.

so, 100/4 = 25 shares

Original Total cost basis = $500 / 25 shares = $20 per share.

Question 29

is the fund’s annual operating expenses divided by the fund’s average annual assets.

Answer 29

Operating expense ratio.

Question 30

also called strategic income bond funds; these funds typically purchase three types of bonds: U.S. government bonds, high-yield corporate bonds, and foreign bonds.

Answer 30

Multi sector bond funds.

Volatility can decrease because these bond markets have a low correlation with each other.

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Question 34

is the least favorable method and is the default method used by the IRS in the event that the investor-taxpayer cannot identify the specific shares or use the average cost method.

Answer 34

First in, first out.

This is due to the first shares bought having the lowest cost. And typically, at a time of sale, your shares are with more.

Question 35

the most frequently used means of calculating shareholder basis. In this method, the investor pools all of the purchased shares into one account and then divides the total cost by the number of shares held. In this case, all shares will have the same unit cost or basis.

Answer 35

Averaged cost method.

Question 36

What are the key differences in share issuance and trading between open-end and closed-end funds?

Answer 36

Open-End Fund: Continuously issues and redeems shares at NAV; shares are not traded on exchanges.

Closed-End Fund: Issues a fixed number of shares during an IPO; shares are traded on stock exchanges at market-determined prices (which may differ from NAV).

Question 37

How are prices determined for open-end vs. closed-end funds, and what are the implications?

Answer 37

Open-End Fund: Share price equals NAV, ensuring fair value at all times.

Closed-End Fund: Price is based on market supply and demand, often trading at a premium or discount to NAV, which can create buying opportunities or risks.

Question 38

What are the main advantages of closed-end funds over open-end funds?

Answer 38

Closed-End Fund: Can use leverage to enhance returns, avoid forced asset sales due to redemptions, and offer intraday trading flexibility.

Open-End Fund: Simpler for investors seeking NAV-based pricing and guaranteed liquidity directly with the fund.

Question 39

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Question 40

How does a Mutual Fund differ in terms of management, compared to, say, a separately managed account?

Answer 40

The account differs from a mutual fund in that the professional manager purchases the securities in the portfolio on behalf of the investor, not on behalf of the fund.

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Question 46

Answer 46

Hedge Funds

Question 47

• consists of several, usually 10 to 30, hedge funds.
• extra layer of management means an extra layer of fees
• offers more liquidity for the investor, but the cost is cash drag caused by the manager keeping extra cash to meet potential withdrawals by other investors
• more highly correlated with equity markets than those of individual hedge fund

Answer 47

fund of funds (FOF)

Question 48

The reason an FOF earns a second layer of fees is ______ ___________ of the FOF portfolio.

Answer 48

The reason an FOF earns a second layer of fees is active management of the FOF portfolio can add value compared to selecting a portfolio of hedge funds at random.

Question 49

Answer 49

fund of funds (FOF)

Question 50

are similar to Certificates of Deposit (CDs) but issued by insurance companies (not commercial banks)

Answer 50

Guaranteed Investment Contracts (GICs)

Though these include the word guaranteed. They involve some level investment risk as they are not covered by FDIC insurance, unlike a certificate deposit.

Question 51

have a guaranteed rate of return set by the insurer for a fixed period (e.g., five years).

• not insured by the FDIC
• typically invested in commercial mortgages, investment-grade corporate bonds, and government bonds.
• Major purchasers are institutions (e.g., employers) for use in 401(k) plans or pension plans.

Answer 51

Guaranteed Investment Contracts (GICs)

Question 52

Major purchasers of GICs are institutions (e.g., employers) for use in 401(k) plans or pension plans.

Employers can choose between participating and nonparticipating contracts:

Answer 52

Participating GIC: Variable interest rate tied to market rates.

Nonparticipating GIC: Fixed interest rate for the entire term.

If interest rates are expected to rise, a participating GIC might be more beneficial. If rates are expected to fall, a nonparticipating GIC might be preferable.

Question 53

What is a Guaranteed Investment Contract (GIC)?

Answer 53

A GIC is an investment product issued by an insurance company that offers a fixed or variable rate of return over a set period, commonly used by institutional investors for retirement plans.

Question 54

What is the difference between a participating and a nonparticipating GIC?

Answer 54

A participating GIC has a variable interest rate that changes with market rates, while a nonparticipating GIC provides a fixed rate for the entire contract term.

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Question 60

As a general rule, anything that involves more than _% of assets is considered material by the SEC.

Answer 60

As a general rule, anything that involves more than 5% of assets is considered material by the SEC.

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Question 62

Answer 62

Correct Answer: B) 42.86%

Question 63

Bear markets expose the risk management policies of a portfolio manager. Bear market performance should be examined not only for a calendar year but also, and more importantly, for an entire bear market cycle. Downside performance can be masked if one examines only year-end performance.

A review of quarterly performance is a good method for examining the consistency of performance. A summary prospectus of a fund will include the fund’s best and worst quarterly performance over the past several years under the Performance Information section.

Answer 63

Finally, funds that demonstrate consistency are generally run by managers with long tenure who have a specific investment process that they closely follow, regardless of market fluctuations. This is a characteristic of good managers and should be used as a checkpoint during the fund selection process.

Question 64

calculated by dividing the excess return (total fund return less the risk-free rate of return) by the fund’s standard deviation.

• used to compare one fund to another.

Answer 64

The Sharpe ratio

• higher the Sharpe ratio, the better the risk-adjusted fund.

Question 65

indicates a fund’s actual performance relative to how well it should have performed given its risk (as measured by beta).

Answer 65

Jensen’s alpha

Question 66

Alpha is an absolute measure of risk-adjusted return, meaning that it does not need to be compared to another fund to determine the scope of its performance; a positive alpha is what we expect.

Answer 66

A negative alpha does not mean a negative performance; in fact, a fund with a negative alpha could have a good absolute performance. The negative alpha simply indicates that the fund should have had a better performance, given the assumed risk.

Also, the larger a negative alpha is, the more it should be regarded with concern. One additional method of calculating a risk-adjusted return is simply dividing the fund’s total return by either beta or standard deviation. This provides a measure of total return per unit of risk—the higher the number, the better.

Question 67

With stock funds, turnover can be an indication of style. In general, stock funds with high turnover tend to follow a _____ style.

Answer 67

With stock funds, turnover can be an indication of style. In general, stock funds with high turnover tend to follow a growth style

while stock funds with low turnover are associated with a value style.

Question 68

True or false?

high turnover by itself is generally seen as a negative fund characteristic.

Answer 68

True

Fast and furious turnover generates:

• high commissions,
  -bid-ask transaction costs (that is, the difference, or spread, between the bid price and the ask price of a security), and
• market-impact costs (the negative effect an order can have on either the bid or ask price)—for example, a sizable buy order could increase the ask price the fund must pay to fill the order.

Question 69

True or false?

You are holding period within a mutual fund determines the tax treatment of the distribution you receive.

Answer 69

False

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