Chapter 2: Financial Markets True/False Page 23
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Note that there is an overlap between the T/F and multiple-choice questions, as some of the T/F
statements are used in multiple-choice questions. See the preface for information on the AACSB
letter indicators (F, M, etc.) on the subject lines.
Multiple Choice: True/False
1
. A financial intermediary is a corporation that takes funds from investors
and then provides those funds to those who need capital. A bank that
takes in demand deposits and then uses that money to make long–term
mortgage loans is one example of a financial intermediary.
a. True
b. False
2
. The NYSE is defined as a “spot” market purely and simply because it has a
physical location. The Nasdaq, on the other hand, is not a spot market
because it has no one central location.
a. True
b. False
3
. The NYSE is defined as a “primary” market because it is one of the
largest and most important stock markets in the world.
a. True
b. False
4
. Primary markets are large and important, while secondary markets are
smaller and less important.
a. True
b. False
5
. Private markets are those like the NYSE, where transactions are handled
by members of the organization, while public markets are those like the
Nasdaq, where anyone can make transactions.
a. True
b. False
CHAPTER 2
FINANCIAL MARKETS AND INSTITUTIONS
Page 24 True/False Chapter 2: Financial Markets
6
. A share of common stock is not a derivative, but an option to buy the
stock is a derivative because the value of the option is derived from the
value of the stock.
a. True
b. False
7
. Financial institutions are more diversified today than they were in the
past, when federal laws kept investment banking houses, commercial banks,
insurance companies, and similar organizations quite separate. Today the
larger financial corporations offer a variety of services, ranging from
checking accounts, to insurance, to underwriting securities, to stock
brokerage.
a. True
b. False
8
. Hedge funds are somewhat similar to mutual funds. The primary
differences are that hedge funds are less highly regulated, have more
flexibility regarding what they can buy, and restrict their investors to
wealthy, sophisticated individuals and institutions.
a. True
b. False
9
. Trades on the NYSE are generally completed by having a brokerage firm
acting as a “dealer” buy securities and adding them to its inventory or
selling from its inventory. The Nasdaq, on the other hand, operates as
an auction market, where buyers offer to buy, and sellers to sell, and
the price is negotiated on the floor of the exchange.
a. True
b. False
10
. The “over–the-counter” market received its name years ago because
brokerage firms would hold inventories of stocks and then sell them by
literally passing them over the counter to the buyer.
a. True
b. False
11
. If you decide to buy 100 shares of Google, you would probably do so by
calling your broker and asking him or her to execute the trade for you.
This would be defined as a secondary market transaction, not a primary
market transaction.
a. True
b. False
Chapter 2: Financial Markets True/False Page 25
12
. The term IPO stands for “individual purchase order,” as when an
individual (as opposed to an institution) places an order to buy a stock.
a. True
b. False
13
. In a “Dutch auction” for new stock individual investors place bids for
shares directly. Each potential bidder indicates the price he or she is
willing to pay and how many shares he or she will purchase at that price.
The highest price that permits the company to sell all the shares it
wants to sell is determined, and this is the “market clearing price.”
All bidders who specified this price or higher are allowed to purchase
their shares at the market clearing price.
a. True
b. False
14
. When a corporation’s shares are owned by a few individuals who are
associated with the firm’s management, we say that the stock is closely
held.
a. True
b. False
15
. A publicly owned corporation is a company whose shares are held by the
investing public, which may include other corporations as well as
institutional investors.
a. True
b. False
16
. If you wanted to know what rate of return stocks have provided in the
past, you could examine data on the Dow Jones Industrial Index, the S&P
500 Index, or the Nasdaq Index.
a. True
b. False
17
. The annual rate of return on any given stock can be found as the stock’s
dividend for the year plus the change in the stock’s price during the
year, divided by its beginning–of-year price.
a. True
b. False
Page 26 Conceptual M/C Chapter 2: Financial Markets
18
. The annual rate of return on any given stock can be found as the stock’s
dividend for the year plus the change in the stock’s price during the
year, divided by its beginning–of-year price. If you obtain such data on
a large portfolio of stocks, like those in the S&P 500, find the rate of
return on each stock, and then average those returns, this would give you
an idea of stock market returns for the year in question.
a. True
b. False
19
. Each stock’s rate of return in a given year consists of a dividend yield
(which might be zero) plus a capital gains yield (which could be
positive, negative, or zero). Such returns are calculated for all the
stocks in the S&P 500. A weighted average of those returns, using each
stock’s total market value, is then calculated, and that average return
is often used as an indicator of the “return on the market.”
a. True
b. False
20
. Each stock’s rate of return in a given year consists of a dividend yield
(which might be zero) plus a capital gains yield (which could be
positive, negative, or zero). Such returns are calculated for all the
stocks in the S&P 500. A simple average of those returns (which gives
equal weight to each company in the S&P 500) is then calculated. That
average is called “the return on the S&P Index,” and it is often used as
an indicator of the “return on the market.”
a. True
b. False
Multiple Choice: Conceptual
21
. You recently sold 100 shares of Microsoft stock to your brother at a
family reunion. At the reunion your brother gave you a check for the
stock and you gave your brother the stock certificates. Which of the
following best describes this transaction?
a. This is an example of a direct transfer of capital.
b. This is an example of a primary market transaction.
c. This is an example of an exchange of physical assets.
d. This is an example of a money market transaction.
e. This is an example of a derivative market transaction.
Chapter 2: Financial Markets Conceptual M/C Page 27.
22
. Which of the following statements is CORRECT?
a. The NYSE does not exist as a physical location. Rather it
represents a loose collection of dealers who trade stock
electronically.
b. An example of a primary market transaction would be your uncle
transferring 100 shares of Walmart stock to you as a birthday gift.
c. Capital market instruments include both long-term debt and common
stocks.
d. If your uncle in New York sold 100 shares of Microsoft through his
broker to an investor in Los Angeles, this would be a primary market
transaction.
e. While the two frequently perform similar functions, investment banks
generally specialize in lending money, whereas commercial banks
generally help companies raise large blocks of capital from
investors.
23
. Which of the following is a primary market transaction?
a. You sell 200 shares of IBM stock on the NYSE through your broker.
b. You buy 200 shares of IBM stock from your brother. The trade is not
made through a broker–you just give him cash and he gives you the
stock.
c. IBM issues 2,000,000 shares of new stock and sells them to the public
through an investment banker.
d. One financial institution buys 200,000 shares of IBM stock from
another institution. An investment banker arranges the transaction.
e. IBM sells 2,000,000 shares of treasury stock to its employees when
they exercise options that were granted in prior years.
24
. Which of the following is an example of a capital market instrument?
a. Commercial paper.
b. Preferred stock.
c. U.S. Treasury bills.
d. Banker’s acceptances.
e. Money market mutual funds.
25
. Money markets are markets for
a. Foreign currencies.
b. Consumer automobile loans.
c. Common stocks.
d. Long-term bonds.
e. Short-term debt securities such as Treasury bills and commercial
paper.
Page 28 Conceptual M/C Chapter 2: Financial Markets
26
. Which of the following statements is CORRECT?
a. If you purchase 100 shares of Disney stock from your brother–in-law,
this is an example of a primary market transaction.
b. If Disney issues additional shares of common stock through an
investment banker, this would be a secondary market transaction.
c. The NYSE is an example of an over–the-counter market.
d. Only institutions, and not individuals, can engage in derivative
market transactions.
e. As they are generally defined, money market transactions involve debt
securities with maturities of less than one year.
27
. You recently sold 200 shares of Disney stock, and the transfer was made
through a broker. This is an example of:
a. A money market transaction.
b. A primary market transaction.
c. A secondary market transaction.
d. A futures market transaction.
e. An over-the–counter market transaction.
28
. Which of the following statements is CORRECT?
a. Hedge funds are legal in Europe and Asia, but they are not permitted
to operate in the United States.
b. Hedge funds are legal in the United States, but they are not
permitted to operate in Europe or Asia.
c. Hedge funds have more in common with investment banks than with any
other type of financial institution.
d. Hedge funds have more in common with commercial banks than with any
other type of financial institution.
e. Hedge funds are not as highly regulated as most other types of
financial institutions. The justification for this light regulation
is that only “sophisticated” investors (i.e., those with high net
worths and high incomes) are permitted to invest in these funds, and
these investors supposedly can do any necessary “due diligence” on
their own rather than have it done by the SEC or some other
regulator.
29
. Which of the following statements is CORRECT?
a. While the distinctions are becoming blurred, investment banks
generally specialize in lending money, whereas commercial banks
generally help companies raise capital from other parties.
b. The NYSE operates as an auction market, whereas Nasdaq is an example
of a dealer market.
c. Money market mutual funds usually invest their money in a well–
diversified portfolio of liquid common stocks.
d. Money markets are markets for long-term debt and common stocks.
e. A liquid security is a security whose value is derived from the price
of some other “underlying” asset.
Chapter 2: Financial Markets Conceptual M/C Page 29.
30
. Which of the following statements is CORRECT?
a. The New York Stock Exchange is an auction market, and it has a
physical location.
b. Home mortgage loans are traded in the money market.
c. If an investor sells shares of stock through a broker, then it would
be a primary market transaction.
d. Capital markets deal only with common stocks and other equity
securities.
e. While the distinctions are blurring, investment banks generally
specialize in lending money, whereas commercial banks generally help
companies raise capital from other parties.
31
. Which of the following statements is CORRECT?
a. The term “IPO” stands for Introductory Price Offered, and it is the
price at which shares of a new company are offered to the public.
b. IPO prices are generally established by the market, and buyers of the
new stock must pay the price that prevails at the close of trading
on the day the stock is offered to the public.
c. In a “Dutch auction,” investors who want to buy shares in an IPO
submit bids indicating how many shares they want to buy and the
price they are willing to pay. The company determines how many
shares it wants to sell. The highest price that enables the company
to sell the desired number of shares is the price that all buyers
must pay.
d. It is possible that the price set in an IPO is so high that
investors will refuse to buy the number of shares that the company
wants to sell. In this situation, the IPO is said to be
oversubscribed.
e. It is possible that the price set in an IPO is so low that investors
will want to buy more shares than the company wants to sell. In
that case, the company will have to issue more shares than it wants
to sell.
32
. Which of the following statements is CORRECT?
a. The most important difference between spot markets versus futures
markets is the maturity of the instruments that are traded. Spot
market transactions involve securities that have maturities of less
than one year whereas futures markets transactions involve
securities with maturities greater than one year.
b. Capital market transactions involve only preferred stock or common
stock.
c. If General Electric were to issue new stock this year, this would be
considered a secondary market transaction since the company already
has stock outstanding.
d. Both Nasdaq dealers and “specialists” on the NYSE hold inventories of
stocks.
e. Money market transactions do not involve securities denominated in
currencies other than the U.S. dollar.
Page 30 M/C Problems Chapter 2: Financial Markets
33
. Which of the following statements is NOT CORRECT?
a. When a corporation’s shares are owned by a few individuals, we say
that the firm is “closely, or privately, held.”
b. “Going public” establishes a firm’s true intrinsic value and ensures
that a liquid market will always exist for the firm’s shares.
c. The stock of publicly owned companies must generally be registered
with and reported to a regulatory agency such as the SEC.
d. When stock in a closely held corporation is offered to the public
for the first time, the transaction is called “going public, or an
IPO,” and the market for such stock is called the new issue or IPO
market.
e. It is possible for a firm to go public and yet not raise any
additional new capital for the firm itself.
Multiple Choice: Problems
34
. You have the following data on three stocks shown below. You decide to
use the data on these stocks to form an index, and you want to find the
average earned rate of return for 2011 on your index. If you follow the
averaging procedure used to calculate the S&P 500 Index return, what
would your index’s rate of return be? Hints: Rates of return are based
on beginning–of-year prices, and the S&P Index is weighted by market
values of the companies in the index.
Shares
Beginning Ending Outstanding
Stock Dividend Price Price (millions)
A $1.50 $30.00 $32.00 5.00
B $2.00 $28.50 $27.00 4.50
C $0.75 $20.00 $24.00 20.00
a. 16.07%
b. 16.92%
c. 17.76%
d. 18.65%
e. 19.59%
Chapter 2: Financial Markets Answers Page 31
CHAPTER 2
ANSWERS AND SOLUTIONS
Page 32 Answers Chapter 2: Financial Markets