Chapter 14 Study Guide – Stocks
1. General
What is Equity Financing?
Money received from the sale of shares of ownership for a business.
Stockholders can earn profit from dividends (a distribution of cash quarterly/yearly) or by an increase in
capital gains (increase in stock price).
Since the end of WWII, stocks have returned almost 10 % a year.
Refresher – Based on the Rule of 72, how long would it take for a stock investment earning the above return
to double in value? 7.2 years
Past stock results guarantee future earnings. (T/F)
Stocks are risky, and therefore there are no guarantees. (T/F)
Since the end of WWII, stocks have returned almost 10 % a year.
Stockholders vote on the company’s board of directors and major corporate policies. (T/F)
Short-term investments (held less than 1 year) are taxed as ordinary income.
Long-term investments (held more than 1 year) are typically taxed at a (higher or lower) rate than short-
term investments.
What is a stock split? A procedure where the stocks of a company are split divided into a larger number of
shares.
Does a stock split guarantee that the stock’s price will increase? No
2. Evaluating a Stock
How do corporate earnings impact stock prices?
When a corporations earnings go up, their stock prices also go up because the shares are the
company's wealth split into shares.
Public companies must report earnings quarterly. (T/F)
Wall Street watches revenue and earnings data carefully and stock prices change based on this data (T/F)
Investors
Define Earnings per Share (EPS) – A corporations after-tax income divided by the number of outstanding
shares of common stock. Generally an increase in earnings is a healthy sign.
Define Price to Earnings (P-E Ratio) - The price per share divided by the earnings per share. This ratio
should be compared to other companies in the same industry. A high P-E ratio means investors are
expecting earnign to increase in the future.
What does Beta measure? A beta approximates the overall volatility of a security's returns against the
returns of a relevant benchmark. (Volatility represents how large an asset's prices swing around the
mean price.)
A more speculative stock will have a Beta greater than 1. (T/F)
The Beta for the S&P 500 is 0. (T/F) It is 1.0
The price of a stock reflects the current value of company and what investors believe the expected growth
of that company will be. (T/F)
3. What is an Initial Public Offering (IPO)? Occurs when a corporation sells stock to the general public for
the first time.
What stocks can you purchase on the Secondary market? Secondary markets include the New York Stock
Exchange (the Big Board), NASDAQ and AMEX.
You can purchase previously owned stocks from other investors.
The majority of stock trading is done in the secondary market. (T/F)
What is a ticker symbol? For example, what is Kroger’s ticker symbol? An abbreviation to identify shares of
a stock of a particular stock market. Kroger's ticker symbol is Kroger Co.
4. There are full-service and discount brokerage firms. Read book and article.
What are the advantages and disadvantages of a Traditional “Full service” Broker (Examples include: Merrill
Lynch, Edward Jones, Morgan Stanley)?
Advantages are that they can help you with anything including financial goal setting and help on what
to invest in. The disadvantages are the high costs of it and taking a higher percent of your earnings on
investments.
What are the advantages and disadvantages of a Discount Broker (examples include: Vanguard, TD
Ameritrade, Fidelity)
The advantages are the low prices that this broker costs and they normally don't take any more than 1%
of your earnings. The disadvantages is the less they can help you with.
Make sure you address the fees charged by both types of Brokers.
5. Investment Strategies
What is the Buy and Hold Technique? A passive strategy where investors keep a relatively stable portfolio
over time regardless of short-term fluctuations.
What is Dollar Cost Averaging? What is the benefit of this strategy? It is investing a fixed amount of money
at set intervals. Their shares will be purchased at times when price is high, but at other times when
the price is low. The benefit of this strategy is that it can reduce the overall impact of price volatility
and lower the average cost per share.
What is Day Trading? Why is this considered similar to gambling? Day Trading is where you buy a stock and
sell it in the same day hoping the price go up. It is similar to gambling because you are taking the risk
of loss or gain in one day.
When someone borrows money from their broker to purchase stock it is called buying on the margin. This
means if the share price decreases, they will have to provide additional cash as collateral. Note:
Investors can set up their brokerage accounts to decline this feature.
6. Staying calm when the Market declines Article
Typically, when the stock market takes a dive, an investor should stay in the market especially if they are in
the market long-term. (T/F)
The market is cyclical and stock prices will go up and down. (T/F)
An investor’s risk tolerance level should be utilized when selecting the right investments for that individual.
(T/F)
It is wise to think long term, instead of panic selling when the stock prices drop. (T/F)
The buy and hold strategy is recommended even during market declines. (T/F)
Chapter 15 – Bonds
1. Describe the characteristics of a Bond?
A corporations written pledge to repay a specified amount of money with interest. Bondholders usually
receive interest payments every 6 months.
Assuming an average yearly return of 4% on bonds, how long would it take for the investment to double in
value (use Rule of 72)? 18 years.
What is Face Value? The dollar amount that the bondholder will receive at the bond's maturity date.
What is the Call feature? This means a corporation/government can call in, or buy back, outstanding
bonds from current bondholders before the maturity date.
2. True/False
Historically bonds earn a lower average rate of return compared to stocks due to lower risk. (T/F)
Bonds earn a set interest rate and it is paid according to a predetermined schedule (T/F)
A Bear Market (when the overall stock market declines) reminds investors the virtues of bonds safety and
stability. (T/F)
Bonds can especially be appropriate for those who cannot tolerate the short-term volatility of the stock
market (i.e., someone who needs the money in a few years). (T/F)
Bonds can be purchased through a broker (for a fee) or directly from the government. (T/F)
The price of bond will be constant until its maturity date. (T/F)