Chapter 11 Questions And Answers

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Interest (simple and compound)
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simple interest is interest paid on the original principal only and compound interest is the interest earned not only on the original principal, but also on all interests earned previously. Interest is what you’re paying to borrow money or what you’re earning to put money in a bank
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Principal
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original amount of money
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Debit card
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a card issued by a bank allowing the holder to transfer money electronically to another bank account when making a purchase.
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Creditor
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person who owes money
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Investment
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the act of redirecting resources from being consumed today so that they may create benefits in the future; the use of assets to earn income or profit
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Financial system
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the system that allows the transfer of money between savers and borrowers
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Financial asset
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claim on the property or income of a borrower
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Financial intermediary
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institution that helps channel funds from savers to borrowers
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Mutual fund
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fund that pools the savings of many individuals and invests this money in a variety of stocks, bonds, and other financial assets
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Diversification
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spreading out investments to reduce risk
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Portfolio
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a collection of financial assets
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Prospectus
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an investment report to potential investors
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Return
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the money an investor receives above and beyond the sum of money initially invested
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Bonds (savings, municipal, corporate, junk)
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loans or IOUs that represent debt that the government or a corporation must repay to an investor
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Savings bond
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low-denomination bond issues by the US government
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Municipal bond
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a bond issued by a state or local government or municipality to finance such improvements as highways, state buildings, libraries, parks, and schools
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Corporate bond
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a bond that a corporation issues to raise money to expand its business
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Junk bond
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a lower-rated, potentially higher-paying bond
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Coupon rate
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the interest rate that a bond issuer will pay to bondholder
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Maturity
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the time at which payment to a bondholder is due
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Par yield
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the amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity
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Yield
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the annual rate of return on a bond if the bond were held to maturity
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NASDAQ
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American market for OTC securities
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Dow Jones Industrial Average
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index that shows how certain stocks have traded
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Securities and Exchange Commission
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an independent agency of the government that regulates financial markets and investment companies
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Capital market
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market in which money is lent for periods longer than a year
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Money market
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market in which is lent for periods of less than a year
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Primary market
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market for selling financial assets that can only be redeemed by the original holder
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Secondary market
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market for reselling financial assets
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Capital gain
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the difference between a higher price and a lower purchase price, resulting in a financial gain for the seller
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Capital loss
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the difference between a lower selling price and a higher purchase price resulting in a financial loss to the seller
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Stock split
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the division of a single share of stock into more than one share
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Stockbroker
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a person who links buyers and sellers of stock
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Brokerage firm
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a business that specializes in trading stocks
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Stock exchange
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a market for buying and selling stock
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OTC market
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an electronic marketplace for stocks and bonds
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Futures
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contracts to buy or sell at a specific date in the future at a price specified today
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Options
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contracts that give investors the choice to buy or sell stock and other financial assets
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Call option
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the option to buy shares of stock at a specified time in the future
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Put option
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the option to sell shares of stock at a specified time in the future
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Bull Market
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a steady rise in the stock market over a period of time
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Bear Market
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a steady drop in the stock market over a period of time
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The Dow
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index that shows how certain stocks have traded
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S & P 500
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index that shows the price changes of 500 different stocks
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Great Crash
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the collapse of the stock market in 1929
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Speculation
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the practice of making high-risk investments with borrowed money in hopes of getting a bug return
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Name several financial intermediaries, institutions that help channel funds from savers to borrowers
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Banks, Savings and Loan Associations and Credit Unions: take deposits form savers, then lend out some of these funds to businesses and individuals Finance companies: make loans to consumers and small businesses, charge higher fees and interest rate to cover their losses from the loans that are not repaid Mutual Funds: pool savings of many individuals and invest this money in a variety of stocks, bonds, and other financial assets Life Insurance Companies: provide financial protection for the family or other beneficiaries of the insured. They collect premiums from customers, and lend money to investors. Pension Funds: an income that a retiree receives after working a certain number of years or reaching a certain age.
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Name three roles of financial intermediaries
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Sharing risk, providing information, providing liquidity
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What is the relationship between risk and return? Why diversify?
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The higher the potential return, the riskier the investment.
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What are the three components of bonds?
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Coupon rate, maturity, par value
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How are bond ratings useful to investors?
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A high bond rating means that the bond will sell at a higher price, and that the firm will be able to issue the bond at a lower interest rate. Look at the grade and see rating, tells you if it’s risky or not.
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What are the various types of bonds?
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Savings bonds, treasury bonds, municipal bonds, corporate bonds, junk bonds
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Name two ways in which investors can earn money from bonds
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a) Coupon rate: interest bond issuer gives to bond holder b) Buy bonds at discount
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How do capital markets and money markets differ?
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In capital markets money is lent for longer than 1 year, while in money markets money is lent for less than a year.
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How can you make money off of stocks?
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Dividends (portions of a corporation’s profits) are paid out to stockholders of many. You can also sell stock for more than you paid for it.
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Describe the difference between income stock and growth stock. Describe the difference between common stock and preferred stock
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Growth stock pays few or no dividends. Instead, the issuing company reinvests earnings into its business. Income stock pays dividends at regular times during the year. Preferred stock owners are nonvoting owners of the company, but receive dividends before the owners of common stock. Investors who buy common stock are voting owners of the company.
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What is a stock split and why might it occur?
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Each single share of stock splits into more than one share. If the price of a company’s stock becomes too high that discourages potential investors from buying it.
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What are some of the major stock markets? What is the OTC market?
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New York Stock Exchange OTC Market NASDAQ (National Association of Securities Dealers Automated Quotations)
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How can you make money off of futures and options?
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You buy something now for a low price and have it delivered in the future when the price is higher, so you end up saving money. Options give you the choice to buy or sell in a certain period. If you pay $100 for a stock and have a 6 months window, and at the end the price has risen, you can sell for profit. If it has dropped you can throw away the option and buy at the going rate.
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How can you make money off of day trading?
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Using computer programs to try and predict minute-by-minute price changes that tell a trader when to buy and sell.
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Describe two popular indexes of stock performance
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Bull (doing well) and Bear (doing poor) Markets.
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What were the causes of the Great Crash? What about the Dot-com crash?
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The Dow had reached an all time high of 381, so eager investors filled brokerage firms t catch the latest news coming in on ticker tape. Prices for many stocks soared far above their real values in terms of the company’s earnings. After the peak, prices fell, and investors began to sell. People worried and tried to get out of the market.

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