Equity investment

A company issues new shares to raise capital for a factory expansion. An institutional investor purchases the entire offering directly from the underwriting syndicate.

A. The transaction occurs in the primary market.
B. The transaction occurs in the secondary market.
C. The transaction is an over-the-counter secondary trade.

Answer: A

Topic: Primary vs Secondary Markets

Key Testable Point: Primary market transactions provide capital to the issuer.

Explanation: The purchase is directly from the issuer through underwriters, so proceeds go to the company. Secondary market trades occur between investors and do not provide new capital to the firm.

Difficulty: Easy

A pension fund wants to sell a large block of shares quickly while minimizing the risk that the market price falls before execution. Which market characteristic is most valuable?

A. High informational efficiency
B. High liquidity
C. High dividend yield

Answer: B

Topic: Market Liquidity

Key Testable Point: Liquidity reduces execution costs and price impact.

Explanation: Liquid markets allow large trades to be executed quickly with minimal price movement. Informational efficiency concerns pricing accuracy, not execution quality.

Difficulty: Easy

An investor submits an order instructing the broker to buy a stock immediately at the best available market price.

A. Limit order
B. Stop order
C. Market order

Answer: C

Topic: Order Types

Key Testable Point: Market orders prioritize execution over price.

Explanation: A market order seeks immediate execution at the current best available price. Limit orders prioritize price, while stop orders activate only after a trigger price is reached.

Difficulty: Easy

An analyst consistently earns abnormal returns using only historical price and trading volume data. Assuming the market is inefficient, which form of efficiency is most likely violated?

A. Weak-form efficiency
B. Semi-strong form efficiency
C. Strong-form efficiency

Answer: A

Topic: Market Efficiency

Key Testable Point: Weak-form efficiency assumes historical prices contain no exploitable information.

Explanation: If past price patterns generate abnormal profits, weak-form efficiency fails. Semi-strong and strong-form efficiency involve broader information sets.

Difficulty: Medium

A pharmaceutical company receives regulatory approval for a breakthrough drug. Within minutes, its stock price adjusts fully to the announcement.

A. The market demonstrates strong-form efficiency.
B. The market demonstrates semi-strong form efficiency.
C. The market demonstrates weak-form efficiency.

Answer: B

Topic: Semi-Strong Market Efficiency

Key Testable Point: Public information is rapidly incorporated into prices.

Explanation: Regulatory approval is public information. Semi-strong efficiency implies prices adjust quickly to such announcements.

Difficulty: Medium

An exchange continuously matches buy and sell orders submitted by investors according to price and time priority.

A. Dealer market
B. Broker market
C. Auction market

Answer: C

Topic: Market Organization

Key Testable Point: Auction markets directly match buyers and sellers.

Explanation: Auction markets use order books to match participants. Dealer markets rely on dealers holding inventory, while broker markets primarily connect buyers and sellers.

Difficulty: Medium

A dealer continuously quotes bid and ask prices for a security from its own inventory.

A. The dealer is acting as principal.
B. The dealer is acting only as an agent.
C. The dealer is acting as an exchange.

Answer: A

Topic: Dealer Markets

Key Testable Point: Dealers trade from inventory as principals.

Explanation: Dealers assume inventory risk by buying and selling securities themselves. Brokers generally act as agents for clients.

Difficulty: Medium

An investor places an order to purchase shares only if the price falls to ¥2,400 or lower.

A. Market order
B. Limit buy order
C. Stop-loss order

Answer: B

Topic: Order Types

Key Testable Point: Buy limit orders specify the maximum acceptable purchase price.

Explanation: The investor wants to avoid paying more than ¥2,400. A market order guarantees execution, while a stop-loss is primarily used for risk management.

Difficulty: Easy

A researcher discovers that corporate insiders consistently earn abnormal profits using confidential information unavailable to the public.

A. Weak-form efficiency is violated.
B. Semi-strong efficiency is violated.
C. Strong-form efficiency is violated.

Answer: C

Topic: Strong-Form Efficiency

Key Testable Point: Strong-form efficiency assumes all information, including private information, is reflected in prices.

Explanation: Profiting from private information contradicts strong-form efficiency. Weak and semi-strong forms do not require private information to be reflected.

Difficulty: Medium

Which investment approach is most consistent with belief in semi-strong market efficiency?

A. Passive index investing
B. Screening stocks using recent earnings announcements
C. Trading based on analyst upgrades

Answer: A

Topic: Market Efficiency

Key Testable Point: Public information cannot consistently generate abnormal returns.

Explanation: Since public information is already reflected in prices, passive investing is generally preferred. The other strategies rely on public information.

Difficulty: Medium

An index assigns each constituent a weight proportional to its total market capitalization.

A. Equal-weighted index
B. Price-weighted index
C. Market capitalization-weighted index

Answer: C

Topic: Equity Indices

Key Testable Point: Market-cap weighting reflects company size.

Explanation: Larger firms receive greater weights. Price-weighted indices depend on share prices, while equal-weighted indices assign identical weights.

Difficulty: Easy

Following a 2-for-1 stock split, one company’s influence on a price-weighted index declines despite no change in firm value.

A. True
B. False because price-weighted indices are unaffected by stock splits.
C. False because market capitalization doubled.

Compared with a market-cap weighted index, an equal-weighted index generally requires:

A. Less rebalancing.
B. More frequent rebalancing.
C. No periodic maintenance.

Answer: B

Topic: Index Construction

Key Testable Point: Equal-weighted indices require regular rebalancing.

Explanation: Price movements alter equal weights over time. Periodic rebalancing restores equal allocations.

Difficulty: Medium

A float-adjusted index excludes shares held by founders that are unlikely to trade.

A. It measures only publicly available shares.
B. It excludes all institutional investors.
C. It ignores companies with controlling shareholders.

Answer: A

Topic: Float-Adjusted Indices

Key Testable Point: Float adjustment reflects investable shares.

Explanation: Float adjustment removes restricted holdings from index weights. Institutions may still own freely tradable shares.

Difficulty: Medium

An industry is characterized by rapid demand growth, many new entrants, and significant uncertainty regarding future winners.

A. Mature stage
B. Shakeout stage
C. Embryonic stage

Answer: C

Topic: Industry Life Cycle

Key Testable Point: Early-stage industries exhibit rapid growth and uncertainty.

Explanation: Embryonic industries experience innovation and new entrants. Mature industries have slower growth.

Difficulty: Easy

A firm possesses strong brand loyalty, making customers reluctant to switch despite slightly higher prices.

A. Low bargaining power of suppliers
B. Sustainable competitive advantage
C. High financial leverage

Answer: B

Topic: Competitive Advantage

Key Testable Point: Brand loyalty creates economic moats.

Explanation: Strong brands reduce customer switching and support pricing power. Supplier power and leverage are unrelated.

Difficulty: Medium

According to Porter’s framework, increasing customer bargaining power most likely:

A. Improves industry profitability.
B. Has little effect on long-run returns.
C. Reduces average industry profitability.

Answer: C

Topic: Competitive Forces

Key Testable Point: Buyer power compresses industry margins.

Explanation: Powerful customers negotiate lower prices or higher quality, reducing profitability.

Difficulty: Medium

A mature utility company typically deserves a higher valuation multiple than a peer only if it has:

A. Higher sustainable growth with similar risk.
B. Lower accounting earnings.
C. Higher debt regardless of profitability.

Answer: A

Topic: Relative Valuation

Key Testable Point: Growth and risk influence valuation multiples.

Explanation: Higher sustainable growth supports higher valuation. Greater leverage alone does not justify higher multiples.

Difficulty: Hard

A cyclical company reports temporarily depressed earnings during a recession. Which valuation multiple may provide a more stable comparison?

A. P/E
B. EV/EBITDA
C. Dividend yield

Answer: B

Topic: Valuation Multiples

Key Testable Point: EV/EBITDA is less affected by capital structure and accounting differences.

Explanation: EBITDA often fluctuates less than net income and excludes financing effects. P/E may become distorted.

Difficulty: Hard

An investor seeks companies trading below intrinsic value based on conservative assumptions.

A. Growth investing
B. Momentum investing
C. Value investing

Answer: C

Topic: Growth vs Value

Key Testable Point: Value investing emphasizes undervaluation.

Explanation: Value investors seek discounted prices relative to intrinsic value. Growth investors focus on future expansion.

Difficulty: Easy

A company pays no dividends but is expected to distribute substantial cash in the distant future. The Dividend Discount Model remains conceptually applicable because:

A. Future expected dividends ultimately determine equity value.
B. Book value always equals intrinsic value.
C. Earnings replace dividends in the DDM formula.

Answer: A

Topic: Dividend Discount Model

Key Testable Point: Equity value equals present value of expected future dividends.

Explanation: Even firms currently paying no dividends may eventually distribute cash. DDM remains conceptually valid.

Difficulty: Hard

A company’s earnings rise solely because it repurchased shares while total profits remained unchanged.

A. P/B ratio automatically falls.
B. EPS increases without operating improvement.
C. Sales growth accelerates.

Answer: B

Topic: P/E Interpretation

Key Testable Point: Share repurchases can mechanically increase EPS.

Explanation: Lower shares outstanding increase EPS despite unchanged profits. Investors should distinguish financial engineering from operational improvement.

Difficulty: Medium

A company’s assets consist mainly of intangible technology that accounting standards largely expense rather than capitalize.

A. P/B is likely more informative than P/S.
B. P/B may understate economic value.
C. Book value should exceed market value.

Answer: B

Topic: Price-to-Book

Key Testable Point: Intangible-intensive firms may have understated book values.

Explanation: Expensed intangible investments reduce book value, making P/B potentially misleading.

Difficulty: Hard

A stock generated a 7% capital gain and paid a 3% dividend during the year.

A. Holding period return equals 10%.
B. Dividend yield equals 10%.
C. Capital gain yield equals 10%.

Answer: A

Topic: Return Measures

Key Testable Point: Total return equals dividend yield plus capital gain yield.

Explanation: Holding period return combines both sources of return. Dividend and capital gain yields remain separate components.

Difficulty: Easy

Two stocks produce identical total returns. Stock X earned most of its return from dividends, while Stock Y earned most from price appreciation.

A. Both investors necessarily face identical tax consequences.
B. The return components differ even if total return is identical.
C. Dividend policy has no effect on investor preferences

Answer: B

Topic: Return Components

Key Testable Point: Total return can arise from different sources.

Explanation: Equal total returns may have different compositions. Taxes and investor preferences may differ.

Difficulty: Medium

A portfolio manager believes markets are weak-form efficient but not semi-strong efficient.

Which strategy is most consistent with that belief?

A. Technical analysis
B. Fundamental analysis of newly released financial statements
C. Trading solely on historical prices

Answer: B

Topic: Market Efficiency

Key Testable Point: Public fundamental information may still offer value if semi-strong efficiency fails.

Explanation: Weak-form efficiency eliminates profits from price history, but fundamental public information may still be useful.

Difficulty: Hard

Compared with a broker market, a dealer market most directly provides:

A. Immediate liquidity through dealer inventory.
B. Lower transaction costs in every situation.
C. Direct matching of investor orders.

Answer: A

Topic: Market Structure

Key Testable Point: Dealers enhance liquidity using inventory.

Explanation: Dealers stand ready to trade from inventory. Brokers mainly connect counterparties.

Difficulty: Medium

A stock is added to a major market-cap weighted index after a substantial increase in its market value.

All else equal, index funds tracking the benchmark will most likely:

A. Sell existing holdings of the stock.
B. Purchase the stock to match index weights.
C. Ignore the addition because prices already reflect information.

Answer: B

Topic: Index Investing

Key Testable Point: Passive funds replicate benchmark composition.

Explanation: Index funds buy newly added constituents to maintain tracking accuracy.

Difficulty: Medium

An industry has slowing demand growth, fewer new entrants, stable market shares, and intense price competition.

A. Growth stage
B. Embryonic stage
C. Mature stage

Answer: C

Topic: Industry Life Cycle

Key Testable Point: Mature industries exhibit slower growth and stronger competition.

Explanation: Mature industries have established competitors, stable demand, and pressure on margins.

Difficulty: Medium

An analyst compares two firms with identical operations but different debt levels.

Which multiple is generally least affected by those financing differences?

A. P/E

B. Dividend yield

C. EV/EBITDA

Answer: C

Topic: Relative Valuation

Key Testable Point: Enterprise value-based multiples reduce the impact of capital structure.

Explanation: EV incorporates both debt and equity, while EBITDA is pre-interest, making EV/EBITDA more comparable across firms with different leverage. P/E is directly affected by financing decisions.

Difficulty: Hard

A technology company’s stock consistently trades with a bid-ask spread of $0.02, while a similar company trades with a spread of $0.20.

The narrower spread most likely indicates:

A. Higher market liquidity
B. Lower market efficiency
C. Higher expected returns

Answer: A

Topic: Market Liquidity

Key Testable Point: Narrow bid-ask spreads generally indicate greater liquidity.

Explanation: Liquid markets typically exhibit tighter bid-ask spreads because competition among market participants reduces transaction costs. A wider spread usually reflects lower liquidity and higher trading costs.

Difficulty: Easy

An investor places a stop-loss sell order at $48 when the stock is currently trading at $52.

The order will most likely:

A. Execute immediately at $48.
B. Become a market order if the price falls to $48.
C. Guarantee execution at exactly $48.

Answer: B

Topic: Order Types

Key Testable Point: Stop orders become market orders once triggered.

Explanation: A stop-loss order activates only after the trigger price is reached. Once triggered, execution occurs at the best available market price, which may differ from the stop price.

Difficulty: Medium

A brokerage firm simply matches clients wishing to buy and sell securities without taking ownership of the securities.

This firm is acting primarily as a:

A. Dealer
B. Market maker
C. Broker