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Quiz on
Long-Term
Investing
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Investors in the financial markets
are generally
either traders or buy-and-holders. This TRUE-FALSE quiz of 15
questions
is aimed at the long term investor who is also interested in
accumulating
savings.
Drag the mouse pointer over the
bracket to
see the answer.
1. For holding periods of 20 years
or more, the
return on a diversified portfolio of large capitalization stocks has
always
exceeded the inflation rate. [True*]
The average annualized return over the long term on the
S&P 500
stock index, with dividends reinvested, has exceeded the inflation rate
by nearly seven percentage points. For long-term corporate bonds,
that margin is only about two percentage points.
2. The S&P500 index is a
measure of the average
price of the 500 stocks comprising the index. [False]
The S&P500 index varies in direct proportion to the
total market
value of its 500 component stocks. An S&P500 index mutual
fund
is basically an investment in the largest 45 corporations because they
comprise over one-half of the total value of those 500 stocks.
3. The total return quoted on a
mutual fund is
a statement of its expected future performance over the specified
period,
with dividends reinvested. [False]
The quoted total return does assume dividends are
reinvested, but it
is only a record of past performance. It is not a reliable predictor of
future performance, particularly in managed funds where the
effectiveness
of investment styles continually ebb and flow.
4. The total return on an
S&P500 index mutual
fund has usually exceeded the return on most managed stock mutual
funds.
[True*]
Although index funds are never the top performers, the
best ones usually
beat the return on about two-thirds of managed funds because of lower
turnover
and thus lower brokerage expenses, the absence of research expenses,
and
lower management fees.
5. Stock mutual funds with a
narrow focus like
sector funds have lower price volatility than broad-based funds.
[False]
The narrower the focus, the greater the
volatility. A broad-based
fund will track the market average more closely than will a sector
fund,
and will have less price volatility due to better
diversification.
However the potential for gain is lower, at least in the short term.
6. Short maturity bonds have lower
price volatility
than long maturity bonds. [True*]
The market price of existing long maturity bonds is
influenced far more
by the effect of changes in interest rates and inflation expectations.
7. For a given maturity, high
coupon bonds have
lower price volatility than low coupon bonds. [True*]
A higher coupon provides greater income up front which
helps compensate
for the effects of interest rate fluctuations on the market price, and
thus results in lower price volatility.
8. Except for management fees,
owning a bond mutual
fund is financially equivalent to owning a share of the bonds
themselves.
[False]
Unlike individual bonds, a bond mutual fund has no
maturity date, and
thus no date-certain market value. The bonds must be continually
replaced to maintain the advertised average maturity of the fund, which
adds transaction costs.
9. When interest rates rise, the
market value
of existing bonds and bond mutual funds rise. [False]
When interest rates rise, the coupons on existing bonds
become less
attractive relative to those available on new issues of the same
maturity,
causing the market price of existing bonds to fall.
10. Individuals can buy newly
issued Treasury
securities directly from the Treasury without commissions or
fees.
[True*]
The Treasury Direct system now enables individuals to
buy newly issued
Treasury securities without fees directly from the Treasury rather than
through a bank or securities dealer. The yield is exactly the
same
as that received by the securities dealers who make the market.
11. A T-note ladder is a set of
Treasury notes
maturing at about equal intervals and rolled over (reinvested) as they
mature. [True*]
Treasury notes of 2- or 5-year maturity can be bought or
reinvested
monthly to create the equivalent of a risk-free short-term Treasury
bond
fund, which is free of service charges and management fees.
12. In addition to ordinary notes
of up to 10-year
maturity, the Treasury issues inflation-indexed securities. [True*]
The Treasury now issues two inflation-indexed
securities: a 10-year
note known as TIPS for Treasury Inflation-Protected Securities, and a
30-year
accrual type security known as the Series I Savings Bond.
13. The quoted yield to maturity
on a bond assumes
that the bond is held to maturity and all coupon payments are
reinvested.
[True*]
The assumed reinvestment rate is the yield to maturity
itself, not the
coupon rate. If the coupon payments are not reinvested, the
return
will be less than the quoted yield.
14. The yield to maturity on a
bond is an accurate
measure of the return if held to maturity. [False]
Since a coupon payment can almost never be reinvested at
exactly the
yield to maturity, that rate is an approximation of the actual return.
One exception is the yield on zero coupon bonds because there are no
coupon
payments to reinvest.
15. The coupon earnings on state
and local municipal
bonds are subject only to federal income tax. [False]
The coupon earnings on munis are free of federal income
tax. For
residents of the state where issued, they are also free of state income
tax. Coupon earnings on Treasury securities are subject to federal
income
tax, but free of state income tax.
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