Investment Fundamentals Test 1 — Questions and Answers
Question 1: The majority of _________ ETFs "reset" everyday, which means they are made to accomplish their investment goal every day.
- Leveraged (Correct answer)
- Sector
- Dividend
- Conventional
Correct answer: Leveraged
Leveraged ETFs (Exchange Traded Funds) are designed to amplify the returns of an underlying index, often by a multiple (e.g., 2x or 3x). These funds typically 'reset' their leverage daily, meaning they aim to achieve their stated investment goal over a single trading day. Due to this daily reset, their long-term performance can significantly diverge from the stated multiple of the underlying index.
Question 2: If you purchase stock in a corporation...
- You gave the business a loan of money.
- You are responsible for the business' debts.
- The business will pay you interest on your initial investment back.
- You have equity in the business. (Correct answer)
Correct answer: You have equity in the business.
When you purchase stock in a corporation, you become a part-owner of that company. This ownership stake is referred to as equity. As a shareholder, you have certain rights, such as voting on company matters and potentially receiving dividends, but you are not lending money to the company or directly responsible for its debts.
Question 3: If you purchase a corporate bond...
- You gave the business a loan of money. (Correct answer)
- You are responsible for the business' debts.
- Shareholder resolutions are up for election.
- You have equity in the business.
Correct answer: You gave the business a loan of money.
Purchasing a corporate bond means you are lending money to the corporation. In return for this loan, the company promises to pay you regular interest payments over a specified period and repay the principal amount at maturity. Bonds are debt instruments, making you a creditor rather than an owner of the company.
Question 4: What kind of bond is the most secure?
- Municipal bond
- Corporate bond
- Don't know/Not sure
- US. Treasury bond (Correct answer)
Correct answer: US. Treasury bond
U.S. Treasury bonds are considered the most secure type of bond because they are backed by the full faith and credit of the United States government. This government guarantee makes them virtually free of default risk, meaning there is an extremely low probability that the government will fail to make its interest or principal payments. This makes them a benchmark for low-risk investments.
Question 5: Which of the following best describes what a "junk bond" is?
- A bond whose value has sharply decreased
- Bond that has fallen into default
- Bonds not subject to regulation
- A bond that rating agencies have deemed to be "below investment-grade" (Correct answer)
Correct answer: A bond that rating agencies have deemed to be "below investment-grade"
A 'junk bond,' also known as a high-yield bond, is a bond that has been rated by credit rating agencies as 'below investment-grade.' This low rating indicates a higher risk of default compared to investment-grade bonds. To compensate investors for this increased risk, junk bonds typically offer significantly higher interest rates.
Question 6: Which of the following entities offers protection against stock market losses?
- SEC (Securities and Exchange Commission)
- SIPC (Securities Investor Protection Corporation)
- FINRA (Financial Industry Regulatory Authority)
- None of the above (Correct answer)
Correct answer: None of the above
None of the listed entities protect investors against losses due to fluctuations in the stock market. The SEC regulates the securities markets, SIPC protects against brokerage firm failure (not market losses), and FINRA regulates broker-dealers. Investing in the stock market inherently carries risk, and the value of investments can go down as well as up.
Question 7: What examples of ownership investments are the following:
- Savings accounts and stocks
- Stocks and bonds
- Collectibles and real estate (Correct answer)
- Certificates of deposit and bonds
Correct answer: Collectibles and real estate
Ownership investments involve directly owning an asset, which can appreciate in value over time. Stocks represent ownership in a company, while real estate and collectibles are tangible assets that investors own. These differ from debt investments (like bonds or CDs) where you lend money, or cash equivalents (like savings accounts) which are typically low-risk and low-return.
Investment Fundamentals Test 1
The majority of _________ ETFs "reset" everyday, which means they are made to accomplish their investment goal every day.