Chapter 13 Study Guide

Chapter 13 Study Guide – Investing Fundamentals
Princess Neethimany
Make sure you read the book AND read the Investment Fundamental Powerpoints within eLearn
1. According to the book, before beginning an investment program, everyone should perform a
financial checkup. This includes considering the following 5 elements:
Why is it recommended that emergency day fund be stored in a “liquid” account?

So that you can easily take out money when you need to use it.
Define liquidity – The availability of liquid assets available to a company.
Give examples of investment that are liquid and others that are not.
Liquid investments: Mutual funds, bond, stock, CD
Nonliquid investments: Real Estate, land
2. What is the difference between the terms Saving and Investing?

Saving money is putting it away and gaining interest with no risk of losing money. Investing is
putting money into a business or company with risk but getting a greater profit than just
saving.
3. List some ideas on how to obtain the money needed to establish an investment program:
Create a budget, reduce spending, increase saving, put money into a 401(k) plan.
4. Time Value of Money (Future Value of an Annuity)
If someone invests $6000 each year for 20 years and earns an 8% return, how much will they have
at the end of 20 years?
Does length of time of the investment matter? Yes

Does rate of return of the investment matter? Yes
5. What are the 3 basic steps (outlined in the Powerpoint) to begin Investing?
1) Set up an investment acccount
2) Owner should set up automatic deposits
3) Owner must select the investments that will be purchased
6. What is the Risk-return tradeoff?

The relationship between the amount of risk taken and the potential return on the investment.
Low levels of uncertainty or risk are associated with low potential returns, whereas high levels of
uncertainty or risk are associated with high potential returns. (T/F)
Note: Historically, the S&P 500 stocks have earned about 9% a year, bonds earn about 5% per year
and bank accounts pay about 1% in interest a year. Based on the Rule of 72, approximately how
many years will it take for each stocks, bonds, and bank accounts to double in value if they each
continue to earn their historical rate of return? See why investors are willing to take risk?
 Stocks- 2 basic types are common and preffered. Shares of which ownership of a corporation
is divided.
 Bonds- A loan to a corporation, the government, or a municipality.
 Bank Account- An account that a person has with a bank that stores their money.
7. What is the formula to Calculate Yearly Rate of Return?
(Change in investment value + Annual Income) / Original investments value
Application of Formula: Shelly buy $1,000 of stocks on January 1 st. She earns $50 of dividends
during the year and then sells the stock on Dec. 31st for $1,070. What is her yearly return as a
percent?
(70+50)/1000 = 12%
8. Asset Allocation
When building an investment plan, an investor must consider the liquidity, the level or risk, the
expected rate of return and the volatility of different investment. (T/F)
Define Asset Allocation - Spreading money among different investment classes to lessen risk.
The percentage of your investments that should be invested in each asset class (stocks, bonds,
cash) will be constant over your lifetime. (T/F)
Individuals can invest more heavily in stocks if they are investing for the long-term. (T/F)
Individuals who are older typically have a higher tolerance for risk. (T/F)
Your book states that many financial planners recommend that you subtract your age from 100, to
get the % of your assets that can be invested in growth investments. (T/F)
Define Diversification- The process of allocating investments into a variety of classes. This helps
reduce risk.
Define Portfolio- A collection of financial investments such as stocks, bonds, commodities, and
cash.
Diversification provides a measure of safety and reduces overall risk. (T/F)
9. Investment Alternatives:
Stocks
Companies issue stock to raise money, this is called Equity financing. (T/F)
Individuals that make an investment to become part owners of a company are called stockholders.
(T/F)
A company that earns a yearly profit must pay out a dividend. (T/F)
When shareholder owns stock in XYZ corporation and decides to sell it, they typically sell it directly
back to the XYZ corporation. (T/F)
A dividend is a distribution of corporate profits paid out to shareholders.
People buy stocks because they can provide a source of income if the company pays dividends and
there is potential for capital appreciation (stock price increases). (T/F)
Corporate or Government Bonds
When someone buys a bond, they are loaning a corporation or government money for a given
period of time.
Maturity is the date on which government or the corporation will repay the borrowed money.
The bondholder will earn the stated interest rate until the bond matures. (T/F)
The bond holder can keep the bond until its maturity date and then redeem it or they can sell it to
another investor before maturity. (T/F)
Bonds can be purchased through a broker. (T/F)
Mutual funds
A mutual fund pools money together from many investors to purchase various stocks, bonds and
other assets. (T/F)
A mutual fund may hold hundreds of different stocks and/or bonds, with the goal of reducing risk
by being diversified. (T/F)
All mutual funds have the same objectives. (T/F)
A major concern for investors who select mutual funds are fees as these fees reduce investment
return. (T/F)
It is possible for an investor to hold a variety of individual stocks and hold a diversified portfolio.
(T/F)
Real Estate
Over many years, the nationwide the average annual increase in real estate is 10% (T/F) 3-5%
Investing in real estate should be considered a long-term investment, not a get-rich-quick scheme.
(T/F)
Other Investment Alternatives
A speculative investment is one that is high-risk and is made in hopes of earning a relatively large
profit in a short period of time.
Give examples of speculative investments:
Options, commodities, derivatives, precious metals and gemstones, coins and stamps,
antiques and collectibles.
10. Sources of Investment Information
From your book (page 477), list some sources available to gather investment information:
The internet, business magazines and newspapers, a corporations annual reports, investor
services and newsletters, prospectus.
What is a prospectus?
A legal document that contains information about an investment. (Mutual funds, index funds,
etc.)
11. Investing vs. Gambling Article
Investing and gambling both involve risk. (T/F)

Investing in the stock market has a positive expected rate of return. (T/F)
Gambling has a positive expected rate of return. (T/F)
The House, when gambling, always has the edge. (T/F)
A gambler owns nothing. (T/F)
A stockholder owns a share of the company. (T/F)
Over time, the odds are in the favor of an investor but not for a gambler. (T/F)

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Chapter 13 Study Guide – Investing Fundamentals

Why is it recommended that emergency day fund be stored in a “liquid” account?

Define liquidity – The availability of liquid assets available to a company.

2. What is the difference between the terms Saving and Investing?

4. Time Value of Money (Future Value of an Annuity)

Does length of time of the investment matter? Yes

6. What is the Risk-return tradeoff?

All mutual funds have the same objectives. (T/F)

Other Investment Alternatives

11. Investing vs. Gambling Article

Investing and gambling both involve risk. (T/F)

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