Chapter 4 Formative Assessment

When a corporation distributes its profit among its shareholders, these payments are called dividends. Dividends are a portion of the company's earnings that are distributed to shareholders as a return on their investment. They are usually paid in cash but can also be paid in the form of additional shares of stock. Dividends are a way for companies to share their profits with shareholders and provide them with a regular income from their investment.

Mutual funds allow individuals to spread out their risk by investing in a diversified portfolio of many investments. These investments are managed by a fund manager, who makes decisions on behalf of the investors. By pooling money from multiple investors, mutual funds provide access to a wide range of securities, such as stocks and bonds. This diversification helps to mitigate the risk associated with investing in a single security, as losses from some investments can be offset by gains from others.

A stock broker is a professional who acts as an intermediary between investors and the stock market. They have the authority to buy and sell shares on behalf of their clients. Therefore, the correct answer is "can buy and sell shares for you."

An initial public offering (IPO) refers to the process of a corporation making its shares available to the general public for the first time. During an IPO, the company sells its shares to investors, allowing them to become shareholders and participate in the company's growth and profits. This is a significant event for a company as it provides an opportunity to raise capital and increase its visibility and reputation in the market. It is a common strategy for companies looking to expand and fuel their growth.

The correct answer is cash, government bonds, bank accounts. These investments are considered "lower risk, lower reward" because they have a lower degree of risk compared to other investment options. Cash, government bonds, and bank accounts are generally considered to be safe investments with a lower potential for loss. They may offer lower returns compared to other investments such as stocks or real estate, but they provide stability and security for investors.

An investment that is liquid is one that can be easily converted into cash without incurring any penalty fees. This means that the investment can be sold or redeemed quickly and without any significant obstacles. This is in contrast to investments that may have restrictions or penalties for early withdrawal or require a lengthy process to convert into cash. Therefore, the correct answer is that a liquid investment can be turned into cash easily.

Investing in the stock of large, corporate companies is a suitable choice for an investor who wants to receive regular dividend payments. Large, corporate companies typically have stable earnings and a consistent track record of paying dividends to their shareholders. These companies often have established business models, strong financial positions, and generate steady cash flows, which allows them to distribute a portion of their profits as dividends. Municipal bonds and U.S. Savings Bonds may not offer regular dividend payments, while investing in the stock of small, start-up companies can be more volatile and may not guarantee regular dividends.

An investor who chooses to put their money in various financial products, such as Treasury bonds, CDs, stocks, mutual funds, and real estate, has a diversified asset allocation portfolio. This means that their investments are spread across different types of assets, reducing the risk of having all their eggs in one basket. By diversifying their portfolio, the investor can potentially minimize the impact of any one investment performing poorly, while also taking advantage of the potential gains from different asset classes.

The author suggests that when you are in your 20s, the majority of your investments should be focused on capital appreciation, which refers to investments that have the potential to increase in value over time. As you approach retirement, the author recommends shifting towards a majority in capital preservation, which involves investments that aim to protect the value of your assets and generate a steady income. This strategy takes into account the longer time horizon and higher risk tolerance in your 20s, and the need for more stability and income preservation as you near retirement.

As a person approaches retirement age, it becomes more important to prioritize capital preservation over capital appreciation. This is because they have less time to recover from potential market downturns and need to protect their savings. By investing more in capital preservation, they can ensure that their money is relatively safe and secure, even if it means sacrificing potential higher returns.

U.S. Savings Bonds are described by the given characteristics. They have interest that is compounded twice a year, they are guaranteed by the federal government, there is no state or local tax on the interest, and there is a penalty for redeeming before five years.

Between 1926 and 2008, stocks have produced an average annual return of 9.6%, which is double the return of bonds over the same period. This means that, on average, stocks have provided investors with a higher rate of return compared to bonds during this time frame. The statement implies that investing in stocks has been more profitable than investing in bonds over the given period.

An advantage of a Roth IRA is that income taxes are avoided on the capital gains, interest, and dividends. This means that any earnings or profits generated within the Roth IRA account are not subject to income taxes when withdrawn, allowing for potential tax-free growth. This can be beneficial for individuals who anticipate being in a higher tax bracket in the future or who want to minimize their tax liability in retirement.

Mutual funds actually offer more diversity than other investments. This is because mutual funds pool money from multiple investors and invest in a variety of securities such as stocks, bonds, and other assets. This diversification helps to spread risk and potentially increase returns. Therefore, the statement that they offer less diversity than other investments is not true.

A dividend yield refers to the percentage of return that an investor receives from owning a particular stock in the form of dividends. The amount of money paid as dividends can vary depending on the company's performance and profitability. Dividends are considered unearned income because they are not directly generated from the investor's labor or active involvement. Therefore, the correct answer is "varies, and is considered unearned income."

Investing money for a winter ski trip in ten months is not advisable because the time horizon is too short. Generally, investments are made for the long term, as they require time to grow and generate returns. In this case, the money is needed in a relatively short period, and investing it may expose it to market volatility and the risk of losing value. It is more appropriate to keep this money in a safe and easily accessible savings account or a short-term investment with low risk.

The Securities and Exchange Commission (SEC) has the power to require public companies to file quarterly and annual reports, recommend new laws and rules to be passed by Congress, and take legal action against wrongdoers. However, setting the fees brokers can charge clients for buying stock is not within the powers of the SEC. This responsibility typically falls under the jurisdiction of self-regulatory organizations, such as the Financial Industry Regulatory Authority (FINRA).

The goal of an income investment is to increase current cash flow. Income investments are typically designed to generate regular income in the form of interest, dividends, or rental payments. The focus is on generating a steady stream of cash flow in the present, rather than waiting for future returns or increasing the value of an asset. By increasing current cash flow, investors can use the income for immediate expenses or reinvest it to further grow their wealth.

Growth investors make their money when they sell a financial product or asset. This is because growth investors focus on investing in assets that have the potential to increase in value over time. They aim to buy these assets at a lower price and sell them at a higher price, thus making a profit. The increase in value of the asset allows growth investors to generate returns when they decide to sell it.

When the question states that "A rise of one point in a share of any stock," it implies that the stock's value has increased by one point. This increase in value corresponds to "one dollar in the price of the stock." Therefore, if the stock's value rises by one point, its price will increase by one dollar.