Question 8: The correct answer is B. Unless the rate of inflation dropped, you would be essentially treading water. In two years, once the effects of inflation were factored in, you would be in the same position as you were when you started with an inflation adjusted investment gain of 0.

Section 3—Understanding Risk

Question 1: The correct answer is C. Due to new information, the market has revalued your stock.

Question 2: The correct answer is C. Your actual return is less than the rate of inflation so you are losing .25% per year as long as these conditions persist.

Question 3: The correct answer is A. With such a high concentration of assets in a single industry, you are assuming a substantial level of industry risk. If the price of oil fell to $40 per barrel, you could lose a lot of money.

Question 4: The correct answer is C. Because of the diversification available through mutual funds, your exposure to most types of asystemic risk including business, credit and valuation risk are reduced. If, however the market decline sufficiently all of your mutual funds would lose value.

Question 5: The correct answer is C. While a sufficient level of diversification will reduce asystemic risk and some types of systemic risk, it will not protect against market risk.

Section 4—Stock Based Mutual Funds

Question 1: The correct answer is A, B, C, and D. Mutual funds are classified based on the size of the companies that they invest in, the style of investing employed by the fund manager, the sectors and industries that they focus on and the part of the world where their investments are located.

Question 2: The correct answer is B. Profitable companies that are growing rapidly.

Question 3: The correct answer is C. Small cap companies are smaller companies with market capitalization of between $300 million and $2 billion.

Question 4: The correct answer is C. Funds that invest in single industry are not only subject to a higher level of industry risk but also a potentially higher level of asystemic risk because of a smaller number of investment candidates.

Question 5: The correct answer is B. Index funds only try to duplicate an indexes performance, not surpass it. Index funds often have lower expenses because of reduced research and transaction costs.

Question 6: The correct answer is C. The risks resulting from political upheaval can be much greater in emerging markets then in mature industrialized countries.

Question 7: The correct answer is D. A well diversified portfolio of stock based mutual funds will reduce most types of asystemic risk but will not reduce market risk.

Section 6—Individual Stocks

Question 1: The correct answer is A. Stocks represent an ownership interest in a corporation.

Question 2: The correct answer is B. When the supply of a stock exceeds the demand for it, someone selling the stock would have to reduce their asking price to attract buyers.

Question 3: The correct answers are A, B, C, and D. Company fundamentals, investor perceptions, news about the company and the overall market trend all help to determine the price of a stock.

Question 4: The correct answer is C. Emotions often dominate at market tops and bottoms. Greed at market tops and fear at market bottoms.

Question 5: The correct answer is D. The best informed investors are typically those who work for large financial institutions. They have extensive research capabilities and are often aware of important events before the general public.

Question 6: The correct answer is B. The overall trend of the market has a great influence on the price of an individual stock. During a bull market, most stocks increase in value. During a bear market most stocks lose value.

Question 7: The correct answers are A, B, C and D. With an individual stock, you are subject to a variety of asystemic risks including business risk, credit risk, liquidity risk and valuation risk. You are also subject to market risk.

Question 8: The correct answers are C and D. To trade stocks successfully requires many years of study and practical experience. Without this preparation, it is almost impossible to be consistently profitable and losses can quickly get out of hand.

Section 7—Individual Bonds

Question 1: The answer is B. Bonds are certificates of debt issued by corporations and government entities.

Question 2: The correct answer is A. When interest rates go up, the price of bonds go down.

Question 3: The correct answer is A. When interest rates go down the price of bonds goes up.

Question 4: The correct answer is A. Other things being equal, the less likely an issuer is to default, the lower the bonds yield. Investors must be induced by higher interest rates to assume the increased risks associated with lower quality bonds.

Question 5: The correct answer is B. With a long maturity bond there is more time for things to go wrong such as an increase in prevailing interest rates or a decrease in the issuers credit rating. This increased risk is offset by higher returns.

Question 6: The correct answer is A. Speculative grade bonds have a higher, and in some cases, a much higher chance of defaulting than investment grade bonds.

Question 7: The correct answer is B. The fluctuation in bond prices is usually much less than the fluctuations in stock prices. There have, however, been exceptions such as the early 1980s when bond prices fluctuated dramatically.

Section 8—Bond Based Mutual Funds

Question 1: The correct answers are A, B and C. Bond funds provide immediate diversification, are professionally managed and will accept the small periodic deposits associated with 401k contributions.

Question 2: The correct answer is A. The odds of the U. S. Government defaulting on its obligation are so low that they are almost non-existent. Consequently, they provide the lowest return.

Question 3: The correct answer is C. The historical return on bond funds have been much less than that of stock funds. Over the course of many years, this difference in return is greatly magnified and can make a huge difference in the amount of money that is ultimately accumulated.

Section 9—Determining Your Risk Tolerance

Question 1: The correct answer is A. Some types of risk are much worse than others. While losses due to market risk can be painful, they are usually temporary. Business risk, however, can be not only catastrophic but also permanent. If a company goes bankrupt, you lose your money and you’re out of the game, with no second chances. This happens more often than you might think. Ask the people who used to work for Enron.

Question 2: The correct answer is A. Although the stock market is subject to dramatic price swings, the overall historical trend has been up. The increase wealth of the U.S. and the world economy is reflected in higher stock prices.

Question 3: The correct answer is C. Due to the inherent diversification of stock based mutual funds, most types of asystemic risks, including business and credit risk, are controlled. Market risk is not.

Question 4: The correct answer is C. During a bear market a great majority of stocks lose value. Stock based mutual funds are composed of stocks so it is logical to assume that they will also lose value.

Question 5: The correct answer is C. Your time horizon is determined by the length of time until the money in your account will be needed. This may or may not coincide with your anticipated retirement date.

Question 6: The correct answer is B. As the time approaches when the money will be needed, you lose the ability to wait out market cycles.

Question 7: The correct answer is B. Emotions, particularly fear and greed, play a large role when it comes to investing. At times, emotions dominate the financial markets. You must be aware that you are subject to these same emotions. You should also be aware that substantial losses, even if they are only temporary, can be very painful and should be prepared for.

Section 10—Creating a Retirement Portfolio Using Mutual Funds

Question 1: The correct answer is A. If you have the ability to assume the risk, you should invest in stock based mutual funds in order to obtain the higher return historically associated with these investments.

Question 2: The correct answer is A. Stocks move in trends. When the primary trend is up, most stocks increase in value. When the primary trend is down most stocks lose value.

Question 3: The correct answer is A. While mutual funds that invest in different size companies and who utilize different investment styles generally follow the prevailing market trend, they do not, move at the same pace at the same time. This reduces portfolio volatility.

Question 4: The correct answer is B. Mutual funds that invest in different size companies and who utilize different investment styles will reduce a portfolio’s volatility, but will not protect against market risk. If things get bad enough, for long enough, almost all stock based mutual funds will lose money.

Question 5: The correct answer is B. The bond market is usually much more stable than the stock market. Consequently bond funds are typically used as a relatively stable store of value for the portion of a portfolio that the investor doesn’t want to put at risk.

Section 11—Market Cycles and Trends

Question 1: The correct answer is B. The Internet has become the great leveler. People have access to the same economic information at the same time. Because investors have the same access to information, they often come to the same buy or sell decisions simultaneously.

Question 2: The correct answer is D. The primary market trend lasts for several years and is usually used to define a bull or a bear market.

Question 3: The correct answer is C. Mutual fund investors profit primarily from sustained upward price moves. This means being in the market during a bull market and out of the market during a bear market.

Questions 4: The correct answer is B. There is no way to be certain about the direction of the primary market trend. The best you can do is to make an educated guess and hope to be on the right side of the primary trend most of the time.

Section 12—How and Why Markets Move

Question 1: The correct answer is C. The U.S. and World economies move from expansion to contraction and back to expansion. Sometimes the contractions are mild and the expansions extensive. At other times the expansions are shallow and the contractions are deep. The overall cycle, however, remains the same.

Question 2: The correct answer is C. The stock market typically looks ahead four to six months. The market is not always right but it is a good indicator of future economic activity. Some very smart and well informed people are putting their money where their mouths are by making investment decisions worth millions or even billions of dollars.

Question 3: The correct answer is D. Stock market tops are often characterized by high price to earnings ratios and increased price volatility, following several years of stock price advances. The presence of these factors, however, doesn’t necessarily mean that the stock market is ready for a bear market decline. This could just as easily be a temporary pause before continued advances.

The onset of a true bear market can only be confirmed after the fact, when the market sells off, rallies to a lower high and then declines to a lower low.

Question 4: The correct answer is A. Bull and bear markets are the result of the cyclical nature of the U.S. economy. During times of expansion, corporate earnings and profits increase resulting in higher stock prices. During times of economic contraction, corporate earnings and profits decrease which is reflected in generally lower stock prices.

Question 5: The correct answers are B and C. During the panic stage of a bear market, the less informed investors sell with abandon, while the most informed investors, meaning the institutions, are picking up bargains. This is not to suggest that you should attempt to try to pick market bottoms. This is incredibly dangerous and is akin to catching a falling knife. When re-entering the market, you should wait for confirmation that the primary trend has reversed.

Question 6: The correct answer is B. It is almost impossible to determine exactly when a bull or bear market begins and ends while events are unfolding. It may be some time before it becomes clear that a primary market trend has reversed.