Basic US Investment Terms Trivia Quiz

Answer: 1929

There have been stock crashes on multiple occasions, most recently in 1987, but it was the effects of the October 1929 crash that led to the creation of the SEC through the Securities Exchange Act of 1934. One of the realizations that came out of the crash was that there was almost no control and regulation of the market and the people that worked in it, so a series of acts were passed in the 1930s installing a control system.

While there have been changes over the years, the core rules that companies and people must follow if they want to work in the investment industry or have their company offer stock and bonds to the public date from that period.

Answer: The stockholder is an owner, and the bondholder is a creditor

When you buy a share of a companies'common stock, you become a part owner of the company. You can buy and sell stock directly from the company, but most transactions happen between two investors. Most owners have a fraction of the overall shares, but if you can buy enough shares, the company is yours to do with as you please.

The prices vary from .01c to well over $1000 a share depending on demand and the number of shares outstanding. Many companies pay dividends to the owners, but in most cases, the owner makes or loses money based on the stock price movement. Bonds are an investment IOU.

The entity that issued the bond, either a company or a governmental body, borrows money from the investor, and agrees to repay the amount plus a fixed rate of interest on a set schedule to the bond holder (If you buy a new $1000 bond maturing in 10 yrs at 5 percent, you get a $25 payment every 6 months, and on the maturity date, get your $1000 back). Like stocks, you can buy the bond through the entity, usually when it's first issued, but in most cases the buy and sell orders go through the open market.

There is generally less activity on a daily basis, so the price is normally much more stable than a stock. Even more than stocks, inflation fluctuations affect bonds, since a bond that pays 4 percent is a less valuable investment if the inflation rate is 5 percent. It's also not unusual for a bond issued when rates are high to have a call provision, so the issuer can buy the bond back before the official maturity date if rates have gone down and issue a new bond at a lower rate.

Answer: Bond

Since bond holders are considered creditors, if there's money to be paid out in a bankruptcy, they'll get it before the stock holders do. The likelihood of you getting your money back can also depend on what kind of stock or bond you own. It's not unusual for a company to issue a preferred stock or bond that gets preference over the common stock or bond, and among other things, guarantees that whoever holds the preferred version gets their money first. Of course, this all assumes that the company has money available to pay anybody back in the first place, as 1 percent of $0 is $0.

Answer: Wall

The origin of the exchange dates to May 17, 1792, when 24 traders got together at a location on Wall Street in lower Manhattan to standardize the rules and process for speculative trading following a major scandal. The modern day New York Stock Exchange dates back to their agreement.

There are smaller exchanges around the US that serve a similar function, but the NYSE is the primary stock exchange in the country in the early 21st century. Essentially, you call your broker to buy stock XYZ, and they send the order to the exchange where it's matched up with an order from someone who owns the stock and will sell it to you at the price you offer to pay.

The exchange computer notes the transaction, and everybody gets a confirmation. You then have 3 business days to put the cash or stock in your brokerage account to cover the trade (called T+3).

The 2 firms then move the cash and reregister the stock, completing the trade.

Answer: False

Amazingly enough, you never have to make a payment toward paying off the debt unless the value of whatever you bought drops below a minimum level that varies with the type of security and the firm that holds the account, although interest is charged on the debt.

Here's an example of how it works: You have $10000 cash in your account, and you buy $20000 of stock XYZ. Your portion of the account, or the equity, is 50%. If the stock price goes up, you can cash out the stock, taking the profit after paying off the debt, or even buy more stock with the increased equity. If the stock goes down, you can find yourself in what's known as a "Margin call", where you have to add money or securities to the account to raise the equity. If you don't get the equity to the required level in time, the firm starts selling positions to pay down the debt, even if you'll take a loss on the sale.

The rules for buying on margin have been tightened up considerably over the years, particularly after the 1929 stock market crash, where a contributing factor was the firms allowing people who couldn't afford the risk to buy on margin, so as the market started dropping, they couldn't meet the margin calls, and lost most or all of their savings when the stocks got sold.

The number of sell orders drove prices down, causing more and more people into margin calls, so you had a vicious circle develop that contributed to the crisis.

Answer: Selling a Call

When you buy an option, you either purchase the right to buy a fixed number of common stock shares at a fixed price for a fixed period of time, known as a call option, or the right to sell the shares under the same conditions, called a put option. The investor that sells you the option is obligated to sell or buy the stock if you exercise the option.

The risk varies considerably depending on the strategy. If stock XYZ is trading at 50, and you buy a call option at 55 for $600 that expires in 1 month, you only risk losing the $600 if the stock stays below $55 for the month. If I sold you the option, my risk is $0 if I already own 100 shares of XYZ, as I either keep the shares and the cash if the stock stays below $55, or sell you the stock if it trades above $55 and is exercised, a strategy known as a Covered call. If I sell you the option but don't own the stock, known as selling a "Naked call", my risk is unlimited, as I could have to buy shares at $100 or more and sell them to you at $55 due to a run up in the price.

When you sell a Naked put, where you have to buy the stock if the price goes down, you don't have unlimited risk, because the price can't drop below $0. As a rule, only experienced investors can use the riskier strategies.

Answer: Net

The net asset value is simply the number of fund shares divided by the value of the fund investments. A Mutual Fund is a pool of money that allows a group of investors to purchase a wider range of securities than any one of them could do separately. Most funds are created and managed by an investment firm, and the investment strategy can be built around almost any kind of theory out there, from low risk Money Market funds that are managed to keep the price fixed at $1 to index funds that mimic a market index to funds that only invest in companies that are considered environmentally friendly, and everything in between.

The cost to the customer varies from fund to fund, and can include a charge to buy the fund and a charge to sell the fund along with the management fee in some combination.

Answer: Wallace 1000

Charles Dow created what would become the Dow Jones Transportation average in 1884 using mostly Railroad stocks, and created the better known Industrial Average in 1896. It was based on 12 stocks, and over the years has evolved to a list of 30 stocks, with General Electric being the only one of the original stocks left. Standard and Poor began creating indices in 1923, and the S&P 500 average was begun in 1957. Because of the larger range of stocks, it is used as a benchmark by many investment firms, and many Mutual Fund companies have an index fund that invests in S&P 500 firms only.

Answer: Both

The most common reason for a stock split is to lower the price per share so that customers can buy shares at a move affordable price. For instance, in a 2 for 1 split a person that owns 100 shares of XYZ at 50 ends up with 200 shares at 25. Although less common, companies will also do what's called a reverse split because the price is too low.

A stock priced at under $1 a share, called a penny stock, is generally seen as a riskier investment, and can be expensive to buy because the commission rate to buy 100 shares is often similar to the one to buy 100 shares at $50.

The company will do a 1 to 5 split as an example, so that 500 shares at 50c becomes 100 shares at $2.50 to address the low price, and make the commission cost a lower percentage of the overall cost.

Answer: General Obligation

A General Obligation bond is backed by the full faith and credit of the issuer. The repayment of the bond comes from general revenue raised by the municipality that issued the bond like property taxes. A Revenue bond is backed by a specific source of revenue dedicated to pay off the bond. An example would be for bonds issued to pay to build a bridge being repaid by toll revenue from the drivers using the bridge.

A city, county, school district, state, or other municipal body can issue bonds for whatever they feel is required. Most bonds require voter approval, but that varies from area to area.