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Investment Foundations practice questions

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Question 1Industry Overview and Structure

In the investment industry, what is the primary role of a buy-side firm such as a mutual fund company or pension fund manager?

  1. It executes trades on an exchange floor for retail customers
  2. It manages or invests capital on behalf of clients or beneficiaries Correct answer.
  3. It writes prospectuses for companies planning a listing
  4. It supervises market conduct and licenses investment advisers

Explanation

Buy-side firms hold and deploy capital, making investment decisions for portfolios they manage for clients or beneficiaries. They are distinguished from sell-side firms, which provide research, brokerage, and underwriting services. Regulatory supervision is carried out by public authorities, not by buy-side firms.

Question 2Industry Overview and Structure

A financial adviser who is compensated only by fees paid directly by the client, with no commissions from product providers, is best described as operating under which model?

  1. Market making
  2. Proprietary trading
  3. Fee-only advisory Correct answer.
  4. Commission-based distribution

Explanation

Fee-only advisory means the adviser receives payment solely from the client and does not accept commissions or third-party payments from product manufacturers. This structure is intended to reduce conflicts of interest in recommendations. Commission-based models and proprietary trading involve different revenue sources and incentives.

Question 3Industry Overview and Structure

Which activity is characteristic of the sell-side of the investment industry?

  1. Underwriting a new bond issue and distributing it to investors Correct answer.
  2. Setting the base interest rate for the banking system
  3. Selecting securities for an insurance company's reserves
  4. Managing a sovereign wealth fund's long-term portfolio

Explanation

Sell-side firms such as investment banks help issuers raise capital through underwriting and then distribute the securities to investors. They also provide research, brokerage, and market-making services. Portfolio management for funds or insurers sits on the buy side, and interest-rate setting is a central bank function.

Question 4Industry Overview and Structure

Which type of investment vehicle pools money from many investors and issues redeemable shares whose price is derived from the value of its underlying portfolio?

  1. A direct real estate holding
  2. A defined benefit pension plan
  3. A closed-end fund trading at a discount to net asset value
  4. An open-end mutual fund Correct answer.

Explanation

Open-end mutual funds continuously issue and redeem shares at a price based on net asset value, pooling investor money into a managed portfolio. Closed-end funds do not redeem shares on demand, so their market price can diverge from net asset value. Pension plans and direct property holdings are not pooled redeemable fund vehicles.

Question 5Industry Overview and Structure

Which market participant typically acts as an intermediary that quotes both a bid and an offer price to facilitate trading in a security?

  1. A proxy adviser
  2. A market maker Correct answer.
  3. A credit rating agency
  4. A custodian bank

Explanation

Market makers stand ready to buy and sell a security by quoting bid and offer prices, thereby providing liquidity to other participants. Custodians safekeep assets, rating agencies assess creditworthiness, and proxy advisers give voting recommendations. None of those roles involves continuous two-way price quoting.

Question 6Industry Overview and Structure

In the investment management industry, what does the term 'assets under management' (AUM) measure?

  1. The regulatory capital a firm must hold against risk
  2. The total market value of assets a firm manages for its clients Correct answer.
  3. The fees a firm has earned in the current year
  4. The amount of capital a firm has raised from its own shareholders

Explanation

Assets under management is the total market value of investments a firm oversees on behalf of clients. It is a common scale indicator used to compare investment managers. Shareholder capital, regulatory capital, and fee revenue are distinct financial measures.

Question 7Industry Overview and Structure

Which regulatory objective is most directly associated with requiring firms to segregate client assets from the firm's own assets?

  1. Investor protection Correct answer.
  2. Tax neutrality
  3. Price stability
  4. Capital formation

Explanation

Segregation of client assets protects investors by ensuring their property is not exposed to the firm's own creditors if the firm fails. It is a core investor-protection safeguard in custody and asset management regulation. Price stability, capital formation, and tax neutrality are separate policy goals.

Question 8Industry Overview and Structure

A company that manages a collective investment scheme is generally required to appoint an independent party to hold the scheme's assets. What is this party called?

  1. The auditor
  2. The custodian or depositary Correct answer.
  3. The distributor
  4. The investment adviser

Explanation

The custodian or depositary holds scheme assets independently of the manager, providing safekeeping and oversight. This separation reduces the risk of misappropriation. Advisers, distributors, and auditors perform different functions and do not hold the assets.

Question 9Industry Overview and Structure

A pension fund with long-dated liabilities and a steady inflow of contributions is deciding how to allocate across asset classes. Which industry concept best explains why such a fund may hold a large allocation to bonds?

  1. Proprietary trading, taking directional bets with firm capital
  2. Liability-driven investing, matching asset cash flows to expected benefit payments Correct answer.
  3. Underwriting, earning fees from new securities issuance
  4. Market making, profiting from bid-offer spreads

Explanation

Liability-driven investing aligns asset cash flows and risk with the timing and amount of future benefit payments. Long-dated bonds can match those liabilities more closely than volatile growth assets. The other options describe trading or underwriting activities rather than asset-liability matching.

Question 10Industry Overview and Structure

An investment firm launches a fund that can be bought or sold on an exchange throughout the day and generally tracks an index. Which industry development does this product most directly illustrate?

  1. Growth of exchange-traded funds as low-cost passive vehicles Correct answer.
  2. Shift from defined benefit to defined contribution pensions
  3. Expansion of central bank reserve management
  4. Rise of private equity buyouts

Explanation

Exchange-traded funds combine intraday exchange trading with index-tracking, typically passive, exposure at low cost. They reflect the broader growth of passive and low-cost investment products. Pension structure changes, private equity, and reserve management are separate industry trends.

Question 11Industry Overview and Structure

A wealth manager charges a tiered percentage of assets and also receives a trailing commission from a fund provider whose products it recommends. What conflict of interest does this arrangement create?

  1. The manager may recommend products that pay higher commissions rather than those best suited to the client Correct answer.
  2. The manager is forced to hold excessive cash to meet redemptions
  3. The manager's fees are automatically capped by regulation
  4. The manager bears no fiduciary duty to the client

Explanation

When a firm earns third-party commissions, it faces an incentive to favor products that pay more, potentially at odds with client interests. Disclosure, inducement rules, and best-execution or suitability obligations are used to manage this conflict. The arrangement does not itself eliminate fiduciary duties or cap fees.

Question 12Industry Overview and Structure

Which statement best distinguishes a defined benefit pension plan from a defined contribution plan from the perspective of the investment industry?

  1. In a defined benefit plan members choose their own investment funds and bear all risk
  2. In a defined contribution plan the employer guarantees a specified retirement income
  3. In a defined benefit plan the employer or plan bears the investment risk, while in a defined contribution plan the individual member bears it Correct answer.
  4. In a defined contribution plan assets are always managed by a sovereign wealth fund

Explanation

Under a defined benefit plan the sponsor promises a benefit and generally bears investment and longevity risk. Under a defined contribution plan the member's retirement outcome depends on contributions and investment performance, so the member bears the risk. This distinction shapes demand for investment products and risk-management services.

Question 13Industry Overview and Structure

A regulator introduces a rule requiring firms to disclose all inducements received from third parties. Which industry issue is this rule primarily addressing?

  1. Systemic risk in clearing houses
  2. Insider trading in equity markets
  3. Conflicts of interest in distribution and advice Correct answer.
  4. Capital adequacy of banks

Explanation

Inducement disclosure targets conflicts of interest that can bias product distribution and advice. Transparency allows clients to judge whether recommendations are influenced by third-party payments. Clearing-house risk, insider trading, and bank capital are governed by different regulatory frameworks.

Question 14Industry Overview and Structure

Which function within an investment management firm is responsible for independently checking that portfolio managers comply with investment mandates and regulatory limits?

  1. Investment research
  2. Sales and distribution
  3. Client reporting
  4. Compliance and risk control Correct answer.

Explanation

Compliance and risk control monitor portfolios against mandates, investment limits, and regulations independently of the investment team. This independence is central to effective control. Sales, research, and client reporting serve other purposes and do not perform this oversight.

Question 15Industry Overview and Structure

An asset manager outsources trade execution to a brokerage firm while retaining investment decision-making. Which description of the parties is correct?

  1. Both parties are sell-side because a trade occurs
  2. The asset manager is buy-side and the brokerage firm is sell-side Correct answer.
  3. Both parties are buy-side because both handle securities
  4. The asset manager is sell-side and the brokerage firm is buy-side

Explanation

The asset manager decides what to buy or sell for client portfolios and is therefore buy-side. The brokerage firm executes and may research or distribute, placing it on the sell side. The occurrence of a trade does not change the fundamental role of each party.

Question 16Industry Overview and Structure

Which factor most directly explains the long-term growth in assets managed by institutional investors such as pension funds and insurers?

  1. The elimination of retail participation from capital markets
  2. A decline in the number of listed companies worldwide
  3. A regulatory ban on collective investment schemes
  4. Accumulation of retirement savings and the need to match long-term liabilities Correct answer.

Explanation

Pension and insurance assets have grown as savings accumulate and institutions must fund long-dated obligations. Their scale makes them major participants in capital markets. A decline in listings, exclusion of retail investors, or bans on funds would not explain institutional growth.

Question 17Industry Overview and Structure

A firm offers a fund that invests in unlisted companies and requires investors to commit capital for a fixed term with no daily redemption. Which segment of the industry does this describe?

  1. Money market fund management
  2. Private markets or alternative investment management Correct answer.
  3. Government bond market making
  4. Exchange-traded index tracking

Explanation

Private equity, private credit, and similar private market strategies invest in unlisted assets, lock up capital for a term, and do not offer daily redemption. Money market funds, index trackers, and market making are all liquid public-market activities with different structures.

Question 18Industry Overview and Structure

Which statement best describes the role of a prime broker in the investment industry?

  1. It assesses the credit rating of sovereign issuers
  2. It sets the official closing price for listed securities
  3. It provides financing, securities lending, and settlement services to hedge funds and other professional investors Correct answer.
  4. It guarantees the retirement benefits of plan members

Explanation

Prime brokers serve professional investors, especially hedge funds, by offering margin financing, securities lending, custody, and settlement. They are a specialized part of the sell side. Price setting, pension guarantees, and credit rating are performed by other institutions.

Question 19Industry Overview and Structure

A country's regulator requires investment firms to hold a minimum amount of capital relative to their operating risks. What is the main purpose of this requirement?

  1. To prevent firms from hiring external auditors
  2. To maximize the fees firms can charge clients
  3. To guarantee positive investment returns for clients
  4. To ensure firms can absorb losses and wind down without harming clients and markets Correct answer.

Explanation

Capital requirements ensure a firm has enough own resources to absorb losses and cover an orderly wind-down, protecting clients and market stability. They are a prudential safeguard rather than a return guarantee or fee control. Audit independence is a separate matter.

Question 20Industry Overview and Structure

Which pairing of investor type and typical objective is most consistent with industry practice?

  1. A defined benefit pension fund seeking long-term income to meet benefit payments Correct answer.
  2. A money market fund seeking long-term capital growth from small-cap equities
  3. A central bank seeking to maximize returns by investing reserves in venture capital
  4. A retail saver seeking daily liquidity from a closed-end private equity fund

Explanation

Defined benefit pension funds typically seek long-term income and growth to meet benefit obligations. Money market funds pursue capital preservation and liquidity, central banks prioritize safety and liquidity for reserves, and private equity funds are illiquid. The other pairings conflict with the standard objectives of those investor types.

Question 21Industry Overview and Structure

An investment bank advises a corporate client on an acquisition and also lends to the same client. Which industry issue does this combination most clearly raise?

  1. Conflicts of interest between advisory, lending, and other business lines Correct answer.
  2. The need to convert the bank into a mutual fund
  3. The absence of any fiduciary obligation to the client
  4. Systemic risk arising from retail deposit insurance

Explanation

Combining advisory, lending, and underwriting creates potential conflicts, such as pressure to favor a transaction that generates lending or financing fees. Firms manage these through information barriers and disclosure. The issue is not an absence of duty, deposit insurance, or a need to change legal form.

Question 22Industry Overview and Structure

Which structural feature most clearly distinguishes a hedge fund from a traditional long-only mutual fund?

  1. Hedge funds are always listed and trade intraday on an exchange
  2. Hedge funds are prohibited from charging any management fee
  3. Hedge funds are restricted to investing only in government bonds
  4. Hedge funds commonly use leverage, short selling, and performance fees within a less restricted mandate Correct answer.

Explanation

Hedge funds typically pursue flexible strategies using leverage, derivatives, and short positions, and often charge performance fees. Long-only mutual funds generally hold long positions within tighter constraints. Hedge funds are usually not exchange-listed and do charge management fees.

Question 23Industry Overview and Structure

A regulator is concerned that several large asset managers hold significant stakes across many competing companies in the same sector. Which industry debate does this scenario most directly raise?

  1. Whether credit rating agencies should be paid by issuers
  2. Whether money market funds should maintain a constant net asset value
  3. Whether custodians should settle trades on a T+1 basis
  4. Common ownership and its potential effect on competition and corporate governance Correct answer.

Explanation

Common ownership refers to large asset managers holding stakes in many firms within a sector, which may affect competitive behavior and governance incentives. It is a distinct debate from money market valuation, settlement cycles, and rating agency payment models. The concern is about the aggregate influence of diversified asset managers.

Question 24Industry Overview and Structure

An asset manager claims its actively managed fund justifies higher fees because it generates superior returns. Which industry concept is most relevant to evaluating this claim?

  1. Whether the fund's shares are redeemable daily
  2. Whether the fund has a published prospectus
  3. Whether the fund holds a custodian independent of the manager
  4. Whether the fund's risk-adjusted performance exceeds its benchmark after costs Correct answer.

Explanation

The value of active management is assessed by comparing risk-adjusted returns with an appropriate benchmark net of fees. Custody, redemption terms, and disclosure are important operational and investor-protection features but do not establish whether active skill added value. Costs directly reduce the net benefit of active strategies.

Question 25Industry Overview and Structure

A pension fund shifts part of its equity portfolio from an active manager to an index-tracking fund. Which industry consequence is most consistent with the economics of this decision?

  1. The fund's assets no longer require custody arrangements
  2. The fund becomes a sell-side participant in the market
  3. The fund's expected management fee falls while its return tracks the index before costs Correct answer.
  4. The fund's investment risk is eliminated entirely

Explanation

Passive index funds typically charge lower fees and aim to match index returns rather than beat them. The pension fund still bears market risk and still needs custody and administration. Shifting to a passive vehicle does not change the fund's buy-side status.

Question 26Industry Overview and Structure

Which type of financial intermediary typically pools capital from many investors and invests it in a diversified portfolio of securities, issuing shares or units that represent ownership in the pool?

  1. A stock exchange
  2. A commercial bank
  3. A central bank
  4. A collective investment scheme Correct answer.

Explanation

A collective investment scheme (CIS) is a pooled investment vehicle that gathers money from multiple investors and invests it according to a defined strategy, issuing units or shares. Commercial banks take deposits and make loans, stock exchanges provide trading venues, and central banks manage monetary policy, so none of these primarily pool investor capital for portfolio investment.

Question 27Industry Overview and Structure

In the investment industry, what is the primary role of a custodian?

  1. To execute buy and sell orders on behalf of portfolio managers
  2. To provide investment advice to retail clients
  3. To audit the financial statements of investment firms
  4. To safeguard client assets and process transactions such as settlements and income collection Correct answer.

Explanation

A custodian holds client securities and cash in safekeeping, settles trades, collects dividends and interest, and performs related administrative functions. Execution is handled by brokers, advice by advisers, and audits by accounting firms, so only the safekeeping and processing role belongs to the custodian.

Question 28Industry Overview and Structure

Which statement best describes the difference between the buy side and the sell side of the investment industry?

  1. The buy side consists of stock exchanges, while the sell side consists of regulators.
  2. The buy side includes firms that manage money and make investment decisions, while the sell side includes firms that create, execute, and distribute securities and related services. Correct answer.
  3. The buy side refers to retail investors, while the sell side refers to institutional investors.
  4. The buy side is responsible for setting accounting standards, while the sell side enforces them.

Explanation

The buy side comprises asset managers, pension funds, insurers, and other investors that buy securities for portfolios. The sell side comprises investment banks, brokers, and dealers that originate, trade, and sell securities and provide services such as research and underwriting. The other options misidentify the participants or their functions.

Question 29Industry Overview and Structure

Which of the following is typically classified as an institutional investor?

  1. A defined benefit pension fund Correct answer.
  2. A retail investor purchasing shares through a mobile app
  3. A family investing its own savings in a mutual fund
  4. An individual saving for retirement through a personal brokerage account

Explanation

Institutional investors are organizations that pool large sums of money and invest on behalf of their members or beneficiaries, such as pension funds, insurance companies, and endowments. Individuals and families investing their own money are retail investors, regardless of the account or app they use.

Question 30Industry Overview and Structure

A pension fund appoints an investment manager under a mandate that specifies a benchmark and allows the manager to deviate from it within defined limits. Which term best describes this arrangement?

  1. Advisory-only mandate
  2. Custody agreement
  3. Prime brokerage agreement
  4. Discretionary management mandate Correct answer.

Explanation

A discretionary management mandate gives the investment manager authority to make portfolio decisions within agreed guidelines, such as a benchmark and deviation limits. An advisory-only mandate requires client approval for each trade, a custody agreement covers safekeeping, and a prime brokerage agreement covers services to hedge funds.

Question 31Industry Overview and Structure

An investment firm offers a fund that invests primarily in short-term money market instruments and aims to maintain a stable net asset value. Which industry segment does this fund belong to?

  1. Private equity
  2. Hedge funds
  3. Real estate investment trusts
  4. Money market funds Correct answer.

Explanation

Money market funds invest in short-term, high-quality debt instruments and seek to preserve capital with a stable net asset value. Private equity invests in unlisted companies, REITs invest in property, and hedge funds pursue a wide range of strategies with less focus on stable NAV.

Question 32Industry Overview and Structure

An asset manager decides to outsource middle-office functions such as trade confirmation and portfolio valuation to a third-party provider. What is the most likely primary motivation for this decision?

  1. To reduce operational costs and focus internal resources on core investment activities Correct answer.
  2. To eliminate the need for a custodian
  3. To transfer investment decision-making responsibility to the provider
  4. To satisfy a regulatory requirement that all firms outsource middle-office functions

Explanation

Outsourcing middle-office functions is typically driven by cost efficiency and the desire to concentrate on core activities such as research and portfolio management. Investment decisions remain with the asset manager, outsourcing is not universally mandated, and custodial services are still required.

Question 33Industry Overview and Structure

Which activity is most characteristic of an investment bank's sell-side role?

  1. Providing custody services to a mutual fund
  2. Underwriting a company's initial public offering and distributing the shares to investors Correct answer.
  3. Managing a pension fund's equity portfolio
  4. Advising a wealthy family on its long-term asset allocation

Explanation

Investment banks on the sell side help companies raise capital by underwriting securities and distributing them to investors. Managing a pension portfolio and advising a family are buy-side or advisory activities, and custody is a separate service typically provided by custodian banks.

Question 34Industry Overview and Structure

A regulator is concerned that an asset manager's compensation structure may encourage excessive risk-taking. Which compensation feature is most likely to align the manager's interests with those of long-term clients?

  1. A commission shared with product providers for each sale
  2. A deferred component tied to multi-year investment performance Correct answer.
  3. A bonus based solely on the volume of trades executed
  4. A fee structure that rewards short-term asset growth regardless of performance

Explanation

Deferring part of compensation and linking it to multi-year performance encourages a longer-term focus and discourages excessive risk-taking. Bonuses based on trading volume, rewards for short-term asset growth, and shared commissions can create conflicts of interest and misaligned incentives.

Question 35Industry Overview and Structure

Which statement best describes the role of a fund administrator?

  1. To market the fund to retail investors
  2. To execute trades on behalf of the fund
  3. To make investment decisions for the fund
  4. To calculate the fund's net asset value and maintain its financial records Correct answer.

Explanation

A fund administrator provides independent middle- and back-office services, including net asset value calculation, accounting, and record-keeping. Investment decisions are made by the investment manager, trade execution is handled by brokers, and marketing is typically performed by distributors.

Question 36Industry Overview and Structure

An insurance company sells a product that guarantees a minimum return to policyholders. To meet these liabilities, how is the insurance company most likely to invest its assets?

  1. In a concentrated portfolio of early-stage venture capital
  2. In short-term money market instruments only
  3. In a portfolio of commodities and digital assets
  4. In a portfolio weighted toward long-duration bonds that match the timing of expected payouts Correct answer.

Explanation

Insurers with guaranteed liabilities typically invest in long-duration bonds to match the timing and amount of expected payouts, managing interest rate and liquidity risk. Concentrated venture capital, money market instruments only, and commodities do not provide the predictable cash flows needed to meet long-term guarantees.

Question 37Industry Overview and Structure

A sovereign wealth fund is established by a government to invest surplus reserves. Which characteristic most distinguishes it from a private pension fund?

  1. It must distribute all returns to citizens annually
  2. It is regulated as a retail investment scheme
  3. It is prohibited from investing in foreign assets
  4. It is owned by a government and invests on behalf of the state rather than private beneficiaries Correct answer.

Explanation

A sovereign wealth fund is a state-owned investment vehicle that manages surplus government reserves for the benefit of the country. Private pension funds are held in trust for individual members. Sovereign wealth funds may invest globally, often retain returns, and are not retail schemes.

Question 38Industry Overview and Structure

An asset manager claims that its active equity fund delivers superior risk-adjusted returns. Which measure would best support this claim?

  1. The fund's gross expense ratio
  2. The number of holdings in the portfolio
  3. The information ratio relative to the benchmark Correct answer.
  4. Total assets under management

Explanation

The information ratio measures active return per unit of tracking error, directly assessing risk-adjusted performance relative to a benchmark. Assets under management, expense ratio, and number of holdings describe scale, cost, or portfolio structure rather than risk-adjusted skill.

Question 39Industry Overview and Structure

A regulator introduces a rule requiring investment firms to separate client money from the firm's own money. Which industry objective does this rule most directly serve?

  1. Protecting client assets in the event of firm insolvency Correct answer.
  2. Increasing the speed of trade execution
  3. Reducing the cost of marketing to retail clients
  4. Maximizing firms' proprietary trading profits

Explanation

Segregation of client assets ensures that client money is identifiable and returnable if the firm fails, which is a core investor protection objective. The rule does not aim to boost proprietary trading, speed execution, or lower marketing costs.

Question 40Industry Overview and Structure

Which development has most significantly increased the role of institutional investors in global financial markets over recent decades?

  1. A decline in the number of listed companies
  2. A reduction in cross-border capital flows
  3. The elimination of securities regulation
  4. The widespread adoption of funded pension arrangements and growth of collective investment schemes Correct answer.

Explanation

The shift toward funded pensions and the growth of mutual funds and other collective schemes have channeled household savings into institutional asset pools, expanding institutional ownership. A decline in listed companies, elimination of regulation, or reduced cross-border flows would not drive institutional growth and are not accurate descriptions.

Question 41Type and Functioning of Markets

In an order-driven equity market, what does the limit order book record?

  1. The margin requirements set for each market participant
  2. The outstanding buy and sell orders at each price level Correct answer.
  3. The schedule of upcoming dividend and coupon payments
  4. The list of registered shareholders and their voting entitlements

Explanation

A limit order book is the electronic record of all resting buy and sell orders, showing the quantity available at each price. It is the mechanism through which an order-driven market matches buyers and sellers continuously.

Question 42Type and Functioning of Markets

A dealer in a government bond market continuously states both a price at which it will buy and a price at which it will sell. Which market function is this dealer performing?

  1. Clearing and settlement
  2. Underwriting
  3. Custody
  4. Market making Correct answer.

Explanation

Quoting two-way prices on a continuous basis is the defining activity of market making, which supplies immediacy and liquidity to other participants. The gap between the buy and sell quotes is the spread that compensates the dealer for bearing inventory risk.

Question 43Type and Functioning of Markets

Which characteristic distinguishes a primary market transaction from a secondary market transaction?

  1. The securities traded must be listed on a regulated exchange
  2. The trade is settled on a shorter settlement cycle
  3. The issuer receives the proceeds from the sale of the securities Correct answer.
  4. The buyer must be an institutional rather than a retail investor

Explanation

In the primary market new securities are issued and the proceeds flow to the issuer, whereas secondary market trades merely transfer existing securities between investors. The distinction is about who receives the cash, not about settlement speed or investor type.

Question 44Type and Functioning of Markets

An investor sells a share she already owns to another investor through an exchange. What is the effect on the issuing company's outstanding share count?

  1. The share count rises because a new buyer has entered
  2. The share count is unchanged because only ownership has been transferred Correct answer.
  3. The share count falls because the seller has exited
  4. The share count changes according to the settlement date

Explanation

A secondary market trade transfers title from one holder to another without creating or cancelling shares, so the number of shares outstanding stays the same. Only primary issuance or corporate actions such as buybacks alter the share count.

Question 45Type and Functioning of Markets

Which market is generally described as a money market rather than a capital market?

  1. The market for 30-year mortgages
  2. The market for three-month Treasury bills Correct answer.
  3. The market for listed equity shares
  4. The market for 10-year corporate bonds

Explanation

Money markets deal in short-term debt instruments with original maturities of one year or less, such as three-month Treasury bills. Capital markets cover longer-dated instruments such as equities and long-term bonds.

Question 46Type and Functioning of Markets

What does a bid-ask spread of 0.10 on a stock quoted at 49.95 bid and 50.05 ask represent?

  1. The difference between the highest price a buyer will pay and the lowest price a seller will accept Correct answer.
  2. The annual dividend yield expressed in currency units
  3. The minimum price movement permitted by the exchange
  4. The commission charged by the exchange to each participant

Explanation

The spread is the gap between the best bid, the highest price buyers currently offer, and the best ask, the lowest price sellers currently require. It is a measure of the immediate cost of trading and a common proxy for liquidity.

Question 47Type and Functioning of Markets

Which type of market participant typically acts as an intermediary that buys securities from issuers and resells them to investors in a new issue?

  1. A custodian bank
  2. An underwriter Correct answer.
  3. A credit rating agency
  4. A central securities depository

Explanation

An underwriter, usually an investment bank, purchases or places a new issue with investors and often guarantees the issuer a price. This bridges the issuer and the investing public in the primary market.

Question 48Type and Functioning of Markets

A stock exchange that matches incoming orders against a central queue of orders without an intermediary is best described as which type of market?

  1. An auction market for new issues
  2. An order-driven market Correct answer.
  3. A brokered market
  4. A quote-driven market

Explanation

In an order-driven market, buy and sell orders are submitted to a central system and matched directly according to price and time priority. No dealer is required to stand between the counterparties, unlike in a quote-driven market.

Question 49Type and Functioning of Markets

An investor submits a market order to buy 500 shares of a thinly traded small-cap stock. Which risk is most directly associated with this order?

  1. Currency risk, because the trade may settle in a foreign currency
  2. Settlement risk, because the counterparty may default
  3. Execution risk, because the order may never be filled
  4. Slippage, because the fill price may be worse than the quoted price Correct answer.

Explanation

A market order prioritises speed of execution over price, so in a thin order book the order can sweep several price levels and fill at an average price worse than the quote. This price impact is known as slippage.

Question 50Type and Functioning of Markets

A trader places a limit order to sell at 52.00 when the current best bid is 51.80 and the best ask is 51.90. What will happen to this order?

  1. It will be rejected because the price is above the market
  2. It will rest in the order book until the market bid reaches 52.00 or better Correct answer.
  3. It will convert automatically into a market order at the close
  4. It will execute immediately at 51.80

Explanation

A sell limit order above the prevailing best bid cannot execute immediately and joins the ask side of the book. It fills only when a buyer is willing to pay 52.00 or more, or when the market moves up to that level.