Chapter 14, Problem 14.2PQ1

(a)

Summary Introduction

To explain:

A blue-chip stock.

Introduction: Common stock refers to a type of security which has ownership rights too. Common stockholders are the owners of the company. Common stock consists of highest risk among the securities issued by a company.

Answer to Problem 14.2PQ1

Solution:

Blue-chip stock is the stock of big and well established companies which got a good reputation in the market.

Explanation of Solution

• Blue-chip stock is the stock of the large companies, which are in market for decades.
• The turnover of these companies is usually in billions. They are generally market leader in their industry.

Hence, blue-chip stock is the stock of big and well established companies.

(b)

Summary Introduction

To explain:

A cyclical stock.

Answer to Problem 14.2PQ1

Solution:

Cyclical stock refers to the stock of those companies whose performance varies with the market conditions.

Explanation of Solution

• Cyclical stock refers to the stock of those companies whose performance varies with the market conditions.
• These companies generally sell those products whose demand fall in recession and rise during boom periods.
• These stocks are generally purchased by those investors who want to earn extra money by timing the market.

Hence, cyclical stock refers to the stock of those companies whose performance varies with the market conditions.

(c)

Summary Introduction

To explain:

A defensive stock.

Answer to Problem 14.2PQ1

Solution:

Defensive stock refers to those stocks whose market value does not fluctuate according to the market conditions.

Explanation of Solution

• Defensive stock refers to those stocks whose market value does not fluctuate according to the market conditions.
• These stocks generally are from those companies who sell daily utilities items.
• These are generally purchased by defensive investors and also purchased by investors when downturn is expected in the market because these stocks perform better in stock market during downturn.

Hence, defensive stocks are those stocks on which market conditions does not have much of an effect.

(d)

Summary Introduction

To determine:

A growth stock.

Answer to Problem 14.2PQ1

Solution:

Growth stock refers to those stocks whose growth is generally expected above average market level rate.

Explanation of Solution

• Growth stock refers to those stocks whose growth is generally expected above average market level rate.
• These stocks generally don’t give dividend as these stocks reinvest the amount earned.
• Growth stocks are chosen by those investors who have some appetite for risk because growth stock contains some risk because the growth of the stock solely depends upon the growth of the company.

Hence, growth stocks are those stocks that grow at a higher rate.

(e)

Summary Introduction

To determine:

An income stock.

Answer to Problem 14.2PQ1

Solution:

An income stock refers to those stocks which give regular dividend payment.

Explanation of Solution

• Income stocks are those stocks which give regular dividend payments.
• These stocks generally give regular payment because their companies are at maturity and have no place to grow more so, they don’t need any additional capital reinvestment because of which they give their earnings as a dividend.

Hence, these are those stocks which give regular dividend.

(f)

Summary Introduction

To determine:

A large-cap stock.

Answer to Problem 14.2PQ1

Solution:

A large cap stock refers to the stock of those companies whose market capitalization is more than $10 billion.

Explanation of Solution

• A large cap stock refers to the stock of those companies whose market capitalization is more than $10 billion.
• These companies are generally those companies which are at peak of their industry.
• These stocks are generally liked by risk averse investors because there are fewer chances of their failures.

Hence, a large cap stock is a stock of a company whose market capitalization is above $10 billion.

(g)

Summary Introduction

To determine:

A mid-cap stock.

Answer to Problem 14.2PQ1

Solution:

A mid cap stock refers to that stock whose market capitalization lies between $2 billion and $10 billion.

Explanation of Solution

• A mid cap stock is those stock whose market capitalization lies between $2 billion and $10 billion.
• These are the stock of those companies which are expected to grow. Risk associated with mid cap stock is bigger than large cap stock but smaller than small cap stock.

Hence, mid cap stocks are those stocks whose market capitalization lies between $2 billion and $10 billion.

(h)

Summary Introduction

To determine:

A small-cap stock.

Answer to Problem 14.2PQ1

Solution:

A small cap stock refers to that stock whose market capitalization is in between $300 million to $2 billion.

Explanation of Solution

• A small cap stock refers to that stock whose market capitalization is in between $300 million to $2 billion.
• It contains the highest risk among the large cap, mid cap and itself. Amount invested in these stocks is done by those investors who can take risk.

Hence, small cap stock refers to that stock whose market capitalization is in between $300 million to $2 billion.

(i)

Summary Introduction

To determine:

A micro-cap stock.

Answer to Problem 14.2PQ1

Solution:

A micro-cap stock is that stock whose market capitalization value varies from $50 million to $300 million.

Explanation of Solution

• A micro-cap stock refers to that stock whose market capitalization value varies from 50 million to $300 million.
• These companies often contain huge risk as these companies generally have unproven products, no solid history, liquidity problem and many other problems too.

Hence, micro-cap stock refers to that stock whose market capitalization is in between $50 million to $300 million.

(j)

Summary Introduction

To determine:

A penny stock.

Answer to Problem 14.2PQ1

Solution:

Earlier a penny stock used to refer to that stock whose market share price is less than a dollar but now it is less than $5.

Explanation of Solution

• A penny stock refers to the stock whose market share price is less than a dollar but now SEC had modified its limit and considered every stock whose market price is below $5 as penny stock.
• It is considered high risk stock because of liquidity problem, lack of regulation, lack of disclosures and due to other reasons as well.

Hence, penny stock refers to the stock whose market share price is less than $5.