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Securities and Investments
1. How would you explain that, although the efficient market
hypothesis applies to the stock market, you can’t successfully
invest by randomly selecting stocks?
A. The hypothesis fails to fully explain the real market
B. The hypothesis fails to consider these monopolies, which
dominate certain segments of the market.
C. Random selection of stocks would ignore an individual
D. New theories are needed to explain stock price behavior
in the new economy.
2. What is the best reason to use the price-to-sales (P/S) ratio instead of the price-to-earnings
(P/E) ratio in valuing stocks?
A. The P/S ratio is influenced by a corporation’s book value.
B. The P/S ratio can be contrasted with the ratio of cash flow to price.
C. The P/S ratio doesn’t have the same weaknesses as the P/E ratio.
D. The P/S ratio is useful for stocks issued by corporations that have no earnings.
3. If you analyzed a stock’s value using the dividend growth model, you would discount
A. future cash flows from dividends, incorporating projected growth in dividends.
B. future cash flows from dividends and from the projected growth in the value of
C. the future value of the stock, assuming a fixed growth and discount rate over a
preestablished time period.
D. the value of a fixed, periodic annuity the way you would discount the value of future
periodic interest payments.
4. If you wanted the safest investment among the following choices, which should you select?
A. The stock of large corporations paying high dividends
B. U.S. Treasury bills
C. The stock of small corporations
D. Long-term government bonds
5. At what rate does $1,000 grow to $1,953 after three years? Use the formula for the future
value of a lump sum, and assume annual compounding.
A. 25 percent C. 75 percent
B. 31.8 percent D. 95.3 percent
6. What is the holding period return on an investment of $1,000 held for 10 months with $30
in dividends and a selling price of $1,250?
A. 28 percent C. 23.3 percent
B. 25 percent D. 3 percent
7. Given a choice between calculating returns using the holding period return (HPR) or the
formula for the future value, you should select the future value formula because the
A. HPR fails to consider the discounted value of the purchase price.
B. future value formula incorporates the timing of cash flows.
C. HPR overstates the internal rate of return in direct proportion to the discount rate.
D. future value formula incorporates cash payments that are omitted in the HPR.
8. Which of the following statements most accurately explains the utility of the dividend
A. Dividend growth increases the total return earned on equity investments.
B. Projected dividend growth can be incorporated into calculation of the discounted value
of cash flows.
C. Stocks with rising dividends generally outperform stocks that don’t pay dividends or
that pay relatively static dividends.
D. Rising dividends, plotted as a function of time, appear as an exponential function with a
9. ABC Corporation recently announced its plans to pay a 5 percent stock dividend in addition
to its scheduled $0.32 quarterly dividend, which has been paid on its common stock in all
of the previous 13 quarters. The ex-dividend date will be one month after the announcement.
ABC Corporation hadn’t paid a stock dividend in the past nine years. You own 100
shares of ABC Corporation common stock valued at $68 per share. Which of the following
explanations accurately projects the effect of these transactions?
A. Dilution will effect a 5 percent decline in price per share. That will be offset by the 2
percent (annualized) dividend for a net decline of 3 percent in the stock price.
B. The 5 percent stock dividend is equivalent to 1-for-20 stock split. Stock prices generally
rise after stocks split, so the 5 percent dilution effect will be reduced to either a price rise
or a decline that’s smaller than 5 percent.
C. The stock price will drop about 5 percent if all other factors remain constant.
D. The discounted value of the stock split and will render a price decline smaller than 5
10. If you purchase a stock one month before the date of record, if a friend purchases the
same stock on the ex-dividend date, and if both of you hold the stock at least two months,
A. both you and your friend receive the dividend.
B. your friend receives the dividend, you don’t.
C. you receive the dividend, your friend’s investment is uncertain.
D. you receive the dividend, your friend doesn’t.
11. In the absence of compelling empirical data to support technical analysis, which of these
arguments supports its use?
A. The Dow Theory has a long history of successful use and has earned respect in
B. Traders of odd lots tend to be smaller, less sophisticated investors who reliably make
the wrong investment decisions.
C. Emotions lead to irrational investment decisions that can be overcome by applying a
strict set of technical methods.
D. Several technical methods capitalize on empirical data supporting the contention that
security prices move in the same direction.
12. The technical analysis methods presented in the textbook use
A. methods that are widely accepted in academic circles.
B. historical price and volume to predict future prices.
C. a combination of price, volume, and analysis of economic and industry factors to arrive
at the intrinsic value of the corporation.
D. methods that are unanimously rejected in academic circles.
13. The rationale behind a moving average is that
A. observations falling within one standard deviation of the moving average are expected
in approximately two-thirds of all observations, and when an observation falls outside of
this range, it’s indicative of a future change in the direction of prices.
B. deviation from historical trends may be indicative of a change in trend.
C. when observations fall more than 1.96 standard deviations from the moving average,
their probability is .05.
D. a change in the direction of the moving average indicates an opposite change in the
direction of stock prices.
14. Investors contribute to the efficiency of security markets by
A. using available information to make investment decisions.
B. applying technical analysis to their investment decisions.
C. combining cash flow analysis and ratio analysis to estimate stock value.
D. avoiding hot tips.
15. In calculating return on assets, you need to know
A. cash flow in order to back out noncash items.
B. earnings after taxes divided by the asset portion of equity.
C. both income statement and balance sheet information.
D. only balance sheet information.
16. Which of the following statements is correct?
A. Security selection can be a complex process that’s aided by Internet financial
B. Security selection is most efficiently practiced by applying both technical and
C. Security selection requires only the use of accounting ratios.
D. Security selection simplifies investment decisions.
17. The rationale for ratio analysis is explained best by the fact that ratios
A. are readily understood and easy to calculate.
B. may be computed and interpreted from two perspectives, time-series analysis, and
C. influence management and creditor decisions.
D. indicate a corporation’s financial and operational effectiveness, which in turn affect the
market value of its stock.
18. When interpreting the difference between the return on assets and the return on equity of
a single corporation for identical periods, you must take into consideration the
A. impact of net income on the corporation’s total return on assets.
B. contribution of current assets to total assets.
C. period-to-period rate of change in revenue.
D. corporation’s use of financial leverage, which is its use of debt.
19. In fundamental analysis, the value added by industry analysis is particularly apparent
A. when inflation rates are high and have a broad negative impact on business in general.
B. in industries where business levels significantly change in certain seasons or in
relation to the business cycle.
C. during recessions when business levels are suppressed across most industries.
D. during the rapid growth stage of an economy.
20. Which of the following reasons best explains why you would include inflation in a fundamental
analysis of stock values?
A. Inflation exerts broad influence on factors that underlie the economy.
B. Inflation generally increases stock prices at a faster rate than other prices.
C. Inflation generally increases stock prices because cash inflows increase.
D. High inflation corresponds with high interest rates and low bond values.
1. A bond will pay principal of $1,000 upon maturity in 10 years
from now, plus it will pay $60 every six months, including the
date of maturity and starting six months from now. What price
would you expect to pay for the bond if comparable bonds yield
A. $1,272 C. $815
B. $1,162 D. $456
2. What is the yield to maturity on a municipal bond scheduled to
pay $10,000 upon maturity 5 years from now? This is a zerocoupon
bond selling for $8,220. Round the yield to maturity to
the nearest percent.
A. 8 percent C. 4 percent
B. 5 percent D. 3 percent
3. What is the yield to maturity on a corporate bond scheduled to pay annual interest of $100
and $1,000 upon maturity 3 years from now? The bond is selling for $1,025.31. Round the
yield to maturity to the nearest percent.
A. 11 percent C. 8 percent
B. 9 percent D. 7 percent
4. What is the duration of a bond that will pay $50 per year in coupon payments and $1,000
after four years? Use a discount rate of 10 percent.
A. 8.4 years C. 3.7 years
B. 4.0 years D. 0.27 years
5. What is the present value of a share of preferred stock that you own indefinitely? The
stock’s dividend is $5. The appropriate discount rate is 6 percent.
A. $13.33 C. $852.33
B. $83.33 D. $852.98
6. A perpetual bond annually pays interest of $35 and alternative investments yield 14 percent.
What is the present value of the bond?
A. $250 C. $490
B. $355 D. $505
7. Duration is a better way to compare cash flows than simply comparing present values
A. duration incorporates cash flow volatility.
B. present value fails to incorporate the timing of cash flows.
C. when maturities differ among compared cash flows, present value inaccurately
represents the yield to maturity.
D. duration effectively treats cash flows as a perpetuity, incorporating the reinvestment rate.
8. One of the benefits of the laddered approach to managing interest rate risk in a bond
portfolio is that
A. reinvestment risk is eliminated because you standardize the timing of bond maturities.
B. the portfolio includes bonds issued by different organizations, thereby reducing default risk.
C. all bonds are liquidated if the investor elects to capitalize on an opportunity.
D. when bonds mature at different intervals, you diversify the timing of reinvestment.
9. If you want to maximize safety and earn federally tax-exempt interest, you should buy
A. municipal bonds backed by the revenue earned on the project funded by the bond.
B. municipal bonds backed by the taxing authority of the issuing government.
C. U.S. Treasury bonds backed by the taxing authority of the U.S. federal government.
D. U.S. Treasury bills backed by the taxing authority of the U.S. federal government.
10. To participate in the U.S. national mortgage market by investing in bonds, the best way
would be to invest in
A. revenue bonds issued by a sprawling suburban city.
B. treasury bonds that ultimately depend on funding from households.
C. mortgage pass-through bonds issued by a federal government agency.
D. stocks issued by banks that make mortgage loans.
11. One strategy for diversifying government-issued bonds and earning tax-exempt interest is
to invest in
A. U.S. Treasury bonds, notes, and bills with diverse maturities.
B. a state-specific municipal bond fund.
C. a combination of state and local bonds plus bonds issued by foreign governments.
D. money market mutual funds and U.S. Treasury bills.
12. What is the key distinction between Series EE bonds and Treasury bills?
A. Series EE bonds pay interest every six months.
B. Series EE bonds aren’t backed by the full faith and credit of the federal government.
C. Treasury bills are deeply discounted bonds with all interest paid upon maturity.
D. Treasury bills can be traded in the secondary market.
13. Why do bond issuers attach a call feature to their bonds?
A. Increases the marketability of the bond
B. Increases the likelihood of issuing bonds at face value or higher
C. Presents an opportunity to capitalize on rising interest rates
D. Frees the organization from high-interest debt if interest rates drop
14. If you were CEO and decided to finance retirement of a bond issue, you would be most
A. issue collateral serial bonds, the proceeds of which would fund the bond retirement.
B. rewrite the debenture to include an option to exchange bonds for shares of stock.
C. set up a payment arrangement with a trustee to fund an account designated for
D. sell production assets and apply the proceeds to bond retirement.
15. If you owned bonds issued by a corporation that announced expectations for a protracted
period of cash flow difficulties, what kind of risk would concern you most?
A. Default risk C. Reinvestment rate risk
B. Interest rate risk D. Price fluctuation
16. When an investor purchases a 12-month T-bill with the intention of selling it after a period
of time, he’s
A. riding the yield curve and selling on a secondary market.
B. minimizing his return on a short-term investment.
C. ensuring that the sale is at maximum discount.
D. maximizing his return on a long-term investment.
17. Which of the following measures would increase the duration of a bond issue?
A. Exercising a call option
B. Offering bondholders early retirement of bonds
C. Prepaying interest
D. Exercising an extendible option
18. If a bond issuer failed to honor terms of the indenture prohibiting the corporation from
merging with another corporation,
A. the bond issue would be considered a fallen angel.
B. the bond issue would be considered in default.
C. the corporation would be obliged to exercise an extendible option.
D. bondholders could exchange their bonds for stock of the issuing corporation.
19. Periods of a negatively sloped yield curve have also been times of
A. rising interest rates and inflation.
B. a bull market in stocks.
C. rapid economic growth that reduced the cost of long-term debt.
D. low commodity prices.
20. The impact of inflation as it relates to a bonding arrangement is most devastating to
A. borrowers. C. corporations and governments.
B. lenders. D. trustees.
1. You own a stock, and you’re concerned that the price of the
stock may decline. What might you do to minimize risk of loss
on the stock?
A. Buy a put C. Write a put
B. Buy a call D. Buy a warrant
2. At a single time, a stock’s price is $10 and the premium for a call option on the stock is $3.
The strike price on the option is $8. How should you explain the additional value of the
premium over the difference between strike price and stock price?
A. The stock price and option price may have been quoted at different times when stock
values were different.
B. The market value of the option premium equals the difference between the strike price
and the market value of the stock.
C. The market value of the option premium equals the difference between the stock
market value and the strike price plus a time premium.
D. The hypothetical price of the option is less than the time premium.
3. Which of the following strategies offers the greatest potential to maximize rate of return on
a stock if the stock price rises after you implement the strategy?
A. Purchase a stock and supplement your return by purchasing a call option on the stock.
B. Assume a naked position in the stock with a call option.
C. Write a covered put on the stock.
D. Write a naked put on the stock.
4. You speculate that the value of a stock won’t drop, and you’re unwilling to purchase the
stock or pay a premium for an option. What position would you take to profit by the stock’s
price not dropping?
A. Write a put. C. Write a call.
B. Purchase a call. D. Employ a covered position.
5. What is your profit or loss under the following circumstances when the stock price rises?
You buy a stock at $15 and simultaneously buy a put. The strike price on the put is $12,
and you pay a $5 premium. The stock price rises to $16.
A. $5 loss C. $2 profit
B. $4 loss D. $3 profit
6. What is your loss in the following situation? You write a naked put when the stock price is
$50. The strike price is $55, and the stock price drops to $40. Assume the option is near
expiration and the market doesn’t assign any additional value to the option’s intrinsic value.
A. $10 C. $20
B. $15 D. $35
7. What is your profit or loss under the following circumstances? You buy a stock for $30, and
its price suddenly drops to $25. To avoid the risk of further losses, you buy a put with a
$30 strike price for $6. Subsequently, the stock price rises to $35, the option expires, and
you sell the stock.
A. $1 profit C. $6 loss
B. $1 loss D. $15 loss
8. What is your profit or loss under the following circumstances? You buy a stock for $25, and
simultaneously write a covered call with a $20 strike price and $7 premium. The stock
price rises to $28, and the buyer exercises the option and you sell your ownership in
A. $3 loss C. $2 profit
B. $2 loss D. $3 profit
9. Which of the following positions would ordinarily minimize potential loss in terms of
percentage of investment? Assume the loss would be realized during the term of
A. Purchase a stock at $25.
B. Purchase a stock at $25 and a call on the stock for a $5 premium with a $21
C. Purchase a call option for $4.
D. Purchase a stock at $25, and a put on the stock for a $5 premium with a $29
10. The risk of shorting a stock is greater than the risk of buying a put because
A. the stock price can fall to zero, while the put limits risk to the amount of the premium.
B. a stock price change results in a relatively smaller change in an option on that stock.
C. the maximum risk of a put is the premium, while the maximum risk of shorting is
unlimited because price can rise without limit.
D. options provide unlimited hedging opportunities that render option positions less risky
than short stock positions.
11. Although arbitrage presents potential profit opportunities, the likelihood of individual
investors finding arbitrage opportunities is limited by
A. the tendency for stock values to fall away from the efficient frontier.
B. hedge strategies that combine option and stock purchases all but eliminate
C. stock and option exchange managers, who are required to notify market makers when
arbitrage opportunities present themselves.
D. market makers, who are in a better position to detect and quickly capitalize before gaps
12. You know that leverage increases risk because
A. leverage increases the opportunity for greater profits and losses.
B. when you lend money to businesses, you increase your exposure to default risk.
C. leverage magnifies the potential return on an investment.
D. leverage brings with it downside risk caused by the time-limited feature of options.
13. If you owned the stock of a company that had also issued a warrant on its stock, how
could you use the warrant to limit your risk in the stock?
A. Buy the warrant and write a put on the stock.
B. Sell the warrant short.
C. Buy a put on the stock.
D. Buy a put on the stock, and buy the warrant.
14. Suppose that you’re a corn farmer preparing to plant. You want to reduce the risk that corn
prices will drop below $2.20 per bushel next September when you harvest. What is the
best strategy to reduce your risk?
A. Enter a long position in corn futures to accept in September to enhance your profit if
corn prices rise.
B. Enter a futures contract to deliver September corn at a price under $2.20.
C. Enter a long position in corn for futures contracts to accept corn in July.
D. Enter a futures contract to deliver September corn at a price above $2.20.
15. Which of the following is most likely to use currency futures to reduce risk?
A. Foreign currency speculators
B. Corporations that accept and make payments in foreign currencies
C. Households located near international borders
D. Wheat farmers who sell to U.S. exporters developing markets in China
16. You have a long position in soybean futures at $4.75 per bushel. The contract is for 5,000
bushels, and initial margin is $1,215. Maintenance margin is $900. An unexpected late
frost destroys newly planted crops in the Midwestern United States, and the futures price
rises to $5.20 per bushel over the next few trading days. Which of the following results is
A. You receive a margin call from your broker.
B. The futures exchange imposes a temporary hold on trading in soybean futures.
C. The contract value rises to $25,000.
D. The contract value rises $2,250.
17. You enter a short position in an oats futures contract. The trading unit is 5,000 bushels,
the futures price is $1.08 per bushel, initial margin is $270, and maintenance margin is
$200. The futures price rises $.02 to $1.10 on projections of poor yields. What is the
most likely result?
A. You consider closing your position to capitalize on a $100 profit.
B. You get a margin call for $70.
C. You get a margin call for $100.
D. The long position exercises the futures contract.
18. Which of the following investors would reduce risk by shorting municipal bonds
A. Someone who owns a large portfolio of municipal bonds
B. An investor who has entered a contract to deliver municipal bonds
C. Someone who has entered a futures contract to accept Treasury notes
D. A city that has issued municipal bonds
19. If you were CFO of a U.S.-based international corporation with significant operations
in Switzerland, which of the following would be the best way to reduce currency risk
A. Enter a short position in the Swiss franc.
B. Purchase Swiss francs and invest them in Swiss certificates of deposit.
C. Enter a swap agreement so that U.S. operating expenses are paid on behalf of a
corporation based in Switzerland.
D. Enter a swap agreement so that Swiss operating expenses are paid by a corporation
based in Switzerland.
20. Which of the following events would increase a futures price?
A. Inflation declines during the term of the contract.
B. Spot price declines because of excess volume in the commodity.
C. The broker increases the maintenance margin.
D. Interest rates rise faster than expected.
1. Base your answer to this question on contents of Exhibit 22.4
on page 821 of your textbook. Use the January 1991–December
1995 data only. Strictly on the basis of the correlation of returns,
investments in which three countries would yield the greatest
A. Brazil, Hungary, Indonesia
B. Turkey, Korea, Chile
C. Turkey, India, Colombia
D. Turkey, Brazil, Malaysia
2. What special advantage do mutual funds confer for investing in emerging markets?
A. Emerging markets typically yield higher rates of returns for a given investment period
because risk is relatively high.
B. The correlation coefficients of returns between emerging and established markets are
C. Emerging funds allow investors to invest in specific markets even though they aren’t
familiar with corporations, laws, and particulars of investing in those markets.
D. Emerging market mutual funds provide diversification not available in global or
3. Which of the following investments would certainly increase your risk exposure if most of
your portfolio is dominated by U.S. investments?
A. International investments characterized by a correlation with U.S. investments near zero
B. International investments with high historical rates of return and, therefore, to the right
side of the security market line
C. A mix of European and Pacific Basin stocks purchased through an international
D. International investments in countries where the exchange rate fluctuates excessively
4. If you were supervisor of a mutual fund investment manager working for an international
growth fund, how would you interpret the following situation? The manager recommends
purchase of stock in General Electric, a New York–based corporation. Her rationale for the
purchase is based on the fact that General Electric’s operations and revenue are truly international,
with a substantial proportion of operations and revenue from over a dozen countries.
A. If the manager were permitted to make the purchase, it would violate the fund’s
B. General Electric’s international exposure would enhance the fund’s diversification.
C. General Electric would add to the fund’s diversification, but the corporation’s large size
is contrary to the growth objective for the fund.
D. General Electric’s diverse operations are a favorable attribute, and the company’s
growth would enhance the fund’s growth objective.
5. If you wanted international diversification but wanted to decide which countries you would
invest in, which strategy would you use?
A. Invest through iShares country-specific exchange-traded funds.
B. Invest through a global mutual fund.
C. Invest through World Equity Benchmark shares.
D. Invest in euros.
6. Of the reasons listed below, which is the most important reason to invest internationally?
A. The overall return on international investments exceeds the return on most domestic
investments, thereby increasing total return.
B. International investments may be riskier than domestic investments, but their diversifying
effect can reduce the risk of the entire portfolio.
C. International investments reduce total portfolio risk because returns on international
investments typically have a lower standard deviation than domestic investments.
D. Although domestic investments offer some growth opportunities, the mature domestic
market lacks the number of growth opportunities in emerging economies.
7. If you lived in a nation that didn’t use the Swiss currency for exchange and were invested
in securities issued by the government of Switzerland, you might expect the value of your
investment to rise if
A. you hedged your investment with currency futures.
B. the value of the Euro dropped in relation to the Swiss franc.
C. political uncertainty in France resulted in a decline in your domestic stock market.
D. your domestic currency fell in relation to the Swiss franc.
8. Use Figure 22.4, on page 819, to answer the following question: How would you interpret
observations in the lower-left quadrant?
A. When one country’s return fell below –20 percent, the S&P 500 return was slightly
B. After a year that the S&P 500 yielded a return slightly below zero, the EAFE lost more
than 20 percent.
C. Roughly every 20 years, you should expect a negative relationship between EAFE
returns and returns in the S&P 500.
D. Lines AB and CD are nearly equidistant from the observation, exemplifying how
diversification can benefit a portfolio.
9. The importance of market efficiency and its contribution to international investing is that
A. obtaining information on which to base foreign investment information may be difficult.
B. the rapid dissemination of new information and the intense competition among
investors produces efficient U.S. financial markets.
C. foreign firms with securities traded on U.S. exchanges meet SEC disclosure requirements.
D. inefficiencies in international markets may present opportunities for excess returns.
10. You might expect a domestic currency devaluation if
A. exports increase, resulting in a flood of foreign currency into the country.
B. significant domestic productivity declines decrease the attractiveness of
C. demand for domestic currency by foreign investors increases the supply of
D. domestic equity market values rise on news of projected interest rate decreases.
11. The cash budget is critical to financial planning because it
A. enumerates receipts and disbursements necessary to project asset allocation.
B. aids the investor when deciding to purchase small cap stocks.
C. helps estimate social security payments.
D. is the best means for establishing one’s financial position.
12. Which of the following should be part of a balance sheet?
A. Bank deposits, salary, and royalties
B. IRA distributions, insurance, and maintenance
C. Pension, money market funds, and Keogh accounts
D. Certificates of deposit, cash value of life insurance, and real estate
13. Before investing, it’s essential that the investor first
A. determine his or her net worth.
B. thoroughly research and hire a professional planner.
C. construct a financial plan.
D. define his or her goal.
14. If a U.S. investor buys the stock of a corporation in Mexico, the investor will certainly sustain
a loss if the stock price
A. falls and the value of the peso rises.
B. rises and the value of the peso rises.
C. falls and the value of the peso falls.
D. rises and the value of the dollar rises.
15. When an investor buys an ETF, he or she
A. knows the return will be based on the movement of dollar cost of the currency purchased.
B. is sure of little fluctuation in the value of his or her currency.
C. physically holds the currency purchased.
D. counts on impure play of one currency’s value versus another’s.
16. A 30-year-old with a portfolio of $50,000 with projected earnings of five percent per year
can expect the portfolio to be worth _______ at age 60.
A. $216, 097.12 C. $132,195.27
B. $160,972.13 D. $108,049.16
17. The single most influential variable in determining investment returns is
A. heavy reliance upon index mutual funds.
B. selection of a fee-only investment advisor experienced in asset allocation.
C. selection of low-cost, high-performing mutual funds.
D. asset allocation decisions driven by investment policy.
18. What is the most likely explanation for discrepancies between targeted asset allocations
and current asset allocations if the portfolio’s allocations matched the target one year ago
and no money was added to or subtracted from the portfolio?
A. Excessive turnover adds costs to the portfolio that put downward pressure on
B. The investment policy may have assigned an over-weight to equity investments.
C. Some asset class values rise and fall faster than others, leading to an imbalance.
D. The portfolio performed much better than expected when targeted asset allocations
19. The real benefit of constructing a cash budget for investors is to
A. ensure that spending doesn’t exceed income.
B. identify sources of cash flow for investments.
C. aid balance sheet construction.
D. identify net cash flow for determination of net worth.
20. A pro forma financial statement identifies
A. what is owed and what is owned.
B. balance sheet and cash budget data.
C. one’s future or projected financial position.
D. what the investor’s present-day “estate” looks like.