Part 2

Question 1

Fundamental Economic Principles
A. Fiscal policy
1. _ and _ set budget

• a. Taxation
• b. _
• The _ is responsible for voting approval of the budget submitted by the _.

B. Monetary policy
1. Federal Reserve Board—three tools

• a. _ requirement (most drastic)
• b. _ rate—set by the Fed
• c. _ operations (most common)

2. Other interest rates

• a. Fed funds—most volatile
• b. Prime rate—set by large banks

3. Money supply shrinks (tight money)

• a. Interest rates increase
• b. Economic activity decreases

4. Money supply grows (easy money)

• a. Interest rates fall
• b. Economic activity increases

Answer 1

Fundamental Economic Principles
A. Fiscal policy
1. President and Congress set budget

• a. Taxation
• b. Spending
• The United States Congress is responsible for voting approval of the budget submitted by the president.

B. Monetary policy
1. Federal Reserve Board—three tools

• a. Reserve requirement (most drastic)
• b. Discount rate—set by the Fed
• c. Open market operations (most common)

2. Other interest rates

• a. Fed funds—most volatile
• b. Prime rate—set by large banks

3. Money supply shrinks (tight money)

• a. Interest rates increase
• b. Economic activity decreases

4. Money supply grows (easy money)

• a. Interest rates fall
• b. Economic activity increases

Question 2

Fundamental Economic Principles
C. Balance of payments
1. Balance of trade—largest part
2. Value of the dollar

• a. Dollar _
  
  • 1) Exports less competitive
  • 2) Imports more competitive
  • 3) Trade deficit
• b. Dollar _
  
  • 1) Exports more competitive
  • 2) Imports less competitive
  • 3) Trade surplus

D. Top down

• 1. Economy
• 2. Industry
• 3. Company

Answer 2

Fundamental Economic Principles
C. Balance of payments
1. Balance of trade—largest part
2. Value of the dollar

• a. Dollar up
  
  • 1) Exports less competitive
  • 2) Imports more competitive
  • 3) Trade deficit
• b. Dollar down
  
  • 1) Exports more competitive
  • 2) Imports less competitive
  • 3) Trade surplus

D. Top down

• 1. Economy
• 2. Industry
• 3. Company

Question 3

Business Cycle
A. Economy
1. GDP
2. _
3. Economic indicators (LO3)
a. Leading
b. _
c. Lagging
4. Business cycle

Recession vs Depression: # of quarters

GDP measures the value of goods and services produced within a country’s borders, by citizens and non-citizens alike. GNP measures the value of goods and services produced by only a country’s _ but both domestically and _.

Answer 3

Business Cycle
A. Economy
1. GDP
2. CPI
3. Economic indicators (LO3)
a. Leading
b. Coincident
c. Lagging
4. Business cycle

Recession vs Depression: # of quarters, 2 vs 6

GDP measures the value of goods and services produced within a country’s borders, by citizens and non-citizens alike. GNP measures the value of goods and services produced by only a country’s citizens but both domestically and abroad.

Question 4

Business Cycle

a. Sector rotation
1) Follows the _ cycle
2) Sell those sectors that are _
3) Buy those sectors that are _

B. Industry

1. Defensive
2. Cyclical
3. Counter-cyclical

Answer 4

Business Cycle

a. Sector rotation
1) Follows the business cycle
2) Sell those sectors that are peaking
3) Buy those sectors that are expanding

Question 5

Inflation and Deflation
A. Inflation: Decrease in purchasing power of monetary unit
1. Measured by _ ( _average _ for a basket of goods and services)

B. Deflation: Opposite of inflation
1. Can lead to _ GDP rate

C. Core inflation: CPI minus _

D. _ inflation: Inflation is steady until an economic shock

Economic indicators

1. Leading
   a. Where the economy is headed—increasing inflation or deflation
2. Coincident
   a. Where we are now—prices stable
3. Lagging
   a. Where we’ve been—explains past inflation or lack of

Answer 5

Inflation and Deflation
A. Inflation: Decrease in purchasing power of monetary unit
1. Measured by Consumer Price Index (CPI) ( weighted average cost for a basket of goods and services)

B. Deflation: Opposite of inflation
1. Can lead to negative GDP rate

C. Core inflation: CPI minus food and energy

D. Inertial inflation: Inflation is steady until an economic shock

Question 6

Yield Curves

A. Positive (normal) yield curve

• 1. Yields _ as maturities lengthen
• 2. Greater risk, greater return

B. Negative (_) yield curve

• 1. Short-term maturities _ yield than long-term
• 2. Most _ to Fed policy
• 3. Indicates that rates will _ soon

C. Flat yield curve

• 1. Yields are the same for all maturities
• 2. Generally a sign of _

D. Yield spread (credit spread) compare:

• 1. Same maturity—different risk
• 2. Same issuer—different maturity
• 3. Narrow spread versus wide spread
     * Spread _ during bad economy and _ during good economy.

Answer 6

Yield Curves

A. Positive (normal) yield curve

• 1. Yields increase as maturities lengthen
• 2. Greater risk, greater return

B. Negative (inverted) yield curve

• 1. Short-term maturities higher yield than long-term
• 2. Most sensitive to Fed policy
• 3. Indicates that rates will change soon

C. Flat yield curve

• 1. Yields are the same for all maturities
• 2. Generally a sign of uncertainty

D. Yield spread (credit spread) compare:

• 1. Same maturity—different risk
• 2. Same issuer—different maturity
• 3. Narrow spread versus wide spread
     * Spread widens during bad economy and narrows during good economy. During good economy, investors will take more chances and buy more corporate bonds instead of gov. bonds, thus driving down coporate bond yields.

Question 7

Balace Sheet

Current Assets - Can be converted into cash in 12 months

Fixed Assets - property, _, factory. Usually can be depreciated. Unlike current assets, cannot be easily converted into _.

Intangible Assets - rights, trademarks, _

Answer 7

Balace Sheet

Current Assets - Can be converted into cash in 12 months

• Cash and equivalents
• Accounts receivable
• Prepaid expenses
• Inventory

Fixed Assets - property, equipment, factory. Usually can be depreciated. Unlike current assets, cannot be easily converted into cash.

Intangible Assets - rights, trademarks, goodwill

Question 8

Balance sheet

Current Liabilities
Current liabilities are corporate debt obligations due for payment within the next 12 months. These include the following:

■
■

■

■
■

Long-Term Liabilities
Long-term debts are financial obligations due for payment after _ months. Examples would include bonds and mortgages.

Answer 8

Current Liabilities
Current liabilities are corporate debt obligations due for payment within the next 12 months. These include the following:

■ Current long-term debt- any portion of long-term debt due within 12 months

■ Accounts payable- amounts owed to suppliers of materials and other business costs
■ Accrued wages payable- unpaid wages, salaries, commissions, and interest

■ Accrued taxes- unpaid federal, state, and local taxes

■ Notes payable- the balance due on equipment purchased on credit or cash borrowed

Long-Term Liabilities
Long-term debts are financial obligations due for payment after 12 months. Examples would include bonds and mortgages.

Question 9

_ equity, also called net worth or _ equity, is the stockholder claims on a company’s assets after all of its creditors have been paid.

Shareholder equity = total _ - total _.

On a balance sheet, shareholder equity = capital _ + capital _ + _

Capital stock includes preferred and common stock, listed at par value. Par value is the dollar value per share assigned when a corporation’s owners (the stockholders) first contributed capital. Par value of common stock is an arbitrary value with no relationship to market price. As you will see in Unit 12, it plays an important role with preferred stock.

Capital in excess of par, often called additional paid-in capital or paid-in surplus, is the amount of money over par value that a company received when issuing its common stock. For example, if the par value was $1 per share and the stock was issued at $ 5 per share, there is a paid-in surplus of $4 per share.

Retained earnings, sometimes called earned surplus or accumulated earnings, are profits that have not been paid out in dividends. Retained earnings represent the total of all earnings held since the corporation was formed less dividends paid to stockholders. Operating losses in any year reduce the retained earnings from prior years.

Answer 9

Shareholder equity, also called net worth or owners’ equity, is the stockholder claims on a company’s assets after all of its creditors have been paid.

Shareholder equity = total assets - total liabilities.

On a balance sheet, shareholder equity = capital stock at par + capital in excess of par + retained earnings.

Capital stock includes preferred and common stock, listed at par value. Par value is the dollar value per share assigned when a corporation’s owners (the stockholders) first contributed capital. Par value of common stock is an arbitrary value with no relationship to market price. As you will see in Unit 12, it plays an important role with preferred stock.

Capital in excess of par, often called additional paid-in capital or paid-in surplus, is the amount of money over par value that a company received when issuing its common stock. For example, if the par value was $1 per share and the stock was issued at $ 5 per share, there is a paid-in surplus of $4 per share.

Retained earnings, sometimes called earned surplus or accumulated earnings, are profits that have not been paid out in dividends. Retained earnings represent the total of all earnings held since the corporation was formed less dividends paid to stockholders. Operating losses in any year reduce the retained earnings from prior years.

Question 10

Shareholder equity = Net worth = _ stock at par + capital in _ of par + retained _.

Net worth = assets - liabilities = total assets - intangible assets - liabilities.

Capitalization =_ + _

Capital structure = the relative amount of _ and _ that composes a company’s capitalization.

Answer 10

Shareholder equity = Net worth = capital stock at par + capital in excess of par + retained earnings.

Net worth = assets - liabilities = total assets - intangible assets - liabilities.

Capitalization = equity securities + long term debt

Capital structure = the relative amount of debt and equity that composes a company’s capitalization.

Question 11

Income Statement
B. Income statement reflects period of time
1. _ income = Sales (revenues) minus expenses

• Profit margin = (_ - _) ÷ _
• Profit margin = operating income ÷ _

2. Operating income minus _ and _ = _ income
3. _ income minus _ on stock = balance carried to retained earnings

Answer 11

Income Statement
B. Income statement reflects period of time
1. Operating income = Sales (revenues) minus expenses

• Profit margin = Net Sales(revenue) - Cost of goods sold(COGS) ÷ Net Sales
• Profit margin = operating income ÷ Net Sales

2. Operating income minus interest and taxes = net income
3. Net income minus dividends on stock = balance carried to retained earnings

Question 12

SEC Reporting
A. Form _-K
1. Event driven

• a. Sale of significant asset
• b. Management change
• c. Change of company name
• d. Bankruptcy filing
• e. Resignation of disgruntled board member

2. Relocation of a _ would not trigger
3. Filed within _ business days of event

B. Form _-K
1. Annual _ financial report

• a. Must use _ accountant

C. Form _-Q
1. Quarterly financial report

D. Annual report

1. Sent to _—may use Form _-K

Answer 12

SEC Reporting
A. Form 8-K
1. Event driven

• a. Sale of significant asset
• b. Management change
• c. Change of company name
• d. Bankruptcy filing
• e. Resignation of disgruntled board member

2. Relocation of a subsidiary would not trigger
3. Filed within four business days of event

B. Form 10-K
1. Annual audited financial report

• a. Must use independent accountant

C. Form 10-Q
1. Quarterly financial report

D. Annual report

1. Sent to stockholders—may use Form 10-K

Question 13

Present value of a future sum:
a. Value today of the future cash flows of an investment
discounted at a specified interest rate
b. Formula is: PV = FV ÷ (1 + r)^n where FV is the value to be
received, r is the investor’s required rate of return (generally
the current market rate), and n is the number of years until the
FV is received
c. Commonly used to determine FMV of a bond

If I will be receiving $50,000 in 5 years and I can get a 10% rate of return, what should thepresent value of that sum be today?

Answer 13

Solution:
PV = FV ÷ (1 + r)^n
$50,000 ÷ (1 + .10)^5 = $50,000 ÷ (1.61051) =
$31,046.07

Question 14

Rule of 72

1. Approximate formula for doubling of investment
2. 72 ÷ return percentage = _
3. 72 ÷ number of years = _

Example: If you can earn 4%, divide 72 by 4 = 18
years time to double your money
Example: If you have 3 years, divide 72 by 3 = 24%
earnings needed to double your money

Answer 14

Rule of 72

1. Approximate formula for doubling of investment
2. 72 ÷ return percentage = years to double
3. 72 ÷ number of years = percentage return needed to double

Example: If you can earn 4%, divide 72 by 4 = 18
years time to double your money
Example: If you have 3 years, divide 72 by 3 = 24%
earnings needed to double your money

Question 15

Net present value (NPV)

1. Subtract cost of the investment from the present value of the future returns (DCF)
   a. _ NPV is desirable

• 1) Cost of bond is $940; if present value is $990
• 2) NPV is +$50—make the investment
• 3) If present value is $900, NPV is –$40 = No!

Internal rate of return (IRR)
1. The discount rate that results in a net present value of _ for a series of future cash flows

• a. In our $25k example above, IRR = 6%
• b. Rate of return needed to get from PV to FV

2. Yield to _ of a bond reflects IRR
3. Expressed as a percentage, not dollar amounts

Answer 15

Net present value (NPV)

1. Subtract cost of the investment from the present value of the future returns (DCF)
   a. Positive NPV is desirable
   1) Cost of bond is $940; if present value is $990
   2) NPV is +$50—make the investment
   3) If present value is $900, NPV is –$40 = No!

Internal rate of return (IRR)
1. The discount rate that results in a net present value of zero for a series of future cash flows

• a. In our $25k example above, IRR = 6%
• b. Rate of return needed to get from PV to FV

2. Yield to maturity of a bond reflects IRR
3. Expressed as a percentage, not dollar amounts

Question 16

A. Mean
1. Arithmetic mean—simple average
2. Geometric mean—always _ (unless all returns equal)
B. Median
C. Mode - appears the _
D. Range/mid-range

• Add together the highest number and the lowest number and divide by _.

Answer 16

A. Mean
1. Arithmetic mean—simple average
2. Geometric mean—always lower (unless all returns equal)
B. Median
C. Mode - appears the most often
D. Range/mid-range

• Add together the highest number and the lowest number and divide by two.

Question 17

Beta (β)
1. Measure of stock’s co-movement relative to _
2. Measures systematic risk: risk associated with the market in general, not the total risk that pertains to a specific security
β = 1 … Average risk investment
β > 1 … Above average risk investment
β < 1 … Below average risk investment

Answer 17

Beta (β)
1. Measure of stock’s co-movement relative to benchmark
2. Measures systematic risk: risk associated with the market in general, not the total risk that pertains to a specific security
β = 1 … Average risk investment
β > 1 … Above average risk investment
β < 1 … Below average risk investment

Question 18

Alpha (α)

1. Compare the actual return in excess of the risk-free rate to the expected return
   a. If higher, positive alpha
   b. If lower, negative alpha
   c. If the same zero alpha

α = r(portfolio) - [r(risk-free)+(r(market) - r(risk-free)) * β]

α = [r(portfolio) - r(risk-free)] - [(r(market) - r(risk-free)) * β]

Alpha example:
The Risk-free rate (RF) is 3%. Stock A has a beta of 1.0; Stock B has a beta of 1.4. Stock A has a return of 13%; Stock B has a return of 19%. What is Stock B’s alpha?
Solution:

Answer 18

α = 0.19 - [0.03 + (0.13-0.03)1.4] = .02

Question 19

Standard deviation (σ)

1. Measures the _ of an investment compared with past returns
2. Standard deviation measures a security’s dispersion of returns versus its historical performance (mean)
3. _ risk = beta
4. Standard deviation measures _ risk (systematic risk and unsystematic risk)
5. Used in computing Capital Market Line

Volatility within

• 1 σ = _% of time
• 2 σ = _%
• 3 σ = _%

Answer 19

Standard deviation (σ)

1. Measures the volatility of an investment compared with past returns
2. Standard deviation measures a security’s dispersion of returns versus its historical performance (mean)
3. Systematic risk = beta
4. Standard deviation measures total risk (systematic risk and unsystematic risk)
5. Used in computing Capital Market Line

Volatility within

• 1 σ = 68% of time
• 2 σ = 95%
• 3 σ = 99%

Question 20

Correlation

• 1. Positive correlation: two securities’ prices move in a similar direction
     * a. Little or no diversification
• 2. Negative correlation: prices of two securities move in opposite direction
     * a. Adds diversification to portfolio
• 3. Perfect correlation: parallel movement (index funds)
• 4. _ correlation: no discernable pattern

Answer 20

Correlation

• 1. Positive correlation: two securities’ prices move in a similar direction
     * a. Little or no diversification
• 2. Negative correlation: prices of two securities move in opposite direction
     * a. Adds diversification to portfolio
• 3. Perfect correlation: parallel movement (index funds)
• 4. Zero correlation: no discernable pattern

Question 21

Valuation Ratios
A. Calculations used in balance sheet analysis:

Liquidate everything, give preferred shareholders back their par value and the rest is book value.

Book value = _ assets - liabilities - par value of _

Book value = Net worth - _ assets - par value of _

Book value per share = Book value/shares of common stock outstanding

Book value: Liquidating (not intrinsic) value
40MM Net Worth
-20MM Preferred stock
- 5MM Intangibles (includes goodwill)
=15MM Book Value
÷ 1MM Number of common shares outstanding
=$15.00 Book value per common share

Answer 21

Valuation Ratios
A. Calculations used in balance sheet analysis:

Book value = tangible assets - liabilities - par value of preferred

Book value = Net worth - intangible assets - par value of preferred

Book value per share = Book value/shares of common stock outstanding

Book value: Liquidating (not intrinsic) value
40MM Net Worth
-20MM Preferred stock
- 5MM Intangibles (includes goodwill)
=15MM Book Value
÷ 1MM Number of common shares outstanding
=$15.00 Book value per common share

Question 22

EPS relates to _ shares and assumes _ dividends were already paid

EPS = earnings available to _ ÷ number of shares

current yield(stock yield) = _ per common share ÷ _ per common share

dividend payout ratio = _ per common share ÷ _

PE ratio = current market price of common share ÷ _

price-to-book ratio = _ common stock ÷ _ per share

Answer 22

EPS relates to common shares and assumes preferred dividends were already paid

EPS = earnings available to common ÷ number of shares

current yield = annual dividends per common share ÷ market value per common share

dividend payout ratio = annual dividends per common share ÷ EPS

PE ratio = current market price of common share ÷ earnings per share (EPS)

price-to-book ratio = Market price of common stock ÷ Book value per share

Question 23

Valuation Ratios
B. Liquidity (balance sheet
1. Working capital = _ – _
$40,000,000 – $10,000,000 = $30,000,000
2. Current ratio (2:1 or better) = _ ÷ _
$40,000,000 ÷ $10,000,000 = 4:1
3. Quick ratio (acid-test) (1:1 or better) = (_ – _) ÷ _
($40,000,000 – $20,000,000) ÷ $10,000,000 = 2:1

Answer 23

Valuation Ratios
B. Liquidity (balance sheet
1. Working capital = Current assets – current liabilities
$40,000,000 – $10,000,000 = $30,000,000
2. Current ratio (2:1 or better) = Current assets ÷ current liabilities
$40,000,000 ÷ $10,000,000 = 4:1
3. Quick ratio (acid-test) (1:1 or better) = (Current assets – inventory) ÷ current liabilities
($40,000,000 – $20,000,000) ÷ $10,000,000 = 2:1

Question 24

Valuation Ratios
C. Capitalization
1. Total capitalization = _ + net worth (_capital)
$50,000,000 + $40,000,000 = $90,000,000
2. Debt ratio = _ debt ÷ _
$50,000,000 ÷ $90,000,000 = 55.56%

Answer 24

Valuation Ratios
C. Capitalization
1. Total capitalization = Long-term debt + net worth (equity capital)
$50,000,000 + $40,000,000 = $90,000,000
2. Debt ratio = Long-term debt ÷ total capitalization
$50,000,000 ÷ $90,000,000 = 55.56%

Question 25

Systematic Risk 1. Risk that overall market conditions will affect individual securities adversely regardless of a specific company’s circumstances a. Can be diversified away? 2. Examples of systematic risks * a. Market risk * 1) Usually measured by beta * b. Interest rate risk * 1) As interest rates go up, fixed income prices go down and vice versa * 2) Long term versus short term * a) Long term debt more volatile (longer duration) * 3) Low coupon versus high coupon * a) Low coupon debt more volatile (longer duration) * c. Inflation (purchasing power) risk * 1) Erosion of the buying power of the local currency unit * 2) Greatest impact on fixed dollar investments * 3) TIPS offer protection * 4) Common stock typical hedge 1. P 2. R 3. I 4. M 5. E

Answer 25

Systematic Risk 1. Risk that overall market conditions will affect individual securities adversely regardless of a specific company’s circumstances a. Cannot be diversified away 2. Examples of systematic risks * a. Market risk * 1) Usually measured by beta * b. Interest rate risk * 1) As interest rates go up, fixed income prices go down and vice versa * 2) Long term versus short term * a) Long term debt more volatile (longer duration) * 3) Low coupon versus high coupon * a) Low coupon debt more volatile (longer duration) * c. Inflation (purchasing power) risk * 1) Erosion of the buying power of the local currency unit * 2) Greatest impact on fixed dollar investments * 3) TIPS offer protection * 4) Common stock typical hedge ``` P = Purchasing Power Risk R = Reinvestment Rate Risk I = Interest Rate Risk M = Market Risk E = Exchange Rate Risk (could be systemtic or unsystemtic) ```

Question 26

Unsystematic risk 1. Risk that a business will fail or perform poorly as a result of specific characteristics of the company or industry in which it operates a. Can be diversified away 2. Examples of unsystematic risk * a. Business risk * 1) Loss of investment due to specific failure of the business * a) Labor problems * b) Poor management decisions * c) Lawsuits * b. Credit (default) risk 1) Minimize through higher ratings 2) Applies to debt securities, not equity 3) Sometimes referred to as financial risk when too much leverage employed * c. Regulatory risk 1) Vulnerability to adverse changes in regulations (EPA, FDA, EEOC, etc.) * d. Legislative or political risk 1) Vulnerability to adverse legislation (tax laws) * e. Sovereign risk 1) Risk that a government could default on its debt (sovereign debt) or other obligations * e. Liquidity risk (marketability) 1) Speed or ease of converting an investment into cash 2) Virtually nonexistent with listed/Nasdaq securities and mutual funds

Answer 26

Business risk Credit risk Regulatory risk Political risk Sovereign risk Liquidity risk

Question 27

Opportunity cost 1. Involves both systematic and unsystematic risk 2. Rate given up on one investment to invest in another Example: Bank CD paying 2% FDIC insured or Stock paying 8% dividend (no guarantees) Choice: Buying the CD incurs an opportunity cost of \_%

Answer 27

Opportunity cost 1. Involves both systematic and unsystematic risk 2. Rate given up on one investment to invest in another Example: Bank CD paying 2% FDIC insured or Stock paying 8% dividend (no guarantees) Choice: Buying the CD incurs an opportunity cost of 6%

Question 28

Liquidation Priority 1) _ debt like mortgage bonds, _ trust certificates, and collateral trust bonds; If the asset(s) securing the debt are insufficient to satisfy the claim, the balance is considered to be an _ debt. In that case, those bondholders are considered _ creditors and share in any remaining assets _ to the amount of the deficiency. 2) \_; 3) \_; 4) _ liabilities (\_) and \_creditors; 5) _ debt; 6) _ stockholders; 7) _ stockholders.

Answer 28

Liquidation Priority 1) secured claims like mortgage bonds, equipment trust certificates, and collateral trust bonds; If the asset(s) securing the debt are insufficient to satisfy the claim, the balance is considered to be an unsecured debt. In that case, those bondholders are considered general creditors and share in any remaining assets proportionate to the amount of the deficiency. 2) unpaid wages; 3) taxes; 4) unsecured liabilities (debentures) and general creditors; 5) subordinated debt; 6) preferred stockholders; 7) common stockholders.

Question 29

A bond is paying $100 per year in annual interest and is selling at par. If the discount rate is 10%, the net present value is A)negative B)positive C)the same as the coupon D)zero

Answer 29

D A bond paying $100 in interest per year has a coupon rate of 10%. Whenever the coupon rate is equal to the discount rate, the NPV is zero. That is, the present value of a bond paying 10% interest when the current market rate is demanding a 10% interest rate is the bond's par value (as is the case with this bond).

Question 30

In this context of Discounted Cash Flow (DCF) analysis, the discount rate refers to the interest rate used to determine the present value. For example, $100 invested today in a savings scheme that offers a 10% interest rate will grow to $110. In other words, $110 (future value) when discounted by the rate of 10% is worth $100 (present value) as of today.

Question 31

Due to changes in market rates, a corporation is able to purchase some of its outstanding 20-year bonds at a discount. Which of the following is CORRECT? I.Working capital is increased. II.Working capital is reduced. III.Net worth is increased. IV.Net worth is reduced. A)II and III B)I and III C)II and IV D)I and IV

Answer 31

A Even though the bonds are purchased for less than par value, working capital is reduced because the company is using a current asset—cash—to pay off a long-term liability. However, the fact that it is reducing its debt for less than the amount shown on the books will result in an increase to net worth.

Question 32

KPT, Inc., is preparing to report its net income for the past year. An increase in which of the following causes a decrease in the reported net income? I.Tax rate II.Cash dividend III.Interest charged on bank loans A)II only B)I and II C)I only D)I and III

Answer 32

D Higher taxes mean less net income. Interest charged on loans is an expense item; increasing it lowers operating income. Dividends are paid out of retained earnings and have no effect on the net income the company reports.

Question 33

ABD Corporation's income statement reports net sales of $100 million; cost of goods sold, $60 million; administrative costs, $20 million; and interest on debt, $5 million. Based on this information, ABD's gross margin is A)40% B)15% C)20% D)35%

Answer 33

A Gross margin, sometimes referred to as gross profit on the exam, is computed by subtracting the cost of goods sold (COGS) from the net sales (or revenues) and dividing the remainder by the net sales. In this case, the computation is $100 million minus $60 million, which equals $40 million, and then dividing that by the $100 million resulting in a gross margin (or margin of profit) of 40%. Administrative costs and interest are not included in COGS.

Question 34

\_ stands for Electronic Data Gathering, Analysis, and Retrieval. It is the easiest (and surely the fastest) way to obtain all of the financial information filed by reporting companies. It is available at \_.

Answer 34

EDGAR stands for Electronic Data Gathering, Analysis, and Retrieval. It is the easiest (and surely the fastest) way to obtain all of the financial information filed by reporting companies. It is available at SEC.gov.

Question 35

When reviewing a corporation's financial statements, shareholders' equity is computed by A)multiplying the current market price per share times the number of outstanding shares. B)subtracting total liabilities from total assets. C)subtracting current liabilities from current assets. D)adding together retained earnings, preferred and common stock, and long-term debts.

Answer 35

B Shareholders' equity is the corporation's net worth, sometimes called, owners' equity. It is computed by subtracting the total liabilities from the total assets. Current assets minus current liabilities is the working capital. Taking all of the equity capital, including retained earnings, and adding the long-term debt to that is the company's total capitalization and the market price per share times the number of outstanding shares is the company's market capitalization.

Question 36

Prepaid expenses, such as advertising, rent, or insurance, are listed as assets on the balance sheet. All _ are assets, while payables are liabilities. Under current accounting practice, deferred tax credits are treated as a \_.

Answer 36

Prepaid expenses, such as advertising, rent, or insurance, are listed as assets on the balance sheet. All receivables are assets, while payables are liabilities. Under current accounting practice, deferred tax credits are treated as a liability.

Question 37

Which of the following is a coincident economic indicator? A)Agricultural employment B)Industrial production C)Machine tool orders D)Stock market prices as measured by the S&P 500

Answer 37

B Industrial production is a coincident indicator. The stock indexes and manufacturing orders are leading indicators. Economists do not use agricultural employment as an indicator.

Question 38

Indicate whether leading, conicident or lagging indicators New manufacturing orders Initial claims for unemployment insurance Industrial production Index of consumer expectations/sentiment Number of employees on non-agricultural payrolls Personal income less transfer payments (e.g. Social Security, welfare) New private housing units Corporate profits Change in the consumer price index for services Average duration of unemployment Supplier delivery delays Stock prices, 500 common stocks Average prime rate charged by banks Commercial and industrial loans outstanding Bond yield, Interest rate spread Ratio of consumer installment credit outstanding to personal income

Answer 38

Leading indicators * Initial claims for unemployment insurance * New manufacturing orders * New private housing units * Supplier delivery delays * Bond yield (inverted curve -\> recession), Interest rate spread * Stock prices, 500 common stocks * Index of consumer expectations/sentiment Coincident Indicators Coincident indicators move in tandem with the broad economy. They include the following. * Number of employees on non-agricultural payrolls * Personal income less transfer payments (e.g. Social Security, welfare) * Corporate profits * Industrial production Lagging Indicators Lagging indicators usually respond after the economy has already begun to change. They are sometimes called "confirming indicators." They include the following. * Average duration of unemployment Save * Average prime rate charged by banks * Commercial and industrial loans outstanding * Ratio of consumer installment credit outstanding to personal income * Change in the consumer price index for services

Question 39

Prime rate vs discount rate vs federal funds rate

Answer 39

* Discount rate - Federal Reserve charges its member banks to borrow to meet reserve requirements. To tighten credit, the Fed increases the discount rate. To loosen credit, the Fed lowers the rate. * Federal funds rate- rate charged on short-term loans b/t banks. Fed targets, but does not directly control this rate. * Prime rate- rate the banks charge their best customers, around 3% higher than ferderal funds rate

Question 40

Which of the following statements is most accurate regarding the net present value (NPV) and internal rate of return (IRR) on a bond? A)IRR assumes the cash flows are reinvested at market interest rates. B)NPV assumes the cash flows can be reinvested at market interest rates. C)NPV assumes that cash flows can be reinvested at the bond’s IRR. D)IRR assumes the cash flows are reinvested annually.

Answer 40

B The first step in finding the NPV is to compute the present value (PV). The PV is computed by taking the future cash flows and discounting them by a "discount" rate. That rate is the current market interest rate. So, if NPV is based on PV and PV assumes reinvestment at the discount rate, that assumption must hold true for figuring NPV. In the case of the IRR, that is the yield to maturity of a bond and assumes that the cash flows are reinvested at that IRR. For example, a bond with a YTM of 7% assumes that all reinvestments will be made at that 7% rate. The periodic cash flow on a bond comes from the semiannual interest payments making reinvestments semiannually, not annually.

Question 41

A significant increase in imports represents a large outflow of U.S. dollars which results in a negative trade balance. Demand for dollar is _ because of so much outflow.

Answer 41

A significant increase in imports represents a large outflow of U.S. dollars which results in a negative trade balance. Demand for dollar is weakened because of so much outflow.

Question 42

The gross domestic product (GDP) for the United States is composed of A)the sum of all consumer goods, capital goods, and services produced in the United States and net exports to other countries B)the national debt C)the balance of payments D)the sum of all goods and services, imports, and foreign investment GDP is measured in actual dollars or constant dollars?

Answer 42

A The (GDP) comprises all consumer goods, capital goods, services produced in the United States, and net U.S. exports (exports minus imports). Constant dollars are mathematically adjusted to remove the effects of inflation, so when economists compare the gross domestic product of one period with that of another, they measure economic activity rather than inflation.

Question 43

An agent is analyzing the financial statements of a corporation. The company has cash on hand of $2 million, accounts receivable of $500,000, accounts payable of $700,000, land valued at $3 million, wages payable of $300,000, goodwill of $100,000, inventory of $1.5 million, and retained earnings of $5 million. From this information, the agent would determine that the acid-test ratio for this company is A)1:1 B)3.375:1 C)4:1 D)2.5:1

Answer 43

D The acid-test, or quick, ratio is all of the current assets, except for inventory, divided by the current liabilities. The non-inventory current assets are the cash on hand and the accounts receivable. The current liabilities are the accounts payable and wages payable. This results in a calculation of $2.5 million divided by $1 million, or 2.5:1.