Ch. 14: Accounting and Economics

What's the current ratio of a company that has current assets of $10, fixed assets of $20, current liabilities of $5, long-term liabilities of $5, and shareholders' equity of $20? a. 2-to-1 b. 0.25-to-1 c. 0.5-to-1 d. 5-to-1

a. 2-to-1 Explanation: To calculate current ratio, current assets are divided by current liabilities. In this question, the current ratio is 2-to-1 ($10 current assets/$5 current liabilities).

Growth stocks would typically have which TWO of the following characteristics? I. High price/earnings ratio II. High dividend-payout ratios III. Low price/earnings ratio IV. Low dividend-payout ratio a. II and III b. I and IV c. III and IV d. I and II

b. I and IV Explanation: The term growth stock applies to a company that has shown a consistent high rate of growth for earnings over a period of time. Historically, investors have been willing to pay more for one dollar of earnings for these stocks compared to other securities and they usually sell at higher price-earnings ratios. Since the company is in a growth stage, a large percentage of the profits will be retained by the company, resulting in a low dividend-payout ratio. Therefore, growth stocks typically have high price-earnings ratios and low dividend-payout ratios.

The difference between a corporation's current assets and its current liabilities is the: a. Cash flow b. Current ratio c. Working capital d. Liquid assets

c. Working capital Explanation: The amount by which a corporation's current assets exceed its current liabilities is referred to as working capital.

ABC Corporation has a book value per share of $10 and a market value per share of $25. The corporation's net income is $25 million, it has 10 million shares of common stock outstanding, and has no preferred stock in its capital structure. Which of the following statements is TRUE? a. The company's stock is trading at a discount to it's book value. b. The company's price-to-earning ratio is four. c. The company's price-to-book value is five. d. The company's price-to-earning ratio is 10.

d. The company's price-to-earning ratio is 10. Explanation: ABC's price-to-earnings (P/E) ratio is 10-to-1. To calculate the PE ratio, a company's share price is divided by it's earnings per share (EPS). The formula for calculating the EPS is (Net Income - Preferred Dividends) ÷ Common Shares Outstanding. In this example, ($25 million net income - $0 Preferred Dividends] ÷ 10 million shares outstanding) = EPS of $2.50. Therefore, ABC's share price of $25 is 10 times its EPS of $2.50. Since ABC's market price of $25 is greater than its book value of $10, the stock is trading at a premium to its book value. Specifically, the price-to-book ratio is 2.5 ($25 market price ÷ $10 book value), or to put it another way, the stock is trading at 2.5 times its book value.

Which of the following is a leverage ratio? a. Assets - Liabilities b. Current Assets - Current Liabilities c. Current Assets/Current Liabilities d. Total Debt/Total Equity

d. Total Debt/Total Equity Explanation: Leverage is a measure of the amount that a firm has borrowed. One of the more common ratios used to measure a company's leverage is the Debt-to-Equity Ratio, which is calculated by taking total debt (i.e., liabilities) and dividing by total equity.

If a company's total assets remain the same but stockholders' equity decreases, which of the following statements is TRUE? a. Capital in excess of par increases b. Retained earnings increase c. Accrued expenses decrease d. Total liabilities increase

d. Total liabilities increase Explanation: When total assets remains the same and stockholders' equity declines, then total liabilities must increase. The correct formula for a balance sheet is: Total Assets = Total Liabilities + Stockholders' Equity

Gross Domestic Product (GDP) has declined for two consecutive quarters in the U.S. Which of the following industries would most likely be negatively affected by this downturn in the economy? a. Food b. Cosmetics c. Medical d. Transportation

d. Transportation Explanation: A downturn in GDP for two consecutive quarters is indicative of a recession. During a recession, cyclical industries, such as transportation, construction, and steel, will generally decline. Defensive industries, including cosmetics, food, and medicine, will not be as strongly affected.

The phase of the business cycle that represents the bottom of the economy's decline is: a. Peak b. Expansion c. Contraction d. Trough

d. Trough Explanation: The trough is considered the bottom of the economy's decline. In this phase, the lower prices of goods should cause the economy to move into a period of expansion.

If an analyst wants to measure the degree to which a company or partnership is leveraged, he would calculate the: a. Debt-to-total capital ratio, which is debt / total capital b. Quick asset test, which is (current assets - inventories) / current liabilities c. Return on equity, which is net income / average stockholders' equity d. Current ratio, which is current assets / current liabilities

a. Debt-to-total capital ratio, which is debt / total capital Explanation: The debt-to-capital and debt-to-equity ratios both measure the amount of a company's capital that is financed with debt (i.e., its degree of leverage). The quick asset test and current ratio both measure a company's liquidity or short-term financial health.

If the dollar is increasing against foreign currencies, which TWO of the following results would most likely occur? I. An improvement in the U.S. balance of trade II. A worsening of the U.S. balance of trade III. An increase in imports into the U.S. IV. Increased exports by the U.S.

III. An increase in imports into the U.S. Explanation: If the U.S. dollar is rising against foreign currencies, U.S. goods will be more expensive to foreigners. This should lead to decreased U.S. exports and increased imports into the U.S. These events would worsen the U.S. balance of trade.

The economic cycle consists of four stages--full recession, early recovery, late recovery, and early recession. Since the market tends to move ahead of the economic cycle, an adviser who believes the economy is in a full recession may advise clients to rotate into what sector? a. Cyclicals, such as transports and technology b. Services and utilities c. Staples and defensive stocks d. Fixed income securities

a. Cyclicals, such as transports and technology Explanation: In anticipation of changes in the economic cycle, an adviser may advocate sector rotation, in which a client's portfolio holdings are rotated from one or more business sectors into others. If the economy is in full recession, one strategy is to rotate into cyclical stocks that would benefit from a recovering economy, such as industrials, e.g., manufacturers of autos, appliances, or houses, which would experience increased sales in a recovery.

The balance sheet equation is: a. Assets - Liabilities = Net Worth b. Total Assets - Current Liabilities = Net Worth c. Total Assets - Total Liabilities = Capital Gains d. Current Assets - Current Liabilities = Net Worth

a. Assets - Liabilities = Net Worth Explanation: The balance sheet equation is Assets - Liabilities = Net Worth. A client's net worth represents the value of the client's assets that have been financed with their own money (equity) and not borrowing (debt).

New claims for unemployment insurance have been rising consistently for the past several months. This would indicate that the economy is in which area of the business cycle? a. Contraction b. Peak c. Trough d. Expansion

a. Contraction Explanation: New claims for unemployment insurance are considered to be a leading economic indicator. If these were rising, it would indicate that the economy was beginning to weaken or contract.

A fundamental analyst, evaluating the common stock of a corporation, would examine all of the following, EXCEPT the: a. Current amount of short interest positions for the stock b. Sales of the corporation c. Current amount of earnings paid as dividends to the shareholders d. Management of the corporation

a. Current amount of short interest positions for the stock Explanation: A fundamental analyst would examine all of the factors listed relating to a common stock except the current amount of short interest for the stock. Short interest is a statistic used by technical analysts. It represents the total amount of shares sold short that will have to be covered in the future.

Which of the following items is NOT included in an income statement? a. Goodwill b. Selling and administrative expenses c. Interest expense d. Income taxes paid

a. Goodwill Explanation: The income statement of a company includes its sales (revenues), less its operating expenses (e.g., selling and administrative expenses), less interest paid on its debt, which equals earnings before taxes. Taxes are then deducted to determine its net income, from which dividends may be declared. The income statement also includes non-recurring events such as the closing of a business or extraordinary items. The amount of goodwill is found on a company's balance sheet.

A stock that is traded on the NYSE has a high P/E ratio, a low dividend payout ratio, and a high level of retained earnings? What type of stock is it? a. Growth b. Value c. Small-cap d. Mid-cap

a. Growth Explanation: Growth stocks are characterized by high P/E ratios, low dividend payout ratios and high levels of retained earnings. Therefore, the stock described in the question is most likely a growth stock. Value stocks, are characterized by low P/E ratios, high dividend payout ratios, and low price-to-book ratios. Many growth stocks are also small cap-stocks which are issued by companies with market capitalizations between $300 million and $2 billion or micro-cap stocks which are issued by companies with market capitalizations of less than $300 million. However, the characteristics of the stock being described fit the definition of a growth stock much more exactly.

If the dollar is declining against foreign currencies, which TWO of the following results would most likely occur? I. An improvement in the U.S. balance of trade II. A worsening of the U.S. balance of trade III. An increase in imports into the U.S. IV. Increased exports by the U.S. a. I and IV b. II and III c. and III d. II and IV

a. I and IV Explanation:

Which TWO the following conditions are generally TRUE when the yield curve inverts? I. Interest rates are relatively low II. Interest rates are relatively high III. Interest rates are expected to fall IV. Interest rates are expected to rise. a. II and III b. I and III c. II and IV d. I and IV

a. II and III Explanation: The yield curve often inverts when interest rates are relatively high but are expected to fall in the near future. In such an environment, investors prefer to lock in relatively high long-term rates. The increased demand for long-term debt drives these prices up (and their yields down), as compared to short-term debt, causing the yield curve to invert.

Deflation will generally cause existing bond prices to: a. Increase b. Decrease by a high percentage c. Decrease by a low percentage d. Remain the same

a. Increase Explanation: Deflation is an economic situation in which the prices of goods and services are declining. It is an unusual occurrence which results in the consumer price index (CPI) decreasing and the economy contracting. In order to stimulate the economy the FRB often lowers interest rates, which causes existing bond prices to rise. Long-term zero coupon bonds tend to perform best during periods of deflation.

Which of the following choices is NOT considered to be a leading economic indicator? a. Industrial production b. Building permits c. Plant and equipment orders d. Index of consumer expectations

a. Industrial production Explanation: Industrial production is a coincident business cycle indicator; the other choices are leading indicators. The following is a list of leading economic indicators. Average workweek (manufacturing) Initial unemployment claims New orders for consumer goods and equipment Vendor performance Plant and equipment orders Building permits Interest rate spreads, 10-year Treasury bonds less federal funds Stock prices (S&P 500) The Money Supply (M2) Index of consumer expectations

Which of the following choices is an example of a variable cost? a. Material used in the production of a product b. The utility cost to operate a factory c. Rent d. The machinery used in the production of a product

a. Material used in the production of a product Explanation: There are two types of cost to operate a business, fixed and variable. Fixed costs are incurred by a company regardless of the amount of goods and services sold by the business. Examples include rent, the machinery and utility costs to operate a factory, and general administrative overhead. Variable costs vary with the amount of output produced by a company. They include direct manufacturing costs and wages used to produce a company's goods and services.

An investment adviser representative has determined that her customer's main objectives are preservation of capital and, secondarily, income. Which of the following investments would be the MOST appropriate for this client? a. Money-market instruments b. Treasury STRIPS c. Treasury bonds currently trading at a premium d. CMO residuals

a. Money-market instruments Explanation: Money-market instruments are high-quality, liquid, debt securities that are the favored investment for those with preservation of capital as a primary goal. They also provide some income, but not as much as other debt instruments. Treasury bonds and STRIPS, while having no credit risk, are subject to interest-rate risk, especially in the longer maturities. STRIPS also provide no current income. CMO residuals have very unpredictable cash flows and are risky investments.

An investor wishing to calculate the basic earnings that a corporation capitalized with common and preferred stock and convertible bonds would divide the: a. Net income minus any preferred dividends paid by the number of common shares outstanding b. Earnings before interest and taxes by the number of common shares outstanding c. Net income after converting the convertible bonds and subtracting the preferred dividends by the number of common shares outstanding d. Net income by the number of shares of common shares outstanding

a. Net income minus any preferred dividends paid by the number of common shares outstanding Explanation: This question is asking for the formula used to calculate earnings per share (EPS). In its simplest form, this formula is net income minus preferred dividends, if any, divided by the number of common shares outstanding. Using net income after conversion would be correct if the question asked for EPS on a fully diluted basis.

A U.S. manufacturer imports steel from Japan. The company manufactures the steel into parts and exports them for sale into Japan. The yen has recently devalued. All of the following items will decrease, EXCEPT: a. Operating expenses b. Revenue c. Operating profit margin d. Cost of goods sold

a. Operating expenses Explanation: The operating expenses of the company are expressed in U.S. dollars. These expenses are unaffected by a devaluation of the yen against the dollar. The cost of goods sold will decrease since the yen has declined in value against the dollar. The decline of the yen, however, will also decrease the revenue the company will receive once the yen (received for the sale of the parts) are converted into U.S. dollars. A portion of the cost of goods sold (machinery and labor) is payable in U.S. dollars. The devaluation of the yen will not impact this portion of the cost of goods sold. Since the operating expenses will not be affected by the currency change and the decrease in the revenue would be a greater percentage than the percentage decrease in cost of goods sold, the profit margin will decrease.

During periods of deflation, the FRB will likely: a. Purchase securities in the open market b. Issue new securities c. Encourage a rise in interest rates d. Sell securities in the open market

a. Purchase securities in the open market Explanation: In an effort to stimulate the economy, the FRB will attempt to move into a period of easy money. Easing money (making it available) may be accomplished by purchasing securities in the open market. On the other hand, selling securities, issuing new securities, or encouraging higher interest rates will have an opposite effect.

ABC Corporation has 10,000,000 shares outstanding and they're currently selling for $50 per share. ABC Corporation is an example of which type of company? a. Small capitalization b. Large capitalization c. Cyclical d. Defensive

a. Small capitalization Explanation: The market capitalization of a company is determined by multiplying the its number of outstanding shares by the current market price of the shares. ABC Company's market capitalization is $500 million (10 million shares x $50 per share). Therefore, ABC is considered a small capitalization company since its market capitalization is between $300 million and $2 billion. There's nothing in the question to suggest that ABC is either a cyclical or a defensive company.

If an adviser is using a sector rotation strategy, which of the following asset classes would they rotate into when the economy appears to be ready for recovery? a. Technology b. Utilities c. Healthcare d. Consumer staples

a. Technology Explanation: During recovery, the sectors that perform the best are technology, industrial, and cyclicals. During a recession, the sectors that perform the best are consumer staples, utilities, service, and financial industries.

A corporation has current assets of $150,000 and current liabilities of $75,000. The corporation uses cash to pay $35,000 in current liabilities. Which of the following statements is TRUE? a. The current ratio increases b. Working capital increases c. Stockholders' equity increases d. Bond interest coverage probably increases

a. The current ratio increases Explanation: When the $35,000 in current liabilities is paid in cash, current assets fall to $115,000 and liabilities fall to $40,000. The result is an increased current ratio of 2.875, compared to 2 before the payment. Working capital and stockholders' equity would stay the same. Bond interest coverage compares earnings before interest and taxes to the bond interest expense, and would not be affected in this case.

Which of the following tools is NOT directly controlled by the FRB? a. The fed funds rate b. The discount rate c. The reserve requirement d. Regulation T

a. The fed funds rate Explanation: The fed funds rate is the rate that's charged by one bank with excess reserves to another bank that needs an overnight loan in order to meet reserve requirements. Although the federal funds rates is greatly influenced by the FRB, it is the only choice that's not under the FRB's direct control.

An investor might purchase a stock with a high P/E ratio because: a. The investor expects higher future earnings b. This indicates the company has sufficient income to pay expenses and possibly make dividend distributions c. The higher the P/E ratio, the greater the potential for higher dividends d. This indicates a stable investment with little chance of volatility due to market fluctuations

a. The investor expects higher future earnings Explanation: The P/E ratio is used by the fundamental analyst to estimate the market's future earnings expectations for a company. A high P/E ratio indicates an investor is paying a high market price for today's earnings; the investor might do so with the expectation of higher future earnings. Stocks with high P/E ratios (typically growth companies) tend to pay a low, or no, dividend.

All of the following shares are included when calculating a company's market capitalization, EXCEPT: a. The number of shares that have been repurchased by the company b. The number of shares held by insiders c. The number of shares of restricted stock held by institutional investors d. The number of shares held by institutions

a. The number of shares that have been repurchased by the company Explanation: Market capitalization is determined by multiplying the number of outstanding shares by the current market price per share. Outstanding shares include those held by institutions, retail investors, restricted shares, and shares held by insiders, but do not include treasury stock (shares repurchased by the company).

How is the book value of a company calculated? a. Total Assets - Total Liabilities b. Current Assets - Current Liabilities c. Current Assets - Inventory d. Fixed Assets - Long-term Liabilities

a. Total Assets - Total Liabilities Explanation: Book value is calculated by taking all of a company's assets and subtracting all of its liabilities. Notice that book value can also be referred to as total shareholders' equity. The Price-to-Book Ratio is a common way to identify overvalued and undervalued companies.

An analyst who wanted to determine a company's ability to pay those debts that would be maturing in one year would be most interested in which of the following? a. Working capital b. The debt-to-equity ratio c. The P/E ratio d. Inventory turnover

a. Working capital Explanation: Measures of liquidity, such as working capital, assess a company's ability to deal with its short-term obligations (one year or less).

The difference between a corporation's current assets and its current liabilities is called: a. Working capital b. Liquid assets c. Current ratio d. Cash flow

a. Working capital Explanation: The formula for working capital is current assets minus current liabilities. Therefore, the difference between a corporation's current assets and its current liabilities is its working capital. Both current assets and current liabilities are found on the balance sheet. Current ratio is found by dividing current assets by current liabilitites.

During a given period of time, the Consumer Price Index has decreased by 10% while the yield on your investment has decreased by 7% of its original rate. How has this affected the purchasing power of your investment? a. Purchasing power has remained relatively stable b. Purchasing power has increased c. Purchasing power has decreased d. Purchasing power is affected only if the dollar also weakens against other major currencies

b. Purchasing power has increased Explanation: If the Consumer Price Index (CPI) decreased by a greater rate than the yield on your investment, the purchasing power of the invested dollars would have increased.

An American firm has manufacturing facilities located in the United States and abroad. The firm has a market capitalization of $45 billion with total revenues of $4.2 billion. Of the $4.2 billion in revenues, $3 billion came from domestic sales while the remaining $1.2 billion was generated through foreign sales. The firm's total net profit of $1 billion was evenly split between its U.S. and foreign operations. The firm's contribution to the gross domestic product (GDP) is: a. $45 billion b. $3.0 billion c. $4.2 billion d. $2.5 billion

b. $3.0 billion Explanation: Gross domestic product (GDP) is the sum of all goods and services produced in the United States regardless of where the firm is domiciled. When calculating GDP, you would not count the company's overseas revenues. The firm's net profit on the products produced is irrelevant.

Currency values in a floating-rate system are established by: a. The World Bank b. Supply and demand for the currency c. The International Monetary Market d. Government regulations

b. Supply and demand for the currency Explanation: Under a floating-rate system, currency values are established by supply and demand for the currency. Supply and demand for currencies may be influenced by the country's rate of inflation, level of interest rates, gold reserves, and trade deficit. The opposite of a floating-rate system is a fixed-rate system, whereby countries agree to a currency exchange rate that will not fluctuate.

Which of the following indexes or averages is made up of the largest number of stocks? a. The NYSE Composite Index b. The Wilshire Associates Equity Index c. The Dow Jones Composite Index d. The S&P 500 Index

b. The Wilshire Associates Equity Index Explanation: The Wilshire Associates Equity Index shows the market value (in dollars) of approximately 3,500 NYSE and Nasdaq listed stocks. Of the choices given, it contains the most stocks.

A corporation has the following financial information: $3 million in cash $5 million in accounts receivable $8 million of inventory $7 million of equipment $2 million in short-term debt $40 million in long-term debt $4 million accounts payable What's the corporation's current ratio? a. 1:2 b. 8:3 c. 4:3 d. 5:1

b. 8:3 Explanation: The current ratio is found by dividing the current assets by the current liabilities. In this question, current assets include cash, accounts receivables, and inventory, totaling $16 million ($3 million cash + $5 million accounts receivable + $8 million inventory). Current liabilities include short-term debt and accounts payable, totaling $6 million ($2 million short-term debt + $4 million accounts payable). Therefore, the current ratio is 16:6 ($16 million ÷ $6 million). Since the ratio of 16:6 is not an appropriate ratio, it must be reduced. To reduce the ratio, the common denominator of 2 can be used. In other words, find the number of times 2 goes into 16 and the number of times it goes into 6. In this case 16:6 is reduced to 8:3. If reducing fractions is an uncomfortable exercise, the decimal method may be used. Since the current ratio can also be stated as 2.6 ($16 million ÷ $6 million), simply calculate the decimal version of the answer choices to determine which answer matches this number (e.g., 8 ÷ 3 = 2.6, which is the correct response, while 4 ÷ 3 = 1.33 and is incorrect).

Which of the following choices is a lagging economic indicator? a. Money supply b. Average prime rate c. Stock prices d. Index of Industrial Production

b. Average prime rate Explanation: Average prime rate is considered a lagging indicator. Money supply and stock prices are leading indicators. The Index of Industrial Production is a coincidental indicator.

The investments that tend to perform the WORST during periods of inflation are: a. ETFs b. Bonds c. Mutual funds d. Gold and silver

b. Bonds Explanation: Bonds tend to perform the worst during periods of inflation since rising interest rates will result in falling bond prices and a decrease in the purchasing power of the interest payments. Mutual funds, ETFs, and gold and silver commodities tend to be good investments for a person seeking to offset inflation.

Which of the following business types is the LEAST likely to be affected by an increase in interest rates? a. Automotive b. Cosmetics c. Manufacturing d. Banks

b. Cosmetics Explanation: When interest rates are rising, industrial corporations that sell expensive items (e.g., manufacturing and automotive) and banks are heavy borrowers and will be adversely affected. However, cosmetic companies—due to the relative inexpensive nature of their business and the low cost of their products—are not as affected by rising interest rates.

A significant decline in the general level of prices is referred to as: a. Expansion b. Deflation c. Disinflation d. Inflation

b. Deflation Explanation: A significant decline in the general level of prices is referred to as deflation. On the other hand, inflation is an increase in the level of prices, while disinflation is a slowing down of the increase in the level of prices. Expansion is the phase of the business cycle during which inflation is a characteristic.

An individual who primarily invests in securities that have a low dividend payout ratio, a high level of retained earnings, and a high price-to-earnings ratio would be described as a: a. Conservative investor b. Growth investor c. Value investor d. Contrarian

b. Growth investor Explanation: Stocks with high retained earnings and low dividend payout ratios are considered growth- oriented investments. A value-oriented investor would seek investment in stocks that have low price-to-earnings ratios, or below what is perceived to be the stocks' intrinsic value. A conservative investor invests in low-risk investments that have stable cash flows. This would be consistent with stocks that have a high dividend payout ratio. A contrarian invests in stocks that are currently out of favor with investors.

The manager of a value fund would look for securities with which of the following characteristics? a. High betas b. High dividend yields c. High market-to-book ratios d. High P/E ratios

b. High dividend yields Explanation: Value investors are looking for stocks that are undervalued. They are the bargain hunters. Value stocks are characterized by low P/E (price/earnings) ratios, high dividend yields, and low market-to-book values (sometimes referred to as price-to-book ratios). Beta is a measure of a stock's volatility.

Interest rates had been very high. During the past three years, rates have decreased dramatically. The present yield curve would MOST likely be: I. Ascending II. Positive III. Inverted IV. Negative a. III and IV b. I and II c. II and III d. I and III

b. I and II Explanation: If rates have declined for the past three years, the present yield curve would most likely be a normal yield curve, which is also referred to as a positive, ascending, or upward-sloping yield curve.

In calculating a company's market capitalization, the treasury stock of a corporation is: a. Subtracted from the market value of outstanding shares at cost b. Ignored c. Added to market value at purchase cost d. Subtracted from market value at market value

b. Ignored Explanation: In order to calculate the market capitalization of a company, multiply the number of outstanding shares of common stock by the current market price. The number of outstanding shares does not include treasury shares, so the latter may be ignored. A company's outstanding shares are found by subtracting the number of treasury shares from the number of shares the company has issued.

The difference between the current ratio calculation and the quick asset ratio calculation is that the quick asset ratio excludes which of the following? a. Current assets b. Inventories c. All assets d. Money-market investments

b. Inventories Explanation: The quick ratio formula is (current assets - inventories) / current liabilities.

A yield curve that rises as maturities lengthen is a(n): a. Descending yield curve b. Normal yield curve c. Inverted yield curve d. Flat yield curve

b. Normal yield curve Explanation: In a normal yield curve, long-term maturities have higher yields than intermediate-term maturities, which in turn are higher than short-term maturities. A normal yield curve is also called a positive or ascending yield curve.

All of the following statements are true regarding yield curves, EXCEPT: a. In an ascending curve, short-term rates are lower than long-term rates b. They are fixed and may only be changed by commercial banks c. In a flat yield curve, both short-term and long-term rates are equal d. In a descending curve, short-term rates are greater than long-term rates

b. They are fixed and may only be changed by commercial banks Explanation: Yield curves are ascending (upward sloping from the shorter to longer maturities) when money is easy. When this occurs, short-term rates are lower than long-term rates. A descending yield curve, which is indicative of a tight money situation, will show short-term rates higher than long-term rates. A flat yield will indicate that short-term and long-term rates are approximately the same.

A high price-to-earnings ratio is usually consistent with: a. Companies with an above-average dividend payout b. Very small companies c. Very large blue chip companies d. Companies with very stable earnings

b. Very small companies Explanation: High price-to-earnings ratios are often found in small, rapidly growing companies. Low margin businesses, such as supermarkets and discount retailers typically have low P/E ratios. Some capital intensive manufacturing businesses (e.g., autos) that have declining sales and profitability prospects would also be expected to have relatively low P/E ratios.

A corporation has the following financial information. $1 million in cash $2 million in accounts receivable $5 million of inventory $10 million of equipment $3 million in short-term debt $50 million in long-term debt $2 million accounts payable What is the corporation's current ratio? a. 2.6 b. 2.0 c. 1.6 d. 3.6

c. 1.6 Explanation: The current ratio is found by dividing the current assets by the current liabilities. In this question, current assets include cash, accounts receivables, and inventory, totaling $8 million. Current liabilities include short-term debt and accounts payable, totaling $5 million. The current ratio is $8 million / $5 million, or 1.6.

If the economy is experiencing rising inflation, this will generally lead to: a. No change in bond prices b. Volatility in bond prices c. A decrease in bond prices d. An increase in bond prices

c. A decrease in bond prices Explanation: Rising inflation will usually lead to the FRB increasing short-term rates. This increase in rates will cause outstanding bond prices to decrease.

When comparing value stocks to growth stocks, one difference is that value stocks have which of the following characteristics? a. A low equity-to-debt ratio b. A higher P/E ratio than growth stocks c. A low price-to-book value d. A low dividend payout ratio

c. A low price-to-book value Explanation: Value stocks are those that are considered undervalued in relation to their book value. Compared to growth stocks, value stocks often have a low P/E ratio and a higher dividend yield.

If a client is interested in purchasing a stock that has a low P/E ratio, a high dividend payout ratio, and wants the issuer to have a large amount of cash reserves, what type of stock should an IAR recommend? a. A small-cap stock b. A growth stock c. A value stock d. A large-cap stock

c. A value stock Explanation: Two of the characteristics of value stocks are low P/E (price/earnings) ratios and high dividend payout out ratios (or high dividend yields). A company's dividend payout ratio is the percentage of its earnings that are paid to investors. Value stocks are also characterized by low price-to-book ratios, which is consistent with a company that has a significant amount of cash on hand. In contrast, growth stocks (choice a) generally have high P/E ratios and low dividend payout ratios. These companies tend to keep most of their earnings in order fund their continued expansion. Large-cap stocks (choice c) are issued by companies that have market capitalizations of greater than $10 billion. Many value stocks may also be large-cap stocks since they tend to be mature companies with a history of regular dividend payments; however, they are NOT necessarily characterized by low P/E ratios.

The amount of money an issuer receives in a stock offering in excess of the par value is recorded on the balance sheet as: a. Retained earnings b. Earned surplus c. Capital surplus d. Capital gains

c. Capital surplus Explanation: Shares are often priced well above par value in an offering. This excess is recorded on the balance sheet as Capital Surplus. For example, if a company prices an IPO at $18 per share and the par value is $10 per share, then $8 is added to the Capital Surplus in the stockholders' equity section of the balance sheet. A more common term for this excess is Additional Paid-in Capital or Capital in Excess of Par. Retained earnings can also be referred to as earned surplus.

If the average current ratio for a sector is 2.0, which of the following companies has the best short-term outlook? a. Company C with a current ratio of 1.3 b. Company D with a current ratio of 0.7 c. Company A with a current ratio of 3.5 d. Company B with a current ratio of 1.7

c. Company A with a current ratio of 3.5 Explanation: The current ratio measures the liquidity or short-term financial health of a company. The formula for calculating the current ratio is Current Assets ÷ Current Liabilities. Typically, a higher current ratio is a signal of a stronger business, especially in the short-term. Since company A has the highest current ratio and is higher than the sector average, it has the best short-term outlook.

If an adviser wants to evaluate a publicly traded firm's ability to pay down its short-term debt, which ratio would be most appropriate? a. Sharpe Ratio b. Debt Coverage Ratio c. Current Ratio d. P/E Ratio

c. Current Ratio Explanation: The best measure of short-term liquidity is the current ratio, which is calculated by dividing current assets by current liabilities. Although the debt coverage ratio also measures liquidity, it actually includes all debt-both short-term and long-term.

If an analyst wanted to determine a company's ability to pay debts that would be maturing in one year, he would be most interested in the: a. Inventory turnover b. Debt-to-equity ratio c. Current ratio d. Acid-test ratio

c. Current ratio Explanation: The current ratio is a comparison of current assets to current liabilities for a one-year period. The acid-test (quick) ratio excludes the inventories and is usually for a one- to three-month period.

All of the following would indicate inflationary pressure on the economy, EXCEPT: a. A rising consumer price index b. Rising retail sales figures c. Falling industrial production d. Falling weekly jobless claims

c. Falling industrial production Explanation: A rising CPI is the definition of inflation. If retail sales figures are going up or jobless claims are falling, consumer demand should rise. These two situations are therefore inflationary. If industrial production is declining, the assumption is that the economy is slowing down.

A fundamental analyst would NOT be interested in which TWO of the following? I. Short interest II. P/E ratio III. Trading volume III. EPS a. II and III b. II and IV c. I and III d. I and IV

c. I and III Explanation: Short interest and trading volume are technical indicators. EPS and the P/E ratio are fundamental indicators.

Which TWO of the following are TRUE regarding the causes of inflation? I. Demand-pull inflation occurs when the demand for money increases and pulls interest rates higher, causing inflation II. Demand-pull inflation occurs when the demand for goods and services increases faster than supply, causing inflation III. Cost-push inflation occurs when the increase in prices of raw materials leads to increasing retail prices, causing inflation IV. Cost-push inflation occurs when the cost of financing the national debt increases, causing rising interest rates and inflation a. I and III b. II and IV c. II and III d. I and IV

c. II and III Explanation: Inflation is an increase in the general level of prices, often as measured by the Consumer Price Index. The two most commonly cited causes are known as demand-pull inflation and cost-push inflation. Demand-pull explains that inflation is caused by a rise in the demand for goods and services that is not matched by an increase in the level of supply of goods and services. When the demand for any individual item increases in relation to its supply, its price will tend to rise. The same thing is true for the economy on a larger scale. Cost-push states that when the price of raw materials increases, that leads to a corresponding increase in the cost of producing goods and services. These increased costs are passed on to the consumer in the form of higher prices.

Which of the following items might be found in a footnote to a balance sheet? I. The P/E ratio II. Methods of depreciation III. Methods of inventory valuation IV. The market price of securities a. I, III, and IV only b. I and IV only c. II, III, and IV only d. I and III only

c. II, III, and IV only Explanation: Footnotes to the balance sheet might disclose methods of depreciation and inventory valuation, the market price of securities, and other data necessary to make information on the balance sheet more complete. The P/E ratio would generally not appear in a corporation's financial statements.

Value investors would be interested in companies that have: a. High price earnings ratios b. High price to book value c. Low price earnings ratios d. Low dividend yields

c. Low price earnings ratios Explanation: Value investing is a method of identifying securities that are undervalued based on company fundamentals. Value stocks tend to have low stock prices in relationship to their earnings, a higher dividend yield than their industry peers, and, typically, trade at a price closer to or at a discount to the book value than their competitors. Value investors believe that the most undervalued companies should rebound and outperform the market. This, of course, assumes that the company is financially sound.

When calculating the current ratio of a corporation, all of the following are included, EXCEPT: a. Accounts payable b. Inventory c. Net income d. Accounts receivable

c. Net income Explanation: The formula for calculating the current ratio is current assets of a firm divided by its current liabilities. Both accounts receivable and inventory are current assets and are therefore included. Accounts payable is a current liability on a company's balance sheet and is also included. However, net income is not actually included on a firm's balance sheet; instead, it appears on the income statement. As a result, net income is not needed when calculating the current ratio.

A listing of coincident economic indicators includes: a. The S&P 500 Index b. Housing starts c. Personal income d. Consumer expectations

c. Personal income Explanation: Personal income is a coincident indicator. Coincident indicators tend to move directly with the business cycle and show what's currently happening in the economy.

Which FRB tools determines the amount of money that member banks must keep on deposit? a. Open market operations b. Regulation T c. Reserve requirements d. Discount rate

c. Reserve requirements Explanation: The FRB sets the reserve requirements for member banks, which determine the amount of money that banks must keep on deposit. When banks have excess funds they tend to lend them to other banks that have deficits.

Value investing is: a. Risky because it's always bearish b. Safe because value companies are unlikely to go bankrupt c. Risky because it's contrarian d. Safe because value companies are profitable

c. Risky because it's contrarian Explanation: When using a value investing approach, and investor's goal is to find and invest in companies that are intrinsically undervalued. Value investors tend to focus on company stocks that have low share prices, high dividends, low P/E ratios, and low price-to-book ratios. Value investors try to find stocks that are trading at prices lower than their intrinsic value (i.e., the market undervalues them). Put another way, value investors are betting against the market as a contrarian strategy.

If inflation and unemployment are low, but energy prices are expected to rise, what results would be expected of stock prices and actions of the FRB? a. Stock prices would correct themselves and the money supply would tighten b. Stock prices would correct themselves and the money supply would loosen c. Stock prices would peak and the money supply would tighten d. Stock prices would peak and the money supply would loosen

c. Stock prices would peak and the money supply would tighten Explanation: Low unemployment and lower-than-expected inflation generally signal the peak of a market. Although the inflation numbers may be low, expectations of higher inflation may cause the FRB to reduce the money supply to keep inflation in check.

A technical analyst will consider which of the following? a. Explanation: P/E ratio b. Beta c. Supply and demand figures d. Risks

c. Supply and demand figures Explanation: P/E ratios and market risks are typically associated with fundamental analysis, rather than technical analysis. Technical analysts can use supply and demand figures to determine when they should buy and sell stocks. Beta is measure of a stock's systematic risk and is not used by technical analysts to make trading decisions.

Which of the following would be used to determine the debt-to-equity ratio? a. The cash flow statement b. The statement of retained earnings c. The balance sheet d. The income statement

c. The balance sheet Explanation: The debt-to-equity ratio is the amount of debt issued by a company in comparison to the amount of shareholders equity. The higher the ratio, the more leveraged a company is. The ratio is calculated by taking total debt capital and dividing by equity capital, which are both found on the balance sheet.

All of the following are true regarding the balance of payments, EXCEPT: a. The purchase of a Treasury bond by a foreign investor would represent a positive entry in the capital account b. The sum of the capital account and the current account must be zero c. The capital account shows the results for trade transactions completed in the current year d. A persistent current account deficit will drain foreign currency reserves

c. The capital account shows the results for trade transactions completed in the current year Explanation: The current account shows the results for the trade transactions completed in the current year. The capital account shows the inflows and outflows of capital in transactions involving property and financial assets. The net of the two accounts must be zero.

What does a debt-to-equity ratio of 1-to-1 signify? a. The company's equity is larger than its debt b. The company's debt is larger than its equity c. The company is highly leveraged d. The company has not utilized any leverage

c. The company is highly leveraged Explanation: The debt-to-equity ratio measures the leverage of a company. A normal debt-to-equity ratio can vary depending on the industry; however, a ratio of 1-to-1 or more typically signifies that the company is highly leveraged. Since the debt-to-equity ratio is 1-to-1 in the question, the debt and equity are the exact same amount.

Imports into the United States have been falling dramatically, while exports have been rising. A major cause of this would be: a. Rising interest rates in the U.S. b. The dollar rising in value relative to the currencies of our trading partners c. The dollar declining relative to our trading partners' currencies d. Falling interest rates in the U.S.

c. The dollar declining relative to our trading partners' currencies Explanation: Normally, if a country's currency is declining in value relative to the currencies of its trading partners, imports would fall and exports would rise. When a country's currency is in decline, its goods would fall in price relative to similar products imported from abroad. Falling interest rates in the U.S. may not always have an effect on lowering the value of the dollar.

If a corporation were to issue bonds with warrants attached, all the following characteristics would be a benefit to the corporation, EXCEPT: a. The marketability of the bonds would improve b. The issuance of warrants would not dilute shareholder ownership c. The issue would increase the debt to equity ratio of the company d. The bonds could be issued with a lower interest rate

c. The issue would increase the debt to equity ratio of the company Explanation: The issuance of bonds would increase the debt to equity ratio of a corporation, which is not a benefit. Warrants attached to bonds are often described as a sweetener for the deal, allowing the bonds to be issued at a lower interest rate, while improving the marketability of the bonds. Warrants are not dilutive to shareholders when issued. However, when warrants are exercised, the action results in more outstanding shares and the dilution of the proportionate ownership of existing shareholders.

If you were examining a balance sheet, you would expect to see: a. Capital expenditures b. Taxes paid c. The number of common shares outstanding d. Income before interest and taxes

c. The number of common shares outstanding Explanation: The balance sheet contains three main categories: assets, liabilities, and net worth (stockholders' equity). Within the net worth section, you will find the number of common shares outstanding. Income before interest and taxes and taxes paid are found in the firm's income statement. Capital expenditures are part of the statement of cash flows.

A company's PE ratio has historically been 30, but it has recently dropped to 15. In this case, what has most likely happened to the company? a. The price of the company's stock has risen. b. The company has started paying common stock dividends. c. The price of the company's stock has fallen. d. The earnings per share (EPS) has declined.

c. The price of the company's stock has fallen. Explanation: The Price-to-Earnings (PE) ratio is the price of a company's stock divided by its Earnings Per Share (EPS) (i.e., PE Ratio = Stock Price ÷ EPS). If the company's PE ratio has fallen, this means that either the stock price has fallen or the EPS of the company has risen. Paying common shareholders a dividend doesn't impact EPS and will most likely cause the stock's price to rise.

If the Wilshire 5000-to-GDP ratio is high, what would a technical analyst suggest that it means about U.S. equities? a. They're undervalued compared to foreign equities b. They're fairly valued c. They're overvalued d. They're under-valued

c. They're overvalued Explanation: The Wilshire 5000 is a stock index that's made up of all U.S. stocks. The Wilshire 5000-to-GDP ratio measures how over- or under-valued U.S. stocks are relative to the U.S. economy. A ratio above 1.0 indicates that U.S. stocks are over-valued, while a ratio below 1.0 indicates U.S. stocks are under-valued.

An investment adviser might create a portfolio in the following manner. She would assess conditions in the global economy at the present time and in the near future. With that in mind, industries are selected that would benefit most from the forecasted economic environment. The adviser would now look at selected companies within those industries and perhaps rate them according to various factors, such as management structure and fiscal health. It is from these companies that a portfolio manager might create or diversify a client portfolio. This approach would best be described as: a. Balloon structure b. Macro trend selection c. Top-down d. Bottom-up

c. Top-down Explanation: This is the philosophy of the top-down approach to investing. A broad analysis of the economy is first conducted, and then specific industries are identified that would seem to benefit from the economic analysis that was done. Then particular companies are chosen from within those industries and the adviser would make selections based on certain factors.

A client calls an investment adviser representative to discuss a stock she is interested in purchasing. The stock has a low P/E ratio, a high dividend payout ratio and its issuer has a large amount of cash reserves. What type of stock is it? a. Small-cap b. Growth c. Value d. Large-cap

c. Value Explanation: Two of the characteristics of value stocks are a low P/E (price/earnings) ratio and a high dividend payout ratio (or high dividend yield). A company's dividend payout ratio is the percentage of its earnings that are paid to investors as a dividend. Value stocks are also characterized by low price-to-book ratios, which is consistent with a company that has a lot of cash on hand. In contrast, growth stocks, generally have a high P/E ratio and a low dividend payout ratio. These companies tend to keep most of their earnings in order to fund their continued expansion. Large-cap stocks are issued by companies that have market capitalizations of more than $10 billion. Many value stocks may also be large-cap stocks since they tend to be issued by mature companies with a history of regular dividend payments but they are NOT characterized by low P/E ratios.

A U.S. portfolio manager that anticipates receiving an interest payment in a foreign currency would be concerned that the currency might: a. Strengthen against the dollar b. Go off the gold standard Weaken against the dollar c. Weaken against the dollar d. Remain the same against the dollar

c. Weaken against the dollar Explanation: If the foreign currency weakens against the dollar, then the interest payment will be worth less in U.S. dollars than expected. If the foreign currency strengthens, the payment will be worth more in U.S. dollars. Last, if the currency remains the same against the dollar, the interest payment will be worth exactly the same in U.S. dollars.

A corporation has $7,000,000 in income after paying preferred dividends of $500,000. The company has 1,000,000 shares of common stock outstanding. The market price of the stock is $56. What is the price-earnings ratio? a. 7.5 times b. 6.5 times c. 8.6 times d. 8 times

d. 8 times Explanation: The price-earnings ratio is the market price of the stock ($56) divided by the earnings per share ($7) which equals eight times.

Which of the following yields results in the highest real inflation-adjusted rate of return? a. A bond yields 12% when inflation is at 8% b. A bond yields 6% when inflation is at 4% c. A bond yields 10% when inflation is at 7% d. A bond yields 8% when inflation is at 3%

d. A bond yields 8% when inflation is at 3%. Explanation: The inflation-adjusted rate of return, also referred to as the real interest rate, is calculated as follows: yield minus inflation rate. The highest inflation-adjusted return is available on the bond that yields 8% when inflation is at 3%, since it's adjusted return is 5% (8% bond yield - 3% inflation rate).

A fundamental analyst could use a corporation's balance sheet to determine all of the following measurements, EXCEPT: a. Debt-to-equity ratio b. Working capital c. Current ratio d. Cash flow

d. Cash flow Explanation: A balance sheet is comprised of three sections: assets, liabilities and stockholder equity. The basic computation for cash flow is net income (found on the income statement, not the balance sheet) plus depreciation, which is also found on the company's income statement.

Who enacts fiscal policy? a. The Federal Reserve Board b. The Comptroller of the Currency c. The FDIC d. Congress

d. Congress Explanation: Fiscal policy is the tax and spending policy of the U.S. government. These policies are set by Congress in conjunction with the president. Monetary policy is set by the Federal Reserve.

If the U.S. economy was experiencing tough times with slow or negative growth, creating an extreme lack of demand for consumer goods, the result might be: a. Inflation b. Disintermediation c. Stagflation d. Deflation

d. Deflation Explanation: Deflation occurs when the prices of goods and services fall. This is a rare occurrence. It would be caused by slow or negative growth, which would lead to extremely small demand for consumer goods in relation to the supply of those goods. Stagflation also involves slow growth but when stagflation exists, prices are rising quickly (inflation), not falling.

Which of the following items is NOT included in an income statement? a. Interest expense b. Operating expenses c. Revenue d. Dividends payable

d. Dividends payable Explanation: The income statement of a company includes its sales (revenues), less its operating expenses, less interest paid on its debt, which equals earnings before taxes. Taxes are then deducted to determine its net income, from which dividends may be declared. The income statement also includes non-recurring events such as the closing of a business or extraordinary items. The entry of dividends payable is found on a company's balance sheet.

All of the following statements concerning the differences between emerging and developed markets are TRUE, EXCEPT the statement that companies in: a. A developed market would have an easier time raising capital b. Emerging markets would have more risk c. A developed market would have less long-term growth potential d. Emerging markets operate in a more regulated environment

d. Emerging markets operate in a more regulated environment Explanation: Emerging markets are markets that are just beginning to develop. They are typically characterized by primitive capital markets, underdeveloped industry, relatively low personal income levels and low profitability levels. There is strong long-term growth potential in such markets, but also above-average risk and significant stability factors. Companies in developed markets are more regulated, have an easier time raising capital, have less risk, and less long-term growth potential.

Which of the following items is found on a balance sheet? a. Interest payments b. Sales c. Expenses of the company d. Equipment

d. Equipment Explanation: Equipment is specifically found in the Fixed Assets section of the balance sheet. Each of the other choices are included on a company's income statement.

In determining the gross profit margin, an analyst would subtract the: a. Net profit from sales, divided by sales b. Net profit from gross sales, divided by net sales c. Gross profit from net sales, divided by gross sales d. Gross profit from sales, divided by sales

d. Gross profit from sales, divided by sales Explanation: The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The higher this ratio, the better from an investor's point of view, because a company that has a higher gross profit margin than its competitors is more efficient. Investors would normally be willing to pay more for a company that has a higher efficiency rating than its competitors.

All of the following would normally be characteristics of a growth company, EXCEPT: a. High price-earnings ratio b. High amount of research and development costs c. Wide trading range for the price of its stock d. High dividend payout ratio

d. High dividend payout ratio Explanation: Growth companies will normally retain most of their earnings to enable the company to continue its growth. They would typically have low dividend payout ratios, high research and development expenses, and high price-earnings ratios, as well as more volatile stock prices.

Which of the following ratios are used to evaluate a company's earnings? I. P/E Ratio II. Sharpe Ratio III. Earnings Per Share IV. Price-to-Book Ratio a. II, III, and IV only b. I and II only c. I, III, and IV only d. I and III only

d. I and III only Explanation: The P/E Ratio, and Earnings Per Share, are ratios used by the fundamental analyst to evaluate a company's earnings. The Sharpe Ratio indicates the amount of return per unit of risk and is a measure used by Modern Portfolio Theorists.

Which TWO of the following are TRUE if the U.S. balance of trade deficit is decreasing? I. The dollar will strengthen II. The dollar will weaken II. U.S. bond yields will rise IV. U.S. bond yields will fall a. II and IV b. I and III c. II and III d. I and IV

d. I and IV Explanation: When the U.S. is running a balance of trade deficit, it is importing more than it is exporting. This means that, on balance, U.S. dollars will be used to purchase foreign currencies to pay for the net imports. This strengthens foreign currency and weakens the dollar. However, if the balance of trade deficit begins to grow smaller, there is relatively less demand for the foreign currency and the dollar will strengthen. A stronger dollar indicates stronger demand for U.S. financial assets, including bonds. Bond prices will rise and their yields will fall.

ABC Corporation has issued $100 million worth of bonds at $1,000 par value. The effect of the issuance of the bonds would be an increase in: I. Working capital II. Total liabilities III. Total Assets IV. Stockholders' equity a. I, II, III, and IV b. I only c. II only d. I, II, and III only

d. I, II, and III only Explanation: Working capital equals current assets minus current liabilities. The cash received from the sale increases current assets. The bonds are a long-term liability, not a current liability. Therefore, working capital would increase. The increase in current assets would increase total assets as well. Long-term liabilities and total liabilities would also be increased by the additional debt. However, there would be no change in stockholders' equity (total assets minus total liabilities), since the money received would be exactly offset by the amount of additional debt.

Which of the following item(s) are listed on the income statement? I. Assets II. Liabilities III. Retained Earnings IV. Operating Expenses a. III only b. III and IV only c. I, II, III, and IV d. IV only

d. IV only Explanation: Assets, liabilities and retained earnings are balance sheet items and are not represented on the income statement. Retained earnings are the funds that a company earned that it did not pay out in the form of cash dividends.

During which phase of the business cycle will an investor experience a decrease in purchasing power? a. Trough b. Contraction c. Expansion d. Peak

d. Peak The peak is the high point of the business cycle, during which the demand for goods starts to overtake supply. During this phase, prices and inflation are increasing, which results in the decline of the consumer's purchasing power.

Detailing a company's net income is accomplished by: a. Figuring a company's cash flow b. Analyzing a company's net working capital c. Calculating a company's net profit margin d. Subtracting expenses from revenues

d. Subtracting expenses from revenues Explanation: A fundamental analyst would examine a company's income statement in order to assess a corporation's performance during a specific period. The purpose of the income statement is to detail the company's net income (or loss). This is calculated by offsetting the revenues with expenses.

Which of the following statements is TRUE if interest rates are lower in the U.S. than they are overseas? a. U.S. investors will invest in the United States. b. Foreign goods will become more attractive. c. The value of the dollar will strengthen. d. U.S. investors will invest overseas.

d. U.S. investors will invest overseas. Explanation: If interest rates are lower in the U.S. than they are overseas, this will typically lead to U.S. investors investing overseas. This will decrease the demand for the dollar, which results in a weaker dollar and foreign goods being less attractive.