Quiz #6
When the market is reaching an "oversold" condition, which of the following statements are TRUE? I Market price averages are decreasing daily II Market price averages are increasing daily III The number of declining issues is decreasing relative to the number of advancing issues IV The number of declining issues is rising relative to the number of advancing issues A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. An oversold condition in the market occurs when the market price averages are decreasing daily, but the strength of the market decline (the number of issues declining versus the number of issues advancing) is weakening. The market is reaching an "oversold" condition, and is approaching a trough. Thus, the next market move is likely to be upwards.
An analysis of yield curves of U.S. Government and lower medium quality corporate bonds shows the yield spread to be widening over the last 4 months. Based upon investor expectations as evidenced by the widening of the yield spread, an appropriate investment is: A. U.S. Government bonds B. Medium quality corporate bonds C. Long term discount bonds D. Long term premium bonds
The best answer is A. If the yield "spread" between Government bonds and lower medium quality corporate bonds is widening, this means that yields on lower grade corporate bonds are higher than normal relative to yields on Government bonds. This occurs because an excess of investors are buying Governments, pushing their yields down; or an excess of investors are selling lower grade corporate bonds, pushing their yields up. This behavior is typical when investors expect a recession. When a recession is expected, there is a "flight to quality." Investors liquidate holdings that are vulnerable in a recession (low grade corporate bonds) and put the money into safe havens such as government bonds.
A retiree who annuitizes a variable annuity contract subjects him or herself to: A. market risk B. purchasing power risk C. regulatory risk D. opportunity cost risk
The best answer is A. In a variable annuity, the annuity payment varies with the performance of the underlying mutual fund that is the source of the funding of the annuity payments. If the mutual fund does well, the payment amount goes up; if the fund does poorly, the payment amount goes down. Thus, the annuitant is exposed to market risk. Typically, the mutual fund backing the annuity is an equity fund, so there is little purchasing power risk. If the mutual fund backing the annuity were a fixed income fund, then there would be purchasing power risk as well. However, market risk is the best of the choices offered.
A $1,000 par bond is issued with 3 years to maturity. The coupon rate on the bond is 2.50%. If the inflation rate for the next 3 years is 1.50%, the bond will be worth how much in 3 years? A. $1,000 B. $1,046 C. $1,077 D. $1,125
The best answer is A. The bond matures in 3 years. At maturity, the bondholder receives par from the issuer. The 2.50% coupon ($25 in interest) is paid to the bondholder annually, divided into semi-annual payments. The inflation rate has nothing to do with this question.
Which of the following statements are TRUE about non-systematic risk? I It is the same as stock specific risk II It is the same as market risk III It can be diversified away IV It cannot be diversified away A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. Non-systematic risk is stock-specific risk in a portfolio. As more and more stocks are added to a portfolio, that portfolio begins to resemble the market as a whole. Thus, non-systematic risk can be diversified away. Once a portfolio is fully diversified, it no longer has non-systematic risk. Now it is left with systematic risk only - that is market risk, which cannot be diversified away (but it can be hedged against).
In 2015, a customer buys 1 GE 10%, $1,000 par debenture, M '40, at 120. The interest payment dates are Jan 1st and Jul 1st. The bond is callable in 3 years at an 8% call premium. The yield to call on the bond is: A. 5.26% B. 8.00% C. 8.37% D. 10.23%
The best answer is A. The formula for yield to call for a premium bond is: Yield to Call Date = Annual Income - Annual Capital Loss to the Call Date ---------------------------------------------------------------------------- (Purchase price + Call Price)/2 $100 - ($120 premium / 3 years to call) -------------------------------------------------------- ($1200 + $1080) / 2 $100 - $40 $60 = --------------- = ----------- = 5.26% $1140 $1140 Note that because there is an 8 point ($80) call premium paid if the bond is called in 3 years, $1,080 the redemption price at that date. Also note that because of the 8 point call premium (8%) paid at early redemption, the full 20 point premium is not lost; rather, only 12 points ($120) is lost when the bond is called at 108.
2 years ago a woman leased a new car by putting $2,000 down and signing a 48 month lease at $500 per month. She has received a letter from the lease company saying that she can complete the lease right now by making a single $10,000 payment and keep the car for 2 more years; or she can finish the lease by making the remaining 24 monthly payments of $500. Assuming that this customer can earn 6% by investing in Treasury securities, and ignoring any tax consequences, to determine the best option, the method to be used is: A. Net Present Value B. Rule of 72 C. Expected Return D. Future Value
The best answer is A. This customer can get out of the lease by making a $10,000 payment now; or can continue to make $500 per month payments for the next 24 months, paying a total of $12,000 to complete the lease. One method to compute the best option (lowest cost) would be to use net present value. The customer can pay off the lease now by paying $10,000 now - this is the present value of this payment. Using NPV and a 6% risk-free rate of return, the present value of continuing the lease payments is: $6,000 paid in 1 yr --------------------------- = $5,660 NPV for year 1 payments 1.06 $6,000 paid in 2 yrs ---------------------------- = $5,340 NPV for year 2 payments 1.06(2) Total NPV = $5,660 + $5,340 = $11,000 Paying off the lease in one payment costs $10,000; while the net present cost of continuing the lease is $11,000. The up-front $10,000 payment is the best alternative (assuming that the customer has the $10,000 on hand!).
Keynesian Theory states that the economy is stimulated by: A. the actions of the Federal Reserve B. increased Government spending C. decreased Government spending D. lowered tax rates
The best answer is B. Keynesian Economic Theory states that economic growth is controlled by government spending and transfer payments (e.g. Social Security). This theory gained adherents in the 1930s during the Great Depression. With the private economy shattered at that time, the only way out was to have the government employ workers in large projects. This increased Government spending; and helped to stimulate economic activity as earnings were placed in individual pockets.
1-year Treasury investments yield 4%; while a "high tech" common stock investment yields 25%. The "risk free" rate of return is: A. 0% B. 4% C. 21% D. 25%
The best answer is B. The "risk free" rate of return is simply that return provided by a "riskless" investment. Treasuries are viewed as a "risk free" investment, since they are backed by the U.S. Government and have shown minimal variability of return over the last 50 years. Thus, the risk free rate of return is the rate given by 1-year Treasuries, which is 4% in this example.
Which item would NOT be found on a corporation's income statement? A. Interest B. Dividends C. Revenue D. Expenses
The best answer is B. There could be a little more clarity here, but dividends are the best choice. The income statement details all items of revenue and expense to arrive at net income after tax. This is the income figure that is used to compute earnings per share. Dividends are paid out of a corporation's net income after tax. Interest income from investments is a revenue item on the income statement; interest expense on bonds outstanding is a deduction. The question does not say whether the interest is income or an expense, but in either case, they are income statement items. The actual dividends paid are shown in a different smaller financial statement - the retained earnings statement. This starts with year prior retained earnings; then adds that year's net income after tax; then subtracts dividends paid; to arrive at the year-end retained earnings for that company.
A 50 year old customer receives an inheritance of $1,000,000 which he places with an investment adviser to invest with the objective of safety of principal and a moderate level of income. As of the end of the first year, the portfolio is worth $1,300,000. As of the end of the second year, the portfolio is worth $1,200,000. Ignoring compounding, the approximate annual return on investment is: A. 5% B. 10% C. 20% D. 30%
The best answer is B. This portfolio started with a $1,000,000 investment. The fact that it was worth $1,300,000 at the end of the first year is irrelevant to the question. The portfolio depreciated by $100,000 in the second year and had a second year-ending value of $1,200,000. Thus, over the course of 2 years, the portfolio had a net increase of $200,000 - or an average yearly increase of $100,000 / $1,000,000 original investment = 10% annual rate of return.
A portfolio of securities with a beta of 1.2 has produced an average annual return of 12%. Which investment should the portfolio manager NOT consider adding? A. An investment with a 7.8% growth rate and a beta of .6 B. An investment with a 15.4% growth rate and a beta of 1.2 C. An investment with a 20% growth rate and a beta of 2.2 D. An investment with a 26% growth rate and a beta of 2.1
The best answer is C. The portfolio has generated a 12% return by taking on extra risk (beta of 1.2 is .2 above the market risk level of 1). If we divide the return by the beta, the market return for the portfolio would be 12% / 1.2 = 10%. Any investment that yields less than this amount (risk adjusted) is a bad one for the portfolio. To risk-adjust the return of each investment offered, divide the investment return by that investment's beta. Any investment that yields less than the 10% risk adjusted portfolio return is a bad one for the portfolio. Choice A: 7.8% /.6 Beta = 13% risk adjusted return Choice B: 15.4% /1.2 Beta = 12.833% risk adjusted return Choice C: 20% /2 Beta = 9.09% risk adjusted return Choice D: 26% /2.1 Beta = 12.38% risk adjusted return
Which technical indicator is considered to be bearish? A. head and should "bottom" formation B. saucer formation C. breakout through a support level D. oversold market
The best answer is C. A bearish technical indicator is a breakout through a support level. If a stock moves through a support level, it is breaking out to the downside. A head and shoulders "bottom" formation is bullish since the market has bottomed out and is trending upwards. A "saucer" formation is bullish since the market has bottomed out and is trending upwards. If the market is "oversold", this means that sellers have pushed prices down too low. Thus, the market is underpriced and ready to move higher (bullish).
The yield to maturity on a bond is more than the yield to call. This bond is trading: A. at par B. at a discount C. at a premium D. in the money
The best answer is C. Aside from the coupon rate earned on a bond, yield to maturity and yield to call computations take into account whether the bond is purchased at a discount or at a premium. If a bond is purchased at a premium, the pro-rata annual loss of the premium as the bond approaches par value at maturity is deducted from the coupon rate, decreasing the yield. If such a bond is called prior to maturity (a likely event), then the premium is lost faster and the yield to the "call date" decreases below the yield to maturity. Thus, for a premium bond, the yield to maturity is higher than the yield to call.
Which of the following are components of common stockholder's equity? I Common at Par II Capital in Excess of Par III Retained Earnings IV Intangibles A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV
The best answer is C. If a corporation sells stock at a price above par value, the par value received is shown on the balance sheet as "par value," while the excess funds are credited to the corporation's capital surplus account. Retained earnings and earned surplus are different names for the same account - corporate earnings that are not paid out as dividends are credited annually to retained earnings; this is technically owned by the common shareholders. Intangibles are assets of a corporation, such as the value of copyrights, patents or trademarks. They are not a component of common stockholder's equity.
A customer buys a $1,000 par Treasury Inflation Protection security with a 4% coupon and a 10 year maturity. If the inflation rate during the first year of the security's life is 5%, the: I coupon rate is adjusted to 9% II coupon rate remains at 4% III principal amount is adjusted to $1,050 IV principal amount remains at $1,000 A. I and III B. I and IV C. II and III D. II and IV
The best answer is C. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities.
A customer has a term loan that is maturing in 3 years in the amount of $100,000. The customer has the cash now, and wants to know the best investment to make for the 3 years until the loan payment is due. The BEST recommendation is to buy: A. Blue chip stocks B. AA rated debentures with a 3 year maturity C. Treasury notes maturing in 3 years D. AA general obligation bonds maturing in 3 years
The best answer is C. Treasury securities have no credit risk, so this is the best choice. The customer knows he will get back the $100,000 in 3 years, plus will have earned interest every 6 months until maturity. A corporate debenture that is rated AA sounds good, but companies can get into business trouble quickly and the bonds could be downgraded in 3 years. AA general obligation bonds are safe (though not as safe as Treasuries), but their yield is lower, so they are not the best choice. Stocks prices can be volatile, so this is another bad choice.
The rate of inflation as measured by the Consumer Price Index has been rising rapidly over the last months. Ignoring other factors, the effect will be to: I raise stock market values II lower stock market values III raise bond market values IV lower bond market values A. I and III B. I and IV C. II and III D. II and IV
The best answer is D. A rising inflation rate is a "lose-lose" situation for both the stock and long term bond markets. If the inflation rate rises, then interest rates are likely to rise, with short term rates rising more than long term rates (the yield curve "flattens" as the Fed tightens credit to tame inflation, with short term rates rising more than long term rates). If interest rates rise, then long term bond prices will fall fastest, and long bondholders will have large losses on their positions. Furthermore, during periods of inflation, corporate earnings tend to fall, because companies are not able to keep raising prices at the same pace as their costs rise. This lowered earnings outlook depresses stock prices. Thus, both stock and long bond prices tend to fall in inflationary periods. Instead, during these periods of high inflation, investors "flee to safety" - they abandon the stock and long term bond markets, and put money in short term money market instruments, which offer safety and relatively high interest rates during inflationary periods; and they also put money into real estate and other "hard" assets that tend to keep pace with inflation.
The balance of payments measures the: A. prices of goods and services in the United States versus the prices of similar goods and services in other countries B. inflation rate in the United States versus the inflation rate in other countries C. gross domestic product of the United States versus the gross domestic product of other countries D. consumption of goods and services produced by other countries in the United States versus the consumption of United States produced goods and services by other countries
The best answer is D. The balance of payments measures the value of goods and services produced in the United States purchased by foreigners; versus the value of goods and services produced in foreign countries that is purchased in the United States. The U.S. tends to run a balance of payments deficit - that is, we buy more from foreign countries than they buy from us. This occurs because U.S. citizens buy a lot of foreign cars; travel a lot to foreign countries; buy a lot of imported clothing; in comparison to the amount of these items that foreigners buy from us.
