S65 - Part 2 Qs

An investment adviser is analyzing 4 bonds of similar quality for a client. Bond A has a coupon of 6%, matures in 12 years, and is currently priced at 50. Bond B has a coupon of 8%, matures in 9 years, and is currently priced at 50. Bond C has a coupon of 4%, matures in 18 years, and is priced at 45. Bond D has a coupon of 12%, matures in 6 years, and is priced at 50. Based on NPV, which of these bonds represents the better value? A) Bond D B) Bond C C) Bond B D) Bond A

B) Bond C Because you don't have the proper calculator to do a real PV calculation, NASAA expects you to use the rule of 72. Remember, under that rule, dividing 72 by the interest rate tells you the number of years it will take for a deposit to double. Or, if you divide 72 by the number of years, it will tell you the interest rate required for a present deposit to double. Finally, a positive NPV is when you can buy the bond for less than its present value. So, let's look at all 4 choices. Bond A, at 6%, takes 12 years to double. That's exactly the time to maturity, so the PV of this bond should be approximately $500 (a quote of 50). The same is true of bonds B and D—their PV should be approximately $500 (72 ÷ 8% = 9 years; 72 ÷ 12% = 6). Because their price is the same as the PV, the NPV is zero. However, with bond C, 72 divided by 4% equals 18 years, so this bond also has a PV of approximately $500 (50), but it can be purchased for less than that: 45 ($450). Therefore, with an NPV of $50, bond C is the best value. One final point: If you are stuck and have to guess, note that 3 of the 4 bonds are selling for $500 with the other priced at $450. If they are all going to mature at $1,000, a good guess would be that the cheapest one is the best deal.

When an analyst adds back the current year's depreciation to the net income, she is computing the company's A) net value of fixed assets B) cash flow from operations C) cash flow from investments D) earnings per share

B) cash flow from operations Cash flow from operations is computed by adding the year's depreciation deduction to the net income.

An analyst interested in how this purchase will affect the company's debt-to-asset ratio would examine A) the statement of cash flows. B) the balance sheet. C) the income statement D) the seaworthiness of the ship.

B) the balance sheet. Where do we find a company's assets, liabilities, and retained earnings? On the balance sheet.

Which of the following equations correctly shows the relationship between the items on a company's balance sheet? A) Assets = stockholders' equity − liabilities. B) Assets + liabilities = net worth. C) Assets = liabilities + stockholders' equity. D) Assets = liabilities − net worth.

C) Assets = liabilities + stockholders' equity. The stockholders' equity, sometimes referred to as net worth, equals the difference between the company's assets and its liabilities (assets − liabilities = stockholders' equity). This formula is often restated as assets = liabilities + stockholders' equity.

The business cycle has expanded, peaked, and contracted. The current economic activity could best be described as a trough. Which of the following would most likely be found in the trough? A high rate of inflation A low rate of inflation A high rate of unemployment A low rate of unemployment A) II and IV B) I and IV C) II and III D) I and III

C) II and III A trough is the latter stage of a recession. Unemployment is higher than normal, and with a lesser demand for goods and services, the inflation rate is low.

Which of the following is most commonly used to evaluate the marketplace's perceived value of a particular stock? A) Dividend payout ratio B) Earnings per share C) Price-to-earnings ratio D) Margin of profit

C) Price-to-earnings ratio

Describe the concept of inertial inflation.

C) prices tend to increase at a steady rate until the system receives an economic shock.

Your client wants to have $1 million in her investment account when she retires at age 70. She is currently 50 and has about $215,000 available to invest today. You tell her that if the portfolio can earn at a compounded rate of 8%, she will reach her goal. That 8% rate is A) the market rate of return B) the present value rate C) the internal rate of return D) the future value rate

C) the internal rate of return The internal rate of return is the earnings rate required to reach a specified future value from an amount that is currently available to invest. This is a future value computation, but there is no such term as future value rate.

An investment adviser representative is looking for a suitable investment for a client. The IAR wishes to find something that will offer an attractive return commensurate with its systematic risk. The choices have been narrowed to Security C and Security L, and the selection will be based on alpha. C has a beta of 1.0 and earned 13%, while L has a beta of 0.8 and earned 10.1%. The alpha of Security L is A) −2.9 B) +0.3 C) −0.3 D) +2.9

C) −0.3 Alpha is obtained by comparing how a security actually performed to the performance one would have expected based on its beta. A beta of 1.0 is used to indicate the expected volatility of the overall market. Because Security C has a beta of 1.0, its 13% return matches that of the "market." With a beta of 0.8, one would expect Security L to produce a lower return, but how much lower? Its return should be 80% of the "market" or, in this case, 80% of 13%, which computes to 10.4%. However, its actual return fell short of that by 0.3%, giving it a negative alpha of 0.3. Had its actual return been 10.7%, it would have had a 0.3 positive alpha. Although this question doesn't ask it, based on the criteria given, the IAR would have selected Security C.

If a security has an anticipated return of 8.7% and a standard deviation of 14.6%, you would expect the returns to have a 95% probability (assuming a normal distribution) of falling between A) −5.9 and +23.3% B) 8.7 and 23.3% C) −20.5 and +37.9% D) 0 and 37.9%

C) −20.5 and +37.9% A security with a normal distribution has a 95% probability of falling within 2 standard deviations of its anticipated return. In this case, that would be −20.5% and +37.9%, which is computed by calculating return movements of 29.2% (14.6 × 2) in either direction.

All the pundits are predicting bad times ahead—not only a recession but a period where prices actually fall (deflation). If they are right, the best place for your client would probably be A) common stock B) real estate C) U.S. Treasury securities D) gold

C) treasury securities It is times like this that the flight to safety has investors commit their funds to U.S. government securities. Gold (and other commodities) tends to increase in price during inflationary, not deflationary, periods. Both real estate and equities tend to rise when things are good, not during recessions. U8LO3

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) 15% B) 35% C) 20% D) 40%

D) 40% Explanation 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.

Which of the following items would be included in a current ratio computation? A) Accounts receivable, inventory, and long-term debt B) Cash, dividends payable, and shareholders' equity C) Inventory, equipment, and cash D) Accounts payable, wages payable, and short-term debt

D) Accounts payable, wages payable, and short-term debt Explanation Current ratio is computed by dividing current assets by current liabilities. Current assets include cash, accounts receivable, and inventory. Current liabilities include accounts payable, wages payable, dividends payable, and short-term debt. Equipment is a fixed asset, and shareholders' equity is net worth.

Of the 4 pairs of assets below, which pair provides the highest level of diversification? A) Assets 1 & 2: with a correlation coefficient of +0.94 B) Assets 3 & 4: with a correlation coefficient of +0.47 C) Assets 5 & 6: with a correlation coefficient of 0 D) Assets 7 & 8: with a correlation coefficient of −0.88

D) Assets 7 & 8: with a correlation coefficient of −0.88 Explanation The highest level of diversification will occur when the correlation coefficient is closest to −1. Of the 4 pairs of assets, assets 7 and 8 offer the highest level of diversification because the correlation coefficient of −0.88 is closest to −1. The returns on assets 7 and 8 should generally move in opposite directions because they are negatively correlated. Assets 1 & 2 will provide virtually no diversification because they have almost perfect correlation.

Which of the following would NOT be considered a defensive security? A) Tobacco stock B) Utility company stock C) Food chain stock D) Steel company stock

D) Steel company stock Steel is cyclical and is not considered defensive; defensive stocks are generally less affected by the business cycle.

Publicly traded corporations are subject to an annual audit of their financial records. Those audits must comply with GAAP (generally accepted accounting principles). When preparing to recommend a stock to a customer, you would most likely want to see that the auditor gave A) a certified opinion. B) a comprehensive opinion. C) a qualified opinion. D) an unqualified opinion.

D) an unqualified opinion. the highest opinion offered under GAAP An unqualified or clean opinion is the best type of report a business can get. The term qualified means that the auditor has some reservations about the information contained in the financial statements. U9LO1

An analyst attempting to determine the extent to which financial leverage is being employed by a company would examine the company's A) acid-test ratio B) working capital C) book value per share D) debt-to-equity ratio

D) debt-to- equity ratio Financial leverage is the use of debt capital. The best way to see the extent to which that exists is through the debt-to-equity ratio. U10LO7

Ending retained earnings = ?

The ending retained earnings = beginning retained earnings + net income - dividend.

Describe Recession

Two consecutive quarters of economic decline is termed a recession.