Chapter 14

An improvement in economic conditions is indicated by an increase in all of the following EXCEPT:

Inventories Increasing inventories result from a decrease in customer demand. This can occur when disposable income is dropping and economic conditions are deteriorating.

Current assets

Inventory

Those industries dealing in durable goods like household appliances are likely to have lower

Inventory turnover ratios as their norm.

BDCs can be listed and traded on US exchanges, or ___________

non-traded

Business cycles go through 4 stages:

Expansion Peak Construction Trough

New orders for durable goods are a

Leading economic indicator

The Dow Jones (DJIA) represents what selection of stocks?

The thinnest selection of stocks

FRB sets

Monetary Policy

All of the following will affect the working capital of a corporation EXCEPT:

A payment of a cash dividend

Depression

6 quarters (18 months or more).

XYZ Aircraft Manufacturing Corporation announces a multimillion dollar order for its new jumbo jet from Fly Airlines, a Japanese carrier. When the sale is completed, there will be:

A credit to the current account of the U.S.

Which of the following capital structures would be considered the most highly leveraged?

A large value of bonds and a small value of common stock. Leverage is using other people's money to enhance equity value. In this case, borrowing at a fixed-rate of payment enhances cash flow, giving the company extra money to invest in its operations. Just as individuals, a company has to be careful not to borrow more than they can afford.

ABC Investors Group is looking to do a leveraged buyout of the XYZ Corporation. Which of the following would be the most likely source of capital to fund this takeover?

A long-term bank loan. The word "leverage" generally implies the use of borrowed money. The acquiring company will either issue a bond or borrow from a bank and use that money to fund the acquisition. In most cases, the assets of the target company are used as collateral for the loan.

The Consumer Price Index (CPI) is

A statistic used by the federal government to measure month-to-month changes in prices to the end-consumer. It includes prices on items such as food, oil, and clothing. The CPI is usually used to indicate the general inflation rate of the economy.

If a corporation has a Stock Split,

A stock split will increase the number of Shares and reduce the Value of each share, but the Total Par Value shown in the equity section of the balance sheet is not affected.

Fundamental Analysts concentrate on

A stock's intrinsic quality; and Are concerned with PE ratios and EPS

The common stock of all of the following corporations is considered defensive stock EXCEPT stock of a(n):

Airplane manufacturer Defensive stocks generally have little volatility. Firms that produce nondurable consumer goods (tobacco, food, drugs, ENERGY) are more immune to the business cycles than other industries and are sometimes called defensive industries. This term has nothing to do with the defense industry that supplies the Pentagon with goods and services.

Growth development companies, also known as business development companies (BDCs):

Allow smaller non-accredited investors the opportunity to invest in startup ventures. Providing startup capital to companies and allowing smaller investors the opportunity to participate are simply characteristics of BDCs. SEC does not approve or disapprove of any investment, so this would not be a suitability issue. A small retail investor should be most concerned with liquidity and being able to divest easily if they need to. Knowing whether a company is non-traded or traded is very important as non-traded development companies are viewed as being illiquid and the opportunity to exit the investment may be limited and come at a discount to current market value

Each of the following would cause a decrease in the balance of trade deficit EXCEPT:

An increase in imports of foreign products. An increase in foreign imports is obviously correct since it is bad for our trade balance and would cause an increase in the deficit instead of a decrease.

An analyst comparing revenues with expenses is most likely analyzing:

Cash Flow

When a dividend is paid

Current Assets will decrease and Current Liabilities will decrease. (this also decreases both total assets and total liabilities.) **working capital does not change because both CA and CL decrease by the same amount.

The decision to buy or sell stock is made by these trends rather than by analysis of specific issuer financial information, as used by

Fundamental Analysts.

Trade deficit occurs when

Imports exceed exports (as they have for years).

The largest component of the S&P 500 index is made up of

Industrial stocks

Value investment style is associated with the purchase of

Low PE stocks; or Stocks trading below their intrinsic value

Odd lot Theory

Proposes that the small investor is usually wrong

Stock of which of the following companies trades on equity?

Public Utility

Considered interest rate sensitive?

Public utility stocks Preferred stocks

If the U.S. economy shows signs of slowing, the Federal Reserve might:

Purchase US gov't securities

The broadest index?

Wilshire index - 5,000

Net worth =

assets - liabilities

Stockholder's equity =

assets - liabilities

Paid in surplus is a

Balance sheet entry that accounts for money raised from the issuance of stock in excess of par value. When more shares are sold, paid-in surplus will increase.

Low short interest is a __________ indicator

Bearish

A rising advance/decline line indicates that more stocks are rising in price than falling; a rising advance/decline line is a _______ indicator.

Bullish

High short interest is a ___________ indicator

Bullish

Fixed assets

Computer equipment Real estate Furniture

Current growth industries:

Computers & bioengineering

Income tax rates are set by

Congress

A company's changing from straight line to accelerated depreciation will:

Decrease income in the early years. Increase income in the later years.

FOMC buying treasury bills -- increase in money supply -- which does what to yields?

Decreases yields

Methods used to manage the economy?

Fiscal policy Monetary policy

M3 includes:

In addition to M1 and M2, M3 includes: Large denomination time deposits ($100,000+); and Repos held longer than one day

The economic philosophy that believes in controlling the money supply to stimulate economic growth is often referred to as:

Monetarist Economic Theory. Controlling the money supply implies a hands-on theory that is referred to as the Monetarist Theory.

Disintermediation is

Money flowing from banks and thrifts into money market instruments. It tends to occur when money is tight, causing rates to rise and making money funds more attractive than passbook savings rates.

Stagnation

Refers to prolonged periods of slow or little economic growth, usually accompanied by high unemployment

A consolidating market is one that

Stays within a narrow price range. When viewed on a graph, the trend line is horizontal and is said to be moving sideways, meaning neither up nor down.

The theory of Arthur Laffer, who believed that heavy taxing and government intervention have a negative effect on the economy. (says economic growth results from lower tax rates and lower government spending)

Supply-side economics

Analysts who are most interested in confirming a market trend would use:

Technical Analysis

According to the Dow theory, reversal of a primary bullish trend must be confirmed by:

The Dow Jones Industrial Average and Transportation Average. Charted price trends can be deceptive, so a trend must be confirmed by the Dow Jones Industrial Average and Transportation Average.

Growth companies retain most of their earnings to fund future growth. Investors select growth companies for ______________________, not for investment income.

Capital gain potential

The LT effect of the Federal Reserve's buying and selling of securities in the marketplace is to:

Check inflation or to create a situation in which the economy can recover from a Recession.

Under what circumstances will a dilution of equity occur?

Conversion of convertible bonds into common stock Dilution of equity occurs when stockholders experience a reduction in their percentage ownership of the company. If bonds are converted, more common shares are issued and the shareholder's equity is diluted. A stock dividend or stock split does not change a stockholder's percentage of ownership. Refunding debts has no effect on stockholders.

Lagging Indicators:

Corporate profits Average duration of unemployment. Labor cost per unit of output. Ratio of inventories to sales. Commercial and industrial loans outstanding. Ratio of consumer installment credit to personal income.

A technical analyst is least concerned with: A) declaration of increased dividends. B) open short positions. C) trading volume. D) new highs and lows.

Declaration of increased dividends A technical analyst is interested in statistics about market or price performance, not the fundamental factors, the market, or the company's dividend policy.

An increase in the Federal Reserve Board's (FRB) reserve requirement has which of the following effects on total bank deposits?

Decreases total bank deposits Multiplier Effect

Steel securities are cyclical and are therefore not considered a ________ security

Defensive

The Federal Reserve Board (FRB) has announced actions to increase the money supply. Which of the following would you expect to see increase first?

Employment; and Production

Private equity is

Equity capital invested in operating companies that are not publicly traded. The investment of capital can be made to aid or assist the company in a number of ways, including, but not limited to, making Acquisitions; strengthening the company's balance sheet; or turning around a distressed company.

Each of the following would add to the balance of trade deficit EXCEPT:

Foreign spending in the U.S. Any spending overseas by U.S. investors or consumers adds to the trade deficit. For instance, the trade deficit increases when imports of foreign goods exceed exports of U.S. goods. Foreign spending in the U.S. would decrease the balance of trade deficit.

Shareholders' equity is only affected by gains, losses, new invested capital, and cash distributions (dividends) to shareholders.

Gains Losses New Invested Capital Cash distributions (dividends) to shareholders

Buying stocks with high PE ratios normally reflects which of the following investment styles?

Growth

Growth Company characteristics:

High earnings retention ratio Potential investment return from capital gains rather than income Low dividend payout ratios High PE ratios

When the U.S. dollar appreciates, which of the following statements are TRUE?

Imports become more competitive with U.S. domestic goods. U.S. exports become less competitive in foreign markets. When the U.S. dollar appreciates against foreign currency, foreign money buys fewer U.S. goods. As a result, U.S. exports to foreign countries go down, but imports go up because U.S. dollars will buy more foreign goods.

Active government manipulation of the economy through tax and budget policies is referred to as:

Keynesian

Which of the following characteristics best exemplifies a value stock?

Low price-to-book, low price-to-earnings ratio. A value investor focuses on share price in anticipation of a market correction and improving company fundamentals. Therefore, such an investor tends to select a stock featuring lower price-to-earnings and price-to-book value ratios. A growth investor focuses on high earnings per share, growth, and high profitability.

The Cash Assets Ratio is the

Most stringent measure of a company's liquidity.

If stock market indexes, such as the S&P 500 and the DJIA, are declining daily, and the number of declining stocks relative to advancing stocks is falling, a technical analyst will conclude that the market is:

Oversold The momentum of the market decline seems to be easing as the number of decliners to advancers is leveling out. It looks like the advance/decline line is moving in a direction away from decliners. A technical analyst would conclude that the market is oversold and approaching a bottom.

Higher inventory ratios are generally associated with companies dealing in

Perishable items.

Dividend Retention Ratio

The dividend retention ratio is the reciprocal of the dividend payout ratio. If the company pays a $2 dividend on earnings of $10, it pays out 20% of the earnings available to common shareholders in the form of the dividend. That means it retains 80% of the available monies.

The Fed is making purchases in the open market. What are the effects of this action?

The fed funds rate is likely to go down Bond prices are likely to rise When the Federal Reserve Board purchases securities in the open market, money flows into the economy. Because there is more money available, interest rates such as the federal funds rate are likely to fall. When interest rates fall, bond prices rise.

Monetarist Theory

A monetarist economist is one that believes that the manipulation of the money supply is the most important tool with regard to affecting the economy. These are the two major types of fiscal policy that basically advocate affecting the economy through manipulation of taxation and the spending policies of the federal government.

Private equity capital can be used for a number of different reasons, and is generally

Capital raised from institutional and accredited investors. Institutional and accredited investors are usually in a better position to commit the larger sums of capital needed for private equity investments and to make the capital commitment for an extended period of time to accommodate the length of time it takes to accomplish the intended goal of the invested capital.

Cash Asset Ratio =

Cash + equivalents / current liabilities

Which of the following analyze corporate financial statements and trends in sales and income?

Fundamentalists Fundamental analysts obtain information from corporate financial statements as well as other relevant sources. Technical analysts review market charts while fundamental analysts are concerned with the earnings ability of corporations derived from corporate financial statements.

When analyzing a company's balance sheet, you notice that it is using the first in, first out (FIFO) accounting method to value its inventory. This information is most likely shown

In a footnote to the balance sheet Notations regarding accounting methods used, such as those for valuing inventory, would generally be found in the footnotes of the balance sheet.

M2 includes:

In addition to M1, M2 includes: Consumer savings deposits Money Market MFs Overnight repos Eurodollar deposits & time deposits less than $100,000 (time deposits include - non-negotiable CDs, money market funds, and overnight repurchase agreements)

Accelerated depreciation increases charged expenses during the early years of equipment life but decreases charged expenses during the later years.

Increases charged expenses during the early years of equipment life, but decreases charged expenses during the later years.

Increases in which of the following indicators are regarded as predictors of the level of business activity?

Increases in building permits Increases in building permits are indicative of increased, future business activity and are therefore considered a leading economic indicator. Increases in personal income and employment levels reflect current, not future activity, and would be considered coincident indicators. Corporate profits are lagging economic indicators.

Keynesian Theory

Keynesian economics is the body of economic thought that believes that active government intervention in the marketplace is the only method of insuring economic growth and stability. And that the government should manipulate the economy through adjusting levels of government expenditure and taxation. A monetarist economist is one that believes that the manipulation of the money supply is the most important tool with regard to affecting the economy. These are the two major types of fiscal policy that basically advocate affecting the economy through manipulation of taxation and the spending policies of the federal government.

If the assets of a company did not change, but stockholders' equity declined, it follows that:

Liabilities increased. Stockholders' equity = assets minus liabilities. If assets stay the same, then an increase in liabilities will cause a decline in equity.

Leading economic indicators:

Money supply (M2) Building permits Average weekly initial claims for state unemployment. Compensation average work week in manufacturing. New orders for consumer goods. Machine tool orders. Changes in inventories of durable goods. Changes in sensitive materials prices. Stock prices. Changes in business and consumer borrowing.

Which of the following balance sheet items is NOT a current liability? Accounts payable Mortgages Accrued taxes LT debt amount that is due within 1 year

Mortgages Short-term or current liabilities are those entries on a balance sheet that are due in 1 year or less. Accounts payable, accrued taxes, and that portion of long-term debt due within the year are all current liabilities. Mortgages are generally long-term liabilities, although that portion of a mortgage that is due within the year would be classified on the balance sheet as a current liability.

M1 includes:

NOW accounts. (largest and most liquid) Credit union share drafts Traveler's checks issued by nonbank companies Demand deposits at savings banks Checking accounts at commercial banks Paper currency & Coins.

If a company issues $10 million in par value convertible debentures, all of the following balance sheet items will be affected EXCEPT:

Net worth Net worth is not affected by the issuance of long-term debt because it does not represent ownership. Assets will be affected (increased) by the issuance of long-term bonds. Liabilities will be affected (increased) by the amount of the issuance. Working capital will also increase.

Defensive industries (least affected by normal business cycles)

Non-durable consumer goods; Food Pharmaceuticals Tabacco

What notations are generally found in the footnotes of the balance sheet?

Notations regarding accounting methods used, such as those for valuing inventory.

Coincident Indicators:

Number of hours worked Employment levels Nonagricultural employment Personal Income Industrial Production Manufacturing and trade sales GDP

FRB 3 policy tools

Open-market operations Changes in the discount rate Changes in reserve requirements

Speaking to a customer about a Private Equity fund a registered representative (RR) makes all of the following statements. Which of the following statements regarding private equity funds is NOT true?

Private equity capital commitments are generally short term and highly liquid from the moment the capital is invested.

To tighten credit, the Fed Reserve can:

Sell US gov't securities in the open market Raise the discount rate Raise reserve requirements

All of the following are functions of the Federal Reserve EXCEPT:

Setting initial margin requirements on exempt securities. The Federal Reserve does not have jurisdiction to set margin for exempt securities. FINRA rules mandate these requirements.

A report by the federal government stating the Consumer Price Index (CPI) has increased by .3% indicates:

The cost of goods purchased by consumers increased, on average, .3% for the month.

If DMF Corporation issues $10 million par value of convertible debentures, all of the following balance sheet items will be affected immediately EXCEPT:

The net worth Net worth (equity in the company) remains unchanged. Assets and liabilities both increase, as does the working capital.

The most frequently used tool of the Fed:

The purchase and sale of government securities by the Federal Open Market Committee (FOMC) is the most frequently used tool of the Fed. (Open market Operations)

Head and Shoulders bottom formation is an indication of: (inverted head and shoulders formation)

The reversal of a downward trend

If the yield curve becomes inverted, a likely cause would be that the Fed has:

Tightened Short-term Credit The Fed's influence on rates is primarily on the short end of the yield curve. Both the discount rate, which it sets, and the federal funds rate, which it influences, are short-term rates. The Fed tightens short-term credit when the economy appears to be overheating. To slow things down, the Fed raises short-term rates to extremely high levels.

Not affected by the issuance of a bond?

Shareholder's equity

Recession

6 months or more

A corporation has $12 million net income after taxes, 5 million common shares outstanding, and $10 million of 6% preferred stock ($100 par). What is the corporation's earnings per share (EPS)?

$2.28 Begin by calculating how much of the net income is available for common stockholders (net income after taxes minus preferred dividends equals earnings available for common stockholders). The preferred stockholders received $600,000 in dividends (100,000 pfd shares × $6 per share dividends = $600,000). After subtracting $600,000 from the net income of $12 million, this leaves $11.4 million (earnings available for common stockholders). Compute EPS (earnings available for common ÷ number of common shares outstanding = $11.4 million / 5 million shares = $2.28 per share EPS).

Which organization or governmental unit sets fiscal policy?

Congress and the President

The GNP measures growth in the economy. To retain an accurate comparison of one year to the next, it must be measured with ________ _________ (inflation-adjusted dollars).

Constant dollars

The purchase of machinery for CASH will reduce

Current Assets; and Working Capital

Working Capital =

Current assets - current liabilities

Defensive stocks such as food company stocks do reasonably well in poor economic climates. If the client were anticipating a _________________, the client would probably get out of equities and into high-quality short-term debt securities.

Depression

Stagflation

Describes the unusual combination of inflation (rise in prices) and high unemployment (stagnation). Usually occurs when the economy isn't growing, there is a lack of consumer demand and business activity, but yet prices for goods are still rising.

Cyclical Industries (highly sensitive to business cycles and inflation trends)

Durable goods; Heavy machinery Raw materials Steel & automobiles

In analyzing the ability of a company to meet its debt obligations, but not wanting to chance that certain accounting decisions or practices will cloud the picture, one measure that you might look at is the firm's

Earnings before interest, taxes, depreciation, and amortization (EBITDA), calculated from the firm's income statement. Earnings before interest, taxes, depreciation, and amortization (EBITDA), is a metric that measures the ability of a company to repay debt obligations (interest and principal), eliminating accounting decisions and techniques that might not allow for the best assessment.

The investment theory that assumes the market adjusts automatically as new information becomes known or relevant about a particular security, thereby resulting in a fair market price at all times, is known as:

Efficient market theory.

Trading on equity relates to a

Highly leveraged company *utility companies are normally highly leveraged.

A company has been experiencing increased earnings but has kept its dividend payments constant, the company's balance sheet would reflect?

Increased Shareholder's Equity

The value of the Dow Jones Composite average would be MOST affected by a change in the value of which of the following market sectors?

Industrial. The Dow Jones Composite Average consists of 65 stocks: 30 industrial, 20 transportation, and 15 utilities issues. Because industrials are the largest component, changes in their prices have the greatest effect on the averages.

Capitalization analysis

Involves examination of LT debt and stock issues

Liquidity analysis

Involves examining Current Assets and Liabilities from the balance sheet

Whenever money from a foreign source enters the United States,

It becomes a credit (CR) item in the U.S. balance of payments.

While looking at a chart for QRS common stock, a technical trader wants to have an order in position in the event that QRS moves higher and breaks out on the chart. A buy stop order would be placed:

Just above the resistance level. To take advantage of a stock moving higher and breaking out on a chart, a technical trader would place a buy stop order just above the resistance level. Technical traders believe that if a stock breaks the resistance level, it will move to and trade within a higher price range. Using a buy stop order placed just above the resistance level ensures that the purchase is not made until the stock has broken through the resistance.

Which of the following fundamental analysis theories might rely on lowering and raising taxes to stimulate or cool down an economy?

Keynesian theory Keynesian theory is interventionist. Supply side theory calls for low taxes and low government spending. Both short interest and breakout theories are technical rather than fundamental analysis theories.

If the dollar is devalued, travel abroad for Americans will become

More expensive. Because the dollar is worth less, it will buy fewer London theater tickets, Swiss watches, or French perfumes. With a cheaper dollar, exports would probably rise and imports decrease, resulting in a smaller deficit in our balance of payments.

Grant anticipation notes (GANs) are

Municipal securities

Earnings per share = (EPS)

Net income (less preferred dividends) / the number of common shares outstanding

A technical analyst is concerned with all of the following trends EXCEPT:

PE ratios Technical analysts are more interested in forecasting market trends and securities prices than in studying individual corporations. Therefore, they are concerned with market prices, trading volumes, changes in the Dow Jones Industrial Average, reversals, support and resistance levels, advance/decline lines, short interest, and many other factors that might help them time buying and selling decisions.

The GDP includes:

Personal consumption Government spending Gross private investment Foreign investment; and Net exports

A registered representative is explaining a particular market theory that maintains that the direction of a single stock or any general market is unpredictable. Which theory is he speaking of?

Random Walk Theory

Payment of a cash dividend will

Reduce the current assets (cash) and current liabilities (dividends payable) by the same amount, leaving Working Capital unchanged.

A payment of CASH:

Reduces Current Assets Working capital is also affected (whenever either CA or CL change, working capital is affected)

When one company sells all the shares of another company it owns, it's called a

Spin-off

What term do economists use to describe a downturn in the economy that is characterized by both unemployment and rising prices?

Stagflation

A leading indicator predicts economic trends. Such Leading indicators include:

Steel shipments Stock market indices Manufacturing orders; and Housing starts.

If the Fed begins selling securities in the open market to tighten credit, what is the first interest rate to feel this change in the Fed policy?

The Fed Funds Rate The Federal Reserve Board's actions to influence the money supply are first felt on the federal funds rates.

What are affected when a corporation declares a Cash Dividend?

The declaration (not payment) of a dividend creates a current liability on the books of the corporation. Because CL are affected, working capital and total liabilities also change. The declaration of a dividend reduces the Net Worth because the dividend will be paid from retained earnings.

Additional paid-in capital is

The difference between the dollar amount received from the sale of stock and the stock's aggregate par value. Earned surplus is another name for Retained Earnings.

A significant increase in imports of foreign goods into the United States would have what effect on the strength of the US dollar?

Weaken

Which items would change if a company buys equipment for cash? The working capital. The total assets. The total liabilities. The shareholders' equity.

The working capital The general balance sheet formula is assets = liabilities + shareholders' equity. A purchase of equipment for cash would affect working capital by reducing current assets. However, it would not affect total assets since it is an exchange of one asset (cash) for another asset of equal value (equipment). Since no loan was needed, it does not affect total liabilities, nor does it affect equity.

The immediate effect of the Federal Reserve's buying and selling of securities in the marketplace is to:

To make credit more or less available

A company's assets remain the same, and its Equity decreases. What happens to Total Liabilities?

Total Liabilities increase

The issuance of a debenture by a company would have an immediate effect on which of the following balance sheet items?

Total assets Total liabilities Working capital

Which of the following balance sheet entries may be affected when a company pays a cash dividend?

Total assets and Total liabilities

Technical Analysts are interested in:

Trading volumes New highs and lows Open short positions

The Federal Open Market Committee (FOMC) trades

U.S. government and Agency securities in the secondary market.

Retained earnings are created by

Undistributed company profits

Importing tends to do what to the U.S. dollar?

Weaken the dollar because it indicates an outflow of money from the US to foreign countries. Much of this outflow is in the form of debt. When our debt (deficit in balance of payments) gets too high, there in international concern about our ability to pay our debts and a reluctance in accepting US dollars as payment for goods - our dollar weakens.

Overbought

When market indexes are rising, but the number of declining stocks relative to the number of advancing stocks is rising (fewer stocks rising).

Basic balance sheet equation:

assets - liabilities = net worth

EPS =

earnings available to common / number of common shares outstanding

Shareholders equity =

total assets - total liabilities