SIE - Analysis Basic Tax Rules

Which of the following statements are TRUE regarding the "help wanted" advertising index?

The amount of "help wanted" advertising shows the current demand for labor. If the number of advertisements is increasing, this would show that employers plan future production and the economy is doing well. If it is decreasing, it shows that future production will be slowing. Thus it is a leading indicator, though is not included as one of the 10 leading economic indicators reported monthly.

A corporation would repurchase its debt for which of the following reasons?

To increase the market value of its equity issues, To reduce its sensitivity to earnings fluctuations due to cyclical conditions, To decrease its capitalization

Which of the following actions by the Federal Reserve will lower interest rates?

To lower interest rates, the Federal Open Market Committee must direct a loosening of the money supply. Purchases of securities by the Fed injects cash to the dealers, and loosens available credit (more money is available to be lent out). In a repurchase agreement, the Fed buys government securities from the bank dealers, thus injecting cash into the bank dealers - who can now lend out more.

Net Worth

Total Assets minus Total Liabilities equals Net worth

A corporation issues $100,000,000 of 10% convertible debentures, convertible at $50. Upon issuance, which of the following are affected?

Total Assets, Total Liabilities, Net Working Capital

interbank market

Trading in the interbank market takes place 24 hours a day at trading desks across the world. There is no trading floor for this market. Trades occur in large blocks and settle either on a spot (1 or 2 business day settlement) or forward contract (settlement on a mutually agreed date in the future) basis.

Which tool would be used by the Federal Reserve to control inflation?

adjusting the discount rate

If the real Gross Domestic Product of the G-20 countries is growing at a slower rate than real Gross Domestic Product growth in the United States, then the value of the U.S. dollar can be expected to:

appreciate

Stockholders' Equity (Net Worth) is affected by all of the following EXCEPT:

declaration of a stock dividend

XYZ Company has 100,000,000 authorized common shares. 25,000,000 shares have been issued and another 10,000,000 shares are currently in registration. The sale of the 10,000,000 shares will result in all of the following EXCEPT a(n)

decrease in net working capital

Inflation has been running at the annualized rate of 6%. You have just received a distribution from a mutual fund investment that has increased by 4%. The purchasing power relating to this investment has:

decreased

Bond Ratio

long term debt divided by total long term capital

During periods of rising unemployment claims, falling consumer spending, and decreased business spending, the Federal Reserve would attempt to minimize the chances of:

recession

The "real" interest rate is the same as reported interest rates:

reduced by the inflation rate.

Bond Interest Coverage

total income before bond interest expense divided by annual bond interest expense.

A corporation issues a stock dividend. Which of the following statements are TRUE?

total stock holders equity and par value per common share will remain the same.

Keynesian theory

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.

The broadest measure of the money supply is:

L

All of the following are methods of depreciation EXCEPT first in first out.

Methods of depreciation include straight line, double declining balance (an accelerated method), and sum of the year's digits (another accelerated method). MACRS is the tax code's Modified Accelerated Cost Recovery System, that gives bigger up-front depreciation deductions on purchased assets used in a business.

Monetarist policy

Monetarists claim that the actions of the Federal Reserve Board to tighten or loosen credit are the driving force behind economic cycles.

Open market operations

Open market operations cause direct changes in money supply levels. (M1 is the money supply measure that includes all currency in circulation and demand deposits). As the money supply expands or contracts, this influences interest rate levels in the economy.

Retained earnings

Retained earnings represents accumulated earnings of a corporation that have not been paid out as dividends. Capital in Excess of Par, Capital Surplus, and Additional Paid In Capital all refer the same account. Any monies that are paid by shareholders that are in excess of the stated par value are credited to this account.

Settlement of spot contracts which have been traded in the Interbank market takes place:

Settlement of "spot" trades in the Interbank market takes place either one or two business days after trade date (the more actively traded currencies settle next day; less actively traded currencies settle in 2 business days).

supply side theory

Supply Side Theory states that economic growth is controlled by individual initiative. If individuals are given the incentive to produce, they will, and the economy will grow. To give this incentive, the theory holds that government spending, and the tax collections necessary to support that government spending, should be reduced. This leaves the individual with an economic incentive to produce, since less of his or her income is being taxed.

FED #2

The Federal Reserve sets monetary policy. Tools of the Fed include setting reserve requirements, open market operations, setting the discount rate, and setting margin rates.

real interest rate

"Real" interest rates factor out the current rate of inflation. If inflation is running at 3%, and the long T-Bond rate is currently 7%, then the real interest rate is 4%.

During periods of increasing interest rates and increasing inflationary expectations, generally:

An economic environment of increasing inflation and increasing interest rates is the worst of all possible worlds for investors. Bond prices fall as interest rates rise; and stock prices fall, since inflation erodes companies' real earnings. This was the economic environment of the late 1970s.

Accelerated depreciation deductions increase reported expenses in early years and decrease reported expenses in later years.

Accelerated depreciation deductions, when compared to straight-line depreciation deductions, are "front loaded." The depreciation deduction is higher in earlier years; but the deduction is lower in later years (as compared to straight line depreciation). Because there are higher deductions in the earlier years, this will increase reported expenses in those years; while the lower deductions in later years will decrease reported expenses for those years.

All of the following items are included on a company's income statement except reinvested dividends.

All sales made by the company are included on the income statement. These include sales of fixed assets, interest and dividend income received from investments, sales, including installment sales.

monetary policy

Changes in tax rates are made with approval of Congress - this is a tool of fiscal policy. Monetary policy actions that can be taken by the Fed include changing the discount rate; open market operations; changing reserve requirements; and changing margin requirements. These can be memorized as "DORM." D is Discount rate; O is Open Market Operations; R is Reserve Requirements; and M is Margin on securities.

Which of the following are components of total long term capital of a corporation?

Common Stockholders' Equity, Preferred Stockholders' Equity, Long Term Bonded Debt

If the Federal Reserve Board tightens credit via open market operations, which of the following will be the slowest to respond?

Consumer rates, such as passbook savings rates and credit card interest rates are fairly constant. Banks do not adjust these rates because consumers are not as sensitive to interest rate changes and are uncomfortable with rapidly changing market rates. If the Federal Reserve tightens credit via open market operations (to do this, it would use reverse repurchase agreements), market driven rates will be the first to respond. The Federal Funds rate (overnight loans of reserves from bank to bank) and the broker loan rate (loans to brokers with securities as collateral) would respond almost instantly.

Which of the following is a leading economic indicator?

Contracts for plant and equipment are a leading indicator, since these must be built or produced over the coming months. Personal income levels is a coincident indicator, showing current earnings for consumers. Both employment duration (how long the average person worked before being terminated) and labor cost per manufactured unit are lagging indicators, since they show what has already happened.

Accrual Accounting must be used for publicly traded companies per SEC rules.

Corporate financial records are kept using accrual accounting - a method that attempts to match revenues and expenses. Very small non-public companies can use cash accounting, which simply records revenues when cash payment is received; and liabilities when payment is made. In contrast, accrual accounting books revenue when services or product is delivered (but payment typically occurs in the future); and liabilities when incurred (again, payment of the liability typically occurs in the future).

The Federal Reserve might consider an easing of credit if which of the following decline?

Declining unemployment means that the economy is chugging along nicely and does not need the stimulus of credit easing. Lower GDP indicates that a credit stimulus may be needed; stock prices fall in response to either higher interest rates or other bad economic news - the Fed may attempt to correct the situation by easing credit. If the Consumer Price Index is falling, inflation is lower, and credit can be eased without kindling inflationary fears.

Recession

During prolonged periods of recession, interest rates drop. This occurs because the Federal Reserve loosens credit to get the economy moving again; and because demand for loans falls as business activity drops.

Which of the following are terms that describe economic indicators?

Economic indicators either lag the economy; lead the economy; or are coincident with the economy. There is no such terminology as a concomitant indicator

During which phase of the economic cycle would one most likely find monetary "inflation" starting to occur?

Expansion

During the expansion phase of an economic cycle is when inflation begins to build. As output expands and there are fewer unemployed workers, pressure is put on employers for wage increases. As output expands, increased demand for goods and services also causes prices to rise. Thus, inflation tends to accelerate.

Expansion phase

FED

Fiscal policy is set by Congress. It includes setting the level of government spending, setting tax rates, and setting the level of transfer payments such as social security payments. The balance of payments (level of imports versus the level of exports) is also influenced by fiscal policy.

Fiscal policy

Fiscal policy is set through Government Actions (approved by Congress) that influence economic activity. Fiscal policy encompasses the tax code, government transfer payment levels, and government spending. Monetary policy is controlled by the Federal Reserve Board.

GDP

GDP is Gross Domestic Product - the sum of all goods and services produced within a country. If a country exports more, it is producing more within that country and GDP increases. If a country imports more, it is producing less within that country and GDP decreases.

Fiscal policy encompasses which of the following?

Government spending, Social security payment levels, Tax policy

Gross Domestic Product

Gross Domestic Product is the sum of all goods and services produced in this country. To make GDP comparisons valid, GDP is measured in constant dollars, using a GDP deflator.

Corporation declares a stock dividend

If a corporation declares a stock dividend, the dividend is "appropriated" from retained earnings (reducing retained earnings) and is used to increase the number of common shares outstanding (increasing aggregate par value and capital in excess of par proportionately). At the same time, par value per common share remains the same. The net result is a "wash," with no dollar change in total stockholders' equity.

stock dividend

If a corporation declares a stock dividend, the dividend is appropriated from retained earnings (reducing retained earnings) and used to increase the number of common shares outstanding. Par value per share remains the same, but since there are more shares outstanding, aggregate par value increases (as does capital in excess of par). The dollar decrease in retained earnings exactly equals the increase in common at par, and capital in excess of par, so the net result is a "wash," with no dollar change in total stockholders' equity.

splits

If a corporation splits its stock, the number of shares is increased proportionately; and the par value per share is reduced proportionately. On the "ex" date, the exchange reduces the market price of the stock to reflect the split. Thus, both Choices I and II are correct. There is no effect on Retained Earnings for a split (though there is a reduction to retained earnings if a "dividend" is paid). Finally, the company's "Price / Earnings" ratio will stay the same, because both the stock's market price and earnings per share will be reduced in the same proportion as a result of the split, keeping the ratio constant.

A corporation declares a cash dividend to shareholders. Which of the following choices are affected?

If a dividend is declared, then it is not yet paid. Dividends payable increases (a current liability) and net worth decreases (since the dividend is appropriated from retained earnings). If current liabilities increase, then working capital falls.

A corporation buys furniture and fixtures, paying cash. Which of the following choices are affected?

If furniture is bought with cash, then cash goes down (a current asset) and property, plant and equipment increases (a long term asset). If current assets drop, then working capital drops. There is no effect on current liabilities because the furniture is paid for; net worth is only affected by a profit, loss, dividend payout, or capital structure change.

If net income before tax falls at a faster rate than operating income then which statement is true? Bond interest expense is increasing at a faster rate than operating expenses.

If net income before tax falls at a faster rate than operating income then bond interest expenses must be increasing at a faster rate than operating expenses such as cost of goods sold and depreciation. Dividends are paid out of after tax net income and would not impact either operating income or reported net income.

The term "hawkish" monetary policy means that:

If the Fed is worried about inflation and an economy that is expanding too rapidly, it needs to reduce the available money supply and reduce the level of loans being made. To do this, it would raise interest rates. This is commonly known as the Fed taking a "hawkish" tone - which comes from Federal Reserve leaders being "inflation hawks" on the watch-out for inflation, and raising rates to keep it in check. In contrast, if the Fed is taking a "dovish tone," then Fed policy makers are taking a looser monetary policy, keeping rates low to fuel growth.

The Federal Reserve Bank has made a policy decision to devalue the U.S. Dollar versus the Japanese Yen. Which of the following intervention actions would decrease the U.S. Dollar's exchange value?

If the Federal Reserve wishes to devalue the U.S. Dollar against the Japanese Yen (which would make our goods cheaper to the Japanese and would increase exports), it would sell U.S. Dollars and buy Japanese Yen. To increase the value of the dollar, it would do just the opposite - buy the dollar and sell the yen.

If the U.S. dollar appreciates against foreign currencies, which statements are TRUE?

If the U.S. dollar appreciates against foreign currencies, then U.S. goods become more expensive to foreigners, while foreign goods become cheaper in the U.S. This should cause exports to decrease, and imports to increase. If the U.S. is running a trade deficit, the increase in net imports will widen the deficit.

If the balance of payments is running a deficit, which of the following statements are TRUE?

If the balance of payments is running a deficit, then more U.S. Dollars are being spent abroad for foreign goods and services than are being spent in the United States by foreigners for domestic goods and services. Increased levels of U.S. imports will cause more dollars to leave the U.S., widening the deficit.

If the dollar falls against foreign currencies, all of the following statements are true EXCEPT:

If the dollar falls, U.S. goods become cheaper to foreigners and foreign goods become more expensive in the U.S. Thus, exports are likely to rise and imports are likely to fall. Since the dollar is cheaper, foreign currencies buy more dollars and/or goods.

A decreasing Consumer Confidence Index indicates that:

If the index is falling, then consumer confidence is low and future spending will be reduced. Conversely, an increasing index indicates that consumers are "confident," and thus are likely to spend money - resulting in increased future output.

reverse stock split

In a reverse stock split, the number of common shares outstanding is decreased and the market price per share is increased proportionately. Because the corporation's earnings will be spread over fewer shares, earnings per share will increase. However, the company's Price / Earnings ratio will remain constant because both the stock market price and the earnings per share will increase in the same proportion, keeping the P / E ratio unchanged.

hich statement is FALSE about GDP

Increasing inflation levels indicate that a country's GDP is increasing

GDP #2

Increasing production levels means that GDP is increasing. If the working population is increasing, then the country has the ability to produce more, so this is a positive for GDP. Increasing inflation is a negative for GDP - it discourages business investment.

A change in each of the following is a lagging economic indicator EXCEPT

Initial Claims for Unemployment is a leading economic indicator (since high initial claims indicate coming production cutbacks). Employment Duration (showing how long someone was employed before being terminated), Reported Corporate Profits (showing what was already earned in the last quarter), and the Inventory to Sales Ratio (showing what was produced and in inventory, relative to current sales) are all lagging indicators.

Speculators in foreign currencies would NOT be subject to which of the following risks?

Interest rate risk only affects fixed income securities. As interest rates rise, the stream of future fixed interest payments and final principal repayment are devalued, reducing the current value of the bond. This risk would not affect foreign currencies, which do not give investors an income stream. Speculators in foreign currencies are simply placing bets on the future value of that currency. They assume political risk, exchange rate risk, and market risk. Market risk in this case is simply the risk of being on the wrong "side" of the market - e.g., being long the currency only to have its value fall; or short the currency only to have its value rise.

money supply

The broadest measure of the money supply is "L." L consists of M-3 plus money market instruments and government savings bonds. Note that the Federal Reserve no longer computes M-3 or L, but these may still be tested.

All of the following ratios measure a company's ability to pay bills as they come due, EXCEPT inventory turnover ratio.

The cash assets ratio is the ratio of cash to current liabilities; this is the most stringent test of liquidity. The quick ratio (or "acid test") is the ratio of current assets - inventories and prepaid expenses to current liabilities. This is a less stringent test than the cash assets ratio. The current ratio is the ratio of all current assets to current liabilities. This is the least stringent test of liquidity. The inventory turnover ratio is the ratio of annual cost of sales to year end inventory. It shows how quickly a company is selling and replacing its inventory.

The interest rate charged from the Federal Reserve to member banks is the

The lowest rate is the Federal Funds Rate. This is the rate on overnight loans of reserves from bank to bank. The next highest rate is the Discount Rate. This is the rate that the Federal Reserve charges member banks for borrowing reserves from the Fed. The next highest rate is the Broker Loan Rate. This is the rate that brokerage firms can borrow from banks using securities as collateral. The highest rate is the Prime Rate. This is the rate for unsecured borrowing from banks by the best corporate customers

money supply #2

The measures of the money supply are: M-1 includes currency in circulation and demand deposits. M-2 includes M-1 plus time deposits of $100,000 or less. M-3 includes M-2 plus time deposits over $100,000. L is M-3 plus savings bonds and money market instruments, and is the broadest money supply measure.

A change in each of the following is a coincident economic indicator EXCEPT:

The money supply level as measured by M-2 is a leading economic indicator, since if the money supply is rising, there is easy credit, encouraging spending. Personal income levels, the index of industrial production, and employment levels all show current activity and are coincident indicators.

The usual order of the economic cycle is:

The normal sequence of the economic cycle is a period of expansion, followed by an economic peak (prosperity), followed by a decline in economic activity (recession), followed by an economic recovery leading to further expansion, etc.

Which of the following will affect net working capital?

When a cash dividend is declared, it is appropriated from retained earnings and set up as a current liability - Dividends Payable. An increase in current liabilities reduces working capital. When a stock dividend is declared, it is appropriated from retained earnings and used to increase common at par and capital in excess of par. There is no effect on working capital. If a company reduces its allowance for bad debts, this increases accounts receivable (a current asset). If current assets rise, working capital rises. Increased depreciation deductions decrease the value of fixed assets and do not affect working capital.

To counter a recession, the Federal Reserve would:

buy securities in the open market

If a corporation declares a stock dividend, which statement is FALSE?

capital in excess of par decreases.

Open market operations of the Federal Reserve:

cause direct changes in M1 and influences interest rate levels.

The Federal Reserve will lend funds at the discount rate to:

commercial banks

Common stock ratio

common at par plus capital in excess of par plus retained earnings (common equity) divided by (total long term capital) which is long term debt plus preferred stock plus common equity.

Which of the following investments is LEAST defensive during deflationary periods?

common stock

Current Ratio total current assets to total current liabilities.

current assets divided by current liabilities equals current ratio.

Net Working Capital

current assets minus current liabilities equals net working capital.

Quick Ratio or acid test

current assets minus inventories and pre-paid expenses over current liabilities equals quick ratio

As the deficit narrows, fewer dollars are being spent abroad and more are being spent in the U.S. Decreased levels of U.S. imports will cause more dollars to stay the U.S., strengthening the dollar and narrowing the deficit. Increased sales of U.S. securities to foreign holders will increase the value of the dollar (foreigners have to spend their currency to buy dollar-denominated securities), narrowing the balance of payments deficit. Increased levels of foreign tourists visiting the U.S. will narrow the deficit, since dollars are being spent in the U.S. by more foreigners. Finally, increased dividends paid to foreign holders of U.S. securities will cause dollars to leave the U.S., widening the deficit.

deficit

In a deflationary period, interest rates will fall, raising the prices of fixed income securities. Thus, fixed income securities are defensive securities in times of deflation. Equity securities' price movements will depend on the state of the economy at the time deflation occurs, and thus would not be defensive.

deflation

During prolonged periods of economic recession all of the following will likely occur EXCEPT:

demand for loans rises

Which of the following will affect the reported net income per share of a corporation?

discontinuance of operations of an operating division, decrease in the number of common shares outstanding, change in accounting method for valuing inventories, increase in cost of goods sold.

During a period of inflation, the Federal Reserve would increase the:

discount rate

The interest rate charged from the Federal Reserve to member banks is the

discount rate

The interest rate charged from one Federal Reserve member bank to another Federal Reserve member bank is the:

federal funds rate

Which of the following interest rates is the lowest?

federal funds rate P D B F

Trading in the Interbank market will affect all of the following EXCEPT

future inflation levels

Keynesian Theory states that the economy is stimulated by:

increased Government spending

Foreign currencies trade in the "Interbank Market." Trading of foreign currency option contracts takes place on the Philadelphia Stock Exchange. Trading of listed equity options takes place on the CBOE, AMEX, PHLX, PAC, and ISE. Trading of bankers acceptances takes place in the "over-the-counter" market.

interbank market

Bond interest expense

of a corporation is deductible after operating expenses but before taxes.

Which tool of the Federal Reserve is used most frequently?

open market operations

Debt service coverage ratio

operating income divided by bond interest expense and upcoming required income payments that are coming due within the year.

Preferred Stock Ratio

preferred stock divided by total long term capital which is long term debt plus preferred stock plus common equity.

If a corporation repurchases its debt, then its capitalization will decrease (a corporation's long term capital consists of equity and long term debt). Corporations will repurchase debt to refinance at lower interest rates (not higher ones); to increase the market value of the corporation's common stock (since the corporation has less debt, the common stock would be valued more highly by the market); and to reduce the corporation's earnings fluctuations due to cyclical conditions. Corporate sales decrease due to cyclical conditions, but fixed interest charges do not. This causes earnings for common shareholders to fall greatly or become non-existent in period of falling sales. To reduce this possibility, a corporation can repurchase its debt.

repurchase of debt

which tool of the federal reserve is used the least?

reserve requirements

If a company sells additional common shares, the funds from the sale increase cash (thus increasing net working capital) and are credited to the company's capital at par and capital surplus (thus increasing net worth). As the number of outstanding shares increase, earnings per common share will fall (become diluted).

shares

An income statement

starts with revenue and deducts all operating expenses to arrive at operating income.

Monetary policy tools of the Federal Reserve Board include changing all of the following EXCEPT:

tax policies

Supply Side Theory states that the economy is stimulated by:

tax rate reductions.

The term "hawkish" monetary policy means that:

the Federal Reserve is tightening credit by raising interest rates

Monetarist Theory states that the economy is stimulated by:

the actions of the Federal Reserve