Unit 7.4 Investment Analysis & Strategies (Series 65)

A head and shoulders bottom formation is an indication of: A) the reversal of an upward trend. B) the reversal of a downtrend. C) a bearish market. D) a bullish market.

Answer: B A head and shoulders bottom formation is also known as an inverted head and shoulders formation. It is that part of a graph in which a downtrend has reversed to become an uptrend. It is not, however, an indicator of the bullishness or bearishness of the market as a whole. It is an indication only of the direction of a trend, which may be either short or long in duration. Reference: 7.4.4.5 in the License Exam Manual.

If a customer purchases a food company stock and a utility stock, the customer's portfolio is: A) balanced. B) defensive. C) diversified. D) cyclical.

Answer: B Food company stocks and utilities are defensive investments. Defensive investments are those that tend to hold up well in economic downturns. Reference: 7.4.2.1 in the License Exam Manual.

Which of the following events is of the greatest importance to a technical analyst? A) The company announced the resignation of its chief financial officer. B) The stock's price recently penetrated its resistance level. C) The issuer's current book value increased. D) Standard & Poor's raised the credit rating of the issuer.

Answer: B Technical analysts focus on market price patterns. Typically, a technical analyst becomes bullish when a stock's price exceeds its resistance level (it penetrates its former ceiling price). Book values, credit ratings, and the resignation of a company's senior officer are of interest to fundamental analysts. Reference: 7.4.4 in the License Exam Manual.

Which of the following rates of return is used by investment professionals as the risk-free rate? A) Discount rate. B) 90-day Treasury bill rate. C) Federal funds rate. D) Prime rate.

Answer: B The interest rate used as the basis for a risk-free rate of return is the 90-day Treasury bill rate. T-bills are U.S.-government guaranteed, the rate is short-term, and the market risk is minimal. Reference: 7.4.1 in the License Exam Manual.

Which of these industries would be considered defensive in the face of a recession? A) Real estate construction. B) Trucking. C) Food producer. D) Automobile manufacturing.

Answer: C Defensive industries are least affected by normal business cycles. Companies in defensive industries generally produce nondurable consumer goods, such as food, pharmaceuticals, tobacco, and energy. Public consumption of such goods remains fairly steady throughout the business cycle. During recessions and bear markets, stocks in defensive industries generally decline less than stocks in other industries. Reference: 7.4.2.1 in the License Exam Manual.

If a company with 10 million shares outstanding with total earnings of $50 million pays a $2 dividend, the dividend payout ratio is: A) 4%. B) 20%. C) 25%. D) 40%.

Answer: D Dividend payout ratio is determined by dividends paid per share divided by earnings per share. In this case, earnings per share (EPS) is $50 million ÷ 10 million shares = $5 per share. The company paid out in dividends $2 for each $5 earned for a 40% payout ratio ($2 ÷ $5). Reference: 7.4.3.9.5 in the License Exam Manual.

An investment adviser reviewing a company's price to book value is using: A) technical analysis. B) financial statement analysis. C) point and figure charting. D) fundamental analysis.

Answer: D Fundamental analysis is using the company's financial statements to determine value. Financial statement analysis is not the proper term (even though that is what is being done). Technical analysis does not look at the company's books. Rather it focuses on charting methods such as point and figure. Reference: 7.4.3.7.8 in the License Exam Manual.

Which of the following would be of least interest to a technical analyst? A) Short interest ratio. B) Advance/decline line. C) Trading volume. D) PE ratio.

Answer: D Technical analysts rely on price and trading trends to determine when to buy or sell stock. They are not interested in the specific financial information of an issuer; PE ratios are of greater interest to fundamental analysts. Reference: 7.4.3.9.6 in the License Exam Manual.

FNK reported earnings of $2.47 per share last year on its stock, which is trading at 24.75. It paid a $.93 dividend on its common stock. What was its dividend payout ratio? A) 26.6%. B) 67%. C) 10%. D) 38%.

Answer: D The company earned $2.47 per share and paid a $.93 dividend per share, which is 38% of the earnings ($.93 ÷ $2.47 = 38%). Reference: 7.4.3.9.5 in the License Exam Manual.

According to technical analysis, when the market is consolidating, a chart showing the market trendline appears to be moving: A) sideways within a narrow range. B) upward to reach a new peak. C) downward to reach a new low. D) downward with sporadic upswings.

Answer: A A consolidating market is one that stays within a narrow price range. When viewed on a graph, the trendline is horizontal and is said to be moving sideways, meaning neither up nor down. Reference: 7.4.4.3 in the License Exam Manual.

All of the following statements would likely be true regarding those who are technical analysts EXCEPT they: A) would focus on the price to book value. B) are not concerned with dividend returns. C) analyze market movements. D) are more concerned with short-term trading than long-term investing.

Answer: A A technical analyst is concerned with market prices, trends, and volumes of securities, but not fundamentals such as book value and dividend returns. Reference: 7.4.4 in the License Exam Manual.

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

Answer: A A technical analyst is interested in statistics about market or price performance, not the fundamental factors, the market, or the company's dividend policy. Technical analysts are interested in trading volume as a market statistic, new highs and lows, and open short positions, which could indicate future buying potential in the security. Reference: 7.4.4 in the License Exam Manual.

In an efficient market: A) any information that could affect a stock's value is quickly reflected in its price. B) information is disseminated slowly. C) it is fairly easy to predict major market swings. D) investors have a good chance of beating the market.

Answer: A An efficient market is one in which every individual can quickly obtain and use information about new events in the marketplace. Because information is disseminated quickly, any new information that could affect a stock's value is quickly reflected in its price. Reference: 7.4.6.1 in the License Exam Manual.

Which of the following analyze corporate financial statements and trends in sales and income? A) Fundamentalists. B) Chartists. C) Technicians. D) Market timers.

Answer: A 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. Reference: 7.4.2 in the License Exam Manual.

Growth companies tend to have all of the following characteristics EXCEPT: A) low PE ratios. B) low dividend payout ratios. C) high earnings retention ratio. D) potential investment return from capital gains rather than income.

Answer: A Growth companies have high PE ratios and a low dividend payout ratio because they retain most if not all of their earnings. Investors anticipating fast growth bid up prices so PE ratios tend to be high. Growth companies retain most of their earnings to fund future growth. Investors select growth companies for capital gain potential, not for investment income. Reference: 7.4.3.9.6 in the License Exam Manual.

A profitable company reports net income of $10 million. A cash dividend of $7 million is declared. From an accounting standpoint, the other $3 million will be credited to which balance sheet account? A) Retained earnings. B) Capital surplus. C) Working capital. D) Dividends payable.

Answer: A Retained earnings are increased to the extent that company profits (net income) are undistributed; in essence, retained. Capital surplus comes from original investors purchasing stock at a price in excess of stated or par value. Working capital is not a balance sheet account; it is a computation. When the dividend is declared, it becomes a current liability (dividends payable), but this question is asking for the portion of the income that is not going to be paid out. Reference: 7.4.3.4.3 in the License Exam Manual.

In the technical analysis of the value of securities, which of the following items is NOT important? A) The amount of a company's past earnings. B) The breadth of market volume. C) A prevailing market trend in response to shifts in supply and demand. D) Resistance and support levels.

Answer: A The amount of a company's past earnings is a factor used in the fundamental analysis of securities, but not technical analysis. Technicians rely on market trends and supply and demand factors, as well as chart indications such as resistance and support levels. Reference: 7.4.4 in the License Exam Manual.

What is the balance sheet equation? A) Assets = liabilities + shareholders' equity. B) Assets = liabilities − shareholders' equity. C) Assets = net worth. D) Assets = shareholders' equity − liabilities.

Answer: A Total assets equal total liabilities plus total shareholders' equity. Reference: 7.4.3.1 in the License Exam Manual.

On a balance sheet, dividends payable would fall under the category of: A) stockholders' equity. B) current liabilities. C) assets. D) fixed liabilities.

Answer: B Dividends payable are dividends that have been declared but have not yet paid out. They are a type of current liability; that is, an obligation that will come due within one year from the date on the balance sheet. Reference: 7.4.3.3.1 in the License Exam Manual.

Which of the following would be of least interest to a chartist? A) The short interest. B) The advance-decline line. C) The relationship between the current market price of an issuer's common stock and most recently reported earnings per share. D) The volume of shares traded during the past month.

Answer: C A chartist is interested in the volume of shares traded, and the short interest for that particular stock. The advance-decline line is another technical indicator. The price-to-earnings ratio is used in fundamental as opposed to technical (charting) analysis. Reference: 7.4.5 in the License Exam Manual.

If an investor wanted to verify a company's working capital, she would do so by reviewing their: A) footnotes. B) income statement. C) balance sheet. D) cash flow statement.

Answer: C Working capital, current assets minus current liabilities, is determined from numbers found on the balance sheet. Reference: 7.4.3.5 in the License Exam Manual.

XYZ Corporation has a market price of $45 per share and earnings per share of $3 when XYZ announces a 3-for-1 split. After the split, the price-to-earnings ratio of XYZ will be: A) 3 B) 5 C) 45 D) 15

Answer: D Before the split, the company had a P/E ratio of 15 ($45 per share ÷ $3). After the split, the price per share and the EPS drop in the same proportion, leaving the PE ratio unchanged (new price = $15, new EPS = $1). Reference: 7.4.3.9.6 in the License Exam Manual.

Which of the following expense items increases a company's cash flow? A) Depreciation. B) Contributions to the firm's qualified retirement plan. C) Interest on long-term debt securities. D) Services provided through outsourcing.

Answer: A The basic computation for cash flow is net income plus depreciation expense for that year. Reference: 7.4.3.8.2 in the License Exam Manual.

Which of the following statements about balance sheets are TRUE? I. Balance sheets provide a snapshot of a company's financial position on a given date. II. Balance sheets represent the relationship between a company's assets, liabilities, and stockholders' equity. III. Balance sheets provide a record of a company's earnings over a given period. A) I, II and III. B) I and II. C) I and III. D) II and III.

Answer: B A balance sheet shows a company's assets, liabilities, and stockholders' equity on a specific date. The financial statement that reflects a company's operating activities and earnings over a period of time is the income statement. Reference: 7.4.3.1 in the License Exam Manual.

If an economist was describing defensive issues, he would probably not include companies that produce: A) tobacco products. B) building materials. C) food products. D) clothing.

Answer: B Defensive issues are issues that are defensive against a downturn in the economy. Building materials are usually susceptible to downturns when the economy is bad. Reference: 7.4.2.1 in the License Exam Manual.

In the assessment of a company's stock, a technical analyst takes into consideration all of the following EXCEPT: A) price momentum. B) volume. C) earnings. D) market price.

Answer: C A market technician (technical analyst) deals primarily with timing of activity and market trends, while a fundamental analyst centers on a particular industry or company within an industry and its relative health and market potential. Reference: 7.4.4 in the License Exam Manual.

KPT, Inc. is preparing to report its net income for the past year. An increase in which of the following causes a decrease in the reported net income? I. Tax rate. II. Cash dividend. III. Allowance for bad debts. A) I and II. B) II only. C) I and III. D) I only.

Answer: C Higher taxes mean less net income. The allowance for bad debts is an expense item; increasing it lowers operating income. Dividends are paid out of retained earnings and have no effect on the net income the company reports. Reference: 7.4.3.8.1 in the License Exam Manual.

Debts that will come due more than 1 year after the date on the balance sheet are known as: A) current liabilities. B) accounts payable. C) deferred charges. D) fixed (or long-term) liabilities.

Answer: D Debts that will come due more than 1 year after the date of the balance sheet are known as fixed (or long-term) liabilities. Current liabilities are debts that may come due within 1 year from the date on the balance sheet. Reference: 7.4.3.3.2 in the License Exam Manual.

Which of the following factors would be considered by an investor who uses fundamental analysis to value a company's stock? I.The company's financial condition, as revealed by its income statement and balance sheet II.General economic conditions, such as employment levels and changes in interest rates III.Charts showing past movements in stock prices and trading volumes A) I and III B) II and III C) I, II, and III D) I and II

Answer: D Fundamental analysis attempts to value stock by examining general economic conditions and the company's financial condition and growth prospects. Technical analysis, on the other hand, tries to identify trends and predict changes in the market. Charts showing past price movements and trading volumes would be used in technical analysis but not in fundamental analysis. Reference: 7.4.2 in the License Exam Manual.

If during a given year a company has net income of $1 million and pays out dividends of $800,000, its retained earnings will: A) decrease by $200,000. B) decrease by $1 million. C) increase by $1 million. D) increase by $200,000.

Answer: D Retained earnings represent the net income a company has retained and not paid out in dividends. If a company has net income of $1 million and pays out only $800,000 in dividends, its retained earnings will increase by $200,000. Reference: 7.4.3.4.3 in the License Exam Manual.

A technical analyst (chartist) with a long position in a particular stock would most likely enter a sell stop order below that stock's: A) resistance level. B) previous high. C) 200-day moving average. D) support level.

Answer: D Sell stops are entered below the market. They are used to turn an order into a market order if the current market value falls below the stop level. In technical analysis, support levels are theoretical levels where the market supports the stock price (keeps it from falling below the stated level). A technical analyst who makes investment decisions by watching the technical graphs and numbers would enter a sell stop below a support level in order to sell out if the support level is breached. A breakthrough of a support level is believed to forecast a major market price decline. Reference: 7.4.4.6 in the License Exam Manual.

Which of the following indices or averages is based on the prices of only 65 stocks (30 industrial, 20 transportation, and 15 utility)? A) S&P Composite. B) Value Line. C) Wilshire 5,000. D) Dow Jones Composite Average.

Answer: D The most widely quoted and oldest measures of changes in stock prices are the Dow Jones averages. They are also the smallest in terms of the number of stocks included in the averages with only 65 stocks. Reference: 7.4.4.12 in the License Exam Manual.

Which of the following statements is TRUE? A) Dividends have a significant influence on the value of the corporation's stock. B) A corporation is required to pay a cash dividend to stockholders if the earnings are sufficient, especially if it is of preferred stock. C) A growth company would be more likely to pay a cash dividend than a stock dividend. D) A stock split increases the owners proportionate share of the company.

Answer: A Dividends play a large role in what someone is willing to pay for the stock. For example, the dividend discount model (DDM) values a stock as the discounted present value of future dividends. A company is not required to pay dividends. A growth company will tend to pay no cash dividends but rather use the money for expansion. Reference: 7.4.3.7.5 in the License Exam Manual.

A technical analyst would be least concerned with A) book value per share. B) short interest. C) S&P 500 index. D) advance/decline.

Answer: A A technical analyst is not concerned with any fundamental aspects of a company, including company financials. Open short interest theory, overall market movements, and advance/decline ratios are of concern to technical analysts. Reference: 7.4.4 in the License Exam Manual.

If a corporation issues mortgage bonds, all of the following would be affected EXCEPT: A) shareholder's equity. B) total assets. C) total liabilities. D) working capital.

Answer: A When issued, the corporation receives the net proceeds in cash, increasing current assets (and thus total assets). Simultaneously, the corporation's long-term liabilities increase reflecting the debt (and thus total liabilities). Working capital increases because of the increase in current assets. Shareholder's equity, or net worth, is only affected by the sale of new equity securities or by any profit or loss generated by the corporation. Reference: 7.4.3.7 in the License Exam Manual.

A company's working capital equals its: A) current assets minus its current liabilities. B) current liabilities minus its current assets. C) fixed assets minus its fixed liabilities. D) cash flow minus its retained earnings.

Answer: A Working capital is a measure of how well a company can meet its current obligations. It is the amount that is left free and clear if all current debts are paid off. Working capital is calculated by subtracting current liabilities from current assets. Reference: 7.4.3.5 in the License Exam Manual.

Which of the following best describe the balance sheet formula? I. Assets minus liabilities equals net worth. II. Sales minus expenses equals operating income. III. Liabilities plus equity equals assets. IV. Dividends plus retained earnings equals net income. A) II and IV. B) I and III. C) I and IV. D) II and III.

Answer: B A balance sheet basically lists what is owned (assets) and what is owed (liabilities). The difference between these two is the net worth or equity. Sales, expenses, and dividends are all found on the income statement. Reference: 7.4.3.1 in the License Exam Manual.

Current assets on a corporate balance sheet would include I. accounts payable. II. accrued wages. III. cash. IV. inventory. A) II and IV. B) III and IV. C) I and II. D) I and III.

Answer: B Cash is the most obvious current asset. The general definition of a current asset is one that is expected to be turned into cash within the year. One would certainly hope that to be true of inventory. Accounts payable and accrued wages are liabilities, obligations that must be paid on a current basis. Reference: 7.4.3.2.1 in the License Exam Manual.

Liquidity ratios measure the solvency of a firm or the firm's ability to meet short-term financial obligations. Which of the following is a liquidity ratio? A) Dividend divided by earnings per share. B) Current assets divided by current liabilities. C) Gross profit divided by net sales. D) Net income divided by average total equity.

Answer: B Current assets divided by current liabilities is the current ratio, a ratio that measures the liquidity of a firm. Gross profit divided by net sales is a profitability ratio that measures the gross profitability of the firm's business operations, not its liquidity. Net income divided by average total equity is the return on stockholders' equity which measures the efficiency of common shareholders' investment or equity in the firm. Dividend amount divided by earnings per share is the dividend payout ratio which measures how much of a company's earnings are distributed to common stockholders. Reference: 7.4.3.5 in the License Exam Manual.

A customer purchased 100 shares of SNP at $38. At the time of purchase, the PE ratio was 12. Approximately what are the earnings per share of SNP? A) $3.80. B) $12.00. C) $3.20. D) $1.20.

Answer: C The PE ratio is a comparison of the current market price at the close to the earnings of the company; $38 (CMV) ÷ 12 (PE ratio) = $3.16 (approximate EPS). Reference: 7.4.3.9.1 in the License Exam Manual.

The dividend payout ratio of common stock is found by dividing the annual dividend per share by the A) market price. B) capitalization per share. C) earnings per share. D) book value.

Answer: C The key to the question is "ratio", which in this case is the relationship between dividends per share and their source of earnings per share. Reference: 7.4.3.9.5 in the License Exam Manual.

Financial statement analysis frequently relies upon a review of the target company's cash flow statement. To get the most accurate indication of cash flow, an analyst will add which of the following to net income: A) Dividends paid. B) Equipment sold. C) Depreciation expense. D) Accumulated depreciation.

Answer: C The most common formula for the cash flow from operations computation is net income plus the depreciation expense taken for the year. Reference: 7.4.3.8.2 in the License Exam Manual.

The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is: A) reported as cash income on the income statement. B) an integral part of the footnotes to the balance sheet required by generally accepted accounting principles. C) the net change in the cash position of the firm for the reporting period. D) reported as a separate line item on the balance sheet.

Answer: C The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is the net change in the cash position of the firm for the reporting period. The sum total, or the net change in cash, is not reported on either the balance sheet or the income statement. It is the sum total of the entries on the statement of cash flows which is a separate financial statement. Reference: 7.4.3.10 in the License Exam Manual.

A corporation calls in a portion of its long term debt at 101. This will have the effect of: I. decreasing working capital. II. increasing working capital. III. decreasing net worth. IV. increasing net worth. A) I and IV. B) II and III. C) II and IV. D) I and III.

Answer: D Working capital is computed by subtracting current liabilities from current assets. Using a current asset, like cash, to call in the bonds, reduces those assets with no corresponding reduction to current liabilities. Whenever a bond is called at a premium, net worth is reduced by that premium. Reference: 7.4.3.7.3 in the License Exam Manual.

The financial ratio that shows the relationship between the price of a company's stock and the company's net worth (stockholders' equity) is the: A) dividend discount ratio. B) price-to-book value ratio. C) price-earnings (PE) ratio. D) price-sales ratio.

Answer: B The price-to-book value ratio is calculated by dividing the price per share by the stockholders' equity per share. This ratio shows the relationship between a company's stock price and the company's book value. Reference: 7.4.3.9.7 in the License Exam Manual.

A client has 100 shares of GHI when the stock undergoes a split. After the split, the client has: A) a proportionately increased interest in the company. B) greater exposure. C) no effective change in the value of the position. D) a proportionately decreased interest in the company.

Answer: C When a stock splits, the number of shares each stockholder has either increases or decreases (in the case of a reverse split). The customer experiences no effective change in position because the proportionate interest in the company remains the same. Reference: 7.4.3.7.5 in the License Exam Manual.

If the assets of a company did not change, but stockholders' equity declined, it would follow that: A) liabilities increased. B) liabilities declined. C) retained earnings increased. D) capital surplus decreased.

Answer: A Stockholders' equity equals assets minus liabilities. If assets stay the same, then an increase in liabilities will cause a decline in equity. Reference: 7.4.3.1 in the License Exam Manual.

Which of the following statements regarding a 2-for-1 stock split are TRUE? I. The share price is reduced by half. II. The total market value of the outstanding stock decreases. III. The total market value of the outstanding stock may increase or decrease as a result of the split. IV. The number of shares doubles. A) II and IV. B) I and IV. C) I and III. D) II and III.

Answer: B In a 2-for-1 stock split, the number of outstanding shares is doubled and the price is reduced by half. The total market value (market cap) of the issuer's stock remains the same. Reference: 7.4.3.7.5 in the License Exam Manual.

The type of financial statement that shows a record of a company's operating activities and earnings over a stated period of time is a(n): A) balance sheet. B) cash flow statement. C) retained earnings statement. D) income statement.

Answer: D An income statement reflects a company's operating activities and earnings over a stated period of time. A balance sheet, on the other hand, provides a snapshot on a given date. A retained earnings statement shows how much of its earnings a company has retained for future growth, while a cash flow statement reflects where the company's cash flow came from and where it went. Reference: 7.4.3.8 in the License Exam Manual.

A fundamental analyst would be most interested in which of the following? A) A 200-day moving average. B) Resistance and support levels. C) The outstanding short interest in the market. D) A PE analysis of the stocks included in the Dow Jones Industrial Average.

Answer: D Fundamentalists look at PE ratios; the other tools mentioned are technical. Reference: 7.4.3.9.6 in the License Exam Manual.

Which of the following statements best describes the risk-free rate of interest? A) The rate of interest earned on a corporate bond that is guaranteed by a highly rated insurance company B) Rate of interest on a municipal security C) Rate of interest in excess of the pure time value of money D) The rate of interest earned on short-term U.S. Treasury securities

Answer: D The rate of interest earned on short-term U.S. Treasury securities, generally the 90-day T-bill, is referred to as the risk-free rate. The rate of interest in excess of the pure time value of money is called the risk premium, not the risk-free rate. Reference: 7.4.1 in the License Exam Manual.

Which of the following is NOT a source of cash reported on the statement of cash flows? A) Cash flows from operations. B) Cash flows from investing. C) Cash flows from financing. D) Cash flows from accounting changes.

Answer: D The statement of cash flows reported by U.S. companies does not contain an entry entitled "cash flows from accounting changes". Reference: 7.4.3.8.2 in the License Exam Manual.

Last year, ABC Corporation had earnings per share of $5 and paid a quarterly dividend of $.75 per share. It has a current market value of $75. What is its price-earnings ratio? A) 50:01:00 B) 15:01 C) 10:01 D) 25:01:00

Answer: B The dividend information is irrelevant. The price-earnings ratio is the price of the stock ($75) divided by the earnings of the stock ($5), or 15:1. Reference: 7.4.3.9.6 in the License Exam Manual.

An individual owns assets worth $500,000 and has debts of $300,000. What is the individual's net worth? A) $500,000.00 B) $800,000.00 C) $200,000.00 D) $300,000.00

Answer: C An individual's net worth equals the individual's assets minus his liabilities. Therefore, if someone has assets of $500,000 and debts of $300,000, the person's net worth is $200,000. Reference: 7.4.3.1 in the License Exam Manual.

One of the valuation ratios used by fundamental analysts is the Price/Earnings ratio. The P/E ratio is the current market price of the stock divided by the: A) investor's cost basis per share. B) dividends per share. C) book value per share. D) earnings per share.

Answer: D An analyst will compute the P/E ratio by taking the current market price per share and dividing it by the earnings per share. Reference: 7.4.3.9.6 in the License Exam Manual.

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

Answer: B 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. Reference: 7.4.3.1 in the License Exam Manual.

If a chart indicates that both the DJIA and the advance/decline line have been increasing since January, and the advance/decline line continues to rise, the market should: A) continue to rise. B) turn down moderately. C) turn down sharply. D) not change.

Answer: A A rising advance/decline line indicates that more stocks are rising in price than falling; a rising advance/decline line is a bullish indicator. Reference: 7.4.5.3 in the License Exam Manual.

Due to changes in customer preferences, a manufacturing company has decided to discontinue the operations of one of its subsidiaries. An explanation of this decision would most likely be found in the company's: A) footnotes to the financial statements. B) balance sheet. C) income statement. D) tax return.

Answer: A Footnotes are used to explain extraordinary items such as the sale of a subsidiary. Reference: 7.4.3.7.8 in the License Exam Manual.

SSS Corporation's total assets amount to $780,000 of which $260,000 represents current assets. Total liabilities equal $370,000, of which $200,000 is considered long-term or other liabilities. What is SSS Corporation's shareholders' equity? A) $410,000.00 B) $170,000.00 C) $980,000.00 D) $1,150,000.00

Answer: A Total assets minus total liabilities equals shareholders' equity ($780,000 − $370,000 = $410,000). Reference: 7.4.3.4 in the License Exam Manual.

ALFA Enterprises pays a quarterly dividend of $.15 and has earnings per share of $2.40. Assuming that payout rate is continued, what is the dividend payout ratio? A) 14.4%. B) 30%. C) 25%. D) 6.25%.

Answer: C Earnings per share are typically calculated for a year. If the quarterly dividend rate of $.15 is continued, that will be an annual payout of $.60 ($.15 × 4). So the annual dividend of $.60 is divided by $2.40 to calculate what percentage of earnings is paid as a dividend; or rather, the dividend payout ratio (.60 ÷ 2.40 = 25%). Reference: 7.4.3.9.5 in the License Exam Manual.

An inverted Head and Shoulders Formation would mean which of the following to a chartist? A) A bull market. B) A bear market. C) A reversal of an uptrend. D) A reversal of a downtrend.

Answer: D Head and Shoulders Formations indicate the reversal of market trends to chartists. An inverted formation would forecast the reversal of a downtrend. A Head and Shoulder's Top Formation would forecast the reversal of an uptrend. Reference: 7.4.4.5 in the License Exam Manual.

Which of the following is a stock valuation ratio? A) Dividend payout ratio. B) Operating profits to net sales. C) Revenues to assets. D) Price-earnings.

Answer: D The price-earnings (PE) ratio is a valuation ratio used to calculate the value of a stock. For example, if a stock has a PE of 20, it means that the security is priced at 20 times earnings. Reference: 7.4.3.9.6 in the License Exam Manual.

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) Margin of profit. D) Price-to-earnings ratio.

Answer: D The price-to-earnings ratio compares the market price of a stock to the company's earnings per share. When investors are very positive regarding a stock's future, the PE ratio will generally be higher than those of other companies in the same industry. Reference: 7.4.3.9.6 in the License Exam Manual.

Which of the following would be considered in the fundamental analysis of a security? I. Support and resistance levels. II. Trading volumes. III. Liquidity ratios. IV. Historical earnings trends. A) III and IV. B) I and II. C) II and III. D) I and IV.

Answer: A Fundamental analysts are concerned with information relating to the economy, industries, and individual companies. A company's liquidity ratios and past earning trends fall within these areas of concern. Concerns about the stock price and volume of trading would be of primary interest to a technical analyst. Reference: 7.4.3 in the License Exam Manual.

A technical analyst would be most interested in which of the following? A) 200-day moving averages. B) Price-to-earnings ratios. C) Capitalization ratios. D) Working capital.

Answer: A Technical analysts try to predict the market by examining price and volume trends. They expect the market to act in the future as it has in the past. Technical analysts are not interested in the fundamental aspects of a company, such as its financial statement ratios. Reference: 7.4.4.8 in the License Exam Manual.

All of the following appear on a corporation's balance sheet as fixed assets EXCEPT: A) real estate. B) furniture. C) computer equipment. D) inventory.

Answer: D Inventory is considered a current asset, not a fixed asset, because the company expects to convert its inventory into cash within a short period of time. The other choices are fixed assets and cannot be liquidated easily. Reference: 7.4.3.2.2 in the License Exam Manual.

If a technician believed in the importance of volume, which of the following would indicate bullish sentiment? A) Prices decrease on heavy volume. B) Prices increase on light volume. C) Prices decrease on light volume. D) Prices increase on heavy volume.

Answer: D Technicians watch volume changes along with price movements as an indicator of changes in supply and demand. A price increase on heavy volume relative to the stock's normal trading volume is interpreted as an indication of bullish activity. Reference: 7.4.4.7 in the License Exam Manual.

The financial ratio that shows the relationship between the price of a company's stock and the company's net worth (stockholders' equity) is the A) price-to-book value ratio B) price-earnings (PE) ratio C) price-sales ratio D) dividend discount ratio

Answer: A The price-to-book value ratio is calculated by dividing the price per share by the stockholders' equity per share. This ratio shows the relationship between a company's stock price and the company's book value. Reference: 7.4.3.9.7 in the License Exam Manual.

Components of a company's net worth would include all of these EXCEPT: A) goodwill. B) operating income. C) inventory. D) fixed assets.

Answer: B Net worth is all of the company's assets minus its liabilities as found on the balance sheet. Operating income is found on the income statement and is neither an asset nor a liability. Reference: 7.4.3.4 in the License Exam Manual.

Proponents of which of the following technical theories assume that small investors are usually wrong? A) Volume of trading. B) Odd lot. C) Breadth of market. D) Short interest.

Answer: B Odd lots are usually traded by small investors; some analysts believe small investors are generally wrong. Reference: 7.4.5.2 in the License Exam Manual.

A fundamental analyst is reviewing a company's financial statements. When attempting to determine their debt exposure, all of the following would be included EXCEPT: A) outstanding principal balance on long-term debt. B) taxes payable. C) accounts receivable. D) accounts payable.

Answer: C Accounts receivable are assets; all of the other listings represent liabilities of the company Reference: 7.4.3.2.1 in the License Exam Manual.

Under what circumstances will a dilution of equity occur? A) Stock dividend. B) Stock split. C) Issue of mortgage bonds to replace debentures. D) Conversion of convertible bonds into common stocks.

Answer: D 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. Reference: 7.4.3.9.2 in the License Exam Manual.

The research department of an investment advisory firm forecasts that the current business cycle should reach its peak within the next 2 months. Under such circumstances, which of the following portfolio adjustments would be most suitable for the firm's customers who actively invest in common stocks? A) Aggressive growth stocks. B) Corporate bonds. C) Cyclical stocks. D) Defensive stocks.

Answer: D The concept of sector rotation involves moving assets from those sectors that are close to their peak and moving into those who will benefit from the next move in the business cycle. Defensive stocks such as those in the food, pharmaceuticals, and energy industries would most likely be suitable for investors who believe the cycle is near its peak. Defensive stocks are least likely to be affected by a reversal in the business cycle. Reference: 7.4.2.1 in the License Exam Manual.

If a corporation has a dividend payout ratio of 70%, the undistributed earnings will: A) increase capital surplus. B) increase retained earnings. C) increase earnings per share. D) decrease book value.

Answer: B Retained earnings represent income that has not been paid out to shareholders. Reference: 7.4.3.4.3 in the License Exam Manual.

A technical analyst is least likely to consider which of the following when selecting securities? A) Advance/decline line. B) Trend lines. C) Corporate earnings. D) Short interest ratio.

Answer: C Corporate earnings would be of least interest to a technical analyst, who is interested in market statistics indicative of future buying, market statistics that could reflect price or market trends, and trading volume. Reference: 7.4.4 in the License Exam Manual.

If a company successfully gets its 7% debenture holders to exchange their 7% debentures for 7% preferred stock, what is the effect on EPS? A) Decrease. B) Increase. C) No effect. D) Not enough information.

Answer: A The 7% payment is moved from a pre-tax deduction to an after-tax payment. This increases the amount of taxable income, thereby increasing the company's tax liability. The 7% payment remains the same. With an increased tax burden and everything else remaining the same, the EPS will decrease. Reference: 7.4.3.7 in the License Exam Manual.

Which items change when a company pays a cash dividend? I. Working capital. II. Total assets. III. Total liabilities. IV. Shareholders' equity. A) II, III and IV. B) II and III. C) I, II and III. D) I and IV.

Answer: B When a dividend is paid, total assets are decreased as are total liabilities. The liabilities were increased at declaration time and are now decreased to reflect the payout. The two accounts affected would be decrease cash and decrease dividend payable. Reference: 7.4.3.6 in the License Exam Manual.

A fundamental analyst would be interested in all of the following EXCEPT: A) innovations within the automotive industry. B) daily trading volumes on the NYSE. C) statistics of the U.S. Department of Commerce on disposable income. D) corporate annual reports.

Answer: B Trading volume interests the technical analyst, who looks at fluctuations in the market, not at fundamental economic values. Reference: 7.4.4 in the License Exam Manual.

An analyst comparing revenues with expenses is most likely analyzing: A) working capital. B) capitalization. C) liquidity. D) cash flow.

Answer: D The analyst is most likely measuring the income statement for cash flow (money coming in against money going out). Working capital analysis would involve examining the balance sheet's current assets and current liability entries, not the income statement. Capitalization analysis involves examination of long-term debt and stock issues. Liquidity analysis involves examining current assets and liabilities from the balance sheet. Reference: 7.4.3.8.2 in the License Exam Manual.

Which items would change if a company declared a cash dividend? I. Working capital. II. Total assets. III. Total liabilities. IV. Shareholders' equity. A) I, III and IV. B) I only. C) I and IV. D) I, II, III and IV.

Answer: A The key word is "declared". Liabilities increase when a dividend is declared, and total assets decrease when it is paid. A declared dividend (but not yet paid) would increase current liabilities (and would therefore decrease working capital). It would increase total liabilities (this is a pending obligation) and reduce shareholders' equity because retained earnings would be decreased by the dividend. Total assets would not be affected until the dividend is actually paid. Reference: 7.4.3.6 in the License Exam Manual.

An analyst interested in measuring the breadth of market movement as an indicator of future market direction would monitor the: A) DJIA. B) Value Line Index. C) betas of the S&P 500 stocks. D) advance/decline line.

Answer: D The advance/decline line, which measures the number of stocks that have advanced versus the number of stocks that have declined, is an indicator of the breadth of the market's advance or decline. Reference: 7.4.5.3 in the License Exam Manual.

An investor's portfolio has a beta coefficient of .85. If the overall market declined by 10% over the course of a year, the portfolio's value has likely: A) decreased by 11.76%. B) decreased by 8.5%. C) increased by 8.5%. D) increased by 10.85%.

Answer: B A beta coefficient of .85 means that the portfolio is considered to be .85 times as volatile as the overall market. Therefore, if the market declines by 10%, the portfolio with a beta of .85 is likely to decline by only 8.5% (.10 × .85). Reference: 7.4.1 in the License Exam Manual.

Fundamental analysts give significant credence to financial ratios. Which of the following tends to give an indication of the profitability of the enterprise? A) Price to earnings ratio. B) Sales to earnings ratio. C) Current ratio. D) Debt ratio.

Answer: B The sales to earnings ratio compares the net sales of the business to its earnings. Companies with a higher percentage of earnings from each dollar of sales are more profitable. Reference: 7.4.3.9.6 in the License Exam Manual.

Which of the following is NOT affected by the issuance of a bond? A) Total liabilities. B) Working capital. C) Shareholders' equity. D) Assets.

Answer: C When bonds are issued, cash is received (thus increasing current assets) and long-term debt increases (increasing total liabilities). Because there is no corresponding increase in current liabilities, working capital increases. There is no effect on shareholders' equity because the increased liability is offset by the asset (cash) received. Reference: 7.4.3.7 in the License Exam Manual.

During the past year, the market price of Kapco common stock has increased from $47 to $50 per share. Over that period, Kapco's earnings per share (EPS) have increased from $2.00 to $2.50 per share, and their dividend payout ratio has decreased from 50% to 40%. Based on this information, the current yield on Kapco common stock is: A) 2%. B) 6.34%. C) 4.26%. D) 2.13%.

Answer: A The current yield on a stock is computed by dividing the annual dividend rate by the current market price. With EPS of $2.50 and a 40% payout ratio, the annual dividend is $1.00. This dollar divided by the current market price of $50 results in a current return of 2%. Reference: 7.4.3.9.4 in the License Exam Manual.

If a stock has a beta of less than 1.0, the stock's price will: A) increase more than the market when the market is up. B) decrease more than the market when the market is down. C) not increase as much as the market when the market is up. D) decrease regardless of whether the market is up or down.

Answer: C Beta compares a stock's price history to the movement of a total market index for the same period. A beta of less than 1 means that the stock's price does not swing as widely, up or down, as the average for the entire market. Reference: 7.4.1 in the License Exam Manual.

If a client has 100 shares of XYZ publicly traded stock and it undergoes a split, afterward the client will have: A) no effective change in the value of his ownership share. B) a proportionately decreased interest in XYZ company. C) a proportionately increased interest in XYZ company. D) a greater role in the daily management of the company.

Answer: A When a stock splits, the number of shares each shareholder holds increases. However, the value of each share decreases proportionately. The client experiences no effective change in the value of his ownership share. Reference: 7.4.3.7.5 in the License Exam Manual.

Which of the following items would normally NOT be considered a current asset on a balance sheet? A) Account receivables. B) Inventories. C) Land. D) Cash.

Answer: C A current asset is an asset that is already cash or that, in the normal course of business, will become cash within one year from the date on the balance sheet. A fixed asset, such as land, is an asset that is used over a long period in the normal course of business and that is not intended for sale. Reference: 7.4.3.2.1 in the License Exam Manual.

A fundamental analyst researching a stock is concerned with all of the following EXCEPT A) capitalization ratio B) volume of shares traded C) the stock's market price as a multiple of the company's earnings D) management efficiency

Answer: B A fundamental analyst is concerned with the economic climate, the inflation rate, how an industry is performing, a company's historical earnings trends, how it is capitalized, and its product lines, management, and financial statement ratios, such as the P/E ratio. A technical analyst is concerned with trading volumes or market trends and prices. Reference: 7.4.2 in the License Exam Manual.

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: A) unstable. B) oversold. C) overbought. D) becoming volatile.

Answer: B 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. Reference: 7.4.4.2 in the License Exam Manual.

During the past year, the market price of Kapco common stock has increased from $47 to $50 per share. Over that period, Kapco's earnings per share have increased from $2.00 to $2.50 per share and their dividend payout ratio has decreased from 50% to 40%. Based on this information: I. Kapco's P/E ratio has decreased. II. Kapco's P/E ratio has increased. III. an investor holding Kapco over this period would have noticed a decrease in income received. IV. an investor holding Kapco over this period would have noticed no change in income received. A) II and IV. B) I and IV. C) I and III. D) II and III.

Answer: B At the beginning of the period, the P/E ratio was 23.5 to 1 ($47 divided by $2.). At the end of the period, the P/E ratio was 20 to 1 ($50 divided by $2.50). Initially, Kapco was paying out 50% of its $2.00 per share earnings, or $1.00 in dividends. At the end, Kapco was paying out 40% of its $2.50 per share earnings, also $1.00 in dividends. Reference: 7.4.3.9 in the License Exam Manual.

The issuance of a debenture by a company would have an immediate effect on which of the following balance sheet items? I. Total assets. II. Total liabilities. III. Working capital. IV. Shareholders' equity. A) II, III and IV. B) I, II and III. C) I, II and IV. D) I, III and IV.

Answer: B The cash received from the sale of the bonds is a current asset of the company, and as such would increase assets and working capital on the balance sheet. The debentures are debt of the company and would increase the liabilities of the company. Shareholders' equity is only affected by gains, losses, new invested capital, and cash distributions (dividends) to shareholders. Reference: 7.4.3.7 in the License Exam Manual.

An investment strategy that is designed to minimize risk and preserve the investor's principal is a(n): A) growth investment strategy. B) market capitalization investment strategy. C) defensive investment strategy. D) aggressive investment strategy.

Answer: C An investment strategy can be either defensive or aggressive. A defensive strategy is one that is intended to minimize risk, preserve capital, and provide a somewhat stable income. An aggressive investment strategy is designed to maximize returns and assume greater risks. Reference: 7.4.2.1 in the License Exam Manual.

A corporation's balance sheet reveals cash of $100,000, accounts receivable of $20,000, and equipment of $300,000, resulting in total assets of $420,000. The document also shows accounts payable of $100,000, long-term liabilities of $200,000, and equity of $120,000. From this information you would determine the working capital to be: A) $200,000.00 B) $320,000.00 C) $20,000.00 D) $120,000.00

Answer: C Working capital is computed by subtracting current liabilities (accounts payable) from current assets (cash plus accounts receivable). In this case, it is $120,000 − $100,000 = $20,000. Reference: 7.4.3.5 in the License Exam Manual.

If a U.S. corporation wishes to issue Eurodollar bonds, which of the following statements are TRUE? I.The corporation will be subject to currency risk. II.The corporation will not be subject to currency risk. III.The issue must be filed with the SEC. IV.The issue need not be filed with the SEC. A) I and III. B) I and IV. C) II and III. D) II and IV.

Answer: D Because Eurodollar bonds are denominated in U.S. dollars, a U.S. corporate issuer will not be subject to foreign exchange risk, regardless of the country of issuance. In addition, because the bonds are issued outside the U.S., the issue is not registered with the SEC. Reference: 7.4.1 in the License Exam Manual.

Due to changes in market rates, a corporation is able to purchase some of its outstanding 20-year bonds at a discount. Which of the following is CORRECT? I. Working capital is increased. II. Working capital is reduced. III. Net worth is increased. IV. Net worth is reduced. A) I and III. B) I and IV. C) II and IV. D) II and III.

Answer: D Even though the bonds are purchased for less than par value, working capital is reduced because the company is using a current asset — cash — to pay off a long-term liability. However, the fact that it is reducing its debt for less than the amount shown on the books will result in an increase to net worth. Reference: 7.4.3.7.3 in the License Exam Manual.

Net income: A) is paid out in cash to stockholders in addition to any declared dividends. B) reflects the operating profits of a firm only. C) must be paid out in dividends. D) represents the amount of money remaining after all expenses including taxes.

Answer: D Net income is not a cash item that is paid out to stockholders. Dividends, both preferred and common, are generally cash distributions paid out from net income. Net income after taxes can reflect all sources of income in addition to the operating income generated by business activities. Net income also reflects investment income as well as operating income. Net income may be paid out in the form of dividends; however, most firms retain a portion of net income in order to reinvest the funds in the business. Reference: 7.4.3.8 in the License Exam Manual.

Which of the following factors would be considered by an investor who uses fundamental analysis to value a company's stock? I. The company's financial condition, as revealed by its income statement and balance sheet. II. General economic conditions, such as employment levels and changes in interest rates. III. Charts showing past movements in stock prices and trading volumes. A) II and III. B) I, II and III. C) I and II. D) I and III.

Answer: C Fundamental analysis attempts to value stock by examining general economic conditions and the company's financial condition and growth prospects. Technical analysis, on the other hand, tries to identify trends and predict changes in the market. Charts showing past price movements and trading volumes would be used in technical analysis but not in fundamental analysis. Reference: 7.4.3 in the License Exam Manual.

Which of the following statements about technical analysis are TRUE? I. Technical analysis tries to identify trends and predict market changes. II. Technical analysis is often accomplished by reviewing data in the form of charts. III. Technical analysis looks primarily at past performance to predict future trends. A) I and III. B) II and III. C) I, II and III. D) I and II.

Answer: C Technical analysts attempt to identify trends so they can predict market changes. They do this by reviewing past performance as depicted in charts and graphs. The type of analysis that attempts to value stock by examining a company's financial condition and growth potential is fundamental analysis. Reference: 7.4.4 in the License Exam Manual.

Which of the following statements about the price-earnings (PE) ratio are TRUE? I. A company's stock will have a relatively high PE ratio if investors feel the company's earnings will grow slowly. II. Young, fast-growing companies generally have higher PE ratios than mature, slower-growth companies. III. A company's PE ratio may also be called its multiple. A) I and III. B) I, II and III. C) II and III. D) I and II.

Answer: C A company's PE ratio, also called its multiple, may indicate investors' expectations about the company's earnings potential. A higher PE generally indicates that investors have high expectations for the company's future growth. Young, fast-growing companies generally have higher PE ratios than mature companies. Reference: 7.4.3.9.6 in the License Exam Manual.