Chapter 3: Practice Questions
A dealer posts a spread on Treasury notes of 103.08 - 103.16. For a $1,000 par note, what is the value of the spread? A. $.80 B. $8 C. $2.50 D. $5.00
***REVIEW A (X) C (O) Treasury notes are quoted in 32nds, and the question stated a par value of $1,000. First, 103.08 means 103 8/32, or a price of $1,030 + 8/32 of $10 ($2.50) = $1,032.50. Second, 103.16 means 10,316/32, or a price of $1,030 + 16/32 of $10 ($5) = $1,035.00. The difference between these two prices is the spread of $2.50.
9. To be considered a qualified plan, a retirement plan in the private sector must meet guidelines set by which of the following acts or agencies? I. IRS II. SEC III. AARP IV. ERISA A. II and IV B. I and IV C. I and III D. II and III
***REVIEW NFC, B?
When prices for a product are higher in one country than another, buyers will buy the product from a country whose currency is less valuable, thereby increasing the demand for the undervalued currency. This tendency toward balance is known as ____.
***REVIEW price equilibrium (X) Purchasing Power Parity (PPP) (O)
All of the following are characteristics of a Treasury bill except: A. They are sold at a discount to the par value. B. They pay low periodic interest payments. C. They are considered the safest of Treasury securities. D. They have a maximum 52-week maturity.
***REVIEW T-BILLS THOROUGHLY A (X) B (O) Treasury bills are issued at a discount from the $100 face value of the bill. They make no periodic interest payments. Because of their short lives, they are considered the safest of the Treasury securities.
How much would you pay for a $1,000 10-year Treasury bond priced at 95.08 (excluding accrued interest)? A. $95.08 B. $950.80 C. $952.50 D. $1,000.00
***REVIEW THIS THOROUGHLY B (X) C (O) Treasury bonds are typically priced in $10 units and in fractions of 32nds. The 95 would equate to $950, and the 0.08 is 8/32 of $10, which works out to $2.50 ($950 + $2.50 = $952.50).
A strengthening dollar will lead to a/n ____ in U.S. imports, while a weakening dollar will lead to a/n ____ in U.S. imports.
***REVIEW relationship between strengthening and weakening of domestic currency vs. demand for imports and exports decrease, increase (X) increase, decrease (O)
Assuming these are all equally available and you have equal knowledge of each and their relationship to the economy, which of the following indicators would be the best predictor of future expansion in the economy? A. Prime rate charged by banks B. Employment cost index C. Performance of the S&P 500 D. Producer Price Index
***review A (X) C (O) Performance of the S&P 500 is a leading indicator that may suggest the direction of the future economy.
7. The riskiest investment grade bond, according to Moody's, is rated: A. B3 B. Ba3 C. Baa3 D. Baa1
***review B (X) C (O) Using Moody's combination of letters and numbers to rate bonds, Baa3 is the lowest quality investment-grade bond available. S&P would rate the same bond BBB-.
2. In examining the suitability of a particular investment recommendation for a client, you are expected to consider all of the following except: A. Information about the client that is commonly known but that the client refuses to disclose B. The client's financial status and past investment experience C. The client's tax status D. The client's investment objectives and expectations
***review C (X) A (O) You are expected to know the client's financial status, tax status, and investment objectives. You are not expected to know information the client refuses to disclose.
14. All of the following statements regarding company balance sheets are true except: A. Balance sheets are broken down into assets, liabilities, and stockholder's equity. B. Balance sheets provide a snapshot of a company's financial well-being on a specific date. C. Balance sheets with excessive liabilities reduce the company's net worth. D. Balance sheets should show stockholder's equity equaling the sum of total assets and total liabilities.
***review C (X) D (O) A balance sheet represents the equation total assets = total liabilities + shareholders' equity. If you put equity on one side of this equation, then it would be equity = assets - liabilities. A company's assets are what the company owns. A company's liabilities are what a company owes, and shareholders' equity is the value of the company that shareholders own. The value of a company's total assets should always equal the value of the company's total liabilities and the company's shareholders' equity. A balance sheet is said to provide a snapshot of the financial condition of a business. The income statement provides a look at the financial condition of a business over a period of time (more like a movie instead of a snapshot).
When the Fed takes measures to increase the money supply, it is pursuing a ____ monetary policy. When the Fed takes measures to decrease the money supply, it is pursuing a ____ monetary policy.
***review inflationary, deflationary (X) stimulative, contractionary (O)
A rumor makes its way around the market that the currency of Pottsylvania is going to depreciate, so investors begin to sell. This is an example of ____.
***review political something? (X) speculation (O)
Which of the following is the most likely to be a spread of Treasury bills with a par value of $1,000? A. 3.25% - 3.35% B. 3.35% - 3.25% C. 97.5 - 98.0 D. 98.0 - 97.5
***review T-bill spreads D (X) B (O) -T-bills are quoted in yields rather than on a dollar or bond point basis. -Because the yield represents the discount that the investor receives of the bill's par value, an investor will want a larger yield and, thus, a larger discount to the price. For this reason, when a T-bill spread is quoted, the bid will be higher than the ask. -The dealer wants to buy T-bills at a higher discount (lower price) and sell at a lower discount (higher price) and profit from the difference.
An investor purchases a $1,000 TIPS note with an interest rate of 2%, and at the end of the first year, the CPI has risen to 3%. Which of the following is true? A. The second interest payment will be $30. B. The second interest payment will be $15. C. The second interest payment will be $20. D. The second interest payment will be $10.30.
***review TIPs NFC, D? (O) At the end of the first year, the CPI has risen to 3%. This means that the Treasury will increase the $1,000 principal by 3% to $1,030. To find the amount of the second interest payment, multiply the principal by half of the interest rate (because interest is paid semiannually) ($1,030 x 1% = $10.30).
8. A primary difference between U.S. Treasury securities and most agency securities is: A. Treasury securities pay higher interest rates. B. Agency securities are issued by individual states. C. Only Agency securities are sold via auction. D. Treasury securities are backed by the full faith and credit of the U.S. government.
***review agency securities (GINNIE, FANNIE, FREDDIE) D Treasury securities (bills, notes and bonds) are backed by the full faith and credit of the U.S. government. Most agency securities are not, though Ginnie Maes are backed by the full faith and credit of the U.S. government.
6. The risk that an investment will lose its value due to an overall decline in the market is called: A. Systematic risk B. Interest rate risk C. Inflation risk D. Specific risk
***review all the different types of risks A Systematic risk refers to the tendency of a downward trend in the overall investment market to depress individual securities.
Buying a ____ would help you hedge against the risk of an increase in the value of a foreign currency. Alternatively, buying a ____ would help you hedge against the risk of a decrease in the value.
***review calls and puts for currency hedging no clue, spots and swaps? (X) call, put (O)
10. Which of the following is not a coincident economic indicator? A. Personal income B. S&P 500 stock index C. Non-agricultural employment D. Index of Industrial Production
***review coincident economic indicators B Four coincident economic indicators are personal income, non-agricultural employment, the Index of Industrial Production, and manufacturing/trade sales. ***The S&P 500 stock index is a leading indicator.***
The discount rate is ____. A. The interest rate banks in the U.S. pay when they borrow money overnight from other banks to adjust their short-term reserves B. The interest rate offered on a discount bond C. The primary interest rate benchmark for short-term and medium-term commercials loans D. The interest rate banks in the U.S. pay when they borrow money overnight from the Federal Reserve
***review difference between federal funds rate and discount rate D The discount rate is what the Federal Reserve charges banks "at the discount window," and it is usually 25 to 100 basis points higher than the federal funds rate, which is what banks charge each other to borrow overnight.
What is the earnings per share of ABC Corporation, which reported before tax and interest earnings of $13,000,000; net income of $10,000,000; preferred dividends to be paid of $1,000,000; 5,000,000 issued shares of stock; and 3,000,000 outstanding shares of stock? A. $10 B. $4 C. $3 D. $2
***review how to calculate earnings per share no clue (X) C (O) -Earnings per share measures how much net income is available to COMMON shareholders per share. -To calculate earnings per share, take net income after taxes and subtract the dividends promised to preferred stockholders. Take this amount and divide it by the total number of outstanding shares of common stock. In this example, ($10,000,000 - $1,000,000) / 3,000,000 = $3.
Which of the following leading indicators does not indicate an expansion of the economy? A. Growing business inventories B. Increase in building permits C. Decrease in unemployment claims D. Narrowing liquidity spread
A Growing business inventories can signal a slowing of the expansion phase and a coming contraction because consumer demand has declined.
In a typical income statement, which of the following items is not deducted from gross revenues to arrive at operating income? A. Taxes B. Selling, general, and administrative expenses C. Depreciation and amortization D. Cost of goods sold
A Taxes are the last item deducted, comprising the difference between pre-tax income and net income after tax.
Why are housing starts an important leading indicator? I. Because construction projects take at least a few months, housing starts indicate optimism on the part of investors and consumers. II. Construction projects have a ripple effect—new workers may be hired and materials must be purchased, boosting the economy. III. Housing is the biggest industry within the GDP. IV. The Fed may react by reducing interest rates to make money less expensive to businesses and potential homeowners. A. I and IV B. I and II C. II and III D. III and IV
B Housing is not the biggest industry within the GDP, and the Fed reduces interest rates after a reduction in housing starts.
The four stages of the business cycle are: A. Expansion, contraction, recession, trough B. Expansion, peak, contraction, trough C. Expansion, peak, contraction, depression D. Expansion, contraction, recession, depression
B The four stages of the business cycle are expansion, peak, contraction, and trough.
Trades for U.S. Treasury securities settle: A. The next day B. The next business day C. The day after the next business day D. The third day after the next day
B Trades for U.S. Treasury securities, such as T-bills, notes, and bonds, settle on the next business day, also known as T + 1, or trade day plus one business day. Corporate and municipal bonds settle like stocks: two business days after the trade date, or T + 2.
A fundamental analyst would typically be least interested in which of the following? A. EPS B. Cash flow C. Performance of the S&P 500 D. P/E ratio
C A fundamental analyst is most concerned with the "fundamentals" of the company itself, such as the P/E ratio, EPS, and cash flow, and much less about the day-to-day activity of the stock or the market at large. In contrast, a technical analyst would base their decisions largely on the performance of the stock itself and the markets, reflected in an index such as the S&P 500.
1. Which of the following economic indicators is believed to give the earliest sign of the future direction of the economy? A. PPI B. CPI C. Housing starts D. GDP
C GDP, or gross domestic product, measures the dollar value of all the finished goods and services produced within the geographic boundaries of a country. GDP is the statistic that is most commonly used for identifying business cycles and for determining whether the country is in a recession or depression. It is considered to be a "coincident" indicator, that is, one that coincides with changes in the business cycle. The CPI or consumer price index is a monthly report released by the Bureau of Labor Statistics. It measures changes in the price of a "basket of goods" that a typical consumer might purchase, including food and energy products. The CPI is considered the best measure of inflation and because of this Treasury Inflation-Protected Securities (TIPS), Social Security, and many other public and private compensation contracts and labor agreements are tied to the CPI. The Producer Price Index (PPI) measures the price level producers pay for the goods and services they need to make their products. Formerly called the wholesale price index, the PPI is considered a coincident economic indicator like GDP. Housing starts and building permits are tracked monthly by the U.S. Census Bureau and the U.S. Department of Housing and Urban Development. While volatile, a trend in housing starts and building permits are considered leading indicators of where the economy is heading because they indicate plans for the future.
In fundamental stock analysis, the ____ is a snapshot of a company's financial condition at a point in time, whereas the ____ shows the results of the company's earnings and expenses over a particular period of time. I. Income Statement II. Pro forma III. Quick Ratio IV. Balance Sheet A. I and IV B. II and IV C. IV and I D. III and II
C Income statements are always stated for a time period, whereas balance sheets are stated as of a particular date.
Most interest-paying bonds pay interest every: A. Month B. Three months C. Six months D. Year
C Most interest-paying bonds pay interest every six months; this is also known as semiannually.
Non-cyclical stocks are also known as: A. Defense stocks B. Coincident stocks C. Defensive stocks D. Indicator stocks
C Non-cyclical stocks are also called defensive stocks. Defensive stocks do not respond to changes in the economy, because their companies produce goods and services that are needed in good times and bad.
11. The primary function of the Federal Reserve Bank is to: A. Issue new money into the U.S. economy B. Insure cash and cash equivalent deposits in private U.S. banks C. Promote a stable U.S. economy by managing the money supply D. Offer loans to small businesses
C The purpose of the Federal Reserve Bank is to promote stable prices, full employment, and economic growth by managing the supply of money in the U.S. economy. It does so by buying and selling debt securities and by setting certain interest rates. It does not issue new money; the U.S. Treasury does that. The FDIC insures savings in U.S. banks.
What happens in open market operations? I. To stimulate the economy, the Fed purchases government securities on the secondary market, which releases more money into the economy, raising interest rates. II. To slow the economy, the Fed will sell Treasury securities, which removes money from the economy, increasing the cost of credit. III. The Fed sells Treasury bonds to select banks, reducing the banks' excess reserves, reducing the supply of federal funds, and causing a decrease in the federal funds rate. IV. When the Fed sells Treasury bonds, the Fed has a federal funds "target rate" in mind. An increase in the federal funds rate means higher borrowing costs for banks, causing them to raise their lending costs to the broader economy. A. I and IV B. I and III C. II and IV D. II and II
C To stimulate the economy, the Fed purchases government securities, which releases more money into the economy, reducing (not raising) interest rates. The Fed sells Treasury bonds to select banks, reducing the banks' excess reserves, reducing the supply of federal funds, and causing an increase (not a decrease) in the federal funds rate.
12. A function of the Federal Reserve Bank is to conduct open market operations. What best describes an open market operation? A. Setting the effective federal funds rate B. Setting the discount rate C. Buying and selling government securities D. Setting monetary policy for the following quarter in public meetings
C When the Federal Reserve conducts open market operations, it buys and sells U.S. Treasury and federal agency debt on the secondary market. By doing so, it tries to meet a desired target for the federal funds rate, but it does not set the rate. The market does that.
3. In the expansionary phase of the business cycle, which of the following characteristics of the economy does not typically apply? A. The unemployment rate falls B. Interest rates fall C. Credit availability falls D. None of the above
C When the economy is in the expansionary phase, the increased production of goods and services allows businesses to hire more people, giving them more money to invest and spend. Credit availability increases as banks gain confidence in the growing economy. Increased credit availability means stable or falling interest rates.
All of the following items are reported to the IRS on a corporation's tax return, as well as being found on the company's income statement except: A. Sales B. Cost of goods sold C. Pre-tax income D. Owner's equity
D A company's income statement is a summary of a company's profit or loss during a given period of time, such as one year. The income statement records all revenues for the business during that period, which is the same sort of information that must be reported to the IRS when the corporation files its tax return. The IRS needs to know the company's revenues in order to assess taxation. Therefore, sales, the cost of goods sold, and pre-tax income would be on both the company's income statement and tax return. However, owner's equity is listed on a company's balance sheet.
13. The risk of fluctuation in the market value of fixed-income investment products, due to interest rate movements, is considered: A. Credit risk B. Call risk C. Market risk D. Interest rate risk
D Interest rate risk refers to the risk of fluctuation in the market value of fixed-income investment products due to interest rate movements. Typically, interest rate risk is higher for fixed-income investment products with longer maturities and higher durations.
Which of the following is not true of fiscal policy? A. Fiscal policy may attempt to stimulate the economy by lowering taxes. B. An expansionary fiscal policy may include increased military spending. C. Contractionary fiscal policy may aim to lower inflation. D. Fiscal policy that is aimed at slowing down the economy may include loosening the money supply.
D Loosening the money supply is considered monetary policy.
5. The risk that a bond might be redeemed by its issuer prior to the maturity date is known as: A. Interest rate risk B. Default risk C. Credit risk D. Call risk
D Often, bond issuers will choose to redeem their higher paying bonds in a declining interest rate environment. This tendency of higher paying bonds to get called before their maturity date is referred to as "call risk."
4. Which of the following measure interbank lending rates? I. Federal funds rate II. Discount rate III. Prime rate IV. LIBOR A. I and II B. II and III C. III and IV D. I and IV
D The federal funds rate is the interest rate that banks in the U.S. pay when they borrow money overnight from other banks via their reserve balances at the Federal Reserve. LIBOR stands for London Interbank Offered Rate and it measures the lending rate between the world's largest banks. The discount rate is the interest rate that the Federal Reserve charges banks to borrow money on a short-term basis. The prime rate is the primary interest rate benchmark for short and medium term loans in the U.S.
15. To qualify for long-term capital gains tax treatment, an asset must be held for: A. A month or more B. More than a month C. A year or more D. More than a year
D To qualify for long-term capital gains tax treatment, an asset needs to be held for more than a year.
16. Which of the following are characteristics of TIPS? I. They are exempt from federal and state taxes. II. They are issued by federal and state agencies and are considered very secure. III. The principal is adjusted up or down based on the CPI. IV. Interest is based on a fixed rate but the interest payment fluctuates. A. I and II B. I and III C. II and III D. III and IV
D Treasury Inflation-Protected Securities, or TIPS, are issued by the U.S. Treasury only, and interest income and growth in principal are subject to the federal income tax but exempt from state and local taxes. The principal of a TIPS is adjusted according to the movement of the Consumer Price Index. Interest payments are based on a fixed rate that is applied to the inflation (or deflation) adjusted principal, and thus, the interest payment varies depending on the rate of inflation or deflation.