Section 2 Series 65
When an analyst adds back the current year's depreciation to the net income, she is computing the company's A) cash flow from investments B) earnings per share C) cash flow from operations D) net value of fixed assets
C. Cash flow from operations is computed by adding the year's depreciation deduction to the net income.
The issuer of an ADR is a: A) foreign branch of a domestic bank. B) domestic branch of a domestic bank. C) domestic branch of a foreign bank. D) foreign branch of a foreign bank.
C. a U.S. Depository Bank The stocks of most foreign companies that trade in the U.S. markets are traded as American Depositary Receipts (ADRs). U.S. depositary banks, (domestic branches of U.S. banks), issue these stocks. Each ADR represents 1 or more shares of foreign stock or a fraction of a share. If you own an ADR, you have the right to obtain the foreign stock it represents, but U.S. investors usually find it more convenient to own the ADR.
Price and Yield are stable seesaw example
Coupon = CY= YTM= YTC
agency trade
Customer - buyer or seller - pays a commission.
An analyst reviewing a company's financial statements would examine the footnotes to
Footnotes to the financial statements are used to convey "off-book" information such as pending lawsuits.
Under SEC rules, Form 8-K must be filed?
Form 8-K is used to report newsworthy events to the SEC. The reporting time limit is four business days.
The MNO Manufacturing Company, headquartered in Springfield, has just filed for bankruptcy. Under federal bankruptcy law, which of the following would have highest priority with the bankruptcy trustee?
Holders of mortgages on real property securing a bond are senior creditors and have the highest priority claim in a bankruptcy. Under federal bankruptcy law, there are several categories of unsecured claims that have a higher priority than other unsecured ones, but secured debt always comes first. Two of the most common high ranking unsecured claims are employee wages as long as the wages were earned during the 180 days prior to the bankruptcy filing, and certain taxes. No matter how many adjectives are placed ahead of preferred stock, it always comes after everyone who is owed money.
what is not marginable
New issues, non-marketable securities, mutual funds, and limited partnership interests are all not marginable when purchased. Exchange and NASDAQ listed stocks and all exempt securities (such as U.S. Governments and Municipals) are marginable
Non qualified stock options
Non-qualified stock options require payment of income tax of the grant price minus the price of the exercised option. NSOs might be provided as an alternative form of compensation. Prices are often similar to the market value of the shares. There is an expectation that the company's share price will increase over time. That means employees stand potentially to acquire stock at a discount if the grant price - also known as the exercise price - is lower than later market prices. However, the employee will pay income tax against the difference with a market share price of the stock when the option is exercised. Once the options are exercised, the employee can choose to sell the shares immediately or retain them.
Price and Yield Example Par bond and interest rates goes up
Price goes down, Nominal coupon remains the same, CY increases, YTM Increases, YTC Increases each following increases more than the next.
Price and Yield Example Par bond and interest rates goes down
Price goes up, Nominal coupon remains the same, CY decreases, YTM decreases, YTC decreases each following decreases more than the next.
prime rate
Rate of interest banks charge on short-term loans to their best customers
A stop order requests that a stockbroker
Sell a stock for a specific amount
thinly traded stock
Stock that allows few public shareholders The lack of ready buyers and sellers usually leads to large disparities between the ask price and bid price. Thinly traded does not describe the value of the security. It does mean that market makers take additional risk in maintaining an inventory and, to compensate, have larger than normal spreads. This is one of those situations where a higher than normal trading cost is not considered unethical, as long as it is disclosed in advance.
The measurement of a portfolio's actual or realized return in excess of (or deficient to) the expected return calculated by the capital asset pricing model (CAPM) is known as
This is the textbook definition of alpha. Portfolio managers strive for a positive alpha (returns in excess of the expected return).
Which of the following attributes of common stock best describes why internal rate of return (IRR) is not generally used to determine the return on common stock?
Uneven cash flows, no maturity, date, and price
In 1986, a sweeping change was made to the U.S. tax code. This change had a severe effect upon those who had been investing in certain limited partnership tax shelters. This is an example of
What happened here was a legislative change severely limiting expenses that could be deducted from income. Changes wrought by government action are legislative in nature.
straight preferred stock
a fixed dividend, no maturity, and no embedded option
sell stop order
an order for a brokerage firm to sell a stock when the price falls to a specified level
Benefits of structuring a business as a general partnership would include A) longevity B) that general partners are only liable to the extent of their investment C) avoidance of taxation at the entity level so the partners are not taxed twice D) the ability to raise large sums of money
c) avoidance of taxation at the entity level so the partners are not taxed twice
Incentive stock option (ISO) plans
corporate programs in which a company grants an employee the opportunity to purchase its stock at some future time at a specified price The favorable tax treatment is lost if the shares acquired through the ISO exercise are sold before 1 year from the date of exercise or 2 years from the date of grant. You are not taxed upon exercise, only upon sale, but the incentive portion of the option could be considered a preference item for purposes of AMT.
Position- Trading Firm
firm trading form its own account
Legislative Risk (Political Risk)
is the potential that regulations or legislation by the government could significantly alter the business prospects of one or more companies. These changes can adversely affect investment holdings in that company.
narrow spread means
more active trading and smaller spread between the bid and ask price
sell stop limit order
placed below current market price; once it hits stop price it is activated and becomes a sell limit order ; to protect against a long position
Investment Company Act of 1940
provides a definition of "investment company" - Face amount Certificates - UIT... Fixed Trust -Management Companies ...open or closed end
restricted stock units
shares awarded over time to defer taxes
federal funds rate
the interest rate at which banks make overnight loans to one another
The discount rate that makes the NPV of all cash flows from a security equal to zero is
the internal rate of return
bid price
the price a dealer is willing to pay for a security
ask price
the price at which a dealer or other trader will sell a security
Form 10-K
what has happened over the previous fiscal year.
A portfolio manager who is successful at market timing will
A portfolio manager expecting a rising market would want to take advantage of that by increasing the beta of the portfolio. This would have the effect of increasing the potential volatility of returns. When things are going good, you want to be in higher beta stocks.
The residual right of common stockholders refers to their right to: A) claim company assets in bankruptcy after wages, taxes, creditors and preferred shareholders have been paid. B) vote in elections for the board of directors and in other important business decisions, such as changes to the charter. C) examine the corporation's annual reports and other reports, and take legal action if irregularities are found. D) receive all announced dividends in accordance with the number of shares held.
A) claim company assets in bankruptcy after wages, taxes, creditors and preferred shareholders have been paid.
Your client wants to have $1 million in her investment account when she retires at age 70. She is currently 50 and has about $215,000 available to invest today. You tell her that if the portfolio can earn at a compounded rate of 8%, she will reach her goal. That 8% rate is A) the internal rate of return B) the future value rate C) the present value rate D) the market rate of return
A. The internal rate of return is the earnings rate required to reach a specified future value from an amount that is currently available to invest. This is a future value computation, but there is no such term as future value rate.
General Obligation Bonds (GOs)
Bonds issued by a municipality that are secured by the full faith and credit of the issuer Not subject to AMT
When a company recognizes a sale only when payment is made, it is using which form of accounting?
CASH Cash and accrual are the two major forms of accounting. In the cash method, sales and expenses are recognized when the money changes hands. With accrual accounting, it is the date of the transaction that is used.
Using industry jargon, the tax on the last dollar of income is at A) the average rate B) the effective rate C) the final rate D) the marginal rate
D) the marginal rate The IRA defines marginal tax rate as "the highest rate that you will pay on your income." Basically, as you make more money, you pay tax at a higher rate incrementally. The effective tax rate is the average that you pay on all of your income.
discount rate
The interest rate on the loans that the Fed makes to banks
margin account
The main purpose of a margin account is to use leverage (borrowed money). There is no leverage at all in a cash account (no borrowing is permitted).
regulatory risk
The risk that changes in regulations and laws may negatively affect the operations of a company.
Which of the following measures the variability of an asset's returns over time?
The standard deviation is a measure of the range of scores within a set of returns over a period of time. The greater the dispersion of the returns from the mean, the greater the volatility of the security.
When the 91-day Treasury bill rate is 3%, an investor decides to purchase a 20-year corporate bond at par with a coupon of 8%. If the corporate bond does not pay as expected, the investor's potential loss is considered
When an investor forgoes the risk-free returns of the 91-day Treasury bill in favor of another investment, anything lost is considered the opportunity cost of passing up the sure thing.
current yield
a bond's annual coupon divided by its current market value/price AI/CMP
limit order
a request to buy or sell a stock at a specified price
Block Trade
a transaction involving over 10,000 shares
Ownership in a corporation is evidenced by holding share of the company's
common or preferred stock
Options
contracts that give investors the choice to buy or sell stock and other financial assets
over the counter market
electronic purchase and sale of stocks and bonds, often of smaller companies, which takes place outside the organized stock exchanges
One difference between common stock and preferred stock is that common stockholders
have voting rights It is rare to find a preferred stock with voting rights and ever rarer to find a common stock without them. Both receive dividends when, and if, declared by the BOD and they are usually paid quarterly. Both are equity securities and preferred has the prior claim.
Technical Analysis
technique that uses charts of past trends in currency prices and other factors to forecast exchange rates
If a client buys a Bond at discount you will have to disclose what i rate?
the YTC since its the lowest between a YTM and YTC Worse case scenario always
If a client buys a Bond at discount you will have to disclose what i rate?
the YTM since its the lowest between a YTM and YTC Worse case scenario always
yield to maturity
the rate of return a bondholder will receive if the bond is held to maturity
Yield to Call
the rate of return earned on a bond when it is called before its maturity date Lowest Yield to the Premium Bond Highest Yield to the Discount bond
put option
the right to sell an asset at a specified exercise price on or before a specified expiration date
An analyst wishing to view a good consolidated indicator of a business's cash inflow and outflow would most likely ask look at
the statement of cash flows
algorithmic trading
the use of computer programs to make rapid trading decisions
Bankruptcy claim order
wages, taxes, creditors, preferred shareholders Common Shareholders
Diversified Fund
-75% of all securities invested -Other 25% can invest in anything In the 75%: -no more than 5% of the 75% in any single company -Cannot own/invest more than 10% of any company
dark pools of liquidity
-not open to the public -generally large volume transactions that occur on crossing networks or ATS systems that match and buy sell orders electronically -usually are institutional traders -does not effect market price quotes -investors can place orders anonymously
1 standard contract is how many shares?
100 Shares
95% of the time =
2 standard deviation
When are estate taxes due?
9 months after death
Rule 144 Control Stock
: Control stock is any security owned by an insider or affiliate (officer, director, or >10% shareholder) of that company. The sale of control stock is subject to volume limitations. Affiliates can sell the greater of: 1% of the outstanding shares, or The average reported weekly trading volume during the preceding four weeks
Odd Lot Theory
A technical analysis theory based on the assumption that the small investor is always wrong. Therefore, if odd-lot sales are up—that is, small investors are selling stock—it is probably a good time to buy.
Principal Trade
A trade with a broker in which the broker commits capital to facilitate the prompt execution of the trader's order to buy or sell.
Liquidity risk would be greatest for an investor whose portfolio was primarily composed of
Any stock listed on the NYSE or traded on Nasdaq has high liquidity. Municipal bonds tend to be thinly traded, thereby exposing their holders to a higher degree of liquidity risk. UITs, regardless of their portfolio, stand ready to redeem their units so liquidity is not a problem for the investor.
Which of the following equations correctly shows the relationship between the items on a company's balance sheet?
Assets = liabilities + stockholders' equity The stockholders' equity, sometimes referred to as net worth, equals the difference between the company's assets and its liabilities (assets − liabilities = stockholders' equity). This formula is often restated as assets = liabilities + stockholders' equity.
If a corporation has a dividend payout ratio of 70%, the undistributed earnings will A) decrease book value B) Increase retained earnings C) increase capital surplus D) increase earnings per share
B. Retained earnings represent income that has not been paid out to shareholders.
Which of the following statements describes the federal funds rate? A) Base rate on corporate loans at large U.S. money center commercial banks B) Rate charged on reserves traded among commercial banks for overnight use in amounts of $1 million or more C) Charge on loans to brokers on stock exchange collateral D) Charge on loans to depositary institutions by the New York FRB
B. The federal funds rate represents the interest charge on reserves, traded among commercial banks for overnight use, in amounts of $1 million or more.
Overnight loans between banks are made at A) the prime rate B) the federal funds rate C) the discount rate D) the call loan rate
B. When a bank borrows from another bank on an overnight basis, it is at the federal funds rate. When a bank borrows from the Federal Reserve, it does do at the discount rate. The prime rate is charged by the banks to their stronger borrowers, and the call loan rate is what broker-dealers pay on stock market collateral pledged for margin accounts.
Which of the following is CORRECT regarding zero-coupon bonds? A) They sell at a premium. B) They eliminate reinvestment rate risk. C) They have low interest rate risk. D) They offer minimum price volatility.
B. Zero-coupon bonds are sold at a deep discount from par value and have no coupon payments. Because there is nothing to reinvest, there is no reinvestment risk. That is why many investors prefer zero-coupon for specific goals, such as college education for children. The tradeoff is that no coupon also means higher interest rate risk. These bonds have maximum price volatility and respond sharply to interest rate changes.
A securities analyst reviewing a corporation's financial statements notes that the enterprise has total current assets of $10 million, inventory of $4 million, cash on hand of $2 million, total current liabilities of $8 million, and net income of $15 million. The company's acid-test ratio is closest to
.75% The acid-test ratio, also known as the quick asset ratio, is computed by subtracting the inventory from the total current assets and then dividing that remainder by the total current liabilities. In this case, that would be $10 million minus $4 million ($6 million) divided by $8 million, or .75%.
A bond is paying $100 per year in annual interest and is selling at par. If the discount rate is 10%, the net present value is A) zero B) positive C) the same as the coupon D) negative
A. A bond paying $100 in interest per year has a coupon rate of 10%. Whenever the coupon rate is equal to the discount rate, the NPV is zero. That is, the present value of a bond paying 10% interest when the current market rate is demanding a 10% interest rate is the bond's par value (as is the case with this bond).
If the Consumer Price Index (CPI) is down but consumer demand is up, the economy is likely in which stage of the business cycle? A) Peak to contraction B) Recovery to expansion C) Recovery to trough D) Contraction to trough
B. As prices trend downward and consumer demand increases, the economy is moving from recovery to expansion. As demand continues to increase, assuming supply remains constant, upward pressure will be put on prices through the expansion to the peak.
Portfolio A has a beta of 1.0 and has returned 8% over the past year. Portfolio B has a beta of 1.5 and, over that same period, has returned 16%. Based on this information, an analyst would conclude that portfolio B has
Positive alpha is when a portfolio (or security) outperforms another portfolio (or the market) by more than is expected based upon its beta coefficient. Although we could calculate the alpha, it should be clear that when one portfolio with a beta that is 50% higher than the other outperforms it by 100%, there is positive alpha.
nominal yield/stated (coupon yield)
The interest rate stated on the face of a bond that represents the percentage of interest the issuer pays on the bond's face value. paid on a semi-annual basis Annual Interest/Face Value
From first to last, in what order would claimants receive payment in the event of bankruptcy?
The liquidation order is as follows: secured debt holders, unsecured debt holders (including general creditors), holders of subordinated debt, preferred stockholders, and common stockholders.
market order
a request to buy or sell a stock at the current market value
All of the following ratios are measures of the liquidity of a corporation
current ratio acid-test ratio quick ratio Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid-test (quick) ratio. However, the debt/equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company's overall capital structure.
An example of an interest-on-interest reinvestment program is
interest left to compound on a bank-insured certificate of deposit Interest-on-interest reinvestment is, as the term implies, the practice of compounding earnings by reinvesting them. This is traditionally the way a bank savings account or certificate of deposit builds in value. Reinvesting the dividends on a bond fund is dividend reinvestment, even though most, if not all, of the fund's income is generated by interest. Same with the UIT and there is no program for reinvesting bond interest similar to a DRIP for reinvesting dividends.
Technical Analyst
investors who attempt to identify undervalued stocks by searching for patterns in past stock prices 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.
call option
the right to buy an asset at a specified price on or before a specified expiration date
An analyst wishing to view a good consolidated indicator of a business's cash inflow and outflow would most likely ask look at A) the statement of cash flows B) the consolidated income statement C) the working capital D) the current ratio
the statement of cash flows Cash flow is the money (cash) that flows into and out of a business. It consolidates the flow of money from operating activities, investing activities, and financing activities. Working capital and current ratio are indicators of current liquidity and in the income statement only reflect income and expenses. Items such as the cash received from the issuance of securities (stocks or bonds) or a loan from a bank do not appear.
One characteristic found in equity securities issued by a corporation is A) a history of keeping pace with inflation B) limited liability C) preemptive rights D) cumulative dividends
B. Limited Liability Equity securities include common and preferred stock. Both have the benefit of limited liability; the investor can never be held liable for debts of the corporation. Only common stock has preemptive rights and the potential for growth to keep pace with inflation. It is preferred stock that can have the cumulative feature regarding its dividends.
All of the following are considered to be components of cash flow EXCEPT A) investing activities B) banking activities C) financing activities D) operating activities
B. There is no such term as banking activities in the context of cash flow. Cash flow is generated through financing (issuing stock or bonds), investing (profits from investments), and, the most significant of all, operations of the entity.
Market makers are ____.
BDs who offer to buy or sell securities in the OTC market by publishing their quotes in an interdealer quotation system
Which of the following describes unsystematic risk? A) It is related to market forces and can be diversified away. B) It is related to market forces and cannot be diversified away. C) It is specific to an investment and cannot be diversified away. D) It is specific to an investment and can be diversified away.
D. It is critical to remember that unsystematic risk is diversifiable. That narrows the choices to 2. Then, we know that it is systematic risk that deals with the overall market, so that cuts it down to 1 possible choice.
Which of the following statements is NOT true? A) A stock with a beta of 1.2 will move 20% more than the market. B) Beta is a measure of a security's deviation from its historical average returns. C) A stock with a beta of 0.8 will move 20% less than the market. D) Beta is a volatility measure of a security compared with the overall market.
B. A measure of a security's deviation from its historical average returns is the security's standard deviation. Beta measures a security's volatility in relation to the overall market. Stocks with a beta greater than 1 are more volatile than the market and stocks with a beta less than 1 are less volatile than the market.
If a security has an anticipated return of 8.7% and a standard deviation of 14.6%, you would expect the returns to have a 95% probability (assuming a normal distribution) of falling between A) 0 and 37.9% B) −20.5 and +37.9% C) 8.7 and 23.3% D) −5.9 and +23.3%
B. A security with a normal distribution has a 95% probability of falling within 2 standard deviations of its anticipated return. In this case, that would be −20.5% and +37.9%, which is computed by calculating return movements of 29.2% (14.6 × 2) in either direction.
Those investors wishing to examine a document that would probably give them the most information about an issuer's current and planned operations would seek out A) the balance sheet B) the Form 10-K C) the investor's brochure D) the annual report
D. The annual report to shareholders is going to contain not only a complete financial report of the prior year's operations but will also include statement from key personnel dealing with the company's future plans. The Form 10-K does not include discussion of future business plans - it is a report of "what has happened over the previous fiscal year."
Under the net present value (NPV) method of evaluating investments, an investment is acceptable if the net present value of the expected returns is
greater than zero Under the net present value (NPV) approach, an investment is acceptable only if the net present value of the expected returns is greater than the amount of the investment outlay. In other words, an investment is acceptable (it will add value) if the net present value is greater than zero. On the other hand, if the NPV is negative (less than zero), it would not be acceptable (it will subtract value) and should not be undertaken.
Many different investments offer the opportunity to reinvest income. If one were to compare the difference between interest-on-interest reinvestment plans and dividend and capital gain reinvestment plans,
in both plans, all income is taxable in the year received, whether reinvested or not Regardless of the type of plan, any income, whether reinvested or not, is always taxed in the current year. Think of an interest-on-interest plan as a passbook savings account where the interest is credited and compounded. Whether taken out or not, the earnings are reported on an annual basis. On the exam, the question may ask for a difference as we have here, but, as you can see, there is no difference.
An investor purchases 100 shares of ABCE common stock at $70 per share. Thirteen months later, the stock is sold when the market price is $50 per share. Which of the following activities made 20 days after the sale of the stock at $50 per share, would NOT violate the wash sale rule? A) Purchasing 5 ABCE convertible bonds with a conversion price of $50 B) Purchasing 100 shares of ABCE common stock C) Purchasing an ABCE put option D) Purchasing an ABCE call option
C) Purchasing an ABCE put option The wash sale rule applies when the same or substantially identical security as a stock sold at a loss is acquired within the 30 day period prior to and after the sale. Buying a put is not a problem because the put only allows the holder to sell the stock, not buy it. Please note that a bond convertible at $50 is convertible into 20 shares, so 5 bonds will enable the investor to convert into 100 shares.
A fundamental analyst would be interested in funds available for use in the business. Doing which of the following would have the greatest impact on future cash flow? A) Retaining earnings B) Depreciation on assets used in the business C) Amortizing goodwill D) Retiring outstanding bonds
D. The retirement of outstanding bonds means that there will be no future interest payments made. Because a major component of cash flow is a company's net income, this reduced expense would lead to increased income resulting in higher cash flow.
Credit agreement (part of margin agreement)
The "credit agreement" discloses the terms of the credit extended by the broker/dealer, including the method of interest computation and situations under which interest rates may change.
Management Companies
- -Open-end MFs: -Continuous Primary --Offer, Prospectus required -No secondary trading -Must redeem Shares -8.5% Max SC -Common Shares only -Price by formula...NAV -Ex-date set by Board of Directors -- Closed-end HF: -Shares are fixed, -No Prospectus after IPO, -Issues Common, preferred, and or bonds, -shares are not redeemable -Secondary (exchange/OTC) -Priced by Supply and Demand - Ex-Dividend date set by Regulators not BOD
house call
When a security purchased on margin suffers a decline in market value, it may cause the equity in the account to fall to a level such that additional funds are required under the terms of the margin agreement between the client and the broker-dealer. The term that describes the request by a broker-dealer rather than an SRO for more money is
Dividend Growth Model
The dividend growth model is a stock valuation model that deals with dividends and their growth, discounted to today. The value of the stock equals next year's dividends divided by the difference between the required rate of return and the assumed constant growth rate in dividends.
