Series 65 unit 3

In the investment industry, the term spread has many different meanings. When used in a discussion about bonds, which of the following would be most appropriate?

A credit spread refers to the difference between yields of bonds with similar maturities but different ratings

In the investment industry, the term spread has many different meanings. When used in a discussion about bonds, which of the following would be most appropriate?

A credit spread refers to the difference between yields of bonds with similar maturities but different ratings. For example, a bond analyst might compare the yield of a 10-year Treasury note with a AAArated bond with 10 years to maturity. Wider spreads generally indicate a concern about the economy (investors are seeking the safety of the Treasury issue) while narrow spreads generally indicate economic optimism. Debit spread and calendar spread refer to options (as does credit spread, but our question asks about bonds). Bond prices and interest rates have an inverse relationship, but that isn't called an inverse spread.

Which of the following statements reflects the monetarist economic position?

Monetarists believe that the economy and inflation are best controlled through the management of the money supply rather than through fiscal policy stimulation.

keynesian

less taxation more government spending

A common measurement used to evaluate attitudes regarding future economic conditions is the difference in yields between U.S. Treasury bonds and corporate bonds. This is known as

yield spread.

A wealthy client wishes to endow her favorite charity with a lump-sum gift that, with an assumed rate of return of 4% per annum, will provide $2,500 per month in perpetuity. What amount does the client need to deposit?

A monthly income of $2,500 is equal to $30,000 per year. At a 4% earning rate, $750,000 must be deposited to generate that amount (30,000 ÷ 4%).

XYZ Corporation has a beta of 1, and ABC has a beta of 1.4. XYZ has returned 12% and ABC 14.8%. Based on this information, ABC had alpha of

Alpha is the extent to which a security's performance exceeds (or falls short of) what would be expected based on its beta. A stock with a beta of 1.4 would be expected to perform 40% better in an up market than one with a beta of 1.0. Because XYZ with a beta of 1.0 gained 12%, ABC should return 140% of that or 16.8% (12% × 1.4). With an actual return of 14.8%, ABC underperformed the expected by 2% and that is why it has a negative alpha.

All of the following statements regarding an investment's internal rate of return (IRR) are true EXCEPT

It is possible, although very difficult, to calculate IRR for investments with uneven cash flows such as growth stocks where dividends are generally not reliable. IRR is the rate of interest that equates the initial investment with the present value of future cash flows; it is the rate of return that results in an investment having a net present value of 0.

The economic theory that says economic growth results from lower tax rates and lower government spending is

Supply-side economics is the theory of Arthur Laffer, who believed that heavy taxing and government intervention have a negative effect on the economy.

Which of the following statements reflects the monetarist economic position?

The amount of money in the economy determines the overall price level over time and, therefore, the Federal Reserve should control the growth in the amount of money in the economy in a gradual and predictable way. Monetarists believe that the economy and inflation are best controlled through the management of the money supply rather than through fiscal policy stimulation.

One measure of a corporation's liquidation value is its book value per share. When performing this computation, which of the following must be taken into consideration?

The computation of book value per share is basically net tangible worth per share of common stock. Included in the net worth are all assets and liabilities (such as long-term debt), as well as the stockholders equity (par value of the preferred stock and par + paid in surplus of the common stock and retained earnings). Subtracted from this to get tangible book value would be the par value of the preferred stock and the value of intangible assets such as goodwill.

A frequently-used metric by analysts is the yield, or credit spread. Common methods of computing this would be comparing bonds of similar quality and similar maturities. bonds of similar quality and different maturities. bonds of different quality and different maturities. bonds of different quality and similar maturities.

The term spread, always signifies a difference. Therefore, the correct choices have to reflect some kind of difference. One way is when the quality (rating) of the bonds is the same, but the length to maturity is different. A very common example of this is the U.S. 2-year Treasury note plotted against the 10-year Treasury note. The other method is to take bonds of different quality (ratings) having the same maturities. An example might be comparing two bonds with a 20-year maturity: one has a AAA rating and the other a BBB rating.

While listening to a commentator on cable TV, you hear the statement "the flight to quality has ended." What would you expect the effect of this to be?

The term yield spread refers to the difference in yield between very-high-quality debt instruments, such as U.S. government bonds, and those with lower ratings. The spread compensates for the additional risk. When investors perceive that the risk has lessened, they won't demand as much in return from the lower-rated instruments.

Which of the following statements about the consumer price index (CPI) is NOT true?

The CPI does not measure the increase or decrease in the level of consumer prices with respect to the level of wholesale prices. The CPI only measures retail prices whether or not wholesale prices are passed through to the consumer.

An agent is analyzing the financial statements of a corporation. The company has cash on hand of $2 million, accounts receivable of $500,000, accounts payable of $700,000, land valued at $3 million, wages payable of $300,000, goodwill of $100,000, inventory of $1.5 million, and retained earnings of $5 million. From this information, the agent would determine that the acid-test ratio for this company is

The acid-test, or quick, ratio is all of the current assets, except for inventory, divided by the current liabilities. The non-inventory current assets are the cash on hand and the accounts receivable. The current liabilities are the accounts payable and wages payable. This results in a calculation of $2.5 million divided by $1 million, or 2.5:1.

An inverted yield curve results in part by

The demand for longer-term bonds is higher than that of short-term bonds and causes a negative slope in the yield curve. If investors were buying short-term bonds in greater demand, the rates of short-term bonds would decline rather than rise.

Which of the following statements is most accurate regarding the net present value (NPV) and internal rate of return (IRR) on a bond?

The first step in finding the NPV is to compute the present value (PV). The PV is computed by taking the future cash flows and discounting them by a "discount" rate. That rate is the current market interest rate. So, if NPV is based on PV and PV assumes reinvestment at the discount rate, that assumption must hold true for figuring NPV. In the case of the IRR, that is the yield to maturity of a bond and assumes that the cash flows are reinvested at that IRR. For example, a bond with a YTM of 7% assumes that all reinvestments will be made at that 7% rate. The periodic cash flow on a bond comes from the semiannual interest payments making reinvestments semiannually, not annually.

A company's current ratio is .5:1. This could be an indication

The formula for current ratio is the current assets divided by the current liabilities. A .5:1 ratio means that the company has current liabilities that are twice its current assets. This would also mean a negative working capital (current assets minus current liabilities) and would probably mean that the company is going to have a difficult time paying its bills.

A review of a corporation's financial statements reveals the following information: Net assets—$50 million Net revenues—$20 million Cost of goods sold—$14 million Depreciation—$1 million Interest—$1 million Long-term debt—$20 million Using the information, the gross margin for the year was

The gross margin, or margin of profit, is usually expressed as a percentage. It is the operating profit remaining after subtracting the cost of goods sold from the revenues (sales), divided by those revenues. In this question, the cost of goods sold is $14 million, and that number includes the depreciation. Subtracting $14 million from $20 million results in an operating profit of $6 million, which is 30% of the $20 million in revenues. You might also see this referred to as pre-tax margin. Please note that, as with so many questions on the exam, there are extra numbers that have no relevance to the question.

Which of the following is most commonly used to evaluate the marketplace's perceived value of a particular stock?

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 P/E ratio will generally be higher than those of other companies in the same industry.

A bond's yield to maturity reflects its

Yield to maturity reflects the internal rate of return on a bond. Internal rate of return (IRR) equates the cost of an investment to the cash flows produced by that investment.

Yield curve analysis plays an important role as a benchmarking and forecasting tool for the future direction of interest rates. In most cases, this analysis involves examining

bonds of a single issuer over varying maturities.