Series 66 Chapter 10

An investor's portfolio has a beta coefficient of 0.85. If the overall market declined by 10% over the course of a year, the portfolio's value has likely A) decreased by 8.5% B) decreased by 11.76% C) increased by 10.85% D) increased by 8.5%

A

Beverly has two stocks with a correlation coefficient of zero. Which of the following is correct? A) These stocks will move independently of each other. B) These stocks are well diversified because they will move in unison. C) These stocks are not well diversified because they move in unison. D) These stocks are well diversified because as one stock appreciates in value, the other decreases in value.

A

Twelve years ago, an investor placed $2,500 into an account. The account is now worth $10,000. Using the Rule of 72, you can determine that the approximate annual return was A) 12% B) 6% C) 36% D) 400%

A

When a company's debt-to-equity ratio is higher than typical for that industry, it might be said that the company is A) highly leveraged B) highly profitable C) about to increase their dividends D) suitable for a conservative investor

A

A client is meeting with you to discuss the best way to invest today to meet the goal of funding their child's college expenses. The least important information needed to determine the amount to deposit is A) current college costs B) parent's salary C) expected inflation rate D) age of the child

B

Dividend payments are not a part of the computation for which of the following risk measurement tools? A) Dividend discount model B) Correlation coefficient C) Net present value D) Dividend growth model

B

Julian and Jane are discussing risk-return measures. Julian states that "beta is used when looking at the performance of a fund or portfolio and refers to the extent of any outperformance against its benchmark." Jane disagrees and says that "outperformance of a fund or portfolio is actually measured by standard deviation." Which of the following statement is correct? A) Both are incorrect. B) Only Julian is correct. C) Both Julian and Jane are correct. D) Only Jane is correct.

B

One of the critical components of making suitable recommendations is the ability to evaluate risk. Risk measurement tools would include all of the following EXCEPT A) standard deviation B) future value C) Sharpe ratio D) beta

B

The statistical measurement that indicates how much an investment's returns have fluctuated compared with its average return over a period of time is known as A) beta B) standard deviation C) duration D) Sharpe ratio

B

The statistical measurement that indicates how much an investment's returns have fluctuated, compared to its average return, over a given period of time is known as A) convexity B) standard deviation C) beta D) R-squared

B

The time value of money is part of the computation for A) the risk-adjusted return B) the internal rate of return C) the after-tax return D) the real rate of return

B

Twelve years ago, an investor placed $2,500 into an account. The account is now worth $10,000. Using the Rule of 72, you can determine that the approximate annual return was A) 400%. B) 12%. C) 36%. D) 6%.

B

Which of the following statements about systematic and unsystematic risk is most accurate? A) As an investor increases the number of stocks in a portfolio, the unsystematic risk will stay the same. B) Total risk equals market risk plus company-specific risk. C) As an investor increases the number of stocks in a portfolio, the systematic risk will go down. D) The unsystematic risk for a specific firm is similar to the unsystematic risk for other firms in the same industry.

B

A concern of some investors is the volatility of a security. Securities with a higher volatility exhibit a greater variability in their returns. A statistical measure used to predict the volatility of a security by examining the dispersion in a set of historical returns is A) beta. B) correlation. C) standard deviation. D) geometric mean.

C

Bond X has an internal rate of return (IRR) of 7%. Bond Y has an IRR of 9%. Both bonds pay interest semiannually. If the required rate of return is A) 9%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y. B) 7%, the net present value (NPV) of Bond X will exceed the NPV of Bond Y. C) 7%, the net present value (NPV) of Bond Y will exceed the NPV of Bond X. D) 9%, both bonds will have a positive NPV.

C

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

C

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) the same as the coupon B) negative C) positive D) zero

D

A financial analyst computing the current ratio of a company whose stock trades on the Nasdaq Stock Market would use which of the following components? A) Accounts receivable B) Operating income C) Rent D) Current liabilities

D

An analyst attempting to determine the extent to which financial leverage is being employed by a company would examine the company's A) acid-test ratio B) working capital C) book value per share D) debt-to-equity ratio

D

Here is a list of the current ratios of 4 companies. The industry standard for an acceptable current ratio is 2:1. Company A: 3.47:1 Company B: 1.47:1 Company C: 1.19:1 Company D: 0.89:1 Which of the following is CORRECT? A) Company D is in the best financial standing. B) Company B is above industry standards. C) Company A is below industry standards. D) Company B's financial status is better than company C.

D

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%

D

Present value is a computation frequently used to determine the amount of deposit needed now to meet a future need, such as a college education. If an investor uses an expected return of 8%, but the actual return over the period is 6%, A) the future value will not be able to be computed B) the accumulated value will meet the objectives C) the yield to maturity will be lower than anticipated D) the present value was insufficient to meet the objective

D

The Zxion Corporation has just distributed a 7½ to 1 split of its common stock. Prior to the split, Zxion had EPS of $15, the market price of Zxion common stock was $225 per share, and the price of its $75 par preferred stock was $82.50. As a result of the split, the price-to-earnings (P/E) ratio is now A) 6 x 1. B) 2 x 1. C) 7.5 x 1. D) 15 x 1.

D

Which of the following statements with regards to net present value and internal rate of return is correct? A) If the net present value is less than zero, then the internal rate of return is greater than the required rate of return. B) If the net present value equals zero, then the internal rate of return is less than the required rate of return. C) If the net present value equals zero, then the internal rate of return is greater than the required rate of return. D) If the net present value is greater than zero, then the internal rate of return is greater than the required rate of return.

D

A portfolio that has a negative correlation coefficient relative to the market will decrease in value as the market declines increase in value as the market declines decrease in value as the market goes up increase in value as the market goes up

2, 3

The future value of an invested dollar is dependent on the exchange rate of the dollar at the beginning and end of the period interest rate at maturity the rate of return it earns the time period over which it is invested

3, 4

A stock's beta coefficient is a measure of the stock's A) volatility relative to the market B) institutional ownership relative to outstanding shares C) consistency of its dividend payment D) profitability relative to its group

A

Investment risk may broadly be categorized as either unsystematic or systematic risk; both types of risk together constitute total, or absolute, risk. Total risk is measured by A) standard deviation B) opportunity cost. C) beta coefficient. D) correlation coefficient.

A Unlike beta, which only measures systematic risk, standard deviation reflects both systematic and unsystematic risk, revealing the total risk of the investment. x

A client who wishes to have $50,000 available to help fund a 3-year-old child's college education in 15 years estimates that if the portfolio can earn 7%, a deposit of $18,122.30 will be required today. This deposit is referred to as A) the future value B) the internal rate of return C) the present value D) the net present value

C

A securities analyst wishing to determine the cash flow for the Lucre Bread Manufacturing Company would find the necessary information on the company's A) bank statements. B) capitalization statement. C) income statement. D) property tax return.

C

An investor's required rate of return is 6%. If the internal rate of return of the investment offered is 5.75%, then the NPV is A) positive B) between 5.75% and 6% C) negative D) zero

C

When a stock has a beta of less than 1, this indicates that A) it will have a high level of unsystematic risk B) it will, on average, give a return in excess of that of a stock with a beta of greater than 1 C) it will, on average, give a return below that of the market D) it will have a high level of systematic risk

C

If an investment can be expected to return 8%, using the rule of 72, what is the present value needed to have $50,000 for a child's education in 18 years? A) $6,250 B) $25,000 C) $12,500 D) $2,777

C Under the rule of 72, dividing 72 by the expected return shows the number of years it will take for a deposited sum to double. 72 divided by 8 equals 9 years. Over an 18-year period, there will be 2 doublings. So, dividing the future value ($50,000) by 4 solves for the present value required. x

A client owns an investment-grade bond with a coupon of 7%. If similarly rated bonds are being issued today with coupons of 5%, and the market is efficient, it would be expected that the client's bond A) has a negative net present value B) will be selling at a discount from par C) has a zero net present value D) has a positive net present value

C With a discount rate of 5% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 7% coupon rate will be selling at a premium (interest rates down, prices up). If the market is efficiently pricing that bond, its market price should be equal to its present value, resulting in an NPV of zero.

A company's current ratio is 0.5:1. This could be an indication A) the company is highly leveraged. B) the company's current assets are twice its current liabilities. C) the company's working capital is sufficient to meet daily needs. D) the company may have trouble paying its bills

D

As the correlation between any 2 assets decreases, A) greater risk is assumed B) the standard deviation of the portfolio increases C) the benefits of diversification decrease D) the benefits of diversification increase

D

Which of the following would best describe working capital? A) The value per share available to shareholders in the event of bankruptcy B) A corporation's net worth C) The amount of money available to the corporation that is currently being held in cash or cash-equivalent positions D) The amount of money a corporation has available to work with if it liquidates its current assets and pays off all of its current liabilities

D

An investment of $5,000 made 10 years ago is now worth $20,000. Using the Rule of 72, the approximate compounded annual rate of return is A) 14.4% B) 40% C) 25% D) 7.2%

a

A fundamental analyst reviewing the current ratios of four different companies would consider which of the following to be in the most liquid position? A) 2.7:1 B) 4.2:1 C) 0.5:1 D) 1.5:1

B

A measurement of investment return that takes the time value of money into consideration is A) holding period return B) internal rate of return (IRR) C) risk-adjusted rate of return D) real rate of return

B

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

1

To calculate the future value of an investment, which of the following must be known? Assumed earnings rate The future sum required Duration of the investment Risk tolerance of the investor

1, 3

An investor's required rate of return is 6%. If the internal rate of return of the investment offered is 6%, then the NPV is A) 6% B) zero C) positive D) negative

B

An investor's required rate of return is 6%. If the internal rate of return of the investment offered is 6.32%, then the NPV is A) zero B) positive C) between 6% and 6.32% D) negative

B

One measure of a corporation's liquidation value is its book value per share. When performing this computation, the value of which of the following would normally be subtracted from the corporation's net worth? Cash Wages payable Patents Preferred stock

3, 4

A corporation's balance sheet shows total assets of $930,000 of which $400,000 are current assets. It also shows $525,000 of total liabilities of which $215,000 are current liabilities. The company's working capital is A) $715,000. B) $185,000. C) $310,000. D) $405,000.

B

A customer's portfolio has a beta coefficient of 1.1. If the overall market increases by 10%, the portfolio's value is likely to A) decrease by 10% B) increase by 11% C) increase by 10% D) decrease by 11%

B

An investment adviser representative is looking for a suitable investment for a client. The IAR wishes to find something that will offer an attractive return commensurate with its systematic risk. The choices have been narrowed to Security C and Security L, and the selection will be based on alpha. C has a beta of 1.0 and earned 13%, while L has a beta of 0.8 and earned 10.1%. The alpha of Security L is A) +0.3 B) +2.9 C) −0.3 D) −2.9

C

If two stocks have positive correlation, which of the following statements is correct? A) The rates of return tend to move in the opposite direction relative to their individual mean returns. B) If one stock doubles in price, the other will also double in price. C) The rates of return tend to move in the same direction relative to their individual mean returns. D) The two stocks must be in the same industry.

C

There are several measures of central tendency used by investment analysts. Included would be all of the following EXCEPT A) median B) mode C) moving averages D) mean

C

Using the net present value method, a potential investment should be undertaken if the present value of all cash inflows minus the present value of all cash outflows (which equals the net present value) is A) positively correlated B) less than zero C) greater than zero D) equal to zero

C

When it comes to computing market returns, it is TRUE to state that A) the mode is always higher than the mean B) the median is always lower than the average C) the geometric mean could never be greater than the arithmetic mean D) the median is always higher than the geometric mean

C

Which of the following best describes net present value? A) The discount rate that results in a return of zero for a series of future cash flows B) The amount of money that must be invested today at some specified rate of return to equal a targeted value in a specified number of years C) The difference between the sum of the discounted cash flows that are expected from an investment and its initial cost D) It is the true interest yield expected from an investment expressed as a percentage

C

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? Goodwill Long-term debt Retained earnings Par value of the preferred stock A) I and II B) II, III, and IV C) I, II, III, and IV D) II and III

C 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.

An analyst is viewing a subject company's financial statements. She notices that the company has current assets of $20 million, fixed assets of $50 million, and total liabilities of $45 million (of which $10 million is considered long-term). This company's debt-to-equity ratio is A) 40% B) 22.2% C) 28.6% D) 64.3%

C The debt-to-equity ratio is computed by dividing the issuer's long-term debt by their total capitalization. Total capitalization is the company's net worth (assets minus liabilities) plus the long-term debt. In this example, the net worth is $70 million minus $45 million, or $25 million. Adding the long-term debt of $10 million results in total capital of $35 million. Divide the $10 million by that $35 million to arrive at 28.57%. As we point out in the LEM, this is really a misnomer—it should be called the debt-to-total-capital ratio, but probably will not be shown that way on the exam.

A senior citizen had the following scenarios presented to him by his IAR. Which one had the lowest volatility? A) Stock high return: +9%; low return: −2%; Standard Deviation: 4.9% B) Stock high return: +18%; low return: −4%; Standard Deviation: 8% C) Stock high return: +12%; low return: −2%; Standard Deviation: 5.5% D) Stock high return: +5%; low return: −1%; Standard Deviation: 3.6%

D

A stock traded on the Nasdaq Stock Market has a beta of 1.20. One could expect that the stock's volatility compared to the S&P 500 would be A) negatively correlated to the S&P B) 20% less volatile C) too variable to tell D) 20% more volatile

D

ABD Corporation's income statement reports net sales of $100 million; cost of goods sold, $60 million; administrative costs, $20 million; and interest on debt, $5 million. Based on this information, ABD's gross margin is A) 15% B) 35% C) 20% D) 40%

D

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 A) 4:1 B) 1:1 C) 3.375:1 D) 2.5:1

D

In portfolio theory, the alpha of a security or a portfolio is A) a measure of the variance in returns of a portfolio divided by its average return B) the risk of the portfolio associated with the macroeconomic factors that affect all risky assets C) the portfolio's average return in excess of the risk-free rate divided by the standard deviation in returns of the portfolio D) the difference in the expected return of the portfolio, given the portfolio's beta, and the actual return the portfolio achieved

D

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) 50:1 B) 10:1 C) 25:1 D) 15:1

D

An IAR is viewing the balance sheet of a corporation. Included in the computation of the company's working capital are all of the following EXCEPT A) cash B) accounts receivable C) marketable securities of other companies D) convertible bonds it has issued

D The working capital of a corporation is equal to its current assets minus its current liabilities (a current liability is payable within 12 months). Because all bonds, convertible or not, issued by the corporation are long-term liabilities, they are not included in the working capital computation. Accounts receivable, marketable securities, and cash are short-term assets included in the calculation of working capital.

Which of the following incorrectly states the relationship between NPV, IRR, and required return? A) If NPV > 0, then IRR > required return. B) If NPV > 0, then IRR < required return. C) If NPV = 0, then IRR = required return. D) If NPV < 0, then IRR < required return.

B

When an IA tells a client who is investigating the common stock of two different issuers that there is no linear relationship between the two stock's returns, it means A) one is listed on an exchange, the other traded OTC B) the correlation coefficient is zero C) one is likely to pay dividends, the other not D) one of the stock's standard deviation is significantly higher than the other

B

When constructing a portfolio, one of the goals is to increase diversification. Which of the following pairs offers the most diversification? A) Municipal GO bonds and long-term U.S. Treasury bonds B) U.S. equity securities and foreign equity securities C) Corporate debentures/convertible bonds D) Large-cap stock/blue-chip stock

B

Which of the following statements best represents a bond's present value? A) Present value represents the internal rate of return (IRR) of the bond. B) Present value is the sum of all the discounted future interest payments. C) Present value is the discounted future repayment of principal. D) Present value is the sum of all the discounted future payments.

D The correct answer is the standard "textbook" statement. There are two future cash flows from a bond. First is the periodic interest payments and second is the repayment of the principal at maturity. The PV of the bond is the sum of the discounted value of both.

The Smiths are saving money for a down payment on a house. The Smiths have $25,000 in cash, and they estimate that in 5 years they will have approximately $31,000 if they deposit their cash in a savings account that compounds interest yearly. To calculate the $31,000 amount, the Smiths determined A) the future value of the $25,000 B) the internal rate of the return on the $25,000 C) the present value of $25,000 D) the net present value of the $25,000

A To determine the money's worth at a future date (in this case, 5 years), the Smiths calculated the future value of the funds. Future value is a compounded rate of return, and in this case, the $25,000 was compounded at 5% per year for 5 years. The present value of an investment is the opposite of future value.

Which of the following statements best describes the risk-free rate of interest? A) The rate of interest required to produce a net present value (NPV) of zero B) The rate of interest earned on the 91-day U.S. Treasury bill C) The rate of interest in excess of the pure time value of money D) The arithmetic mean of the CPI over the past 12 months

B

Which of the following statements is correct? A) Portfolio managers have a goal of reaching zero alpha. B) Beta is a measure of relative systematic risk for stock or portfolio returns. C) Beta is a measure of relative unsystematic risk for stock or portfolio returns. D) A stock or portfolio's beta increases as its alpha declines.

B

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) $750,000 B) $75,000 C) $100,000 D) $1,000,000

A

One of your clients wishes to give her daughter $200,000 to start her own business. The daughter expects to be finished with graduate school and an internship in 8 years. The expected rate of return is 9%. Using the Rule of 72, calculate the amount the client must deposit today to meet that future goal. A) $100,000 B) $72,000 C) $144,000 D) $112,500

A

The present value of a dollar A) indicates how much needs to be invested today at a given interest rate to equal a specific cash value in the future B) cannot be calculated without knowing the level of inflation C) is the amount of goods and services the dollar will buy in the future at today's rate price level D) is equal to its future value if the level of interest rates stays the same

A

XYZ Corporation has a beta of 1.0, and ABC has a beta of 1.4. XYZ has returned 12% and ABC 14.8%. Based on this information, ABC had alpha of A) −2% B) 14.8% C) 2% D) 2.8%

A

An investor's portfolio consists of a single stock. If a stock with a correlation of +.95 was added to the portfolio and the stock market turned bearish, what would be the likely effect of having added this additional security? A) Almost no noticeable impact. B) The portfolio's value would increase. C) Not enough information to tell. D) The portfolio's value would remain the same.

A Adding additional securities to a portfolio usually increases the diversification, lowering the overall risk. However, that is more apparent when there is low or negative correlation. A +.95 correlation means that the "new" stock will perform close to exactly the same as the existing one so its addition should have little to no impact on performance. In a bearish market, values go down, not up or remain the same. If this additional stock had a negative correlation, that could have resulted in the portfolio going up or remaining the same, but not with a +.95 correlation. It is almost never that a question on the exam does not have enough information to arrive at the correct answer - steer away from that choice.

Which of the following statements regarding investment theory is not correct? A) The beta coefficient may be used to help select a portfolio that is consistent with an investor's willingness to assume unsystematic risk. B) A correlation coefficient of 0.14 between the returns of Stock C and Stock L indicates that very little of Stock C's returns can be attributed to the returns of Stock L. C) Combining two stocks with a negative correlation coefficient can significantly reduce the portfolio's standard deviation. D) In a well-diversified portfolio, diversifiable risk is zero.

A Beta is a measure of systematic risk, not unsystematic risk. The beta coefficient may be used to help select a portfolio that is consistent with an investor's willingness to assume systematic risk. Diversifiable risk (unsystematic risk) can be brought down to zero with proper diversification. Including securities with negative correlation is a prime method of reducing overall risk (expressed by the portfolio's standard deviation) and the closer the correlation coefficient gets to zero (and 0.14 is close), the more random the relationship between the returns earned by two securities.

An investment adviser is analyzing 4 bonds of similar quality for a client. Bond A has a coupon of 6%, matures in 12 years, and is currently priced at 50. Bond B has a coupon of 8%, matures in 9 years, and is currently priced at 50. Bond C has a coupon of 4%, matures in 18 years, and is priced at 45. Bond D has a coupon of 12%, matures in 6 years, and is priced at 50. Based on NPV, which of these bonds represents the better value? A) Bond C B) Bond D C) Bond B D) Bond A

A Bond A, at 6%, takes 12 years to double. That's exactly the time to maturity, so the PV of this bond should be approximately $500 (a quote of 50). The same is true of bonds B and D—their PV should be approximately $500 (72 ÷ 8% = 9 years; 72 ÷ 12% = 6). Because their price is the same as the PV, the NPV is zero. However, with bond C, 72 divided by 4% equals 18 years, so this bond also has a PV of approximately $500 (50), but it can be purchased for less than that: 45 ($450). Therefore, with an NPV of $50, bond C is the best value. One final point: If you are stuck and have to guess, note that 3 of the 4 bonds are selling for $500 with the other priced at $450. If they are all going to mature at $1,000, a good guess would be that the cheapest one is the best deal.

When determining whether to make an investment in a real estate limited partnership, Bill is concerned with the discount rate that equates the net investment cash inflows to the net investment cash outflows. Which calculation is Bill using to make this prudent investment decision? A) Internal rate of return B) Net present value C) Future value D) Duration

A The internal rate of return (IRR) is the discount rate that, when applied to the cash flows of an investment, equates the net cash inflows to the net cash outflows. If the IRR calculated is greater than or equal to the investor's required rate of return, then the investor should consider making the investment, all other factors being equal. If the IRR is less than the investor's required rate of return, the investment should not be made.

A client owns an investment-grade bond that has a coupon of 7% and is priced to yield 5.4%. If similarly rated bonds are being issued today with coupons of 5%, it would be expected that the client's bond A) has a positive net present value B) has a negative net present value C) has a zero net present value D) will be selling at a discount from par

A With a discount rate of 5% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 7% coupon rate will be selling at a premium (interest rates down, prices up). We are told that this bond is offering a yield of 5.4%, which is more than the current market rate. Because a present value computation using a 5.4% rate would reflect a lower value than a 5% rate (the higher the discount rate, the lower the value), the bond can be purchased at a price below its present value. Any time that occurs, the instrument has a positive net present value (the difference between the price and the present value).

Which of the following statements regarding the correlation coefficient is not correct? A) Perfectly positively correlated assets have a correlation coefficient of +1.0. B) Combining assets with less than perfect positive correlation will not reduce the total risk of the portfolio. C) A correlation coefficient of 0.0 means there is no relationship between the returns of the assets. D) Perfectly negatively correlated assets have a correlation coefficient of -1.0.

B

Which of the following statements is most accurate regarding the net present value (NPV) and internal rate of return (IRR) on a bond? A) NPV assumes that cash flows can be reinvested at the bond's IRR. B) NPV assumes the cash flows can be reinvested at market interest rates. C) IRR assumes the cash flows are reinvested at market interest rates. D) IRR assumes the cash flows are reinvested annually.

B 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.

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

C

Which of the following purchases is most suitable for an investor pursuing an aggressive investment strategy? A) DOH stock with a beta coefficient of 0.7 B) AMF stock with a beta coefficient of 1.0 C) GHI stock with a beta coefficient of 1.3 D) LMN stock with a beta of -0.6

C

Which of the following statements regarding internal rate of return (IRR) is TRUE? A) IRR ignores the time value of money. B) IRR cannot be used effectively to measure return on investments with even cash flows, such as bonds. C) IRR is a discount rate at which the net present value (NPV) of an investment is equal to zero. D) If the IRR is higher than the cost of borrowing to fund an investment, the investment is likely to be unprofitable.

C

A financial ratio used by some analysts to help determine if a company's stock is over or undervalued is A) the dividend payout ratio B) the price-to-book-value ratio C) the current ratio D) the quick asset ratio

B

One of your clients has $150,000 in his 401(k) plan at work. He is assuming the portfolio will increase in value at a rate of 7% compounded annually for the next 5 years. If that is the case, the portfolio value at the end of that 5-year period will be closest to A) $202,500. B) $210,383. C) $240,867. D) $160,500.

B

Which of the following statements regarding the time value of money is NOT correct? A) Future value is the future amount to which a sum of money today will increase on the basis of a defined interest rate and period. B) Compound interest is interest earned on the initial investment. C) Future value of an ordinary annuity is the future amount to which a series of deposits of equal size will increase. D) Compound interest is interest earned on interest.

B

Beta is most frequently measured against which of the following? A) S&P 100 B) Dow Jones Industrial Average C) S&P 500 D) Nasdaq Composite Index

C

XYZ Corporation common stock 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 stock will be A) 45 B) 3 C) 15 D) 5

C Before the split, the stock 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 P/E ratio unchanged (new price = $15, new EPS = $1).

A corporation calls in a portion of its long-term debt at 101. This will have the effect of decreasing working capital increasing working capital decreasing net worth increasing net worth

1, 3 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.

A client wishes to endow an annual scholarship of $40,000 at her alma mater. If the investment can provide a perpetual return of 4.2% per annum, the lump sum deposit required to provide this income is A) $952,380.95. B) $168,000.00. C) $1,052,631.50. D) $417,536.53.

A

All of the following statements about the price-earnings (PE) ratio are true EXCEPT A) a company's stock will have a relatively high P/E ratio if investors feel the company's earnings will grow slowly B) young, fast-growing companies generally have higher P/E ratios than mature, slower-growth companies C) it is computed by dividing the current market price of the common stock by the earnings per share D) a company's P/E ratio may also be called its multiple

A

An investment adviser representative is researching a security and notices that its beta is zero. Which of the following securities is probably the subject of that research? A) A 91-day U.S. Treasury bill B) An ETF tracing the index of gold stocks C) A public utility stock D) A 5-year U.S. Treasury note

A

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

A

If your customer is pursuing an aggressive stock buying strategy, which of the following is most suitable for him? A) GHI stock with a beta coefficient of 1.20 B) DEF stock with a beta coefficient of 0.93 C) ABC stock with a beta coefficient of 1.0 D) Convertible bonds of a mid-cap company

A

A bond's yield to maturity reflects its A) internal rate of return B) return based on annual interest as a percentage of current price C) taxable equivalent return D) nominal return

A 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.

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

A x

All of the following statements regarding an investment's internal rate of return (IRR) are true EXCEPT A) IRR is most often used with growth stocks B) investments are acceptable when their internal rates of return exceed the investor's required rate of return C) IRR is the one rate of return that results in an investment having a net present value (NPV) of 0 D) IRR expresses the rate of interest that matches the initial investment with the present value of future cash flows

A 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.

Which of the following rates of return is used by investment professionals as the risk-free rate? A) Federal funds rate B) 91-day Treasury bill rate C) Prime rate D) Discount rate

B

Which of the following is most commonly used to evaluate the marketplace's perceived value of a particular stock? A) Dividend payout ratio B) Price-to-earnings ratio C) Earnings per share D) Margin of profit

B 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.

Which of the followings measures should be used to assess the risk-adjusted return of an active portfolio manager? A) Beta B) Gamma C) Alpha D) Theta

C

You have determined that the net present value (NPV) of your client's investment is positive. If your client's required rate of return is 8%, which of the following is most likely the investment's internal rate of return (IRR)? A) 0% B) 8% C) 9% D) 4%

C

All of the following ratios are measures of the liquidity of a corporation except A) the debt/equity ratio. B) the acid-test ratio. C) the current ratio. D) the quick ratio.

A

The main difference between the current ratio and the quick ratio is that the quick ratio excludes A) inventory. B) assets. C) goodwill. D) cost of goods sold.

A

FNK Corporation reported earnings of $2.47 per share last year on its stock, currently trading at $9.42 per share. Dividends paid out during the year totalled $0.93 per share. FNK's dividend payout ratio is closest to A) 27% B) 38% C) 10% D) 67%

B

Here are the past seven years of returns for XYZ common stock, 17%, 3%, 13%, 3%, 5%, 9%, 8%. As a measure of central tendency, the value 8 is most accurately described as A) the standard deviation. B) the median. C) the mean. D) the mode.

B

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) −5.9 and +23.3% B) −20.5 and +37.9% C) 8.7 and 23.3% D) 0 and 37.9%

B

XYZ Corporation has a beta of 1, and ABC has a beta of 1.4. XYZ has returned 12% and ABC 18.8%. Based on this information ABC had alpha of A) 18.8% B) 2% C) 6.8% D) 4.8%

B x

Hermon Industries is operating in a sector where the average prospective price-to-earnings ratio is currently eight times. If Hermon's earnings per share (EPS) are expected to be $0.30 per quarter, the implied value of a Hermon share is closest to A) $7.70. B) $2.40. C) $9.60. D) $8.00.

C

Moonglow Specialties, Inc., is paying a quarterly dividend per share of $0.05. Based on a current share price of $10, the dividend yield is closest to A) 0.50%. B) 1.25%. C) 2.00%. D) 20.00%.

C

To make a quantitative evaluation using the present value computation, which of the following is NOT needed? A) Anticipated rate of return of the portfolio B) Time period involved C) Account value at the beginning of the period D) Account value at the end of the period

C

Which of the following statements regarding standard deviation is TRUE? A) Standard deviation is expressed in dollars. B) Standard deviation quantifies expected return. C) Two investments with the same expected return will not necessarily have the same level of risk and standard deviation. D) The smaller the deviation from the average performance, the riskier the investment becomes.

C

In a rising market, which of the following is least volatile? A) A stock with a beta of 0.5 B) A stock with an alpha of 0.5 C) A stock with an alpha of 2.0 D) A stock with a beta of 2.0

A

Which of the following securities has an easily determinable internal rate of return? A) Zero-coupon bond B) 6% Ginnie Mae C) 5% municipal bond D) 7% corporate bond

A The only security that does not have reinvestment risk (the risk that periodic interest payments cannot be reinvested at the same yield as the bond providing the interest payments) is a zero-coupon bond such as Treasury STRIPS. With a zero-coupon bond, there are no periodic interest payments to reinvest, so a yield can be locked in. The interest rate that discounts the redemption price (par) to the discounted purchase price is the locked-in yield, which is the same as the internal rate of return, also referred to as the yield to maturity.

ALFA Enterprises pays a quarterly dividend of $0.15 and has earnings per share of $2.40. Assuming that payout rate is continued, what is the dividend payout ratio? A) 6.25% B) 25% C) 30% D) 14.4%

B

Present value is a computation that is frequently used to determine the amount of a deposit needed now to meet a future need, such as a college education. If an investor uses an expected return of 8% but the actual return over the period is 10%, the future value will be A) too varying to tell B) higher than anticipated C) lower than anticipated D) the same as anticipated

B

Moonglow Specialties, Inc., is currently trading at $20 per share. Recently, the company reported net income of $1 million. The company is capitalized with 200,000 common shares and $5 million of 20-year debentures with a coupon of 4%. Given the data, Moonglow's price-to-earnings (P/E) ratio is closest to A) 2 times. B) 4 times. C) 3 times. D) 5 times.

B P/E ratio = market price per share ÷ earnings per share. Earnings per share = net income ÷ shares = $1 million ÷ 200,000 shares = $5. P/E = 20 ÷ 5 = 4. The net income is after all expenses including the interest on the debentures. As is frequently the case, the question includes information irrelevant to the answer. x

Assume Frank has a portfolio with an actual return of 10.50% for the past year. The portfolio beta equals 1.25, the return on the market equals 9.75%, and the risk-free rate of return equals 3%. Based on this information, what is the alpha for Frank's portfolio and did it outperform or underperform the market? A) +3.3750%, outperform B) −1.6875%, underperform C) -.9375%, underperform D) +9.1875%, outperform

C

Cecil has a discretionarily-managed account with Pelf Reliable Advisors (PRA), an investment adviser registered in States C, D, and G. Over the past year, the portfolio produced a 12% return with a beta of 1.05. The risk-free rate is 3.5%, and the overall market returned 10.85%. Based on this information, calculate alpha and determine if PRA added any value to the portfolio. A) Alpha = 1.15%; the adviser outperformed the market by 1.15% B) Alpha = -1.21%; the adviser underperformed the market by 1.21% C) Alpha = 0.78%; the adviser outperformed the market by 0.78% D) Alpha = 0.78%; the adviser underperformed the market by 2.72%

C

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) Gross profit divided by net sales B) Dividend divided by earnings per share C) Net income divided by average total equity D) Current assets divided by current liabilities

D

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 A) the earnings per share B) the book value per share C) the dividends per share D) the investor's cost basis per share

A

Over the past 5 years, an investor's portfolio has shown returns of 6%, 4%, 11%, 10%, and 4%. Which of the following statements is correct? The mean return is 7%. The median return is 6%. The mode is 4%. The range is 7%. A) I, II, III, and IV B) I, II, and III C) I and II D) III and IV

A

One way in which internal rate of return (IRR) differs from most return computations is that A) it is always an annualized rate of return B) it takes into consideration the time value of money C) its application to debt securities is limited D) it takes into consideration the rate of inflation

B

Of the 4 pairs of assets below, which pair provides the highest level of diversification? A) Assets 3 & 4: with a correlation coefficient of +0.47 B) Assets 1 & 2: with a correlation coefficient of +0.94 C) Assets 7 & 8: with a correlation coefficient of −0.88 D) Assets 5 & 6: with a correlation coefficient of 0

C

When analyzing a security's standard deviation, which of the following statements accurately describes observations according to a normal frequency distribution curve? A) Approximately 97.5% of all observations will be within three standard deviations of the mean. B) Approximately 95.5% of all observations will be within three standard deviations of the mean. C) Approximately two-thirds, or 68%, of observations will be within one standard deviation on either side of the mean. D) Approximately 97.5% of all observations will be within two standard deviations on either side of the mean.

C

Which of the following statements is NOT true? A) Beta is a volatility measure of a security compared with the overall market. B) A stock with a beta of 1.2 will move 20% more than the market. C) Beta is a measure of a security's deviation from its historical average returns. D) A stock with a beta of 0.8 will move 20% less than the market.

C

While searching for a suitable investment for your client, you narrow the choice to the following four companies. Company A with returns over the past 4 years of: 12%, 4%, 8%, 6% Company B with returns over the past 4 years of: 7%, 8%, 9%, 6% Company C with returns over the past 4 years of: 10%, 12%, −2%, 10% Company D with returns over the past 4 years of: 15%, 20%, −8%, 3% Which of these choices has the highest volatility? A) Company A B) Company B C) Company D D) Company C

C

Which of the following items would be included in a current ratio computation? A) Inventory, equipment, and cash B) Cash, dividends payable, and shareholders' equity C) Accounts payable, wages payable, and short-term debt D) Accounts receivable, inventory, and long-term debt

C Current ratio is computed by dividing current assets by current liabilities. Current assets include cash, accounts receivable, and inventory. Current liabilities include accounts payable, wages payable, dividends payable, and short-term debt. Equipment is a fixed asset, and shareholders' equity is net worth.

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

C 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.

Securities analysts would agree that it makes sense to purchase a fixed-income security when its net present value (NPV) is A) zero B) variable C) negative D) positive

D

Your client has $10,000 to invest and expects to earn an after-tax return of 8% to send his daughter to college in 12 years. Which of the following items will help determine whether the investment is likely to satisfy the client's goal? A) Present value B) Client's marginal federal income tax bracket C) Consumer Price Index D) Expected cost of college

D

From the following 4 portfolios, choose the 1 that would generally be considered to be the most diversified. A) DCB common stock, beta 1.00, correlation to the S&P 500, +0.75; HGF common stock, beta 0.10, correlation to the S&P 500, +0.25; KJI common stock, beta −0.50, correlation to the S&P 500 +0.50 B) STU common stock, beta 0.95, correlation to the S&P 500, +0.84, VWX common stock, beta 0.90, correlation to the S&P 500, +0.07; YZA common stock, beta 0.88, correlation to the S&P 500, −0.45 C) JKL common stock, beta 1.50, correlation to the S&P 500, +0.77; MNO common stock, beta 1.00, correlation to the S&P 500, +0.93, PQR common stock, beta 0.50, correlation to the S&P 500, +0.34 D) ABC common stock, beta 1.20, correlation to the S&P 500, +0.82; DEF common stock, beta 0.90, correlation to the S&P 500, +0.91; GHI common stock; beta +0.65, correlation to the S&P 500, +0.06

B Most analysts would agree that the greatest portfolio diversification occurs when there are some holdings with a negative correlation. Beta measures volatility, so varying those positions will offer some protection against volatility. However, including securities that move in opposite directions will provide protection against general market declines.

When analyzing a company's financial statements, gross profit is computed by subtracting from revenues A) the cost of goods sold B) all expenses, including income tax C) the cost of goods sold plus interest expense D) all expenses, including income tax plus preferred dividends

A

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

Which of the following statements is NOT correct? A) Net present value (NPV) is the difference between the initial cash outflow (investment) and the future value of discounted cash flows. B) Time-weighted returns show performance without the influences of additional investor deposits or withdrawals from the account. C) Net present value analysis (NPV) is a commonly used time value of money technique employed by businesses and investors to evaluate the cash flows associated with capital projects and capital expenditures. D) Internal rate of return (IRR) is a method of determining the exact discount rate to equalize cash inflows and outflows, thus allowing comparison of rates of return on alternative investments of unequal size and investment amounts.

A Net present value (NPV) is the difference between the initial cash outflow (investment) and the present value of discounted cash flows (NPV = PV of CF − cost of investment). That is why it is called net present value instead of net future value. x

An investor places $10,000 into BCD common stock 12 years ago. Today, that stock has a market value of $20,000. Using the Rule of 72, the internal rate of return on BCD is closest to A) 6.8%. B) 6%. C) 5%. D) 8%.

B

If an investor wished to compute the mean return of her portfolio, she is going to A) compute the standard deviation B) find the arithmetic mean C) find the median D) compute using straight-line averaging

B

The following numbers (in %) represent the returns from an investment fund over the past seven years: 2014: 13%, 2015: 11%, 2016: 2%, 2017: 6%, 2018: 5%, 2019: 8%, 2020: 6%. Using the range measure would indicate that the seven-year returns from the fund had a range of A) 11%. B) 4%. C) 2%. D) 9%.

A

A client owns an investment-grade bond with a coupon of 5% that is priced to yield 6.7%. If similarly rated bonds are being issued today with coupons of 7%, it would be expected that the client's bond A) has a zero net present value B) has a negative net present value C) will be selling at a premium over par D) has a positive net present value

B With a discount rate of 7% (the discount rate in a present value computation is the current market interest rate), a debt instrument with a 5% coupon rate will be selling at a discount (interest rates up, prices down). We are told that this bond is offering a yield of 6.7%, which is less than the current market rate. Because a present value computation using a 6.7% rate would reflect a higher value than a 7% rate (the higher the discount rate, the lower the value), that would mean that the bond can be purchased at a price above its present value. Anytime that occurs, the instrument has a negative net present value (the difference between the price and the present value).

The price-to-earnings ratio A) reflects how liberal the company's dividend policies are B) indicates current cash flows C) is higher for value stocks than for growth stocks D) shows how much investors value the stock as a function of earnings to the company's market price

D

RAP mutual fund had the following returns over the past 3 years: Year 1: 15%. Year 2: -5%. Year 3: 7%. What is the arithmetic mean of the returns for the RAP fund? A) 9.00% B) 20.00% C) 7.00% D) 5.67%

D

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, Kapco's P/E ratio has decreased Kapco's P/E ratio has increased an investor holding Kapco over this period would have noticed a decrease in income received an investor holding Kapco over this period would have noticed no change in income received

1, 4 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. x

Although there may be some slight differences in methodology, when S&P or Moody's evaluate a security in order to assign a rating, they would be least likely to consider the issuer's A) cash flow to debt ratio B) profitability ratio C) liquidity ratio D) asset turnover ratio

D What is the purpose of a security's rating? To inform investors of the financial risk of the investment. The higher the rating, the lower the risk. This is one of those questions that students answer correctly because all of the other choices are incorrect (they are important factors). Remember, this is a negative question: "least likely." Certainly profitability of the issuer is a key factor in assessing the safety of the issue. Liquidity and cash flow are important factors as well. The rate at which assets are turned over is not nearly as important to determining a rating as the other three.

The rate that produces a net present value of a series of discounted cash flows equal to zero is called A) the average rate of return. B) the return on investment (ROI). C) the opportunity cost of investing. D) the internal rate of return (IRR).

D

The terms mean, median, and mode are all measures of A) beta coefficient B) standard deviation C) correlation coefficient D) central tendency

D

Which of the following methods of calculating investment returns are discounted cash flow (DCF) techniques? Net present value (NPV) Holding period return (HPR) Internal rate of return (IRR)

1, 3

An analyst viewing a corporate income statement will be able to review all of the following except A) pre-tax income. B) current ratio. C) net sales or net revenues. D) operating expenses.

B

Selmer Jones has just inherited some money and wants to set some of it aside for a vacation in Hawaii one year from today. His bank will pay him 5% interest on any funds he deposits. In order to determine how much of the money must be set aside now and held for the trip, he should use the 5% as a A) discount rate. B) opportunity cost. C) required rate of return. D) nominal rate of return.

A This is a present value question. Selmer needs to figure out how much the trip will cost in one year, and use the 5% as a discount rate to convert the future cost to a present value. Thus, in this context the rate is best viewed as a discount rate. Although you would never have to compute it, for each $1,000 Selmer needs, he would have to put away $952.38 (the present value of $1,000 at 5% in 1 year).

Mr. and Mrs. Rose, advisory clients of yours, request a meeting with you to discuss the options available if they wish to deposit a lump sum to save for college tuition for their child. All of these would be factors to consider EXCEPT A) the age of the child B) the expected inflation rate C) current college costs D) the Roses' salaries

D

Plymouth Standard's common stock has an average return of 12%; its returns fall within a range of -2% to +26% approximately 68% of the time. Which one of the following numbers is closest to the standard deviation of returns of Plymouth Standard's stock? A) 19% B) 8% C) 28% D) 14%

D

If a company successfully gets the owners of its long-term bond issue paying 7% annual interest to exchange them on a dollar-for-dollar basis with the company's preferred stock paying a 7% annual dividend, what is the effect on EPS? A) Decrease B) No effect C) Increase D) Not enough information

A The 7% interest payment is moved from a pre-tax deduction to an after-tax dividend 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. x

Use the following chart to answer this question: STOCK 50% 30% 10% 0% BONDS 50% 70% 90% 100% High return39.4% 37.2% 34.3% 32.7% Low return1. 4% 6.5% 7.2% 8.5% Ave. return1 5.8% 16.2% 15.5% 15.2% Std. Dev. 11.25 10.75 10.15 10.34 Which portfolio mix would you recommend to a client who is most concerned about projected near-term volatility? A) 100%/0% B) 10%/90% C) 50%/50% D) 30%/70%

B Although this might look complicated, this is very simple if you realize that standard deviation is the measure of volatility. So, just pick the allocation with the lowest standard deviation and that is the 10%/90% at 10.15.

When a bond's NPV is zero, it is usually an indication that A) the bond is a zero-coupon bond. B) the market is highly efficient. C) the bond is highly rated. D) the bond is mispriced.

B An NPV of zero indicates that there is no difference between the bond's present value and its current market price. That usually indicates a highly efficient market. x

Which of the following are likely to have a low beta? A) Technology stocks B) Aerospace stocks C) Software stocks D) Public utility stocks

D

Which ratio would be looked at to determine the liquidity of a corporation? A) Price/earnings B) Dividend payout C) Debt/equity D) Current

D

If the net present value of a series of discounted cash flows is less than zero, one could conclude that A) the return on investment is higher than the internal rate of return. B) the rate of return is higher than the cost of capital. C) the discounted cash flows are lower than the investment outlay. D) the internal rate of return equals the discount rate.

C A negative net present value of a series of discounted cash flows means the investment outlay exceeds the discounted cash flows. Net present value is the difference between the initial cash flows and the present value of future cash inflows. If the net present value is negative, the present value of future cash flows is less than the initial investment. An investment with a negative net present value is generally an undesirable investment.

The difference between present value and net present value represents A) the credit risk premium B) the discounted cash flow C) the initial cash outlay D) the internal rate of return

C When computing the net present value, we remember that the word net means that something must be subtracted. The number subtracted is the initial cost of the investment. x

If you were using the discounted cash flow method to determine the appropriate value of a security, you would want to purchase that security when A) the current market price equals the PV B) the current market price is above the PV C) the rating of the security has just been upgraded D) the current market price is below the PV

D Those who use the DCF to value a security would recommend purchasing when the current market price is below the PV—that is, when the NPV is positive.

A securities analyst reviewing the financial statements of the XYZ Corporation observes that the company's total liabilities are in excess of its total assets. From this information, the analyst could conclude that XYZ has A) a negative book value per share. B) a high current ratio. C) a highly leveraged capital structure. D) a low price-to-earnings ratio.

A When the liabilities exceed the assets, there is a negative net worth. By extension, that means a negative book value per share. We don't know anything about the current assets and current liabilities, so we can't measure the current ratio. We also don't know if the debt is from borrowing or just an excess of payables over receivables, so we don't know if financial leverage has been employed. Likewise, we have no information about the company's earnings, so we can't compute the PE ratio. It is likely that it is low, but if this is a start-up enterprise, it is possible that the PE could be rather high. In any event, when faced with two choices that could be correct, always go with the one that is correct without any exceptions. x

If the required rate of return is higher than anticipated in a present value calculation, the effect would be that A) the present value would be higher B) the yield to maturity would increase C) the future value would be higher D) the present value would be lower

D Try to follow me on this one. The present value computation is used to determine how much money must be deposited now (in the present) to reach a specified future goal when you know how many years you have to reach that goal. One critical component of the formula is the rate of return. As a simple example, if you need $100,000 in 18 years for your newborn's college education and you expect to earn 4%, using the rule of 72, you'll have to deposit $50,000 now (present value) to reach the goal. However, if it turns out that the earnings rate is higher than anticipated—say, 8%—you would only need to deposit half as much today ($25,000). Therefore, we answer this question by indicating that a higher rate of return will require a lower present value (deposit).