Unit 7

Which of the following are key assumptions of the Capital Asset Pricing Model (CAPM)? I. Investors hold diversified portfolios II. Income tax rates are stable III. Investors can borrow and lend at the risk-free rate IV. There is a perfect capital market

I., III., IV

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

...

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.

...

current assets- current liabilities = working capital

...

A client approaches the IAR handling the advisory account with a request to find a preferred stock that will offer a 6% income return. The IAR suggests a stock paying a $.28 quarterly dividend. That stock will meet the income objective if it has a current market price of A) $18.67 B) $6.72 C) $11.91 D) $4.67

A) $18.67. Annual dividend / required rate of return

Which of the following market analysts is using the efficient market theory? A) An analyst picks company names out of a hat. B) An analyst sells stock when he sees small investors buying. C) An analyst has developed a system for identifying reversals in downward trendlines. D) Before he invests in a company, an analyst visits its headquarters to see whether management is running the company effectively.

A) An analyst picks company names out of a hat. Efficient market theory holds that securities are efficiently priced and therefore, it makes no sense to analyze particular stocks

You have been following GEMCO stock for the past couple of months and notice a recent increase in the stock's volatility. In the past month, several negative reports have been published about GEMCO's product line. This has caused a drop in the market price of the stock even though the GEMCO has just reported earnings that exceeded analyst's projections. This is an example of: A) market risk. B) purchasing power risk. C) volatility risk. D) financial risk.

A) market risk. Company had good earnings, but the stock still fell. It is likely that the overall market dropped.

In order to compute an investor's real rate of return on a common stock holding, all of the following are necessary EXCEPT: A) inflation rate. B) marginal tax bracket. C) appreciation. D) dividends.

B) marginal tax bracket. Tax bracket is only needed to calculate after- tax return.

A recession is defined as a drop in GDP for: A) three consecutive quarters. B) six consecutive quarters. C) two consecutive quarters. D) four consecutive quarters.

C) two consecutive quarters.

An investor purchases shares of ABC stock at $50 per share. One year later, ABC is selling for $54 per share and, at the end of the second year, the price is $52 per share. ABC has paid dividends of $2 per year. Upon liquidation, the investor would have earned a return of: A) $4 per share. B) $8 per share. C) $2 per share. D) $6 per share.

D) $6 per share. The investor paid $50 and sold it for $52 for a $2 per share gain. During the two year holding period, $4 in dividends were paid. That is a total return of $6 per share.

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

D) 15. EPS stays the same after the split.

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: A) regulatory risk. B) market risk. C) business risk. D) legislative risk.

D) legislative risk.

One popular method used to predict the expected return of a stock is the Capital Asset Pricing Model. Analysts using CAPM rely on all of these EXCEPT the: A) expected return on the market. B) beta coefficient of the stock. C) risk-free rate available in the market. D) standard deviation of the stock.

D) standard deviation. we can determine the expected return of any given stock by taking the risk-free rate and adding to that the product of that stock's beta coefficient and the difference between the expected return on the market and the risk-free rate. Standard deviation is not a factor in this computation.

Which items change when a company pays a cash dividend? I. Working capital. II. Total assets. III. Total liabilities. IV. Shareholders' equity.

II & III.

One measure of a corporation's intrinsic 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? I. Cash II. Wages payable III. Patents IV. Preferred stock

III & IV. The computation of book value per share is basically net tangible worth per share of common stock. Therefore, we subtract both the par value of the preferred stock and the value listed on the balance sheet for the intangible assets, such as patents

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

B) Account value at the beginning of the period.

dividend payout ratio = dividends paid per share / EPS

...

To reduce a client's exposure to systematic risk in his equity portfolio, you would look at which of the following factors? A) Beta. B) Earnings history. C) Investment return compared to the inflation rate. D) Credit rating.

A) Beta. Beta is a measure of a portfolio's volatility compared to the volatility of the overall market. Since systematic risk is risk associated with investing in the market, lowering the client's volatility (beta) relative to that of the market should lower his exposure to market risk.

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

A) Defensive stocks.

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

A) Depreciation expense. The most common formula for the cash flow from operations computation is net income plus the depreciation expense taken for the year.

With respect to the fiscal policy of the United States, the annual budget is submitted by the: A) President. B) Congress. C) Internal Revenue Service. D) Federal Reserve Board.

A) President

An investor is considering the purchase of some bonds to diversify his portfolio. If he should decide to purchase Treasury STRIPS instead of Treasury Bonds, his major risk would be: A) Reinvestment risk. B) Purchasing power risk. C) Credit risk. D) Interest rate risk.

A) Reinvestment risk. Treasury STRIPS are zero coupon bonds and, as such, have a longer duration than those paying semi-annual interest. The longer the duration, the greater the interest rate risk.

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) 8.7 and 23.3%. B) -20.5 and 37.9%. C) 0 and 37.9%. D) -5.9 and 23.3%.

B) -20.5 and 37.9%. You want to find the return movements in either (2) directions. SD * 2.

Early in the year, an investor purchased 100 shares of KAP common stock at a price of $60 per share. Just before the end of the year, after receiving three quarterly dividends of $1, the investor liquidated all of the KAP at a price of $59 per share. If the CPI increased by 3%, the investor's total return over the holding period was: A) 2%. B) 3.33%. C) 0.33%. D) 5%.

B) 3.33%. An investor's total return is computed by adding together income plus capital gain (loss). That resulted in a total return of $2, which, when divided by the $60 cost, results in a percentage return of 3.33%.

A corporation ends its accounting year on September 30th. It would be correct to state that they use a (an): A) accounting year. B) fiscal year. C) alternative year. D) nine-month year.

B) fiscal year. Fiscal-year accounting is the term used to describe whenever an entity ends its accounting year on a date other than December 31st.

If an investor buys a utility stock with a stable 5% dividend, and after a year the investor's total return in the stock is 10%, the most likely reason for this is the: A) investor reinvested the quarterly dividends. B) the stock appreciated by 5%. C) company doubled its dividend payment. D) stock price declined.

B) the stock appreciated by 5%.

Many fixed income investors are looking to avoid loss of principal. Which of the following would likely have the lowest degree of exposure to credit risk? A) Ba rated corporate mortgage bond. B) Baa rated municipal revenue bond. C) Aa rated corporate debenture. D) A rated general obligation muncipal bond.

C) Aa rated corporate debenture. The higher the rating, the lower the credit risk.

Which of the following will be the most likely risk that you will face during the first year after purchasing a corporate AA bond that matures in 15 years? A) Liquidity. B) Inflation. C) Interest rate. D) Market.

C) Interest rate. With 15 years to maturity, even an investment-grade bond is subject to interest rate risk. This is particularly true during the early years because price fluctuations are greater when duration is longer.

A bond's duration is: A) expressed as a percentage. B) an indication of a bond's yield that ignores its price volatility. C) longer for a 10-year bond with a 5% coupon than it is for a 10-year bond with a 10% coupon. D) identical to its maturity for an interest-bearing bond.

C) longer for a 10-year bond with a 5% coupon than it is for a 10-year bond with a 10% coupon. Lower coupon = longer duration.

One measure of an investor's total return is called holding period return. The computation includes both income and appreciation and is used for both debt and equity securities. An investor's holding period return would be less than the bond's yield to maturity if A) the bond was called at a discount B) the investor purchased a put option on the bond C) the coupons were reinvested at a rate below the yield to maturity D) the bond was redeemed at a premium

C) the coupons were reinvested at a rate below the yield to maturity. The calculation of yield to maturity assumes reinvestment of the bond's interest at the coupon rate. Therefore, if the investor was only able to do less than that, the holding period return would be decreased.

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 the: A) present value of $25,000. B) net present value of the $25,000. C) internal rate of the return on the $25,000. D) future value of the $25,000.

D) future value of the $25,000. To determine the money's worth at a future date (in this case, 5 years), the Smiths calculated the future value of the funds.

Proponents of the concept of inflation inertia believe that: A) prices will remain the same for a protracted period of time. B) prices will rise rapidly and then begin to contract. C) the rate of inflation will parallel the CPI. D) prices will rise slowly and then begin to increase at a faster rate.

D) prices will rise slowly and then begin to increase at a faster rate.

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

D) the net change in the cash position of the firm for the reporting period. The sum total, or the net change in cash, is not reported on either the balance sheet or the income statement. It is the sum total of the entries on the statement of cash flows which is a separate financial statement.

expected ROR under CAPM = RFR + beta * (ER - RFR)

...

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

I & IV. EPS * Payout ratio. See the difference after both changes

In order to calculate an investor's holding period return, it is necessary to know: I. value of the portfolio at the beginning of the period. II. value of the portfolio at the end of the period. III. income received during the period. IV. capital appreciation or depreciation over the period.

I., II., & III. (when you know the beginning and ending values, that tells you the capital appreciation or depreciation.)

Which school of economists encourages a government to spend money to move the economy into an expansionary phase? A) Keynesian. B) Supply side. C) Monetarist. D) Classical.

A) Keynesian. They advocate government intervention.

cash flow from operations = net income + depreciation expense

...

a company's annual filing

Form 10-K

used to report significant events of importance to investors

Form 8-K

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

B) current assets minus its current liabilities.

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 the: A) annual report. B) Form 10-K. C) balance sheet. D) investor's brochure.

A) annual report. Provides a complete financial report and the company's plans for the future.

One of your clients owns 2 different 6% corporate bonds maturing in 15 years. The first bond is callable in 5 years, while the second has 10 years of call protection. If interest rates begin to fall, which bond is likely to show a greater change in price? A) Bond with the 10-year call. B) Bond with the 5-year call. C) Both will decrease by the same amount. D) Both will increase by the same amount.

A) Bond with the 10-year call. As interest rates fall, the investor benefits from having the highest interest rate for as long as possible.

In comparing the change in the GDP from one year to another, to arrive at an accurate figure, each year's GDP should be converted to which of the following? A) Constant dollars. B) International dollars. C) Dollars valued by exchange with foreign currencies. D) Dollars in terms of gold bullion.

A) Constant dollars. The GDP must be adjusted for inflation to get an accurate comparison from one year to the next.

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

A) income statement.

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) parent's salary. B) expected inflation rate. C) age of the child. D) current college costs.

A) parent's salary.

All of the following are leading indicators for economic growth EXCEPT: A) orders for durable goods. B) average prime rate. C) average weekly initial claims for state unemployment compensation. D) stock prices as measured by the S&P 500 index.

B) average prime rate. This is a lagging indicator.

Your client purchases 100 shares of XYZ Electric Auto Company on the assumption that rising fuel costs will create more interest in this more efficient means of transportation. If he is wrong, the resulting drop in the market price of that stock would be due to: A) purchasing power risk. B) business risk. C) market risk. D) money rate risk.

B) business risk. (investing in the success of a specific company)

When a member of the board of directors of a publicly traded company resigns due to a disagreement over an operational matter, A) the Administrator must be notified no later than the close of the business day following the event B) FINRA must be notified promptly C) Form 10-K must be filed with the SEC within four business days of the event D) Form 8-K must be filed with the SEC within four business days of the event

D) Form 8-K must be filed with the SEC within four business days of the event. The Form 8-K is used to report significant events of importance to investors.

The Sharpe ratio is the average annual return of a security: A) divided by the expected return of the market. B) plus the risk-free rate divided by the security's beta. C) divided by the risk-free rate. D) minus the risk-free rate for the period divided by the security's standard deviation.

D) minus the risk-free rate for the period divided by the security's standard deviation. The Sharpe ratio is basically a risk- adjusted return.

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

I & III. Cash is used to call the bonds, so working capital is decreased. Whenever a bond is called at a premium, net worth is reduced by that premium.

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

I & III. Holding period return does NOT take into account the time value of money.

Which of the following would appear as assets on a corporation's balance sheet? I. Prepaid expenses II. Deferred tax credits III. Notes payable IV. Notes receivable

I & IV.

According to the efficient market hypothesis, information found when reading the Wall Street Journal would be considered: A) strong-form market efficiency. B) weak-form market efficiency. C) useless. D) semi-strong form market efficiency.

B) weak-form market efficiency. The closer to inside information, the stronger the information. Anything published in widely read media would be considered very weak.

An analyst uses the Dividend Growth Model to assist in determining appropriate stocks to recommend. This analyst would consider all of the following factors EXCEPT: A) required rate of return. B) growth of the dividend. C) current dividend. D) dividend payout ratio.

D) dividend payout ratio. The classic definition of the Dividend Growth Model is "a stock valuation model that deals with dividends and their growth, discounted to today". The payout ratio has nothing to do with this, it is strictly the amount of the dividend that counts.

Which of the following statements about the federal government's fiscal policy is TRUE? I. The federal government's fiscal policy is its policy for managing taxation, spending, and debts. II. The federal government's fiscal policy can have a great impact on the securities markets. III. The federal government finances its deficit spending by selling bonds.

I, II, III.

An inverted yield curve results in part by: A) declining interest rates. B) investors buying long-term bonds and selling short-term bonds. C) investors buying short-term bonds and selling long-term bonds. D) rising interest rates.

B) investors buying long-term bonds and selling short-term bonds. 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 securities are the most interest-rate sensitive? I. Utility stocks. II. Growth stocks. III. Preferred stocks. IV. Common stocks.

I & III. Utility stocks are highly leveraged, and therefore sensitive to rates. Preferred stocks have a set dividend and fluctuate in price like bonds when interest rates change.

There is an inverse relationship between a bond's coupon rate and its duration. A higher coupon will pay the investor back through cash flow at a faster rate. Therefore, a zero-coupon bond with no cash flow has a duration equal to its maturity.

...

Which of the following would constitute political risk that might affect a security? A) New environment regulations B) FED monetary policy decisions C) A strike by the union representing the company's employees D) A bad decision by the company's CEO

B) FED monetary policy decisions. Fed is the only answer connected to a political body.

What generally happens to outstanding fixed-income securities when the rate of inflation slows? A) Short-term securities are affected the most. B) Prices go up. C) Yields go up. D) Coupon rates go up.

B) Prices go up. When inflation slows, coupon rates are lowered, causing prices to go up.

This risk measures the possibility that a change in the law will affect the value of an investment.

legislative risk

An investment of $1,000 made 10 years ago is now worth $4,000. Using the Rule of 72, the approximate compounded annual rate of return is A) 25%. B) 40%. C) 7.2%. D) 14.4%.

This investment has quadrupled in 10 years. For Rule of 72, we compute the rate of return when an investment doubles. 72 / years = 14.4%.