Series 7 Chapter 14

Which of the following investment strategies makes sense for an investor who believes in the efficient market hypothesis (EMH)? A) Market timing. B) Investing in actively managed mutual funds. C) Hedging through the purchase of derivative investments. D) Investing in a market index fund.

Your answer, Hedging through the purchase of derivative investments., was incorrect. The correct answer was: Investing in a market index fund. A market index fund is a favorite strategy of those who believe in the efficient market hypothesis, which holds that all relevant information has already been taken into account by the market, and it is pointless to try to outperform the broader market indexes.

A corporation has $12 million net income after taxes, 5 million common shares outstanding, and $10 million of 6% preferred stock ($100 par). What is the corporation's earnings per share (EPS)? A) $2.52. B) $2.28. C) $1.20. D) $2.40.

Your answer, $1.20., was incorrect. The correct answer was: $2.28. Begin by calculating how much of the net income is available for common stockholders (net income after taxes minus preferred dividends equals earnings available for common stockholders). The preferred stockholders received $600,000 in dividends (100,000 pfd shares × $6 per share dividends = $600,000). After subtracting $600,000 from the net income of $12 million, this leaves $11.4 million (earnings available for common stockholders). Compute EPS (earnings available for common ÷ number of common shares outstanding = $11.4 million / 5 million shares = $2.28 per share EPS).

A customer buys XYZ stock at $60 per share. The stock is currently trading at a 10:1 price-to-earnings (PE) ratio. The firm declares a 3:1 stock split. What will the PE ratio be after the split if earnings remain unchanged? A) 3:1. B) 12:1. C) 5:1. D) 10:1.

Your answer, 3:1., was incorrect. The correct answer was: 10:1. If earnings remain unchanged, the PE ratio remains the same, 10:1. Earnings are currently $6 per share ($60 / 10). After a 3:1 split, each share will be valued at $20. If earnings are unchanged, the same $6 of earnings is now applicable to 3 shares or $2 per share. Price divided by earnings equals PE ratio ($20 / $2 = 10:1 PE ratio).

Which of the following is a defensive stock? A) Steel company stocks. B) Utility company stocks. C) Food company debentures. D) Airline company stocks.

Your answer, Food company debentures., was incorrect. The correct answer was: Utility company stocks. Utility companies are going to generate revenue no matter what the economy does. Therefore, they are considered defensive in the face of a bad economy.

Financial footnotes found in which of the following would be of the greatest importance to your broker/dealer's retail customers? The BD's principal approved advertising Balance sheets of stocks you've recommended to them Income statements of stocks you've recommended to them Your BD's Website page showing the history of the firm A) I and IV B) I and III C) II and IV D) II and III

Your answer, I and III, was incorrect. The correct answer was: II and III While footnotes found anywhere are of importance, those found in financial statements like balance sheets and income statements would be the most important to your BD's customers when evaluating investment recommendations.

When investing in a foreign bond fund, a customer will profit if: the U.S. dollar strengthens. the U.S. dollar weakens. foreign currencies strengthen. foreign currencies weaken. A) I and III. B) II and III. C) II and IV. D) I and IV.

Your answer, I and III., was incorrect. The correct answer was: II and III. Since the fund is purchasing bonds denominated in foreign currencies, a weakening of the U.S. dollar or strengthening of foreign currencies will be beneficial.

Which of the following would be considered in the fundamental analysis of a security? Support and resistance levels. Trading volumes. Liquidity ratios. Historical earnings trends. A) I and II. B) II and III. C) I and IV. D) III and IV.

Your answer, I and IV., was incorrect. The correct answer was: III and IV. Fundamental analysts are concerned with information relating to the economy, industries, and individual companies. A company's liquidity ratios and past earning trends fall within these areas of concern. Concerns about the stock price and volume of trading would be of primary interest to a technical analyst.

Which items would change if a company buys equipment for cash? The working capital. The total assets. The total liabilities. The shareholders' equity. A) II and IV. B) I only. C) I and II. D) IV only.

Your answer, I only., was correct!. The general balance sheet formula is assets = liabilities + shareholders' equity. A purchase of equipment for cash would affect working capital by reducing current assets. However, it would not affect total assets since it is an exchange of one asset (cash) for another asset of equal value (equipment). Since no loan was needed, it does not affect total liabilities, nor does it affect equity.

Active government manipulation of the economy through tax and budget policies is referred to as: A) supply side. B) soft landing. C) Keynesian. D) monetarist.

Your answer, Keynesian., was correct!. Keynesian economics is the body of economic thought that believes that active government intervention in the marketplace is the only method of insuring economic growth and stability, and that the government should manipulate the economy through adjusting levels of government expenditure and taxation. A monetarist economist is one that believes that the manipulation of the money supply is the most important tool with regard to affecting the economy. These are the two major types of fiscal policy that basically advocate affecting the economy through manipulation of taxation and the spending policies of the federal government.

The Conference Board releases information about the economy on a monthly basis. Included are a number of different indicators. Economic indicators can be leading, lagging, or coincidental, which indicates the timing of their changes relative to how the economy as a whole changes. New orders for durable goods is what kind of economic indicator? A) Coterminous. B) Leading. C) Lagging. D) Coincident.

Your answer, Lagging., was incorrect. The correct answer was: Leading. New orders for durable goods are a leading economic indicator.

Which of the following would be characterized as a coincident indicator? A) First-time unemployment claims. B) New housing starts. C) Industrial production. D) Prime rate.

Your answer, New housing starts., was incorrect. The correct answer was: Industrial production. Housing starts and unemployment claims are leading indicators, whereas prime rate is a lagging indicator. Only industrial production is coincident to the current economy.

The Dow Jones Industrial Average is which of the following? A) Unweighted average of 300 stocks, primarily transportation. B) Price-weighted average of 300 stocks, primarily industrial. C) Price-weighted average of 30 stocks, primarily industrial. D) Unweighted average of 30 stocks, primarily transportation.

Your answer, Price-weighted average of 30 stocks, primarily industrial., was correct!. The Dow Jones Industrial Average (DJIA), published by Dow Jones & Company, is a price-weighted average of 30 stocks. These stocks represent primarily industrial corporations but also include AT&T, American Express, and Microsoft.

Stock of which of the following companies trades on equity? A) Car manufacturer. B) Public utility. C) Steel manufacturer. D) Drug manufacturer.

Your answer, Steel manufacturer., was incorrect. The correct answer was: Public utility. Trading on equity relates to a highly leveraged company. Utility companies are normally highly leveraged.

Which of the following would most likely be considered a leading economic indicator? A) Bankrupt businesses. B) The GNP. C) The S&P 500. D) The CPI.

Your answer, The S&P 500., was correct!. Leading indicators tend to forecast business cycles in the economy, such as securities markets. The best answer is the S&P 500.

Which of the following would best describe working capital? A) 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. B) The amount of money available to the corporation that is currently being held in cash or cash equivalent positions. C) The value per share available to shareholders in the event of bankruptcy. D) A corporation's net worth.

Your answer, The value per share available to shareholders in the event of bankruptcy., was incorrect. The correct answer was: 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. Working capital equals current assets minus current liabilities.

A head and shoulders bottom formation is an indication of: A) a bullish market. B) the reversal of a downtrend. C) a bearish market. D) the reversal of an upward trend.

Your answer, a bearish market., was incorrect. The correct answer was: the reversal of a downtrend. A head and shoulders bottom formation is also known as an inverted head and shoulders formation. It is that part of a graph in which a downtrend has reversed to become an uptrend. It is not, however, an indicator of the bullishness or bearishness of the market as a whole. It is an indication only of the direction of a trend, which may be either short or long in duration.

The Federal Reserve Board can manage the money supply with all the following tools EXCEPT: A) open market operations. B) income tax rate. C) bank reserve requirements. D) discount rate.

Your answer, bank reserve requirements., was incorrect. The correct answer was: income tax rate. The Federal Reserve Board uses several tools to manage the money supply, including bank reserve requirements, open market operations (trading government securities), and the discount rate. Income tax rates are set by Congress.

Included in the working capital computation of a corporation are all of the following EXCEPT: A) accounts receivable. B) convertible bonds it has issued. C) cash. D) marketable securities of other companies.

Your answer, convertible bonds it has issued., was correct!. 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.

To curb excessive economic activity, the Fed would: A) sell bonds to the public at auction. B) decrease discount rate. C) sell securities in open market operations. D) decrease reserve requirements.

Your answer, decrease reserve requirements., was incorrect. The correct answer was: sell securities in open market operations. The Federal Open Market Committee can take money out of circulation during inflationary times through the sale of securities to primary dealers.

The economic theory that says economic growth results from lower tax rates and lower government spending is: A) monetary theory. B) supply-side theory. C) demand-side theory. D) Keynesian theory.

Your answer, demand-side theory., was incorrect. The correct answer was: supply-side theory. Supply-side economics is the theory of Arthur Laffer, who believed that heavy taxing and government intervention have a negative effect on the economy.

A company's balance sheet dated December 31 shows retained earnings of $100,000. You can deduce from this information that the company: A) has had $100,000 in undistributed profits since its inception. B) earned a profit of $100,000 for this year. C) has at least $100,000 in cash. D) has had total net income of $100,000 since its inception.

Your answer, has at least $100,000 in cash., was incorrect. The correct answer was: has had $100,000 in undistributed profits since its inception. Retained earnings represent the accumulated total of all earnings that have been retained in the company since its inception. It is quite possible that the company did not earn $100,000 in that particular year and does not have $100,000 in cash.

While looking at a chart for QRS common stock, a technical trader wants to have an order in position in the event that QRS moves higher and breaks out on the chart. A buy stop order would be placed: A) just below the support level. B) just below the resistance level. C) just above the support level. D) just above the resistance level.

Your answer, just above the support level., was incorrect. The correct answer was: just above the resistance level. To take advantage of a stock moving higher and breaking out on a chart, a technical trader would place a buy stop order just above the resistance level. Technical traders believe that if a stock breaks the resistance level, it will move to and trade within a higher price range. Using a buy stop order placed just above the resistance level ensures that the purchase is not made until the stock has broken through the resistance.

You note that "help wanted" advertisements in "The Wall Street Journal" have been increasing. This economic measure is a: A) lagging indicator. B) leading indicator. C) none of these. D) coincident indicator.

Your answer, leading indicator., was correct!. The number of employment advertisements is viewed as a leading indicator that will predict a change in the economy. The duration of unemployment claims is considered a lagging indicator-a result of a change in the economy.

A technical analyst is least concerned with: A) open short positions. B) new highs and lows. C) declaration of increased dividends. D) trading volume.

Your answer, new highs and lows., was incorrect. The correct answer was: declaration of increased dividends. A technical analyst is interested in statistics about market or price performance, not the fundamental factors, the market, or the company's dividend policy. Technical analysts are interested in trading volume as a market statistic, new highs and lows, and open short positions, which could indicate future buying potential in the security.

The theory that the small investor is usually wrong is called: A) none of these. B) the Odd-Lot Theory. C) the Dow Theory. D) the Small Investor Theory.

Your answer, the Small Investor Theory., was incorrect. The correct answer was: the Odd-Lot Theory. The Odd-Lot Theory is based on the belief that the smaller investor (who normally buys in odd lots) is usually wrong. If odd-lot purchase volume increases, it indicates a market decline is near. If odd-lot sale volume increases, it indicates that market prices will appreciate.

Balance sheets contain: A) gross revenues for the year. B) the net worth of the firm as of the date of the balance sheet. C) the amount of cash and cash equivalents expended during the first half of the fiscal year as opposed to the second half. D) no reference to the accounting methods used to construct the balance sheet.

Your answer, the amount of cash and cash equivalents expended during the first half of the fiscal year as opposed to the second half., was incorrect. The correct answer was: the net worth of the firm as of the date of the balance sheet. The balance sheet provides a snapshot of the financial condition of the firm on that date. It does not provide information on the flow of expenses, revenues, and cash during the reporting period as they would appear on the income statement.

The Federal Open Market Committee's (FOMC) open market operations affect all of the following EXCEPT: A) interest rates. B) bank excess reserves. C) the amount of money in circulation. D) the national debt.

Your answer, the amount of money in circulation., was incorrect. The correct answer was: the national debt. When the Fed buys and sells securities on the open market, it attempts to expand or contract the amount of money in circulation. When the Fed buys, bank excess reserves go up; when the Fed sells, bank excess reserves go down. This, in turn, affects the money supply, credit, and interest rates. The national debt is affected only when the government issues and redeems treasury securities, not when it trades them in the market.

To determine the amount of change in the GDP from one year to another, both years' GDP should be converted into: A) constant dollars. B) international depositary receipts. C) the current dollar price of gold bullion. D) the exchange value of the dollar, as compared with major foreign currencies.

Your answer, the current dollar price of gold bullion., was incorrect. The correct answer was: constant dollars. To compare GDP from one year to another, and thus to compare the amount of actual economic activity, economists use constant dollars to eliminate distortions caused by inflation.

When a member bank of the Federal Reserve System borrows from the Federal Reserve, it would pay: A) the federal funds rate. B) the call money rate. C) the discount rate. D) the prime rate.

Your answer, the discount rate., was correct!. The discount rate is set by the FRB to designate the rate at which member banks can borrow from the Fed.

A tool that is NOT used by the FRB to control the money supply is: A) the discount rate. B) the prime rate. C) the FOMC. D) the required reserve rate.

Your answer, the discount rate., was incorrect. The correct answer was: the prime rate. The prime rate is the rate of interest charged by banks to their best customers. The prime rate reacts to the FRB's tools, but it is not one of them.