Q Bank Unit 14 – Flashcards

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question
Which of the following is a leading economic indicator? A) S&P 500 index. B) Gross domestic product. C) Duration of unemployment claims. D) Industrial production.
answer
Answer: A Broad stock market indices are generally leading indicators. GDP and industrial production are coincident indicators, and the duration of unemployment claims is a lagging indicator.
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Which of the following is considered the most accurate method of measuring GDP? A) Constant dollars. B) Actual dollars. C) Eurodollars. D) As a function of GNP.
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Answer: A Constant dollars are mathematically adjusted to remove the effects of inflation, so when economists compare the gross domestic product of one period with that of another, they measure economic activity rather than inflation.
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To reflect a more accurate picture of economic results, gross domestic product is adjusted: A) to include bank reserves. B) downward by the balance of payments. C) for inflation. D) to match foreign GDP.
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Answer: C By adjusting GDP for inflation, one can measure economic activity with less distortion. A constant dollar adjustment is made to remove the effects of inflation.
question
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. Which of the following is a lagging economic indicator? A) Hours worked. B) Corporate profits. C) S&P 500. D) Housing permits issued.
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Answer: B Both the S&P 500 and housing permits are leading economic indicators, as is the measure of hours worked because it reflects changes in the average workweek during the current period of time. Corporate profits are a lagging indicator.
question
To determine the amount of change in the GDP from one year to another, both years' GDP should be converted into: A) international depositary receipts. B) the current dollar price of gold bullion. C) constant dollars. D) the exchange value of the dollar, as compared with major foreign currencies.
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Answer: C 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.
question
In what order do the following economic phases typically occur? Recovery. Trough. Decline. Prosperity. A) II, I, III, IV. B) III, IV, I, II. C) IV, III, I, II. D) I, IV, III, II.
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Answer: D Economists consider expansion (recovery) the beginning of the business cycle, followed by the peak (prosperity), contraction (decline), and trough.
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During the past 2 quarters, the GDP declined by 3%, unemployment rose by .7%, and the Consumer Price Index fell off by 1.3%; this economic condition is called: A) inflation. B) depression. C) stagflation. D) recession.
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Answer: D Two consecutive quarters of economic decline is termed a recession.
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Which of the following economists supports demand-side economics? A) Adam Smith. B) Arthur Laffer. C) Milton Friedman. D) John Maynard Keynes.
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Answer: D John Maynard Keynes was the first demand-side economist. He believed that by increasing the income available for spending and saving, a government could increase demand and improve the country's economic well-being. Higher taxes and higher government spending are key tenets of this theory.
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According to Keynesian economic theory, an economy's health can be ensured if the government: A) does not interfere. B) increases aggregate demand. C) cuts taxes for businesses and the wealthy. D) increases the money supply.
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Answer: B Keynesians theorize that government efforts to increase aggregate demand by increasing purchases of goods and services result in the healthiest economy. In general, higher taxes and higher government spending lead to favorable economic conditions.
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What term do economists use to describe a downturn in the economy that is characterized by both unemployment and rising prices? A) Stagflation. B) Inflation. C) Depression. D) Recession.
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Answer: A "Stagflation" is the term used to describe the unusual combination of inflation and unemployment (stagnation).
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Which of the following is a NOT a leading economic indicator? A) Duration of unemployment. B) New housing permits. C) Money supply. D) Orders for durable goods.
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Answer: A The average amount of time it takes for an unemployed person to find a new job is a lagging indicator, not a leading one. Employment is usually one of the last things to pick up as the economy enters a period of expansion. Layoffs are one of the last resorts for companies when the economy turns down.
question
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) Lagging. C) Leading. D) Coincident.
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Answer: C New orders for durable goods are a leading economic indicator.
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Industrial production is what kind of economic indicator? A) Leading. B) Coterminous. C) Lagging. D) Coincident.
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Answer: D Industrial production is a coincident economic indicator.
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Statistics from which of the following industries are considered a leading indicator of economic growth? A) Automotive. B) High technology. C) New housing. D) Natural gas.
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Answer: C A leading indicator predicts economic trends. Such indicators include steel shipments, stock market indices, manufacturing orders, and housing starts.
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Which of the following indicators reflects the current level of business activity? A) Level of inventories. B) Personal incomes. C) Building permits. D) Expenditures on plant and capital equipment
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Answer: B Personal income levels reflect the current state of the economy. Building permits and expenditures on plant and capital equipment indicate future economic activity and are considered leading indicators. Inventory levels are considered a lagging indicator.
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The Conference Board releases information about the economy on a periodic basis. Included are a number of different indicators. These indicators can be used to predict how the economy as a whole might change. Which of the following would be considered a leading indicator? A) Stock prices as measured by a broad index such as the S 500. B) Gross domestic product. C) Corporate profits. D) Industrial production.
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Answer: A The stock market, which anticipates economy activity, is a leading economic indicator. GDP and industrial production are coincident, or current, economic indicators. Corporate profits are a lagging indicator.
question
Which of the following is the CORRECT order of the stages in a business cycle? A) Trough, contraction, expansion, peak. B) Expansion, peak, contraction, trough. C) Peak, expansion, contraction, trough. D) Contraction, trough, peak, expansion.
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Answer: B The correct order for the stages of a business cycle is expansion followed by a peak, then a contraction that ends in a trough. The cycle then repeats. Note that because this order represents a cycle, the correct answer has no set starting point or ending point as long as the stages are shown in the right order
question
Expansions in the business cycle are characterized by: A) higher consumer debt, rising inventories. B) increase in want ads in newspapers, decrease in nonfarm jobs. C) increasing college enrollments and enlistment in military service. D) increasing consumer demand for goods and services, increasing industrial production, and rising stock markets and property values.
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Answer: D Expansions in the business cycle are characterized by increasing consumer demand for goods and services, increasing industrial production, and rising stock markets and property values. Each of the remaining characterizations would more likely be associated with periods of contraction in the economic business cycle.
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The economic theory that says economic growth results from lower tax rates and lower government spending is: A) demand-side theory. B) supply-side theory. C) monetary theory. D) Keynesian theory.
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Answer: B Supply-side economics is the theory of Arthur Laffer, who believed that heavy taxing and government intervention have a negative effect on the economy.
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You note that "help wanted" advertisements in "The Wall Street Journal" have been increasing. This economic measure is a: A) none of these. B) leading indicator. C) lagging indicator. D) coincident indicator.
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Answer: B 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.
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A recession is defined as a drop in GDP for: A) 3 consecutive quarters. B) 4 consecutive quarters. C) 6 consecutive quarters. D) 2 consecutive quarters.
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Answer: D A recession is a drop in GDP for 2 consecutive quarters.
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Which of the following choices does NOT influence the level of interest rates? A) Federal Reserve's monetary policy. B) New housing starts. C) Amount of loanable funds in the financial markets. D) Inflation expectations.
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Answer: B New housing starts are affected by the level of interest rates, but they are not a factor in the determination of interest rates. Interest rates are determined by the supply and demand for loanable funds. The more money that is available for lending, the lower the rates.
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The economy has gone through three consecutive quarters of economic decline with no immediate end in sight, and therefore could be said to be: A) in a Depression. B) in a Recovery. C) Lagging. D) in a Recession.
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Answer: D Recession is defined as 2 or more consecutive quarters of economic decline. It would have to be at least 6 quarters to be considered a depression.
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Which of the following fundamental analysis theories might rely on lowering and raising taxes to stimulate or cool down an economy? A) Breakout. B) Keynesian. C) Supply side. D) Short interest.
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Answer: B Keynesian theory is interventionist. Supply side theory calls for low taxes and low government spending. Both short interest and breakout theories are technical rather than fundamental analysis theories.
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Which of the following is a leading indicator of the economic future? A) Machine tool orders. B) Unemployment statistics. C) The Gross National Product. D) The Consumer Price Index.
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Answer: A Machine tool orders anticipate the business cycle, because they come first in the manufacturing process.
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Which of the following is a coincident economic indicator? A) Industrial production. B) The S&P 500 Index. C) Capital goods purchased. D) Housing starts.
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Answer: A Coincident economic indicators measure the strength of the current economy at specific intervals. Industrial production is such an indicator.
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When comparing the change in the GNP from one year to another, each year's GNP should be converted into: A) international dollars. B) dollars in terms of gold bullion. C) dollars valued by the exchange ratios with foreign currencies. D) constant dollars.
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Answer: D The GNP measures growth in the economy. To retain an accurate comparison of one year to the next, it must be measured with constant dollars (inflation-adjusted dollars).
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Which of the following would most likely be considered a leading economic indicator? A) Bankrupt businesses. B) The S 500. C) The CPI. D) The GNP.
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Answer: B Leading indicators tend to forecast business cycles in the economy, such as securities markets. The best answer is the S 500.
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Which of the following is a lagging indicator? A) The GNP. B) Housing starts. C) Durable goods orders. D) Corporate profits.
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Answer: D Corporate profits are a lagging indicator, as the economic direction has been established before it is reflected in corporate profits.
question
The economic philosophy that believes in controlling the money supply to stimulate economic growth is often referred to as: A) the Demand Side Economic Theory. B) the Fiscal Economic Theory. C) the Monetarist Economic Theory. D) the Supply Side Economic Theory.
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Answer: C Controlling the money supply implies a hands-on theory that is referred to as the Monetarist Theory.
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A report by the federal government stating the Consumer Price Index (CPI) has increased by .3% indicates: A) the economy experienced deflation. B) consumers purchased .3% more higher-priced products than lower-priced products. C) the cost of goods purchased by consumers increased, on average, .3% for the month. D) consumers purchased .3% more goods that month.
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Answer: C The Consumer Price Index (CPI) is a statistic used by the federal government to measure month-to-month changes in prices to the end-consumer. It includes prices on items such as food, oil, and clothing. The CPI is usually used to indicate the general inflation rate of the economy.
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To stimulate a sluggish economy using fiscal policy measures, policymakers would: A) increase income taxes. B) increase the money supply. C) reduce the money supply. D) reduce income taxes.
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Answer: D Reducing income taxes is a fiscal policy tool intended to increase overall demand for goods and services. Adjusting the money supply is a monetary policy tool.
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Increases in which of the following indicators are regarded as predictors of the level of business activity? A) Building permits. B) Personal incomes. C) Corporate profits. D) Employment levels.
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Answer: A Increases in building permits are indicative of increased, future business activity and are therefore considered a leading economic indicator. Increases in personal income and employment levels reflect current, not future activity, and would be considered coincident indicators. Corporate profits are lagging economic indicators.
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Which of the following would be considered a lagging indicator? A) Housing permits issued. B) Hours worked. C) Corporate profits. D) S 500.
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Answer: C Corporate profits are a lagging indicator because profits are reported the quarter after they have been earned. The S 500 is a leading indicator because stock prices are based on expectations of future earnings. Housing permits are also leading indicators of future economic activity. The measure of hours worked is a coincident indicator because it reflects current levels of employment.
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The US gross domestic product (GDP) consists of the annual sum of all goods and services produced within the nation. It includes: personal consumption, private investment, foreign investment, net exports and all A) federal debt. B) wages paid to employees. C) government purchases. D) Treasury securities issued.
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Answer: C The gross domestic product includes everything produced in the United States in a year, whether used domestically, shipped abroad, or sold to the government.
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Which of the following would be characterized as a coincident indicator? A) New housing starts. B) First-time unemployment claims. C) Prime rate. D) Industrial production.
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Answer: D Housing starts and unemployment claims are leading indicators, whereas prime rate is a lagging indicator. Only industrial production is coincident to the current economy.
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Active government manipulation of the economy through tax and budget policies is referred to as: A) supply side. B) monetarist. C) soft landing. D) Keynesian.
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Answer: D 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.
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Newspaper reports indicate that the GNP has been declining steadily over the past 2 quarters. This would suggest: A) expansion. B) a depression. C) a recession. D) inflation.
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Answer: C Recession is 6 consecutive months of economic decline. Depression is 6 consecutive quarters of economic decline.
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Which economic theory states that a reduced tax rate will result in a healthy economy that will in turn generate more taxes? A) The Keynesian Economic Theory. B) The Demand Side Economic Theory. C) The Supply Side Economic Theory. D) The Monetarist Economic Theory.
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Answer: C The Supply Side Economic Theory (Reaganomics) is that reduced tax rates will result in a healthier economy, which will generate more taxes to compensate for the reduced rates.
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The Consumer Price Index (CPI) is released: A) monthly. B) weekly. C) quarterly. D) semiannually.
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Answer: A The U.S. Bureau of Labor Statistics releases the CPI monthly.
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All of the following are functions of the Federal Reserve EXCEPT: A) setting the discount rate. B) setting initial margin requirements on exempt securities. C) acting as fiscal agent for the U.S. Treasury. D) setting reserve requirements for banks.
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Answer: B The Federal Reserve does not have jurisdiction to set margin for exempt securities. FINRA rules mandate these requirements.
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Which of the following are used by the Federal Reserve to control the money supply? Open market operations. Setting reserve requirements for member banks. Setting the discount rate. Setting the federal funds rate. A) I and III. B) II and IV. C) I, II, III and IV. D) I, II and III.
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Answer: D The federal funds rate is a market rate of interest heavily influenced by, but not set by, the Fed.
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The Federal Reserve System is responsible for all of the following EXCEPT: A) acting as an agent for the U.S. Treasury. B) conducting monetary policy. C) acting as a coordinator of the money supply. D) setting the prime rate.
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Answer: D The prime rate is set by large commercial banks in competition with one another
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If the yield curve becomes inverted, a likely cause would be that the Fed has: A) loosened long-term credit. B) tightened short-term credit. C) loosened short-term credit. D) tightened long-term credit.
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Answer: B The Fed's influence on rates is primarily on the short end of the yield curve. Both the discount rate, which it sets, and the federal funds rate, which it influences, are short-term rates. The Fed tightens short-term credit when the economy appears to be overheating. To slow things down, the Fed raises short-term rates to extremely high levels.
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All of the following might be done by the Federal Reserve to influence interest rates and the money supply EXCEPT: A) raise or lower the discount rate. B) adjust marginal tax rates. C) change the reserve requirement. D) buy or sell short term treasury debt.
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Answer: B The Federal Reserve implements monetary policy. Taxation is part of fiscal policy, and only Congress has the ultimate authority to raise or lower taxes.
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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.
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Answer: C The discount rate is set by the FRB to designate the rate at which member banks can borrow from the Fed.
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If the FRB decides to tighten the money supply, which of the following would the Fed be most likely to do? A) Raise the discount rate. B) Lower the discount rate. C) Raise the prime rate. D) Lower taxes.
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Answer: A Raising the discount rate discourages borrowers and shrinks the money supply. The FRB has no authority over tax levels. The prime rate and broker call loan rate are determined by banks, not the FRB.
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Which of the following most quickly reflects changes in FRB policy? A) The prime rate. B) The call money rate. C) The CD rate. D) The discount rate.
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Answer: D The FRB has direct control of the discount rate. If the FRB changes policy, the discount rate is the key indicator.
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A tool that is NOT used by the FRB to control the money supply is: A) the FOMC. B) the prime rate. C) the required reserve rate. D) the discount rate.
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Answer: B 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.
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The Fed would be inclined to increase the money supply if which of the following were declining? The Gross National Product. Unemployment. Bond yields. The Consumer Price Index. A) I and II. B) II and III. C) III and IV. D) I and IV.
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Answer: D Increasing the money supply tends to increase business activity through lower interest rates. If the GNP is declining, business is slowing down, and the Fed would want to stimulate the economy by making more money available. If the CPI is declining, inflation is receding, which usually occurs when business is contracting, which the Fed would usually wish to counteract. There is a danger of increased inflation if the Fed is too generous.
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If the FOMC is buying Treasury bills, this indicates that yields will: A) increase. B) not change. C) not be affected. D) decrease.
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Answer: D When the FOMC is buying T-bills, it is increasing the money supply. This causes yields to decrease.
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If the rate of inflation has slowed down and the Federal Reserve Board (FRB) takes action to spur the economy forward, which of the following statements regarding outstanding fixed-income securities trading in the secondary market as a result of the FRB action is TRUE? A) Their maturities will be extended. B) Their prices will rise. C) Their yields will rise. D) Their coupon rates will rise.
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Answer: B To spur the economy forward, the Federal Reserve Board lowers interest rates. Lowering the interest rates causes the prices of outstanding bonds to rise in the secondary market.
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Which of the following activities of the FRB would cause interest rates to increase? A) A reduction in the discount rate. B) An increase in the purchase of government securities by the FOMC. C) An increase in the reserve requirements. D) A reduction in the reserve requirements.
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Answer: C Interest is the cost of borrowing money. If less money is available, the cost (interest rates) of borrowing will go up (supply and demand). Therefore, anything the FRB does to reduce the money supply will increase interest rates.
question
If the FOMC sells government securities in the open market, it will: A) decrease the money supply. B) increase the money supply. C) not change the money supply. D) none of these.
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Answer: A The selling of government securities in the open market takes dollars out of the money supply and increases short-term interest rates.
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All of the following are purchasers of Treasury securities in the primary market EXCEPT: A) investment companies. B) commercial banks. C) financial institutions. D) the Federal Reserve Board.
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Answer: D The FRB trades in governments in the secondary market; they are not primary purchasers.
question
If the Federal Open Market Committee (FOMC) purchases T-bills in the open market, which of the following scenarios are likely to occur? Secondary bond prices will rise. Secondary bond prices will fall. Interest rates will rise. Interest rates will fall. A) I and IV. B) I and III. C) II and III. D) II and IV.
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Answer: A When the FOMC purchases T-bills in the open market, it pays for the transaction by increasing member banks' reserve accounts. The net effect of this action increases the total money supply and signals a period of relatively easier credit conditions, declining interest rates, and a rise in the price for existing or secondary bonds.
question
The Federal Reserve Board can manage the money supply with all the following tools EXCEPT: A) income tax rate. B) bank reserve requirements. C) open market operations. D) discount rate.
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Answer: A 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.
question
In its attempt to increase the money supply, the Federal Open Market Committee (FOMC) buys T-bills. This action should cause the yield on T-bills to: A) stabilize. B) decrease. C) increase. D) fluctuate.
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Answer: B The FOMC purchase is meant to increase the attractiveness (market price) of T-bills. Because the price will be driven up by an increased market demand and a decreased supply, yields should decrease.
question
If the Federal Reserve Board (FRB) decides that the rate of inflation is too high, which is it most likely to do? Tighten the money supply. Loosen the money supply. Lower the discount rate. Raise the discount rate. A) I and III. B) II and III. C) II and IV. D) I and IV.
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Answer: D If the FRB decides to attempt to curb inflation, it can raise the discount rate which in turn tightens the money supply.
question
An increase in the Federal Reserve Board's (FRB) reserve requirement has which of the following effects on total bank deposits? Decrease. Increase. Multiplier effect. Logarithmic effect. A) II and IV. B) I and III. C) I and IV. D) II and III.
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Answer: B If the FRB raises the reserve requirement, total bank deposits decrease, with the overall impact being increased because of the multiplier effect. If banks must meet a higher reserve requirement, they will have less money available to lend.
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The Federal Open Market Committee's (FOMC) open market operations affect all of the following EXCEPT: A) bank excess reserves. B) the amount of money in circulation. C) interest rates. D) the national debt.
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Answer: D 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.
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Which of the following are part of M2, but NOT M1? A) Currency in circulation. B) Demand deposits at S&Ls. C) Checking accounts at commercial banks. D) Money market mutual funds.
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Answer: D Money market funds are part of M2, but not M1. M2 includes everything in M1, plus time deposits and money market funds.
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Through its open market operations, the Federal Reserve trades all of the following EXCEPT: A) Treasury notes. B) Treasury bills. C) Grant anticipation notes. D) Ginnie Maes.
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Answer: C The Federal Open Market Committee (FOMC) trades U.S. government and agency securities in the secondary market. Grant anticipation notes (GANs) are municipal securities.
question
To tighten credit during inflationary periods, the Federal Reserve Board can take any of the following actions EXCEPT: A) to lower taxes. B) to raise reserve requirements. C) to increase the amount of U.S. government debt held by primary dealers. D) to sell securities in the open market.
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Answer: A To curb inflation, the Fed can sell securities in the open market, thus changing the amount of U.S. government debt institutions hold. It can also raise the reserve requirements, discount rate, or margin requirements. The Fed has no control over taxes, which are changed by Congress.
question
The Federal Reserve Board foresees the probability of an overheated economy and the resumption of double-digit inflation. Therefore, the FRB takes actions to slow down the economy, including increasing the discount rate. Which of the following are likely effects of these moves? An increase in the prime rate. An increase in bond yields and an accompanying decrease in bond prices. A slowdown in corporate growth. A decrease in corporate earnings. A) I and II. B) I, III and IV. C) III and IV. D) I, II, III and IV.
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Answer: D The FRB attempts to slow down the economy and decrease the money supply with a corresponding increase in interest rates. When interest rates rise, the prime rate increases, bond yields rise, and bond prices drop. Higher interest rates have a tendency to slow down corporate growth, with a resulting slowdown in earnings; these events occur in this approximate sequence.
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If the Fed begins selling securities in the open market to tighten credit, what is the first interest rate to feel this change in the Fed policy? A) Discount rate. B) Prime rate. C) Interest rate on long-term debentures. D) Federal funds rate.
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Answer: D The Federal Reserve Board's actions to influence the money supply are first felt on the federal funds rates.
question
The Fed is making purchases in the open market. What are the effects of this action? The money supply will become tighter. The federal funds rate is likely to go down. Bank reserves are likely to decrease. Bond prices are likely to rise. A) I and III. B) I and IV. C) II and III. D) II and IV.
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Answer: D When the Federal Reserve Board purchases securities in the open market, money flows into the economy. Because there is more money available, interest rates such as the federal funds rate are likely to fall. When interest rates fall, bond prices rise.
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Which of the following tools is most often used by the Federal Reserve Board to control the money supply? A) Lowering the discount rate. B) Changing margin requirements. C) Engaging in open market operations. D) Altering the reserve requirements.
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Answer: C The Federal Reserve Board has 3 tools to influence the money supply: the discount rate, the reserve requirement, and open market operations. The purchase and sale of government securities by the Federal Open Market Committee (FOMC) is the most frequently used tool of the Fed.
question
Wall Street closely monitors Federal Open Market Committee (FOMC) activities because of its effect on all of the following EXCEPT: A) bank excess reserves. B) income tax rates. C) money supply. D) interest rates.
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Answer: B The FOMC is one of the most influential committees in the Federal Reserve System, and its decisions affect the money supply, interest rates, and reserves that member banks must maintain. Their decisions do not affect income tax rates.
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The immediate effect of the Federal Reserve's buying and selling of securities in the marketplace is to: A) check inflation. B) stop a recession. C) set reserve requirements for Fed. member banks. D) make credit more or less available.
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Answer: D The immediate effect is to make credit more or less available. The long-term effect is to check inflation or to create a situation in which the economy can recover from a recession.
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To curb excessive economic activity, the Fed would: A) sell securities in open market operations. B) decrease reserve requirements. C) decrease discount rate. D) sell bonds to the public at auction.
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Answer: A The Federal Open Market Committee can take money out of circulation during inflationary times through the sale of securities to primary dealers
question
The federal funds rate has been decreasing. A likely cause would be: A) heavy borrowing by banks to meet reserve requirements. B) heavy open market sales by the Fed. C) a low level of noncompetitive bids at the auction. D) heavy open market purchases by the Fed.
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Answer: D The Fed increases the money supply by buying securities in the open market. This causes interest rates to fall.
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If the U.S. economy shows signs of slowing, the Federal Reserve might: A) increase the reserve requirement. B) sell securities in open market operations. C) purchase securities in open market operations. D) increase the discount rate.
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Answer: C To counter a slowing economy, the Fed would probably try to inject liquidity into the economy by purchasing U.S. government securities from primary dealers in a repurchase arrangement. The other choices would tend to tighten liquidity.
question
Which of the following are methods used to manage the economy? Modern portfolio theory. Monetary policy. Fiscal policy. Efficient market theory. A) I and III. B) I and IV. C) III and IV. D) II and III.
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Answer: D Fiscal and monetary policies are two methods used to manage the nation's economic activity.
question
The Federal Reserve sets which of the following? The reserve requirement. The federal funds rate. The discount rate. Initial margin requirements for nonexempt securities. A) I and IV. B) II and III. C) III and IV. D) I, III and IV.
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Answer: D The federal funds rate (charged in bank-to-bank borrowing) is a market rate of interest. It is, however, heavily influenced by Fed action. The Fed is responsible for setting the reserve requirement, the discount rate, and the initial margin requirement for nonexempt securities.
question
In its efforts to control the money supply, the Board of Governors of the Federal Reserve System has a number of tools at its disposal. The one used most frequently is: A) open market transactions by the FOMC. B) changing the discount rate. C) changing the reserve requirements. D) adjusting margin requirements.
answer
Answer: A The Federal Open Market Committee (FOMC) meets every 6 weeks. The other actions are taken as needed, sometimes less than once per year.
question
The Federal Reserve Board (FRB) has announced actions to increase the money supply. Which of the following would you expect to see increase first? Pass book savings account rate. Employment. Production. Corporate profits. A) II and III. B) I and III. C) I and IV. D) II and IV.
answer
Answer: A When the Federal Reserve Board takes actions to increase the money supply, more dollars become available for lending. Of the choices given, an increase in lending would stimulate production and employment first.
question
If the Federal Reserve Board tightens the money supply, this will push interest rates up push interest rates down allow consumers easier access to credit and loans make access to credit and loans more difficult for consumers A) II and III B) II and IV C) I and IV D) I and III
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Answer: C When the FRB tightens the money supply, it takes dollars out of the economy. When the demand for credit and loans exceeds the available dollars, interest rates rise, making access to credit and loans more difficult for consumers.
question
If the U.S. dollar has fallen relative to foreign currencies, which of the following statements are TRUE? U.S. exports are likely to rise. U.S. exports are likely to fall. Foreign currencies buy fewer U.S. dollars. Foreign currencies buy more U.S. dollars. A) II and IV. B) I and IV. C) I and III. D) II and III.
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Answer: B When the U.S. dollar loses value compared to a foreign currency, the same amount of the foreign currency now buys more dollars. As a result, U.S. goods are cheaper in terms of that foreign currency, which means that the foreign country and its residents tend to buy more U.S. products and U.S. exports rise.
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If the U.S. dollar has been appreciating against foreign currencies, all of the following statements are true EXCEPT: A) U.S. goods become more expensive in foreign countries. B) foreign goods become cheaper in the United States. C) U.S. exports become more competitive. D) the U.S. dollar buys more of foreign currencies.
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Answer: C The U.S. exports will cost more to foreigners and become less competitive. The dollar is worth more in terms of foreign currencies and will purchase more foreign goods per dollar.
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All of the following actions will increase the deficit in the U.S. balance of payments EXCEPT: A) purchase by foreigners of U.S. securities. B) investments by U.S. firms abroad. C) U.S. foreign aid. D) Americans buying Japanese cars.
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Answer: A A debit in the U.S. balance of payments occurs when the country pays out more abroad than it takes in. This occurs when the U.S. imports more than it exports, invests money abroad, or sends money to foreign countries in the form of foreign aid.
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XYZ Aircraft Manufacturing Corporation announces a multimillion dollar order for its new jumbo jet from Fly Airlines, a Japanese carrier. When the sale is completed, there will be: A) a credit to the current account of the U.S. B) no effect on the balance of trade. C) a debit to the current account of the U.S. D) a credit to the current account of Japan.
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Answer: A Whenever money from a foreign source enters the United States, it becomes a credit item in the U.S. balance of payments.
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Disintermediation is a movement of funds which could result from all of the following EXCEPT: A) money market rates are higher than typical savings account rates. B) the discount rate is decreased by FRB. C) the money supply tightens. D) the Federal Reserve Board increases reserve requirements.
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Answer: B Disintermediation is money flowing from banks and thrifts into money market instruments. It tends to occur when money is tight, causing rates to rise and making money funds more attractive than passbook savings rates.
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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) II and IV. B) II and III. C) I and III. D) I and IV.
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Answer: B 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.
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An investment in a foreign common stock carries: market risk. political risk. currency risk. A) I and III. B) II and III. C) I, II and III. D) I and II.
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Answer: C All stock investments entail market risk. Political risk is the risk that the country of investment will experience economic and social turmoil, putting the investment in jeopardy. All foreign investments involve currency exchange risk.
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An upward sloping yield curve represents all of the following EXCEPT: A) time value of money. B) increased risk of default over time. C) inflation expectations. D) foreign interest rate differentials.
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Answer: D Foreign interest rate differentials are not reflected in an upward sloping yield curve. Interest rate differentials between countries reflect differences in domestic monetary and fiscal conditions. The time value of money is reflected in the upward sloping yield curve.
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If the dollar weakens, which of the following statements is TRUE? A) U.S. exports will fall. B) Foreign securities denominated in their domestic currency decrease in value to the U.S. investor. C) A rise in U.S. interest rates might strengthen the dollar. D) The dollar buys more foreign currency.
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Answer: C If U.S. interest rates rise, foreign investors would invest in U.S. dollar-denominated securities, thereby increasing the demand for dollars and causing the dollar to strengthen.
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All of the following could account for the dollar falling in value against the yen EXCEPT: A) a severe political crisis in Japan. B) a worsening trade deficit with Japan. C) the Fed selling dollars in the interbank market. D) the Fed buying yen in the interbank market.
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Answer: A A severe political crisis in Japan would have a negative effect on the value of the yen versus the dollar. The other choices would have a positive effect on the relative value of the yen.
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The term "disintermediation" refers to: A) the flow of money from traditional, low-yielding savings accounts to higher- yielding money market instruments. B) the flow of money from money market instruments into traditional savings vehicles. C) using margin to leverage one's returns. D) protecting a diversified portfolio through the purchase of index put options.
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Answer: A This is the industry-accepted definition of disintermediation, and it typically occurs when the Federal Reserve Board tightens the money supply and interest rates rise faster in the marketplace than at bank accounts.
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A significant increase in imports of foreign goods into the United States would have what effect on the strength of the US dollar? A) No effect. B) Fluctuation both ways. C) Weaken. D) Strengthen.
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Answer: C Importing tends to weaken the dollar because it indicates an outflow of money from the United States to foreign countries. Much of this outflow is in the form of debt. When our debt (deficit in balance of payments) gets too high, there is international concern about our ability to pay our debts and a reluctance in accepting U.S. dollars as payment for goods-our dollar weakens.
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Which organization or governmental unit sets fiscal policy? A) Secretary of the Treasury. B) Congress and the President. C) Federal Reserve Board (FRB). D) Federal Open Market Committee (FOMC).
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Answer: B Congress and the President set fiscal policy, while the FRB sets monetary policy.
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Disintermediation is most likely to occur when: A) interest rates are low. B) margin requirements are high. C) the interest ceilings on certificates of deposit have been raised. D) money is tight.
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Answer: D Disintermediation is the flow of deposits out of banks and savings and loans into alternative, higher paying investments. It occurs when money is tight and interest rates are high because these alternative investments may then offer higher yields than S&Ls and banks.
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If the U.S. dollar depreciates in value, which of the following statements is NOT true? A) Travel abroad would be less expensive for Americans. B) The same number of yen would buy more dollars. C) The balance of payments deficit would probably be reduced. D) Foreign goods would become more expensive in the United States.
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Answer: A If the dollar is devalued, travel abroad for Americans will become more expensive. Because the dollar is worth less, it will buy fewer London theater tickets, Swiss watches, or French perfumes. With a cheaper dollar, exports would probably rise and imports decrease, resulting in a smaller deficit in our balance of payments.
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When the U.S. dollar appreciates, which of the following statements are TRUE? Imports become more competitive with U.S. domestic goods. Imports become less competitive with U.S. domestic goods. U.S. exports become more competitive in foreign markets. U.S. exports become less competitive in foreign markets. A) I and IV. B) I and III. C) II and III. D) II and IV.
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Answer: A When the U.S. dollar appreciates against foreign currency, foreign money buys fewer U.S. goods. As a result, U.S. exports to foreign countries go down, but imports go up because U.S. dollars will buy more foreign goods.
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If the value of the U.S. dollar increases with respect to other currencies, it would make: U.S. exports, like heavy equipment, more competitive in foreign markets. U.S. exports, like heavy equipment, less competitive in foreign markets. foreign imports into the United States, such as cars, less competitive in U.S. markets. foreign imports into the United States, such as cars, more competitive in U.S. markets. A) I and III. B) I and IV. C) II and III. D) II and IV.
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Answer: D When the value of the U.S. dollar rises in relation to other currencies, exported products become more expensive in those foreign markets and are less competitive. On the other hand, imported products become less expensive in U.S. markets and are more competitive.
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Each of the following would cause a decrease in the balance of trade deficit EXCEPT: A) an increase in imports of foreign products. B) an increase in exports of U.S. products. C) an increase in dividends paid on U.S. stocks held by foreign investors. D) an increase in dividends paid on foreign stocks to U.S. investors.
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Answer: A The trade deficit occurs when imports exceed exports (as they have for years). We want to know which one of these would not be helpful to our balance of trade-that is, which one would cause the negative balance to increase. If you read it correctly, an increase in foreign imports is obviously correct since it is bad for our trade balance and would cause an increase in the deficit instead of a decrease.
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Each of the following would add to the balance of trade deficit EXCEPT: A) U.S. investing abroad. B) Imports of foreign goods into the U.S. C) Foreign spending in the U.S. D) U.S. spending abroad.
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Answer: C Any spending overseas by U.S. investors or consumers adds to the trade deficit. For instance, the trade deficit increases when imports of foreign goods exceed exports of U.S. goods. Foreign spending in the U.S.would decrease the balance of trade deficit.
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The investment theory that assumes the market adjusts automatically as new information becomes known or relevant about a particular security, thereby resulting in a fair market price at all times, is known as: A) Dow theory. B) Efficient market theory. C) Supply side economics. D) Odd-lot theory.
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Answer: B The efficient market theory is based on the hypothesis that markets adjust automatically and quickly to relevant information regarding a security as it becomes known. In theory, this results in fair and efficient pricing at all times.
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According to technical analysis, when the market is consolidating, a chart showing the market trendline appears to be moving: A) downward with sporadic upswings. B) sideways within a narrow range. C) upward to reach a new peak. D) downward to reach a new low.
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Answer: B A consolidating market is one that stays within a narrow price range. When viewed on a graph, the trendline is horizontal and is said to be moving sideways, meaning neither up nor down.
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Four of the best-known indexes and averages are listed below. How do they rank on the scale of most to fewest issues in the index? Dow Jones Industrial Average NYSE Composite Index Standard & Poor's 500 Wilshire A) II, III, I, IV B) III, II, IV, I C) IV, II, III, I D) I, IV, III, II
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Answer: C Of the indexes and averages listed, the Wilshire, sometimes referred to as the Wilshire 5000, is the broadest measure of the market; it contains more than 5,000 issues (exchange listed and OTC securities). The NYSE Composite Index is based on the prices of all of the common stocks listed on the Exchange. The S 500, as the name implies, is based on the prices of 500 stocks. The index recording the fewest issues is the Dow Jones Industrial Average-only 30 stocks.
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The Dow Jones Industrial Average is which of the following? A) Unweighted average of 300 stocks, primarily transportation. B) Price-weighted average of 30 stocks, primarily industrial. C) Price-weighted average of 300 stocks, primarily industrial. D) Unweighted average of 30 stocks, primarily transportation.
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Answer: B 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, American Express, and Microsoft.
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One of your customers notices that the short interest on the NYSE is high. When she asks you for an interpretation, you should tell her that this signals a: A) period of stability in the market. B) period of volatility in the market. C) bullish market. D) bearish market.
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Answer: C Even though short interest represents the number of shares sold short, many investors consider it a bullish indicator when this number is high. Each share that has been sold short must be replaced (covered) at some point. To replace the stock shorted, an investor must go into the market to buy that stock. When all of those short sellers have to buy back stock they shorted, it puts upward pressure on the prices of those stocks.
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In the assessment of a company's stock, a technical analyst takes into consideration all of the following EXCEPT: A) market price. B) price momentum. C) volume. D) earnings.
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Answer: D A market technician (technical analyst) deals primarily with timing of activity and market trends, while a fundamental analyst centers on a particular industry or company within an industry and its relative health and market potential.
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Proponents of which of the following technical theories assume that small investors are usually wrong? A) Short interest. B) Volume of trading. C) Odd lot. D) Breadth of market.
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Answer: C Odd lots are usually traded by small investors; some analysts believe small investors are generally wrong.
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According to the Dow theory, reversal of a primary bullish trend must be confirmed by: A) the duration of the secondary movements. B) the advance/decline line. C) five consecutive days of upward price trends. D) the Dow Jones Industrial Average and Transportation Average.
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Answer: D Charted price trends can be deceptive, so a trend must be confirmed by the Dow Jones Industrial Average and Transportation Average.
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A technical analyst is concerned with all of the following trends EXCEPT: A) reversals. B) support levels. C) changes in the DJIA. D) PE ratios.
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Answer: D Technical analysts are more interested in forecasting market trends and securities prices than in studying individual corporations. Therefore, they are concerned with market prices, trading volumes, changes in the Dow Jones Industrial Average, reversals, support and resistance levels, advance/decline lines, short interest, and many other factors that might help them time buying and selling decisions. Fundamental analysts, on the other hand, concentrate on a stock's intrinsic quality and are concerned with PE ratios and earnings per share.
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A registered representative is explaining a particular market theory that maintains that the direction of a single stock or any general market is unpredictable. Which theory is he speaking of? A) Modern portfolio B) Odd-Lot C) Dow D) Random walk
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Answer: D The random walk theory maintains that the direction of any stock, sector, or market in general is unpredictable. The theory is based on the "efficient market" theory, which holds that the stock market is perfectly efficient with prices reflecting all known information at any given time.
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A head and shoulders bottom formation is an indication of: A) the reversal of a downtrend. B) a bearish market. C) a bullish market. D) the reversal of an upward trend.
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Answer: A 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.
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Analysts who are most interested in confirming a market trend would use: A) fundamental analysis. B) confidence theory. C) random walk theory. D) technical analysis.
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Answer: D Technical analysis involves the confirmation of market and pricing trends through charts and market indicators. The decision to buy or sell stock is made by these trends rather than by analysis of specific issuer financial information, as used by fundamental analysts.
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Which of the following would be of least interest to a technical analyst? A) Advance/decline line. B) Trading volume. C) PE ratio. D) Short interest ratio.
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Answer: C Technical analysts rely on price and trading trends to determine when to buy or sell stock. They are not interested in the specific financial information of an issuer; PE ratios are of greater interest to fundamental analysts.
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The largest component of the S 500 index is made up of A) financial stocks. B) small-cap stocks. C) technology stocks. D) industrial stocks.
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Answer: D The S 500 index is a weighted index. The index components and weighting have been adjusted over time. While the index consists of large capitalization companies the majority of them historically have been industrial stocks.
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If a chart indicates that both the DJIA and the advance/decline line have been increasing since January, and the advance/decline line continues to rise, the market should: A) continue to rise. B) turn down moderately. C) turn down sharply. D) not change.
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Answer: A A rising advance/decline line indicates that more stocks are rising in price than falling; a rising advance/decline line is a bullish indicator.
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A technical analyst is least likely to consider which of the following when selecting securities? A) Corporate earnings. B) Short interest ratio. C) Advance/decline line. D) Trend lines.
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Answer: A Corporate earnings would be of least interest to a technical analyst, who is interested in market statistics indicative of future buying, market statistics that could reflect price or market trends, and trading volume.
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A technical analyst is least concerned with: A) trading volume. B) new highs and lows. C) open short positions. D) declaration of increased dividends.
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Answer: D 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.
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Which of the following events is of the greatest importance to a technical analyst? A) Standard & Poor's raised the credit rating of the issuer. B) The company announced the resignation of its chief financial officer. C) The stock's price recently penetrated its resistance level. D) The issuer's current book value increased.
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Answer: C Technical analysts focus on market price patterns. Typically, a technical analyst becomes bullish when a stock's price exceeds its resistance level (it penetrates its former ceiling price). Book values, credit ratings, and the resignation of a company's senior officer are of interest to fundamental analysts.
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The value of the Dow Jones Composite average would be most affected by a change in the value of which of the following market sectors? A) Industrial. B) Utility. C) Transportation. D) Growth.
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Answer: A The Dow Jones Composite Average consists of 65 stocks: 30 industrial, 20 transportation, and 15 utilities issues. Because industrials are the largest component, changes in their prices have the greatest effect on the averages.
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A fundamental analyst would be interested in all of the following EXCEPT: A) innovations within the automotive industry. B) daily trading volumes on the NYSE. C) statistics of the U.S. Department of Commerce on disposable income. D) corporate annual reports.
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Answer: B Trading volume interests the technical analyst, who looks at fluctuations in the market, not at fundamental economic values.
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The S 100 Index and the Wilshire Index are examples of A) standardized, capped equity options. B) single security futures options. C) broad-based indexes. D) narrow-based indexes.
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Answer: C Broad-based indexes attempt to reflect the status of the market as a whole, not the status of particular market segments such as a gold or oil index.
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Which index represents the thinnest selection of stocks? A) S 500 B) Wilshire C) Dow Jones Industrial Average D) Value Line Index
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Answer: C Of those listed, the DJIA represents the fewest stocks (30).
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If stock market indexes, such as the S 500 and the DJIA, are declining daily, and the number of declining stocks relative to advancing stocks is falling, a technical analyst will conclude that the market is: A) becoming volatile. B) unstable. C) oversold. D) overbought.
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Answer: C The momentum of the market decline seems to be easing as the number of decliners to advancers is leveling out. It looks like the advance/decline line is moving in a direction away from decliners. A technical analyst would conclude that the market is oversold and approaching a bottom.
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An analyst interested in measuring the breadth of market movement as an indicator of future market direction would monitor the: A) DJIA. B) Value Line Index. C) betas of the S 500 stocks. D) advance/decline line.
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Answer: D The advance/decline line, which measures the number of stocks that have advanced versus the number of stocks that have declined, is an indicator of the breadth of the market's advance or decline.
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Which of the following investment strategies makes sense for an investor who believes in the efficient market hypothesis (EMH)? A) Investing in a market index fund. B) Market timing. C) Investing in actively managed mutual funds. D) Hedging through the purchase of derivative investments.
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Answer: A 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.
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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 above the resistance level. C) just above the support level. D) just below the resistance level.
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Answer: B 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.
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A technical analyst would be most interested in which of the following? A) Working capital. B) 200-day moving averages. C) PE ratios. D) Quick ratios.
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Answer: B Technical analysts try to predict the market by examining price and volume trends. They expect the market will act in the future as it has in the past. Technical analysts are not interested in the fundamental aspects of a company, such as its financial statement ratios.
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An inverted Head and Shoulders Formation would mean which of the following to a chartist? A) A bull market. B) A bear market. C) A reversal of an uptrend. D) A reversal of a downtrend.
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Answer: D Head and Shoulders Formations indicate the reversal of market trends to chartists. An inverted formation would forecast the reversal of a downtrend. A Head and Shoulder's Top Formation would forecast the reversal of an uptrend.
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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.
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Answer: B 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.
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Which of the following is the broadest index? A) The S 500. B) The Wilshire Index. C) The Dow Jones Industrial Average. D) The S 100.
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Answer: B Of the choices listed, the Wilshire Index, commonly referred to as the Wilshire 5000, contains the greatest number of securities. In contrast, the Dow Jones Industrial Average (DJIA) represents the thinnest selection of stocks.
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In an efficient market, which of the following statements are TRUE? Spreads narrow. Spreads widen. Trading volume decreases. Trading volume increases. A) I and IV. B) I and III. C) II and III. D) II and IV.
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Answer: A The efficient market hypothesis (EMH) suggests that, at any given time, prices fully reflect all available information on a particular stock and/or market. Thus, no investor has an advantage in predicting a return on a stock price since no one has access to information not already available to everyone else. As a result, spreads will narrow, and volume will increase.
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In the technical analysis of the value of securities, which of the following items is NOT important? A) A prevailing market trend in response to shifts in supply and demand. B) Resistance and support levels. C) The amount of a company's past earnings. D) The breadth of market volume.
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Answer: C The amount of a company's past earnings is a factor used in the fundamental analysis of securities, but not technical analysis. Technicians rely on market trends and supply and demand factors, as well as chart indications such as resistance and support levels.
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Which of the following is most likely to be regarded as a defensive stock? A) A food company stock. B) An aerospace stock. C) A stock selling at an extremely high PE ratio. D) A stock with a strong cash position and little debt.
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Answer: A A defensive stock maintains future earnings that are likely to withstand an economic downturn. Typical examples are stocks of those firms that supply basic consumer necessities such as foodstuffs. A stock selling at an extremely high PE ratio is indicative of a speculative company or one that can decline in value rapidly.
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Investments that move in the opposite direction of the economic cycles are known to be counter cyclical. Historically investments that fit into this category are: A) Utility stocks. B) Pharmaceutical stocks. C) Consumer goods manufacturing stocks. D) Precious metals such as gold
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Answer: D Historically precious metals, like gold, are counter cyclical and move opposite of the economic cycles. Utility and pharmaceutical companies are defensive or noncyclical and their movement is not tied to the economic cycles while manufactures of consumer goods move with the economic cycles.
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Which of the following industries is most likely to be considered cyclical? A) Pharmaceutical. B) Utilities. C) Food. D) Durable goods.
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Answer: D The production of durable goods depends on whether the economy is in an expansion or a contraction phase. Pharmaceuticals, utilities, and food are always necessary.
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A fundamental analyst is concerned with all of the following EXCEPT: A) capitalization. B) trading volumes. C) historical earnings trends. D) inflation rates.
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Answer: B A fundamental analyst is concerned with the economic climate, the inflation rate, how an industry is performing, a company's historical earnings trends, how it is capitalized, and its product lines, management, and balance sheet ratios. A technical analyst is concerned with trading volumes or market trends and prices.
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The common stock of all of the following corporations is considered defensive stock EXCEPT stock of a(n): A) pharmaceutical company. B) airplane manufacturer. C) retail grocery chain. D) utility.
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Answer: B Defensive stocks generally have little volatility. Firms that produce nondurable consumer goods (tobacco, food, drugs, energy) are more immune to the business cycles than other industries and are sometimes called defensive industries. This term has nothing to do with the defense industry that supplies the Pentagon with goods and services.
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Which of the following stocks is regarded as a defensive stock? A) Stock with a strong cash position and a low ratio of debt. B) Electric utility stock. C) Aerospace stock. D) Stock selling close to its support level.
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Answer: B Analysts regard a defensive stock as one that is in an industry that is least affected by business cycles. Most defensive industries produce nondurable consumer goods (for example, the food industry or the utility industry).
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Which of the following would NOT be considered a defensive security? A) Food chain stock. B) Steel company stock. C) Tobacco stock. D) Utility company stock.
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Answer: B Steel is cyclical and is not considered defensive; defensive stocks are generally less affected by the business cycle.
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Which of the following analyze corporate financial statements and trends in sales and income? A) Market timers. B) Fundamentalists. C) Chartists. D) Technicians.
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Answer: B Fundamental analysts obtain information from corporate financial statements as well as other relevant sources. Technical analysts review market charts while fundamental analysts are concerned with the earnings ability of corporations derived from corporate financial statements.
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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 IV. B) III and IV. C) I and II. D) II and III.
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Answer: B 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.
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The investment policy department of an investment firm forecasts that the current business cycle should reach its peak within the next 2 months. Under such circumstances, which of the following purchases 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
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Answer: A Defensive stocks such as those in the food, pharmaceuticals, and energy industries would most likely be suitable for investors who actively manage their equity portfolios. Defensive stocks are least likely to be affected by a reversal in the business cycle.
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If a registered representative were explaining the characteristics of different stocks and industries to a customer, it would be CORRECT to say that: automobile stocks are cyclical. pharmaceutical stocks are cyclical. companies producing appliances are defensive. the tobacco industry is defensive. A) I and III. B) II and III. C) II and IV. D) I and IV.
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Answer: D Cyclical industries and stocks, such as those producing durable goods like automobiles, are highly sensitive to business cycles and inflation trends. Defensive industries are least affected by normal business cycles. Companies in defensive industries generally produce nondurable consumer goods, such as food, pharmaceuticals, and tobacco.
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A defensive issue would NOT include companies producing: A) foodstuff. B) clothing. C) tobacco products. D) building materials.
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Answer: D Food, clothing, and tobacco will be bought during every phase of a business cycle; however, building materials will not usually be purchased in poor economic times. Thus, these types of items (food, clothing, and tobacco) are said to be defensive because they should suffer much less loss in bad economic times.
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Which of the following is a defensive stock? A) Food company debentures. B) Utility company stocks. C) Steel company stocks. D) Airline company stocks.
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Answer: B 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.
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Which of the following stocks would NOT be considered a defensive security? A) Brewery company. B) Steel company. C) Tobacco. D) Utility company.
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Answer: B Steel securities are cyclical and therefore are not considered defensive. Tobacco, alcohol, and utilities are defensive securities because they are not affected by the business cycle.
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If disposable personal income has fallen steadily over the past year, which of the following is most likely to be affected? A) Automotive industry. B) Defense industry. C) Tobacco industry. D) Firm that produces nondurable consumer goods.
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Answer: A The automobile industry is cyclical and of the choices, the most likely to be affected by a change in the business cycle as indicated by declining personal income.
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If a customer purchases a food company stock and a utility stock, the customer's portfolio is: A) cyclical. B) balanced. C) defensive. D) diversified.
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Answer: C Food company stocks and utilities are defensive investments. Defensive investments are those that tend to hold up well in economic downturns.
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A new corporation with no existing products or services has a patent pending with the U.S. government. Which of the following describes this type of company? A) Special situation. B) Value. C) Growth. D) Asset allocation.
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Answer: A A company with a patent pending is known as a special situation.
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Which of the following would you most likely consider characteristics of a growth stock? A) Low PE and low dividend yield. B) High PE and high dividend yield. C) High PE and low dividend yield. D) Low PE and high dividend yield.
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Answer: C Growth stocks generally have high PE ratios and low (or no) dividends. Value stocks normally have low PE ratios with higher dividend payouts.
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Buying stocks with high PE ratios normally reflects which of the following investment styles? A) Special situations. B) Turnaround. C) Growth. D) Value.
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Answer: C The purchase of stocks with high PE ratios represents a growth investment style. Growth-oriented investors will pay for high PE ratios. Value investment style is associated with the purchase of low PE stocks or stocks trading below their intrinsic value.
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If one of your clients has recently bought several defensive stocks, she is probably anticipating: A) a recession. B) strong economic growth. C) mild economic growth. D) a depression.
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Answer: A Defensive stocks such as food company stocks do reasonably well in poor economic climates. If the client were anticipating a depression, the client would probably get out of equities and into high-quality short-term debt securities.
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All of the following are characteristics of business development companies (BDCs) EXCEPT A) all BDCs are fairly liquid and easy to divest of B) they allow smaller nonaccredited investors to invest in more speculative startup ventures C) BDCs can be listed and traded on exchanges or be nontraded D) BDCs are created to assist small companies while still in the initial stages of development
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Answer: A BDCs are created to assist small companies while still in the initial stages of development. They allow smaller nonaccredited investors to invest in more speculative startup ventures usually considered more suitable for accredited investors. They can be both listed and traded on US exchanges or nontraded, but with nontraded BDCs illiquidity or the risk of being able to exit the investment easily should be a primary suitability consideration.
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One company is guaranteeing the debt service of another company (guaranteed bond). In which of the following scenarios is this most likely to occur? A) In a spin-off where one company, the parent company, has divested itself of some equity and some debt to form a separate company B) When 2 competitors have merged C) When a company guarantees the debt of one of its own existing creditors D) Never, because SEC rules prohibit "guaranteed" bonds
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Answer: A Of the scenarios listed, in a spin-off, where one company, a parent company, divests itself of some of its equity and debt to form a new separate company, it is likely that the parent company would guarantee the debt of the new company.
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An increase in which of the following economic indicators would predict a decrease in business activity? A) Personal incomes. B) Building permits. C) Expenditures on plant and equipment. D) Levels of inventories.
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Answer: D The buildup of inventories is a disincentive for manufacturers to produce more goods and, therefore, may indicate a decrease in business activity. Increase in personal incomes, building permits, and expenditures on plant and equipment point to an increase in business activity.
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An improvement in economic conditions is indicated by an increase in all of the following EXCEPT: A) consumer orders. B) inventories. C) industrial production. D) S 500.
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Answer: B Increasing inventories result from a decrease in customer demand. This can occur when disposable income is dropping and economic conditions are deteriorating.
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KPT, Inc. is preparing to report its net income for the past year. An increase in which of the following causes a decrease in the reported net income? Tax rate. Cash dividend. Allowance for bad debts. Retained earnings. A) II and III. B) II and IV. C) I and III. D) I and II.
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Answer: C Higher taxes mean less net income. The allowance for bad debts is an expense item; increasing it lowers operating income. Dividends are paid out of retained earnings which have no effect on the net income the company reports.
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Which of the following describes additional paid-in capital? A) Total of all earnings since a corporation was formed, less dividends. B) The difference between the total dollar amount received from the issuance of common stock and the stock's aggregate par value. C) Also called earned surplus. D) Total of all residual claims that stockholders have against the corporation's assets.
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Answer: B Additional paid-in capital is the difference between the dollar amount received from the sale of stock and the stock's aggregate par value. Earned surplus is another name for retained earnings.
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All of the following appear on a corporation's balance sheet as fixed assets EXCEPT: A) inventory. B) real estate. C) furniture. D) computer equipment.
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Answer: A Inventory is considered a current asset, not a fixed asset, because the company expects to convert its inventory into cash within a short period of time. The other choices are fixed assets and cannot be liquidated easily.
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The board of ABC has voted to pay a $.32 dividend to holders of its common stock. These dividends will be paid from: A) operating income. B) debt service. C) new stock issues. D) retained earnings.
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Answer: D Cash dividends are typically paid from retained earnings.
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SSS Corporation's total assets amount to $780,000 of which $260,000 represents current assets. Total liabilities equal $370,000, of which $200,000 is considered long-term or other liabilities. What is SSS Corporation's shareholders' equity? A) $170,000. B) $980,000. C) $1,150,000. D) $410,000.
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Answer: D Total assets minus total liabilities equals shareholders' equity ($780,000 - $370,000 = $410,000).
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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 at least $100,000 in cash. B) has had total net income of $100,000 since its inception. C) has had $100,000 in undistributed profits since its inception. D) earned a profit of $100,000 for this year.
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Answer: C 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
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What is the balance sheet equation? A) Assets = net worth. B) Assets = shareholders' equity ? liabilities. C) Assets = liabilities + shareholders' equity. D) Assets = liabilities ? shareholders' equity.
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Answer: C Total assets equal total liabilities plus total shareholders' equity.
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Stock of which of the following companies trades on equity? A) Public utility. B) Drug manufacturer. C) Car manufacturer. D) Steel manufacturer.
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Answer: A Trading on equity relates to a highly leveraged company. Utility companies are normally highly leveraged.
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A highly leveraged company has the smallest percentage of its total capitalization in: A) preferred stock. B) short-term debt. C) long-term debt. D) common stock.
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Answer: D Common stock, which represents ownership, would account for the smallest amount of capitalization of a highly leveraged company. Highly leveraged companies have the largest amount of their capitalization in debt instruments. Preferred stock, although an equity, is more like a debt instrument because of the stated dividend rate.
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If XYZ Corporation sells an additional 1 million common stock with a par value of $1 for $10 per share, which of the following is TRUE? A) Current ratio will decrease. B) Its paid-in surplus will increase. C) Its EPS will increase. D) Its liquidity ratio will decrease.
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Answer: B Paid-in surplus is a balance sheet entry that accounts for money raised from the issuance of stock in excess of par value. When more shares are sold, paid-in surplus will increase.
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An analyst comparing revenues with expenses is most likely analyzing: A) liquidity. B) cash flow. C) working capital. D) capitalization.
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Answer: B The analyst is most likely measuring the income statement for cash flow (money coming in against money going out). Working capital analysis would involve examining the balance sheet's current assets and current liability entries, not the income statement. Capitalization analysis involves examination of long-term debt and stock issues. Liquidity analysis involves examining current assets and liabilities from the balance sheet.
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The issuance of a debenture by a company would have an immediate effect on which of the following balance sheet items? The total assets. The total liabilities. The working capital. The shareholders' equity. A) I, II and IV. B) I, III and IV. C) II, III and IV. D) I, II and III.
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Answer: D The cash received from the sale of the bonds is a current asset of the company and as such would increase assets and working capital on the balance sheet. The debentures are debts of the company and would increase the liabilities of the company. Shareholders' equity is only affected by gains, losses, new invested capital, and cash distributions (dividends) to shareholders.
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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) IV only. C) I only. D) I and II.
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Answer: C 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.
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Which of the following capital structures would be considered the most highly leveraged? A) A large value of bonds and a small value of common stock. B) A large value of common stock and a small value of bonds. C) Common stock only. D) Equal values of common stock and bonds.
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Answer: A Leverage is using other people's money to enhance equity value. In this case, borrowing at a fixed-rate of payment enhances cash flow, giving the company extra money to invest in its operations. Just as individuals, a company has to be careful not to borrow more than they can afford.
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A company's changing from straight line to accelerated depreciation will: increase income in the early years. decrease income in the early years. increase income in the later years. decrease income in the later years. A) II and III. B) I and III. C) I and IV. D) II and IV.
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Answer: A Accelerated depreciation increases charged expenses during the early years of equipment life but decreases charged expenses during the later years.
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Included in the working capital computation of a corporation are all of the following EXCEPT: A) cash. B) convertible bonds it has issued. C) accounts receivable. D) marketable securities of other companies.
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Answer: B 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.
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Which of the following may be affected when a company buys machinery for cash? Shareholders' equity. Current assets. Total liabilities. Working capital. A) II and III. B) II and IV. C) I and III. D) I and IV.
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Answer: B The purchase of machinery for cash will reduce current assets and working capital.
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Which of the following may be affected when a company declares a cash dividend? Shareholders' equity. Total assets. Total liabilities. Current assets. A) I and III. B) I and II. C) III and IV. D) II and IV.
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Answer: A When a company declares a cash dividend, it will reduce retained earnings (part of shareholders' equity) and increase current liabilities (dividends payable), which will increase total liabilities. Assets are not affected until the cash is paid out several weeks later.
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Which of the following balance sheet entries may be affected when a company pays a cash dividend? Shareholders' equity. Total assets. Total liabilities. Working capital. A) II and III. B) II and IV. C) I and IV. D) I and III.
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Answer: B When a company pays a cash dividend, the dividends payable (a current liability) and the cash account (current assets) are reduced by the same amount. Because liabilities and assets are each reduced by the same amount, working capital is not affected. Shareholders' equity, or net worth, is also not affected when the dividend is paid.
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If a company issues $10 million in par value convertible debentures, all of the following balance sheet items will be affected EXCEPT: A) working capital. B) net worth. C) assets. D) liabilities.
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Answer: B Net worth is not affected by the issuance of long-term debt because it does not represent ownership. Assets will be affected (increased) by the issuance of long-term bonds. Liabilities will be affected (increased) by the amount of the issuance. Working capital will also increase.
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A corporation buys back its stock on the open market for all of the following reasons EXCEPT: A) reduce interest charges. B) increase earnings per share. C) use it for stock options. D) use it for future acquisitions.
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Answer: A The repurchase of common stock does not reduce interest payments; however, it does reduce total dividends paid.
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Which of the following balance sheet items is NOT a current liability? A) Long-term debt amount that is due within 1 year. B) Mortgages. C) Accounts payable. D) Accrued taxes.
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Answer: B Short-term or current liabilities are those entries on a balance sheet that are due in 1 year or less. Accounts payable, accrued taxes, and that portion of long-term debt due within the year are all current liabilities. Mortgages are generally long-term liabilities, although that portion of a mortgage that is due within the year would be classified on the balance sheet as a current liability.
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Balance sheets contain: A) no reference to the accounting methods used to construct the balance sheet. B) the net worth of the firm as of the date of the balance sheet. C) gross revenues for the year. D) the amount of cash and cash equivalents expended during the first half of the fiscal year as opposed to the second half.
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Answer: B 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.
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The working capital of a corporation includes all of the following EXCEPT: A) cash. B) convertible bonds. C) accounts receivable. D) marketable securities of other companies.
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Answer: B 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 convertible bonds are long-term (not short-term) liabilities, they are not included as working capital.
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All of the following will affect the working capital of a corporation EXCEPT: A) an increase in assets. B) payment of a cash dividend. C) declaration of a cash dividend. D) a decrease in liabilities.
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Answer: B Working capital is defined as current assets minus current liabilities. Payment of a cash dividend will reduce current assets (cash) and current liabilities (dividend payable) by the same amount, leaving working capital unchanged.
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In a rising price environment, which of the following inventory valuation methods will result in the highest reported earnings? A) LIFO. B) Average cost. C) Straight line. D) FIFO.
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Answer: D Using first in, first out (FIFO) means lower cost inventory is used first in determining the cost of goods sold. This has the effect of inflating earnings. Using last in, first out (LIFO) means higher cost inventory is used to determine the cost of goods sold. In a rising price environment, LIFO better matches cost with revenue.
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If the assets of a company did not change, but stockholders' equity declined, it follows that: A) liabilities declined. B) retained earnings increased. C) capital surplus decreased. D) liabilities increased.
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Answer: D Stockholders' equity is assets minus liabilities. If assets stay the same, then an increase in liabilities will cause a decline in equity.
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A profitable company distributes 70% of its earnings in the form of cash dividends. What is the effect on the balance sheet of the 30% earnings NOT distributed? A) A decrease to retained earnings. B) An increase to retained earnings. C) An increase to capital surplus. D) A decrease to capital surplus.
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Answer: B Capital surplus comes from original investors. Retained earnings are created by undistributed company profits.
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All of the following are true of stockholders' equity EXCEPT: A) that it consists of stock issued, capital surplus, and retained earnings. B) that it is reflected in the book value of the stock. C) that it is also called net worth. D) that it is carried as an asset on the balance sheet.
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Answer: D Stockholders' equity or net worth (total assets less liabilities) is what a stockholder is entitled to should a company liquidate.
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If DMF Corporation issues $10 million par value of convertible debentures, all of the following balance sheet items will be affected immediately EXCEPT: A) the net worth. B) the assets. C) the liabilities. D) the working capital.
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Answer: A Net worth (equity in the company) remains unchanged. Assets and liabilities both increase, as does the working capital.
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The amount paid in excess of par value on the sale of common shares by an issuer is reflected in which of the following accounts on the corporate financial records? A) In the capital stock. B) In the earned surplus. C) In the retained earnings. D) In the paid-in surplus.
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Answer: D Paid-in surplus, or capital surplus, is the excess over par value that investors pay for stock on its original issue. Generally, par value on common stock is a matter of record for accounting purposes.
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A corporation has a net income of $5.2 million after taxes. If 4 million shares of common stock are outstanding, the earnings per share is: A) $0.80. B) $1.78. C) $5.20. D) $1.30.
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Answer: D Earnings per share equals net income (less preferred dividends) divided by the number of common shares outstanding. In this case, $5.2 million divided by 4 million equals an EPS of $1.30.
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Which of the following is NOT affected by the issuance of a bond? A) Assets. B) Total liabilities. C) Working capital. D) Shareholders' equity.
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Answer: D When bonds are issued, cash is received (thus increasing current assets) and long-term debt increases (increasing total liabilities). Because there is no corresponding increase in current liabilities, working capital increases. There is no effect on shareholders' equity because the increased liability is offset by the asset (cash) received.
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If a corporation has a dividend payout ratio of 70%, the undistributed earnings will: A) increase retained earnings. B) increase earnings per share. C) decrease book value. D) increase capital surplus.
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Answer: A Retained earnings represent income that has not been paid out to shareholders.
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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) 10:1. C) 12:1. D) 5:1.
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Answer: B 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).
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Working capital is: A) total assets - total liabilities. B) only the cash and equivalents. C) current assets - inventory. D) current assets - current liabilities.
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Answer: D Current means cash or assets that would be exchanged for cash in the ordinary course of business in the current year. In the case of liabilities, current means maturing or falling due within the current year. The net of current assets less the current liabilities implies the company has cash availability of the remainder with which to work.
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XYZ corporation divests itself of all of the shares of another company it owns. This is known as: A) a merger. B) a spin-off. C) an acquisition. D) a recapitalization.
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Answer: B When one company sells all of the shares of another it owns, this is called a spin-off.
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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) II and III C) II and IV D) I and III
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Answer: B 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.
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Net worth is equal to: A) liabilities minus income. B) assets minus liabilities. C) income minus liabilities. D) liabilities minus assets.
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Answer: B The balance sheet offers a "snap shot" view of a firm's resources and obligations based on the firm's most recent reporting date. The basic balance sheet equation is: assets ? liabilities = net worth.
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Which of the following is defined as profits after taxes and interest paid, less preferred dividends, divided by the number of shares of outstanding common stock? A) Earnings per share (EPS). B) Cash flow per share. C) Book value per share. D) Price-earnings (P/E).
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Answer: A Dividing net income after taxes, interest, and payment of preferred dividends by the number of common shares outstanding determines earnings per share (EPS).
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Which of the following describes when debt is used to acquire a firm? A) Takeover arbitrage. B) Leveraged buyout (LBO). C) Spin-off. D) Hostile takeover.
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Answer: B Financial leverage is a company's ability to use long-term debt to increase its return on equity. Acquiring another firm using debt is one way a company might attempt to do this. Using debt in this way is known as a leveraged buyout.
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A fund is investing capital raised from both institutional and private investors in a nonpublic company to assist the company with an anticipated acquisition. This type of investment would be known as A) a nonqualified plan B) a general partnership C) selling away D) private equity
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Answer: D Private equity is equity capital invested in operating companies that are not publicly traded. The investment of capital can be made to aid or assist the company in a number of ways, including, but not limited to, making acquisitions; strengthening the company's balance sheet; or turning around a distressed company.
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Speaking to a customer about a private equity fund a registered representative (RR) makes all of the following statements. Which of the following statements regarding private equity funds is NOT true? A) Private equity investments can be used to take an existing public company private. B) Private equity investments can fund the turnaround of a distressed company. C) Private equity capital investments are generally considered more suitable for either institutional or accredited investors as opposed to individual investors. D) Private equity capital commitments are generally short term and highly liquid from the moment the capital is invested.
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Answer: D Private equity capital can be used for a number of different reasons and is generally capital raised from institutional and accredited investors. Institutional and accredited investors are usually in a better position to commit the larger sums of capital needed for private equity investments and to make the capital commitment for an extended period of time to accommodate the length of time it takes to accomplish the intended goal of the invested capital.
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Your customer wants to know what portion of earnings one of the companies held in her portfolio has available to pay interest expense on bonds the company currently has outstanding. You would be able to find this information A) by contacting the Internal Revenue Service (IRS) B) on the firm's most recent balance sheet C) on the firm's income statement indicated as earnings before interest and taxes (EBIT) D) on a firm's income statement by subtracting preferred dividends from EBIT
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Answer: C Earnings before interest and taxes (EBIT) is the amount of money a company has retained before paying taxes and interest on outstanding debt issues. This can be found by looking at the income statement for the company.
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In analyzing the ability of a company to meet its debt obligations but not wanting to chance that certain accounting decisions or practices will cloud the picture, one measure that you might look at is the firm's A) cash flow found on a cash flow statement B) net worth found on the firm's balance sheet C) price-to-earnings (P/E) ratio D) earnings before interest, taxes, depreciation, and amortization (EBITDA), calculated from the firm's income statement
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Answer: D Earnings before interest, taxes, depreciation, and amortization (EBITDA), calculated from the firm's income statement, is a metric that measures the ability of a company to repay debt obligations (interest and principal), eliminating accounting decisions and techniques that might not allow for the best assessment.
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When analyzing a company's balance sheet, you notice that it is using the first in, first out (FIFO) accounting method to value its inventory. This information is most likely shown A) at the end of the balance sheet in a summary statement required by the SEC B) next to the inventory listing in the current assets portion of the balance sheet C) in a footnote to the balance sheet D) on the cover of the balance sheet or at the top of the first page
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Answer: C Notations regarding accounting methods used, such as those for valuing inventory, would generally be found in the footnotes of the balance sheet.
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You are reviewing a company's financial statements to assist a customer. What kind of information is most likely to be found in the footnotes to those financial statements? A) The name, address, and contact information for the firm's chief executive officer B) The length of time each director has served on the board of directors (BOD) C) Accounting methods used D) The names of the company's most formidable competitors
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Answer: C Footnotes to a company's financial statements will contain important financial information such as accounting methods used as well as important management philosophy that may impact the company's overall financial health and performance.
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Several of your firm's customers have expressed interest in a new non-traded business development company (BDC). Which of the following customer accounts would be considered LEAST suited for this type of investment? A) A joint retail account showing a couple with a net worth of $1 million dollars, approved for both margin transactions and uncovered options trading. B) A joint retail account currently valued at $1 million with a short-term investment time horizon noted due to anticipated upcoming college expenses. C) An individual retail customer account with several million dollars currently invested in both equity and debt products and a customer profile showing her as having made private equity investments in the past. D) An institutional trading account with over $100 million dollars to invest having a history of investing in new opportunities.
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Answer: B While there could certainly be a number of factors for each account that are left unaddressed such as age, employment status and investment criteria, test takers must rely on only the information given when answering suitability or recommendation questions. Of the profiles listed this type of investment would be the least suitable for the account having a short investment time horizon. The non-traded characteristic of this BDC makes illiquidity a primary factor to be considered. All of the other accounts show evidence of either being more likely to afford such an investment, having investment experience with similar investments in the past, or already being approved for investments or types of accounts that have inherent risk characteristics associated with them.
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Which of the following characteristics best exemplifies a value stock? A) Low earnings per share growth, high profitability. B) Low price-to-book, low price-to-earnings ratio. C) Low price-to-book, high price-to-earnings ratio. D) High earnings per share growth, high profitability.
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Answer: B A value investor focuses on share price in anticipation of a market correction and improving company fundamentals. Therefore, such an investor tends to select a stock featuring lower price-to-earnings and price-to-book value ratios. A growth investor focuses on high earnings per share, growth, and high profitability.
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Market interest rates have risen steadily over the past several months. The market price of which 2 of the following shares would probably reflect the biggest impact of this change? Growth stock. Money market mutual fund. Preferred stock. Public utility stock. A) I and IV. B) II and III. C) III and IV. D) I and II.
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Answer: C Stocks that are interest rate sensitive will reflect the impact of a change to market interest rates more than others. Preferred stock with its fixed dividend and utility stocks with their high degree of debt leverage are considered interest rate sensitive. The yield of the money market fund will change, but the price is fixed at $1 per share.
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The dividend payout ratio of common stock is found by dividing the annual dividend per share by: A) the market price. B) the capitalization per share. C) the earnings per share. D) the book value.
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Answer: C The key to the question is ratio, which in this case is the relationship between dividends per share and their source of earnings per share.
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When a company issues additional preferred stock and bonds, which of the following will be the net result? A) Leverage is decreased. B) Leverage is not affected since one issue is equity, the other is debt, and the net effect on leverage is zero. C) It is impossible to tell without the specific amounts of equity and debt issued. D) Leverage is increased.
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Answer: D Leverage is the use of someone else's money at a fixed cost to benefit the common shareholders. Both preferred stock and bonds are fixed rate issues. Therefore, issuing more preferred stock or bonds increases the leverage of the common stockholders.
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A company reported annual earnings of $2.40 per share and paid annual dividends of $.60. If the dividends were distributed quarterly, what was the amount and payout rate? A) $.15 at 25%. B) $.15 at 6.25%. C) $.60 at 25%. D) $.60 at 10%.
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Answer: A One quarter of $.60 is $.15. $.60 is 25% of $2.40.
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A customer purchased 100 shares of SNP at $38. At the time of purchase, the PE ratio was 12. Approximately what are the earnings per share of SNP? A) $3.16. B) $1.20. C) $3.80. D) $12.00.
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Answer: A The PE ratio is a comparison of the current market price at the close to the earnings of the company. $38 (CMV) / 12 (PE ratio) = $3.16 approximate EPS.
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ALFA Enterprises pays a quarterly dividend of $.15 and has earnings per share of $2.40. What is the dividend payout ratio? A) 30%. B) 25%. C) 6.25%. D) 14.4%.
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Answer: B Earnings per share are typically calculated for a year. So the annual dividend of $.60 ($.15 × 4) is divided by $2.40 to calculate what percentage of earnings is paid as a dividend; or rather, the dividend payout ratio (.60 / 2.40 = 25%).
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If XYZ common stock has a $4 dividend, a yield of 4.2%, a PE ratio of 12, and is trading at $96, its approximate earnings per share (EPS) is: A) $4.00. B) $48.00. C) $50.40. D) $8.00.
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Answer: D The stock's PE ratio is price to earnings per share (EPS). Dividing the stock's price by the PE will give the earnings per share ($96 / 12 = $8 EPS).
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All of the following ratios are measures of the liquidity of a corporation EXCEPT: A) current ratio. B) quick ratio. C) debt/equity ratio. D) acid-test ratio.
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Answer: C Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid-test (quick) ratio. However, the debt/equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company's overall capital structure.
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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) $2.40. B) $2.52. C) $2.28. D) $1.20.
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Answer: C 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).
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Under what circumstances will a dilution of equity occur? A) Stock dividend. B) Stock split. C) Issue of mortgage bonds to replace debentures. D) Conversion of convertible bonds into common stocks.
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Answer: D Dilution of equity occurs when stockholders experience a reduction in their percentage ownership of the company. If bonds are converted, more common shares are issued and the shareholder's equity is diluted. A stock dividend or stock split does not change a stockholder's percentage of ownership. Refunding debts has no effect on stockholders.
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Which of the following is the most stringent test of liquidity? A) (Cash + cash equivalents) / current liabilities. B) Assets / current liabilities. C) Current assets / current liabilities. D) (Current assets - inventory) / current liabilities.
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Answer: A Of the answers given, the cash assets ratio is the most stringent because it excludes inventories and accounts receivable.
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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) 15 D) 3
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Answer: C Before the split, the company 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 PE ratio unchanged (new price = $15, new EPS = $1).
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ABC, with 3 million shares outstanding, reports after-tax earnings of $7.5 million. Annual cash dividends total $1 per share. The dividend payout ratio is: A) 20%. B) 25%. C) 33%. D) 40%.
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Answer: D To compute this ratio, multiply the $1 dividend by 3 million shares to get the total dividend paid of $3 million. $3 million is 40% of the $7.5 million in earnings available to common.
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A stock pays a $.50 quarterly dividend. The company had earnings per share last year of $10. The companies dividend retention ratio is: A) 20%. B) 5%. C) 10%. D) 80%.
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Answer: D The dividend retention ratio is the reciprocal of the dividend payout ratio. If the company pays a $2 dividend on earnings of $10, it pays out 20% of the earnings available to common shareholders in the form of the dividend. That means it retains 80% of the available monies.
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Which of the following would best describe working capital? A) The value per share available to shareholders in the event of bankruptcy. B) The amount of money available to the corporation that is currently being held in cash or cash equivalent positions. C) 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) A corporation's net worth.
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Answer: C Working capital equals current assets minus current liabilities.
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All of the following are liquidity measures EXCEPT: A) cash equivalents and receivables divided by current liabilities. B) current assets minus inventory divided by current liabilities. C) annual dividends per share divided by EPS. D) current assets divided by current liabilities.
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Answer: C Liquidity is the ability to convert an asset into cash. All of the options listed are used to measure the liquidity of a company except for the dividend payout ratio which would tell you nothing about liquidity
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Growth companies tend to have all of the following characteristics EXCEPT: A) low PE ratios. B) low dividend payout ratios. C) high earnings retention ratio. D) potential investment return from capital gains rather than income.
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Answer: A Growth companies have high PE ratios and a low dividend payout ratio because they retain most if not all of their earnings. Investors anticipating fast growth bid up prices so PE ratios tend to be high. Growth companies retain most of their earnings to fund future growth. Investors select growth companies for capital gain potential, not for investment income.
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Your client lists an investment objective as being income from dividends. Which of the following would be the least suitable recommendation given that objective? A) Investment in preferred shares B) Investment in stocks found in the DJIA C) Investment in utility stocks D) Investment in a growth company
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Answer: D Of the answer choices listed, growth companies would be the least likely to pay dividends. Generally their earnings, if any exist, are put back into the company to help fund growth. All of the others would be more likely to pay dividends.
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ABC Investors Group is looking to do a leveraged buyout of the XYZ Corporation. Which of the following would be the most likely source of capital to fund this takeover? A) XYZ's liquid assets. B) XYZ's creditors. C) A long-term bank loan. D) ABC's liquid assets.
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Answer: C The word "leverage" generally implies the use of borrowed money. The acquiring company will either issue a bond or borrow from a bank and use that money to fund the acquisition. In most cases, the assets of the target company are used as collateral for the loan.
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Your customer asks you to help evaluate several companies she is considering adding to her portfolio. One of the tools you are using is the asset coverage ratio to assess A) if the company has enough in liquid assets only to cover its debt obligations B) if the company can cover the cost of new inventory using only its monetary assets C) if the company has raised enough debt capital to purchase new tangible assets such as buildings and equipment D) the value of the assets the company holds, both tangible and monetary, in relation to its debt obligations
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Answer: D The asset coverage ratio measures the tangible and monetary assets of a company in relation to its outstanding debt obligations. It is but one tool that can be utilized to assess the overall strength or weakness of a company's financial health.
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Your customer wants to add 1 or 2 stocks of companies manufacturing household appliances to his portfolio. One of the tools he is using to compare companies to one another is the inventory turnover ratio. He makes all of the following correct statements to you EXCEPT A) the ratio can indicate how efficiently inventory is being handled B) dissimilar industries would generally have different acceptable norms for this measurement C) comparing inventory turnover ratios is just one point of comparison between companies in the same industry D) the ratio is always higher in industries dealing in durable goods like household appliances
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Answer: D Higher inventory ratios are generally associated with companies dealing in perishable items. Those industries dealing in durable goods like household appliances are likely to have lower inventory turnover ratios as their norm.
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