Chapter 6 Flashcards
What are the advantages/disadvantages of a sole proprietorship?
Advantages:
No or low start up and maintenance costs.
Losses may be used to offset income for tax purposes.
Disadvantages:
Unlimited personal liability
Must run the business, record keep, etc.
What are the main features of a general partnership?
Partners jointly share in the management, profits, losses, and liabilities of the partnership. They are the easies to form. They do not offer continuous existence. Transfer of ownership requires approval from all general partners. Partners have unlimited liability.
What are the main features of a limited partnership?
Passive participation by partners, limited liability, no management authority, primary function is to provide capital.
What are the advantages/disadvantages of a “C” corporation?
Advantages:
Owners (shareholders) have limited personal liability
Unlimited life
Net capital losses may be carried forward for to offset capital gains for up to 5 years.
Disadvantages:
Double taxation - The corp is taxed and then the shareholders are taxed on dividends received.
What are advantages/disadvantages of a “S” corporation?
Advantages:
Income flows through to the shareholders and is taxed only once.
Limited liability
Unlimited life
Taxes passed through to shareholders as capital gains/losses.
Disadvantages:
Can only have 100 or fewer shareholders
What are the features of a limited liability corporation?
Owners have limited liability. LLC’s have limited existence. Ownership is not as freely transferrable as corporate shares.
What is the basic balance sheet equation?
Assets = Liabilities + equities
What would not need to be reviewed to develop an investment strategy for a client?
The client’s mortgage rate, the prime rate, inflation.
What types of products would perform well in times of inflation?
Tangible assets such as gold coins etc.
What is an example of non-systematic risk?
The risk that a company will fail.
What is competitive risk?
The risk that a company will fail to keep up with competing firms and new developments in the industry sector.
What is the internal rate of return?
It’s the means of calculating an investment’s projected rate of return to evaluate whether this rate of return will meet or exceed an investor’s minimum desired rate of return. Cash inflows and outflows are equal to zero. The higher the IRR, the better the investment. The inflows if the IRR are assumed to be reinvested at the investment’s IRR.
What is the “risk free rate of return?”
The rate of return on a 3 month treasury bill.
What is “risk premium”?
A term used to describe the additional return an investor can expect for taking risk above and beyond risk-free investments (3 month treasury bills).
What is the “sharpe ratio?”
This is used to distinguish how well the return of an asset compensates the investor for the amount of risk taken. It’s calculated as follows: rate of return - risk free return divided by standard deviation.
This higher the ratio, the safer the strategy.
When would immunization of a portfolio take place?
When the duration of a portfolio’s assets equal the duration of the portfolios liabilities.
What is the month carlo simulation?
It is a simulation that runs thousands of chance scenarios to product probable outcomes involving a number of random variables. It creates a frequency distribution based on a wide range of potential outcomes.
What makes up the dow jones industrial average?
30 selected large cap blue chip stocks divided by a constant.
What is the Russell 3000 index?
3000 of the largest companies. The Russell 2000 is the small cap segment of the Russell 3000 index.
What is your “marginal tax rate”?
It’s the tax rate that is paid on the last dollar that you made. In the U.S., the progressive income tax causes the marginal rate.
Under what circumstances, would you be able to file as the “head of household” for tax purposes?
1) Unmarried or considered unmarried on the last day of the year.
2) Paid more than half the cost of keeping up the cost of a home for the year.
3) A “qualified person” lived with you in the home for more than half the year.
4) A divorced parent with custody of young children should file as “head of household”.
What is the “debt to equity” calculation?
Total net worth/net worth. Net worth is the same as the shareholders equity
If you were to invest in a $1,000 Treasury Bond with a 5.5% coupon and you buy the bond at par, holding it to maturity, what will your real rate of return be over the holding period if the CPI is 2% and the IRR is 3%?
3.5%. The real rate of return (aka - the inflation adjusted rate of return) equals the coupon rate of return (5.5% in this case) minus the rate of inflation (CPI = 2%). The IRR is the Internal Rate of Return and is the rate that will discount future cash flows to the present value (market price). The IRR is irrelevant in this particular question.
How do you best best define the term Net Present Value (NPV)?
NPV is the present value of cash inflows less the present value of cash outflows discounted by costs and interest received.
An investor purchases stock for $25,000. Three years later, the investor sells the stock for $40,000. What is the investors after tax return on investment if the long term capital gains rate is 20%?
$40,000 sale - $25,000 purchase price = $15,000 gain.
$15,000 gain x .20 = 3000 tax from sale
$15,000 - 3000 = $12,000
$12,000/25,000 = 48%
What does the “quick ratio” include?
The Quick Ratio, also called the Acid Test Ratio uses current assets LESS INVENTORY divided by current liabilities.
What does the “current ratio” include?
The Current Ratio uses Current Assets divided by Current Liabilities.
What is “market risk”?
It can also be called “systematic risk”. It’s the risk common to all securities of the same general class (stocks, bonds etc.). It therefore cannot be minimized or eliminated with diversification. It would include general market forces and sentiment.
