Key important Q bank flashcards

Question 1

The rate that produces a net present value of a series of discounted cash flows equal to zero is called

Answer 1

IRR

IRR, or internal rate of return, is a metric used in financial analysis to estimate the profitability of potential investments.

Question 2

A bond analyst who determines the value of a debt security by adding the present value of the future coupons to the present value of the maturity value is using which of the following valuation methods?

Answer 2

Discounted cash flow

Discounted cash flow (DCF) is a valuation method that estimates the value of an investment using its expected future cash flows. Analysts use DCF to determine the value of an investment today, based on projections of how much money that investment will generate in the future.

Question 3

If a company successfully gets the owners of its long-term bond issue paying 7% annual interest to exchange them on a dollar-for-dollar basis with the company’s preferred stock paying a 7% annual dividend, what is the effect on EPS?

Answer 3

Decrease

The 7% interest payment is moved from a pre-tax deduction to an after-tax dividend payment. This increases the amount of taxable income, thereby increasing the company’s tax liability. The 7% payment remains the same. With an increased tax burden and everything else remaining the same, the EPS will decrease.

Question 4

A pension consultant who advises corporate retirement plans with assets of $135 million must register with which of the following?

Answer 4

State

Under the Dodd-Frank bill, until a pension fund manager has at least $200 million in AUM, registration with the states is required. Once the $200 million level is reached, SEC registration becomes an option.

Question 5

The Sharpe ratio is the average annual return of a security

Answer 5

minus the risk-free rate for the period with the remainder divided by the security’s standard deviation.

The Sharpe ratio is a risk-adjusted return because it measures the amount of return per unit of risk taken; the most common risk-free rate is that paid by 91-day U.S. Treasury bills.

Question 6

Market cap vs price weighted index funds

Answer 6

Market cap is the value of all the shares of a company or the total value of a company. So a market cap weighted would have a greater weight in Apple than Tesla. In a price weighted index it is just the price of the individual stock so Tesla would have a greater weighting than Apple

Market cap - Heavier weighting of large, stable companies can contribute to lower portfolio volatility. Cap-weighting increases exposure to fast-growing companies, which are most at risk of being overvalued. A bubble can result, which is great for returns – until the bubble pops.

Question 7

What is standard deviation

Answer 7

Standard Deviation Formula and Uses vs. Variance
This means that it shows how much the price of that investment has fluctuated over time. The greater the standard deviation of securities, the greater the variance between each price and the mean, which shows a larger price range.

Approximately two-thirds, or 68.26%, of observations will be within one standard deviation on either side of the mean. Approximately 95% will be within two standard deviations and approximately 99% will be within three.

Question 8

What does a negative net present value of a series of discounted cash flows mean?

Answer 8

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

Question 9

What ADV forms are required for registration? For IA at federal vs state

Answer 9

ADV part 1A

ADV part 1A & B for state

Form ADV Part 1A is the form filed by all applicants for registration as an investment adviser. If the applicant is registering on the state level, Part 1B is also required. Part 2A is the brochure, and Part 2B is the brochure supplement. Both Part 2A and 2B are filed with the Administrator when registering in a state. But when registering with the SEC, those forms are not filed with the SEC but are maintained in the principal office of the adviser. Form ADV-W is used when withdrawing from registration.

Question 10

When can an administrator designate officer to what?

Answer 10

Administrative functions

An official designated by the Administrator may serve subpoenas because that is basically an administrative function; however, an Administrator may not designate another official to grant registration exemptions or issue cease and desist orders. The recordkeeping requirements are set by law and cannot be altered by the Administrator.

Question 11

When an investor’s original value is subtracted from the ending value, and then has the income received over that time period added to it, which is then divided by the original cost, the result is

Answer 11

This is the method of computing holding period return.

Question 12

Holding period return

Answer 12

The sum of your capital appreciation and income return is your total return. By dividing your total return over your beginning value, we arrive at holding period return

Question 13

Internal rate of return

Answer 13

The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero.

In other words, it is the expected compound annual rate of return that will be earned on a project or investment.

Put another way, the initial cash investment for the beginning period will be equal to the present value of the future cash flows of that investment. (Cost paid = present value of future cash flows, and hence, the net present value = 0).

Question 14

expected return & annualized return

Question 15

How to do sharpe ratio

Answer 15

The Sharpe ratio is calculated by subtracting the risk-free rate of return from the expected rate of return, then dividing the resulting figure by the standard deviation

Question 16

How to figure out standard deviation

Question 17

Liquidity ratio

Answer 17

Current assets divided by current liabilities

Question 18

profitability ratio

(think about what this is asking, percentage of your sales is actually profit)

Answer 18

Gross profit divided by net sales

Question 19

return on stockholders’ equity

Answer 19

Net income divided by average total equity

Question 20

payout ratio

Answer 20

Dividend amount divided by earnings per share

Question 21

Zero coupon rate question to understand

Expressed as a percentage, what is the total return on a 1-year, newly issued (365 days to maturity) zero coupon debt obligation priced at 95?

Answer 21

5.26%

Zero coupon bonds get their name from the fact that there is no coupon interest paid. The investor’s return is the difference between the discounted price paid and the $1,000 maturity value. In this question, the price paid was 95 ($950) and the maturity value is $1,000. That $50 difference is the investor’s return. To determine the total return percentage on this zero coupon debt obligation, the $50 capital appreciation is divided by the cost of the bond, in this case $950, for a total return of 5.26%. Total return of a zero coupon security is made up entirely of the difference between the cost of the security and its sale or maturity price. The market price of the security, not current interest rates, is used in the calculation of total return.

Question 22

Discounted cash flow

Answer 22

Discounted cash flow analysis helps to determine the value of an investment based on its future cash flows.

The present value of expected future cash flows is calculated using a projected discount rate.

If the DCF is higher than the current cost of the investment, the opportunity could result in positive returns and may be worthwhile.

Question 23

f an adviser reports on its annual updating amendment that it has less than $90 million under management and it is not otherwise eligible to register with the SEC, it must withdraw from SEC registration within

Answer 23

180 days of the adviser’s fiscal year-end by filing Form ADV-W.

Question 24

In the field of securities analysis, there are many tools available. Which of the following would most likely be used by an analyst to approximate a reasonable price for a common stock?

Answer 24

The simplest model for valuing equity is the dividend discount model—the value of a stock is the present value of expected dividends on it.

Question 25

CAPM formula

The capital asset pricing model (CAPM) is used by many to assess the expected return of a security. If the current risk-free rate is 2%, the current return on the market is 10%, and a particular stock’s beta is 1.5 with a standard deviation of 3.2, the expected return would be

Answer 25

14%

The formula for this computation is as follows: 10% (the return on the market is a beta of 1.0) minus the risk-free rate of 2%, or 8%.

Then, multiply that by the beta of this stock (1.5) to arrive at 12%.

That is, the stock should return 12% above the risk-free rate of 2%, or 14%. The standard deviation is not relevant to this computation.

Question 26

Progressive taxes are those

Answer 26

where the tax rate increases as the amount being taxed increases. The opposite of that is the regressive tax, where the rate remains the same regardless of the dollar amount being taxed.