Quant, Accounting, and Econ

Question 1

safety-first ratio

Answer 1

Tip: talk about minimum acceptable level of return (threshold), it is safety first ratio.

Optimal portfolio minimizes the probability that the return of the portfolio falls below some minimum acceptable level.

the one that maximizes the safety-first ratio will minimize the probability that the return will be less than the minimum acceptable return if we assume returns are normally distributed. This is the optimal portfolio.

Question 2

Items that appear in other comprehensive income, but are excluded from the income statement, include:

A)
losses due to expropriation of assets.
Incorrect Answer
B)
gains and losses due to foreign currency translation.
Correct Answer
C)
unrealized gains and losses on trading securities.
Incorrect Answer

Answer 2

Other comprehensive income includes unrealized gains and losses on available-for-sale securities, foreign currency translation gains and losses, minimum pension liability adjustments, and unrealized gains and losses on derivatives used for cash flow hedging.

Unrealized gains and losses on held-for-trading securities are included in net income on the income statement. Losses due to expropriation of assets would be included in net income, most likely as an unusual or infrequent item. (Module 18.5, LOS 18.l)

Question 3

Financial reporting quality vs Quality of earning

Other things equal, which of the following conditions would place a company highest on a spectrum of financial reporting quality?

A)
Reported earnings that are not sustainable.
Correct Answer
B)
Efforts by management to keep net income steady over time.
Incorrect Answer
C)
Financial statements that reflect the company’s economic activities accurately but are not in compliance with accounting principles.

Answer 3

Financial reporting quality
- adherence to generally accepted accounting principles (GAAP) in the jurisdiction in which the firm operates
- High quality financial reporting must be decision useful (Relevance, which is material, and faithful representation, which is neutral, complete…)

Highest (best) to lowest (worst) for assessing financial reporting:
1. Reporting is compliant with GAAP and decision useful; earnings are sustainable and adequate.
2. Reporting is compliant with GAAP and decision useful, but earnings quality is low (earnings are not sustainable or not adequate).
3. Reporting is compliant with GAAP, but earnings quality is low and reporting choices and estimates are biased.
4. Reporting is compliant with GAAP, but the amount of earnings is actively managed to increase, decrease, or smooth reported earnings.
5. Reporting is not compliant with GAAP, although the numbers presented are based on the company’s actual economic activities.
6. Reporting is not compliant and includes numbers that are essentially fictitious or fraudulent.

Quality of earning
- Sustainability of earnings (can it be continued in the future?)
- Adequacy of earnings (provide adequate return to shareholders)

Question 4

A company purchases an asset in the first quarter and decides to capitalize the asset. Compared to expensing the asset cost, capitalizing the asset cost will result in higher cash flows in the first quarter from:

A)
investing.
Incorrect Answer
B)
financing.
Incorrect Answer
C)
operations.
Correct Answer

Answer 4

Important
If the cost is expensed, the cash outflow is classified as CFO, but if the asset is capitalized, the cash outflow is classified as CFI. Cash flow from financing is not affected by the decision to capitalize.

Capitalizing the cost of the asset results in higher CFO and lower CFI in the period of the purchase, compared to expensing the entire cost.
(Module 23.1, LOS 23.c)

Question 5

In the short run, real GDP can be less than its full-employment level (a recessionary gap that causes downward pressure on prices) or more than its full-employment level (an inflationary gap that causes upward pressure on prices).

In long-run macroeconomic equilibrium, actual real GDP is equal to potential real GDP and there is no upward or downward pressure on the price level. (Module 10.3, LOS 10.i)

Question 6

continuous random variable

Answer 6

number of possible outcomes is infinite, even if lower and upper bounds exist.

The probability of an outcome to be equal one number is 0.

Question 7

Chi square test (represented as population variance)

Answer 7

chi-square test is used for hypothesis tests concerning the variance of a normally distributed population. It assumes that the population sample being used is normal. So, it is not able to tell if the population used in normal or not.

Question 8

XYZ Company has decided to issue $10 million of unsecured bonds. If issued today, the 4% semi-annual coupon bonds would require a market interest rate of 12%. Under U.S. GAAP, how will these bonds affect XYZ’s statement of cash flows?

A)
The coupon payments will decrease operating cash flow each year and the discount will decrease financing cash flow at maturity.
Correct Answer
B)
The periodic interest expense will decrease operating cash flow and the discount will decrease financing cash flow at maturity.
Incorrect Answer
C)
The coupon payments and the discount amortization will decrease financing cash flow each year.

Answer 8

It is the coupon payment, not the interest expense, that results in an outflow of cash. The difference between the coupon payment and interest expense is the discount amortization. The amortization does not result in a cash outflow.

Under U.S. GAAP, the coupon payment is reported as an operating cash flow. The discount, when paid at maturity, is reported as a financing cash flow. (Module 25.2, LOS 25.b)

The discount payment is the dividend payment in this case.

“Memorize the table”

Question 9

Premium/ Discounted bonds: Interest expense vs amortization

Answer 9

For a bond issued at a premium or discount, interest expense and coupon interest payments are not equal.

The effective interest rate method of amortizing a discount or premium is required under IFRS. Under U.S. GAAP, the effective interest rate method is preferred, but the straight-line method is allowed if the results are not materially different.

Firms that follow U.S. GAAP must report cash interest paid in the cash flow statement as an operating cash flow.

Firms that follow IFRS can report cash interest paid as either an operating or financing cash flow. Therefore, it may be necessary to reclassify interest paid when comparing firms that follow different standards.

Question 10

Tariff

Answer 10

Placing a tariff on an imported good increases the good’s domestic price, which reduces the quantity demanded.

However, the quantity supplied by domestic firms increases with the domestic equilibrium price, as does producer surplus for domestic firms. (Module 14.2, LOS 14.e)

Question 11

Consider two currencies, the VKN and the PKR. The PKR is trading at an annual premium of 2.3% relative to the VKN in the forward market. The 1-year risk-free PKR rate is 3.0%. If no arbitrage opportunities are available, the current 1-year risk-free VKN interest rate is closest to:

A)
0.7%.
Incorrect Answer
B)
2.3%.
Incorrect Answer
C)
5.3%.
Correct Answer

Answer 11

Because the PKR is trading at a forward premium (the forward VKN/PKR exchange rate is greater than the spot VKN/PKR exchange rate), the VKN interest rate must be greater than the PKR interest rate.

VKN should have an interest rate higher than that for PKR by the amount of the forward premium, or approximately 3.0% + 2.3% = 5.3%. (Module 15.2, LOS 15.h)

Question 12

standard auditor’s opinion

Answer 12

Unqualified opinion (also known as an unmodified or clean opinion) indicates that the auditor believes the statements are free from material omissions and errors.

qualified opinion and explain these exceptions in the audit report.

adverse opinion if the statements are not presented fairly or are materially nonconforming with accounting standards.

Question 13

An analyst has a sample of 28 observations with a sample mean of 14.2% and a sample variance of 0.00131. For a test about the population mean, she should use:

A)
a t-test if the population is normally distributed.
Correct Answer
B)
a z-test if the population is normally distributed.
Incorrect Answer
C)
either a z-test or a t-test regardless of the population distribution..

Answer 13

With a small sample size, a normally distributed population, and an unknown population variance, a t-test is the appropriate test for a hypothesis about the population mean.

Question 14

A firm has undertaken a contract with an estimated total cost of $500 million at a price of $800 million. At the end of the first reporting period, the firm has devoted resources of $180 million to the project. The customer has been billed for $250 million and made payments of $160 million. The amount of revenue the firm should record for the period is closest to:

Answer 14

Using the percentage of total costs incurred to date as an estimate of the portion of the performance obligations completed, revenue should be (180 / 500) × $800 million = $288 million. (Module 18.2, LOS 18.c)

Question 15

Inventory cost is most likely to include:

A)
storage costs for finished goods until they are actually sold.
Incorrect Answer
B)
shipping cost for delivery to the customer.
Incorrect Answer
C)
an allocation of fixed production overhead.
Correct Answer

Answer 15

An allocation of fixed production overhead based on normal production capacity is included in inventory cost. Neither storage costs that are not required as part of the production process nor shipping costs for delivery to the customer are included in inventory cost. (Module 22.1, LOS 22.a)

Question 16

Inventory cost

Answer 16

Production cost (capitalized as inventory)
- Conversion cost including labor and overhead
- Other cost necessary to bring the inventory to its present location
“Capitalized inventory cost includes the raw materials cost, conversion cost, and freight-in to plant”

Period cost (expensed when incurred)
- Abnormal waste
- Storage costs
- Selling and administrative costs
“The storage cost, abnormal waste, and the freight-out to customers are expensed as incurred.”

Question 17

Which of the following statements most accurately describes the general features of financial statements under IFRS?

A)
All of the required financial statements are prepared using accrual accounting.
Incorrect Answer
B)
Assets may not be offset against liabilities unless specifically permitted or required by a standard.
Correct Answer
C)
Prior-period information may only be presented when specifically permitted or required by a standard.
Incorrect Answer

Answer 17

One of the general requirements stated in IAS No. 1 is that firms not offset assets against liabilities unless a specific standard permits or requires it.

The statement of cash flows is not prepared using accrual accounting.

IAS No. 1 states that firms should present comparative information for prior periods unless a specific standard states otherwise. (Module 17.2, LOS 17.d)

Question 18

Tony Borden is analyzing the earnings of two companies. For each company, Borden estimates a probability that its earnings will exceed the consensus estimate. To estimate the probability that at least one of the companies will exceed its earnings estimate, Borden should use the:

A)
total probability rule.
Incorrect Answer
B)
addition rule of probability.
Correct Answer
C)
multiplication rule of probability.
Incorrect Answer

Answer 18

The addition rule of probability is used to calculate the probability that at least one of two events will occur: P(A or B) = P(A) + P(B) − P(AB). The total probability rule is used to calculate the unconditional probability of an event given conditional probabilities related to the event: P(A) = P(A|B1)P(B1) + P(A|B2)P(B2) + … + P(A|BN)P(BN). The multiplication rule of probability is used to calculate the joint probability that two events will occur together: P(AB) = P(A|B) × P(B). (Module 3.1, LOS 3.e)

Question 19

An analyst who expects the economy to experience stagflation should most appropriately recommend investing in:

A)
bonds.
Incorrect Answer
B)
equities.
Incorrect Answer
C)
commodities.
Correct Answer

Answer 19

Stagflation is a period of economic contraction with increasing inflation, typically brought on by a sharp decrease in aggregate supply. Investments in equities tend to perform poorly in an economic contraction due to decreasing profitability of companies.

Fixed income investments decrease in price when nominal interest rates increase due to increases in inflation.

Commodity prices tend to increase with inflation. (Module 10.3, LOS 10.l)

Question 20

An analyst has calculated the arithmetic, harmonic, and geometric mean using the last 10 years of returns on a stock. Which of these means should the analyst most appropriately use to forecast next year’s return on the stock?

A)
Harmonic mean.
Incorrect Answer
B)
Geometric mean.
Incorrect Answer
C)
Arithmetic mean.
Correct Answer

Answer 20

The arithmetic mean is statistically the best estimate (expected value) of the next year’s return.

The harmonic mean is not typically used to compute the historical performance or forecast the expected performance of an investment; rather it is used to compute the average cost of shares purchased over time.

The geometric mean is used to calculate average annual compound returns. It is the best estimate of future multi-year annual compound returns, but the arithmetic mean is the best estimate of a single year’s return. (Module 2.3, LOS 2.h)

Question 21

Currency rates for basis points and % change. Know the differences

Answer 21

The AUD/EUR spot exchange rate is 0.7313 with the 1-year forward rate quoted at +3.5 points. What is the 1-year forward AUD/EUR exchange rate?
Answer: The forward exchange rate is 0.7313 + 0.00035 = 0.73165.

The AUD/EUR spot rate is quoted at 0.7313, and the 120-day forward exchange rate is given as –0.062%. What is the 120-day forward AUD/EUR exchange rate?

Answer: The forward exchange rate is 0.7313 (1 − 0.00062) = 0.7308.

Question 22

Declaration and payment of a dividend during the most recent accounting period would be shown on a company’s statements of:

A)
cash flows and changes in equity.
Correct Answer
B)
cash flows and comprehensive income.
Incorrect Answer
C)
changes in equity and comprehensive income.
Incorrect Answer

Answer 22

Declaration of a dividend will be recorded as a decrease in equity, and payment of a dividend will be shown on a company’s cash flow statement, but neither affects income or comprehensive income. (Module 16.1, LOS 16.b)

Question 23

The statement of comprehensive income reports all changes in equity except for shareholder transactions (e.g., issuing stock, repurchasing stock, and paying dividends).

The income statement (also known as the statement of operations or the profit and loss statement) reports on the financial performance of the firm over a period of time. The elements of the income statement include revenues, expenses, and gains and losses.

Answer 23

Declaration of a dividend will be recorded as a decrease in equity, and payment of a dividend will be shown on a company’s cash flow statement, but neither affects income or comprehensive income. (Module 16.1, LOS 16.b)

Payment of dividend affect balance sheet but it wont affect I/S or comprehensive income.

Question 24

Which of the following most likely describes a loss that consumers suffer under an unregulated monopoly compared to a competitive market?

A)
Monopolies produce less goods than a competitive market would.
Correct Answer
B)
Costs of production are higher with monopolies.
Incorrect Answer
C)
Monopolists charge the maximum price.
Incorrect Answer

Answer 24

A reduction in output and increase in price under monopoly decrease consumer surplus and welfare compared to perfect competition. A natural monopoly may have lower costs than several competitive suppliers. Monopolists charge the profit maximizing price, not the “maximum price.” (Module 9.4, LOS 9.b)

Question 25

During 20X1, Tusa Company sold machinery with an original cost of $100,000, and recognized a $15,000 gain from the sale. At the time of the sale, the accumulated depreciation of the machinery was $80,000. Ignoring taxes, the machinery sale will produce a:

A)
$15,000 inflow from investing activities.
Incorrect Answer
B)
$20,000 inflow from operating activities.
Incorrect Answer
C)
$35,000 inflow from investing activities.
Correct Answer

Answer 25

Ignoring taxes, the cash flow for 20X1 consists of the sale proceeds. The sale proceeds equal $35,000, or the $20,000 book value ($100,000 cost – $80,000 accumulated depreciation) plus the $15,000 gain. The proceeds are reported as an inflow from investing activities. (Module 20.2, LOS 20.f)

Question 26

Jackknife vs Bootstrap

Answer 26

J: calculates multiple sample means, each with one of the observations removed from the sample

B: we draw repeated samples of size n from the full data set (replacing the sampled observations each time)

Question 27

Under the production function approach to modeling economic growth, will growing an economy’s amount of physical capital at a constant rate support long-term economic growth at that rate?
A)
No, because physical capital depreciates over time.
Incorrect Answer
B)
Yes, because output is a positive function of both labor and capital.
Incorrect Answer
C)
No, because physical capital exhibits diminishing marginal productivity.
Correct Answer

Answer 27

A constant growth rate of physical capital will increase output over time, but because capital exhibits diminishing marginal productivity, the economy will grow at a rate that decreases over time. (Module 10.3, LOS 10.o)

Question 28

Selected information on Reckner Company’s income taxes appears in the following table:

20X1 20X2 20X3
Taxes payable 250 500 500
Deferred tax assets 200 300 200
Deferred tax liabilities 200 300 400
Compared to 20X2, Reckner’s 20X3 income tax expense:

A)
increased.
Correct Answer
B)
decreased.
Incorrect Answer
C)
remained the same.
Incorrect Answer

Answer 28

Explanation
Income tax expense = taxes payable + ΔDTL – ΔDTA. Income tax expense in 20X2 was 500 + (300 − 200) − (300 − 200) = 500. Income tax expense in 20X3 was 500 + (400 − 300) − (200 − 300) = 700. Income tax expense increased by 200. (Module 24.2, LOS 24.c)

Question 29

A decrease in accumulated depreciation is most likely to result from:

A)
selling or disposing of a long-lived asset.
Correct Answer
B)
increasing the salvage value of a long-lived asset.
Incorrect Answer
C)
decreasing the estimated useful life of a long-lived asset.
Incorrect Answer

Answer 29

When a long-lived asset is sold or otherwise disposed of, its original cost and accumulated depreciation are removed from the balance sheet. Changing the estimated salvage value or useful life of a long-lived asset will change depreciation expense in the subsequent periods but does not affect accumulated depreciation. (Module 23.3, LOS 23.k)

Question 30

Elastic approach vs Absorption approach

Answer 30

Under the elasticities approach, currency depreciation will result in greater improvement in the trade deficit when either import or export demand becomes more elastic. One shortcoming of the elasticities approach is that it considers trade flows and ignores capital flows.

The absorption approach considers both. Under the absorption approach, depreciation of the domestic currency will improve the balance of trade if it increases domestic savings (i.e., increases national income relative to expenditures). (Module 15.3, LOS 15.j)

Question 31

continuously compounded rate of return

The continuously compounded annual rate of return that would increase the value of an investment by 20% in three years is closest to:

A)
5.7%.
Incorrect Answer
B)
6.1%.
Correct Answer
C)
6.7%.
Incorrect Answer

Answer 31

Use e and convert it to Ln.

The continuously compounded annual rate of return is ln(1.20) / 3 = 0.0608 or 6.08%. (Module 4.3, LOS 4.m)

Question 32

Magnus Aerospace produces and sells aircraft and has approximately a 2-year operating cycle. Magnus’s liabilities include commercial paper due in 270 days, a bank note due in one year, and bonds that will mature in 18 months. Magnus should most appropriately classify as current liabilities:

A)
all of these liabilities.
Correct Answer
B)
only the commercial paper.
Incorrect Answer
C)
the commercial paper and the bank note.
Incorrect Answer

Answer 32

Current liabilities are obligations due within one year or the company’s operating cycle, whichever is longer. With an operating cycle of two years, Magnus should classify as current any liabilities that must be settled in less than two years. (Module 19.3, LOS 19.d)

Question 33

Kinked demand curve

Answer 33

This assumes competitors will match a price decrease but not a price increase.

Question 34

Question 90

An analyst gathers the following selected financial information on Quip Corp.

Partial financials for 20X8 Quip Corp
Sales $350,000
Cost of goods sold 270,000
Net income 35,000
Current assets 165,000
Current liabilities 130,000
20X8 LIFO reserve 30,000
20X7 LIFO reserve 20,000
To compare Quip and its competitors, an analyst makes the necessary adjustments to restate Quip’s financial statements to reflect the FIFO inventory accounting method. Quip’s adjusted gross profit margin is closest to:

Answer 34

Explanation
adjusted cost of goods sold Quip = 270,000 − (30,000 − 20,000) = 260,000

adjusted gross profit margin Quip = (350,000 − 260,000) / 350,000 = 0.257 ≈ 26%

(Module 27.2, LOS 27.e)