Unit 3 Economic Factors

Question 1

One measure of a corporation's intrinsic value is its book value per share. When performing this computation, which of the following must be taken into consideration?
I. Goodwill
II. Long-term debt
III. Retained earnings
IV. Par value of the preferred stock

Answer 1

I, II, III and IV

The computation of book value per share is basically net tangible worth per share of common stock. Included in the net worth are all assets and liabilities (such as long-term debt) as well as the stockholders equity (par value of the preferred stock and par + paid in surplus of the common stock and retained earnings). Subtracted from this to get tangible book value would be the par value of the preferred stock and the value of intangible assets such as goodwill.

Reference: 11.4.1.5 in the License Exam Manual

Question 2

You have been following GEMCO stock for the past couple of months and notice a recent increase in the stock’s volatility. In the past month, several negative reports have been published about GEMCO’s product line. This has caused a drop in the market price of the stock even though the GEMCO has just reported earnings that exceeded analyst’s projections. This is an example of: _______ risk

Answer 2

Market Risk

Market risk is the uncertainty that a stock’s price will move in a manner unrelated to the company’s fundamentals. A prime example of this is when earnings go one way and the stock price the other. What we are not told in the question is the performance of the stock market. It is likely that the overall market has declined over this period (and that must be assumed here – poor test question writing).

Question 3

Which of the following statements related to computing the internal rate of return (IRR) are CORRECT?

I. It is the discount rate that makes the future value of an investment equal to its present value.

II. In order to compute, it is necessary to know the initial cost of the investment.

III. In order to compute, it is necessary to know the cash flow of the investment.

IV. It is equivalent to a bond’s yield to maturity.

Answer 3

All four statements are true. IRR is a complicated subject, just learn that all 4 are needed.

Question 4

The ______ rate of interest is the nominal rate minus the inflation rate.

Banks charge a nominal rate rather than a _____ interest rate. The nominal rate of interest measures the time value of money plus investors’ expectations about future prices or inflation. The best known use of the term “nominal rate” is a bond’s coupon rate. When an issuer borrows money, the rate is determined by these factors plus the issuer’s credit rating.
Reference: 11.2.1.1 in the License Exam Manual

Answer 4

Real rate of interest

Question 5

__________ Averages are used to smooth out the fluctuations in a stock price over a period of time.

Answer 5

Moving Averages

Question 6

Median, Mode and Mean are all measures of _______ _______

Answer 6

Central Tendency

Question 7

Fixed income investments are subject to purchasing power risk, also called, _________ risk.

Answer 7

Inflation risk

Question 8

A beta of zero means a _______-______ investment

Answer 8

Risk-free investment

Question 9

A beta of 1.1 means the portfolio is considered to be 1.1 times more volatile than the overall market. If the market is up 10%, the portfolio with a beta of 1.1 is likely to be up _____%

Answer 9

11%

Question 10

The difference between the sum of the discounted cash flows that are expected from an investment and its initial cost.

Answer 10

Net Present Value

Net present value is a computation taking into consideration future cash flows, discounted to the present, and comparing that to the capital investment necessary to obtain those flows. It is always expressed in monetary units and, if positive, indicates a potentially worthwhile investment.

Reference: 12.1.1.4 in the License Exam Manual

Question 11

Securities with a _______ correlation add diversification to a growth portfolio because they move in the opposite direction of the balance of the holdings. Therefore, losses are offset by gains.

Reference: 12.2.7 in the License Exam Manual

Answer 11

Negative Correlation

Question 12

________ deviation is the statistic that indicates how much an investment’s returns have fluctuated compared to its average returns over a given period of time.

Reference: 12.2.6 in the License Exam Manual

Answer 12

Standard Deviation

An investment with a high standard deviation tends to have a higher level of risk than an investment with a low standard deviation.

Question 13

The uncertainty that the value of an investor’s assets will decrease as measured by real dollar purchasing power.

Answer 13

Inflation Risk

Inflation risk is the uncertainty that an investment’s purchasing power will decrease due to the shrinking value of the currency. An investor’s real rate of return is the nominal rate less the inflation rate.

Reference: 13.1.3 in the License Exam Manual

Question 14

Interest rate risk is the danger that interest rates will rise and adversely affect a bond’s price. This risk is greatest for ______-term bonds; ______-term debt securities are affected the least if interest rates change.

Reference: 13.1.2 in the License Exam Manual

Answer 14

The risk is greatest for long-term bonds;

Short-term debt securities are affected the least if interest rates change

Question 15

Whenever the coupon rate is equal to the discount rate, the NPV is ______.

Answer 15

Zero