Cfa Flashcards
Standard-setting bodies
professional organizations of accountants and auditors that establish financial reporting standards
Regulatory Authorities
Government agencies that have the legal authority to enforce compliance with financial reporting standards
International Organization of Securities Commissions
(1) protect investors (2) ensure the fairness, efficiency, and transparency of markets (3) reduce systemic risk. Because of globalization increasing in securities markets: uniform goal of financial regulations across countries
Form S-1 (Registration Statement)
Registration statement filed prior to the sale of new securities to the public. The registration statement includes audited financial statements, risk assessment, underwriter identification, and the estimated amount and use of the offering proceeds.
Form 10-K (Annual Report)
Required annual filing that includes information about the business and its management, audited financial statements and disclosures, and disclosures about legal matters involving the firm. Information required in 10-K is similar to that which a firm typically provides in its annual report to shareholders. However, a firm's annual report is not a substitute for the required 10-K filing. Equivalent SEC forms for foreign issuers in the U.S. markets are Form 40-F for Canadian companies and Form 20-F for other foreign issuers.
Form 10-Q (Quarterly Report)
U.S. firms are required to file this form quarterly, with updated financial statements (unlike Form 10-K, these statements do not have to be audited) and disclosures about certain events such as significant legal proceedings or changes in accounting policy. Non-U.S. companies are typically required to file the equivalent Form 6-K semiannually.
Form DEF-14A
When a company prepares a proxy statement for its shareholders prior to the annual meeting or other shareholder vote, it also files the statement with the SEC as Form DEF-14A
Form 8-K
Companies must file this form to disclose material events including significant asset acquisitions and disposals, changes in management or corporate governance, or matters related to its accountants, its financial statements, or the markets in which its securities trade
Form 144
A company can issue securities to certain qualified buyers without registering the securities with the SEC but must notify the SEC that it intends to do so.
Forms 3,4 and 5
Involve the beneficial ownership of securities by a company's officers and directors. Analyst can use these filings to learn about purchases and sales of company securities by corporate insiders.
2 Fundamental Characteristics that make financial information useful
Relevance and Faithful representation
4 Characteristics that Enhance Relevance and Faithful Representation
Comparability, Verifiability, Timeliness, Understandability
Assets
Resources controlled as a result of past transactions that are expected to provide future economic benefits.
Liabilities
Obligations as a result of past events that are expected to require an outflow of economic resources.
Equity
The owner's residual interest in the assets after deducting the liabilities
Income
An increase in economic benefits, either increasing assets or decreasing liabilities in a way that increases owners' equity (but not including contributions by owners). Includes: revenues and gains
Expenses
Decreases in economic benefits, either decreasing assets or increasing liabilities in a way that decreases owners' equity(but not including distributions to owners). Includes: losses
Measurement Base
includes: historical cost, amortized cost, current cost, net realizable value, present value, and fair value - help determine which items are reported in the financial statement
General features of financial statements according to IAS No. 1 are:
Fair presentationGoing ConcernAccrual accountingConsistencyMaterialityAggregationNo offsettingReporting FrequencyComparative information
Remaining differences of IASB and FASB
- IASB lists income and expenses as performance elements, while the FASB lists revenues, expenses, gains, losses , and comprehensive income- Minor differences in the definition of assets (FASB uses the word probable when defining Assets & Liabilities).- FASB does not allow the upward revaluation of most assets
For firms that list their shares in the United States but do not use U.S. GAAP or IFRS, they are required to:
Reconcile their financial statements with U.S. GAAP. Reconciliation is no longer required for IFRS firms who list their shares in the the U.S.
A Coherent financial reporting framework should exhibit:
Transparency, Comprehensiveness, and Consistency
Barriers to creating a coherent framework:
issues of valuation, standard setting, and measurement
Which of the following organizations is least likely involved with enforcing compliance with financial reporting standards?A. Financial Conduct AuthorityB. Securities and Exchange CommissionC. International Accounting Standards Board
C. The IASB is a standard-setting body.SEC (U.S.) and the Financial Conduct Authority (United Kingdom) are regulatory authorities
Which of the following most accurately lists a required reporting element that is used to measure a company's financial position and one that is used to measure a company's performance?
Position: Assets, Liabilities, Owner's EquityPerformance: Income and Expenses
The FASB framework lists:
Revenue, expenses, gains, losses, and comprehensive income related to financial performance
The IASB framework lists only:
Income and expenses
The income statement is sometimes referred to as:
"Statement of operations""Statement of earnings"or ""Profit and loss statement"
Income Statement Equation (short)
Net Income = Revenues - Expenses
Under IFRS, the income statement can be combined with __________________ and presented as a single statement of _____________ ____________.
"other comprehensive income" "comprehensive income"alternatively can be presented separately
Investors examine a firm's income statement for valuation purposes, while lenders examine the income statement for :
Information about the firm's ability to make the promised interest and principal payments on its debt
Grouping expenses by function is sometimes referred to as :
The cost of sales method
Income Statement Equation
Net Income = Revenues - ordinary expenses + other income - other expenses + gains - losses
If a firm has a controlling interest in a subsidiary, the pro rata share of the the subsidiary's income not owned by the parent is reported in the parents income statement as the:
Non-controlling interest
Gross Profit
the amount that remains after the direct costs of producing a product or service are subtracted from revenue
Operating Profit/Income
Subtotal resulting from subtracting Operating Expenses (such as selling, general, and administrative expenses) from Gross Profit
Under the accrual method of accounting, revenue is recognized when _______ and expenses are recognized when _________.
earned, incurred
According to IASB, revenue is recognized from the sale of goods when:
1. risk & reward of ownership is transferred2. no continuing control or mgmt over the goods sold3. revenue can be reliably measured4. probable flow of economic benefits5. cost can reliably measured
According to IASB, revenue is recognized from services rendered:
1. The amount of revenue can be reliably measured2. probable flow of economic benefits3. Stage of completion can be measured4. Cost incurred and cost of completion can be reliably measured
According to FASB, revenue is recognized in the income statement when:
Realized/realizable and Earned
The Securities and Exchange Commision (SEC) provides additional guidance by listing 4 criteria to determine whether revenue should be recognized:
1. There is evidence of an arrangement between the buyer and seller2. The product has been delivered or the service has been rendered3. The price is determined or determinable4. The seller is reasonably sure of collecting money
If a firm receives cash before revenue recognition is complete, the firm reports it as :
Unearned Revenue
Installment sale
occurs when a firm finances a sale and payments are expected to be received over an extended period.If collectibility cannot be reasonably estimated, the installment method is used, if highly uncertain, the cost recovery method is used, otherwise revenue is recognized at the time of sale using the normal revenue recognition criteria
Under the installment method, profit is recognized as:
Cash is collected.Profit = Cash collected during the period multiplied by the total expected profit as a percentage of sale
Under the cost recovery method, profit is recognized only when
cash collected exceeds costs incurred
Under Net Revenue Reporting only the ___________ is reported
difference in sales and cost
The following criteria must be met in order to use gross revenue reporting under U.S. GAAP:
1. Be the primary obligor under the contract2. Bear the inventory risk & credit risk3. Be able to choose its supplier4. Have reasonable latitude to establish the price
Users of financial information must consider 2 points when analyzing a firm's revenue:
1. how conservative are the firm's revenue recognition policies2. extent to which the firm's policies rely on judgement & estimates
Converged standards for recognizing revenue 5 step process:
1. Identify the contract(s) with a customer.2. Identify the performance obligations in the contract.3. Determine the transaction price.4. Allocate the transaction price to the performance obligations in the contract.5. Recognize revenue when (or as) the entity satisfies a performance obligation
Matching Principle (Expense Recognition Principle)
Requires that firms match revenues recognized in a period with the expenses required to generate them (Inventory for example is recognized in the period when sold, not purchased)
Period costs
Not all expenses can be directly tied to revenue recognition. These costs are known as period costs such as: administrative costs, and are expensed in the period incurred
FIFO Method
First in, first out: the cost of inventory acquired first (beginning inventory and early purchases) is used to calculate the cost of goods sold for the period. The cost of the most recent purchases is used to calculate ending inventory.FIFO is appropriate for inventory that has a limited shelf life.
LIFO Method
Last in, first out: the last item purchased is assumed to be the first item sold. The cost of inventory most recently purchased is assigned to the cost of goods sold for the period. The costs of beginning inventory and earlier purchases are assigned to ending inventory. LIFO is appropriate for inventory that does not deteriorate with age. For example, a coal distributor will sell coal off the top of the pile.
In an inflationary environment, _______ results in higher cost of goods sold.
LIFO- higher cogs results in lower taxable income, and therefore, lower income taxes (income tax benefits is why LIFO is popular in the U.S.)
Weighted average cost method ..... makes no assumption about:
makes no assumption about the physical flow of inventory
Permitted under both U.S. GAAP and IFRS
FIFO and Average cost-LIFO is prohibited under IFRS
Allocation of cost over an asset's life is known as:
Depreciation (tangible assets), Depletion (natural resources), or Amortization (intangible assets)
Straight line depreciation
used by most firms; recognizes an equal amount of depreciation expense each period; SL depreciation expense = cost - residual value /Useful life
accelerated depreciation method
Speeds up the recognition of depreciation expense in a systematic way to recognize more depreciation expense in the early years of the asset's life and less depreciation in the later years of its life. Primarily used for assets that generate more benefits in the early years of their economic life and fewer benefits in the later years. (Total Depreciation expense over the life of the asset will be the same as it would if straight-lined depreciation were used)
Declining balance method
Also known as diminishing balance (DB) method - applies to a constant rate of depreciation to an asset's (declining) book value each year.
Double-declining balance (DBB)
Applies 2 times the Straight-Line rate to the declining balance. DDB depreciation = (2 / useful life) (cost - accumulated depreciation)
Amortization
the allocation of the cost of an intangible asset (such as a franchise agreement) over its useful life. Amortization expense should match the proportion of the asset's
If the asset is expected to have no residual value, the DB method will never fully depreciate it, so the DB method is typically change to:
Straight-line depreciation (at some point in the asset's life)
Delayed expense recognition increases...
current net income, and is therefore more aggressive than accelerated recognition
Any income or loss from discontinued operations is reported:
separately in the income statement, net of tax, after income from continuing operations.Any past income statements presented must be restated, separating the income or loss from the discontinued operations. On the measurement date, the company will accrue any estimated loss during the phaseout period and any estimated loss on the sale of business. Any expected gain on the disposal cannot be reported until after the sale is completed.
Extraordinary Items
Under U.S. GAAP, historically, was a material transaction or event that was both unusual and infrequent in occurrence. IFRS does not allow items to be treated as extraordinary.
Unusual and infrequent items include:
- gains or losses from the sale of assets or part of a business, if these activities are not a firm's ordinary operations.- impairments, write-offs, write-downs, and restructuring costs
Change in accounting principle from one (GAAP or IFRS method, LIFO/FIFO) to another requires:
Retrospective Application - all prior period financial statements currently presented are restated to reflect the change
Change in accounting estimate
is generally the result of a change in management's judgement, usually due to new information. (For example: Asset has a longer or shorter life than originally expected) Change in estimate is applied PROSPECTIVELY and does not require the restatement of prior financial statements
Prior-period adjustment
Made by restating results for all prior periods presented in the current financial statements to change from an incorrect accounting method to one that is acceptable under GAAP or IFRS or the correction of an accounting error made in previous financial statements. Disclosure of the nature of the adjustment and its effect on net income is also required.
Earnings Per Share (EPS)
-one of the most commonly used corporate profitability performance measures for publicly-traded firms (nonpublic companies are not required to report)-is reported only for share of common stock (also known as ordinary stock)
Simple Capital Structure
-contains no potentially dilutive securities-contains only common stock, nonconvertible debt, and nonconvertible preferred stock
Complex Capital Structure
- contains potentially dilutive securities such as options, warrants, or convertible securities- must report both basic and diluted EPS
Basic EPS calculation
Net Income - Preferred dividends / Weighted average # of common shares outstanding
Net income - preferred dividends =
income available to common stockholders
Weighted average number of common shares
# of shares outstanding during the year, weighted by the portion of the year they were outstanding.
Stock dividend
distribution of additional shares to each shareholder in an amount proportional to their current number of shares. If a 10% stock dividend is paid, the holder of 100 shares of stock would receive 10 additional shares
Stock split
refers to the division of each "old" share into a specific number of "new" (post-split) shares. The holder of 100 shares will have 200 shares after a 2-for-1 split or 150 shares after a 3-for-2-split
Weighted average shares outstanding calculation
- the weighting system is days outstanding / # of days in a year (on the exam, the monthly approximation method will probably be used)- Shares issued enter into the computation from the date of issuance- Reacquired shares are excluded from the computation from the date of reacquisition- Shares sold or issued in a purchase of assets are included from the date of issuance.- A stock split or stock dividend is applied to all shares outstanding prior to the split or stock dividend and to the beginning-of-period weighted average shares. A stock split or stock dividend adjustment is not applied to any shares issued or repurchased after the split or dividend date.
Diluted securities
stock options, warrants, convertible debt, or convertible preferred stock that would DECREASE EPS if exercised or converted to common stock
Antidilutive securities
stock options, warrants, convertible debt, or convertible preferred stock that would INCREASE EPS if exercised or converted to common stock
Common Size Income Statement
Expresses each category of the income statement as a percentage of revenue- eliminates the effects of size allowing for comparison of income statement items over time (time-series analysis) and across firms (cross-sectional analysis)
Gross Profit Margin Ratio
Gross Profit / Revenue
Net Profit Margin Ratio
Net Income / Revenue
Retained Earnings
At the end of each accounting period, the net income of the firm is added to stockholder's equity through an account known as ___________________.- therefore, any transaction that affects the income statement (net income) will also affect stockholders' equity.
Comprehensive Income
more inclusive measure that includes all changes in equity except for owner contributions and distributions. That is, comprehensive income is the sum of net income and other comprehensive income.
Other comprehensive income
not included in net income:1. Foreign currency translation gains and losses2. Adjustments for minimum pension liability3. Unrealized gains and losses from cash flow hedging derivatives.4. Unrealized gains and losses from available-for-sale securities
Available-for-sale securities
investment securities that are not expected to be held to maturity or sold in the near term. Available-for-sale securities are reported on the balance sheet at fair value. The unrealized gains are not reported in the income statement but are reported directly in stockholders' equity as a component of other comprehensive income
Current Ratio
Current Assets / Current Liabilities
Quick Ratio
(cash + marketable securities + receivables) / Current Liabilities
Cash Ratio
Cash + Marketable Securities / Current Liabilities
Solvency ratios
measure the firm's ability to satisfy its long-term obligations. Solvency ratios include the long-term debt-to-equity ratio, the total debt-to-equity ratio, the debt ratio, and the financial leverage ratio
Long-term debt-to-equity
Long-term debt / Total Equity
Total Debt-to-Equity
Total debt / total equity
Debt ratio
total debt / total assets
Financial Leverage
avg Total Assets / avg Total Equity
Which inventory valuation method is required by the accounting schedule-setting bodies?
Lower of cost or net realizable value
Receivables Turnover
Annual Sales/Average Receivables
What is the inverse of receivables turnover?
Average Collection Period/ Days of Sales Outstanding
Days of Sales Outstanding (DSO) Ratio
365 / Receivables Turnover
Inventory Turnover
COGS/Average Inventory
Days of Inventory on Hand
365/inventory turnover
Payables Turnover ratio
Purchases/Average Trade Payables
Number of Days of Payables
365/payables turnover ratio
Total Asset Turnover
Revenue/Average Total Assets
Fixed Asset Turnover (utilization of fixed assets)
Revenue / Average Net Fixed Assets
Working Capital Turnover
Revenue / Average working capital
Current Ratio
Current Assets/Current Liabilities
Quick Ratio
Cash + Marketable Securities + Receivables / Current Liabilities
Cash Ratio
Cash + Marketable Securities / Current Liabilities
Defensive Interval
Cash + marketable securities + receivables / average daily expenditures
Cash Conversion Cycle
(Days Sales Outstanding) + (Days of Inventory on hand) - (# of days of payables)
A conversion cycle that is too high implies
that the company has an excessive amount of capital investment in the sales process
Debt-to-capital
total debt / total debt + total shareholders' equity
Interest Coverage Ratio
Earning before interest & taxes / interest payments
Fixed Charge Coverage Ratio
EBIT + Lease pmts / interest pmts + lease pmts
Operating profitability ratios
Look at how good management is at turning their efforts into profits. Operating ratios compare the top of the income statement (sales) to profits
Gross profits
Net sales - COGS
Operating profits
EBIT
Net Income
Earning after taxes but before dividends
Total capital
long-term debt + short-term debt + common & preferred equityortotal assets (the difference between these two definitions is working capital liabilities such as accounts payable) Some analysts consider these liabilities a source of financing for a firm and include them
Net Sales - COGS =
Gross Profit
Gross Profit - Operating Expense =
Operating profit (EBIT)
EBIT - Taxes =
Earnings after tax (EAT)
Net income - Preferred Dividends =
Income available to common
Gross Profit Margin =
Gross Profit / Revenue
Operating profit margin =
operating income (EBIT) / revenue
Pretax margin =
EBT / Revenue
Return on Assets (ROA) =
Net income / Average total assetsalternatively,Net Income + Interest Expense (1- Tax rate) / Average total assets
Operating return on assets
Operating Income / Average Total Assetsor EBIT / Average Total Assets
Return on Total Capital (ROTC)
EBIT/Average Total Capital
Return on Equity (ROE)
Net income / average total equity (including preferred stock)
Return on common equity =
= net income - preferred dividends / average common equity= net income available to common / average common equity
Standard costing
-often used by manufacturing firms-involves assigning predetermined amounts of materials, labor, and overhead to goods produced
Retail method
- used by firms that measure inventory at retail prices and then subtract gross profit in order to determine cost
Owner's equity
residual interest in assets that remains after subtracting an entity's liabilities- includes: contributed capital, preferred stock, treasury stock, retained earnings, non-controlling interest, and accumulated other comprehensive income
Contributed capital
(aka issued capital) amount contributed by equity shareholders
Par value
- a stated or legal value - has no relationship to fair value- some common shares are even issued without a par valuewhen par value exists, it is reported separately in stockholders' equity - in that case, the total proceeds from issuing an equity security are the par value of the issued shares plus "additional paid-in capital"
Authorized shares
# of shares that may be sold under the firm's articles of incorporation
Issued shares
# of shares that have actually been sold to shareholders
Outstanding shares
issued shares less shares that have been reacquired by the firm (i.e., treasury stock)
Preferred stock
has certain rights and privileges not conferred by common stockFor example: preferred shareholders are paid dividends at a specified rate, usually expressed as a percentage of par value, and have priority over the claims of the common shareholders in the event of liquidation-preferred stock can be classified as debt or equity depending on the termsFor example: perpetual preferred stock that is non-redeemable is considered equity, but preferred stock that calls for mandatory redemption in fixed amounts is considered a financial liability
common-size balance sheet
expresses each item of the balance sheet as a percentage of total assets
Treasury stock given Authorized, Issued and Shares Outstanding
Issued - Shares Outstanding
Cash flow from operating activities (CFO)
inflows & outflows of cash resulting from transactions that affect a firm's net income
Cash flow from investing activities (CFI)
inflows & outflows of cash resulting from the acquisition or disposal of long-term assets & certain investments
Cash flow from financing activities (CFF)
inflows & outflows of cash resulting from transactions affecting a firm's capital structure
Direct Method ((of presenting operating CF) encouraged by both standard setters)
Each line item of the accrual-based income statement is converted into cash receipts or cash payments- the direct method converts an accrual-basis income statement into a cash-basis income statement
Indirect method (of presenting operating CF)
Net income is converted to operating cash flow by making adjustments for transactions that affect net income but are not cash transactions.These adjustments include eliminating non-cash expenses (e.g., depreciation & amortization), non-operating items (e.g., gains & losses), and changes in balance sheet accounts resulting from accrual accounting events
Direct Method: common CF components that appear on Statement of Cash Flow
- cash collected from customers (main component of CFO)-cash used in production of goods & services (cash inputs)-cash operating expenses-cash paid for interest-cash paid for taxes
Direct Method: Investing cash flows (CFI) are calculated by...
Examining the change in the gross asset accounts that result from investing activities, such as property, plan, & equipment, intangible assets, and investment securities. related accumulated depreciation or amortization accounts are ignored since they do not represent cash expenses
If assets were sold during the period, you must use what formula to determine cash paid for new asset?
cash paid for new asset = ending gross assets + gross cost of old assets sold - beginning gross assetsorbeginning gross assets + cash paid for new assets - gross cost of assets sold = ending gross assets
Calculating the cash flow from an asset that has been sold:
cash from asset sold = book value of the asset + gain (or - loss) on sale
Direct Method: Financing cash flows (CFF) are determined by...
-measuring the cash flows occurring between the firm & its suppliers of capital-cash flows between the firm and its creditors result from new borrowings (positive CFF) and debt principal repayments (negative CFF)- interest paid is technically a CF to creditors, but it is included in CFO under U.S. GAAP.-Cash flows between the firm and its shareholders occur when equity is issued, shares are repurchased, or dividends are paid.
CFF is the sum of these two measures:
net cash flows from creditors = new borrowings - principal amounts repaidnet cash flows from shareholders = new equity issued - share repurchases - cash dividends paid
Indirect method of calculating CFO steps
Step 1: Begin with Net IncomeStep 2: Subtract gains or add losses that resulted from financing or investing cash flows (such as gains from sale of land)Step 3: Add back all non-cash charges to income (such as depreciation and amortization) and subtract all noncash components of revenueStep 4: Add or subtract changes to balance sheet operating accounts as follows:- increases in operating asset accounts (uses of cash) - increases in the operating liability accounts (sources of cash) are added, while decreases (uses of cash) are subtracted
Free cash flow
a measure of cash that is available for discretionary purposes - cash flow available once the firm has covered its capital expenditures. this is a fundamental cash flow measure and is often used for valuationthere are several measures of free cash flow - two of the more common measures are free cash flow to the firm and free cash flow to equity
Free cash flow to the firm (FCFF)
the cash available to all investors, both equity owners and debt holders.FCFF can be calculated by starting with either net income or operating cash flow.
FCFF calculated from Net income
FCFF = NI + NCC + [Int x ( 1 - tax rate)] - FCInv - WCInvNI = net incomeNCC = non-cash charges (depreciation&amortization)Int = interest expenseFCInv = fixed capital investment (net capital expenditures)WCInv = working capital investment
FCFF calculated from Operating cash flow
FCFF = CFO + [Int x (1 - tax rate)] - FCInvCFO = cash flow from operationsInt = interest expense FCInv = fixed capital investment (net capital expenditures)
Free Cash Flow to Equity (FCFE)
cash flow that would be available for distribution to common shareholders.
FCFE calculation
FCFE = CFO - FCInv + net borrowingCFO = cash flow from operationsFCInv = fixed capital investment (net capital expenditures)net borrowing = debt issued - debt repaid*note: If firms that follow IFRS have subtracted dividends paid in calculating CFO, dividends must be added back when calculating FCFE
Cash flow to revenue ratio
CFO / Net Revenue
Cash Return on Assets Ratio
CFO / average total assets
Cash Return on Equity Ratio
CFO / average total equity
Cash to Income Ratio
CFO / operating income
Cash flow per share
a variation of basic earnings per share measured by using CFO instead of net incomeCFO - preferred dividends / weighted average # of common shares*note: if common dividends were classified as operating activities under IFRS, they should be added back to CFO for purposes of calculating cash flow per share
Debt Coverage Ratio
CFO / total debt measures financial risk and leverage
Interest Coverage Ratio
CFO + interest paid + taxes paid / interest paidmeasures firm's ability to meet interest obligations*note: if interest paid was classified as a financing activity under IFRS, no interest adjustment is necessary
Reinvestment Ratio
CFO / cash paid for long-term assetsmeasures firm's ability to acquire long-term assets with operating cash flow
Debt Payment Ratio
CFO / cash long-term debt repaymentmeasures firm's ability to satisfy long-term debt with operating cash flow
Dividend Payment Ratio
CFO / dividends paidmeasures the firm's ability to make dividend payments from operating cash flow
Investing and Financing Ratio
CFO/ cash outflows from investing &financing activitiesmeasures the firm's ability to purchase assets, satisfy debts, and pay dividends
Which of the following is least likely considered a cash flow from financing activity under U.S. GAAP?a. Receipt of cash from the sale of bondsb. Payment of cash for dividendsc. Payment of interest on debt
c. Payment of interest on debt- changes operating cash flow
Which of the following is least likely considered a change in investing cash flow?a. The sale of a division of the companyb. The purchase of new machineryc. An increase in depreciation expense
c. An increase in depreciation expense- changes operating cash flow
Which of the following is least likely a change in cash flow from operations under U.S. GAAP?a. A decrease in notes payableb. An increase in interest expensec. An increase in accounts payable
a. A decrease in notes payable-change in financing cash flow
Where are dividends paid to shareholders reported in the cash flow statement under U.S. GAAP and IFRS?a. U.S. GAAP: operating or financing activities IFRS: operating or financing activities b. U.S. GAAP: financing activities IFRS: operating or financing activities c. U.S. GAAP: operating activities IFRS: financing activities
b. U.S. GAAP: financing activities IFRS: operating or financing activities
Sales of inventory would be classified as:
operating cash flow
Issuing bonds would be classified as:
financing cash flow
Sale of land would be classified as:
investing cash flow
Under U.S. GAAP, taxes paid would be classified as:
operating cash flow
An increase in notes payable would be classified as:
financing cash flow
Under U.S. GAAP, interest paid would be classified as:
operating cash flow
Continental Corporation reported sales revenue of $150,000 for the current year. If accounts receivable decreased $10,000 during the year and accounts payable increased $4,000 during the year, cash collections were:A. $154,000.B. $160,000.C. $164,000.
B. $160,000.150,000 + 10,000 ; accounts payable does not affect cash collections
The write-off of obsolete equipment would be classified as:
no cash flow impact
Sale of obsolete equipment would be classified as:
investing cash flow
Under IFRS, interest expense wouldbe classified as:
either operating cash flow or financing cash flow
Depreciation expense would be classified as:
no cash flow impact
Under U.S. GAAP, dividends received from investments would be classified as:
operating cash flow
Torval, Inc. retires debt securities by issuing equity securities. This is considered a:
non-cash transaction
In preparing a common-size cash flow statement, each cash flow is expressed as a percentage of:
total revenues
Which of the following is least likely a limitation of financial ratios?A. Data on comparable firms are difficult to acquireB. Determining the target or comparison value for a ratio requires judgementC. Different accounting treatments require the analyst to adjust the data before comparing ratios
A. Data on comparable firms are difficult to acquire
An analyst who is interested in a company's long-term solvency would most likely examine the:a. return on total capitalb. defensive interval ratioc. fixed charge coverage ratio
C. Fixed charge coverage is a solvency ratio. Return on total capital is a measure of profitability and the defensive interval ratio is a liquidity measure
DuPont system of analysis
an approach that can be used to analyze return on equity (ROE)uses basic algebra to break down ROE into a function of different ratios, so an analyst can see the impact of leverage, profit margins, and turnover on shareholder returns.2 variants: the original three-part approach and the extended five-part system
Extended (5-way) DuPont equation
takes the net profit margin and breaks it down further.ROE = (NI/EBT)(EBT/EBIT)(EBIT/revenue)(revenue/average assets)(average assets/average equity)ROE = (tax burden)(interest burden)(EBIT margin)(asset turnover)(financial leverage)
Total dividends on a firm-wide basis are referred to as :
Dividends declared
dividend payout ratio
dividends declared / net income available to common
retention rate =
= (Net income available to common - Dividends declared) / Net income available to common= 1 - dividend payout ratiodividend payout ratio = dividends declared/Net Income available to common
discounted cash flow models (or present value models)
stock's value is estimated as the present value of cash distributed to shareholders (dividend discount models) or the present value of cash available to shareholders after the firm meets its necessary capital expenditures and working capital expenses (free cash flow to equity models)
multiplier models (or market multiple models)
used to estimate intrinsic values.- 1st type: the ratio of stock price to such fundamentals as earnings, sales, book value, or cash flow per share is used to determine if a stock is fairly valued. For example, the price to earnings (P/E) ratio is frequently used to by analysts-2nd type: based on the ratio of enterprise value to either earnings before interest, taxes, depreciation, and amortization (EBITDA) or revenue. Enterprise value is the Market Value of all a firm's outstanding securities minus cash and short-term investments. Common stock value can be estimated by subtracting the value of liabilities and preferred stock from an estimate of enterprise value
enterprise value
the Market Value of all a firm's outstanding securities minus cash and short-term investments. Common stock value can be estimated by subtracting the value of liabilities and preferred stock from an estimate of enterprise value
Asset-based models
the intrinsic value of common stock is estimated as total asset value minus liabilities and preferred stock.analysts typically adjust the book values of the firm's assets and liabilities to their fair values when estimating the market value of its equity with an asset-based model
cash dividends
payments made to shareholders in cash - may be regularly scheduled dividends or one-time special dividends
regular dividends
occur when a company pays out a portion of profits on a consistent schedule (e.g., quarterly)a long-term record of stable or increasing dividends is widely viewed by investors as a sign of a company's financial stability
special dividends
are used when favorable circumstances allow the firm to make a one-time cash payment to shareholders, in addition to any regular dividends the firm pays. Many cyclical firms (e.g., automakers) will use a special dividend to share profits with shareholders when times are good but maintain the flexibility to conserve cash when profits are poor. Other names for special dividends include extra dividends and irregular dividends
stock dividends
dividends paid out in new shares of stock rather than cashthere will be more shares outstanding , but each one will be worth less; total shareholders' equity remains unchanged. stock dividends are commonly expressed as a percentage; a 20 % stock dividend means every shareholder gets 20% more stock
Stock splits
divide each existing share into multiple shares; there are now more shares, but the price of each share will drop correspondingly to the number of shares created, so there is no change in the owner's wealth. Splits are expressed as a ratio. In a 3-for-1 stock split, each old share is split into three new shares. Stock splits are currently more common than stock dividends.
reverse stock splits
opposite of stock splits. After a reverse stock split, there are fewer shares outstanding but there is a higher stock price. Because these factors offset one another, shareholder wealth is unchanged
share repurchase
a transaction in which a company buys outstanding shares of its own common stock. share repurchases are an alternative to cash dividends as a way of distributing cash to shareholders, and they have the same effect on shareholders' wealth as cash dividends of the same size.a company might repurchases shares to support their price or to signal that management believe the shares are undervalued.share repurchases may also be used to offset an increase in outstanding shares from the exercise of employee stock options. In countries that tax capital gains at lower rates than dividends, shareholders may prefer share repurchases to dividend payments as a way to distribute cash to shareholders
Declaration date
the date the board of directors approves payment of a dividend, specifying the per-share dividend amount, the date shareholders must own the stock to receive the dividend (record date) , and the date the dividend payment will be made (payment date)
Ex-dividend date
the first day on which a share purchaser will not receive the next dividend.the ex-dividend date is one or two business days before the holder-of-record date, depending on the settlement period for stock purchases. If you buy the share on or after the ex-dividend date, you will not receive the dividend
Holder-of-record date (record date)
the date on which all owners of shares will receive the dividend payment on their shares
payment date
date dividend checks are mailed to, or payment is made electronically to, holders of record
One-year holding period DDM
For a holding period of one year, the value of the stock today is the PV of any dividends during the year plus the PV of the expected price of the stock at the end of the year (referred to as its terminal value)value = [dividend to be received/ (1+Ke)] + [year-end price / (1+Ke)]Ke = required rate of return on common equity
Multiple-year holding period DDM
sum the PVs of the estimated dividends over the holding period and the estimated terminal value
Advantages of Discounted cash flow models
- easy to calculate- widely accepted in the analyst community- FCFE model is useful for firms that currently do not pay a dividend- Gordon growth model is useful for stable, mature, noncyclical firms- multisatge models can be used for firms with nonconstant growth
Disadvantages of Discounted cash flow models
- inputs must be forecast- estimates are very sensitive to inputs- for the Gordon growth model specifically: Very sensitive to the k-g denominator,Required return on equity must be > growth rate,Required return on equity & growth rate must remain constant,Firm must pay dividends
Advantages of price multiples
- Often useful for predicting stock returns-Widely used by analysts- Easily calculated and readily available- Can be used in time series and cross-sectional comparisons- EV/EBITDA multiples are useful when comparing firm values independent of capital structure or when earnings are negative and the P/E ratio cannot be used
Disadvantages of price multiples
- P/E ratio based on fundamentals will be very sensitive to the inputs- May not be comparable across firms, especially internationally- Multiples for cyclical firms may be greatly affected by economic conditions. P/E ratio may be especially inappropriate. (the P/S multiple may be more appropriate for cyclical firms)- a stock may appear overvalued by the comparable method but undervalued by the fundamental method or vice versa- Negative denominator results inn a meaningless ratio; the P/E ratio is especially susceptible to this problem- A potential problem with EV/EBITDA multiples is that the market value of a firm's debt is often not available
Advantages of asset-based models
-Can provide floor values- Most reliable when the firm has mostly tangible short-term assets, assets with a ready market value, or when the firm is being liquidated.- May be increasingly useful for valuing public firms if they report fair values
Disadvantages of asset-based models
- Market values of assets can be difficult to obtain and are usually different than book values- Inaccurate when a firm has a large amount of intangible assets or future cash flows not reflected in asset value- Asset values can be difficult to value during periods of hyperinflation
The theory that deals with conflicts of interest between a company's owners and its creditors is most appropriately called:
stakeholder theory
For which two of a company's stakeholders does information asymmetry most likely make monitoring more difficult?a. suppliers and employeesb. employees and managersc. managers and shareholders
c. managers and shareholders
The least likely item to be a requirement for good stakeholder management is:a. maintaining effective communication with other stakeholdersb. an understanding of the interests of several stakeholder groupsc. the ability to put aside the interests of one's stakeholder group
c. the ability to put aside the interests of one's stakeholder group
An agreement between a company and a labor union that represents most of its employees would be most appropriately considered part of a company's:a. legal infrastructureb. contractual infrastructurec.organizational infrastructure
b. contractual infrastructure
The method of ESG integration that does not exclude any sectors but seeks to invest in the companies with the best practices regarding employee rights and environmental sustainability is:A. impact investingB. positive screening c. negative screening
positive screening does not exclude any sectors but seeks to invest in the companies with the best practices.
negative screening
typically excludes companies in specific industry sectors from consideration for the portfolio based on their practices regarding human rights, environmental concerns, or corruption
Impact investing
refers to making an investment in a company or project in order to advance specific social or environmental goals.
preferred stock
pays a dividend that is usually fixed and usually has an indefinite maturity. when the dividend is fixed and the stream of dividends is infinite, the infinite period dividend discount model reduces to a simple ratio: Dp/Kp
WACC (weighted average cost of capital) =
(Wd)[Kd(1-t)] + (Wps)(Kps) + (Wce)(Kce)
Interest expense on a firm's debt is tax deductible, so the pretax cost of debt must be reduced by...
the firm's marginal tax rate to get an after-tax cost of debt capital
The cost of preferred stock is equal to:
Preferred stock dividend / Market Price
A company's $100, 8% preferred stock is currently selling at $25, what is the company's cost of preferred equity?
9.4%100(8%) = 8, 8/85 = 9.4%
Expected dividend: $2.50 for a share of stock priced at $25. What is the cost of equity given that LT growth rate in dividends is expected to be 8%?
Dividend yield + growth rate modelKce = (D1/P0) + g2.50/25 + 8% = 18%
cost of equity using CAPM approach:
Kce = Rf + β[E(Rmkt) - Rf] or = Rf + β(risk premium)
cost of equity using dividend discount model:
D1 = D0 (1 + g) Kce= (D1/P0) + g
What happens to a company's weighted average cost of capital (WACC) if the firm's corporate tax rate increases? (assume a beta of less than one)
Tax rate increase: Decrease in WACCAn increase in the corporate tax rate will reduce the after-tax cost of debt, causing the WACC to fall.
What happens to a company's weighted average cost of capital (WACC) if the Federal Reserve causes an increase in the risk-free rate? (assume a beta of less than one)
Increase in the risk-free weight: Increase in WACCIf the risk-free rate were to increase, the costs of debt and equity would both increase, thus causing the firm's cost of capital to increase
informationally efficient capital market
one in which the current price of a security fully, quickly, and rationally reflects all available information about that security
the market value of an asset is its...
current price
the intrinsic or fundamental value of an asset is the...
value that a rational investor with full knowledge about the asset's characteristics would willingly pay- bond's coupon, maturity, default risk, liquidity, etc.
in markets that are highly efficient, investors can typically expect market values to reflect _________ ______
intrinsic values
if markets are not completely efficient, active managers will buy assets for which they think intrinsic values are _______ ____ ______ _____ and sell assets for which they think intrinsic values are _______ ____ ______ _____.
greater than market values, less than market values
the weak form of the efficient markets hypothesis (EMH) states that ...
security prices fully reflect all past price and volume information
the semi-strong form of the efficient markets hypothesis (EMH) states that ...
security prices fully reflect all publicly available information
the strong form of the efficient markets hypothesis (EMH) states that ...
security prices fully reflect all public and private information
If markets are weak-form efficient, _________ ________ does not consistently result in abnormal profits.
technical analysis
If markets are strong-form efficient, _______ __________ __________ does not consistently result in abnormal profits.
active investment management
market anomaly
is something that deviates from the efficient market hypothesis or would lead us to reject the hypothesis of market efficiency- most evidence suggest they are not violations of market efficiency but are due to the methodologies used in anomaly research, such as data mining or failing to adjust adequately for risk
Anomalies that have been identified in time-series data include...
Calendar anomalies such as the January effect, Overreaction anomalies, and momentum anomalies
The January effect or turn-of-the-year effect is:
the finding that during the first five days of January, stock returns, especially for small firms, are significantly higher than they are the rest of the year. in an efficient market, traders would exploit this profit opportunity in January, and in so doing, eliminate itexplanations include: tax-loss selling (as investors sell losing positions in December and realize losses for tax purposes and then repurchase stocks in January, pushing their prices up) and window dressing ( as portfolio managers sell risky stocks in December to remove them from their year-end statements and repurchase them in January)
Overreaction anomaly/effect
the finding that firms with poor stock returns over the previous three or five years (losers) have better subsequent returns than firms that had high stock returns over the prior period.-pattern attributed to investor overreaction to both unexpected good news and unexpected bad news; and international markets
momentum effect (market anomalies)
high short-term returns are followed by continued high returns
Anomalies that have been identified in cross-sectional data include :
a size effect (small-cap stocks outperform large-cap stocks) and a value effect (value stock outperform growth stocks)
value stocks
those with lower price-to-earnings (P/E), lower market-to-book (M/B), and higher dividend yields
growth stocks
those with higher price-to-earnings (P/E), higher market-to-book (M/B), and lower dividend yields
closed-end investment funds
shares trade at prices that sometimes deviate from the net asset value (NAV) of the fund shares, often trading at large discounts to NAV. Such large discounts are an anomaly because by arbitrage, the value of the pool of assets should be the same as the market price for closed-end shares.Various explanations have been put forth to explain this anomaly, including management fees, taxes on future capital gains, and share illiquidity. None of these explanations fully explains the pricing discrepancy. However, transactions costs would eliminate any profits from exploiting the unexplained portion of closed-end fun discounts.
Behavioral finance
examines whether investors behave rationally, how investor behavior affects financial markets, and how cognitive biases may result in anomalies.describes investor irrationality but does not necessarily refute market efficiency as long as investors cannot consistently earn abnormal risk-adjusted returns
In an informationally efficient capital market:
security prices quickly reflect new information
In terms of market efficiency, short selling most likely:a. leads to excess volatility, which reduces market efficiency.b. promotes market efficiency by making assets less likely to become overvalued.c. has little effect on market efficiency because short sellers face the risk of unlimited losses.
promotes market efficiency by making assets less likely to become overvalued
Research has revealed that the performance of professional money managers tends to be:a. equal to the performance of a passive investment strategyb. inferior to the performance of a passive investment strategyc. superior to the performance of a passive investment strategy
inferior to the performance of a passive investment strategy
Which of the following best describes the majority of the evidence regarding anomalies in stock returns?a. weak-form market efficiency holds but semi-strong form efficiency does not.b. neither weak-form nor semi-strong form market efficiency holds.c. Reported anomalies are not violations of market efficiency but are the results of research methodologies.
Reported anomalies are not violations of market efficiency but are the results of research methodologies.
Investors who exhibit loss aversion most likely:a. have symmetric risk preferencesb. are highly risk aversec. dislike losses more than they like equal gains
dislike losses more than they like equal gains
Common Shareholders have a residual claim on ______ ______ and govern the corporation through _____ ______.
firm assets; voting rights
common shares have variables dividends which...
the firm is under no legal obligation to pay
Callable common shares allow the firm the right to:
repurchase the shares at a pre-specified price.
Putable common shares give the shareholder the right to:
sell the shares back to the firm at a pre-specified price.
Preferred stock typically does not mature, does not have voting rights, and has dividends that are:
fixed in amount but are not a contractual obligation of the firm
Cumulative preferred shares require any dividends that were missed in the past (dividends in arrears) to be paid before:
common shareholders receive any dividends
Effective annual rate (EAR) calculation
Each dollar invested will grow to:EAR = (1+ stated annual rate / m )^m - 1 in one year:EAR = (1+ stated annual rate / m )^m
interest rate (interpretation)
1. the rate of return required in equilibrium for a particular investment,2. the discount rate for calculating the PV of future cash flows3. the opportunity cost of consuming now, rather than saving and investing
real risk-free rate
a theoretical rate on a single-period loan when there is no expectation of inflation. nominal risk-free rate = real risk free rate + expected inflation rate
Securities may have several risks, and each increases the required rate of return - these include:
default riskliquidity riskmaturity risk
required rate of return on a security (calculation)
= real risk-free rate + expected inflation rate + default risk premium + liquidity risk premium + maturity risk premium
Future Value
FV = PV ( 1 + I/Y) ^N
Present Value
PV = FV / ( 1 + I/Y) ^N
Annuity
a series of equal cash flows that occurs at evenly spaced intervals over time
Ordinary annuity cash flows occur ...
at the end of each time period
Annuity due cash flows occur...
at the beginning of each time period
Perpetuities are...
annuities with infinite lives (perpetual annuities)
How to calculate present value of a perpetuity
PVperpetuity =PMT/(I/Y)
NPV
the PV of a project's future cash flows, discounted at the firm's cost of capital, less the project's cost
IRR
the discount rate that makes the NPV = 0 (equates the PV of the expected future cash flows to the project's initial cost)
The NPV rule states that you should accept a project if :
the NPV is greater than 0
The IRR rule is to accept a project if:
the IRR > required rate of return
NPV and IRR produce the same exact decision if:
independent (single) project
For mutually exclusive projects, IRR rankings and NPV rankings may differ due to differences in project size or in the timing of the cash flows. Choose the project with the higher:
NPV as long as its positive
holding period return (or yield) is the:
total return for holding an investment over a certain period of time
Holding Period Yield (calculation)
HPY = P1 - P0 + D1 / P0 = [(P1 + D1) / P0] - 1
The money-weighted rate of return is the
IRR calculated using periodic cash flows into and out of an account and is the discount rate that makes the PV of cash inflows equal to the PV of cash outflows
time-weighted rate of return measures ...
compound growththe rate at which $1 compounds over a specified performance horizon
What is the preferred measure of a manager's ability to select investments?
Time-weighted return
Given a $1000 T-bill with 100 days to maturity and a discount of $10 (price of $990), calculate the bank discount yield
Bank discount yield = (10 /1000) x (360/100) = 3.6%
Given a $1000 T-bill with 100 days to maturity and a discount of $10 (price of $990), calculate the holding period yield
holding period yield = 1000-990/990 = 1.01%(P1 - P0)/P0
Given a $1000 T-bill with 100 days to maturity and a discount of $10 (price of $990), calculate the effective annual yield
effective annual yield = 1.0101^365/100 - 1 = 3.74%(1 + HPR)^365/t - 1
Given a $1000 T-bill with 100 days to maturity and a discount of $10 (price of $990), calculate the money market yield
1.01% x 360/100 = 3.636%HPY x (360/t)
Given a money market security with n days to maturity,calculate holding period yield
bank discount yield(n/360) / 1 - bank discount yield(n/360)
Given a money market security with n days to maturity,calculate money market yield
holding period yield x (360/n)
Given a money market security with n days to maturity,calculate Effective annual yield
(1+ holding period yield)^ (365/n) - 1
Given a money market security with n days to maturity,calculate holding period yield
(1+effective annual yield)^ (n/365) - 1
Given a money market security with n days to maturity,calculate bond equivalent yield
[(1 + effective annual yield)^(1/2) - 1] x 2
Descriptive statistics
used to summarize the important characteristics of large data sets.
Inferential statistics
used to make probabilistic statements (forecasts, estimates, or judgments) about a population based on a sample.
Nominal scale
data is put into categories that have no particular order
Ordinal scale
data is put into categories that can be ordered with respect to some characteristics
Interval scale
differences in data values are meaningful, but ratios, such as twice as much or twice as large, are not meaningful
Ratio scale
ratios of values, such as twice as much or half as large, are meaningful and zero represents, the complete absences of the characteristics being measured
frequency distribution
tabular presentation of statistical data that aids the analysis of large data sets - groups observations into classes, or intervals
Relative frequency is
the % of total observations falling within an intervalabsolute frequency of each return interval / total number of observations
Cumulative relative frequency for an interval is
the sum of the relative frequencies for all values less than or equal to that interval's maximum value
For any frequency distribution, the interval with the greatest frequency is referred to as the ...
modal interval
histogram
graphical presentation of the absolute frequency distribution; bar chart of continuous data that has been classified into a frequency distributionattractive feature of a histogram: it allows us to quickly see where most of the observations are concentrated
frequency polygon
the midpoint of each interval is plotted on the horizontal axis, and the absolute frequency for that interval is plotted on the vertical axiseach point is then connected with a straight line
measures of central tendency
identify the center, or average, of a data setthis central point can then be used to represent the typical, or expected, value in the data set
population mean
all observed values in the population are summed and divided by the # of observations in the population, N. A given population only has one mean
sample mean
sum of all values in a sample of a population, divided by the # of observations in the sample, n. It is used to make inferences about the population mean.
what is the most widely used measure of central tendency?
arithmetic mean
when a set of data has two or three values that occur most frequently , it is said to be:
bimodal or trimodal
geometric mean
often used when calculating investment returns over multiple periods or when measuring compound growth ratesG = [(X1)(X2)(X3)...(Xn)]^(1/n)
calculating geometric mean for a returns data set:
1 + RG = [(1+R1)(1+R2)(1+R3)...(1+Rn)]^(1/n)RG = geometric mean return
harmonic mean
used for certain computations, such as the average cost of shares purchased over timeN / â 1/Xi
Quantile
a value at or below which a stated proportion of the data in a distribution liesmay be expressed as a percentile
Quantiles and measures of central tendency are known collectively as:
measures of location
What is the third quartile for the following distribution of returns?8%, 10%, 12%, 13%, 15%, 17%, 17%, 18%, 19%, 23%
The point below which 75% of the observations lie.Ly = (10 + 1) x 75/100 = 8.25When the data is arranged in ascending order, the third quartile is one-fourth(.25) of the way from the eighth data point (18%) to the ninth data point (19%), or 18.25%. This means that 75% of all observations lie below 18.25%.
Dispersion
the variability around the central tendencyThe common theme in finance & investments is the trade-off between reward & variability, where the central tendency is the measure of the reward and dispersion is a measure of risk.
Mean Absolute Deviation (MAD)
the average of the absolute values of the deviations of individual observations from the arithmetic mean
population variance
the average of the squared deviations from the mean. uses the values for all members of a population
population standard deviation
square root of the population variance
sample variance
s^2 ; is the measure of dispersion that applies when we are evaluating a sample of n observations from a population.
biased estimator
systematic underestimation of population variance caused by the sample variance using n-1 instead of n in the denominator
Chebyshev's inequality states that:
for any set of observations (sample or population and regardless of the shape of the distribution) the percentage of the observations that lie within k standard deviations of the mean is at least 1 - 1/k^2 for all k > 1*applies to any distribution
What is the minimum percentage of any distribution that will lie within +/- 2 standard deviations of the mean? (Chebyshev's inequality)
= 1-1/k^2 = 1 - 1/2^2 = 1 - 1/4 = .75 = 75%
Relative dispersion (CV):
the amount of variability in a distribution relative to a reference point or benchmarkcommonly measured with the coefficient of variation (CV), which is computed as:std deviation of x / average value of x
Sharpe Ratio
widely used for investment performance measurement and measures excess return per unit of riskportfolio return - risk free return / standard deviation of portfolio returns
Deferred tax liability
refers to balance sheet amounts that are created when tax expense is greater than taxes payable
When an increase in the tax rate is enacted, deferred tax:A. assets & liabilities both increase in valueB. assets decrease in value and deferred tax liabilities increase in valueC. liability and asset accounts are maintained at historical tax rates until they reverse.
assets & liabilities both increase in value- the liability method takes a balance sheet approach and adjusts deferred tax assets and liabilities to future tax rates. An increase in the tax rate increase the value of both deferred tax assets and deferred tax liabilities
Under U.S. GAAP, an asset is considered impaired if its book value is:a. less than its market valueb. greater than the present value of its expected future cash flowsc. greater than the sum of its undiscounted expected cash flows
greater than the sum of its undiscounted expected cash flows
Which of the following pairs of general categories are LEAST likely to be considered in the formulas used by credit rating agencies to determine the capacity of a borrower to repay a debt?a. Operational efficiency; leverageb. Margin stability; availability of collateralC. Leverage; scale and diversification
Margin stability; availability of collateral
A firm using a revenue recognition method that is aggressive will ...
inflate current period earnings at a minimum and perhaps inflate overall earnings.
Which method is more aggressive? Percentage-of-completion method or completed-contract method
% of completion because of the estimates involved
Which method of calculation is more aggressive?Installment method or the cost recovery method
Installment method
Which of the following would least likely increase pretax income?A. Decreasing the bad debt expense estimateB. Increasing the useful life of an intangible assetC. Decreasing the residual value of a depreciable tangible asset
Decreasing the residual value of a depreciable tangible asset(results in higher depreciation expense and, thus, lower pretax income)
According to converged accounting standards issued in May 2014, the first step in the revenue recognition process is to:A. determine the price.B. identify the contract.C. identify the obligations
identify the contract.
Which of the following is least likely considered a non-operating transaction from the perspective of a manufacturing firm?A. Dividends received from available-for sale securitiesB. Interest expense on subordinated debenturesC. Accruing bad debt expense for goods sold on credit.
Accruing bad debt expense for goods sold on credit.- bad debt expense is an operating expense; the others are non-operating expenses from the perspective of a manufacturing firm
Which of the following transactions would most likely be reported below income from continuing operations, net of tax?A. Gain or loss from the sale of equipment used in a firm's manufacturing operationB. a change from the accelerated method of depreciation to the straight-line methodC. The operating income of a physically and operationally distinct division that is currently for sale, but not yet sold
The operating income of a physically and operationally distinct division that is currently for sale, but not yet sold
Which of the following statements about nonrecurring items is least accurate?A. Discontinued operations are reported net of taxes at the bottom of the income statement before net incomeB. unusual or infrequent items are reported before taxes above net income from continuing operations.C. A change in accounting principle is reported in the income statement net of taxes after extraordinary items and before net income.
C. A change in accounting principle is reported in the income statement net of taxes after extraordinary items and before net income.- a change in accounting principle requires retrospective application; that is, all prior period financial statements currently presented are restated to reflect the change
...
...
Under U.S. GAAP, which of the following statements about the financial statement effects of issuing bonds is least accurate?A. Issuance of debt has no effect on cash flow from operationsB. Periodic interest payments decrease cash flow from operations by the amount of interest paidC. Payment of debt at maturity decreases cash flow from operations by the face value of the debt
Payment of debt at maturity decreases cash flow from operations by the face value of the debt
Which of the following statements about the component costs of capital is least accurate?A. the cost of common equity is the required rate of return on common stockB. the cost of preferred stock is the preferred dividend divided by the preferred's par valueC. The after-tax cost of debt is based on the expected yield to maturity on newly issued debt
B. the cost of preferred stock is the preferred dividend divided by the preferred's par value-the cost of preferred stock is calculated as the preferred dividend divided by the market price, not the par value
Jay Construction Company is considering whether to accept a new bridge-building project. Jay will use the pure-play method to estimate the cost of capital for the project, using Cass Bridge Builders as a comparable company. To calculate the project beta, Jay should :A.estimate Cass's cost of equity and apply it to the projectB. use the CAPM equation, substituting Cass's equity beta for its ownC. adjust Cass's equity beta for any difference in leverage between Cass and Jay
adjust Cass's equity beta for any difference in leverage between Cass and Jay- to use the pure-play method, an asset beta is calculated by removing the effects of leverage (deliverying) from the comparable company's equity beta, then a project beta is estimated by adjusting the asset beta (relevering) based on the capital structure of the company that is evalutating the project.
Which of the following would most likely indicate deterioration of a firm's working capital management?A. an increase in days of payables outstanding B. an increase in days of receivables outstandingC. a decreased amount of cash and cash equivalents
B. an increase in days of receivables outstanding- an increase in days of receivables outstanding, other things equal, will lengthen both the operating and cash conversion cycles, indicating poorer working capital management. -An increase in days of payables outstanding, other things equal, would decrease the cash conversion cycle.-A decrease in cash and marketable securities could simply indicate better management of cash (e.g., buying back its common stock or investing excess cash in profitable business opportunities or securities)
For a more profitable company, issuing debt in order to retire common stock will most likely:A. increase both net income and return on equityB. decrease both operating income and net income.C. increase both the level and variability of return on equity.
C. increase both the level and variability of return on equity. - an increase in debt will increase interest expense, which will decrease net income but not operating income, which is calculated before subtracting interest expense. For a proftiable firm, the decrease in net income will be offset by the decrease in equity from the repurchase of common stock, so that ROE increases. The effect of the increase in financial leverage will, however, increase the variability of ROE for a given change in operating earnings.
A financial market is said to be operationally efficient if: A.transactions costs are low B. prices adjust quickly to new information.C. it results in resources being allocated to their most productive uses.
A.transactions costs are low
Smith has more steeply sloped risk-return indifference curves than Jones. Assuming these investors have the same expectations, which of the following best describes their risk preferences and the characteristics of their optimal portfolios?Smith is:A. less risk averse than Jones and will choose an optimal portfolio with a lower expected return. B. more risk averse than Jones and will choose an optimal portfolio with a lower expected returnC. more risk averse than Jones and will choose an optimal portfolio with a higher expected return
B. more risk averse than Jones and will choose an optimal portfolio with a lower expected return
A stock has a beta of 0.9 and an estimated return of 10%. The risk-free rate is 7%, and the expected return on the market is 11%. According to the CAPM, this stock:A. is overvaluedB. is undervaluedC. is properly valued
A. is overvaluedE(R) = 7% + 0.9(11% - 7%) = 10.6%
Which of the following terms refer to the same type of risk?A. Total risk and the variance of returnsB. Systematic risk and firm-specific riskC. Undiversifiable risk and unsystematic risk
A. Total risk and the variance of returnsVariance is a measure of total risk
Greenbaum, Inc. stock pays no dividend and currently trades at $54. Based on the CAPM and assuming an expected return on the market of 12% and a risk-free rate of 8%, the expected price for Greenbaum one year from now is $62. The beta of Greenbaum shares is closest to:A. 1.5B. 1.6C. 1.7
C. 1.762/54= 14.8%14.8%-8% = 6.8%market risk premium = 12%-8% = 4%6.8% / 4% = 1.7 = Beta
A primary reason for developing a strategic asset allocation is to: A. minimize a portfolio's exposure to systematic riskB. prevent the overweighting of any single asset classes.C. determine asset classes offering unique risk and return profiles with low correlation to one another.
C. determine asset classes offering unique risk and return profiles with low correlation to one another.
A financial market is said to be operationally efficient if:A. transaction costs are lowB. prices adjust quickly to new informationC. it results in resources being allocated to their most productive uses
A. transaction costs are low
The weak form of the efficient market hypothesis (EMH) implies that:A. no one can achieve abnormal returns using market information.B. insiders, such as specialists and corporate board members, cannot achieve abnormal returns on averageC. investors cannot achieve abnormal returns, on average, using techincal analysis, after adjusting for transaction costs and taxes
C. investors cannot achieve abnormal returns, on average, using technical analysis (market information), after adjusting for transaction costs and taxes-Evidence has shown that insiders can achieve positive abnormal returns on average, but this relates to the strong form of the EMH
Which of the following statements about alternative investment indexes is most accurate?A. an investor can replicate a commodity index by making direct investments in the underlying physical commoditiesB. Real Estate Investment Trust indexes track the prices of shares of publicly traded companies that invest in the mortgages or real property.C. Hedge fund indexes accurately represent the investment performance of the hedge fund industry
B. Real Estate Investment Trust indexes track the prices of shares of publicly traded companies that invest in the mortgages or real property.-REIT indexes represent a convenient way to invest in real estate. Commodity indexes are based on futures prices of commodities, and are not replicated by investing in the commodities themselves. Hedge fund indexes are biased upward because hedge funds are not required to disclose their performance to index providers and poorly performing funds are less likely to do so (self-selection bias)
The present value of an equity security's future cash flow is most likely to be significantly different from the company's:A. book value per share.B. market value per share.C. intrinsic value per share.
A. book value per share.-book value typically does not equal intrinsic value -intrinsic value: PV of security's future CFs-market value of a share is the cumulative investors' estimation of this intrinsic value, and market value is usually somewhat in line with the intrinsic value
An analyst is valuing a company's perpetual preferred stock that pays a $6 annual dividend. The company's bonds currently yield 7.5% and preferred shares are selling to yield 75 basis points below the company's bond yield. The value of the preferred stock is closest to:A. $72B. $80C. $89
C. 89step 1: discount rate: 7.5% - .75% = 6.75%step 2: value the preferred:$6 / .0675 = $88.89 ~ 89
An investor buys a stock at $32 a share and deposits 50% initial margin. Assume that the maintenance margin is 25%, the stock pays no dividends, and transaction costs and interest on the margin loan are zero. The price at which the investor would receive a margin call is closest to:A. $16B. $21C. $24
B. $21[32 x (1 - .05)]/(1-.25) = $16.00/0.75 = $21.33
Which of the following industries is best described as non-cyclical and defensive?A. EnergyB. TechnologyC. Consumer staples
C. Consumer staples
Transaction costs incurred from portfolio rebalancing are most likely to be highest for funds that track:A. price-weighted indexesB. value-weighted indexesC. equal-weighted indexes
C. equal-weighted indexes
ABS securities may have a higher credit rating than the seller's corporate bonds because:A. they are issued by a special purpose entityB. the seller's ABS are senior to its corporate bondsC. ABS are investment grade while corporate bonds may be speculative grade.
A. they are issued by a special purpose entity
All else equal, which of the following is least likely to increase the interest rate risk of a bond?A. a longer maturityB. inclusion of a call featureC. a decrease in the YTM
B. inclusion of a call feature-inclusion of a call decreases the duration of a fixed income security - all others increase the duration
When the underlying asset does not pay any cash flows, the value of an American call option is:A. equal to the value of an otherwise identical European call optionB. less than the value of an otherwise identical European call optionC. greater than the value of an otherwise identical European call option.
A. equal to the value of an otherwise identical European call option- because the right to exercise a call option early is not valuable when the underlying asset does not pay any cash flows, the value of an American call option is equal to the value of an otherwise identical European call option
The value of a put option on a stock trading at 35 will decrease when:A. the risk-free rate is higherB. the volatility of the stock price is higherC. the dividends paid on the stock are higher
A. the risk-free rate is higher- an increase in the risk-free rate will decrease the value of a put option. -An increase in the volatility of the stock price or a higher dividend payment during the option's life will increase the value of a put option
During the life of a European option, the amount by which its price is greater than its exercise is most accurately described as its:A. time valueB. moneynessC. intrinsic value
A. time value- before expiration, an option can have a price greater than its exercise or intrinsic value. This amount by which an option's price is greater than its exercise value is referred to as its time value.
Which of the following statements about plain vanilla interest rate swaps is most accurate? the swap counterparties:A. typically make a margin deposit with a clearinghouseB. exchange fixed rate payments for variable rate paymentsC. exchange the notional principal at initiation and termination
B. exchange fixed rate payments for variable rate payments- the counterparties do not exchange the notional principal on an interest rate swap
The convenience yield associated with holding the underlying asset of a derivative is most accurately described as:A. the non-monetary benefits of holding the assetB. the monetary and non-monetary benefits of holding the assetC. the monetary and non-monetary benefits of holding the asset, net of its holding cost
A. the non-monetary benefits of holding the asset- convenience yield refers to the non-monetary benefits of holding an asset, for example being in a position to sell an overvalued asset that is difficult to sell short. -Convenience yield does not include monetary benefits such as interest and dividend income. -The costs of holding the asset, net of the monetary and non-monetary benefits of holding it, is referred to as the net cost of carry.
Which of the following statements about futures margin is least accurate?A. the initial margin is set by the clearinghouse based on the volatility of the price of the underlying assetB.If the balance of the margin account exceeds the initial margin requirement, the trader can remove the excess funds from the account.C. If the margin account balance falls below the maintenance margin level, the account balance must be brought back up to the maintenance level.
C. If the margin account balance falls below the maintenance margin level, the account balance must be brought back up to the maintenance level.
Josh Lacy, CFA, is analyzing a portfolio company held by his private equity firm to estimate its value in liquidation. Lacy should most appropriately use a(n):A. asset-based approachB. comparables-based approach.C. discounted cash flow-based approach.
A. asset-based approach-asset-based approach uses either the liquidation values or fair market values of assets. -The discounted cash flow approach involves calculating the present value of expected future cash flows. -The comparable-based approach uses market or private transaction values of similar companies to estimate multiples of EBITDA, net income, or revenue.
Which of the following statements with respect to hedge fund investing is least accurate?A. Hedge funds only publicly disclose performance information on a voluntary basis.B. Hedge funds are not typically registered with the SEC in the United States.C. Survivorship bias in hedge fund data causes risk to be overstated because funds that take on more risk tend to have higher returns.
C. Survivorship bias in hedge fund data causes risk to be overstated because funds that take on more risk tend to have higher returns-because a hedge fund database only includes the more stable funds that have survived, the risk measure of hedge funds as an asset class is biased downward.
An investor who wants to hedge against inflation by allocating a portion of a portfolio to alternative investments should most appropriately invest in:A. real estate and commoditiesB. private equity and real estate.C. commodities and private equity
A. real estate and commodities- real estate and commodities offer potential hedges against inflation because rents, property values, and commodity prices tend to increase with inflation in the long term.
A leveraged buyout firm that carries out a secondary sale has:A. offered additional share to the publicB. exited an investment in a portfolio companyC. received new capital from its general or limited partners
B. exited an investment in a portfolio company- In a secondary sale, a private equity firm sells one of its portfolio companies to a group of investors or another private equity firm
The notice period for a hedge fund is best described as the period following:A. the opening of the fund to investors, before the fund is closed to new investorsB. a request for redemption of shares, within which the fund must fulfill the requestC. an investment in the fund, during which the investor is not permitted to redeem shares.
B. a request for redemption of shares, within which the fund must fulfill the request. -the notice period is the time within which a hedge fund must fulfill a request for redemption of shares. The period during which investors may not redeem shares is called a lockup period.
The odds for an event occurring are calculated by dividing:A. one by the probability that the event occurs.B. the probability that the event does not occur by the probability that an event occurs.C. the probability that the event occurs by the probability the event does not occur.
C. the probability that the event occurs by the probability the event does not occur. -If p is the probability that an event occurs, then the odds for the event occurring divided by the probability that the event does not occur. The odds against the event are expressed as the reciprocal of the odds for the event.