NASAA Series 65 — All Questions

During the contraction phase of the business cycle, which of the following typically occurs?

• a.Gross domestic product rises for at least two consecutive quarters
• b.Unemployment rises while business inventories tend to increase✓
• c.The central bank aggressively raises short-term interest rates
• d.Consumer spending accelerates and corporate profits expand

A contraction is marked by falling output, rising unemployment, and weakening demand, which often leaves unsold goods and swelling inventories. Two consecutive quarters of rising GDP describe an expansion, not a contraction. Central banks generally cut rates during downturns to stimulate activity.

An economist states that the money supply and general price level tend to move together over time. This view is most closely associated with which school of thought?

• a.Monetarist economics✓
• b.Keynesian economics
• c.Supply-side economics
• d.Behavioral economics

Monetarists, led by Milton Friedman, argue that changes in the money supply are the primary driver of inflation and nominal output. Keynesians emphasize aggregate demand and fiscal policy. Supply-siders focus on tax and regulatory incentives to production.

Which government body sets U.S. monetary policy by adjusting the federal funds target and open market operations?

• a.The Federal Open Market Committee of the Federal Reserve✓
• b.Congress through the annual budget process and its statutory authority to set the federal funds target rate
• c.The Securities and Exchange Commission
• d.The U.S. Treasury Department

Monetary policy is conducted by the Federal Reserve, and specifically the Federal Open Market Committee (FOMC), through open market operations and interest rate targets. Congress and the Treasury handle fiscal policy such as taxing and spending. The SEC regulates securities markets, not monetary policy.

An investor expects $10,000 in 5 years and wants its present value at a 6% annual discount rate. Which statement is correct?

• a.A higher discount rate would raise the present value
• b.The present value equals $10,000 multiplied by 1.06 raised to the fifth power
• c.The present value is greater than $10,000
• d.The present value equals $10,000 divided by 1.06 raised to the fifth power✓

Present value discounts a future amount back to today by dividing by (1 + rate) raised to the number of periods. Because money has time value, the present value is less than the future $10,000. A higher discount rate lowers, not raises, present value.

A portfolio has an expected return of 9% and a standard deviation of 12%. What does the standard deviation measure?

• a.The portfolio's sensitivity to overall market movements, a role that is actually captured by the asset's beta coefficient
• b.The portfolio's return in excess of a risk-free asset
• c.The correlation between the portfolio and a benchmark index
• d.The dispersion or variability of the portfolio's returns around its mean✓

Standard deviation is a statistical measure of total volatility, showing how widely returns are dispersed around their average. Sensitivity to the market is measured by beta, and excess return over the risk-free rate relates to alpha or the risk premium. Correlation is a separate measure of co-movement between two series.

Two assets have a correlation coefficient of -1.0. What is the diversification implication?

• a.The assets are unrelated and provide moderate diversification because a correlation of negative one would imply no linear relationship at all
• b.The assets move perfectly together, offering no diversification benefit because their returns move up and down in lockstep every period
• c.The assets move exactly opposite, offering maximum diversification benefit✓
• d.Correlation cannot fall below zero for real assets and is bounded strictly between zero and positive one at all times

A correlation of -1.0 means two assets move in exactly opposite directions, which allows losses in one to be offset by gains in the other and provides the greatest diversification benefit. A correlation of +1.0 offers no diversification. Correlation ranges from -1.0 to +1.0, so negative values are possible.

A stock's beta is 1.5. If the market rises 10%, what does beta suggest about the stock's expected move?

• a.The stock is uncorrelated with the market
• b.The stock would be expected to rise about 6.7%
• c.The stock would be expected to fall about 15%
• d.The stock would be expected to rise about 15%✓

Beta measures systematic risk relative to the market; a beta of 1.5 means the stock is expected to move 1.5 times as much as the market. A 10% market gain implies an expected 15% gain. Beta above 1.0 indicates greater volatility than the market.

Which of the following is a leading economic indicator?

• a.The unemployment rate
• b.The average duration of unemployment
• c.Corporate profits reported for the prior quarter
• d.New building permits issued for housing✓

Leading indicators, such as new building permits and stock prices, tend to change before the broader economy does. The unemployment rate and average duration of unemployment are lagging indicators. Prior-quarter corporate profits reflect activity that has already occurred.

A company's current ratio is calculated as which of the following?

• a.Net income divided by total shareholders' equity
• b.Current assets divided by current liabilities✓
• c.Earnings before interest and taxes divided by interest expense
• d.Total liabilities divided by total assets

The current ratio measures short-term liquidity by dividing current assets by current liabilities. Net income over equity is return on equity, and total liabilities over assets is a leverage ratio. EBIT over interest expense is the interest coverage ratio.

An investor earns a 12% nominal return in a year when inflation is 4%. Using the approximate method, the real return is closest to which of the following?

• a.48%
• b.16%
• c.3%
• d.8%✓

The approximate real return is the nominal return minus the inflation rate, or 12% minus 4%, which equals about 8%. Real return adjusts nominal gains for the loss of purchasing power. This distinction matters when evaluating whether an investment truly grows wealth.

Which measure best captures the total percentage gain from an investment, including both price change and reinvested income?

• a.Nominal yield
• b.Total return✓
• c.Current yield
• d.Coupon rate

Total return combines price appreciation and income (such as dividends or interest), giving the complete measure of performance. Current yield reflects only annual income relative to price. Coupon rate and nominal yield reflect only a bond's stated interest, not price changes.

The Consumer Price Index (CPI) is primarily used to measure which of the following?

• a.The total output of the economy, measured as the real gross domestic product produced across all sectors
• b.Changes in the price level of a basket of consumer goods and services✓
• c.Corporate earnings growth
• d.The unemployment level

The CPI tracks the average change over time in prices paid by consumers for a representative basket of goods and services, serving as a common inflation gauge. Total output is measured by GDP. Unemployment and corporate earnings are separate economic statistics.

Under the time value of money, which factor increases the future value of a single deposit?

• a.A shorter investment horizon that leaves the deposit invested for fewer total compounding periods
• b.A higher interest rate compounded over more periods✓
• c.A lower rate of compounding
• d.More frequent withdrawals made throughout the period, which add to the deposit's accumulated future value

Future value grows with higher interest rates and more compounding periods, because each period's interest earns further interest. Shorter horizons and lower rates reduce future value. Withdrawals reduce the balance that can compound.

A yield curve that slopes downward, with short-term rates higher than long-term rates, is described as which of the following?

• a.A flat yield curve
• b.A normal yield curve
• c.A humped yield curve
• d.An inverted yield curve✓

An inverted yield curve occurs when short-term interest rates exceed long-term rates and is often watched as a potential recession signal. A normal curve slopes upward. A flat curve shows little difference between short and long maturities.

Which statement about the Sharpe ratio is correct?

• a.It ignores the risk-free rate entirely
• b.It measures return earned per unit of systematic risk, using beta
• c.A lower Sharpe ratio indicates better risk-adjusted performance, which is the reverse of how the ratio is properly interpreted by analysts
• d.It measures return earned per unit of total risk, using standard deviation✓

The Sharpe ratio divides a portfolio's excess return over the risk-free rate by its standard deviation, measuring reward per unit of total risk. A higher ratio indicates better risk-adjusted performance. The Treynor ratio, by contrast, uses beta as the risk measure.

An analyst using fundamental analysis of a common stock would most likely focus on which of the following?

• a.Chart patterns and trading volume trends studied to forecast the stock's short-term price direction from the charts
• b.The company's earnings, revenues, and competitive position✓
• c.Support and resistance price levels plotted on a price chart alongside momentum and volume indicators
• d.The stock's 200-day moving average together with other trend lines drawn from historical price data

Fundamental analysis evaluates a company's financial statements, earnings, revenues, management, and industry position to estimate intrinsic value. Chart patterns, moving averages, and support and resistance levels are tools of technical analysis, which studies price and volume history instead.

Fiscal policy, as distinct from monetary policy, is carried out through which of the following?

• a.Government decisions on taxation and public spending made by Congress and the President✓
• b.The SEC's registration of newly issued securities
• c.Federal Reserve open market operations and reserve requirements
• d.Commercial banks setting their prime lending rates

Fiscal policy is the use of federal taxing and spending decisions by Congress and the President to influence the economy. Monetary policy, by contrast, is the Federal Reserve's domain, using tools like open market operations and reserve requirements. The prime rate is set by banks, and the SEC oversees securities registration; the trap is mistaking the Fed's monetary tools for fiscal policy.

Demand-pull inflation is best described as rising prices caused by:

• a.A sharp contraction in the money supply engineered by the central bank's aggressive tightening
• b.Falling consumer confidence and reduced spending
• c.Rising input and production costs pushing prices upward as rising wages and raw-material costs push prices steadily upward
• d.Aggregate demand outpacing the economy's productive capacity✓

Demand-pull inflation occurs when total demand exceeds what the economy can produce, pulling prices upward. Cost-push inflation, by contrast, stems from rising production costs, which is the trap in the second option. A shrinking money supply or falling demand would be disinflationary, not inflationary.

Using the Rule of 72, approximately how long will it take an investment earning 8% compounded annually to double in value?

• a.About 6 years
• b.About 9 years✓
• c.About 12 years
• d.About 8 years

The Rule of 72 estimates doubling time by dividing 72 by the annual rate: 72 divided by 8 equals 9 years. The trap answers come from subtracting the rate (8 years) or misdividing (72 divided by 12, or 72 divided by 6). It is a quick approximation for compound growth.

Using the constant-growth dividend discount model, a stock expected to pay a $2 dividend next year, growing 4% annually, with a required return of 9%, has an estimated value closest to:

• a.$22.22
• b.$50.00
• c.$20.00
• d.$40.00✓

The constant-growth (Gordon) dividend discount model values a stock as next year's dividend divided by the required return minus the growth rate: $2 divided by (0.09 minus 0.04) equals $2 divided by 0.05, or $40. The $22.22 trap comes from forgetting to subtract growth ($2 divided by 0.09), and $50 from dividing by the growth rate alone.

A company's stock trades at $60 and reported earnings of $3 per share. Its price-to-earnings (P/E) ratio is:

• a.5
• b.0.05
• c.180
• d.20✓

The price-to-earnings ratio equals share price divided by earnings per share: $60 divided by $3 equals 20. The 0.05 trap inverts the ratio (earnings divided by price), and 180 comes from multiplying instead of dividing. A P/E of 20 means investors pay $20 for each $1 of annual earnings.

Gross domestic product (GDP) measures which of the following?

• a.The federal government's annual budget deficit, calculated as total government spending minus the total tax revenue collected during the fiscal year
• b.The change in consumer prices over a year
• c.The total market value of all final goods and services produced within a country during a period✓
• d.The total money supply held by commercial banks

GDP measures the market value of all final goods and services produced within a country's borders over a period, the broadest gauge of national output. The change in consumer prices is the Consumer Price Index, a separate inflation measure and the trap here. Money supply and the deficit are unrelated aggregates.

Which of the following is generally classified as a coincident economic indicator?

• a.Industrial production and personal income✓
• b.The average duration of unemployment
• c.New orders for consumer goods and materials
• d.Building permits for new private housing

Coincident indicators move in step with the overall economy; industrial production and personal income are classic examples. New orders and building permits are leading indicators that turn before the economy, and the average duration of unemployment is a lagging indicator. The trap is confusing leading indicators with coincident ones.

Real gross domestic product differs from nominal GDP in that real GDP:

• a.Measures only the output of the government sector
• b.Is adjusted for inflation, expressing output in constant dollars✓
• c.Includes the value of intermediate goods double-counted at each stage of production
• d.Is always larger than nominal GDP during periods of rising prices

Real GDP adjusts nominal output for inflation using a price deflator, stating production in constant-dollar terms so growth is not overstated by rising prices. During inflation, nominal GDP exceeds real GDP, so the claim that real is larger is the trap. GDP measures total final output, not only government.

A recession is conventionally identified by:

• a.A sustained rise in real GDP over a full year
• b.Any month in which stock prices fall
• c.A single quarter of rising unemployment
• d.Two consecutive quarters of declining real GDP✓

The common shorthand for a recession is two consecutive quarters of falling real GDP, reflecting a broad contraction in output. A one-month stock decline or a single quarter of higher unemployment is not the standard definition. A year of rising GDP describes an expansion.

Stagflation describes the unusual combination of:

• a.Rising output with falling unemployment
• b.Stagnant growth and high unemployment occurring together with rising prices✓
• c.Stable prices and full employment
• d.Falling prices with rapid economic growth that steadily lifts employment across every sector of the economy

Stagflation pairs stagnation (weak growth and high unemployment) with inflation at the same time, as seen in the 1970s. It challenges the usual inverse trade-off between unemployment and inflation captured by the Phillips curve. Falling prices with growth would be the opposite condition.

The discount rate set by the Federal Reserve is the interest rate at which:

• a.Corporations issue commercial paper to investors
• b.The Fed lends short-term funds to member banks through the discount window✓
• c.The Treasury sells new bills at auction
• d.Banks lend excess reserves to one another overnight, a rate the Federal Reserve sets directly by statute each morning

The discount rate is what the Fed charges banks that borrow at its discount window. The overnight interbank lending rate is the federal funds rate, which is the trap. Treasury auctions and commercial paper are unrelated to the discount rate.

If the Federal Reserve lowers the reserve requirement, the most likely effect is to:

• a.Increase the money supply by allowing banks to lend a larger share of deposits✓
• b.Have no effect on the amount banks can lend
• c.Force banks to hold more cash against their deposits, which in turn pushes market interest rates sharply lower
• d.Reduce the money supply and raise interest rates

A lower reserve requirement frees a larger share of deposits for lending, expanding the money supply and tending to lower interest rates. This is an expansionary monetary tool. Raising the requirement would do the opposite by forcing banks to hold more.

During the expansion phase of the business cycle, which of the following typically occurs?

• a.Increasing GDP, rising consumer spending, and growing corporate profits✓
• b.A sharp decline in industrial production across sectors
• c.Rising unemployment and shrinking corporate profits
• d.A steady contraction in business inventories caused only by collapsing demand

An expansion features rising GDP, employment, consumer spending, and corporate profits as demand strengthens. Rising unemployment and falling profits describe a contraction. Declining industrial production is also a downturn signal, not an expansion.

An economist who argues the government should increase spending during a downturn to boost aggregate demand is applying which school of thought?

• a.Keynesian economics✓
• b.Supply-side economics
• c.Monetarist economics
• d.Classical laissez-faire economics

Keynesians emphasize aggregate demand and active fiscal policy, favoring government spending and tax changes to smooth the business cycle. Monetarists focus on the money supply, supply-siders on production incentives, and classical economists on minimal intervention.

Supply-side economics primarily emphasizes:

• a.Government deficit spending to stimulate demand
• b.Central bank control of short-term interest rates achieved mainly by adjusting reserve requirements and the discount window
• c.Lowering taxes and reducing regulation to encourage production and investment✓
• d.Increasing the money supply to control inflation

Supply-side economics focuses on incentives to produce, chiefly cutting marginal tax rates and easing regulation to spur output and investment. Deficit spending to lift demand is Keynesian, and money-supply and interest-rate tools are monetarist or central-bank levers.

The prime rate is best described as:

• a.The rate on overnight interbank loans targeted by the FOMC, which commercial banks are prohibited from exceeding when pricing loans
• b.The rate the Fed charges banks at the discount window
• c.The yield on three-month Treasury bills
• d.The interest rate commercial banks charge their most creditworthy corporate customers✓

The prime rate is what banks charge their most creditworthy customers and serves as a benchmark for many consumer and business loans. It is set by banks, not the Fed. The discount rate, fed funds rate, and T-bill yield are separate rates.

A company reports current assets of $300,000, inventory of $100,000, and current liabilities of $100,000. Its quick (acid-test) ratio is:

• a.3.0
• b.0.5
• c.2.0✓
• d.1.0

The quick ratio equals (current assets minus inventory) divided by current liabilities: ($300,000 minus $100,000) divided by $100,000 equals 2.0. It excludes inventory as a less-liquid asset. Including inventory gives the current ratio of 3.0, which is the trap.

Using current assets of $300,000 and current liabilities of $100,000, a company's working capital is:

• a.$400,000
• b.$3.00
• c.$200,000✓
• d.$30,000

Working capital equals current assets minus current liabilities: $300,000 minus $100,000 equals $200,000. It measures the short-term liquidity cushion available to fund operations. Adding the two figures ($400,000) is the trap.

A firm has total debt of $6 million and total shareholders' equity of $3 million. Its debt-to-equity ratio is:

• a.0.5
• b.2.0✓
• c.9.0
• d.3.0

Debt-to-equity equals total debt divided by equity: $6 million divided by $3 million equals 2.0. A higher ratio signals greater leverage and financial risk. Inverting the fraction gives the 0.5 trap.

A corporation earns net income of $10 million, pays $1 million in preferred dividends, and has 3 million common shares outstanding. Earnings per share (EPS) is:

• a.$2.70
• b.$9.00
• c.$3.33
• d.$3.00✓

EPS equals net income minus preferred dividends, divided by common shares: ($10 million minus $1 million) divided by 3 million equals $3.00. Forgetting to subtract preferred dividends yields the $3.33 trap. Preferred claims come before common.

A company reports net income of $2 million on shareholders' equity of $20 million. Its return on equity (ROE) is:

• a.10%✓
• b.20%
• c.5%
• d.2%

Return on equity equals net income divided by shareholders' equity: $2 million divided by $20 million equals 10%. ROE gauges how efficiently a firm turns equity capital into profit. It is a core profitability ratio in fundamental analysis.

A company earns $5.00 per share and pays a $1.50 annual dividend. Its dividend payout ratio is:

• a.150%
• b.30%✓
• c.3.3%
• d.50%

The payout ratio equals dividend per share divided by EPS: $1.50 divided by $5.00 equals 30%. The remaining 70% is the retention ratio reinvested in the business. Inverting the fraction gives distractor traps.

A firm has common shareholders' equity of $40 million and 2 million common shares outstanding. Its book value per share is:

• a.$0.05
• b.$20.00✓
• c.$80.00
• d.$2.00

Book value per share equals common equity divided by common shares: $40 million divided by 2 million equals $20.00. It is an accounting measure of net worth per share, not a market price. Multiplying instead of dividing gives the $80 trap.

A company has earnings before interest and taxes (EBIT) of $8 million and interest expense of $2 million. Its interest coverage ratio is:

• a.4 times✓
• b.0.25 times
• c.16 times
• d.2 times

The interest coverage ratio equals EBIT divided by interest expense: $8 million divided by $2 million equals 4 times. A higher ratio indicates a greater ability to service debt from operating earnings. Inverting the ratio gives the 0.25 trap.

A savings instrument pays a stated (nominal) annual rate of 6% compounded quarterly. Its effective annual yield is:

• a.6% only if held for exactly one quarter
• b.Exactly 6%, because compounding frequency does not matter to the effective yield on any deposit account of any size
• c.Greater than 6%, because interest is earned on interest more than once a year✓
• d.Less than 6%

More frequent compounding raises the effective annual yield above the stated nominal rate; 6% compounded quarterly equals about 6.14% effective, using (1 plus 0.06 divided by 4) raised to the fourth power minus 1. Only annual compounding leaves the two equal.

Using the Rule of 72, an investment earning 6% compounded annually will take approximately how long to double?

• a.8 years
• b.6 years
• c.18 years
• d.12 years✓

The Rule of 72 estimates doubling time by dividing 72 by the annual rate: 72 divided by 6 equals 12 years. It is a quick approximation for compound growth. Subtracting or misdividing produces the trap answers.

What is the approximate present value of $5,000 to be received in 3 years, discounted at 8% annually?

• a.About $4,600
• b.About $3,969✓
• c.About $5,000
• d.About $6,299

Present value equals the future amount divided by (1 plus the rate) raised to the number of periods: $5,000 divided by 1.08 cubed equals about $3,969. Discounting reduces the amount below $5,000; compounding forward to about $6,299 is the trap.

An analyst who studies the advance/decline line and moving-average crossovers to forecast price direction is engaged in:

• a.Discounted cash flow valuation of the firm
• b.Credit analysis of the issuer's balance sheet
• c.Technical analysis of market and price data✓
• d.Fundamental analysis of earnings quality

Advance/decline lines, moving averages, and chart patterns are technical-analysis tools that study price and volume history to predict direction. Fundamental and credit analysis instead examine a company's financials and intrinsic value.

Two assets have a correlation coefficient of +0.3. This indicates:

• a.The assets move in perfect lockstep, offering no diversification because a correlation of +0.3 behaves just like a correlation of +1.0
• b.That a correlation this low is mathematically impossible
• c.The assets always move in exactly opposite directions
• d.A weak positive relationship, so combining them still provides meaningful diversification✓

A correlation of +0.3 is a weak positive relationship; because it is well below +1.0, blending the assets still lowers portfolio risk. Only +1.0 offers no diversification benefit, and correlation ranges from -1.0 to +1.0, so +0.3 is valid.

A weakening U.S. dollar relative to foreign currencies generally:

• a.Helps U.S. importers by lowering the cost of foreign goods
• b.Guarantees lower domestic inflation over the coming year
• c.Helps U.S. exporters by making their goods cheaper abroad✓
• d.Has no effect on international trade flows

A weaker dollar makes U.S. exports cheaper and more competitive abroad, helping exporters, while making imports more expensive. This is a currency-risk consideration for international investing. It does not guarantee lower inflation and typically raises import prices.

Rising consumer prices that are driven by higher raw-material and wage costs rather than by stronger buyer demand are best described as:

• a.Deflation, in which the general level of prices actually falls from period to period
• b.Disinflation, in which the rate of price increases slows while prices still rise
• c.Cost-push inflation, in which higher input and labor costs are passed along in prices✓
• d.Demand-pull inflation, in which total spending outruns the economy's productive capacity

Cost-push inflation originates on the supply side: energy, materials, or wage costs rise, producers' margins compress, and they raise selling prices. Demand-pull inflation originates on the demand side, when spending exceeds what the economy can produce. Disinflation is a slowing of the inflation rate, and deflation is an outright decline in the price level. Knowing which force is at work matters because cost-push inflation can coexist with weak growth, which limits how aggressively a central bank can ease.

When the Federal Open Market Committee buys U.S. government securities from banks in the open market, the most direct effect is that:

• a.Bank reserves and the money supply expand, putting downward pressure on short-term rates✓
• b.Bank reserves contract and short-term interest rates are pushed sharply higher
• c.The federal budget deficit is reduced because the Treasury retires outstanding public debt
• d.Commercial banks are required to hold a larger percentage of their deposits in reserve

Open market operations are the Federal Reserve's primary monetary tool. When the Fed buys securities it pays the selling banks by crediting their reserve accounts, so reserves and the money supply grow and the cost of overnight money tends to fall. Selling securities drains reserves and pushes rates up. Retiring public debt is a Treasury (fiscal) function, and reserve requirements are a separate tool set by the Fed, not a consequence of a purchase.

The federal funds rate is best defined as the interest rate at which:

• a.Banks lend excess reserve balances to one another on an overnight basis✓
• b.Banks charge their most creditworthy corporate customers for short-term loans
• c.The U.S. Treasury borrows for terms of one year or less through bill auctions
• d.The Federal Reserve lends directly to member banks through the discount window

The fed funds rate is the market rate on overnight interbank loans of reserve balances, and the FOMC steers it toward a target range. The discount rate is charged by the Fed itself when it lends at the discount window. The prime rate is what banks charge their best commercial customers. Treasury bill yields are set by auction in the government securities market.

An economy's annual inflation rate falls from 5% to 2% over two years while the price level continues to rise. This is best described as:

• a.Disinflation, a slowing in the rate at which prices increase✓
• b.Hyperinflation, an accelerating collapse in the value of money
• c.Deflation, a sustained decline in the general price level
• d.Stagflation, high inflation combined with stagnant output

Disinflation means inflation is decelerating: prices are still going up, just more slowly. Deflation requires the price level itself to fall, which would be a negative inflation rate. Stagflation pairs high inflation with weak growth and high unemployment. Hyperinflation is extreme, accelerating inflation. Candidates lose points by treating any decline in the inflation rate as deflation.

The Producer Price Index differs from the Consumer Price Index because the Producer Price Index measures:

• a.The total value of all finished goods and services produced within a nation
• b.Prices received by domestic producers for their output at the wholesale level✓
• c.Prices paid by urban households for a fixed basket of retail goods and services
• d.The average hourly wage paid across the private nonfarm business sector

The PPI tracks selling prices from the producer's point of view, which is why it is often watched as an early warning of consumer inflation still working its way through the supply chain. The CPI tracks what households actually pay at retail. Total output is measured by GDP, and wage data come from separate labor statistics releases.

The fundamental accounting equation reflected on a corporation's balance sheet states that:

• a.Net income equals total revenue minus the cost of the goods sold
• b.Working capital equals current assets plus current liabilities
• c.Total assets equal total liabilities plus total shareholders' equity✓
• d.Total assets equal total revenues minus total operating expenses

A balance sheet balances because everything the company owns was financed either by creditors or by owners: Assets = Liabilities + Shareholders' Equity. Revenue minus expenses produces net income on the income statement, not assets. Working capital is current assets MINUS current liabilities, not the sum of them.

A company reports net sales of $5,000,000 and cost of goods sold of $3,000,000. Its gross profit margin is:

• a.20%
• b.40%✓
• c.60%
• d.167%

Gross profit = $5,000,000 - $3,000,000 = $2,000,000. Gross profit margin = $2,000,000 / $5,000,000 = 0.40, or 40%. The 60% figure is the cost of goods sold as a percentage of sales, which is the complement of the answer, not the margin itself. Gross margin measures production efficiency before operating expenses, interest, and taxes.

A firm earns net income of $600,000 on net sales of $8,000,000. Its net profit margin is closest to:

• a.4.8%
• b.13.3%
• c.0.8%
• d.7.5%✓

Net profit margin = net income / net sales = $600,000 / $8,000,000 = 0.075, or 7.5%. The 13.3% figure inverts the ratio ($8,000,000 / $600,000 = 13.3 times, which is not a margin). Net margin captures what survives after every expense, so it is compared across firms in the same industry rather than across industries.

A common stock trades at $40 per share and pays a quarterly dividend of $0.30. Its current dividend yield is:

• a.3.33%
• b.13.3%
• c.0.75%
• d.3.0%✓

Annualize the dividend first: $0.30 x 4 = $1.20 per year. Dividend yield = $1.20 / $40.00 = 0.03, or 3.0%. Using the quarterly $0.30 without annualizing produces the 0.75% trap. Dividend yield rises when the share price falls, so a suddenly high yield can signal market doubt about the dividend rather than a bargain.

A company's common shares trade at $45 while its book value per share is $30. Its price-to-book ratio is:

• a.15.0
• b.1.5✓
• c.1.15
• d.0.67

Price-to-book = market price per share / book value per share = $45 / $30 = 1.5. The 0.67 figure inverts the ratio. A price-to-book above 1.0 means the market values the company above its accounting net worth, often because of intangible assets or expected growth that the balance sheet does not capture.

An investor deposits $10,000 in an account paying 6% compounded annually. Ignoring taxes, the balance after two years is:

• a.$11,236✓
• b.$11,000
• c.$12,360
• d.$11,200

Year one: $10,000 x 1.06 = $10,600. Year two: $10,600 x 1.06 = $11,236. Equivalently, $10,000 x (1.06)^2 = $11,236. The $11,200 answer applies simple interest of $600 per year and ignores the $36 of interest earned on the first year's interest, which is exactly the compounding effect the question is testing.

Compared with an ordinary annuity that pays the same amount for the same number of periods, an annuity due has:

• a.A higher present value, because each payment arrives at the beginning of the period✓
• b.An unpredictable present value, because the payer chooses the timing each period
• c.An identical present value, because the number of payments does not change
• d.A lower present value, because each payment arrives at the end of the period

In an annuity due each cash flow is received one period sooner than in an ordinary annuity, so each is discounted for one less period and the present value is higher. Rent and insurance premiums are typical annuities due; bond coupons and most loan payments are ordinary annuities. The count of payments is the same in both, which is why timing alone drives the difference.

Under the net present value method, a proposed capital project should be accepted when:

• a.The total undiscounted inflows exceed the accounting profit reported for the project
• b.The present value of the expected cash inflows exceeds the initial cost of the project✓
• c.The discount rate applied to the project is greater than its internal rate of return
• d.The payback period is longer than the estimated useful life of the new equipment

Net present value discounts every expected future cash flow back to today at the required rate of return and subtracts the outlay. A positive NPV means the project earns more than the required rate and adds value. A discount rate above the internal rate of return produces a negative NPV, and a payback period longer than the asset's life means the outlay is never recovered.

The internal rate of return on an investment is best defined as the discount rate that:

• a.Makes the net present value of all expected cash flows equal to zero✓
• b.A lender charges the investor to finance the purchase of the asset
• c.Reflects the rate of inflation expected over the investment's holding period
• d.Equals the average annual accounting profit divided by the initial outlay

The internal rate of return is the break-even discount rate: apply it to the cash flows and the present value of inflows exactly equals the outflow, so NPV is zero. For a bond held to maturity, the IRR of the cash flows is the yield to maturity. Accounting profit measures, borrowing costs, and inflation expectations are all separate concepts.

A retailer reports cost of goods sold of $6,000,000 and average inventory of $1,500,000. Its inventory turnover ratio is:

• a.9.0 times
• b.4.0 times✓
• c.2.5 times
• d.0.25 times

Inventory turnover = cost of goods sold / average inventory = $6,000,000 / $1,500,000 = 4.0 times per year. That implies roughly 365 / 4 = 91 days of inventory on hand. A falling turnover ratio can warn that merchandise is not selling and that write-downs may follow.

The point in the business cycle at which output stops declining and begins to recover is called the:

• a.Peak, the turning point that ends an expansion
• b.Recession, two consecutive quarters of falling output
• c.Trough, the turning point that ends a contraction✓
• d.Plateau, a period of entirely unchanging real output

The four phases of the business cycle are expansion, peak, contraction, and trough. The trough is the low point where activity bottoms and the next expansion begins. The peak is the opposite turning point. A recession is a phase of decline, not a turning point, and 'plateau' is not a recognized phase of the cycle.

On a corporation's statement of cash flows, cash spent to repurchase the company's own common stock is classified as:

• a.A noncash item, because no funds actually leave the corporation
• b.An operating activity, because it arises from day-to-day business
• c.A financing activity, because it changes the firm's capital structure✓
• d.An investing activity, because it involves a purchase of securities

The statement of cash flows has three sections. Financing activities cover transactions with owners and lenders: issuing or repurchasing stock, paying dividends, and borrowing or repaying debt. Investing activities cover the purchase and sale of long-term assets and of securities of OTHER issuers. Operating activities cover the cash effects of running the business.