CMA Part II Flashcards
1
Q
Prospective Financial Statements
A
These are financial statements that are based on a set of assumptions and cover a future period. Whenever prospective financial statements are prepared, the significant accounting policies and significant assumptions that were made need to be disclosed.
2
Q
Accounts receivable turnover will normally decrease as a result of?
A
Accounts receivable turnover is calculated as annual credit sales divided by the average accounts receivable. It measures the number of times the accounts receivable “turn over”
during a year’s time. Therefore, this number will decrease if there is a decrease in credit sales or an increase in the average receivables. If the company lengthens the period for cash discounts, more companies will take longer to pay their bills, which will increase the average receivables. This will, in turn, decrease the accounts receivable turnover ratio. A decrease in the accounts receivable turnover ratio means the accounts turn over less frequently; and in this case, that is because the level of accounts receivable is higher.
3
Q
Times Interest Earned
A
The times interest earned ratio (interest coverage ratio) is EBIT(operating profit) / Interest Expense.
4
Q
The Amortization of Bond Premium
A
The amortization of bond premium is like the amortization of a deferred gain. Since this is a noncash transaction, however, this “gain” needs to be taken out of net income and this is done by subtracting it from net income under the indirect method.
5
Q
Degree of Financial Leverage
A
Degree of Financial Leverage is EBIT (operating profit) divided by EBT (Earnings Before Interest & Taxes + Earnings Before Taxes).
6
Q
Everything else being equal, a (A) highly leveraged firm will have (B) earnings per share.
A
In firms that are less highly leveraged, the company has lower fixed costs. Because fixed costs are lower, profits as a percentage of sales fluctuate less as the level of sales changes than would be the case for a more highly leveraged firm. This will lead to less volatile, more stable earnings per share.
7
Q
The P/E Ratio
A
The P/E ratio is measured as the market price of the share divided by diluted earnings per share (DEPS).
8
Q
GAAP Income Statement ON TIDE N OC
A
O = Operating
N = Non Operating Income
T = Taxes (current and deferred)
I = Income from Continuing Operations
D = Discontinued Operations
E = Extra Ordinary Gain /(Losses)
N = Net Income
O = Other Comprehensive Income (DENT)
D= Derivatives
E= Excess adj. of Pension PBO& FV Plan
N= Net unrealized gain or loss on AFS security
T= Translation Adjustment
C = Comprehensive Income
9
Q
Which one of the following factors indicates that a foreign affiliate’s functional currency is the U.S. dollar?
A
Sales prices are responsive to short-term changes in exchange rates and worldwide competition.
The definition of a foreign entity’s functional currency is that it is normally the currency in which the entity generates and expends cash. If a company generates and expends cash in one currency only, then its purchases and its sales will not be subject to exchange rate risk. Furthermore, a company that operates only in the currency of its own economy will find that its selling prices are determined by its local market or its local government’s regulations. In this case, the entity’s functional currency should be the currency it buys and sells in, and that will be its local currency.
On the other hand, if the entity’s sales prices are determined more by worldwide competition or by international prices, that is an indication that it may be buying and selling goods in currencies other than its own currency. And when the foreign entity is buying and selling goods in currencies other than its own currency, then the FASB Accounting Standards Codification recommends that its functional currency be designated as the U.S. parent’s currency and not the foreign entity’s local currency.
10
Q
Vertical, Common-Size Analysis
A
Vertical, common-size analysis creates financial statements in which each component is measured as a percentage of another element of the financial statements for that same period. For example, all items on the balance sheet are measured as a percentage of total assets and all income statement items are measured as a percentage of total sales.
Advertising expense being 2% of sales is such an example of vertical, common-size analysis.
11
Q
The Degree of Operating Leverage (DOL)
A
The degree of operating leverage (DOL) is a measure of the change in net operating income associated with a given change in sales volume. For a particular level of output,
Degree of Operating Leverage is calculated as follows:
% Change in Operating Profit (EBIT) /
% Change in Revenue
Degree of operating leverage is calculated as Contribution Margin divided by Operating Income. Because bad debt expense is a percentage of sales, it is a variable expense.
12
Q
The Direct Method (Reconciliation)
A
Only the direct method of preparing the Statement of Cash Flows requires a reconciliation between net income and net cash flows from operating activities. This reconciliation is exactly the same as the net cash flows from operating activities as it is presented under the indirect method.
An increase in an asset account must be subtracted from net income because it represents cash paid out that is not on the income statement. Therefore, the increase in prepaid expenses will be a deduction from net income to reconcile net income to cash flow from operating activities. The amortization of premium on bonds payable reduces interest expense and thus it increases net income without increasing cash. Therefore, it will also need to be deducted from net income in the reconciliation.
13
Q
The ratio that measures a firm’s ability to generate earnings from its resources is?
A
Asset turnover is calculated as sales divided by total assets and is a measure of the company’s ability to generate earnings from all of its resources.
14
Q
FIFO = COGS (LISH)
A
If cost are going up: LISH = Last In Still Here COGS - Understated NI- Overstated Ending Inventory is okay
15
Q
LIFO= COGS (FISH)
A
If Costs are going up: FISH = First In Still Here Profits OK- Income statement is fair Ending Inventory - Understated Income Statement is OK but Balance Sheet is not.
16
Q
Average Number of Days to sell inventory for the current year?
A
The average number of days to sell inventory is calculated as 365 divided by the inventory turnover ratio. Inventory turnover is calculated as the cost of goods sold (COGS) divided by average inventory. Cost of goods sold was $4,380,000 and average inventory was $870,000 (the average of the beginning and ending balances). This gives an inventory turnover of 5.03. Dividing 365 by 5.03 gives us 72.5 days as the average number of days to sell inventory.
17
Q
The average number of days to collect receivables
A
The average number of days to collect receivables is calculated as 365 divided by the receivables turnover ratio. Receivables turnover is calculated as net annual credit sales divided by average receivables. Credit sales were $6,205,000 and average receivables were $335,000 (the average of the beginning and ending balances). This gives a
receivables turnover ratio of 18.52. Dividing 365 by 18.52 gives us 19.71 days as the number of days to collect receivables.
18
Q
Horizontal Common-Size Analysis
A
Horizontal common-size analysis occurs when the financial information is presented as a percentage of the company’s financial information from a previous period. The current year amounts are stated in comparison to the base period for that company, which is given a value of 100%.
19
Q
Systematic Risk
A
Systematic risk is risk that all investments are subject to. It is caused by factors that affect all assets. Examples would be inflation, macroeconomic instability such as recessions, major political upheavals and wars. Systematic risk cannot be diversified away, and so it remains even in a fully diversified portfolio.
20
Q
Covariance
A
Covariance is a measure of the strength of the correlation between two (or more) sets of random variables. Those two random variables could be the historical returns of two securities; or they could be the historical returns of an individual security and the historical returns of the market portfolio.
If an individual security’s return moves with the return to the market or moves with the return to another individual security – both increasing at the same time and both decreasing at the same time – the covariance between the security and the other security or between the security and the market will be greater than zero. If one decreases when the other increases or increases when the other decreases, their covariance will be less than zero. If there is no correlation at all between the two, their covariance will be zero.
21
Q
The Coefficient of Variation:(The risk of different investments)
A
The risk of different investments is measured using the coefficient of variation. The Coefficient of Variation is calculated as the standard deviation divided by the expected return. The higher this value, the more risky the stock. The coefficient of variation for stock A is .75 (15%/20%). The coefficient of variation for Stock B is .9 (9%/10%). Therefore, the investment in Stock B is riskier because it has a higher coefficient of variation.
22
Q
The risk premium for an individual security:
A
The risk premium for an individual security is its beta times the difference between the return to the market and the risk-free rate. Thus, the security’s risk premium is .5(.09 - .04), which is .025 or 2.5%.
23
Q
The expected risk premium for a stock (or a portfolio)
A
The expected risk premium for a stock (or a portfolio) is the difference between the expected return on the market and the risk-free rate multiplied by the stock’s (or portfolio’s) beta. The expected return on the market minus the risk-free rate multiplied by the beta is 1.2 x (.11 - .02), which is equal to .108 or 10.8%.
24
Q
The formula for Arbitrage Pricing Theory is:
A
r = rf + B1k1 +B2k2 + B3k3
Risk Factor Est. Risk Premium
Interest rate changes +0.5% (k1)
Inflation +1.0% (k2)
Real GNP Changes +1.5% (k3)
Int. Rate Inflation Real GNP Chrgs. BCD Appliance +1.2 +1.8 +1.9
r =.05 +(1.2 x .005)+ (1.8 x .01) + (1.9 x .015)
r =.05 +.006 + .018+.0285 = .1025 or 10.25%
25
The optimal capital budget is determined by:
Calculating the point at which marginal cost of capital meets the projected rate of return, assuming that the most profitable projects are accepted first.
In economics, a basic principle is that a firm should increase output until marginal cost equals marginal revenue. Similarly, the optimal capital budget is determined by calculating the point at which marginal cost of capital (which increases as capital requirements increase) and the marginal efficiency of investment (which decreases if the most profitable projects are accepted first) intersect
26
The total cost of the safety stock
The total cost of the safety stock is the carrying cost plus the expected stock-out cost.
If the company carries 100 units of safety stock, the cost of carrying the safety stock will be $1,000 for the year. This is calculated as 20% of the value of the safety stock. The average inventory investment per unit is $50.
For 100 units, the carrying cost is $50 * 100 * .20, or $1,000.
The stock-out cost is $5 per unit. At a safety stock level of 100 units, if a stock-out occurs, the number of units the company would be short would be 100 units (from the "Stock-out" column). Therefore, the cost of one stock-out would be 100 * $5, or $500.
The company orders inventory an average of 10 times per year. The probability of a stock-out occurring at a safety stock level of 100 units is 15%. Therefore, during a year's time, the expected number of stock-outs is 10 * .15, or 1.5 times. At a cost of $500 per stock-out, this is an expected annual cost of $750 ($500 * 1.5).
Since the total cost of the safety stock is the carrying cost plus the expected stock-out cost, the total cost of the safety stock on an annual basis with a safety stock level of 100 units is $1,000 carrying costs plus $750 stock-out costs, or $1,750.
27
The cost of retained earnings, Using the Capital Assets Pricing Model (CAPM)
The beta coefficient for a stock is 1.15, the risk-free rate of interest is 8.5%, and the market return is estimated at 12.4%. If a new issue of common stock were used in this model, the flotation costs would be 7%.
Asset Pricing Model (CAPM) equation:
```
R = Rf + B(Rm - Rf)
R= Rate
Rf = Risk Free Rate
B= Beta
Rm = Market Return
This gives us: 8.5% + [1.15(12.4% - 8.5%)] = 12.99% as the cost of retained earnings
```
28
Commercial paper:
Commercial paper:
1) Usually only sold through investment banking
dealers.
2) Has an interest rate lower than Treasury bills.
3) Has a maturity date greater than 1 year.
4) Ordinarily has an active secondary market.
29
A Zero-Balance Account:
A zero-balance account reduces the cost of cash management because it reduces the:
1) time that managers need to spend transferring funds from one account to another to cover checks written. The bank does charge for the service, but the bank's fee is lower than the cost to the company would be to make the calculations and then to make the transfers manually.
2) A zero-balance account reduces excess bank balances, because the company needs to monitor the balance in only one account. The other accounts are maintained at zero balances, so the company does not have to leave excess funds in those accounts to make sure they do not get overdrawn.
30
The amount of safety stock that a company is required to hold will be affected by:
The amount of safety stock that a company is required to hold will be affected by:
1) the variability of the lead time,
2) the variability of the demand for the product,
3) the cost of stock-out.
The more variable either of the first two items, the more safety stock the company will need to guard against stock-outs in the case of an unusually high demand or an unusually long lead time. If these items are more consistent and predictable, the company can reduce the amount of its safety stock because there is a smaller chance of needing so many items in stock. The greater the cost of a stock-out, the more safety stock the company will need to keep because the potential loss from a stock-out is higher.
31
The optimal amount of cash to be raised by selling securities is:
The amount of cash that should be obtained through the sale of marketable securities is calculated in order to balance the cost of the conversion and the lost return by having the assets as cash instead of invested in a higher-return investment.
When two things are inversely related, when one increases, the other decreases and vice versa. The higher the return is on marketable securities, the lower will be the amount in cash that will be converted from securities at any one time, in order to keep as much money as possible working and earning a return for as long as possible.
When two things are directly related, when one increases, the other also increases and vice versa. The higher the cost is for a transaction, the larger will be the amount (in cash) of marketable securities that will be converted each time a conversion is made, in order to minimize the overall transaction costs.
32
The payment of a stock
| dividend
The payment of a stock dividend is accounted for by reducing retained earnings by a portion of the stock dividend's value and increasing common stock (or common stock and additional paid-in
capital), Thus, a stock dividend would reduce retained earnings - though it would not reduce total equity - while a stock split would not.
Cash dividends are also accounted for by reducing retained earnings. A cash dividend cannot be paid if there is an insufficient balance in the retained earnings account.
Therefore, payment of a stock dividend could limit the company's ability to pay future cash dividends, whereas a stock split would not.
33
What is the optimal plan to implement?
To answer this question, we calculate the net income after tax generated by each of the four plans. We will include the cost of capital to carry the accounts receivable and inventory last, after we have calculated the Operating Income After Tax, since the cost of capital given in the problem is an after-tax cost.
To calculate the cost of capital for each of the four proposed plans, we will multiply the average accounts receivable by 80% (the variable cost of the sales that the company has invested and needs to finance), add the average inventory to it, and multiply the total by the after-tax cost of capital to calculate the after-tax interest expense that will be required to carry the costs in the average accounts receivable and average inventory for one year.
Plan A: (($20,000 * .8) + $40,000) x .15 = $8,400
Plan B: (($40,000 * .8) + $50,000) * .15 = $12,300
Plan C: (($60,000 * .8) + $60,000) * .15 = $16,200
Plan D: (($80,000 * .8) + $70,000) x .15 = $20,100
Net income calculations:
Plan A:($200,000 *.20) - $1,000 - $1,000 = $38,000 net operating income before tax.
Net operating income aftertax = $38,000 *.70 = $26,600. $26,000 - $8,400 after-tax cost of capital = net income of $18,200.
Plan B: ($250,000 *.20)-$3,000-$2,000 = $45,000 net operating income before tax.
Net operating income aftertax=$45,000 *.70 = $31,500. $31,500 - $12,300 after-tax cost of capital = net income of $19,200.
Plan C: ($300,000 *.20)-$6,000 - $5,000 = $49,000 net operating income before tax.
Net operating income aftertax = $49,000 *.70 = $34,300. $34,300 - $16,200 after-tax cost of capital = net income of $18,100.
Plan D: ($350,000 *.20)-$12,000-$8,000 = $50,000 net operating income before tax.
Net operating income aftertax = $50,000 *.70 = $35,000. $35,000 - $20,100 after-tax cost of capital = net income of $14,900.
34
On a graph of the Security Market Line, betas:
The return to the market is the market return at the point where beta is 1.0. On a graph of the Security Market Line, betas are on the horizontal axis and expected returns are on the vertical axis.
35
Unsystematic risk is:
Unsystematic risk is risk that affects only one company or one industry and that is separate from economic or political factors that affect all securities systematically. Unsystematic risk can be eliminated in a portfolio through proper diversification.
36
Systematic risk, or market risk, is:
Systematic risk, or market risk, is the risk that changes in a security's price will result from changes that affect all firms. Systematic risk, or market risk, cannot be eliminated by diversification in a portfolio. Investors will always be exposed to the uncertainties of the market, no matter how many stocks they hold.
37
Amount Received from Factoring:
The amount that is going to be received is going to be calculated by starting with the amount of the receivable itself, $100,000. This will be reduced by the reserve and the commission, both of which are calculated from the $100,000 amount. In total, this is 7% and reduces the amount to $93,000. This is the amount on which the interest will be charged. The interest rate is 10% and this gives an annual interest of $9,300. However, the time period before the receivable is due to be collected is only 3 months, so only ¼ of the annual interest will be charged. This is $2,325. This is also withheld from the amount received and brings the amount received down to $90,675.
Receivable =$100,000
Reserve = 6,000 (.06x100,000)
Commission = 1,000 (.01x100,000)
Subtotal = 93,000
Interest calc. = 10% (93000) x .25(90 days)
Interest total = 2,325
Total Received = 90,675
38
The company increases sales by $100,000 what is the profit after tax:
```
Sales $100,000
Selling expenses by 70% $ 70,000
Gross Margin $ 30,000
Bad debt expense 15% $ 15,000
Collection expense 5% $ 5,000
Subtotal $ 10,000
Tax rate is 40% $ 4,000
Total $ 6,000
```
39
A poison pill:
A poison pill is a defense in which the shareholders of the company have the option to buy the shares of the merged company at a reduced price. Because of this potential dilution of ownership through this discounted sale of shares, an acquiring company will be less likely to buy the company.
40
Preemptive Rights:
Preemptive rights allow the existing shareholders to purchase the same percentage of a new issuance that they owned of the outstanding shares prior to the issuance. Before the new issue of stock, there were 1,000,000 common shares outstanding ($5,000,000 divided by $5 par value per share). This shareholder held 1 % of the outstanding shares (10,000 shares divided by 1,000,000 shares) before the issuance, so they have the right to purchase 1%, or 2,000 shares, of the new issue.
41
The Optimum Capital Structure
Financial structure is the composition of the financing sources of the assets of a firm. Traditionally, the financial structure consists of current liabilities, long-term debt, retained earnings, and stock. For most firms, the optimum structure includes a combination of debt and equity. Debt is cheaper than equity, but excessive use of debt increases the firm's risk and drives up the weighted-average cost of capital.
42
Factoring Receivables:
In the process of factoring the receivables, the company will save $18,000 per year. However, there will also be some costs associated with this. Of the amount sold, the company will lose 2% of the amount of receivables. This is $24,000 per year ($100,000 * 12 * .02), giving a net cost of $6,000 per year. Additionally, they will need to pay 10% interest on the amount that is advanced to them connected to the factoring. They will receive 80% of the monthly amount of receivables, or $80,000 and because this will be done each month we can treat this as if there is always $80,000 outstanding during the year. The annual interest on this is $8,000 and adding this to the $6,000 net cost gives a total cost of $14,000 to receive a loan of $80,000. Therefore the cost is 17.5% ($14,000 / $80,000).
43
What is the value of one right?
A stockholder owns 10 shares of S Corporation common stock at a current market price of $10 per share. The corporation will allow each shareholder to buy proportional new shares of stock at $9 per share. Currently, there are 5,000 shares outstanding and 500 new shares will be issued. What is the value of one right.
In order to determine the value of the right when it is selling rights-on. This is done using the following formula
Po-Pn
Vr = _____________
r+1
Where:
Po = The value of a share with the rights still attached
Pn = The subscription (sales) price of a share
r = The number of rights needed to buy a new share
Vr = The value of the right
Since 5,000 shares are outstanding and 500 new shares will be issued, 10 shares will be required to buy a new share (5,000 / 500).
Putting the values into the formula, we calculate that the value of one right is
10-9
Vr = _____________ =.0909
10+1
44
If an importer worries that the U.S. dollar
| may depreciate sharply against the British pound in the short term, it would be well advised to:
By purchasing pounds now, the American importer is able to determine now the amount of dollars that will be required to settle that invoice when it comes due. As such, they are protected against the situation in which the dollar depreciates against the pound. If the dollar were to depreciate and the importer had not entered into this agreement, they would need to spend more dollars in order to settle the invoice.
45
Weighted marginal cost of capital:
The cost of the bonds equals the interest rate times one minus the tax rate, or 5.4% [9% x (100% - 40%)]. The cost of preferred stock equals the preferred dividend amount divided by the net issuance price. No tax adjustment is necessary because preferred dividends paid are not tax deductible. The cost of the preferred stock is therefore 6% of the par value of the preferred stock {[$4,800,000 net issuance price / (100% - 4% flotation cost)] = $5,000,000 par value} divided by the net issuance price, or 6.25% [(6% x $5,000,000) / $4,800,000]. The cost of the common stock is given as 15%.
So the weighted average is as follows:
Weighted
Weight Cost Average
Bonds 40% x 5.40% = 2.160%
Preferred Stock 10% x 6.25% = 0.625%
Common Stock 50% x 15.00% = 7.500%
=10.285
46
U.S. multinational corporation's use the foreign currency market:
The foreign currency markets will not enable the company to improve the return on the investment of a foreign subsidiary as the foreign currency markets can be used only to protect against losses due to fluctuations of the exchange rate. Assuming that the foreign subsidiary's return on investments would involve cash inflows and outflows in the foreign subsidiary's currency only, those cash flows would not be subject to exchange rate risk.
One of those reasons is to reduce the risk of devaluation of dividend payments as a result of
fluctuations of the exchange rate.
47
The order of priority of the claims against the assets are as follows in a liquidation:
1. Secured bonds
2. Court/trustee costs
3. Credit from suppliers since filing
4. Wages payable
5. Taxes owed
6. Senior unsecured debt
7. Junior unsecured debt
8. Preferred shares (at par)
9. Common shares (at par)
48
Country R's currency would tend to depreciate relative to Country T's currency when
If real interest rates are higher in Country T than in Country R, more people will want to invest in Country T. This will cause the demand for Country T's currency to increase, and that will lead to appreciation of Country T's currency relative to Country R's currency. When Country T's currency appreciates relative to Country R's currency, Country R's currency depreciates relative to Country T's currency.
49
Residual Dividend Theory
Under the residual dividend theory it is assumed that the profits of the company should be distributed as dividends only if that is the best use of the money. If the company has investment opportunity that is better than what the shareholders are able to earn, the money should be reinvested and not paid as dividends. When there are no options that provide a higher return than the shareholders earn, the company should pay dividends and let the shareholders make the best investment available to them.
50
The following economic policies would not tend to correct a balance of payments deficit in the U.S.
An increase in the value of U.S. currency will raise the comparative price of US products. This will reduce the number of U.S. exports and increase imports as the relative price of U.S. goods increases, thus the balance of payments deficit will increase, not decrease, if the value of the US currency increases.
51
The slope of the Security Market Line.
The slope of the Security Market Line is the market risk premium. The market risk premium is the difference between the return to the market and the risk-free rate. It is also the amount by which the expected return for an individual security or portfolio increases for each 1 unit increase in the security's or portfolio's beta, graphed horizontally. For a beta of 0.5, the expected return is 7.5%. For a beta of 1.5 (1.0 greater), the expected return is 16.5%. The difference, 9%, is the slope of the Security Market Line.
52
Calculate the cost of capital by:
To calculate the cost of capital for each of the four proposed plans, we will multiply the average accounts receivable by 80% (the variable cost of the sales that the company has invested and needs to finance), add the average inventory to it, and multiply the total by the cost of capital to calculate the interest expense that will be required to carry the costs in the average accounts receivable and average inventory for one year.
Plan A: (($1,500 * .8) + $2,000) * .10 = $320
Plan B: (($2,000 * .8) + $2,300) * .10 = $390
Plan C: (($3,500 * .8) + $2,500) * .10 = $530
Plan D: (($5,000 * .8) + $2,500) * .10 = $650
Net income calculations:
Plan A: ($12,000 x .20) - $100 - $100 - $320 + 0 = $1,880 net operating income before tax.
Plan B: ($13,000 x .20) - $125 - $125 - $390 + 0 = $1,960 net operating income before tax.
Plan C: ($14,000 x .20) minus; $300 - $250 - $530 + 0 = $1,720 net operating income before tax.
Plan D: ($14,000 x .20) - $400 - $350 - $650 + $500 = $1,900 net operating income before tax.
53
The standard deviation:
The standard deviation from the mean of the possible annual returns is within the range of the 68% confidence interval about the mean. The 68% confidence interval represents the range from one standard deviation on the left side of the mean to one standard deviation on the right side of the mean. The mean is 4%, and the range of possible results about the mean that falls within the 68% confidence interval is between 2% and 6%. 2% is 2% below the mean of 4%, and 6% is 2% above the mean of 4%. Thus, the standard deviation must be 2% (equal to the difference between 4% and 2% and also to the difference between 4% and 6%).
54
A hazard risk :
A hazard risk is the type of risk that can be insured against. For example, the risk of a natural disaster such as a fire or flood can be managed with property insurance; the risk of the death of a key employee can be managed with key person life insurance; and the risk of a person getting injured on the premises can be managed with liability insurance.
55
Risk assessment:
Risk assessment is the process of analyzing and considering risks from two perspectives: (1) the likelihood of the risk's occurring and (2) the potential impact of the event if it does occur.
56
Factoring Formula:
Face amount of the receivables
- Reserve (calculated face amount of receivables)
- Factor's fee (calculated from the face amount)
= Amount the seller needs to pay interest on
- Interest for time period before collection rec'bles
= Cash Received Now
57
A forward contract:
A forward contract is an over-the-counter agreement between two parties to buy or sell an asset at a certain time in the future for a certain price.
The distinguishing characteristic of forward contracts is that they are not traded on any market or exchange. They are therefore called "over-the-counter." Brokers bring together the buyer and the seller, who then negotiate the terms of the contract.
58
A futures contract:
A futures contract is similar to a forward contract, in that it is an agreement to buy or sell a specified quantity of a specified asset on a future date for a specified price.
59
Determining the yield of a treasury security:
Yield of a Treasury security of the same term
+ Default premium
+ Liquidity premium
+/- Premium or Discount for tax status
+/- Premium or Discount for special provisions
= Yield of debt security
60
To convert a Nominal rate to Real Rate:
Real Rate = 1 + Nominal Rate - 1
1 + Inflation Rate
nominal rate that contains an inflation premium
61
The Liquidity Premium (or Preference) Theory
The Liquidity Premium Theory says that it investors increase their risk by holding long-term bonds, they will require higher compensation in the form of a higher interest rate for assuming that increased risk. Thus, the forward rate must be higher than the expected spot rate. The difference between the forward rate and the expected spot rate is called the liquidity premium. According to the Liquidity Preference Theory, the yield
curve should nearly always be upward sloping. The Liquidity Preference Theory does recognize, though, that the yield curve could be downward sloping if future spot rates are expected to fall. However, the Liquidity Preference Theory would foresee a less dramatic downward slope than would the Pure Expectations Theory.
The Liquidity Preference Theory holds that the yield curve is a function of two things: (1) the market's expectations for future interest rates and (2) a liquidity premium. The liquidity premium gets larger as the term gets longer.
62
The Segmented Markets Theory
The Segmented Markets Theory focuses on cash needs of different groups of investors and borrowers and maintains that each group chooses securities that meet its forecasted cash needs. Each group of investors and borrowers determines the term of its investment or borrowing in light of its cash needs and not because of expectations of future interest rates.
The Segmented Markets Theory contrasts with the Pure Expectations Theory because the Pure Expectations Theory assumes that maturity markets are perfect substitutes for one another and the only determining factor is future expectations of interest rates.
63
Preferred Habitat Theory (or Composite Theory)
The Preferred Habitat Theory is a compromise. It agrees with the Segmented Markets Theory in saying that investors and borrowers normally concentrate on a particular maturity market. However, it also recognizes, in agreement with the Pure Expectations Theory, that expectations about future interest rate movements can cause investors and borrowers to leave their preferred maturity markets for other maturity markets.
64
The before-tax profit formula
```
The before-tax profit formula is
Total Revenue
- Total Variable Cost
- Total Fixed Cost
= Before-Tax Profit.
```
To convert after-tax profit to before-tax profit, we divide after-tax profit by (1 - tax rate). If after-tax profit needs to be $75,000, before-tax profit needs to be $75,000 /.60, or $125,000.
65
Value-at-Risk
Value-at-Risk can be used to estimate the probable maximum loss that may be incurred at the end of the year
Value-at-Risk (VaR) measures the potential loss in value of a risky asset or event over a defined period for a given confidence interval. It is based on the assumption that the possible outcome of the event is represented by a normal distribution (bell curve). With a normal distribution, we know that 95% of the results will lie within 1.96 standard
deviations of the mean, and that 99% of the results will lie within 2.57 standard deviations of the mean. Using this information, we can predict what the range of results will be with a measured level of confidence.
66
The breakeven point in sales revenue:
The breakeven point in sales revenue is equal to fixed cost divided by the contribution margin ratio. If the sales price and the variable costs increase by the same percentage, then the contribution margin ratio will remain unchanged and the breakeven point in sales revenue will also remain unchanged.
67
Relevant costs
Relevant costs are incremental or differential costs that will vary among the possible choices. Relevant costs are important to see cost differences, not in determining product
price.
68
Debt to Equity
Debt to Equity = Total Liabilities / Total Equity
69
Long-term Debt to Equity Capital
Long-term Debt to Equity Capital =
| Total Debt − Current Liabilities / Total Equity
70
Debt to Total Assets
Debt to Total Assets = Total Liabilities / Total Assets
71
Fixed Assets to Equity Capital
Fixed Assets to Equity Capital =
| Net Fixed Assets / Total Equity
72
Times Interest Earned or (Times Interest Earned)
```
Interest Coverage (Times Interest Earned) =
Earnings Before Interest and Taxes (EBIT) / Interest Expense
```
73
Fixed Charge Coverage or (Earnings to Fixed Charges)
Fixed Charge Coverage (Earnings to Fixed Charges) =
Earnings Before Fixed Charges and Taxes /
Fixed Charges
74
Fixed Charges is calculated as:
Interest expense on loans and capital leases
+ Required principal payments on loans and capital leases
+ Total payments on operating leases
= Total Fixed Charges
75
Cash Flow to Fixed Charges
Cash Flow to Fixed Charges =
| Adj. Operating Cash Flow / Fixed Charges
76
Accounts Receivable Turnover Ratio
Accounts Receivable Turnover Ratio =
| Net Annual Credit Sales / Average Accounts Receivable (trade receivables only)
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Days Sales in Receivables (Average Collection Period)
Days Sales in Receivables (Average Collection Period) =
| 365, 360 or 300 / Receivables Turnover
78
Days Sales in Receivables (Average Collection Period)
Days Sales in Receivables (Average Collection Period) =
| Average Accounts Receivable / Average Daily Sales (i.e., Annual Credit Sales ÷ 365, 360 or 300)
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Inventory Turnover Ratio
Inventory Turnover Ratio =
Cost of Goods Sold / Average Inventory
* If inventory turns over too much then it might mean that we do not have enough inventory to satisfy customers. It is impacted by the inventory valuation (FIFO, LIFO, etc.)
80
Days Sales in Inventory
Days Sales in Inventory =
| 365, 360 or 300 / Inventory Turnover
81
Days Sales in Inventory
Days Sales in Inventory =
| Average Inventory / Average Daily Cost of Sales (i.e., Annual Cost of Sales ÷ 365, 360 or 300)
82
Accounts Payable Turnover Ratio
Accounts Payable Turnover Ratio =
Annual Credit Purchases / Average Accounts Payable
We have more control over this ratio.
83
Operating Cycle
Operating Cycle = Days Sales in Receivables + Days Sales in Inventory
operating cycle is the length of time it takes to convert an investment of cash in inventory back into cash (through collections of sales).
From buying the inventory to collection the cash. We want this to be as short as possible.
84
Cash Cycle
Cash Cycle = Days Sales in Receivables + Days Sales in Inventory – Days Purchases in Payables.
Time from payment until cash collected from customer. We want this time to be as short as possible. If negative we collect cash from customer before paying supplier.
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Income Available to Common Shareholders (IAC)
Net Income
− Noncumulative preferred dividends DECLARED
− Cumulative preferred dividends EARNED
= Income Available for Common Shareholders (IAC)
Cumulative preferred dividends are subtracted in the year they are earned whether or not they are declared and paid in that year. If cumulative preferred dividends are not paid in the year they are earned but are paid in a future year, they are not subtracted in the future year when they are paid, because they have already been subtracted in the year they were earned.
86
Return on assets formula:
Profit margin on sales
Asset turnover
Profit margin on sales is net income divided by sales.
asset turnover is sales divided by total assets. Return on assets is equal to the profit margin on sales multiplied by the asset turnover. Return on assets is also equal to net income divided by total assets.
ROA = (Net Income / Sales) x (Sales / Total Assets)
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Limitations to the information provided on the statement of financial position:
1) judgments and estimates used regarding the collectibility, salability, and longevity of assets,
2) lack of current valuation for most assets and liabilities.
3) omission of items that are of financial value to the business such as the worth of the employees.
88
Return on Equity
Net Income / Average Total Equity
```
Total equity is:
Common Stock
+ Reserve for bond retirement
+ Retained earnings payable
+ *Reserve for bond retirement is an equity account
=Total Equity
```
*The reserve for bond retirement account is an appropriation of retained earnings. All retained earnings start out classified as Unappropriated Retained Earnings.
"Unappropriated" means that the dividends are available to be distributed to shareholders in the form of dividends. Occasionally, however, a company does not want to distribute its retained earnings and this can be communicated to the shareholders (and potential shareholders) through the process of appropriating retained earnings.
89
The degree of total leverage:
The degree of total leverage is equal to the degree of operating leverage times the degree of financial leverage. Thus, a decrease in either of these ratios results in a decrease in total leverage. If the company had no preferred stock, the DFL and the DTL would be lower because the pretax income necessary to pay the preferred dividends [PI (1 -T)] is subtracted from the denominator of the DFL.
The formula for Degree of Operating Leverage is: % Change in EBIT / % Change in Revenue (Sales), (or alternatively, Contribution Margin / EBIT). So if the Degree of Operating Leverage is 3, then the percentage of change in the numerator of that formula must be 3 times as great as the percentage of change in the denominator. Therefore, a 1% increase in revenue
(i.e., sales) causes a 3% increase in EBIT.
90
The definition of a foreign entity's functional currency:
The definition of a foreign entity's functional currency is that it is normally the currency in which the entity generates and expends cash. If a company generates and expends cash in one currency only, then its purchases and its sales will not be subject to exchange rate risk. Furthermore, a company that operates only in the currency of its own economy will find that its selling prices are determined by its local market or its local government's regulations. In this case, the entity's functional currency should be the currency it buys and sells in, and that will be its local currency.
On the other hand, if the entity's sales prices are determined more by worldwide competition or by international prices, that is an indication that it may be buying and selling goods in currencies other than its own currency. And when the foreign entity is buying and selling goods in currencies other than its own currency, then the FASB Accounting Standards Codification recommends that its functional currency be designated as the U.S. parent's currency and not the foreign entity's local currency. The reason for this is that the foreign entity is not operating in its local currency only. It is operating in multiple currencies. Therefore, since it is necessary to choose one currency to be the functional currency, it is better to just make the functional currency the U.S. dollar. That limits the number of currency conversions that are necessary to convert the entity's financial statements into the parent's currency, which is assumed to be the U.S. dollar.
Therefore, when sales prices are influenced by changes in the exchange rate between the dollar and the foreign currency, this is an indication that the foreign entity is operating in multiple currencies, and thus the dollar is the functional currency. Note that this is an indication and this is not the strongest indication that could exist, but it is the best of the choices provided.
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When financial leverage is being used:
When financial leverage is being used, an increase in Earnings Before Interest and Taxes (EBIT) will cause an even greater increase in net income, and a decrease in EBIT will cause an even greater decrease in net income. EPS is simply net income per share, so we can say the same thing about EPS as we say about net income, although we do need to change it a little because EBIT is for the company as a whole, whereas EPS is a per share amount. When financial leverage is being used, an increase in EBIT will cause an even greater proportionate increase in EPS, and a decrease in EBIT will cause an even greater proportionate decrease in EPS.
92
Depreciation expense is calculated:
Depreciation expense is calculated as follows: The Accumulated Depreciation account had a balance of $70,000 CR at the end of the previous year. When the old equipment was sold, it had a cost of $60,000 and a net carrying value of $53,000. Therefore, the accumulated depreciation assigned to that asset was $7,000 at the time of sale. When the old equipment was sold, the accumulated depreciation assigned to it was reversed, resulting in a debit of $7,000 to the Accumulated Depreciation account. The new balance in the Accumulated Depreciation account after the sale of the equipment was recorded was $63,000 CR. Since the balance in the Accumulated Depreciation account was $83,000 at the end of the current year, depreciation expense recorded for the year must have been $20,000 ($83,000 - $63,000).
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The company that has been conservatively managed:
The company that has been conservatively managed, is shown by its high times interest earned, return on assets and current ratios and low debt/equity ratio and degree of financial leverage compared to its competitor. These ratios all indicate that a company maintains a high level of liquid assets along with a low level of debt. However, they also indicate that a company may not have been aggressive enough in seeking financing to expand its product line, and that could be the reason its competitor has been introducing new products more quickly. The company has room to increase its financial leverage and debt/equity ratio somewhat by seeking outside financing for some new product introductions.
94
The major distinction between the multiple-step and single-step income statement formats:
The major distinction between the multiple-step and single-step income statement formats is how operating and non-operating data is separated. In the single-step format all revenues and gains are put together and all expenses and losses are reported together. In the multiple-step format, individual classes of operating revenues and expenses are reported and after this, all other gains and losses are reported.
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Miscellaneous or non-recurring income:
Miscellaneous or non-recurring income would not be included in operating profit or gross profit, so it would not affect the operating profit margin or the gross profit margin. It would affect the debt-to-equity ratio only minimally (through year-to-date net income to be transferred to retained earnings) because it is an income statement item. Net profit margin would be most affected by miscellaneous or non-recurring income.
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Statement of Cash Flows – Operating Activities
```
Receipts from customers and payment to suppliers
Interest Paid
Interest Received
Dividends Received
Cash Paid for Taxes
Tax Refunds
Trading Securities (Purchase and Sell)
```
97
Statement of Cash Flows - Financing Activities
```
Issuing Stock
Treasury Stock Reissue and Repurchase
Paying Dividend
Issuing Debt (Bonds)
Obtaining and Repaying Loans
```
* Fixed assets, loans, stock, debt, investments
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Statement of Cash Flows – Investing Activities
Purchase and Sell of Fixed Assets
Loaning Money and Collecting Loans
Stock of Other Companies (Purchase and Sell)
Acquiring and Disposal of Debt
Available for Sale or Held to Maturity Securities
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A change in the estimate for bad debts
A change in the estimate for bad debts is a change of accounting estimate. Changes in accounting estimates are made prospectively. That is, no change is made to previously reported results or to opening balances. No attempt is made to "catch up" for prior periods. Instead, the effect of all changes is accounted for in (a) the period of change if the change affects that period only; or (b)the period of change and future periods if the change affects both. A change in the estimate for bad debts would be accounted for in the period of the change only, as the change would affect only that period.
100
In order to understate the days' sales-in-receivables ratio:
The days' sales-in-receivables ratio is calculated as the days in the year divided by the receivables turnover ratio. The receivables turnover ratio is calculated as sales divided by average receivables. In order to understate the days' sales-in-receivables ratio, either the sales need to be understated or the receivables turnover ratio needs to be overstated. If the company uses the natural business year for its accounting period, the accounts receivable balances will be understated. This is because the natural business year will start
and end at the down cycle of the business, understating receivables. Because the receivables will be understated, the receivables turnover will be higher than it would be otherwise. This will lead to an understated days' sales-in-receivables ratio.
101
To determine the operating cycle for a wholesaler, which one of the following pairs of items is needed?
Accounts receivable turnover and inventory turnover.
The operating cycle is the length of time it takes to convert an investment of cash in inventory back into cash (through collections of sales). It is calculated as the days sales in inventory + days sales in receivables. Both of these amounts can be calculated from the information provided in this choice.
102
The sale of available-for-sale securities should be accounted for on the statement of cash flows as a(n):
Investing activities are those activities that the company undertakes to generate a future profit, or return, such as purchasing and selling fixed assets, purchasing and selling stock of other companies, purchasing and selling debt instruments, and purchasing and selling available-for-sale or held-to-maturity securities.
Therefore, the sale of available-for-sale securities should be classified on the statement of cash flows as an investing activity. According to the FASB Codification, Paragraph 230-10-45-11, "Cash flows from purchases, sales, and maturities of available-for-sale securities shall be classified as cash flows from investing activities and reported gross in
the statement of cash flows."
103
When compared to a debt-to-assets ratio, a debt to equity ratio would:
Because the asset balance of a company is higher than its equity, a debt-to-equity ratio will be higher than a debt-to-asset ratio. This is because when equity is used in the
denominator, the denominator will be smaller than when assets are used in the denominator. We know that the assets of the company must be higher than the equity of the
company because of the accounting equation of assets = liabilities + equity.
104
In reconciling net income on an accrual basis to net cash provided by operating activities, what adjustment is needed to net income because or (1) an increase during the period in prepaid expenses and (2) the periodic amortization of premium on bonds payable?
Only the direct method of preparing the Statement of Cash Flows requires a reconciliation between net income and net cash flows from operating activities. This reconciliation is
exactly the same as the net cash flows from operating activities as it is presented under the indirect method.
Under both the indirect method and in the reconciliation required under the direct method, an increase in an asset account must be subtracted from net income because it represents cash paid out that is not on the income statement. Therefore, the increase in prepaid expenses will be a deduction from net income to reconcile net income to cash flow from operating activities. The amortization of premium on bonds payable reduces interest expense and thus it increases net income without increasing cash. Therefore, it will
also need to be deducted from net income in the reconciliation.
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A company doing business in a country experiencing significant inflation, its method of inventory costing from first-in, first-out (FIFO) to last-in, first-out (LIFO) would have what effect changing from FIFO to LIFO have on the current
ratio and the inventory turnover ratio?
The current ratio is Current Assets / Current Liabilities. If the company changes from FIFO to LIFO during a period of inflation, inventory will decrease because the inventory on the
balance sheet will consist of units purchased or manufactured first, when the costs were lower. When Inventory decreases, Current Assets will decrease as well. If the numerator of the current ratio decreases while the denominator stays the same, the Current Ratio will decrease.
The inventory turnover ratio is Annual COGS/ Average Inventory. If the company changes from FIFO to LIFO during a period of inflation, inventory will decrease and COGS will increase. COGS will increase because the units sold will be the last units purchased, when costs were higher. If the numerator of the inventory turnover ratio increases and the denominator decreases, the
inventory turnover ratio will increase.
106
Economic profit is calculated:
```
Economic profit is calculated as follows:
Revenue
- Explicit Costs
- Implicit Costs
= Economic Profit
```
Implicit costs are the opportunity costs of the assets that are used in the operation of the business.
107
When using the indirect method to prepare the statement of cash flows, the impairment of goodwill should be presented as a(n).
The impairment of goodwill is an adjustment to net income, and it needs to be added to net income. This is because the impairment of the goodwill reduced the net income of the company, but since it was not paid out in cash, it needs to be added back in to determine cash flows.
108
The gain on the sale of the plant asset is:
The gain on the sale is included in the proceeds from the sale of the assets, so if we were to include it in cash flows from investing activities, we would be counting it twice. The amount of the gain is an adjustment in the operating activities section of the statement of cash flows.
109
The dividend yield is calculated as the cash dividend per share divided by the market price per share.
The dividend yield is calculated as the cash dividend per share divided by the market price per share. Assume that the P-E ratio is made up of a $12 market price and $1 of earnings. This gives us the P-E ratio of 12. The payout ratio tells us what percentage of earnings were distributed as cash, and since it is .6, in this example $.60 would have been distributed to the shareholders. We
now know the necessary information to calculate the dividend yield. The market price is $12 and the cash dividend was $.60. $.60 divided by $12 equals a dividend yield of 5%.
110
The accounts payable turnover ratio:
The accounts payable turnover ratio is total annual credit purchases divided by average accounts payable. We can calculate the average accounts payable from the information given as the average of the beginning and ending accounts payable balances ([$3,320 + $3,680] + 2 = $3,500). Purchases for a reseller (retailer) can be approximated by adjusting cost of goods sold by the amount of change in inventory. However, that cannot be used for a manufacturer. We are not told whether this company is a retailer or a manufacturer, so it would not be a good idea to assume that it is a retailer. We need to work with what we have, and the only thing we have to use is cost of goods sold. So we will use cost of goods sold in the place of purchases.
This is total credit sales divided by average accounts payable.
111
The ratio that measures a firm's ability to generate earnings from its resources is:
Asset turnover is calculated as sales divided by total assets and is a measure of the company's ability to generate earnings from all of its resources.
112
Under the indirect method of reconciling the statement of cash flows:
Increases in operating asset accounts and decreases in operating liability accounts and gains from investing and financing activities are deducted
from net income. The amortization of bond premium is in essence the amortization of a gain. It decreases interest expense on the income statement, even though it is a non-cash
transaction. Since it decreases interest expense, it increases net income, so it should be deducted from net income in the preparation of the operating section of the statement of
cash flows, because it does not represent any cash received.
113
When the company makes a new investment in an asset :
When the company makes a new investment in an asset that is financed by debt, total assets will increase. When total assets increases, average total assets will also increase. Because the numerator of the Total Asset Turnover ratio remains the same while the denominator increases, the Total Asset Turnover will decrease. Return on Assets is net income divided by average total assets. Return on Assets will decrease also because net income in the numerator will remain the same while average total assets in
the denominator increases.
114
The cash ratio is
The cash ratio is:
| Cash + Cash Equivalents + Short-Term Securities / Current Liabilities
115
The cash ratio is
The cash ratio is:
Cash + Cash Equivalents + Short-Term Securities
Owned / Current Liabilities
116
The correct method of reporting a change to the first-in, first-out method of inventory valuation on the financial statements is:
A change from one inventory cost flow assumption to another is a change of accounting principle. According to the FASB Codification 250-10-45-5, a change of accounting principle shall be reported through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so. Retrospective application requires all of the following:
a.) The cumulative effect of the change to the new accounting principle on periods prior to those presented shall be reflected in the carrying amounts of assets and liabilities as of the
beginning of the first period presented.
b.) An offsetting adjustment, if any, shall be made to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial
position) for that period.
c.) Financial statements for each individual prior period presented shall be adjusted to reflect the period-specific effects of applying the new accounting principle.
117
Weighted Average Cost of Capital
Total cost of Financing / Total Fair Value of Financing
118
Cost of Debt
Cost of Debt= C (1-t)
119
Effective Interest Rate for the first year only
Interest Expense / Cash Received from the sale of bonds
120
Dividend Growth Model- Cost of Retained Earnings
Cre = d1 / + g
P0
Cre = Cost of retained earnings, expressed as a percentage
d1 = The next dividend that is to be paid (last year’s dividend multiplied by 1 + the annual expected % growth in dividends)
P0 = Common stock price today
g = The annual expected % growth in dividends
121
Capital Asset Pricing Model (CAPM)
r = rF + β(rM – rF)
```
r = Cost of Retained Earnings (based upon investors’ required rate of return)
rF = Risk-free rate of return
β = Beta coefficient
rM = Market rate of return
```
122
Market risk premium
market risk premium (rM – rF) measures the additional return (above the risk-free rate) that investors demand in order to move investments into the stock market, which is obviously riskier than the bond market.
123
Beta coefficient
beta coefficient represents the correlation between the expected returns of a given stock vs. the expected return of the average stock in the market as represented by some index of market activity such as the S&P 500.
* A beta that is over 1.0 means the stock has historically been more volatile (riskier) than the market. Its price moves more (both up and down) than the market moves.
* A beta of less than 1.0 but greater than zero means the stock has historically been less risky than the market. Its price moves less (up and down) than the market moves.
* A risk free asset has a beta of 0.
* A negative beta (less than zero) means the stock has historically moved counter to the market. When the market has moved up, the stock price has gone down, and vice versa.
* A beta of exactly 1.0 means the stock has historically moved in exactly the same direction and in exactly the same amount as the market has moved. That is not likely to occur in an individual stock. However, it is important to know that the beta of the market as a whole is 1.0.
124
Arbitrage Pricing Theory (APT)
r = rf +β1k1 + β2k2 + β3k3
```
R = Expected rate of return
rf = Risk-free rate
β1,2,3 = Individual factor beta coefficients
k1,2,3 = Individual factor risk premiums (Required Returns for factor – rf)
```
125
Dividend Growth Model- Cost of New Shares
Cns = d1 / + g
Pn
Cns = Cost of new shares, expressed as a percentage
d1 = The next dividend that is to be paid (last year’s dividend multiplied by 1 + the annual expected % growth in dividends)
Pn = Net proceeds of the issue (selling price minus costs)
g = The annual expected % growth in dividends
126
Dividend Growth Model- Cost of New Shares
Cns = d1 / + g
Pn
Cns = Cost of new shares, expressed as a percentage
d1 = The next dividend that is to be paid (last year’s dividend multiplied by 1 + the annual expected % growth in dividends)
Pn = Net proceeds of the issue (selling price minus costs)
g = The annual expected % growth in dividends
127
Weak-form efficiency
Weak-form efficiency says that market prices of securities reflect all historical information: price movements and trading volume, and that investors will not be able to “beat the market” by basing their analysis and strategy solely on past price movements.
128
Semi-strong-form efficiency
Semi-strong-form efficiency says that security prices reflect not only historical price and trading volume information but also all other published information.
129
Strong-form efficiency
Strong-form efficiency suggests that security prices reflect all possible information, including the private information known only to insiders.
130
Weak-form efficiency
Weak-form efficiency says that market prices of securities reflect all historical information: price movements and trading volume, and that investors will not be able to “beat the market” by basing their analysis and strategy solely on past price movements.
131
Semi-strong-form efficiency
Semi-strong-form efficiency says that security prices reflect not only historical price and trading volume information but also all other published information.
132
Strong-form efficiency
Strong-form efficiency suggests that security prices reflect all possible information, including the private information known only to insiders.
133
Past patterns in prices and trading volume.
Investors may try to analyze past price movements in order to improve their returns today. This is the type of analysis done in technical analysis.
134
All other published information
All other published information. This is all the information that investors can gain by reading financial news, such as earnings announcements, new stock issues, mergers, new products, and other news such as economic news. Stock analysts use this information to perform fundamental analysis on securities.
135
Private or inside information.
Private or inside information. Board members, senior managers, and some employees of a publicly-held company may have access to inside information before it is released to the public, such as information about earnings or about a pending merger.
136
Firm commitment
the underwriter agrees to purchase the entire issue and absorb any securities that they are not able to resell, the investment bank is assuming all the risks associated with the issue and the underwriter receives a sizable fee for assuming the risk.
137
Best Efforts Issue
the underwriter's agreement may provide that the investment banker will act as an agent rather than as a principal and will simply market the new issue without underwriting it. The lead manager acts only as an agent, agreeing to sell as many shares as possible, but it does not guarantee any sale price for the company and it does not purchase the shares itself for resale.
138
All-or-None Issue
a corporation may need to raise a specific amount of capital to satisfy business needs. It would not be able to use a lesser amount, and therefore specifies that either all of the issue is sold or the distribution is to be cancelled.
139
A residual dividend policy
A residual dividend policy is one in which a dividend will be paid only if the funds are not needed for investment. This is considered a passive dividend policy.
140
Depreciation Tax Shield
Depreciation expense is a tax deductible expense. The amount of tax deductible depreciation will cause an equal reduction in the company’s taxable income. That will, in turn, cause a reduction in the amount of tax that will be due. The amount of tax savings that results is called the depreciation tax shield.
