IMC Economics and Accounting 2 — Questions and Answers
Question 1: What does the price-to-earnings (P/E) ratio indicate about a company's shares?
- The company's total debt relative to equity
- How much investors are willing to pay per pound of earnings (Correct answer)
- The dividend paid per share
- The company's operating cash flow per share
Correct answer: How much investors are willing to pay per pound of earnings
The P/E ratio divides the current share price by earnings per share, showing how much investors are prepared to pay for each pound of the company's earnings. A higher P/E may suggest investors expect higher future growth.
Question 2: In the context of monetary policy, what is 'quantitative easing' (QE)?
- Raising interest rates to control inflation
- The central bank purchasing government bonds to inject money into the economy (Correct answer)
- Reducing government spending to lower the deficit
- Increasing the reserve requirements for commercial banks
Correct answer: The central bank purchasing government bonds to inject money into the economy
Quantitative easing involves the central bank (Bank of England) creating new money electronically to purchase government bonds and other securities. This increases the money supply, lowers long-term interest rates, and encourages lending and investment.
Question 3: Which financial statement shows a company's financial position at a specific point in time?
- The income statement
- The cash flow statement
- The statement of financial position (balance sheet) (Correct answer)
- The statement of changes in equity
Correct answer: The statement of financial position (balance sheet)
The statement of financial position (balance sheet) provides a snapshot of a company's assets, liabilities, and equity at a specific date. Unlike the income statement and cash flow statement, which cover a period, the balance sheet reflects a moment in time.
Question 4: What is the effect of depreciation on a company's financial statements?
- It increases cash flow from operations
- It reduces the carrying value of an asset and is charged as an expense (Correct answer)
- It increases the value of assets on the balance sheet
- It has no impact on the income statement
Correct answer: It reduces the carrying value of an asset and is charged as an expense
Depreciation systematically allocates the cost of a tangible asset over its useful life. It reduces the asset's carrying value on the balance sheet and is recorded as an expense on the income statement, reducing reported profit but not affecting actual cash flow.
Question 5: A recession is technically defined in the UK as:
- A single quarter of negative GDP growth
- Two consecutive quarters of negative GDP growth (Correct answer)
- An increase in the unemployment rate above 5%
- A fall in the FTSE 100 index of more than 20%
Correct answer: Two consecutive quarters of negative GDP growth
A technical recession in the UK is commonly defined as two consecutive quarters (six months) of negative GDP growth. A single quarter of contraction alone does not meet this threshold.
Question 6: Which of the following would increase a company's return on equity (ROE)?
- Issuing new shares at a premium
- Increasing net profit while shareholders' equity remains constant (Correct answer)
- Paying a special dividend from retained earnings
- Revaluing fixed assets upwards
Correct answer: Increasing net profit while shareholders' equity remains constant
ROE = Net Profit / Shareholders' Equity. Increasing net profit while equity stays the same directly increases the ratio. Issuing new shares increases equity (denominator), which would reduce ROE. While paying dividends reduces equity, it doesn't increase net profit.
IMC Economics and Accounting 2
What does the price-to-earnings (P/E) ratio indicate about a company's shares?