Multiple Choice
What is a collection of stocks used to track the performance of sectors of the market called?
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7. Receivables and Investments
Introduction to Investments in Securities
Struggling with Financial Accounting?
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In the context of investments in securities, investors typically assess expected cash flows before making investment decisions. What is the primary reason for this assessment?
A
To determine the historical cost of the security
B
To comply with tax regulations
C
To estimate the potential return and risk associated with the investment
D
To calculate the book value of the investment
Verified step by step guidance1
Understand the concept of expected cash flows: Expected cash flows represent the anticipated inflows and outflows of money associated with an investment over a specific period. Investors use this information to evaluate the financial viability of the investment.
Recognize the purpose of assessing expected cash flows: The primary reason for this assessment is to estimate the potential return (profit) and risk (uncertainty) associated with the investment. This helps investors make informed decisions about whether the investment aligns with their financial goals and risk tolerance.
Eliminate irrelevant options: The historical cost of the security refers to its original purchase price, which is not determined by expected cash flows. Similarly, compliance with tax regulations is a separate consideration and does not directly involve assessing expected cash flows. Calculating the book value of the investment pertains to accounting records and is unrelated to the estimation of returns and risks.
Focus on the correct answer: The correct answer is 'To estimate the potential return and risk associated with the investment,' as this aligns with the purpose of analyzing expected cash flows in investment decision-making.
Apply this understanding to real-world scenarios: Investors often use tools like discounted cash flow (DCF) analysis or net present value (NPV) calculations to quantify expected cash flows and assess the attractiveness of an investment opportunity.
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