65- Sec. 10: Analytical Methods

Book value per share

(Tangible assets-liabilities-par value of preferred)/shares of common stock outstanding Does NOT use intangible assets like patents and copyrights since this is about liquidity

quick asset ratio (acid test)

(current assets-inventory)/current liabilities OR Sum of current assets EXCEPT inventory divided by current liabilities

1 2 & 3 standard deviations

68.3%, 95.5% & 99.7%

A portfolio manager who is successful at market timing will A) increase the beta of the portfolio in advance of a rising market B) have a portfolio beta less than the beta required by the client C) increase the beta of the portfolio in advance of a declining market D) decrease the beta of the portfolio in advance of a rising market

A A portfolio manager expecting a rising market would want to take advantage of that by increasing the beta of the portfolio. This would have the effect of increasing the potential volatility of returns. When things are going good, you want to be in higher beta stocks.

Which of the following attributes of common stock best describes why internal rate of return (IRR) is not generally used to determine the return on common stock? A) Uneven cash flows, no maturity, date, and price B) Uneven cash flows and no maturity C) Uneven cash flows D) No net present value

A Internal rate of return (IRR) best measures investments with a known price and maturity. The internal rate of return is the discount rate that makes the future value of an investment equal to its present value. The yield to maturity on a bond is actually its internal rate of return.

Which of the following rates of return is used by investment professionals as the risk-free rate? A) 91-day Treasury bill rate B) Prime rate C) Federal funds rate D) Discount rate

A The interest rate used as the basis for a risk-free rate of return is the 91-day Treasury bill rate. T-bills are U.S.-government guaranteed, the rate is short-term, and the market risk is minimal.

Earnings Per Share (EPS)

A measure of the net income earned on each share of common stock =earnings available to common/number of shares outstanding Relates to common stock ONLY. Preferred stockholders have no claims to earnings beyond the stipulated preferred stock dividends

Current Yield (Dividend Yield)

Annual dividend per common share / Market value per common share

An analyst attempting to determine the extent to which financial leverage is being employed by a company would examine the company's A) book value per share B) debt-to-equity ratio C) acid-test ratio D) working capital

B Financial leverage is the use of debt capital. The best way to see the extent to which that exists is through the debt-to-equity ratio.

Investment risk may broadly be categorized as either unsystematic or systematic risk; both types of risk together constitute total, or absolute, risk. Total risk is measured by A) opportunity cost. B) standard deviation C) correlation coefficient. D) beta coefficient.

B Unlike beta, which only measures systematic risk, standard deviation reflects both systematic and unsystematic risk, revealing the total risk of the investment. U10LO5q

A stock traded on the Nasdaq Stock Market has a beta of 1.20. One could expect that the stock's volatility compared to the S&P 500 would be A) negatively correlated to the S&P B) too variable to tell C) 20% more volatile D) 20% less volatile

C Beta is a measurement of a security's volatility when compared with the overall market, best measure by the S&P 500. The "market" is assigned a beta of 1.00, so when the beta is higher than 1.00, the stock has greater volatility and when lower than 1.00, the volatility is less.

Which of the following items would be included in a current ratio computation? A) Inventory, equipment, and cash B) Cash, dividends payable, and shareholders' equity C) Accounts payable, wages payable, and short-term debt D) Accounts receivable, inventory, and long-term debt

C Current ratio is computed by dividing current assets by current liabilities. Current assets include cash, accounts receivable, and inventory. Current liabilities include accounts payable, wages payable, dividends payable, and short-term debt. Equipment is a fixed asset, and shareholders' equity is net worth. U10LO7

Which of the following securities has an easily determinable internal rate of return? A) 7% corporate bond B) 6% Ginnie Mae C) Zero-coupon bond D) 5% municipal bond

C The only security that does not have reinvestment risk (the risk that periodic interest payments cannot be reinvested at the same yield as the bond providing the interest payments) is a zero-coupon bond such as Treasury STRIPS. With a zero-coupon bond, there are no periodic interest payments to reinvest, so a yield can be locked in. The interest rate that discounts the redemption price (par) to the discounted purchase price is the locked-in yield, which is the same as the internal rate of return, also referred to as the yield to maturity.

A bond's yield to maturity reflects its A) taxable equivalent return B) return based on annual interest as a percentage of current price C) nominal return D) internal rate of return

D

The present value of a dollar A) is the amount of goods and services the dollar will buy in the future at today's rate price level B) is equal to its future value if the level of interest rates stays the same C) cannot be calculated without knowing the level of inflation D) indicates how much needs to be invested today at a given interest rate to equal a specific cash value in the future

D

Securities analysts would agree that it makes sense to purchase a fixed-income security when its net present value (NPV) is A) variable B) zero C) negative D) positive

D A positive NPV means the security is available for a price below its present value—it is a good buy. With a negative NPV, the price is too high. With a zero NPV, it is accurately priced.

The price-to-earnings ratio A) indicates current cash flows B) reflects how liberal the company's dividend policies are C) is higher for value stocks than for growth stocks D) shows how much investors value the stock as a function of earnings to the company's market price

D The 2 components of the price-to-earnings ratio are the current market price and the earnings per common share. When a company has a high P/E ratio, it means that investors are placing greater value on expected growth in earnings. That is one of the reasons why growth stocks carry higher P/E ratios than do value stocks. U10LO7

If stocks market price and PE ratio is know, EPS can be calculated as:

EPS=current market price of common stock/PE ratio

Income in Perpetuity

For when people say they want to provide an annual income "forever" for a relative Take the desired annual income and divide it by the rate of return. This will give you the lump sum required to get that income

Dividend payout ratio

Measures the proportion of earnings paid to stockholders dividends Annual dividend per common share / earnings per share

Price to Earnings Ratio (P/E)

Provides a rough idea of the relationship between the prices of different stock compared with the earnings that accrue to one share of stock current market price per common share/earnings per share

earnings available to common stockholders

Remaining earnings after the preferred dividend has been paid.

difference between PV and NPV

The initial cash outlay NET means something is subtracted. The number that is subtracted is the initial cost of the investment

Rule of 72

The number of years it takes for an investment to double in value is equal to 72 divided by its annual rate of interest. Ex: investment of 2000 earning 6% will double in 12 years (72/6=12) Also works in reverse: if you know the number of years you have, you can compute the required earnings rate to double by using 72 Ex: you have 9 years before your child begins college, what will you have to earn in order for a deposit mode today to double? 72/9= 8% earnings rate will double your money

Beta

Used to measure the variability between a particular stock's movement and that of the market in general -stock w/ beta 1.00= similar risk to the market as a whole -stock w/ beta 1.50= more volatile than market -stock w/ beta .70= less volatile than market -Can also have a negative beta --if stock has a -1.2, a 10% move up in market's return will cause the stock return to decline by 12%

Future Value

What the amount invested today will be worth in the future FV= PV x (1+r)^n

working capital

amount of liquid capital or cash a company has available =current assets - current liabilities

gross profit =

net sales - cost of goods sold

Current ratio

ratio of assets to liabilities Divide assets by liabilities Higher the ratio, the more liquid the company is

Examples of negatively correlated assets

stocks in gold industry Bonds

Present Value

the amount of money you would need to deposit now in order to have a desired amount in the future PV= FV/(1+r)^n

Net Present Value (NPV)

the difference between an investment's market value and its cost Computed by subtracting the market price from the PV

standard deviation

volatility of an investments projected fee returns -higher the SD=higher the risk because there is more volatility

alpha

-how did the investment do in comparison to what was anticipated -positive: Outperforming the market -negative: Underperforming (portfolio return-risk free rate) - (beta(Market return - risk free rate))

correlation coefficient

-ranges from -1 to +1 -perfectly correlated = +1 -unrelated = 0 -negative correlation= -1

factors that decrease working capital include increasing liabilities such as:

-declaring cash dividends -paying off long term debt whether if called at maturity or if called earlier -net operating losses

Factors that increase working capital include increases in cash from:

-issuing securities (long term debt or equity) -profits from the business operations -sale of noncurrent assets, such as equipment no longer in use

If the required rate of return is less than anticipated in a present value calculation, the effect would be that the A) present value would be higher B) present value would be lower C) future value would be lower D) yield to maturity (YTM) would decrease

A The present value computation is used to determine how much money must be deposited now (present) to reach a specified future goal when you know how many years you have to reach that goal. One critical component of the formula is the rate of return used in the formula. As a simple example, if you need $100,000 18 years from now for your newborn's college education and you expect to earn 8%, you'll have to deposit approximately $25,000 now (present value) to reach the goal. However, if it turns out that the earnings rate is less than anticipated, say only 4%, then you would have to deposit twice as much presently. Therefore, we answer this question by indicating that a lower rate of return will require a higher present value.

Fundamental analysts give significant credence to financial ratios. Which of the following tends to give an indication of the profitability of the enterprise? A) Current ratio B) Price-to-earnings ratio C) Sales-to-earnings ratio D) Debt ratio

C The sales-to-earnings ratio compares the net sales of the business with its earnings. Companies with a higher percentage of earnings from each dollar of sales are more profitable.

Internal Rate of Return (IRR)

the discount rate that makes the NPV of an investment zero