FIN 492 Exam 2

Price given Future earnings (e) Past earnings (p) Past dividend (d) Required Return (r) Expected sell (s)

((p/d)*e)/(1+r) + s/(1+r)

Trailing PS Multiple

(1+Growth)*(Profit Margin)*(Payout Ratio) / (COE - Growth)

Forward PS Multiple

(Profit Margin * Payout Ratio) / (COE - Growth)

Trailing Price Book Multiple

(ROE * Payout) / (COE - Growth)

Tax Cost

1 - ((1 + Tax) / (1 + Pre Tax))

Payout Ratio

1 - RR

Active

Attempts to outperform a passive benchmark portfolio on a risk adjusted basis by seeking the "alpha" value

Top-Down

Broad country and asset class allocations Sector allocation decisions Individual securities selection

Sampling

Buys a representative of stocks in a benchmark index, could see tracking error

Price given dividend

Dividend / (Required Return - Growth)

FCFE

EPS * Payout Ratio

No Growth Value

EPS / Cost of Equity

Intrinsic Value

EPS(1-RR) / (Cost of Equity - Growth Rate) Growth = ROE x RR

Optimal Portfolio

ER - (sd^2 / Risk Tolerance)

Bottom-Up

Emphasizes market selection of securities without any initial market or sector analysis Form a portfolio that can be purchased at a substantial discount to what his or her valuation model indicates they are worth

A resistance level is the price range at which the technician would expect an increase in the demand of stock and a price reversal.

False

Even when fees and costs are considered, most mutual fund managers outperform the aggregate market.

False

Fundamentalists (those who support fundamental analysis) contend that past price movements will indicate future price movements.

False

In the context of discounted cash flow based valuation, FCFF and FCFE require the use of the same discount rate.

False

Tests have shown that if small filters are used in simulating trading rules, these trading rules have produced above average returns after transactions costs are factored in.

False

The weak form of the efficient market hypothesis (EMH) contends that stock prices fully reflect all public and private information.

False

The weak-form efficient market hypothesis assumes all publicly available information is reflected in current stock prices.

False

Under the top down approach, an optimistic economic and stock-market outlook for a given country should lead to an underweighting of the allocation to that particular country in investment portfolio.

False

Value Investor

Focuses on share price in anticipation of market correction and possibly improving company fundamentals

Growth Investor

Focuses on the future economic story of the company and less regard to share valuation

Full Replication

Fully matches

Forward Price Book Multiple

Isn't calculated by analysts

Passive

Long-Term buy and hold Usually Tracks an Index Designed to match market performance Manager is judged on how well they track the index

Forward PE Multiple

Payout Ratio / (Cost of Equity - Growth)

PE

Payout Ratio / (Required Return - Growth)

Quadratic

Put into a computer program to try and minimize the tracking error

Cost of Equity

Risk Free Return + (Beta*Risk Premium)

Passive Trading

Risk-Free + Risk Premium

Active Trading

Risk-Free + Risk Premium + Alpha

Portfolio Turnover

Sales / Assets

In any multi-stage discounted cash flow based valuation, the terminal value captures the portion of the firm's value arising from its long-term, steady growth stage.

True

Technical analysts believe that security prices do not adjust rapidly.

True

Words to know

Time the equity market Shift funds amongst different equity sectors Stock picking Contrarian Investment Strategy Price Momentum Strategy Factor-Based Earnings Momentum Calendar-Related Anomalies Firm-Specific Attributes Active Share Statistic

"Quality financial statements" are those which are a good reflection of the firm's financial reality, and which do not use accounting tricks and one-time changes to make the firm appear strong that it really is.

True

A green (filled) candle stick chart has no "tails". This indicates that the highest price during the time period was the closing price.

True

An efficient capital market is one in which prices fully reflect all available information and rapidly adjust to new information.

True

An equity investor's required rate of return is influenced by the economy's real risk-free rate, the expected rate of inflation, and a risk premium.

True

An example of a relative valuation technique would be if the analyst estimated the value of a particular firm's stock by multiplying that firm's expected free cash flow per share by the industry average Price/Cash Flow ratio.

True

An overvalued investment is one which is so expensive that the investor will not receive a fair return if the investment is undertaken.

True

Because numerous investors believe in and use technical analysis, large investment firms provide extensive support for technical analysis, and a large proportion of the discussion related to securities market in the media is based on a technical view of the market.

True

Because technicians are suspicious of financial statements, they consider it advantageous not to depend on them.

True

Behavioral finance considers how various psychological traits affect how individuals or groups act as investors, analysts, and portfolio managers.

True

For technical trading rules to consistently generate superior returns, the market would have to be inefficient.

True

Fusion investing is the integration of two elements of investment valuation - fundamental value and investor sentiment.

True

Many analysts recommend that you should read an annual report "backward" - that is, you would read the footnotes first.

True

Non-operating assets are assets which are not directly required for the day to day operation of the firm, and which therefore do not contribute to the generation of the firm's Free Cash Flow.

True

One way to distinguish between the strategies adopted by various portfolio managers is to decompose the total actual return that the portfolio manager attempts to produce into a passive and an active component.

True

Results from studies on the effects of unexpected world events have consistently indicated that the price change is so rapid that it takes place between the close of one day and the opening of the next day.

True

Results of initial public offering (IPOs) studies tend to support the semi-strong EMH because it appears that prices adjusted rapidly after initial underpricing.

True

Studies of corporate insiders did not support the strong-form hypothesis.

True

The "random walk hypothesis" contends that changes in stock prices occur randomly, following no discernible pattern.

True

The two essential components that are required in order to carry out discounted cash flow based asset valuation are (1) the forecasted stream of expected cash flows and (2) the required rate of return.

True

The use of the sustainable growth rate equation to estimate the rate of potential corporate growth requires the assumptions that 1) the firm will keep its capital structure the same and 2) the firm is not becoming any more or less efficient.

True

The weak form of the efficient market hypothesis implies that technical trading rules should have little value.

True

When using a relative valuation technique, it is important to ensure that the analyst has identified an appropriate set of comparable entities.

True

Without access to superior analytical advice, you should run your portfolio like and index fund or an ETF.

True

Which of the following is a step in the "Three Step Process" of security valuation discussed in the textbook? a. Analysis of Alternative Economies and Security Markets b. Analysis of Alternative Industries c. Analysis of Individual Companies and Stocks d. All of the above

d. All of the above

Which of the following is not one of the four general categories of technical trading rules? a. Follow-the-smart-money tactics b. Contrary-opinion rules c. Stock price and volume techniques d. Follow through reversal triggers e. Momentum indicators

d. Follow through reversal triggers

The deconstruction of the Price/Sales ratio discussed in class and in the textbook reveals that investors should pay more for a company if it has which of the following? a. a higher profit margin b. more efficient operations c. less risky cash flows d. higher growth e. all of the above

e. all of the above

Abnormal rates of return (risk)

return for stock - (beta)(return for aggregate market)

Abnormal rates of return (no risk)

return for stock - return for aggregate market