Investment Principles 2

Based on the sustainable growth model, if a firm increases the dividend payout ratio, will this increase or decrease the growth in earnings per share in the future? Why or why not?

" The sustainable growth model looks at how much growth a firm can generate by maintaining the same financial relationships as the year before." pg 173-174 Review also the retention ratio info and formula for this question

What is the difference between a growth stock and a growth company?

"A growth stock may be defined as the common stock of a company generally growing faster than the economy or market norm. Growth companies, on the other hand, are those companies that exhibit rising returns on assets each year and sales that are growing at an increasing rate." pg 175-176 Put into your own words

A corporate bond quoted at 108.25 is selling for: A. $108.25. B. $1,082.50. C. $10,825. D. None of the above

$1,082.50. pg 299

The P/E ratio of a particular firm would probably be affected by which of the following? A. Investors' perception of the quality of the firm's management B. The firm's accounting practices C. Supply and demand for the security D. All of the above

? All of the above P/E ratio is influenced by - sales growth of the firm - risk or volatility in performance - debt-equity structure of the firm - dividend payment policy - quality of management - etc

The Oxford Fixed Income Fund invests heavily in bonds. If the fund manager thinks that interest rates are going to fall, what changes should she make in her investment portfolio? A. Increase investment in long-term bonds B. Increase investment in short-term debt instruments C. Increase investment in equity securities D. Buy callable bonds E. Buy real assets

?? Increase investment in long-term bonds pg 323-325 Expectations hypothesis ???

A down-sloping yield curve indicates: A. investors' anticipation of lower interest rates. B. investors' anticipation of lower inflation. C. that institutional investors are selling long-term bonds. D. More than one of the above

?? More than one of the above. pg 325

What effect, if any, will a decrease in interest rates have on bond values? A. Bond values will increase B. Bond values will decrease C. Bond values may increase or decrease, depending on the maturity, quality, and coupon rate D. None of the above

Bond values will increase

The general dividend valuation model assumes the investor knows the _______ and the discount rate. A. exact dividend to be paid in each and every year B. current year's dividend, the anticipated annual dividend growth rate C. investor's required rate of return D. book value per share of the company

exact dividend to be paid in each and every year

When should an investor calculate both yield to maturity and yield to call? A. Whenever there is a call provision B. When the sum of the present values of the interest payments exceeds the call price C. When the market price is greater than or equal to the call price D. Whenever the funds can be reinvested E. When interest rates increase above the coupon rate

When the market price is greater than or equal to the call price

The most widely used theory to explain the term structure of interest rates is the: A. liquidity preference theory. B. market segmentation theory. C. expectations hypothesis. D. interest allocation theory.

expectations hypothesis.

The major provisions in the bond agreement are spelled out in the bond debenture

false

A high P/E ratio calculated using the latest 12 months of earnings may be misleading A. in an inflationary economy. B. if the firm is in a cyclical industry, like automobiles. C. if the firm has a strong future growth rate. D. More than one of the above

if the firm is in a cyclical industry, like automobiles

If the equity risk premium (ERP) expands, Ke will: A. increase by beta times the equity risk premium. B. not be affected. C. go down. D. decrease by beta times the equity risk premium. E. increase by beta minus the equity risk premium.

increase by beta times the equity risk premium.

In general, the P/E ratio of a stock _______________ as inflation _____________. A. increases; decreases B. increases; increases C. decreases; decreases D. none of the above

increases; decreases

Beta measures: A. the relationship of the P/E ratio to the earnings growth rate. B. individual company stock price risk, relative to the market. C. the risk within a portfolio than cannot be diversified away. D. the stock price growth of one company compared to that of a second company.

individual company stock price risk, relative to the market.

The demand side of the bond market is dominated by A. the federal government. B. wealthy individual investors. C. institutional investors. D. None of the above

institutional investors pg 294

The upward slope of the yield curve is caused by investors' recognition of the relative difficulty of converting long-term securities to cash. This is the: A. expectations hypothesis. B. liquidity preference theory. C. market segmentation theory. D. More than one of the above

liquidity preference theory.

Municipal bonds normally pay: A. higher rates than taxable bonds. B. lower rates than taxable bonds. C. the same rate as taxable bonds. D. None of the above

lower rates than taxable bonds. pgs 290-290

What does beta represent?

measures individual company risk against the market risk A beta coefficient is a measure of the volatility, or systematic risk, of an individual stock in comparison to the unsystematic risk of the entire market pg 165 - put into own words

One basic problem with the application of the Capital Asset Pricing Model when computing Ke is that A. (Km- RF) is not observable in the market. B. the analyst needs to forecast dividends for next year. C. beta is a historical number. D. the risk-free rate changes every day.

(Km- RF) is not observable in the market.

A Treasury note normally has a maturity of: A. less than one year. B. 1 to 5 years. C. 1 to 10 years. D. 10 to 30 years. E. 30 to 100 years.

1 to 10 years.

Assuming interest rates are expected to fall, which of the following will most likely maximize price increase? A. Commercial paper B. U.S. Treasury bills C. 30-year corporate bonds D. There is not enough information to tell

30-year corporate bonds

Assets must be currently producing income in order to give a company value

False

The difference between a general obligation and a revenue bond is: A. the general obligation bond is backed by the full faith, credit, and "taxing power" of the governmental unit. B. that for a revenue bond, the repayment of the issue is fully dependent on the revenue-generating capability of a specific project or venture. C. that general obligation bonds are usually of high quality because of the taxing power behind most of them. D. All of the above

All of the above

The market segmentation theory focuses on: A. the impact of institutional investors on the yield curve. B. the maturity preferences of banks and those of life insurance companies. C. phases of the business cycle. D. All of the above

All of the above

The value of the price-earnings ratio is affected by: A. the earnings period used for its calculation. B. expected growth in earnings per share. C. overall conditions in the stock market. D. inflationary expectations. E. All of the above

All of the above

The value of the price-earnings ratio is affected by: A. the earnings period used for its calculation. B. expected growth in earnings per share. C. overall conditions in the stock market. D. inflationary expectations. E. All of the above

All of the above Pg 177-178 7-3. The price-earnings ratio is affected by the earnings used in the calculation, the expected growth of earnings, the overall conditions in the market, and inflationary expectations

The required rate of return is intended to provide A. compensation for expected inflation. B. a premium for risk assumed. C. a minimum real rate of return. D. All of the above

All of the above compensation for expected inflation, a premium for risk assumed, a minimum real rate of return.

P/E ratios are influenced by a company's A. growth rate. B. risk. C. capital structure. D. management. E. All of the above and more

All of the above and more

All of the following are available to individual investors except: A. commercial paper. B. bankers' acceptances. C. money market funds. D. All of the above are available to individual investors

All of the above are available to individual investors

Which of the following would most likely affect the P/E ratio of the market in general? A. A significant change in government fiscal policy B. Declining earnings of the S&P 500 companies C. Investors' expectations about inflation changes and becomes either more positive or more negative D. All of the above could have a significant impact.

All of the above could have a significant impact.

Studies generally show that the price-earnings ratio is a function of: A. expected changes in interest rates. B. future estimated growth of earnings for the individual company. C. expected changes in the required rate of return, Ke. D. All of the above impact price-earnings ratios

All of the above impact price-earnings ratios

The basis of stock valuation includes an analysis of A. economic variables. B. industry variables. C. financial statements. D. All of the following

All of the following

What formula measure would an investor use to calculate the yield on a 20-year bond with 10 years to maturity, if he or she only intends to hold the bond for 5 years? A. Anticipated realized yield B. Yield to call C. Current yield D. Yield to maturity E. Any one of the above will measure the yield

Anticipated realized yield

Which of the following statements about stock valuation based on asset value is NOT true? A. Natural resources often give a company value, even if an income stream is not produced B. The value of the assets may not even appear on the balance sheet C. Current assets are usually excluded from the valuation process, since they will be used up in the next business cycle D. Hidden assets can add substantial value to the firm

Current assets are usually excluded from the valuation process, since they will be used up in the next business cycle

Mathematically, the price-earnings ratio (P/E) is simply the price per share divided by earnings per share.

True (see pg 177)

Which is not a theory related to the term structure of interest ratio? A. Expectations hypothesis B. Liquidity preference theory C. Efficient market hypothesis D. Market segmentation theory

Efficient market hypothesis

A call provision allows the corporation to retire a bond before maturity by paying a small discount below par value.

False

As inflation increases, the required rate of return on common stocks falls, as well as the prices.

False

#). If the Treasury bill rate (RF) increases, then Ke will A. decrease. B. increase. C. stay the same. D. go up by beta times the Treasury bill rate.

Increase Refer to Equation 7-2. Using equation 7-2, if the Treasury bill rate, RF, increases, then Ke increases.

One way of calculating Ke is to use the Capital Asset Pricing model, as follows: A. Ke = RF + (KM - RF) B. Ke = RR + IP + ERP C. Ke = RF + b(KM - RF) D. Ke = D1/P0 + g E. Ke = RF + b(KM)

Ke = RF + b(KM - RF)

If Rf = 6%, beta = 1.3, and the ERP is6.5%, compute Ke.

Ke=Rf + β(Km-Rf) Pg 165 .06+ 1.3(.065) .06+.0845 0.1445 14.45%

Which of the following types of bond issues is the most price-sensitive? A. Fixed-rate long-term bonds B. Floating-rate bonds C. Long-term zero-coupon bonds D. Fixed-rate short-term bonds E. Treasury bills

Long-term zero-coupon bonds

Which of the following bond pricing rules is incorrect? A. Bond prices and interest rates are inversely related B. Prices of long-term bonds are less sensitive to changes in interest rates than short-term bonds C. Bond price sensitivity increases at a decreasing rate as maturity increases D. Bond prices are more sensitive to a decline in market yield to maturity

Prices of long-term bonds are less sensitive to changes in interest rates than short-term bonds

In general, if the market perceives that the direction of interest rates and inflation is down, this perception will have a positive effect on price-earnings ratios.

True

Which of the following is NOT a characteristic of a growth company? A. The company has sales growth greater than the economy by a reasonable margin B. The company usually pays a dividend equal to 40-50% of earnings C. The company has consistently stable and high profit margins D. The company has a growth rate that is significantly higher than the growth of GDP

The company usually pays a dividend equal to 40-50% of earnings Check this one 175-176

What will happen to the market value of a bond if interest rates increase? A. The market value will decrease B. The market value will increase C. The market value will increase or decrease, depending on the general economic climate D. The market value should remain level

The market value will decrease

Inflation has an indirect effect on price-earnings ratios through its impact on Ke

True

To determine the required rate of return (Ke), what factor is added to the risk free rate?

The total return required on an investment. For common stock, it is composed of the risk-free rate plus an equity risk premium. Once determined it becomes the discount rate applied to future cash flows

All dividend valuation models are based on the present value of a future income stream.

True

All things being equal, the more rapid growth a firm enjoys , the higher the P/E ratio

True

Corporate bonds carry a higher yield than government issues, and are fully taxable for federal, state, and local purposes

True

Junk bonds normally provide: A. a higher yield than Treasury bonds. B. a lower yield than Treasury bonds. C. a lower yield than AA corporate bonds. D. More than one of the above is true

a higher yield than Treasury bonds.

The P/E ratio approach to stock valuation is based on: A. a yearly range of historical P/E ratios resulting in an average expected P/E ratio, an earnings forecast derived from expected growth rates in earnings, and the stock's current P/E ratio. B. the average yearly P/E ratio, relative to the market; a yearly range of P/E ratios; and earnings based on an assumed constant growth rate. C. an increasing yearly range of P/E ratios and an earnings forecast based on the EPS of previous years.

a yearly range of historical P/E ratios resulting in an average expected P/E ratio, an earnings forecast derived from expected growth rates in earnings, and the stock's current P/E ratio

The reason price-earnings ratios and inflation are related is because: A. as inflation increases, the required return in the market rises, pushing down the prices of securities. B. as inflation increases, the required return in the market rises, pushing up the prices of securities. C. as price-earnings ratios fall, the market changes its expectations about the future rate of inflation. D. as price-earnings ratio rise, the market anticipates that inflation will decrease, sending stock prices higher.

as inflation increases, the required return in the market rises, pushing down the prices of securities

A good example of an industry that has a lot of growth companies in it is the: A. automobile industry. B. biotechnology industry. C. food and beverage industry. D. consumer products industry.

biotechnology industry.

A legal document which is administered by an independent trustee and spells out the major provisions of a bond agreement is called the A. bond contract. B. bond indenture. C. debenture. D. bond subordination.

bond indenture.

An example of secured debt would be a: A. contract where two signatures specified how the contract would be paid. B. contract in which a court kept the contract in its possession to see that nothing would happen to it. C. contract in which real assets are pledged as security for a loan. D. debenture.

contract in which real assets are pledged as security for a loan.

Public utility issues have a greater yield than other corporate issues, primarily because: A. nuclear utility issues carry an extremely high risk premium. B. public utility issues generally have a longer maturity. C. investor demand for utility issues is greater than for other issues. D. utilities' demands for funds is greater than that of other segments.

pg 293 utilities' demands for funds is greater than that of other segments.

. The junk bond market includes all of the following except: A. fallen angels. B. profitable companies undergoing expansion. C. growth companies (small firms not that well established, making them unable to receive an investment quality rating). D. companies undergoing restructuring because of a leveraged buyout (LBO) or unfriendly takeover.

profitable companies undergoing expansion.

A bond with a put provision allows the investor to: A. convert the bond to a specified number of shares of common stock. B. sell the bond back to the corporation at a small premium over par at a specified time period. C. sell the bond back to the corporation at par at a specified time period. D. receive additional interest payments if inflation goes above a specified level

sell the bond back to the corporation at par at a specified time period.

When the bond investor believes interest rates are going to fall, the best strategy would be to: A. take a bearish position in the market by selling long-term bonds. B. take a bullish position in the market by buying long-term bonds. C. move out of bonds completely. D. keep his portfolio unchanged.

take a bullish position in the market by buying long-term bonds.

The most important feature of municipal bonds is: A. the wide range of denominations and maturities. B. that the interest is not taxable by the federal government. C. the risk-free nature of this investment. D. its appeal to investors needing growth.

that the interest is not taxable by the federal government.

In order for any dividend valuation model to reflect a valid stock price for a company, A. the company must pay dividends. B. the dividend growth rate must remain constant. C. the required rate of return (discount rate) must remain constant. D. More than one of the above is true

the company must pay dividends.

What does the equity risk premium represent?

the extra return or premium the stock market must provide compared with the rate of return an investor can earn on U.S. government Treasury securities. Pg 165 - Put into your own words

The investor in deep-discount bonds generally accepts a lower yield because of: A. the unique conversion feature associated with deep discount bonds. B. the extremely low risk of a call. C. the fact that the return represents pure interest income. D. More than one of the above

the extremely low risk of a call.

A call feature may be valuable to: A. investors. B. the issuing company. C. corporate employers. D. the IRS.

the issuing company.

The value of a bond at any given time is the sum of: A. the future interest payments and the par value. B. the present value of future interest payments and the present value of the par value. C. the future value of the interest payments and the future value of the par value. D. the present value of future interest payments and the market value. E. the present value of future interest payments and the future value of the par value.

the present value of future interest payments and the present value of the par value.

The term structure of interest rates refers to: A. the relationships between interest rates and term to maturity. B. the idea that any long-term rate is the average of expected future short-term rates. C. a general expectation of higher future interest rates. D. the idea that the terms of the bond may change as time to maturity changes. E. More than one of the above are true

the relationships between interest rates and term to maturity.

Stock valuation based on the relationship between a stock's P/E ratio and the market may result in superior returns if: A. the firm is riskier than the market. B. the firm has a high P/E ratio, relative to the market. C. the stock is trading at the low end of its P/E ratio, relative to the market. D. More than one of the above

the stock is trading at the low end of its P/E ratio, relative to the market.

The purpose of stock valuation is A. to set the fair market price for a given common stock. B. to determine whether the common stock's value is fairly represented by its market price. C. of limited value, since the efficient market hypothesis proves that all common stock is always fairly priced. D. to find common stocks whose market price equals the intrinsic value.

to determine whether the common stock's value is fairly represented by its market price.

While the stock market has an active secondary market, the bond market consists primarily of investors who buy and hold bond issues to maturity.

true

The total return an investor would receive from income plus capital appreciation, assuming a bond is held to maturity, is called the: A. call premium. B. current yield. C. yield to maturity. D. capital gains yield. E. More than one of the above

yield to maturity.