Module 4 - Bond & Stock Valuation Concepts

Assume a $1,000 par value bond with three years until maturity is currently trading for $1,027.23. The bond has a coupon rate of 6% (annual coupon payments) and a current YTM of 5%. The bond has a duration of 2.51 years. Calculate what the new market price for the bond would be if the YTM changed from 5% to 4.5%. A) $1,041.66 B) $1,032.36 C) $1,053.01 D) $1,016.75

A) $1,041.66 The new price of the bond should be $1,041.23. Using a financial calculator, use the following inputs for semiannual payments: FV = $1,000 PMT = $1,000 x 6% = $60/2 = $30 I/YR = 4.5/2 = 2.25% N = 6 (3 x 2 periods per year) Solve for PV = -1,041.6586, or $1,041.66

Amelia is considering buying shares of HSO stock valued at $50 per share. She forecasts the stock to trade in excess of $75 per share over the next three years. During this time, she expects to receive annual dividends of $4.50 per share. Given a 10% required rate of return, calculate the intrinsic value of the stock. A) $45.00 B) $46.50 C) $29.50 D) $50.00

A) $45.00 The intrinsic value of the stock is $45, using the perpetuity dividend discount model, calculated as follows: $4.50 ÷ 0.10 = $45.

Kinzie owns a stock that consistently pays a $.50 dividend. Assuming Kinzie's required rate of return is 9.5%, calculate the intrinsic value of the stock. A) $5.26 B) $5.76 C) $4.75 D) $10.00

A) $5.26 Using the no-growth (perpetuity) dividend discount model: V = D1 ÷ r = 0.50 ÷ 0.095 = 5.2632, or $5.26

If a $100 par value preferred stock pays an annual dividend of $5 and comparable yields are 10%, the price of the preferred stock will be A) $50. B) $25. C) $100. D) $75.

A) $50. $5 ÷ 0.10 = $50 for preferred stocks, the zero-growth model is used because the preferred stock's dividend is fixed. The formula is V = D0/r, where D0 is the dividend and r is the required return.

Tate is considering the purchase of a stock that just paid a dividend of $0.30 in the last quarter. That dividend has been steady for all of the past year. The company is expected to grow the dividend at 15% per year for the next three years, after which it is expected to grow at a constant rate of 8%. The required return is 11%. What is the maximum price Tate should pay for this stock? (Select the closest answer.) A) $51.91 B) $11.30 C) $45.14 D) $12.98

A) $51.91 Using the three-step approach, first determine the dividend at the end of each of the first three years. The amount of $0.30 is a quarterly dividend and must be multiplied by 4 to get $1.20 for the current annual dividend. This amount is multiplied by 1.15 for each year in order to get: Year | Dividend 1 | 1.38 2 | 1.587 3 | 1.8251 Next determine the value of the stock at the end of year 3 based on the dividend at the end of year 4: [1.8251(1.08)] ÷ (0.11 - 0.08) = 65.70 Using the CFj keys on the calculator (with dividends rounded), solve as follows: 11 I/YR 0 CF0 1.38 CF1 1.59 CF2 1.83 + 65.70 CF3 SHIFT, NPV = 51.91

JEM Corporation always pays a dividend of $5.50 per share. Calculate the intrinsic value of the stock assuming a required rate of return of 8% and a risk-free rate of return of 4%. A) $68.75 B) $15.94 C) $137.50 D) $45.83

A) $68.75 The intrinsic value of the stock is $68.75 ($5.50 ÷ 0.08) using the no-growth (perpetuity) dividend discount model.

A bond has a current yield to maturity (YTM) of 3.80%. Market interest rates are expected to rise to 4.50% soon. The bond has a duration of 5.5 years. Calculate the estimated price change of the bond. A) -3.71% B) +3.50% C) -2.18% D) +0.70%

A) -3.71% The market price of the bond is expected to decrease by 3.71%, calculated as follows: ΔP/P = −5.5[(0.045 − 0.038) ÷ (1 + 0.038)] ΔP/P = −5.5(0.007 ÷ 1.038) ΔP/P = −5.5(0.006745) ΔP/P = −0.0371, or −3.71%

ABC Corporation has a P/E ratio of 5.00 and an expected growth rate in earnings for the next year of 9.5%. Assuming an investor's required rate of return is 12%, calculate the firm's PEG ratio. A) 0.5263 B) 0.4167 C) 0.8333 D) 0.1667

A) 0.5263 Calculate the firm's PEG ratio as follows: 5.00 ÷ (0.095 × 100) = 0.5263. After calculating this ratio, it then would be compared to ABC Corporation's peers to determine whether a purchase is warranted.

JEM Technologies, Inc. has assets of $500 million and $50 million in liabilities. For the past year the company earned $125 million, and paid out $50 million in dividends. Calculate the company's return on equity (ROE). A) 28% B) 20% C) 52% D) 38%

A) 28% The answer is 28%. $500,000,000 - $50,000,000 = $450,000,000 in equity. $125,000,000 profit ÷ $450,000,000 equity = 0.2778, or 28% ROE.

Which of these choices correctly illustrates the relationship between a bond's price and various yields? A) For a discount bond: coupon rate < current yield < yield to maturity B) For a premium bond: coupon rate > yield to maturity > current yield C) For a discount bond: yield to maturity > coupon rate > current yield D) For a premium bond: current yield > yield to maturity > coupon rate

A) For a discount bond: coupon rate < current yield < yield to maturity When a bond trades at a discount, its yield to maturity will be greater than its current yield, which will be greater than its coupon rate.

Which of these statements concerning technical analysis is CORRECT? I. The focus of technical analysis is market timing with an emphasis on likely price changes. II. Technicians tend to concentrate on the past price movements to forecast future price movements. III. The focus of technical analysis is the process by which stock prices rapidly adjust to new information. IV. Technical analysis is based on the underlying fundamentals of a stock's value. A) I and II B) II and III C) III and IV D) I, II, and IV

A) I and II Technicians tend to concentrate on the short run, looking for short-term price movements. The focus of technical analysis is the gradual process whereby stock prices adjust to new information. Fundamental analysis is based on the underlying fundamentals of a stock's value. Technical analysis involves analyzing past stock prices to forecast future prices.

Companies A and B have exactly the same dollar amount of assets and net income. Company A has a capitalization structure of 70% equity and 30% debt; Company B has a capitalization structure of 40% equity and 60% debt. Which one of these statements is CORRECT? I. Company B has a higher ROE than Company A. II. Company B has a higher ROA than Company A. III. Company A has a higher debt-to-equity ratio than Company B. A) I only B) II only C) III only D) None of these

A) I only All else being equal, a profitable company with a higher debt level will have a higher return on equity. If income is the same for both companies, then the only difference is the percentage of equity. With a lower equity, Company B will have a higher return on equity. Company B has a higher debt-to-equity ratio.

Identify which of these statements concerning technical analysis is CORRECT. I. Technical analysis is focused on the process by which stock prices rapidly adjust to new information. II. Technical analysis is based on the underlying fundamentals of a stock's value. III. The focus of technical analysis is market timing with an emphasis on price changes. IV. Technicians concentrate on past stock price movements to forecast future stock price movements. A) III and IV B) I and II C) II only D) I, III, and IV

A) III and IV Statements I and II are incorrect. Fundamental analysis is based on the underlying fundamentals of a stock's value. Technicians concentrate on the short run, looking for short-term price movements. The focus of technical analysis is the gradual process whereby stock prices adjust to new information. Technical analysis involves analyzing past stock prices to forecast future prices.

FER stock has a current dividend of $0.75 per share that has been growing at a rate of 1.25% per year. If an investor's required rate of return is 15% and the stock is currently selling for $6.34 per share, determine whether the investor should purchase the stock. A) No, the stock is overvalued based on the constant growth dividend discount model. B) No, the stock is not a wise purchase based on the risk-return trade-off. C) Yes, the stock is undervalued using the perpetuity dividend discount model. D) Yes, the stock is undervalued based on the constant growth dividend discount model.

A) No, the stock is overvalued based on the constant growth dividend discount model. Based on the constant growth dividend discount model, the intrinsic value of the stock is $5.52, calculated as follows: [0.75 × (1 + 0.0125)] ÷ (0.15 - 0.0125) = 0.7594 ÷ 0.1375 = 5.5227, or $5.52. Because FER is currently trading at a price of $6.34 per share, it is overvalued, and the investor should not buy the stock.

All of these statements correctly describe the price-to-earnings divided by growth (PEG) ratio except A) PEG is an indication of how much an investor is paying for a specific revenue stream. B) PEG is used to compare companies with different growth rates. C) PEG is calculated by dividing a firm's P/E ratio by the firm's expected growth rate of earnings. D) companies with a lower PEG ratio have higher expected rates of return.

A) PEG is an indication of how much an investor is paying for a specific revenue stream. Companies with a lower PEG ratio have a higher expected rate of return and vice versa. The PEG ratio is a measure of relative valuation that can be used to compare companies with different growth rates. Proponents of the PEG ratio believe that companies with a low PEG ratio will have higher rates of return. The price-to-sales ratio is an indication of how much an investor is paying for a specific revenue stream.

Lynn and Stuart Wagman are a middle-aged couple who would like to add an equity investment to their portfolio. They require a 12% rate of return and are considering the purchase of one of these common stocks: Stock 1: Dividends currently are $1.50 annually and are expected to increase 8% annually; market price = $35. Stock 2: Dividends currently are $2.25 annually and are expected to increase 7% annually; market price = $50. Using the dividend growth model, determine which stock would be more appropriate for the Wagmans to purchase at this time. A) Stock 1, because the expected return on investment is greater than the Wagmans' required return B) Stock 1, because its dividend growth rate is greater than Stock 2's growth rate C) Stock 2, because the stock is undervalued D) Stock 2, because the return on investment is greater than the Wagmans' required return

A) Stock 1, because the expected return on investment is greater than the Wagmans' required return Compute the intrinsic value and expected return first, then determine which stock should be purchased. The intrinsic value of Stock 1 is $40.50; of Stock 2, $48.15. The expected return on investment of Stock 1 is 12.6%; of Stock 2, 11.8%. Stock 1 has a D0 of $1.50, thus D1 is ($1.50 x 1.08) or $1.62. Current market price is stated as $35 and the stated growth rate is 8%. ($1.62/$35) + .08 = 12.63% expected return for Stock 1. Stock 2 has a D0 of $2.25, thus D1 is ($2.25 x 1.07) or $2.4075. Current market price is stated as $50 and the stated growth is 7%. ($2.4075/$50) + .07 =11.8% expected return for Stock 2.

Marvin is considering adding XYZ stock to his holdings. The stock has these characteristics: Beta = 1.45 Standard deviation = 15.58% Current dividend = $1.35 Required rate of return = 8% Risk-free rate of return = 2% The current dividend is expected to grow for three years at a rate of 2% and then 3% thereafter. Based on the information provided, calculate the intrinsic value of XYZ stock and determine if Marvin should add XYZ to his portfolio if it is currently trading at $24.50. A) With an intrinsic value of $27.13, the stock is undervalued and should be added to the portfolio. B) With an intrinsic value of $22.90, the stock is overvalued and should not be added to the portfolio. C) With an intrinsic value of $21.60, the stock is overvalued and should not be added to the portfolio. D) With an intrinsic value of $29.60, the stock is undervalued and should be added to the portfolio.

A) With an intrinsic value of $27.13, the stock is undervalued and should be added to the portfolio. The intrinsic value of the stock using the multistage growth dividend discount model is $27.13. Because the intrinsic value is greater than the fair market value, the stock is considered undervalued by the market and should be purchased for the portfolio. Compute the value of each future dividend until the growth rate stabilizes (Years 1-3). D1 = $1.35 × 1.02 = $1.38 D2 = $1.38 × 1.02 = $1.41 D3 = $1.41 × 1.02 = $1.44 Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 4). D4 = $1.44 × 1.03 = $1.48 V = $1.48 ÷ (0.08 - 0.03) = $29.60 Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 = $0 CF1 = $1.38 CF2 = $1.41 CF3 = $1.44 + $29.60 = $31.04 I/YR = 8% Solve for NPV = 27.1272, or $27.13

Marcy may add 100 shares of LKM corporation stock to her investment portfolio. The stock recently paid a dividend of $1.85 per share. The dividend is expected to grow at a constant rate of 2.25% per year. Her required rate of return is 7%. The stock is currently trading for $35.75 per share. Determine whether she should purchase the stock and why. A) Yes, the stock is undervalued based on an intrinsic value of $39.82. B) No, the stock is overvalued based on an intrinsic value of $32.87. C) Yes, the stock is undervalued based on an intrinsic value of $33.46. D) No, the stock is overvalued based on an intrinsic value of $38.95.

A) Yes, the stock is undervalued based on an intrinsic value of $39.82. Using the constant growth dividend discount model, the intrinsic value of the stock is $39.82. V = ($1.85 × 1.0225) ÷ (0.07 - 0.0225) V = 1.8916 ÷ 0.04750 V = 39.8232, or $39.82 Based on this value, the stock is undervalued relative to its price in the secondary market.

Interest rate changes have the greatest effect on A) long-term bonds. B) staggered maturity bonds. C) short-term bonds. D) medium-term bonds.

A) long-term bonds. The rule-of-thumb approach to measuring the estimated price change of a bond is to multiply the bond's duration by the estimated change in interest rates (for small rate changes—less than 1% or 100 basis points—only). Therefore, longer-term bonds have the greatest duration and the most price volatility.

CAR stock is currently paying a dividend of $1 per share. Assume the stock's dividend is expected to grow for three years at 5% per year. After three years, the dividend is expected to grow at a constant 2% rate. The investor's required rate of return is 8%. What is the intrinsic value of CAR stock? A. $18.45 B. $19.67 C. $20.83 D. $22.98

A. $18.45 This is found by using the multistage growth dividend discount model, which shows the intrinsic value of CAR stock is $18.45. 1. Compute the value of each future dividend until the growth rate stabilizes (Years 1-3). D1 = $1.00 × 1.05 = $1.05 D2 = $1.05 × 1.05 = $1.10 D3 = $1.10 × 1.05 = $1.16 2. Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 4). D4 = $1.16 × 1.02 = $1.18 V = $1.18 ÷ (0.08 - 0.02) = $19.67 3. Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 = $0 CF1 = $1.05 CF2 = $1.10 CF3 = $1.16 + $19.67 = $20.83 I/YR = 8% Solve for NPV = $18.45

Which of the following describes the flow of the top-down valuation process? A. Economic analysis, industry analysis, company analysis B. Company analysis, industry analysis, economic analysis C. Economic analysis, company analysis, industry analysis D. Picking the best stocks regardless of the industry or economic conditions

A. Economic analysis, industry analysis, company analysis Top-down analysis works from the macro to the micro level—economic analysis, industry analysis, company analysis.

An assumption of technical analysis is that market prices A. exhibit identifiable trends and patterns that persist and repeat. B. are the only information necessary to analyze a freely trading market. C. reflect supply and demand conditions because actual transactions reflect rational decisions by buyers and sellers. D. reflect only irrational investor behavior.

A. exhibit identifiable trends and patterns that persist and repeat. Technical analysis assumes persistent trends and repeating patterns in market prices can be used to forecast price behavior. Technical analysts believe prices reflect supply and demand but that buying and selling can be motivated by both rational and irrational causes. Volume, along with price, is important information to a technical analyst.

XYZ Corporation issued bonds with a 25-year maturity, $1,000 par value, and 5.75% coupon (paid semiannually). Five years after issue, interest rates on similar bonds fell to 4.75%. Calculate the price that XYZ bonds should sell for in the marketplace. A) $1,000.00 B) $1,128.20 C) $1,189.84 D) $882.05

B) $1,128.20 XYZ bonds should sell for $1,128.20, calculated using the following inputs: FV = $1,000 PMT = (57.50 ÷ 2) = $28.75 N = 40 (20 x 2 periods per year) I/YR = 4.75% Solve for PV = -1,128.1979, or $1,128.20

Lou owns a stock that consistently pays a $1.50 dividend. If his required rate of return is 8.5%, what is the intrinsic value of the stock? A) $16.39 B) $17.65 C) $12.75 D) $13.73

B) $17.65 Using the no-growth (perpetuity) dividend discount model: V = D1 ÷ r = 1.50 ÷ 0.085 = $17.65

Caralla Foods produced before-tax earnings of $15 million last year. A large institutional investor has determined an appropriate capitalization for valuing this company is 8%. In addition, the risk-free rate of return is 5%. Based on this information, calculate the value of Caralla Foods using the discounted earnings model. A) $500,000,000 B) $187,500,000 C) $300,000,000 D) Not enough information is provided.

B) $187,500,000 The formula for the discounted earnings model: V = E ÷ RD = 15,000,000 ÷ 0.08 = 187,500,000 Using the discounted earnings method produces a current corporate valuation of $187,500,000.

An analyst's report on Derjet Industries has provided the following corporate information: Total assets = $100,000,000 Total equity = $50,000,000 Net income = $12,500,000 Earnings per share = $3.50 P/E ratio = 2.2 Dividend growth rate = 1.65% Assuming an investor has a required rate of return of 15%, calculate the maximum price that should be paid for this stock in the secondary market. A) $14.38 B) $7.70 C) $25.83 D)$35.46

B) $7.70 Calculate the intrinsic value of the stock using EPS and the P/E ratio, which is $7.70 ($3.50 × 2.2).

What is the duration of a zero-coupon bond yielding 9%, maturing in 10 years, and selling for $422.41? A) 9 years B) 10 years C) 8 years D) 7 years

B) 10 years Because the bond is a zero-coupon bond, the duration must be 10 years.

Kevin owns a $1,000 par value corporate bond with three years remaining until maturity. This bond is currently trading for $1,020.91. The bond has a coupon rate of 4.5% (annual coupon payments) and a current YTM of 3.75%. What is the duration of this bond? A) 1.0067 B) 2.8741 C) 2.0910 D) 3.7500

B) 2.8741 Determine the duration of the bond. Year | Cash Flow(CF) | Present Value(PV) of CF | PV × Year 1 | $45 | $43.37 | $43.37 2 | $45 | $41.81 | $83.62 3 | $1,045 | $935.73 | $2,807.19 $1,020.91 | $2,934.18 Divide the sum in the last column ($2,934.18) by the total PV/market price of the bond ($1,020.91) to derive the duration of 2.8741 years. Using a financial calculator with the following inputs: For year 1, FV = $45, I/YR = 3.75, N = 1, solve for PV. For year 2, change N to 2 without clearing your calculator and solve for PV. For year 3, FV = $1,045, I/YR = 3.75%, N = 3, solve for PV.

ABC Technologies, Inc., a publicly-traded company, uses both equity and debt to finance its operations. The company's stock is currently trading for $52.50 per share and has earnings of $1.50 per share. Calculate ABC's price-to-earnings (P/E) ratio. A) 25 B) 35 C) 5 D) 52

B) 35 ABC Technologies, Inc. has a P/E ratio of 35 ($52.50 ÷ $1.50).

An investor is considering the following three bonds: | Rating | Coupon | Maturity Bond 1 | AA rated | 7% | 6 years Bond 2 | AAA rated | 8% | 5 years Bond 3 | BBB rated | 7% | 5 years All of the following statements correctly assess these bonds except A) Bond 2 is least susceptible to price fluctuations because of its coupon rate and maturity. B) Bond 2 is more susceptible to price fluctuations than Bond 3 because it has a larger coupon. C) Bond 2 is less susceptible to price fluctuations than Bond 1 because it has a shorter maturity. D) Bond 1 is more susceptible to price fluctuations than Bond 3 because it has a longer maturity.

B) Bond 2 is more susceptible to price fluctuations than Bond 3 because it has a larger coupon. A low-coupon bond is more susceptible to price fluctuations than a high-coupon bond, everything else being equal. A long-term bond is more susceptible to price fluctuations than a short-term bond, everything else being equal.

Company A and Company B are in the same industry and have approximately the same dollar amount of assets and operating income. Company A has a return on equity (ROE) of 28% and Company B has an ROE of 12%. Which of the following statements best identifies the major difference causing the disparity in ROE between Company A and Company B? A) Company B has a higher level of depreciation expense than Company A. B) Company A has more debt than Company B. C) Company A has lower selling, general, and administrative (S, G, & A) expenses. D) Company B has an extraordinary loss.

B) Company A has more debt than Company B. Generally, the most significant factor in raising one company's ROE above another company's is the greater use of debt. The company having the greater percentage of debt, assuming the cost of the debt is less than the return earned from the debt proceeds, will have the highest ROE.

Which of the following are factors used in industry analysis for investment purposes? I. Financial leverage II. Government rules and regulations III. Labor conditions IV. Technological advances A) I and II B) II, III, and IV C) III and IV D) I, II, and IV

B) II, III, and IV Option I is not a factor used for industry analysis, but rather for company analysis.

Linda and Ralph Stewart have never invested in the stock market, but they would like to begin an investment program to cover college expenses for their two young children. The Stewarts' required rate of return is 11%. They are considering the purchase of one of these two stocks: Stock 1: Dividends are currently $1.85 annually and are expected to increase 9% annually; market price = $59 Stock 2: Dividends are currently $1.58 annually and are expected to increase 6% annually; market price = $37 Which stock would be most appropriate for the Stewarts to purchase at this time, and why? A) Stock 2, because the stock is undervalued B) Stock 1, because the return on investment is greater than the Stewarts' required rate of return C) Stock 1, because the stock is overvalued D) Stock 2, because the return on investment is greater than the Stewarts' required rate of return

B) Stock 1, because the return on investment is greater than the Stewarts' required rate of return The intrinsic value of Stock 1 = $100.83 [($1.85 × 1.09) ÷ (0.11 - 0.09)]. Because $100.83 is more than $59, the stock is undervalued and would return more than their required return. The intrinsic value of Stock 2 = $33.50 [($1.58 × 1.06) ÷ (0.11 - 0.06)]. Because $33.50 is less than $37, the stock is overvalued and would return less than their required return.

Which of the following statements regarding fundamental and technical analysis is CORRECT? A) Fundamental analysis may result in better returns than the overall market under both the weak and semistrong forms of the efficient market hypothesis. B) Technical analysis is not considered valid under the efficient market hypothesis, because this type of analysis is attempting to predict future prices based on past price movement. C) Investors looking for excellent companies to invest in may use bottom-up analysis, which is a form of technical analysis. D) In top-down analysis, an investor would start by researching various industries, and then choose stocks within that industry

B) Technical analysis is not considered valid under the efficient market hypothesis, because this type of analysis is attempting to predict future prices based on past price movement. This is correct, as any form of EMH does not coexist with technical analysis.

Juliet owns a PRT Inc. bond with a par value of $1,000. PRT is a AA rated bond maturing in seven years. Juliet receives $55 of interest income from PRT semiannually. Comparable debt, i.e., AA rated, seven-year maturity, yields 12%. The bond's duration is five years. Assume the Fed is concerned about inflation and increases the discount rate. As a consequence, market interest rates on seven-year AA rated bonds change from 12% to 13%. How will the price of Juliet's bond change? A) The price will increase by approximately 5%. B) The price will decrease by approximately 5%. C) The price will increase by approximately 7%. D) The price will decrease by approximately 7%.

B) The price will decrease by approximately 5%. The bond's duration can be seven years only if it is a zero-coupon bond. No information in the facts states that it is a zero-coupon bond. The facts do state that the bond has a coupon. Therefore, its duration will be less than seven years. The only other indicated possibility is a five-year duration. So, a five-year duration multiplied by an interest rate change of 1% results in a price change of 5%. Because rates rose, the price of the bond must decrease.

When a company issues long-term debt securities instead of common stock, which one of these outcomes is the company most likely trying to achieve? A) To increase the company's financial risk B) To increase the company's return on equity C) To increase the company's fixed asset turnover rate D) To increase the company's taxable income

B) To increase the company's return on equity When debt, instead of equity capital, is issued by a company, its shareholder's equity portion of the balance sheet remains constant. If the additional capital raised increases net income, then return on equity will rise, and the company will see a positive effect from the issuance of debt. Leverage, properly employed, helps a company increase its return on equity.

All else remaining equal, if the dividend payout ratio decreases, the value of a company's common stock would A) increase because the company's risk premium will decrease. B) increase because the company's dividend growth rate will increase. C) decrease because the company's return on equity (ROE) will decrease. D) decrease because the company's dividend growth rate will decrease.

B) increase because the company's dividend growth rate will increase. A decrease in the dividend payout ratio means that the earnings retention ratio (rr in the following formula) will increase. An increase in rr will cause an increase in g. When the higher g is inserted in the dividend discount model formula, the denominator decreases, thereby causing the value of the stock to increase. g = ROE × rr

The use of financial leverage affects all of these except A) earnings per share. B) monetary policy. C) risk to stockholders. D) return on equity.

B) monetary policy. Return on equity and earnings per share are magnified with leverage, and the risk to stockholders increases as a firm's leverage increases. A country's monetary policy is not affected by a company's use of financial leverage.

All of these statements explain the attributes of technical analysis except A) technical analysts attempt to predict the future movement of stock prices based on past trends. B) technical analysts rely heavily on financial ratios in their analysis of stocks. C) technical analysts use terms such as "trendline," "support," and "resistance" in analyzing stocks. D) technical analysts rely on charts to predict the future prices of stocks.

B) technical analysts rely heavily on financial ratios in their analysis of stocks. Analysts do not rely on financial ratios in their analysis of stocks. Instead, they rely on charts of past price history and volume to predict future price movements.

All of the following statements concerning security valuation and analysis are CORRECT except A) for successful security analysis, it is necessary to understand the characteristics of and the factors that affect various securities. B) the intrinsic value of a security is the future value of expected future cash flows inflated at an appropriate risk-free rate, without taking the risk of the investment into consideration. C) for successful security analysis, a valuation model is applied to securities to estimate their price, or value. D) value is a function of the expected future returns on a security and the associated risk.

B) the intrinsic value of a security is the future value of expected future cash flows inflated at an appropriate risk-free rate, without taking the risk of the investment into consideration. The intrinsic value of a security is the present value of expected future cash flows discounted at an appropriate discount rate, taking the risk of the investment into consideration.

KRF Corporation offers $100 preferred stock that will always pay a $1.50 potential dividend to any investor. If an investor has a required rate of return of 12%, how much should the investor pay for KRF preferred stock? A. $1.68 B. $12.50 C. $15.00 D. $100.00

B. $12.50 Using the perpetuity model, an investor should pay no more than $12.50 for the preferred stock of KRF Corporation. The $12.50 is derived by dividing the $1.50 first-year dividend (or any year) by the investor's required rate of return of 12%.

Alphabet stock is selling for $67 per share. Alphabet's earnings per share last year were $8.90. Comparable firms in the same industry have P/E ratios of 8.0. Which of the following statements is CORRECT? A. Alphabet stock is undervalued because its P/E ratio is greater than 8.0. B. Alphabet stock is undervalued because its intrinsic value is $71.20. C. Alphabet stock is overvalued because its P/E ratio is less than 8.0. D. Alphabet stock is overvalued because its intrinsic value is $71.20.

B. Alphabet stock is undervalued because its intrinsic value is $71.20. Alphabet's P/E ratio is $67 ÷ $8.90 = 7.53. Because its P/E is lower than that of comparable firms, Alphabet is considered undervalued. Alphabet's intrinsic value is $8.90 × 8.0 = $71.20.

Which of the following bonds would you recommend if the investor's time horizon is 10 years? A. ABC bond: AAA rated, 5% coupon, 12-year maturity, duration 8.15 years B. DEF bond: AAA rated, 4% coupon, 10-year maturity, duration 9.50 years C. JKL bond: AAA rated, 4.5% coupon, 15-year maturity, duration 9.25 years D. XYZ bond: AAA rated, 5% coupon, 15-year maturity, duration 9.35 years

B. DEF bond: AAA rated, 4% coupon, 10-year maturity, duration 9.50 years The DEF bond, with a duration of 9.50 years, is the closest to the investor's time horizon of 10 years.

Which of the following approaches would be emphasized by an investor who believes in the importance of fundamental security analysis? A. Support and resistance levels B. Financial statement review C. The strong form of the efficient market hypothesis (EMH) D. Indexing

B. Financial statement review Fundamental analysts attempt to determine the intrinsic value of a security and, therefore, review the financial statements of companies to help them determine this value. If an investor believes in the strong form of EMH, fundamental analysis is of no use. Support and resistance levels are used by technical analysts.

Assume that ABC stock pays a dividend in the current year of $1.56 per share. The company's dividend is expected to grow by 1.5% per year. Calculate the stock's price if an investor has a required rate of return of 7%. A) $14.29 B) $20.54 C) $28.79 D) $28.36

C) $28.79 The formula for the constant growth dividend discount model: V = D1 ÷ (r - g) Therefore, the intrinsic value of ABC stock equals $28.79 [(1.56 × 1.015) ÷ (0.07 - 0.015)].

Jack is interested in purchasing LFM stock. LFM has an estimated free cash flow to equity (FCFE) for the next year of $2.75 per share, which is expected to grow at a constant rate of 3.5% per year. Jack's required rate of return is 12%. Using the FCFE valuation model, calculate the intrinsic value of LFM stock. A) $23.71 B) $33.48 C) $32.35 D) $81.32

C) $32.35 Using the model V = FCFE1 ÷ (r - g), the intrinsic value of the stock is $32.35 [$2.75 ÷ (0.12 - 0.035)].

LFM Corporation has an estimated free cash flow to equity (FCFE) of $2.50 per share in the current year. Moreover, its FCFE is expected to grow at a constant rate of 2% per year. Assuming an institutional investor has a required rate of return of 6.5%, calculate the intrinsic value of LFM stock. A) $40.76 B) $133.13 C) $56.67 D) $55.56

C) $56.67 The formula for the discounted free cash-flow model: V = FCFE1 ÷ (r - g) = ($2.50 × 1.02) ÷ (0.065 - 0.02) = 2.55 ÷ 0.045 = 56.6667, or $56.67

LJM Corporation has a bond issue with a coupon rate of 8% and seven years remaining until maturity. Assuming a par value of $1,000 and semiannual coupon payments, calculate the intrinsic value of the bond if current market conditions justify a 10% required rate of return. A) $1,033.32 B) $941.58 C) $901.01 D) $920.81

C) $901.01 The intrinsic value of LJM's bond is $901.01, calculated using the following inputs on a semiannual basis: N = 14 (7 x 2 periods per year) 10 / 2 = 5% I/YR 8% × $1,000 ÷ 2 = $40 = PMT $1,000 = FV Solve for PV = -901.01, or $901.01.

George has a five-year bond with a coupon rate of 3.65% (paid semiannually). Assuming the comparable yield for this quality bond is 4.85%, calculate the intrinsic value of his bond. A) $1,054.39 B) $1,179.84 C) $947.28 D) $1,000.00

C) $947.28 The intrinsic value of George's bond equals $947.28, indicating the bond would be trading at a discount to par. The value is calculated using the following inputs: FV = 1$,000 N = 10 (5 x 2 periods per year) I/YR = 4.85% PMT = (3.65% × 1,000 ÷ 2) = $18.25 Solve for PV = -947.2835, or $947.28

Assume a 3-year, $1,000 par value corporate bond is currently trading for $959.53. The bond has a coupon rate of 4% (paid once per year) and a yield to maturity of 5.50%. Calculate the duration for this bond. A) 3.5871 years B) 1.4418 years C) 2.8835 years D) 3.4680 years

C) 2.8835 years The duration for this bond is 2.8835 years, calculated as follows: Year | Cash Flow(CF) | Present Value(PV) of CF | PV × Year 1 | 40.00 | 37.91 | 37.91 2 | 40.00 | 35.94 | 71.88 3 | 1,040.00 | 885.68 | 2,657.04 - 959.53 | 2,766.83 To solve for the PV of a given CF (example Year 1): FV = 40, N = 1, PMT = 0, 5.5 = I/YR, solve for PV. Divide the sum in the last column (2,766.83) by the total PV/market price of the bond (959.53) to derive the duration of 2.8835 years.

Given a required rate of return of 8%, a growth rate of 4%, a beta of 1.25, and a standard deviation of 2.5%, calculate the price-to-free-cash flow for this particular investment. A) 28.0 B) 20.8 C) 26.0 D) 16.6

C) 26.0 The formula for price-to-free-cash flow: P/FCF = (1 + G) ÷ (r - g) = (1 + 0.04) ÷ (0.08 - 0.04) = 1.04 ÷ 0.04 = 26.0 After calculating this ratio, an investor would compare this P/FCF to other investments to see whether a purchase is warranted.

Investors may use P/E ratios and price/sales ratios to value stocks. If this analysis is used, which of the following is desirable? A) A high P/E and a high price/sales ratio B) A high P/E and a low price/sales ratio C) A low P/E and a low price/sales ratio D) A low P/E and a high price/sales ratio

C) A low P/E and a low price/sales ratio Low prices to either earnings or sales might indicate an undervalued stock.

The use of P/E ratios to select stocks suggests which of these? A) Low P/E ratio stocks are overvalued. B) A stock should be purchased if it is selling near its historic high P/E. C) A stock should be purchased if it is selling near its historic low P/E. D) High P/E stocks should be purchased.

C) A stock should be purchased if it is selling near its historic low P/E. While purchasing stocks near their historically high P/E ratio could continue to represent value, a much better time would be to purchase stocks that are at their historic low ratios.

Which one of the following statements CORRECTLY matches a technical indicator to the information it provides in signaling a change from a bear to a bull market? A) Most financial advisers become bullish. B) A moving average chart indicates that actual prices have dropped through the average. C) Barron's Confidence Index indicates that the yield differential between low-quality bonds and high-quality bonds is decreasing. D) Odd lot sales exceed purchases.

C) Barron's Confidence Index indicates that the yield differential between low-quality bonds and high-quality bonds is decreasing. In a bull market, there is less fear so there is a lower spread between high-quality and lower-quality bonds.

Choose the form of the efficient market hypothesis that supports technical analysis. A) Weak B) Strong C) None of these D) Semistrong

C) None of these The efficient market hypothesis is in direct contradiction to technical analysis because the efficient market hypothesis is founded on the notion that all historical price and volume data, which is used by technical analysts, is already accounted for in the current stock price.

When an analyst divides the P/E ratio by the earnings growth rate, which one of these ratios is being used? A) P/B ratio B) P/S ratio C) PEG ratio D) P/E ratio

C) PEG ratio This identifies the P/E to Growth (PEG) ratio. P/B is price to book; P/E is price to earnings; P/S is price to sales; DDM is dividend discount model.

You are about to analyze a growth company that has chosen to retain all of its earnings for growth and has had a positive cash flow, but a negative earnings per share, for the past several years. Which of the following valuation approaches would you consider when analyzing the company? A) Constant growth dividend discount model B) Price/earnings-to-growth (PEG) ratio C) Price-to-sales (P/S) ratio D) Price-to-earnings (P/E) ratio

C) Price-to-sales (P/S) ratio The P/S ratio is an indication of how much an investor is willing to pay for a specific revenue stream, in this case the company's annual sales.

Al, age 37, wants to add to his common stock portfolio. He wants long-term capital appreciation and requires a 14% rate of return on stock investments. He is considering the purchase of one of these two stocks: Stock 1:Dividends are currently $1.20 annually and are expected to increase 10% annually; market price = $38Stock 2:Dividends are currently $1.00 annually and are expected to increase 11% annually; market price = $30 Which stock would be most appropriate for Al to purchase at this time, and why? A) Stock 1, because the return on investment is greater than Al's required rate of return B) Stock 2, because the stock is overvalued C) Stock 2, because the return on investment is greater than Al's required rate of return D) Stock 1, because the stock is undervalued

C) Stock 2, because the return on investment is greater than Al's required rate of return The intrinsic value of Stock 1 = $33 [($1.20 x 1.10) ÷ (0.14 - 0.10)]. Because $33 is less than $38, the stock is overvalued and would return less than his required return. The intrinsic value of Stock 2 = $36.67 [($1.00 x 1.11) ÷ (0.14 - 0.11)]. Because $36.67 is more than $30, the stock is undervalued and would return more than his required return.

Robin purchased a 20-year bond with a duration of 11 years for $1,323.18. Which of these statements is CORRECT? A) The coupon rate is higher than the yield to maturity, and the YTM is higher than the current yield. B) The current yield is higher than both the coupon rate and the yield to maturity. C) The yield to maturity (YTM) is less than both the current yield and the coupon rate. D) The coupon rate is lower than the YTM, and the current yield should be higher than the coupon rate.

C) The yield to maturity (YTM) is less than both the current yield and the coupon rate. CR = coupon rate CY = current yield YTM = yield to maturity Premium bonds: CR > CY > YTM Par bonds: CR = CY = YTM Discount bonds: CR < CY < YTM Because the bond was purchased at a premium, the yield to maturity is less than both the current yield and the coupon rate.

Yvette is saving for her son's college education. Her son is expected to start college in 8 years. Choose the bond portfolio that would most likely be immunized with respect to this goal. A) Weighted average time to maturity of bonds is 6 years with coupon of 8%. B) Weighted average time to maturity of bonds is 10 years with coupon of 0%. C) Weighted average time to maturity of bonds is 10 years with coupon of 5%. D) Weighted average time to maturity of bonds is 8 years with coupon of 3%.

C) Weighted average time to maturity of bonds is 10 years with coupon of 5%. To immunize the portfolio, the duration of the portfolio should match the investor's time horizon. Coupon-paying bonds have durations that are less than their time to maturity. Zero-coupon bonds have durations equal to their time to maturity.

If all of these bonds are of similar credit risk, choose which will be the least sensitive to interest rate changes. A) 3% coupon bond maturing in six years B) Zero-coupon bond maturing in eight years C) Zero-coupon bond maturing in six months D) 8% coupon bond maturing in six years

C) Zero-coupon bond maturing in six months Coupon-paying bonds have durations that are less than their time to maturity. Zero-coupon bonds have durations that are equal to their time to maturity. Bonds with shorter durations are less sensitive to changes in interest rates. Thus, the six-month zero-coupon bond is the least sensitive to changes in interest rates.

The duration of a zero-coupon bond is A) less than the bond's maturity. B) greater than the bond's maturity. C) equal to the bond's maturity. D) equal to zero.

C) equal to the bond's maturity. The duration of a zero-coupon bond is equal to the bond's maturity.

Financial leverage affects A) risk to stockholders. B) return on equity. C) return on equity, earnings per share, and risk to stockholders. D) earnings per share.

C) return on equity, earnings per share, and risk to stockholders. The answer is return on equity, earnings per share, and risk to stockholders. ROE and earnings per share are magnified with leverage, and the risk to stockholders increases as a firm's leverage increases.

XYZ stock has a current dividend of $1.75 that has been growing at a constant rate of 8% per year. If the stock is currently selling for $100 and your required rate of return is 10%, would you buy the stock at today's price? A. Yes, because the stock is undervalued on the basis of the constant growth dividend discount model. B. Yes, because the stock is a good buy on the basis of its risk-return relationship. C. No, because the stock is overvalued on the basis of the constant growth dividend discount model. D. No, because the stock is not a good investment on the basis of its risk-return relationship.

C. No, because the stock is overvalued on the basis of the constant growth dividend discount model. On the basis of the constant growth dividend discount model, the intrinsic value of XYZ stock is $94.50, calculated as follows: D0(1 + g) ÷ (r - g) = $1.75(1.08) ÷ (0.10 - 0.08) = $94.50. Because XYZ stock is currently selling for $100 per share, it is overvalued in the market and the investor should not buy the stock.

Debbie owns a five-year AAA rated municipal bond with a coupon rate of 3.50% (paid semiannually). If the comparable yield for this quality bond is currently 2.75%, what is the present value of her bond? A) $966.14 B) $823.27 C) $1,064.80 D) $1,034.81

D) $1,034.81 The present value of her bond is $1,034.81, calculated using the following inputs on a semiannual basis: N = 10 (5 x 2 periods per year) I/YR = 1.375% (2.75 ÷ 2) PMT = $17.50 (3.50% × 1,000 ÷ 2) FV = $1,000 Solve for PV = -1,034.81, or $1,034.81

Calculate the present value of a five-year bond with a coupon rate of 5.50% (paid semiannually) if similar quality bonds are currently yielding 4.35%. A) $950.32 B) $929.47 C) $1,026.97 D) $1,051.18

D) $1,051.18 The present value of the bond is $1,051.18, calculated using the following inputs: N = 10 (5 x 2 periods per year) I/YR = 4.35% PMT = (5.50% × 1,000 ÷ 2) = $27.50 FV = $1,000 Solve for PV = -1,051.18, or $1,051.18.

Amber purchased a bond for $1,038.90 exactly two years ago. At that time, the bond had a maturity of five years and a coupon rate of 10% (paid semiannually). Assuming the rates below are the prevailing rates for this type of bond at different maturities, calculate the price that Amber could sell her bond for today. Maturities | 1 year | 3 years | 5 years | 10 years |30 years Interest rates | 6% | 7% | 8.5% | 10% | 12% A) $1,060.08 B) $1,038.31 C) $1,078.73 D) $1,079.93

D) $1,079.93 Using the 3-year rate of 7% for the calculation on a semiannual basis: FV = $1,000 I/YR = 7% PMT = $50 (10% x 1000 = 100 ÷ 2) N = 6 (3 x 2 periods per year) PV = -1,079.9283, or $1,079.93

You are considering purchase of a stock that is currently selling for $23 and pays a dividend of $1.15 per share. The dividend is expected to grow at a rate of 15% per year for the next three years. After that, the dividend is expected to grow at a constant rate of 8%. Your required return is 13%. The maximum price you should pay for this stock is A) $26.74. B) $33.62. C) $30.22. D) $29.76.

D) $29.76. The value is calculated on the HP 10bII+ by solving for the NPV of uneven cash flows as follows: 13 = I/YR 0 = CF0 1.3225 = CF1 1.5209 = CF2 1.7490 + 37.7784 = CF3 SHIFT, NPV = 29.7559 The 37.7784 is calculated from the constant growth DDM, starting at the end of the third year: [1.7490(1.08)] ÷ (0.13 - 0.08) = 37.7784

Lawrence purchases a 20-year corporate bond with a coupon rate of 7.5% paid semiannually. Assuming the comparable yield for this type of bond is 9.5%, calculate the intrinsic value of his bond. A) $872.69 B) $823.75 C) $410.78 D) $822.37

D) $822.37 Intrinsic value is calculated using the following inputs on a semiannual basis: N = 40 (20 x 2 periods per year) I/YR = 9.5 ÷ 2 = 4.75% PMT = $37.50 (7.5% × 1,000 ÷ 2) FV = $1,000 Solve for PV = 822.37 or $822.37.

Jose owns a 30-year corporate bond with 22 years remaining until maturity, featuring a coupon rate of 6.25% (paid semiannually). Assuming the comparable yield for this quality bond is currently 7%, calculate the intrinsic value of his bond. A) $1,138.38 B) $906.46 C) $1,000.00 D) $916.44

D) $916.44 Jose's bond has an intrinsic value of $916.44, calculated using the following inputs: FV = $1,000 PMT = (6.25% × 1,000 ÷ 2) = $31.25 N = 44 (22 x 2 periods per year) I/YR =7% Solve for PV = -916.4395, or $916.44

Springfield municipal bonds have 12 years remaining to maturity. The bonds pay interest semiannually at an annual coupon rate of 4.25%. The bonds have a yield to maturity of 5%. Calculate the current market price of these bonds. A) $961.53 B) $1,039.35 C) $933.53 D) $932.93

D) $932.93 The current market price of these bonds is $932.93, calculated using the following inputs on a semiannual basis: FV = $1,000 PMT = 4.25% x 1000 ÷ 2 = $21.25 N = 24 (12 x 2 periods per year) I/YR = 5% ÷ 2 = 2.5% Solve for PV = -932.9313, or $932.93

Henry owns a 10-year bond with a coupon rate of 4.85% (paid semiannually). Assuming the comparable yield for this quality bond is currently 5.5%, calculate the intrinsic value of his bond. A) $929.67 B) $930.51 C) $847.03 D) $950.51

D) $950.51 The intrinsic value of his bond is $950.51, calculated using the following inputs: N = 20 (10 x 2 periods per year) I/YR = 5.5% PMT = (4.85% × 1,000 ÷ 2) = $24.25 FV = $1,000 Solve for PV = -950.51, or $950.51.

Lauren's bond has a current market value of $987.56 and Macaulay duration of 3.2. Assuming the bond's yield to maturity (YTM) changes from 6.5% to 6%, calculate the estimated percent change in the price of the bond and the new expected market price of the bond. A) +3.0%, $1,017.19 B) −3.0%, $957.93 C) −1.5%, $972.75 D) +1.5%, $1,002.37

D) +1.5%, $1,002.37 The formula for determining the change in the price of the bond: ΔP/P = −D[Δy ÷ (1 + y)] ΔP/P = −3.2[(0.06 − 0.065) ÷ (1 + 0.065)] ΔP/P = −3.2(-0.004695) = 0.01502, or 1.5% This means that the bond's price should increase by 1.5% and sell for $1,002.37 (a slight premium to par) in the secondary market.

Calculate the estimated change in the price of a bond with a present value of $987.56 and Macaulay duration of 4.8 years when its YTM changes from 7% to 6%. A) +4.53% B) -4.53% C) -4.49 D) +4.49%

D) +4.49% Given the inverse relationship between bond prices and market interest rates, the price of the bond must increase by 4.49%, calculated as follows: ΔP/P = -4.8 × [(0.06 - 0.07) ÷ (1 + 0.07)] = 0.0449, or 4.49%.

VUL stock has a current market price of $25.65 and sales per share of $1.67. Calculate the price-to-sales ratio for this stock. A) 17.20 B) 34.87 C) 22.77 D) 15.36

D) 15.36 The formula for the price-to-sales (P/S) ratio: P/S = market price per share ÷ sales per share P/S = $25.65 ÷ $1.67 = 15.3592, or 15.36 This ratio would then be compared to its industry peers to determine whether the stock appears to be overvalued or undervalued.

DMM stock has a P/E ratio of 12 and is expected to have an expected growth rate of earnings of 6%. Based on this information, calculate the PEG ratio of DMM stock. A) 5 B) 4 C) 7.2 D) 2

D) 2 The PEG ratio is calculated by dividing a company's P/E ratio by the firm's expected growth rate of earnings: PEG = P/E ÷ g. Therefore, the PEG of DMM stock is 2 (12 ÷ 6). DMM's ratio would then be compared to its peers to determine whether the stock is a good buy.

MLM Corporation exhibits an expected growth in earnings of 11% for the next year. If an investor's required rate of return is 14%, what is the firm's price-to-free-cash-flow (P/FCF) ratio? A) 10.36 B) 38.00 C) 7.93 D) 37.00

D) 37.00 The firm's P/FCF ratio is 37.00, calculated as follows: (1 + 0.11) ÷ (0.14 - 0.11) = 37.00. After calculating this ratio, an investor would compare the result with the stock's peers to determine if a purchase is warranted.

Which of the following is an example of technical analysis? A) Interest rate trends B) Debt as a percentage of total capital C) Growth rate of the industry of which a company is a part D) 39-week moving average of a company's stock prices

D) 39-week moving average of a company's stock prices The 39-week moving average is one technical indicator.

LMN Company has assets of $250 million and $100 million in liabilities. For the past year the company earned $75 million, and paid out $10 million in dividends. What is the company's return on equity (ROE)? A) 30% B) 40% C) 25% D) 50%

D) 50% $250,000,000 - $100,000,000 = $150,000,000 in equity. $75,000,000 profit ÷ $150,000,000 equity = 0.50, or 50% ROE.

Which of these best describes the concept of convexity? A) Helps explain the changes in stock prices not accounted for by the constant growth dividend discount model B) A precise measure of the change in the price of a bond, given a respective change in GDP C) The average time it takes a bondholder to receive the interest and principal payments from a bond in present value dollars D) A measure of the curvature of the relationship between a bond's YTM and its market price (value)

D) A measure of the curvature of the relationship between a bond's YTM and its market price (value) Specifically, convexity helps explain the change in bond prices not accounted for simply by the bond's duration; in other words, convexity gives us a more precise measure of the change in the price of a bond, given a respective change in market interest rates.

Select the INCORRECT statement regarding a company's book value. A) Different inventory accounting methods may yield a different value for company assets, thereby affecting the book value of the corporation. B) Book value is determined by subtracting company liabilities from company assets. C) Book value per share may be derived by dividing the stockholder's equity portion by the total number of common shares outstanding. D) Book value represents an accurate measure of the fair market value of the company.

D) Book value represents an accurate measure of the fair market value of the company. Generally, book value does not represent an accurate measure of the fair market value of the company because this value is determined using historical costs.

Companies A and B have exactly the same dollar amount of assets and net income. Company A has a capitalization structure of 70% equity and 30% debt; Company B has a capitalization structure of 40% equity and 60% debt. Which of the following statements is CORRECT? A) Company B has a higher return on assets (ROA) than Company A. B) Company A has a higher earnings before interest, tax, depreciation, and amortization (EBITDA) than Company B. C) Company A has a higher debt-to-equity ratio than Company B. D) Company B has a higher return on equity (ROE) than Company A.

D) Company B has a higher return on equity (ROE) than Company A. If income is the same for both companies, then the only difference is the percentage of equity. With a lower equity, Company B will have a higher return on equity. EBITDA and ROA would be equal, and Company B has a higher debt-to-equity ratio.

Which of these statements best describes the concept of bond duration? A) Duration is used as an estimate of the change in the price of a bond given a negative one percentage point change in mortgage rates. B) Duration assumes the price of a bond will stay constant because the market price of the underlying stock stays constant. C) Duration measures the extent to which two variables move together, either positively (together) or negatively (opposite). D) Duration is the average weighted time it takes the bondholder to receive the interest and principal payments from a bond in present value dollars.

D) Duration is the average weighted time it takes the bondholder to receive the interest and principal payments from a bond in present value dollars. Covariance measures the extent to which two variables move together, either positively (together) or negatively (opposite). Duration is a measure of the sensitivity of a bond's price to changes in interest rates.

Which of the following are NOT used in technical analysis? A) Supply and demand of stocks B) Graphs C) Moving averages D) Financial statement ratios

D) Financial statement ratios Financial statement ratios are part of fundamental analysis.

Which one of these conclusions regarding fundamental analysis will an investor reach if he or she believes in the weak form of the efficient market hypothesis? A) Fundamental analysis cannot be used to identify undervalued securities. B) Fundamental analysis must be combined with technical analysis to identify undervalued securities. C) Fundamental analysis, applied in a top-down manner, can be used to identify undervalued securities. D) Fundamental analysis can be used to identify undervalued securities.

D) Fundamental analysis can be used to identify undervalued securities. An investor subscribing to the weak form of the EMH believes that fundamental analysis can be used to identify undervalued securities.

Top-down analysis includes which of these? I. Economic and market factors II. Industry analysis III. Company analysis A) II and III B) I and II C) I and III D) I, II, and III

D) I, II, and III Top-down analysis includes all these elements. Top-down analysis allows investors to look at the big picture first and then work their way down to the details.

Choose the stock value that is defined as the discounted present value based on future cash flows as determined by some form of a dividend discount model. A) Market value B) Par value C) Book value D) Intrinsic value

D) Intrinsic value A stock's intrinsic value is its discounted present value based on future cash flows as determined by some form of a dividend discount model.

Which of these valuation methods is the most appropriate to use when analyzing a stock? A) Non-constant dividend growth model B) Dividend discount model C) P/E ratio D) Multiple methods

D) Multiple methods No single equity valuation method should be used alone—an analyst should use various valuation methods and compare the results of each.

PQR stock has a current dividend of $1.75 that has been growing at a constant rate of 8% per year. If the stock is currently selling for $100 and your required rate of return is 10%, would you buy the stock at today's price? A) Yes, because the stock is a good buy on the basis of its risk-return relationship. B) Yes, because the stock is undervalued on the basis of the constant growth dividend discount model. C) No, because the stock is not a good investment on the basis of its risk-return relationship. D) No, because the stock is overvalued on the basis of the constant growth dividend discount model.

D) No, because the stock is overvalued on the basis of the constant growth dividend discount model. On the basis of the constant growth dividend discount model, the intrinsic value of XYZ stock is $94.50, calculated as follows: D0(1 + g) ÷ (r - g) = $1.75(1.08) ÷ (0.10 - 0.08) = $94.50. Because XYZ stock is currently selling for $100 per share, it is overvalued in the market and the investor should not buy the stock.

Which of the following bond strategies should not be recommended if an investor expects interest rates to increase? A) Sell U.S. Treasury bonds and buy U.S. Treasury bills. B) Sell low-coupon bonds and buy bonds with high coupons. C) Sell long-term bonds and buy short-term bonds. D) Sell low-duration bonds and buy longer duration bonds.

D) Sell low-duration bonds and buy longer duration bonds. Prices decline when interest rates rise. An investor expecting an increase in interest rates should sell more volatile bonds and purchase less volatile bonds. Bonds with large coupons and short durations are less price volatile than low-coupon, long-term, and long duration bonds.

All of the following statements correctly illustrate convexity and duration relationships except A) convexity has an inverse relationship with the coupon rate. B) duration has an inverse relationship with the yield to maturity. C) duration has an inverse relationship with the coupon rate. D) convexity has a direct relationship with the yield to maturity.

D) convexity has a direct relationship with the yield to maturity. Convexity has an inverse relationship with yield to maturity. Convexity relationships are the same as those for duration.

All of the following statements correctly illustrate bond relationships except A) long-term bonds are more affected by interest rate changes than short-term bonds. B) everything else being equal, the larger the coupon, the shorter the duration. C) bonds with longer durations are more affected by interest rate changes than bonds with shorter durations. D) higher-rated bonds have more price volatility than lower rated bonds.

D) higher-rated bonds have more price volatility than lower rated bonds. Higher-rated bonds are less risky and are less volatile than lower rated bonds.

The technical analysis approach suggests that future stock prices are forecasted by A) fiscal policy. B) monetary policy. C) financial ratios. D) past stock prices.

D) past stock prices. Past stock price movements are used by technicians to forecast future price movements.

Robyn's bond has a current market value of $1,456.78 and a Macaulay duration of 12.5. Assuming the bond's yield to maturity (YTM) changes from 5.55% to 6.25%, calculate the estimated percent change in the price of the bond and the new expected market price of the bond (based on the percent change). A) +8.29%, $1,577.55 B) +3.48%, $1,507.48 C) −0.70%, $1,446.58 D) −8.29%, $1,336.01

D) −8.29%, $1,336.01 The formula for determining the change in the price of the bond: ΔP/P = −D(Δy ÷ (1 + y)) ΔP/P = −12.5[(0.0625 − 0.0555) ÷ 1+0.0555] ΔP/P = −12.5(0.0066) = −0.08290, or −8.29% The bond's price should decrease by 8.29% and, therefore, sell for $1,336.01 in the secondary market.

Wade purchased a noninvestment-grade bond for $1,038.90 exactly two years ago today. The bond had a maturity of five years and a coupon rate of 10% (paid semiannually). Assuming the following are the prevailing rates for this type of bond at different maturity dates, how much could Wade sell his bond for today? Maturity | 1 Year | 2 Years | 3 Years | 5 Years Interest Rate | 6% | 6.5% | 7% | 8.5% A. $1,038.90 B. $1,060.08 C. $1,078.73 D. $1,079.93

D. $1,079.93 The intrinsic value of Wade's bond (what it should sell for today) is $1,079.93. END Mode, 2 P/Yr N = 3, DOWNSHIFT, N = 6 (number of periodic payments remaining) I/YR = 7 (periodic interest rate based on comparable three-year-term bonds) PMT = 10% × 1,000 ÷ 2 = 50 (semiannual coupon payment) FV = 1,000 Solve for PV = -1,079.9283, or $1,079.93 With only three years remaining until the maturity date of Wade's bond, you must use the interest rate associated with a maturity date of three years provided in the table

Jeff is interested in BEC stock. BEC's earnings and dividends are expected to grow at a constant rate of 6% per year for the foreseeable future. If Jeff's required rate of return is 11%, what is the intrinsic value of BEC stock if it is currently paying a dividend of $1.20? A. $10.91 B. $20.00 C. $24.00 D. $25.44

D. $25.44 This is found by using the constant growth dividend discount model: intrinsic value = D0(1 + g) ÷ (r - g) = $1.20(1.06) ÷ (0.11 - 0.06) = $25.44.

Company EHO has assets of $500 million and $125 million in liabilities. For the past year, the company earned $150 million and paid out $20 million in dividends. What is the company's return on equity (ROE)? A. 10% B. 25% C. 30% D. 40%

D. 40% $500 million - $125 million = $375 million in equity. $150 million profit ÷ $375 million equity = 0.40, or 40% ROE.

Which of the following correctly presents the relationships that exist between different yield measures? I. For a premium bond: coupon rate > current yield > yield to maturity II. For a par bond: coupon rate = current yield = yield to maturity III. For a discount bond: coupon rate < current yield < yield to maturity IV. For a premium bond: current yield < yield to maturity < coupon rate A. IV only B. I and II C. II and IV D. I, II, and III

D. I, II, and III Only Statement IV is incorrectly stated. Certain relationships exist between different yield measures depending on whether the bond is trading at par, at a discount, or at a premium.

All of the following are examples of assets unique to a business except A. accounts receivable. B. inventory. C. machinery and equipment. D. notes payable.

D. notes payable. Notes payable are an example of a business liability

Kristy has a fixed-income portfolio that consists of three individual bonds. | FMV | Duration Bond A | $5,000 | 5.0 Bond B | $3,000 | 8.0 Bond C | $2,000 | 12.0 What is the duration of Kristy's portfolio? A) 6.9 B) 7.0 C) 7.3 D) 8.3

The weighted duration of Kristy's portfolio is 7.3, calculated as follows: | FMV | Duration | Product Bond A | $5,000 | 5.0 | $25,000 Bond B | $3,000 | 8.0 | $24,000 Bond C | $2,000 | 12.0 | $24,000 Total | $10,000 | | $73,000 portfolio duration = $73,000 ÷ $10,000 = 7.3