Types & Characteristic of Equity Unit 12

An investor believes that he can study the history of security trades and security markets in order to identify buying opportunities. Furthermore, he prepares and studies charts on the past prices of the securities he is most interested in purchasing for his portfolio. He uses these charts to try to predict the future activity of a particular stock. What type of strategy is this investor using to make his investment decisions? A) Technical analysis B) Ratio analysis C) Fundamental analysis D) Tactical asset allocation

A) Technical analysis Technical analysis is an attempt by an analyst to predict the direction of a security's future market price. Such terms as moving average, trendline, and support and resistance level are then used by an analyst to determine when the time is right to purchase (or sell) the security.

Sortel Industries has preferred stock outstanding that pays annual dividends of $3.75 a share. If an investor wants to earn a rate of return of 8.5%, how much should she be willing to pay for a share of Sortel preferred stock? A) $31.88 B) $44.12 C) $42.10 D) $33.89

B) $44.12 This is a middle school math question. It is asking, 3.75 is 8.5% of what number? The computation is: 3.75 / 0.085 = $44.12.

Which of the following is used in technical analysis in an attempt to modify fluctuations of stock prices over the long term into a smoothed trend? A) Trend lines B) Moving averages C) Consolidation D) Support and resistance

B) Moving averages To avoid the volatility frequently present in stock price trends, analysts will frequently use moving averages. These averages reduce short-term distortions to a minimum.

Discounted cash flow is commonly thought of as applying solely to fixed-income securities. However, forms of DCF used for the valuation of common stock also include I. the price-to-earnings ratio II. the dividend discount model III. the discounted book value model IV. the dividend growth model A) II and III B) I and IV C) II and IV D) I and II

C) II and IV The 2 most common forms of DCF used in the valuation of common stock are the dividend discount and dividend growth models.

If a technician believed in the importance of volume, which of the following would indicate bullish sentiment? A) Prices decrease on heavy volume. B) Prices increase on light volume. C) Prices increase on heavy volume. D) Prices decrease on light volume.

C) Prices increase on heavy volume. Prices decrease on heavy volume. Prices increase on light volume. Prices increase on heavy volume. Prices decrease on light volume.

Which of the following statements regarding preemptive rights is TRUE? A) Both common and preferred stockholders have the right to subscribe to a rights offering. B) Neither common nor preferred stockholders have the right to subscribe to a rights offering. C) Common stockholders do not have the right to subscribe to a rights offering. D) Preferred stockholders do not have the right to subscribe to a rights offering.

D) Preferred stockholders do not have the right to subscribe to a rights offering. Preferred stockholders have a preference as to liquidation and distribution of dividends, but the right to maintain a proportionate interest in the company only applies to common stock.

One method used by some analysts to estimate the future value of a stock is the dividend growth model. This model would probably be most useful in the case of A) a AAA corporate bond B) a small-cap stock C) a preferred stock D) a large-cap stock

D) a large-cap stock The dividend growth model is a method to value the common stock of a company on the basis of assumed constant growth of dividends in the future. Therefore, it can only be applied to a corporation whose dividends might be expected to increase. It is far more likely that a large-cap stock will be paying dividends than a small-cap. Bonds don't pay any dividends, and in any event, their interest, just like the dividends on preferred stock, is fixed; there is no growth possible.

A technical analyst would be least concerned with A) short interest B) advance/decline C) S&P 500 index D) book value per share

D) book value per share A technical analyst is not concerned with any fundamental aspects of a company, including company financials. Open short interest theory, overall market movements, and advance/decline ratios are of concern to technical analysts.

When using the dividend discount model, A) future expected dividends are discounted to compute the present value of the stock B) the discount rate is generally lower than the expected rate of return C) the degree of accuracy in forecasting the price of preferred stock is less than that obtained by using the dividend growth model D) best results are obtained from stocks that pay irregular dividends

A) future expected dividends are discounted to compute the present value of the stock This method of common stock valuation takes the investor's expected future dividend returns and then discounts that amount by the expected rate of return to arrive at the supposed present value. Expected (or required) rate of return is a component of both the dividend discount model and the dividend growth model, and only the DDM is used for preferred stocks because the dividend can never increase. When using any dividend model, the greater the regularity of dividends, the more accurate the forecast.

Reasons why a corporation might issue a convertible preferred stock would include A) giving those shareholders an opportunity to participate in the future success of the company B) a lower cost to the issuer than would be incurred by the issuance of convertible bonds C) tax savings to the issuer D) giving those shareholders the ability to convert into the issuer's bonds

A) giving those shareholders an opportunity to participate in the future success of the company The benefit of any convertible security, bond or preferred stock, is that the ability to convert into the issuer's common stock allows those investors to participate in the potential future growth of the company. One does not convert into a bond, and because preferred dividends are an after-tax outlay, there are no tax savings, as there would be with bond interest. Because stock is lower in claim than bonds, the dividend rate would have to be higher than the interest rate on bonds.

During the analysis of XYZ stock, a technical analyst concludes that XYZ's support level has been broken. Being a technician, the most appropriate decision should be to A) rate the stock as a sell. B) rate the stock as a buy. C) purchase additional shares of the stock. D)rate the stock as a hold.

A) rate the stock as a sell. If a support level is broken, this provides a sell signal. Once the stock has lost its support, expectations are that it will continue to fall. The breaking of a resistance level, as the price of the asset gathers momentum to the upside, indicates a buying opportunity.

Which of the following is not a characteristic of American depositary receipts (ADRs)? A) Because ADRs are traded on the exchanges, they are relatively liquid and marketable investments. B) Dividends are declared in the foreign currency, so exchange rate, or currency, risk is completely eliminated. C) ADRs are denominated and pay dividends in U.S. dollars, not foreign currencies, thus saving the investor transaction costs with respect to converting currencies. D) ADR holders may surrender ADRs in exchange for receiving the shares of the non-U.S. company.

B) Dividends are declared in the foreign currency, so exchange rate, or currency, risk is completely eliminated. ADRs are receipts issued by a U.S. bank for shares of a foreign company purchased and held by a foreign branch of the bank. Dividends are declared in the local currency, so exchange rate, or currency, risk is not completely eliminated. They are generally traded on one of the major exchanges ensuring liquidity. They are an alternative to investing directly in foreign companies or foreign mutual funds. If the investor desires the foreign shares, the ADR may be surrendered and the exchange made.

A client is considering the purchase of American depositary receipts (ADRs). The client is looking to further diversify her portfolio. Which of the following is not a feature of this type of investment vehicle? A) Information regarding the foreign company is more easily attainable than if directly purchased. B) They are not subject to exchange rate, or currency, risk. C) ADRs are denominated and pay dividends in U.S. dollars. D) ADRs are both liquid and marketable.

B) They are not subject to exchange rate, or currency, risk Even though ADRs are denominated in U.S. dollars, they are subject to exchange rate, or currency, risk. The bank furnishes information about the underlying security in English rather than the foreign language and ADRs are traded like any domestic stock.

In the technical analysis of the value of securities, which of the following items is NOT important? A) Resistance and support levels B) The breadth of market volume C) The amount of a company's past earnings D) A prevailing market trend in response to shifts in supply and demand

C) The amount of a company's past earnings The amount of a company's past earnings is a factor used in the fundamental analysis of securities, but not technical analysis. Technicians rely on market trends and supply and demand factors, as well as chart indications such as resistance and support levels

A fundamental analyst would be interested in all of the following EXCEPT A) statistics of the U.S. Department of Commerce on disposable income B) innovations within the automotive industry C) daily trading volumes on the NYSE corporate D) annual reports

C) daily trading volumes on the NYSE corporate Trading volume interests the technical analyst, who looks at fluctuations in the market, not at fundamental economic values.

All the following factors support fundamental analysis while assessing a wide range of qualitative factors except A) the company's business model. B) the company's management team's quality and experience. C) the company's stock price trend. D) the company's competitive position.

C) the company's stock price trend. The company's stock price trend is important to technical analysis. Remember that a technician "charts prices and volume over time". The others are factors to consider in fundamental analysis.

A support level is the price range at which a technical analyst would expect A) the supply of a stock to decrease substantially. B) the demand for a stock to decrease substantially. C) the demand for a stock to increase substantially. D) the supply of a stock to increase substantially.

C) the demand for a stock to increase substantially Most stock prices remain relatively stable and fluctuate up and down from their true value. The lower limit to these fluctuations is called a support level—the price range where a stock appears cheap and attracts buyers. The upper limit is called a resistance level. Generally, a support level will develop after a stock has experienced a steady decline from a higher price level. Technicians believe that, at some price below the recent peak, other investors who did not buy prior to the first price increase and have been waiting for a small reversal to get into the stock will now buy. When the price reaches this support price, demand surges, and price and volume begin to increase again.

The type of analysis that attempts to value securities by examining general economic trends and the growth potential and productivity of individual companies is A) holding period analysis B) technical analysis C) credit analysis D) fundamental analysis

D) fundamental analysis There are two main approaches to valuing securities. Fundamental analysis takes the approach described in this question. The other approach—technical analysis—relies on charts of past performance to forecast future price movements.

A company's dividend on its common stock is A) mandatory if the company is profitable B) specified in the company charter C) voted on by shareholders D) determined by its board of directors

D) determined by its board of directors A common stock's dividend payment and amount are determined by the company's board of directors.

Corporations have found that one way to increase employee motivation is to grant options to purchase stock in the company. Incentive (qualified) options differ from nonqualified options in all of the following respects except A) there is a maximum 10-year limit for exercising an ISO; no such time limit exists for an NSO. B) the holder of an ISO can recognize capital gain (loss) as a result of exercise, whereas ordinary income (loss) is the result with an NSO. C) ISOs may only be granted to employees while NSOs may be given to virtually anyone. D) the recipient of the grant of the ISO has no income tax consequences at the time of the grant.

D) the recipient of the grant of the ISO has no income tax consequences at the time of the grant. Whether the grant is of an ISO (qualified) or an NSO (nonqualified), there are no tax consequences to the recipient at the time of the grant. It is only after exercise (NSO) and sale after exercise (ISO) that the recipient of the grant has tax consequences. Each of the other choices represents a difference. ISOs can only be granted to employees while the NSO can also be granted to members of the board of directors and even to vendors. With an ISO, capital gain (loss) treatment is available upon the sale of the stock if the recipient holds the stock purchased through exercise at least 1 year from the date of exercise and at least 2 years from the date of the grant. With an NSO, the recipient can only have ordinary income (loss) based on the difference between the exercise price and the market value when the option is exercised. Finally, if the recipient of an ISO does not exercise the option within 10 years of the grant, it is treated as an NSO for tax purposes.