FIN 4318 EXAM 2

Studies often claim to find a "hot hands" phenomenon with mutual funds. Which of the following leads this to finding? a. A high percent of mutual fund winners repeat as winners the next year b. A high percent of mutual fund losers become winners the next year c. Mutual fund winners this year are just as likely to be losers next year as winners

a. A high percent of mutual fund winners repeat as winners the next year

Ben Graham's screens for value stocks have been modified and adapted over time. Which of the following types of companies do the Graham screens try to find? a. Cheap companies that pay high dividends, have low risk and reasonable growth prospects b. Cheap companies that generate high and stable earnings, with little growth c. Cheap companies that will have high growth in the future, while paying some dividends d. Cheap companies that have very little debt e. None of the above

a. Cheap companies that pay high dividends, have low risk and reasonable growth prospects

Passive value investors often look for cheap companies with good management and significant competitive advantages. Which of the following combinations of quantitative screens would you use to find these companies? a. Stable earnings, high return on capital b. Volatile earnings, high return on capital c. Stable earnings, low return on capital d. Volatile earnings, low return on capital

a. Stable earnings, high return on capital

The key to being a successful growth investor is valuing growth potential. Which of the following companies is likely to have the highest value for growth? (You can assume that they have the same cost of capital of 10%) a. A company with expected growth = 20%, Return on capital = 10% b. A company with expected growth = 20%, Return on capital = 15% c. A company with expected growth = 5%, Return on capital = 10% d. A company with expected growth = 5%, Return on capital = 15%

b. A company with expected growth = 20%, Return on capital = 15%

A concern when investing in small cap companies is that they are far less likely to be followed by equity research analysts and there is less public information on these companies. That makes them more risky as investments. a. True b. False

b. False

If you do not believe that beta is a good measure of equity risk, you cannot do discounted cash flow valuation a. True b. False

b. False

You can invest only in index funds and still be an active investor. a. True b. False

b. False

A widely used GARP strategy is to buy stocks that trade at PE ratios less than their expected growth rates. If you adopt this strategy, which of the following are you likely to face? a. You will find too many cheap stocks when interest rates are low and the economy is growing strongly b. You will find too many cheap stocks when interest rates are high and the economy is growing strongly c. You will find too many cheap stocks when interest rates are low and the economy is in recession d. You will find too many cheap stocks when interest rates are high and the economy is in recession

b. You will find too many cheap stocks when interest rates are high and the economy is growing strongly

In a classic index fund, which of the following does the fund do? a. Hold an equally weighted portfolio of all of the stocks in the index b. Hold a market-cap weighted portfolio of all of the stocks in the index c. Hold a portfolio of all of the stocks in the index, with the same weights that they have in the index d. None of the above

c. Hold a portfolio of all of the stocks in the index, with the same weights that they have in the index

In passive value screening, which of the following combinations are you looking for? a. Low price (PE,PBV), low growth, low risk, high returns on investments b. Low price (PE, PBV), high growth, high risk, high returns on investments c. Low price (PE, PBV), high growth, low risk, high returns on investments d. Low price (PE, PBV), low growth, high risk, low returns on investments e. Low price (PE, PBV), low growth, low risk, low returns on investments f. Low price (PE, PBV), high growth, high risk, low returns on invesments

c. Low price (PE, PBV), high growth, low risk, high returns on investments

Looking at stock returns over the decades, it is clear that stocks with low price to book ratios have delivered higher returns than stocks with high price to book ratios. Which of the following may best explain the extra returns? a. Low price to book stocks have higher growth potential than high price to book stocks b. Low price to book stocks generally have higher returns on equity than high price to book stocks c. Low price to book stocks may be riskier than high price to book stocks d. Low price to book stocks are more likely to have intangible assets on their balance sheets

c. Low price to book stocks may be riskier than high price to book stocks

Morningstar ranks mutual funds, based upon past performance and other criteria and assigns a ranking/rating for each fund. Which of the following best summarizes the findings in studies that have looked at the predictive power of Morningstar ratings? a. Morningstar ratings have no predictive power b. Morningstar ratings have always had strong predictive power c. Morningstar ratings used to have little predictive power before 2002, but a revamp of the system has improved their predictive power d. Morningstar ratings used to have strong predictive power before 2002, but a revamp of the system has worsened their predictive power

c. Morningstar ratings used to have little predictive power before 2002, but a revamp of the system has improved their predictive power

Mutual funds vary in terms of time horizon and trading volume. Which of the following best summarizes the evidence on the link between trading and performance? a. Mutual funds that trade more have higher total returns but lower risk adjusted returns than the market b. Mutual funds that trade more have lower total returns but higher risk adjusted returns than the market c. Mutual funds that trade more have lower total returns and lower risk adjusted returns than the market d. Mutual funds that trade more earn about the same returns on a risk-adjusted basis as the market

c. Mutual funds that trade more have lower total returns and lower risk adjusted returns than the market

The Jensen study in the late 1960s was the first to take a comprehensive look at the risk-adjusted returns at mutual funds. Which of the following conclusions did that study come to? a. Mutual funds, on average, earn higher returns than the rest of the market on a risk-adjusted basis b. Mutual funds, on average, earn about the same returns as the rest of the market on a risk-adjusted basis c. Mutual funds, on average, earn lower returns than the rest of the market on a risk-adjusted basis

c. Mutual funds, on average, earn lower returns than the rest of the market on a risk-adjusted basis

Which of the following is the best measure of the payoff to "active" value investing? a. The difference between the average returns earned by active value investors and an index fund of all stocks. b. The difference between the average returns earned by active value investors and a growth index fund. c. The difference between the average returns earned by active value investors and an value index fund d. The difference between the average returns earned by value index fund and a growth index fund. e. The difference between the average returns earned by value index fund and an index fund of all stocks

c. The difference between the average returns earned by active value investors and an value index fund

If you are a growth investor, which of the following do you believe about the market? a. The market always under values growth assets b. The market always over values growth assets c. The market is more likely to make mistakes in valuing growth assets than assets-in-place d. The market is more likely to make mistakes in valuing assets-in-place than growth assets e. None of the above

c. The market is more likely to make mistakes in valuing growth assets than assets-in-place

High PE stocks have historically delivered lower annual returns than low PE stocks. If you are a growth investor, which of the following justifications may you offer for still making a bet on high PE stocks? a. High PE stocks are usually less risky than low PE stocks b. High PE stocks have lower transactions costs than low PE stocks c. There are periods where high PE stocks do better than low PE stocks, and you are good at timing these periods d. High PE stocks generally pay higher dividends than low PE stocks

c. There are periods where high PE stocks do better than low PE stocks, and you are good at timing these periods

Which of the following empirical findings best characterizes the "small cap" premium"? a. Young companies, on average, have earned higher risk-adjusted returns than older companies b. Growth companies, on average, have earned higher risk-adjusted returns than mature companies c. Companies with small revenues have earned higher risk adjusted returns than companies with larger revenues d. Companies with low market capitalization have earned higher risk adjusted returns than companies with high market capitalization

d. Companies with low market capitalization have earned higher risk adjusted returns than companies with high market capitalization

Which of the following does an enhanced index fund try to accomplish? a. Deliver higher returns than the index in question by investing in companies outside the index b. Deliver higher returns than the index in question by investing in a subset of the stocks in the index c. Deliver higher return per unit of risk than the index in question by investing in companies outside the index d. Deliver a higher return per unit of risk than the index in question by investing in a subset of the stocks in the index

d. Deliver a higher return per unit of risk than the index in question by investing in a subset of the stocks in the index

If you are a value investor, which of the following statements best characterizes your view of growth opportunities? a. Growth opportunities dont usually exist b. Growth does not add to value, since companies have to reinvest to generate growth c. Growth is too speculative and this should not be paid for d. Growth can add value, but if it does, it should be viewed as a bonus on the investment, not as the reason for the investment e. None of the above

d. Growth can add value, but if if does, it should be viewed as a bonus on the investment, not as the reason for the investment

Transition probabilities measure the likelihood that institutional investors in a given quartile based upon performance in the last period will stay in that quartile in the next period. Assuming that there is no continuity in performance, which of the following probabilities should you see in the table for investors in quartile 1 for the following year? a. Quartile 1: 100%, Quartile 2: 0%, Quartile 3: 0%, Quartile 4: 0% b. Quartile 1: 50%, Quartile 2: 50%, Quartile 3: 0%, Quartile 4: 0% c. Quartile 1: 33.33%, Quartile 2: 33.33%, Quartile 3: 33.33%, Quartile 4: 0% d. Quartile 1: 25%, Quartile 2: 25%, Quartile 3: 25%, Quartile 4: 25% e. None of the above

d. Quartile 1: 25%, Quartile 2: 25%, Quartile 3: 25%, Quartile 4: 25%

With a sampled index fund, the fund holds only a subset of the stocks in the index. Which of the following is the best measure of how good a sampled index fund is performing? a. The returns generated on the fund should be higher than the returns on the index b. The standard deviation on the fund should be lower than the standard deviation of the index c. The correlation in returns between the index fund and the index returns should be close to zero d. The correlation in returns between the index fund and the index returns should be close to one

d. The correlation in returns between the index fund and the index returns should be close to one

If you invest in small cap stocks, you may see some or all of your excess returns dissipate as a result of transactions costs. Which of the following may cause these higher transactions costs? a. Small cap stocks tend to be held less by institutional investors b. Small cap stocks generally have lower trading volume c. Small cap stocks are more likely to be traded over the counter d. Small cap companies are more likely to have low-priced shares e. All of the above

e. All of the above

In recent years, investors have migrated from using PE ratios to EV/EBITDA multiples to assess whether companies are cheap or expensive. Which of the following explains this shift? a. A distrust of accounting earnings and a trust in cash flows b. Differences in depreciation methods across companies c. Differences in debt policy across companies d. Fewer companies have negative EBITDA than have negative net income e. All of the above

e. All of the above

One simple strategy for investing in growth stocks is to invest in those stocks that have delivered the highest historical earnings growth. Why might this strategy not work? a. Historical earnings growth is not a good predictor of future earnings growth b. Even if historical growth has predictive power, the market may already be pricing in this growth c. High earnings growth companies may be in riskier businesses than low earnings growth companies d. Earnings growth may not be more the result of accounting plows than operating success e. All of the above

e. All of the above

Warren Buffett is a legendary investor, and investors have long followed his maxims on investing. Which of the following types of companies has he generally favored as investments? a. Companies with simple businesses that are easy to understand b. Companies with strong competitive advantages and high returns on investments c. Companies with strong balance sheets and solid cash flows d. Companies with good managers that you can trust e. All of the above

e. All of the above

Which of the following is the best characterization of a "value" investor? a. An investor who cares about value and finding undervalued companies b. An investor who incorporates fundamentals into his or her valuation judgement c. An investor who buys stocks that trade at low PE ratios d. An investor who buys stocks that trade at less than book value e. An investor who wants to buy a company for less than the value of just its assets in place

e. An investor who wants to buy a company for less than the value of just its assets in place

Assume that you use passive value screens on the entire market and come up with a list of 25 companies that pass your screens. If most of the companies on this list come from one sector, which of the following may explain why this might be happening? a. The over represented sector is undervalued b. The over represented sector shares a risk characteristic that you did not screen for c. The over represented sector is in a declining business where future growth is questionable d. The over represented sector is facing increasing competition, potentially lowering returns on capital and equity e. Any or all of the above

e. Any or all of the above

The PEG ratio is the ratio of PE to expected growth. One GARP strategy is to buy stocks that trade at low PEG ratios. If you use this strategy, which of the following groups of stocks will you bias yourself towards in your investments? a. Low risk, low growth, low return on equity stocks b. Low risk, high growth, low return on equity stocks c. Low risk, high growth, high return on equity stocks d. High risk, low growth, low return on equity stocks e. High risk, high growth, low return on equity stocks f. High risk, high growth, high return on equity stocks

e. High risk, high growth, low return on equity stocks

As a passive investor, you often have a choice between investing in an exchange-traded fund or an index fund. Why might you choose to invest in the ETF? a. The ETF will follow the index more closely than the index fund b. The ETF will be less risky than an index fund c. The ETF will deliver higher returns than an index fund d. It costs less to buy an ETF than to buy an index fund e. You can trade an ETF like any stock but you do not have the same flexibility with an index fund

e. You can trade an ETF like any stock but you do not have the same flexibility with an index fund

If you want to replicate what Warren Buffett has done in today's markets, which of the following is the biggest impediment that you will face? a. Markets have become efficient and stocks are not mispriced any more b. Everyone has access to information at the same time c. Companies no longer have strong competitive advantages d. All of the best companies are in businesses that are difficult to understand e. Your clients may not have the patience to allow you to make long-term bets

e. Your clients may not have the patience to allow you to make long-term bets

Which of the following best characterizes the findings in studies of active individual investors? a. On average, active individual investors beat the market, with the most active among them doing the best. b. On average, active individual investors break even with the market, with the most active among them doing the best. c. On average, active individual investors do worse than the market, with the most active among them doing the best. d. On average, active individual investors beat the market, with the most active among them doing the worst. e. On average, active individual investors break even with the market, with the most active among them doing the worst. f. On average, active individual investors do worse than the market, with the most active among them doing the worst

f. On average, active individual investors do worse than the market, with the most active among them doing the worst