Chapter 11 Exam II Review

Protsky Inc. just paid a dividend of $2.20 per share. The dividend growth rate for Protsky's dividends is 3 percent per year. If the required rate of return on Protsky stock is 12 percent, the stock should be valued at $____ per share according to the dividend discount model. a. 24.44 b. 25.18 c. 18.88 d. 75.53

b. 25.18

The ____ is commonly used to determine what a stock's price should have been. a. Capital Asset Pricing Model b. Treynor Index c. Sharpe Index d. B and C

a. Capital Asset Pricing Model

____ is (are) not a firm-specific factor(s) that affect(s) stock prices. a. Exchange rates b. Dividend policy changes c. Stock offerings and repurchases d. Earnings surprises e. All of the above are firm-specific factors that affect stock prices.

a. Exchange rates

The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock's volatility. a. Sharpe b. Treynor c. arbitrage d. margin

a. Sharpe

The ____ is commonly used as a proxy for the risk-free rate in the Capital Asset Pricing Model. a. Treasury bond rate b. prime rate c. discount rate d. federal funds rate

a. Treasury bond rate

The expected acquisition of a firm typically results in ____ in the target's stock price. a. an increase b. a decrease c. no change d. none of the above

a. an increase

When evaluating stock performance, ____ measures variability that is systematically related to market returns; ____ measures total variability of a stock's returns. a. beta; standard deviation b. standard deviation; beta c. intercept; beta d. beta; error term

a. beta; standard deviation

The beta of a stock portfolio is equal to a weighted average of the a. betas of stocks in the portfolio. b. betas of stocks in the portfolio, plus their correlation coefficients. c. standard deviations of stocks in the portfolio. d. correlation coefficients between stocks in the portfolio.

a. betas of stocks in the portfolio.

Stock prices of U.S. firms primarily involved in exporting are likely to be ____ affected by a weak dollar and ____ affected by a strong dollar. a. favorably; adversely b. adversely; adversely c. favorably; favorably d. adversely; favorably

a. favorably; adversely

The general mood of investors represents: a. investor sentiment. b. beta. c. systematic risk. d. unsystematic risk.

a. investor sentiment.

Which of the following is not a reason the PE ratio method may result in an inaccurate valuation for a firm? a. potential errors in the forecast of the firm's beta b. potential errors in the forecast of the firm's future earnings c. potential errors in the choice of the industry composite used to derive the PE ratio d. All of the above are reasons the PE ratio method may result in an inaccurate valuation for a firm.

a. potential errors in the forecast of the firm's beta

The "January effect" refers to a large a. rise in the price of small stocks in January. b. decline in the price of small stocks in January. c. decline in the price of large stocks in January. d. rise in the price of large stocks in January.

a. rise in the price of small stocks in January.

The demand by foreign investors for the stock of a U.S. firm sold on a U.S. exchange may be higher when the dollar is expected to ____, other things being equal. (Assume the firm's operations are unaffected by the value of the dollar.) a. strengthen b. weaken c. stabilize d. B and C

a. strengthen

The standard deviation of a stock's returns is used to measure a stock's a. volatility. b. beta. c. Treynor Index. d. risk-free rate.

a. volatility.

If security prices fully reflect all market-related information (such as historical price patterns) but do not fully reflect all other public information, security markets are a. weak-form efficient. b. semi-strong form efficient. c. strong form efficient. d. B and C e. none of the above

a. weak-form efficient.

Morgan stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Treynor index of Morgan stock is a. 0.04. b. 0.05. c. 0.35. d. 0.03. e. none of the above

b. 0.05.

Zilo stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Sharpe index of Zilo stock is a. 0.36. b. 0.35. c. 0.28. d. 0.45. e. none of the above

b. 0.35.

Boris stock has an average return of 15 percent. Its beta is 1.5. Its standard deviation of returns is 25 percent. The average risk-free rate is 6 percent. The Sharpe index for Boris stock is a. 0.35. b. 0.36. c. 0.45. d. 0.28. e. none of the above

b. 0.36.

If the returns of two stocks are perfectly correlated, then a. their betas should each equal 1.0. b. the sum of their betas should equal 1.0. c. their correlation coefficient should equal 1.0. d. their portfolio standard deviation should equal 1.0.

c. their correlation coefficient should equal 1.0.

Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as Tarzak is 15. Tarzak is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzak requires a return of 12 percent. The estimated stock price of Tarzak today should be ____ using the adjusted dividend discount model. a. $116.41 b. $104.91 c. $161.15 d. none of the above

a. $116.41

A stock has a standard deviation of daily returns of 1 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock's expected daily return is .2 percent. The lower boundary is a. -1.45 percent. b. -1.85 percent. c. 0 percent. d. -1.65 percent.

a. -1.45 percent.

Vansel Inc. retains most of its earnings. The company currently has earnings per share of $11. Vansel expects its earnings to grow at a constant rate of 2 percent per year. Furthermore, the average PE ratio of all other firms in Vansel's industry is 12. Vansel is expected to pay dividends per share of $3.50 during each of the next three years. If investors require a 10 percent rate of return on Vansel stock, a fair price for Vansel stock today is $____. a. 113.95 b. 111.32 c. 105.25 d. none of the above

a. 113.95

If the standard deviation of a stock's returns over the last 12 quarters is 4 percent, and if there is no perceived change in volatility, there is a ____ percent probability that the stock's returns will be within ____ percentage points of the expected outcome. a. 68; 4 b. 68; 8 c. 95; 8 d. 95; 6 e. none of the above

a. 68; 4

Kandle stock just paid a dividend of $4.76 per share and plans to pay a dividend of $5 per share next year, which is expected to increase by 3 percent per year subsequently. The required rate of return is 15 percent. The value of Kandle stock, according to the dividend discount model, is $____. a. 39.67 b. 41.67 c. 33.33 d. 31.73 e. none of the above

b. 41.67

The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock's beta. a. Sharpe b. Treynor c. arbitrage d. margin

b. Treynor

The capital asset pricing model (CAPM) suggests that the required rate of return on a stock is directly influenced by the stock's : a. prevailing level of the industry competition. b. beta. c. liquidity. d. size (market capitalization).

b. beta.

The ____ is not a factor used in the capital asset pricing model (CAPM) to derive the return of an asset. a. prevailing risk-free rate b. dividend growth rate c. market return d. covariance between the asset's returns and market returns e. All of the above are factors used in the CAPM.

b. dividend growth rate

According to the text, other things being equal, stock prices of U.S. firms primarily involved in exporting could be ____ affected by a weak dollar. Stock prices of U.S. importing firms could be ____ affected by a weak dollar. a. adversely; favorably b. favorably; adversely c. favorably; favorably d. adversely; adversely

b. favorably; adversely

Holding other factors constant, an increase in the capital gains tax rate will: a. have more effect on the valuation of dividend-paying stocks than on stocks with high growth prospects. b. have less effect on the valuation of dividend-paying stocks than on stocks with high growth prospects. c. have no effect on the valuations of stocks. d. have the same effect on the valuation of dividend-paying stocks and stocks with high growth prospects.

b. have less effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.

The ____ is not a measure of a stock's risk. a. stock's price volatility b. stock's return c. stock's beta d. value-at-risk method e. All of the above are measures of a stock's risk.

b. stock's return

A beta of 1.1 means that for a given 1 percent change in the value of the market, the is expected to change by 1.1 percent in the same direction. a. risk-free rate b. stock's value c. stock's standard deviation d. correlation coefficient

b. stock's value

The limitations of the dividend discount model are more pronounced when valuing stocks a. that pay most of their earnings as dividends. b. that retain most of their earnings. c. that have a long history of dividends. d. that have constant earnings growth.

b. that retain most of their earnings.

The market risk premium is: a. the yield on newly issued Treasury bonds. b. the return of the market in excess of the risk-free rate. c. the covariance between the risk-free rate and the return of the market. d. the return of the market in excess of expected cash flows.

b. the return of the market in excess of the risk-free rate.

A firm is expected to generate earnings of $2.22 per share next year. The mean ratio of share price to expected earnings of competitors in the same industry is 15. Based on this information, the valuation of the firm's shares based on the price-earnings (PE) method is a. $2.22. b. $6.76. c. $33.30. d. none of the above

c. $33.30.

A stock has a standard deviation of daily returns of 3 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock's expected daily return is .1 percent. The lower boundary is a. -1.65 percent. b. -3.00 percent. c. -4.85 percent. d. -5.05 percent.

c. -4.85 percent.

Bolwork Inc. is expected to pay a dividend of $5 per share next year. Bolwork's dividends are expected to grow by 3 percent annually. The required rate of return for Bolwork stock is 15 percent. Based on the dividend discount model, a fair value for Bolwork stock is $____ per share. a. 33.33 b. 166.67 c. 41.67 d. 60.00

c. 41.67

Which of the following is incorrect regarding the capital asset pricing model (CAPM)? a. It is sometimes used to estimate the required rate of return for any firm with publicly traded stock. b. It is based on the premise that the only important risk of a firm is systematic risk. c. It is concerned with unsystematic risk. d. All of the above are true.

c. It is concerned with unsystematic risk.

Emerging market stocks tend to exhibit all of the following except: a. high political risk. b. high exchange risk. c. high correlation with stocks of more developed countries. d. high volatility.

c. high correlation with stocks of more developed countries.

A higher beta of an asset reflects a. lower risk. b. lower covariance between the asset's returns and market returns. c. higher covariance between the asset's returns and the market returns. d. none of the above

c. higher covariance between the asset's returns and the market returns.

Investors can avoid unsystematic risk by: a. using the capital asset pricing model. b. investing in stocks with low PE ratios. c. holding diversified portfolios. d. using the free cash flow model.

c. holding diversified portfolios.

Value at risk estimates the ____ a particular investment for a specified confidence level. a. beta of b. risk-free rate of c. largest expected loss to d. standard deviation of

c. largest expected loss to

Stock X has a lower beta than Stock Y. The market return for next month is expected to be either 1 percent, +1 percent, or +2 percent with an equal probability of each scenario. The probability distribution of Stock X returns for next month is a. the same as that of Stock Y. b. more dispersed than that of Stock Y. c. less dispersed than that of Stock Y. d. zero.

c. less dispersed than that of Stock Y.

Which of the following statements is incorrect? a. Market-makers take positions to capitalize on the discrepancy between the prevailing stock price and their own valuation of a stock. b. Specialists and market-makers may take the opposite position of uninformed investors and therefore stand to benefit if their expectations are correct. c. For each stock that is traded in the Nasdaq market, there are 50 market-makers on average. d. The spread quoted for a given stock may vary among market-makers.

c. For each stock that is traded in the Nasdaq market, there are 50 market-makers on average.

LeBlanc Inc. currently has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as LeBlanc Inc. is 15. LeBlanc is expected to pay a dividend of $3 per share over the next four years, and an investor in LeBlanc requires a return of 12 percent. What is the forecasted stock price of LeBlanc in four years, using the adjusted dividend discount model? a. $150.00 b. $163.91 c. $45.00 d. $168.83 e. none of the above

d. $168.83

A stock's average return is 10 percent. The average risk-free rate is 7 percent. The standard deviation of the stock's return is 4 percent, and the stock's beta is 1.5. What is the Treynor Index for the stock? a. .03 b. .75 c. 1.33 d. .02 e. 50

d. .02

Steam Corp. has a beta of 1.5. The prevailing risk-free rate is 5 percent and the annual market return in recent years has been 11 percent. Based on this information, the required rate of return on Steam Corp. stock is ____ percent. a. 21.5 b. 6.5 c. 16.5 d. 14.0 e. none of the above

d. 14.0

Sorvino Co. is expected to offer a dividend of $3.2 per share per year forever. The required rate of return on Sorvino stock is 13 percent. Thus, the price of a share of Sorvino stock, according to the dividend discount model, is $____. a. 4.06 b. 4.16 c. 40.63 d. 24.62 e. none of the above

d. 24.62

Fabrizio, Inc. is expected to generate earnings of $1.50 per share this year. If the mean ratio of share price to expected earnings of competitors in the same industry is 20, then the stock price per share is $____. a. 13.33 b. 3.00 c. 20.00 d. 30.00 e. none of the above

d. 30.00

If security markets are semi-strong form efficient, investors cannot solely use ____ to earn excess returns. a. previous price movements b. insider information c. publicly available information d. A and C

d. A and C

Which of the following is not a type of factor that drives stock prices, according to your text? a. economic factors b. market-related factors c. firm-specific factors d. All of the above are factors that affect stock prices.

d. All of the above are factors that affect stock prices.

The price-earnings valuation method applies the ____ price-earnings ratio to ____ earnings per share in order to value the firm's stock. a. firm's; industry b. firm's; firm's c. average industry; industry d. average industry; firm's

d. average industry; firm's

The Sharpe Index measures the a. average return on a stock. b. variability of stock returns per unit of return c. stock's beta adjusted for risk. d. excess return above the risk-free rate per unit of risk.

d. excess return above the risk-free rate per unit of risk.

Holding other factors constant, a stock portfolio has more volatility when its individual stock volatilities are ________ and its individual stock returns have _______ correlations. a. high; low b. low; high c. low; low d. high; high

d. high; high

According to the capital asset pricing model, the required return by investors on a security is a. inversely related to the risk-free rate. b. inversely related to the firm's beta. c. inversely related to the market return. d. none of the above

d. none of the above

Technical analysis relies on the use of ____ to make investment decisions. a. interest rates b. inflationary expectations c. industry conditions d. recent stock price trends

d. recent stock price trends

The limitations of the dividend discount model are most pronounced for a firm that a. has a high beta. b. has high expected future earnings. c. distributes most of its earnings as dividends. d. retains all of its earnings. e. none of the above

d. retains all of its earnings.

The formula for a stock portfolio's volatility does not contain the a. weight (proportional investment) assigned to each stock. b. variance (standard deviation squared) of returns of each stock. c. correlation coefficients between returns of each stock. d. risk-free rate.

d. risk-free rate.

A stock's beta can be measured from the estimate of the using regression analysis. a. intercept b. market return c. risk-free rate d. slope coefficient

d. slope coefficient

Which of the following is not commonly used as the estimate of a stock's volatility? a. the estimate of its standard deviation of returns over a recent period b. the trend of historical standard deviations of returns over recent periods c. the implied volatility derived from an option pricing model d. the estimate of its option premium derived from an option pricing model

d. the estimate of its option premium derived from an option pricing model

The January effect refers to the ____ pressure on ____ stocks in January of every year. a. downward; large b. upward; large c. downward; small d. upward; small

d. upward; small

A stock's average return is 11 percent. The average risk-free rate is 9 percent. The stock's beta is 1 and its standard deviation of returns is 10 percent. What is the Sharpe Index? a. .05 b. .5 c. .1 d. .02 e. .2

e. .2

A stock's beta is estimated to be 1.3. The risk-free rate is 5 percent, and the market return is expected to be 9 percent. What is the expected return on the stock based on the CAPM? a. 5.2 percent b. 11.7 percent c. 16.7 percent d. 4 percent e. 10.2 percent

e. 10.2 percent