Chapter 11
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.
$116.41
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?
$168.83
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
-4.85 percent.
Morgan stock has an average return minus the average risk-free rate of 12.5 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Treynor index of Morgan stock is:
0.05
Zilo stock has an average return minus the average risk-free rate of 5 percent, a beta of 1, and a standard deviation of returns of 20 percent. The Sharpe index of Zilo stock is:
0.25
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:
0.36
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 $____.
113.95
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.
14.0
Sorvino Co. is expected to offer a dividend of $3.20 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 $____.
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 $____.
30.00
Kandle Company paid a dividend of $4.76 per share this year 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 $____.
41.67
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.
41.67
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.
68; 4
____ are not a firm-specific factor that affect stock prices.
Exchange rates
Portfolio managers who monitor systematic risk rather than total risk are more concerned about stock volatility than about beta.
False
The market risk premium is stable over time and is not affected by stock market conditions.
False
Which of the following is incorrect regarding the capital asset pricing model (CAPM)?
It is concerned with unsystematic risk.
According to the capital asset pricing model, the required return by investors on a security is
None of these are correct.
The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock's volatility.
Sharpe
The ____ is commonly used as a proxy for the risk-free rate in the capital asset pricing model.
Treasury bond rate
The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock's beta.
Treynor
Beta serves as a measure of risk because it can be used to derive a probability distribution of returns based on a set of market returns.
True
Regarding the implied standard deviation, by plugging in the actual option premium paid by investors for a specific stock in the option-pricing model, it is possible to derive the anticipated volatility level.
True
Regarding the value-at-risk method, the same methods used to derive the maximum expected loss of one stock can be applied to derive the maximum expected loss of a stock portfolio for a given confidence level.
True
The Treynor index is similar to the Sharpe index, except that is uses beta rather than standard deviation to measure the stock's risk.
True
The value-at-risk method is intended to warn investors about the potential maximum loss that could occur.
True
While the previous year's earnings are often used as a base for forecasting future earnings, the recent year's earnings do not always provide an accurate forecast of the future.
True
The expected acquisition of a firm typically results in ____ in the target's stock price.
an increase
When evaluating stock performance, ____ measures variability that is systematically related to market returns; ____ measures total variability of a stock's returns.
beta; standard deviation
The ____ is often used to estimate the required rate of return for any firm with public traded stock.
capital asset pricing model
The ____ is not a factor used in the capital asset pricing model (CAPM) to derive the return of an asset.
dividend growth rate
The Sharpe index measures the
excess return above the risk-free rate per unit of risk.
A beta of 1.8 implies that the stock has a risk premium of 1.8 percent.
false
A portfolio's beta is the sum of the individual forecasted betas, weighted by the market value of each stock.
false
If beta is thought to be the appropriate measure of risk, a stock's risk-adjusted returns should be determined by the Sharpe index.
false
The U.S. government's budget deficit has a significant impact on the bond market but does not affect the stock market.
false
The main source of uncertainty in computing the return of a stock is the dividend to be received next year.
false
The prime rate is commonly used as a proxy for the risk-free rate in the capital asset pricing model (CAPM).
false
VIX (CBOE Volatility Index) indicates the volatility of the bond market in general.
false
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.
favorably; adversely
Holding other factors constant, an increase in the capital gains tax rate will
have less effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
Holding other factors constant, a stock portfolio has more volatility when its individual stock volatilities are ________ and its individual stock returns have _______ correlations.
high; high
A higher beta for an asset reflects
higher covariance between the asset's returns and the market returns.
Investors can avoid unsystematic risk by
holding diversified portfolios.
The general mood of investors represents:
investor sentiment
If security markets are semistrong-form efficient, investors cannot solely use ____ to earn excess returns.
previous price movements AND publicly available information
The limitations of the dividend discount model are most pronounced for a firm that
retains all of its earnings.
The "January effect" refers to a large
rise in the price of small stocks in January.
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.
stock's value
The limitations of the dividend discount model are more pronounced when valuing stocks
that retain most of their earnings.
Which of the following is NOT commonly used as an estimate of a stock's volatility?
the estimate of its option premium derived from an option pricing model
The market risk premium is
the return of the market in excess of the risk-free rate.
If the returns of two stocks are perfectly correlated, then
their correlation coefficient should equal 1.0.
A firm's stock price is affected not only by macroeconomic and market conditions but also by firm-specific conditions.
true
A stock with a beta of 2.3 means that for every 1 percent change in the market overall, the stock tends to change by 2.3 percent in the same direction.
true
A weak dollar may enhance the value of a U.S. firm whose sales are dependent on the U.S. economy.
true
Divestitures are commonly viewed as a favorable signal about a firm if the divested assets are unrelated to the firm's core business.
true
For firms that do not pay dividends, the free cash flow model may be more suitable than the dividend discount model.
true
The dividend discount model can be adapted to assess the value of any firm, even those that retain most or all of their earnings.
true
The dividend discount model states that the price of a stock should reflect the present value of the stock's future dividends.
true
The January effect refers to the ____ pressure on ____ stocks in January of every year.
upward; small
The standard deviation of a stock's returns is used to measure the stock's
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:
weak-form efficient
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?
.02
A stock's average return is 11 percent. The average risk-free rate is 9 percent. The stock's beta is 1, and the standard deviation of its returns is 10 percent. What is the Sharpe index?
.05
Which of the following is not a type of factor that drives stock prices, according to your text?
All of the above are factors that affect stock prices.
A stock portfolio has more volatility when its individual stock returns are uncorrelated.
False
If investors agree on a firm's forecasted earnings, they will derive the same value for that firm using the PE method to value the firm's stock.
False
The capital asset pricing model (CAPM) is based on the premise that the only important risk of a firm is unsystematic risk.
False
The price-earnings valuation method applies the ____ price-earnings ratio to the ____ earnings per share in order to value the firm's stock.
average industry; firm's
The capital asset pricing model (CAPM) suggests that the required rate of return on a stock is directly influenced by the stock's :
beta.
The beta of a stock portfolio is equal to a weighted average of the
betas of stocks in the portfolio.
Value at risk estimates the ____ a particular investment for a specified confidence level.
largest expected loss to
Technical analysis relies on the use of ____ to make investment decisions.
recent stock price trends
A stock's beta can be measured from the estimate of the ________ using regression analysis.
slope coefficient
