Financial Markets Chapter 13

According to the Gordon growth model, what is an investor's valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investor's required return is 11 percent?

$110

According to the Gordon growth model, what is an investor's valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investor's required return is 15 percent?

$22

As of 2016, the price of an average house is around

$232,500

A stock currently sells for $25 per share and pays $0.24 per year in dividends. What is an investor's valuation of this stock if she expects it to be selling for $30 in one year and requires a 15 percent return on equity investments?

$26.30

A stock currently sells for $30 per share and pays $1.00 per year in dividends. What is an investor's valuation of this stock if he expects it to be selling for $37 in one year and requires a 12 percent return on equity investments?

$33.93

Suppose the average industry PE ratio for auto parts retailers is 20. What is the current price of Auto Zone stock if the retailer's earnings per share is projected to be $1.85?

$37

Holding other things constant, a stock's value will be highest if its most recent dividend is

$5.00.

(I) The market price of a security at a given time is the highest value any investor puts on the security. (II) Superior information about a security increases its value by reducing its risk.

(I) is false, (II) is true

(I) Conventional mortgages are originated by private lending institutions, and FHA or VA loans are originated by the government. (II) Conventional mortgages are insured by private companies, and FHA or VA loans are insured by the government.

(I) is false, (II) true

(I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders, but after that of bondholders. (II) Firms issue preferred stock in far greater amounts than common stock.

(I) is true, (II) false.

(I) The largest of the organized stock exchanges in the United States is the New York Stock Exchange. (II) To be listed on the NYSE, a firm must have a minimum of $100 million in market value or $10 million in revenues.

(I) is true, (II) false.

(I) ARMs offer lower initial rates and the rate may fall during the life of the loan. (II) Conventional mortgages do not allow a borrower to take advantage of falling interest rates.

(I) is true, (II) is false

What is true of mortgages?

-a mortgage is a long-term loan secured by real estate -a borrower pays off a mortgage in a combination of principal and interest payments that result in full payment of the debt by maturity -over 72 percent of mortgage loans finance residential home purchases -most mortgages during the 1920s and 1930s were balloon loans are true

What is an advantage of Electronic Communications Networks (ECNs)?

-all unfilled orders are available for review by ECN traders -transactions costs are lower for ECN trades -trades are made and confirmed faster

What is true regarding Electronic Communications Networks (ECNs)?

-archipelago and Instinet are two examples of ECNs -competition from ECNs has forced NASDAQ to cut its fees -traders benefit from lower trading costs and faster service

Securities not listed on one of the exchanges trade in the over-the-counter market. In this exchange, dealers "make a market" by

-buying stocks for inventory when investors want to sell -selling stocks from inventory when investors want to buy

What terms are found in mortgage loan contracts to protect the lender from financial loss?

-collateral -down payment -private mortgage insurance

The interest rate borrowers pay on their mortgages is determined by

-current long-term market rates -the term -the number of discount points

Stock values computed by valuation models may differ from actual market prices because it is difficult to

-estimate future dividend growth rates -estimate the risk of a stock -forecast a stock's future dividends

Mortgage-backed securities

-have been growing in popularity in recent years as institutional investors look for attractive investment opportunities -are securities collateralized by a pool of mortgages -are securities collateralized by both insured and uninsured mortgages

What is true of mortgage interest rates?

-interest rates on mortgage loans are determined by three factors: current long-term market rates, the term of the mortgage, and the number of discount points paid -mortgage interest rates tend to track along with Treasury bond rates -the interest rate on 15-year mortgages is lower than the rate on 30-year mortgages, all else the same -in exchange for points, lenders reduce interest rates on mortgage loans -longer-term mortgages have higher interest rates than shorter-term mortgages

Distinct elements of a mortgage loan include

-investment -servicing

Distinct elements of a mortgage loan include

-origination -investment -servicing

What factors are used in determining a person's FICO score?

-past payment history -outstanding debt -length of credit history

Which of the following is a characteristic of a balloon loan?

-prior to maturity, the borrower only pays interest (usually monthly) -at maturity, the entire loan amount is due are true

The mortgage market is well suited to providing online service for several reasons, including

-that the mortgage market is information-based and no products have to be shipped or inventoried -that mortgages tend to be the same across all lenders.

Which of the following are important ways in which mortgage markets differ from the stock and bond markets?

-the usual borrowers in the capital markets are government entities and businesses, whereas the usual borrowers in the mortgage markets are individuals -most mortgages are secured by real estate, whereas the majority of capital market borrowing is unsecured -because mortgages are made for different amounts and different maturities, developing a secondary market has been more difficult

Exchange traded funds (ETFs) have which of the following features?

-they are listed and traded as individual stocks on a stock exchange -they are indexed rather than actively managed -their value is based on the underlying net asset value of the stocks held in the index basket

The Federal National Mortgage Association (Fannie Mae)

-was set up to buy mortgages from thrifts so that these institutions could make more loans -funds purchases of mortgages by selling bonds to the public

Holding other things constant, a stock's value will be highest if its dividend growth rate is

15%.

From 2014 to 2015, the Dow Jones Industrial Average has fluctuated between

16,000 and 19,000

The most commonly quoted index is the Dow Jones Industrial Average (DJIA), an index based on the performance of the stocks of ________ large companies.

30

The share of the mortgage market held by depository institutions (banks) is approximately

30 percent

In 2013, the NYSE traded ________ shares on an average trading day.

4 billion

Typically, discount points should not be paid if the borrower will pay off the loan in ________ years or less

5

Holding other things constant, a stock's value will be highest if the investor's required return on investments in equity is

5%.

Which of the following protects the mortgage lender's right to sell property if the underlying loan defaults?

A lien

The most active stock exchange in the world is the

A) Nikkei Stock Exchange.

The problem with buying foreign stocks is that most foreign companies are not listed on any of the U.S. stock exchanges, so the purchase of shares is difficult. Intermediaries have found a way to solve this problem by selling

ADRs

(I) A share of common stock in a firm represents an ownership interest in that firm. (II) A share of preferred stock is as much like a bond as it is like common stock.

Both are true

(I) Firms issue common stock in far greater amounts than preferred stock. (II) In a given year, the total volume of stock issued is much less than the volume of bonds issued.

Both are true

(I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders. (II) Bondholders hold a claim on assets that has priority over the claims of preferred stockholders.

Both are true

Which of the following is true regarding the Gordon growth model?

Dividends are assumed to grow at a constant rate forever.

What is FALSE regarding Electronic Communications Networks (ECNs)?

ECNs allow institutional investors, but not individuals, to trade after hours.

What is NOT an advantage of Electronic Communications Networks (ECNs)?

ECNs work well for thinly traded stocks.

More stock trading in the U.S. occurs in over-the-counter markets rather than on organized exchanges. (T/F)

False

________ issues participation certificates, and ________ provides federal insurance for participation certificates

Freddie Mac; no one

Which of the following are useful for home buyers who expect their income to rise in the future?

GPMs and GEMs are useful

Which of the following statements about trading operations in an organized exchange is correct?

In most trades, specialists match buy and sell orders.

The main cause of fluctuations in stock prices is changes in

Information available to investors.

What is the primary disadvantage of an ETF?

Investors have to pay a broker commission each time they buy or sell shares.

What is NOT true of mortgages?

Less than 65 percent of mortgage loans finance residential home purchases

Security prices are set by active market participants. Which of the following is not a consequence of this fact?

Market participants have a strong incentive to reveal private information about a security.

Retired people can live on the equity they have in their homes by using a

RAM

What is useful for home buyers who expect their income to fall in the future?

RAMs

The Securities Acts of 1933 and 1934 established the S.E.C. to enforce which of the follow laws?

Require firms to tell the public the truth about their businesses andRequire brokers, dealers, and exchanges to treat investors fairly are laws the S.E.C. enforces

Which of the following is not a division of the S.E.C.?

The Division of Fraud Investigation

Which of the following is NOT a characteristic of a balloon loan?

The loan is typically 10 - 15 years in maturity.

A high price earnings ratio (PE) gives what interpretation?

The market expects the earnings to rise in the future.

A basic principle of finance is that the value of any investment is

The present value of all future net cash flows generated by the investment

Which of the following is not an element of the Gordon growth model of stock valuation?

The stock's expected future price

Which of the following are important ways in which mortgage markets differ from stock and bond markets?

The usual borrowers in capital markets are businesses and government entities, whereas the usual borrowers in mortgage markets are individuals

In over-the-counter markets, dealers increase the liquidity of thinly traded securities.

True

A loan for borrowers who do not qualify for loans at the usual market rate of interest because of a poor credit rating or because the loan is larger than justified by their income is

a subprime mortgage

Which of the following is not an objective of the Securities and Exchange Commission?

advise investors about which particular stocks are good buys

During the early years of a balloon mortgage loan, the lender applies

all of the monthly payment to interest on the loan

During the last years of a balloon mortgage loan, the lender applies

all of the monthly payment to interest on the loan

The subprime financial crisis led to one of the worst bear markets in the last 50 years. Stock prices likely fell due to

an increase in required returns on equity investments.

A weakness of the PE approach to valuing stock is that it is

based on industry averages rather than firm-specific factors.

The PE ratio approach to valuing stock is especially useful for valuing

both privately held firms and firms that don't pay dividends.

REMICs are most like

collateralized mortgage obligations

A loan-servicing agent will

collect payments from the borrower

The riskiest capital market security is

common stock

Preferred stockholders hold a claim on assets that has priority over the claims of

common stockholders, but after that of bondholders.

The 2001 terrorist attacks and the Enron financial scandal caused anticipated dividend growth to ________, investors' required return on equity to ________, and stock prices to ________.

decrease; increase; decrease

The percentage of the total loan paid back immediately when a mortgage loan is obtained, which lowers the annual interest rate on the debt, is called

discount points

What reduces moral hazard for the mortgage borrower?

down payments

Borrowers tend to prefer ________ to ________, whereas lenders prefer ________.

fixed-rate loans; ARMs; ARMs

Growing-equity mortgages (GEMs)

help the borrower pay off the loan in a shorter time

A ________ PE may indicate that the market feels the firm's earnings are very ________ risk and is therefore willing to pay a ________ for them.

high; low; premium

Ginnie Mae

insures pass-through certificates

In the generalized dividend valuation model, a stock's value depends only on

its future dividend payments and the required return on equity.

The share of the mortgage market held by life insurance companies is

less than 5 percent

To list on the NYSE, a firm must

meet have earnings of at least $10 million per year and have a total of $100 million in market value requirements.

The most common type of mortgage-backed security is the

mortgage pass-through

During the early years of an amortizing mortgage loan, the lender applies

most of the monthly payment to interest on the loan.

During the last years of an amortizing mortgage loan, the lender applies

most of the monthly payment to the outstanding principal balance.

The PE ratio approach to valuing stock is especially useful for valuing

neither publicly held corporations nor firms that regularly pay dividends.

A borrower who qualifies for an FHA or VA loan enjoys the advantage that

only a very low or zero down payment is required

Second mortgages serve the following purposes:

only they give borrowers a way to use the equity they have in their homes as security for another loan and they allow borrowers to get a tax deduction on loans secured by their primary residence or vacation home

The possibility that mortgages will prepay and force investors to seek alternative investments, usually with lower expected returns, is called

prepayment risk

The Federal Housing Administration (FHA)

provides insurance for certain mortgage contracts

In the one-period valuation model, a stock's value falls if the ________ rises.

required return on equity

A borrower with a 30-year loan can create a GEM by

simply increasing the monthly payments beyond what is required and designating that the excess be applied entirely to the principal.

In the one-period valuation model, a stock's value will be higher

the higher its expected future price is.

What is a disadvantage of a second mortgage compared to credit card debt?

the loans are secured by the borrower's home

The most common type of mortgage-backed security is

the mortgage pass-through, a security that has the borrower's mortgage payments pass through the trustee before being disbursed to the investors

A share of common stock in a firm represents an ownership interest in that firm and allows stockholders to

vote and receive dividends.