Midterm 2-Review Questions

Which of the following is NOT a technical trading rule category?

. anti-fundamental and anti-portfolio approaches

Studies of the relationship between P/E ratios and stock returns have found that

. low P/E stocks of small cap stocks outperformed high P/E stocks of large cap stocks.

Between 1986 and 1996, the standard deviation of the returns for the NYSE and the DJIA indexes were 0.10 and 0.09, respectively, and the covariance of these index returns was 0.0009. What was the correlation coefficient between the two market indicators?

.1000

According to the dividend growth model, if a company were to declare that it would never pay dividends, its value would be

0

Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a rate of 9 percent per year for the next three years. After that dividends are expected to grow at a normal rate of 5 percent per year. Assume that the appropriate discount rate is 7 percent.Refer to Exhibit 8.4. The future price of the stock in year 3 is

101.85

What is the standard deviation of an equally weighted portfolio of two stocks with a covariance of 0.009, if the standard deviation of the first stock is 15% and the standard deviation of the second stock is 20%?

14.2%

Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate of 8 percent per year for the next five years. After that dividends are expected to grow at a normal rate of 5 percent per year. Assume that the appropriate discount rate is 7 percent.Refer to Exhibit 8.3. The future price of the stock in year 5 is

154.35

Calculate the expected return for A Industries, which has a beta of 1.75 when the risk free rate is 0.03 and you expect the market return to be 0.11.

17.0 percent

The National Motor Company's last dividend was $1.25, and the directors expect to maintain the historic 4 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7 percent for the next three years and the stock will then reach $25.00 per share.Refer to Exhibit 8.2. How much should you be willing to pay for the stock if you require a 16 percent return?

19.21

XCEL Corporation paid a dividend yesterday for $1.50. They expect to pay dividends annually at a constant 6 percent annual growth rate indefinitely. If the required rate of return on this investment is 12 percent, what is the current value of this common stock?

26.50

In 2018, Swisten Inc. issued a $150 par value preferred stock that pays an 8 percent annual dividend. Due to changes in the overall economy and in the company's financial condition, investors are now requiring a 15 percent return. What price would you be willing to pay for a share of the preferred if you receive your first dividend one year from now?

80

A good portfolio is a collection of individually good assets.

False

In the presence of transactions costs, the SML will be

a set of lines rather than a single straight line.

Which of the following is NOT an advantage of technical analysis identified by technicians?

a. Fundamental analysis may not time the investment properly when trading under- or over-valued securities. b. The majority of investors cannot consistently process new information correctly. c. Fundamental analysis depends heavily on financial accounting statements. d. The majority of investors cannot process new information quickly enough.

A portfolio manager without superior analytical skills should

a. determine and quantify the risk preferences of a client. b. maintain the specified risk level. c. ensure that the portfolio is completely diversified. d. minimize transaction costs.

All of the following are ways in which a firm can increase its growth rate of equity earnings without any external financing EXCEPT

a. increasing its return on equity (ROE). b. increasing its retention ratio. c. increasing its return on assets (ROA). d. decreasing its dividend payments.

The purpose of calculating the covariance between two stocks is to provide a(n) ____ measure of their movement together.

absolute

According to Dow Theory, a major market

advance does not go straight up, because some investors will take profits.

When the 50-day moving average crosses the 200-day moving average from ____ on ____ volume, this would be a ____ signal.

below, high, bullish.

Advances and declines are associated with market

breadth

The slope of the efficient frontier is calculated as follows

d. E(σportfolio)/ E(Rportfolio)

Assuming that everyone agrees on the efficient frontier (given a set of costs), there would be consensus that the optimal portfolio on the frontier would be where the ratio of return per unit of risk was greatest.

false

Because the market portfolio is reasonable in theory, it is easy to implement when testing or using the CAPM.

false

Beta is a measure of unsystematic risk.

false

Discounted cash flow techniques for equity valuation may use one of the following: (1) dividends, (2) free cash flow, or (3) coupons.

false

In dividend discount models (DDM) with supernormal growth, supernormal growth may continue indefinitely.

false

In tests of the semistrong-form EMH, it is not necessary to use risk-adjusted rates of return.

false

In the APT model, the identity of all the factors is known.

false

Securities with returns that lie below the security market line are undervalued.

false

Studies have shown that a well-diversified investor needs as few as five stocks.

false

Studies strongly suggest that the CAPM be abandoned and replaced with the APT.

false

Technical analysis and the efficient market hypothesis have a consistent set of assumptions concerning stock market behavior.

false

Tests have shown that if small filters are used in simulating trading rules, these trading rules have produced above average returns after transactions costs are factored in.

false

The APT assumes that security returns are normally distributed.

false

The introduction of lending and borrowing severely limits the available risk/return opportunities.

false

When considering markets in Europe, it is inappropriate to assume a level of efficiency similar to that for U.S. markets.

false

he planning period for the CAPM is the same length of time for every investor.

false

here can be only one zero-beta portfolio.

false

n a three-asset portfolio, the standard deviation of the portfolio is one-third of the square root of the sum of the individual standard deviations.

false

All of the following are assumptions of the Capital Asset Pricing Model (CAPM) EXCEPT

investors can have different time horizons, daily, weekly, annual, or some other period.

A high-quality balance sheet typically has

limited use of debt or leverage.

Net margins are defined as

net income/sales

Which of the following is NOT considered a basic economic force?

p/e

To a technician that believed in the importance of volume, a bullish signal would

prices increase on heavy volume.

An individual investor's utility curves specify the tradeoffs he or she is willing to make between

return and risk.

Using the constant growth model, an increase in the required rate of return from 14 to 18 percent combined with an increase in the growth rate from 8 to 12 percent would cause the price to

rise more than 4%

The gross margin is defined as

ross Profit/Sales.

A relative valuation technique is appropriate to consider when you have a good set of comparable entities.

true

A risk-free asset is one in which the return is completely guaranteed; there is no uncertainty.

true

An efficient market requires a large number of profit-maximizing investors.

true

An example of a relative valuation technique is the Price/Cash Flow ratio.

true

An increase in debit balances in brokerage accounts is viewed by technicians as a bullish sign.

true

An overvalued investment is so expensive that we will not receive a fair return if we bought it.

true

As an analyst performs ratio analysis, he hopes to determine whether earnings represent cash flows and whether those cash flows will recur.

true

Because technicians are suspicious of financial statements, they consider it advantageous not to depend on them.

true

Candlestick charts indicate the price change from open to close by shading whether the market went down or up for the day.

true

Empirical tests of the APT model have found that as the size of a portfolio increased, so did the number of factors.

true

If the covariance of two stocks is positive, these stocks tend to move together over time.

true

If the estimated value of an asset is greater than the market price, you would want to buy the investment.

true

If you borrow money at the RFR and invest the money in the market portfolio, the rate of return on your portfolio will be higher than the market rate of return.

true

Increasing the correlation among assets in a portfolio results in an increase in the standard deviation of the portfolio.

true

Investors choose a portfolio on the efficient frontier based on their utility functions that reflect their attitudes towards risk.

true

Multifactor models of risk and return can be broadly grouped into models that use macroeconomic factors and models that use microeconomic factors.

true

Quality financial statements are a good reflection of reality; accounting tricks and one-time changes are not used to make the firm appear stronger than it really is.

true

Results of initial public offering (IPOs) studies tend to support the semi-strong EMH because it appears that prices adjusted rapidly after initial underpricin

true

Risk is defined as the uncertainty of future outcomes.

true

The T-Bill-Eurodollar yield spread widens during periods of international crisis.

true

The correlation coefficient and the covariance are measures of the extent to which two random variables move together.

true

The dividend discount model (DDM) can be used to value preferred stock by simply using a growth rate of zero in the DDM model.

true

The existence of transaction costs indicates that at some point the additional cost of diversification relative to its benefit would be excessive for most investors.

true

The importance of an industry's performance on an individual stock's performance varies across industries.

true

The random walk hypothesis contends that stock prices occur randomly.

true

The real risk-free rate depends on the real growth in the economy and can be affected for short time periods by temporary tightness or ease in the capital markets.

true

The weak form of the efficient market hypothesis contends that technical trading rules are of little value.

true

Those who employ the bottom-up approach start their search immediately at the company level.

true

Two approaches to defining factors for multifactor models are to use macroeconomic variables or individual characteristics of the securities.

true

In a multifactor model, time horizon risk represents

unanticipated changes in investors' desired time to receive payouts.