Chapter 12B Finance 407

All of the following statements regarding systematic and unsystematic risk are correct EXCEPT A. The risk applicable to common stocks can be divided into two types- a general component known as unsystematic risk and a specific (issuer) component known as systematic risk B. Systematic risk represents that portion in the variability of a stock's total return that is directly associated with overall movements in the general economy or stock market D. Unsystematic risk represents that portion in the variability of a stock's total return that is not related to the variability in general economic (market) activity; rather, it is specific to a company, industry, or country D. Investors should focus on unsystematic risk because it is part of portfolio risk that can be eliminated through diversification

A. Statement A is incorrect because the general component of common stock risk is known as systematic risk. The specific (issuer) risk is known as unsystematic risk.

All of the following statements regarding equity securities are correct EXCEPT A. Equity securities provide a preferential claim-before payment of all obligations to fixed-income claims-on the income and assets of a corporation B. There are two forms of equities, preferred stock and common stock C. Preferred stock is an equity security with an intermediate claim (between the bondholders and the common stockholders) on a firm's assets and earnings D. Common stock is an equity security representing an ownership interest in a corporation

A. Statement A is incorrect because unliked fixed-income securities, equity securities provide a residual claim on income and assets.

Which of the following statements regarding margin accounts for futures and stock accounts is(are) CORRECT? I. Both futures and stock accounts have a required initial margin and maintenance margin. II. If the equity in the account falls below the maintenance margin for futures and stock accounts, the investor must restore the equity to the initial margin. A. I only B. II only C. Both I and II D. Neither I nor II

A. Statement II is incorrect because stock accounts requires the inestor to restore the maintenance margin when the equity has decreased below the maintenance margin.

If a preferred stock is paying a dividend of $4 and the investor' required rate of return is 10%, what is the value of the stock using the no-growth dividend discount model? A. $40 B. $4 C. $10 D. $12.50

A. Using no-growth dividend discount model, the value of the preferred stock equals $40 (4 / 10%)

Due to an extensive investment in research and development, Banana Inc., recently developed a new wireless communication system that should greatly increase the stock's dividend. One analyst believes the current dividend of $1.00 will increase by 20% for each of the next three years and then 6% for the foreseeable future. What is the intrinsic value per share of the company's stock assuming a required rate of return of 10%? A. $76.42 B. $91.58 C. $95.91 D. $78.49

A. Using the multistate growth dividend discount model, the intrinsic value of the stock is $76.42, calculated as follows: Compute the value of each future dividend until the growth rate stabilizes (Years 1-3) D1= $1.00 x 1.20 = $1.20 D2= $1.20 x 1.20 = $1.44 D3= $1.44 x 1.20 = $1.73 Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 4) D4= $1.73 x 1.06 = $1.83 V= $1.83 / (.08-.06) = $91.58 Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0= $0 CF1= $1.20 CF2= $1.44 CF3 = $1.73 + $91.58 = $93.31 I/YR = 8% Solve for NPV= $76.42

Which of the following statements regarding preferred stock is NOT correct? A. Like an equity, security preferred stock has an infinite life and pays dividends; like a fixed-income security, the dividends is fixed in amount and known in advance. B. Preferred stock resembles bonds in that dividend income continues for a predetermined period unless the stock issue is called. C. Preferred stockholders are paid after bondholders but before common stockholders in terms of priority of payment of income and in case of liquidation. D. Preferred stock dividends are not legally binding but must be voted on each period by the corporation's board of directs.

B. Preferred stock differs from bonds in that dividend income continues in perpetuity, unless the stock issue is called or otherwise retired.

All of the following statements regarding common stock valuation are correct EXCEPT I. Fundamental analysis seeks to estimate the intrinsic value of a stock, which is a function that its expected return and risk II. As for expected returns, because dividends are the only cash flows directly paid by a corporation, they are logical choice for a present value model A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II are correct.

Which of the following statements describing the characteristics of common stock is(are) CORRECT? I. A stock dividend occurs when a dividend payment is made by the corporation in shares of stock rather than in cash. II. The P/E ratio is the ratio of stock price to earnings, using historical, current, or estimated data. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II are correct.

Which of the following statements describing the characteristics of common stock is(are) CORRECT? I. The aggregate market value for a corporation, calculated by multiplying the market price per share of the stock by the number of shares outstanding, represents the total value of the firm as determined in the marketplace. II. the common stockholder has no specific promises to receive cash from the corporation because the stock never matures and dividends do not have to be paid. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II are correct.

Which of the following statements describing the characteristics of common stock is(are) CORRECT? I. The dividend yield is the income component of a stock's return and stated on a percentage basis. II. The dividend payout ratio is the ratio of dividends to earnings. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II are correct.

Which of the following statements regarding equity securities is(are) CORRECT? I. Preferred stock is an equity security with an intermediate claim (between the bondholders and the common stockholders) on a firm's assets and earning. II. Common stock is an equity security representing an ownership interest in a corporation A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II are correct.

Which of the following statements regarding systematic and unsystematic risk is(are) CORRECT? I. Systematic risk represents the portion in the variability of a stocks' total return that is directly associated with overall movements in the general economy or stock market. II. Unsystematic risk represents the portion in the variability of a stock's total return that is not related to the variability in general economic (market) activity. A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II are correct.

Which of the following statements regarding systematic and unsystematic risk is(are) CORRECT? I. Total risk can be divided into systematic risk and unsystematic risk II. Unsystematic risk, also called diversifiable risk, can be eliminated by diversification. A. I only B. II only C, Both I and II D. Neither I nor II

C. Both I and II are correct.

Which of the following statements regarding the P/E ratio approach to common stock valuation is(are) CORRECT? I. P/E ratios are inversely related to interest rates because interest rates are directly related to required rates of return. II. The P/E ratio is determined by dividing the current market price of the security by the earnings per share (EPS) for the company A. I only B. II only C. Both I and II D. Neither I nor II

C. Both I and II are correct.

Which of the following statements regarding the total risk of an asset is(are) CORRECT? I. Systematic (market) risk is the risk attributable to broad economic factors affecting all securities, such as interest rate, market, and inflation risks. II. Unsystematic (non-market) risk is the risk attributable to factors unique to a security, such as business, financial, and liquidity risks. A. I only B. II only C. Both I and II D, Neither I nor II

C. Both I and II are correct.

All of the following statements regarding international investing are correct EXCEPT A. Many U.S. companies now derive a large percentage of their revenues from abroad. B. U.S. investors should be aware of capital flows from abroad into domestic financial markets C. Emerging markets are markets of less developed countries, characterized by high risk and consistently high returns D. The rates of return available in foreign securities have often been larger than those available from U.S. markets

C. Emerging markets are markets of less developed countries, characterized by high risks and potential, but not consistent, high returns.

Which of the following statements regarding the evaluation of a portfolio's risk and return is(are) CORRECT? I. The dollar-weighted rate of return measures the rate of return earned by the portfolio manager. II. The time-weighted rate of return equates all cash flows, including the ending market value with the beginning market value of the portfolio A. I only B. II only C. Both I and II D. Neither I nor II

D. Neither I nor II are correct. Statement I is incorrect because the time-weighted rate of return measures the rate of return earned by the portfolio manager. Statement II is incorrect because the dollar-weighted rate of return equates all cash flows, including the ending market value, with the beginning market value of the portfolio.

Which of the following statements regarding security valuation and analysis is(are) CORRECT? A. For successful security analysis, an analyst should understand the characteristics of various securities and the factors that affect them. B. For successful analysis, a valuation model is applied to securities to estimate their price, or value. C. Value is a function of the expected future returns on a security and the associated risk. D. All of these.

D. Statement A, B, and C are correct

All of the following statements regarding stock market indicators are correct EXCEPT? A. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 3- leading industry stocks, used as a measure of stock market activity B. The Standard & Poor's 500 Composite Index (S & P 500) is a market capitalization-weighted index covering 500 stocks C. The Russell 2000 Index is a well-known index that is used to benchmark small capitalization companies D. The MSCI EAFE Index (Electronics, Aeronautics, Financial & Equities Index) is a value-weighted index of the equity performance of major technology markets.

D. Statement D is incorrect because MSCI EAFE Index (Morgan Stanley Capital International Europe, Australasia, and Far East) is a value-weighted index of the equity performace of major foreign markets.

All of the following statements regarding common stocks are correct EXCEPT A. As the residual claimants of the corporation, stockholders are entitled to income remaining after the fixed-income claimants (including preferred stockholders) have been paid B. As the residual claimants of the corporation, common stockholders are entitled to the remaining assets after all other claims (including preferred stock( we satisfied in case of liquidation C. Common stockholders are entitled to elect the directors and vote on major issue D. Common stockholders have unlimited liability, meaning that there is no set limit to which stockholder can be held liable in the event of a judgement against the corporation

D. Statement D is incorrect because common stockholders have limited liability, which means they cannot lose more than their investment in the corporation.

All of the following statements regarding financial markets are correct EXCEPT A. Primary markets are where new issues are sold, and secondary markets are where existing securities are treaded. B. Primary markets involve investment bankers who specialize in selling new securities. C. Underwriting is the process by which investment bankers purchase an issue of securities from a firm and resell the securities to the public. D. In public placements, new issues are sold directly to financial institutions.

D. Statement D is incorrect because new issues are sold directly to financial institutions in prive placements.

Which of the following statements regarding financial markets is(are) CORRECT? I. Secondary markets involve investment bankers who specialize in selling new securities. II. Primary markets, where securities are traded, consist of equity markets, bond markets, and derivative markets. A. I only B. II only C. Both I and II D. Neither I nor II

D. Statement I is incorrect because the primary market involves investment banks who specialize in selling new securities. Statement II is incorrect because it is the secondary market where securities are traded, which consists of equity, bond, and derivative markets.

One negative aspect of short selling is the potential for the short seller to have to make a dividend payment.

False- A dividend payment by the short seller is irrelevant because the price of the security should dcline by the same amount as the dividend payment.

Time-weighted returns and dollar-weighted returns are both methods of determining an internal rate of return and have very similar purposes.

False- Although time-weighted returns and dollar-weighted returns are both methods of determining an internal rate of return, they have very different purposes.

American depositary receipts (ADRs) are one of the most difficult means of acquiring foreign securities.

False- American depositary receipts (ADRs) are one of the easiest methods of acquiring foreign.

Common stock dividends typically remain steady over time.

False- Common stock dividends typically do not remain steady over time.

Cyclical stocks tend to do poorly in expanding economies and tend to prosper during down business cycles.

False- Cyclical stocks tend to prosper in expanding economies and tend to do poorly during down business cycles.

Growth stocks are stocks issued by companies that have sales, earnings, and market shares growing rates approximately equal to the general economy.

False- Growth stocks are stocks issued by companies that have sales, earnings, and market share growing at higher rates than those of average companies or the general economy.

If a corporation is required to pay unpaid preferred dividends from the prior years before paying a current dividend to the common stockholders, the preferred stock is referred to as restricted.

False- If a corporation is required to pay unpaid preferred dividends from prior years before paying a current dividend to the common stockholders, the preferred stock is referred to as cumulative.

Bob buys a stock on margin for $70 with an initial margin of 60% and a maintenance margin of 40%. Bob would have to put up $6.67 to restore his maintenance margin if the stock dropped to $40.

False- Only $4 per share would be the amount needed to restore equity.

Stocks trading at prices that are high given their historical earnings and current asset value are referred to as value stocks.

False- Stock trading at prices that are low given their historical earnings and current asset value are referred to as value stocks.

Stocks that are affected by general fluctuations in the economy are considered to be defensive stocks.

False- Stocks that are relatively unaffected by general fluctuations in the economy are considered to be defensive stocks.

Technical analysis is consistent with the efficient market hypothesis, which, at all levels, states that the current price already reflects all historical price data.

False- Technical analysis directly contradicts the efficient market hypothesis, which, at all levels, states that the current market price already reflects all historical data.

The Wilshire 5000 Index has created as a measure of the international securities markets.

False- The MSCI EAFE Index was created as a measure of the international securities markets.

The fourth market is comprise of traders who trade with the help of brokers.

False- The fourth market is comprised of traders who trade without the help of brokers.

The most popular type of order is the limit order.

False- The most popular type of order is the market order.

If a prederred stock is paying a dividend of $5 and the investor's required rate of return equals 11%, the value of the preferred stock should equal $55.

False- The stock price should equal $45.15 ($5 / 11%)

A common stock is paying a dividend that is currently $4 and is growing a constant rate of %5 per year. If the investor's required rate of return equals 10%, the value of the common stock should equal $84.

True

A company has two choices with regard to the additional earnings or cash flow: the additional cash can be reinvested into the business in the form of new or existing projects, or can be paid as dividends to the shareholders of the corporation.

True

A good benchmark should include the characteristics of ambiguous, investable, measurable, and reflective of current investment opinions.

True

A short position allows the investor to benefit from a decline in the value of a security.

True

Business risk is the riskiness of the specific business, which includes the speculative nature of the business, the management of the business, the philosophy of the business.

True

Cumulative voting may be advantageous for minority shareholders by giving them a greater opportunity to offset the votes of large shareholders.

True

Fundamental analysis is the process of determining the true value of a security, which is referred to as the intrinsic value.

True

Growth stocks are stocks issued by companies that have sales, earnings, and market share growing at higher rates than those of average companies or the general economy.

True

If a corporation is required to pay unpaid preferred dividends from prior years before paying a dividend to the common stockholders, the preferred stock is referred to as cumulative.

True

In addition to the returns from dividend income and capital appreciation, owners of common stock have voting rights.

True

In the process of underwriting an IPO, the investment banker may assume some of the risk associated with selling the securities to the public.

True

Interest rate risk is one of the major risks affecting fixed-income securities and bond portfolios.

True

Margin accounts allow the investor to borrow funds from the broker to purchase additional securities without adding additional cash to the account.

True

Market orders must be filled before the other types of orders are considered.

True

Price appreciation is appealing to investors because it remains untaxed until the appreciation is recognized.

True

Shareholders of common stock have certain rights and benefits, including the right to receive dividends, the right to vote on corporate issues, the right to limited liability, and the right to ultimate distribution of assets in the event of liquidation.

True

Stocks trading at prices that are low given their historical earnings and current asset value are referred to as value stocks.

True

The dividend yield measure is useful for selecting stocks to be included in a portfolio for an investor who needs the income derived from the portfolio.

True

The dollar-weighted return is most appropriately used fro determining a client's return over time when the client is either investing additional money in the account or removing money from the account.

True

The most prevalent type of position investors take is referred to as a long position.

True

The purpose of a market index or average is to provide information to investors and advisors concerning the overall movement and performance of the securities markets.

True

The secondary market is where investors buy and sell securities that have been previously issued in the primary market.

True

The term free cash flow to equity describes the available cash after meeting all of the firms operating and financial needs.

True

The time-weighted return is used to compare returns from portfolio managers without the influence of cash contributions or withdrawals from the portfolio.

True

The uncertainty of returns in foreign investments resulting from changes in the value of a foreign currency relative to the valuation of the investor's domestic currency is referred to as exchange rate risk.

True

Voting can take the form of statutory voting or cumulative voting.

True