Equity Investments 41-48

Current-year sales for ABC Co. are $20 million. Although Annie Mann, CFA, forecasts overall growth of 5% heading into next year, she would like to further refine her estimates by assigning the following probabilities based on actions she thinks the competition may take. GrowthProbability6 percent30%5 percent20%4 percent50% Using these probabilities, what is Mann's forecasted sales total for next year?

$20,960,000. The weighted average probability of the three scenarios is equal to 4.8% (6% × 30%) + (5% × 20%) + (4% × 50%); $20,000,000 × 1.048 = $20,960,000. The number $20,800,000 assumes 4% growth (because 50% is the highest probability), and $21,000,000 assumes 5% growth (because that is the overall figure).

Becky Kirk contacted her broker and placed an order to purchase 1,000 shares of Bricko Corp. stock at a price of $60 per share. Kirk wishes to buy on margin. Assuming the margin requirement is 40%, how much money does Kirk have to pay up front to make the purchase?

$24,000. The margin requirement represents the amount of money an investor must put down on the purchase. So Kirk must put $24,000 down ($60,000 × .40 = $24,000) and can borrow the balance.

A company's main product sells for $20 per unit and has variable costs of $15 per unit. If fixed costs are $25,000 and the company is able to sell 8,000 units, the total contribution margin is equal to:

$40,000. The contribution margin per unit is equal to the sale price per unit less variable costs per unit ($20 - $15 = $5 per unit). The total contribution margin is equal to 8,000 units × $5 per unit = $40,000—$15,000 represents the operating profit, and $25,000 is the fixed cost total.

A pet food company earned $500 million in revenue in the current year. Based on an estimated market share of 10%, what is the market size for pet food?

$5.0 billion. Market share = revenue / market size = 0.10 = $500 million / market size. So, market size = $5 billion. (Module 45.2, LOS 45.c)

An investor buys 200 shares of ABC at the market price of $100 and posts the required initial margin of $8,000. The maintenance margin requirement is 25%.At what share price will the investor's account balance be reduced to the maintenance margin level?

$80. he initial margin requirement is $8,000 / (200 × $100) = 0.40. In a long stock position, the equation to determine the margin call price is: long = [(original price)(1 - initial margin %)] / [1 - maintenance margin %] = $100(1 - 0.4) / (1 - 0.25) = $80 Alternatively, the margin loan is (200 × $100) - $8,000 = $12,000. The minimum value of the long position that meets the maintenance margin requirement is $12,000 / (1 - 0.25) = $16,000. The share price at which the long position has this value is $16,000 / 200 = $80.

A trader pays $100 per share to buy 500 shares of a non-dividend-paying firm. The purchase is done on margin, and the leverage ratio at purchase is 3.0X. Three months later, the trader sells the shares for $90 per share. Ignoring transaction costs and interest paid on the margin loan, the trader's 3-month return was closest to:

-30%. With a leverage ratio of 3 and a 10% decrease in share value, the investor's return is 3 × -10% = -30%.

An analyst is performing scenario analysis for a company's gross margin. Selected financial data from the current period is provided here: Average selling price per product$10Quantity sold4.5 millionGross profit margin60% For the next period, input prices are expected to increase by 15% and the analyst expects the company to increase selling prices by 12%, resulting in a 10% decrease in volume sold. The forecast decrease in gross profit margin for the company in the next period is closest to:

1%. Forecast average selling price = $10 × 1.12 = $11.20 Forecast quantity sold = 4,500,000 × (1 - 0.10) = 4,050,000 Forecast average input cost = [(45,000,000 × 0.40) / 4,500,000] × 1.15 = $4.60 Forecast total revenues = 4,050,000 × $11.20 = $45,360,000 Forecast gross profit = 4,050,000 × ($11.20 - $4.60) = $26,730,000 Forecast gross profit margin = $26,730,000 / $45,360,000 = 58.92%, which is 1.08% less than 60%.

An analyst is reviewing an income statement that reflects two years of information. Over those two years, sales have risen from $10 million to $12 million. At the same time, operating profit has risen from $1.2 million to $1.5 million. The company's degree of operating leverage is closest to:

1.25. Here, operating profit has increased 25% ($1.2 million to $1.5 million). Sales have increased 20% ($10 million to $12 million). The degree of operating leverage (DOL) = 25% / 20% = 1.25. With the other answer options, 0.15 is equal to the change in operating profit ($0.3 million) by the change in sales ($2.0 million), and 0.80 puts the sales change of 20% over the operating profit change of 25%.

Jayco, Inc., sells 10,000 units at a price of $5 per unit. Jayco's fixed costs are $8,000, interest expense is $2,000, variable costs are $3 per unit, and EBIT is $12,000. Disregarding taxes, the degree of operating leverage (DOL) and degree of financial leverage (DFL) are closest to:

1.67 DOL and 1.20 DFL. Jayco's operating income is $12,000. If its sales increase by 1%, its operating income will increase to 1.01(10,000)($5 - $3) - $8,000 = $12,200, which is an increase of $200 / $12,000 = 0.0167 or 1.67%. Therefore Jayco's DOL is 1.67% / 1% = 1.67. Jayco's net income is $12,000 - $2,000 = $10,000. If its operating income increases by 1% to 1.01($12,000) = $12,120, its net income will increase to $12,120 - $2,000 = $10,120, which is an increase of $120 / $10,000 = 0.012 or 1.2%. Therefore Jayco's DFL is 1.20% / 1% = 1.20.

In one year, a security market index has the following quarterly price returns: First quarter3%Second quarter4%Third quarter-2%Fourth quarter5% The price return for the year is closest to:

10.2%. Return for the year = (1.03)(1.04)(0.98)(1.05) − 1 = 10.23%.

The table below lists information on price per share and shares outstanding for three stocks. As of Beginning of YearAs of End of YearStockPrice per Share ($)# Shares OutstandingPrice per Share ($)# shares OutstandingMertz1010,0001510,000Norton505,000505,000Rubble10050085500 At the beginning of the year, the value of a market-cap weighted index of these three stocks was 100. The index value at year-end is closest to:

110.6. Market-cap weighted index = (ending market capitalization / beginning market capitalization) × beginning index value. Beginning market capitalization = (10)(10,000) + (50)(5,000) + (100)(500) = 400,000 Ending market capitalization = (15)(10,000) + (50)(5,000) + (85)(500) = 442,500 Index value = (442,500 / 400,000) × 100 = 110.6

An investor purchases 100 shares of Lloyd Computer at $26 a share. The initial margin requirement is 50%, and the maintenance margin requirement is 25%. The price below which the investor would receive a margin call is closest to:

17.33. 26 × (1 - 0.5)/(1 - 0.25) = $17.33.

Sonia Fennell purchases 1,000 shares of Xpressoh Inc. for $35 per share. One year later, she sells the stock for $42 per share. Xpressoh Inc. pays no dividends. The initial margin requirement is 50%. Fennell's one-year return assuming an all-cash transaction, and if she buys on margin (assume she pays no transaction or borrowing costs and has not had to post additional margin), are closest to:All-cash50% margin

20%40% All-cash return = 42/35 - 1 = 20% Margin return = (42 - 35)/[(35)(0.5)] = 40%

Based on growth strategies outlined by the company's CEO, an analyst forecasts overall growth of 5%. With inflation forecasted by economists at 3%, an analyst will likely forecast capital expenditures related to maintenance to grow by what percentage next year?

3%. Maintenance-related capital expenditures are typically forecasted to grow by the inflation rate (3%, in this case). Capital expenditures related to growth will align with the overall forecasted growth rate of the company (5% here). The 8% answer choice incorrectly sums the two forecasts.

Mark Ritchie purchased, on margin, 200 shares of TMX Corp. stock at a price of $35 per share. The margin requirement was 50%. The stock price has increased to $42 per share. What is Ritchie's return on investment before commissions and interest if he decides to sell his TMX holdings now?

40%. 200 shares × $35 = $7000 Initial Market Value $7000 × .50 = $3500 cash payment and $3500 borrowed. The new market value of the stock after price increase is (200 × $42) = $8400. If Ritchie sold his holdings he would have $4900 ($8400 - $3500) left after the loan was paid. So Ritchie's return on his original $3500 investment is: $4900/3500 - 1 = 1.4 - 1.0 = 0.40 = 40%.

An investor purchases 200 shares of Rubble, Inc. on margin. The shares are trading at $40. Initial and maintenance margins are 50% and 25%. If the company pays a dividend of $0.75 and the investor sells the stock at year-end for $50 per share, the return on the investment would be closest to:

53.75%. Dividend income = 0.75 × 200 = $150 Profit = 10,000 - 8,000 + 150 = 2,150 Return = 2,150 / 4,000 = 53.75%

An index was recently begun with the following two stocks: Company A - 50 shares valued at $2 each. Company B - 10 shares valued at $10 each. Given that the value-weighted index was originally set at 100 and Company A's stock is currently selling for $4 per share while Company B's stock is still at $10 per share, what is the current value of the price-weighted index and the market-cap-weighted index? Price-weightedMarket-cap-weighted

7. 150 Price weight = [(4) + (10)] / 2 = 7 Market-cap weight = [(4)(50) + (10)(10)] / [(2)(50) + (10)(10)](100) = 150

Use the data below to determine which of the statements is most accurate? As of December 31CompanyStock PriceShares OutstandingA$2520,000B$5020,000C$10010,000

A 100% increase in the stock price of Company A will have a smaller impact on the price-weighted index than a 100% increase in the stock price of Company C.

Which of the following statements about securities markets is least accurate?

A limit buy order and a stop buy order are both placed below the current market price.

Which of the following statements about indexes is CORRECT?

A price-weighted index assumes an equal number of shares (one of each stock) represented in the index.

Which of the following elements can be found in the "front matter" section of a company research report?

A target buy price of $12 per share.

Which of the following represents a benefit to an analyst incorporating scenario analysis into her forecasting?

Accounting for potential changes in the company's economic environment.

The prospectus for the Horizon Fund states that it invests only in real assets. Which of the following would the Horizon Fund most likely include in its portfolio?

An apartment complex.

A company's CFO plans to spend $45 million on capital expenditures in the next year. These expenditures will be funded through cash held in the company's bank accounts ($30 million) and $15 million coming from a planned debt issuance at the end of the current year. An analyst forecasting the capital structure of the firm will project which of the following?

An increase in the debt-to-equity ratio.

Which approach is most appropriate for an analyst to use to forecast revenues for a company in a highly cyclical industry?

Analyst's discretionary forecast.

An analyst develops a style box that categorizes industries based on growth rate and sensitivity to economic business cycles. Which of the following industries will most likely land in the box for (higher) growth and defensive sensitivity to cycles?

Biotechnology.

Which of the following is NOT a reason bond market indexes are more difficult to create than stock market indexes?

Bond deviations tend to be relatively constant.

Which of the following statements is most accurate regarding a company who is experiencing economies of scale as production output is increasing?

Both fixed costs per unit and variable costs per unit may be decreasing.

Ken Miller, CFA, wants to compare the returns on government agency bonds to the returns on corporate bonds. Peg Egan, CFA, wants to compare the returns on high yield bonds in developed markets to the returns on investment grade bonds in emerging markets. Which of these analysts is most likely able to use bond indexes for their analysis?

Both of these analysts.

If the momentum effect persists over time, it would provide evidence against which of the following forms of market efficiency?

Both weak form and semistrong form.

An analyst forecasts average selling prices for each product and service a company provides, as well as expected sales volumes. Using these estimates is an example of which type of revenue forecasting?

Bottom up.

Which of the following option positions is said to be a long position?

Buyer of a put option.

Which of the following indexes of alternative investments is most likely to be calculated from derivatives prices?

Commodity Index

With which of the following types of equity shares does the investor typically have the greatest voting power?

Common shares.

A market has 10 companies and total revenue of $88 million in the last fiscal year. Company XYZ had revenue last year of $17.6 million. Which of the following statements is most accurate about this market and Company XYZ?

Company XYZ's market share is larger than the average company in this market.

Which of the following assets are best characterized as contracts?

Currency swaps.

Which of the following measures will an analyst most likely use to develop a forecasted capital structure mix for a company he is reviewing?

Debt-to-equity ratio.

Which of the following types of industries is typically characterized by stable performance during both expansions and contractions of the business cycle?

Defensive.

Which of the following sets of indexes are price-weighted?

Dow Jones Industrial Average and Nikkei Dow Jones Stock Market Average.

Which of the following items is an example of a summary measure?

Free cash flow.

A top-down revenue forecast is most likely to be based on expected:

GDP growth.

Equal weighting is the most common weighting methodology for indexes of which of the following types of assets?

Hedge funds.

A highly competitive market structure will reflect which of the following characteristics?

High levels of commoditization.

Which of the following statements is most accurate regarding a firm that chooses to employ a focus-based competitive strategy?

It is often a hybrid strategy, as it may involve elements of both cost leadership and differentiation.

Investor overreaction that has been documented in securities markets is most likely attributable to investors exhibiting:

Loss aversion

Which of the following barriers to entry will increase the competitiveness of the companies within an industry?

Low up-front capital requirements.

Which of the following best describes a cost leadership strategy?

Managerial incentives promote operational efficiency.

Which of the following statements regarding margin accounts is most accurate?

Margin accounts can be used to purchase securities by borrowing part of the purchase price.

Most of the widely used global security indexes are:

Market capitalization weighted

Which of the following statements concerning market efficiency is least accurate?

Market efficiency assumes that individual market participants correctly estimate asset prices.

Which of the following causes of an increase in return on equity is most likely a positive sign for a firm's equity investors?

Net income is increasing at a faster rate than book value of equity.

Toby Jensen originally purchased 400 shares of CSC stock on margin at a price of $60 per share. The initial margin requirement is 50% and the maintenance margin is 25%. CSC stock price has fallen dramatically in recent months and it closed today with a sharp decline bringing the closing price to $40 per share. Will Jensen receive a margin call?

No, he meets the minimum maintenance margin requirement. Total original value held by Jensen is 400 × $60 = $24,000. Amount of equity is 50% ($24,000) = $12,000. Current total value is 400 × $40 = $16,000. So Jensen's equity is $16,000 - $12,000 = $4,000 which is 4,000/16,000 = 25% of the total market value.

Which of the following items will most likely be found in both the initial company research report and any subsequent reports that are issued?

Recommendations and associated rationales.

Which of the following best describes the majority of the evidence regarding anomalies in stock returns?

Reported anomalies are not violations of market efficiency but are the result of research methodologies.

Which of the following ratios should an analyst use who wishes to evaluate the returns a company generates based on the amount of financial leverage?

Return on equity (ROE).

In forecasting revenue for the next year, an analyst is most likely going to exclude which of the following situations from his forecasted number?

Significant gains due to the remeasurement of subsidiary financial statements.

Which of the following statements regarding bond market indexes is least accurate?

The bond universe is more stable than the stock universe.

Which of the following is a limitation to fully efficient markets?

The gains to be earned by information trading can be less than the transaction costs the trading would entail.

As part of an industry and competitive analysis, an analyst first defines and then surveys an industry. Which of the following assessments will be made as part of the survey step?

The growth rate of the industry over the last several years.

An analyst studying the defense industry will focus on political influences in a PESTLE analysis for which of the following reasons?

The primary buyers are governmental entities.

Which of the following statements about primary and secondary markets is least accurate?

The proceeds from a sale in the secondary market go to the issuer.

Which of the following statements about selling a stock short is least likely accurate?

The short seller may withdraw the proceeds of the short sale.

In a period when U.S. equity prices are increasing and the U.S. dollar is depreciating, which of the following investors in U.S. equities is most likely to earn the highest return in the investor's local currency?

U.S. investor who reinvests dividends.

Which type of equity market index is most likely to be adjusted for free float?

Value weighted.

Compared to a market order to sell, a limit order to sell will specify:

a price that can be higher or lower than the current market price.

A market that directs capital to its most productive use is best described as:

allocationally efficient.

An electronic crossing network is best described as:

an order-driven market.

The type of index weighting that produces a portfolio similar to that of a momentum strategy is an index with weights that are:

based on market capitalization.

For a non-dividend paying firm, an increase in net income must increase:

book value of equity.

The value of a total return index:

can be calculated by multiplying the beginning value by the geometrically linked series of periodic total returns.

A securities exchange where traders buy and sell long-term government bonds from and to other traders would best be described as part of the:

capital market.

Six months after inception, the price return and the total return of an equal-weighted index will be different if:

constituent securities have paid dividends.

An aggressive price reduction to gain market share is most likely to be associated with a:

cost leadership strategy.

The main functions of the financial system most likely include:

determining equilibrium interest rates and allocating capital to its most productive uses.

An analyst estimates a value of $45 for a stock with a market price of $50. The analyst is most likely to conclude that a stock is overvalued if:

few analysts follow the stock and the analyst is confident in his model inputs.

An analyst will often include pro forma financial statements in a company research report because they are useful in helping investors understand:

forecasted bottom-line profits over the next several years.

Compared to S&P 500 index weighting, an equities index that is weighted based on a fundamental factor, such as earnings, will most likely:

have a value tilt.

An analyst is using the Herfindahl-Hirschman Index (HHI) to evaluate industry concentration. The industry has four firms with the following market shares: 45%, 25%, 20%, and 10%. This industry's concentration will be considered:

high.

A high yield bond fund states that through active management, the fund's return has outperformed an index of Treasury securities by 4% on average over the past five years. As a performance benchmark for this fund, the index chosen is:

inappropriate, because the index does not reflect the actual bonds in which the fund invests.

Factors that increase competition in an industry most likely include:

low barriers to entry, low concentration, and high unused capacity.

Which of the following is least likely required when defining a security market index? The:

number of securities in the index.

A financial system in which transactions have low costs is said to exhibit:

operational efficiency.

An investor sells a stock short. To protect against a large loss on this position, the investor is most likely to:

place a stop buy order.

Two of the five competitive forces in the Porter framework are:

power of suppliers and threat of substitutes.

Commercial index providers typically classify companies by:

principal business activity.

Industry classification systems from commercial index providers typically classify firms by:

products and services.

Compared to preferred stock, common stock is most likely to:

provide a higher average return.

Which of the following statements least likely describes the role of a portfolio manager in perfectly efficient markets? Portfolio managers should:

quantify client's risk tolerance, communicate portfolio policies and strategies, and maintain a strict buy and hold policy avoiding any changes in the portfolio to minimize transaction costs.

Items in an initial research report on a company that are most likely to also appear in subsequent reports include a(n):

rationale for the investment recommendation.

The Top Banking Index contains stocks in the finance industry that represent more than 90% of the total market capitalization for the finance industry. The index is best described as a:

sector index.

Financial intermediaries that issue securities which represent interests in a pool of similar financial assets are best characterized as:

securitizers.

An order placed to protect a short position is called a:

stop loss buy.

An equity index comprised of value stocks, identified by their price-to-earnings ratios, is best described as a:

style index.

An analyst is most likely to forecast summary measures for a company, rather than forecasting specific financial statement items, when:

summary measures are relatively stable over time.

An analyst is using an historical base rate convergence approach to estimate the growth rate of a company in an established industry. If the analyst forecasts sales growth for this company of 4% next year, it is most likely because:

the industry average is forecasted at 4%.

An analyst using the capital asset pricing model is most likely to use a security market index as a proxy for:

the market return.

When using a security market index to represent a market's performance, the performance of that market over a period of time is best represented by:

the percent change in the index value.

Firms and industries are most appropriately classified as cyclical or non-cyclical based on:

the sensitivity of their earnings to the business cycle.

The measure of return on a security market index that includes any dividends or interest paid by the securities in the index is known as the:

total return.

A security that represents an equity share in a foreign firm and for which the voting rights are retained by the depository bank, is a(n):

unsponsored depository receipt.