FIN 3100 Exam 3

Walker Laboratories, Inc. pays a $2.00 dividend every quarter and will maintain this policy forever. What price should you pay for one share of common stock if you want an annual percentage return (APR) of 8% on your investment?

$100 Quarterly rate of 8%/4 = 2% (or 0.02). Price = Dividend / r = P = 2/0.02 = $100

Bartlett Batteries Inc. just paid an annual dividend of $1.12. If you expect a constant growth rate of 4% and have a required rate of return of 13%, what is the current stock price according to the constant growth dividend model?

$12.94 The Dividend Growth Model states that P0 = (Div0 x (1 + g)) / r - g Inserting our values gives: P0 = (Div0 x (1 + g)) / r - g = ($1.12 x (1.04)) / 0.13 - 0.04 = $1.165 / 0.09 = $12.94

Tesla is expected to pay no dividends over the next 4 years, pay a dividend of $5 at the end of year 5, and then grow the dividends by 6% each year afterwards. The required rate of return (r) is 8%. What should be the stock price today according to the two-stage growth model?

$183.76 P4 = D5/(r-g) = 5/(0.08-0.06)= $250. P0 = $250/1.08^4 = $183.76

A preferred stock is currently priced at $28.00 per share. The firm is expected to pay a constant dividend every year in the future. If the required rate of return is 10%, what is the dividend?

$2.8 P=D/r 28=D/0.1 D=2.8

Walmart is expected to pay a dividend of $2.12 next year, and then grow the dividend by 3% each year afterwards. The required rate of return (r) is 4%. What should be the stock price today?

$212 P0 = D1/(r-g) = 2.12/(0.04-0.03)= $212

You want to invest in a stock that pays $2.00 annual cash dividends for the next four years. At the end of the four years, you will sell the stock for $27.00. If you want to earn 11% on this investment, what is a fair price for this stock if you buy it today?

$23.99

You buy a stock for which you expect to receive an annual dividend of $2.10 for the ten years that you plan on holding it. After 10 years, you expect to sell the stock for $26.15. What is the present value of a share for this company if you want an 8% return?

$26.20

Mark owns the following portfolio of securities. What is the beta for the portfolio? Americas - Beta: 0.75; Percent of portfolio: 10% Atlantic Industries - Beta: 1.00; Percent fo Portfolio: 55% TGIS Restaurants - Beta: 1.55; Percent of Portfolio: 35%

1.1675 βp = Σ βi ∗ wi = .75 ∗ 10% + 1.00 ∗ 55% + 1.55 ∗ 35% = 1.1675

Rene owns the following portfolio of securities. What is the beta for the portfolio? Company Beta Percent of Portfolio Microsoft - Beta: 1.82; Percent of Portfolio: 50% GM - Beta: 0.53; Percent of Portfolio: 30% Dullco - Beta: 0.67; Percent of Portfolio: 20%

1.20 βp = Σ βi ∗ wi = 1.82 ∗ 50% + 0.53 ∗ 30% + 0.67 ∗ 20% = 1.20.

Joan owns the following portfolio of securities. What is the beta for the portfolio? Alphabet - Beta: 2.00; Percent of Portfolio: 25% Chase - Beta: 0.75; Percent of Portfolio: 50% Amazon - Beta: 1.40; Percent of Portfolio: 25%

1.225 βp = Σ βi ∗ wi = 2.00 ∗ 25% + 0.75 ∗ 50% + 1.40 ∗ 25% = 1.225.

Richard owns the following portfolio of securities. What is the beta for the portfolio?Apple - 2.50; 25% Wells Fargo - 0.65; 50% eBay - 1.70; 25%

1.38 βp = Σ βi ∗ wi = 2.5 ∗ 25% + .65 ∗ 50% + 1.70 ∗ 25% = 1.38

Kip owns the following portfolio of securities. What is the beta for the portfolio? Apple - Beta: .82; Percent of Portfolio: 50% Ford - Beta: 2.53; Percent of Portfolio: 30% Federal Express - Beta: 1.67; Percent of Portfolio: 20%

1.50

What is the standard deviation of the returns in question 6?

10.677% Variance = [(-0.1-0.03)2 + (0.14-0.03)2 + (0.09-0.03)2 + (-0.01-0.03)2]/3 = 0.0114 Standard deviation = 0.01141/2 = 0.10677

Find the standard deviation for a security that has three one-year returns of -5%, 15%, and 20%.

13.23% Average return = Σrt/n = (-5% + 15% + 20%)/3 = 10% Std Dev(r) = [Σ (ri - average)2 / (n - 1) ]^(1/2) = [[(-5% - 10%)2 + (15% - 10%)2 + (20% - 10%)2]/(3 - 1)]^(1/2) = (175%)^(1/2) = 13.23%.

The stock of Hybrid Motors, Inc. has a beta of 0.8. The market risk premium is 10 percent and the risk-free rate is 6 percent. What is the expected return on this stock?

14% [(1-0.05)(1+0.23)(1+0.12)(1+0.18)]1/4-1 = 0.1148

You purchased 100 shares of stock for $10 per share. After holding the stock for 10 years and not receiving any dividends, you sell the stock for $42 per share. What is the effective annual rate of return on this investment?

15.43% HPR = (Ending price + Distributions - Beginning Price) / Beginning Price = ($42 - $10)/$10 = 320% EAR = (1 + hpr) (1/n) - 1 = (1+3.2)(1/10) - 1 = 15.43%.

Given an expected market return of 10.0%, a beta of 1.75 for Carlson Industries, and a risk-free rate of 2.0%, what is the expected return for the firm?

16.0% The equation for the SML is E(ri) = rf + βi × [E(rm) - rf] = 2.00% + 1.75 ∗ (10.00% - 2.00%) = 16.00%.

Assume the following information about the market and Lithium Motors Stock. Lithium's beta = 1.80, the risk-free rate is 2.50%, the market risk premium is 8.0%. Using the SML, what is the expected return for the firm's stock?

16.90% The equation for the SML is E(ri) = rf + βi × [E(rm) - rf] = 2.50% + 1.80 ∗ (10.50% - 2.50%) = 16.90%.

Sahali Shopping Center Corporation is expected to grow its dividends by 5% per year forever. The required rate of return on the stock is 7%. What is the dividend yield?

2% r= dividend yield + g dividend yield = r- g = 7% - 5% = 2%

Given annual returns of -10%, 14%, 9% and -1%, what is the geometric average?

2.578% [(1-0.1)(1+0.14)(1+0.09)(1-0.01)]1/4-1 = 0.02578

Given annual returns of -9%, 14%, 0% and 7%, what is the geometric average?

2.64% [(1-0.09)(1+0.14)(1+0)(1+0.07)]1/4-1 = 2.64%

Gary bought a share of stock for $15.75 that paid a dividend of $.45 and sold three months later for $18.65. What was his holding period return?

21.27% Profit = Ending Value + Distributions - Original Cost Profit = $18.65 + $0.45 - $15.75 = $3.35. HPR = (ending Price + distributions - Beginning Price) / Beginning Price= ($18.65 _ $0.45 - $15.75) / $15.75 = 21.27%.

What is the arithmetic average of the returns in question 6?

3.0% (-0.1+0.14+0.09-0.01)/4=0.03

Sahali Shopping Center Corporation is expected to grow its dividends by 3% per year forever. The required rate of return on the stock is 7%. What is the dividend yield?

4% r= dividend yield + g dividend yield = r- g = 7% - 3% = 4%

Find the standard deviation for a security that has three one-year returns of 5%, 10%, and 15%.

5.00% Average return = Σrt/n = (5% + 10% + 15%)/3 = 10% Std Dev(r) = [Σ (ri - average)2 / (n - 1) ]^(1/2) = [[(5% - 10%)2 + (10% - 10%)2 + (15% - 10%)2]/(3 - 1) ]^(1/2) = 25%^(1/2) = 5%

Given annual returns of -9%, 14%, 12% and 7%, what is the geometric average?

5.593% [(1-0.09)(1+0.14)(1+0.12)(1+0.07)]1/4-1 = 0.05593

The stock of Hybrid Motors, Inc. has a beta of 0.84. The market risk premium is 5.2 percent and the risk-free rate is 2.6 percent. What is the expected return on this stock?

6.968% E(ri) = rf + i(E(rM) - rf) = 0.026 + 0.84×0.052 =0.06968

You purchased 100 shares of stock for $5 per share. After holding the stock for 8 years and not receiving any dividends, you sell the stock for $42 per share. What are the holding period and annual return on this investment?

740%, 30.48%

Find the standard deviation of annual returns of -9%, 14%, 0% and 7%.

9.38% Mean = (-0.09+0.14+0+0.07)/4 = 0.03 Variance = [(-0.09-0.03)2 + (0.14-0.03)2 + (0-0.03)2 + (0.07-0.03)2]/3 = 0.00966667 Standard deviation = 0.0983

Janet bought a share of stock for $47.50 that paid a dividend of $.72 and sold one year later for $51.38. What was her holding period return?

9.68% Profit = Ending Value + Distributions - Original Cost Profit = $51.38 + $0.72 - $47.50 = $4.60. HPR = (Ending Price + Distributions - Beginning Price) / Beginning Price = ($51.38 + $0.72 - $47.50) / $47.50 = 9.68%.

Which of the following is NOT a definition of beta?

A measure of risk that can be avoided

In regards to the fact that the pricing of stocks is more difficult than the pricing of bonds, which of the below statements is FALSE?

A stock's final sale is fixed in time on its maturity date.

You want to invest in a stock that pays $1.50 annual cash dividends for the next six years. At the end of the six years, you will sell the stock for $18.50. If you want to earn 7.5% on this investment, what is a fair price for this stock if you buy it today?

About $19.03

Which of the following statements is true about variance?

All of the above statements are true.

You wish to diversify your single-security portfolio in a way that will maximize your reduction in risk. Which of the following securities should you add to your portfolio?

Alpha Company stock that has a correlation coefficient of -0.25 with your current security

Which of the following statements is TRUE? A) Individuals do not have to pay taxes on dividend income. B) Dividend payments are not tax deductible. C) A firm that skips a dividend is bankrupt. D) Dividends are a liability of a firm.

B) Dividend payments are not tax deductible

Craftwell Inc. pays a $0.75 dividend every quarter and will maintain this policy forever. What price should you pay for one share of common stock if you want an annual return of 10.5% on your investment?

$28.57 We use the perpetuity formula to derive the answer. When computing a perpetuity, we have to make sure that both the payment and the discount rate represent the same period. In this problem, let us use a quarter of a year (or three months) as our period. Thus, we restate the annual required rate of 10.5% as a quarterly rate of 10.5% / 4 = 2.625% (or 0.02625). Applying the constant dividend model with infinite horizon and with the quarterly rate of return and a quarterly dividend of $0.75, we get: Price = Dividend / r = P = $0.75 / 0.02625 = $28.57

The last dividend (Div0) is $1.80, the growth rate (g) is 6%, and the required rate of return (r) is 12%. What is the stock price according to the constant growth dividend model?

$31.80

Giant Motorcycles Inc. pays a $0.77 preferred dividend every quarter and will maintain this policy forever. What price should you pay for one share of preferred stock if you want an annual return of 9.25% on your investment?

$33.30 We use the perpetuity formula to derive the answer. When computing a perpetuity, we have to make sure that both the payment and the discount rate represent the same period. In this problem, let us use 3 months as our period. Thus, we restate the annual required rate of 9.25% as a quarterly (or three-month) rate of = 2.3125% (or 0.023125). Applying the constant dividend model with infinite horizon and with the quarterly rate of return and a quarterly dividend of $1.77, we get: = $33.30. We use the perpetuity formula to derive the answer. When computing a perpetuity, we have to make sure that both the payment and the discount rate represent the same period. In this problem, let us use 3 months as our period. Thus, we restate the annual required rate of 9.25% as a quarterly (or three-month) rate of = 2.3125% (or 0.023125). Applying the constant dividend model with infinite horizon and with the quarterly rate of return and a quarterly dividend of $1.77, we get: = $33.30.

Tesla is expected to pay no dividends over the next 4 years, pay a dividend of $5 at the end of year 5, and then grow the dividends by 7% each year afterwards. The required rate of return (r) is 8%. What should be the stock price today according to the two-stage growth model?

$367.51 P4 = D5/(r-g) = 5/(0.08-0.07)= $500. P0 = $500/1.08^4 = $367.51

Richard bought a share of stock for $47.50 that paid a dividend of $.72 and sold one year later for $51.38. What was Richard's dollar profit or loss and holding period return?

$4.60, 9.68%

You have $1,200,000 to invest in a stock portfolio. Your choices are stock X with an expected return of 15% and stock Y with an expected return of 9%. Your goal is to create a portfolio with an expected return of 13%. How much money do you invest in stock Y?

$400,000 E(rP) = wX E(rX) + wY E(rY) E(rP) = wX E(rX) + (1-wX )E(rY) 0.13= wX 0.15+ (1-wX )0.09 0.13 = 0.06 wX + 0.09 wX =2/3,wY =1/3 (1/3)×$1,200,000 = $400,000

You want to invest in a stock that pays $6.00 annual cash dividends for the next five years. At the end of the five years, you will sell the stock for $30.00. If you want to earn 10% on this investment, what is a fair price for this stock if you buy it today?

$41.37

Rogue Motors Inc. has a 11% required rate of return. The firm does not expect to initiate dividends for 10 years, at which time it will pay $2.00 per share in dividends. At that time, the firm expects its dividends to grow at 6% forever. What is an estimate of the firms' price in 10 years (P10) if its dividend at the end of year 10 is $2.00?

$42.40 We use the formula: P10 = (Div10 x (1+g)) / r-g. Inserting our values, we get: P10 = ($2.00 x (1 + 0.06)) / 0.11 - 0.06 = $212 / 0.05 = $42.40.

Walker Laboratories, Inc. pays a $1.37 dividend every quarter and will maintain this policy forever. What price should you pay for one share of common stock if you want an annual percentage return (APR) of 12.5% on your investment?

$43.84

Lifecycle Motorcycle Company is expected to pay a dividend in year 1 of $2 and a dividend in year 2 of $3. After year 2, dividends are expected to grow at the rate of 4% per year. An appropriate required return for the stock is 10%. Using the DDM, the stock should be worth _______ today.

$47.27 V1 = $3/(.1 - .04) = $50, which is the present value at t=1 of D2, D3, . . . ∞ The total value at time 1 is $2 + 50 = $52. So at time 0, V0=52/(1+.1)=52/1.1=47.27

Nash Inc. has an 12% required rate of return. It does not expect to initiate dividends for 15 years, at which time it will pay $3.00 per share in dividends. At that time, Nash expects its dividends to grow at 6% forever. What is an estimate of Nash's price in 15 years (P15) if its dividend at the end of year 15 is $3.00?

$53.00 We use the formula: P15 = (Div20 x (1 + g)) / r-g. Inserting our values, we get: P15 = ($3.00 x (1 + 0.06)) / (0.12 - 0.06) = $3.18 / 0.06 = $53.00.

Lifecycle Motorcycle Company is expected to pay a dividend in year 1 of $2 and a dividend in year 2 of $3. After year 2, dividends are expected to grow at the rate of 4% per year. An appropriate required return for the stock is 9%. Using the DDM, the stock should be worth _______ today.

$56.9 V1 = $3/(.09 - .04) = $60, which is the present value at t=1 of D2, D3, . . . ∞ The total value at time 1 is $2 + 60 = $62. So at time 0, V0=62/(1+0.09)=62/1.09=56.9

You want to invest in a stock that pays $6.00 annual cash dividends for the next five years. At the end of the five years, you will sell the stock for $90.00. If you want to earn 10% on this investment, what is a fair price for this stock if you buy it today?

$78.63 Today's price (P) =6[1 - 1/1.1^5] / .1 + 90 / 1.1^5 = ($6 × 3.790787) + ($90 × 0.620921) = $22.745 + $55.883 = $78.63

The dividend to be paid at the end of the year (Div1) is $0.75, the growth rate (g) is 5%, and the stock price is $25. What is the required rate of return (r) according to the constant growth dividend model?

0.08 P0 = 0.75/(r-0.05)= $25. r=0.08 or r = Dividend yield + g = 0.75/25 + 0.05 = 0.03 + 0.05 = 0.08

In regards to the fact that the pricing of stocks is more difficult than the pricing of bonds, which of the below statements is FALSE? A) Cash dividends, unlike coupons for bonds, typically change from year to year. B) The ending price of the stock at any point in time is not fixed like the par value of the principal. C) A stock's final sale is fixed in time on its maturity date. D) Because a stock has no maturity date, the number of its payments are unknown.

C) A stock's final sale is fixed in time on its maturity date. Technically, a stock does not have a "maturity" date like a bond. Thus, the final sale of a stock by an investors is NOT fixed in time on a maturity date. An investor is free to choose his or her own selling point in time, and the point in time is not limited by a maturity date.

Which of the statements below is TRUE? A) Shareholders elect the board of directors, which ultimately selects the bondholder team that runs the day-to-day operations of the company. B) Stockholders are paid before debt holders (bondholders) if a company fails. C) The profits for common stock owners come after payment to the employees, suppliers, government, and creditors. D) Stock is a minor financing source for public companies.

C) The profits for common stock owners come after payment to the employees, suppliers, government, and creditors. Shareholders elect the board of directors that ultimately selects the MANAGEMENT team that runs the day-to-day operations of the company. Stock is a MAJOR financing source for public companies. Common stockholders are low in terms of priority of claims to assets in the case of company failure. Debt holders will be paid first.

Which of the following statements is TRUE about variance? A) Variance describes how spread out a set of numbers are around their mean or average. B) Variance is essentially the variability from the average. C) The larger the variance, the greater the dispersion. D) All of these statements are true.

D) All of these statements are true

Which of the statements below is TRUE concerning risk-averse investors? A) Investors want to minimize return and maximize risk. B) Investors want to minimize return and minimize risk. C) Investors want to maximize return and maximize risk. D) Investors want to maximize return and minimize risk.

D) Investors want to maximize return and minimize risk

Which of the statements below is FALSE? A) For the shareholder, receipt of dividends is a taxable event. B) Unlike coupon payments on bonds, which are treated as an interest expense of the firm, common stock dividends are considered a return of capital to shareholders and not an expense of the firm. C) A typical practice of many companies is to distribute part of the earnings to shareholders through cash dividends. D) The payment of cash dividends to shareholders is a deductible expense for the company.

D) The payment of cash dividends to shareholders is a deductible expense for the company. The payment of cash dividends to shareholders is NOT a deductible expense for the company.

Which of the statements below is FALSE? A) Common stock's ownership claim on the assets and cash flow of a company is often referred to as a residual claim. B) Stock is a major financing source for public companies. C) Shareholders elect the board of directors, which ultimately selects the management team that runs the day-to-day operations of the company. D) The profits for common stock owners come before payment to employees, suppliers, government, and creditors.

D) The profits for common stock owners come before payment to employees, suppliers, government, and creditors. The profits for common stock owners come AFTER payment to the employees, suppliers, government, and creditors

The practice of not putting all of your eggs in one basket is an illustration of _______.

Diversification

The practice of not putting all of your eggs in one basket is an illustration of ________.

Diversification

From 1925-2006, the portfolio of large U.S. stocks has had a greater variance than the portfolio of small U.S. stocks.

False

In a bull market stock prices have been falling for a prolonged period of time.

False

A bull market is a prolonged declining market.

False A BEAR market is a prolonged declining market.

The goal of diversification is to eliminate

Firm-specific risk

Which of the statements below is TRUE?

Investors want to maximize return and minimize risk.

Historically, the ________ risk an investor is willing to accept the ________ the potential return for the investment.

More, greater

Diversification is most effective when security returns are _________.

Negatively correlated

Which of the statements below is FALSE?

No stock has multiple classes with unequal voting rights.

Which of the following classifications of securities had the largest range of annual returns, historically speaking?

Small-company stock

Rank the average annual returns on different types of securities from the highest to lowest from 1925 through 2006 in the US.

Small-company stocks, large-company stocks, long-term government bonds, 3-month U.S. Treasury bills

Assume the CAPM holds. Stock A has a beta of 1.28 and standard deviation of returns of 35%. Stock B has a beta of 1.15 and a standard deviation of returns of 43%. Stock C has a beta of 0 and a standard deviation of returns of 0%. Which stock should have the highest expected return?

Stock A

Stock A has a beta of 0.98 and standard deviation of returns of 35%. Stock B has a beta of 1.15 and a standard deviation of returns of 23%. Which stock has more total risk?

Stock A

Stocks A, B, C, and D have standard deviations, respectively, of 20%, 5%, 10%, and 15%. Which one is the riskiest?

Stock A

Stocks A, B, C, and D have standard deviations, respectively, of 20%, 5%, 10%, and 15%. Which one presents the most total risk?

Stock A

________ is risk that cannot be diversified away.

Systematic risk

Which of the statements below is FALSE?

The payment of cash dividends to shareholders is a deductible expense for the company.

Which of the statements below is FALSE?

The profits for common stock owners come before payment to employees, suppliers, government, and creditors.

Which of the following investments is considered to be default risk-free?

Treasury bills

In ________, current prices reflect the price history and trading volume of the stock. It is of no use to chart historical stock prices to predict future stock prices such that you can identify mispriced stocks and routinely outperform the market.

Weak-form efficient markets

Unsystematic risk ________.

can be diversified away

________ means that the percentage increase in the dividend is the same each year.

constant growth

________ has to do with the speed and accuracy of processing a buy or sell order at the best available price.

operational efficiency

The value of a financial asset is the ________.

present value of all of the future cash flows that will be received

The value of a financial asset is the ________.

present value of all of the future cash flows that will be received The value, or price, of a financial asset is the present value of all of the future cash flows that you will receive while you maintain ownership of the asset. If you sell the asset, then your selling price becomes one of the future cash flows you receive.

The ________ is the market of first sale in which companies first sell their authorized shares to the public.

primary market There are two major markets for the sale of stock, the primary market and the secondary market. The primary market is the market of first sale, in which companies first sell their authorized shares to the public. The secondary market is the after-sale market of the existing outstanding shares in which individual or institutional owners of stocks sell their shares to other investors.

________ may be defined as a measure of uncertainty in a set of potential outcomes for an event in which there is a chance for some loss.

risk

Stocks are different from bonds because ________.

stocks, unlike bonds, represent residual ownership

Stocks are different from bonds because ________.

stocks, unlike bonds, represent residual ownership Stocks and bonds are both major sources of funds. Bonds do not represent residual ownership. Bonds, unlike stocks, give owners legal claims to payments. Stocks, unlike bonds, represent voting ownership.

The constant growth dividend model requires that ________.

the return rate r is greater than the growth rate g of the dividend stream

The type of risk that can be diversified away is called ________.

unsystematic risk