Security Analysis

A firm has a P/E ratio of 12 and a ROE of 13% and a market to book value of _________. A. 0.64 B. 0.92 C. 1.08 D. 1.56 E. None of these is correct.

D. 1.56 P/E * E/B E/P = ROE/(P/B); 1/12 = 0.13 P/B; 0.0833 = 0.13/(P/B); 0.0833(P/B) = 0.13; P/B = 1.56.

which one of the following is an industry with below-average sensitivity to the state of the economy a. an asset play industry b. a cyclical industry c. a defensive industry d. a stalwart industry

c. a defensive industry

Alan Barnett is 43 years old and has accumulated $78,000 in his self-directed defined contribution pension plan. Each year he contributes $1,500 to the plan and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will live to age83. The plan allows for two types of investments. One offers a 4% risk-free real rate of return.The other offers an expected return of 10% and has a standard deviation of 34%. Alan now has40% of his money in the risk-free investment and 60% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation How much can Alan be sure of having in the safe account at retirement? A. $59,473 B. $62,557 C. $78,943 D. $89,211 E. $104,632

D. $89,211

General pension funds typically invest __________ of their funds in equity securities. A. none B. 5-10% C. 15-35% D. 40-60% E. more than 60%

D. 40-60%

A firm has a lower quick (or acid test) ratio than the industry average, which implies A. the firm has a lower P/E ratio than other firms in the industry. B. the firm is less likely to avoid insolvency in the short run than other firms in the industry. C. the firm may be more profitable than other firms in the industry. D. the firm has a lower P/E ratio than other firms in the industry and the firm is less likely to avoid insolvency in the short run than other firms in the industry. E. the firm is less likely to avoid insolvency in the short run than other firms in the industry andthe firm may be more profitable than other firms in the industry

E. the firm is less likely to avoid insolvency in the short run than other firms in the industry andthe firm may be more profitable than other firms in the industry

Selling Discipline Short sale rule of thumb

-Don't short on just valuation alone. Catalyst? Fundamental problem (share, product, market, etc.) -Don't short great companies.High P/E growth co's. Cult stocks. -Don't short possible/rumored takeover candidates. -Overbought ST and LT? Good place to look. -Cover at 15% loss.• Avoid illiquid stocks

Buy Discipline Buying Dont's

-Don't try to catch falling knives. -Avoid toxic market psychology/Stocks already widely played. -Avoid eroding franchises regardless of value. -Don't buy if you don't understand it. -Ugly balance sheets. -Avoid declining ROIC.

Buy Discipline: Buying Do's

-Good valuation and a catalyst. -Improving fundamentals and estimates. -Good ROA, ROIC, ROE. Improving? -Good balance sheet. -Significant upside—say 20%? -Oversold ST and LT? -Watch supply/demand/pricing-is it improving? -Upside to downside risk 2 to 1 or better. - Have an edge. Different angle from consensus. -Insiders buying or not selling.

Selling Discipline Selling Do's

-Reaches price target. -Story changes significantly. -Reason you bought no longer true. -15% stop loss.• Overbought ST and LT- sell. -Feel like you're fighting the tape- sell. -Catalyst has passed. Sell. -Insiders selling increasing? Sell.

Alan Barnett is 43 years old and has accumulated $78,000 in his self-directed defined contribution pension plan. Each year he contributes $1,500 to the plan and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will live to age83. The plan allows for two types of investments. One offers a 4% risk-free real rate of return.The other offers an expected return of 10% and has a standard deviation of 34%. Alan now has40% of his money in the risk-free investment and 60% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation. 10. How much does Alan currently have in the safe account; how much in the risky account? A. $31,200, $46,800 B. $39,000, $39,000 C. $15,900, $62,100 D. $45,300, $32,700 E. $64,000, $14,000

A. $31,200, $46,800

A firm has an ROA of 14%, a debt/equity ratio of 0.8, a tax rate of 35%, and the interest rateon the debt is 10%. The firm's ROE is ________. A. 11.18% B. 8.97% C. 11.54% D. 12.62% E. None of these is correct

A. 11.18% ROE = (1-t)*[ ROA + (ROA - Int. Rate)*D/E]

__________ a snapshot of the financial condition of the firm at a particular time. A. The balance sheet provides B. The income statement provides C. The statement of cash flows provides D. All of these provide E. None of these provides

A. The balance sheet provides

The premise of behavioral finance is that A. conventional financial theory ignores how real people make decisions and that people make a difference. B. conventional financial theory considers how emotional people make decisions but the market is driven by rational utility maximizing investors. C. conventional financial theory should ignore how the average person makes decisions because the market is driven by investors that are much more sophisticated than the average person. D. B and C E. none of the above

A. conventional financial theory ignores how real people make decisions and that people make a difference.

The first step a pension fund should take before beginning to invest is to __________. A. establish investment objectives B. develop a list of investment managers with superior records to interview C. establish asset allocation guidelines D. decide between active and passive management E. None of these is true.

A. establish investment objectives

An example of ________ is that a person may reject an investment when it is posed in terms of risk surrounding potential gains but may accept the same investment if it is posed in terms of risk surrounding potential losses. A. framing B. regret avoidance C. overconfidence D. conservatism E. none of the above

A. framing

if a firm has a positive tax rate, a positive ROA, and the interest rate on debt is the same asROA, then ROA will be _______. A. greater than the ROE B. equal to the ROE C. less than the ROE D. greater than zero but it is impossible to determine how ROA will compare to ROE E. negative in all cases

A. greater than the ROE

If the interest rate on debt is lower than ROA, then a firm will __________ by increasing the use of debt in the capital structure. A. increase the ROE B. not change the ROE C. decrease the ROE D. change the ROE in an indeterminable manner E. None of these is correct

A. increase the ROE

Statman (1977) argues that ________ is consistent with some investors' irrational preferencefor stocks with high cash dividends and with a tendency to hold losing positions too long. A. mental accounting B. regret avoidance C. overconfidence D. conservatism E. none of the above

A. mental accounting

Psychologists have found that people who make decisions that turn out badly blame themselves more when that decision was unconventional. The name for this phenomenon is A. regret avoidance B. framing C. mental accounting D. overconfidence E. obnoxicity

A. regret avoidance

A firm has a market to book value ratio that is equivalent to the industry average and an ROE that is less than the industry average, which implies _______. A. the firm has a higher P/E ratio than other firms in the industry B. the firm is more likely to avoid insolvency in the short run than other firms in the industry C. the firm is more profitable than other firms in the industry D. the firm is utilizing its assets more efficiently than other firms in the industry E. None of these is correct

A. the firm has a higher P/E ratio than other firms in the industry

Alan is 43 years old, has accumulated $78,000 in his self-directed defined contribution pension plan. Yearly he contributes $1,500 to the plan and his employer contributes an equal amount. He will retire at age60 and figures he will live to age83. The plan allows for two types of investments. One offers a 4% risk-free real rate of return.The other offers an expected return of 10% and has a standard deviation of34%. He now has40% of his money in the risk-free investment and 60% in the risky investment. He plans to continue saving at same rate and keep same proportions invested in each of the investments.Salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Alan and by his employer on hisbehalf, how much will he put into the safe account each year; how much into the risky account? A. $1,500, $1,500 B. $1,200, $1,800 C. $2,000, $1,000 D. $2,500, $500 E. $1,400, $1,600

B. $1,200, $1,800 The safe account gets .4*($1,500+1,500)=$1,200 and the risky account gets6*($1,500+1,500)=$1,800

Alan Barnett is 43 years old and has accumulated $78,000 in his self-directed defined contribution pension plan. Each year he contributes $1,500 to the plan and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will live to age83. The plan allows for two types of investments. One offers a 4% risk-free real rate of return.The other offers an expected return of 10% and has a standard deviation of 34%. Alan now has40% of his money in the risk-free investment and 60% in the risky investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary will grow at the same rate as inflation How much can Alan expect to have in his risky account at retirement? A. $158,982 B. $309,529 C. $543,781 D. $224,651 E. $345,886

B. $309,529

A firm has an ROE of -2%, a debt/equity ratio of 1.0, a tax rate of 0%, and an interest rate ondebt of 10%. The firm's ROA is _______. A. 2% B. 4% C. 6% D. 8% E. None of these is correct.

B. 4% -.02 = (1-0) [ROA +(ROA -.10%)*1]-.02 = [ROA +ROA -.10%]+.08 = 2 ROA

U. S. mutual funds are restricted to holding no more than __________ of any publicly tradedcorporation. A. 1% B. 5% C. 10% D. 25% E. There is no restriction on percentage ownership

B. 5%

Which of the following are commonly thought to be good general investment guidelines?I) Don't try to outguess the market, buying and holding generally pays off.II) Diversify investments to spread risk.III) Investments should be highly concentrated in your company's stock.IV) 401K money is best placed in money market accounts because risk is very low.V) Investments should be allocated to stocks, bonds, and money-market funds. A. I, III, IV B. I, II, V C. II, IV, V D. III, IV, V E. I, II, IV, V

B. I, II, V

If you wish to compute economic earnings and are trying to decide how to account for inventory, ______. A. FIFO is better than LIFO B. LIFO is better than FIFO C. FIFO and LIFO are equally good D. FIFO and LIFO are equally bad E. None of these is correct.

B. LIFO is better than FIFO

___________ may be responsible for the prevalence of active versus passive investments management. A. Forecasting errors B. Overconfidence C. Mental accounting D. Conservatism E. Regret avoidance

B. Overconfidence

__________ of the profitability of the firm over a period of time such as a year. A. The balance sheet is a summary B. The income statement is a summary C. That statement of cash flows is a summary D. The audit report is a summary E. None of these is a summary

B. The income statement is a summary

DeBondt and Thaler believe that high P/E result from investors A. earnings expectations that are too extreme. B. earnings expectations that are not extreme enough. C. stock price expectations that are too extreme. D. stock price expectations that are not extreme enough. E. none of the above.

B. earnings expectations that are not extreme enough.

Kahneman and Tversky (1973) report that __________ and __________. A. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information B. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information C. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough given the uncertainty of their information D. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough given the uncertainty of their information E. none of the above

B. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information

An example of ________ is that it is not as painful to have purchased a blue-chip stock that decreases in value, as it is to lose money on an unknown start-up firm. A. mental accounting B. regret avoidance C. overconfidence D. conservatism E. none of the above

B. regret avoidance

A study by Speidell and Bavishi (1992) found that when accounting statements of foreignfirms were restated on a common accounting basis, A. the original and restated P/E ratios were quite similar. B. the original and restated P/E ratios varied considerably. C. most variation was explained by tax differences. D. most firms were consistent in their treatment of goodwill. E. None of these is correct.

B. the original and restated P/E ratios varied considerably.

Assume that at retirement you have accumulated $500,000 in a variable annuity contract. Theassumed investment return is 6% and your life expectancy is 15 years. What is the hypotheticalconstant benefit payment? A. $30,000.00 B. $33,333.33 C. $51,481.38 D. $52,452.73. E. cannot tell without additional information.

C. $51,481.38 PV = -500,000, i = 6, n = 15, PMT = 51,481.38

J.C. Penney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of$1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at the rateof 8% per year. An appropriate required return for the stock is 11%. The stock should be worth_______ today. A. $33.00 B. $40.67 C. $71.80 D. $66.00 E. None of these is correct

C. $71.80

Which of the following are issues when dealing with the financial statements of international firms? I) Many countries allow firms to set aside larger contingency reserves than the amounts allowed for U.S. firms. II) Many firms outside the U.S. use accelerated depreciation methods for reporting purposes, whereas most U.S. firms use straight-line depreciation for reporting purposes. III) Intangibles such as goodwill may be amortized over different periods or may be expensed rather than capitalized. IV) There is no way to reconcile the financial statements of non-U. S. firms to GAAP. A. I and II B. II and IV C. I, II, and III D. I, III, and IV E. I, II, III, and IV

C. I, II, and III

__________ of the cash flow generated by the firm's operations, investments and financial activities. A. The balance sheet is a report B. The income statement is a report C. The statement of cash flows is a report D. The auditor's statement of financial condition is a report E. None of these is a report

C. The statement of cash flows is a report

If the interest rate on debt is higher than ROA, then a firm will __________ by increasing the use of debt in the capital structure. A. increase the ROE B. not change the ROE C. decrease the ROE D. change the ROE in an indeterminable manner E. None of these is correct

C. decrease the ROE

An income beneficiary is __________. A. a stockbroker who remained working on Wall Street after the 1987 crash B. an employee of a trustee C. one who receives interest and dividend income from a trust during their lifetime D. one who receives the principal of a trust when it is dissolved E. None of these is true

C. one who receives interest and dividend income from a trust during their lifetime

The risk management section of an Investment Policy Statement for individual investors typically contains ________. A. relevant constraints B. other relevant considerations C. performance measurement accountabilities, metrics for risk measurement, and the rebalancing process D. relevant constraints and other relevant considerations E. All of these are true

C. performance measurement accountabilities, metrics for risk measurement, and the rebalancing process

The optimal portfolio on the efficient frontier for a given investor does not depend on A. the investor's degree of risk tolerance. B. the coefficient, A, which is a measure of risk aversion. C. the investor's required rate of return. D. the investor's degree of risk tolerance and the investor's required rate of return. E. the investor's degree of risk tolerance and the coefficient, A, which is a measure of riskaversion.

C. the investor's required rate of return.

In periods of inflation, accounting depreciation is __________ relative to replacement cost and real economic income is ________. A. overstated, overstated B. overstated, understated C. understated, overstated D. understated, understated E. correctly, correctly

C. understated, overstated

Assume that at retirement you have accumulated $500,000 in a variable annuity contract. Theassumed investment return is 6% and your life expectancy is 15 years. If the first year's actualinvestment return is 8%, what is the starting benefit payment? A. $30,000.00 B. $33,333.33 C. $51,481.38 D. $52,452.73 E. cannot tell without additional information

D. $52,452.73

The market capitalization rate on the stock of Flexsteel Company is 12%. The expected ROEis 13% and the expected EPS are $3.60. If the firm's plowback ratio is 75%, the P/E ratio will be_______. A. 7.69 B. 8.33 C. 9.09 D. 11.11 E. None of these is correct

D. 11.11

Over a period of thirty-odd years in managing investment funds, Benjamin Graham used theapproach of investing in the stocks of companies where the stocks were trading at less than theirworking capital value. The average return from using this strategy was approximately _____. A. 5% B. 10% C. 15% D. 20% E. None of these is correct

D. 20%

A firm has a (net profit/pretax profit ratio) of 0.625, a leverage ratio of 1.2, a (pretaxprofit/EBIT) of 0.9, an ROE of 17.82%, a current ratio of 8, and a return on sales ratio of 8%.The firm's asset turnover is ________. A. 0.3 B. 1.3 C. 2.3 D. 3.3 E. None of these is correct.

D. 3.3

A firm has a (net profit/pretax profit) ratio of 0.6, a leverage ratio of 2, a (pretax profit/EBIT)of 0.6, an asset turnover ratio of 2.5, a current ratio of 1.5, and a return on sales ratio of 4%. The firm's ROE is ________. A. 4.2% B. 5.2% C. 6.2% D. 7.2% E. None of these is correct.

D. 7.2%

Which of the following are commonly thought to be bad general investment guidelines?I) Don't try to outguess the market, buying and holding generally pays off.II) Diversify investments to spread risk.III) Investments should be highly concentrated in your company's stock.IV) 401K money is best placed in money market accounts because risk is very low.V) Investments should be allocated to stocks, bonds, and money-market funds. A. I, III, IV B. I, II, IV C. II, IV, V D. III, IV E. I, II, IV, V

D. III, IV

For an individual investor, the value of home ownership is likely to be viewed A. as a hedge against increases in rental rates. B. as a guarantee of availability of a particular residence. C. as a hedge against inflation. D. as a hedge against increases in rental rates and as a guarantee of availability of aparticular residence. E. All of these are true

D. as a hedge against increases in rental rates and as a guarantee of availability of aparticular residence.

To create a common size balance sheet ____________ all items on the balance sheet by___________. A. multiply; owners equity B. multiply; total assets C. divide; owners equity D. divide; total assets E. multiply; debt

D. divide; total assets

To create a common size income statement ____________ all items on the income statement by ___________. A. multiply; net income B. multiply; total revenue C. divide; net income D. divide; total revenue E. multiply; COGS

D. divide; total revenue

The desirable components of an Investment Policy Statement for individual investors can be divided into ________. A. three main elements consisting of scope and purpose, governance, and risk management. B. three main elements consisting of scope and purpose, governance, and investment, return and risk objectives. C. four main elements consisting of scope and purpose, governance, risk management, and feedback. D. four main elements consisting of scope and purpose, governance, risk management, and investment, return and risk objectives. E. five main elements consisting of scope and purpose, governance, risk management, investment, return and risk objectives, and evaluation

D. four main elements consisting of scope and purpose, governance, risk management, and investment, return and risk objectives.

A firm has a lower asset turnover ratio than the industry average, which implies A. the firm has a lower P/E ratio than other firms in the industry. B. the firm is less likely to avoid insolvency in the short run than other firms in the industry. C. the firm is less profitable than other firms in the industry. D. the firm is utilizing assets less efficiently than other firms in the industry. E. the firm has lower spending on new fixed assets than other firms in the industry

D. the firm is utilizing assets less efficiently than other firms in the industry.

A firm has a higher asset turnover ratio than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry. B. the firm is more likely to avoid insolvency in the short run than other firms in the industry. C. the firm is more profitable than other firms in the industry. D. the firm is utilizing assets more efficiently than other firms in the industry. E. the firm has higher spending on new fixed assets than other firms in the industry

D. the firm is utilizing assets more efficiently than other firms in the industry.

a. IBX's stock dividend at the end of this year is expected to be $2.15, and it is expected togrow at 11.2% per year forever. If the required rate of return on IBX stock is 15.2% per year,what is its intrinsic value? b. If IBX's current market price is equal to this intrinsic value, what is next year's expectedprice? c. If an investor were to buy IBX stock now and sell it after receiving the $2.15 dividend a year from now, what is the expected capital gain (i.e., price appreciation) in percentage terms? What is the dividend yield, and what would be the holding-period return

D1/(k-g) = $2.15/(0.152-0.112) = $53.75 b. P1 = P0(1+g) = $53.75(1.112) = $59.77 c. The expected capital gain equals $59.77 - $53.75 = $6.02, for a percentage gain of11.2%. The dividend yield is D1/P0 = 2.15/53.75 = 4%, for a holding-period return of 4% +11.2% = 15.2%

Exercise Bicycle Company is expected to pay a dividend in year 1 of $1.20, a dividend in year 2 of $1.50, and a dividend in year 3 of $2.00. After year 3, dividends are expected to grow at the rate of10% per year. An appropriate required return for the stock is 14%. The stock should be worth_______ today. A. $33.00 B. $39.86 C. $55.00 D. $66.00 E. $40.68

E. $40.68 V3=D4/(k-g)=2.2/(.14-.10)=55 V0=1.20/1.14 +1.5/(1.14)^2 + 2.00/(1.14)^3 +55/(1.14)^3=$40.68

Boaters World is expected to have per share FCFE in year 1 of $1.65, per share FCFE in year 2of $1.97, and per share FCFE in year 3 of $2.54. After year 3, per share FCFE is expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A. $77.53 B. $40.67 C. $82.16 D. $66.00 E. $71.80275

E. $71.80275 V3=FCF4/(k-g)=2.7432/(.11-.08)=$91.44 V0=1.65/1.11 +1.97/(1.11)^2 + 2.54/(1.11)^3 +91.44/(1.11)^3=$71.80

The market capitalization rate on the stock of Fast Growing Company is 20%. The expectedROE is 22% and the expected EPS are $6.10. If the firm's plowback ratio is 90%, the P/E ratiowill be _______. A. 7.69 B. 8.33 C. 9.09 D. 11.11 E. 50

E. 50

Institutional investors will rarely invest in which of these asset classes? A. Bonds B. Stocks C. Cash D. Real estate E. Precious metals

E. Precious metals

The governance section of an Investment Policy Statement for individual investors typically contains ________. A. assigning the responsibility for determining investment policy B. the review process for the IPS C. assigning the responsibility for risk management D. the review process for the IPS and assigning the responsibility for risk management E. assigning the responsibility for determining investment policy, the review process for theIPS, and assigning the responsibility for risk management

E. assigning the responsibility for determining investment policy, the review process for theIPS, and assigning the responsibility for risk management

The scope and purpose section of an Investment Policy Statement for individual investors typically consists of defining the ________. A. return, distribution, and risk requirements B. process for review of the IPS C. appropriate metrics for risk measurement D. relevant constraints E. context, investor, and structure

E. context, investor, and structure

An example of a liquidity ratio is ______. A. fixed asset turnover B. current ratio C. acid test or quick ratio D. fixed asset turnover and acid test or quick ratio E. current ratio and acid test or quick ratio

E. current ratio and acid test or quick ratio

If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors. A. framing B. selection bias C. overconfidence D. conservatism E. forecasting

E. forecasting

Economic value added (EVA) is also known as A. excess capacity. B. excess income. C. value of assets. D. accounting value added. E. residual income

E. residual income

A firm has a higher quick (or acid test) ratio than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry. B. the firm is more likely to avoid insolvency in the short run than other firms in the industry. C. the firm may be less profitable than other firms in the industry. D. the firm has a higher P/E ratio than other firms in the industry and the firm is more likely to avoid insolvency in the short run than other firms in the industry. E. the firm is more likely to avoid insolvency in the short run than other firms in the industry and the firm may be less profitable than other firms in the industry

E. the firm is more likely to avoid insolvency in the short run than other firms in the industry and the firm may be less profitable than other firms in the industry

The optimal portfolio on the efficient frontier for a given investor depends on A. the investor's degree of risk tolerance. B. the coefficient, A, which is a measure of risk aversion. C. the investor's required rate of return. D. the investor's degree of risk tolerance and the investor's required rate of return. E. the investor's degree of risk tolerance and the coefficient, A, which is a measure of risk aversion.

E. the investor's degree of risk tolerance and the coefficient, A, which is a measure of risk aversion.

The risk-free rate of return is 10%, the required rate of return on the market is 15%, andHigh-Flyer stock has a beta coefficient of 1.5. If the dividend per share expected during thecoming year, D1, is $2.50 and g = 5%, at what price should a share sell?

High-Flyer stock.K = rf + b*(kM - rf) = .10+1.5(.15-.10) = .10+.075 = .175G = .05.Therefore, P0 = D1/(k-g) = $2.50/(.175-.05) = $20

Discuss the relationships between investor objectives, constraints, and policies

Investor objectives reflect the investor's attitude toward the risk/return tradeoff. That is, how much risk is the investor willing to take, and what is the maximum return the investor can expect at that risk level. Investor constraints refer to actions the investor is unwilling to take or must take due to certain needs. Examples of constraints are the liquidity needs of the investor, the investment horizon date of the investor, regulation governing various institutional investors, whether or not the investor is subject to taxation, and any other unique needs of the investor(such as social investing constraints).Meeting the investor objectives, subject to the investor constraints, results in the formulation of investment policies. Investment policies relate to how the portfolio will be managed, such as the determination of asset allocation, diversification, risk level, tax status, and income generation

Publicly traded firms must prepare audited financial statements according to generallyaccepted accounting principles (GAAP). How do comparability problems arise?

Many accounts may be valued by more than one generally accepted accounting principle. As aresult, firms often select the GAAP that presents the firm in the most attractive position. Thus,the analyst trying to compare firms using different GAAPs must be aware of these differencesand make his or her own adjustments of the financial statements in order to determine which firmis the more attractive investment alternative. Generally accepted accounting principles forinventory valuation and depreciation are two of the more common areas where comparabilityproblems may arise

21. The principle of duration matching is not A. used only in bond portfolio management B. a useful concept for investments with target dates C. a means matching one's assets to one's objectives D. a useful concept for investments with target dates and a means matching one's assets to one's objectives E. None of these is true

NA

Discuss investments as a hedge against inflation

Perfect hedges against inflation are virtually non-existent. CPI futures contracts would be perfecthedges. Floating rate bonds are hedges to the extent that the inflation rate is correlated withinterest rates; such a correction is far from perfect. Real assets, such as gold and real estate, andcommodities have been suggested as inflation hedges. However, although the price changes onthese assets are positively correlated with price changes, the correlations are not very large. Thesame correlation relationships exist between common stocks and inflation.24. Discuss fourfactors you would need to include if you were constructing a retirement planning worksheet.

Many different debt, or financial leverage, ratios are reported. Explain the relationshipbetween total assets/equity and debt/equity

Total assets/equity is the ratio used in computing the ROE in the "duPont breakout formula".Assets may be purchased with either debt or equity or some combination thereof. Thus, the sumof debt and equity financing equals total assets. If one is given the debt/equity ratio and needs thetotal assets/equity ratio (for example, for the above cited calculation), one merely adds theamounts of debt and equity in the capital structure in order to obtain the amount of total assets.For example:Debt = $50,000;Equity = $50,000;Debt/equity = 1;$50,000 + $50,000 = $100,000 (total assets);Total assets/Equity = $100,000/$50,000 = 2; or 1 + 1 = 2.

Ace Frisbee Corporation produces a good that is very mature in their product life cycles. AceFrisbee Corporation is expected to pay a dividend in year 1 of $3.00, a dividend in year 2 of$2.00, and a dividend in year 3 of $1.00. After year 3, dividends are expected to decline atthe rate of 2% per year. An appropriate required return for the stock is 8%. Using themultistage DDM, the stock should be worth __________________. a) $13.06 b) $13.38 c) $18.25 d) $18.78

a) 13.06

Interior Airline is expected to pay a dividend of $3 in the upcoming year. Dividends are expectedto grow at the rate of 10% per year. The risk-free rate of return is 4% and the expected return on themarket portfolio is 13%. The stock of Interior Airline has a beta of 4.00. Using the constant growthDDM, the intrinsic value of the stock is __________. a. $10.00 b. $22.73 c. $27.78 d. $41.67

a. $10.00 CAPM: k=4%+4*(13%-4%)=40% or .40 V=3/(.40-.10) = $10

You expect the price of IBX stock to be $59.77 per share a year form now. Its current marketprice is $50, and you expect it to pay a dividend one year form now of $2.15 per share. a. What is the stock's expected dividend yield, rate of price appreciation, and holding-period return? b. If the stock has a beta of 1.15, the risk-free rate is 6% per year, and the expected rate ofreturn on the market portfolio is 14% per year, what is the required rate of return on IBXstock? c. What is the intrinsic value of IBX stock, and how does it compare to the current marketprice?

a. Dividend yield = $2.15/$50 = 4.3%Capital gains yield = (59.77 - 50)= 19.54%Total return = 4.3% + 19.54% = 23.84% b. k = 6% + 1.15(14% - 6%) = 15.2% c. V0 = ($2.15 + $59.77)/1.152 = $53.75, which exceeds the market price. This wouldindicate a 'buy' opportunity.

A firm that has an ROE of 12% is considering cutting its dividend payout. The stockholders of thefirm desire a dividend yield of 4% and a capital gain yield of 9%. Given this information which ofthe following statement(s) is/are correct? I. All else equal the firm's growth rate will accelerate after the payout change II. All else equal the firm's stock price will go up after the payout change III. All else equal the firm's P/E ratio will increase after the payout change a. I only b. I and II only c. II and III only d. I, II and III

a. I only K= dividend yield of 4% and a capital gain yield of 9%=13%, So we know that ROE < k, the spread(ROE - k) is negative.

a. MF Corp. has an ROE of 16% and a plowback ratio of 50%. If the coming year'searnings are expected to be $2 per share, at what price will the stock sell? The marketcapitalization rate is 12%. b. What price do you expect MF shares to sell for in three years?

a. g = ROE*b = 16%*.5 = 8%D1 = $2(1-b) = $2*(1-.5) = $1.00P0 = D1/(k-g) = $1/(.12-.08) = $25 b. P3 = P0(1+g)3 = $24(1.08)3 = $31.49

If you believe the economy is about to fo into a recession you might change your asset allocation by selling ____ and buying ___ a. growth stocks long-term bonds b. long-term bonds, growth stocks c. defensive stocks, growth stocks d. defensive stocks, long-term bonds

a. growth stocks long-term bonds

The degree of operating leverage (DOL) measures the ____ a. sensitivity of profits to changes in sales revenues b. sensitivity of profits to changes in fixed costs c. sensitivity of profits to changes in the tax rate d. sensitivity of profits to changes in interest rates

a. sensitivity of profits to changes in sales revenues

Small firms have tended to earn abnormal returns primarily in ___ a. the month of January b. the month of July c. the trough of the business cycle d. the peak of the business cycle

a. the month of January

Which statement is NOT an example of a good buying discipline rule a. the stock is down 70% from its high. One should buy the stock, b/c it is now cheap and represents a great value b. My analysis suggests that downside risk to potential upside is 1 to 2, so one should buy the stock c. one should generally buy companies with a strong balance sheet d. one should generally buy companies with good and improving fundamentals and estimates e. all the above

a. the stock is down 70% from its high. One should buy the stock, b/c it is now cheap and represents a great value

Grott and Perrin, Inc. has expected earnings of $3 per share for next year. The firm's ROE is20% and its earnings retention ratio is 70%. If the firm's market capitalization rate is 15%,what is the present value of its growth opportunities?a) $20 b) $70 c) $90 d) $115

b) $70

Caribou Gold Mining Corporation is expected to pay a dividend of $4 in the upcoming year.Dividends are expected to decline at the rate of 3% per year. The risk-free rate of return is5% and the expected return on the market portfolio is 13%. The stock of Caribou GoldMining Corporation has a beta of NEGATIVE 0.50 (-0.50). Using the CAPM, the return youshould require on the stock is ____________________. a) -2% b) 1% c) 2% d) 9%

b) 1%

Tommy Teleportation Inc. has expected earnings of $3 per share for next year. The firm's ROE is 20% and its earnings retention ratio is 70%. If the firm's market capitalization rate (i.e., the requiredrate of return on the company's stock) is 15%, what is the present value of its growth opportunities? a. $20 b. $70 c. $90 d. $115 e. $110

b. $70 NGV = 3/.15 =$20. PVGO = V - NGV= 90-20

Google's share price was $475 per share on January 11, 2006. Google had a P/E ratio of about 68and an estimated market capitalization rate of 11.5%. Google pays no dividends. What percentage ofGoogle's stock price is represented by PVGO? a. 92% b. 87% c. 77% d. 64%

b. 87% Price / (P/E) = E; E= 475/68 = $6.985 NGV=e/k = $6.985/.115 = $60.74PVGO = 475-60.74 =$414.258 PVGO/P = 414.258/475 =87.2%

4. A firm cuts its dividend payout ratio. As a result you know that the firm's a. Return on assets will increase b. Earnings retention ratio will increase c. Earnings growth rate will fall d. Stock price will fall

b. Earnings retention ratio will increase RR=1-div p/o rati

__________ is the amount of money per common share that could be realized by breaking up thefirm, selling its assets, repaying its debt, and distributing the remainder to shareholders. a. Book value per share b. Liquidation value per share c. Market value per share d. Tobin's Q

b. Liquidation value per share

P/E ratios tend to be _______ when inflation is _______. a. Higher, higher b. Lower, lower c. Higher, lower d. They are unrelated

c. Higher, lower Lower Inflation = Lower discount rate = Higher PV = Higher price

Firm A has a stock price of $35 and 60% of the value of the stock is in the form of PVGO. FirmB also has a stock price of $35 but only 20% of the value of Stock B is in the form of PVGO. Weknow that I. Stock A will give us a higher return than Stock B II. An investment in Stock A is probably riskier than an investment in Stock B III. Stock A has higher forecasted earnings growth than Stock B a. I only b. I and II only c. II and III only d. I, II and III

c. II and III only

One of the well-documented market anomalies is that firms with high P/E ratios____ a. earned higher average returns than firms with low P/E ratios b. earned the same average returns as firms with low P/E ratios c. earned lower average returns than firms with low P/E ratios d. had higher dividend yields than firms with low P/E ratios

c. earned lower average returns than firms with low P/E ratios

Which of the following observations would provide evidence against the semi-strong form of the efficient market theory? Explain. a. mutual fund managers do not on average make superior returns b. you cannot make superior profits by buying (or selling) stocks after the announcement of an abnormal rise in earnings c. low P/E stocks tend to provide abnormal adjusted returns d. in any year, approximately 50% of pension funds outperform the market

c. low P/E stocks tend to provide abnormal adjusted returns

according to ___ economists, the growth of the US economy in the 1980s can be attributed to lower marginal tax rates which improved the incentives for people to work a. keynesian b. monetarist c. supply-side d demand-side

c. supply-side

Discuss the differences between economic earnings and accounting earnings. Which ispreferred in financial analysis? Which is most widely used, and why?

conomic earnings consist of the sustainable cash flow that can be paid out to stockholderswithout impairing the productive capacity of the firm. The focus is on the present value ofexpected cash flows. Accounting earnings are based on accrual methods and can be manipulatedto a certain extent. They are subject to the firm's decisions about its accounting methods such asinventory valuation and amortization of capital expenditures. Net Income will be different ineach case. Financial analysis is based on economic earnings, which are often difficult tomeasure, whereas accounting earnings are widely available. Annual and quarterly reports containa firm's financial statements. They do provide important information about the health andprospects of the firm. Accounting earnings are therefore most frequently used for analysis

Which of the following statements is/are correct? a. if a market is weak form efficient it is also semi- and strong form efficient b. If a market is semi-strong efficient it is also strong form efficient c. IF a market is strong form efficient it is also semi-strong but not weak form efficient d. If a market is strong form efficient it is also semi - and weak form efficient

d. If a market is strong form efficient it is also semi - and weak form efficient

Generally speaking the higher a firm's ROA the _________ the dividend payout ratio and the_________ the firm's growth rate of earnings. a. Higher; lower b. Higher; higher c. Lower; lower d. Lower; higher

d. Lower; higher Generally speaking, the higher the ROA, the greater the need for reinvestment into the co'sbusiness, the higher the growth rate and the lower the div payout ratio.

If a firm increases its plowback ratio this will probably result in a(n) _______ P/E ratio. a. Higher b. Lower c. Unchanged d. Unable to determine

d. Unable to determine Intrinsic Value will increase only when ROE >k. We need to know if the spread (ROE- k) is positive or not.

Growth stocks usually exhibit____ price-to-book ratios and _____ price-to-earnings ratios a. low, low b. low, high c high, low d. high, high

d. high, high

a market anomaly refers to ___ a. an exogenous shock to the market that is sharp but not persitent b. a price or volume event that is inconsistent with historical price or volume trends c. a trading or pricing structure that interferes with efficient buying and selling of securities d. price behavior that differs from the behavior predicted by the efficient market hypothesis

d. price behavior that differs from the behavior predicted by the efficient market hypothesis

Whenever OPEC attempts to influence the price of oil by significantly altering production, economists refer to this type of event as a. demand shock b. equilibrium event c. expanding commodity event d. supply shock

d. supply shock

Which of the following most appears to contradict the proposition that the stock market is weakly efficicnet ? Explain a. over 25% of mutual funds outperform the market on average b. insiders earn abnormal trading profits c. every november, the stock market earns above average monthly returns d. you can earn abnormal returns if you buy stocks of the companies that have just announced positive earnings surprises e. you can earn abnormal returns if you buy the stocks of the companies that went up 20% in the previous two quarters

e. you can earn abnormal returns if you buy the stocks of the companies that went up 20% in the previous two quarters