Investment Management Exam-2

Beta is a measure of unsystematic risk.

-False -Systematic

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

.1000

The betas for the market portfolio and risk-free security are:

1, 0

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

101.85

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

14.2%

The expected return for a stock, calculated using the CAPM, is 25 percent. The risk-free rate is 7.5 percent, and the beta of the stock is 0.80. Calculate the implied return on the market.

14.38%

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

154.35

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

17%

The National Motor Company's last dividend was $1.25, and the directors expect to maintain the historic 4 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7 percent for the next three years and the stock will then reach $25.00 per share.

19.21

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

26.50

Fast Grow Corporation is expecting dividends to grow at a 20 percent rate for the next two years. The corporation just paid a $2 dividend, and the next dividend will be paid one year from now. After two years of rapid growth, dividends are expected to grow at a constant rate of 9 percent forever.Refer to Exhibit 8.5. If the required return is 14 percent, what is the value of Fast Grow Corporation common stock today?

52.63

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

ANS: D% = P2/P1 = [(D0)(1 + g2)/(k2 g2)] [(D0)(1 + g1)/(k1 g1)] 1= [(D0)(1 + 0.12)/(0.18 0.12)] [(D0)(1 + 0.08)/(0.14 0.08)] 1= (18.66 18.00) 1 = 3.77% < 4%

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

Absolute

The slope of the efficient frontier is calculated as follows

E(Rportfolio)/E(σportfolio)

A good portfolio is a collection of individually good assets.

False

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

False

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

False

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

False

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

False

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

False

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

False

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

False

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

False

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

False

The APT assumes that security returns are normally distributed.

False

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

False

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

False

There can be only one zero-beta portfolio

False

Net margins are defined as

Net Income/Sales.

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

P/E Ratio

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

True

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

True

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

True

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

True

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

True

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

True

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

True

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

True

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

True

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

True

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

True

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

True

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

True

Risk is defined as the uncertainty of future outcomes.

True

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

True

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

True

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

True

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

True

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

True

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

True

In the presence of transactions costs, the SML will be

a set of lines rather than a single straight line

All of the following are ways in which a firm can increase its growth rate of equity earnings without any external financing EXCEPT a. decreasing its dividend payments. b. increasing its return on equity (ROE). c. increasing its return on assets (ROA). d. increasing its retention ratio.

all choices are correct

A high-quality balance sheet typically has

c. limited use of debt or leverage.

The gross margin is defined as

gross profit/ sales

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

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

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

return and risk

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

true

In a multifactor model, time horizon risk represents

unanticipated changes in investors' desired time to receive payouts.

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

zero