Download FIN432 Investments

FIN352 Investments
Final exam preparatory questions and answers to end of the slides questions
1. High P/E ratios are typically associated with stocks that display:
a)
b)
c)
d)
below-average risk.
below-average dividend payout ratios. *
below-average historical returns.
below-average historical EPS growth.
2 A retention rate of 75% and a ROE of 16% implies sustainable growth of:
a)
b)
c)
d)
6.7%.
12%. *
75%.
60%.
Solution: Sustainable growth = Retention × ROE = 0.75 × 16% = 12%
3 According to the PEG ratio rule-of-thumb, if PEG 1, then a stock
a. may be worthy of investment attention and possible purchase. *
b. is definitely worthy of investment attention, and may represent a very attractive
investment.
c. is apt to represent an extraordinarily attractive investment opportunity.
d. none of these.
4. "Open interest" is the number of option contracts:
a)
b)
c)
d)
5.
bought during a given day of trading.
sold during a give day of trading.
created during a given day of trading.
none of these. *
Out-of-the-money call options have an exercise price that:
a) exceeds the current market price of the underlying common stock. *
b) exceeds the strike price.
c) is less than the current market price of the underlying common stock.
d) is less than the strike price.
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59. The writer of a put option is said to have a:
>
a)
b)
c)
d)
long position.
short position.
covered position.
uncovered position.
7. An investor bought one ABC $25 (exercise price is $25) call contract for a premium
of $5 per share. At the maturity (expiration), ABC stock price is $30.
Which is the net profit/loss of this investment?
a) $500
b) $0 *
c) -$500
d) $100
8. An investor sold one ABC $25 (exercise price is $25) call contract for a premium of
$5 per share. At the maturity (expiration), ABC stock price is $40.
Which is the net profit/loss of this investment?
a) $1000
b) $0
c) -$1000 *
d) -$500
9. In top-down, fundamental analysis, the first step is always to analyze:
a.
b.
c.
d.
the economy *
the industry
the company
the particular security
10. EPS are of higher quality if:
a.
b.
c.
d.
the company is a blue chip.
the auditor's reputation is high.
they were derived using conservative principles. *
FASB has approved them.
11. On a company’s balance sheet, shareholder’s equity is nearly always described by its?
a.
b.
c.
d.
Book value *
Market value
Current value
Stock value
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12. Which of the following represents the rate at which a company can grow from
internal sources?
a.
b.
c.
d.
return on assets
sustainable growth rate *
adjusted EPS
return on equity
13. If the dividend growth rate increases for a firm, its P/E will ---------, other things the
same.
a.
b.
c.
d.
increase *
stay the same
decrease
increase or decrease but not stay the same
14. For adequately diversified common stock portfolios, market effects often account
for -------- percent and more of the variability of the portfolio’s return.
a.
b.
c.
d.
60
70
80
90 *
15. Which of the following is TRUE regarding the risk premium? The risk premium
a.
b.
c.
d.
must reflect all the uncertainty involved in the asset. *
does not apply to low beta stocks.
is directly related to changes in the interest rate.
reflects only the financial risk of a security.
16. If security markets are totally efficient, the best common stock strategy to take is:
a.
b.
c.
d.
an asset allocation approach.
the modern portfolio theory.
an active strategy.
a passive strategy. *
17. The central focus of a security analyst’s job is to:
a.
b.
ascertain the accuracy of financial statements of selected companies.
find growth stocks.
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c.
d.
forecast a specific company’s return. *
determine the market demand for a specific company’s stock.
18.
An analyst employed by a pension fund to search for stocks for the fund to invest
in would be referred to as:
a.
b.
c.
d.
a sell-side analyst.
a buy-side analyst. *
an institutional analyst.
a money manager.
19.Which of the following statements regarding defensive stocks is true?
a.
b.
c.
d.
They are often expected to have above-average future growth.
They often have high P/E multiples.
They are expected to be adversely affected by high interest rates.
They often produce necessary items such as food and prescription drugs. *
20.Historically, sell-side equity research has typically been _________to the target
company?
a.
b.
c.
d.
very unfavorable
unfavorable
favorable *
neutral
21.
____________ funds are especially popular with momentum investors.
a.
b.
c.
d.
Index.
Managed
Global
Sector *
22.Put and call options on equity securities are considered:
a.
b.
c.
d.
Commodity derivatives
Financial derivatives *
Forward contracts
Futures contracts
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One important reason for the existence of derivatives is that they:
a.
help lower transactions costs.
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b.
c.
d.
have valuable tax benefits.
contribute to market completeness. *
are risk-free.
24. A major difference between new shares being sold by a corporation and
sold under a call option is that:
a.
b.
c.
d.
there is no profit or loss under the shares sold under the call.
there is no risk to the investor with the call.
there is no increase in the shares outstanding with the call. *
there is no commission to the investor with the call.
25.
Which of the following statements is true regarding a call writer:
a.
b.
c.
d.
The call writer expects the stock to move upward.
The call writer expects the stock to remain the same or move down.*
The call writer expects the stock to split.
The call writer expects to sell the stock prior to expiration of the option.
27.
Options sold on exchanges are protected against
a.
b.
c.
d.
stock dividends and splits. *
cash dividends.
interest rate movements.
inflation.
shares
28. If the price of the common stock exceeds the exercise price of a call for the holder the
call is said to be
a.
b.
c.
d.
naked.
out of the money.
in the money. *
covered.
29.
Which of the following is true regarding option pricing:
a.
b.
c.
d.
the longer the maturity of the option, the higher the premium. *
the more volatile the underlying stock, the lower the premium.
option prices are less volatile than equity prices.
the shorter the maturity of the option, the lower the premium.
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30.A stock is at $68. A two-month put (strike price = $70) is available at a $5 premium..
The intrinsic value is ___ and the time value is ____.
a.
b.
c.
d.
$5 . . . $0.
$0 . . . $5.
$3 . . . $2.
$2 . . . $3. *
32 One percentage point of a bond yield represents:
a.
b.
c.
d.
1 basis point
10 basis points
100 basis points *
1000 basis points
33 The yield to maturity consists solely of interest income if:
a.
b.
c.
d.
the bond is a zero coupon bond.
the bond was purchased at par.*
the bond was purchased above par.
the bond was purchased below par.
34 In order to have a yield to maturity greater than the coupon rate, the bond must be:
a.
b.
c.
d.
selling at a discount.*
selling at par.
selling at a premium.
a zero coupon bond.
35 If a bond is callable, this means:
a.
b.
c.
d.
the issuer may change the coupon rate.
the investor may convert the bond into stock.
the issuer may redeem the bond early.*
the investor may cash in the bond at any time.
36 The YTM calculation assumes:
a.
b.
c.
d.
reinvestment of interest is at the coupon rate.
no reinvestment of interest.
reinvestment of interest is at YTM rate.*
reinvestment of interest is at the risk-free rate.
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37 An increase in reinvestment rate risk
a.
b.
c.
d.
is caused by an increase in interest rates.
leads to a decline in coupon rates.
results from a decline in interest rates.*
results from an increase in inflation.
38. The __________ equates the present value of the total future dollars expected to be
available at the end of a specific time period, given certain assumptions, to the
price of the bond.
a.
b.
c.
d.
horizon return*
promised return
expected return
coupon return
39. Find the price of a 10 percent coupon bond with three years to maturity if the yield to
maturity is now 12 percent. Use semiannual discounting.
a.
b.
c.
d.
$1196.70
$950.85
$952.20
$999.80
Solution:
Use 6 percent and 6 periods
Price = 50(4.917) + 1000(0.705)= 950.85
Price= 50/(1+0.06)^1 +50/(1+0.06)^2 +50/(1+0.06)^3 +50/(1+0.06)^4 +50/(1+0.06)^5 +
50/(1+0.06)^6 +1000/(1+0.06)^6 +
40 With an upward sloping yield curve, which of the following maturities will have
the highest yield?
a.
b.
c.
d.
5-year.
10-year.
30-year.*
90-day.
41.
Which of the following statements regarding changes in bond prices relative to
changes in market yields is true?
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a.
b.
c.
d.
Short-term bond prices will increase more than long-term bond prices if market
yields increase.
Short-term bond prices will increase less than long-term bond prices if market
yields decrease.*
Short-term bond prices will increase more than long-term bond prices if market
yields decrease.
Short-term bond prices will remain constant and long-term bond prices will
increase if market yields decrease.
42 Maturity and coupon being equal, which of the following bonds will have the highest
yield to maturity?
a.
b.
c.
d.
Treasury bond.
AAA- rated corporate bond.
BBB+ rated corporate bond.
BB- rated corporate bond.*
43.
Which of the following statements about bond prices is FALSE?
a.
b.
Bond price volatility and time to maturity are directly related.
A decrease in yields raises prices more than an increase in yields lowers
prices.
Bond price fluctuations and bond coupons are directly related.*
Bond prices move inversely to bond yields.
c.
d.
44. Markowitz's main contribution to portfolio theory is:
a.
b.
c.
d.
that risk is the same for each type of financial asset.
that risk is a function of credit, liquidity and market
factors.
risk is not quantifiable.
insight about the relative importance of variances and covariances in determining
portfolio risk. *
45. Which of the following is not one of the assumptions of the Capital Market Theory?
a.
b.
c.
d.
All investors have the same one-period time horizon.
There are no personal income taxes.
There is no interest rate charged on borrowing. *
There are no transaction costs.
46. Select the INCORRECT statement regarding the CML.
a.
The CML is an equilibrium relationship for efficient portfolios and individual
securities. *
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b.
c.
d.
The CML represents the risk-return tradeoff in equilibrium for efficient portfolios.
The intercept of the CML is the reward per unit of time available to investors for
deferring consumption.
Standard deviation is the measure of risk which determines a portfolio's
equilibrium return.
47. If markets are truly efficient and in equilibrium
a.
b.
c.
d.
all securities would lie on the SML.
any security that plots below the SML would be considered undervalued.
any security that lies above the SML would be considered overvalued.
no security would lie on the SML..
48.The relative valuation measure that is most heavily utilized by market
participants today is:
a.
b.
c.
d.
P/E ratio. *
Price/book value ratio
Price/sales ratio
E/P ratio
49. The estimated value of common stock is the:
a.
b.
c.
d.
present value of all expected cash flows. *
present value of all capital gains.
future value of all dividend payments.
present value of all dividend payments.
50.What is the estimated value of a stock with a required rate of return of 12
percent, a projected constant growth rate of dividends of 7 percent and
expected dividend of $3.00
a.
b.
c.
d.
$12
$60
$150
$5
Solution:
P0
=
=
=
D1/(k – g)
3/(.12 - .07)
$60
51. Which of the following statements regarding intrinsic value and market
price is true?
a. If intrinsic value is greater than the current market price, the stock should be
avoided
or, if already held, sold.
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b.
If intrinsic value is less than the current market price, the stock is
undervalued.
c. If intrinsic value is equal to the current market price, the stock is correctly
valued. *
d. If the intrinsic value is greater than the current market price, the stock is
considered speculative.
52. Which of the following variables has an inverse relationship with the P/E
ratio?
a.
b.
c.
d.
payout ratio
expected growth rate of dividends
expected growth rate of earnings
required rate of return *
53. Brotech Unlimited sells at $40 per share, and its latest 12 month earnings were
$8 per share, of which $3.20 per share were paid as dividends.
(a)
(b)
(c)
What is Brotech's current P/E ratio?
If Brotech's earnings are expected to grow by 9 percent per year, what is
the projected price for next year assuming that the P/E ratio remains
constant?
If you had a required rate of return of 15 percent, expected the dividend
payout ratio to remain constant, and dividends to grow at a rate of 9
percent, would you buy this stock? Explain your answer.
Solution:
(a)
40/8
Current P/E = Current Price/Current earnings
=
5
=
(b)
=
E1 x P/E
=
$43.60
(c)
=
P0
=
$58.13
D1/(k - g)
P1
8(1.09) x 5
=
=
3.20(1.09)/(.15 - .09)
Yes, I would buy this stock since its intrinsic value of $58.13 is greater than its
current price of $40.
54. A fast growing company paid a dividend this year of $1.25, which is expected to
grow at 20% for two years. Afterwards, the growth rate will be 9%. If the required
is 12%, what is the value of this stock?
a. $41.67
b. $15.62
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c. $65.40
d. $54.91
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Solution: D1 = $1.25×1.20 = $1.50, D2= $1.50×1.20 = $1.80, D3 =
$1.25×1.202×1.09 = $1.962, then price in year 2 will be 1.962/(0.12-0.09)
= $65.40, so PV = 1.50/1.12 + (1.80+65.40)/1.122 = $54.91
55. Select the correct statement regarding the market portfolio. It:
a.
b.
c.
d.
is readily and precisely observable.
is a risky portfolio. *
is the lowest point of tangency between the risk-free rate and the efficient
frontier.
should be composed of stocks or bonds.
56. Select the INCORRECT statement regarding the CML.
a.
b.
c.
d.
The CML is an equilibrium relationship for efficient portfolios and individual
securities.*
The CML represents the risk-return tradeoff in equilibrium for efficient portfolios.
The intercept of the CML is the reward per unit of time available to investors for
deferring consumption.
Standard deviation is the measure of risk which determines a portfolio's
equilibrium return.
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