Multiple Choice (1 Point each) One of the basic premises of security analysis,

| June 10, 2016

Multiple Choice (1 Point each)

1. One of the basic premises of security analysis, and in particular fundamental analysis, is that

A) a stock’s price is based on its past cash flows, rather than on

anticipated future cash flows.

B) market sectors do not move in concert with business cycles.

C) all securities have an intrinsic value, but some securities may be

incorrectly priced in the market at any given time.

D) a security’s risk has relatively little effect on the security’s return.

2. Increases in interest rates and increases in taxes both tend to

A) have an expansionary impact on the economy.

B) have a contractionary impact on the economy.

C) signal the beginning of a bull market.

D) signal the trough of a recessionary market.

3. The risk-free rate of return is 5.5 percent, the expected market return is 11 percent, and the beta for Lea, Inc. is 0.85. What is Lea’s required rate of return?

A) 4.7 percent

B) 10.2 percent

C) 14.9 percent

D) 15.7 percent

4. Intrinsic value is based on which of the following factors?

I the applied discount rate

II. the amount of risk inherent in a particular stock.

III. historical net profits of the company

IV. estimated future cash flows of the company

A) II and IV only

B) I, II and III only

C) I, II and IV only

D) I,II,III and IV

5. Followers of the random walk hypothesis believe that

A) security analysis is the best tool to utilize when investing in the stock


B) the price movements of stocks are unpredictable, and therefore security

analysis will not help to predict future market behavior.

C) the price movements of stocks follow a “flag” formation, and charting this

formation can help an investor time his or her purchases in the stock


D) support levels and resistance lines, when combined with basic chart

formations, yield buy and sell signals.

6. One widely followed measure of the business cycle represents the market value of all goods and services produced in a country over the period of a year. This measure is the

A) industrial production index.

B) money supply.

C) gross domestic product.

D) productivity average.

7. The Federal Reserve through monetary policy can help expand the economy by

A) lowering income taxes on individuals.

B) increasing foreign exports by reducing tariffs.

C) supporting a moderate growth of the money supply.

D) increasing regulation on banks

8. When investors say that the market is efficient, they mean that

A) the closing prices of all stocks can be found quickly and easily in The

Wall Street Journal and in most daily newspapers.

B) the business cycles that underlie stock fluctuations occur in a

somewhat predictable fashion.

C) industrial production, and overall productivity in the economy, is

growing at a constant pace.

D) securities consistently trade at prices very close to their intrinsic


9. At the end of year X, the Petersen Company’s stock is expected to have an EPS of $2.50, a payout ratio of 0.55, and a P/E ratio of 18. Based on this information, the estimated share price of Petersen at the end of year X is

A) $9.90.

B) $12.80.

C) $24.75.

D) $45.00.

10. The risk-free rate of return is 5.5 percent, the expected market return is 11 percent, and the beta for Lea, Inc. is 0.85. What is Lea’s required rate of return?

A) 4.7 percent

B) 10.2 percent

C) 14.9 percent

D) 15.7 percent

11. The single most important issue in the stock valuation process is a company’s

A) past earnings record.

B) historic dividend growth rate.

C) future cash flow.

D) capital structure.

12. For the purpose of security analysis, which one of the following statements concerning a

firm’s successful past performance is correct?

A) It means the firm’s future performance will also be successful.

B) It provides a basis for having greater confidence in management’s

future performance.

C) It means the firm will experience problems in the future.

D) It provides no useful information concerning the firm’s future


13. One stock valuation model holds that the value of a share of stock is a function of its future dividends, and that the dividends will increase at an annual rate which will remain unchanged over time. This stock valuation model is known as the

A) approximate yield model.

B) holding period return model.

C) dividend reinvestment model.

D) constant growth dividend valuation model.

14. An internal rate of return (IRR) is the discount rate that

A) represents the minimal rate that an individual investor will accept.

B) is the minimal rate that a buy-and-hold investor will accept.

C) produces a future value equal to or greater than an investor’s required

rate of return.

D) produces a present value of future benefits equal to the market price of

a stock

15. In the price/earnings approach to stock valuation,

A) historical stock prices are utilized.

B) forecasted EPS are typically used.

C) the P/E ratio is computed by multiplying the stock price by the earnings

per share.

D) professional stock analysts recommend stocks based on their past


16. The system of analysis which emphasizes studying the stock market itself and the forces at work in the marketplace is called

A) fundamental analysis.

B) security analysis.

C) industry analysis.

D) technical analysis.

17. As an investment vehicle, bonds can provide income in the form of

A) current income only.

B) capital gains only.

C) both current income and capital gains.

D) neither current income nor capital gains.

18. The single most important force in the bond market is

A) the rate of inflation.

B) the movement of the stock market.

C) the real rate of return.

D) the behavior of interest rates.

19. In general, the bond market is considered bearish when

A) market interest rates are low or falling.

B) market interest rates are high or rising.

C) the risk-free rate of return exceeds the required rate of return.

D) more bonds are called in a particular period than are issued.

20. Which one of the following correctly describes the effect of a decline in interest rates on bond prices?

A) The prices of existing bonds are not affected.

B) The prices of existing bonds fall.

C) The prices of existing bonds rise.

D) The prices of newly issued bonds are lowered.

21. Which one of the following economic conditions helps create capital gains on

outstanding bonds?

A) falling interest rates

B) rising inflation rates

C) rising supply of bonds

D) declining demand for bonds

22. How often do bonds typically pay interest?

A) monthly

B) quarterly

C) semi-annually

D) annually

23. The major source of risk faced by investors who purchase bonds is

A) purchasing power risk.

B) interest rate risk.

C) liquidity risk.

D) event risk.

24. The call feature of a bond stipulates

A) the coupon rate and the maturity date of the bond.

B) the bond’s degree of default risk and the collateral used to guarantee the


C) the terms under which the bond can be retired prior to maturity.

D) whether the bond trades in a thin market or a broad market.

25. One of the major problems associated with mortgage-backed securities is that

A) the principal portion of each payment is considered taxable income.

B) they are refundable.

C) they are self-liquidating.

D) they are serial issues.

26. The required return on bonds can be equated to

A) the real rate of return plus a risk premium plus an expected inflation


B) the real rate of return plus the coupon interest rate plus the current

inflation rate.

C) the risk-free rate plus the real rate of return plus an expected inflation


D) an expected inflation premium minus the real rate plus the risk-free rate.

27. The yield curve depicts the relationship between a bond’s yield to maturity and its

A) duration.

B) term to call.

C) term to maturity.

D) volatility.

28. A $1,000 par value, 10-year bond carries a coupon rate of 9 percent. If the current yield of this bond is 8 percent, its market price would be

A) $1,000

B) $1,080

C) $1,067

D) $1,250

29. The mathematical link between bond price and interest rate changes is

A) Macaulay duration

B) modified duration

C) yield to market

D) weighted average yield

30. One basis point equals

A) 10 percent

B) 1 percent

C) 1/10 of 1 percent

D) 1/100 of 1 percent

(20 Points)

You are an analyst at Dewey, Cheatum, and Howe. The director of research presents the following free cash flow data for ABC Corp (in millions of $).

Year Cash Flow

2006 1250

2007 1300

2008 1600

2009 1700

2010 1800

He asks you to please calculate the:

Geometric Total Return

Geometric Annualized Return

Then, the director asks you to make a 10 year forecast based upon the geometric annualized return.

Next, he asks you to value the company’s shares based on your 10 year forecast and the following assumptions.

Current weighted average cost of capital: 12.7%.

Terminal Growth Rate: 3%

Terminal Cost of Capital: 14%

Shares outstanding: 550 million

Shares of ABC are trading at $35 per share. Do you recommend a buy or a sell rating?

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