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Answer: TRUE
4) A temporary decline in earnings per share usually results in
a temporary reduction of dividends.
Answer: FALSE
5) A decline in earnings that investors expect to be temporary
may actually increase a firm's P/E ratio.
Answer: TRUE
6) The Merry Co. has current annual sales of $350,000 and a
net profit margin of 6%. Sales are expected to increase by 5%
annually while the profit margin is expected to remain
constant. What is the projected after-tax earnings for two years
from now?
A) $19,294
B) $22,050
C) $23,100
D) $23,153
Answer: D
7) P/E ratios could rise even as earnings fall if
A) earnings fall at a faster rate than stock prices.
B) earnings fall at a slower rate than stock prices.
C) investors expect lower stock prices to be permanent.
D) investors expect lower earnings to be permanent.
Answer: A
8) Even if a company does not officially follow a fixeddividend policy, dividend payments are
A) extremely difficult to predict.
B) very volatile and subject to economic conditions.
C) fairly stable from one time period to another.
D) directly tied to a company's P/E ratio.
Answer: C
9) Whisper numbers are
A) officially published forecast numbers provided by company
management.
B) the official released estimates prepared by financial
analysts.
C) generally less accurate than the released estimates by
analysts.
D) generally higher than the released analysts' forecasts.
Answer: D
Learning Outcome: F-09 Discuss the fundamentals of stocks
and how to value them
AACSB: 3 Analytic Skills
Question Status: Previous Edition
10) If the market multiple is 23.0 and the P/E ratio of a
company is 27.4, then the stock's relative P/E is
A) 0.84.
B) 1.19.
C) 3.21.
D) 4.40.
Answer: B
11) The current annual sales of Flower Bud, Inc. are $178,000.
Sales are expected to increase by 4% next year. The company
has a net profit margin of 5% which is expected to remain
constant for the next couple of years. There are 10,000 shares
of common stock outstanding. The market multiple is 16.4 and
the relative P/E of the firm is 1.21. What is the expected
market price per share of common stock for next year?
A) $15.18
B) $17.66
C) $18.37
D) $19.29
Answer: C
12) The major forces behind earnings per share are
A) return on assets and total asset value.
B) gross revenue and the stock price.
C) growth and the number of shares outstanding.
D) net income and the number of shares outstanding.
Answer: D
13) GLOO stock's P/E ratio is 45 at a time when the market's
P/E ratio is 15. GLOO's relative P/E ratio is
A) 30.
B) -30.
C) 3.
D) .33.
Answer: C
14) Which one of the following is a correct equation to
calculate earnings per share?
A) (ROA)(book value per share)
B) (profit margin)(total asset turnover)(equity multiplier)(book
value per share)
C) (profit margin)(equity multiplier)(book value per share)
D) (profit margin)(book value per share)
Answer: B
15) Which one of the following is is most likely to increase the
price of a stock?
A) rapid growth in sales.
B) rapid growth in dividends.
C) rapid growth in earnings.
D) rapid increases in bond interest rates.
Answer: C
16) Global Warning's EPS for the current year is $2.75 and its
current P/E ratio is 50. You have forecasted that EPS will
grow by 10% but the P/E ratio will fall to 40. What do you
expect the price of a share of GW's stock to be at the end of
next year?
A) $110
B) $121
C) $137.50
D) $151.25
Answer: B
17) Over the last year, a firm's earnings per share increased
from $1.20 to $1.40, its dividends per share increased from
$0.50 to $0.60, and its share price increased from $21 to $24.
The firm maintained a relative P/E of 1.10 over the entire time
period. Given this information, it follows that the
A) stock experienced an increase in its P/E ratio.
B) company had a decrease in its dividend payout ratio.
C) current P/E of the overall market is 26.4.
20) 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.
Answer: D
21) What is the required rate of return on a common stock that
is expected to pay a $0.75 annual dividend next year if
dividends are expected to grow at 2 percent annually and the
current stock price is $8.59?
A) 8.73%
B) 8.91%
C) 10.73%
D) 11.38%
Answer: C
22) The constant-growth dividend valuation model is best
suited for use with
A) stocks of new or emerging companies.
B) small-cap stocks within growing industries.
C) the stocks of mature, dividend-paying companies.
D) the stocks of cyclical companies.
Answer: C
23) When using the constant-growth dividend valuation
model, which of the following will lower the value of the
stock?
A) An increase in the required rate of return.
B) A decrease in the required rate of return.
C) An increase in the dividend payout ratio.
D) An increase in the growth rate of the dividends.
Answer: A
24) Newton, Inc. just paid an annual dividend of $0.95. Their
dividends are expected to increase by 4% annually. Newton
Company stock is selling for $11.54 a share. What is the
required rate of return on this stock implied by the dividendgrowth model?
A) 8.23%
B) 12.2%
C) 12.6%
D) 13.9%
Answer: C
25) The Frisco Company just paid $2.20 as its annual
dividend. The dividends have been increasing at a rate of 4%
annually and this trend is expected to continue. The stock is
currently selling for $63.60 a share. What is the rate of return
on this stock?
A) 3.46%
B) 3.60%
C) 7.46%
D) 7.60%
Answer: D
B) 10.25%.
C) 11.99%.
D) 13.85%.
Answer: C
18) Early in 2013, Mathew is analyzing shares of Janeff Corp.
He expects the following dividends per share (end of year).
2013
$1.00
2014
$1.25
2015
$1.50
He expects 2015 earnings per share to be $4.50 and Janeff's
P/E ratio to be 20. His required rate of return for this stock is
12%. He should pay no more than
A) $43.75 per share.
B) $67.02 per share.
C) $68.75 per share.
D) $93.75 per share.
Answer: B
19) Which of the following approaches to stock valuation is
NOT based on a multiple of some figure from the financial
statements?
A) the price to cash flow approach
B) the price to sales approach
C) the dividends-and-earnings approach
D) the price to earnings approach
Answer: C
20) The Highlight Company has a book value of $56.50 per
share, and is currently trading at a price of $59.00 per share.
You are interested in investing in Highlight, and have just used
a present-value based stock valuation model to calculate a
present (intrinsic) value of $55.00 per share for Highlight's
stock. Assuming that your calculations are correct you should
A) buy the stock, because the current market price per share is
higher than the present value.
B) buy the stock, because the book value per share is greater
than the present value.
C) not buy the stock, because the present value is less than the
market price per share.
D) buy the stock, because the book value and the current
trading price are very close to one another in value.
Answer: C
21) According to the price/earnings approach to stock
valuation, if the dividend growth rate is expected to drop or if
the required return goes up, the net effect is a
A) higher P/E ratio.
B) lower P/E ratio.
C) higher stock price.
D) higher retention rate.
Answer: B
8.6 Learning Goal 6
1) The constant growth dividend valuation model works best
for mature companies with a long record of paying dividends.
Answer: TRUE
2) The P/E approach is too complicated to be widely used in
practice.
Answer: FALSE
C) near bankruptcy.
D) undervalued.
Answer: D
Chapter 9 Market Efficiency and Behavioral Finance
13) The weak form of the efficient market theory contends that
A) past price performance is useless in predicting future price
movements.
B) past performance can help determine the general direction
of future price movements.
C) any publicly available information is useless in predicting
future price movements.
D) price movements are not random but follow a general trend
over a period of time.
Answer: A
profits.
B) abnormal profits are randomly distributed.
C) no one can consistently earn a profit.
D) no one can consistently earn abnormal profits.
Answer: D
market behavior.
B) suggests that random patterns appear but only over long
periods of time.
C) has been disproved based on recent computer simulations.
D) accounts for market anomalies such as calendar effects.
Answer: A
14) The tendency to hold onto losing stocks in the hope that
they will recoup is called
A) loss aversion.
B) representativeness.
C) narrow framing.
D) biased self-attribution.
Answer: A
15) Which of the following characteristics are referred to as
representativeness?
I. hesitating to sell stocks at a loss
II. basing conclusions on small samples
III. underestimating the effects of random chance
IV. underestimating the level of risk in an investment
A) I and IV only
B) II and III only
C) I, II and III only
D) I, II, III and IV only
Answer: B
16) Which of the following are common but dysfunctional
investor behaviors?
I. overinvesting in companies with familiar names
II. dividing their funds equally among available choices,
even if several of the choices serve the same
purpose
IV. hastily disposing of stocks that have dropped in price in
order to take advantage of tax breaks
IV. exaggerating the role of luck and randomness in
investment success or failure
A) I and IV only
B) II and III only
C) I, II and III only
D) I, II, III and IV only
Answer: C
17) People tend to
A) ignore information that contradicts their current beliefs.
B) overestimate the effects of random chance.
C) be underconfident in their judgment of investments.
D) look at the entire situation when analyzing an individual
security.
Answer: A
19) Investors who buy mutual funds that have had large gains
over the last few years are exhibiting a tendency known as
A) overconfidence.
B) narrow framing.
C) loss aversion.
D) representativeness.
Answer: D
20) Investors who obsessively monitor their last few stock
purchases while paying little attention to the rest of their
portfolio are exhibiting the tendency known as
A) overconfidence.
B) narrow framing.
C) loss aversion.
D) representativeness.
Answer: B
21) Which of the following accurately reflect appropriate
investment guidelines?
I. Always invest in last years best performing mutual fund.
II. Trade frequently to increase your investment returns.
III. Sell losing stocks unless you are willing to buy them at
the current price.
IV. Take corrective action when so indicated.
A) I and II only
B) III and IV only
C) I, III and IV only
D) I, II, III and IV
Answer: B
22) Which of the following statements correctly present
recommendations based on behavioral finance?
I. Don't hesitate to sell a losing stock.
II. Trade frequently.
III. Chase performance.
IV. Be humble and open-minded.
A) I and II only
B) I and IV only
C) II and III only
D) III and IV only
Answer: B
23) Evidence suggests that the price of a stock continues to
move up or down for a period of
A) a decade or more.
B) 3 to 5 years.
C) 1 to 3 years.
D) 6 to 12 months.
Answer: D
24) Market bubbles such as the technology bubble of the
1990s and the housing bubble of 2004-2007 are best explained
by
A) the efficient market hypothesis.
B) behavioral finance and economics.
C) rational expectations theory.
D) anomaly theory.
Answer: B
9.4 Learning Goal 4
1) Recent academic studies in behavioral finance confirm that
markets are even more efficient than previously believed.
Answer: FALSE
2) The efficient market hypothesis has some trouble
explaining the existence of market anomalies.
Answer: TRUE
3) Evidence suggests that growth stocks tend to outperform
value stocks.
Answer: FALSE
Answer: TRUE
6) Market volume is a function of market demand for and
supply of stocks.
Answer: TRUE
7) The breadth of the market refers to the spread between the
number of stocks advancing and those declining in value.
Answer: TRUE
8) A relatively high level of short sells is an indicator of a
current bull market.
Answer: FALSE
9) The odd-lot theory supports buying into the market when
the number of odd-lot trades rises.
Answer: FALSE
10) Technical analysis is a mechanical approach to investing.
Answer: TRUE
11) You are most likely better off doing the opposite of what
most investment newsletter experts advise doing.
Answer: TRUE
12) An oversold market is generally considered to be
overvalued.
Answer: FALSE
13) Technical analysis primarily monitors shifts in the
________ in the market.
A) level of risk
B) supply and demand forces
C) volume of trading
D) rate of return
Answer: B
14) Which of the following are included in technical analysis?
I. charting price movements
II. tracking trading volume
III. determining the investor's risk tolerance
IV. monitoring odd-lot trading
A) I and II only
B) II and III only
C) I, II and III.
D) I, II and IV
Answer: D
15) Technical analysis is used for which of the following
purposes?
I. deciding when to enter the market
II. deciding whether to sell a stock
III. deciding which stocks to buy
IV. deciding whether basic economic conditions are favorable
for investing
A) I and II only
B) II and III only
C) I, II and III only
D) I, II, III and IV
Answer: C
B) to fall in tandem.
C) to move in opposite directions.
D) to become less volatile.
Answer: C
12) Which of the following types of risk affect bonds?
I. call risk
II. business risk
III. purchasing power risk
IV. liquidity risk
A) III and IV only
B) II, III and IV only
C) I, III and IV only
D) I, II, III and IV
Answer: D
13) 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 than issued over a given period of
time.
Answer: B
14) Under normal economic conditions, the major source of
risk faced by investors who purchase investment grade bonds
is
A) purchasing power risk.
B) interest rate risk.
C) liquidity risk.
D) default risk.
Answer: B
15) In a severe recession, the major source of risk faced by
investors who purchase corporate bonds is
A) purchasing power risk.
B) interest rate risk.
C) liquidity risk.
D) default risk.
Answer: D
16) When interest rates are falling, most of the return on bonds
will come from
A) inflation gains.
B) interest income.
C) capital gains.
D) risk premiums.
Answer: C
17) Which type of risk is based on the financial integrity of a
bond issuer?
A) liquidity risk
B) call risk
C) default risk
D) interest rate risk
Answer: C
10.2 Learning Goal 2
1) Each interest payment on a 6%, semi-annual bond is $60.
Answer: FALSE
Answer: D
C) a premium.
D) a discount.
Answer: D
16) Which one of the following combination of features
causes bond prices to be the most volatile?
A) low coupon, short maturity
B) high coupon, short maturity
C) low coupon, long maturity
D) high coupon, long maturity
Answer: C
17) Bob expects to retire in a few years and his primary goal is
to avoid major losses in his 401-K account. Which of the
following bond characteristics should he be seeking?
I. long maturities
II. high ratings
III high yields
IV. short maturities
A) I and III only.
B) I, III and III only
C) II and IV only
D) II, III and IV only.
Answer: C
18) If you expect market interest rates to rise, you should
purchase
A) short term, low coupon bonds.
B) short term, high coupon bonds.
C) long term, low coupon bonds.
D) long term, high coupon bonds.
Answer: B
19) A bond quoted at a price of 101.2
A) is a deep discount bond.
B) yields 10.12%.
C) yields 12%.
D) has a coupon rate that exceeds the market rate.
Answer: D
10.4 Learning Goal 4
1) A debenture is secured only by the issuer's promise to repay
the debt.
Answer: TRUE
2) The par value of a Treasury inflation-indexed obligation is
established as $1,000 over the life of the bond.
Answer: FALSE
3) In an inflationary environment, the interest payments on
Treasury inflation-indexed obligations increase over time.
Answer: TRUE
4) If the inflation rate is 2%, the principal of a Treasury
inflation protection security will from $1,000 to $1,020.
Answer: TRUE
5) If you hold a zero-coupon bond to maturity, the fully
compounded rate of return is virtually guaranteed to be equal
to the rate stated at the time the bond was purchased.
Answer: TRUE
6) Zero coupon bonds have very limited price volatility.
Answer: FALSE
7) Municipal bonds are most attractive to residents of states
with high income tax rates.
Answer: TRUE
8) Mortgage-backed bonds are issued primarily by state
governments and are secured by home mortgages.
Answer: FALSE
9) Mortgage-backed securities are self-liquidating.
Answer: TRUE
10) Collateralized mortgage obligations are relatively low risk
investments.
Answer: FALSE
11) Junk bond prices tend to be volatile just like common
stock prices.
Answer: TRUE
12) The various CMO tranches can have significantly different
degrees of prepayment risk.
Answer: TRUE
13) CMO tranches are structured to create long, intermediate
and short-term securities.
Answer: TRUE
14) Which one of the following statements concerning
Treasury bonds is correct?
A) The coupon rate of a TIPS is adjusted periodically in
response to changes in the rate of inflation.
B) Treasury bonds have maturity dates ranging from two to
ten years.
C) Interest earned on Treasury bonds is tax-exempt at the
federal level.
D) All Treasury securities are backed by the "full faith and
credit" of the U.S. government.
Answer: D
15) Which of the following statements about U.S. Treasury
bonds are true?
I. They are backed by the "full faith and credit" of the U.S.
government.
II. They are all indexed and adjusted for inflation.
III. They trade in a very thin market.
IV. They are traded in both U.S. and foreign markets.
A) I, II and IV only
B) I, III and IV only
C) II and III only
D) I and IV only
Answer: D
16) Debt securities issued by the Federal Home Loan Bank,
the Student Loan Marketing Association and the Government
National Mortgage Association are known as
A) agency bonds.
B) organizational bonds.
C) municipal bonds.
D) Treasury bonds.
Answer: A
17) Which of the following statements concerning mortgage
backed securities are correct?
I. They are secured by a pool of residential mortgages.
II. A portion of the income stream is a non-taxable return of
capital.
III. They are backed by the full faith and credit of the U.S.
government.
IV. Their maturity depends on prepayments of the mortgages
in the pool.
A) I and III only
B) I and IV only
C) II, III and IV only
D) I, II and IV only
Answer: D
Answer: FALSE
5) An American investor who holds euro-denominated bonds
will profit if the euro weakens against the dollar.
Answer: FALSE
6) One type of foreign bond that carries no currency exchange
rate risk for a U.S. investor is a
A) Eurodollar bond.
B) foreign-pay bond.
C) PIK bond.
D) Yankee bond.
Answer: D
7) Which one of the following statements concerning a global
view of the bond market is correct?
A) The United States today accounts for about seventy-five
percent of the available fixed-income securities worldwide.
B) U.S. pay bonds distribute both interest and principal
payments in euros.
C) Foreign bonds, like junk bonds, have high default risk.
D) Exchange rate fluctuations influence the returns earned on
foreign-pay bond holdings.
Answer: D
8) A type of bond that is issued and traded outside the United
States and which is denominated in U.S. dollars but is not
registered with the SEC is
A) a Yankee bond.
B) an issue of the World Bank.
C) an issue of the InterAmerican Bank.
D) a Eurodollar bond.
Answer: D
9) Which of the following statements are correct concerning
Eurodollar bonds?
I. Initial offerings of Eurodollar bonds are sold in U.S. bond
markets.
II. Eurodollar bonds are denominated in dollars.
III. The Eurodollar market is dominated by foreign-based
investors.
IV. Eurodollar bonds originate outside the United States.
A) II and III only
B) I and IV only
C) II, III and IV only
D) I, II and IV only
Answer: C
10) Eurodollar bonds are
A) purchased with dollars but redeemed in euros.
B) purchased with euros but redeemed in dollars.
C) purchased with dollars, but redeemable in either euros or
dollars.
D) purchased and redeemed in dollars but issued by entities
outside the U.S.
Answer: D
11) In general, foreign-pay bonds provide ________ rates of
return and ________ diversification effects for U.S. investors.
A) non-competitive; positive
B) competitive; positive
C) non-competitive; negative
D) competitive; negative
Answer: B
10.6 Learning Goal 6
1) When the call price of a convertible bond stock exceeds the
conversion value of the bond, the issuing company is likely to
force conversion by calling the bonds.
Answer: FALSE
2) The coupon rate on convertible bonds is usually higher than
the coupon rate on equivalent bonds that are not convertible.
Answer: FALSE
3) The conversion ratio denotes the number of shares for
which a convertible bond can be exchanged.
Answer: TRUE
4) Convertible bonds will retain their value as bonds even if
stock prices are falling.
Answer: TRUE
5) LYON's or liquid yield option notes are a type of
convertible security.
Answer: TRUE
6) When convertible bonds are first issued:
I. the conversion price of the stock is higher than the market
price.
II. the market price of the stock is higher than the conversion
price.
III. the coupon rate is higher than if the bond were not
convertible.
IV. the coupon rate is lower than if the bond were not
convertible.
A) I and III only
B) II and IV only
C) I and IV only
D) II and III only
Answer: C
7) Which of the following is most likely to happen with a
convertible bond when the market price of the stock exceeds
the conversion price. The stock does not pay a dividend.
A) The bondholders will immediately convert their bonds to
stock.
B) The issuing company will call the bonds and the
bondholders will redeem them for the call price.
C) The issuing company will call the bonds and bondholders
will convert them to common shares.
D) Both the issuing company and the bondholders will wait
for the bonds to reach their maturity date.
Answer: C
8) Bonhomme Co. issued $1,000 par value bonds with a 6%
coupon rate, convertible into 25 share of Bonhomme common
stock. When the bonds were issued the stock traded at $25 per
share. The stock is now at $42 per share and pays a $0.10 per
share annual dividend. In the near future
A) the bondholders will voluntarily convert their bonds to
stock.
B) The issuing company will call the bonds and the
bondholders will redeem them for the call price (par).
C) The issuing company will call the bonds and bondholders
will convert them to common shares.
D) Both the issuing company and the bondholders will wait
for the bonds to reach their maturity date.
Answer: C
9) When convertible bonds are first issued
I. the conversion price of the stock is higher than the market
price.
II. the market price of the stock is higher than the conversion
price.
III. the coupon rate is higher than if the bond were not
convertible.
IV. the coupon rate is lower than if the bond were not
convertible.
A) I and III only
B) II and IV only
C) I and IV only
D) II and III only
Answer: C