Deck 10: Equity Markets

Question 1

Systematic risk can be significantly reduced through diversification.

Answer 1

False

Question 2

Convertible preferred stock can be exchanged into common stock at a predetermined ratio.

Answer 2

True

Question 3

Among financial institutions, mutual funds are the largest holders of corporate equity securities.

Answer 3

True

Question 4

A stock which is expected to pay a $4 dividend next year, growing constantly at 6%, and is priced to yield a required return of 18% must be selling for $33.33.

Question 5

Limited liability of stockholders protects them from losses on their stock portfolio.

Question 6

Preferred stockholders have the same voting rights as common shareholders.

Question 7

At NYSE, limit orders are usually entered into the specialist's limit order book.

Question 8

Shelf registration permits a corporation to register several types of security issues and sell them at once.

Question 9

The New York Stock Exchange is an example of a secondary market.

Question 10

The secondary market for capital market securities is important because it provides funds directly to deficit spending units.

Question 11

Diversification attempts to lower or eliminate the unsystematic risk of a portfolio of securities.

Question 12

A market with breadth has a large number of diverse investors.

Question 13

The NASDAQ is a stock exchange.

Question 14

The underwriter's spread is inversely related to the size of the primary offering.

Question 15

The market rate of return on a $100 par value preferred stock, priced at $90, paying an $8.00 annual dividend, is 8 per cent.

Question 16

Primary capital market securities provide marketability and possibilities for investors to alter the riskiness of their portfolios.

Question 17

Stock with betas less than one tend to have more price variability than the market.

Question 18

The Dow Jones Industrial Average is a price-weighted index.

Question 19

A publicly traded company issuing additional shares of common stock does it through an IPO.

Question 20

A wide spread between the bid and ask quotes of a security dealer may represent weak operational market efficiency.

Question 21

The capital market is allocationally efficient if

A) funds are channeled to their most productive use.
B) market makers such as dealers and brokers are making reasonable, not excessive rates of return.
C)
C) only if informational and operational market efficiencies are high.
D) both a and

Question 22

In a board of directors election for five directors and straight voting, a majority group of shareholders will elect

A) four directors.
B) five directors.
C) four or five depending on how the cumulative voters vote.
D) the same proportional share of directors as their ownership share.

Question 23

The term shareholder equity means

A) a right to dividends.
B) a contractual relationship with a corporation.
C) an ownership claim.
D) a prior claim on income and assets.

Question 24

A shareholder in a troubled corporation is not likely to lose his/her

A) money invested in the stock.
B) house.
C) dividends declared.
D) par value.

Question 25

If the stock markets are semi-strong efficient, stock prices reflect all historic and current public information about a firm but prices do not reflect inside information.

Question 26

Which of the following is not associated with characteristics of common stock?

A) residual claim on income and assets
B) proxy
C) cumulative dividends
D) dual-class stock

Question 27

A stock purchased at $40 at the beginning of the year paid $10 in dividends and was sold for a net price of $42 at the end of the year. The total annual return is

A) 25%
B) 100%
C) 30%
D) 40%
E) 12%

Question 28

Security exchanges provide a valuable function in that they

A) create interest in stocks.
B) increase the marketability of securities.
C) provide a legal way to gamble.
D) supply money to deficit spending units.
E) both a and d

Question 29

Which of the following statements is not true?

A) Electronically linking equity dealers and exchange markets is slowly leading toward a national market system.
B) Electronically linking international markets has created 24-hour trading opportunities for some stocks.
C) U. S. stock exchanges have extended (after hours) their normal trading hours in which shares are traded electronically, linking U. S. with the hours of international markets.
D) All of the above statements are true.

Question 30

Investors with 30 per cent of the voting stock of a corporation, interested in a seat on the board of directors, had better have __________ voting privileges.

A) straight
B) cumulative
C) proxy
D) limited

Question 31

Which of the following terms is associated with secondary equity markets?

A) seasoned equity offering
B) initial public offering
C) underwriter's spread
D) bid-ask spread
E) shelf registration

Question 32

The sale of securities to the public via an investment banker by a new corporation raising funds is called

A) a seasoned offering.
B) a secondary offering.
C) an initial public offering.
D) a best efforts offering.

Question 33

A proxy is an absentee ballot that allows a representative to vote on behalf of the stockholder.

Question 34

Preferred stockholders have a claim junior to common stock but senior to bondholders.

Question 35

Which of the following is not true about American Depository Receipts (ADRs)?

A) ADRs are claims issued by U.S. financial intermediaries (FIs) against shares in foreign companies, with the shares held in custody by the FIs for investors.
B) ADRs are issued in the U.S. and are denominated in U.S. dollars. All cash flows to the investor are in dollars.
C) An ADR enhances a company's visibility, status and profile in the U.S. and internationally among investors.
D) An ADR decreases the foreign firm's U.S. liquidity (and potentially total global issuer liquidity).

Question 36

Equity capital can be raised through the money market and the NYSE bond market.

Question 37

Which of the following is not an example of capital market securities?

A) common stocks
B) convertible bonds
C) commercial paper
D) mortgages

Question 38

The household sector is the largest surplus sector and invests in the capital market

A) directly by purchasing stocks and bonds.
B) directly by issuing assets payable in the capital market.
C) indirectly through mutual funds and pension funds
D) both a and c

Question 39

Regulators provide a valuable function for the capital markets because they

A) try to keep the market participants honest.
B) try to prevent excessive speculation from destabilizing the market.
C) make sure all pertinent information about publicly traded securities is disclosed.
D) all of the above

Question 40

Which of the following terms is not associated with common stock?

A) contractual
B) residual
C) ownership
D) limited liability

Question 41

Which of the following is not a result of advances in technology and competition in equity markets?

A) higher transaction costs
B) the development of a national market system
C) 24-hour trading of some stocks
D) globalization of equity markets

Question 42

The percentage bid-ask spread for equity securities

A) is higher with higher priced stocks.
B) is large for very small and very large transactions.
C) is less for less than round lot trades.
D) all of the above.

Question 43

Which of the following statements is true about secondary markets?

A) A buyer may incur search costs and find a seller on their own through a direct search.
B) A broker may bring buyers and sellers together, charging a commission.
C) A dealer may sell and buy securities using his inventory, therefore reducing search costs. The dealer's return is the bid/ask spread.
D) An auction market allocates the selling shares to the highest bidder.
E) All of the above statements are true.

Question 44

Which of the four types of secondary markets listed below has low search costs, price risk, and the expense of a bid/ask spread?

A) direct search
B) brokered
C) dealer
D) auction

Question 45

The New York Stock Exchange is a(n) ________ market.

A) auction
B) exchange
C) secondary
D) all of the above

Question 46

Which of the following is not a reason for not listing a stock on an exchange?

A) limited trading in the stock
B) small issue size
C) having excellent support by NASD dealers
D) having a large number of public shareholders

Question 47

The over-the-counter market trades ______ stocks than exchanges, and exchanges tend to list ________ companies.

A) less; smaller
B) less; larger
C) more; larger
D) more; smaller

Question 48

The bid-ask spread for equity securities tends to be _______ for more frequently traded stocks and _______ for stocks which have more traders with inside information.

A) less; more
B) less; less
C) more; more
D) more; less

Question 49

The daily pink sheets of the OTC market were replaced

A) by the emerging dealer market.
B) by the brokers relaying information to their customers.
C) by the NASDAQ system.
D) when the NASD required that dealers be registered.

Question 50

The underwriter's spread (%) is

A) directly related to the size of the primary offering.
B) directly related to the riskiness of the issue.
C) greater when the shelf registration process is used.
D) smaller for stocks than for bonds.

Question 51

An order to the New York Stock Exchange to buy or sell at the best price available is called

A) a limit order.
B) a stop order.
C) a market order.
D) none of the above.

Question 52

Which of the following market participants functions in the primary equity markets?

A) broker
B) specialist
C) underwriter
D) dealer
E) none of the above

Question 53

Sampson Corporation, through its investment banker, First Ohio Securities, recently sold 200,000 shares of common stock to the public, grossing $7.4 million. Issuing expenses paid by Sampson totaled $200,000, and the underwriter's spread was $3 per share. How much net financing did Sampson Corporation raise in the deal?

A) $6.6 million
B) $7.2 million
C) $6.4 million
D) $7.0 million
E) $6.8 million

Question 54

Which of the four types of secondary markets listed below achieves economies of scale in search costs but does not guarantee that orders will be executed promptly?

A) direct search
B) brokered
C) dealer
D) auction

Question 55

In response to competition from foreign stock exchanges, U.S. stock exchanges have

A) shortened their trading hours to decrease the volatility of stock prices.
B) implemented after-hours discussion session between floor brokers and customers.
C) expanded electronic after-hour trading for stocks.
D) listed more stocks to compete with foreign stock exchanges.

Question 56

Which of the four types of secondary markets listed below minimizes price risk, but search costs are often high?

A) direct search
B) brokered
C) dealer
D) auction

Question 57

Which of the four types of secondary markets listed below involves considerable costs and no third party?

A) direct search
B) brokered
C) dealer
D) auction

Question 58

The NASDAQ system provides price input capability for

A) brokers.
B) dealers.
C) stock-trading customers of dealers.
D) the Securities and Exchange Commission.

Question 59

Which of the following is not one of three major sources of active bids and offerings in a stock issue at a stock trading post on an exchange?

A) floor brokers handling customer orders.
B) limit price orders held by floor brokers.
C) the specialists making trades for his/her own account.
D) the specialist executing limit price orders.

Question 60

Which of the following is not associated with the over-the-counter market for stocks?

A) NASDAQ
B) unlisted
C) auction market
D) dealer market

Question 61

Stocks with beta values of one

A) will have very predictable rates of return.
B) will have little risk compared to the market portfolio.
C) has had return variability similar to the market.
D) has had a constant rate of return.
E) both a and b

Question 62

Suppose MBI Co. recently paid $2 annual dividend. The company is projecting that its dividends will grow by 20 percent next year, 12 percent annually for the two years after that, and then at 6 percent annually. Based on this information, how much should the company's common stock sell for today if the required return is 10.5%?

A) $50.90
B) $59.22
C) $66.60
D) $77.50

Question 63

A stock currently trading at $50 expects to pay a $4.50 dividend this year. The dividends and stock price has been growing at 8% per year for 10 years. What is the expected total return on the stock this year?

A) 17%
B) 18%
C) 20%
D) 9%
E) 15%

Question 64

When constructing a stock market index, which two items are needed to start the index?

A) the starting date and an estimate of future prices.
B) the starting date and the base index value.
C) the starting and ending dates of the index.
D) 1,000 is the base value, combined with the starting date.

Question 65

The federal legislation that made the Securities and Exchange Commission responsible for the broad oversight of securities markets was

A) The Securities Act of 1933.
B) The Securities Exchange Act of 1934.
C) The Investment Company Act of 1940.
D) The National Securities Company Act of 1932.
E) none of the above.

Question 66

Which of the followings statements is correct?

A) The stock market does a poor job of predicting economic recessions.
B) The stock market does a good job of predicting economic recessions.
C) Economic recessions always precede poor stock market performance.
D) Positive stock market returns are not possible during economic recessions.

Question 67

The security market line shows

A) the amount of risk demanded for each unit of return.
B) the return for each level of risk.
C) the sum of the systematic and unsystematic risks.
D) the risk/return tradeoff over time.

Question 68

A stock just paid an annual dividend of $2. The dividends are expected to grow at 20% per year over each of the next three years and 5% per year thereafter. What is the value of the stock if the required rate of return is 12%?

A) $34.29
B) $36.49
C) $39.84
D) $43.80
E) $58.74

Question 69

What is the value of a stock expected to pay a constant $5 dividend each year forever, if the market required rate of return is 18%?

A) $90
B) $28
C) $36
D) $23

Question 70

Ace Corporation preferred stock pays an 8% dividend on a par value of $50 and is currently selling at $47.50. What is required rate of return on the stock?

A) 7.5%
B) 8%
C) 8.4%
D) 12.5%
E) 16%

Question 71

At the beginning of year one, the stock market index had a value of 225.4. Two years later the value was 298. What was the average annual rate of return on the index portfolio?

A) 28.6%
B) 30.0%
C) 36.3%
D) 15.0%
E) 14.3%

Question 72

What is the required rate of return on a stock if the risk-free rate is 7%, the return on the market portfolio is 15%, and the beta is 1.5?

A) 12 %
B) 19%
C) 22.5%
D) 29.5%
E) 33%

Question 73

Suppose Zina & Co. has an expected dividend next year of $5.6 per share, a growth rate of dividends of 10 percent, and a required return of 20%. The value of a share of common stock is.

A) $22.40
B) $28.00
C) $18.67
D) $56.00
ESSAY QUESTIONS

Question 74

The current dividend yield, which is the recent dividend divided by the current stock price, on common stock of Formosan Freedom Co. is 4.8 %. The company just paid a $2.10 dividend. The dividend will be $2.205 in next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on stock of Formosan Freedom Co.?

A) 10.04 percent
B) 16.07 percent
C) 21.88 percent
D) 43.75 percent

Question 75

The slope of the security market line is

A) the market risk premium.
B) beta
C) the risk-free rate
D) the return on the market portfolio.
E) none of the above

Question 76

Stocks XX, YY, and ZZ, initially priced at $35, $65, and $72, respectively, comprise a price-weighted index with a base value of 100. One year later the stocks above were valued at $40, $69, and $87, respectively. What was the value of the index at the end of year one?

A) 88
B) 100
C) 114
D) 124
E) 196

Question 77

What is the estimated value of a stock, which paid a $5 dividend this year, expects dividends to grow at 6 per cent, and requires a 20 per cent return?

A) $35.71
B) $37.86
C) $25.00
D) $20.38
E) $26.50

Question 78

The primary federal regulator of stock markets is

A) the Federal Reserve.
B) the Federal National Securities Corporation.
C) the National Association of Securities Dealers (NASD).
D) the Securities Investor Protection Corporation.
E) the Securities and Exchange Commission.

Question 79

If the risk-free rate is 7%, the return on the market portfolio is 15%, and the beta is 1.5, what is the value of the stock if the current dividend (D₀) is $1.20 and it is expected to grow at a constant rate of 6% per year?

A) $6.30
B) $6.70
C) $9.20
D) $9.80
E) $20.00

Question 80

Investors in well diversified stock portfolios are concerned about ________ risk.

A) specific stock
B) unsystematic
C) systematic
D) diversifiable