Deck 11: Stock Valuation and Risk

Question 1

The PE method to stock valuation may result in an inaccurate valuation for a firm if errors are made in forecasting the firm's future earnings or in choosing the industry composite used to derive the PE ratio.

Answer 1

True

Question 2

If security prices fully reflect all market-related information (such as historical price patterns)but do not fully reflect all other public information, security markets are

A)weak-form efficient.
B)semistrong-form efficient.
C)strong-form efficient.
D)semistrong-form efficient AND strong-form efficient.
E)None of these are correct.

Answer 2

A

Question 3

The expected acquisition of a firm typically results in ____ in the target's stock price.

A)an increase
B)a decrease
C)no change
D)None of these are correct.

Answer 3

A

Question 4

The limitations of the dividend discount model are more pronounced when valuing stocks

A)that pay most of their earnings as dividends.
B)that retain most of their earnings.
C)that have a long history of dividends.
D)that have constant earnings growth

Question 5

The ____ is commonly used as a proxy for the risk-free rate in the capital asset pricing model.

A)Treasury bond rate
B)prime rate
C)discount rate
D)federal funds rate

Question 6

A stock's average return is 11 percent. The average risk-free rate is 9 percent. The stock's beta is 1, and the standard deviation of its returns is 10 percent. What is the Sharpe index?

A).05
B).5
C).1
D).02
E).2

Question 7

The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock's beta.

A)Sharpe
B)Treynor
C)arbitrage
D)margin

Question 8

When evaluating stock performance, ____ measures variability that is systematically related to market returns; ____ measures total variability of a stock's returns.

A)beta; standard deviation
B)standard deviation; beta
C)intercept; beta
D)beta; error term

Question 9

Bolwork Inc. is expected to pay a dividend of $5 per share next year. Bolwork's dividends are expected to grow by 3 percent annually. The required rate of return for Bolwork stock is 15 percent. Based on the dividend discount model, a fair value for Bolwork stock is $____ per share.

A)33.33
B)166.67
C)41.67
D)60.00

Question 10

A weak dollar may enhance the value of a U.S. firm whose sales are dependent on the U.S. economy.

Question 11

A beta of 1.8 implies that the stock has a risk premium of 1.8 percent.

Question 12

The ____ index uses the standard deviation of a stock's return to measure the stock's risk-adjusted performance.

A)Sharpe
B)Treynor
C)arbitrage
D)margin

Question 13

A stock's average return is 10 percent. The average risk-free rate is 7 percent. The standard deviation of the stock's return is 4 percent, and the stock's beta is 1.5. What is the Treynor index for the stock?

A).03
B).75
C)1.33
D).02
E)50

Question 14

The January effect refers to the ____ pressure on ____ stocks in January of every year.

A)downward; large
B)upward; large
C)downward; small
D)upward; small

Question 15

Stock price volatility increased during the credit crisis.

Question 16

Vansel Inc. retains most of its earnings. The company currently has earnings per share of $11. Vansel expects its earnings to grow at a constant rate of 2 percent per year. Furthermore, the average PE ratio of all other firms in Vansel's industry is 12. Vansel is expected to pay dividends per share of $3.50 during each of the next three years. If investors require a 10 percent rate of return on Vansel stock, a fair price for Vansel stock today is $____.

A)113.95
B)111.32
C)105.25
D)130.72

Question 17

The Sharpe index measures the

A)average return on a stock.
B)variability of stock returns per unit of return.
C)stock's beta adjusted for risk.
D)excess return above the risk-free rate per unit of risk.

Question 18

Stock prices of U.S. firms primarily involved in exporting are likely to be ____ affected by a weak dollar and ____ affected by a strong dollar.

A)favorably; adversely
B)adversely; adversely
C)favorably; favorably
D)adversely; favorably

Question 19

The price-earnings valuation method applies the ____ price-earnings ratio to the ____ earnings per share in order to value the firm's stock.

A)firm's; industry
B)firm's; firm's
C)average industry; industry
D)average industry; firm's

Question 20

If security markets are semistrong-form efficient, investors cannot solely use ____ to earn excess returns.

A)previous price movements
B)insider information
C)publicly available information
D)previous price movements AND publicly available information

Question 21

According to the text, other things being equal, stock prices of U.S. firms primarily involved in exporting could be ____ affected by a weak dollar. Stock prices of U.S. importing firms could be ____ affected by a weak dollar.

A)adversely; favorably
B)favorably; adversely
C)favorably; favorably
D)adversely; adversely

Question 22

A stock's beta can be measured from the estimate of the ________ using regression analysis.

A)intercept
B)market return
C)risk-free rate
D)slope coefficient

Question 23

The "January effect" refers to a large

A)rise in the price of small stocks in January.
B)decline in the price of small stocks in January.
C)decline in the price of large stocks in January.
D)rise in the price of large stocks in January.

Question 24

A higher beta for an asset reflects

A)lower risk.
B)lower covariance between the asset's returns and market returns.
C)higher covariance between the asset's returns and the market returns.
D)None of these are correct.

Question 25

Zilo stock has an average return minus the average risk-free rate of 5 percent, a beta of 1, and a standard deviation of returns of 20 percent. The Sharpe index of Zilo stock is

A)0.05.
B)0.35.
C)0.25.
D)0.45.
E)None of these are correct.

Question 26

Sorvino Company is expected to offer a dividend of $3.20 per share per year forever. The required rate of return on Sorvino stock is 13 percent. Thus, the price of a share of Sorvino stock, according to the dividend discount model, is $____.

A)4.06
B)4.16
C)40.63
D)24.62
E)None of these are correct.

Question 27

Kandle Company paid a dividend of $4.76 per share this year and plans to pay a dividend of $5 per share next year, which is expected to increase by 3 percent per year subsequently. The required rate of return is 15 percent. The value of Kandle stock, according to the dividend discount model, is $____.

A)39.67
B)41.67
C)33.33
D)31.73
E)None of these are correct.

Question 28

Morgan stock has an average return minus the average risk-free rate of 12.5 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Treynor index of Morgan stock is

A)0.0625.
B)0.05.
C)0.35.
D)0.03.
E)None of these are correct.

Question 29

If the returns of two stocks are perfectly correlated, then

A)their betas should each equal 1.0.
B)the sum of their betas should equal 1.0.
C)their correlation coefficient should equal 1.0.
D)their portfolio standard deviation should equal 1.0.

Question 30

Technical analysis relies on the use of ____ to make investment decisions.

A)interest rates
B)inflationary expectations
C)industry conditions
D)recent stock price trends

Question 31

Boris stock has an average return of 15 percent. Its beta is 1.5. Its standard deviation of returns is 25 percent. The average risk-free rate is 6 percent. The Sharpe index for Boris stock is

A)0.35.
B)0.36.
C)0.45.
D)0.28.
E)None of these are correct.

Question 32

The standard deviation of a stock's returns is used to measure the stock's

A)volatility.
B)beta.
C)Treynor index.
D)risk-free rate.

Question 33

The demand by foreign investors for the stock of a U.S. firm sold on a U.S. exchange may be higher when the dollar is expected to ____, other things being equal. (Assume the firm's operations are unaffected by the value of the dollar.)

A)strengthen
B)weaken
C)stabilize
D)weaken and then stabilize

Question 34

Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as Tarzak is 15. Tarzak is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzak requires a return of 12 percent. The estimated stock price of Tarzak today should be ____ using the adjusted dividend discount model.

A)$116.41
B)$104.91
C)$161.15
D)$128.64

Question 35

A beta of 1.1 means that for a given 1 percent change in the value of the market, the _______ is expected to change by 1.1 percent in the same direction.

A)risk-free rate
B)stock's value
C)stock's standard deviation
D)correlation coefficient

Question 36

The beta of a stock portfolio is equal to a weighted average of the

A)betas of stocks in the portfolio.
B)betas of stocks in the portfolio, plus their correlation coefficients.
C)standard deviations of stocks in the portfolio.
D)correlation coefficients between stocks in the portfolio.

Question 37

According to the capital asset pricing model, the required return by investors on a security is

A)inversely related to the risk-free rate.
B)inversely related to the firm's beta.
C)inversely related to the market return.
D)None of these are correct.

Question 38

LeBlanc Inc. currently has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as LeBlanc Inc. is 15. LeBlanc is expected to pay a dividend of $3 per share over the next four years, and an investor in LeBlanc requires a return of 12 percent. What is the forecasted stock price of LeBlanc in four years, using the adjusted dividend discount model?

A)$150.00
B)$163.91
C)$45.00
D)$168.83
E)None of these are correct.

Question 39

The capital asset pricing model (CAPM)suggests that the required rate of return on a stock is directly influenced by the stock's

A)prevailing level of industry competition.
B)beta.
C)liquidity.
D)size (market capitalization).

Question 40

The ____ is often used to estimate the required rate of return for any firm with public traded stock.

A)capital asset pricing model
B)Treynor index
C)Sharpe index
D)Treynor index AND Sharpe index

Question 41

The dividend discount model states that the price of a stock should reflect the present value of the stock's future dividends.

Question 42

Which of the following is NOT  commonly used as an estimate of a stock's volatility?

A)an estimate of its standard deviation of returns over a recent period
B)a time-series trend of historical standard deviations of returns over recent periods
C)the implied volatility derived from the stock option pricing model
D)an estimate of its option premium derived from the stock option pricing model

Question 43

A stock has a standard deviation of daily returns of 3 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock's expected daily return is .1 percent. The lower boundary is

A)- 1.65 percent.
B)- 3.00 percent
C)- 4.85 percent.
D)- 5.05 percent.

Question 44

A stock portfolio has more volatility when its individual stock returns are uncorrelated.

Question 45

If investors agree on a firm's forecasted earnings, they will derive the same value for that firm using the PE method to value the firm's stock.

Question 46

A relatively simple method of valuing a stock is to apply the mean price-earnings (PE)ratio of all publicly traded competitors in the respective industry to the firm's expected earnings for the year.

Question 47

The capital asset pricing model (CAPM)is based on the premise that the only important risk of a firm is unsystematic risk.

Question 48

If an investor has a $50,000 investment in a stock and has used beta to measure the maximum daily percentage loss as −5 percent, the maximum daily loss in dollars would be $10,000.

Question 49

Value at risk estimates the ____ a particular investment for a specified confidence level.

A)beta of
B)risk-free rate of
C)largest expected loss to
D)standard deviation of

Question 50

The dividend discount model can be adapted to assess the value of any firm, even those that retain most or all of their earnings.

Question 51

The main source of uncertainty in computing the return of a stock is the dividend to be received next year.

Question 52

When there is a sharp decline in the CBOE Volatility Index (VIX), stock prices also tend to decline.

Question 53

The credit crisis caused major problems in the mortgage market but had no impact on the stock market.

Question 54

While the previous year's earnings are often used as a base for forecasting future earnings, the recent year's earnings do not always provide an accurate forecast of the future.

Question 55

A firm's stock price is affected not only by macroeconomic and market conditions but also by firm-specific conditions .

Question 56

A stock with a beta of 2.3 means that for every 1 percent change in the market overall, the stock tends to change by 2.3 percent in the same direction.

Question 57

A stock has a standard deviation of daily returns of 1 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock's expected daily return is .2 percent. The lower boundary is

A)- 1.45 percent.
B)- 1.85 percent
C)0 percent.
D)- 1.65 percent.

Question 58

For firms that do not pay dividends, the free cash flow model may be more suitable than the dividend discount model.

Question 59

The prime rate is commonly used as a proxy for the risk-free rate in the capital asset pricing model (CAPM).

Question 60

When a firm's announced earnings are lower than expected, investors will increase their valuation of the firm's future cash flows and its stock.

Question 61

Regarding the value-at-risk method, the same methods used to derive the maximum expected loss of one stock can be applied to derive the maximum expected loss of a stock portfolio for a given confidence level.

Question 62

Portfolio managers who monitor systematic risk rather than total risk are more concerned about stock volatility than about beta.

Question 63

Beta serves as a measure of risk because it can be used to derive a probability distribution of returns based on a set of market returns.

Question 64

Steam Corp. has a beta of 1.5. The prevailing risk-free rate is 5 percent, and the annual market return in recent years has been 11 percent. Based on this information, the required rate of return on Steam Corp. stock is ____ percent.

A)21.5
B)6.5
C)16.5
D)14.0
E)None of these are correct.

Question 65

Investors can avoid unsystematic risk by

A)using the capital asset pricing model.
B)investing in stocks with low PE ratios.
C)holding diversified portfolios.
D)using the free cash flow model.

Question 66

____ are not a firm-specific factor that affect stock prices.

A)Exchange rates
B)Dividend policy changes
C)Acquisitions
D)Earnings surprises
E)All of these are firm-specific factors that affect stock prices.

Question 67

Which of the following is NOT a limitation of the PE method of valuing stocks?

A)Stock buybacks can distort a firm's earnings.
B)Using previous earnings may not be useful for a firm that is restructuring.
C)The earnings of firms in a cyclical industry may vary dramatically depending on whether the economy is strong or weak.
D)Creative accounting may distort a firm's reported earnings.
E)All of the above are limitations of the PE method.

Question 68

A portfolio's beta is the sum of the individual forecasted betas, weighted by the market value of each stock.

Question 69

The ____ is not a factor used in the capital asset pricing model (CAPM)to derive the return of an asset.

A)prevailing risk-free rate
B)dividend growth rate
C)market return
D)covariance between the asset's return and the market return
E)All of these are factors used in the CAPM.

Question 70

Fabrizio, Inc. is expected to generate earnings of $1.50 per share this year. If the mean price-earnings ratio of competitors in the same industry is 20, then the valuation of Fabrizio's shares is $____.

A)13.33
B)3.00
C)20.00
D)30.00
E)None of these are correct.

Question 71

The value-at-risk method is intended to warn investors about the potential maximum loss that could occur.

Question 72

The U.S. government's budget deficit has a significant impact on the bond market but does not affect the stock market.

Question 73

Regarding the implied standard deviation, by plugging in the actual option premium paid by investors for a specific stock in the option pricing model, it is possible to derive the anticipated volatility level.

Question 74

If the standard deviation of a stock's returns over the last 12 quarters is 4 percent, and if there is no perceived change in volatility, there is a ____ percent probability that the stock's returns will be within ____ percentage points of the expected outcome.

A)68; 4
B)68; 8
C)95; 8
D)95; 6
E)None of these are correct.

Question 75

Which of the following is NOT used to measure a stock's risk?

A)the stock's price volatility
B)the stock's return
C)the stock's beta
D)the value-at-risk method
E)All of these are used to measure risk.

Question 76

Which of the following is NOT correct regarding the capital asset pricing model (CAPM)?

A)It is sometimes used to estimate the required rate of return for any firm with publicly traded stock.
B)It is based on the premise that the only important risk of a firm is systematic risk.
C)It is concerned with unsystematic risk.
D)All of these are correct.

Question 77

The Treynor index is similar to the Sharpe index, except that is uses beta rather than standard deviation to measure the stock's risk.

Question 78

The general mood of investors represents

A)investor sentiment.
B)beta.
C)systematic risk.
D)unsystematic risk.

Question 79

Which of the following is not a type of factor that drives stock prices, according to your text?

A)economic factors
B)market-related factors
C)firm-specific factors
D)All of the above are factors that affect stock prices.

Question 80

If beta is thought to be the appropriate measure of risk, a stock's risk-adjusted returns should be determined by the Sharpe index.