Deck 15: Options Markets

Question 1

If the expected ROE on reinvested earnings is equal to k,the multistage DDM reduces to

A) V₀= (Expected Dividend Per Share in Year 1)/k
B) V₀= (Expected EPS in Year 1)/k
C) V₀= (Treasury Bond Yield in Year 1)/k
D) V₀= (Market return in Year 1)/k
E) none of these

Answer 1

B

Question 2

Historically,P/E ratios have tended to be ________.

A) higher when inflation has been high
B) lower when inflation has been high
C) uncorrelated with inflation rates but correlated with other macroeconomic variables
D) uncorrelated with any macroeconomic variables including inflation rates
E) none of these

Answer 2

B

Question 3

Recent empirical research indicates ______.

A) that real rates of return on stocks are positively correlated with inflation
B) that real rates of return on stocks are uncorrelated with inflation
C) that real rates of return on stocks are negatively correlated with inflation
D) the ratio of the real rate of return on stocks to inflation is 1.0.
E) nothing about real rates of return on stocks

Answer 3

C

Question 4

Construction Machinery Company has an expected ROE of 11%.The dividend growth rate will be _______ if the firm follows a policy of paying 25% of earnings in the form of dividends.

A) 3.0%
B) 4.8%
C) 8.25%
D) 9.0%
E) none of these

Question 5

_________ is equal to (common shareholders' equity/common shares outstanding).

A) Book value per share
B) Liquidation value per share
C) Market value per share
D) Tobin's Q
E) none of these

Question 6

High P/E ratios tend to indicate that a company will _______,ceteris paribus.

A) grow quickly
B) grow at the same speed as the average company
C) grow slowly
D) not grow
E) none of these

Question 7

A preferred stock will pay a dividend of $3.50 in the upcoming year,and every year thereafter,i.e. ,dividends are not expected to grow.You require a return of 11% on this stock.Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

A) $0.39
B) $0.56
C) $31.82
D) $56.25
E) none of these

Question 8

One of the problems with attempting to forecast stock market values is that

A) there are no variables that seem to predict market return.
B) the earnings multiplier approach can only be used at the firm level.
C) the level of uncertainty surrounding the forecast will always be quite high.
D) dividend payout ratios are highly variable.
E) none of these.

Question 9

Bonded Paper Company has a balance sheet which lists $85 million in assets,$40 million in liabilities and $45 million in common shareholders' equity.It has 1,400,000 common shares outstanding.The replacement cost of the assets is $115 million.The market share price is $90.What is Bonded Paper's book value per share?

A) $1.68
B) $2.60
C) $32.14
D) $60.71
E) none of these

Question 10

________ are analysts who use information concerning current and prospective profitability of a firms to assess the firm's fair market value.

A) Credit analysts
B) Fundamental analysts
C) Systems analysts
D) Technical analysts
E) Specialists

Question 11

The ______ is a common term for the market consensus value of the required return on a stock.

A) dividend payout ratio
B) intrinsic value
C) market capitalization rate
D) plowback rate
E) none of these

Question 12

You are considering acquiring a common stock that you would like to hold for one year.You expect to receive both $2.50 in dividends and $28 from the sale of the stock at the end of the year.The maximum price you would pay for the stock today is _____ if you wanted to earn a 15% return.

A) $23.91
B) $24.11
C) $26.52
D) $27.50
E) none of these

Question 13

Bonded Paper Company has a balance sheet which lists $85 million in assets,$40 million in liabilities and $45 million in common shareholders' equity.It has 1,400,000 common shares outstanding.The replacement cost of the assets is $115 million.The market share price is $90.What is Bonded Paper's Tobin's Q ratio?

A) 0.98
B) 2.80
C) 32.14
D) 60.71
E) none of these

Question 14

The Gordon model

A) is a generalization of the perpetuity formula to cover the case of a growing perpetuity.
B) is valid only when g is less than k.
C) is valid only when k is less than g.
D) a and b.
E) a and c.

Question 15

_______ is the amount of money per common share that could be realized by breaking up the firm,selling the assets,repaying the debt,and distributing the remainder to shareholders.

A) Book value per share
B) Liquidation value per share
C) Market value per share
D) Tobin's Q
E) None of these

Question 16

________ is equal to the total market value of the firm's common stock divided by (the replacement cost of the firm's assets less liabilities).

A) Book value per share
B) Liquidation value per share
C) Market value per share
D) Tobin's Q
E) None of these.

Question 17

The _________ is the fraction of earnings reinvested in the firm.

A) dividend payout ratio
B) retention rate
C) plowback ratio
D) a and c
E) b and c

Question 18

Since 1955,Canada bond yields and earnings yields on stocks were

A) identical
B) negatively correlated
C) positively correlated
D) uncorrelated

Question 19

The _______ is defined as the present value of all cash proceeds to the investor in the stock.

A) dividend payout ratio
B) intrinsic value
C) market capitalization rate
D) plowback ratio
E) none of these

Question 20

Agricultural Equipment Company has an expected ROE of 10%.The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends.

A) 3.0%
B) 4.8%
C) 7.2%
D) 6.0%
E) none of these

Question 21

Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the coming year.Dividends are expected to decline at the rate of 2% per year.The risk-free rate of return is 6% and the expected return on the market portfolio is 14%.The stock of Old Quartz Gold Mining Company has a beta of -0.25.The intrinsic value of the stock is _____.

A) $80.00
B) $133.33
C) $200.00
D) $400.00
E) none of these

Question 22

Suppose that the average P/E multiple in the oil industry is 16.Mobil Oil is expected to have an EPS of $4.50 in the coming year.The intrinsic value of Mobil Oil stock should be ____.

A) $28.12
B) $35.55
C) $63.00
D) $72.00
E) none of these

Question 23

Civil Engineering Corporation is expected to pay a dividend of $1.00 in the upcoming year.Dividends are expected to grow at the rate of 6% per year.The risk-free rate of return is 5% and the expected return on the market portfolio is 13%.The stock of Civil Engineering Corporation has a beta of 1.2.What is the intrinsic value of Civil Engineering's stock?

A) $14.29
B) $14.60
C) $12.33
D) $11.62
E) none of these

Question 24

Civil Engineering Corporation is expected to pay a dividend of $1.00 in the upcoming year.Dividends are expected to grow at the rate of 6% per year.The risk-free rate of return is 5% and the expected return on the market portfolio is 13%.The stock of Civil Engineering Corporation has a beta of 1.2.What is the return you should require on Civil Engineering's stock?

A) 12.0%
B) 14.6%
C) 15.6%
D) 20%
E) none of these

Question 25

High Tech Chip Company is expected to have EPS in the coming year of $2.50.The expected ROE is 14%.An appropriate required return on the stock is 11%.If the firm has a dividend payout ratio of 40%,the intrinsic value of the stock should be

A) $22.73
B) $27.50
C) $28.57
D) $38.46
E) none of these

Question 26

Sunshine Corporation is expected to pay a dividend of $1.50 in the upcoming year.Dividends are expected to grow at the rate of 6% per year.The risk-free rate of return is 6% and the expected return on the market portfolio is 14%.The stock of Sunshine Corporation has a beta of 0.75.The intrinsic value of the stock is ________.

A) $10.71
B) $15.00
C) $17.75
D) $25.00
E) none of these

Question 27

If Dominion's intrinsic value is $21.00 today,what must be its growth rate?

A) 0.0%
B) 10%
C) 4%
D) 6%
E) 7%

Question 28

High Fly Airline is expected to pay a dividend of $7 in the coming year.Dividends are expected to grow at the rate of 15% per year.The risk-free rate of return is 6% and the expected return on the market portfolio is 14%.The stock of High Fly Airline has a beta of 3.00.The intrinsic value of the stock is ________.

A) $46.67
B) $50.00
C) $56.00
D) $62.50
E) none of these

Question 29

The market capitalization rate on the stock of Flexible Dividend Company is 12%.The expected ROE is 13% and the expected EPS are $3.60.If the firm's plowback ratio is 75%,the P/E ratio will be _______.

A) 7.69
B) 8.33
C) 9.09
D) 11.11
E) none of these

Question 30

Dominion Tool Company is expected to pay a dividend of $2 in the upcoming year.The risk-free rate of return is 4% and the expected return on the market portfolio is 14%.Analysts expect the price of Dominion Tool Company shares to be $22 a year from now.The beta of Dominion Tool Company's stock is 1.25.What is the intrinsic value of Dominion's stock today?

A) $20.60
B) $20.00
C) $12.12
D) $22.00
E) none of these

Question 31

The most popular approach to forecasting the overall stock market is to use

A) the dividend multiplier.
B) the aggregate return on assets.
C) the historical ratio of book value to market value.
D) the aggregate earnings multiplier.
E) Tobin's Q.

Question 32

High Tech Chip Company paid a dividend last year of $2.50.The expected ROE for next year is 12.5%.An appropriate required return on the stock is 11%.If the firm has a plowback ratio of 60%,the dividend in the coming year should be

A) $1.00
B) $2.50
C) $2.69
D) $2.81
E) none of these

Question 33

An analyst has determined that the intrinsic value of IBM stock is $80 per share using the capitalized earnings model.If the typical P/E ratio in the computer industry is 22,then it would be reasonable to assume the expected EPS of IBM in the coming year is ______.

A) $3.63
B) $4.44
C) $14.40
D) $22.50
E) none of these

Question 34

High Tech Chip Company is expected to have EPS in the coming year of $2.50.The expected ROE is 12.5%.An appropriate required return on the stock is 11%.If the firm has a plowback ratio of 70%,the growth rate of dividends should be

A) 5.00%
B) 6.25%
C) 6.60%
D) 7.50%
E) 8.75%

Question 35

Questionable Systematic Risk Company is expected to pay a dividend of $3.50 in the coming year.Dividends are expected to grow at a rate of 10% per year.The risk-free rate of return is 5% and the expected return on the market portfolio is 13%.The stock is trading in the market today at a price of $90.00.What is the market capitalization rate for Questionable Systematic Risk?

A) 13.6%
B) 13.9%
C) 15.6%
D) 16.9%
E) none of these

Question 36

Questionable Systematic Risk Company is expected to pay a dividend of $3.50 in the coming year.Dividends are expected to grow at a rate of 10% per year.The risk-free rate of return is 5% and the expected return on the market portfolio is 13%.The stock is trading in the market today at a price of $90.00.What is the approximate beta of Questionable's stock?

A) 0.8
B) 1.0
C) 1.1
D) 1.4
E) none of these

Question 37

Old Quartz Gold Mining Company is expected to pay a dividend of $8 in the upcoming year.Dividends are expected to decline at the rate of 2% per year.The risk-free rate of return is 6% and the expected return on the market portfolio is 14%.The stock of Old Quartz Gold Mining Company has a beta of -0.25.The return you should require on the stock is _______.

A) 2%
B) 4%
C) 6%
D) 8%
E) none of these

Question 38

Dominion Tool Company is expected to pay a dividend of $2 in the upcoming year.The risk-free rate of return is 4% and the expected return on the market portfolio is 14%.Analysts expect the price of Dominion Tool Company shares to be $22 a year from now.The beta of Dominion Tool Company's stock is 1.25.The market's required rate of return on Dominion's stock is ____.

A) 14.0%
B) 17.5%
C) 16.5%
D) 15.25%
E) none of these

Question 39

High Fly Airline is expected to pay a dividend of $7 in the coming year.Dividends are expected to grow at the rate of 15% per year.The risk-free rate of return is 6% and the expected return on the market portfolio is 14%.The stock of High Fly Airline has a beta of 3.00.The return you should require on the stock is ________.

A) 10%
B) 18%
C) 30%
D) 42%
E) none of these

Question 40

The market capitalization rate on the stock of Flexible Dividend Company is 12%.The expected ROE is 13% and the expected EPS are $3.60.If the firm's plowback ratio is 50%,the P/E ratio will be _________.

A) 7.69
B) 8.33
C) 9.09
D) 11.11
E) none of these

Question 41

The growth in dividends of ABC,Inc.is expected to be 15%/year for the next three years,followed by a growth rate of 8%/year for two years;after this five year period,the growth in dividends is expected to be 3%/year,indefinitely.The required rate of return on ABC,Inc.is 13%.Last year's dividends per share were $1.85.What should the stock sell for today?

A) $8.99
B) $25.21
C) $40.00
D) $27.74
E) None of these is correct

Question 42

Which of the following would tend to reduce a firm's P/E ratio?

A) The firm significantly decreases financial leverage
B) The firm increases return on equity for the long term
C) The level of inflation is expected to increase to double-digit levels
D) The rate of return on Treasury bills decreases
E) None of these

Question 43

Mature Products Corporation produces goods that are very mature in their product life cycles.Mature Products Corporation is expected to pay a dividend in year 1 of $2.00,a dividend of $1.50 in year 2,and a dividend of $1.00 in year 3.After year 3,dividends are expected to decline at a rate of 1% per year.An appropriate required rate of return for the stock is 10%.The stock should be worth ________.

A) $9.00
B) $10.57
C) $20.00
D) $22.22
E) none of these

Question 44

According to James Tobin,the long run value of Tobin's Q should tend toward

A) 0.
B) 1.
C) 2.
D) infinity.
E) none of these.

Question 45

Antiquated Products Corporation produces goods that are very mature in their product life cycles.Antiquated Products Corporation is expected to pay a dividend in year 1 of $1.00,a dividend of $0.90 in year 2,and a dividend of $0.85 in year 3.After year 3,dividends are expected to decline at a rate of 2% per year.An appropriate required rate of return for the stock is 8%.The stock should be worth ____.

A) $8.49
B) $10.57
C) $20.00
D) $22.22
E) None of these is correct

Question 46

Consider the constant growth DDM.In a non-inflationary environment,KD Picture Frame Company is expected to pay a dividend of $2.60 in the coming year,the growth rate of dividends is expected to be 0%,and the required return on the stock will be 8%.If the inflation rate is 4%,KD Picture Frame Company is expected to pay a dividend of $2.70 in the coming year,the dividend growth rate will be 4%,and the required return on the stock will be 12.32%.In the inflationary environment with inflation at 4%,a share of KD Picture Frame's stock should be worth ________.

A) $21.10
B) $31.25
C) $32.45
D) $62.50
E) none of these

Question 47

A firm's earnings per share increased from $10 to $12,dividends increased from $4.00 to $4.80,and the share price increased from $80 to $90.Given this information,it follows that _________.

A) the stock experienced a drop in the P/E ratio
B) the firm had a decrease in dividend payout ratio
C) the firm increased the number of shares outstanding
D) the required rate of return decreased
E) none of these

Question 48

If a firm's required rate of return equals the firm's return on equity,there is no advantage to increasing the firm's growth.Suppose a no-growth firm had a required rate of return and a ROE of 12% and a stock price of $40.However,if the firm is able to increase the ROE to 15% with a plowback ratio of 50%,what is the present value of growth opportunities now? (Last year's dividends were $2.00/share).

A) $9.78
B) $7.78
C) $10.78
D) $12.78
E) none of these

Question 49

Consider the free cash flow approach to stock valuation.Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year.The firm's corporate tax rate is 30%.It is expected that $200,000 of operating cash flow will be invested in new fixed assets.Depreciation for the year will be $100,000.After the coming year,cash flows are expected to grow at 6% per year.The appropriate market capitalization rate for unleveraged cash flow is 15% per year.The firm has no outstanding debt.The total value of the equity of Utica Manufacturing Company should be

A) $1,000,000
B) $2,000,000
C) $3,000,000
D) $4,000,000
E) none of these

Question 50

Consider the free cash flow approach to stock valuation.Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year.The firm's corporate tax rate is 30%.It is expected that $200,000 of operating cash flow will be invested in new fixed assets.Depreciation for the year will be $100,000.After the coming year,cash flows are expected to grow at 6% per year.The appropriate market capitalization rate for unleveraged cash flow is 15% per year.The firm has no outstanding debt.The projected free cash flow of Utica Manufacturing Company for the coming year is ________.

A) $150,000
B) $180,000
C) $300,000
D) $380,000
E) none of these

Question 51

Lifecycle Bicycle Company is expected to pay a dividend in year 1 of $1.20,a dividend in year 2 of $1.50,and a dividend in year 3 of $2.00.After year 3,dividends are expected to grow at the rate of 10% per year.An appropriate required return for the stock is 14%.The stock should be worth _______ today.

A) $33.00
B) $40.67
C) $55.00
D) $66.00
E) none of these

Question 52

Company A paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of earnings as dividends for the foreseeable future.If the firm is expected to generate a 10% return on equity in the future,and if you require a 12% return on the stock,the value of the stock is _______.

A) $17.67
B) $13.00
C) $16.67
D) $18.67
E) none of these

Question 53

Other things being equal,a low ________ would be most consistent with a relatively high growth rate of firm earnings and dividends.

A) dividend payout ratio
B) degree of financial leverage
C) variability of earnings
D) inflation rate
E) none of these

Question 54

In the dividend discount model,_______ which of the following are not incorporated into the discount rate?

A) real risk-free rate
B) risk premium for stocks
C) return on assets
D) expected inflation rate
E) none of these

Question 55

A company whose stock is selling at a P/E ratio greater than the P/E ratio of a market index most likely has ________.

A) an anticipated earnings growth rate which is less than that of the average firm
B) a dividend yield which is less than that of the average firm
C) less predictable earnings growth than that of the average firm
D) greater cyclicality of earnings growth than that of the average firm
E) none of these.

Question 56

A firm has a return on equity of 20% and a dividend payout ratio of 30%.The firm's anticipated growth rate is _______.

A) 6%
B) 10%
C) 14%
D) 20%
E) none of these

Question 57

Assume that at the end of the next year,Company A will pay a $2.00 dividend per share,an increase from the current dividend of $1.50 per share.After that,the dividend is expected to increase at a constant rate of 5%.If you require a 12% return on the stock,the value of the stock is ________.

A) $28.57
B) $28.79
C) $30.00
D) $31.78
E) none of these

Question 58

If a firm has a required rate of return equal to the ROE

A) the firm can increase market price and P/E by retaining more earnings.
B) the firm can increase market price and P/E by increasing the growth rate.
C) the amount of earnings retained by the firm does not affect market price or the P/E.
D) a and b.
E) none of these.
If required return and ROE are equal,investors are indifferent as to whether the firm retains more earnings or increases dividends.Thus,retention rates and growth rates do not affect market price and P/E.

Question 59

Consider the constant growth DDM.In a non-inflationary environment,KD Picture Frame Company is expected to pay a dividend of $2.60 in the coming year,the growth rate of dividends is expected to be 0%,and the required return on the stock will be 8%.If the inflation rate is 4%,KD Picture Frame Company is expected to pay a dividend of $2.70 in the coming year,the dividend growth rate will be 4%,and the required return on the stock will be 12.32%.In the non-inflationary environment,a share of the KD Picture Frame's stock should be worth _________.

A) $20.00
B) $30.00
C) $31.25
D) $32.50
E) none of these

Question 60

The growth in dividends of XYZ,Inc.is expected to be 10%/year for the next two years,followed by a growth rate of 5%/year for three years;after this five year period,the growth in dividends is expected to be 2%/year,indefinitely.The required rate of return on XYZ,Inc.is 12%.Last year's dividends per share were $2.00.What should the stock sell for today?

A) $8.99
B) $25.21
C) $40.00
D) $110.00
E) none of these

Question 61

According to Peter Lynch,a rough rule of thumb for security analysis is that

A) the growth rate should be equal to the plowback rate.
B) the growth rate should be equal to the dividend payout rate.
C) the growth rate should be low for emerging industries.
D) the growth rate should be equal to the P/E ratio.
E) none of these.

Question 62

Which of the following statements is true?

A) A firm's book value can never be below its market value.
B) A firm's market value can never be below its book value.
C) A firm's book value is equal to its market value.
D) A firm's market value can be below its book value.
E) Market value isn't important-only book value matters.

Question 63

Because the DDM requires multiple estimates,investors should

A) carefully examine inputs to the model.
B) perform sensitivity analysis on price estimates.
C) not use this model without expert assistance.
D) feel confident that DDM estimates are correct.
E) both a and b.

Question 64

The dividend discount model

A) ignores capital gains.
B) incorporates the after-tax value of capital gains.
C) includes capital gains implicitly.
D) restricts capital gains to a minimum.
E) none of these.

Question 65

Who popularized the dividend discount model,which is sometimes referred to by his name?

A) Burton Malkiel
B) Frederick Macaulay
C) Harry Markowitz
D) Marshall Blume
E) Myron Gordon

Question 66

Investors want high plowback ratios

A) for all firms.
B) whenever ROE > k.
C) whenever k > ROE.
D) only when they are in low tax brackets.
E) whenever bank interest rates are high.

Question 67

The present value of growth opportunities (PVGO)is equal to
I)the difference between a stock's price and its no-growth value per share.
II)the stock's price
III)zero if its return on equity equals the discount rate.
IV)the net present value of favorable investment opportunities.

A) I and IV
B) II and IV
C) I,III,and IV
D) II,III,and IV
E) III and IV

Question 68

Which of the following combinations will produce the highest growth rate? Assume that the firm's projects offer a higher expected return than the market capitalization rate.

A) a high plowback ratio and a high P/E ratio
B) a high plowback ratio and a low P/E ratio
C) a low plowback ratio and a low P/E ratio
D) a low plowback ratio and a high P/E ratio
E) Neither the plowback ratio nor the P/E ratio is related to a firm's growth.

Question 69

Which of the following are comparative valuation ratios?
I)the plowback ratio
II)the price-to-book ratio
III)the dividend payout ratio
IV)the price-to-sales ratio
V)the price-to-cash flow ratio

A) I,IV,and V
B) II and III
C) IV and V
D) II,IV,and V
E) I,II,III,IV,and V

Question 70

An example of a highly cyclical industry is __________.

A) the automobile industry
B) the tobacco industry
C) the food industry
D) a and b
E) b and c

Question 71

Dividend discount models and P/E ratios are used by __________ to try to find mispriced securities.

A) technical analysts
B) statistical analysts
C) fundamental analysts
D) dividend analysts
E) psychoanalysts

Question 72

If a firm follows a low-investment-rate plan (applies a low plowback ratio),its dividends will be _______ now and _______ in the future than a firm that follows a high-reinvestment-rate plan.

A) higher,higher
B) lower,lower
C) lower,higher
D) higher,lower
E) It is not possible to tell.

Question 73

A decrease in the federal government deficit should _______ the level of interest rates.

A) increase
B) decrease
C) sometimes increase and sometimes decrease
D) have no effect on
E) none of these

Question 74

Demand-side economics is concerned with _______.

A) government spending and tax levels
B) monetary policy
C) fiscal policy
D) a and b
E) a,b,and c

Question 75

The goal of fundamental analysts is to find securities

A) whose intrinsic value exceeds market price.
B) with a positive present value of growth opportunities.
C) with high market capitalization rates.
D) all of these.
E) none of these.

Question 76

For most firms,P/E ratios and risk

A) will be directly related.
B) will have an inverse relationship.
C) will be unrelated.
D) will both increase as inflation increases.
E) none of these.

Question 77

The most widely used monetary tool is _______.

A) altering the discount rate
B) altering the reserve requirements
C) open market operations
D) altering marginal tax rates
E) none of these

Question 78

Many stock analysts assume that a mispriced stock will

A) immediately return to its intrinsic value.
B) return to its intrinsic value within a few days.
C) never return to its intrinsic value.
D) gradually approach its intrinsic value over several years.
E) none of these.

Question 79

Low P/E ratios tend to indicate that a company will _____,ceteris paribus.

A) grow quickly
B) grow at the same speed as the average company
C) grow slowly
D) P/E ratios are unrelated to growth
E) None of these is correct

Question 80

Dividend discount models and P/E ratios are used by __________ to try to find mispriced securities.

A) technical analysts
B) statistical analysts
C) fundamental analysts
D) dividend analysts
E) psychoanalysts