Deck 11: Stock Valuation and Risk

Question 1

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

Answer 1

False

Question 2

Protsky Inc. just paid a dividend of $2.20 per share. The dividend growth rate for Protsky's dividends is 3 percent per year. If the required rate of return on Protsky stock is 12 percent, the stock should be valued at $____ per share according to the dividend discount model.

A)24.44
B)25.18
C)18.88
D)75.53

Answer 2

B

Question 3

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.

Answer 3

D

Question 4

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 5

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

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

Question 6

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 the above

Question 7

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

Question 8

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 9

The price-earnings valuation method applies the ____ price-earnings ratio to ____ 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 10

Stock price volatility increased during the credit crisis.

Question 11

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)none of the above

Question 12

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 13

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

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

Question 14

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 15

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 16

A firm is expected to generate earnings of $2.22 per share next year. The mean ratio of share price to expected earnings of competitors in the same industry is 15. Based on this information, the valuation of the firm's shares based on the price-earnings (PE) method is

A)$2.22.
B)$6.76.
C)$33.30.
D)none of the above

Question 17

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 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 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.

Question 20

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 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

The ____ is commonly used to determine what a stock's price should have been.

A)Capital Asset Pricing Model
B)Treynor Index
C)Sharpe Index
D)B and C

Question 23

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 24

Kandle stock just paid a dividend of $4.76 per share 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 the above

Question 25

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

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

Question 26

Zilo stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Sharpe index of Zilo stock is

A)0.36.
B)0.35.
C)0.28.
D)0.45.
E)none of the above

Question 27

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)semi-strong form efficient.
C)strong form efficient.
D)B and C
E)none of the above

Question 28

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 the above

Question 29

Morgan stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Treynor index of Morgan stock is

A)0.04.
B)0.05.
C)0.35.
D)0.03.
E)none of the above

Question 30

A higher beta of 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 the above

Question 31

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)B and C

Question 32

Sorvino Co. is expected to offer a dividend of $3.2 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 the above

Question 33

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 the industry competition.
B)beta.
C)liquidity.
D)size (market capitalization).

Question 34

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 35

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)none of the above

Question 36

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 the above

Question 37

The formula for a stock portfolio's volatility does not contain the

A)weight (proportional investment) assigned to each stock.
B)variance (standard deviation squared) of returns of each stock.
C)correlation coefficients between returns of each stock.
D)risk-free rate.

Question 38

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 the above

Question 39

A stock's beta is estimated to be 1.3. The risk-free rate is 5 percent, and the market return is expected to be 9 percent. What is the expected return on the stock based on the CAPM?

A)5.2 percent
B)11.7 percent
C)16.7 percent
D)4 percent
E)10.2 percent

Question 40

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

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

Question 41

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 42

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 43

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 44

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 45

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

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

Question 46

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 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

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

Question 49

Stock X has a lower beta than Stock Y. The market return for next month is expected to be either -1 percent, +1 percent, or +2 percent with an equal probability of each scenario. The probability distribution of Stock X returns for next month is

A)the same as that of Stock Y.
B)more dispersed than that of Stock Y.
C)less dispersed than that of Stock Y.
D)zero.

Question 50

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

Question 51

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 52

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 53

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 54

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 55

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

Question 56

When new information suggests that a firm will experience lower cash flows than previously anticipated or lower risk, investors will revalue the corresponding stock downward.

Question 57

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 58

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 59

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

Question 60

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 61

Which of the following is not a reason the PE ratio method may result in an inaccurate valuation for a firm?

A)potential errors in the forecast of the firm's beta
B)potential errors in the forecast of the firm's future earnings
C)potential errors in the choice of the industry composite used to derive the PE ratio
D)All of the above are reasons the PE ratio method may result in an inaccurate valuation for a firm.

Question 62

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

Question 63

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 64

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 65

Stock repurchases are commonly viewed as an unfavorable signal about the firm.

Question 66

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 returns and market returns
E)All of the above are factors used in the CAPM.

Question 67

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

Question 68

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

Question 69

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

Question 70

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

Question 71

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 72

The limitations of the dividend discount model are most pronounced for a firm that

A)has a high beta.
B)has high expected future earnings.
C)distributes most of its earnings as dividends.
D)retains all of its earnings.
E)none of the above

Question 73

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

Question 74

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 75

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 the above

Question 76

Which of the following is incorrect 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 the above are true.

Question 77

The ____ is not a measure of a stock's risk.

A)stock's price volatility
B)stock's return
C)stock's beta
D)value-at-risk method
E)All of the above are measures of a stock's risk.

Question 78

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

A)13.33
B)3.00
C)20.00
D)30.00
E)none of the above

Question 79

Stocks that have relatively little trading are normally subject to less price volatility.

Question 80

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