Chapter 11: Stock Valuation and Risk
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1. 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
ANSWER:
d
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Bloom’s: Knowledge
2. 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.
a.
True
b.
False
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
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Bloom’s: Comprehension
3. 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.
b.
c.
d.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
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Bloom’s: Application
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.
Chapter 11: Stock Valuation and Risk
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d.
that have constant earnings growth
ANSWER:
b
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Bloom’s: Knowledge
5. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Challenging
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Bloom’s: Application
6. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
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Bloom’s: Comprehension
7. 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
ANSWER:
a
Chapter 11: Stock Valuation and Risk
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b.
upward; large
c.
downward; small
d.
upward; small
ANSWER:
d
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1
DIFFICULTY:
Moderate
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Bloom’s: Knowledge
12. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
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13. 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
ANSWER:
a
POINTS:
1
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Easy
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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
ANSWER:
b
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15. Stock price volatility increased during the credit crisis.
a.
True
b.
False
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
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16. 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:
d
POINTS:
1
DIFFICULTY:
Easy
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Bloom’s: Knowledge
17. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
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United States – BUSPROG.FMAI.MADU.15.03
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POINTS:
1
DIFFICULTY:
Easy
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18. 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
ANSWER:
d
POINTS:
1
DIFFICULTY:
Moderate
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Bloom’s: Application
19. 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.
B and C
e.
none of the above
ANSWER:
a
POINTS:
1
DIFFICULTY:
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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.
A and C
ANSWER:
d
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
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Bloom’s: Comprehension
KEYWORDS:
Bloom’s: Application
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d.
none of the above
ANSWER:
c
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1
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Easy
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Bloom’s: Comprehension
25. 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.
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
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26. 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
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
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27. 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).
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
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28. 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
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
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29. 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
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
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Bloom’s: Application
30. 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 the above
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FMAI.MADU.15.11.05
LEARNING OBJECTIVES:
FMAI.MADU.15.11.02
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31. 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 the above
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
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Bloom’s: Application
32. Sorvino Co. 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 the above
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
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Bloom’s: Application
33. 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 the above
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
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Bloom’s: Application
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34. 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
ANSWER:
d
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FMAI.MADU.15.11.07
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Bloom’s: Application
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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
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Bloom’s: Application
36. 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.
ANSWER:
a
POINTS:
1
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Bloom’s: Application
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37. 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.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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Bloom’s: Comprehension
38. 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
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
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39. 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
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FMAI.MADU.15.11.02
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STATE STANDARDS:
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DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FMAI.MADU.15.11.04
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40. 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.
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
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Bloom’s: Comprehension
41. 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
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
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Bloom’s: Knowledge
42. 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.
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
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Bloom’s: Application
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
KEYWORDS:
Bloom’s: Analysis