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Indicate whether the statement is true or false.
1. The U.S. government’s budget deficit has a significant impact on the bond market but does not affect the stock market.
a. True
b. False
2. The capital asset pricing model (CAPM) is based on the premise that the only important risk of a firm is unsystematic
risk.
a. True
b. False
3. The CBOE Volatility Index (VIX) indicates the volatility of the bond market in general.
a. True
b. False
4. 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.
a. True
b. False
5. The market risk premium is stable over time and is not affected by stock market conditions.
a. True
b. False
6. A portfolio’s beta is the sum of the individual forecasted betas, weighted by the market value of each stock.
a. True
b. False
7. 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.
a. True
b. False
8. 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.
a. True
b. False
9. 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.
a. True
b. False
10. A firm’s stock price is affected not only by macroeconomic and market conditions but also by firm-specific
conditions.
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a. True
b. False
11. The value-at–risk method is intended to warn investors about the potential maximum loss that could occur.
a. True
b. False
12. A stock portfolio has more volatility when its individual stock returns are uncorrelated.
a. True
b. False
13. The main source of uncertainty in computing the return of a stock is the dividend to be received next year.
a. True
b. False
14. The credit crisis caused major problems in the mortgage market but had no impact on the stock market.
a. True
b. False
15. The dividend discount model can be adapted to assess the value of any firm, even those that retain most or all of their
earnings.
a. True
b. False
16. 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.
a. True
b. False
17. For firms that do not pay dividends, the free cash flow model may be more suitable than the dividend discount model.
a. True
b. False
18. A beta of 1.8 implies that the stock has a risk premium of 1.8 percent.
a. True
b. False
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.
a. True
b. False
20. Even though a foreign stock appears to be undervalued in its own country, the stock may not generate a reasonable
return for a U.S. investor if the currency of that country depreciates against the U.S. dollar.
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a. True
b. False
21. The dividend discount model states that the price of a stock should reflect the present value of the stock’s future
dividends.
a. True
b. False
22. 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.
a. True
b. False
23. If beta is thought to be the appropriate measure of risk, a stock’s risk-adjusted returns should be determined by the
Sharpe index.
a. True
b. False
24. When there is a sharp decline in the CBOE Volatility Index (VIX), stock prices also tend to decline.
a. True
b. False
25. 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.
a. True
b. False
26. Stock price volatility increased during the credit crisis.
a. True
b. False
27. The prime rate is commonly used as a proxy for the risk-free rate in the capital asset pricing model (CAPM).
a. True
b. False
28. 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.
a. True
b. False
29. Portfolio managers who monitor systematic risk rather than total risk are more concerned about stock volatility than
about beta.
a. True
b. False
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30. A weak dollar may enhance the value of a U.S. firm whose sales are dependent on the U.S. economy.
a. True
b. False
31. 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.
a. True
b. False
32. The Treynor index is similar to the Sharpe index, except that is uses beta rather than standard deviation to measure the
stock’s risk.
a. True
b. False
33. As a result of market integration, stock markets in emerging markets are likely to be as efficient as U.S. stock markets.
a. True
b. False
Indicate the answer choice that best completes the statement or answers the question.
34. 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.
35. 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.
36. Holding other factors constant, an increase in the capital gains tax rate will have
a. more effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
b. less effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
c. no effect on the valuations of stocks.
d. the same effect on the valuation of dividend-paying stocks and stocks with high growth prospects.
37. If the returns of two stocks are perfectly correlated, then
a. their betas should each equal 1.0.
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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.
38. 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
39. The general mood of investors represents
a. investor sentiment.
b. beta.
c. systematic risk.
d. unsystematic risk.
40. 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
41. 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.
42. 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).
43. 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.
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e. All of the above are limitations of the PE method.
44. 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
45. 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
46. 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.
47. 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.
48. 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.
49. 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
50. Technical analysis relies on the use of ____ to make investment decisions.
a. interest rates
b. inflationary expectations
c. industry conditions
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d. recent stock price trends
51. 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.
52. 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.
53. 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.
54. 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
55. 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.
56. 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
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57. 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
58. 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.
59. 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
60. 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.
61. 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
62. 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
63. 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
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d. .02
e. .2
64. ____ 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.
65. 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
66. 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.
67. 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.
68. 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
69. 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.
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70. 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
71. 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.
72. 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.
73. 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.
74. 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
75. 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
76. The market risk premium is
a. the yield on newly issued Treasury bonds.
b. the return of the market in excess of the risk-free rate.
c. the covariance between the risk-free rate and the return of the market.
d. the return of the market in excess of expected cash flows.
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77. 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.
78. 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.
79. 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.
80. 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.
81. 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
82. 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
83. 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.
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d. −1.65 percent.
84. 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
85. 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.
86. Holding other factors constant, a stock portfolio has more volatility when its individual stock volatilities are ________
and its individual stock returns have _______ correlations.
a. high; low
b. low; high
c. low; low
d. high; high
87. 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
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Answer Key
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