In this chapter, we examined nine stock valuation procedures: • Zero-growth DVM • Constant-growth DVM • Variable-growth DVM • Free cash flow to equity approach • Expected return (IRR) approach • P/E approach • Price-to-cash-flow ratio • Price-to-sales ratio • Price-to-book-value ratio a. Which one (or more) of these procedures would be appropriate when trying to put a value on: 1. A growth stock that pays little or nothing in dividends? 2. The S&P 500? 3. A relatively new company that has only a brief history of earnings? 4. A large, mature, dividend-paying company? 5. A preferred stock that pays a fixed dividend? 6. A company that has a large amount of depreciation and amortization? b. Of the nine procedures listed above, which three do you think are the best? Explain. c. If you had to choose just one procedure to use in practice, which would it be? Explain. (Note: Confine your selection to the list above.)
> Briefly describe each of the following: a. Gross domestic product b. Leading indicators c. Money supply d. Producer prices
> Describe how, if at all, a conservative and an aggressive investor might use each of the following types of orders as part of their investment programs. Contrast these two types of investors in view of these preferences. a. Market b. Limit c. Stop-loss
> Why do you think some large, well-known companies such as Cisco Systems, Intel, and Microsoft prefer to trade on the Nasdaq OMX markets rather than on an organized securities exchange such as the NYSE (for which they easily meet the listing requirements)
> From 1999 to 2014, the average IPO rose by 19% in its first day of trading. In 1999, 117 deals doubled in price on the first day. What factors might contribute to the huge first-day returns on IPOs? Some critics of the current IPO system claim that under
> Following is a sample of 12 Level-I CFA exam questions that deal with many of the topics covered in Chapters 14 and 15 of this text, including basic properties of options and futures, pricing characteristics, return behavior, and various option strategie
> Critics of longer trading hours believe that expanded trading sessions turn the stock market into a casino and place the emphasis more on short-term gains than on long-term investment. Do you agree? Why or why not? Is it important to have a “breathing pe
> On the basis of the current structure of the world’s financial markets and your knowledge of the NYSE and Nasdaq OMX markets, describe the key features, functions, and problems that would be faced by a single global market (exchange) on which transaction
> What role, if any, will short-term investments play in your portfolio? Why? Complete the following table for the short-term investments listed. Find their current yields online, and explain which, if any, you would include in your investment portfolio.
> Assume that you are 35 years old, are married with two young children, are renting a condo, and have an annual income of $90,000. Use the following questions to guide your preparation of a rough investment plan consistent with these facts. a. What are yo
> Carolyn Bowen, who just turned 55, is employed as an administrative assistant for the Xcon Corporation, where she has worked for the past 20 years. She is in good health, lives alone, and has two grown children. A few months ago her husband died, leaving
> On the basis of the information provided, indicate how much profit or loss you would make in each of the futures transactions listed below. (Hint: You might want to visit http:// www.cmegroup.com for the size of the contract, pricing unit, and so on.)
> Three of the biggest U.S. commodities exchanges—the CME, CBOT, and NYMEX—were identified in this chapter. Other U.S. exchanges and several foreign commodities exchanges are also closely followed in the United States. Go to the Wall Street Journal Online,
> Wally Wilson is a commercial artist who makes a good living by doing freelance work—mostly layouts and illustrations—for local ad agencies and major institutional clients (such as large department stores). Wally has be
> Assume you hold a well-balanced portfolio of common stocks. Under what conditions might you want to use a stock-index (or ETF) option to hedge the portfolio? a. Briefly explain how such options could be used to hedge a portfolio against a drop in the mar
> Alcan stock recently closed at $52.51. Assume that you write a covered call on Alcan by writing one September call with a strike price of $55 and buying 100 shares of stock at the market price. The option premium that you obtain from writing the call is
> Using the Facebook stock option quotations in Figure 14.1, find the option premium, the time value, and the stock index breakeven point for the following puts and calls. Figure 14.1: a. The August put with a strike price of $82.50 b. The August call w
> In the absence of any load charges, open-end mutual funds are priced at (or very close to) their net asset values, whereas closed-end funds rarely trade at their NAVs. Explain why one type of fund would normally trade at its NAV while the other type (CEF
> Following is a sample of 10 Level-I CFA exam questions that deal with many of the topics covered in Chapters 10 and 11 of this text, including bond prices and yields, interest rates and risks, bond price volatility, and bond redemption provisions. (When
> Describe an ETF and explain how these funds combine the characteristics of both open end and closed-end funds. Consider the Vanguard family of funds. Which of its funds most closely resembles a “spider” (SPDR)? In what respects are the Vanguard fund (tha
> For each pair of funds listed below, select the one that is likely to be less risky. Briefly explain your answer. a. Growth versus growth-and-income funds b. Equity-income versus high-grade corporate bond funds c. Balanced versus sector funds d. Global v
> Why is Jensen’s measure (alpha) generally preferred over the measures of Sharpe and Treynor for assessing portfolio performance? Explain.
> Describe the process of creating an ETF. How does it differ from the process by which an open-end fund is created?
> Contrast mutual fund ownership with direct investment in stocks and bonds. Assume your class is going to debate the merits of investing through mutual funds versus investing directly in stocks and bonds. Develop some arguments on each side of this debate
> Assume that an investor comes to you looking for advice. She has $200,000 to invest and wants to put it all into bonds. a. If she considers herself a fairly aggressive investor who is willing to take the risks necessary to generate the big returns, what
> Why is the business cycle so important to economic analysis? Does the business cycle have any bearing on the stock market?
> Briefly explain what will happen to a bond’s duration measure if each of the following events occur. a. The yield to maturity on the bond falls from 8.5% to 8%. b. The bond gets 1 year closer to its maturity. c. Market interest rates go from 8% to 9%. d.
> Briefly describe each of the following theories of the term structure of interest rates. a. Expectations hypothesis b. Liquidity preference theory c. Market segmentation theory According to these theories, what conditions would result in a downward-slopi
> Using the resources at your campus or public library or on the Internet, find the information requested below. a. Select any two convertible debentures (notes or bonds) and determine the conversion ratio, conversion parity, conversion value, conversion p
> Describe LYONs, and note how they differ from conventional convertible securities. Are there any similarities between LYONs and conventional convertibles? Explain.
> Why do companies like to issue convertible securities? What’s in it for them?
> Jim Pernelli and his wife, Polly, live in Augusta, Georgia. Like many young couples, the Pernellis are a two-income family. Jim and Polly are both college graduates and hold high-paying jobs. Jim has been an avid investor in the stock market for a number
> Briefly describe each of the following measures for assessing portfolio performance and explain how they are used. a. Sharpe’s measure b. Treynor’s measure c. Jensen’s measure (Jensen’s alpha)
> Dara Simmons, a 40-year-old financial analyst and divorced mother of two teenage children, considers herself a savvy investor. She has increased her investment portfolio considerably over the past five years. Although she has been fairly conservative wit
> Treasury securities are guaranteed by the U.S. government. Therefore, there is no risk in the ownership of such bonds.” Briefly discuss the wisdom (or folly) of this statement.
> Identify and briefly describe each of the following types of bonds. a. Agency bonds b. Municipal bonds c. Zero-coupon bonds d. Junk bonds e. Foreign bonds f. Collateralized mortgage obligations (CMOs) What type of investor do you think would be most attr
> Using the bond returns in Table 10.1 as a basis of discussion: Table 10.1: a. Compare the total returns on Treasury bonds during the 1970s to those produced in the 1980s. How do you explain the differences? b. How did the bond market do in the 1990s?
> Describe the general concept of economic analysis. Is this type of analysis necessary, and can it really help the individual investor make a decision about a stock? Explain.
> Briefly define each of the following and note the conditions that would suggest the market is technically strong. a. Breadth of the market b. Short interest c. Relative strength index d. Theory of contrary opinion e. Head and shoulders
> Describe each of the following approaches to technical analysis and note how it would be used by investors. a. Confidence index b. Arms index c. Trading action d. Odd-lot trading e. Charting f. Moving averages g. On-balance volume Which of these approach
> Briefly describe how technical analysis is used as part of the stock valuation process. What role does it play in an investor’s decision to buy or sell a stock?
> Describe how representativeness may lead to biases in stock valuation.
> Briefly define each of the following terms and describe how it can affect investors’ decisions. a. Loss aversion b. Representativeness c. Narrow framing d. Overconfidence e. Biased self-attribution
> What is an odd-lot differential? How can you avoid odd-lot differentials? Which of the following transactions would involve an odd-lot differential? a. Buy 90 shares of stock b. Sell 200 shares of stock c. Sell 125 shares of stock
> Each year financial periodicals like the Wall Street Journal and Money Magazine publish a list of the top performing mutual fund managers. And every year there are some fund managers who earn much higher returns than the market average, and in some cases
> Much has been written about the concept of an efficient market. It’s probably safe to say that some of your classmates believe the markets are efficient and others believe they are not. Have a debate to see whether you can resolve this issue (at least am
> T. J. Patrick is a young, successful industrial designer in Portland, Oregon, who enjoys the excitement of commodities speculation. T. J. has been dabbling in commodities since he was a teenager—he was introduced to this market by his dad, who is a grain
> Assume an investor uses the constant-growth DVM to value a stock. Listed below are various situations that could affect the computed value of a stock. Look at each one of these individually and indicate whether it would cause the computed value of a stoc
> Explain the role that the future plays in the stock valuation process. Why not just base the valuation on historical information? Explain how the intrinsic value of a stock is related to its required rate of return. Illustrate what happens to the value o
> Would there be any need for security analysis if we operated in an efficient market environment? Explain.
> As an investor, what kind(s) of economic information would you look for if you were thinking about investing in the following? a. An airline stock b. A cyclical stock c. An electrical utility stock d. A building materials stock e. An aerospace firm, with
> Economic analysis is generally viewed as an integral part of the top-down approach to security analysis. In this context, identify each of the following and note how each would probably behave in a strong economy. a. Fiscal policy b. Interest rates c. In
> Briefly define each of the following types of investment programs and note the kinds of stock (blue chips, speculative stocks, etc.) that would best fit with each. a. A buy-and-hold strategy b. A current-income portfolio c. Long-term total return d. Aggr
> Why is comparing a portfolio’s return to the return on a broad market index generally inadequate? Explain.
> Identify and briefly describe the three sources of return to U.S. investors in foreign stocks. How important are currency exchange rates? With regard to currency exchange rates, when is the best time to be in foreign securities? a. Listed below are excha
> Assume that a wealthy woman comes to you looking for some investment advice. She is in her early forties and has $250,000 to put into stocks. She wants to build up as much capital as she can over a 15-year period and is willing to tolerate a “fair amount
> Look at the record of stock returns in Table 6.1. a. How would you compare the average annual returns for the various decades? b. Considering the average annual returns that have been generated over holding periods of 10 years or more, what rate of retur
> Suppose you are on an airplane and you overhear two executives of a company talking about a merger that is about to take place. If you buy stock based on what you overheard, are you committing insider trading?
> A little more than 10 months ago, Luke Weaver, a mortgage banker in Phoenix, bought 300 shares of stock at $40 per share. Since then, the price of the stock has risen to $75 per share. It is now near the end of the year, and the market is starting to wea
> Will this regulation be able to eliminate conflict of interest? Discuss.
> How would you describe a satisfactory investment? How does security analysis help in identifying investment candidates?
> Susan Lussier is 35 years old and employed as a tax accountant for a major oil and gas exploration company. She earns nearly $135,000 a year from her salary and from participation in the company’s drilling activities. An expert on oil a
> Differentiate among the following types of investments, and cite an example of each: (a) securities and property investments; (b) direct and indirect investments; (c) debt, equity, and derivative securities; and (d) short-term and long-term investments.
> Define the term investment, and explain why individuals invest.
> Describe the steps involved in measuring portfolio return. Explain the role of the portfolio’s HPR in this process and explain why one must differentiate between realized and unrealized gains.
> Discuss the impact of the Internet on the individual investor and summarize the types of resources it provides.
> Describe the risks of investing internationally, particularly currency exchange risk.
> Describe how foreign security investments can be made, both indirectly and directly.
> Why is globalization of securities markets an important issue today? How have international investments performed in recent years?
> Explain how the dealer market works. Be sure to mention market makers, bid and ask prices, the Nasdaq market, and the OTC market. What role does the dealer market play in initial public offerings (IPOs) and secondary distributions?
> For each of the items in the left-hand column, select the most appropriate item in the right-hand column. a. Prospectus b. Underwriting 1. Trades unlisted securities 2. Buying securities from firms and reselling them to investors 3. Conditions a fir
> Briefly describe the IPO process and the role of the investment banker in underwriting a public offering. Differentiate among the terms public offering, rights offering, and private placement.
> Hector Francisco is a successful businessman in Atlanta. The box-manufacturing firm he and his wife, Judy, founded several years ago has prospered. Because he is self-employed, Hector is building his own retirement fund. So far, he has accumulated a subs
> What is intrinsic value? How does it fit into the security analysis process?
> Describe the key advantages and disadvantages of short selling. How are short sales used to earn speculative profits?
> What is active portfolio management? Will it result in superior returns? Explain.
> Judd Read and Judi Todd, senior accounting majors at a large midwestern university, have been good friends since high school. Each has already found a job that will begin after graduation. Judd has accepted a position as an internal auditor in a medium-s
> Consider the model of Section 7.8. Suppose, however, that monetary policy responds to current inflation and output: rt = φππt +φyyt +uMP t . (a) For the case of white-noise disturbances, find expressions analogous to (7.92) (7.94). What are the effects o
> Consider a continuous-time version of the Mankiw Reis model. Opportunities to review pricing policies follow a Poisson process with arrival rate α>0. Thus the probability that a price path set at time t is still being followed at time t +i is e−αi. The o
> Consider the analysis of the new Keynesian Phillips curve with indexation in Section 7.7. Suppose, however, that the indexation is only partial. That is, if a firm does not have an opportunity to review its price in period t, its price in t is the previo
> Suppose the economy is described by the model of Section 7.2, except that instead of half of firms setting their prices each period, fraction f set their prices in odd periods and fraction 1− f set their prices in even periods. Thus the price level is fp
> (a) Consider the model in equations (6.29) (6.32). Solve the model using the method of undetermined coefficients. That is, conjecture that the solution takes the form yt =AuIS t , and find the value that A must take for the equations of the model to hold
> Consider the model in equations(6.29) (6.32).Suppose, however, there are shocks to the MP equation but not the I Sequation. Thus rt =byt+uMP t ,uMP t = ρMPuMP t−1+e MP t (where −1
> Consider the following model. The dynamics of inflation are given by the continuous-time version of (6.23) (6.24): π(t) = λ[y(t)− y(t)], λ>0. The IS curve takes the traditional form, y(t) =− [i(t) − π(t)]/θ , θ>0. The central bank sets the interest rate
> Suppose the economy is described by two equations. The first is the IS equation, which for simplicity we assume takes the traditional form, Yt =−rt/θ. The second is the money-market equilibrium condition, which we can write as m −p=L(r +πe,Y), Lr+πe < 0,
> Let gt be growth of output per worker in period tπt inflation, and πW t wage inflation. Suppose that initially g is constant and equal to gL and that unemployment is at the level that causes inflation to be constant. g then rises permanently to gH > gL.
> The analysis of Case 1 in Section 6.2 assumes that employment is determined by labor demand. Under perfect competition, however, employment at a given real wage will equal the minimum of demand and supply; this is known as the short-side rule. Draw diagr
> Consider the following variant of the model in equations (11.39) (11.42). The firm’s profits are π = AF(LI +LO)−wI LI −wOLO, where LI and LO are the numbers of insiders and outsiders the firm hires, and wI and wO are their wages. LI always equals LI, and
> Consider a consumer with a steady flow of real purchases of amount αY,0
> Consider an economy consisting of some firms with flexible prices and some with rigid prices. Let p f denote the price set by a representative flexible-price firm and pr the price set by a representative rigid-price firm. Flexible-price firms set their p
> Suppose that the money supply is determined by mt = czt−1 +et, where c and z are vectors and et is an i.i.d. disturbance uncorrelated with zt−1. et is unpredictable and unobservable. Thus the expected component of mt is czt−1, and the unexpected componen
> Consider the problem facing an individual in the Lucas model when Pi/P is unknown. The individual chooses Li to maximize the expectation of Ui; Ui continues to be given by equation (6.74). (a) Find the first-order condition for Yi, and rearrange it to ob
> Consider an island consisting of N people and many palm trees. Each person is in one of two states, not carrying a coconut and looking for palm trees (state P) or carrying a coconut and looking for other people with coconuts (state C). If a person withou
> Suppose production at firm i is given by Yi =SLα i , where S is a supply shock and 0
> Consider an economy consisting of many imperfectly competitive, price setting firms. The profits of the representative firm, firm i, depend on aggregate output, y, and the firm’s real price, ri: πi = π(y,ri), where π22 < 0 (subscripts denote partial deri
> Consider an economy consisting of many imperfectly competitive firms. The profits that a firm loses relative to what it obtains with pi =p∗ are K(pi − p∗)2, K >0. As usual, p∗=p+φy and y =m − p. Each firm faces a fixed cost Z of changing its nominal pric
> Consider the model in equations(6.29) (6.32).Suppose, however, that the Et[yt+1] term in (6.31) is multiplied by a coefficient ω,0
> Describe how, if at all, each of the following developments affects the curves. (a) The coefficient of relative risk aversion, θ, rises. (b) The curvature of (•),χ, falls. (c) We modify the utility function, (6.2), to bet βt[U(Ct)+B(Mt/Pt)−V(Lt)], B > 0,
> Consider the model of Section 11.3. Suppose, however, that only the firm observes A. In addition, suppose there are only two possible values of A, AB and AG (AB < AG), each occurring with probability 1 2. We can think of the contract as specifying w and
> Consider the setup in Problem 5.8. Assume, however, that the technological disturbances (the e’s) are absent and that the instantaneous utility function is u(Ct) = Ct −θ(Ct +νt)2. The ν’s are mean-zero, i.i.d. shocks. (a) Find the first-order condition (
> Consider an economy consisting of a constant population of infinitely lived individuals. The representative individual maximizes the expected value of∞ t=0 u(Ct)/(1+ρ)t, ρ>0. The instantaneous utility function, u(Ct), is u(Ct) = Ct −θC2 t , θ>0. Assume t
