Question: Mary Smith, a CFA candidate, was recently
Mary Smith, a CFA candidate, was recently hired for an analyst position at the Bank of Ireland. Her first assignment is to examine the competitive strategies employed by various French wineries. Smith’s report identifies four wineries that are the major players in the French wine industry. Key characteristics of each are cited in Table 12.6. In the body of Smith’s report, she notes that over the past five years, the French wine industry has not responded to changing consumer tastes. Profit margins have declined steadily, and the number of firms representing the industry has decreased from 10 to 4. It appears that participants in the French wine industry must consolidate to survive. Table 12.6: 
Smith’s report notes that French consumers have strong bargaining power over the industry. She supports this conclusion with the following five points: Many consumers are drinking more beer than wine with meals and at social occasions. Increasing sales over the Internet have allowed consumers to better research the wines, read opinions from other customers, and identify which producers have the best prices. The French wine industry is consolidating and consists of only 4 wineries today compared to 10 wineries five years ago. More than 65% of the business for the French wine industry consists of purchases from restaurants. Restaurants typically make purchases in bulk, buying four to five cases of wine at a time. Land where the soil is fertile enough to grow grapes necessary for the wine production process is scarce in France. Smith takes her report to her boss, Ron Van Driesen, to review and tells him, “In my report I have classified the South Winery as a stuck-in-the-middle firm. It tries to be a cost leader by selling its wine at a price that is slightly below the other firms, but it also tries to differentiate itself from its competitors by producing wine in bottles with curved necks, which increases its cost structure. The end result is that the South Winery’s profit margin gets squeezed from both sides.†Van Driesen replies, “I believe that the South Winery could succeed at following both a cost leadership and a differentiation strategy if its operations were separated into distinct operating units, with each unit pursuing a different competitive strategy.†Smith makes a note to do more research on generic competitive strategies to verify Van Driesen’s assertions before publishing the final draft of her report. Smith notes in her report that the West Winery might differentiate its wine product on attributes that buyers perceive to be important. Which of the following attributes would be the most likely area of focus to create a differentiated product? a. The method of delivery for the product. b. The price of the product. c. A focus on customers aged 30 to 45.
> The market consensus is that Analog Electronic Corporation has an ROE of 9% and a beta of 1.25. It plans to maintain indefinitely its traditional plowback ratio of 2/3. This year’s earnings were $3 per share. The annual dividend was just paid. The consen
> In what circumstances is it most important to use multistage dividend discount models rather than constant growth models?
> The DuPont formula defines the net return on shareholders’ equity as a function of the following components Operating margin. Asset turnover. Interest burden. Financial leverage. Income tax rate.Using only the data in Table 14.20: a. C
> a. MF Corp. has an ROE of 16% and a plowback ratio of 50%. If the coming year’s earnings are expected to be $2 per share, at what price will the stock sell? The market capitalization rate is 12%. b. What price do you expect MF shares to sell for in thre
> Even Better Products has come out with an even better product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of 0.30. Its earnings this year will be $2 per share. Investors expect a 12% rate of return on the stock.
> a. Computer stocks currently provide an expected rate of return of 16%. MBI, a large computer company, will pay a year-end dividend of $2 per share. If the stock is selling at $50 per share, what must be the market’s expectation of the growth rate of MBI
> Explain why the following statements are true/false/uncertain. a. With all else held constant, a firm will have a higher P/E if its beta is higher. b. P/E will tend to be higher when ROE is higher (assuming plowback is positive). c. P/E will tend to be
> The risk-free rate of return is 5%, the required rate of return on the market is 10%, and High-Flyer stock has a beta coefficient of 1.5. If the dividend per share expected during the coming year, D1, is $2.50 and g = 4%, at what price should a share sel
> A common stock pays an annual dividend per share of $2.10. The risk-free rate is 7% and the risk premium for this stock is 4%. If the annual dividend is expected to remain at $2.10, what is the value of the stock?
> Fin Corp’s free cash flow to the firm is reported as $205 million. The firm’s interest expense is $22 million. Assume the corporate tax rate is 21% and the net debt of the firm increases by $3 million. What is the market value of equity if the FCFE is pr
> Eagle Products’ EBIT is $300, its tax rate is 21%, depreciation is $20, capital expenditures are $60, and the planned increase in net working capital is $30. What is the free cash flow to the firm?
> Sisters Corp. expects to earn $6 per share next year. The firm’s ROE is 15% and its plowback ratio is 60%. If the firm’s market capitalization rate is 10%, what is the present value of its growth opportunities?
> Miltmar Corporation will pay a year-end dividend of $4, and dividends thereafter are expected to grow at the constant rate of 4% per year. The risk-free rate is 4%, and the expected return on the market portfolio is 12%. The stock has a beta of 0.75. Wha
> Scott Kelly is reviewing Master Toy’s financial statements to estimate its sustainable growth rate. Using the information presented in Table 14.19: a. Identify and calculate the components of the DuPont formula. b. Calculate the ROE fo
> In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm?
> Which of the following is not a governmental structural policy that supply-side economists believe would promote long-term growth in an economy? a. A redistributive tax system. b. Promotion of competition. c. Minimal government interference in the eco
> Which of the following is consistent with a steeply upwardly sloping yield curve? a. Monetary policy will be expansive and fiscal policy will be expansive b. Monetary policy will be expansive while fiscal policy will be restrictive. c. Monetary policy wi
> Define each of the following in the context of a business cycle. a. Peak. b. Contraction. c. Trough. d. Expansion
> The present value of a firm’s projected cash flows are $15 million. The breakup value of the firm if you were to sell the major assets and divisions separately would be $20 million. This is an example of what Peter Lynch would call a(n): a. Stalwart. b
> How do each of the following affect the sensitivity of profits to the business cycle? a. Financial leverage. b. Operating leverage.
> The price of oil fell dramatically in 2020. What sort of macroeconomic shock would this be considered?
> Which one of the following firms would be described as having belowaverage sensitivity to the state of the economy? a. An asset play firm. b. A cyclical firm. c. A defensive firm. d. A stalwart firm.
> Mary Smith, a CFA candidate, was recently hired for an analyst position at the Bank of Ireland. Her first assignment is to examine the competitive strategies employed by various French wineries. Smith’s report identifies four wineries t
> Institutional Advisors for All Inc. (IAAI) is a consulting firm that advises foundations, endowments, pension plans, and insurance companies. The research department predicts an upward trend in job creation and consumer confidence, which it expects to co
> The information in the following table comes from the 2020 financial statements of QuickBrush Company and Smile White Corporation: Determine which company has the higher quality of earnings by discussing each of the three notes.
> Institutional Advisors for All Inc. (IAAI) is a consulting firm that advises foundations, endowments, pension plans, and insurance companies. The research department predicts an upward trend in job creation and consumer confidence, which it expects to co
> Institutional Advisors for All Inc. (IAAI) is a consulting firm that advises foundations, endowments, pension plans, and insurance companies. The research department predicts an upward trend in job creation and consumer confidence, which it expects to co
> General Weed killers dominates the chemical weed control market with its patented product Weed-ex. The patent is about to expire, however. What are your forecasts for changes in the industry? Specifically, what will happen to industry prices, sales, the
> You have $5,000 to invest for the next year and are considering three alternatives: a. A money market fund with an average maturity of 30 days offering a current annualized yield of 3%. A two-year CD at a bank offering an interest rate of 4.5%. c. A 20
> Why do you think the change in the index of labor cost per unit of output is a useful lagging indicator of the macroeconomy? (See Table 12.2.) Table 12 .2:
> Why do you think the index of consumer expectations for business conditions is a useful leading indicator of the macro economy? (See Table 12.2 Table 12.2:
> In which stage of the industry life cycle would you place the following industries? (Note: There is considerable room for disagreement concerning the “correct” answers to this question. a. Oil well equipment. b. Computer hardware. c. Computer software
> For each pair of firms, choose the one that you think would be more sensitive to the business cycle. a. General Autos or General Pharmaceuticals. b. Friendly Airlines or Happy Cinemas.
> Why does it make intuitive sense that the slope of the yield curve is considered a leading economic indicator?
> Here are four industries and four forecasts for the macro economy. Choose the industry that you would expect to perform best in each scenario. Industries: housing construction, health care, gold mining, steel production. Economic Forecasts: Deep recessio
> Janet Ludlow is a recently hired analyst. After describing the electric toothbrush industry, her first report focuses on two companies, QuickBrush Company and SmileWhite Corporation, and concludes: Quick Brush is a more profitable company than Smile Whit
> According to supply-side economists, what will be the long-run impact on prices of a reduction in income tax rates? [Hint: Think about the wage rate that workers are willing to accept
> Consider two firms producing smart phones. One uses a highly automated robotics process, while the other uses human workers on an assembly line and pays overtime when there is heavy production demand.) a. Which firm will have higher profits in a recessi
> Unlike other investors, you believe the Fed is going to dramatically loosen monetary policy. What would be your recommendations about investments in the following industries? a. Gold mining. b. Construction
> If you believe the U.S. dollar is about to depreciate more dramatically than do other investors, what will be your stance on investments in U.S. auto producers?
> What monetary and fiscal policies might be prescribed for an economy in a deep recession?
> Choose an industry and identify the factors that will determine its performance in the next three years. What is your forecast for performance in that time period?
> ATech has fixed costs of $7 million and profits of $4 million. Its competitor, ZTech, is roughly the same size and this year earned the same profits, $4 million. But it operates with higher fixed costs of $8 million and lower variable costs. a. Which fi
> If the nominal interest rate is 5% and the inflation rate is 3%, what is the real interest rate?
> What is typically true of corporate dividend payout rates in the early stages of an industry life cycle? Why does this make sense?
> What are the differences between bottom-up and top-down approaches to security valuation? What are the advantages of a top down approach?
> Use the financial statements for Chicago Refrigerator Inc. (see Tables 14.15 and 14.16) to compute ratios a through h for 2022.) a. Quick ratio. b. Return on assets. c. Return on common shareholders’ equity. d. Earnings per share of
> As part of your analysis of debt issued by Monticello Corporation, you are asked to evaluate two specific bond issues, shown in the table below. a. Using the duration and yield information in the table, compare the price and yield behavior of the two bon
> Mary Smith, a CFA candidate, was recently hired for an analyst position at the Bank of Ireland. Her first assignment is to examine the competitive strategies employed by various French wineries. Smith’s report identifies four wineries t
> Mary Smith, a CFA candidate, was recently hired for an analyst position at the Bank of Ireland. Her first assignment is to examine the competitive strategies employed by various French wineries. Smith’s report identifies four wineries t
> A 12.75-year-maturity zero-coupon bond selling at a yield to maturity of 8% has convexity of 150.3 and modified duration of 11.81 years. A 30-year-maturity 6% coupon bond making annual coupon payments also selling at a yield to maturity of 8% has nearly
> A 30-year maturity bond has a 7% coupon rate, paid annually. It sells today for $867.42. A 20-year maturity bond has a 6.5% coupon rate, also paid annually. It sells today for $879.50. A bond market analyst forecasts that in five years, 25-year maturity
> Currently, the term structure is as follows: One-year bonds yield 7%, two-year zero-coupon bonds yield 8%, three-year- and longer-maturity zero-coupon bonds all yield 9%. You are choosing between one-, two-, and three-year maturity bonds all paying annua
> A 30-year maturity bond making annual coupon payments with a coupon rate of 12% has duration of 11.54 years and convexity of 192.4. The bond currently sells at a yield to maturity of 8%. a. Use a financial calculator or spreadsheet to find the price of
> a. Footnote 2 in the chapter presents the formula for the convexity of a bond. Build a spreadsheet to calculate the convexity of the 8% coupon bond in Spreadsheet 11.1 at the initial yield to maturity of 10%. b. What is the convexity of the zero-coupon
> a. Use a spreadsheet to calculate the durations of the two bonds in Spreadsheet 11.1 if the market interest rate increases to 12%. Why does the duration of the coupon bond fall while that of the zero remains unchanged? (Hint: Examine what happens to the
> Find the convexity of a seven-year maturity, 6% coupon bond selling at a yield to maturity of 8%. The bond pays its coupons annually. (Hint: You can use the spreadsheet from this chapter’s Excel Application on Convexity, setting cash flows after year 7 e
> Which of the following best explains a ratio of “net sales to average net fixed assets” that exceeds the industry average?) a. The firm added to its plant and equipment in the past few years. b. The firm makes less efficient use of its assets than othe
> You manage a pension fund that will provide retired workers with lifetime annuities. You determine that the payouts of the fund are going to closely resemble level perpetuities of $1 million per year. The interest rate is 10%. You plan to fully fund the
> What is the duration of the bond in the previous problem if coupons are paid annually? Explain why the duration changes in the direction it does.
> Find the duration of a bond with settlement date May 27, 2018, and maturity date November 15, 2027. The coupon rate of the bond is 7%, and the bond pays coupons semiannually. The bond is selling at a yield to maturity of 8%. You can use Spreadsheet 11.2,
> You are managing a portfolio of $1 million. Your target duration is 10 years, and you can choose from two bonds: a zero-coupon bond with maturity five years and a perpetuity, each currently yielding 5%. a. How much of (i) the zero-coupon bond and (ii) t
> Spice asks Meyers (see previous problem) to quantify price changes from changes in interest rates. To illustrate, Meyers computes the value change for the fixed-rate note in the table. Specifically, he assumes an increase in the level of interest rate of
> Frank Meyers, CFA, is a fixed-income portfolio manager for a large pension fund. A member of the Investment Committee, Fred Spice, is very interested in learning about the management of fixed-income portfolios. Spice has approached Meyers with several qu
> Pension funds pay lifetime annuities to recipients. If a firm remains in business indefinitely, the pension obligation will resemble a perpetuity. Suppose, therefore, that you are managing a pension fund with obligations to make perpetual payments of $2
> You will be paying $10,000 a year in tuition expenses at the end of the next two years. Bonds currently yield 8%. a. What are the present value and duration of your obligation? b. What maturity zero-coupon bond would immunize your obligation? c. Suppo
> Long-term Treasury bonds currently are selling at yields to maturity of nearly 6%. You expect interest rates to fall. The rest of the market thinks that they will remain unchanged over the coming year. In each question, choose the bond that will provide
> Rank the interest rate sensitivity of the following pairs of bonds. a. Bond A is a 6% coupon, 20-year-maturity bond selling at par value. Bond B is a 6% coupon, 20-year-maturity bond selling below par value. b. Bond A is a 20-year, noncallable coupon b
> Jones Group has been generating stable after-tax return on equity (ROE) despite declining operating income. Explain how it might be able to maintain its stable after-tax ROE.
> You own a fixed-income asset with a duration of five years. If the level of interest rates, which is currently 8%, goes down by 10 basis points, how much do you expect the price of the asset to go up (in percentage terms)?
> If the plan in the previous problem wants to fully fund and immunize its position, how much of its portfolio should it allocate to one-year zero-coupon bonds and perpetuities, respectively, if these are the only two assets funding the plan?
> A pension plan is obligated to make disbursements of $1 million, $2 million, and $1 million at the end of each of the next three years, respectively. Find the duration of the plan’s obligations if the interest rate is 10% annually.
> A nine-year bond paying coupons annually has a yield of 10% and a duration of 7.194 years. If the bond’s yield changes by 50 basis points, what is the percentage change in the bond’s price?
> a. Find the duration of a 6% coupon bond making annual coupon payments if it has three years until maturity and a yield to maturity of 6%. b. What is the duration if the yield to maturity is 10%?
> Short-term interest rates are more volatile than long-term rates. Despite this, the rates of return of long-term bonds are more volatile than returns on short-term securities. How can these two empirical observations be reconciled?
> Is the decrease in a bond’s price corresponding to an increase in its yield to maturity more or less than the price increase resulting from a decrease in yield of equal magnitude?
> You are being interviewed for a job as a portfolio manager at an investment counseling partnership. As part of the interview, you are asked to demonstrate your ability to develop investment portfolio policy statements for the clients listed below: a. A
> Under the flat tax (Spreadsheet 21.4), will a 1% increase in ROR offset a 1% increase in the tax rate?
> What savings rate from real income (Spreadsheet 21.3) will produce the same retirement annuity as a 15% savings rate from nominal income?
> To continue with Sundanci, Abbey Naylor, CFA, has been directed to determine the value of Sundanci’s stock using the free cash flow to equity (FCFE) model. Naylor believes that Sundanci’s FCFE will grow at 27% for two years and 13% thereafter. Capital ex
> With a 3% inflation rate (Spreadsheet 21.2), by how much would your retirement annuity grow if you increase the savings rate by 1%? Is the benefit greater in the face of inflation?
> With no taxes or inflation (Spreadsheet 21.1), what would be your retirement annuity if you increase the savings rate by 1%?
> Why does a progressive tax code produce a retirement annuity for a middle-class household that is similar to that which would follow from a flat tax?
> What is the insurance aspect of the Social Security annuity?
> What type of investors would be interested in a target date retirement fund? Why?
> The same ship owner advertises a tariff whereby the freight charged per pound for all cargo will be the same. What kind of cargo can the ship owner expect to attract?
> Give another example of a moral hazard problem.
> In addition to expected longevity, what traits might affect an individual’s demand for a life annuity?
> Give another example of adverse selection
> Project your Social Security benefits with the parameters of Section 21.6.
> Helen Morgan, CFA, has been asked to use the dividend discount model to determine the value of Sundanci, Inc. Morgan anticipates that Sundanci’s earnings and dividends will grow at 32% for two years and 13% thereafter.Calculate the curr
> What is the trade-off between ROR and the rate of inflation with a Roth plan under a progressive tax (Spreadsheet 21.8)?
> Verify that the traditional tax shelter with a progressive tax (Spreadsheet 21.7) acts as a hedge. Compare the effect of a decline of 2% in the ROR to an increase of 2% in ROR.
> With a progressive tax (Spreadsheet 21.6), compare the effects of an increase of 1% in the lowest tax bracket to an increase of 1% in the highest tax bracket
> With a traditional tax shelter (Spreadsheet 21.5), compare the effect on real consumption during retirement of a 1% increase in the rate of inflation to a 1% increase in the tax rate
> A ship owner is attempting to insure an old vessel for twice its current market value. Is this an adverse selection or moral hazard issue?
> Why is it harder to assess the performance of a hedge fund portfolio manager than that of a typical mutual fund manager?
> How might the incentive fee of a hedge fund affect the manager’s proclivity to take on high-risk assets in the portfolio?
> Which of the following hedge fund types is most likely to have a return that is closest to risk free? a. A market-neutral hedge fund. b. An event-driven hedge fund. c. A long-short hedge fund.
> With respect to hedge fund investing, the net return to an investor in a fund of funds would be lower than that earned from an individual hedge fund because of: a. Both the extra layer of fees and the higher liquidity offered. b. No reason; funds of fu
