Investments Test 2 Study Guide

TEST 2
B) 6.6%
C) 8.4%
D) 8.7%
Answer: B
Fundamentals of Investing, 12e

(Smart/Gitman/Joehnk)
Chapter 5 Modern Portfolio Concepts
9) A portfolio consisting of four stocks is expected to

produce returns of 9%, 11%, 3% and 17%,
respectively, over the next four years. What is the
standard deviation of these expected returns?
A) 5.00%
B) 5.77%
C) 25.00%
D) 33.33%
Answer: B
5.1 Learning Goal 1

1) Portfolio objectives should be established before
beginning to invest.
Answer: TRUE
2) A portfolio that offers the lowest risk for a given
level of return is known as an efficient portfolio.
Answer: TRUE
10) The stock of a technology company has an

expected return of 15% and a standard deviation of
20%. The stock of a pharmaceutical company has an
expected return of 13% and a standard deviation of
18%. A portfolio consisting of 50% invested in each
stock will have an expected return of 14 % and a
standard deviation
A) less than the average of 20% and 18%.
B) the average of 20% and 18%.
C) greater than the average of 20% and 18%.
D) the answer cannot be determined with the
information given.
Answer: A
3) By plotting the efficient frontier, investors can find

the unique portfolio that is ideal for all investors.
Answer: FALSE
4) Portfolio objectives should be established
independently of tax considerations.
Answer: FALSE
5) If the actual rate of return on an investment
portfolio is constant from year to year, the standard
deviation of that portfolio is zero.
Answer: TRUE
11) The statement "A portfolio is less than the sum of

its parts." means:
A) it is less expensive to buy a group of assets than to
buy those assets individually.
B) portfolio returns will always be lower than the
returns on individual stocks.
C) a diversified group of assets will be less volatile
than the individual assets within the group.
D) for reasons that are not well understood, the value
of a portfolio is less than the sum of the values of its
components.
Answer: C
6) An efficient portfolio maximizes the rate of return

without consideration of risk.
Answer: FALSE
7) Melissa owns the following portfolio of stocks.
What is the return on her portfolio?
A) 8.0%
B) 9.0%
C) 9.8%
D) 10.9%
Answer: C
5.2 Learning Goal 2
8) Marco owns the following portfolio of stocks.

What is the expected return on his portfolio?
2) Correlation is a measure of the relationship

between two series of numbers.
Answer: TRUE
1) Negatively correlated assets reduce risk more than

positively correlated assets.
Answer: TRUE
3) Risk can be totally eliminated by combining two

assets that are perfectly positively correlated.
Answer: FALSE
4) Investing globally offers better diversification than
A) 4.7%
1
Copyright 2014 Pearson Education, Inc.
investing only domestically.

Answer: TRUE
B) tend to be somewhat negatively correlated.

C) tend to be uncorrelated.
D) tend to be either perfectly positively or perfectly
negatively correlated.
Answer: A
5) Studies have shown that investing in different

industries as well as different countries reduces
portfolio risk.
Answer: TRUE
15) The risk of a portfolio consisting of two

uncorrelated assets will be
A) equal to zero.
B) greater than the risk of the least risky asset but less
than the risk level of the more risky asset.
C) greater than zero but less than the risk of the more
risky asset.
D) equal to the average of the risk level of the two
assets.
Answer: C
6) Coefficients of correlation range from a maximum

of +10 to a minimum of -10.
Answer: FALSE
7) Maximum international diversification can be
achieved by investing solely in U.S. multinational
corporations.
Answer: FALSE
8) In severe market downturns different asset classes
become less correlated.
Answer: FALSE
16) Over the long term, a portfolio consisting of an

S&P 500 index and an EAFE index will generally
produce ________ returns and have ________ risk
than a portfolio comprised solely of the S&P 500
index.
A) higher; more
B) higher; less
C) lower; more
D) lower; less
Answer: B
9) Investing in emerging markets is an effective

means of diversifying a U.S. portfolio.
Answer: TRUE
10) The transaction costs of investing directly in
foreign-currency-denominated assets can be reduced
by purchasing American Depositary Shares (ADSs).
Answer: TRUE
17) Which one of the following will provide the

greatest international diversification?
A) directly purchasing a foreign stock
B) purchasing stock of a U.S. multinational firm
C) purchasing an ADS
D) purchasing shares of an international mutual fund
Answer: D
11) If there is no relationship between the rates of

return of two assets over time, these assets are
A) positively correlated.
B) negatively correlated.
C) perfectly negatively correlated.
D) uncorrelated.
Answer: D
18) American investors have several alternatives

available to diversify their portfolios internationally.
In terms of transaction costs, which of the
alternatives below is least attractive?
A) mutual funds with an international focus.
B) stocks of U.S. based companies with extensive
foreign sales and/or operations.
C) direct investment in foreign stocks.
D) American Depositary Shares
Answer: C
12) Combining uncorrelated assets will

A) increase the overall risk level of a portfolio.
B) decrease the overall risk level of a portfolio.
C) not change the overall risk level of a portfolio.
D) cause the other assets in the portfolio to become
positively related.
Answer: B
13) Two assets have a coefficient of correlation of -.4.
A) Combining these assets will increase risk.
B) Combining these assets will have no effect on risk.
C) Combining these assets may either raise or lower
risk.
D) Combining these assets will reduce risk.
Answer: D
19) American depositary shares (ADS) are

A) shares of foreign companies traded on the U.S.
markets.
B) shares of American companies traded on foreign
markets.
C) foreign currency deposits in American banks.
D) American currency deposits in foreign banks
Answer: A
14) In the real world, most of the assets available to

investors
A) tend to be somewhat positively correlated.
5.3 Learning Goal 3
2
II. the economy goes into a recessionary period

III. a company's product is recalled for defects
IV. the Federal Reserve unexpectedly changes
interest rates
A) I, II and IV only
B) II and IV only
C) I and III only
D) I, II and III only
Answer: C
1) Diversifiable risk is also called systematic risk.

Answer: FALSE
2) Standard deviation is a measure that indicates how
the price of an individual security responds to market
forces.
Answer: FALSE
3) Market return is estimated from the average return
on a large sample of stocks such as those in the
Standard & Poor's 500 Stock Composite Index.
Answer: TRUE
15) Which of the following represent systematic

risks?
I. the president of a company suddenly resigns
II. the economy goes into a recessionary period
III. a company's product is recalled for defects
IV. the Federal Reserve unexpectedly changes
interest rates
B) II and IV only
C) I and III only
Answer: B
4) It is relatively easy to obtain the beta for actively

traded stocks.
Answer: TRUE
5) A negative beta means that on average a stock
moves in the opposite direction of the market.
Answer: TRUE
6) A beta of 0.5 means that a stock is half as risky the
overall market.
Answer: TRUE
16) Estimates of a stock's beta may vary depending

on
I. when the estimate was made
II. the standard deviation of the stock's returns
III. how many months of returns were used to
estimate the beta
IV. the index used to represent market returns.
B) II and IV only
C) I, III and IV only
Answer: C
7) The index used to represent market returns is

always assigned a beta of 1.0.
Answer: TRUE
8) The betas of most stocks are constant over time.
Answer: FALSE
9) A stock with a beta of 1.3 is less risky than a stock
with a beta of 0.42.
Answer: FALSE
17) Which one of the following conditions can be

effectively eliminated through portfolio
diversification?
A) a general price increase nationwide
B) an interest rate reduction by the Federal Reserve
C) increased government regulation of auto
emissions
D) change in the political party that controls
Congress
Answer: C
10) For stocks with positive betas, higher risk stocks

will have higher beta values.
Answer: TRUE
11) Adding stocks with higher standard deviations to
a portfolio will necessarily increase the portfolio's
risk.
Answer: FALSE
12) Beta measures diversifiable risk while standard
deviation measures systematic risk.
Answer: FALSE
18) Which one of the following types of risk cannot

be effectively eliminated through portfolio
diversification?
A) inflation risk
B) labor problems
C) materials shortages
D) product recallsAnswer: A
20) Systematic risks
A) can be eliminated by investing in a variety of
economic sectors.
13) Historical betas are always reliable predictors of

future return fluctuations.
Answer: FALSE
14) Which of the following represent unsystematic
risks?
I. the president of a company suddenly resigns
3
B) are forces that affect all investment categories.

C) result from random firm-specific events.
D) are unique to certain types of investment.
Answer: B
27) When the stock market has bottomed out and is

beginning to recover, the best portfolio to own is the
one with a beta of
A) 0.0.
B) +0.5.
C) +1.5.
D) +2.0.
Answer: D
21) A measure of systematic risk is

A) standard deviation.
B) correlation coefficient.
C) beta.
D) variance.
Answer: C
28) The best stock to own when the stock market is at

a peak and is expected to decline in value is one with
a beta of
A) +1.5.
B) +1.0.
C) -1.0.
D) -0.5.
Answer: C
22) Beta can be defined as the slope of the line that

explains the relationship between
A) the return on a security and the return on the
market.
B) the returns on a security and various points in
time.
C) the return on stocks and the returns on bonds.
D) the risk free rate of return versus the market rate
of return.
Answer: A
29) Security A has a beta of .99, security B has a beta

of 1.2, and security C has a beta of -1.0. This
information indicates that
A) security A has the highest degree of market risk.
B) security B has 20% more systematic risk than the
market.
C) security C has the highest degree of market risk.
D) security C would be the best investment if a
strong bull market is expected.
Answer: B
23) In designing a portfolio, relevant risk is

A) total risk.
B) unsystematic risk.
C) event risk.
D) nondiversifiable risk.
Answer: D
30) Beta is the slope of the best fit line for the points
with coordinates representing the ________ and the
________ for each one of several years.
A) rate of return; level of risk for an individual
security
B) rate of inflation; rate of return for an individual
security
C) risk level of a stock; market rate of return
D) market rate of return; security's rate of return
Answer: D
24) Which of the following best describes the

relationship between a stock's beta and the standard
deviation of the stock's returns?
A) The higher the standard deviation, the higher the
beta.
B) The higher the standard deviation, the lower the
beta.
C) There is no particular relationship between a
stock's standard deviation of returns and it's beta.
D) Standard deviation and beta are different ways of
measuring the same thing.
Answer: C
31) The stock of ABC, Inc. has a beta of 1.10. The

market rate of return is expected to increase in value
by 5%. ABC stock should
A) increase in value by 0.5%.
B) increase in value by 5.5%.
C) decrease in value by 0.5%.
D) decrease in value by 5.5%.
Answer: B
25) A stock's beta value is a measure of

A) interest rate risk.
B) total risk.
C) systematic risk.
D) diversifiable risk.
Answer: C
32) Analysts commonly use the ________ to measure

market return.
A) the Dow Jones Industrial Average
B) the rate of return on 10 year Treasury bonds
C) some large, mainstream company such as General
Electric
D) the Standard & Poor's 500 Index
Answer: D
26) The beta of the market is

A) -1.0.
B) 0.0.
C) 1.0.
D) undefined.
Answer: C
4
required return for this investment is

A) 8.85%.
B) 11.48%.
C) 13.98%.
D) 14.85%.
Answer: C
33) The market rate of return increased by 8% while

the rate of return on XYZ stock increased by 4%. The
beta of XYZ stock is
A) -2.0.
B) -0.40.
C) 0.50.
D) 2.0.
Answer: C
7) OKAY stock has a beta of 0.73. The market as a

whole is expected to decline by 20% thereby causing
OKAY stock to
A) decline by 14.6%.
B) decline by 20.7%.
C) increase by 14.6%.
D) increase by 20.7%.
Answer: A
34) Which of the following statements concerning

beta are correct?
I. Adding stocks with high betas to a portfolio
increases the portfolio's risk.
II. The higher the beta, the higher the expected
return.
III. A beta can be positive, negative, or equal to zero.
IV. A beta of .35 indicates a lower rate of risk than a
beta of -0.50.
A) II and III only
B) I and IV only
C) II, III and IV only
D) I, II, III and IV
Answer: D
8) The Capital Asset Pricing Model (CAPM) is a

mathematical model that depicts the
A) positive relationship between risk and return.
B) standard deviation between a risk premium and an
investment's expected return.
C) exact price that an investor should be willing to
pay for any given investment.
D) difference between a risk-free return and the
expected rate of inflation.
Answer: A
5.4 Learning Goal 4

1) The basic theory linking portfolio risk and return is
the Capital Asset Pricing Model.
Answer: TRUE
9) When the Capital Asset Pricing Model is depicted

graphically, the result is the
A) standard deviation line.
B) coefficient of variation line.
C) security market line.
D) alpha-beta line.
Answer: C
2) The CAPM estimates the required rate of return on

a stock held as part of a well diversified portfolio.
Answer: TRUE
3) The Dow Jones Industrial Average of thirty stocks
is a suitable proxy for market returns in the CAPM.
Answer: FALSE
10) Which of the following factors comprise the

CAPM?
I. dividend yield
II. risk-free rate of return
III. the expected rate of return on the market
IV. risk premium for the firm
A) I and III only
B) II and IV only
C) III and IV only
D) II, III and IV only
Answer: D
4) In the Capital Asset Pricing Model, beta measures

a stock's sensitivity to overall market returns.
Answer: TRUE
5) According to the CAPM, the required rate of a
return on a stock can be estimated using only beta
and the risk-free rate.
Answer: FALSE
11) The Franko Company has a beta of 1.09. By what

percent will the rate of return on the stock of Franko
Company increase if the market rate of return rises by
3%?
A) 1.91%
B) 2.75%
C) 3.27%
D) 4.09%
Answer: C
6) You have gathered the following information

concerning a particular investment and conditions in
the market.
According to the Capital Asset Pricing Model, the
5
12) What is the expected return on a stock with a beta

of 1.09, a market risk premium of 8%, and a risk-free
rate of 4%?
A) 4.36%
B) 8.36%
C) 8.72%
D) 12.72%
Answer: D
B) 5.3%
C) 12.2%
D) 14.0%
Answer: B
17) Which of the following statements about the
Security Market Line are correct?
I. The intercept point is the risk-free rate of return.
II. The slope of the line is beta.
III. An investor should accept any return located
above the SML line.
IV. A beta of 1.0 indicates the risk-free rate of
return.
A) I and II only
B) III and IV only
C) II, III and IV only
D) I, III and IV only
Answer: D
13) According to MSN money, the stock of Orange

Corporation has a beta of 1.5, but according to Yahoo
Finance it is 1.75. The expected rate of return on the
market is 12% and the risk free rate is 2%. What is
the difference between the required rates of return
calculated using each of these betas?
A) 1.50%
B) 1.75%
C) 2.0%
D) 2.5%
Answer: D
5.5 Learning Goal 5
14) The Capital Asset Pricing Model (CAPM)

includes which of the following in its base
assumptions?
I. Investors should earn a minimum return equal to
the risk-free rate.
II. Investors in the market should earn a return
greater than the return on the overall market.
III. Investors should be rewarded for the amount of
risk they assume.
IV. Investors should earn a return located above the
Security Market Line.
A) I and III only
B) II and IV only
C) I, II and III only
Answer: A
1) Both the efficient frontier and beta are important

aspects of MPT.
Answer: TRUE
15) Small company stocks are yielding 15.7% while

the U.S. Treasury bill has a 4.3% yield and a bank
savings account is yielding 3.8%. What is the risk
premium on small company stocks?
A) 7.6%
B) 11.4%
C) 11.9%
D) 15.7%
Answer: B
5) Traditional portfolio management

A) concentrates on only the most recent "hot" sectors
of the market.
B) typically centers on interindustry diversification.
C) uses portfolio betas and standard deviations to
minimize risk.
D) is based on statistical measures to develop the
portfolio plan.
Answer: B
16) The risk-free rate of return is 2% while the

market rate of return is 12%. Parson Company has a
historical beta of .85. Today, the beta for Delta
Company was adjusted to reflect internal changes in
the structure of the company. The new beta is 1.38.
What is the amount of the change in the expected rate
of return for Delta Company based on this revision to
beta?
A) 8.5%
6) Traditional portfolio managers prefer well-known

companies because
I. stocks of well-known firms tend to be less risky
than stocks of lesser-known firms.
II. individuals are more apt to purchase a mutual
fund if it contains stocks of well-known firms.
III. window dressing encourages the purchase of
well-known stocks.
IV. institutional investors tend to exhibit "herd-like"
2) Portfolios located on the efficient frontier are

preferable to all other portfolios in the feasible set.
Answer: TRUE
3) Portfolios located on the efficient frontier may not
be part of the feasible set.
Answer: FALSE
4) Modern portfolio theory seeks to minimize risk
and maximize return by combining highly correlated
assets.
Answer: FALSE
6
behavior.
A) I only
B) I and II only
C) II and III only
D) I, II , III and IV
Answer: D
12) Modern portfolio theory does not consider

diversifiable risk relevant because
A) it is easy to eliminate.
B) it is impossible to eliminate.
C) its effects are unpredictable.
D) its effects are too small to make a difference in
portfolio returns.
Answer: A
7) Which of the following measures or concepts are

deliberately used by modern portfolio theory?
I. beta
II. inter industry diversification
III. efficient frontier
IV. correlation
A) II and III only
B) I and IV only
Answer: C
5.6 Learning Goal 6

1) An investment portfolio should be built around the
needs of the individual investor.
Answer: TRUE
2) Beta is more useful in explaining an individual
security's return fluctuations than a large portfolio's
return fluctuations.
Answer: FALSE
8) Portfolios falling to the left of the efficient frontier

A) have too much risk for the expected return.
B) would be desirable if only they were possible.
C) do not use all of the assets in the portfolio.
D) fall within the set of feasible portfolios.
Answer: B
3) A portfolio with a beta of 1.5 will be 50% more

volatile than the market portfolio.
Answer: TRUE
4) Both modern portfolio theory and traditional
portfolio management result in diversified portfolios,
but they take different approaches to diversification.
Answer: TRUE
9) The efficient frontier

A) is represented by the rightmost boundary of the
feasible set of portfolios.
B) represents the best attainable tradeoff between risk
and return.
C) includes all feasible sets of portfolios based on
risk and return characteristics.
D) provides the highest level of risk for the lowest
level of return.
Answer: B
5) Portfolio betas will always be lower than the

weighted average betas of the securities in the
portfolio.
Answer: FALSE
6) Jonathan has the following portfolio of assets.
10) Investors are rewarded for assuming

A) total risk.
B) diversifiable risk.
C) nondiversifiable risk.
D) any type of risk.
Answer: C
What is the beta of Jonathan's portfolio?

A) 1.08
B) 1.11
C) 1.13
D) 1.15
Answer: C
11) The optimal portfolio for an individual investor is

represented by the point that lies on the
A) lowest possible utility curve and connects to the
efficient frontier.
B) utility curve which is just tangent to the right side
of the feasible set of risk-return options.
C) utility curve which is just tangent to the efficient
frontier.
D) utility curve which represents the highest possible
rate of return within the feasible set of risk-return
options.
Answer: C
7) Amanda has the following portfolio of assets.
7
Answer: D
What is the beta of Amanda's portfolio?
A) 1.06
B) 1.10
C) 1.13
D) 3.02
Answer: B
FundamentalsofInvesting,12e
Chapter6CommonStocks
6.1LearningGoal1
8) A portfolio with a beta of 1.06

A) is 106% more risky than the overall market.
B) has less risk than the lowest risk security held
within that portfolio.
C) is 6% more risky than a risk-free asset.
D) is slightly more risky than the overall market.
Answer: D
1)Everyshareholderisapartownerofthefirmand,
assuch,hasadirectclaimonaportionofthefirm's
assets.
Answer:FALSE
2)Thereisastrongertendencyforthestockmarket
toincreaseinvalueratherthandecreaseinvalueover
time.
Answer:TRUE
9) Which of the following will lower a portfolio's

beta?
I. Diversify among different types of securities and
across industry and geographic lines.
II. Add investments with low betas to the portfolio.
III. Hold more cash or Treasury Bills in the
portfolio.
IV. Reduce the percentage of the portfolio invested
in high beta securities.
B) II, III and IV only
Answer: B
3)Since1960,returnsontheDowJonesIndustrial
Averagehaveneverbeennegativefor3consecutive
years.
Answer:FALSE
4)Formoststocksthereturnsfromdividendincome
farexceedthereturnfromcapitalgains.
Answer:FALSE
5)Between1956and2011approximately70%of
yearshadpositivereturns.
Answer:TRUE
10) Which of the following guidelines are appropriate

for inclusion in a portfolio management policy?
I. Diversify among different types of securities and
across industry and geographic lines.
II. Determine the risk level and financial situation
of the individual investor.
III. Utilize beta to help align the portfolio to the risk
level of the investor.
IV. Minimize the standard deviation of each security
in the portfolio.
Answer: C
6)Between1956and2011approximately30%of
yearshadpositivereturns.
Answer:FALSE
7)Between2009and2011thestockregainedmuch
ofthevaluelostin2007and2008.
Answer:TRUE
8)Becausecommonshareholdersareentitledtothe
profitsthatremainafterallofacorporation'sother
obligationshavebeenmet,commonshareholdersare
knownas
A)residualowners.
B)temporaryowners.
C)debtowners.
D)ownersoflastresort.
Answer:A
11) The investment choice of an individual is affected

by
I.
their tolerance for risk.
II. their prior investment experience.
III. their marginal tax bracket.
IV. the stability of their income.
A) II and III only
9)Ifstocksearnanaveragerateofreturnof12%,
theirvaluedoublesevery
A)4years.
B)6years.
C)8years.
8
D)12years.
Answer:B
11%.
Answer:TRUE
10)Whichoneofthefollowingstatementsabout
commonstockistrue?
A)Commonstockcanprovideattractivecapital
appreciationopportunities.
B)Dividendsgenerallyprovidethegreatestrateof
returnoncommonstocks.
C)Commonstocksgenerallyhaveanegativerateof
returnoveratenyearperiod.
D)TheDJIAisthebestindicatoroftheoverall
performanceofcommonstocks.
Answer:A
7)Theperiodfromlate2007throughtheendof2011
isbestdescribedasaprolongedbearmarket.
Answer:FALSE
11)Whichofthefollowingarebenefitsrelatedto
stockownership?
I. easeoftrading
II. attractiveinflationadjustedratesofreturn
III. guaranteeoflongtermpositivereturns
IV. affordability
A)IandIIonly
B)IIandIVonly
C)IandIIIonly
D)I,IIandIVonly
Answer:D
9)$10,000investedintheNASDAQCompositeat
thebeginningof1995wouldhaveincreasedinvalue
toover$50,000bytheendof1999.
Answer:TRUE
8)Fortheperiod2000through2009,theaverage
annualreturnonstockswas
A)16%.
B)8%.
C)1%.
D)50%.
Answer:C
10)$10,000investedintheNASDAQCompositeat
thebeginningof2000wouldhaveincreasedinvalue
toabout$20,000bytheendof2005.
Answer:FALSE
6.2LearningGoal2
11)Thetechnologybubbleofthe1990slastedabout
18months.
Answer:TRUE
1)Amarketcorrectionisdefinedasastockmarket
declineof10%ormore.
Answer:TRUE
12)Stocksgenerallyhaveproducedpositive
inflationadjustedratesofreturnoverthelongterm.
Answer:TRUE
2)Whilemanystocksincreaseinvalueoverthelong
run,mostofthereturnonstockscomesfrom
dividends.
Answer:FALSE
13)Anindividualstockgenerallyprovidesa
A)dividendpaymentthatensurestotalprotection
frompurchasingpowerrisk.
B)refugefromeventrisk.
C)currentincomethatislesspredictablethanthat
availablefromothertypesofinvestments.
D)predictableannualrateofreturn.
Answer:C
3)Abearmarketisdescribedasastockmarket
declineof20%ormore.
Answer:TRUE
4)Overthelongterm,thecapitalgainonmoststocks
willexceedthedividendincome.
Answer:TRUE
14)FromOctober2007toMarch2009,stockprices
asmeasuredbytheS&P500Index
A)nearlydoubledinvalue.
B)lostmorethanhalftheirvalue.
C)declinedbynearly10%.
D)rosebynearly25%.
Answer:B
5)Althoughbearmarketsonaverageoccurevery3to
4years,thetimingofbearmarketsisveryhardto
predict.
Answer:TRUE
15)FromMarch2009toJanuary2012,stockprices
asmeasuredbytheS&P500Index
A)morethandoubledinvalue.
B)lostmorethanhalftheirvalue.
6)Overthe50yearperiodof19602010,thestock
marketasmeasuredbytheS&P500Indexprovided
anaverageannualrateofreturnofapproximately
9
C)declinedbynearly10%.
D)rosebynearly25%.
Answer:A
5)Thetotalvalueofaninvestor'sholdingsina
companywillincreaseasadirectresultofastock
split.
Answer:FALSE
16)Whichofthefollowingperiodsprovided
particularlyhighreturnstostockinvestors?
A)February1972October1974
B)March2009December2011
C)September2000September2002
D)October2007March2009
Answer:B
6)Treasurystockisameansofincreasingthe
numberofsharesoutstanding.
Answer:FALSE
7)Firmstendtorepurchasesharesoftheir
outstandingstockwhentheyviewthesharesas
undervalued.
Answer:TRUE
17)Overtheperiod19562011,stockshaveprovided
investorswithannualreturnsbetween
A)6%to8%.
B)8%to10%.
C)10%to12%.
D)12%to14%.
Answer:C
8)Differentclassesofstockgenerallyhaveeither
differentvotingrightsordifferentdividends.
Answer:TRUE
9)Transactioncostscansignificantlyreducetherate
ofreturnonstockinvestments.
Answer:TRUE
18)Theextraordinaryrunupinstockpricesduring
thelate1990sprimarilyaffected
A)energystocks.
B)retailstocks.
C)pharmaceuticalstocks.
D)technologystocks.
Answer:D
10)Sinceeachshareofcommonstockrepresents
ownershipinacompany,sharesofcommonstockare
oftenreferredtoas
A)illiquidinvestments.
B)equitysecurities.
C)fixedincomesecurities.
D)unitcostsecurities.
Answer:B
19)Stockvaluesdeclinedsharplybetween
A)1994and1997.
B)1997and2000.
C)2003and2007.
D)2007and2008.
Answer:D
11)Whichoneofthefollowingstatementsabout
commonstockiscorrect?
A)Eachshareofstockhasaspecifiedmaturitydate.
B)Commonstockgivesstockholdersfirsttitletoa
shareofthecompany'searnings,priortoother
corporateobligations.
C)Commonstocktypicallyprovideshigherlevelsof
currentincomethandosimilargradecorporate
bonds.
D)Eachshareofcommonstockofagivenclass
entitlestheholdertoanequalownershippositionand
anequalvoteinthecorporation.
Answer:D
6.3LearningGoal3
1)Sharesofpubliclytradedstockcanbeissuedeither
throughapublicofferingorarightsoffering.
Answer:TRUE
2)Companiestypicallyissuenewsharesthroughan
initialpublicoffering(IPO).
Answer:TRUE
3)Shareholdersmusteitherexercisetheirrights
grantedviaarightsofferingorletthemexpire
unused.
Answer:FALSE
12)Stocksthatarereadilyavailabletothegeneral
publicandthatareboughtandsoldontheopen
marketareknownas
A)initialpublicofferings.
B)publiclytradedissues.
C)treasurystocks.
D)bluechipstocks.
Answer:B
4)Corporationsoftensplittheirstockswhenthey
believethatthepricemakesthemlessattractiveto
averageinvestors.
Answer:TRUE
10
B)treasurystock.
C)classifiedstock.
D)bookstock.
Answer:B
13)Whenacompany,workingwithanunderwriter,
offerstheinvestingpublicacertainnumberofshares
ofitsstockatacertainprice,thecompanyismaking
whatisknownasa
A)publicoffering.
B)rightsoffering.
C)stockspinoff.
D)treasuryoffering.
Answer:A
19)Tiffanyowned1000sharesofGIAstockwhich
wassellingfor$1.50persharewhenthecompany
declareda1for10reversesplit.Afterthesplit,
Tiffanyowned
A)10,000sharesworthapproximately$1.50per
share.
B)10,000sharesworthapproximately$0.15per
share.
C)100sharesworthapproximately$15pershare.
D)100sharesworthapproximately$1.50pershare.
Answer:C
14)Inarightsoffering,the
A)existingstockholdersaregiventhefirst
opportunitytopurchasenewsharesinproportionto
theircurrentownershipposition.
B)underwriterofferstheinvestingpublicacertain
numberofsharesatacertainprice.
C)totalequityremainsconstantwhilethenumberof
sharesofcommonstockoutstandingincreases.
D)amountofdebtinthecapitalstructureincreases
bytheamountoftherightsoffering.
Answer:A
15)Robowns300sharesofBlackwoodcommon
stockvaluedat$9ashare.Blackwoodhasdeclareda
3for1stockspliteffectivetomorrow.Afterthesplit,
Robwillown
A)100sharesvaluedatabout$27ashare.
B)100sharesvaluedatabout$3ashare.
C)900sharesvaluedatabout$27ashare.
D)900sharesvaluedatabout$3ashare.
Answer:D
20)Treasurystockcanbeusedtodowhichofthe
following?
I. payforanacquisition
II. paythecompanyemployees
III. paystockdividends
IV. coveremployeestockoptionplancontributions
A)IandIIIonly
B)IIandIVonly
C)IIIandIVonly
D)I,IIIandIVonly
Answer:D
21)Whataretheeffectsofacompanyrepurchasing
itsownstockasTreasuryshares?
A)Usuallynegativeintheshorttermbutuncertain
overthelongterm.
B)Usuallypositiveintheshorttermbutuncertain
overthelongterm.
C)Usuallypositiveinboththeshorttermandthe
longterm.
D)Noeffectineithertheshorttermorthelongterm.
Answer:B
16)Engines,Inc.declaresa4for10stocksplit.The
stockcurrentlysellsfor$3ashare.Ashareholder
whoowned1000sharesofstockpriortothesplitwill
nowown
A)400sharesvaluedatabout$7.50ashare.
B)40sharesvaluedatabout$1.20ashare.
C)250sharesvaluedatabout$7.50ashare.
D)250sharesvaluedatabout$1.20ashare.
Answer:A
22)Onemotiveforissuingclassifiedstockwith
differentvotingrightsisto
A)increasethemarketvalueofthecompany.
B)avoidSECreportingrequirements.
C)allowthecompany'sfounderstoretaincontrolof
thecompany.
D)facilitatetheissueofadditionalsharesinthe
future.
Answer:C
17)Whenacorporationdeclaresastocksplit,it
usuallydoessobecause
A)thefirm'sretainedearningsareexcessive.
B)therearetoomanysharesofstockoutstanding.
C)investorssometimesrequirenontaxablereturns.
D)itwantstomakeitsstockmoreaffordableto
averageinvestors.
Answer:D
23)StockquotesonmostInternetserviceproviders
suchasYahooFinanceinclude
I. thehighestandlowestpriceoverthelast52
weeks.
18)Stockwhichhasbeenissuedandsubsequently
reacquiredbytheissuingcorporationiscalled
A)letterstock.
11
II. theclosingpricefortheprevioustradingday.
III. theopeningpricefortheday.
IV. thebidpriceandaskprice.
A)IandIIIonly
B)IIandIVonly
C)I,IIandIIIonly
D)II,IIIandIVonly
Answer:D
7)Anothertermforthestatedvalueorfacevalueofa
stockisits
A)bookvalue.
B)liquidationvalue.
C)parvalue.
D)proxyvalue.
Answer:C
8)Theparorstatedvalueofcommonstockis
importantfor
A)accountingpurposesonly.
B)helpingtheinvestordeterminethestock'sintrinsic
value.
C)helpingtheboardofdirectorsdeterminethe
dividendpayout.
D)helpingthemarketdeterminethetradingpriceof
thestock.
Answer:A
24)Aroundlotconsistsof
A)1share.
B)10shares.
C)100shares.
D)1,000shares.
Answer:C
25)AssumethePlumCorporationhastwodifferent
issuesofcommonstock.Oneissuecarriesvoting
rights,andtheotherissuedoesnot.Inthissituation,
Plumissaidtohaveissued
A)buybackstock.
B)treasurystock.
C)OTCstock.
D)classifiedstock.
Answer:D
9)Thevaluethatrepresentstheamountof
stockholders'equityinafirmiscalledthe
A)parvalue.
B)bookvalue.
C)liquidationvalue.
D)marketvalue.
Answer:B
6.4LearningGoal4
10)Ifafirmhasa2millionsharesoutstandingand
itsstocktradesat$25pershare,thecompanyalso
has$10,000,000indebt.Thecompany'smarket
capitalizationis
A)$40,000,000.
B)$49,000,000.
C)$50,000,000.
D)$60,000,000.
Answer:C
1)Astock'smarketvaluewouldnormallybehigher
thanit'sbookvalue.
Answer:TRUE
2)Investorsshouldneverpaymorethanbookvalue
forastock.
Answer:FALSE
3)Astockcanhaveonlyonemarketvalue,but
differentinvestmentvaluesfordifferentinvestors.
Answer:TRUE
11)WestlakeIndustrieshastotalassetsof$42.5
million,totaldebtof$29.3million,and$2.4million
of6%preferredstockoutstanding.Ifthecompany
has250,000sharesofcommonstockoutstanding,its
bookvaluepersharewouldbe
A)$32.33.
B)$33.60.
C)$43.20.
D)$52.80.
Answer:C
4)Astock'sinvestmentvaluecanbemuchhigher
thanitsbookvalue.
Answer:TRUE
5)Theinvestmentvalueforapubliclytradedstock
canreadilybefoundinthefinancialsectionofthe
newspaperorontheInternet.
Answer:FALSE
12)Asageneralrule,whichoneofthefollowing
statementsconcerningthevariousvaluesofcommon
stockiscorrect?
A)Marketvaluesareusuallybelowbookvalues.
B)Parvaluesareusuallyabovebookvalues.
C)Marketvaluesareusuallybelowparvalues.
6)Ifafirmhasa2millionsharesoutstandingandits
stocktradesat$25pershare,thecompanyhasa
marketcapitalizationof$50,000,000.
Answer:TRUE
12
D)Bookvaluesareusuallybelowmarketvalues.
Answer:D
exdividenddate,butbeforethedateofrecord,will
stillreceivethedeclareddividend.
Answer:TRUE
13)Whichofthefollowingwilltendtoincrease
transactioncosts?
A)buyingorsellingfewerthan100sharesatatime
B)buyingorsellingsharesthroughanonlinebroker
C)buyingorsellingmorethan1000sharesina
singletrade
D)buyingorsellingattimeswhenvolumeishigh
andtheexchangesarebusy
Answer:A
3)Highdividendyieldsaretypicalofrapidly
growingcompanies.
Answer:FALSE
4)Withrespecttodividendpaymentsonstocks,the
dateofrecordisthedateonwhichthepaymentis
actuallypaid.
Answer:FALSE
14)TheJenningsCompanyhas4millionsharesof
stockoutstanding.Thestockhasaparvalueof$0.10
pershareandiscurrentlytradingat$18pershare.
Accordingtothisinformation,themarket
capitalizationofJenningsis
A)$400,000.
B)$7.2million.
C)$40million.
D)$72million.
Answer:D
5)Stockdividendsdonotincreasethevalueofa
shareholder'sposition.
Answer:TRUE
6)Stockdividendsandstocksplitsbothincreasethe
numberofsharesbutaddnothingtothevalueofthe
company.
Answer:TRUE
7)Thevalueofastockdistributionisconsidered
taxableincomeatthetimeofthedistribution.
Answer:FALSE
15)Youaregiventhefollowinginformationona
company.
8)ThestocklistingforacompanyshowsaP/Eof18,
adividendyieldof2.4%andaclosingpriceof
$23.76.Whatistheamountofdividendspershare?
A)$0.03
B)$0.57
C)$1.03
D)$1.32
Answer:B
Whichoneofthefollowingstatementsiscorrect
basedontheinformationprovided?
A)Themarketpriceis$21.34pershare.
B)Theinvestmentvalueis$2.67pershare.
C)Theparvalueis$2.67pershare.
D)Thebookvalueis$21.34pershare.
Answer:A
9)Thedecisionofhowmuchmoneytopayoutin
dividendsismadebythe
A)boardofdirectors.
B)companyshareholders.
C)chiefexecutiveofficer.
D)chieffinancialofficer.
Answer:A
16)Thevaluethatinvestorsplaceonastockiscalled
its
A)bookvalue.
B)investmentvalue.
C)liquidationvalue.
D)parvalue.
Answer:B
10)Factorsconsideredinmakingadecisionona
firm'sdividendincludethe
I. cashpositionofthefirm.
II. firm'sgrowthprospects.
III. theexpectationsoftheshareholders.
IV. minimumdividendsrequiredbylaw.
A)IIandIVonly
B)I,IIandIVonly
C)I,IIandIIIonly
D)I,II,IIIandIV
Answer:C
6.5LearningGoal5
1)Acompany'sboardofdirectorsmustdeclarea
dividendifthefirmisprofitable.
Answer:FALSE
2)Shareholderswhoselltheirstockonorafterthe
13
A)themarketpriceofoneshareofstockbythe
annualdividendpershare.
B)theannualdividendpersharebythemarketprice
ofoneshareofstock.
C)earningspersharebymarketpricepershare.
D)annualdividendpersharebyearningspershare.
Answer:B
11)Thedateonwhichaninvestormustbea
registeredshareholderofthefirminordertoreceive
adividendiscalledthe
A)dateofrecord.
B)exdividenddate.
C)paymentdate.
D)purchasedate.
Answer:A
17)Ifacorporationdeclaresa10%stockdividend,
then
A)thesharepriceofthestockwillmostlikely
declinebyabout9%.
B)thesharepriceofthestockwillmostlikely
increasebyabout10%.
C)thesharepriceofthestockwillmostlikelyremain
unchanged.
D)eachshareholderwillgeta10%cashrebateoff
hisorhernextroundlotpurchaseofthestock.
Answer:A
12)TheLimbergerCorporationdeclaredaquarterly
dividendof$0.10pershare.Theexdividenddate
wasJuly15,thedateofrecordwasJuly18,andthe
paymentdatewasJuly28.Ifyouhadowned100
sharesoftheLimbergerCorporationandsoldthem
onJuly15,then
A)youwouldcollect$10.00individends,andthe
purchaserwouldnotcollectanydividends.
B)thepurchaserwouldcollect$10.00individends,
andyouwouldnotcollectanydividends.
C)youwouldcollect$5.00individends,andthe
purchaserwouldcollect$5.00individends.
D)neitheryounorthepurchaserwouldcollectany
moneyindividends.
Answer:A
18)GypsumCorp.paysout25%ofitsearningsas
dividends.Earningspersharearecurrently$1.32,
bookvaluepershareis$16.80,andthemarketprice
pershareis$22.44.Whatisthedividendyield?
A)1.5%
B)2.0%
C)5.9%
D)7.9%
Answer:A
13)ThecommonsharesoftheOwlCompanyhavea
bookvalueof$10.80andamarketvalueof$14.30.
Thecompanypays$0.14individendseachquarter.
Whatisthedividendyield?
A)1.0%
B)1.3%
C)3.9%
D)5.2%
Answer:C
19)PilgrimCorp.stockcurrentlysellsfor$25per
share?Thedividendyieldis$1.00pershareand
earningspershareare$3.00.Thedividendyieldis
________andthedividendpayoutratiois________.
A)12%,.48%
B)8.33%,25%
C)4%,33%
D)33%,4%.
Answer:C
14)Since2003,mostdividendsaretaxed
A)atahigherratethancapitalgains.
B)atalowerratethancapitalgains.
C)atthesamerateasordinaryincome.
D)atthesamerateascapitalgains.
Answer:D
20)PilgrimCorp.stockcurrentlysellsfor$25.The
dividendyieldis4%andthedividendpayoutratiois
25%.Thedividendis________andtheearningsper
shareare________.
A)$3.00,$1.00
B)$1.00,$3.00
C)$.12,$1.00
D)$.25,$6.25
Answer:B
15)Between1950and2010,theaveragereturnon
stocksasrepresentedbytheS&P500Indexhasbeen
11%.Ofthatamount,theaveragereturnfrom
dividendshasbeen
A)1.8%.
B)2.7%.
C)3.6%.
D)4.6%.
Answer:C
21)Totakeadvantageoftheopportunitytoacquire
additionalsharesofacompany'sstockwithout
incurringanybrokeragecommissions,many
investorsparticipatein
16)Dividendyieldiscalculatedbydividing
14
A)initialpublicofferings.
B)dividendreinvestmentplans.
C)deferredequitysecurities.
D)corporatetrusts.
Answer:B
Answer:FALSE
11)Anincreaseinthedollarrelativetotheeurohasa
negativeeffectonthereturnsofU.S.investorswho
investinEuropeanfirms.
Answer:TRUE
22)Reinvesteddividends
A)aretaxedwhenthesharespurchasedwiththe
reinvesteddividendaresold.
B)aretaxedatthetimethedividendispaid.
C)donotincreasethevalueofaninvestorsholdings.
D)aregenerallysoldatapremiumoverthemarket
price.
Answer:B
12)Themostcommonreasonforaninvestortoadopt
thequalitylongtermgrowthinvestmentstrategyis
forlongtermaccumulationofcapital.
Answer:TRUE
13)Thetotalreturnapproachconcentratessolelyon
capitalgainsoverthelongterm.
Answer:FALSE
6.6LearningGoal6
14)Whichoneofthefollowingisacharacteristicof
bluechipstocks?
A)guaranteedminimumannualdividendof$2a
share
B)annualdividendsofmorethan$5pershare
C)longandstabledividendandearningsrecords
D)relativelyhighriskexposure
Answer:C
1)Stockswhichperformwellinafalteringeconomy
arecalleddefensivestocks.
Answer:TRUE
2)Midcapstocksaregenerallyclassifiedasthose
withamarketcapitalizationbetween$1and$5
billion.
Answer:TRUE
15)Investorsseekingcurrentincomethattendsto
increaseovertimeshouldpurchase
A)corporatebonds.
B)incomestocks.
C)growthstocks.
D)speculativestocks.
Answer:B
3)"Babyblues"isatermusedtorefertotelecom
stocks.
Answer:FALSE
4)Astockcanbebothatechstockandabluechip
stockatthesametime.
Answer:TRUE
16)Companieswithstrongearningsbutlimited
growthopportunities
A)donotgenerallypayanydividends.
B)arecalledbluechipstocks.
C)generallypayhighdividends.
D)arespeculativestocks.
Answer:C
5)Socalledincomestockspayfixeddividends
similartointerestonbonds.
Answer:FALSE
6)AmericanDepositaryReceipts(ADRs)areissued
againstsharesofU.S.corporationsandaretradedon
foreignsecurityexchanges.
Answer:FALSE
17)Characteristicsofestablishedgrowthcompanies
includeallofthefollowingEXCEPT
A)highoperatingmargins.
B)steadyearningsgrowth.
C)adequatecashflowtoservicetheirdebt.
D)highdividendpayoutratios.
Answer:D
8)Overtheperiod1900to2011,U.S.stockshadthe
highestrateofreturnofanycountry.
Answer:FALSE
9)Therateofreturnonaforeigninvestmentis
affectedbychangesintheexchangerates.
Answer:TRUE
18)Stockswhosepricesareexpectedtoremain
stable,orevenprosper,wheneconomicactivityis
slowingdownareknownas
A)defensivestocks.
B)cyclicalstocks.
10)Anincreaseinthevalueofthedollarrelativeto
theyenhasapositiveeffectonthereturnsofU.S.
investorswhoinvestinstocksofJapanesefirms.
15
C)growthstocks.
D)speculativestocks.
Answer:A
B)Alcoa
C)Amazon
D)Walmart
Answer:D
19)Whichofthefollowingarecharacteristicsof
smallcapstocks?
I. strongbalancesheets
II. annualrevenueslessthan$250million
III. potentialforhighreturnsalongwithhighrisk
IV. potentiallydramaticchangesintheirearnings
A)IIIandIVonly
B)IIandIIIonly
C)I,IIIandIVonly
D)II,IIIandIVonly
Answer:D
25)Whichofthefollowingbestfitsthedescription
"bluechipstock"?
A)Facebook
B)UnderArmour
C)GeneralElectric
D)ChipotleMexicanGrill
Answer:C
26)Onecharacteristicofmidcapstocksisthatthey
A)aregenerallynewfirmswithhighgrowth
potential.
B)tendtobehighlyvolatile.
C)arefairlygoodsizedcompaniesthatoffer
attractivereturnopportunities.
D)aretradedprimarilythroughpinksheetbids.
Answer:C
20)Whichofthefollowingarecharacteristicsof
bluechipstocks?
I. solidbalancesheets
II. generousdividendyields
III. immunityfrombearmarkets
IV. somegrowthpotential
A)IIIandIVonly
B)IIandIIIonly
C)I,IIandIVonly
D)II,IIIandIVonly
Answer:C
27)Whichcategoryofstocksrepresentsthehighest
levelofrisk?
A)largecap
B)midcap
C)babyblue
D)smallcap
Answer:D
21)StocksrelatedtocomputersandtheInternetare
classifiedas
A)bluechipstocks.
B)incomestocks.
C)cyclicalstocks.
D)techstocks.
Answer:D
28)TheU.S.stockmarket
A)currentlyrepresentsabout66%oftheworld's
equitymarket.
B)consistentlyoutperformstheforeignmarketsonce
exchangeratesareconsidered.
C)isdecreasingasapercentageoftheworld'sequity
market.
D)listsover25,000stocks.
Answer:C
22)Typicalcharacteristicsofgrowthstocksinclude
A)rapidlygrowingdividends.
B)highratesofgrowthinoperationsandearnings.
C)acquisitionsofcompetingcompanies.
D)strongperformanceeveninmarketdownturns.
Answer:B
29)Whichofthefollowingfactorsshouldbe
consideredwheninvestinginforeignstocks?
I. exchangerates
II. differingaccountingstandards
III. taxsystems
IV. ADRs
A)IandIIonly
B)IandIIIonly
C)I,IIandIIIonly
D)I,II,IIIandIV
Answer:D
"speculativestock"?
A)Facebook
B)Apple
C)Amazon
D)HomeDepot
Answer:A
"defensivestock"?
A)Facebook
30)ADRs
I. aresharesofU.S.companiestradedonforeign
16
exchanges.
II. aresharesofforeigncompaniestradedonU.S.
exchanges.
III. paydividendsinU.S.dollarsiftheypay
dividends.
IV. aresubjecttoexchangeraterisk.
A)IandIIonly
B)IIandIIIonly
C)II.IIIandIVonly
D)I,II,IIIandIV
Answer:C
Answer:D
31)AmandapurchasedstockinaGermanfirmata
pricepershareof35euroswhentheU.S.$/euro
exchangeratewas$1.40.Aftersixmonths,Annsold
thestockfor37euroswhentheU.S.$/euroexchange
ratewas$1.28.Thestockdoesnotpayadividend.
WhatisAnn'srateofreturnonthisinvestment?
A)3.35%
B)3.35%
C)5.7%
D)9.2%
Answer:B
36)Aggressivestockmanagementfocusesonthe
pursuitof
A)dividendincome.
B)shorttermcapitalgains.
C)longtermcapitalgains.
D)alloftheabove.
Answer:B
35)Thecommonstockinvestmentstrategythatisthe
mostbasicstrategyandispopularwithconservative,
qualityconsciousindividualslookingforcompetitive
returnsoverthelongrunisthe
A)buyandholdstrategy.
B)currentincomestrategy.
C)growthstrategy.
D)speculationandshorttermtradingstrategy.
Answer:A
37)Whichofthefollowingstrategiesappealto
investorswhoplaceprimaryemphasisonthestorage
ofvalueaspectsofaninvestment?
I. buyandhold
II. shorttermtrading
III. qualitylongtermgrowth
IV. consistentdividendrecord
A)IandIVonly
B)IandIIIonly
C)I,IIandIIIonly
D)I,IIIandIVonly
Answer:D
32)Aggressivestockmanagement
A)requiresholdingspeculativestocksforthelong
term.
B)involvesactivestocktradingintheshorttermin
thequestforcapitalgains.
C)concentratesonthelongtermgrowthaspectsofa
security.
D)concentratesonhighdividendyieldingstocks.
Answer:B
38)Whichstrategyappliestoinvestorswhofund
longtermgoalswithhighqualitystockswhichthey
retainfortheentireinvestmentperiod?
A)qualitylongtermgrowth
B)buyandhold
C)speculation
D)currentincome
Answer:B
33)Whichofthefollowingareadvantagesofthebuy
andholdstrategy?
I. rapidaccumulationofwealth
II. lowtransactioncosts
III. capitalgainstaxedatthelongtermrate
IV. Portfoliorequireslesstimeandenergyto
managethanformostotherstrategies.
A)IandIIonly
B)IIandIIIonly
C)II,IIIandIVonly
D)I,II,IIIandIV
Answer:C
39)Incomestocksarewellsuitedforretireesbecause
A)dividendincomeistaxfree.
B)thecapitalgainsarepredictable.
C)dividendyieldstendtoexceedbondyields.
D)dividendstendtoincreaseovertime.Answer:D
Fundamentals of Investing, 12e
Chapter 7 Analyzing Common Stocks
34)Whichoneofthefollowinginvestmentstrategies
wouldNOTappealtoaninvestorwhoismost
concernedwithstorageofvalue?
A)buyandhold
B)highincome
C)qualitylongtermgrowth
D)speculationandshorttermtrading
7.1 Learning Goal 1

1) An investor should buy a stock only if the
prevailing market price exceeds the intrinsic value of
17
the stock.
Answer: FALSE
A) III and IV only

B) I, II and IV only
Answer: B
2) An investment should offer an expected return

commensurate with the risk involved.
Answer: TRUE
10) The security analysis process should help

investors to
I. purchase investments that are priced at or above
their intrinsic value.
II. sell investments that are priced at or above their
intrinsic value.
III. purchase investments that are priced at or below
their intrinsic value.
IV. identify investments appropriate for their goals.
A) I and IV only
B) II and III only
D) II, III and IV only
Answer: D
3) Advocates of the efficient market hypothesis

would argue that it is virtually impossible for any
investor to consistently outperform the market.
Answer: TRUE
4) Investors who believe that most securities are
efficiently priced should not be concerned with
fundamental analysis.
Answer: FALSE
5) Fundamental analysis can only be profitable if
some securities are at least temporarily mispriced.
Answer: TRUE
11) Top-down security analysis

A) starts with the fundamental analysis of a firm.
B) includes economic, industry, and fundamental
analysis.
C) concentrates on the competency of the senior
management of a firm.
D) centers on the past performance of a firm.
Answer: B
6) Markets can only be efficient if many competent

analysts are performing fundamental analysis.
Answer: TRUE
7) One of the basic premises of security analysis, and
in particular fundamental analysis, is that
A) a stock's price is based on its past cash flows
rather than on anticipated future cash flows.
B) market sectors do not move in concert with
business cycles.
C) all securities have an intrinsic value that their
market value will approach over time.
D) a security's risk has relatively little effect on the
security's return.
Answer: C
12) Top-down security analysis begins with

A) an analysis of a company's top management.
B) determining an investment's risk and an
appropriate discount rate.
C) an analysis of broad economic factors affecting
the financial markets.
D) identifying specific industries that are likely to
grow faster than the overall economy.
Answer: C
8) The intrinsic value of a security is based on the

I. amount of risk.
II. current market value of the security.
III. discount rate applicable to the security.
IV. estimated future cash flows from the security.
A) I and III only
B) III and IV only
Answer: D
13) Fundamental analysis involves the in-depth study

of the
A) role of nondiversifiable risk in an investor's
portfolio.
B) financial condition and operating results of a
given firm.
C) pattern of security prices as revealed in chart
formations.
D) role of diversifiable risk in an investor's portfolio.
Answer: B
9) The three steps in determining a stock's intrinsic

value are
I. estimating the stock's future cash flows.
II. estimating the risk associated with future cash
flows.
III. careful analysis of patterns in the stock's recent
price history.
IV. estimating an appropriate discount rate to apply
to future cash flows.
14) Investment analysts who believe that a thorough

investigation of a company's financial condition,
product development, management and other
intrinsic factors can discover stocks that are priced
above or below their intrinsic value are advocates of
A) fundamental analysis.
B) behavioral analysis.
18
C) the efficient market hypothesis.

D) technical analysis.
Answer: A
Answer: B
11) The Federal Reserve through monetary policy can
help expand the economy by
A) lowering income taxes on individuals.
B) reducing tariffs such that foreign exports can
increase.
C) supporting a moderate growth of the money
supply.
D) increasing government spending on the national
infrastructure.
Answer: C
7.2 Learning Goal 2

1) Firms tend to be more profitable and have higher
stock values when the economy is strong.
Answer: TRUE
2) The purpose of economic analysis is to gain an
insight into the underlying health or vitality of the
economy and to formulate expectations about future
security prices.
Answer: TRUE
12) Rising interest rates tend to

A) contract the level of economic activity.
B) increase the level of business investment.
C) indicate governmental expansion of the economy.
D) signal the trough of a recessionary market.
Answer: A
3) The business cycle reflects economic changes only

in the industrial sectors of the economy.
Answer: FALSE
4) The best time to buy stock is at the peak of an
economic cycle.
Answer: FALSE
13) The government has an expansionary economic

policy when it
A) increases taxes.
B) increases government spending.
C) promotes rising interest rates.
D) limits exports of goods and services.
Answer: B
5) Developing a general economic outlook assists in

the identification of industries and firms that might
be good investment opportunities.
Answer: TRUE
14) Rising corporate profits and are likely to have the

greatest effect on which of the following industrial
sectors?
A) business equipment
B) defense
C) food and agriculture
D) consumer durables
Answer: A
6) Federal budget deficits tend to further depress an

already depressed economy.
Answer: FALSE
7) Changes in stock prices tend to lag changes in
level of economic activity by several months.
Answer: FALSE
8) Economic analysis is relatively useless for
investment purposes since the stock market is used to
forecast the economy.
Answer: FALSE
15) Which of the following businesses will be

positively impacted by a weak dollar?
A) retailing
B) imports
C) exports
D) personal services
Answer: C
9) Which measure of the business cycle represents

the market value of all goods and services produced
in a country over a twelve-month period?
A) industrial production index
B) money supply
C) gross domestic product
D) productivity average
Answer: C
16) Which of the following businesses will be

negatively impacted by a strong dollar?
A) retailing
B) imports
C) exports
D) automotive
Answer: C
10) Which one of the following is likely to have a

negative effect on stock prices?
A) falling interest rates
B) a decrease in the money supply (M2)
C) low inflation
D) a decrease in the unemployment rate
17) Which of the following tend to signal that stock

prices are likely to rise in the future?
I. Employment increases after several months of
recession.
19
II. Interest rates are low compared to the recent

past.
III. Major market indexes have just reached record
highs.
IV. Housing starts increase after several months of
decline.
A) I and II only
B) II and III only
C) I, II and IV only
Answer: C
debt levels.
Answer: TRUE
6) When the economic outlook for an industrial
sector is strong, the outlook for many of the stocks of
firms within that sector will also be strong.
Answer: TRUE
7) Investors who conduct industry analyses typically
favor companies with strong market positions over
companies with less secure market positions because
firms with strong market positions tend to
I. be price leaders.
II. benefit more from economies of scale.
III. have better R&D programs.
IV. have lower production costs.
A) II and IV only.
B) I, II and IV only.
Answer: D
18) Which of the following tend to increase security

market prices?
I. an increase in industrial production
II. an increase in corporate profits
III. an increase in the federal deficit when the
economy is strong
IV. an increase in interest rates
A) I and II only
B) II and III only
Answer: A
8) The consumer electronics would be most

significantly affected by
A) developments in technology.
B) interest rates and inflation.
C) labor relations.
D) government regulations.
Answer: A
19) Which one of the following statements is correct?

A) Stock prices are independent of the economic
cycle.
B) Stock prices change simultaneously with the
economy.
C) Stock prices are often used to predict changes in
the economy.
D) Changes in stock prices generally lag changes in
the economy.
Answer: C
9) Which of the following factors are considered

when analyzing an industry?
I. the nature and conditions of governmental
regulations
II. the involvement and relations, if any, with labor
unions
III. the development of new technologies relevant to
the industry
IV. the extent of competition within the industry
Answer: D
7.3 Learning Goal 3

1) To predict the demand for an industrial sector, it is
essential to understand the economic forces that
affect the industry.
Answer: TRUE
2) Economic factors such as a weak dollar will have a
negative impact on all industrial sectors.
Answer: FALSE
10) Which stage of an industry's growth cycle is most

influenced by economic events?
A) initial development
B) stability or decline
C) mature growth
D) rapid expansion
Answer: C
3) Industries in the rapid expansion stage will be

especially sensitive to a slowing economy.
Answer: FALSE
4) In addition to company reports, Value Line also
publishes industry analyses.
Answer: TRUE
11) Which stage of an industry's growth cycle is

interesting only for potentially high dividend
payouts?
5) The economy will expand more slowly if

consumers decided to save more and reduce their
20
B) stability or decline
C) mature growth
D) rapid expansion
Answer: B
6) A company may appear to be profitable on its

income statement, but fail to generate strong cash
flows.
Answer: TRUE
12) The rapid expansion phase of an industry is

characterized by
A) extreme sensitivity to interest rates and other
economic factors.
B) high returns and relatively low risks.
C) willingness of investors to buy almost any stock
associated with the industry.
D) many decades of sustained above average growth.
Answer: C
7) The balance sheet summarizes the company's

operations over the last fiscal year.
Answer: FALSE
8) EBITDA stands for earnings before inflation,
taxes, depreciation, and adjustments.
Answer: FALSE
9) For a company to remain in business for the long
term, cash flow from investing activities and
financing activities must generally be positive
numbers.
Answer: FALSE
13) The stage in an industry's growth cycle in which

product acceptance is spreading, investors can
foresee the industry's future, and overall economic
variables have little to do with the industry's overall
performance, is known as the
A) initial development stage.
B) rapid expansion stage.
C) mature growth stage.
D) stability or decline stage.
Answer: B
10) Which of the following are considered in the

company analysis phase of a fundamental analysis of
a firm?
I. the composition and growth in sales
II. the capital structure of the firm
III. the outlook of the national economy
IV. the composition and liquidity of the company's
assets
A) I and II only
C) II and IV only
Answer: B
14) Which stage of an industry's growth cycle offers

the greatest opportunity for an investor who is
seeking capital gains?
B) mature growth
C) stability or decline
D) rapid expansion
Answer: D
11) Which of the following accounting practices are

potentially misleading or even fraudulent?
I. writing off goodwill as an extraordinary loss
II. using accrual rather than cash basis reporting
III. off-balance sheet liabilities
IV. recognizing revenues prematurely
A) I and II only
C) III and IV only
Answer: D
7.4 Learning Goal 4

1) Fundamental analysis is based on the presumption
that the value of a stock is influenced by the financial
performance of the issuing company.
Answer: TRUE
2) Fundamental analysis encompasses return, but not
risk, in the valuation process.
Answer: FALSE
3) The statement of cash flows is used to assess a
company's long-term solvency.
Answer: FALSE
12) Which one of the following statements

concerning accounting reports is correct?
A) The income statement reflects the position of a
firm as of a single point in time.
B) The total equity of a firm is equal to the total
assets plus the total liabilities.
C) The statement of cash flows identifies both the
sources and the uses of cash.
D) The income statement reflects the amount of cash
available for investment and financing activities.
Answer: C
4) The income statement indicates how successfully a

company has utilized its assets.
Answer: TRUE
5) Positive cash flow from investing activities is
typical of firms experiencing healthy growth.
Answer: FALSE
21
Answer: D
13) Cash flow from operations
A) represents the amount of cash generated by the
company.
B) is the least important section of the Statement of
Cash Flows.
C) is the amount of cash acquired from the borrowing
activities of the firm.
D) represents the cash flows from the purchase and
sale of long-term assets.
Answer: A
18) Which of the following accounting practices are

potentially misleading or even fraudulent?
I.
writing off goodwill as an extraordinary loss
II. using accrual rather than cash basis reporting
III. off-balance sheet liabilities
IV. recognizing revenues prematurely
A) I and II only
C) III and IV only
Answer: D
14) Which of the following would be typical of a

Statement of Cash Flows for a healthy firm in a
sustainable business?
A) Cash flow from operations is negative, cash flows
from investment activities and financing activities are
positive.
B) Cash flow from operations , investment activities
and financing activities must all be positive.
C) Cash flow from operations is positive, cash flows
from investment activities and financing activities are
negative.
D) If the Statement shows a net increase in cash, the
source is unimportant.
Answer: C
19) On September 30, the Simpson Company

reported the following information on its financial
statements.
What is the amount of the stockholder's equity in the

Simpson Company?
A) $243,000
B) $277,000
C) $927,000
D) $3,217,000
Answer: A
15) Which of the following measures excludes noncash charges against income.
A) operating expenses
B) EBIT
C) net income before taxes
D) EBITDA
Answer: D
7.5 Learning Goal 5

1) Ratio analysis is the study of the relationships
between various financial statement accounts.
Answer: TRUE
16) Which of the following would be found on a

company's income statement?
I. cost of goods sold
II. interest expense
III. cash flow from operations
IV. earnings before taxes
A) I an IV only
B) I, II and III only
Answer: C
2) Financial ratios can reveal a lot about a company's

liquidity, activity, and profitability.
Answer: TRUE
3) A low current ratio may reveal liquidity problems
in a profitable company.
Answer: TRUE
4) Return on assets is a very important analytical tool
because it measures how effectively management is
using a firm's assets to generate profits.
Answer: TRUE
17) Which of the following would be found on a

company's balance sheet?
I. Accounts receivable
II. Interest expense
III. Property plant and equipment
IV. Total stockholders' equity
A) I an IV only
5) A firm with a very low debt-equity ratio has a low

risk of defaulting on its loans.
Answer: TRUE
6) A firm with a very low debt-equity ratio might be
able to increase return on equity by taking on
22
additional debt.
Answer: TRUE

Answer: A
7) The Allied Computer Co. has sales of $300

million, a net profit margin of 9%, and 10 million
shares of common stock outstanding. It has no
preferred stock outstanding. If Allied stock trades at
$50 per share, it has a price/earnings ratio of 20.9.
Answer: FALSE
18) Financial ratios

I. allow comparisons across firms without concern
over firm size.
II. can compare a firm's operating and financial
status to industry norms.
III. reflect the future outlook for a firm as well as
past performance.
IV. look at the liquidity, activity, leverage,
profitability and market measures of a firm.
A) II and IV only
B) I and II only
Answer: C
8) Return on equity (ROE) is computed by dividing

net income by the market value of equity.
Answer: FALSE
9) The fact that assets are recorded on the balance
sheet at historical rather current values prevents the
return on assets ratio (ROA) from being distorted by
inflation.
Answer: FALSE
10) In seeking potential stock investments, most
analysts look for companies that have PEG ratios that
are equal to or less than one.
Answer: TRUE
19) On December 31, the Gold Standard Company

reported the following information on its financial
statements.
11) Banks can use the times interest earned ratio as a

measure of a borrower's ability to repay their loan.
Answer: TRUE
12) If a firm has an equity multiplier of 3, this means
that the firm has $3 in equity for every $1 in longterm debt.
Answer: FALSE
According to this information, the company's current

ratio is approximately
A) 1.39.
B) 1.68.
C) 1.73.
D) 1.90.
Answer: A
13) Return on equity can be expressed

mathematically as "(net profit margin)(total asset
turnover)(equity multiplier)."
Answer: TRUE
20) To determine whether a company is using

leverage effectively, an analyst should consider
A) the current ratio and net working capital.
B) inventory, accounts receivable and total asset
turnover ratios.
C) the debt to equity and times interest earned ratios.
D) ROA and the net profit margin.
Answer: C
14) A high P/E ratio may be an indication that a stock

is overpriced.
Answer: TRUE
15) Price-to-book-value indicates how aggressively a
stock is being priced.
Answer: TRUE
21) A company has sales of $640,000, net profit after

taxes of $23,000, and a total asset turnover of 2.5.
What is the return on assets?
A) 3.6%
B) 4.5%
C) 8.1%
D) 9.0%
Answer: D
16) High dividend payout ratios are more of a

concern to analysts than low payout ratios.
Answer: TRUE
17) Which of the following are measures of liquidity?
I. net working capital
II. accounts receivable turnover
III. current ratio
IV. times interest earned
A) I and III only
22) A company has sales of $640,000, net profit after
23
taxes of $23,000, a total asset turnover of 2.5 and an

equity multiplier of 1.67. What is the return on
equity?
A) 15%
B) 9.0%
C) 8.1%
D) 4.5%
Answer: D
What is the available net working capital for

Adolpha, Inc.?
A) -$126,922
B) -$66,133
C) $60,789
D) $936,510
E)
Answer: A
23) Substituting EBITDA for EBIT when computing

the times interest earned ratio will make the company
appear
A) more leveraged.
B) less leveraged.
C) more profitable.
D) less efficient.
Answer: B
28) A company has a net loss for the year of

$(10,000,000) and a deficit (negative equity) of
$(1,000,000). ROE will be
A) 1000% indicating an exceptional opportunity.
B) 1000% and meaningless.
C) -1000% indicating that the company is in dire
straits.
D) 10.
Answer: B
24) For their last fiscal year, the Short Company

reported the following information.
29) The measure that indicates how efficiently assets

are being used to support sales is called the
A) total asset turnover.
B) current ratio.
C) book value.
D) net profit margin.
Answer: A
What is the accounts receivables turnover rate?

A) 0.8
B) 2.8
C) 4.5
D) 7.3
Answer: D
30) A lending institution would prefer that a firm

have a ________ debt-equity ratio and a ________
times interest earned ratio.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
Answer: C
25) The inventory turnover rate for a firm is 14.5 as

compared to the relevant industry rate of 13.2. In this
case, the firm is
A) selling its inventory slower than the industry.
B) underperforming the industry.
C) averaging less days of sales in inventory than the
industry.
D) generating less sales per dollar of inventory.
Answer: C
31) Marco's just reported an EPS of $1.68 on

revenues of $440 million. The company has 12
million shares outstanding. Total assets are $280
million, current liabilities equal $48 million, and
long-term debt is $112 million. Net fixed assets are
worth $230 million. Given this information, which
one of the following statements is correct?
A) Marco's debt-equity ratio is 0.75.
B) Marco's current ratio is 1.75.
C) Marco's total asset turnover is 3.67.
D) Marco's net working capital is $2 million.
Answer: D
26) A total asset turnover of 3 means that every

A) $1 in sales is supported by $3 of assets.
B) $3 in assets produces $1 in net earnings.
C) $1 in total assets is replaced on average every 3
years.
D) $1 in assets produces $3 in sales.
Answer: D
27) On March 31, Adolpha, Inc. reported the
following information on its financial statements.
32) Worcester Corporation has a P/E ratio of 15.

Natick Corporation is in the same industry as
24
Worcester, but has a P/E ratio of 20. Possible

interpretations of this discrepancy include
A) Worcester Corporation is overpriced.
B) Natick Corporation has higher earnings per share.
C) Investors expect Natick to grow faster than
Worcester.
D) Natick's stock price is higher than Worcester's.
Answer: C
extra dividends.
D) firm is losing money.
Answer: B
39) Kim has gathered the following information on a
company.
33) Nadine Enterprises has total assets of $240,000, a

debt-equity ratio of 0.60, and a return on assets of
9%. What is the return on equity?
A) 5.4%
B) 5.6%
C) 14.4%
D) 15.0%
Answer: C
What is the amount of the earnings per share?

A) $0.14
B) $0.25
C) $0.28
D) $0.30
Answer: B
34) Quick Cement has a return on assets of 8%. If it

has $1.5 million in total assets and a total asset
turnover of 2, it follows that the firm must have a net
profit margin of
A) 4%.
B) 6%.
C) 8%.
D) 12%.
Answer: A
40) A high P/E ratio may be justified if

A) the market to book ratio is also high.
B) if ROA is higher than ROE
C) the PEG ratio is also high
D) the PEG ratio is low.
Answer: D
41) JJ Industries has a P/E ratio of 18 and an EPS of
$0.93. This means that JJ's stock is currently selling
for
A) $16.74 per share.
B) $17.07 per share.
C) $18.00 per share.
D) $19.35 per share.
Answer: A
35) Investors are most interested in which one of the

following ratios?
A) return on assets
B) current ratio
C) net profit margin
D) return on equity
Answer: D
42) For most companies, the dividend payout ratio

falls within the range of
A) 10 to 20%.
B) 20 to 40%.
C) 40 to 60%.
D) 60 to 80%.
Answer: C
36) Which one of the following is a leverage

measure?
A) times interest earned
B) net working capital
C) return on equity
D) net profit margin
Answer: A
43) Which of the following may be signs of future

problems for a company?
I. Inventories growing faster than sales.
II. Rapidly increasing debt to equity ratio.
III. Cash flow from operations is higher than net
income.
IV. Current liabilities increasing faster than current
assets.
A) I and III only
B) II and IV only
Answer: C
37) If a company's ROA is high, then an investor can

assume that the company
A) is in danger of defaulting on its loans.
B) pays a high dividend.
C) is profitable.
D) has more equity than debt in its capital structure.
Answer: C
38) If a firm has an ROA of 10% and an ROE of
10%, then the
A) operating results of the firm are improving.
B) firm has no financial leverage.
C) firm must have enough cash on hand to pay some
25
industries such as energy or banking.

III. compare them to previous years.
IV. compare them to absolute standards established
by the CFA Institute.
A) I and II only
B) I and III only
C) III and IV only
D) IV only
Answer: B
44) The PEG ratio

A) preferred by investors is equal to 2.0 or higher.
B) compares the price/earnings ratio to the rate of
growth of the company's earnings.
C) is a measure of a firm's liquidity.
D) measures the ability of a firm's assets to generate
growth for the firm.
Answer: B
45) Which of the following directly impact return on
equity?
I. net profit margin
II. leverage
III. return on assets
IV. cash flow from investment activities
A) I and III only
B) II and IV only
Answer: D
8) Which of the following is a readily available

source of industry comparisons.
I. Standard & Poor's
II. MSN Money, Yahoo Finance and other financial
portals
III. Mergent (Moody's)
IV. The Wall Street Journal
A) I and II only
B)I,IIandIIIonly
C)IIIandIVonly
D)II,IIIandIVonly
Answer:B
7.6 Learning Goal 6
9)Acomparisonofafirm'scurrentfinancialratiosto
thoseofprioryearsallowsoneto
A)accuratelypredictthefutureperformanceofa
firm.
B)seehowafirm'sperformancecomparestothatof
acompetitor.
C)seetrendsthataredeveloping.
D)determineifthefirmisperformingbetterthanthe
overallindustry.
Answer:C
1) A companies ratios are more meaningful when

compared to other companies in the same industry.
Answer: TRUE
2) The debt to equity ratio should be approximately
the same across all industrial sectors.
Answer: FALSE
3) Financial ratios give little indication whether a
company is well managed or not.
Answer: FALSE
10)Amgen'sdebttoequityratiois.54while
Walmart'sis.68.Bycomparingtheseratioswecan
conclude
A)thatWalmartisindangerofbankruptcy.
B)thatAmgenusestoolittledebtfinancing.
C)thatWalmartusestoolittleequityfinancing.
D)verylittlebecausethefirm'sareindifferent
industries.
Answer:D
4) Investors who want to analyze a company's ratios

usually need to compute them from the financial
statements.
Answer: FALSE
5) Historical comparisons will reveal whether a
company's performance is improving or deteriorating.
Answer: TRUE
6) Generally, the market price of a stock is
A) below its book value.
B) above its book value.
C) equal to its par value.
D) equal to its book value.
Answer: B
FundamentalsofInvesting,12e
Chapter8StockValuation
7) To determine whether a pharmaceutical company's

profitability ratios indicate strength or weakness, we
should
I. compare them to others in the same industry.
II. compare them to companies in unrelated
1)Themostimportantfactorsinfluencingastock's
currentpriceareitspastearningsanddividends.
Answer:FALSE
8.1LearningGoal1
2)Thekeytothefuturebehaviorofacompanyliesin
26
thesalesgrowthandthenetprofitmargin.
Answer:TRUE
11)Whichofthefollowingmightcauseafirm'sP/E
ratiotofall?
I. Earningsincreasesinlinewithpastexpectations.
II. Theindustryfacesincreasedcompetition.
III. Inflationandinterestratesrise.
IV. Theoverallmarketmultiplerises.
A)I,IIandIIIonly
B)I,IIandIVonly
C)I,IIIandIVonly
D)I,II,IIIandIV
Answer:A
3)CompanieswithhighP/Eratiostendtoalsohave
highdividendpayoutratios.
Answer:FALSE
4)Higherratesofgrowthandlowerdebtlevels
contributetohigherP/Eratios.
Answer:TRUE
5)Acompany'sestimatedfutureearningsanditsP/E
ratiocanbeusedtoestimatethestock'sfutureprice.
Answer:TRUE
12)WhichofthefollowingcontributestohighP/E
ratios?
A)highdividendpayoutratios
B)highrateofearningsgrowth
C)periodsofhighinflation
D)highdebtratios
Answer:B
6)Theestimatedpriceofastockinthefutureis
importantbecauseitincludestheprojectedcapital
gainonthestock.
Answer:TRUE
7)Thesinglemostimportantissueinthestock
valuationprocessisacompany's
A)pastearningsrecord.
B)historicdividendgrowthrate.
C)expectedfuturereturns.
D)capitalstructure.
Answer:C
13)HighP/Eratioscanbeexpectedwheninvestors
expect
A)ahighrateofgrowthinearnings.
B)lowearnings.relativetomarketprices.
C)highinterestrates.
D)abearmarket.
Answer:A
8)Mostanalystswouldnotfeelcomfortable
forecastingafirm'sfutureearningsformorethan
A)thenextquarter.
B)1to3years.
C)4or5years.
D)thenextbusinesscycle.
Answer:B
14)Whichofthefollowingwillmostdirectly
influenceacompany'smarketvalue?
A)thestateoftheeconomy
B)thebookvalueofitsassets
C)theuseoffinancialleverage
D)itsfuturecashflows
Answer:D
9)Thevalueofastockisafunctionof
A)futurereturns.
B)historicdividendgrowthrate.
C)mostrecentearningspershare.
D)pastreturns.
Answer:A
8.2LearningGoal2
1)ArelativeP/Eratiogreaterthan1indicatesthata
companymaybeundervalued.
Answer:FALSE
10)WhichofthefollowingvariablesaffecttheP/E
ratio?
I. capitalstructureofafirm
II. amountofdividendspaid
III. inflationrate
IV. earningsrateofgrowth
A)I,IIandIIIonly
B)I,IIandIVonly
C)I,IIIandIVonly
D)I,II,IIIandIV
Answer:D
2)Ifnetincomerises,butthenumberofshares
outstandingremainsthesame,EPSwillrise.
Answer:TRUE
3)Thecommonsizeincomestatementexpresses
everyitemontheincomestatementasapercentage
ofsales.
Answer:TRUE
4)Atemporarydeclineinearningspershareusually
resultsinatemporaryreductionofdividends.
27
Answer:FALSE
year.Thecompanyhasanetprofitmarginof5%
whichisexpectedtoremainconstantforthenext
coupleofyears.Thereare10,000sharesofcommon
stockoutstanding.Themarketmultipleis16.4and
therelativeP/Eofthefirmis1.21.Whatisthe
expectedmarketpricepershareofcommonstockfor
nextyear?
A)$15.18
B)$17.66
C)$18.37
D)$19.29
Answer:C
5)Adeclineinearningsthatinvestorsexpecttobe
temporarymayactuallyincreaseafirm'sP/Eratio.
Answer:TRUE
6)TheMerryCo.hascurrentannualsalesof
$350,000andanetprofitmarginof6%.Salesare
expectedtoincreaseby5%annuallywhiletheprofit
marginisexpectedtoremainconstant.Whatisthe
projectedaftertaxearningsfortwoyearsfromnow?
A)$19,294
B)$22,050
C)$23,100
D)$23,153
Answer:D
12)Themajorforcesbehindearningspershareare
A)returnonassetsandtotalassetvalue.
B)grossrevenueandthestockprice.
C)growthandthenumberofsharesoutstanding.
D)netincomeandthenumberofsharesoutstanding.
Answer:D
7)P/Eratioscouldriseevenasearningsfallif
A)earningsfallatafasterratethanstockprices.
B)earningsfallataslowerratethanstockprices.
C)investorsexpectlowerstockpricestobe
permanent.
D)investorsexpectlowerearningstobepermanent.
Answer:A
13)GLOOstock'sP/Eratiois45atatimewhenthe
market'sP/Eratiois15.GLOO'srelativeP/Eratiois
A)30.
B)30.
C)3.
D).33.
Answer:C
8)Evenifacompanydoesnotofficiallyfollowa
fixeddividendpolicy,dividendpaymentsare
A)extremelydifficulttopredict.
B)veryvolatileandsubjecttoeconomicconditions.
C)fairlystablefromonetimeperiodtoanother.
D)directlytiedtoacompany'sP/Eratio.
Answer:C
14)Whichoneofthefollowingisacorrectequation
tocalculateearningspershare?
A)(ROA)(bookvaluepershare)
B)(profitmargin)(totalassetturnover)(equity
multiplier)(bookvaluepershare)
C)(profitmargin)(equitymultiplier)(bookvalueper
share)
D)(profitmargin)(bookvaluepershare)
Answer:B
9)Whispernumbersare
A)officiallypublishedforecastnumbersprovidedby
companymanagement.
B)theofficialreleasedestimatespreparedby
financialanalysts.
C)generallylessaccuratethanthereleasedestimates
byanalysts.
D)generallyhigherthanthereleasedanalysts'
forecasts.
Answer:D
15)Whichoneofthefollowingismostlikelyto
increasethepriceofastock?
A)rapidgrowthinsales.
B)rapidgrowthindividends.
C)rapidgrowthinearnings.
D)rapidincreasesinbondinterestrates.
Answer:C
10)Ifthemarketmultipleis23.0andtheP/Eratioof
acompanyis27.4,thenthestock'srelativeP/Eis
A)0.84.
B)1.19.
C)3.21.
D)4.40.
Answer:B
16)GlobalWarning'sEPSforthecurrentyearis
$2.75anditscurrentP/Eratiois50.Youhave
forecastedthatEPSwillgrowby10%buttheP/E
ratiowillfallto40.Whatdoyouexpectthepriceof
ashareofGW'sstocktobeattheendofnextyear?
A)$110
B)$121
C)$137.50
11)ThecurrentannualsalesofFlowerBud,Inc.are
$178,000.Salesareexpectedtoincreaseby4%next
28
D)$151.25
Answer:B
2)Astockwillbeanattractiveinvestmentifthe
requiredrateofreturnexceedstheexpectedrateof
return.
Answer:FALSE
17)Overthelastyear,afirm'searningspershare
increasedfrom$1.20to$1.40,itsdividendspershare
increasedfrom$0.50to$0.60,anditsshareprice
increasedfrom$21to$24.Thefirmmaintaineda
relativeP/Eof1.10overtheentiretimeperiod.Given
thisinformation,itfollowsthatthe
A)stockexperiencedanincreaseinitsP/Eratio.
B)companyhadadecreaseinitsdividendpayout
ratio.
C)currentP/Eoftheoverallmarketis26.4.
D)overallmarketP/Eisdeclining.
Answer:D
3)Thereisnoassurancethattheactualrateofreturn
onanassetwillbesimilartotheprojectedrateof
return.
Answer:TRUE
4)Thegreatertheperceivedriskofanasset,the
lowertheexpectedrateofreturn.
Answer:FALSE
5)Bothbetaandtheexpectedreturnonthemarket
portfolioincorporateriskintotheCapitalAsset
PricingModel.
Answer:TRUE
18)Whichofthefollowingwillleadtoanincreasein
earningspershare?
A)anincreaseintheP/Eratio.
B)anincreaseinthedividendpayoutratio.
C)anincreaseinreturnonequityifbookvalueper
sharestaysthesame.
D)adecreaseinthenumberofsharesifreturnon
equitystaysthesame.
Answer:C
6)Therequiredrateofreturndenotestheminimum
rateofreturnaninvestorshouldexpect.
Answer:TRUE
7)Theintrinsicvalueofanassetequalsthepresent
valueofallfuturecashflowsatagivendiscountrate.
Answer:TRUE
19)MarkhemEnterprisesisexpectedtoearn$1.34
persharethisyear.Thecompanyhasadividend
payoutratioof40%andaP/Eratioof18.What
shouldoneshareofcommonstockinMarkhem
Enterprisesbesellingforinthemarket?
A)$9.65
B)$14.47
C)$24.12
D)$33.77
Answer:C
8)Theintrinsicvalueofastockprovidesapurchase
priceforthestock
A)thatisreasonablegiventheassociatedlevelof
risk.
B)whichwillassuredlyyieldtheanticipatedcapital
gain.
C)whichwillguaranteetheexpectedrateofreturn.
D)thatisalwaysbelowthemarketvaluebutyet
yieldstheexpectedrateofreturn.
Answer:A
20)ThecommonstockofJennifer'sFurnitureOutlet
iscurrentlysellingat$32.60ashare.Thecompany
adherestoa60%dividendpayoutratioandhasaP/E
ratioof19.Thereare21,000sharesofstock
outstanding.Whatistheamountoftheannualnet
incomeforthefirm?
A)$21,619
B)$36,032
C)$48,327
D)$60,053
Answer:B
9)Theriskfreerateofreturnis2.2percent,the
expectedmarketreturnis11percent,andthebetafor
Solstice,Inc.is1.12.WhatisSolstice'srequiredrate
ofreturn?
A)8.80%
B)12.05%
C)13.20%
D)14.30%
Answer:B
8.3LearningGoal3
10)Theriskfreerateis2%.Theexpectedrateof
returnonthemarketis12%.Betaandtheexpected
rateofreturnforfourstocksareasfollows.:ABC.8,
10%;DEF1,12%;GHI1.2,13%,andJKL2,22%.
Whichofthesestocksshouldnotbepurchased?
1)Riskisbroughtintothestockvaluationprocess
throughtherequiredrateofreturn.
Answer:TRUE
29
A)ABC
B)DEF
C)GHI
D)JKL
Answer:C
B)IandIIIonly
C)I,IIandIVonly
D)II,IIIandIVonly
Answer:D
14)Aninvestorshouldpurchaseastockwhen
A)themarketpriceexceedstheintrinsicvalue.
B)theexpectedrateofreturnequalsorexceedsthe
requiredreturn.
C)thecapitalgainsrateislessthantherequired
returnandnodividendsarepaid.
D)themarketpriceisgreaterthanthejustifiedprice.
Answer:B
11)Whichofthefollowingarekeyinputsto
determiningthevalueofanasset?
I. therequiredrateofreturn
II. futurecashflows
III. currentstockprice
IV. timingoffuturecashflows
A)IandIIonly
B)IandIIIonly
C)I,IIandIVonly
D)II,IIIandIVonly
Answer:C
15)Williamisthetypeofstockmarketinvestorwho
focusesonfactorssuchasacompany'sbookvalue,
debtload,returnonequity,andcashflow.In
searchingforstockinvestments,helooksata
company'shistoricalperformanceandattemptsto
findundervaluedstocks.Thisinformationindicates
thatSamisthetypeofinvestorknownas
A)agrowthinvestor.
B)apremiuminvestor.
C)anearningsinvestor.
D)avalueinvestor.
Answer:D
12)IntheCapitalAssetPricingModel,whichofthe
followingfactorsareusedtodeterminetherequired
rateofreturn?
I. theriskfreeinterestrate
II. futurecashflows
III. expectedreturnonthemarketportfolio
IV. beta
A)IandIIonly
B)I,IIandIIIonly
C)II,IIIandIVonly
D)I,IIIandIVonly
Answer:D
16)Stephanieisaninvestorwhobelievesthatthereal
keytoacompany'sfuturestockpriceliesinitsfuture
earnings.Wheninvestinginacompany,shecarefully
studiesitsfutureearningspotential,andsellsa
company'sstockatthefirstsignofanytrouble.This
informationindicatesthatDellawouldcorrectlybe
classifiedas
A)agrowthinvestor.
B)avalueinvestor.
C)abuyandholdinvestor.
D)anindexinvestor.Answer:A
13)Whichofthefollowingcharacteristicsappealto
socalledvalueinvestors?
I. highP/Eratios.
II. lowdebttoequityratios
III. highcashflowrelativetoprice
IV. highbookvaluerelativetomarketprice
A)IandIIonly
30

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TEST 2

Fundamentals of Investing, 12e

9) A portfolio consisting of four stocks is expected to

5.1 Learning Goal 1

10) The stock of a technology company has an

3) By plotting the efficient frontier, investors can find

11) The statement "A portfolio is less than the sum of

6) An efficient portfolio maximizes the rate of return

5.2 Learning Goal 2

8) Marco owns the following portfolio of stocks.

2) Correlation is a measure of the relationship

1) Negatively correlated assets reduce risk more than

3) Risk can be totally eliminated by combining two

investing only domestically.

B) tend to be somewhat negatively correlated.

5) Studies have shown that investing in different

15) The risk of a portfolio consisting of two

6) Coefficients of correlation range from a maximum

16) Over the long term, a portfolio consisting of an

9) Investing in emerging markets is an effective

17) Which one of the following will provide the

11) If there is no relationship between the rates of

18) American investors have several alternatives

12) Combining uncorrelated assets will

19) American depositary shares (ADS) are

14) In the real world, most of the assets available to

5.3 Learning Goal 3

II. the economy goes into a recessionary period

1) Diversifiable risk is also called systematic risk.

15) Which of the following represent systematic

4) It is relatively easy to obtain the beta for actively

16) Estimates of a stock's beta may vary depending

7) The index used to represent market returns is

17) Which one of the following conditions can be

10) For stocks with positive betas, higher risk stocks

18) Which one of the following types of risk cannot

13) Historical betas are always reliable predictors of

B) are forces that affect all investment categories.

27) When the stock market has bottomed out and is

21) A measure of systematic risk is

28) The best stock to own when the stock market is at

22) Beta can be defined as the slope of the line that

29) Security A has a beta of .99, security B has a beta

23) In designing a portfolio, relevant risk is

24) Which of the following best describes the

31) The stock of ABC, Inc. has a beta of 1.10. The

25) A stock's beta value is a measure of

32) Analysts commonly use the ________ to measure

26) The beta of the market is

required return for this investment is

33) The market rate of return increased by 8% while

7) OKAY stock has a beta of 0.73. The market as a

34) Which of the following statements concerning

8) The Capital Asset Pricing Model (CAPM) is a

5.4 Learning Goal 4

9) When the Capital Asset Pricing Model is depicted

2) The CAPM estimates the required rate of return on

10) Which of the following factors comprise the

4) In the Capital Asset Pricing Model, beta measures

11) The Franko Company has a beta of 1.09. By what

6) You have gathered the following information

According to the Capital Asset Pricing Model, the

12) What is the expected return on a stock with a beta

13) According to MSN money, the stock of Orange