Financial Management Exam 2 |
Questions and Correct answers
How do you deal with a stock split when calculating holding period returns? - Ans multiple
prices before the split x (1/split multiplier)
*page 14 in notes for example
Nominal vs. Real Return - Ans nominal return: raw % of return, not adjusted for inflation
real return: nominal return less inflaction
Geometric Average Return vs. Arithmetic Average Return - Ans geometric average(mean) return:
compounded rate of return over a given period = CAGR, compound annual growth rate
arithmetic average(mean) return: sum of periodic returns divided by number of returns;
"typical" return over a given period
Historically, which category of securities is the most volatile? Least volatile? Has highest
returns? Lowest returns? - Ans Most volatile: stocks(especially small company stocks)
Least volatile: T-bills
Highest returns: stocks(especially small stocks)
Lowest returns: T-bills
What is the relationship between risk and return across different classes of security? - Ans more
volatile securities typically have higher returns: higher risk = higher return
Risk Premium - Ans reward for bearing risk, the difference between a risky investment
return and the risk-free rate
, Common Shareholder Characteristics - Ans voting rights- shareholders typically vote on board
of directors, a unique feature
"residual" claimants- if company goes bankrupt, shareholders get what's left after bondholders
and preferred stockholders
Dividends - Ans dividends optional- don't have to pay them and can change them whenever;
mostly come up with a pattern and stick to it
dividends are not tax-deductible for corporations- dividends are paid after taxes are taken out
"Double taxation" - dividends are fully taxable for shareholders and not deducted for
the corporation; meaning both the company and shareholders pay taxes on dividends
Infinite Life - Ans as long as the company goes on, the stock goes on
How do you price a stock using the dividend discount model? - Ans price of any security = the
PV of its future cash flows; we can price a share of stock based on its expected future
dividend stream
price = PV of all future dividends
What model do you use for a constant dollar dividend(no growth) stock? - Ans PV = pmt/i
= DIV/"r"
What model do you use for a constant growth dividend stock? - Ans Dn = D0(1+g)^n -> D0
=most recently paid dividend
Example: D0 = $1.50, g = 6% forever
D8 = 1.50(1.06)^8 = $2.39
Gordon Growth Model - Ans Pt= (D(t+1))/ (r-g)
- g = % growth in dividend assumed to occur every period
- r = required return on stock
- D(t+1) = dividend paid 1 payment after period calculating for
Questions and Correct answers
How do you deal with a stock split when calculating holding period returns? - Ans multiple
prices before the split x (1/split multiplier)
*page 14 in notes for example
Nominal vs. Real Return - Ans nominal return: raw % of return, not adjusted for inflation
real return: nominal return less inflaction
Geometric Average Return vs. Arithmetic Average Return - Ans geometric average(mean) return:
compounded rate of return over a given period = CAGR, compound annual growth rate
arithmetic average(mean) return: sum of periodic returns divided by number of returns;
"typical" return over a given period
Historically, which category of securities is the most volatile? Least volatile? Has highest
returns? Lowest returns? - Ans Most volatile: stocks(especially small company stocks)
Least volatile: T-bills
Highest returns: stocks(especially small stocks)
Lowest returns: T-bills
What is the relationship between risk and return across different classes of security? - Ans more
volatile securities typically have higher returns: higher risk = higher return
Risk Premium - Ans reward for bearing risk, the difference between a risky investment
return and the risk-free rate
, Common Shareholder Characteristics - Ans voting rights- shareholders typically vote on board
of directors, a unique feature
"residual" claimants- if company goes bankrupt, shareholders get what's left after bondholders
and preferred stockholders
Dividends - Ans dividends optional- don't have to pay them and can change them whenever;
mostly come up with a pattern and stick to it
dividends are not tax-deductible for corporations- dividends are paid after taxes are taken out
"Double taxation" - dividends are fully taxable for shareholders and not deducted for
the corporation; meaning both the company and shareholders pay taxes on dividends
Infinite Life - Ans as long as the company goes on, the stock goes on
How do you price a stock using the dividend discount model? - Ans price of any security = the
PV of its future cash flows; we can price a share of stock based on its expected future
dividend stream
price = PV of all future dividends
What model do you use for a constant dollar dividend(no growth) stock? - Ans PV = pmt/i
= DIV/"r"
What model do you use for a constant growth dividend stock? - Ans Dn = D0(1+g)^n -> D0
=most recently paid dividend
Example: D0 = $1.50, g = 6% forever
D8 = 1.50(1.06)^8 = $2.39
Gordon Growth Model - Ans Pt= (D(t+1))/ (r-g)
- g = % growth in dividend assumed to occur every period
- r = required return on stock
- D(t+1) = dividend paid 1 payment after period calculating for
