FIN 420 EXAM 3 QUESTIONS WITH VERIFIED SOLUTIONS LATEST UPDATE 2026

FIN 420 EXAM 3 QUESTIONS WITH VERIFIED SOLUTIONS LATEST UPDATE 2026 Identify terminology, characteristics, and sources of risk of common stock and preferred stock - Answers The option to convert becomes more valuable as common stock appreciates, which causes the preferred stock to appreciate - Preferred stock has less risk than common stock (stable dividend, priority) Equity investments are exposed to the following risks: - Market risk (Systematic risk) - Interest rate risk (security down if IR go up) - Business risk (specific) - Financial risk (too much fixed debt/leverage) - bonds (default/credit) A big risk of owning preferred stocks is that shares are often sensitive to changes in interest rates. At stock split is a non-cash event in which the number of stocks are increased to reduce the per share price. For example, a 2-for-1 split on a $50 priced stock would translate to two shares for $25 each. - Answers - The market value of the company is unchanged - The earnings per share decreases (more shares of stock) - The P/E ratio remains the same - A lower stock price gives a broader audience a chance to purchase the stock - There is no realized taxable income - The tax basis per share is adjusted downward constant growth dividend discount model (Gordon growth model) - Answers used to compute a stock's intrinsic value. used w/ dividends growing at a constant rate to perpetuity. this model is the assumption it goes into perpetuity No growth model - Answers preferred stock that have a fixed dividend rate and no maturity. Implies stock value higher (V ^) if: - Answers Larger dividend per share (D1 ↑) | Lower expected return rate (r ↓) | Higher expected growth rate of dividends (g ↑) | This model works if r g The Black-Scholes option valuation model estimates the value of a European option by using a mathematical model that incorporates five factors. - Answers •The current underlying stock price on which the option is written •The option's exercise price •The time to expiration of the option •The risk-free rate of return •The volatility (standard deviation) of the security's returns Differentiate a cash dividend from a non-cash dividend - Answers A stock dividend is a non-cash payment. It is a payment to shareholders of record in the form of stock.- The market value of the company is unchanged - The stock price per share decreases - Earnings per share decreases (more shares of stock) - The P/E ratio remains the same - There is no realized taxable income - The tax basis per share is adjusted downward Compute the intrinsic value of preferred stock using the no-growth dividend discount model - Answers V = D/r. V = intrinsic value of the stock D = fixed dividend r = investor's required rate of return Compute the intrinsic value of common stock using the constant growth dividend discount - Answers Constant Growth Dividend Discount Model - XYZ stock paid a dividend of $4.81 this past year. The dividend is expected to increase by 4% annually and investors who own stock in similar firms require a return of 18%. What is the market value of the firm's stock? G=4%, R=18%; D1 -- 1.04 | D1 = D0 (1+g)^1 = 4.81(1.04) = 5.00; 5/(.18-.04) = 35.71 Compute the intrinsic value of common stock using a multi-state dividend discount model - Answers Multi-state Growth Dividend Discount Model Relative Value Methods (didn't pay dividend, had to use this) - Price-to-Earnings (P/E) Ratio Compute the value of stock using a non-dividend valuation model: P/E ratio, PEG ratio, P/Sales - Answers Price-to-Earnings Divided by Growth (PEG) Ratio (can stand alone) - The PEG ratio determines the market price of a stock by comparing the firm's earnings growth rate with an industry average PEG (or peer comparison). This valuation method is useful when a firm does not pay a dividend, and when the price investors pay for earnings growth is relevant. Should be around 1. PEG = P/E ÷ g PEG 1 = Growth potential (Value stock) |PEG Industry PEG = Undervalued |PEG Industry PEG = Overvalued Stock XYZ is trading at $60 per share. The earnings per share (EPS) is $3. The P/E ratio for XYZ is 20 and the firm's earnings growth rate is 22%. The investor observes that comparable firms have a P/E ratio of 22 and an earnings growth rate of 22%. (P/E = 60/3 = 20) Company PEG = 20 ÷ 22 = .91 | Industry PEG = 22 ÷ 22 = 1 Company PEG 1 = Growth potential (Value stock) | Company PEG Industry PEG = Undervalued .91 1 Interpret the variables of stock valuation models and the impact a change in variables has on the valuation of stocks - Answers The no-growth (perpetuity) dividend discount model may be used to compute a stock's intrinsic value. This valuation model is commonly used for preferred stock that have a fixed dividend rate and no maturity. Determine if a stock is overvalued or undervalued - Answers The P/E ratio determines the market price of a stock by comparing the firm's earnings with an industry average P/E (or peer comparison). This valuation method is useful when a firm does not pay a dividend, and when the price investors pay for earning per share (EPS) is relevant. Company P/E Industry P/E = Undervalued | Company P/E Industry P/E = Overvalued Characteristics of alternatives, tangible, gold, natural resources - Answers Gold has an inverse relationship with stock prices (negative correlation). Historically it has been viewed as a safe haven in times of economic distress. Countries with high inflation will hold gold rather than their currency. Gold does not pay interest. When high-interest environments persist, investors prefer bonds to gold. 1. Directly purchase of gold exposure - Storage issues - ETF investment vehicle issues 2. Indirect gold exposure through the purchase of mining stocks - Volatile mining stocks - International stock issues - Inefficient operating costs Natural resources include oil and gas assets, and timberland. Often oil and gas assets have pass-through benefits. Returns are enhanced when demand is greater than supply. They act as a good diversifier because prices are often inversely related to stock prices, especially when inflation is higher. Emerging markets also contribute to rapid growth in natural resource sectors. Natural Resource Investment 1. Limited partnerships involved in land purchase 2. Stock purchases of natural resource companies 3. Mutual fund purchase of portfolios of natural resource companies Intrinsic value models - Answers No-growth Discount Model | Constant Growth Dividend Discount Model | Multi-state Growth Dividend Discount Model G= ROE x RR - Answers ROE = NI/e A=L+E Relative Value Methods (didn't pay dividend, had to use this) - Answers - Price-to-Earnings (P/E) Ratio | Price-to-Earnings by Growth (PEG) Ratio | Price-to-Sales (P/S) Ratio Price-to-Sales (P/S) Ratio determines the market price of a stock by comparing the firm's sales with an industry average P/S (or peer comparison). This valuation method is useful when - Answers neither earnings nor dividends are relevant, and when the price investors pay for sales, or the firm's revenue stream, is relevant. Company P/S Industry P/S = Undervalued | Company P/S Industry P/S = Overvalued rental properties - Answers Residential rental: A building rented by people to live in. - Single-family home - Apartment - Condominium - Hotels Commercial real estate: A building rented by people to run a business. - Office - Shopping centers - Banks - Restaurants - Retail stores - Industrial warehouse REMIC - Answers A real estate mortgage investment conduit (REMIC) is a self-liquidating, flow-through entity that invests through real estate mortgages or mortgage back securities. The REMIC terminates when the underlying mortgages have been paid. A common REMIC is a collateralized mortgage obligation (CMO). REMIC characteristics: - Issues debt securities (bonds) to raise capital to invest in mortgages - Provide monthly cash flow to REMIC investors ($1,000 to $25,000) - Bond maturity is structured (3 to 30 years) - Pass-through, REMIC is tax exempt - CMOs offer multiclass securities divided into tranches (A safest, Z riskiest) REIT - Answers Liquid and marketable: actively traded on exchanges. Corporate structure with a board of directors. Theoretically can last forever. Loss of purchase power. - Diversification - Marketability - Federal income tax exempt* (90% earnings distribution, 75% income from real estate) - Inflation hedge - Global real estate exposure - Real estate philosophy * Exemption is at the REIT level. The investor is still responsible for capital gains/losses and income taxes. can be like a fixed income bond (stuck at rate) RELP - - Answers Private: not actively traded on exchanges. Lack liquidity and marketability. Partnership structure which terminates upon the death of the general partner. Liquidity and marketability risks. Undeveloped land - - Answers investments are passive and produce negative cash flows as a result of no income while maintaining ongoing expense. The investment objective is capital appreciation. Taxes on capital appreciation are deferred until the investor sells the land. Real estate taxes while holding the land, are tax deductible. Undeveloped Land Risks: - Rezoning - Permitting - Access - Population growth (demand) Compute the value of real estate using NOI and a cap rate - Answers Intrinsic = NOI/CAP rated ADR - Answers trasparent, traded on exchanges (liquid and marketable) price based on foreign stock price You're evaluating a commercial retail building. The lease specifies that the NOI is 245,000 annually over the next 10 years. Which is true? - Answers The value of the property is ___ if the investor requires a ___ return. Foreign security considerations emerging markets, developed markets: risks, vehicles, - Answers Higher standard deviations Low correlations - stocks Low correlations - bonds Different accounting standards (US - GAAP; International - IFRS) Foreign currency exposure Foreign taxes Developed vs Emerging markets Foreign Security Risks: 1) Exchange rate risk 2) Country risk emerging markets risks, vehicles, - Answers Emerging Markets Characteristics Low GDP (doesn't mean low growth)