FIN 3400 Chapter 08 Assignment Questions and Answers- Florida International University

FIN 3400 Chapter 08 Assignment Questions and Answers- Florida International University Select all that apply Which of these apply to publicly-issued common stock? Select all that apply. Multiple select question. Ownership position Valueless security unless dividends are currently being paid Value determined on the stock exchanges Stock value depends on the issuer's business success How important is the liquidity provided by stock exchanges to the equity markets? Multiple choice question. Of little importance Not important Somewhat important Very important A stock quote displays the last price as 28.13, down 0.10. What was the previous day's closing price? Multiple choice question. $28.23 $25.32 $31.05 $28.03 Reason: Prior day's close = $28.13 + $0.10 = $28.23 , located around the perimeter of the floor of the stock exchange, act as agents for those buying and selling stocks. Brokers Select all that apply Which of these characteristics apply to the New York Stock Exchange (NYSE)? Select all that apply. Multiple select question. Specialists No actual trading floor Brokers Physical trading floor Select all that apply Which of these descriptions apply to common stock? Select all that apply. Multiple select question. An equity security that offers ownership benefits in a corporation A security that provides voting privileges A security that provides the potential for its owner to receive both dividends and capital gains A financial security which provides guaranteed dividend payments Select all that apply Which of these characteristics apply to the American Stock Exchange but not to NASDAQ? Select all that apply. Multiple select question. Ticker symbols of one to five letters Dealers who use an electronic dealer market to affect trades. One designated market maker overseeing the process for an individual stock on a trading floor Physical trading floor Which of these is the key service provided by stock exchanges that attracts investors? Multiple choice question. Research information Ticker symbols Liquidity Trading volume reports Which of these terms best describes the trading process used by NASDAQ? Multiple choice question. Specialist system Face-to-face trading Broker system Multiple market maker system A stock quote shows a P/E of 18. How is the ratio defined? Multiple choice question. Current stock price/Last four quarters of earnings Current stock price/Estimated annual earnings for the next 12 months Average price for the last 52-week period/Last four quarters of earnings Average price for the last 52-week period/Estimated annual earnings for the next 12 months True or false: The value of a firm as measured by its market capitalization is solely dependent upon the market value of the firm's stock. True false question. True False A(n) symbol is the unique code for a company on a stock exchange. It consists of one to five letters. Select all that apply Which of these services should you expect to receive from a full-service brokerage firm? Select all that apply. Multiple select question. Low transaction costs In-depth research on individual stocks ticker Guaranteed rates of returns on equity securities Investment advice Which one of these is a factor that has minimum requirements which a firm must meet to be listed on the NYSE? Multiple choice question. Number of stockholders Number of corporate directors Dividends per share Number of employees What is the key difference between a floor broker on AMEX and a dealer on NASDAQ? Multiple choice question. A dealer sells securities and a broker buys them. A broker is a market maker while a dealer is not. A dealer operates on a trading floor while a broker deals only with electronic trades. A dealer buys and sells only from his own inventory while a floor broker executes trades both for himself and others. True or false: A dealer will buy stock from an investor at the ask price. True false question. True False If you purchase shares of stock on NASDAQ, who is the most likely seller of those shares? Multiple choice question. Broker Individual investor Specialist Dealer Select all that apply Which statements are correct? Select all that apply. Multiple select question. A market order will execute immediately, regardless of the price. A limit sell order will only execute at the limit price or higher. A limit sell order may never be executed. A limit buy order will execute as soon as the market price reaches or exceeds the limit price. What is the definition of market capitalization? Multiple choice question. Book value per share times number of shares outstanding Book value of equity Current stock prices times number of shares traded Current stock price times number of shares outstanding Which one of these is an advantage of a market order? Multiple choice question. The order will execute only at the designated price or better. The order will execute immediately. The price will be known in advance. The price obtained will be better than the going market price. Which one of the following characteristics most applies to a discount brokerage firm? Multiple choice question. Buy and sell advice offered to clients High commissions Investors place trades on the firm's Internet site In-depth stock research What is the key advantage of a limit order? Multiple choice question. The order will be executed immediately. The order must execute within 24 hours at the limit price. The order will only execute at the limit price or better. The order must execute within 48 hours at the limit price. Which one of these defines the current value of a stock? Multiple choice question. Discounted value of both the future dividends and the future stock price Compounded value of both the future dividends and the future stock price Discounted value of a future stock price Summation of future dividends and the future stock price Which of these is correct? Multiple choice question. Investors earn the spread. Investors buy stocks at the bid price. Dealers are willing to purchase stocks at the ask price. Dealers are willing to sell stocks at the ask price. Mary placed an order to purchase 100 shares of ABC stock at the going price. The order was filled as soon as it reached the floor of the exchange. What type of order did Mary place? Multiple choice question. Limit buy order Market sell order Market buy order Limit sell order Just before the market closes, ABC stock is selling for $43 a share, so you place a market sell order for 300 shares. The order reaches the trading floor after the market closes for the day. The next morning, ABC stock opens at a price of $28 a share. What happens to your order? Multiple choice question. The order is executed at a price of $43 a share. The order is never executed. The order will execute but only if the price increases to $43 a share. The order is executed at a price of $28 a share. What is the primary disadvantage of a limit order? Multiple choice question. A limit order executes after 48 hours at that day's closing price if the limit price is not obtained. The execution price may be unacceptable. A limit order may not execute. A limit order executes after 24 hours at the market price if the limit price is not obtained. Assume you are computing P0, which is the current price of a stock. What discount factor will you use to discount the dividend in year 3? Multiple choice question. (1 + i) i i 3 (1 + i) 3 Which one of these applies to stock valuation? Multiple choice question. The value of a stock today equals the discounted value of the future expected cash flows. The value of a stock can be computed with certainty. The value of a stock today is determined by the stock's historical values. The value of a stock today is based on guaranteed future cash flows. A stock is expected to pay a dividend of $2 in year 2, $3 in year 3, and sell for $40 at the end of year 3. The discount rate is 11 percent. Which one of these is the correct formula for computing the current stock price? Multiple choice question. P0 = $2/1.11 + $3/1.112 + $40/1.113 P0 = $2/1.11 + [($3 + $40)/1.112] P0 = $2/1.112 + [($3 + $40)/1.113] P0 = $2 + [($3 + $40)/1.111] True or false: A dealer will buy stock from an investor at the ask price. True false question. True False What is the key premise upon which the dividend discount model is based? Multiple choice question. The dividend amount must remain constant. Dividends are paid only for a limited number of years. Only dividends for the first 10 years are considered. All future cash flows from a stock are dividend payments. Select all that apply Which statements are correct? Select all that apply. Multiple select question. A limit buy order will execute as soon as the market price reaches or exceeds the limit price. A market order will execute immediately, regardless of the price. A limit sell order will only execute at the limit price or higher. A limit sell order may never be executed. A firm just paid an annual dividend of $1.40 and increases that dividend by 2 percent each year. How do you find the price of the firm's stock at year 4 if the discount rate is 13 percent? Multiple choice question. P4 = ($1.40 × 1.025)/(0.13 - 0.02) P4 = ($1.40 × 1.023)/(0.13 - 0.02) P4= ($1.40 × 1.02)/(0.13 - 0.02) P4 = ($1.40 × 1.024)/(0.13 - 0.02) In a stock valuation formula, what does the symbol D1 represent? Multiple choice question. Estimated dividend in time period 1, or next year's dividend when solving for the current price The price of the stock at time period 1, or next year's stock price The discount rate for time period 1 The first dividend to be received, regardless of the timing of that dividend What is the basic assumption of the constant-growth model? Multiple choice question. If the dividend amount changes each year, it does so by a constant percentage. Dividends increase by a constant dollar amount each year. Dividends must increase by a constant percentage each year. The model assumes that dividends become a constant dollar amount after a set number of years. A stock is expected to pay annual dividends of $1.20 and sell for $42.60 three years from today. Which of these is the correct formula for computing the value of the stock today if the discount rate is 9 percent? Multiple choice question. P0 = ($1.20/1.09) + ($1.20/1.092) + ($42.60/1.093) P0 = $1.203 /1.093 + ($42.60/1.093) P0 = ($1.20/1.09) + ($1.20/1.092) + [($1.20 + $42.60)/1.093] P0 = $1.20 + ($1.20/1.09) + [($1.20 + $42.60)/1.092] The overall rate of growth for a firm and its industry is 3.5 percent. Which of these combinations of dividend growth rates are acceptable when computing the current value of the firm's stock? Multiple choice question. Short-run growth = 5 percent; Long-run growth = 4 percent Short-run growth = 20 percent; Long-run growth = 5 percent Short-run growth = 15 percent; Long-run growth = 3 percent Short-run growth = 2 percent; Long-run growth = 4 percent Which one of these best defines the dividend discount model? Multiple choice question. A method of valuing a stock based on a fixed dividend amount A stock valuation method based on the present value of future dividends and an expected future stock price A method of valuing a stock by limiting the number of future dividends that are to be discounted A stock valuation method based on the present value of all future dividends Which one of these generally applies to preferred stock? Multiple choice question. Principal repaid at maturity Higher dividend yields than common stock issued by the same issuer Stock prices that are directly related to market interest rates Constant stock price Mary placed an order to purchase 100 shares of ABC stock at the going price. The order was filled as soon as it reached the floor of the exchange. What type of order did Mary place? Multiple choice question. Limit sell order Market sell order Limit buy order Market buy order Select all that apply How can a preferred stock be valued? Select all that apply. Multiple select question. Preferred stock can be valued using the constant-growth model. Preferred stock can be valued the same as a bond. Preferred stock should be valued by dividing the annual dividend by the current market price. Preferred stock can be valued as a perpetuity, PV = PMT/i A stock just paid its annual dividend of $1.20. Future dividends are expected to increase by 2 percent annually and the discount rate is 9 percent. Which of these is the correct formula for computing the current stock price? Multiple choice question. P0 = ($1.20 × 1.02)/(0.09 - 0.02) P0 = $1.20/(0.09 - 0.02) P0 = ($1.20/0.09) - 0.02 P0 = ($1.20 × 1.022)/(0.09 - 0.02) Select all that apply Assume a preferred stock pays a constant annual dividend. Which of these is a correct computation of the dividend yield? Select all that apply. Multiple select question. Dividend yield = D0/P0 Dividend yield = D1/P1 Dividend yield = D/P0 Dividend yield = D1/P0 Which of these is a limitation that applies to the constant-growth dividend model? Multiple choice question. g 3 percent g i or g = i g 0 g i How is the discount rate used to value a stock related to the expected return on the stock? Assume the stock price fairly reflects the stock's value. Multiple choice question. The discount rate should equal the expected rate of return. The discount rate should be less than the expected rate of return. The discount should be equal to or less than the expected rate of return. The discount rate should exceed the expected rate of return. Select all that apply Which of these accurately recaps dividend growth estimations and limitations as they apply to the dividend growth model? Select all that apply. Multiple select question. Dividend growth can be estimated based on historical data, dividend trends, or analyst's forecasts. Dividends can grow quickly in the short-run but cannot exceed the overall economic growth rate over the long-run. Dividend growth must not exceed the economic growth rate in either the short-run or the long-run. Dividend growth must be based on actual historical data. A stock has an expected rate of return of 10.6 percent based on a 9 percent rate of growth. What will the expected rate of return be if analysts revise the firm's growth rate to 7.5 percent? Multiple choice question. 7.5 percent 5.9 percent 9.1 percent 12.1 percent Reason: Dividend yield = 10.6% - 9% = 1.6%; Expected rate of return = 1.6% + 7.5% = 9.1% A preferred stock has which of these characteristics? Multiple choice question. Owned primarily by individual investors Zero dividend growth Residual ownership claim Guaranteed voting rights Lew's increases its annual dividend by 2 percent annually. The last dividend paid was $1.42 and the stock price is $46. How is the expected rate of return computed? Multiple choice question. i = [($1.42 × 1.02)/$46] + 0.02 i = ($1.42/$46) - 0.02 i = [($1.42 × 1.02)/$46] - 0.02 i = ($1.42/$46) + 0.02 Which of these applies to the valuation of a preferred stock? Select all that apply. Multiple select question. Preferred dividend payments are assumed to have a finite life. Preferred dividends are assumed to be a constant dollar amount. Preferred dividends are assumed to have a constant, non-zero rate of growth. Preferred dividend payments are assumed to be infinite. What is the best definition of the variable-growth rate stock valuation method? Multiple choice question. Stock valuation method used when a firm is expected to go out of business Stock valuation method used when a firm is expected to pay totally irregular dividends into infinity Stock valuation method used when a firm's current growth rate is expected to change in the future Stock valuation method used when a firm has variable earnings but a constant dividend rate of growth How is the dividend yield on a constant-dividend preferred stock defined? Multiple choice question. Last four quarters of dividend income/Current stock price Last semi-annual dividend payment/Current stock price Last quarterly dividend/Current stock price Next expected quarterly dividend/Current stock price What is the purpose of the terminal price that is used in conjunction with a variable-growth rate stock valuation formula? Multiple choice question. To replace the future price at time n To replace all of the dividends paid in stage 1 To replace all of the dividends paid in stage 2 To replace all of the dividends paid How is the discount rate used to evaluate a security related to the security's level of risk? Multiple choice question. The higher the level of risk, the lower the discount rate needs to be. There is no relationship between the discount rate and the risk level. The lower the level of risk, the higher the discount rate needs to be. The higher the level of risk, the higher the discount rate needs to be. A stock just paid an annual dividend of $1.10. The dividend is expected to increase by 10 percent per year for the next two years and then increase by 2 percent per year thereafter. The discount rate is 14 percent. Which of these correctly computes the current stock price? Multiple choice question. P0= $1.10(1.1)1.14$1.10(1.1)1.14 + $1.10(1.1)21.142$1.10(1.1)21.142+ $1.10(1.1)3+$1.10(1.1)3(1.02)0.14−0.021.143$1.10(1.1)3+$1.10(1.1)3(1.02)0.14-0.021.143 P0 = $1.10(1.14)1.1$1.10(1.14)1.1 + $1.10(1.14)2+ $1.10(1.14)2(1.02)0.1−0.021.12$1.10(1.14)2+$1.10(1.14)2(1.02)0.1-0.021.12 P0 = $1.10(1.1)1.14$1.10(1.1)1.14 + $1.10(1.1)2+$1.10(1.1)2(1.02)0.14−0.021.142 A stock has a dividend yield of 1.4 percent. What is the expected return if the growth rate is 4 percent? What if the growth rate is 8 percent? Multiple choice question. 5.4 percent; 9.4 percent 2.6 percent; 6.6 percent 5.4 percent; 8.4 percent 4 percent; 8 percent Which of these is a correct interpretation of a P/E ratio? Multiple choice question. The stock with the highest P/E has the lowest current price per dollar of earnings. The stock with the lowest P/E has the highest rate of growth. The stock with the lowest P/E has the lowest current price per dollar of earnings. The stock with the highest P/E has the highest stock price. A stock just announced that its next annual dividend will be $1.02 and it expects to increase that dividend by 2.5 percent annually. The stock is currently selling for $28 a share. How do you compute the expected rate of return? Multiple choice question. i = ($1.02 × 1.025)/$28 i = [($1.02 × 1.025)/$28] + 0.025 i = ($1.02/$28) - 0.025 i = ($1.02/$28) + 0.025 What is the primary purpose of the P/E valuation formula? Multiple choice question. Estimate future dividends Estimate the future price of a stock Estimate a firm's future earnings Determine the appropriate P/E for a firm Which of these are basic assumptions of a variable growth rate valuation? Select all that apply. Multiple select question. g1 applies to a designated number of years g1 can be negative, positive, or equal to zero g1 must be a sustainable rate of growth g2 i What does it mean when a P/E is designated as a trailing P/E? Multiple choice question. Both the price and the earnings used in the P/E calculation were last year's values. The price used in the P/E calculation was last year's price. The earnings used in the P/E calculation were for a period greater than 12 months. The earnings used in the P/E calculation were for the past four quarters. Why do you have to use the dividend at time n + 1 to compute the terminal price in the two-stage growth valuation model? Multiple choice question. You don't. The dividend used to compute the terminal price should be the time n dividend. The terminal price is the time n + 1 price. Thus, the dividend must be the time n + 1 price. The terminal price is the time n price. The dividend used to compute a price must always be one time period ahead of the price. True or false: A growth stock is considered to be a bargain stock. True false question. True False A stock just paid an annual dividend of $0.40 per share. The firm expects to increase the dividend by 20 percent per year for the next four years and 3 percent per year thereafter. The discount rate is 11 percent. Which one of these is correct regarding the two-stage growth formula? Multiple choice question. g1 = 0.11 D0 = $0.40 × (1 + 0.20) g2 = 0.03 D1 = $0.40 A firm is expected to have net earnings of $1,480,000 three years from now. There are 500,000 shares of stock outstanding. The firm's current P/E ratio is 18 and it is expected to remain at that level. What is the firm's expected stock price for year 3? Multiple choice question. $55.07 $44.29 $49.16 $53.28 Reason: P3 = 18 × ($1,480,000/500,000) = $53.28 True or false: A P/E is a measure of relative value. True false question. True False If you want to estimate a future price, Pn, using the P/E valuation formula, you should use the estimated earnings for which year? Multiple choice question. Year n + 1 Year 0 Year n - 1 Year n Which one of these statements is correct? Multiple choice question. Media outlets generally report the forward P/E. The trailing P/E includes investor's expectations of future profits. A forward P/E is less accurate than a trailing P/E. Investors generally use the trailing P/E. Which of these indicates a value stock? Multiple choice question. High P/E, low growth Low P/E, low growth High P/E, high growth Low P/E, high growth A firm is expected to have net earnings of $4.00 per share of stock outstanding. The firm's current P/E ratio is 14 and it is expected to remain at that level. What is the firm's expected stock price for year 2? Multiple choice question. $53.28 $18.00 $102.00 $56.00 Reason: P2 = 14 × $4.00 = $56.00 A firm is expected to have net earnings of $1,480,000 three years from now. There are 500,000 shares of stock outstanding. The firm's current P/E ratio is 18 and it is expected to remain at that level. What is the firm's expected stock price for year 3? Multiple choice question. $44.29 $55.07 $53.28 $49.16 Reason: P3 = 18 × ($1,480,000/500,000) = $53.28