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essentials of investments

Questions and Answers of Essentials of Investments

2. Use the data from Market Insight (www.mhhe.com/edumarketinsight) to do the following:a. Estimate the intrinsic value of one firm from the Population sample. You will need to calculate the firm’s
1. Find the ROEs, the P/E ratios, and the 5-year historical growth rates for 20 of the firms included in the Market Insight Web page at www.mhhe.com/edumarketinsight. Select the firms by clicking on
Why do bond prices go down when interest rates go up? Don’t bond lenders like to receive high interest rates?
13. Shaar (from the previous problem) has revised slightly her estimated earnings growth rate for Rio National and, using normalized (underlying) EPS, which is adjusted for temporary impacts on
Define the following types of bonds:a. Catastrophe bondb. Eurobondc. Zero-coupon bondd. Samurai bonde. Junk bondf. Convertible bond g. Serial bond h. Equipment obligation bond i. Original-issue
12. While valuing the equity of Rio National Corp. (from the previous problem), Katrina Shaar is considering the use of either cash flow from operations (CFO) or free cash flow to equity(FCFE) in her
11. Rio National Corp. is a U.S.-based company and the largest competitor in its industry. Tables 18F–18I present financial statements and related information for the company. Table 18J presents
10. Janet Ludlow’s firm requires all its analysts to use a two-stage dividend discount model (DDM)and the capital asset pricing model (CAPM) to value stocks. Using the CAPM and DDM, Ludlow has
9. Peninsular Research is initiating coverage of a mature manufacturing industry. John Jones, CFA, head of the research department, gathered the following fundamental industry and market data to help
8. Mike Brandreth, an analyst who specializes in the electronics industry, is preparing a research report on Dynamic Communication. A colleague suggests to Brandreth that he may be able to determine
7. Dynamic Communication is a U.S. industrial company with several electronics divisions. The company has just released its 2008 annual report. Tables 18C and 18D present a summary of Dynamic’s
6. Christie Johnson, CFA, has been assigned to analyze Sundanci using the constant dividend growth price/earnings (P/E) ratio model. Johnson assumes that Sundanci’s earnings and dividends will grow
5. Abbey Naylor, CFA, has been directed to determine the value of Sundanci’s stock using the Free Cash Flow to Equity (FCFE) model. Naylor believes that Sundanci’s FCFE will grow at 27%for 2
4. Helen Morgan, CFA, has been asked to use the DDM to determine the value of Sundanci, Inc.Morgan anticipates that Sundanci’s earnings and dividends will grow at 32% for 2 years and 13%thereafter.
3. At Litchfield Chemical Corp. (LCC), a director of the company said that the use of dividend discount models by investors is “proof” that the higher the dividend, the higher the stock price.a.
2. Which of the following assumptions does the constant-growth dividend discount model require?I. Dividends grow at a constant rate.II. The dividend growth rate continues indefinitely.III. The
1. A common stock pays an annual dividend per share of $2.10. The risk-free rate is 7%, and the risk premium for this stock is 4%. If the annual dividend is expected to remain at $2.10, what is the
17. Chiptech, Inc., is an established computer chip firm with several profitable existing products as well as some promising new products in development. The company earned $1 a share last year, and
16. The MoMi Corporation’s cash flow from operations before interest and taxes was $2 million in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen,
15. The Generic Genetic (GG) Corporation pays no cash dividends currently and is not expected to for the next 4 years. Its latest EPS was $5, all of which was reinvested in the company. The firm’s
14. The Duo Growth Company just paid a dividend of $1 per share. The dividend is expected to grow at a rate of 25% per year for the next 3 years and then to level off to 5% per year forever.You think
13. Recalculate the intrinsic value of Honda shares using the free cash flow model of Spreadsheet 18.2 (available at www.mhhe.com/bkm; link to Chapter 18 material) under each of the following
12. Recalculate the intrinsic value of Honda in each of the following scenarios by using the threestage growth model of Spreadsheet 18.1 (available at www.mhhe.com/bkm; link to Chapter 18 material).
11. The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next 5 years. Its latest EPS was $10, all of which was reinvested in the
10. The risk-free rate of return is 8%, the expected rate of return on the market portfolio is 15%, and the stock of Xyrong Corporation has a beta coefficient of 1.2. Xyrong pays out 40% of its
9. The stock of Nogro Corporation is currently selling for $10 per share. Earnings per share in the coming year are expected to be $2. The company has a policy of paying out 50% of its earnings each
8. The FI Corporation’s dividends per share are expected to grow indefinitely by 5% per year.a. If this year’s year-end dividend is $8 and the market capitalization rate is 10% per year, what
7. If the expected rate of return of the market portfolio is 15% and a stock with a beta of 1.0 pays a dividend yield of 4%, what must the market believe is the expected rate of price appreciation on
6. The market consensus is that Analog Electronic Corporation has an ROE 9%, has a beta of 1.25, and plans to maintain indefinitely its traditional plowback ratio of 2/3. This year’s earnings
5.a. MF Corp. has an ROE of 16% and a plowback ratio of 50%. If the coming year’s earnings are expected to be $2 per share, at what price will the stock sell? The market capitalization rate is
4.a. Computer stocks currently provide an expected rate of return of 16%. MBI, a large computer company, will pay a year-end dividend of $2 per share. If the stock is selling at $50 per share, what
3. If a security is underpriced (i.e., intrinsic value > price), then what is the relationship between its market capitalization rate and its expected rate of return?
2. In what circumstances is it most important to use multistage dividend discount models rather than constant-growth models?
1. In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm?
2. Compare the price-to-earnings (P/E) ratios for these industries. Why might biotech have a negative P/E ratio in some periods? Why is its P/E ratio (when positive)so much higher than that of water
1. Go to www.mhhe.com/edumarketinsight. Find the Industry Profile for the biotechnology and the water utility industries. Compare the price-to-book ratios for the two industries. (Price-to-book is
8.a. Based on historical data and assuming less-than-full employment, periods of sharp acceleration in the growth rate of the money supply tend to be associated initially with:i. Periods of economic
7. Dynamic Communication dominates a segment of the consumer electronics industry. A small competitor in that segment is Wade Goods & Co. Wade has just introduced a new product, the Carrycom, which
5. Janet Ludlow is preparing a report on U.S.-based manufacturers in the electric toothbrush industry and has gathered the information shown in Tables 17A and 17B . Ludlow’s report concludes that
4. Adams’s research report (see the preceding problem) continued as follows: “With a business recovery already under way, the expected profit surge should lead to a much higher price for
3. Universal Auto is a large multinational corporation headquartered in the United States. For segment reporting purposes, the company is engaged in two businesses: production of motor vehicles and
2. An unanticipated expansionary monetary policy has been implemented. Indicate the impact of this policy on each of the following four variables:a. Inflation rate.b. Real output and employment.c.
1. Briefly discuss what actions the U.S. Federal Reserve would likely take in pursuing an expansionary monetary policy using each of the following three monetary tools:a. Reserve requirements.b. Open
15. Your business plan for your proposed start-up firm envisions first-year revenues of $120,000, fixed costs of $30,000, and variable costs equal to one-third of revenue.a. What are expected profits
14. General Weedkillers dominates the chemical weed control market with its patented product Weed-ex. The patent is about to expire, however. What are your forecasts for changes in the industry?
13. Why do you think the change in the index of labor cost per unit of output is a useful lagging indicator of the macroeconomy? (See Table 17.2 .)
12. Why do you think the index of consumer expectations is a useful leading indicator of the macroeconomy?(See Table 17.2 .)
11. For each pair of firms, choose the one that you think would be more sensitive to the business cycle.a. General Autos or General Pharmaceuticals.b. Friendly Airlines or Happy Cinemas.
10. In which stage of the industry life cycle would you place the following industries?( Note: There is considerable room for disagreement concerning the “correct” answers to this question.)a.
9. Here are four industries and four forecasts for the macroeconomy. Match the industry to the scenario in which it is likely to be the best performer.Industry Economic Forecasta. Housing
8. Consider two firms producing DVD recorders. One uses a highly automated robotics process, whereas the other uses workers on an assembly line and pays overtime when there is heavy production
7. According to supply-side economists, what will be the long-run impact on prices of a reduction in income tax rates?
6. Unlike other investors, you believe the Fed is going to loosen monetary policy. What would be your recommendations about investments in the following industries?a. Gold miningb. Construction
5. What characteristics will give firms greater sensitivity to business cycles?
4. What are the differences between bottom-up and top-down approaches to security valuation?What are the advantages of a top-down approach?
3. Choose an industry and identify the factors that will determine its performance in the next 3 years. What is your forecast for performance in that time period?
2. If you believe the U.S. dollar will depreciate more dramatically than do other investors, what will be your stance on investments in U.S. auto producers?
1. What monetary and fiscal policies might be prescribed for an economy in a deep recession?
Two investment advisers are comparing performance. One averaged a 19% rate of return and the other a 16% rate of return. However, the beta of the first investor was 1.5, whereas that of the second
Portfolio Expected Return Standard Deviation Risk-free 10% 0%Market 18% 24%A 16% 22%For Problems 10 through 16: If the simple CAPM is valid, which of the following situations are possible? Explain.
Portfolio Expected Return Beta Risk-free 10% 0 Market 18% 1.0 A 16% 0.9 For Problems 10 through 16: If the simple CAPM is valid, which of the following situations are possible? Explain. Consider each
Portfolio Expected Return Beta Risk-free 10% 0 Market 18% 1.0 A 16% 1.5 For Problems 10 through 16: If the simple CAPM is valid, which of the following situations are possible? Explain. Consider each
Portfolio Expected Return Standard Deviation Risk-free 10% 0%Market 18% 24%A 20% 22%For Problems 10 through 16: If the simple CAPM is valid, which of the following situations are possible? Explain.
Portfolio Expected Return Standard Deviation Risk-free 10% 0%Market 18% 24%A 16% 12%For Problems 10 through 16: If the simple CAPM is valid, which of the following situations are possible? Explain.
Portfolio Expected Return Standard Deviation A 30% 35%B 40% 25%For Problems 10 through 16: If the simple CAPM is valid, which of the following situations are possible? Explain. Consider each
Portfolio Expected Return Beta A 20% 1.4 B 25% 1.2 For Problems 10 through 16: If the simple CAPM is valid, which of the following situations are possible? Explain. Consider each situation
Consider the following table, which gives a security analyst’s expected return on two stocks in two particular scenarios for the rate of return on the market:Market Return Aggressive Stock
You are a consultant to a large manufacturing corporation that is considering a project with the following net after-tax cash flows (in millions of dollars):Years from Now After-Tax Cash Flow 0 −40
Kaskin, Inc., stock has a beta of 1.2 and Quinn, Inc., stock has a beta of .6. Which of the following statements is most accurate?a. The expected rate of return will be higher for the stock of
Here are data on two companies. The T-bill rate is 4% and the market risk premium is 6%.Company $1 Discount Store Everything $5 Forecasted return 12% 11%Standard deviation of returns 8% 10%Beta 1.5
The market price of a security is $50. Its expected rate of return is 14%. The risk-free rate is 6%, and the market risk premium is 8.5%. What will be the market price of the security if its
How much is expected performance affected by recognizing the relation between realized alphas and the original alpha forecasts?
Suppose that on the basis of the analyst’s past record, you estimate that the relationship between forecast and actual alpha is:Actual abnormal return = .3 × Forecast of alpha Use the alphas from
A portfolio manager summarizes the input from the macro and micro forecasters in the following table:Macro Forecasts Asset Expected Return (%) Standard Deviation (%)T-bills 8 0 Passive equity
Rework Problem 13 for portfolio Q with investment proportions of .50 in P, .30 in the market index, and .20 in T-bills.
For portfolio P with investment proportions of .60 in A and .40 in B, rework Problems 9, 10, and 12.
What is the covariance between each stock and the market index?
What are the covariance and the correlation coefficient between the two stocks?
Break down the variance of each stock into its systematic and firm-specific components.
What is the standard deviation of each stock?
The following are estimates for two stocks.Stock Expected Return Beta Firm-Specific Standard Deviation A 13% 0.8 30%B 18 1.2 40 The market index has a standard deviation of 22% and the risk-free rate
Your client ponders whether to switch the 70% that is invested in your fund to the passive portfolio.a. Explain to your client the disadvantage of the switch.b. Show him the maximum fee you could
What is the largest percentage fee that a client who currently is lending (y < 1) will be willing to pay to invest in your fund? What about a client who is borrowing (y > 1)?For Problems 27 through
Solve Problems 23 and 24 for a client who uses your fund rather than an index fund.
What is the range of risk aversion for which a client will neither borrow nor lend, that is, for which y = 1?
Draw a diagram of your client’s CML, accounting for the higher borrowing rate. Superimpose on it two sets of indifference curves, one for a client who will choose to borrow, and one for a client
Investment Management Inc. (IMI) uses the capital market line to make asset allocation recommendations.IMI derives the following forecasts:• Expected return on the market portfolio: 12% •
Look at the data in Table 6.7 on the average excess return of the U.S. equity market and the standard deviation of that excess return. Suppose that the U.S. market is your risky portfolio.a. If your
Your client’s degree of risk aversion is A = 3.5.a. What proportion, y, of the total investment should be invested in your fund?b. What is the expected value and standard deviation of the rate of
Suppose that your client prefers to invest in your fund a proportion y that maximizes the expected return on the complete portfolio subject to the constraint that the complete portfolio’s standard
Suppose that your client decides to invest in your portfolio a proportion y of the total investment budget so that the overall portfolio will have an expected rate of return of 16%.a. What is the
Draw the CAL of your portfolio on an expected return–standard deviation diagram. What is the slope of the CAL? Show the position of your client on your fund’s CAL.
Suppose that your risky portfolio includes the following investments in the given proportions:Stock A 25%Stock B 32%Stock C 43%What are the investment proportions of your client’s overall
Your client chooses to invest 70% of a portfolio in your fund and 30% in an essentially risk-free money market fund. What is the expected value and standard deviation of the rate of return on his
Repeat Problem 11 for an investor with A = 3.What do you conclude?
Calculate the utility levels of each portfolio of Problem 10 for an investor with A = 2.What do you conclude?
Calculate the expected return and variance of portfolios invested in T-bills and the S&P 500 index with weights as follows:Wbills Windex 0 1.0 0.2 0.8 0.4 0.6 0.6 0.4 0.8 0.2 1.0 0
What must be true about the sign of the risk aversion coefficient, A, for a risk lover? Draw the indifference curve for a utility level of .05 for a risk lover.For Problems 10 through 12: Consider
Draw the indifference curve in the expected return–standard deviation plane corresponding to a utility level of .05 for an investor with a risk aversion coefficient of 3.(Hint: Choose several
Consider a portfolio that offers an expected rate of return of 12% and a standard deviation of 18%. T-bills offer a risk-free 7% rate of return. What is the maximum level of risk aversion for which

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