Pete andJessica, on the advice of theirnext-door neighbor, recently purchased 600

600 shares of asmall-capitalization Internetstock, trading at $ 78.91

$78.91 per share. Their neighbor told them that the stock was a"real moneymaker" because it recently had atwo-for-one stock split and would probably split again soon. Evenbetter, according to theneighbor, the company was expected to earn $ 1.49

$1.49 per share and pay a $ 0.27

$0.27 dividend next year. Pete and Jessica have so far been less than impressed with thestock's performancelong dash

the stock has underperformed theS&P 500 Index this year. Pete and Jessica have come to you for some independent advice.

Questions

1. Assuming that the stock actually splits two forone, how many shares will Pete and Jessicaown? What will be the market value of their stock after thesplit? How will the split affect the value of theirholdings? Was their neighbor correct in thinking that the stock split made the stock a"real moneymaker"?

2. Using the informationprovided, calculate thestock's P/E ratio. Would you classify this investment as a growth or valuestock?

3. SincePete, inparticular, is worried about the price of thestock, explain to him how and why corporate earnings are so important in the valuation of common stocks.

4. Should Pete and Jessica be using theS&P 500 Index as a benchmark for thisstock? Why or whynot? What benchmark recommendation would youmake?

5. Yesterday they received a cold call from a stockbroker wanting to sell them an initial public offering in a cable television company. Jessica was worried because the broker promised a"no-lose guarantee." Should they invest with this type ofbroker?

6. Name at least five things Pete and Jessica need to look out for when making stock investments.

1. Assuming that the stock actually splits two forone, how many shares will Pete and Jessicaown?

After thetwo-for-one split, they will own

nothing

shares.(Round to the nearestinteger.)

What will be the market value of their stock after thesplit?

The shares will be valued at $

nothing

. (Round to the nearestdollar.)

How will the split affect the value of theirholdings?(Select the best choicebelow.)

A.

The market value will double after the stock split since this is atwo-for-one split.

B.

The market value will remain the same before and after the stock split.

C.

The market value will be cut in half after the stock split since this is atwo-for-one split.

D.

None of the above.

Was theirnext-door neighbor correct in thinking that the stock split made the stock a"real moneymaker"?(Select from thedrop-down menu.)

Their neighbor was

correct

incorrect

in thinking that a stock split will automatically increase the value of the stock.

2. Using the informationprovided, calculate thestock's P/E ratio.

Thestock's P/E ratio is

nothing

. (Round to two decimalplaces.)

Would you classify this investment as a growth or valuestock?(Select from thedrop-down menu.)

By all measures(both dividend payout andP/E Ratio) this is a

value stock

growth stock

.

3. SincePete, inparticular, is worried about the price of thestock, explain to him how and why corporate earnings are so important in the valuation of common stocks.(Select all the choices thatapply.)

A.

Thelong-term value of any stock is most closely aligned with afirm's earnings. The faster a firm can compoundearnings, the greater thelong-term value of thefirm's stock.

B.

Corporate earnings are important because analysts use earnings as a proxy for acompany's ability to pay dividends in the future.Thus, Pete should pay close attention to the earnings outlook for the stock.

C.

Theshort-term value of any stock is most closely aligned with afirm's earnings. The faster a firm can compoundearnings, the greater thelong-term value of thefirm's stock.

D.

Corporate earnings are important because analysts use earnings as proxy for acompany's ability to pay its bills in the future.Thus, Pete should pay close attention to the earnings outlook for the stock.

4. Should Pete and Jessica be using theS&P 500 Index as a benchmark for thisstock? Why or whynot? What benchmark recommendation would youmake?(Select all the choices thatapply.)

A.

TheS&P 500 index is an inappropriate benchmark for Pete and Jessica because themake-up of the index does not include any Internet company.

B.

Pete and Jessica should consider tracking the performance of their stock to an index comprised of other Internet companies(e.g., NASDAQindex)

C.

TheS&P 500 index is an inappropriate benchmark for Pete and Jessica because themake-up of the index does not represent the type of company they own.

D.

Pete and Jessica should consider tracking the performance of their stock to an index comprised of other Internet companies(e.g., FTSE 100index)

5. Yesterday they received a cold call from a stockbroker wanting to sell them an initial public offering in a cable television company. Jessica was worried because the broker promised a"no-lose guarantee." Should they invest with this type ofbroker?(Select the best choicebelow.)

A.

They should definitely not invest with this or any other broker who makes cold calls promising unlimited returns or guarantees against losses for aninvestment, unless they can put the"no-lose guarantee" in writing.

B.

They should definitely not invest with this or any other broker who makes cold calls promising unlimited returns or guarantees against losses for aninvestment, unless the investment opportunities involve initial public offerings.

C.

They should definitely not invest with this or any other broker who makes cold calls promising unlimited returns or guarantees against losses for an investment.

D.

They should definitely invest with this or any other broker who makes cold calls promising unlimited returns or guarantees against losses for an investment. These opportunitiesdon't come around very often.

6. Name at least five things Pete and Jessica need to look out for when making stock investments.

Before making any stockinvestment, Pete and Jessica needto:(Select all thatapply.)

A.

be prepared for the risks involved with broker"churning" when they employ an investment strategy and asset allocation model that meets or exceeds their risk beta.

B.

be aware ofmisrepresentation, telephone salespitches, or recommendations based on"inside information" or other tips.

C.

be aware of"hot tips" and"insider information" that will help them choose the best stocks.

D.

be aware of psychological impacts on investment decisions.

E.

understand the types and potential impacts of the various risks they would be exposed to.

F.

understand the concept of beta and how the beta of a stock tells how much and in what direction an individual stock price has moved relative to the market. High beta stocks have much more volatile price swings than low beta stocks.

G.

be aware of excessive transactions undertaken by broker"churning", if they use a broker.

H.

be prepared for losses and be wary of claims for easy profit or"hot tips", if they use an online account.

I.

employ an appropriate investment strategy and asset allocaion model that meets their risk tolerance.