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Multiple Choice (1 Point each)
 
1. One of the basic premises of security analysis, and in particular fundamental analysis, is that
 
A) a stock’s price is based on its past cash flows, rather than on
anticipated future cash flows.
B) market sectors do not move in concert with business cycles.
C) all securities have an intrinsic value, but some securities may be
incorrectly priced in the market at any given time.
D) a security’s risk has relatively little effect on the security’s return.
 

2. Increases in interest rates and increases in taxes both tend to
 
A) have an expansionary impact on the economy.
B) have a contractionary impact on the economy.
C) signal the beginning of a bull market.
D) signal the trough of a recessionary market.

 
3. The risk-free rate of return is 5.5 percent, the expected market return is 11 percent, and the beta for Lea, Inc. is 0.85. What is Lea’s required rate of return?
 
A) 4.7 percent
B) 10.2 percent
C) 14.9 percent
D) 15.7 percent
 
4. Intrinsic value is based on which of the following factors?
 
I the applied discount rate
II. the amount of risk inherent in a particular stock.
III. historical net profits of the company
IV. estimated future cash flows of the company
 
A) II and IV only
B) I, II and III only
C) I, II and IV only
D) I,II,III and IV
 

5. Followers of the random walk hypothesis believe that
 
A) security analysis is the best tool to utilize when investing in the stock
market.
B) the price movements of stocks are unpredictable, and therefore security
analysis will not help to predict future market behavior.
C) the price movements of stocks follow a “flag” formation, and charting this
formation can help an investor time his or her purchases in the stock
market.
D) support levels and resistance lines, when combined with basic chart
formations, yield buy and sell signals.

 
6. One widely followed measure of the business cycle represents the market value of all goods and services produced in a country over the period of a year. This measure is the
 
A) industrial production index.
B) money supply.
C) gross domestic product.
D) productivity average.

 
7. The Federal Reserve through monetary policy can help expand the economy by
 
A) lowering income taxes on individuals.
B) increasing foreign exports by reducing tariffs.
C) supporting a moderate growth of the money supply.

 

8. When investors say that the market is efficient, they mean that
 
A) the closing prices of all stocks can be found quickly and easily in The
Wall Street Journal and in most daily newspapers.
B) the business cycles that underlie stock fluctuations occur in a
somewhat predictable fashion.
C) industrial production, and overall productivity in the economy, is
growing at a constant pace.
D) securities consistently trade at prices very close to their intrinsic
values.

 
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9. At the end of year X, the Petersen Company’s stock is expected to have an EPS of $2.50, a payout ratio of 0.55, and a P/E ratio of 18. Based on this information, the estimated share price of Petersen at the end of year X is
 

A) $9.90.
B) $12.80.
C) $24.75.
D) $45.00.
 
10. The risk-free rate of return is 5.5 percent, the expected market return is 11 percent, and the beta for Lea, Inc. is 0.85. What is Lea’s required rate of return?
 
A) 4.7 percent
B) 10.2 percent
C) 14.9 percent
D) 15.7 percent
 
11. The single most important issue in the stock valuation process is a company’s
 
A) past earnings record.
B) historic dividend growth rate.
C) future cash flow.
D) capital structure.
 

12. For the purpose of security analysis, which one of the following statements concerning a firm’s successful past performance is correct?
 
A) It means the firm’s future performance will also be successful.
B) It provides a basis for having greater confidence in management’s future performance.
C) It means the firm will experience problems in the future.
D) It provides no useful information concerning the firm’s future
prospects.
 

13. One stock valuation model holds that the value of a share of stock is a function of its future dividends, and that the dividends will increase at an annual rate which will remain unchanged over time. This stock valuation model is known as the
 
A) approximate yield model.
B) holding period return model.
C) dividend reinvestment model.
D) constant growth dividend valuation model.
 
14. An internal rate of return (IRR) is the discount rate that
 
A) represents the minimal rate that an individual investor will accept.
B) is the minimal rate that a buy-and-hold investor will accept.
C) produces a future value equal to or greater than an investor’s required
rate of return.
D) produces a present value of future benefits equal to the market price of
a stock
 
15. In the price/earnings approach to stock valuation,
 
A) historical stock prices are utilized.
B) forecasted EPS are typically used.
C) the P/E ratio is computed by multiplying the stock price by the earnings
per share.
D) professional stock analysts recommend stocks based on their past
performance.
 

16. The system of analysis which emphasizes studying the stock market itself and the forces at work in the marketplace is called
 
A) fundamental analysis.
B) security analysis.
C) industry analysis.
D) technical analysis.
 
17. As an investment vehicle, bonds can provide income in the form of
 
A) current income only.
B) capital gains only.
C) both current income and capital gains.
D) neither current income nor capital gains.
 
18. The single most important force in the bond market is
 
A) the rate of inflation.
B) the movement of the stock market.
C) the real rate of return.
D) the behavior of interest rates.
 

19. In general, the bond market is considered bearish when
 
A) market interest rates are low or falling.
B) market interest rates are high or rising.
C) the risk-free rate of return exceeds the required rate of return.
D) more bonds are called in a particular period than are issued.
 
20. Which one of the following correctly describes the effect of a decline in interest rates on bond prices?
 
A) The prices of existing bonds are not affected.
B) The prices of existing bonds fall.
C) The prices of existing bonds rise.
D) The prices of newly issued bonds are lowered.
 

21. Which one of the following economic conditions helps create capital gains on outstanding bonds?
 
A) falling interest rates
B) rising inflation rates
C) rising supply of bonds
D) declining demand for bonds
 
22. How often do bonds typically pay interest?
 
A) monthly
B) quarterly
C) semi-annually
D) annually
 
23. The major source of risk faced by investors who purchase bonds is
 
A) purchasing power risk.
B) interest rate risk.
C) liquidity risk.
D) event risk.
 
24. The call feature of a bond stipulates
 
A) the coupon rate and the maturity date of the bond.
B) the bond’s degree of default risk and the collateral used to guarantee the
issue.
C) the terms under which the bond can be retired prior to maturity.
D) whether the bond trades in a thin market or a broad market.
 

25. One of the major problems associated with mortgage-backed securities is that
 
A) the principal portion of each payment is considered taxable income.
B) they are refundable.
C) they are self-liquidating.
D) they are serial issues.

 
26. The required return on bonds can be equated to
 
A) the real rate of return plus a risk premium plus an expected inflation
premium.
B) the real rate of return plus the coupon interest rate plus the current
inflation rate.
C) the risk-free rate plus the real rate of return plus an expected inflation
premium.
D) an expected inflation premium minus the real rate plus the risk-free rate.

 
27. The yield curve depicts the relationship between a bond’s yield to maturity and its
 
A) duration.
B) term to call.
C) term to maturity.
D) volatility.
 
28. A $1,000 par value, 10-year bond carries a coupon rate of 9 percent. If the current yield of this bond is 8 percent, its market price would be
 
A) $1,000
B) $1,080
C) $1,067
D) $1,250
 
29. The mathematical link between bond price and interest rate changes is
 
A) Macaulay duration
B) modified duration
C) yield to market
D) weighted average yield

 

30. One basis point equals

A) 10 percent
B) 1 percent
C) 1/10 of 1 percent
D) 1/100 of 1 percent

 
(20 Points)
1. You are an analyst at Dewey, Cheatum, and Howe. The director of research presents the following free cash flow data for ABC Corp (in millions of $).
 
Year Cash Flow
2006 1250
2007 1300
2008 1600
2009 1700
2010 1800
 
He asks you to please calculate the
 

Geometric Total Return
Geometric Annualized Return
 
Then, the director asks you to make a 10 year forecast based upon the geometric annualized return.

Next, he asks you to value the company’s shares based on your 10 year forecast and the following assumptions.
 
Current weighted average cost of capital: 12.7%.
Terminal Growth Rate: 3%
Terminal Cost of Capital: 14%
Shares outstanding: 550 million
 
Shares of ABC are trading at $35 per share. Do you recommend a buy or a sell rating?
 
2. a. How is the DuPont System helpful to the Analyst?
 
b. Eleanor’s computers is a retailer of computer products. Using the financial data provided, complete the financial ratio calculations for 2013. Advise management of any ratios that indicate potential problems and provide an explanation of possible causes of the problems.
 
Financial Ratios 2011 2012 2013 industry average (2013)
Current Ration 1.71X 1.6X 1.70X
Quick Ratio 0.92X 0.89X 0.95X
Average Collection period 60 days 6o days 65days
Inventory turnover 4.2Ox 3.90X 4.50X
Fixed asset turnover 3.20X 3.33X 3.00X
Total Asset turnover 1.40X 1.35X 1.75X
Debt Ratio 59.20% 61% 60%
Times Interest earned 4.20x 3.70X 4.75X
Gross Profit Margin 25% 23% 22.50%
Operating Profit Margin 12.50% 12.70% 12.50%
Net Profit Margin 6.10% 6.00% 6.50%
Return on Total Assets 8.54% 8.10% 8.91%
Return on equity 20.93% 20.74% 22.28%
 
Income Statement for year ended 12/31/13 Balance Sheet at 12/31/13
Sales $1,500,000 Cash $125,000
Cost of Goods Sold 1,200,000 Account Receivable 275,000
Gross Profit $ 300,000 Inventory 325,000
Operating expenses 100,000 Current Assets $ 725,000
Operating profit $ 200,000 Fixed Assets (Nets) $ 420,000
Interest expense 72,000 Total Assets $ 1,145,000
Earnings before Tax 128,000 Accounts Payable $ 150,000
Income tax (40%) 51,200 Notes Payable 225, 0000
Net Income $76,800 Accrued Liabilities 100,000
Current liabilities 475,000
Long term debt 400,000
Total Liabilities $875,000
Equity 270,000
Total Liabilities and equity $1,145,000
 
c. Luna Lighting, a retail firm, has experienced modest sales growth over the past three years but has had difficulty translating the expansion of sales into improved profitability. Using three year’s financial statements, you have developed the following ratio calculations and industry comparisons. Based on this information, suggest possible reasons for Luna’s profitability problems.
 

2013 2012 2011 Industry Averages 2013
Current 2.3X 2.3X 2.2X 2.1X
Average collection period 45 days 46 days 47 days 50days
Inventory turnover 8.3X 8.2X 8.1X 8.3X
Fixed asset turnover 2.7X 3.0X 3.3X 3.5X
Total Asset turnover 1.1X 1.2X 1.3X 1.5X
Debt Ratio 50% 50% 50% 54%
Times interest earned 8.1X 8.2X 8.1X 7.2X
Fixed Charge Coverage 4.0X 4.5X 5.5X 5.1X
Gross Profit Margin 43% 43% 43% 40%
Operating Profit margin 6.3% 7.2% 8.0% 7.5%
Net profit margin 3.5% 4.0% 4.3% 4.2%
Return on Assets 3.7% 5.0% 5.7% 6.4%
Return on equity 7.4% 9.9% 11.4% 11.8%
 

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