Chapter 8

TheStockMarket

.1

Multiple Choice Questions

1.

(I)Ashareofcommonstockinafirmrepresentsanownershipinterestinthatfirm.(II)
Ashareofpreferredstockisasmuchlikeabondasitislikecommonstock.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

2.

Preferredstockholdersholdaclaimonassetsthathaspriorityovertheclaimsof
(a) bothcommonstockholdersandbondholders.
(b) neithercommonstockholdersnorbondholders.
(c) commonstockholders,butafterthatofbondholders.
(d) bondholders,butafterthatofcommonstockholders.
Answer: C

3.

(I)Preferredstockholdersholdaclaimonassetsthathaspriorityovertheclaimsof
commonstockholders,butafterthatofbondholders.(II)Firmsissuepreferredstockin
fargreateramountsthancommonstock.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.

Answer: A
4.

(I)Preferredstockholdersholdaclaimonassetsthathaspriorityovertheclaimsof
commonstockholders.(II)Bondholdersholdaclaimonassetsthathaspriorityoverthe
claimsofpreferredstockholders.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

5. (I)Firmsissuecommonstockinfargreateramountsthanpreferredstock.(II)Thetotal
volumeofstockissuedismuchlessthanthevolumeofbondsissued.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
6.

Theriskiestcapitalmarketsecurityis
(a) preferredstock.
(b) commonstock.
(c) corporatebonds.
(d) Treasurybonds.
Answer: B

7.

Organizedexchangesaccountforabout_________percentofthetotaldollarvolume
ofdomesticstocksharestraded.

(a) 30
(b) 45
(c) 60
(d) 70
Answer: D
8.

Organizedexchangesaccountforabout_________percentofthetotaldollarvolume
ofdomesticstockstraded.
(a) 60
(b) 70
(c) 80
(d) 90
Answer: B

9.

(I)ThelargestoftheorganizedstockexchangesintheUnitedStatesistheNewYork
StockExchange.(II)TobelistedontheNYSE,afirmmusthaveaminimumof$100
milliondollarsinmarketvalueor$10millioninrevenues.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: A

10.

TolistontheNYSE,afirmmust
(a) haveearningsofatleast$100millionforeachofthelastthreeyears.
(b) haveatleast$500millionofmarketvalueand$100millionofrevenue.
(c) haveatotalof$100millioninmarketvalueofpubliclytradedshares.

(d) meetalloftheaboverequirements.
(e) meet(a)and(b)oftheaboverequirements.
Answer: E
11. Securitiesnotlistedononeoftheexchangestradeintheoverthecountermarket.Inthis
exchange,dealersmakeamarketby
(a) buyingstocksforinventorywheninvestorswanttosell.
(b) sellingstocksfrominventorywheninvestorswanttobuy.
(c) doingbothoftheabove.
(d) doingneitheroftheabove.
Answer: C
12.

Themostactivestockexchangeintheworldisthe
(a) NikkeiStockExchange.
(b) LondonStockExchange.
(c) ShanghaiStockExchange.
(d) NewYorkStockExchange.
Answer: A

13.

Whichofthefollowingstatementsabouttradingoperationsinanorganizedexchange
arecorrect?
(a) Floortradersalldealinawidevarietyofstocks.
(b) Inmosttrades,specialistsmatchbuyandsellorders.
(c) Inmosttrades,specialistsbuyfororsellfromtheirowninventories.
(d) TheSuperDOTsystemisusedtoexpeditelargetradesofover100,000shares.

Answer: B
14.

WhichofthefollowingisnotanadvantageofElectronicCommunicationsNetworks
(ECNs)?
(a) AllunfilledordersareavailableforreviewbyECNtraders.
(b) TransactionscostsarelowerforECNtrades.
(c) Tradesaremadeandconfirmedfaster.
(d) ECNsworkwellforthinlytradedstocks.
Answer: D

15.

WhichofthefollowingstatementsisfalseregardingElectronicCommunications
Networks(ECNs)?
(a) ArchipelagoandInstinetaretwoexamplesofECNs.
(b) CompetitionfromECNshasforcedNASDAQtocutitsfees.
(c) Tradersbenefitfromlowertradingcostsandfasterservice.
(d) ECNsallowinstitutionalinvestors,butnotindividuals,totradeafterhours.
Answer: D

16.

Abasicprincipleoffinanceisthatthevalueofanyinvestmentis
(a) thepresentvalueofallfuturenetcashflowsgeneratedbytheinvestment.
(b) theundiscountedsumofallfuturenetcashflowsgeneratedbytheinvestment.
(c) unrelatedtothefuturenetcashflowsgeneratedbytheinvestment.
(d) unrelatedtothedegreeofriskassociatedwiththefuturenetcashflowsgenerated
bytheinvestment.
Answer: A

17. Astockcurrentlysellsfor$25pershareandpays$0.24peryearindividends.Whatisan
investorsvaluationofthisstockifsheexpectsittobesellingfor$30inoneyearandrequires
15percentreturnonequityinvestments?

(a) $30.24
(b) $26.30
(c) $26.09
(d) $27.74
Answer: B
18.

Astockcurrentlysellsfor$30pershareandpays$1.00peryearindividends.Whatis
aninvestorsvaluationofthisstockifheexpectsittobesellingfor$37inoneyearand
requires12percentreturnonequityinvestments?
(a) $38
(b) $33.50
(c) $34.50
(d) $33.93
Answer: D

19.

Intheoneperiodvaluationmodel,astocksvaluewillbehigher
(a) thehigherisitsexpectedfutureprice.
(b) thelowerisitsdividend.
(c) thehigheristherequiredreturnoninvestmentsinequity.
(d) alloftheabove.
Answer: A

20.

Intheoneperiodvaluationmodel,astocksvaluefallsifthe_________rises.
(a) dividend
(b) expectedfutureprice
(c) requiredreturnonequity

(d) currentprice
Answer: C
21.

Inthegeneralizeddividendvaluationmodelastocksvaluedependonlyon
(a) itsfuturedividendpaymentsanditsfutureprice.
(b) itsfuturedividendpaymentsandtherequiredreturnonequity.
(c) itsfuturepriceandtherequiredreturnoninvestmentsonequity.
(d) itsfuturedividendpayments.
Answer: B

22.

WhichofthefollowingisnotanelementoftheGordongrowthmodelofstock
valuation?
(a) thestocksmostrecentdividendpaid.
(b) theexpectedconstantgrowthrateofdividends.
(c) therequiredreturnoninvestmentsinequity.
(d) thestocksexpectedfutureprice.
Answer: D

23. AccordingtotheGordongrowthmodel,whatisaninvestorsvaluationofastockwhose
currentdividendis$1.00peryearifdividendsareexpectedtogrowataconstantrateof10
percentoveralongperiodoftimeandtheinvestorsrequiredreturnis11percent?
(a) $110
(b) $100
(c) $11
(d) $10
(e) $5.24

Answer: A
24.

AccordingtotheGordongrowthmodel,whatisaninvestorsvaluationofastock
whosecurrentdividendis$1.00peryearifdividendsareexpectedtogrowataconstant
rateof10percentoveralongperiodoftimeandtheinvestorsrequiredreturnis15
percent?
(a) $20
(b) $11
(c) $22
(d) $7.33
(e) $4.40
Answer: C

25.

Holdingotherthingsconstant,astocksvaluewillbehighestifitsdividendgrowthrate
is
(a) 15percent
(b) 10percent
(c) 5percent
(d) 2percent
Answer: A

26.

Holdingotherthingsconstant,astocksvaluewillbehighestifitsmostrecentdividend
is
(a) $2.00
(b) $5.00
(c) $0.50
(d) $1.00
Answer: B

27.

Holdingotherthingsconstant,astocksvaluewillbehighestiftheinvestorsrequired
returnoninvestmentsinequityis

(a) 20percent
(b) 15percent
(c) 10percent
(d) 5percent
Answer: D
28. SupposetheaverageindustryPEratioforautopartsretailersis20.Whatisthecurrent
priceofAutoZonestockiftheretailersearningspershareareprojectedtobe$1.85?
(a) $21.85
(b) $37
(c) $10.81
(d) $9.25
Answer: B
29.

WhichofthefollowingistrueregardingtheGordongrowthmodel?
(a) Dividendsareassumedtogrowataconstantrateforever.
(b) Thedividendgrowthrateisassumedtobegreaterthantherequiredreturnon
equity.
(c) Both(a)and(b).
(d) Neither(a)nor(b).
Answer: A

30.

ThePEratioapproachtovaluingstockisespeciallyusefulforvaluing
(a) privatelyheldfirms.
(b) firmsthatdontpaydividends.

(c) both(a)and(b).
(d) neither(a)nor(b).
Answer: C
31.

ThePEratioapproachtovaluingstockisespeciallyusefulforvaluing
(a) publiclyheldcorporations.
(b) firmsthatregularlypaydividends.
(c) both(a)and(b).
(d) neither(a)nor(b).
Answer: D

32.

AweaknessofthePEapproachtovaluingstockisthatitis
(a) difficulttoestimatetheconstantgrowthrateofafirmsdividends.
(b) difficulttoestimatetherequiredreturnonequity.
(c) difficulttopredicthowmuchafirmwillpayindividends.
(d) basedonindustryaveragesratherthanfirmspecificfactors.
Answer: D

33.

Afirmisexpectedtopayadividendof$1.00nextyearandthedividendisexpectedto
growataconstantrateof4percentovertime.Someinvestorshaverequiredreturnson
investmentsinequityof12percent,some10percent,andsome8percent.Themarket
priceofthisfirmsstockwillbeslightlyabove
(a) $25
(b) $18
(c) $16.67
(d) $12.50
Answer: C

34. (I)Themarketpriceofasecurityatagiventimeisthehighestvalueanyinvestorputson
thesecurity.(II)Superiorinformationaboutasecurityincreasesitsvaluebyreducingitsrisk.
(a) (I)istrue,(II)isfalse.
(b) (I)isfalse,(II)istrue.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
35.

Themaincauseoffluctuationsinstockpricesischangesin
(a) taxlaws.
(b) errorsintechnicalstockanalysis.
(c) dailytradingvolumeinstockmarkets.
(d) informationavailabletoinvestors.
(e) totalhouseholdwealthintheeconomy.
Answer: D

36.

Stockvaluescomputedbyvaluationmodelsmaydifferfromactualmarketprices
becauseitisdifficultto
(a) estimatefuturedividendgrowthrates.
(b) estimatetheriskofastock.
(c) forecastastocksfuturedividends.
(d) alloftheabovearetrue.
Answer: D

37.

The2001terroristattacksandtheEnronfinancialscandalcausedanticipateddividend
growthto_________,investorsrequiredreturnonequityto_________,andstock
pricesto_________.

(a) decreases;increase;decrease
(b) decrease;increase;increase
(c) increase;decrease;decrease
(d) increase;decrease;increase
Answer: A
38.

WhichofthefollowingisnotanobjectiveoftheSecuritiesandExchange
Commission?
(a) maintainintegrityofthesecuritiesmarkets
(b) adviseinvestorsaboutwhichparticularstocksaregoodbuys
(c) requirefirmstoprovidespecificinformationtoinvestors
(d) regulatemajorparticipantsinsecuritiesmarkets
Answer: B

.2

True/False

1.

MorestocktradingintheU.S.occursinoverthecountermarketsratherthanon
organizedexchanges.
Answer:

2.

Inoverthecountermarkets,dealersincreasestheliquidityofthinlytradedsecurities.
Answer:

3.

TRUE

Abouthalfofnewequityissuesarepreferredstock.
Answer:

10.

FALSE

TheSecuritiesandExchangeCommissionrequiresfirmstosubmitvariousdocuments
toincreasetheflowofinformationtoinvestorsbutdoesnotverifytheaccuracyofthat
information.
Answer:

9.

TRUE

TheDowJonesIndustrialAverageisthebroadestandbestindicatorofthestock
markets
daytodayperformance.
Answer:

8.

TRUE

TheEnronfinancialscandalincreaseduncertaintyaboutthequalityofaccounting
informationandasaresultincreasedrequiredreturnoninvestmentinstocks.
Answer:

7.

FALSE

Commonstockistheriskiestcorporatesecurity,followedbypreferredstockandthen
bonds.
Answer:

6.

FALSE

Allstockspaydividends,asthatistheonlywayaninvestorcanprofitfromholding
stock.
Answer:

5.

TRUE

ElectronicCommunicationsNetworksapplytechnologytomakeorganizedexchanges
moreefficientandspeedy.
Answer:

4.

FALSE

FALSE

Astocksmarketvaluewillbehigherthehigherisitsexpecteddividendstream.
Answer:

TRUE

11.

TheGordongrowthmodelassumesthatastocksdividendgrowsataconstantrate
forever.
Answer:

12.

TRUE

Astocksmarketvaluewillbehigherthehigheristheinvestorsrequiredrateofreturn.
Answer:

FALSE

Essay
1.

Howdocorporatestocksdifferfrombonds?

2.

Howdocommonstocksdifferfrompreferredstock?

3.

Howdooverthecountermarketsdifferfromorganizedexchanges?

4.

Whatistheroleofspecialistsonastockexchange?

5.

WhataretheadvantagesanddisadvantagesofElectronicCommunicationsNetworks
(ECNs)fortradingstocks?

6.

Whatistheroleoftherequiredreturnonequityinvestmentsinstockvaluationmodels?

7.

UsingtheGordongrowthmodel,explainwhythe2001teroristattacksandtheEnron
financialscandalcausedstockpricestodecline.

8.

WhatareAmericanDepositoryReceipts(ADRs)?

9.

WhataretheobjectivesoftheSecuritiesandExchangeCommission?