CHAPTER 12

1.

A top-down analysis of a firm's prospects starts with an analysis of the ____.

A. firm's position in its industry

B. U.S. economy or even the global economy
C. industry
D. specific firm under consideration
2.

An increase in the value of the yen against the U.S. dollar can cause the Japanese
automaker Toyota to either _____________ on its U.S. sales.

A. lose market share or reduce its profit margin

B. gain market share or reduce its profit margin
C. lose market share or increase its profit margin
D. gain market share or increase its profit margin
3.

You can earn abnormal returns on your investments via macro forecasting ______.

A. if you can forecast the economy at all

B. if you can forecast the economy as well as the average forecaster
C. if you can forecast the economy better than the average forecaster
D. only if you can forecast the economy with perfect accuracy
4.

Which of the following is not an example of fiscal policy?

A. Social Security spending

B. Medicare spending
C. Fed purchases of Treasury securities
D. Changes in the tax rate

5.

Which one of the following describes the amount by which government spending exceeds
government revenues?

A. Balance of trade
B. Budget deficit
C. Gross domestic product
D. Output gap
6.

GDP refers to _________.

A. the amount of personal disposable income in the economy

B. the difference between government spending and government revenues
C. the total manufacturing output in the economy
D. the total production of goods and services in the economy
7.

Inflation is caused by ________________.

A. unions
B. rapid growth of the money supply
C. excess supply
D. low rates of capacity utilization
8.

To obtain an approximate estimate of the real interest rate, one must _________ the
__________ the nominal risk-free rate.

A. add; default premium to

B. subtract; default premium from
C. add; expected inflation to
D. subtract; expected inflation from

9.

The supply of funds in the economy is controlled primarily by ____________.

A. the Federal Reserve System

B. Congress
C. money center banks
D. the Treasury department
10.

Cash cows are typically found in the _________ stage of the industry life cycle.

A. start-up
B. consolidation
C. maturity
D. relative decline
11.

Large-growth companies generally emerge in the __________ stage.

A. start-up
B. consolidation
C. maturity
D. relative decline

12.

Whenever OPEC attempts to influence the price of oil by significantly altering production,
economists refer to this type of event as a ______________.

A. demand shock
B. equilibrium event
C. expanding commodity event
D. supply shock
13.

The nominal interest rate is 10%. The real interest rate is 4%. The inflation rate must be
_________.

A. -6%
B. 4%
C. 5.77%
D. 14.4%

14.

Attempting to forecast future earnings and dividends is consistent with which of the
following approaches to securities analysis?

A. Technical analysis
B. Fundamental analysis
C. Both technical analysis and fundamental analysis
D. Indexing

15.

Which of the following are barriers to entry?

I. Large economies of scale required to be profitable
II. Established brand loyalty
III. Patent protection for the firm's product
IV. Rapid industry growth

A. I and II only
B. I, II, and III only
C. II, III, and IV only
D. III and IV only

CHAPTER 13

1.

A firm is planning on paying its first dividend of $2 three years from today. After that,
dividends are expected to grow at 6% per year indefinitely. The stock's required return is
14%. What is the intrinsic value of a share today?

A. $25
B. $16.87
C. $19.24
D. $20.99
Intrinsic value at time 2 = $2/(.14 - .06) = $25
Intrinsic value today = $25/(1.14)2 = $19.24
2.

Gagliardi Way Corporation has an expected ROE of 15%. If it pays out 30% of its earnings
as dividends, its dividend growth rate will be _____.

A. 4.5%
B. 10.5%
C. 15%
D. 30%
b = 1 - .3 = .7
g = b ROE = .7 15% = 10.5%

3.

You are considering acquiring a common share of Sahali Shopping Center Corporation
that you would like to hold for 1 year. You expect to receive both $1.25 in dividends and
$35 from the sale of the share at the end of the year. The maximum price you would pay
for a share today is __________ if you wanted to earn a 12% return.

A. $31.25
B. $32.37
C. $38.47
D. $41.32

4.

You want to earn a return of 11% on each of two stocks, A and B. Stock A is expected to pay a
dividend of $3 in the upcoming year, while stock B is expected to pay a dividend of $2 in the
upcoming year. The expected growth rate of dividends for both stocks is 4%. Using the
constant-growth DDM, the intrinsic value of stock A _________.

A. will be higher than the intrinsic value of stock B

B. will be the same as the intrinsic value of stock B
C. will be less than the intrinsic value of stock B
D. The answer cannot be determined from the information given.

5.

The constant-growth dividend discount model (DDM) can be used only when the
___________.

A. growth rate is less than or equal to the required return

B. growth rate is greater than or equal to the required return
C. growth rate is less than the required return
D. growth rate is greater than the required return

6.

Grott and Perrin, Inc., has expected earnings of $3 per share for next year. The firm's ROE
is 20%, and its earnings retention ratio is 70%. If the firm's market capitalization rate is
15%, what is the present value of its growth opportunities?

A. $20
B. $70
C. $90
D. $115
Value with no growth = $3/.15 = $20
Growth rate = .7 20% = 14%
Value with growth = $3 (1 - .7)/(.15 - .14) = $90
PVGO = $90 - 70 = $20
7.

Cache Creek Manufacturing Company is expected to pay a dividend of $4.20 in the

upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free
rate of return is 4%, and the expected return on the market portfolio is 14%. Investors use
the CAPM to compute the market capitalization rate on the stock and use the constantgrowth DDM to determine the intrinsic value of the stock. The stock is trading in the market
today at $84. Using the constant-growth DDM and the CAPM, the beta of the stock is
_________.

A. 1.4
B. .9
C. .8
D. .5
k = $4.20/$84 + .08 = .13
.13 = .04 + (.14 - .04)
= .09/.10 = .9

8.

Todd Mountain Development Corporation is expected to pay a dividend of $2.50 in the

upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free
rate of return is 5%, and the expected return on the market portfolio is 12%. The stock of
Todd Mountain Development Corporation has a beta of .75. Using the CAPM, the return
you should require on the stock is _________.

A. 7.25%
B. 10.25%
C. 14.75%
D. 21%

9.

Todd Mountain Development Corporation is expected to pay a dividend of $3 in the

upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free
rate of return is 5%, and the expected return on the market portfolio is 17%. The stock of
Todd Mountain Development Corporation has a beta of .75. Using the constant-growth
DDM, the intrinsic value of the stock is _________.

A. 4
B. 17.65
C. 37.50
D. 50
k = .05 + .75(.17 - .05) = .14
V0 = [3/(.14 - .08)] = 50

10.

Lifecycle Motorcycle Company is expected to pay a dividend in year 1 of $2, a dividend in

year 2 of $3, and a dividend in year 3 of $4. After year 3, dividends are expected to grow
at the rate of 7% per year. An appropriate required return for the stock is 12%. Using the
multistage DDM, the stock should be worth __________ today.

A. $63.80
B. $65.13
C. $67.95
D. $85.60
V3 = $4 (1.07)/(.12 - .07) = $85.60 is the value of D4, D5, . . .
The total value at time 3 is $4 + 85.60 = $89.60
The discounted cash flows are

11.

A firm has an earnings retention ratio of 40%. The stock has a market capitalization rate of
15% and an ROE of 18%. What is the stock's P/E ratio?

A. 12.82
B. 7.69
C. 8.33
D. 9.46

12.

Transportation stocks currently provide an expected rate of return of 15%. TTT, a large
transportation company, will pay a year-end dividend of $3 per share. If the stock is selling
at $60 per share, what must be the market's expectation of the constant-growth rate of
TTT dividends?

A. 5%
B. 10%
C. 20%
D. None of these options
k = D1/P0 + g
.15 = 3/60 + g
g = .10
13.

When Google's share price reached $475 per share, Google had a P/E ratio of about 68
and an estimated market capitalization rate of 11.5%. Google pays no dividends.
Approximately what percentage of Google's stock price was represented by PVGO?

A. 92%
B. 87%
C. 77%
D. 64%
EPS = $475/68 = $6.985
PVGO = $475 - ($6.985/.115) = $414.26
$414.26/$475 = 87.21%

14.

In what industry are investors likely to use the dividend discount model and arrive at a
price close to the observed market price?

A. Import/export trade
B. Software
C. Telecommunications
D. Utility
15.

The greatest value to an analyst from calculating a stock's intrinsic value is _______.

A. how easy it is to come up with accurate model inputs

B. the precision of the value estimate
C. how the process forces analysts to understand the critical variables that have the
greatest impact on value
D. how all the different models typically yield identical value results

CHAPTER 15

1.

You purchase one IBM July 120 call contract for a premium of $5. You hold the option until
the expiration date, when IBM stock sells for $123 per share. You will realize a ______ on
the investment.

A. $200 profit
B. $200 loss
C. $300 profit
D. $300 loss
Long call profit = Max [0, ($123 - $120)(100)] - $500 = -$200
2.

You purchase one IBM July 120 put contract for a premium of $3. You hold the option until
the expiration date, when IBM stock sells for $123 per share. You will realize a ______ on
the investment.

A. $300 profit
B. $300 loss
C. $500 loss
D. $200 profit
Long put profit = Max [0, ($120 - $123)(100)] - $300 = -$300
3.

______ option can only be exercised on the expiration date.

A. A Mexican
B. An Asian
C. An American
D. A European

4.

An American put option gives its holder the right to _________.

A. buy the underlying asset at the exercise price on or before the expiration date
B. buy the underlying asset at the exercise price only at the expiration date
C. sell the underlying asset at the exercise price on or before the expiration date
D. sell the underlying asset at the exercise price only at the expiration date
5.

A time spread may be executed by _____.

A. selling an option with one exercise price and buying a similar one with a different
exercise price
B. buying two options that have the same expiration dates but different strike prices
C. selling two options that have the same expiration dates but different strike prices
D. selling an option with one expiration date and buying a similar option with a different
expiration date

6.

You sell one Hewlett Packard August 50 call contract and sell one Hewlett Packard August
50 put contract. The call premium is $1.25 and the put premium is $4.50. Your strategy will
pay off only if the stock price is __________ in August.

A. either lower than $44.25 or higher than $55.75

B. between $44.25 and $55.75
C. higher than $55.75
D. lower than $44.25
You have positive profit in the range $50 - ($1.25 + $4.50) and $50 + ($1.25 + $4.50).
7.

You are cautiously bullish on the common stock of the Wildwood Corporation over the next
several months. The current price of the stock is $50 per share. You want to establish a
bullish money spread to help limit the cost of your option position. You find the following
option quotes:

To establish a bull money spread with calls, you would _______________.

A. buy the 55 call and sell the 45 call

B. buy the 45 call and buy the 55 call
C. buy the 45 call and sell the 55 call
D. sell the 45 call and sell the 55 call

8.

The common stock of the Avalon Corporation has been trading in a narrow range around
$40 per share for months, and you believe it is going to stay in that range for the next 3
months. The price of a 3-month put option with an exercise price of $40 is $3, and a call
with the same expiration date and exercise price sells for $4.
Selling a straddle would generate total premium income of _____.

A. $300
B. $400
C. $500
D. $700
Sell a straddle = sell a put + sell a call
Premium income for selling a straddle = (P0 + C0)100 = ($3 + $4)(100) = $700
9.

What combination of puts and calls can simulate a long stock investment?

A. Long call and short put

B. Long call and long put
C. Short call and short put
D. Short call and long put
10.

If you combine a long stock position with selling an at-the-money call option, the resulting net
payoff profile will resemble the payoff profile of a _______.

A. long call
B. short call
C. short put
D. long put

CHAPTER 16

1.

A stock priced at $65 has a standard deviation of 30%. Three-month calls and puts with an
exercise price of $60 are available. The calls have a premium of $7.27, and the puts cost
$1.10. The risk-free rate is 5%. Since the theoretical value of the put is $1.525, you believe
the puts are undervalued.
If you want to construct a riskless arbitrage to exploit the mispriced puts, you should
____________.

A. buy the call and sell the put

B. write the call and buy the put
C. write the call and buy the put and buy the stock and borrow the present value of the
exercise price
D. buy the call and buy the put and short the stock and lend the present value of the
exercise price
For parity to hold, the following condition must be met: C - P = S0 - Xe-rT

Buy what's underpriced (the left side of the equation) and sell what's overpriced (the right
side of the equation)

2.

According to the put-call parity theorem, the payoffs associated with ownership of a call
option can be replicated by __________________.

A. shorting the underlying stock, borrowing the present value of the exercise price, and
writing a put on the same underlying stock and with the same exercise price
B. buying the underlying stock, borrowing the present value of the exercise price, and
buying a put on the same underlying stock and with the same exercise price
C. buying the underlying stock, borrowing the present value of the exercise price, and
writing a put on the same underlying stock and with the same exercise price
D. shorting the underlying stock, lending the present value of the exercise price, and
buying a put on the same underlying stock and with the same exercise price

3.

Which one of the following will increase the value of a put option?

A. A decrease in the exercise price

B. A decrease in time to expiration of the put
C. An increase in the volatility of the underlying stock
D. An increase in stock price

4.

The stock price of Bravo Corp. is currently $100. The stock price a year from now will be either
$160 or $60 with equal probabilities. The interest rate at which investors invest in riskless
assets is 6%. Using the binomial OPM, the value of a put option with an exercise price of $135
and an expiration date 1 year from now should be worth __________ today.

A. $34.09
B. $37.50
C. $38.21
D. $45.45

Selling the stock and buying a 1-year discounted note with a $160 face value will give the same
payoff as investing in (1/.75) puts.

5.

If a stock price increases, the price of a put option on the stock will __________ and the
price of a call option on the stock will __________.

A. decrease; decrease
B. decrease; increase
C. increase; decrease
D. increase; increase
6.

A higher-dividend payout policy will have a __________ impact on the value of a put and a
__________ impact on the value of a call.

A. negative; negative
B. negative; positive
C. positive; negative
D. positive; positive
7.

The delta of a call option on a stock is always __________.

A. negative and less than -1

B. between -1 and 1
C. positive
D. positive but less than 1
8.

Of the variables in the Black-Scholes OPM, the __________ is not directly observable.

A. price of the underlying asset

B. risk-free rate of interest
C. time to expiration
D. variance of the underlying asset return

9.

The delta of an option is __________.

A. the change in the dollar value of an option for a dollar change in the price of the
underlying asset
B. the change in the dollar value of the underlying asset for a dollar change in the call
price
C. the percentage change in the value of an option for a 1% change in the value of the
underlying asset
D. the percentage change in the value of the underlying asset for a 1% change in the
value of the call
10.

A __________ is an option valuation model based on the assumption that stock prices can
move to only two values over any short time period.

A. nominal model
B. binomial model
C. time model
D. Black-Scholes model