Chapter 11 Stock Valuation and Risk 355 Chapter 11 Stock Valuation and Risk 1 The common price earnings valuation method applies the price earnings ratio to earnings per share in order to value the firm s stock A firm s industry B firm s the firm s C average industry industry D average industry the firm s ANSWER D 2 A firm is expected to generate earnings of 2 22 per share next year The mean ratio of share price to expected earnings of competitors in the same industry is 15 Based on this information the valuation of the firm s shares based on the price earnings PE method is A 2 22 B 6 76 C 33 30 D none of these ANSWER C 3 Bolwork Inc is expected to pay a dividend of 5 per share next year Bolwork s dividends are expected to grow by 3 percent annually The required rate of return for Bolwork stock is 15 percent Based on the dividend discount model a fair value for Bolwork stock is per share A 33 33 B 166 67 C 41 67 D 60 00 ANSWER C 4 Protsky Inc just paid a dividend of 2 20 per share The dividend growth rate for Protsky s dividends is 3 percent per year If the required rate of return on Protsky stock is 12 percent the stock should be valued at per share according to the dividend discount model A 24 44 B 25 18 C 18 88 D 75 53 ANSWER B 356 Chapter 11 Stock Valuation and Risk 5 The limitations of the dividend discount model are more pronounced when valuing stocks A that pay most of their earnings as dividends B that retain most of their earnings C that have a long history of dividends D that have constant earnings growth ANSWER B 6 Hancock Inc retains most of its earnings The company currently has earnings per share of 11 Hancock expects its earnings to grow at a constant rate of 2 percent per year Furthermore the average PE ratio of all other firms in Hancock s industry is 12 Hancock is expected to pay dividends per share of 3 50 during each of the next three years If investors require a 10 percent rate of return on Hancock stock a fair price for Hancock stock today is A 113 95 B 111 32 C 105 25 D none of these ANSWER A 7 When evaluating stock performance measures variability that is systematically related to market returns measures total variability of a stock s returns A beta standard deviation B standard deviation beta C intercept beta D beta error term ANSWER A 8 The rate is commonly used as a proxy for the risk free rate in the Capital Asset Pricing Model A Treasury bond B prime C discount D federal funds ANSWER A 9 Stock prices of U S firms primarily involved in exporting are likely to be affected by a weak dollar and affected by a strong dollar A favorably adversely B adversely adversely C favorably favorably D adversely favorably ANSWER A Chapter 11 Stock Valuation and Risk 357 10 The January effect refers to the pressure on stocks in January of every year A downward large B upward large C downward small D upward small ANSWER D 11 The expected acquisition of a firm typically results in in the target s stock price A an increase B a decrease C no change D none of these ANSWER A 12 Which of the following statements is incorrect A Analysts play an important role in the market valuation of stocks because they influence buying and selling decisions B Many analysts are assigned to specific stocks and issue ratings that can indicate whether investors should buy or sell the stock C Analysts at the largest brokerage firms typically recommend sell for about 50 percent of all the stock for which they provide ratings D Many analysts are employed by securities firms that have other investment banking relationships with the firms that they rate ANSWER C 13 The Sharpe Index measures the A average return on a stock B variability of stock returns per unit of return C stock s beta adjusted for risk D excess return above the risk free rate per unit of risk ANSWER D 14 A stock s average return is 11 percent The average risk free rate is 9 percent The stock s beta is 1 and its standard deviation of returns is 10 percent What is the Sharpe Index A 05 B 5 C 1 D 02 E 2 ANSWER E 358 Chapter 11 Stock Valuation and Risk 15 A stock s average return is 10 percent The average risk free rate is 7 percent The standard deviation of the stock s return is 4 percent and the stock s beta is 1 5 What is the Treynor Index for the stock A 03 B 75 C 1 33 D 02 E 50 ANSWER D 16 If security prices fully reflect all market related information such as historical price patterns but do not fully reflect all other public information security markets are A weak form efficient B semi strong form efficient C strong form efficient D none of these ANSWER A 17 If security markets are semi strong form efficient investors cannot solely use to earn excess returns A previous price movements B insider information C publicly available information D previous price movements and insider information ANSWER D 18 The is are commonly used to determine what a stock s price should have been A Capital Asset Pricing Model B Treynor Index C Sharpe Index D Treynor Index and the Sharpe Index ANSWER A 19 A stock s beta is estimated to be 1 3 The risk free rate is 5 percent and the market return is expected to be 9 percent What is the expected return on the stock based on the Capital Asset Pricing Model CAPM A 5 2 percent B 11 7 percent C 16 7 percent D 4 percent E 10 2 percent ANSWER E Chapter 11 Stock Valuation and Risk 359 20 According to the text other things being equal stock prices of U S firms primarily involved in exporting could be affected by a weak dollar Stock prices of U S importing firms could be affected by a weak dollar A adversely favorably B favorably adversely C favorably favorably D adversely adversely ANSWER B 21 The demand by foreign investors for the stock of a U S firm sold on a U S exchange may be higher when the dollar is expected to other things being equal Assume the firm s operations are unaffected by the value of the dollar A strengthen B weaken C stabilize D weaken or stabilize ANSWER A 22 A higher beta of an asset reflects A lower risk B lower covariance between the asset s returns and market returns C higher covariance between the asset s returns and the market returns D none of these ANSWER C 23 The January effect refers to a large A rise in the price of small stocks in January B decline in …