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CME-1 (Part 2) English > Chapter 9 > Flashcards

Chapter 9 Flashcards

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1
Q

What type of approach does valuation of securities generally follow?

A

The valuation of securities generally follows a top down approach.

To begin with, the analyst assesses the state of the macro economy in terms of inflation, unemployment rates, exchange rates, balance of payments, and other macro parameters that will have an impact on the value of the security.

Moving down, the characteristics of industry to which the firm belongs will have to be examined.

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2
Q

What are demand side factors?

A

On the demand side, analysts try to identify who the end-users of products are and how they may change their behavior in the future.

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3
Q

What are supply side factors?

A

On the supply side, analysts try to identify the degree of concentration ratio. This measures how much of the industry is dominated by the largest firms.

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4
Q

Four stages of a typical industry life cycle:

A 
A typical cycle involves four stages: 
startup followed by 
a period of rapid growth, 
reaching a period of consolidation and maturity and 
then the final stage of decline.

It is important for analysts to understand the stage or phase of an industry, since the future prospects and risks of the firm depend on the remaining life of the industry.

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5
Q

What are cyclical industries?

A

Cyclical industries are industries that are particularly sensitive to the business cycle. Such industries tend to outperform other industries when the economy is coming out of a recession, but do worse than other industries when the economy goes into a recession.

Durable goods, luxury items and automobiles tend to fall into this category.

Stocks of companies in cyclical industries will show attractive gains just before and during an upturn in the economy.

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6
Q

What are defensive industries?

A

Defensive industries on the other hand find that their sales and profits are relatively immune to the business cycle.

For example, a grocery store will continue to sell a similar amount of basic groceries regardless of whether the economy is expanding or contracting.

Firms in such industries will tend to have a superior performance relative to other firms when the economy enters a recession.

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7
Q

Investment returns from equity generally come in two forms:

A
  1. Capital gains as the price appreciates and the equity is sold for more than the investor paid for it; and
  2. Dividend income paid by the issuing company to its shareholders.
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8
Q

How do we determine investment value?

A

Present value of all of the future dividends the investment will provide.

The required rates of return by investors act as the relevant discount rate.

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9
Q

What is technical analysis?

A

Technical analysis looks purely at the history of the stock price to determine predictable patterns, which can be exploited.

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10
Q

What is fundamental analysis?

A

Fundamental analysis looks at all relevant information that is likely to give clues about the future performance of the firm. The information set includes ratio analysis, assessing the macroeconomic environment in which the firm operates, evaluating the quality of management and other similar facts.

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11
Q

What are examples of technical analysis?

A
  1. Charting
  2. Market Fundamentals
  3. Price Evaluation
  4. Trading activity
  5. Sentiment indicators
  6. Flow of funds indicators
  7. Market structure indicators
  8. Other statistical methods such as moving averages
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12
Q

1 - A share of common stock has just paid a dividend of SR15.00. If the expected long-run growth rate for this stock is 5 percent, and if investors require an 11 percent rate of return, what is the price of the stock?

(a) SR 265
(b) SR 250
(c) SR 262.5
(d) SR 300

A

(c) SR 262.5

Gordon’s Growth Model:
D0(1+g) / Ke - g

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13
Q

2 - If the expected rate of return on a stock exceeds its required rate,

(a) The stock should be sold.
(b) The company is probably not trying to maximize price per share.
(c) The stock is a good buy.
(d) Dividends are not being declared.

A

(c) The stock is a good buy.

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14
Q

3 - Which securities can be valued by dividing the annual dividend by the required rate of return?

(a) Low coupon bonds
(b) Junk bonds
(c) Common stocks and preferred stock
(d) Preferred stocks only

A

(c) Common stocks and preferred stock

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15
Q

4 - According to the dividend growth model, if a company were to declare that it would never pay dividends, The share value would be:

(a) Based on earnings.
(b) Higher than similar firms since it could reinvest a greater amount in new projects.
(c) Zero.
(d) Can’t be determined.

A

(a) Based on earnings.

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16
Q

5 - Dividend growth is a function of

(a) Return on equity.
(b) The retention rate.
(c) The sales revenue growth rate.
(d) (a) and b).

A

(d) (a) and (b).

17
Q

6 - in 2011, an American company issued a $100 par value preferred stock that pays a 8 percent annual dividend. Due to changes in the overall economy and in the company’s financial condition investors are now requiring a 15 percent return. What price would an investor be willing to pay for a share of the preferred if first dividend is to be received one year from now?

(a) $100.00
(b) $53.33
(c) $86.95
(d) $92.59

A

(b) $53.33

Vp = Dp / Kp
Dp = 100 * 8% = 8
Kp = 15%
18
Q

7 - Using the constant growth model, an increase in the required rate of return from 16 to 19 percent combined with an increase in the growth rate from 8 to 11 percent would cause the price to

(a) Rise more than 3%
(b) Rise less than 3%.
(c) Remain constant
(d) Fall less than 3%.

A

(b) Rise less than 3%.

19
Q

8 - Manarat Company had a dividend payout ratio of 60% in 2010. The retention rate in 2010 was

(a) 40%
(b) 50%
(c) 60%
(d) 0%

A

(a) 40%

20
Q

9 - The P/E ratio for XYZ Company is 18, and the P/Sales ratio is 6.5. The industry P/E ratio is 30 and the industry P/Sales ratio is 8. Based on relative valuation (company ratios relative to the industry ratios), the stock of XYZ company is:

(a) Undervalued on the basis of relative P/E and relative P/S.
(b) Overvalued on the basis of relative P/E and undervalued on the basis of relative P/S.
(c) Undervalued on the basis of relative P/E and overvalued on the basis of relative P/S.
(d) Overvalued on the basis of relative P/E and relative P/S.

A

(a) Undervalued on the basis of relative P/E and relative P/S.

21
Q

10 - A preferred stock will pay a dividend of SR 10 in the upcoming year, and every year thereafter, i.e., dividends are not expected to grow. The required return on this stock is 10%. Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

(a) SR 10
(b) SR 100
(c) SR 90
(d) SR 110

A

(b) SR 100

10/.1

22
Q

11 - A preferred stock will pay a dividend of SR 15 in the upcoming year, and every year thereafter, i.e., dividends are not expected to grow. You require a return of 9% on this stock. What is the intrinsic value of this preferred stock?

(a) SR 15
(b) SR 166.67
(c) SR 16.67
(d) SR 30

A

(b) SR 166.67

15/.09

23
Q

If the industry P/E average is 20 and Qasim Cement stock made EPS of 5 last year, and it is expected to grow by 20% the stock price is:

A. 120
B. 12
C. 20
D. 22

A

A. 120

P/E = 20
EPS = 5*1.2 = 6

P = E * EPS = 20 * 6

24
Q

If the required rate of return on company X is 12% and expected dividends for the coming year is 1.8 and expected growth rate is 6.5%, and EPS is 6.6 what is P/E:

A. 5
B. 9.09
C. 7.66
D. 8.33

A

A. 5

P/E = Market Price of Share / EPS

Market Price of Share = 1.8 / (.12 - .065)

25
Q

If the expected earnings are S.R 30 and the company retains 40% of its profits, the dividend growth rate is 10% and the required rate of required rate of return is 16% what is the price:

A. 300
B. 250
C. 330
D. 280

A

A. 300

SR * 60% = 18
18 / (.16-.10) = 300

26
Q

An American company preferred stock price is 100 and the dividends are 8%, what is the amount to be paid for such stock if the required rate of return is 15%:

A. $53.3
B. $530
C. $108
D. $ 155

A

A. $53.3

27
Q

All of the following are used to value common stock, except:

A. Price to book ratio
B. Price to sales
C. Price total assets

A

C. Price total assets

28
Q

Which of the following securities is (are) valued by dividing dividends by required rate of return:

A. Preferred
B. Common share with zero growth in dividends
C. Common share with constant growth
D. A and B

A

D. A and B

29
Q

The value of the preferred share is simply the present value of:

A. All dividends plus principal
B. All of the future dividends
C. All of the future dividends plus principal
D. All future dividends

A

D. All future dividends

30
Q

Zero dividend growth stock is calculated:

A. By calculating future value
B. Much like preferred stocks
C. By compounding
D. None of the above

A

B. Much like preferred stocks

P = Dividend / r

31
Q

In a typical industry life cycle, consolidation is followed by:

A. Decline
B. Maturity
C. Start up

A

A. Decline

32
Q

The constant growth rate formula is:

A. Retention ratio divided by RoE
B. Payout ratio multiplied by RoE
C. Retention ratio multiplied by RoE
D. Retention ratio plus Roe

A

C. Retention ratio multiplied by RoE

Retention Ratio = b = (1-payout ratio)

g = b * RoE

33
Q

RoE = 15% and payout ratio 45% the constant growth rate will be:

A. 8.25%
B. 6.75%
C. 4.5%
D. 5.5%

A

A. 8.25%

g = (1 - payout ratio) * RoE

34
Q

When analysts, to begin with, assess the state of the macro economy in terms that will have an impact on the value of the security, this is called:

A. Top down approach
B. Bottom up approach
C. Horizontal analysis
D. Vertical analysis

A

A. Top down approach

35
Q

Constant growth rate in valuation of stocks depends on:

a. Return on equity b. retention ratio c. dividends

A. A only
B. A and B
C. A and C
D. B and C

A

B. A and B

36
Q

Stock price is S.R 40, EPS to S.R 5 dividends S.R 2 what is the payout ratio

A. 40%
B. 60%
C. 5%
D. 15%

A

A. 40%

DPS / EPS

37
Q

The par value of a stock is S.R 5, the company distributed S.R 10 as dividends, the market price of the stock is S.R 125, the dividend yield will be:

A. 8%
B. 5%
C. 12.5%
D. 10%

A

A. 8%

Dividend per share (DPS) / Share Price

38
Q

If (a) bond is rated AAA, and (b) bond is rated BBB which of the following is true:

A. Bond (a) has higher risk (b)
B. Required rate of return on bond (a) is higher than (b)
C. Bond (a) has less risk than (b)
D. Bond (a) expects higher return than (b)

A

C. Bond (a) has less risk than (b)

39
Q

Arrange the following according to return lowest to highest:

a. Preferred stocks b. Common stocks c. Corporate bonds d. Government bonds

A. Dcab
B. Cdab
C. Bacd
D. Abdc

A

A. Dcab

CME-1 (Part 2) English (8 decks)

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