Questions – Equity Investments
Question 1
If the expected dividend payout ratio of a firm is expected to rise from 50 percent to 55 percent, the cost of equity
is expected to increase from 10 percent to 11 percent, and the firm's growth rate remains at 5 percent, what will
happen to the firm's price-to-equity (P/E) ratio? It will:
A) decline.
B) increase.
C) be unchanged.
Question 2
With respect to a well-functioning securities market, a market that exhibits operational efficiency will have:
A) price continuity.
B) low transaction costs.
C) rapid price reactions to new information.
Question 3
The table below lists information on price per share and shares outstanding for three companies–Lair
Enterprises, Kurlew, Inc., and Mowe, Ltd.
As of Beginning of Year As of End of Year
Stock Price Per Share ($) # Shares Outstanding Price Per Share ($) # Shares Outstanding
Lair 15 10,000 10 10,000
Kurlew 45 5,000 60 5,000
Mowe 90 500 110 500
Assume that at the beginning of the year, the value of the market-weighted index was 100. The one-year return
on the market-cap weighted index is closest to:
A) 13.33%.
B) 30.0%.
C) 8.33%.
Question 4
Private equity investment securities are issued:
A) only by private firms.
B) by both public and private firms.
C) by public firms but not by private firms.
Question 5
A company has a market share of 5% and sales of $16 million. If overall industry sales are forecasted to grow
4% and the company's market share is expected to increase to 6%, expected sales for the company will
be closest to:
A) $19,968,000.
B) $17,600,000.
C) $16,640,000.
Question 6
A company's CFO plans to spend $45 million on capital expenditures in the next year. These expenditures will
be funded through cash held in the company's bank accounts ($30 million) and $15 million coming from a
planned debt issuance at the end of the current year. An analyst forecasting the capital structure of the firm will
project which of the following?
A) An increase in the debt-to-equity ratio.
B) A decrease in financial leverage.
C) An increase in cash flows from investing activities.
Question 7
An analyst is reviewing an industry and its associated barriers to entry and bargaining power of suppliers. This
assessment of industry profitability and competitiveness is a part of which step of the industry and competitive
analysis process?
A) Analyze the industry structure.
B) Survey the industry.
C) Define the industry.
Question 8
Which of the following indexes is a price weighted index?
A) The New York Stock Exchange Index.
B) The Nikkei Dow Index.
C) The Standard and Poor's Index.
Question 9
A firm's cost of equity capital is least accurately described as the:
A) expected total return on the firm’s equity shares in equilibrium.
B) minimum rate of return investors require to invest in the firm’s equity securities.
C) ratio of the firm’s net income to its average book value.
Question 10
A highly competitive market structure will reflect which of the following characteristics?
A) Significant barriers to entry.
B) High levels of commoditization.
C) Relatively high switching costs.
Question 11
An investor purchases 100 shares of Lloyd Computer at $26 a share. The initial margin requirement is 50%, and
the maintenance margin requirement is 25%. The price below which the investor would receive a margin call
is closest to:
A) 15.25.
B) 17.33.
C) 19.45.
Question 12
An investor who is more risk averse with respect to potential negative outcomes than potential positive
outcomes most likely exhibits which behavioral finance characteristic?
A) Mental accounting.
B) Loss aversion.
C) Conservatism.
Question 13
A unique item such as fine art is most likely to be exchanged in a(n):
A) brokered market.
B) order-driven market.
C) quote-driven market.
Question 14
What is the price-weighted index of the following three stocks?
As of December 31, 2001
Company Stock Price Shares Outstanding
A $50 10,000
B $35 20,000
C $110 30,000
A) 65.
B) 75.
C) 80.
Question 15
The first step in developing a security market index is choosing the index's:
A) constituent securities.
B) target market.
C) weighting method.
Question 16
Equal weighting is the most common weighting methodology for indexes of which of the following types of
assets?
A) Equities.
B) Fixed income securities.
C) Hedge funds.
Question 17
An asset-based valuation model is most appropriate for a company that:
A) has a high proportion of intangible assets among its total assets.
B) is likely to be liquidated.
C) is expected to remain profitable for the foreseeable future.
Question 18
An investor buys 200 shares of ABC at the market price of $100 and posts the required initial margin of $8,000.
The maintenance margin requirement is 25%.
At what share price will the investor's account balance be reduced to the maintenance margin level?
A) $112.
B) $48.
C) $80.
Question 19
Calculate the value of a preferred stock that pays an annual dividend of $5.50 if the current market yield on AAA
rated preferred stock is 75 basis points above the current T-Bond rate of 7%.
A) $42.63.
B) $70.97.
C) $78.57.
Question 20
Current-year sales for ABC Co. are $20 million. Although Annie Mann, CFA, forecasts overall growth of 5%
heading into next year, she would like to further refine her estimates by assigning the following probabilities
based on actions she thinks the competition may take.
Growth Probability
6 percent 30%
5 percent 20%
4 percent 50%
Using these probabilities, what is Mann's forecasted sales total for next year?
A) $20,800,000.
B) $20,960,000.
C) $21,000,000.
Question 21
An analyst gathered the following information about an industry. The industry beta is 0.9. The industry profit
margin is 8%, the total asset turnover ratio is 1.5, and the leverage multiplier is 2. The dividend payout ratio of
the industry is 50%. The risk-free rate is 7% and the expected market return is 15%. The industry P/E
is closest to:
A) 14.20.
B) 12.00.
C) 22.73.
Question 22
A stock has the following elements: last year's dividend = $1, next year's dividend is 10% higher, the price will be
$25 at year-end, the risk-free rate is 5%, the market risk premium is 5%, and the stock's beta is 1.5. The stock's
price is closest to:
A) $20.20.
B) $23.20.
C) $23.50.
Question 23
If a preferred stock that pays a $11.50 dividend is trading at $88.46, what is the market's required rate of return
for this security?
A) 13.00%.
B) 7.69%.
C) 11.76%.
Question 24
In its latest annual report, a company reported the following:
Net income = $1,000,000
Total equity = $5,000,000
Total assets = $10,000,000
Dividend payout ratio = 40%
Based on the sustainable growth model, the most likely forecast of the company's future earnings growth rate is:
A) 12%.
B) 8%.
C) 6%.
Question 25
Enterprise value is most accurately described as a firm's:
A) market value of assets minus market value of liabilities, plus cash and short-term investments.
B) market value of stock plus cash and short-term investments, minus market value of debt.
C) market value of stock plus market value of debt, minus cash and short-term investments.
Question 26
With which of the following types of equity shares does the investor typically have the greatest voting power?
A) Common shares.
B) Participating preference shares.
C) Unsponsored depository receipts.
Question 27
All else equal, the price-to-earnings (P/E) ratio of a stable firm will increase if the:
A) dividend payout is decreased.
B) long-term growth rate is decreased.
C) ROE is increased.
Question 28
The risk-free rate is 5%, and the expected return on the market index is 15%. A stock has a:
Beta of 1.0.
Dividend payout ratio of 40%.
Return on equity (ROE) of 15%.
If the stock is expected to pay a $2.50 dividend, its intrinsic value using dividend discount model is closest to:
A) $41.67.
B) $27.77.
C) $53.33.
Question 29
Voluntary reporting of performance by hedge fund managers leads to:
A) an upward bias in hedge fund index returns.
B) a downward bias in hedge fund index returns.
C) no appreciable bias in hedge fund index returns.
Question 30
The idea that uninformed traders, when faced with unclear information, observe the actions of informed traders
to make decisions, is referred to as:
A) herding behavior.
B) information cascades.
C) narrow framing.
Question 31
If the return on equity for a firm is 15% and the retention rate is 40%, the firm's sustainable growth rate
is closest to:
A) 9%.
B) 15%.
C) 6%.
Question 32
An analyst attends a management call where the CEO projects revenue and operating expense growth of 4%–
6% next year, respectively. Understanding the natural tendency of management when communicating these
numbers, an analyst will most likely project which of the following?
A) Operating expense growth of 5%–7%.
B) Revenue growth of 5%– 7%.
C) Operating expense growth of 4%–6%.
Question 33
Assuming the risk-free rate is 5% and the expected return on the market is 12%, what is the value of a stock with
a beta of 1.5 that paid a $2 dividend last year if dividends are expected to grow at a 5% rate forever?
A) $12.50.
B) $17.50.
C) $20.00.
Question 34
Jaylin Company declares a dividend that will be paid on August 28. The holder-of-record date is August 16. Will
an investor who buys Jaylin stock on August 15 receive this dividend?
A) No.
B) Yes, because the purchase occurs before the payment date.
C) Yes, because the purchase occurs before the holder-of-record date.
Question 35
Hume Inc. announces fourth quarter earnings per share of $1.20, which is 15% higher than last year. Hume's
earnings are equal to the consensus analyst forecast for the quarter. Assuming markets are efficient, the
announcement will most likely cause the price of Hume's stock to:
A) decrease.
B) increase.
C) remain the same.
