Answer Options:
a. the expected future return must be less than the most recent past realized return.
b. the past realized return must be equal to the expected return during the same period.
c. the required return must equal the realized return in all periods.
d. the expected return must be equal to both the required future return and the past realized return.
e. the expected future return must be equal to the required return.
Answer: E. the expected future return must be equal to the required return.
Question: The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.
Answer Options:
a. True
b. False
Answer: A. True
Question: Preferred stock is a hybrid—a sort of cross between a common stock and a bond—in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.
Answer Options:
a. True
b. False
Answer: B. False
Question: If a stock’s expected return as seen by the marginal investor exceeds this investor’s required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to the required return.
Answer Options:
a. True
b. False
Answer: A. True
Question: According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock.
Answer Options:
a. True
b. False
Answer: B. False
Question: The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT?
Answer Options:
a. If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.
b. If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X.
c. If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price.
d. The stocks must sell for the same price.
e. Stock Y must have a higher dividend yield than Stock X.
Answer: A. If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.
Question: If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks
Answer Options:
a. the stock is experiencing supernormal growth.
b. the stock should be sold.
c. the stock is a good buy.
d. management is probably not trying to maximize the price per share.
e. dividends are not likely to be declared.
Answer: C. the stock is a good buy.
Question: Which of the following statements is CORRECT?
Answer Options:
a. If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but under all state charters the two classes must have the same voting rights.
b. The preemptive right gives stockholders the right to approve or disapprove of a merger between their company and some other company.
c. The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm’s common stock.
d. The stock valuation model, P0 = D1/(rs – g), cannot be used for firms that have negative growth rates.
e. The stock valuation model, P0 = D1/(rs – g), can be used only for firms whose growth rates exceed their required return.
Answer: C. The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm’s common stock.
Question: Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the assets in liquidation.
Answer Options:
a. Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the assets in liquidation.
b. The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock.
c. Corporations cannot buy the preferred stocks of other corporations.
d. Preferred dividends are not generally cumulative.
e. A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.
Answer: B. The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock.
Question: If a stock’s market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor’s estimate of the intrinsic value.
Answer Options:
a. True
b. False
Answer: A. True
Question: An increase in a firm’s expected growth rate would cause its required rate of return to
Answer Options:
a. increase.
b. decrease.
c. fluctuate less than before.
d. fluctuate more than before.
e. possibly increase, possibly decrease, or possibly remain constant.
Answer: E. possibly increase, possibly decrease, or possibly remain constant.
Question: A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms.
Answer Options:
a. True
b. False
Answer: A. True
Question: Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
Answer Options:
a. The stocks have the same price.
b. The stocks have the same dividend per share.
c. If one stock has a higher dividend yield, it must also have a higher dividend growth rate.
d. If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
e. The two stocks must have the same dividend yield.
Answer: D. If one stock has a higher dividend yield, it must also have a lower dividend growth rate.
Question: From an investor’s perspective, a firm’s preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer’s standpoint, these risk relationships are reversed: bonds are the most risky for the firm, preferred is next, and common is least risky.
Answer Options:
a. True
b. False
Answer: A. True
Question: A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock’s current price?
Answer Options:
a. $17.39
b. $17.84
c. $18.29
d. $18.75
e. $19.22
Answer: B. $17.84
Question: A major disadvantage of financing with preferred stock is that preferred stockholders typically have supermajority voting rights.
Answer Options:
a. A major disadvantage of financing with preferred stock is that preferred stockholders typically have supermajority voting rights.
b. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm’s common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.
c. The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to acquire new issues of stock, expanding to preferred stock.
Answer: B. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm’s common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.
Question: For a stock to be in equilibrium, two conditions are necessary: (1) The stock’s market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor’s required return.
Answer Options:
a. True
b. False
Answer: A. True
Question: One year from now, Stock X should have the higher price.
Answer Options:
a. Stock X has a higher dividend yield than Stock Y.
b. Stock Y has a lower expected growth rate than Stock X.
c. Stock Y has the higher expected capital gains yield.
Answer: B. Stock Y has a lower expected growth rate than Stock X.