Chapter 12

Question 1

What is a stop order?

Answer 1

A suspended market order

A stop-limit order becomes a limit order once activated.

Question 2

What does fundamental analysis involve?

Answer 2

Researching a company’s sales, long-term strategy, and information in financial statements

Financial statements include balance sheets and income statements.

Question 3

What is a Form 8-K?

Answer 3

Filed with the SEC upon the occurrence of any event that could materially affect a company’s share price or financial condition

Events are listed in Sections 1-6 and 9 of the form.

Question 4

When must a Form 8-K be filed?

Answer 4

Within four business days upon the occurrence of a material event.

Question 5

What can the income statement be used to estimate?

Answer 5

A company’s cash flows.

Question 6

What do leverage ratios measure?

Answer 6

The amount of debt that a company has and the additional debt it can issue.

Question 7

What does the debt-to-equity ratio measure?

Answer 7

The degree of leverage for a company.

Question 8

What does a low debt-to-equity ratio indicate?

Answer 8

A company is primarily capitalized by its shareholders.

Question 9

What does a debt-to-equity ratio of 1.0 indicate?

Answer 9

The accounting value of a company’s liabilities and equity are equal.

Question 10

How is the Price-to-Earnings (PE) Ratio calculated?

Answer 10

Stock Price ÷ Earnings Per Share (EPS).

Question 11

What is an asset’s book value?

Answer 11

The accounting value, not the market value.

Question 12

What does the price-to-book ratio compare?

Answer 12

The market price of a company’s stock to the accounting value of the company.

Question 13

What values can be used to calculate the debt-to-equity ratio?

Answer 13

Market value or book value of the debt and shares.

Question 14

If a company’s PE ratio recently fell, what could have happened?

Answer 14

Either the share price declined or EPS increased.

Question 15

If a company’s PE ratio recently rose, what could have happened?

Answer 15

Either the share price increased or EPS declined.

Question 16

What is the Wilshire 5000-to-GDP ratio used for?

Answer 16

To determine whether U.S. stocks are over- or under-valued.

Question 17

What is the basic measure of risk in Modern Portfolio Theory?

Answer 17

Standard deviation.

Question 18

According to CAPM, what are the two specific types of risk?

Answer 18

• Diversifiable (non-systematic risk)
• Non-diversifiable (systematic risk)

Question 19

What does alpha measure?

Answer 19

Non-systematic risk.

Question 20

What does beta measure?

Answer 20

Systematic risk.

Question 21

What does beta correlate with?

Answer 21

A stock’s covariance or correlation with the overall stock market (e.g., S&P 500 Index).

Question 22

What may tactical asset allocation include?

Answer 22

Sector rotation.

Question 23

What do strategic investors believe about markets?

Answer 23

Markets are efficient and active investment management doesn’t produce excess risk-adjusted returns.

Question 24

What are tax-adjusted returns adjusted for?

Answer 24

Taxes, but not inflation.

Question 25

According to the dividend discount model, when is a stock a good investment?

Answer 25

When its market value is less than the present value of future dividends.

Question 26

What is the formula for net yield (after-tax yield)?

Answer 26

Taxable yield x (100% - tax bracket %)

Question 27

What is the formula for calculating inflation adjusted return (real return)?

Answer 27

Nominal yield – inflation rate.

Question 28

How many times per year must a reporting company file a Form 10-Q?

Answer 28

Three times.

Question 29

How often is a Form 10-K filed?

Answer 29

Annually.

Question 30

How do you calculate the amount needed to assure payments in perpetuity?

Answer 30

Divide the annual income desired by the rate of interest needed to produce the future income.

Question 31

What is a measure of profitability?

Answer 31

Earnings per share (EPS).

Question 32

How is a company’s market capitalization calculated?

Answer 32

Multiplying the current market value of its stock by the number of shares outstanding.

Question 33

What happens if a company purchases an asset and finances it through debt?

Answer 33

It increases its percentage of debt capital-to-equity capital.

Question 34

What does technical analysis use to make trading decisions?

Answer 34

Charts, pricing trends, and support and resistance levels.

Question 35

What moving averages might a technical analyst examine?

Answer 35

* 50-day moving average * 200-day moving average

Question 36

What characterizes value stocks?

Answer 36

* Low P/Es * Low price-to-book ratios * High dividend payout ratios

Question 37

What characterizes growth stocks?

Answer 37

* High P/Es * High price-to-book ratios * Low dividend payout ratios

Question 38

What is the dividend discount model?

Answer 38

A stock valuation method that estimates future dividends and discounts them to their present value.

Question 39

What formula does the dividend discount model use?

Answer 39

The same formula as the present value of a perpetuity (e.g., PV = Perpetual Payment ÷ Discount Rate).

Question 40

What concept is covered in behavioral finance?

Answer 40

Loss aversion.

Question 41

What type of index is the S&P 500 Index?

Answer 41

A capitalization-weighted index.

Question 42

What type of index is the Dow Jones Industrial Average (DJIA)?

Answer 42

A price-weighted index.

Question 43

What does the MSCI EAFE index represent?

Answer 43

An index of foreign (non-U.S.) stocks.

Question 44

What is the best way to calculate a fund’s annual return over several years?

Answer 44

Geometric means.

Question 45

What is the formula for Total Return?

Answer 45

(Sale Price – Purchase Price + Dividends/Interest) ÷ Purchase Price

Question 46

What is the formula for Net Present Value (NPV)?

Answer 46

Discounted Value of Cash Flows – Market Price (i.e., NPV = PV – Market Price)

Question 47

What is an investment’s internal rate of return (IRR)?

Answer 47

The return that makes the net present value (NPV) of the investment equal to zero.

Question 48

What cash flows does an investment’s IRR consider?

Answer 48

Only the positive cash flows and negative cash flows from an investment.

Question 49

If the net present value (NPV) of an investment is greater than zero, what does it indicate?

Answer 49

The investment’s current market price is less than the discounted cash flows.

Question 50

If the net present value (NPV) of an investment is less than zero, what does it indicate?

Answer 50

The investment’s current market price is greater than the discounted cash flows.

Question 51

What will buying investments with a positive NPV do?

Answer 51

Increase an investor’s wealth.