Chapter 9

Question 1

What is stock valuation?

Answer 1

The process of determining the intrinsic value of a company’s stock.

Question 2

True or False: Stock valuation is only relevant for publicly traded companies.

Answer 2

False

Question 3

What are the two main approaches to stock valuation?

Answer 3

The fundamental approach and the technical approach.

Question 4

Fill in the blank: The _____ model is commonly used to value stocks based on their dividends.

Answer 4

Dividend Discount Model (DDM)

Question 5

What does DDM stand for?

Answer 5

Dividend Discount Model

Question 6

What is the formula for the Gordon Growth Model?

Answer 6

P = D / (r - g)

Question 7

In the Gordon Growth Model, what does ‘P’ represent?

Answer 7

The price of the stock.

Question 8

In the Gordon Growth Model, what does ‘D’ represent?

Answer 8

The expected dividend next year.

Question 9

In the Gordon Growth Model, what does ‘r’ represent?

Answer 9

The required rate of return.

Question 10

In the Gordon Growth Model, what does ‘g’ represent?

Answer 10

The growth rate of dividends.

Question 11

What is the Price-to-Earnings (P/E) ratio?

Answer 11

A valuation ratio calculated by dividing the current share price by the earnings per share (EPS).

Question 12

True or False: A high P/E ratio indicates that a stock is undervalued.

Answer 12

False

Question 13

What does a low P/E ratio suggest?

Answer 13

It may indicate that the stock is undervalued or that the company is experiencing difficulties.

Question 14

Fill in the blank: The _____ model values a stock by comparing it to the dividends of similar companies.

Answer 14

Comparable Company Analysis

Question 15

What is the significance of the discount rate in stock valuation?

Answer 15

It reflects the risk associated with the investment and the time value of money.

Question 16

What is the purpose of a Discounted Cash Flow (DCF) analysis?

Answer 16

To estimate the value of an investment based on its expected future cash flows.

Question 17

What are free cash flows?

Answer 17

Cash generated by a company that can be distributed to investors after covering operating expenses and capital expenditures.

Question 18

True or False: The terminal value accounts for all future cash flows beyond a certain point in time.

Answer 18

True

Question 19

What is the terminal growth rate?

Answer 19

The rate at which a company is expected to grow indefinitely after a specific forecast period.

Question 20

Fill in the blank: The _____ approach to valuation focuses on historical price movements and trading volume.

Answer 20

Technical analysis

Question 21

What does beta measure in stock valuation?

Answer 21

The volatility of a stock in relation to the market.

Question 22

What is the Capital Asset Pricing Model (CAPM)?

Answer 22

A model that describes the relationship between risk and expected return, used to price risky securities.

Question 23

What is the expected return according to the CAPM formula?

Answer 23

E(R) = R_f + β(E(R_m) - R_f)

Question 24

In the CAPM formula, what does ‘R_f’ represent?

Answer 24

The risk-free rate.

Question 25

In the CAPM formula, what does 'E(R_m)' represent?

Answer 25

The expected return of the market.

Question 26

What is a stock's intrinsic value?

Answer 26

The perceived or calculated value of a stock based on fundamentals.

Question 27

What is the difference between intrinsic value and market value?

Answer 27

Intrinsic value is the true value based on fundamentals, while market value is the current trading price.

Question 28

Fill in the blank: The _____ model assumes that dividends will grow at a constant rate indefinitely.

Answer 28

Gordon Growth Model

Question 29

What is the role of analysts in stock valuation?

Answer 29

To evaluate stocks using financial metrics and make recommendations.

Question 30

What is the significance of the price-to-book (P/B) ratio?

Answer 30

It compares a company's market value to its book value, indicating how much investors are willing to pay for each dollar of net assets.

Question 31

True or False: A P/B ratio less than 1 indicates that the stock is overvalued.

Answer 31

False

Question 32

What does a high dividend yield indicate?

Answer 32

It suggests that a company is returning a significant amount of income to shareholders relative to its stock price.

Question 33

What is an undervalued stock?

Answer 33

A stock that is trading for less than its intrinsic value.

Question 34

What is an overvalued stock?

Answer 34

A stock that is trading for more than its intrinsic value.

Question 35

Fill in the blank: The _____ ratio is used to evaluate a company's ability to pay its short-term liabilities.

Answer 35

Current ratio

Question 36

What is the importance of market sentiment in stock valuation?

Answer 36

It can significantly influence stock prices beyond fundamental values.

Question 37

What is the purpose of sensitivity analysis in stock valuation?

Answer 37

To assess how different assumptions impact the valuation outcome.

Question 38

True or False: Stock valuation is a one-time process.

Answer 38

False

Question 39

What is the role of macroeconomic factors in stock valuation?

Answer 39

They can affect overall market conditions and influence stock performance.

Question 40

What does it mean to 'discount' future cash flows?

Answer 40

To adjust future cash flows to present value using a discount rate.

Question 41

What is the significance of the risk premium in stock valuation?

Answer 41

It compensates investors for taking on additional risk compared to risk-free investments.

Question 42

What is a market correction?

Answer 42

A decline in stock prices that typically occurs after a period of overvaluation.

Question 43

Fill in the blank: The _____ is the rate of return required by an investor to invest in a stock.

Answer 43

required return