Equity - Market Efficiency + overview of equity securities + industry analysis (Rd 46-48) Flashcards
(192 cards)
1
Q
Which of the following statements about market efficiency is least accurate?
A)
The semi-strong form EMH addresses market and non-market public information.
B)
The weak-form EMH suggests that fundamental analysis will not provide excess returns while the semi-strong form suggests that technical analysis cannot achieve excess returns.
C)
The strong-form EMH assumes cost free availability of all information, both public and private.
A
B
The weak-form EMH suggests that technical analysis will not provide excess returns while the semi-strong form suggests that fundamental analysis cannot achieve excess returns. The weak-form EMH assumes the price of a security reflects all currently available historical information. Thus, the past price and volume of trading has no relationship with the future, hence technical analysis is not useful in achieving superior returns.
The other choices are correct.
The strong-form EMH states that stock prices reflect all types of information: market, non-public market, and private. No group has monopolistic access to relevant information; thus no group can achieve excess returns. For these assumptions to hold, the strong-form assumes perfect markets - information is free and available to all.
2
Q
____ reflects current available security market data
____ reflects info from both public and private source
____ reflects without bias to new public information
A
p - weak form market efficiency
f - strong form market efficiency
mf - semi-strong form market efficiency
3
Q
Investors ___ (can/cannot) achieve positive risk adjusted returns on average by using technical analysis in weak form market efficiency
A
cannot
4
Q
Investors ___ (can/cannot) achieve positive risk adjusted returns on average by using _____ analysis in weak form market efficiency
A
technical
5
Q
Investors cannot achieve positive risk adjusted returns on average by using technical analysis in ___ form market efficiency
A
weak
6
Q
Investors ___ (can/cannot) achieve positive risk adjusted returns on average by using fundamental analysis in semi strong form market efficiency
A
cannot
7
Q
Investors cannot achieve positive risk adjusted returns on average by using ____ analysis in semi strong form market efficiency
A
fundamental or technical - not consistently achieve
However, fundamental analysis is necessary if market prices are to be semi-strong form efficient.
8
Q
Investors cannot achieve positive risk adjusted returns on average by using fundamental analysis in ____ form market efficiency
A
semi strong
9
Q
____ form market efficiency doesn’t really exist in real life since markets prohibit inside trading
A
strong
10
Q
Which of the following forms of the EMH assumes that no group of investors has monopolistic access to relevant information?
A) Weak-form.
B) Both weak and semistrong form.
C) Strong-form.
A
C
According to the strong-form EMH, security prices reflect all information, which includes the privately available (monopolistic) information.
11
Q
An efficient capital market:
A)
fully reflects all of the information currently available about a given security, including risk.
B)
does not fully reflect all of the information currently available about a given security, including risk.
C)
fully reflects all of the information currently available about a given security, excluding risk.
A
A
An efficient capital market fully reflects all of the information currently available about a given security, including risk.
12
Q
The more ____ a market is, the ____ its reaction will be to new information.
A
efficient; quicker
13
Q
If the market is ____, active investment strategies cannot earn positive risk-adjusted returns consistently, and investors should therefore use a passive strategy.
A
fully efficient
14
Q
If the market is fully efficient, active investment strategies ____ earn positive risk-adjusted returns consistently, and investors should therefore use a _____ strategy.
A
cannot; passive
15
Q
The statement, “Stock prices fully reflect all information from public and private sources,” can be attributed to which form of the efficient market hypothesis (EMH)?
A) Strong-form EMH.
B) Weak-form EMH.
C) Semistrong-form EMH.
A
A
This is the definition of the strong-form EMH. Private sources include insider information, such as persons holding monopolistic access to information relevant to the formation of prices.
16
Q
Octagon Advisors believes that the market is semi-strong efficient. The firm’s portfolio managers most likely will use:
A) an enhanced indexing strategy that relies on trading patterns.
B) passive portfolio management strategies.
C) active portfolio management strategies.
A
B
If the market is semi-strong efficient, portfolio managers should use passive management because neither technical analysis nor fundamental analysis will generate positive abnormal returns on average over time.
- price rapidly adjust according to new information, so using passive technique is better
17
Q
If markets are strong-form efficient, ___ (active/passive) investment management does not consistently result in abnormal profits.
A
active
18
Q
Even if markets are strong-form efficient, portfolio managers can add value by establishing and implementing portfolio risk and return objectives and assisting with ____ (3)
A
- portfolio diversification
- asset allocation
- tax minimization
19
Q
Even if markets are ___ efficient, portfolio managers can add value by establishing and implementing portfolio risk and return objectives and assisting with portfolio diversification, asset allocation, and tax minimization.
A
strong-form
20
Q
The measure of an asset’s value that can most likely be determined without estimation is its:
A) fundamental value.
B) market value.
C) intrinsic value.
A
B
The current price of a traded asset is its market value. An asset’s intrinsic or fundamental value is the price a rational investor with complete information about the asset would pay for it.
21
Q
The value of an asset that a rational investor with full knowledge about the asset’s characteristics would willingly pay is best described as the asset’s:
A) market value.
B) intrinsic value.
C) theoretical value.
A
B
Intrinsic value is the price a rational investor with full knowledge about an asset’s characteristics would willingly pay for the asset.
22
Q
If the momentum effect persists over time, it would provide evidence against which of the following forms of market efficiency?
A) Both weak form and semistrong form.
B) Weak form only.
C) Semistrong form only.
A
A
The momentum effect suggests it is possible to earn abnormal returns using market data. All three forms of market efficiency (weak form, semistrong form, and strong form) assume that market prices fully reflect market data.
23
Q
Investor overreaction that has been documented in securities markets is most likely attributable to investors exhibiting:
A) loss aversion.
B) conservatism.
C) risk aversion.
A
A
Loss aversion refers to the tendency for investors to dislike downside risks more than upside risks creating asymmetrical risk preferences. This dislike of losses may be a cause of investor overreaction.
C - The standard economic notion of risk aversion assumes symmetric risk preferences.
B - Conservatism is the behavioral bias whereby investors react slowly to new information and is unlikely to cause overreaction.
24
Q
A market’s efficiency is most likely to negatively affected by:
A) a ban on short selling.
B) a high amount of trading activity.
C) substantial analyst coverage of the exchange listed companies
A
A
Research supports the conclusion that short selling helps to prevent market prices from becoming overvalued, while limiting short selling has the opposite effect. More analyst coverage and more liquidity contribute to market efficiency.
25
A ____ is something that deviates from the efficient market hypothesis.
market anomaly
26
What tend to make markets more efficient? (2)
- Large numbers of market participants
| - Greater information availability
27
What tend to make markets less efficient? (2)
- Impediments to arbitrage short selling
| - High costs of trading and gathering information
28
Impediments to arbitrage short selling makes markets ___ efficient
less
29
Greater information availability makes markets ___ efficient
more
30
High costs of trading and gathering information makes markets ___ efficient
less
31
Large numbers of market participants makes markets ___ efficient
more
32
Which of the following would provide evidence against the semistrong form of the efficient market theory?
A)
Low P/E stocks tend to have positive abnormal returns over the long run.
B)
All investors have learned to exploit signals related to future performance.
C)
Trend analysis is worthless in determining stock prices.
A
P/E information is publicly available information and therefore this test relates to the semistrong-form EMH.
C - Trend analysis is based on historical information and therefore relates to the weak-form EMH.
B - In an efficient market one would expect 50% of pension fund managers to do better than average and 50% of pension fund managers to do worse than average. If all investors exploit the same information no excess returns are possible.
33
Compared to a publicly traded firm, a private equity firm is most likely to:
A) exhibit stronger corporate governance.
B) be more concerned with short-term results.
C) disclose less information about its financial performance.
C
Private equity firms are not held to the same financial reporting requirements as publicly traded firms. Less public scrutiny and limited financial disclosure may lead to weaker corporate governance. However, with less pressure from public shareholders, a private equity firm is typically more able to focus on long-term performance.
34
Compared to publicly traded firms, private equity firms have
- ____ reporting costs
- ____ ability to focus on long-term prospects
- (potentially) _____ return for investors once the firm goes public.
- lower reporting costs,
- greater ability to focus on long-term prospects,
- (potentially) greater return for investors once the firm goes public.
35
Private equity investments are
____ (illiquid/liquid)
- firm financial disclosure may be ____ (more/less) than public companies
- corporate governance may be ____ (stronger/weaker) than public companies
- _____ focus on long-term prospects
- private equity investments are illiquid
- firm financial disclosure may be limited
- corporate governance may be weaker
- less focus on long-term prospects.
36
Private equity securities most likely:
A) are issued to individual investors.
B) trade in over-the-counter dealer markets.
C) are illiquid and do not have quoted prices.
C
Private equity securities are illiquid and do not trade in public securities markets. Holders of private equity must negotiate with other investors to sell the securities. Private equity securities are typically issued to qualified institutional investors.
37
______ is the difference between the financial statement value of the firm's assets and liabilities.
Book value of equity
38
The book value of equity is the difference between ____ and _____
- financial statement value of the firm's assets
| - liabilities
39
____ of equity reflect the firm's past operating and financing choices.
BV
40
____ (positive/negative) retained earnings increase the book value of equity.
Positive
41
Positive retained earnings _____ (increase/decrease) the book value of equity.
increase
42
The ____ value of equity is the share price multiplied by the number of shares outstanding.
market
43
____ value of equity reflects investors' expectations about the timing, amount, and risk of the firm's future cash flows.
Market
44
The market value of equity is _____.
the share price multiplied by the number of shares outstanding
45
Market value reflects investors' expectations about the _____, ______, and _____ of the firm's future _____
```
timing, amount, and risk
cash flows (value or prospect are both ok)
```
46
Which of the following statements about book value of equity is most accurate?
A)
Book value of equity reflects the market's perception of the firm's prospects.
B)
Increases in retained earnings decrease book value.
C)
The primary goal of firm management is to increase the book value of the firm's equity.
C
Increasing book value is the primary goal of firm management.
B - Increases in retained earnings increase book value.
A - The market value of equity reflects investor perception of the firm's future value.
47
Other things equal, which of the following types of stock has the most risk from the investor's perspective?
A) Callable common share.
B) Callable preferred share.
C) Putable common share.
A
Callable shares have more risk than putable shares because the issuer can exercise the call option (which limits the investor's potential gains) while the investor can exercise the put option (which limits the investor's potential losses, assuming the firm is able to meet its obligation).
B - Preferred shares have less risk for the investor than common shares because preferred shares have a higher priority claim on the firm's assets in the event of liquidation, and because preferred dividends typically must be paid before common dividends may be paid.
48
_____ stockholders must receive dividends before ____ stock dividends can be paid
Preferred; common
49
_____ stock is less risky than ____ stock because the former pays a known, fixed dividend to investors.
Preferred; common
50
____ stockholders have a claim equal to ___value if the firm is liquidated.
Preferred; par
51
Order of risk:
- putable vs callable
- non-cumulative preferred vs cumulative preferred
- common vs preferred
- Putable shares are the least risky and callable shares are the most risky.
- Cumulative preferred shares are less risky than non-cumulative preferred shares, as any dividends missed must be paid before a common stock dividend can be paid.
- preferred stock is less risky than common stock
52
Common equity share types ranked from least risky to most risky are:
A) putable, option-free, callable.
B) callable, putable, option-free.
C) option-free, putable, callable.
A
Putable shares are the least risky because the investor can sell the shares back to the issuer at a predetermined price. Callable shares are the most risky because the issuer can buy the securities back at a predetermined price, which limits the upside for the investor.
53
The primary reason for a firm to issue equity securities is to:
A) increase publicity for the firm's products.
B) improve its solvency ratios.
C) acquire the assets necessary to carry out its operations.
* what are some solvency ratios?
C
While issuing equity securities can improve a company's solvency ratios and increase the firm's visibility with the public, the primary reason to issue equity is to raise the capital needed to acquire operating assets.
solvency ratios include:
- debt to equity
- debt (total liabilities over total assets) low is bettter
- equity ratio (total equity over total assets) high is better
54
Which of the following statements about the role of equities in financing a company's assets is most accurate?
A) The book value and market value of equities is usually the same.
B) Equity capital is typically used for the purchase of long-term assets and expansion into new areas.
C) Management can directly increase the market value of equity by increasing net income.
B
Equity capital is used for the purchase of long-term assets, equipment, research and development and expansion into new businesses or geographic areas.
A - Book value and market value of equities are almost always valued differently.
C - Management can only indirectly affect the market value of equity.
55
Two investors, Craig Tower and Erin Gray, own 100 shares each of the same company. Tower receives a quarterly dividend while Gray does not. This is most likely because Tower:
A) owns common shares while Gray owns preferred shares.
B) owns a different class of stock than Gray.
C) purchased his shares after Gray purchased her shares.
B
Different classes of common stocks can have different features with respect to dividends, stock splits, voting power and seniority if the firm's assets are liquidated.
A - If Gray owns preferred shares, she would be more likely to receive a dividend than Tower's common shares.
C - If Gray had purchased shares before an ex-dividend date and Tower purchased the same class of shares after that ex-dividend date, Gray would receive a dividend that Tower did not.
56
Cheryl Brower and Todd Sutter each own 100 shares of Hills Company stock. In a recent proxy vote, Brower had 100 votes but Sutter had 10 votes. The most likely reason for this difference in voting rights is that:
A) Brower is a director of Hills Company.
B) Hills Company uses a statutory voting method.
C) Brower and Sutter own different classes of stock.
C
Companies may issue classes of stock (e.g., Class A and Class B shares) that differ in aspects such as voting rights, dividends, or priority of claims in liquidation.
57
With which of the following types of equity shares does the investor typically have the greatest voting power?
A) Common shares.
B) Unsponsored depository receipts.
C) Participating preference shares.
A
While common shares have voting rights, preference shares typically do not. With unsponsored depository receipts, the depository bank retains the right to vote the shares.
58
Liquidity of private equity is most likely:
A) greater than liquidity of public equity.
B) less than liquidity of public equity.
C) about equal to liquidity of public equity.
B
Private equity securities are not registered to be traded in a public market, and therefore are less liquid that public equity.
59
When analyzing an industry characterized by increasing book values of equity, return on equity for a period is most appropriately calculated based on:
A) beginning book value.
B) ending book value.
C) average book value.
C
When book values are not stable, analysts should calculate ROE based on the average book value for the period. When book values are more stable, beginning book value is appropriate.
60
In a period when U.S. equity prices are increasing and the U.S. dollar is depreciating, which of the following investors in U.S. equities is most likely to earn the highest return in the investor's local currency?
A) U.S. investor who reinvests dividends.
B) Non-U.S. investor who reinvests dividends.
C) Non-U.S. investor who does not reinvest dividends.
A
Sources of return on equity securities include price appreciation or depreciation, dividend income, and foreign exchange gains or losses for investors outside the country. In an increasing equity market, reinvesting dividends is likely to increase returns compared to not reinvesting dividends. If the currency is depreciating, investors from outside the country will experience foreign exchange losses that decrease their returns.
61
A firm's cost of equity capital is least accurately described as the:
A) minimum rate of return investors require to invest in the firm's equity securities.
B) expected total return on the firm's equity shares in equilibrium.
C) ratio of the firm's net income to its average book value.
C
The ratio of the firm's net income to its average book value is the firm's return on equity, which can be greater than, equal to, or less than the firm's cost of equity.
B and A - Cost of equity for a firm can be defined as the expected equilibrium total return in the market on its equity shares, or as minimum rate of return that investors require as compensation for the risk of the firm's equity securities.
62
The ratio of the firm's net income to its average book value is the firm's _____, which can be greater than, equal to, or less than the firm's cost of equity.
return on equity
63
The ratio of the firm's net income to its average book value is the firm's return on equity, which can be ____ than the firm's cost of equity.
greater than, equal to, or less
64
The ratio of ______ is the firm's return on equity, which can be greater than, equal to, or less than the firm's cost of equity.
the firm's net income to its average book value
65
Cost of equity is defined as? (2)
- expected equilibrium total return in the market on its equity shares
- minimum rate of return that investors require as compensation for the risk of the firm's equity securities.
66
Johnson Company shuts down and is liquidated. Bob Smith owns 100 common shares of Johnson, but has a lower priority of claims than Al Jones, who also owns 100 common shares. Smith most likely owns:
A) Class B shares.
B) non-cumulative shares.
C) non-participating shares.
A
Some firms have different classes of common stock (e.g., Class A and Class B shares). These classes may be distinguished by factors such as voting rights and priority in the event of liquidation. Participating and non-participating, cumulative and non-cumulative refer to characteristics of preferred stock.
67
Compared to preferred stock, common stock is most likely to:
A) exhibit a lower standard deviation of returns.
B) provide a higher average return.
C) pay more frequent dividends.
B
Common stock is more risky than preferred stock and is expected to provide higher average returns. Preferred stock promises fixed periodic dividends. Common stock can be dividend-paying or non-dividend paying and the dividends are at management's discretion.
68
common stock dividend has the following characteristics (comparing to preferred stock):
- ____ average return
- ____ risk
- ____ dividend at mgt discretion
- higher
- higher
- varied or none
69
Two seats on a board of directors are to be elected. A voting system in which the owner of 100 shares may cast 100 votes in each of the board elections is a:
A) statutory voting system.
B) proportional voting system.
C) cumulative voting system.
A
In a statutory voting system, a shareholder can vote in each separate board election based on the number of shares she owns. Under cumulative voting, the shareholder may choose to cast her total number of votes (200 in this example) for a candidate in one of the elections.
70
In a ____ voting system, a shareholder can vote in each separate board election based on the number of shares she owns
statutory
71
In a ____ voting system, the shareholder may choose to cast her total number of votes (200 in this example) for a candidate in one of the elections.
cumulative
72
______ preferred shares require any dividends that were missed in the past (dividends in arrears) to be paid before common shareholders receive any dividends.
Cumulative
73
____ preferred shares receive extra dividends if firm profits exceed a pre-specified level and a value greater than the par value if the firm is liquidated.
Participating
74
Characters of preferred stock dividend
- fixed rate
| - not contractually obligated to pay
75
What are some types of preferred stocks? (3)
- participating vs non-participating
- convertible vs non-convertible
- cumulative vs non-cumulative
76
Does preferred stock have voting rights?
No
77
types of common stocks?
Callable vs puttable
| Different class
78
For a non-dividend paying firm, an increase in net income must increase:
A) both book value and market value of equity.
B) book value of equity.
C) market value of equity.
B
Book value of equity is the company's assets minus its liabilities. For a non-dividend paying firm, positive net income will increase the book value of equity. An increase in book value of equity may or may not increase the market value of equity. An increase in net income that does not meet investors' prior expectations may decrease the market value of equity.
79
Hodges Fund provides mezzanine stage financing to private companies. In which type of private equity investing is Hodges Fund most likely involved?
A) Private investment in public equity.
B) Venture capital.
C) Leveraged buyout.
B
Venture capital providers invest in firms that are early in their life cycles. Stages of venture capital financing include seed stage, early stage, and mezzanine financing.
C - In a leveraged buyout, an investor purchases all of a public firm's equity, taking the firm private.
A - In a private investment in public equity (PIPE), an investor purchases private equity issued by a public firm.
80
_____ invest in firms that are early in their life cycles. List the stages
Venture capital providers
| stages: seed stage, early stage, and mezzanine
81
In a _____, an investor purchases all of a public firm's equity, taking the firm private.
leveraged buyout
82
In a leveraged buyout, an investor ______
purchases all of a public firm's equity, taking the firm private.
83
In a _____, an investor purchases private equity issued by a public firm.
private investment in public equity (PIPE)
84
In a private investment in public equity (PIPE), an investor _____.
purchases private equity issued by a public firm
85
Compared to publicly traded firms, privately held firms have which of the following characteristics?
A) Higher reporting costs.
B) More limited financial disclosure.
C) Less ability to focus on long-term prospects.
B
Private firms have fewer financial disclosure requirements, and therefore lower reporting costs, because they are not listed on an exchange. Private firms generally have greater ability to focus on long-term results because they do not experience pressure from public shareholders.
86
A security that represents an equity share in a foreign firm and for which the voting rights are retained by the depository bank, is a(n):
A) American depository share.
B) unsponsored depository receipt.
C) global registered share.
B
In an unsponsored DR, the depository bank retains the voting rights of the equity shares of the foreign firm. In a sponsored DR, the investor in the DR has the voting rights.
A - For an American depository receipt, an American depository share is the underlying security that trades in the issuing firm's domestic market.
C - A global registered share is an equity security that trades in the local currencies on stock exchanges around the world.
87
In an _____ DR, the depository bank retains the voting rights of the equity shares of the foreign firm
unsponsored
88
In a sponsored DR, _____ has the voting rights.
the investor in the DR
89
For ______, an American depository share is the underlying security that trades in the issuing firm's domestic market.
an American depository receipt
90
For an American depository receipt, an American depository share is ______
the underlying security that trades in the issuing firm's domestic market.
91
A _____ is an equity security that trades in the local currencies on stock exchanges around the world.
global registered share
92
A global registered share is an equity security that _____
trades in the local currencies on stock exchanges around the world.
93
Investors who buy foreign stock directly on a foreign stock exchange receive a return denominated in a ____ currency, must abide by the _____ regulations and procedures, and may be faced with ____ (less/more) liquidity and ____ (less/more) transparency than is available in the investor's domestic markets.
- foreign currency
- foreign stock exchange's regulations
- less liquidity
- less transparency
94
_____ are issued outside the United States and outside the issuer's home country.
Global depository receipts
95
Global depository receipts are issued _____ (location).
outside the United States and outside the issuer's home country
96
American depository receipts are denominated in ____ and are traded _____
U.S. dollars; on U.S. exchanges.
97
______ are denominated in U.S. dollars and are traded on U.S. exchanges.
American depository receipts
98
_____ are common shares of a firm that trade in different currencies on stock exchanges throughout the world.
Global registered shares
99
Global registered shares are common shares of a firm that trade in _____
different currencies on stock exchanges throughout the world.
100
_____ are exchange-traded funds that invest in depository receipts.
Baskets of listed depository receipts
101
Baskets of listed depository receipts are _____
exchange-traded funds (ETFs) that invest in depository receipts.
102
Dividends on non-participating preference shares are typically:
A) lower than the dividends on common shares.
B) a contractual obligation of the company.
C) a fixed percentage of par value.
C
Similar to the interest payments on a debt security, dividends on non-participating preference shares (preferred stock) are typically fixed. Unlike the interest payments on a debt security, the company is not contractually obligated to pay preferred dividends. Preferred dividends are typically higher than a firm's common dividends.
103
Pearl River Heavy Industries shows the following information in its financial statements:
```
Total Assets HK$146,000,000
Total Liabilities HK$87,000,000
Net Income HK$27,000,000
Price per Share HK$312
Shares Outstanding 200,000
The equity securities of Pearl River have a:
```
A) book value of HK$59,000,000.
B) book value of HK$62,400,000.
C) market value of HK$146,000,000.
A
Book value = Total assets − total liabilities = 146,000,000 − 87,000,000 = HK$59,000,000
Market value of equity = Market price per share × shares outstanding = HK$312 × 200,000 = HK$62,400,000
104
A basket of listed depository receipts (BLDR) is best described as a(n):
A) exchange traded fund of depository receipts.
B) special purpose vehicle for issuing depository receipts in multiple countries.
C) index of global depository receipts that trade on a specific exchange.
A
105
Securities that can be sold back to the issuing firm at a specific price are best described as:
A) convertible.
B) putable.
C) callable.
B
106
Global depository receipts are most likely issued:
A) outside the issuer's home country and denominated in U.S. dollars.
B) in the United States and denominated in U.S. dollars.
C) outside the issuer's home country and denominated in the exchange's home currency.
A
Global depository receipts are issued outside the U.S. and the issuer's home country and are most often denominated in U.S. dollars.
B - Depository receipts issued in the United States and denominated in U.S. dollars are called American depository receipts.
C - Global registered shares are denominated in the home currencies of the exchanges on which they trade.
107
An equity security that requires the firm to pay any scheduled dividends that have been missed, before paying any dividends to common equity holders, is a:
A) participating preference share.
B) convertible preference share.
C) cumulative preference share.
C
108
Which of the following changes would most likely cause a firm's return on equity to increase?
A) Net income increases by 5% and average book value of equity increases by 5%.
B) Net income increases by 5% and average book value of equity increases by 10%.
C) Net income decreases by 5% and average book value of equity decreases by 10%.
C
Return on equity is net income divided by average book value of equity. If the book value of equity decreases relatively more than net income decreases, return on equity will increase. This illustrates that an increase in ROE is not necessarily positive for the firm. An analyst must examine the reasons for changes in ROE.
109
Participating preference shares most likely:
A) give the shareholder the right to sell the shares back to the firm at a specific price.
B) can be exchanged for common stock at a ratio determined at issuance.
C) receive extra dividends if firm profits exceed a predetermined threshold.
C
Participating preference shares receive extra dividends if firm profits exceed a predetermined threshold.
B - Convertible preference shares can be exchanged for common stock at a conversion ratio determined at issuance.
A - Putable common shares give the shareholder the right to sell the shares back to the firm at a specific price.
110
Preference shares will have the most risk for the investor if the shares are:
A) callable and non-cumulative.
B) non-callable and non-cumulative.
C) callable and cumulative.
```
A
Preference shares (preferred stock) has more risk for the investor if they are non-cumulative than if they are cumulative, because with cumulative preference shares the firm must pay the holder any omitted dividends before it can pay any dividends to common shareholders. Callable shares have more risk for the investor than non-callable shares because the call option limits their potential for price appreciation.
```
111
Equity securities are least likely issued to finance:
A) research and development.
B) inventories.
C) equipment.
B
Equity securities are typically issued to finance a firm's long-lived assets, such as equipment, and long-term projects such as research and development.
112
The difference between a firm's balance sheet assets and liabilities is equal to the firm's:
A) intrinsic value of equity.
B) market value of equity.
C) book value of equity.
C
113
Other things equal, preference shares have the most risk for the investor when they are:
A) callable and non-cumulative.
B) non-callable and non-cumulative.
C) putable and cumulative.
A
Callable shares have more risk than otherwise equivalent non-callable shares. Putable shares have less risk than otherwise equivalent non-putable shares. Cumulative preference shares have less risk than otherwise equivalent non-cumulative preference shares.
114
The book value of equity is equal to a firm's assets:
A) minus its liabilities.
B) plus its accumulated other comprehensive income.
C) plus its retained earnings.
A
115
Commercial industry classification systems such as the Global Industry Classification Standard (GICS) typically classify firms according to their:
A) principal business activities.
B) sensitivity to business cycles.
C) correlations of historical returns.
A
Commercial providers of industry classification systems such as the GICS classify firms according to principal business activity, such as Consumer Staples, Financial Services, or Health Care.
116
Firms can be grouped into industries according to ___ (3)
- principal business activities
- stats model (historical correlation in return)
- business cycle sensitivity
117
Industry classification systems from commercial providers include: (3)
- Global Industry Classification Standard (by S&P)
- Russell Global Sectors
- Industry Classification Benchmark (Dow Jones)
118
Governments also develop classifications. List some differences.
- update less often
| - do not disclose composition
119
Commercial index providers typically classify companies by:
A) sensitivity to business cycles.
B) principal business activity.
C) statistical grouping.
B
Commercial providers such as Standard and Poor's and MSCI Barra classify companies according to their principal business activity and the products and services they provide.
120
Wallace Kidwell is classifying an industry as to its life-cycle stage. Kidwell notes that the industry's growth is stable and largely limited to replacement demand and overall population increases. The companies that comprise the industry have achieved efficient cost structures and strong brand loyalty. This level of brand loyalty has resulted in very few price wars. Kidwell will most likely classify the industry life cycle stage as being:
A) Shakeout.
B) Mature.
C) Decline.
B
The mature stage exhibits little or no growth, industry consolidation, and high barriers to entry. Kidwell has noted that the industry is growing, but slowly (replacement demand and population gains). Furthermore, the firms have efficient cost structures and strong brand loyalty; both of which are high barriers to entry.
C - The decline stage exhibits negative growth, excess capacity, and high competition. Kidwell has observed positive, slow growth and a lack of price wars. Both of these observations are contrary to what would be expected in the decline stage.
A - The shakeout stage exhibits slowing growth, intense competition, and declining profitability. Kidwell has observed that growth is stable, the firms have achieved efficient cost structures, and price wars are uncommon. Hence, growth is not slowing, competition must not be intense because there are price wars (these occur when competition is intense), and profitability is likely stable given the efficient cost structures.
121
What are the 5 stages of life cycle?
Embryonic, growth, shakeout, mature, decline
122
What stage has these characteristics?
| Slow growth; high prices; large investment required; high risk of failure.
Embryonic
123
What stage has these characteristics?
| Negative growth; declining prices; consolidation.
Decline
124
What stage has these characteristics?
| Slowing growth; intense competition; industry overcapacity; declining profitability; cost cutting; increased failures.
Shakeout
125
What stage has these characteristics?
| Slow growth; consolidation; high barriers to entry; stable pricing; superior firms gain market share.
Mature
126
What stage has these characteristics?
| Rapid growth; little competition; falling prices; increasing profitability.
Growth
127
Which stages have slow growth?
- Mature
- Decline (negative growth)
- Shakeout (slowing growth)
128
Which stages have consolidation?
Mature and decline (2 later stages)
129
Describe price characters for different stages
- Embryonic: high prices
- Growth: falling prices and increasing profitability
- Shakeout: cost cutting and declining profitability
- Mature: staple pricing
- Decline: declining prices
130
Describe failure characters for different stages
```
Embryonic: high risk of failure.
Growth: little competition
Shakeout: increased failure
Mature: high barriers to enter
Decline: N/A
```
131
In which stage do superior firms gain market share?
Mature
132
An aggressive price reduction to gain market share is most likely to be associated with a:
A) cost leadership strategy.
B) service differentiation strategy.
C) product differentiation strategy.
A
Michael Porter identified two competitive strategies: cost leadership and product or service differentiation. A firm that uses a cost leadership or low-cost strategy seeks to have low production costs that will enable it to offer lower prices than its competitors to protect or gain market share. A product or service differentiation strategy seeks to gain a price premium for its products by making them distinctive to the consumer.
133
For relative valuation, a peer group is best described as companies:
A) with similar business activities and competitive factors.
B) in a similar sector or industry classification.
C) at a similar stage of the industry life cycle.
A
134
Companies can employ a _____ strategy or a ____ strategy.
cost leadership (low-cost); product or service differentiation
135
A _____ firm seeks to have the lowest costs of production in its industry, offer the lowest prices, and generate enough volume to make a superior return.
cost leadership
136
A cost leadership firm seeks to have the _____ costs of production in its industry, offer the _____ prices, and generate ____ volume to make a superior return.
lowest; lowest; enough
137
A _____ firm's products and services should be distinctive in terms of type, quality, or delivery.
differentiating
138
A differentiating firm's products and services should be distinctive in terms of ___, ____, or ______
type, quality, or delivery.
139
A ____ should consist of companies with similar business activities, demand drivers, cost structure drivers, and availability of capital.
peer group
140
A peer group should consist of companies with similar _____ (4)
- business activities,
- demand drivers,
- cost structure drivers,
- availability of capital.
141
Auto manufacturers and home builders would most likely be grouped together in an industry classification system based on:
A) dividend yields.
B) type of business activity.
C) sensitivity to business cycles.
C
Auto manufacturing and home building are both cyclical industries. An industry classification system based on business cycle sensitivity would be the most likely to group firms from these industries together.
142
When classifying companies into peer groups for analysis, an analyst should:
A) disregard industry classifications from commercial providers.
B) examine firms' annual reports to see if they identify competitors.
C) include each company in only one peer group.
B
Annual reports are a good source of information when identifying peer groups because companies may identify their key competitors.
C - It is often appropriate to include a company in more than one peer group.
A - An analyst forming peer groups can use commercially available industry classification systems to identify which companies are in the same industry.
143
Can a company be in more than one peer group?
Yes
| It is often appropriate to include a company in more than one peer group.
144
Ways to identify competitors forming peer group?
- look at company's annual report
- look at industry publications
- look at annual reports of competitors identified by first firm's annual report
145
During the contraction phase of the business cycle, how will an active portfolio manager using an industry rotation strategy treat stocks of companies in a cyclical industry?
A) Maintain the target weight of the industry.
B) Overweight the industry.
C) Underweight the industry.
C
A cyclical industry is one that is expected to outperform during an expansion and underperform in a contraction. The industry rotation strategy for a cyclical industry is to overweight during an expansion and underweight during a contraction.
146
A ____ industry is one that is expected to outperform during an expansion and underperform in a contraction.
cyclical
147
A cyclical industry is one that is expected to ____ during an expansion and _____ in a contraction. It also has high ____ costs
outperform; underperform; fixed
148
Which of the following statements about the industry life cycle is most accurate?
A) The growth stage is typically characterized by decreasing prices.
B) Industry growth rates are highest in the embryonic stage.
C) The mature stage is followed by a shakeout stage and a decline stage.
A
growth stage: Rapid growth; little competition; falling prices; increasing profitability.
first picked B. Industry growth is slow during the embryonic stage as firms develop products and attempt to gain customer acceptance.
C - mature stage is followed by decline. (EGSMD)
149
Which of the following statements about switching costs is most accurate?
A) Switching costs tend to be lower for specialized products.
B) Low switching costs contribute to market share stability.
C) Switching costs include the time needed to learn to use a competitor's product.
C
Switching costs include the time and expense of learning to use a competitor's product and tend to be higher for specialized or differentiated products.
A &B - High switching costs contribute to market share stability and pricing power.
150
Capacity is ___ in the short run and ____ in the long run.
fixed; variable
151
Starr Company is an asset management firm. Thomas Company is a manufacturer of apparel. Assuming these firms are representative of their industry groups, how are they best classified with regard to their sensitivity to the business cycle?
Starr Thomas
A) Non-cyclical Non-cyclical
B) Cyclical Cyclical
C) Cyclical Non-cyclical
B
Asset management firms are classified in the financial services industry group. Apparel manufacturers are classified in the consumer discretionary industry group. Financial services and consumer discretionary are cyclical industry groups.
152
A firm that pursues a differentiation strategy is most likely to emphasize:
A) gains in market share.
B) operating efficiency.
C) market research.
C
A firm that follows a product or service differentiation strategy needs to emphasize market research to identify needs for which customers are willing to pay a premium. Market share and operating efficiency are more of a focus for firms that pursue a low-cost strategy.
153
Changes in population size and average age that affect industry growth and profitability are best described as:
A) demographic influences.
B) social influences.
C) macroeconomic influences.
A
154
Macroeconomic influences on industries include long-term trends in factors such as ____, _____, and ______, as well as structural factors such as ____
- GDP growth, interest rates, and inflation,
| - the education level of the workforce.
155
______ influences on industries include long-term trends in factors and structural factors
Macroeconomic
156
Macroeconomic influences on industries include _____ factors and ____ factors
long-term trends; structural
157
What are the five influences on industries?
- governmental
- social
- demographic
- macroeconomic
- technologic
158
____ factors include tax rates, regulations, empowerment of self-regulatory organizations, and government purchases of goods and services.
Government
159
Government factors include ? (4)
- tax rates,
- regulations,
- empowerment of self-regulatory organizations,
- and government purchases of goods and services.
160
When constructing a peer group of firms, an analyst should least appropriately consider the firms':
A) cost structures.
B) industry classification.
C) business cycle sensitivity.
C
A peer group should consist of firms that are alike in their principal lines of business, along with other similarities such as cost structures and access to capital. Firms can be similar in business cycle sensitivity but dissimilar in terms of their business activities (e.g., a firm in the home building industry and a firm in the heavy equipment manufacturing industry).
*peer group should consist of companies with similar business activities, demand drivers, cost structure drivers, and availability of capital. (this is the definition)
161
After completing a thorough industry analysis, which of the following is most likely an additional element an analyst should examine when analyzing a specific company within the industry?
A) Competitive strategy.
B) Threat of entry.
C) Power of buyers.
A
Company analysis involves examining a specific firm's financial condition, products and services, and competitive strategy (cost leadership or differentiation). Industry analysis should include examining competitive forces such as the threat of entry and the power of buyers.
*注意審題是company還是industry，B和C都是industry analysis的東西
162
Economic profits are most likely to be earned by firms in an industry that is characterized by:
A) low threat of substitutes and high rivalry among existing competitors.
B) high power of suppliers and low threat of entry.
C) high barriers to entry and low power of buyers.
C
High barriers to entry (low threat of entry) and low power of suppliers both increase the potential for economic profits within an industry. The five forces that shape industry competition are rivalry among existing competitors, threat of entry, threat of substitutes, power of buyers, and power of suppliers. The stronger any of these forces are within an industry, the less potential that industry has to generate (or continue to earn) economic profits.
163
The five forces that shape industry competition are___? How do these forces influence profit?
- rivalry among existing competitors,
- threat of entry,
- threat of substitutes,
- power of buyers, and
- power of suppliers.
The stronger any of these forces are within an industry, the less potential that industry has to generate (or continue to earn) economic profits.
164
The threat of substitutes is most likely to be low for a firm that:
A)
produces a commodity product in an industry with significant unused capacity.
B)
produces a differentiated product with high switching costs.
C)
operates in a fragmented market with little unused capacity.
B
The threat of competition from substitute products is likely to be low for a firm that produces a differentiated product with high switching costs.
AC - Unused capacity and low industry concentration (a fragmented market) tend to intensify rivalry among industry competitors but are not directly related to the threat of substitutes.
165
Factors that increase competition in an industry most likely include:
A) high barriers to entry, low concentration, and low unused capacity.
B) low barriers to entry, low concentration, and high unused capacity.
C) low barriers to entry, high concentration, and high unused capacity.
B
Low barriers to entry increase competition as more firms can enter the business. Industries that are fragmented and have unused capacity tend to be highly competitive as they fight for market share and attempt to utilize excess manufacturing resources.
166
A firm is most likely to have pricing power if:
A) its market share is high.
B) costs to exit the industry are high.
C) its product is differentiated.
C
Firms offering products that are differentiated in terms of quality and features are more likely to have pricing power than firms that produce undifferentiated (commodity-like) products.
A - High market share does not necessarily imply pricing power; for example, if four firms each have 25% market share, none of them are likely to have significant pricing power.
B - High exit costs can create overcapacity in an industry and result in a high degree of price competition as firms try to maintain production volume during a period of reduced demand.
167
The industry experience curve illustrates the relationship between:
A) cumulative output and cost per unit.
B) company age and profitability.
C) productivity and average years of employment.
*what is the slope like?
A
The industry experience curve shows cost per unit relative to cumulative output. Cost per unit typically decreases over time due to higher utilization rates for fixed capital, improvements in the efficiency of labor, and better product design and manufacturing methods.
*slope is downwards because of increases in productivity and economies of scale, especially in industries with high fixed costs.
168
Stages of an industry life cycle in chronological order are:
A) embryonic, growth, mature, shakeout, and decline.
B) embryonic, growth, shakeout, mature, and decline.
C) growth, shakeout, mature, decline, and embryonic.
B
169
Which of the following industries is likely to be most sensitive to the business cycle?
A) Confectionery.
B) Pharmaceutical.
C) Automobile.
C
The automobile industry is cyclical because demand for new autos fluctuates with the business cycle.
A - The confectionery industry tends to be non-cyclical and defensive because demand for candy tends to be stable through the business cycle.
B - The pharmaceutical industry is non-cyclical because demand for medicines is independent of the business cycle.
170
A firm is most likely to have pricing power if it operates in an industry characterized by:
A) high concentration, undercapacity, and high market share stability.
B) high concentration, undercapacity, and low market share stability.
C) low concentration, overcapacity, and high market share stability.
A
Firms in highly concentrated industries are more likely to have pricing power than firms in fragmented industries. Firms in industries with tight capacity constraints are more likely to have pricing power than firms in industries with excess capacity. High market share stability is indicative of pricing power because competition is likely less intensive.
171
Which of the following industries is most likely to operate in a fragmented market?
A) Pharmaceuticals.
B) Confections.
C) Oil services.
C
Most areas of the oil services industry are characterized by many small competitors. The confections and pharmaceutical industries each have a small number of very large firms.
172
fragmented market means ___ (many/few) competitors and ____ (high/low) industry concentration
many, low
173
Pricing power for the firms in an industry is most likely to result from low:
A) industry concentration.
B) barriers to entry.
C) levels of capacity.
C
Low capacity is associated with pricing power because it increases the likelihood that supply in the short run will be less than demand at current prices. Low barriers to entry and low industry concentration (a fragmented market) typically suggest firms have little pricing power.
174
Declining prices that result from the development of substitute products are most likely to characterize an industry in the:
A) shakeout stage.
B) mature stage.
C) decline stage.
C
The decline stage of the industry life cycle is often characterized by declining prices as substitute products or global competition emerge, or as a result of decreasing demand due to societal changes.
(first picked A). Shakeout is characterized by slowing growth; intense competition; industry overcapacity; declining profitability; cost cutting; increased failures. It focuses more on intra industry competitor. When there is sub or societal changes, it means the industry is shrinking as a whole ==> decline stage.
175
Which of the following types of industries is typically characterized by stable performance during both expansions and contractions of the business cycle?
A) Cyclical.
B) Defensive.
C) Growth.
B
176
A ____ firm has earnings that are highly dependent on the business cycle.
cyclical
177
A cyclical firm has earnings that are highly ____ (independent/dependent) on the business cycle.
dependent
178
Non-cyclical industries or firms can be classified as _____ or _____
defensive; growth
179
Non-cyclical industries or firms can be classified as defensive (demand for the product tends _____ with the business cycle) or growth (demand is ____ by the business cycle because _____)
not to fluctuate; unaffected; demand is very strong
180
Industry analysis is most likely to provide an analyst with insight about a company's:
A) financial performance.
B) competitive strategy.
C) pricing power.
C
Industry analysis provides a framework for an analyst to understand a firm in relation to its competitive environment, which determines how much pricing power a firm has.
A&B - Competitive strategy and financial performance are aspects of company analysis.
181
The experience curve, which illustrates the cost per unit relative to output:
A) slopes downward.
B) slopes upward.
C) slopes upward in the early years and downward in the later years.
A
The experience curve, which shows the cost per unit relative to output, slopes downward because of increases in productivity and economies of scale, especially in industries with high fixed costs.
182
Which of the following conditions is most likely to indicate that barriers to entry into an industry are low?
A) The industry has significant economies of scale.
B) Investment capital is available at low cost.
C) Market shares have been stable over the last two business cycles.
B
Readily available capital tends to make entry into an industry easier.
C - If an industry is composed of the same firms over a long period of time, barriers to entry are likely high.
A - Economies of scale are a barrier to entry because existing firms are likely to be producing at a lower cost per unit than a new competitor can achieve.
183
The competitive forces identified by Michael Porter include:
A) power of existing competitors and threat of entry.
B) threat of substitutes and rivalry among suppliers.
C) rivalry among existing competitors and power of buyers.
C
Porter's five competitive forces are: (1) rivalry among existing competitors; (2) threat of entry; (3) threat of substitutes; (4) power of buyers; (5) power of suppliers.
184
A firm's earnings are most likely to be cyclical if:
A) the firm operates in a growth industry.
B) the firm produces luxury items.
C) most of the firm's costs depend on its level of output.
B
Producers of luxury items tend to have cyclical earnings because consumers typically decrease their purchases of these items during economic recessions.
C - The earnings of firms with high percentages of variable costs are not as likely to be cyclical as those of firms with high percentages of fixed costs (i.e., high operating leverage).
A - A growth industry has demand that is strong enough that earnings remain relatively unaffected by the business cycle. *non-cyclical industries could be further classified as growth or defensive.
185
In which of the following industries are technological factors least likely a significant influence?
A) Pharmaceuticals.
B) Oil services.
C) Confections.
C
Technological influences are relatively important in the pharmaceuticals and oil services industries, but they are generally not a significant influence in the confections industry.
186
Which of the following types of industries is typically characterized by above-normal expansion in sales and profits independent of the business cycle?
A) Counter-cyclical.
B) Defensive.
C) Growth.
C
A - pattern is against business cycle
B - growth is stable
187
Which of the following industries is most likely to be classified as non-cyclical?
A) Utilities.
B) Autos.
C) Housing.
A
Non-cyclical industries are those for which demand is not highly sensitive to business cycles, such as utilities, health care, and food and beverages. Housing and autos are examples of cyclical industries.
188
Market share stability within an industry is least likely to result from a high level of:
A) switching costs.
B) barriers to entry.
C) product innovation.
C
Frequent introductions of new products and innovations tend to make firms' market shares within an industry less stable.
A&B - High barriers to entry into the industry and high switching costs for customers to change to a competing product both contribute to market share stability.
189
A manager tells a research analyst, "A thorough industry analysis should use more than one approach to estimate industry variables," and "An analyst should not compare his valuations to those of other analysts." Which of these two statements is (are) CORRECT?
A) Only one of these statements is accurate.
B) Neither of these statements is accurate.
C) Both of these statements are accurate.
A
The first statement is accurate. When analyzing an industry, an analyst should use different approaches and scenarios when estimating industry variables. The second statement is inaccurate. Comparing one's own forecasts with those of other analysts can be useful for confirming the soundness of the analysis and for identifying industries that are potentially overvalued or undervalued by the consensus view.
190
Technological changes are most likely to result in which of the following effects? Evolving technology is likely to result in changes in:
A) the relative demand for various products only.
B) educational curriculum and the relative demand for various products.
C) educational curriculum only.
B
If technological changes result in changes in the set of skills required of workers, this is likely to lead to changes in educational curriculum (and possibly delivery). Such changes often result in the production and demand for new or different products.
191
Factors affecting industry growth that are related to the composition and age distribution of the population are best described as:
A) macroeconomic factors.
B) demographic factors.
C) social influences.
B
192
Food, beverage, and utility companies are examples of:
A) defensive industries.
B) declining industries.
C) cyclical industries.
A
Food, beverage, and utility companies provide basic necessities of life and are considered to be defensive industries. In a recession, the demand for their products will not fall as much as for some of the other industry groups.
