quizbank 2 Flashcards
(10 cards)
XYZ company paid a dividend of $3.00 this year and anticipates the dividend to grow each year by: Year 1: 5% Year 2: 7% Year 3: 8% After the third year, they anticipate dividends growing at 6%. If Sydney’s required rate of return is 10%, how much would she be willing to pay for this stock?
Answer: D Step #1: Determine the dividend to be paid each year. Year 1: 3.00 x (1.05) = 3.15 Year 2: 3.15 x (1.07) = 3.37 Year 3: 3.37 x (1.08) = 3.64 Step #2: Apply the constant growth dividend formula to value the stock as of year 3. V = 3.64 (1.06) ÷ (.10 - .06) V = 96.46 Step #3: Use uneven cash flows to determine the NPV of the stock at time period zero (today). CF0 = 0 CF1 = 3.15 CF2 = 3.37 CF3 = 3.64 + 96.46 = 100.10 I = 10 NPV = ? Answer: $80.86
Using the constant growth dividend valuation model, calculate the intrinsic value of a stock that pays a dividend this year of $2.00 and is expected to grow at 6%. The beta for this stock is 1.5, the risk free rate of return is 3% and the market return is 12%.
The correct answer is “D.” Use the constant growth dividend model to solve for intrinsic value. The question does not provide the required rate of return, however the capital asset pricing model can be used solve for required rate of return. V = D1/(r - g) V = 2 (1.06) / (.165 - .06) V = $20.19 R = Rf + b(Rm - Rf) R = .03 + 1.5(.12 - .03) R = .165
how do you calculate holding period yield - when buying on margin)
holding period yield, not holding period return. To calculate the holding period yield, you simply subtract the purchase price from the selling price and divide by the purchase price — when buying on margin, yield calculation is not impacted
XYZ company anticipates paying the following dividends, starting next year: Year 1: 2.25 Year 2: 2.75 Year 3: 3.01 After the third year, they anticipate dividends growing at 6%. If Diego’s required rate of return is 12%, how much would he be willing to pay for this stock?
Step #1: Apply the constant growth dividend formula to value the stock as of year 3. V = 3.01(1.06) ÷ (.12 - .06) V = 53.18 Step #2: Use uneven cash flows to determine the NPV of the stock at time period zero (today). CF0 = 0 CF1 = 2.25 CF2 = 2.75 CF3 = 3.01 + 53.18 = 56.19 I = 12 NPV = ? Answer: $44.20
In reviewing a client’s portfolio, Elizabeth West, CFP®, notes that several securities contained in the portfolio have suffered severe reductions in market price. Indeed, two of these stocks have dramatically underperformed, falling in value from $80.00 to $7.50 in one case and from $300.00 to $12.00 in the second case. When Elizabeth discussed with her client the possibility of selling these stocks, the client replied that his analysis, conducted more than five years ago, indicated these stocks to be excellent investments and that he has no reason to believe that analysis to have changed.
The client’s statement is least consistent with:
over confidence -
Anchoring, belief perseverance, and regret avoidance are all consistent with holding on to losers too long.
Overconfidence is more likely to lead to overtrading rather than holding losers too long.
A is incorrect. Anchoring represents the investor’s inability to objectively review and analyze new information. One manifestation of anchoring is a tendency to hold losers too long.
B is incorrect. Belief perseverance is similar to anchoring in that people are unlikely to change their views given new information. One manifestation of belief perseverance is a tendency to hold losers too long.
D is incorrect. Regret avoidance, also known as the disposition effect, causes investors to take action (or inaction) in hopes of minimizing any regret. One manifestation of regret avoidance is a tendency to hold losers too long.
What is Loss Aversion
Loss aversion notes that people more strongly prefer to avoid losses than to seek gains.
Many individuals, indeed most individuals, exhibit loss aversion.
Loss aversion was identified by Amos Tversky and Daniel Kahneman. Kahneman received the Nobel Prize in Economics in 2002 for his work on prospect theory and loss aversion.
what is risk aversion
Risk aversion is not considered to be a behavioral bias. Rather, risk aversion is an assumption of traditional financial analysis based on the precepts of rational, utility-maximizing economic theory.
Which of the following behavioral biases is closest to the two identified in Ms. Wallace’s diagram?
Behavioral bias: Consequence:
Hindsight bias Belief that one has predicted an event that, in fact, they did not predict
Cognitive dissonance Minimizing or forgetting past losses
Exaggerating past gains
Hindsight bias and cognitive dissonance are each a type of overconfidence.
what is similar to anchoring
Belief perseverance is similar to anchoring in that people are unlikely to change their views given new information.
Regret avoidance is also known as what?
disposition effect - causes investors to take action (or inaction) in hopes of minimizing any regret.
