Questions Set 84: Solution

Solution

How would you explain that, although the efficient market hypothesis applies to the stock market, you can’t successfully invest by randomly selecting stocks?

1. The hypothesis fails to fully explain the real market environment.
2. The hypothesis fails to consider these monopolies, which dominate certain segments of the market.
3. Random selection of stocks would ignore an individual investor’s goals.
4. New theories are needed to explain stock price behavior in the new economy

At what rate does $1,000 grow to $1,953 after three years? Use the formula for the future value of a lump sum, and assume annual compounding.

1. 25 percent
2. 75 percent
3. 31.8 percent
4. 95.3 percent

Given a choice between calculating returns using the holding period return (HPR) or the formula for the future value, you should select the future value formula because the

1. HPR fails to consider the discounted value of the purchase price.
2. future value formula incorporates the timing of cash flows.
3. HPR overstates the internal rate of return in direct proportion to the discount rate.
4. future value formula incorporates cash payments that are omitted in the HPR.

Which of the following statements most accurately explains the utility of the dividend growth model?

1. Dividend growth increases the total return earned on equity investments.
2. Projected dividend growth can be incorporated into calculation of the discounted value of cash flows.
3. Stocks with rising dividends generally outperform stocks that don’t pay dividends or that pay relatively static dividends.
4. Rising dividends, plotted as a function of time, appear as an exponential function with a positive slope.

ABC Corporation recently announced its plans to pay a 5 percent stock dividend in addition to its scheduled $0.32 quarterly dividend, which has been paid on its common stock in all of the previous 13 quarters. The ex-dividend date will be one month after the announcement. ABC Corporation hadn’t paid a stock dividend in the past nine years. You own 100 shares of ABC Corporation common stock valued at $68 per share. Which of the following explanations accurately projects the effect of these transactions?

1. Dilution will effect a 5 percent decline in price per share. That will be offset by the 2 percent (annualized) dividend for a net decline of 3 percent in the stock price.
2. The 5 percent stock dividend is equivalent to 1-for-20 stock split. Stock prices generally rise after stocks split, so the 5 percent dilution effect will be reduced to either a price rise or a decline that’s smaller than 5 percent.
3. The stock price will drop about 5 percent if all other factors remain constant.
4. The discounted value of the stock split and will render a price decline smaller than 5 percent.

In the absence of compelling empirical data to support technical analysis, which of these arguments supports its use?

1. The Dow Theory has a long history of successful use and has earned respect in non-academic circles.
2. Traders of odd lots tend to be smaller, less sophisticated investors who reliably make the wrong investment decisions.
3. Emotions lead to irrational investment decisions that can be overcome by applying a strict set of technical methods.
4. Several technical methods capitalize on empirical data supporting the contention that security prices move in the same direction.

Which of the following statements is correct?

1. Security selection can be a complex process that’s aided by Internet financial information services.
2. Security selection is most efficiently practiced by applying both technical and fundamental analysis.
3. Security selection requires only the use of accounting ratios.
4. Security selection simplifies investment decisions.

Which of the following reasons best explains why you would include inflation in a fundamental analysis of stock values?

1. Inflation exerts broad influence on factors that underlie the economy.
2. Inflation generally increases stock prices at a faster rate than other prices.
3. Inflation generally increases stock prices prices because cash inflows increase.
4. High inflation corresponds with high interest rates and low bond values.

In fundamental analysis, the value added by industry analysis is particularly apparent

• When inflation rates are high and have a broad negative impact on business in general.
• In industries where business levels significantly change in certain seasons or in relation to the business cycle.
• During recessions when business levels are suppressed across most industries.
• During the rapid growth stage of an economy.