BA250

Chapter 13 Review Questions Page 436 # 1 3, 13, 18

1. Explain how stocks generate returns. Is one form of return preferable over the
other? Be sure to consider both liquidity and taxation in your answer.

Stocks generate returns by the company they are invested in doing well in their business.
The profit of the company can be distributed to the shareholders by either dividends or
capital appreciation. A dividend can be either as cash or more company stock where
capital appreciation is an increase in the selling price of the shares of stock. Since stock
prices and change almost instantaneously, having a dividend is less risky then capital
appreciation. A bird in the hand is worth two in the bush.

2. List and describe four reasons why someone should consider investing in stocks.

Over time, common stocks outperform all other investments stocks usually give a
greater return for your money as historical comparisons convey.
Stocks reduce risk through diversification holding different types of stock can greatly
reduce your risk because diverse stocks move differently over time.
Stocks are liquid you can sell your stocks anytime you want.
The growth in your investment is determined by more that just interest rates some
investments depend on interest rates rising and falling but stock mainly depend on how
well the business is prospering.

3. List the six questions an investor should ask periodically to check the progress of
stock investments.

1. Is the return on my investment meeting my expectations and goals?

2. Is the company making money?
3. How much money will I get back if I sell my investment today?
4. How much am I paying in commission or fees?
5. Have my goals changed?
6. What criteria will I use to decide when to sell?

13. Describe the basic differences between technical analysis and fundamental
analysis. List examples of different tools a technical analyst and a fundamental
analyst might use when valuing an investment.

Technical analysis is a method of stock analysis that focuses on supply and demand,
using charts and computer programs to identify and project price trends for a stock of for
the market as a whole. Fundamental analysis is determining the value of a share of stock
by focusing on such determinants as future earnings and dividends, expected levels of
interest rates, and the firms risk.

18. Explain two ways an investor can reduce risk when purchasing stocks.
Diversification can reduce risk by investing in different stocks where if one increases and
the other decreases, they can balance each other out. Using a beta can measure systematic
risk of how responsive a stock pr portfolio is to changes in the market portfolio.

Chapter 13 Problems and Activities Page 437 # 2, 5

2. The Haley Corporation has just announced year-end results as follows:

Value of company assets $12,500,000
Value of company liabilities $6,500,000
Net income $1,600,000
Common stock dividends $250,000
Preferred stock dividends $400,000
Number of shares of common stock outstanding 1,000,000
Closing price of Haley Corporations stock $45 per share

a. Calculate the book value per share = 12,500,000 6,500,000 / 1,000,000 = 6

b. Calculate earnings per share = 1,600,000-400,000 / 1,000,000 = 1.2
c. Calculate Haley Corporations dividend yield = 250,000/1,000,000 = .55%
45
d. Calculate the market-to-book ratio = 45 / 6 = 7.5

5. Wildcat Corporation recently disclosed the following information:

Earnings / Revenue $1,500,000
Assets $7,000,000
Liabilities $1,500,000
Shares outstanding 500,000
Market price per share $ 33
Calculate the price/book ratio, the price/earnings ratio, and the book value per
share for each of the following separate scenarios.

a. Based on current information = 7,000,000-1,500,000 / 500,000 = BVPS of 11

33 / 11 = 3 price to book ratio
33 / 1,500,000/500,000 = 33/3 = 11 price/earnings ratio

b. Earnings fall to $1,000,000 = 7,000,000-1,500,000 / 500,000 = BVPS of 11

33 / 11 = 3 price to book ratio
33 / 500,000/500,000 = 33 price/earnings ratio

c. Liabilities increase to $2,500,000 =7,000,000-2,500,000 / 500,000 = BVPS of 9

33 / 9 = 3.66 price to book ratio
33 / 1,500,000/500,000=33/3= 11 price/earnings ratio

d. The company does a 3:1 stock split with no change in market capitalization
7,000,000-1,500,000 / 1,500,000 = BVPS of 3.66
11 / 3.66 = 3 price to book ratio
11 / 1,500,000/1,500,000= 11/1 =11 price/earnings ratio
e. The company repurchases 20% of outstanding stock, incurring additional liability
to finance the purchase.
7,000,000-1,500,000-3,300,000 = 2,200,000
2,200,000 / 400,000 = BVPS of 5.5
33 / 5.5 = 6 price to book ratio
33 / 1,500,000/400,000 = 33/3.75 = 8.8 price/earnings ratio

Chapter 14 Review Questions Page 471 # 1, 2, 6, 10, 11, 19, 21

1. What are three reasons investors should consider adding bonds to their
portfolios?

Bonds reduce risk through diversity

Bonds produce steady income
Bonds can be a safe investment if held to maturity

2. Compared to stocks, why are bonds generally considered to be relatively safe

investments?

Interest on bonds must be paid unlike dividends from stocks. Bond payments must be
made or else the business can be forced into bankruptcy.

6. Why is U.S. Treasury debt considered risk free? Describe the possibility of
default risk associated with Treasury debt.

U.S. Treasury debt is generally risk free because the government can tax and print more
money to pay their debts so there is no default risk. Also the government no longer issues
callable bonds.

10. What advantages do I bonds offer investors? At purchase, how do I bonds differ
from EE bonds?

Series I bonds are issued at face value and accrue interest earnings for up to 30 years.
You have to wait a minimum of 6 months at purchase before you can cash it in where
series EE bonds can be cashed at any time.

11. What type of entities issue municipal bonds? What significant feature of
municipal bonds attracts investors? Given this feature, who should consider
investing in municipal bonds?

States, counties and cities and other agencies such as school districts and highway
authorities issue municipal bonds. They are tax exempt by the federal government and by
the state as long as you live in the state it was issued. They would be a good investment
for someone who is in a higher tax bracket and wanting to earn money without loosing
35% in taxes.
19. Describe the relationship between interest rates and bond values. If investors
required rate of return decreases, what should happen to the value of bonds?
Would this bond be purchased at a premium or discount? How did you make this
determination?

There is an inverse relationship between bonds and interest rates. When interest rates rise,
bond values drop, and when interest rates drop, bond values rise. If investors required
rate of return decreases, then the value of the bond should increase. This bond would be
purchased at a premium because it would be worth more due to the maturity value
balancing at the par value

21. Describe the differences between direct and indirect real estate investment.

Direct real estate investments are where you directly own the property which could be a
vacation home or commercial property like an apartment. Indirect real estate investments
are where you are an investor in a group that owns the property and has hired a
professional to manage it like a real estate investment trust (REIT)

Chapter 15 Review Questions Page 506 # 1 3, 6, 11, 18

1. What is a mutual fund? What makes a mutual fund different from owning a
stock or bond directly?

A mutual fund is an investment fund that raises funds from investors, pools the money,
and invests it in stocks, bonds, and other investments. Each investor owns a share of the
fund proportionate to the amount of their investment. The instant diversification makes
mutual funds popular as well as being able to be a small investor and invest like a large
one.

2. List and explain the seven advantages associated with owning a mutual fund.
Which of these advantages relates to Principle 3? How?

Diversification the fund is already set up for investing in multiple areas.

Professional Management fund managers control spending and evaluate investments
Minimal Transaction costs trading in large quantities causes less commission fees
Liquidity just pick up phone or go online to buy or sell and the money is yours
Flexibility over 8,000 different mutual funds to choose from high or low risks
Service bookkeeping, checking accounts, automatic add or withdrawal, phone or net
Avoidance of Bad Brokers the fund manager does not make money on trade
commissions, only hired to make money for you.

Diversification and flexibility are principle 3 because both give you the choice to change
your risk levels.
3. List and explain the five disadvantages of mutual funds.

Lower than market performance they underperform the stock market but still have
made profit over the annual trends
Costs some charge sales fees or load up to 8.5% plus an additional annual expense ratio
up to 3%
Risks not all are truly safe, some are not as diversified as others and can loose money is
in the same sectors of the market
Systematic Risk all risk is not equal and market risk, risk resulting from factors that
affect all stocks, still affects the fund
Taxes mutual funds are not long term capital gains, when there is a profit you pay the
taxes now and not later.

6. Describe the organization of a mutual fund. What is the role of the investment
manager or advisor? How are they typically compensated?

The fund is organized as a corporation or trust and is owned by shareholders who elect a
board of directors. The fund is then run by a management company (Fidelity, Vanguard)
and then hires an investment advisor to oversee the fund. The advisor supervises the
trading of securities and is paid a percentage of the total value of the fund on an annual
basis usually one half to one percent. Other operating expenses bring the total expenses
to at least one percent annually.

11. List the six major categories of mutual funds. What is the fundamental
difference among these categories? What two categories are most alike? Why?

Money Market Mutual Funds, Stock Mutual Funds, Balanced Mutual Funds, Asset
Allocation funds, Life Cycle and Target Retirement Funds, Bond Funds, Exchange
Traded Funds. The fundamental differences between these are their objectives and
financial goals. Balanced and Asset Allocation Funds are alike in that they invest in a mix
of stocks, bonds, and money market securities.

18. How does an automatic investment plan facilitate Principle 13?

An automatic investment plan falls under Principle 13-pay yourself first by allowing an
automatic withdrawal from your bank account without you having to do it which allows
you do not have or even see that money to spend.