Dakota State University
Unit Three: Investing in Common Stock
Chapter 9: All
Chapter 11: All except pp. 339-345
Chapter 12: All
Chapter 13: All, including appendix
Chapter 14: All
Chapter 9: 1, 2, 3, 4, 5, 6, 7, 8, 9
Chapter 11: 1, 2, 3, 4, 5
Chapter 12: 1, 2, 6, 7, 9, 10
Chapter 13: 1, 2, 3, 4, 5, 6, 7, 8
Chapter 14: 1, 2, 4, 5, 6, 7
Chapter 9: 1, 2, 3, 4, 5, 7
Chapter 11: 1, 2
Chapter 12: None
Chapter 13: 1, 2, 3, 7
Chapter 14: None
Chapter 9: The Valuation of Common Stock
Common Stock Valuation
1. State what common stock represents.
2. Give the typical balance sheet accounts associated with common
3. Explain what the following common stock terms mean:
a) par value
b) additional paid-in capital
c) retained earnings
d) book value
e) book value per share
4. State an important characteristic of ownership in large
5. Describe how stockholders exercise control of a corporation.
6. Explain or describe the following common stock terms mean:
a) preemptive right
b) classes of common stock
c) claims on earnings and assets in bankruptcy
d) treasury stock and its impact on per share calculations
e) market value
f) investment value
7. Given a section of common stock quotes from the Wall Street
Journal explain what each line of numbers and symbols means.
* 8. State how the value of an economic asset should be calculated.
9. Calculate the present value (expected price) of a preferred
stock given its dividend and an appropriate discount rate.
10. Calculate the present value (expected price) of a common stock
given its expected dividend, the appropriate discount rate
(required rate of return), and the expected growth rate in the
11. Explain how the above method can be used to detect overvalued or
12. Describe the following ratio methods of common stock valuation:
a) P/E ratio
b) price/book value
d) PEG ratio
e) price/cash flow
13. For the P/E method of common stock valuation state:
a) two methods of estimating future EPS
b) two methods of estimating future P/E ratios
c) some difficulties with the method
d) importance to stocks not paying dividends
14. State some difficulties in applying the price/book value common
stock valuation method.
15. State some problems in using the ratio methods of common stock
a) determining what values are high or low
b) interpreting high or low values
c) difference between analysts
16. Relate the ratio common stock valuation methods to being either
value or growth approaches.
Efficient Market Hypothesis
17. State several reasons why the market should be efficient.
18. State very precisely the two parts of the random walk theory.
19. State several implications of the efficient market hypothesis in
a) how prices and price changes are determined
b) importance of adjusting investment returns for risk
c) easiness of beating the market consistently
20. State what is meant by "abnormal" profits.
21. State the three forms of the efficient market hypothesis.
22. Summarize the findings of tests of the weak-form efficient market
*23. Describe two ways in which returns on stocks are adjusted for
market performance to detect abnormal profits.
24. Summarize the results of stock split studies, initial public
offering studies, and stock prices and world events studies
regarding the validity of the semi-strong form efficient
*25. Describe the following market anomalies to the semi-strong form
efficient market hypothesis:
a) aggregate (index) dividend yields
b) quarterly earnings reports
c) low P/E ratio stocks
d) small size (small-cap) effect
e) low-priced stocks
f) neglected firm effect
h) the January effect
i) owner-manager effect
j) cash dividend effect
k) book value/market value ratio
26. Summarize the conclusion drawn from the above anomalies about the
validity of the semi-strong form efficient market hypothesis.
27. State a criticism of anomaly studies in terms of risk
28. State how easily the above anomalies can be exploited profitably
in practice and why.
29. State two groups of investors who disprove the strong-form
efficient market hypothesis.
30. State the implication of the efficient market hypothesis for:
a) technical analysis
b) fundamental analysis
31. Explain what is meant by a superior analyst.
32. Describe the optimum investment policy for a portfolio manager
without superior analysts.
33. Describe how an index funds, Diamonds, and SPDRs operate.
*34. Give a thorough description of the two basic types of stock
investing strategies- growth and value.
*35. Describe the following more specific stock investing strategies:
a) sector rotation
b) momentum investing
c) buy and hold
d) high income
e) quality long-term growth
f) aggressive stock management
*36. Describe the following types of companies and stocks:
d) tech stocks
h) special situation
i) “cap” stocks
k) foreign stocks
l) widows and orphans’ stocks
m) penny stocks
n) drill-bit stocks
Chapter 11: Dividends: Past, Present, and Future
37. State and explain the tradeoff between paying dividends and
future growth of a company.
38. Define the optimal dividend policy.
*39. Describe the following dividend theories:
a) irrelevance (M&M)
b) bird-in-the-hand (Gordon & Lintner)
c) tax preference
40. Describe the market's attitude toward changes in dividends and the
impact of the announcements of those changes on stock prices.
41. State several other factors that could influence dividend policy.
42. Describe the following choices of dividend policies:
a) residual dividend
b) constant payout
c) low regular plus extras
d) stable and predictable
*43. State the two parts of a typical management's dividend policy.
44. Explain what is meant by dividends being “sticky” and why they
45. Describe the following dates regarding dividends:
a) declaration date c) ex-dividend date
b) holder-of-record date d) payment date
46. Describe a stock split including definition and rationale.
47. Describe the typical market response to announcements of stock
splits and what can happen to the stock price afterwards.
47. Describe a stock dividend including definition and rationale.
48. Describe the typical market response to announcements of stock
49. Describe the change in stock prices upon the implementation of a
stock split or stock dividend.
50. Describe the change in stock prices upon a stock going ex-
*51. For given stock dividends and stock splits state:
a) the change in proportional ownership
b) the change in par value of the common stock
c) the change in balance sheet accounts: common stock,
additional paid-in capital, retained earnings
d) the change in the number of shares
e) the change in book value per share
f) the change in EPS
Chapter 12: The Macroeconomic Environment for Investment Decisions
52. State the three (actually four) steps in the typical security
53. Explain why selecting a company to invest in is not necessarily
the same as selecting a stock to buy.
54. Describe some of the factors involved in the three-step valuation
a) economy and markets
*55. In regard to tests of the three-step valuation process, state:
a) the approximate percent of a company's earnings variability
associated with the economy, the company's industry, and
the specific company,
b) the characterization of systematic (market-related) stock
price fluctuations for the short-term, medium-term, and
c) the usual lead time that the stock market shows relative
to the general economy,
d) the usual sign and rough value of the correlation
of individual stocks with the overall stock market,
e) the conclusion about the possibility of timing the market
56. State three things that investing and trading of securities will
57. State some reasons for investing globally.
58. Explain what is meant by leading economic indicators and give
59. Give several reasons for performing industry analyses.
60. Distinguish between the macro and micro approaches to
forecasting industry performance.
61. State the two forecasts that have to be made to forecast the
future returns for an industry (micro approach).
62. Describe, using a diagram and comments, the stages in the life
cycle of an industry (and a company).
63. State several items that would be examined in an industry
analysis with regard to the following:
a) price history
b) operating data
c) comparative results of industries
d) markets for products
e) financial performance
64. State several sources of industry information.
Chapter 13: Security Selection: Analysis of Financial Statements
*65. Given financial statements for a corporation and appropriate
market data calculate the following ratios:
a) current ratio
b) quick ratio
c) inventory turnover (cgs method)
d) average collection period
e) total assets turnover
f) times interest earned
g) total debt/total liabilities & equity
h) long-term debt/common equity
i) return on common equity
j) return on total assets
k) return on sales (net profit margin)
l) price/earnings ratio
m) market value/book value
n) dividend payout ratio
o) dividend yield
p) any other specified ratio
66. Explain what trend analysis is in ratio analysis and why trend
analysis is so important.
67. Explain why comparisons are needed and which ones are frequently
68. State what is usually specifically meant by simply “cash flow”
of a company.
69. State a quick way to calculate a rough measure of the cash flow
from operations for a corporation.
70. State what the net cash flow for a corporation could typically
be and relate it to the size of net income, cash flow from
71. Interpret a given specific cash flow statement in terms of:
a) whether cash flow is positive or negative for each of the
three sections of a cash flow statement
b) what the overall net cash flow is for the company
c) an explanation of what the company is doing in the
investing and financing sections
* d) a short scenario of how the three parts of the cash flow
statement relate to each other
Chapter 14: Technical Analysis
72. Make a general statement of the purpose and methods of technical
73. Describe the criticisms made by technical analysts of fundamental
analysis with regard to the following:
c) general applicability
d) financial statements
e) P/E ratios
f) processing of new information
g) timing of investing in a stock and the market's reevaluation
of the stock
h) psychology of the market
i) value vs. price
74. Describe the criticisms made by fundamental analysts of technical
analysis with regard to the following:
a) the efficient market hypothesis
b) price patterns
c) self-fulfilling prophecies
d) self-defeatism of successful trading strategies
e) objectivity vs. subjectivity
75. Describe the theory of technical analysis with regard to all
aspects of supply and demand, trends, and chart patterns, etc.
*76. State the characteristics of technical analysis with regard to:
a) market vs financial data
c) time horizon
d) adjustment of the market to new information
e) stock prices and market indicators
f) the one aspect most criticized by fundamental analysts
77. Explain what is meant by the contrarian approach to investing.
78. Explain how paired moving averages can be used to generate buy and
79. Describe the following types of charts:
a) line charts d) moving average charts
b) bar charts e) candlestick
c) point and figure charts
80. Describe the following commonly referred to patterns:
a) head and shoulders g) support
b) triangles h) resistance
c) gaps i) gaps
d) V bases j) trends
e) saucers k) pennants and flags
f) channels l) breakouts
81. Explain what is meant by the following technical trading terms:
e) trading market
f) trending market
*82. Given a chart of stock prices, use technical analysis to make a
forecast of the future stock price level, drawing on the chart
itself the patterns and trends seen and adding commentary
demonstrating familiarity with technical analysis terminology