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  • 1. Dakota State University BUS 411 Investments Spring 2003 Study Guide Unit Three: Investing in Common Stock Reading Assignments Chapter 9: All Chapter 11: All except pp. 339-345 Chapter 12: All Chapter 13: All, including appendix Chapter 14: All Question Assignments 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 Problem Assignments Chapter 9: 1, 2, 3, 4, 5, 7 Chapter 11: 1, 2 Chapter 12: None Chapter 13: 1, 2, 3, 7 Chapter 14: None Objectives 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 stock. 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
  • 2. 4. State an important characteristic of ownership in large corporations today. 5. Describe how stockholders exercise control of a corporation.
  • 3. -2- 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 dividend. 11. Explain how the above method can be used to detect overvalued or undervalued stocks. 12. Describe the following ratio methods of common stock valuation: a) P/E ratio b) price/book value c) price/sales 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 valuation including: 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 terms of: 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.
  • 4. 21. State the three forms of the efficient market hypothesis. 22. Summarize the findings of tests of the weak-form efficient market hypothesis.
  • 5. -3- *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 market hypothesis. *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 g) overreaction 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 specification. 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. Investing Strategies *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 g) trading h) contrarian *36. Describe the following types of companies and stocks:
  • 6. a) blue chip b) income stocks c) growth
  • 7. -4- d) tech stocks e) defensive f) cyclical g) speculative h) special situation i) “cap” stocks j) IPOs 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 are so. 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 dividends. 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- dividend. *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,
  • 8. 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
  • 9. -5- Chapter 12: The Macroeconomic Environment for Investment Decisions 52. State the three (actually four) steps in the typical security valuation process. 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 process: a) economy and markets b) industry c) company-specific *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 long -term, 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 coefficient of individual stocks with the overall stock market, e) the conclusion about the possibility of timing the market consistently 56. State three things that investing and trading of securities will likely become. 57. State some reasons for investing globally. 58. Explain what is meant by leading economic indicators and give some examples. 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 f) operations g) management 64. State several sources of industry information.
  • 10. -6- 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 used. 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 operations, etc. 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 analysis. 73. Describe the criticisms made by technical analysts of fundamental analysis with regard to the following: a) ease b) speed
  • 11. c) general applicability d) financial statements e) P/E ratios
  • 12. -7- 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 j) fun 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 b) timing 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 sell signals. 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: a) overbought b) oversold c) support d) resistance 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 and jargon.