A well‐functioning securities market is least likely to:

Ian Goode, CFA, is analyzing the price of the preferred stock of MegaGym. Goode estimates that MegaGym's earnings growth rate over the next five years will be 20%, and that MegaGym's earnings will then grow at a sustainable rate of 5%. The most appropriate method for Goode to value MegaGym's preferred stock is to:

divide the preferred dividend by the required rate of return on MegaGym’s preferred stock.

The value of preferred stock is the preferred dividend divided by the required rate of return on the preferred. Earnings growth rates do not factor into the valuation of preferred stock since the dividend is typically fixed. Therefore, neither a historical price-to-earnings model nor a multistage dividend discount model is appropriate.

An analyst classifies Mettler, Inc., an operator of retail grocery stores, in the same industry group as Powell Corporation, a manufacturer of industrial machinery. This analyst’s classification system is most likely based on:

statistical methods.

This grouping is most likely the result of a cluster analysis and may have arisen by chance. The two firms clearly offer different products and services. An industrial machinery manufacturer is likely to be a cyclical firm, while a grocery retailer is likely to be a non-cyclical firm.

Under which of the following conditions are market values of securities most likely to be persistently greater than their intrinsic values?

Short selling is restricted.

Restrictions on short sales remove some of the selling pressure on overvalued securities that would otherwise drive their market values down toward their intrinsic values in an efficient market. Market inefficiency caused by high transactions costs or restriction on arbitrage trading may allow market values that are different from intrinsic values to persist both for overvalued and undervalued securities.

Evelyn Stram, CFA, places a good-till-cancelled limit buy order at 86 for a stock. Strain’s order specifies:

validity and execution instructions.

Good-till-cancelled is a validity instruction, which indicates when an order may be filled. Execution instructions include limit orders and market orders, as well as instructions regarding trade size and visibility. A clearing instruction indicates how to arrange final settlement of the trade.

A firm has a constant growth rate of 7% and just paid a dividend of $6.25. If the required rate of return is 12%, what will the stock sell for two years from now based on the dividend discount model?

$153.13.

1212value t=2=

An electronic crossing network is best described as:

an order-driven market.

A crossing network is an example of an order-driven market. Orders are batched together and crossed (matched) at specific times during the trading day at prices based on those of another exchange. Price-driven markets and quote-driven markets are other terms for dealer or over-the-counter markets.

Consider the following statements:
Statement 1: Commercial industry classification systems are reviewed and updated less frequently than government industry classification systems.
Statement 2: Commercial industry classification systems do not distinguish between for-profit and not‐for‐profit organizations.
Which of the following is most likely?

Both statements are incorrect.

Commercial industry classification systems are reviewed and updated more frequently than government industry classification systems.
Government industry classification systems do not distinguish between for‐profit and not‐for‐ profit organizations.

A contract that requires one party to pay $ 100,000 each quarter to another company that will make a variable quarterly payment based on the market value of an equities portfolio is referred to as:

a swap.

In an equity swap, one party pays a fixed amount periodically in return for a payment that is calculated using a specific amount and the return on a stock or portfolio of stocks.

Sacco Inc. has nine directors on its board. Board members serve 3-year terms, and three seats are elected annually using a cumulative voting system. If an investor owns 1,000 shares of Sacco common stock, what is the maximum number of votes the investor may cast for one board candidate?

3,000.

Under cumulative voting, with three board seats up for election, the shareholder can cast up to 3,000 votes for one candidate. In a statutory voting system, an investor who holds 1,000 shares can cast 1,000 votes in the election for each seat.

Robert Higgins is estimating the price-earnings (P/E) ratio that will be appropriate for an index at the end of next year. He has estimated that:
•Expected annual dividends will increase by 10% compared to this year. Expected earnings per share will increase by 10% compared to this year.
The expected growth rate of dividends will be the same as the current estimate of 5%.
• The required rate of return will rise from 8% to 11%.
Compared to the current P/E, the end-of-the-year P/E will be:

50% lower.

The numerator of the formula for the P/E is the payout ratio, which is unchanged (both expected earnings and dividends increase by the same percentage). The denominator (k — g) doubles from 3% to 6%, which will decrease the PIE by half .

An analyst determines that a company has a return on equity of 16% and pays 40% of its earnings in dividends. If the firm recently paid a $1.50 dividend and the stock is selling for $40, what is the required rate of return on the stock if it is priced according to the dividend discount model?

13.7%.

1212g = (1 - payout)(ROE) = (1 - 0.40)(l6%) = 9.6%

Ron Egan, CFA, classifies firms in the transportation industry in peer groups that include airlines and bus operators. Egan learns that one of the airlines, Acme, derives half its revenue from its Acme Bus Lines subsidiary. Egan adds Acme to his peer group for bus operators while continuing to include Acme in his peer group for airlines. Is Egan’s treatment of Acme appropriate?

Yes.

Peer groups should include comparable companies with similar business activities. An analyst can appropriately include a company in multiple peer groups if the company’s business activities are comparable to firms in more than one peer group.

If the analyst estimates that the selling price of the company’s stock after one year will be $43, the value of the company’s common stock today is closest to:

$41.

Use the one‐period DDM.
Cost of equity = 0.05 + 1.1 (0.08) = 13.8%
Stock’s value = (3.75 / 1.138) + (43 / 1.138) = $41.08

Archer Products is in an industry that has experienced low levels of price competition but recently excess capacity has led to aggressive price cutting. An analyst would be least likely to describe Archer’s industry as:

in the maturity stage with high barriers to entry.

The maturity phase of an industry life cycle is not typically characterized by excess capacity or price competition. The conditions described may be consistent with a concentrated industry (typically characterized by low levels of price competition, since firms in the industry seek to avoid it) that is moving into the decline phase of an industry life cycle (excess capacity leads to aggressive price cutting, especially when barriers to exit are high). These conditions could also be consistent with an industry that is moving into the shakeout phase (characterized by developing excess capacity and intense price competition) following the growth phase (during which price competition is low).

Kate Johnson, CFA, owns shares of a stock that currently trades at $15. If Johnson wants to buy more shares if the price increases to $17, she should enter a:

stop buy order at $17.

An order to buy if a price increases to a specified level is a stop buy order. A limit order at $17 will execute immediately if the market price is $15. A market order does not specify a price, but is executed at the prevailing market price.

A well‐functioning securities market is least likely to:

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