Liam Rice:

Homework 4

Due before October 29, 2017

Total Points 100

Chapter 11

Question 1: What is the benefit of analyzing the market and alternative industries
before individual securities?
The value of security depends on the economic environment and performance of the
industry. The benefit of analyzing the market and alternative industries is whether we
should get the profit or not by investing in that particular stock. If the economy is in a
boom, then we get more return otherwise if it is in recession or returns are declined.
Depending on the analyses only one can choose the investment alternatives

Question 2: Discuss why estimating the value for a bond is easier than estimating
the value for common stock?

Estimating the value of a bond is easier than the estimating value of common stock.
Value of a bond is the present value of all future cash inflows plus the present value of
face value of a bond. In the valuation of a bond, we know the size and time pattern of
cash flows of the bond. Whereas in common stock, we cannot expect the time pattern of
cash flows occur over the current stock price.

Example - Exhibit 11.1

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
 A major retailer is reevaluating its bonds since it is planning to issue a new bond in the current
market. The firm's outstanding bond issue has 8 years remaining until maturity. The bonds were
issued with a 6.5 percent coupon rate (paid quarterly) and a par value of $1,000. The required rate
of return is 4.25 percent.

A. Refer to Exhibit 11.1. What is the current value of these securities?

a. $1149.94
b. $433.15
c. $1151.92
d. $860.50
e. $863.35

ANS: C

B. Refer to Exhibit 11.1. What will be the value of these securities in one year if the required return
is 7 percent?
a. $970.14
b. $388.13
c. $1031.15
d. $1035.81
e. $972.52

ANS: E

Question 3: Use above Exhibit 11.1 to answer the followings:

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

A major manufacturer is reevaluating its bonds since it is planning to issue a new bond in the
current market. The firm's outstanding bond issue has 7 years remaining till maturity. The bonds
were issued with an 8 percent coupon rate (paid quarterly) and a par value of $1,000. The
required rate of return is 10 percent.
A. What is the current value of these securities?
a. $900.18
b. $1151.92
c. $972.52
d. $1113.63
e. $904.00

Answer: A
Interest amount = 1000 x .08/4 = 1000 x 2 = $20.00
Iinterest rate = .1/4 = .025
Periods = 7 x 4 = 28
P = 20(PVIFA 2.5, 28) 1,000 x PVIF(2.5,28)
P = 900.18

B. What will be the value of these securities in one year if the required return is 6 percent?
a. $1151.92
b. $972.52
c. $1100.15
d. $900.18
e. $936.72

Answer: C

Example - Exhibit 11.6

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Consider a firm that has just paid a dividend of $2. An analyst expects dividends to grow at a rate
of 8% per year for the next five years. After that dividends are expected to grow at a normal rate
of 5% per year. Assume that the appropriate discount rate is 7%.

A. Refer to Exhibit 11.6. The dividends for years 1, 2, and 3 are

a. $2, $2.08, $2.16
b. $2, $2.05, $2.10
c. $2.16, $2.24, $2.32
d. $2.16, $2.33, $2.52
e. $2.07, $2.14, $2.21

ANS: D
Year 1 Dividends = 2(1 + .08) = $2.16
Year 2 Dividends = 2(1 + .08)2 = $2.33
Year 3 Dividends = 2(1 + .08)3 = $2.52
B. Refer to Exhibit 11.6. The future price of the stock in year 5 is
a. $113.40
b. $122.47
c. $132.27
d. $142.85
e. $154.35

ANS: E
Future price of stock in year 5 = P5 = D6/(k  g)
where g is the normal growth rate = 5%
D6 = 2(1 + .08)5(1 + .05) = $3.087
P5 = 3.087/(.07  .05) = $154.35

C. Refer to Exhibit 11.6. The present value today of dividends for years 1 to 5 is
a. $4.06
b. $10.28
c. $12.40
d. $14.52
e. $10.0
ANS: B
The present value today of dividends from years 1 to 5 =
2.16/(1.07) + 2.33/(1.07)2 + 2.52/(1.07)3 + 2.72/(1.07)4 + 2.94/(1.07)5 = $10.28

D. Refer to Exhibit 11.6. The price of the stock today (P0) is

a. $136.29
b. $133.03
c. $120.33
d. $123.43
e. $126.60
ANS: C
P0 = PV of dividends yr1 to yr5 + PV of P5
= 10.28 + 154.35/(1.07)5 = $120.33

Question 4: Use above Exhibit 11.6 to answer the followings:

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)

Consider a firm that has just paid a dividend of $1.5. An analyst expects dividends to grow at a
rate of 9% per year for the next three years. After that dividends are expected to grow at a normal
rate of 5% per year. Assume that the appropriate discount rate is 7%.

A. The dividends for years 1, 2, and 3 are

a. $1.5, $2.0, $2.05
b. $1.64, $1.78, $1.94
 c. $1.64, $1.94, $2.24
d. $1.5, $2.40, $3.30
e. $2.07, $2.14, $2.21

Answer: B
Year one dividends = 1.5 (1 + .09) = 1.64
Year two dividends = 1.5 (1 + .09) ^2 = 1.78
Year three dividends = 1.5 (1 + .09) ^3 = 1.94

B. The future price of the stock in year 3 is

a. $81.75
b. $84.81
c. $92.56
d. $101.85
e. $111.16

Answer: D
D4 = 1.5 (1 + .09) ^3 (1 + .05) = 2.037
P3 = 2.037 / (.07 - .05) = 101.85

C. The present value today of dividends for years 1 to 3 is

a. $4.67
b. $3.08
c. $5.67
d. $4.5
e. $1.53

Answer: A
Pv of year 1 – 3 = 1.64/ (1.07) + 1.78 / (1.07)^2 + 1.94 / (1.07)^3
= 1.53271028 + 1.554720936 + 1.583617881
= 4.671049097

D. The price of the stock today (P0) is

a. $84.81
b. $87.81
c. $91.09
d. $94.32
e. $97.61

Answer: B
P0 = 4.67 + 101.85 / (1.07)^3
P0 = 87.80993876
Chapter 13
Question 5: Several studies have examined the difference in risk for alternative industries
during a specified time period. Describe the results of these studies, and discuss their
implications for industry analysis.

Several studies that were conducted on the risk for alternative industries suggest that there are a
variety of risks for the different sectors. The risks will only increase due to the rise and fall in the
markets. The stability of the risks is only for the individual industries. The difference in risk for
an industry is more fluctuating, but the difference in risk for an individual industry is
comparatively more stable. Therefore, analysis of the industry risk is essential as it helps to
analyze the risk that may be faced by the industry in the future.
The implications of the study are, returns obtained from different industries vary which implies
that the industry analysis is essential to be carried out. The yields obtained from the individual
sectors may differ from the return collected from the industry as a whole, so the company
analysis is also carried out. The return of the industry may vary from the yield obtained from that
sector in the past. So, the industry analysis should be carried out every year and should not be
based on predictions of past performance. Lastly, The risk in each industry varies within a range

Chapter 15
Question 6: Discuss why an increase in debit balances is considered bullish or bearish.

Debit balances in brokerage accounts represent borrowing by knowledgeable investors from their
brokers. These balances indicate the attitude of sophisticated investors who engage in margin
transactions. Therefore, an increase in debit balances implies buying by their sophisticated
investors and considered as a bullish sign, while a decline in debit balances would indicate
selling and would be a bearish indicator.

Question 7: Describe the Dow Theory and its three components. Which component is most
important? What is the reason for an intermediate reversal?

Technical analysts who use price and volume data should consider the Dow Theory because it is
the basis for many technical indicators. It describes stock prices as moving trends analogous to
the movement of water. The three types of price movements that Dow postulated are major
trends that are like tides in the ocean, intermediate trends that resemble waves, and short-run
movements that are like ripples. The most important component of all the three components is
the major trends in price. They recognized this as the most important because major market
advance does not go straight up, but rather includes small price declines as some investors decide
to take profits. Technicians who look for every recovery to reach a new peak above their prior
peak, and this price risk should be accompanied by heavy trading volume. Alternatively, a profit
taking reversal that follows an increase to a new peak should have a trough above the prior
trough, with relatively light trading volume during the profit taking reversals. When this pattern
of price and volume movements changes, the major trend may be entering a period of
consolidation or a major reversal.