TRUE/FALSE
1. A main limitation of the NBER indicator series is false signals.
ANS: T PTS: 1
2. Stock prices move coincidentally with the economy.
ANS: F PTS: 1
3. The cyclical indicator approach to market analysis is based on the belief that the economy expands and contracts in a random manner.
ANS: F PTS: 1
4. Leading indicators of the business cycle include economic series that reach peaks or troughs before the peaks and troughs of the overall economy.
ANS: T PTS: 1
5. Coincident indicators include economic time series that have peaks and troughs that roughly occur at the same time as the peaks and troughs of overall economic activity.
ANS: T PTS: 1
6. The economy and the stock market have a strong, consistent relationship, but the stock market generally turns before the economy does.
ANS: T PTS: 1
7. Diffusion indexes indicate the spread in interest rates between major economies.
ANS: F PTS: 1
8. The economic factor assumed to be closely related to stock prices is productivity.
ANS: F PTS: 1
9. The best known monetary variable is the level of taxes.
ANS: F PTS: 1
10. Recent studies show that money supply changes have an important impact on stock price movements.
ANS: T PTS: 1
11. Recent studies indicate that one can earn excess returns in the stock market by forecasting unanticipated changes in the money supply.
ANS: T PTS: 1
12. The first step in the Goldman Sachs analysis of world markets examines a country's aggregate economy and its components that relate to the valuation of securities.
ANS: T PTS: 1
13. The Goldman Sach analysis recommends an allocation of equity investments among countries in comparison to the country's normal weighting based on its relative market value.
ANS: T PTS: 1
14. It is important to analyze the economies and security markets before analyzing alternative industries or companies.
ANS: F PTS: 1
15. Over the last 20 years, increases in the return on equity for the S&P Index has been associated with decreases in return of assets.
ANS: F PTS: 1
16. It is more important to estimate future earnings than the future earnings multiplier.
ANS: F PTS: 1
17. An analysis of U.S. equity markets using the cash flow techniques concludes that the market is not fully valued.
ANS: F PTS: 1
18. There is a negative relationship between the capacity utilization rate and the profit margin.
ANS: F PTS: 1
19. Estimating net profit margin directly is difficult because it is so volatile.
ANS: T PTS: 1
20. An increase in the required rate of return k will increase the P/E ratio.
ANS: F PTS: 1
21. Future tax rates are difficult to estimate because they are politically influenced.
ANS: T PTS: 1
22. As the market's return on equity increases so will the P/E ratio.
ANS: T PTS: 1
23. It is reasonable to expect corporate sales to be closely related to GNP.
ANS: T PTS: 1
24. Dividend growth is positively related to the return on equity.
ANS: T PTS: 1
25. Changes in the dividend payout ratio are positively related to changes in the retention rate.
ANS: F PTS: 1
26. In well developed economies, markets are not affected by changes in expected inflation.
ANS: F PTS: 1
27. The valuation techniques presented in the chapter can only be applied to the stock market in the United States, since the U.S. stock market is inefficient.
ANS: F PTS: 1
28. One of the economic series included in the National Bureau of Economic Research (NBER) coincident indicator is the index of industrial production.
ANS: T PTS: 1
29. A major advantage of the cyclical indicator approach is that it spans all important major economic sectors including the service sector and import-exports.
ANS: F PTS: 1
30. The University of Michigan Consumer Sentiment Index is an example of a leading indicator.
ANS: T PTS: 1
31. When estimating a major stock market value using the earnings multiplier approach near-term estimates of the required rate of return and growth rate are essential due to the impact of near-term events on cash flows.
ANS: F PTS: 1
32. The authors of the text prefer forward valuation ratios as opposed to historical valuation variables in relative valuation methods.
ANS: T PTS: 1
33. Interest rate spread, 10-year Treasury bonds less federal funds, is listed as a lagging indicator in the National Bureau of Economic Research (NBER).
ANS: F PTS: 1
34. Building permits for new private housing units are listed as a leading indicator by the National Bureau of Economic Research (NBER).
ANS: T PTS: 1
35. An increase in the retention ratio will cause a decrease in the growth rate.
ANS: F PTS: 1
MULTIPLE CHOICE
1. The index of leading indicators includes all of the following, except:
a. M2 money supply.
b. S & P 500 index.
c. Orders for plant and equipment.
d. Changes in the sensitive materials price.
e. Index of industrial production.
ANS: D PTS: 1 OBJ: Multiple Choice
2. Which of the following are not cyclical indicators?
a. Selected series b. Coincident indicators c. Diffusion indicators d. Leading indicators e. Lagging indicators
ANS: C PTS: 1 OBJ: Multiple Choice
3. The U.S. balance of payments, the federal deficit and military contract awards are ____ of aggregate economic activity.
a. Leading indicators b. Coincident indicators c. Lagging indicators d. Not categorized indicators e. Not indicators
ANS: D PTS: 1 OBJ: Multiple Choice
4. Which of the following series does not include the long-leading index?
a. Dow Jones Industrial Average
b. Dow Jones Bond Prices, Percent Face Value c. Price to Unit Labor Cost
d. M2 Money Supply, Deflated e. New Building Permits
ANS: A PTS: 1 OBJ: Multiple Choice
5. Which of the following variables was considered not significant in explaining stock returns?
a. Industrial production
b. Changes in the risk premium c. Consumption
d. Twists in the yield curve e. Inflation
ANS: C PTS: 1 OBJ: Multiple Choice
6. If a diffusion index for new orders went from 87 to 74 and then to 68, it would indicate ____ receipt of new orders and indicate a ____ in breadth and the possibility of a future ____ in the series.
a. Limited, strengthening, decline b. Limited, weakening, increase c. Widespread, strengthening, increase d. Widespread, weakening, decline e. Widespread, weakening, increase
ANS: D PTS: 1 OBJ: Multiple Choice
7. The correlation of stock market returns between the U.S. and Japan is ____ and ____.
a. High, increasing.
b. High, decreasing.
c. Low, increasing.
d. Low, decreasing.
e. Low, remaining constant.
ANS: C PTS: 1 OBJ: Multiple Choice
8. Which of the following is not an analytical measure used by the NBER to examine behavior within a series?
a. Diffusion indexes b. Rates of change c. Direction of change d. Ratios among series
e. Comparison with previous cycles
ANS: D PTS: 1 OBJ: Multiple Choice
9. Excess liquidity is defined as
a. The year-to year percentage change in the M2 money supply less the year-to-year percentage change in the nominal GNP.
b. The growth rate in M2 money supply less the growth rate in M1 money supply.
c. The year-to-year percentage change in the M1 money supply less the year-to-year percentage.
d. The year-to-year percentage change in the "real" GNP less the year-to-year percentage change in the nominal GNP.
e. None of the above
ANS: D PTS: 1 OBJ: Multiple Choice
10. Which of the following is not normally associated with cyclical indicators?
a. The Securities and Exchange Commission (SEC) b. The National Bureau of Economic Research (NBER) c. Business Week
d. Center for International Business Cycle Research (CIBCR) e. All of the above
ANS: C PTS: 1 OBJ: Multiple Choice
11. Which of the following is not a reason given for why forecaster are so often incorrect?
a. There is a temptation for economic forecasters to stay fairly close to the "norm," that is,
"group think."
b. Many analysts are simply too short-sighted.
c. Economists and economic forecaster often suffer from information overload.
d. Some economic forecasters are too broad-minded, trying to include a number of ideas in their forecasts.
e. None of the above (that is, all are reasons cited for why forecasters are often incorrect)
ANS: D PTS: 1 OBJ: Multiple Choice
12. Which of the following statements concerning asset allocation is false?
a. Diversification across international boundaries can improve risk-adjusted portfolio returns.
b. Economies expected to grow at an above-average rate with above-average profit growth should be considered as candidates to overweight in a global portfolio.
c. Severe currency blockages should not impact global diversification selections.
d. Portfolio allocation among asset classes may provide higher portfolio returns while lowering portfolio risk levels.
e. None of the above (that is, all statements are true).
ANS: C PTS: 1 OBJ: Multiple Choice
13. The National Bureau of Economic Research (NBER) has derived the following indicator series in order to monitor business cycles.
a. M2, leading, and lagging.
b. Leading, coincident, and consumer expectations.
c. Leading, coincident, and lagging.
d. Leading, coincident, and M2.
e. Consumer expectations, leading, and lagging.
ANS: C PTS: 1 OBJ: Multiple Choice
14. An examination of the relationship between stock prices and the economy has shown that the relationship is
a. Weak, and that stock prices turn after the economy does.
b. Nonexistent.
c. Strong, and that stock prices turn after the economy does.
d. Strong, and that stock prices turn before the economy does.
e. Weak, and that stock prices turn before the economy does.
ANS: D PTS: 1 OBJ: Multiple Choice
15. Which of the following economic series are included in the NBER leading indicator group?
a. Average weekly hour of production workers.
b. Average weekly initial claims for unemployment insurance.
c. Index of bond prices.
d. a and b.
e. b and c.
ANS: D PTS: 1 OBJ: Multiple Choice
16. Which of the following economic series are included in the NBER coincident indicator group?
a. Employees on nonagricultural payrolls.
b. Change in consumer price index for services.
c. Index of consumer expectations.
d. Spread of 10-year Treasury yield less fed funds.
e. Index of stock prices.
ANS: A PTS: 1 OBJ: Multiple Choice
17. Which of the following economic series are included in the NBER lagging indicator series?
a. Vendor Performance.
b. Index of industrial production.
c. Manufacturing and trade sales data in 1992 dollars.
d. Manufacturers' new orders, non-defense capital goods.
e. Average duration of unemployment in weeks.
ANS: E PTS: 1 OBJ: Multiple Choice
18. The initial effect of a change in monetary policy appears in ____ and only later in ____.
a. The aggregate economy, financial markets.
b. Financial markets, the aggregate economy.
c. Bond markets, stock markets, d. Stock markets, bond markets.
e. None of the above.
ANS: B PTS: 1 OBJ: Multiple Choice
19. Jensen, Johnson, and Mercer showed that the relationship between stock returns and size and price-to- book ratio holds in periods when monetary policy is
a. Neutral.
b. Tight.
c. Easy.
d. All of the above.
e. None of the above.
ANS: C PTS: 1 OBJ: Multiple Choice
20. If interest rates increase due to inflation, but expected cash flows to a firm do not change, then you would expect stock prices to
a. Rise.
b. Rise and then decline.
c. Remain unchanged.
d. Decline.
e. None of the above.
ANS: D PTS: 1 OBJ: Multiple Choice
21. If interest rates rise due to inflation, and expected cash flows to a firm rise, then you would expect stock prices to
a. Rise.
b. Rise and then decline.
c. Remain unchanged.
d. Decline.
e. None of the above.
ANS: C PTS: 1 OBJ: Multiple Choice
22. There are three techniques available to help an investor make a market decision. Which of the following is not such an analysis technique?
a. Macro techniques that are based on the strong relationship between the economy and security markets.
b. Micro techniques that estimate future market values by applying one of several basic valuation models to equity markets.
c. Technical analysis where an investor analyzes past and recent market movements for indications of future performance.
d. Fundamental analysis that considers the effect of market on the entire portfolio.
e. None of the above (that is, all are techniques available to make market decisions)
ANS: D PTS: 1 OBJ: Multiple Choice
23. Which of the following is not a factor under the Free Cash Flow to Equity (FCFE) Model?
a. Depreciation expense b. Capital expenditure c. Change in working capital d. Principal debt repayment e. Earnings multiplier
ANS: D PTS: 1 OBJ: Multiple Choice
24. Expected earnings per share estimates requires all of the following except a. A sales per share estimate.
b. A GDP estimate.
c. An aggregate operating profit margin estimate d. An estimate of the real risk-free rate.
e. A tax rate estimate.
ANS: D PTS: 1 OBJ: Multiple Choice
25. The dividend payout ratio, the required rate of return on common equity, and the expected growth rate of stock dividends are the major variables that affect
a. The profit margin for the S&P Industrials Index.
b. The earnings multiplier for common stock.
c. Aggregate tax revenues.
d. Capital gains tax revenues.
e. Aggregate GDP.
ANS: B PTS: 1 OBJ: Multiple Choice
26. Aggregate return on equity increases as a. Profit margins increase.
b. Total asset turnover increases.
c. Financial leverage increases.
d. Equity turnover decreases.
e. All of the above.
ANS: D PTS: 1 OBJ: Multiple Choice
27. All of the following factors affect the required rate of return except a. The economy's risk free rate.
b. Corporate business risk.
c. Return on equity.
d. Country risk.
e. Expected rate of inflation.
ANS: C PTS: 1 OBJ: Multiple Choice
28. The growth rate (g) of dividends is affected by all of the following except a. Required return
b. Retention rate c. Total asset turnover d. Financial leverage e. Net profit margin
ANS: A PTS: 1 OBJ: Multiple Choice
29. Unit labor costs, the rate of inflation, the level of foreign competition, and the capacity utilization rate were variables tested by Finkel and Tuttle as determinants of the
a. Balance of payments.
b. The exchange rate.
c. Aggregate operating profit margin.
d. Aggregate profit margin.
e. Aggregate cost margin.
ANS: D PTS: 1 OBJ: Multiple Choice
30. Which of the following is not a determinant of the aggregate gross profit margin?
a. Unit labor costs of production b. Rate of inflation
c. Unemployment rate
d. Level of foreign competition e. Growth rate of M2 money supply
ANS: E PTS: 1 OBJ: Multiple Choice
31. A microeconomic estimate of the market earnings multiple requires an estimate for which of the following variables?
a. Dividend payout ratio b. Return on equity c. Real RFR d. All of the above e. None of the above
ANS: D PTS: 1 OBJ: Multiple Choice
32. Which of the following economic series is not included in the National Bureau of Economic Research (NBER) leading indicator group?
a. Average weekly initial claims for unemployment b. Index of 500 consumer stock prices
c. Real money supply, M2 d. Index of industrial production
e. All of the above are included in the NBER leading indicator group
ANS: D PTS: 1 OBJ: Multiple Choice
33. Which of the following economic series is not included in the National Bureau of Economic Research (NBER) lagging indicator group?
a. Average duration of unemployment
b. Ratio of manufacturing and trade inventories to sales c. Number of employees on nonagricultural payrolls
d. Percentage change in the labor cost per unit of output in manufacturing e. All of the above are included in the NBER lagging indicator group
ANS: C PTS: 1 OBJ: Multiple Choice
34. The multiplier approach for estimating the intrinsic market value of a major stock market series requires the following step(s):
a. Estimating the future earnings per share for the stock market series b. Estimating the appropriate earnings multiplier for the stock market series c. Estimating long-run required rates of return and growth rates
d. Both a and b e. All of the above
ANS: E PTS: 1 OBJ: Multiple Choice
35. You are attempting to estimate expected earnings per share for a major stock market series. You have determined an appropriate estimate for sales per share. Which of the following methods can be used to estimate the profit margin?
a. Base the estimate on recent trends of net profit margins.
b. Estimate the net before tax (NBT) profit margin along with a tax estimate.
c. Incorporate an estimate an operating profit margin, defined as earnings before interest, taxes, and depreciation.
d. All of the above methods are appropriate.
e. None of the above methods are appropriate.
ANS: D PTS: 1 OBJ: Multiple Choice
36. A 1971 study by Finkel and Tuttle hypothesizes that all of the following variables affect the aggregate profit margin except
a. Capacity utilization rate b. Unit labor costs
c. Variable labor costs d. Rate of inflation e. Foreign competition
ANS: C PTS: 1 OBJ: Multiple Choice
37. Which of the following economic series is not included in the National Bureau of Economic Research (NBER) coincident economic indicator group?
a. Total value of commercial loans b. Employees on nonagricultural payrolls c. Personal income less transfer payments d. Industrial production
e. Manufacturing and trade sales
ANS: A PTS: 1 OBJ: Multiple Choice
38. Which of the following is not a major variable that affects the aggregate stock market earning multiplier in a country?
a. Required rate of return on common stock in the country b. Expected growth rate of dividends for the stocks in the country c. Composite dividend-payout ratio for common stocks in country d. Composite debt to equity ratio for firms in the country
e. All of the above are major variables for a country's aggregate stock market earnings multiplier
ANS: D PTS: 1 OBJ: Multiple Choice
39. The growth rate will most likely increase if the:
a. Retention ratio decreases b. Payout ratio decreases c. Return on equity decreases d. Net income increases e. Both a and c
ANS: B PTS: 1 OBJ: Multiple Choice
40. When applying the earnings multiplier model all of the following will cause the required rate of return, k, to change except
a. Changes in the real risk free rate b. Changes in the retention rate c. Changes in the rate of inflation
d. Changes in the risk premium for common stock
e. All of the above changes will cause a change in the required rate of return
ANS: B PTS: 1 OBJ: Multiple Choice
41. If, for the S&P Industrials Index, the profit margin was 0.35 and the equity turnover ratio was 10, the ROE would be:
a. 0.035%
b. 2.857%
c. 3.500%
d. 28.57%
e. 35.00%
ANS: C
ROE = (Profit Margin) × (Equity Turnover) = (0.35)(10) = 3.5 PTS: 1 OBJ: Multiple Choice Problem
42. If, for the S&P Industrials Index, the profit margin was 0.30 and the equity turnover ratio was 11, the ROE would be:
a. 0.033%
b. 3.300%
c. 33.00%
d. 36.70%
e. 333.00%
ANS: B
ROE = (Profit Margin) × (Equity Turnover) = (0.30)(11) = 3.3 PTS: 1 OBJ: Multiple Choice Problem
43. If, for the S&P Industrials Index, the profit margin was .25 and the equity turnover ratio was 12, the ROE would be:
a. 0.83%
b. 0.48%
c. 3.00%
d. 30.00%
e. 48.00%
ANS: C
ROE = (Profit Margin) × (Equity Turnover) = (0.25)(12) = 3.0 PTS: 1 OBJ: Multiple Choice Problem
44. If, for the S&P Industrials Index, the profit margin was 0.20 and the equity turnover ratio was 13, the ROE would be:
a. 0.026%
b. 2.600%
c. 6.500%
d. 26.00%
e. 65.00%
ANS: B
ROE = (Profit Margin) × (Equity Turnover) = (0.20)(13) = 2.6 PTS: 1 OBJ: Multiple Choice Problem
45. The dividend payout ratio for the aggregate market is 55 percent, the required rate of return is 15 percent, and the expected growth rate for dividends is 7 percent. Compute the current earnings multiple.
a. 3.93 b. 78.6 c. 6.88 d. 39.3
e. None of the above ANS: C
P/E = Payout ÷ (k − g) = .55 ÷ (.15 − .07) = 6.88 PTS: 1 OBJ: Multiple Choice Problem
46. The dividend payout ratio for the aggregate market is 65 percent, the required rate of return is 13 percent, and the expected growth rate for dividends is 8 percent. Compute the current earnings multiple.
a. 7 b. 13 c. 4.61 d. 14.61
e. None of the above ANS: B
P/E = Payout ÷ (k − g) = .65 ÷ (.13 − .08) = 13
PTS: 1 OBJ: Multiple Choice Problem
47. The dividend payout ratio for the aggregate market is 65 percent, the required rate of return is 12 percent, and the expected growth rate for dividends is 6 percent. Compute the current earnings multiple.
a. 5.41 b. 16.25
c. 6.25 d. 10.83
e. None of the above ANS: D
P/E = Payout ÷ (k − g) = .65 ÷ (0.12 − .06) = 10.83 PTS: 1 OBJ: Multiple Choice Problem
48. The dividend payout ratio for the aggregate market is 50 percent, the required rate of return is 16 percent, and the expected growth rate for dividends is 6 percent. Compute the current earnings multiple.
a. 5 b. 2.81 c. 7.5 d. 4
e. None of the above ANS: A
P/E = Payout ÷ (k − g) = .50 ÷ (.16 − .06) = 5
PTS: 1 OBJ: Multiple Choice Problem Exhibit 12.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that the dividend payout ratio will be 65 percent when the rate on long-term government bonds falls to 8 percent. Since investors are becoming more risk averse, the equity risk premium will rise to 7 percent and investors will require a 15 percent return. The return on equity will be 12 percent.
49. Refer to Exhibit 12.1. What is the expected sustainable growth rate?
a. 2.80%
b. 4.20%
c. 5.25%
d. 7.80%
e. 9.75%
ANS: B
g = (1 − Payout) × (ROE) = 0.35 × 12 = 4.2%
PTS: 1 OBJ: Multiple Choice Problem
50. Refer to Exhibit 12.1. What is your expectation of the market P/E ratio?
a. 8.33 b. 5.33 c. 9.03 d. 6.02 e. 3.24 ANS: D
P/E = Payout ÷ (k − g) = .65 ÷ (0.15 − .042) = 6.02 PTS: 1 OBJ: Multiple Choice Problem