BFPL 3002 Week 13

INVESTMENT ANALYSIS – FINAL EXAM REVIEW

Chapter 1: Investment Setting

NAME: I.D. #

Question 1 (2 marks)
You purchased a stock for $44.00 per share and two years later you sold it for $52.00 a share.
The stock pays an annual dividend of $1.00 per share. Compute your annual holding period
return (HPR) and annual holding period yield (HPY) on this investment.

HPR = (52.00 + 1.00)/44.00 = =

(1.2045)^1/2
H -1

Question 2 (2 marks)
a) The expected rate of inflation next year is 3.50% and the estimated long-term real
growth rate in the economy 5.25%. Calculate the interest rate that you would expect on
U.S. government Treasury bills using the method illustrated in the textbook.

Nominal = (1 + 0.0525)*(1 +
0.035) - 1

b) If the required rate of return on common stocks is 12.5%, what is the approximate risk
premium for common stocks?
Risk premium = required return -
NRFR
= 12.5 - 8.9338
Question 3 (2 marks)
You buy 100 shares of Toyota Motor Corporation at 6,800 yen when the exchange rate is 72 yen
to the Canadian dollar. A year later you sell the shares for 7,600 yen when the exchange rate is
88 yen to the Canadian dollar. Calculate the return for a Japanese investor (i.e. in yen) and a
Canadian investor (i.e. in dollars).

Return in Yen = (7600 - 6800)/6800 = 0.1176

or 11.76% Buy = 6800/72 = 94.44
Sell = 7600/88 = 86.36
Return in CAD = (86.36 - 94.44)/94.44 = -0.08556
Question 4 (2 marks)
What conditions will lead to a movement along the security market line (SML)? Explain your
answer or provide an example.

Movement along the SML happens when one of its risk sources
change, for example, an increase in financial risk leads to
investors demanding higher returns to compensate. This creates

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BFPL Week

Chapter 2: Asset Allocation and Security Selection

Question 1 (2 marks)
You have just graduated from college and started your career as a financial planner. How
would your investment portfolio differ from that of a 65-year old client who has just retired and
is now living on a fixed income? Explain your answer.
It would differ because I would be in the accumulation phase; therefore I would have a higher
risk tolerance and can invest in more equities as I have time to recover from them. A 65-year
old would be in the spending phase and would have a more conservative portfolio as they are
not able to earn more income to recover from any losses.
Question 2 (2 marks)
The textbook notes several common mistakes that investors make when constructing their
investment policy statement and trading stocks. Describe two of these mistakes and explain how
each will impact investment returns.
Investing in a clients retirement fund in the employers stock -->
not diverse Trading too frequently --> investor ensures high
costs
Question 3 (2 marks)
You have a $2 million investment portfolio which is completely invested in government bonds.
Describe an advantage and a disadvantage of selling $500,000 worth of bonds and purchasing
common stocks. Explain your answers.
a) Advantage
Diversification of portfolio, has opportunities for

b) Disadvantage
Higher risk and volatility, would receive less

Question 4 (2 marks)
Calculate the covariance and coefficient of correlation for the following two companies. Show
your work (i.e. four decimal places)
Year ABC DEF ABC – DEF − A×B (A)2 (B)2
Inc. Ltd. Avg. (A) Avg. (B)
2021 9% 10% 4 1 1 1
4
2022 4% 5% 1
- - 1 1
2023 2% 3% 9
- - 9 9
5 6 2 2 2

Covariance = 26/3 = 8.67

ABC Variance = 26/3 = 8.67 --> standard

deviation = 2.94 DEF Variance = 26/3 = 8.67 --
> standard deviation = 2.94
/8
Coefficient of correlation = 8.67 / (2.94*2.94)

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 BFPL Week

Chapter 3: Organization of Securities Markets

Question 1 (2 marks)
The Securities and Exchange Commission (SEC) in the United States introduced rules 415 and
144A, which deal with shelf registrations and private placements, respectively, for equity issues.
Explain the relevance of each.
a) Shelf registrations
SEC Rule 415: Shelf registration: Allows large firms to register security issues
and sell them piecemeal during the following two years. It provides flexibility,
reduces registration fees and expenses, and allows issuer to request
competitive bids from investment banks.
b) Private placements
SEC Rule 144A: Rather than using a public sale through one of these
arrangements, primary offerings can be sold privately, referred to as a private
placement. Investment bank sells issue directly to small group of large,
sophisticated institutional investors. Issuing costs are lower for firm as there are
no extensive registration documents. Over 80% of high yield bonds are sold as
Question 2 (2 marks)
You buy 500 shares of QWE Inc. for $60 per share and borrow the maximum amount of money
given an initial margin requirement of 50%.
a) If the stock price increases to $72 per share, what will be your equity position (i.e. percent)
in the stock?
500*72 = 36,000
500*60*50% = 15,000
= 36,000 - 15,000 =
21,000
= 21,000/36,000
b) If the maintenance margin is 25%,=what is the margin call price?
500p - 15,000/500p =
0.25
500p - 15,000 = 125p
375p = 15,000
Question 3 (2 marks)
Describe two major characteristics of a good market for goods and services cited in the textbook
and explain the relevance of each.
Timely and accurate information about the volume and prices of past transactions and all current
outstanding bids and offers Liquidity, the ability to buy or sell an asset quickly and at a price close to the
prices for previous transactions (price continuity); assumes no new information is available; price continuity
requires numerous potential buyers and sellers (i.e. depth)
Low transaction costs: the cost of reaching the market; actual brokerage costs; costs of transferring assets
Prices rapidly adjust4to
Question (2any new information. Ensures that the prevailing price is fair; reflects all available
marks)
Why would you execute a short sale, how is it done, and how might you limit your potential loss
if the trade goes against you?
Investors execute short sales to profit from declining stock prices. This involves
borrowing shares from a broker and selling them at the market price, hoping to
buy them back later at a lower price. If successful, the investor makes a profit
from the difference. Must pay any dividends due to the investor who lent the
stock.
To limit potential losses from a short sale, investors can use a stop buy order, /8
which automatically buys the stock if it reaches a specified price, capping
losses if the trade goes against you
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 BFPL Week

Chapter 4: Security-Market Indexes

Use this chart to answer Questions 1 and 2

Stock No. of shares Price (T) Price (T + 1)
ABC 10,000,000 30 35
DEF 15,000,000 25 28
GHI 20,000,000 20 24

Question 1 (2 marks)
Construct a value-weighted index for the three stocks listed above, and compute the percentage
change in the index for the period from T to T + 1.

Period T: (30*10)+(25*15)+(20*20)=
1075 Period T+1:
(35*10)+(28*15)+(24*20)= 1250

Question 2 (2 marks)
Construct a price-weighted index for the three stocks listed above, and compute the percentage
change in the index for the period from T to T + 1.

Period T:
(30+25+20)/3= 25
Period T+1:
Question 3
Stock Price After 2-for-1 split by ABC
ABC $38 $19
JKL $22 $22
XYZ $14 $14
Use the information in the table to calculate the new divisor for the index after the two-for-one
stock split by ABC

Original = 38+22+14/3 =
24.67 After Split =
(19+22+14)/X = 24.67
55/X = 24.67
Question 4 (2 marks)
Describe the purpose of index funds and explain why they were developed.

Index funds provide a low-cost way for investors to obtain a diversified portfolio
that tracks a specific market index, like the S&P 500. Unlike actively managed
mutual funds, they aim to match the index's composition by buying the same
securities in the same proportions, resulting in lower costs. A well-known example
is Vanguard’s 500 Index Fund, which closely follows its benchmark. While they
offer affordability and diversification, index funds have limitations, such as no /8

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 BFPL Week

Chapter 8 (Part 1): Analysis of Financial Statements

Question 1 (2 marks)
Calculate the sustainable growth rate for QWE Corporation if the return on equity was 18.0%,
the net income per share was $3.00 and the company declared a dividend of $0.90 last year.
= 0.90 /
3.00 g = 0.18 x 0.70
= 0.30 g = 0.126 or
Question 2 (2 marks) = 1 - 0.30
Briefly describe the difference between cash flow from investing activities and cash flow from
financing activities.
INVESTING: Lists investments in noncurrent and fixed assets and the equity of other firms.

FINANCING: Cash inflows are created by issuing bonds and stock, while cash outflows are created by
repurchasing bonds
Question 3 (4and stock.
marks)
Use the financial statements below to provide a Du Pont analysis of the company’s return on
equity by calculating the following three ratios to four decimal places and show the ROE.

Income Statement ($000) Balance Sheet ($000)

Net sales 11,190 Current assets Current liabilities
Cost of goods sold 9,400 Cash 671 Bank loan 50
Gross profit 1,790 Acct. receivable 1,343 Acct. payable 1,007
Expenses Inventories 1,119 Current LTD 60
SGA 1,019 Prepaid expense 14 Accrued wages 5
Interest 100 Total current asst. 3,147 Total current liabil. 1,122
Earn. before tax 671 Net fixed assets 128 Long-term debt 960
Tax 302 Total assets 3,275 Total liabilities 2,082
Earn. after tax 369 Common stock 150
Retained earnings 1,043
Total liab. & S/E 3,275

Profit margin
= Net profit / Net
sales
= 369 / 11,190
Asset turnover
= Net Sales / Total
Assets
Financial leverage= 11,190 / 3275
= Total Assets / Shareholders'
Equity
= 3275 / (3275 - 2082)
Return on equity (ROE)

DuPont = 0.0329 x 3.4167 x 2.7451 = 0.30934375

or 30.93%
ROE = Net profit / Shareholder
Equity ROE = 369 / (3275 - /8

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 BFPL Week

Chapter 8 (Part 2): Equity Valuation

Question 1 (2 marks)
ABC Inc. earned $7.20 per share last year and paid a dividend of $2.16 per share. Next year,
you expect ABC to earn $8.40 per share and continue its payout ratio. Assume that you expect to
sell the stock for $90.00 a year from now. If you require 12% on this stock, how much would
you be willing to pay for it?
Payout ratio = 2.16/7.20 = PV = (2.16/1.12) +
0.30 Expected dividend = (90.00/1.12) PV = 82.61
0.30 x 8.40
Question 2 (2 marks)
QWE Inc. has consistently paid out 40% of its earnings in dividends. The company’s return on
equity is 12%.
a) What would you estimate as its dividend growth rate?

= (1 - 0.40) x
0.12
b) If you found out that the company was only growing at 4%, how much (i.e. the rate
in percent) could the company afford to pay out?

=
0.04/0.1 = (1 - 0.3333)
= 0.6667 Afford to
Question 3 (4 marks)
FGH had $30 of sales per share last year, which you expect to grow by 5% for this year and next
year, and then at 3% in perpetuity. The company has a return on equity of 15%, which you
expect to continue forever. Its net margins are 6% and the cost of equity is 11%. Use the free
cash flow to equity model to value this stock.

Year 1 2 3
Sales
STEP = 30 x = 31.50 x = 33.08 x
1.05 1.05 1.03
EPS
STEP = 31.50 x = 33.08 x = 33.08 x
x net margins 6% 6% 6%
FCFE
STEP = 1.89 x = 1.9848 x = 2.0442 x
g = ROE x 0.66667 0.66667 0.80

STEP 3 STEP 5
First 1&2 RR = 5/15 = Terminal Value = 1.635360 / (0.11
0.33333 payout = 1 - - 0.03)
STEP 6
0.33333 = 0.66667 PV of
Third year RR = 3/15 N=1 N=2
I/Y = 11 I/Y = 11
PMT= 0 PMT= 0 /8
FV = 1.26 FV = 20.4420 +
CPT PV = 1.3232 CPT PV =

Fall STEP 7: Stock Value = 1.135135135 + Page

BFPL Week

Chapter 9: Top-Down Analysis

Question 1 (2 marks)
Describe the two following economic indicators and explain why each is either a leading,
coincident, or lagging indicator.
a) Stock market
Leading as it reflects investor's expectations for the future of the economy and
interest rates. Increased confidence for investor's --> more spending, hiring,

b) Housing starts
Leading, before the economy starts going into the recovery phase; labour and raw materials
will be cheaper to purchase to start building houses. This is to meet future demand that
builders will be expecting when the recession ends.

Question 2 (2 marks)
Describe two ways that a strong U.S. dollar will impact American companies and explain the
reasons for each.
Strong U.S. dollar means American companies exports will become more expensive - so this
decreases exports (buying power of other countries is weakened). Imports will become
cheaper for American companies, so imports will increase instead as the dollar can buy more.

Question 3 (2 marks)
You are given the following estimated per share data for the S&P 500 Index: sales of $3,150,
depreciation of $180, interest expense of $120, operating profit margin (EBIT) of 18% and tax
rate of 32%. Compute the estimated EPS.
Estimated EPS = (3150*18%) - 180
What Robert wrote in class:
- 120
= 267.00*(1 - 32%)
Sales x EBIT = 3150*18% = 567.00
- depreciation = 567 - 180 = 387.00
- interest = 387 - 120 = 267.00
Profit*(1 - tax) = 267.00*(1 - 32%) =
Question 4 (2 marks)
A stock is currently priced at $40.00 and is expected to pay a dividend next year of $1.28. If the
expected growth rate of dividends is 5%, compute the expected long-term total return on the
stock using the constant growth dividend discount model.

Expected total return = (Dividend /

price) + g
= (1.28 / 40.00) + 0.05

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 BFPL Week

Chapter 10: Fundamental Investing

Question 1 (2 marks)
Briefly describe two anti-takeover provisions that a company may use in order to protect itself
from a hostile takeover.
Poison pill, required supermajority shareholder, sell most profitable part of company, and
staggered board. Poison pill = Issue new shares to dilute the current share price to
discourage takeover
Require supermajority shareholder = requires a majority of shareholders to agree on selling
Question 2 (3 marks)
QWE Ltd. goes public at $26 per share and issues 30 million shares. The underwriters charge a
7% spread, and the company will pay $1.5 million in audit fees, $2.5 million in legal fees, and
$750,000 in printing costs. The stock closes the first day at $30 per share.
a) What is the total cost of the offering, including the underpricing?
Underpricing fee = 30m x $26 x 7% =
54.6 million Underpricing = 30m x ($30 -
$26) = 120 million
b) What are the total costs of going public for QWE as a percentage of the total pre-cost equity
value using the closing price at the end of the first day of trading?
$30 per share x 30 million shares = 900 million

--> pre-cost equity = 179.35 / 900 = 0.199277778

Question 3 (1 mark)
JKL Ltd. declares a $0.45 quarterly dividend on Monday, November 11, to shareholders of
record on Monday, November 25, payable on Friday, December 6. If you sell the shares on
Thursday, November 21, do you receive the dividend? Explain.

Dividend would not be eligible, missed

Question 4 (2 marks)
Describe two reasons that explain why many initial public offerings (IPOs) are underpriced.
To compensate institutional investors (and help them get out) and to protect reputation from
litigation risks. There is also the "winners curse" (overbidding) that some investors may be afraid
of (either over or underbidding) so they leave it to company to decide the pricing.
Question 5 (2 marks)
FGH shares trade for $55 with a price-earnings multiple of 15. There are 100 million shares
outstanding and your model indicates that the stock is worth $50. The company announces that
it will use $200 million to repurchase shares. After the repurchase, what is the value of the stock
according to your model?

Outstanding = 100,000,000 x $50 =

5,000,000,000 Repurchase = 200,000,000 /10
/ $55 = 3,636,363.636

Stock value after repurchase = (5,000,000,000 - 200,000,000) / (100,000,000 -

/66
3,636,363.636)

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