Chapter 19

Question 1

beta values

Answer 1

• Indicates sensitivity of individual stock’s rtns. vs. rtns. on overall stock market
• Firms in high-growth industries, volatile earnings usually have values beta > 1.0

Question 2

yield to worst (YTW)

Answer 2

• approach to analyze callable bonds
• determine all possible YTC (yield to call) values; lowest potential value = YTW

Question 3

capital asset pricing model (CAPM)

Answer 3

method to est. relationship btw. common stock’s required ROR and its risk level

• CAPM assumes investors hold a diversified portfolio of stocks, only systematic risk is relevant in stock pricing.
• Individual stock’s degree of systematic risk is measured using beta.
• Standard deviation measures return variability (to help assess risk of common stock in isolation). Thus, standard deviation is not appropriate to assess a stock’s risk when held in a diversified portfolio.

Question 4

Systematic risk factors:

list 4 examples

Answer 4

1. recession
2. inflation
3. oil prices
4. political instability

Question 5

formula: portfolio beta

Answer 5

sum of the weighted average Beta for each portfolio class, based on each class’ % of total portfolio

Question 6

use of standard deviation (re: stock valuation)

Answer 6

• helps develop bands around an individ. stock’s expected value.
• standard deviation refers to the avg. deviation from the expected value
• However, when a common stock is owned in combination with other common stocks in a portfolio, a different perspective on risk is needed. This is because the overall risk level of the portfolio depends on the covariance between the various stocks.

Question 7

securities lending

Answer 7

practice where securities owner lends specific securities to another party.

• normally, securities lender requires borrower to provide collateral (e.g. other securities, letter of credit, equal to or greater in value than the securities lent)
• allows borrower to hedge or short-sell securities that it does not own, in anticipation of the securities’ value declining.
• owner of LT securities earns additional income (i.e. interest from borrower) on holdings they can’t/prefer to not sell

Question 8

Gordon growth model

Answer 8

to value common stock

following 2 assumptions are required:

• required return > dividend growth rate
• dividend growth rate expected to remain constant in perpetuity

Question 9

formula: value of common stock

Answer 9

Question 10

yield to maturity (YTM)

Answer 10

• • For a bond, the pre-tax cost = its yield to maturity (YTM), or the ROR earned over the bond’s remaining life, based on mkt price @ date measured

Question 11

formula: PV of an asset/investment

Answer 11

Question 12

Common stock valuation differs from bond and preferred stock valuation because…

Answer 12

timing and amt. of cash flows associated with stock ownership are not fixed.

Comm. stock, valuation requires investor to: est. PV of future dividend stream

• est. future dividends
• determine appropriate req’d rate of return on the issuer’s equity.