Price–Earnings Model Explain the use of the price–earnings ratio for valuing a stock. Why might investors derive different valuations for a stock when using the PE method? Why might investors derive an inaccurate valuation of a firm when using the PE method?
17) Market Efficiency A consulting firm was hired to determine whether a particular trading strategy could generate abnormal returns. The strategy involved taking positions based on recent historical movements in stock prices. The strategy did not achieve abnormal returns. Consequently, the consulting firm concluded that the stock market is weak-form efficient. Do you agree? Explain.
1) Risk-Adjusted Return Measurements Assume the following information over a five-year period:
■Average risk-free rate = 6% ■
Average return for Crane stock = 11% ■
Average return for Load stock = 14% ■
Standard deviation of Crane stock returns = 2%
Standard deviation of Load stock returns = 4%
Beta of Crane stock = 0.8
Beta of Load stock = 1.1
Determine which stock has higher risk-adjusted returns according to the Sharpe index. Which stock has higher risk-adjusted returns according to the Treynor index? Show your work.
5) Using the Dividend Discount Model Micro, Inc., will pay a dividend of $2.30 per share next year. If the company plans to increase its dividend by 9 percent per year indefinitely, and you require a 12 percent return on your investment, what should you pay for the company’s stock?
13) Measuring the Portfolio Beta Using the information from Problem 12, suppose that you instead decide to invest $20,000 in IBM, $30,000 in LUV, and $50,000 in ODP. What is the beta of your portfolio now?
10) Long versus Short Hedge Explain the difference between a long hedge and a short hedge used by financial institutions. When is a long hedge more appropriate than a short hedge?
14) Stock Index Futures Describe stock index futures. How could they be used by a financial institution that is anticipating a jump in stock prices but does not yet have sufficient funds to purchase large amounts of stock? Explain why stock index futures may reflect investor expectations about the market more quickly than stock prices.
1) Profit from T-Bill Futures Spratt Company purchased T-bill futures contracts when the quoted price was 93.50. When this position was closed out, the quoted price was 94.75. Determine the profit or loss per contract, ignoring transaction costs.
3) Profit from T-Bill Futures Toland Company sold T-bill futures contracts when the quoted price was 94.00. When this position was closed out, the quoted price was 93.20. Determine the profit or loss per contract, ignoring transaction costs.
7) Profit from Stock Index Futures Marks Insurance Company sold S&P 500 stock index futures that specified an index of 1690. When the position was closed out, the index specified by the futures contract was 1720. Determine the profit or loss, ignoring transaction costs.