BFC3241 Final Exam, S1 2022 Question 1 The average company in the healthcare sector has a P/E ratio of 38.84. Pfizer is expected to pay an annual dividend per share of $1.20. Pfizer pays out 45% of its earnings as dividends. Based on the given information, the intrinsic value of its stock is: a) Not enough information to determine b) $84.74 c) $103.57 d) $47.25 Question 2 Which of the following is NOT true about the multiples valuation approach: a) It is based on the idea that similar assets should be traded at similar prices b) It works best when comparing firms with similar revenue drivers c) It assumes that the market accurately values a group of peer stocks d) It allows identifying whether the stock is mispriced Question 3 The most recent annual dividend of Z-Best Ltd. was $0.62 per share. The company is in the fast- growing stage right now, and it grows by 100% each year. This growth is expected to last for the following 2 years. After that, the company is expected to grow by 12% indefinitely. The WACC of Z- Best Ltd. is 20%. What is the intrinsic value of the Z-Best Ltd. stock price a) $26.87 b) $7.75 c) $22.39 d) Not enough information to determine Question 4 Pick the best option: a) Both the Dividend Discount Model (DDM) and the Free Cash Flow to Equity (FCFE) model estimate the intrinsic value of equity b) The Free Cash Flow to Equity (FCFE) model cannot be used to estimate the entire value of the firm that uses debt c) The Free Cash Flow to Firm (FCFF) model can be used to estimate the entire value of the firm that uses debt d) All of the above statements are correct. Question 5 Virtu Financial Inc. reported an EBIT of $1,112 million in 2021. The effective tax rate of Virtu is 35%. The estimated market value of debt is $4,784 million. The firm is supposed to maintain a long- term growth rate of 5.2% and continue reinvestment 30% of its earnings. The WACC of Virtu is 6.85%. There are 1,100 million outstanding shares. What is the fair value of a Virtu share 2 a) $24.98 b) $29.33 c) $27.88 d) $23.53 Question 6 Which of the following statements about sell-side analysts is correct a) They research information only on those stocks that are good candidates for being sold from the portfolios of their clients b) They make recommendations on investments for the investment funds they work for c) Most of them make correct recommendations d) They tend to avoid issuing “sell” recommendations to keep a good relationship with the management of the companies they make recommendations on Question 7 Which type of equity research analysis do Porter’s Five Forces deal with a) Industry analysis b) Macroeconomic analysis c) Business cycle analysis d) None of the above Question 8 Which of the following is NOT a typical part of an equity research report a) Description of the company, its products, and services b) A description of the company’s management political connection c) A forecast of the company’s future financial performance d) A recommendation to buy, sell or hold a stock Question 9 Since _________ industries perform better during economic expansions, equity research analysts usually focus on companies from these industries —for example, ____________ industries—when the economy is booming. a) cyclical… mining and airline b) defensive… mining and airline c) cyclical… fast-moving consumer goods and utilities d) defensive… fast-moving consumer goods and utilities Question 10 Macroeconomic analysis performed by equity research analysts can help them to: a) Narrow down the subset of stocks for potential equity research consideration b) Understand the growth opportunities of companies that they research better c) Estimate the required rate of return on companies that they research d) All of the above 3 Question 11 Which of the following statements about the Grossman-Stiglitz paradox is correct a) if information collection is costly, security analysis would be redundant b) if information collection is costly, security analysis would be a valuable service c) even if information collection is costly, markets can still be fully informationally efficient d) None of the above Question 12 Which of the following is a violation of the semi-strong form of market efficiency a) ABC Inc. has announced decreased year-over-year earnings, yet its stock price has increased following that announcement b) ABC Inc. stock price return follows a random walk c) John Dow made money in ABC Inc. based on his private information analysis d) None of the above Question 13 The cumulative abnormal stock return pattern of XYZ Ltd. around its positive corporate news announcement looks as follows. Before the announcement, it stays around 0%; on the announcement day, it increases to 10%; and on the days following the announcement, this return decreases to 5%. This cumulative abnormal return pattern indicates: a) overreaction of market participants to the news b) underreaction of market participants to the news c) correct reaction of market participants to the news d) None of the above Question 14 Which of the following explanations for return anomaly persistence is consistent with the efficient market hypothesis a) Return anomalies represent compensation for undiversifiable risks not captured by the CAPM b) Return anomalies appear in the data by chance and disappear once replicated for other periods c) Return anomalies are a result of data mining and disappear once replicated for other periods d) All of the above Question 15 In an asset pricing model, a beta reflects: a) the exposure of the stock to the specific source of undiversifiable risk b) the exposure of the stock to the specific source of idiosyncratic risk c) the sensitivity of the stock price return to the firm-specific shocks d) All of the above Question 16 Which of the following is NOT an example of limits to arbitrage for arbitrageur D e) Limited capital available to arbitrageur D to be able to correct the observed mispricing f) Trading costs 4 g) Shot-selling costs h) Systematic risk Question 17 Which of the following behaviors is an example of an information processing mistake a) Splitting your investment account into two sub-accounts—one for bonds and one for stocks— so that all trading decisions are made separately within each account b) Buying a “hot” stock that has been featured a lot on Twitter c) Overweighting information from more recent events to make an investment decision d) Holding on to your losing investment position instead of selling it Question 18 Regret avoidance attributable to many market participants may prompt them to avoid investing in less-known small stocks and invest in well-known large stocks instead. Such a behavior coupled with limits to arbitrage can lead to the following return anomaly pattern. a) Small stocks consistently outperform large stocks on a risk-adjusted basis b) Small stocks consistently underperform large stocks on a risk-adjusted basis c) Large stocks consistently outperform small stocks on a risk-adjusted basis d) None of the above Question 19 Which of the following behaviors can contribute to the post-earnings announcement drift a) Investors who bought stocks before upcoming positive earnings announcements tend to sell their winning positions prematurely b) Investors tend to underreact to earnings surprises initially because they are slow to update their prior beliefs c) Investors who bought stocks before upcoming negative earnings announcements tend to hold on to their losing positions d) All of the above Question 20 Ms.Y has to choose between (i) a sure gain of $200 and (ii) the game of rolling a 6-sided dice with the following payoff structure: The number on a dice 1 2 3 4 5 6 Payoff +$75 +$125 +$175 +$225 +$275 +$325 If Ms.Y is behaving according to the Prospect Theory, which choice would he make a) She would choose (i) b) She would choose (ii) c) She is indifferent between (i) and (ii) d) Not enough information to determine Question 21 Which of the following statements about active and passive funds is correct a) Both active and passive funds are indirect investment vehicles 5 b) Both active and passive funds charge management fees c) Both active and passive funds are professionally managed by fund managers d) All of the above Question 22 You are an authorized market participant of the QQQ ETF (Nasdaq 100 ETF). The current best bid and ask prices of QQQ are $318.82 and $319.12, respectively. You can buy one basket of securities underlying one QQQ for $318.80 and sell this basket for $318.70. Based on this information, you have decided to conduct an arbitrage using market orders. What is the maximum profit you can make for a trading block of 200,000 QQQ ETF shares, assuming that you can buy and sell this amount at the best bid and ask prices a) $800 b) $4,000 c) $400 d) $8,000 Question 23 Vanguard DAX 30 Mutual Fund seeks to track the return of the DAX 30 Index, the index consisting of the 30 major German blue-chip stocks. Vanguard DAX 30 Exchange Traded Fund seeks to track the return of the same DAX 30 Index. Which of the following statements about the above mutual fund and ETF is correct a) Both of these funds can be bought on the German stock exchange b) The mutual fund is professionally
managed, while the exchange traded fund is not c) Both of these funds can be bought directly via Vanguard (the investment company) d) None of the above Question 24 Which of the following statements is correct a) Most open-end mutual funds are passive b) Most closed-end mutual funds are passive c) Major country stock market indexes can have several ETFs tracking their returns d) Residential REITs comprise the largest proportion of the REIT market in Australia Question 25 Pick the best option. Which of the following statements about ETF providers is correct a) They create ETF shares in exchange for securities underlying these shares supplied to them by authorized market participants b) They redeem ETF shares in exchange for securities underlying these shares supplied to them by authorized market participants c) Both a) and b) are correct d) Neither a) nor b) is correct Question 26 What is the NAV of the closed-end fund XYZ currently traded at $150.50 per share if it consists 6 of stocks that are currently worth $130 million and bonds that are currently worth $18 million Assume that the fund has no liabilities and has 1 million outstanding shares. a) $150.50 b) $130.00 c) $148.00 d) Not enough information to determine Question 27 Which of the following investment styles usually has the lowest risk a) Small-Cap Blend b) Mid-Cap Growth c) Small-Cap Value d) Large-Cap Value Question 28 Which of the following hedge fund strategies has the lowest exposure to systematic risks a) Global macro b) Emerging markets c) Convertible arbitrage d) Long-short equity hedge Question 29 Which of the following statements is correct a) Active mutual funds typically charge higher incentive fees compared to hedge funds b) Funds with the highest Active Share outperform their benchmarks c) Active share measures the standard deviation of the fund’s returns relative to the benchmark d) The activeness of mutual funds as measured by Active Share has been stable in the past three decades Question 30 The hedge fund’s AUM is $200 million. The fund has a typical “two and twenty” fee structure. The fund’s benchmark, Barclays Hedge Fund Index, showed a return of 15.5% for 2021, while the hedge fund itself was able to generate a return of 29.5% during the same period. How much fees does an investor in this hedge fund pay for the year 2021 a) 2.00% b) 2.20% c) 4.80% d) 7.90% Question 31 Portfolio A has an annual return of 25% with a standard deviation of 38.5%. Its market beta is 2.1. The annual return on the T-bill is 0.35%, and the annual return on the market index is 8.55%. What is the Treynor ratio of Portfolio A a) 0.46 7 b) 0.12 c) 0.14 d) 0.64 Question 32 Which of the following statements is correct a) A comparison of two investment funds is normally based on a comparison of their historical returns b) It does not matter whether investors use a Sharpe or a Treynor ratio for their investment decisions since both approaches lead to the same conclusions c) Taking into account the portfolio risk level when choosing between two alternative investment portfolios is not a correct approach d) None of the above Question 33 In 2021, fund ABC generated a return of 29% with a standard deviation of 57%. During the same period, the return of the market portfolio was 12%, with a standard deviation of 19%. What was M2 in 2021 for fund ABC if its market beta for the same period was 2.5 and the risk-free rate was 5% a) 1.00% b) -2.33% c) 6.50% d) 2.647% Question 34 AussieBest mutual fund invests in Australian and International Equities. It reported the following figures for the year 2020. AussieBest return Weight in AussieBest Benchmark weight Benchmark return (1) (2) (3) (4) Australian Equity 12.5% 0.70 0.65 11.5% International Equity 15.5% 0.25 0.30 16.0% Cash -0.05% 0.05 0.05 -0.01% What was the fund’s return over- or under-performance in that period a) –0.35% b) +0.15% c) –0.15% d) +0.35% Question 35 Which of the following statements about market timing is correct a) Market timing strategies provide little improvements to fund performance b) If one expects the market to boom, they should buy low-beta stocks c) If a fund manager can time the market, it would be reflected in their fund’s Sharpe ratio d) None of the above 8 Question 36 Future of Financial Advice Legislation requires all financial advisors to retail investors in Australia to: a) act in the best interests of their clients b) renew their agreements on fees with the clients at least every two years c) disclose fees they charge their clients on an annual basis d) All of the above Question 37 Which of the following statement about fiduciary duty in fund management is correct a) Fiduciary duty implies that a fund manager must act in the best interest of the fund’s existing clients b) Fiduciary duty implies that a fund manager must take professional advice from investment advisors if necessary c) Fiduciary duty implies that a fund manager must periodically review the performance of the fund d) All of the above Question 38 During a round of golf, Smith, CFO of ABC Inc., mentions to Jones, a local investment adviser, and long-time personal friend, that ABC Inc. is having an exceptional sales quarter. Smith expects the results to be almost 10% above the current estimates. The next day, Jones initiates the purchase of a large stake in the local exchange-traded retail fund for her personal account. Pick the best option from below. a) Jones violated the CFA Code of Ethics and Professional Standards by investing in the exchange traded fund that included ABC Inc. b) Jones did not violate the CFA Code of Ethics and Professional Standards because she did not invest directly in the securities of ABC Inc. c) Smith did not violate the CFA Code of Ethics and Professional Standards because the comments made to Jones were not intended to solicit an investment in ABC Inc. Question 39 Ned Kelly, a portfolio manager for a local investment advisory firm, is planning to sell a portion of his personal investment portfolio to cover the costs of his child’s academic tuition. Ned wants to sell a portion of his holdings in XYZ Ltd., but his firm recently upgraded the stock to “strong buy.” Which of the following describes Ned’s options under the CFA Code of Ethics and Professional Standards a) Based on his firm’s “buy” recommendation, Ned cannot sell the shares because he would be improperly prospering from the inflated recommendation. b) Ned is free to sell his personal holdings once his firm is properly informed of his intentions c) Ned can sell his personal holdings but only when a client of the firm Question 40 Holden is a financial analyst with Robinhood Brokerage Firm. She is preparing a purchase 9 recommendation on Wesfarmers. Which of the following situations is most likely to represent a conflict of interest for Holden that would have to be disclosed a) Holden frequently purchases items produced by Wesfarmers b) Robinhood holds for its own account a substantial common stock position in Wesfarmers c) Holden’s sister-in-law is a supplier to Wesfarmers d) b) and c) Short-Answer Question (20 Marks) There is a long-standing debate in finance about whether markets are efficient. Eugene Fama, the laureate of the 2013 Nobel Memorial Prize in Economic Sciences, believes that they are. In contrast, Robert Shiller, who got the Noble Prize jointly with Fama, does not think that markets are efficient. a) Describe the efficiency market hypothesis (10 marks) b) Whom do you support in the market efficiency debate: Fama or Shiller Provide arguments for your position [if you are not sure whom you support, you can provide arguments both in favor of the Fama’s and Shiller’s positions] (10 marks) 10 SOLUTIONS MCQs 1c, 2d, 3d, 4d, 5a, 6d, 7a, 8b, 9a, 10d, 11b, 12d, 13a, 14d, 15a, 16h, 17c, 18a, 19d, 20a, 21d, 22b, 23d, 24c, 25a, 26c, 27d, 28c, 29b, 30c, 31b, 32d, 33a, 34d, 35d, 36d, 37d, 38a, 39b, 40b. Short-answer question a) 2.5 marks for mentioning that the market efficiency hypothesis is about the reflection of the information in prices, 2.5 marks for describing each form of market efficiency b) Any reasonable argument – 5 marks. Examples of reasonable arguments for Fama: – Normally only a small proportion of stocks’ returns isn’t explained by an asset pricing model – Prices quickly reflect public info in event studies → semi-strong-form EMH holds – If accounting for time-varying risks / limits to arbitrage / all inconsistencies with market efficiency will likely disappear – All inconsistencies with market efficiency will likely appear due to data mining – All inconsistencies with market efficiency will likely disappear once market participants are aware of them and start to trade on them – If accounting for time-varying risks, all inconsistencies with market efficiency will likely disappear Examples of reasonable arguments for Shiller: – Mentioning various types of anomalies as inconsistent with weak or semi-strong form EMH – Mentioning results from event studies that indicate slow incorporation of public info into prices – Mentioning that inside info leakage doesn’t correct prices immediately → inconsistent with strong-form EMH