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82. An analyst gathers the following data to determine the attractiveness of the company’s common stock:

Dividends per share in 2002	$2
Dividends per share in 2008	$3
Expected return on the market	17%
Expected nominal risk-free return	9%
Stock’s beta	1.8
Stock’s market price as of 1 January 2009	$19

Using the constant growth dividend discount model, the stock’s intrinsic value is closest to:

A. $12.82.
B. $18.29.
C. $19.57.

83. Value Line Index, an unweighted index, uses which of the following methods in the computation of the holding period returns of underlying stocks?

A. Geometric mean.
B. Arithmetic mean.
C. Value-weighted mean.

84. The behavior of investors who put more money into a failure that they feel responsible for, rather than into a success, is most accurately described as:

A. escalation bias.
B. confirmation bias.
C. overconfidence bias.

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82. An analyst gathers the following data to determine the attractiveness of the company’s common stock:

Dividends per share in 2002	$2
Dividends per share in 2008	$3
Expected return on the market	17%
Expected nominal risk-free return	9%
Stock’s beta	1.8
Stock’s market price as of 1 January 2009	$19

Using the constant growth dividend discount model, the stock’s intrinsic value is closest to:

A. $12.82.
B. $18.29.
C. $19.57.

Answer: C
“The Time Value of Money” Richard A. DeFusco, CFA, Dennis W. McLeavey, CFA, Jerald E. Pinto, CFA, and David E. Runkle, CFA 2009 Modular Level I, Volume 1, p. 199
“An Introduction to Asset Pricing Models,” Frank K. Reilly, CFA and Keith C.
Brown, CFA 2009 Modular Level I, Volume 4, pp. 260-261; “An Introduction to Security Valuation,” Frank K. Reilly CFA, and Keith C. Brown, CFA 2009 Modular Level I, Volume 5, pp. 130-131
Study Session 1-5-e; 12-51-e; 14-56-c Draw a time line, and solve time value of money applications (for example, mortgages and savings for college tuition or retirement).
Calculate, using the SML, the expected return on a security, and evaluate whether the security is overvalued, undervalued, or properly valued. Calculate and interpret the value both of a preferred stock and a common stock using the dividend discount model (DDM). g = growth rate of dividends: [(3/2)1/6] - 1= 7%; Alternatively, PV = 2, FV = -3 n= 6, compute I/Y; k = 9 + 1.8 (17 – 9) = 23.4% V = 3(1.07) / (0.234-0.07) = 19.57

83. Value Line Index, an unweighted index, uses which of the following methods in the computation of the holding period returns of underlying stocks?

A. Geometric mean.
B. Arithmetic mean.
C. Value-weighted mean.

Answer: A
“Security-Market Indexes,” Frank K. Reilly CFA, and Keith C. Brown, CFA 2009 Modular Level I, Volume 5, pp. 44-46
Study Session 13-53-a Compare and contrast the characteristics of, and discuss the source and direction of bias exhibited by, each of the three predominant weighting schemes used in constructing stock market indexes, and compute a price-weighted, value-weighted, and un-weighted index series for three stocks.
The Value Line Index, an un-weighted index, uses the geometric mean return approach.

84. The behavior of investors who put more money into a failure that they feel responsible for, rather than into a success, is most accurately described as:

A. escalation bias.
B. confirmation bias.
C. overconfidence bias.

Answer: A
“Efficient Capital Markets,” Frank K. Reilly, CFA, and Keith C. Brown, CFA 2009 Modular Level I, Volume 5, pp. 83-84
Study Session 13-54-d Define behavioral finance and describe overconfidence bias, confirmation bias, and escalation bias.
Escalation bias refers to the investor behavior of putting more money into a failure that they feel responsible for rather than into a success. This leads to the practice of “averaging down” by viewing the additional purchase as a “bargain” rather than considering the initial purchase as a mistake and selling the stock.

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79. In securities exchange markets, a member who executes stop loss or stop buy orders when the specified price occurs is most likely a:

A. specialist.
B. registered trader.
C. commission broker.

Answer: A
“Organization and Functioning of Securities Markets,” Frank K. Reilly CFA, and Keith C. Brown, CFA 2009 Modular Level I, Volume 5, pp. 24-26, 29
Study Session 13-52-e Compare and contrast major characteristics of exchange markets including exchange membership, types of orders, and market markers. The specialists (market makers) have two major functions. They act as brokers to match buy and sell orders, including special (stop loss or stop buy) orders.

80. An analyst gathers the following data for a company to estimate the expected growth rate of dividends and use it as an input for valuing the company’s common stock.

Return on Assets	10%
rofit Margin	5 %
Financial Leverage	1.67
ayout Ratio	25%

The company’s expected growth rate is closest to:

A. 4.2%.
B. 6.3%.
C. 12.5%.

Answer: C
“An Introduction to Security Valuation,” Frank K. Reilly CFA, and Keith C. Brown, CFA 2009 Modular Level I, Volume 5, pp. 146-147
Study Session 14-56-f, g
Estimate the dividend growth rate, given the components of the required return on equity and incorporating the earnings retention rate and current stock price.
Describe a process for developing estimated inputs to be used in the DDM, including the required rate of return and expected growth rate of dividends.
g = RR x ROE; RR = (1 – Payout Ratio) = 1 – 0.25 = 0.75
ROE = ROA x Financial Leverage; ROE = 10% x 1.67 = 16.67%; g = 0.75 x 16.67 = 12.5%

81. Which of the following statements about the short sale of a stock is least accurate?

A. The short seller must pay any dividends due to the lender of shares.
B. A stop buy order would enable a short seller to minimize potential losses.
C. Short sales involve time limits for returning the shares borrowed to the lender.

Answer: C
“Organization and Functioning of Securities Markets,” Frank K. Reilly CFA, and Keith C. Brown, CFA
2009 Modular Level I, Volume 5, pp. 25-26
Study Session13-52-f
Describe the process of selling a stock short and discuss an investor’s likely motivation for selling short.
A short sale has no time limit, the other two statements are correct.