CFA Level I Equities

Next year's dividend is $2, the required return is 8% and dividends grow 4% a year forever. What is the share worth?

Gordon growth model: D1 / (r − g) = 2 / 0.04.

The dividend just paid is $2. It grows 5% a year and the required return is 10%. What is the share worth?

D1 = 2 × 1.05 = 2.10, and 2.10 / 0.05 = 42.

A share trades at $40 and earnings per share are $2.50. What is the P/E ratio?

40 / 2.5. The earnings yield is 6.25%.

Payout ratio is 40%, required return 10% and growth 6%. What is the justified forward P/E?

Payout / (r − g) = 0.4 / 0.04.

Free cash flow to equity equals:

It is the cash available to shareholders after reinvestment and debt flows.

If markets are weak-form efficient:

Semi-strong efficiency rules out profits from all public information too.

If markets are semi-strong efficient, which still might earn abnormal returns?

Only strong-form efficiency rules out private information.

A price-weighted index has three shares priced at 10, 20 and 90. What is its value?

Sum of prices / number of shares. Higher-priced shares carry more weight.

Which index weighting needs the most frequent rebalancing?

Price moves pull an equal-weighted index away from equal weights.

You buy shares with 40% initial margin. The price rises 10%. Ignoring interest and costs, what is your return on equity?

Leverage = 1 / 0.4 = 2.5, and 2.5 × 10% = 25%.

You buy at $50 with 50% initial margin. The maintenance margin is 25%. Below what price do you get a margin call?

P = 50 × (1 − 0.5) / (1 − 0.25).

A limit order to buy at $20 will execute:

It may never execute if the price stays above the limit.

What does a short seller do?

Losses on a short position are, in theory, unlimited.

A preferred share pays a fixed $5 dividend forever and the required return is 8%. What is it worth?

A perpetuity: 5 / 0.08.

Which is one of Porter's five forces?

The others are new entrants, buyer power, supplier power and rivalry.

In the shakeout stage of an industry life cycle:

It comes between growth and maturity.

Market cap is 500, debt 200 and cash 50. EBITDA is 65. What is EV/EBITDA?

EV = 500 + 200 − 50 = 650, and 650 / 65 = 10.

Which sector is usually defensive?

Defensive businesses sell essentials whose demand holds up in a downturn.

Shareholders' equity is 1,000 and there are 50 shares. What is book value per share?

1,000 / 50.

A share trades at $40, next year's dividend is $2 and growth is 5%. What return does the market imply?

r = D1 / P + g = 5% + 5%.

Dividends are $1.00 next year and $1.20 the year after, then grow 4% forever. The required return is 10%. What is the share worth today?

P2 = 1.20 × 1.04 / 0.06 = 20.80. PV = 1/1.1 + (1.20 + 20.80)/1.21.

A company sells new shares to investors for the first time. This happens in the:

Later trading between investors is the secondary market.

Which is a well-known market anomaly?

Many anomalies fade once they are published or after costs.

ROE is 15% and the company retains 60% of earnings. What is its sustainable growth rate?

g = retention ratio × ROE = 0.6 × 15%.

Why might a company issue a second class of shares with fewer votes?

Dual-class structures can weaken outside shareholders' influence.

A stock's P/B is 0.8. What does it mean?

It can signal value or that assets are overstated.