Principles of InvestingFIN 330

Phase 2 ExamMultiple Choice, Short Essay, True/False

Company analysis is conducted in a Top to Down manner: from the macro to micro. Chief among the macro factors is Fed Policy. Fed Policy tends to manage the impact of economic and business cycles. Especially as they impact employment and personal income.

A. How does Federal Reserve [Monetary] Policy influence company behavior? (think interest rates & credit supply)

B. Why do stock prices tend to lead business cycles?C. How do economic indicators work? Leading, Coincident,

LaggingD. Why do investors look at the Fed’s Beige Book?

Chapter 5: Economic Activity

Stock prices are influenced by industry effects. Industries undergo life cycles very similar to product life cycles. Sensitivity to where an industry is going, relative to their life cycles, can be important in establishing a range of values.

A. How does the industry life cycle resemble the product life cycle?

B. How is the industry structured in general? Lots of competition or very little?

1. Does the domestic industry have much foreign competition?

C. How do we classify industries?

Chapter 6: Industry Analysis

The basic process for valuation of any business is to look at its revenue stream (sales) and how well it converts sales into profits. There are several competing models for valuing stock.

A. Gordon Growth Model (Normal): Stock price = Dividend to be received divided by (cost of equity capital minus the growth rate in dividends) Price = D1 / (Ke–g)

B. P/E Model: Attractiveness of firms reflected earnings multiple that investors are willing to pay for a share of stock. Higher P/E means more attractive. Lower is less attractive.

C. Capital Asset Pricing Model: stock returns are a function of risk premiums and beta (b). The expected return [E(Ri)] equals expected return on the risk free asset plus beta times the risk premium: E(R i) = E(Rf) + b [E(Rm) – E(Rf)]. E(Ri) the is used the same way as Ke in the Gordon Growth Model.

D. The Sustainable Growth rate is also of interest to analysts: SGR = ROE * Retention Ratio (How much of the firm’s profit is reinvested in the business.)

Chapter 7: Valuation of the Firm

The objective of financial statement analysis (FSA) is to direct managerial attention to areas of concern in corporate financial performance. FSA does not provide solutions to corporate problems nor does it consider all the possible interactions. FA is first and always an analytical tool.

A. What are some measures we can use to gauge or measure managerial efficiency in the following areas?

1. Liquidity management?2. Asset management?3. Debt management and strategy?4. Profitability?

B. What is the primary objective of the DuPont system of financial analysis?C. How does debt impact DuPont analysis? Asset investment? Net profit margins?D. What types of information are contained in the balance sheet? (LHS versus RHS)E. What information is contained in the income statement?F. What information is contained in the statement of cash flows?

Chapter 8: Financial Statement Analysis