1. If a share price is $1.00 or greater, what number of shares is one round lot? 100 shares make one round lot for shares trading at $1.00 or greater.
3. Voting shares entitle a shareholder to vote on daily routine matters, such as who will be hired as the next vice-president of finance. True or false? False, shareholders with voting shares are entitled to vote on “big picture” matters at periodic shareholder meetings. This would include merger actions and other matters that may significantly alter the direction of a company.
5. What is meant by “limited liability” when holding common shares?
The personal liability of shareholders in an incorporated business is limited to the amount they have invested. Creditors have no access to the individual net-worth of the investors.
7. Explain the effect on a shareholder of a 5-for-1 stock split with 50 shares of Kompass Financial Advisory Inc. that were worth $100 per share before the split. Does the total value of the investment change solely because of the split? A shareholder with 50 shares before the split would have 250 shares (5 × 50) after the split, and each share would be worth $20 post-split ($100 ÷ 5). The total value of these shares will remain the same as follows: Before stock split: 50 shares x $100 each = $5,000 After stock split: 250 shares x $20 each = $5,000 The total investment does not change solely because of the split; however, sometimes the split is a signal that management believes the shares will trend higher.
9. What do investors own when they purchase shares in a company?
An investor that purchases shares (shareholder) owns a portion of the entire corporation, based upon the number of shares the owner holds as a portion of the total number of shares issued and outstanding. Accordingly, that same portion of the equity in the company is owned by the shareholder. All equity belongs to the common shareholders. As owners of common shares, investors usually have certain rights, including the right to vote on important issues at a shareholders' meeting, the right to receive a proportionate share of profits in the form of dividends (if dividends are paid), the right to receive a
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proportionate share of liquidation proceeds in the case of company windup or asset sell- off, and other possible rights that are associated with a common share.
11. Define “stock repurchase”.
A stock repurchase occurs when a company “buys back” shares from shareholders. A company would do this to change their capital structure, that is, the balance of capital financing that comes from debt (such as bond issues) versus equity (common shares). As a result, each shareholder owns a bigger piece of the company.
13. Which of the following accurately defines a “growth stock”?
(a) A stock from a well-known, financially stable, and reliable company (b) A speculative stock that has large reward–risk potential (c) A company whose revenues and profits tend to grow faster than the industry average (d) A stock whose market price is lower than the intrinsic value determined though analysis Answer: (c) A company whose revenues and profits tend to grow faster than the industry average.
15. Explain the concept of beta (β). What is the market’s beta? Beta is a measure of risk based on volatility in the price of a stock. The market’s beta is considered to be 1.0. If a stock has a beta of greater (less) than 1.0, then its price will fluctuate greater (less) than the market. We must select a representative of the market, which is typically a stock index such as the S&P TSX Composite, which represents the TSX’s largest companies in Canada. A portfolio’s beta is the weighted average of the security betas held within it.
17. Which of the following statements is false regarding initial public offerings (IPOs)? (a) This is the first time the shares are being offered to the public. (b) If shares are sold through an IPO, they will never be available on the secondary market. (c) An IPO can be a very expensive and lengthy process for a company to undertake. (d) Before making an IPO, a company must obtain the approval of the governing securities commission. Answer: (b) If shares are sold through an IPO, they will never be available on the secondary market.
19. If you are concerned that a certain stock may fall in price on the next day, you can have it sold at a certain price using which of the following forms of order? (a) Market order (b) Call option
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(c) Sell order
(d) Stop-loss order Answer: (d) Stop loss order Note the price with a stop loss order is uncertain because the selling will simply start when the stop loss order price is reached, but this does not guarantee at what price a specific investor’s stock will be sold at.
21. An investor short sells 100 shares of DOG Machinery Ltd. Which of the following terms could you refer to his opinion of the stock as? (a) Bearish (b) Black (c) Bullish (d) Blueish
Answer: (a) Bearish
23. Define and explain “technical analysis”.
Technical analysis is a form of financial analysis used to evaluate securities and attempt to forecast their future price movements. This is done through analysis of volume and price movement and trends. This analysis usually focuses strictly on graphing of price trends over time, and does not directly consider fundamentals or intrinsic value.
25. Define the following terms relative to put and call options: i. In the money It is when the option would result in a profit to the holder if it were exercised. ii. At the money It is when the option would result in a break-even for the holder if it were exercised. iii. Out of the money It is when the option would result in a loss for the holder if it were exercised.
27. What is a “discretionary account”?
A discretionary account is where the client gives up control of buy, hold and sell decisions; all decisions are made solely by the investment advisor.
Problems 1. If a company has a price-to-earnings (P/E) ratio of 13.2 and an earnings per share (EPS) of $2.67, what is its current share price? P/E ratio = Market share price ÷ EPS
3. Kompass Financial Advisory Inc. recently released the following information regarding its financials: Total Assets $122,500,000 Total Liabilities $93,450,000 Total Equity $29,050,000 Net Income $13,500,000 Common Shares Outstanding 5,000,000 Share Price @ close Dec. 31 $44.51
Calculate the P/E ratio, EPS, and market-to-book (M/B) ratio. According to the M/B ratio, are the shares “highly valued”? EPS = Net Income ÷ Shares Outstanding EPS = $13,500,000 ÷ 5,000,000 EPS = $2.70 P/E = Share Price ÷ EPS P/E = $44.51 ÷ $2.70 P/E = 16.49 Market to Book Ratio = Market Share Price ÷ Book Value per Share Market to Book Ratio = $44.51 ÷ ($29,050,000 ÷ 5,000,000) Market to Book Ratio = $44.51 ÷ $5.81 Market to Book Ratio = 7.66 Yes, the shares are “highly value” because investors are willing to pay more for them than they are valued in the financial statements (book value).
5. In the problem above, suppose that, instead of no change in the BMW dividend amount, it is projected to grow at a constant annual rate of 5%. What is the intrinsic value now? P0 = D1 ÷ (R – g) P0 = $1.28 ÷ (.08 – .05) = $42.67 intrinsic value. The intrinsic value of $42.67 is higher than the market price of $33.38, and therefore this could be considered a value stock in this hypothetical example.
7. On November 15, the shares of ABC Ltd traded at $15.00. Subsequently, an investor purchased one call option contract for 100 shares at $0.50 per share with an exercise price of $25.00. The investor exercised the options at a time when the shares were trading at $27.50. How much profit did the investor make? If the option had expired out of the money, how much profit would the option writer have made? Call Profit = (share market price – exercise price) x number of shares – option price
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Call Profit = ($27.50 – $25.00) × 100 shares – (100 shs × $0.50) = $200.00 profit for the investor. If the options expire out of the money, then the option price is the profit to the writer which is $100 shares × $0.50 = $50 for the one contract.
