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FTIP practice questions

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Question 1Financial products and markets

An investor buys a bond with a face value of $1,000, a 5% annual coupon, and exactly one year to maturity. If the investor pays $980 for the bond and holds it to maturity, what is the current yield?

  1. 5.10% Correct answer.
  2. 5.00%
  3. 6.12%
  4. 4.90%

Explanation

Current yield equals the annual coupon payment divided by the purchase price. The annual coupon is $50, and $50 divided by $980 is approximately 5.10%. The coupon rate of 5.00% ignores the discount price paid.

Question 2Financial products and markets

Which type of fund is priced once per day at the close of trading at its net asset value per share?

  1. An exchange-traded fund
  2. A closed-end fund
  3. A real estate investment trust
  4. An open-end mutual fund Correct answer.

Explanation

Open-end mutual funds issue and redeem shares at net asset value, which is calculated once daily after the market closes. Their shares are not traded intraday on an exchange. This forward pricing is a defining feature of the structure.

Question 3Financial products and markets

A company issues a bond that can be converted into a fixed number of its common shares at the holder's option. Which feature describes this arrangement?

  1. A convertible feature Correct answer.
  2. A put provision
  3. A sinking fund provision
  4. A call provision

Explanation

A convertible feature gives the bondholder the right to exchange the bond for a set number of common shares. This gives the holder upside participation in the issuer's equity. The conversion ratio is fixed when the bond is issued.

Question 4Financial products and markets

An investor buys 200 shares of a stock at $40 and later sells all of them at $47. Ignoring commissions, what is the total capital gain?

  1. $1,400 Correct answer.
  2. $7,000
  3. $700
  4. $940

Explanation

Capital gain equals the price difference multiplied by the number of shares. The difference is $7 per share, and 200 shares times $7 equals $1,400. Commissions would reduce this figure but are excluded here.

Question 5Financial products and markets

Which market is best described as one where securities are issued and sold by the issuer to investors for the first time?

  1. The secondary market
  2. The derivatives market
  3. The primary market Correct answer.
  4. The money market

Explanation

The primary market is where new securities are sold by the issuer to raise capital, such as through an initial public offering. Subsequent trading between investors occurs in the secondary market. The two are distinguished by who receives the proceeds.

Question 6Financial products and markets

An investor wants exposure to a broad equity index with intraday trading and typically low expense ratios. Which product most directly meets this need?

  1. A Treasury bill
  2. An exchange-traded fund tracking the index Correct answer.
  3. A money market fund
  4. A single-name common stock

Explanation

An exchange-traded fund tracking an index provides diversified index exposure, trades intraday on an exchange, and generally carries low costs. A single stock gives no diversification. Money market funds and Treasury bills are short-term cash instruments.

Question 7Financial products and markets

Which characteristic most distinguishes preferred stock from common stock?

  1. Preferred stock must be repaid at a fixed maturity date.
  2. Preferred stock typically pays a stated dividend and ranks ahead of common stock in liquidation. Correct answer.
  3. Preferred stock always carries voting rights that common stock lacks.
  4. Preferred stock has no claim on the issuer's assets.

Explanation

Preferred stock generally pays a fixed or stated dividend and has priority over common stock for dividends and in liquidation. Common shareholders typically hold the voting rights. Preferred stock is usually perpetual and has no maturity date.

Question 8Financial products and markets

A US Treasury bill with 90 days to maturity is quoted at a discount rate. Which feature is most characteristic of this instrument?

  1. It has a maturity of ten years or more.
  2. It pays semiannual coupons.
  3. It is sold at a discount and pays no periodic interest. Correct answer.
  4. It carries default risk comparable to corporate bonds.

Explanation

Treasury bills are short-term discount instruments: investors buy below face value and receive face value at maturity, with no coupon payments. They are backed by the full faith and credit of the US government. Their maturities are one year or less.

Question 9Financial products and markets

An investor holds a bond with a modified duration of 6. If interest rates rise by 0.50%, what is the approximate percentage change in the bond's price?

  1. A decrease of about 0.5%
  2. An increase of about 6.0%
  3. A decrease of about 3.0% Correct answer.
  4. An increase of about 3.0%

Explanation

Modified duration estimates price sensitivity to yield changes: percentage price change is approximately negative duration times the yield change. Here that is minus 6 times 0.005, or about minus 3.0%. Rising rates reduce bond prices.

Question 10Financial products and markets

A stock trades at $50 and pays an annual dividend of $2.00 per share. What is the dividend yield?

  1. 25.00%
  2. 0.40%
  3. 2.00%
  4. 4.00% Correct answer.

Explanation

Dividend yield equals the annual dividend divided by the share price. Two dollars divided by $50 equals 0.04, or 4.00%. This measures the income return relative to the price paid.

Question 11Financial products and markets

A call option on a stock has a strike price of $60, and the stock is trading at $68 at expiration. What is the intrinsic value of the call per share?

  1. $68
  2. $60
  3. $0
  4. $8 Correct answer.

Explanation

A call option's intrinsic value at expiration is the stock price minus the strike price when that difference is positive. Here $68 minus $60 equals $8 per share. If the stock were below the strike, intrinsic value would be zero.

Question 12Financial products and markets

An investor concerned about a sharp decline in a stock index over the next three months wants to protect a portfolio. Which strategy most directly provides downside protection while retaining most of the existing holdings?

  1. Buying additional index shares on margin
  2. Writing uncovered put options on the index
  3. Selling index futures contracts Correct answer.
  4. Selling covered calls on the index

Explanation

Selling index futures creates a short position that offsets losses in a long portfolio if the index falls. This hedge reduces downside exposure without selling the underlying holdings. The trade-off is that gains are also limited.

Question 13Financial products and markets

Which statement best describes the relationship between bond prices and market interest rates for a fixed-rate bond?

  1. Prices are unaffected by interest rate changes.
  2. Prices rise only when the issuer's credit rating falls.
  3. Prices and yields move in the same direction.
  4. Prices and yields move in opposite directions. Correct answer.

Explanation

When market interest rates rise, the fixed coupon stream is worth less, so the bond price falls, and vice versa. This inverse relationship is fundamental to fixed-income valuation. The sensitivity grows with maturity and duration.

Question 14Financial products and markets

A firm with a market capitalization of $2 billion and 50 million shares outstanding announces a 2-for-1 stock split. What happens to the share price and share count, all else equal?

  1. Neither the price nor the share count changes.
  2. The price doubles and the share count halves.
  3. Both the price and the share count double.
  4. The price halves and the share count doubles. Correct answer.

Explanation

A 2-for-1 split doubles the number of shares and halves the price per share, leaving total market value unchanged. Each holder owns twice as many shares at half the price. The split does not change the firm's economics.

Question 15Financial products and markets

Which measure of risk captures only the portion of a stock's volatility that cannot be diversified away in a broad portfolio?

  1. The stock's dividend yield
  2. The stock's price-to-earnings ratio
  3. Beta Correct answer.
  4. Standard deviation of the stock's returns

Explanation

Beta measures a stock's sensitivity to movements in the market portfolio, which reflects systematic risk that diversification cannot eliminate. Total standard deviation includes diversifiable idiosyncratic risk. Valuation ratios and dividend yield are not risk measures of this kind.

Question 16Financial products and markets

An investor buys a stock at $80 and one year later sells it at $92 after receiving $3 in dividends. What is the total holding-period return?

  1. 12.0%
  2. 15.0%
  3. 18.75% Correct answer.
  4. 3.75%

Explanation

Holding-period return includes both price appreciation and dividends divided by the initial price. The gain is $12 plus $3 in dividends, or $15, and $15 divided by $80 equals 18.75%. Ignoring dividends would understate the return.

Question 17Financial products and markets

Which feature of a corporate bond most directly reduces the issuer's cost of borrowing when interest rates are expected to fall?

  1. A call provision Correct answer.
  2. A restrictive covenant
  3. A conversion premium
  4. A put provision

Explanation

A call provision lets the issuer redeem the bond early, which is valuable if rates fall and the debt can be refinanced more cheaply. Investors demand a yield premium for this issuer option. Conversion and put features benefit the holder rather than the issuer.

Question 18Financial products and markets

A money market mutual fund advertises a stable $1.00 net asset value. Which risk is most relevant to investors in such a fund?

  1. Default risk from a concentrated high-yield bond portfolio
  2. Interest rate risk from long-duration bonds
  3. Currency risk from emerging market equities
  4. The possibility that the stable net asset value could break below $1.00 Correct answer.

Explanation

Money market funds seek a stable net asset value, but a fund can break the buck if holdings default or lose value. This is the key risk despite the short maturities and high credit quality of the holdings. The stable value is a target, not a guarantee.

Question 19Financial products and markets

An investor expects the price of a stock to decline substantially and wants a position that profits from that decline with defined maximum loss. Which strategy fits best?

  1. Buying a put option on the stock Correct answer.
  2. Buying the stock on margin
  3. Writing a naked call option on the stock
  4. Buying a call option on the stock

Explanation

A long put gains value as the stock falls, and the maximum loss is limited to the premium paid. This gives defined downside risk while expressing a bearish view. The other strategies either profit from rising prices or carry large or unlimited risk.

Question 20Financial products and markets

A bond has a yield to maturity of 6%, a coupon rate of 4%, and a face value of $1,000. Which statement about its price is correct?

  1. The bond trades at a premium to face value.
  2. The bond trades at a discount to face value. Correct answer.
  3. The bond trades exactly at face value.
  4. The price cannot be determined without the maturity date.

Explanation

When the yield to maturity exceeds the coupon rate, the bond's cash flows are discounted at a rate higher than the coupon, so the price falls below face value. Such a bond trades at a discount. A premium occurs when the coupon rate exceeds the yield.

Question 21Financial products and markets

Which of the following best describes the role of a clearinghouse in an exchange-traded derivatives market?

  1. It guarantees performance on contracts by acting as the counterparty to both sides. Correct answer.
  2. It sets the underlying asset's market price.
  3. It issues the underlying securities to the exchange.
  4. It determines the issuer's dividend policy.

Explanation

A clearinghouse interposes itself between buyers and sellers, becoming the counterparty to each side and guaranteeing performance through margin and default funds. This reduces counterparty risk for participants. It does not set prices or issue underlying assets.

Question 22Financial products and markets

A portfolio returned 10% over a year, while the risk-free rate was 2% and the portfolio's beta was 1.5. Using the capital asset pricing model, what was the portfolio's alpha if the market return was 6%?

  1. +2.0% Correct answer.
  2. +4.0%
  3. -2.0%
  4. 0.0%

Explanation

CAPM expected return is the risk-free rate plus beta times the market excess return: 2% plus 1.5 times 4%, which equals 8%. Actual return was 10%, so alpha is 10% minus 8%, or +2.0%. Alpha measures performance beyond what beta predicts.

Question 23Financial products and markets

A bond portfolio has a modified duration of 5 and a convexity of 60. For a 1% decrease in yields, which estimate of the percentage price change is most accurate?

  1. About +5.00%
  2. About +5.30% Correct answer.
  3. About +6.00%
  4. About +4.70%

Explanation

The duration effect for a 1% yield decline is plus 5%, and the convexity adjustment adds one-half times convexity times the yield change squared, or 0.5 times 60 times 0.0001, which is 0.30%. The combined estimate is about +5.30%. Convexity makes the price gain larger than duration alone predicts.

Question 24Financial products and markets

An analyst compares two bonds with the same maturity and coupon but different credit ratings. The lower-rated bond offers a higher yield to maturity. What does this yield spread primarily compensate investors for?

  1. Higher credit risk and the associated probability of default Correct answer.
  2. Lower interest rate sensitivity
  3. Greater liquidity risk only
  4. A longer time to maturity

Explanation

A yield spread between otherwise similar bonds mainly compensates for differences in credit risk, including default probability and loss given default. Investors demand extra yield to hold riskier debt. Maturity and coupon are held equal here, so those factors are not the driver.

Question 25Financial products and markets

An investor holds a long position in a stock and simultaneously writes a covered call. Which outcome best describes the payoff profile at expiration?

  1. Capped upside above the strike and reduced downside by the premium received Correct answer.
  2. Unlimited upside and unlimited downside
  3. Unlimited upside and no downside
  4. Capped downside below the strike and unlimited upside

Explanation

A covered call combines a long stock position with a short call, so gains are capped once the stock rises above the strike while the premium received provides a small buffer against losses. Downside remains substantial because the stock can fall. The strategy trades upside for income.

Question 26Financial products and markets

An investor buys a stock at $100 and writes a call option on the same stock with a strike price of $110, receiving a premium of $5. At expiration, the stock price is $120. What is the investor's net profit or loss on the combined position?

  1. Loss of $5
  2. Profit of $5
  3. Profit of $15 Correct answer.
  4. Profit of $25

Explanation

The stock is sold at the strike price of $110 because the call is exercised, resulting in a $10 gain on the stock. The investor also keeps the $5 premium, so the net profit is $15. The call obligation caps the stock's upside at the strike price, but the premium adds to the return.

Question 27Financial products and markets

Which type of fund is required to distribute at least 90% of its taxable income to shareholders to avoid paying corporate-level tax?

  1. Closed-end fund
  2. Real estate investment trust Correct answer.
  3. Mutual fund
  4. Exchange-traded fund

Explanation

Real estate investment trusts (REITs) must distribute at least 90% of their taxable income to shareholders to qualify for pass-through tax treatment under the Internal Revenue Code. This requirement does not apply to mutual funds, ETFs, or closed-end funds, which are regulated under different provisions.

Question 28Financial products and markets

An investor purchases a Treasury Inflation-Protected Security (TIPS) with a 2% real yield. If inflation over the next year is 3%, what is the approximate nominal return on the bond, assuming the coupon and principal are adjusted for inflation?

  1. 2%
  2. 3%
  3. 5% Correct answer.
  4. 6%

Explanation

The nominal return on a TIPS is approximately the sum of the real yield and the inflation rate. Here, 2% real yield plus 3% inflation gives about 5%. The actual return also depends on the compounding of the inflation adjustment, but the approximation is standard.

Question 29Financial products and markets

Which of the following best describes the payoff profile of a long straddle options position?

  1. Limited profit potential and limited loss potential
  2. Limited profit potential and unlimited loss potential
  3. Unlimited profit potential and unlimited loss potential
  4. Unlimited profit potential and limited loss potential Correct answer.

Explanation

A long straddle involves buying a call and a put with the same strike and expiration. The maximum loss is limited to the total premium paid, while the profit potential is unlimited on the upside (from the call) and substantial on the downside (from the put). Thus, the profile is unlimited profit and limited loss.

Question 30Financial products and markets

A company has a current dividend of $2.00 per share, a required rate of return of 10%, and a constant growth rate of 4%. Using the Gordon Growth Model, what is the intrinsic value of the stock?

  1. $33.33
  2. $50.00
  3. $34.67 Correct answer.
  4. $20.00

Explanation

The Gordon Growth Model values a stock as D1 / (r - g), where D1 is the next year's dividend. D1 = $2.00 × 1.04 = $2.08. Then $2.08 / (0.10 - 0.04) = $2.08 / 0.06 = $34.67. Using the current dividend of $2.00 instead of D1 would give $33.33, which is incorrect.

Question 31Financial products and markets

Which of the following statements about the yield curve is most accurate?

  1. An inverted yield curve typically signals expectations of rising inflation.
  2. A flat yield curve suggests that market participants expect stable interest rates.
  3. A normal yield curve indicates that long-term bonds have lower yields than short-term bonds.
  4. A inverted yield curve often precedes economic recessions. Correct answer.

Explanation

An inverted yield curve, where short-term yields exceed long-term yields, has historically been a reliable predictor of economic recessions. It often reflects expectations of falling future interest rates and economic contraction. Normal curves slope upward, and flat curves indicate uncertainty about future rates.

Question 32Financial products and markets

An investor wants to hedge against a decline in the value of a corporate bond portfolio using Treasury bond futures. Which risk is most directly reduced by this strategy?

  1. Liquidity risk
  2. Inflation risk
  3. Interest rate risk Correct answer.
  4. Credit risk

Explanation

Treasury bond futures are primarily used to hedge interest rate risk because their prices move inversely with interest rates, similar to corporate bonds. However, the hedge is imperfect because corporate bonds also carry credit risk, which Treasury futures do not address. Thus, the strategy most directly reduces interest rate risk.

Question 33Financial products and markets

Which of the following is a key difference between a forward contract and a futures contract?

  1. Forward contracts are standardized and traded on exchanges, while futures contracts are customized.
  2. Futures contracts carry counterparty credit risk, while forward contracts do not.
  3. Forward contracts require margin, while futures contracts do not.
  4. Futures contracts are subject to daily settlement, while forward contracts are settled at maturity. Correct answer.

Explanation

Futures contracts are marked to market daily, meaning gains and losses are settled each day. Forward contracts are private agreements settled at maturity. This daily settlement reduces counterparty risk for futures but requires margin maintenance.

Question 34Financial products and markets

A portfolio manager wants to create a position that profits if a stock's price remains stable or rises slightly, while generating income. Which strategy is most appropriate?

  1. Covered call Correct answer.
  2. Short strangle
  3. Long straddle
  4. Protective put

Explanation

A covered call involves holding the stock and writing a call option. It generates premium income and profits if the stock stays flat or rises up to the strike price. A long straddle profits from volatility, a protective put hedges against declines, and a short strangle profits from low volatility but has unlimited risk.

Question 35Financial products and markets

Which of the following best describes the role of a specialist or designated market maker on an exchange?

  1. To execute trades on behalf of institutional clients only.
  2. To set the official opening and closing prices for securities.
  3. To trade for their own account and profit from price movements.
  4. To maintain a fair and orderly market by quoting bid and ask prices. Correct answer.

Explanation

A specialist or designated market maker is responsible for maintaining liquidity and orderly trading by continuously quoting bid and ask prices for assigned securities. They may also trade for their own account to stabilize prices, but their primary obligation is to the market.

Question 36Financial products and markets

An investor holds a bond with a face value of $1,000, a coupon rate of 5%, and a yield to maturity of 6%. If the bond matures in 10 years, what is its price?

  1. $1,075.00
  2. $1,000.00
  3. $926.40 Correct answer.
  4. $1,134.20

Explanation

The bond price is the present value of its future cash flows discounted at the yield to maturity. Using the formula: Price = $50 × [1 - (1+0.06)^-10] / 0.06 + $1,000 / (1+0.06)^10 = $50 × 7.3601 + $558.39 = $926.40. Since the coupon rate is below the YTM, the bond trades at a discount.

Question 37Financial products and markets

Which of the following statements about the efficient market hypothesis (EMH) is most accurate?

  1. The semi-strong form of EMH suggests that fundamental analysis is always profitable.
  2. The semi-strong form of EMH implies that insider trading is legal.
  3. The strong form of EMH asserts that all public and private information is reflected in stock prices. Correct answer.
  4. The weak form of EMH states that technical analysis cannot generate excess returns.

Explanation

The strong form of the efficient market hypothesis asserts that all information, both public and private, is already reflected in stock prices. This implies that no investor can consistently achieve excess returns, even with insider information. The weak form relates to historical prices, and the semi-strong form to public information.

Question 38Financial products and markets

A company issues a bond with a face value of $1,000, a coupon rate of 6%, and a maturity of 5 years. The bond is callable after 3 years at a call price of $1,050. If interest rates decline, which of the following is most likely to occur?

  1. The bond's price will fall below $1,000.
  2. The bond's duration will extend beyond 5 years.
  3. The bond will be called, and the investor will receive $1,050. Correct answer.
  4. The bond's yield to maturity will increase.

Explanation

When interest rates decline, the issuer can refinance by calling the bond and reissuing at a lower rate. The bondholder receives the call price of $1,050, which is higher than the face value. This call feature benefits the issuer and limits the bond's price appreciation.

Question 39Financial products and markets

Which of the following best describes the concept of 'duration' in bond portfolio management?

  1. The time until a bond's first coupon payment.
  2. The difference between a bond's yield and its coupon rate.
  3. The total return of a bond over its life.
  4. A measure of a bond's price sensitivity to interest rate changes. Correct answer.

Explanation

Duration measures the sensitivity of a bond's price to changes in interest rates, often expressed in years. It is used to estimate the percentage price change for a given change in yields. It is not simply the time to first coupon or total return.

Question 40Financial products and markets

An investor is considering two bonds with the same maturity and coupon rate but different credit ratings. The lower-rated bond offers a higher yield. Which type of risk is the investor being compensated for?

  1. Inflation risk
  2. Interest rate risk
  3. Liquidity risk
  4. Credit risk Correct answer.

Explanation

The higher yield on the lower-rated bond reflects the additional credit risk, which is the risk that the issuer may default. Investors demand a credit spread to compensate for this risk. Interest rate risk and inflation risk affect all bonds similarly, while liquidity risk may also play a role but is not the primary differentiator here.

Question 41Investment analysis and valuation

In discounted cash flow valuation, the free cash flow to the firm is discounted at which rate?

  1. The risk-free rate
  2. The weighted average cost of capital Correct answer.
  3. The pre-tax cost of debt
  4. The cost of equity only

Explanation

FCFF represents cash available to all capital providers, so it must be discounted at a rate reflecting the blended required return of debt and equity holders, which is the WACC. Using a single component rate would mismatched the cash flow with its claimholders.

Question 42Investment analysis and valuation

A bond with a face value of 1,000 pays a 6% annual coupon and is priced at 1,050. What is its current yield?

  1. 6.00%
  2. 6.30%
  3. 5.40%
  4. 5.71% Correct answer.

Explanation

Current yield equals the annual coupon divided by the market price, so 60 divided by 1,050 equals about 5.71%. It ignores capital loss on redemption, which is why yield to maturity would be lower still for a premium bond.

Question 43Investment analysis and valuation

A stock just paid a dividend of 2.00 per share, dividends are expected to grow at 4% forever, and the required return is 12%. Using the Gordon growth model, what is the intrinsic value?

  1. 25.00
  2. 24.00
  3. 16.67
  4. 26.00 Correct answer.

Explanation

The Gordon model values the next expected dividend, not the one just paid, so the numerator is 2.00 times 1.04, or 2.08. Dividing 2.08 by the 0.08 spread between required return and growth gives 26.00.

Question 44Investment analysis and valuation

Which measure of central tendency is most appropriate for summarizing the distribution of price-to-earnings ratios across a peer group that contains a few extreme outliers?

  1. The geometric mean
  2. The arithmetic mean
  3. The standard deviation
  4. The median Correct answer.

Explanation

The median is a positional measure that is unaffected by extreme values, so it better represents the typical multiple when the distribution is skewed. The mean would be pulled upward by a handful of very high multiples.

Question 45Investment analysis and valuation

A portfolio holds 60% in asset A with expected return 10% and 40% in asset B with expected return 5%. What is the portfolio's expected return?

  1. 15.0%
  2. 7.0%
  3. 8.0% Correct answer.
  4. 7.5%

Explanation

Portfolio expected return is the weighted average of component returns, so 0.60 times 10% plus 0.40 times 5% equals 8.0%. Correlation affects risk, not the expected return of the combination.

Question 46Investment analysis and valuation

Which statement best describes the security market line in the capital asset pricing model?

  1. It plots expected return against systematic risk measured by beta Correct answer.
  2. It plots realized return against the risk-free rate over time
  3. It plots expected return against total risk measured by standard deviation
  4. It plots portfolio variance against the number of holdings

Explanation

The security market line is the graphical form of the CAPM, with beta on the horizontal axis and expected return on the vertical axis. Its intercept is the risk-free rate and its slope is the market risk premium.

Question 47Investment analysis and valuation

A firm has a beta of 1.4, the risk-free rate is 3%, and the expected market return is 8%. According to the CAPM, what is the required return on equity?

  1. 9.4%
  2. 8.0%
  3. 10.0% Correct answer.
  4. 11.2%

Explanation

The CAPM required return equals the risk-free rate plus beta times the market risk premium, so 3% plus 1.4 times 5% equals 10.0%. The market risk premium is the expected market return minus the risk-free rate.

Question 48Investment analysis and valuation

An analyst values a company at an enterprise value of 5,000. The company has debt of 1,200, cash of 300, and 100 shares outstanding. What is the estimated value per share?

  1. 38.00
  2. 47.00
  3. 41.00 Correct answer.
  4. 50.00

Explanation

Equity value equals enterprise value minus debt plus cash, so 5,000 minus 1,200 plus 300 equals 4,100. Dividing by 100 shares gives 41.00 per share.

Question 49Investment analysis and valuation

In relative valuation, which is the most defensible adjustment when comparing price-to-earnings ratios of companies with materially different expected growth rates?

  1. Compare only the trailing rather than forward P/E ratios
  2. Subtract the risk-free rate from the P/E ratio
  3. Multiply the P/E ratio by the dividend payout ratio
  4. Divide the P/E ratio by the expected earnings growth rate Correct answer.

Explanation

Because P/E ratios rise with expected growth, dividing by the growth rate produces a PEG-style ratio that normalizes for that driver. This makes comparisons across firms with different growth prospects more meaningful.

Question 50Investment analysis and valuation

A project requires an initial outlay of 10,000 and generates 4,000 per year for four years. At a 10% discount rate, what is the approximate net present value?

  1. 6,000
  2. 1,200
  3. 3,000
  4. 2,679 Correct answer.

Explanation

The present value of a four-year annuity of 4,000 at 10% is about 12,679, using the annuity factor of roughly 3.170. Subtracting the 10,000 outlay leaves an NPV of approximately 2,679.