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Chapter 17 - Macroeconomic and Industry AnalysisChapter17Macroeconomic and industry Analysis1.A top down analysis of a firm starts with _.D.the global economy2.An example of a highly cyclical industry is _.A.the automobile industry3.Demand-side economics is concerned with _.A.government spending and tax levelsB.monetary policyC.fiscal policyE.A, B, and C4.The most widely used monetary tool is _.C.open market operations5.The real, or inflation-adjusted, exchange rate, isC.the purchasing power ratio.6.The normal range of price-earnings ratios for the S&P 500 Index isD.between 12 and 257.Monetary policy is determined byC.the board of Governors of the Federal Reserve System.8.A trough is _.B.a transition from a contraction in the business cycle to the start of an expansion9.A peak is _.A.a transition from an expansion in the business cycle to the start of a contraction10.If the economy is growing, firms with high operating leverage will experience _.A.higher increases in profits than firms with low operating leverage.11.If the economy is shrinking, firms with high operating leverage will experience _.A.higher decreases in profits than firms with low operating leverage.12.If the economy is growing, firms with low operating leverage will experience _.C.smaller increases in profits than firms with high operating leverage.13.If the economy is shrinking, firms with low operating leverage will experience _.C.smaller decreases in profits than firms with high operating leverage.14.Industrial production refers to _.C.the total manufacturing output in the economy.15.GDP refers to _.D.the total production of goods and services in the economy16.A rapidly growing GDP indicates a(n) _ economy with _ opportunity for a firm to increase sales.D.expanding; ample17.A declining GDP indicates a(n) _ economy with _ opportunity for a firm to increase sales.A.stagnant; little18.The average duration of unemployment and changes in the consumer price index for services are _.C.lagging economic indicators19.A firm in an industry that is very sensitive to the business cycle will likely have a stock beta _.A.greater than 1.020.If the economy were going into a recession, an attractive industry to invest in would be the _ industry.B.medical services21.The stock price index and contracts and new orders for nondefense capital goods areA.leading economic indicators.22.A firm in the early stages of the industry life cycle will likely have _.B.high risk.C.rapid growthE.B and C23.Assume the U.S. government was to decide to increase the budget deficit. This action will most likely cause _ to increaseA.interest ratesB.government borrowingD.both A and B24.Assume the U.S. government was to decide to decrease the budget deficit. This action will most likely cause _ to decreaseA.interest ratesB.government borrowingD.both A and B25.Assume that the Federal Reserve decreases the money supply. This action will cause _ to decrease.C.investment in the economy26.If the currency of your country is depreciating, the result should be to _ exports and to _ imports.B.stimulate, discourage27.If the currency of your country is appreciating, the result should be to _ exports and to _ imports.C.discourage, stimulate28.Increases in the money supply will cause demand for investment and consumption goods to _ in the short run and cause prices to _ in the long run.A.increase, increase29.The North American Industry Classification System (NAICS)A.are for firms that operate in the NAFTA region.B.group firms by industry.D.A and B.30.If interest rates increase, business investment expenditures are likely to _ and consumer durable expenditures are likely to _.D.decrease, decrease31.Fiscal policy generally has a _ direct impact than monetary policy on the economy, and the formulation and implementation of fiscal policy is _ than that of monetary policy.B.more, slower32.Fiscal policy is difficult to implement quickly becauseA.it requires political negotiations.B.much of government spending is nondiscretionary and cannot be changed.D.A and B.33.InflationA.is the rate at which the general level of prices is increasing.B.rates are high when the economy is considered to be overheated.D.A and B.Two firms, A and B, both produce widgets. The price of widgets is $1 each. Firm A has total fixed costs of $500,000 and variable costs of 50 cents per widget. Firm B has total fixed costs of $240,000 and variable costs of 75 cents per widget. The corporate tax rate is 40%. If the economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession, each firm will sell 1,100,000 widgets.34.If the economy enters a recession, the after-tax profit of Firm A will be _.C.$30,00035.If the economy enters a recession, the after-tax profit of Firm B will be _.E.none of the above36.If the economy is strong, the after-tax profit of Firm A will be _.D.$60,00037.If the economy is strong, the after-tax profit of Firm B will be _.C.$36,00038.Calculate firm As degree of operating leverage.A.11.039.Calculate firm Bs degree of operating leverage.C.29.8640.Classifying firms into groups, such as _ provides an alternative to the industry life cycle.A.slow-growersB.stalwartsD.A and B41.Supply-side economists wishing to stimulate the economy are most likely to recommendD.a decrease in the tax rate.42.Which of the following are not examples of defensive industries?B.durable goods producers.43.Which of the following are examples of defensive industries?A.food producers.C.pharmaceutical firms.D.public utilitiesE.A, C and D44._ is a proposition that a strong proponent of supply side economics would most likely stress.B.Higher marginal tax rates promote economic inefficiency and thereby retard aggregate output as they encourage investors to undertake low productivity projects with substantial tax shelter benefits45.The industry life cycle is described by which of the following stage(s)?A.start-up.B.consolidation.D.A and B.46.In the start-up stage of the industry life cycleA.it is difficult to predict which firms will succeed and which firms will fail.B.industry growth is very rapid.D.A and B.47.In the consolidation stage of the industry life-cycleC.the performance of firms will more closely track the performance of the overall industry.48.In the maturity stage of the industry life cycleA.the product has reached full potential.B.profit margins are narrower.C.producers are forced to compete on price to a greater extent.E.A, B, and C.49.In the decline stage of the industry life cycleA.the product may have reached obsolescence.B.the industry will grow at a rate less than the overall economy.C.the industry may experience negative growth.E.A, B, and C.50.A variety of factors relating to industry structure affect the performance of the firm, includingA.threat of entry.B.rivalry between existing competitors.E.A and B.51.The process of estimating the dividends and earnings that can be expected from the firm based on determinants of value is calledD.fundamental analysis.52.The emerging market exhibiting the highest growth in real GDP in 2007 wasA.China53.The emerging stock market exhibiting the highest U.S. dollar return in 2007 wasA.China54.The life cycle stage in which industry leaders are likely to emerge is theC.consolidation stage.55.Investment manager Peter Lynch refers to firms that are in bankruptcy or soon might be asE.turnarounds.56.A top-down analysis of a firms prospects starts withD.an assessment of the broad economic environment.57.Over the period 1999-2006, which of the following countries had a change in its real exchange rate that was favorable for U.S. consumers who want to buy its goods?E.Japan58.Over the period 1999-2006, which of the following countries had a change in its real exchange rate that was most unfavorable for U.S. consumers who want to buy its goods?A.Canada59.In recent years, P/E multiples haveB.risen dramatically.60.In recent years, P/E multiples for S&P 500 companies haveD.ranged from 12 to 25.61.The industry with the highest ROE in 2007 wasD.iron/steel.62.The industry with the lowest ROE in 2007 wasE.airlines.63.The industry with the lowest return in 2007 wasA.home construction.64.The industry with the highest return in 2007 wasB.oil equipment.65.Investors can _ invest in an industry with the highest expected return by purchasing _.B.not; industry-specific iShares66.Which of the following are key economic statistics that are used to describe the state of the macroeconomy? I) gross domestic productII) the unemployment rateIII) inflationIV) consumer sentimentV) the budget deficitE.I, II, III, IV, and V67.An example of a positive demand shock isE.a decrease in tax rates.68.An example of a negative demand shock isA.a decrease in the money supply.B.a decrease in government spending.E.A and B.69.During which stage of the industry life cycle would a firm experience stable growth in sales?A.Consolidation70.The emerging stock market exhibiting the highest local currency return in 2007 wasB.ChinaE.China71.Sector rotationC.is shifting the portfolio more heavily toward an industry or sector that is expected to perform well in the future.72.According to Michael Porter, there are five determinants of competition. An example of _ is when new entrants to an industry our pressure on prices and profits.A.Threat of Entry73.According to Michael Porter, there are five determinants of competition. An example of _ is when competitors seek to expand their share of the market.B.Rivalry between Existing Competitors74.According to Michael Porter, there are five determinants of competition. An example of _ is when the availability limits the prices that can be charged to customers.C.Pressure from Substitute Products75.According to Michael Porter, there are five determinants of competition. An example of _ is when a buyer purchases a large fraction of an industrys output and can demand price concessions.D.Bargaining power of Buyers76.Assume the U.S. government was to decide to increase the budget deficit. This action will most likely cause _ to increaseA.interest ratesB.government borrowingD.both A and B77.If interest rates decrease, business investment expenditures are likely to _ and consumer durable expenditures are likely to _.A.increase, increase78.An example of a defensive industry is _.B.the tobacco industryC.the food industryE.B and CTwo firms, C and D, both produce coat hangers. The price of coat hangers is $1.20 each. Firm C has total fixed costs of $750,000 and variable costs of 30 cents per widget. Firm D has total fixed costs of $400,000 and variable costs of 50 cents per widget. The corporate tax rate is 40%. If the economy is strong, each firm will sell 2,000,000 widgets. If the economy enters a recession, each firm will sell 1,400,000 widgets.79.If the economy enters a recession, the total revenue of Firm C will be _.A.$1,680,00080.If the economy enters a recession, the total cost of Firm C will be _.B.$1,170,00081.If the economy enters a recession, the before tax profit of Firm C will be _.C.$510,00082.If the economy enters a recession, the tax of Firm C will be _.D.$204,00083.If the economy enters a recession, the after tax profit of Firm C will be _.E.$306,00084.If the economy is strong, the total revenue of Firm C will be _.D.$2,400,00085.If the economy is strong, the total cost of Firm C will be _.C.$1,305,00086.If the economy is strong, the before tax profit of Firm C will be _.B.$1,050,00087.If the economy is strong, the tax of Firm C will be _.A.$420,00088.If the economy is strong, the after-tax profit of Firm C will be _.E.$630,00089.If a firms sales decrease by 15% and profits decrease by 20% during a recession, the firms operating leverage is _?A.1.33Short Answer Questions90.Discuss the tools of the U.S. governments demand-side policy. Include in your discussion of these tools the relative advantages and disadvantages of each in terms of the effect of the use of these tools on the economy.The two tools of the governments demand-side policy are fiscal and monetary policy. Fiscal policy is the use of government spending and taxing for the specific purpose of stabilizing the economy. Fiscal policy, once enacted, has the most direct and immediate effect on the economy. However, the formulation and implementation of fiscal policy is extremely slow, as such policy must be approved by both the legislative and executive branches of the federal government. Monetary policy consists of actions taken by the Board of Governors of the Federal Reserve System (FRS) to influence the money supply and/or interest rates. Monetary policy is relatively easy to formulate and to implement, but has less direct impact on the economy than fiscal policy. The most widely used tool of the FRS is the open market operations, in which the Fed buys or sells bonds for the Feds account. Buying securities increases the money supply; selling securities decreases the money supply. Open market operations occur daily. Other FRS tools include adjusting the discount rate, which is the interest rate the Fed charges banks on short-term loans, and altering reserve requirements, which are the fraction of deposits that banks must maintain in cash deposits with the Fed. Reductions in the money supply signal an expansionary monetary policy; lowering reserve requirements increase the money supply, and thus, stimulate the economy. The Fed walks a fine line: expansionary monetary policy probably will lower interest rates and stimulate investment and consumption in the short run, but ultimately inflation probably will result.Feedback: The rationale of this question is to ascertain whether the student has an understanding of the basic principles of macroeconomics.91.Discuss the National Bureau of Economic Research (NBER)s indexes of economic indicators, and how each of the categories of these indicators might be used by the securities analyst.The NBER has developed a set of cyclical indicators to help forecast, measure, and interpret short-term fluctuations in economic activity. The leading economic indicators are those that tend to increase or decrease in advance of the rest of the economy. These indicators are used to forecast the state of the economy for the coming period (usually one year). Coincident economic indicators move in tandem with the broad economy, and are used to confirm (or disconfirm) an earlier economic prediction. Lagging economic indicators are those that move after the broad economy, and are used to identify the end of a stage of the business cycle (such as a trough) and as an indication that another stage of business cycle (such as the expansion) is about to begin. The S&P 500 stock index is an excellent leading economic indicator, as would be expected by market efficiency proponents. However, if the stock market anticipates general economic trends, the task of the fundamentalist using economic forecasts to identify attractive industries (and thus stocks) for the future becomes even more impossible.Feedback: The purpose of this question is to ascertain the students understanding of the widely quoted economic indicators and the usefulness (and lack thereof) in securities analysis.92.Discuss the industry life cycle, how this concept can be used by security analysts, and the limitations of this concept for security analysis.The industry life cycle may be defined by the following stages: start up (rapid and increasing growth), consolidation (sable growth), maturity (slowing growth), and relative decline (minimal or negative growth). Investors interested in identifying new, and presumably ultimately successful, industries will use this technique, trying to get in on the ground floor. In the start up stage, no historical data is present; thus, one cannot identify potentially successful firms. However, typically, all of the firms are selling at low prices and the investor will diversify across the industry by buying many different stocks in the industry. If the industry becomes successful, the surviving firms will appreciate substantially in value; the non-surviving firms will be written off as losses. Typically, in this stage, firms are paying little or no dividends. Investment in this stage is for the risk-tolerant investor. As the industry moves from the start up to the consolidation stage, firms begin paying or increasing dividends; the surviving firms become more successful, begin to enjoy economies of scale, and are moving up the learning curve in terms of cost efficiency. In the maturity stage, the growth has slowed and dividends may have increased; less risk is involved. By the relative decline stage, the firm has no new exciting capital budgeting projects and may have become an income stock, by paying out a higher than average level of dividends. At this stage, the stock may be attractive for the risk-averse retiree interested in dividend income. Ho