NEW ERA UNIVERSITY
COLLEGE OF BUSINESS ADMINISTRATION
School of Management
No. 9 New Era Central Avenue, Quezon City
VIRNALIE C. MIRANDA SECURITY ANALYSIS
MODULE QUIZ 1 DR. DAISY AILEEN E. BALDONILLO
1. Discuss the difference between the top-down and bottom-up approaches. What is the major
assumption that causes the difference in these two approaches?
The top-down valuation process begins by examining the influence of the general economy on all firms
and the security markets. The next step is to analyze the various industries in light of the economic
environment. The final step is to select and analyze the individual firms within the superior industries and
the common stocks of these firms. The top-down approach thus assumes that the first two steps
(economy-market and industry) have a significant influence on the individual firm and its stock (the third
step). In contrast, the bottom-up approach assumes that it is possible to select investments (i.e. firms)
without considering the aggregate market and industry influences.
2. What is the benefit of analyzing the market and alternative industries before individual securities?
There are several possible benefits to analyze the market: to conduct a company stock valuation and
predict its probable price evolution, to make a projection on its business performance, to evaluate its
management and make internal business decisions, to calculate its credit risk.
3. Discuss why you would not expect all industries to have a similar relationship to the economy. Give an
example of two industries that have different relationships to the economy.
so the 2 industries I pick are corn and ethanol, so how they will they affect the economy affect them
differently, so they Different different industries fit in different stages of production, okay, and so that
different stages of production really mean different kind of parts. In the economy, for example, corn
industry is in the primary stage of producing raw goods and corn. The final industry is in the secondary
stage, manufacturing corn fuel. The economies affect them differently, because their pricing and
processes are different, like how, like the corn has grown out of the ground. You know so there they
depend on weather and soil. You know and then ethanol well, that kind of depends on corn you, you
know they different things affect them, but they're part of the same kind of production line yeah. So, the
processes are different prices change differently for things in different stages.
4. Discuss why estimating the value for a bond is easier than estimating the value for common stock.
Estimating the value for a bond is easier than estimating the value for common stock since the size and
the time pattern of returns from the bond over its life are known amounts. Specifically, a bond promises
to make interest payments during the life of the bond (usually every 6 months) plus payment of principal
on the bond’s maturity date. With common stock, there are no such guarantees. In addition, the required
return on a bond is based upon factors such as time to maturity and credit rating. Using financial market
data an investor can determine what the appropriate yield to maturity should be on a bond under
consideration for purchase. The common stock it is much more difficult to estimate required return.
5. Would you expect the required rate of return for a U.S. investor in U.S. common stocks to be the same
as the required rate of return on Japanese common stocks? What factors would determine the required
rate of return for stocks in these countries?
Investors demand a higher risk-free rate of return (which might correspond, for example, to the 10-year T-
bond rate) in countries where the inflation expectation is higher. This rate is currently higher in the US
than (for example) Europe and Japan, and our currency value with respect to the world's other major
currencies is also falling.
The required rate of return for stocks tends to be higher than that for bonds, because of the higher
volatility of stocks. Therefore, two factors influencing the relative rate in different countries are 1:
inflation expectation for the currency and 2: stock market volatility (usually represented by a "beta"
coefficient). Most developing countries have a higher stock market beta than the USA. Japan suffered a
major stock market collapse and slow recovery that has lasted over 20 years. Memories of this continue
to affect investor confidence in Japan.
