Financial Management 543 Part 2

QUESTION 1

A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?

                       

The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity.

                       

The periodic interest rate is greater than 3%.

                       

The periodic rate is less than 3%.

                       

The present value would be greater if the lump sum were discounted back for more periods.

                       

The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually.

 

QUESTION 2

Your bank offers a 10-year certificate of deposit (CD) that pays 6.5% interest, compounded annually. If you invest $2,000 in the CD, how much will you have when it matures?

                       

$3,754.27

                       

$3,941.99

                       

$4,139.09

                       

$4,346.04

                       

$4,563.34

 

 

QUESTION 3

You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?

                       

The discount rate increases.

                       

The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.

                       

The discount rate decreases.

                       

The riskiness of the investment's cash flows increases.

                       

The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years

 

QUESTION 4

How much would Roderick have after 6 years if he has $500 now and leaves it invested at 5.5% with annual compounding?

                       

$591.09

                       

$622.20

                       

$654.95

                       

$689.42

                       

$723.89

 

 

QUESTION 5

Which of the following statements is CORRECT?

                       

An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.

                       

The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity.

                       

If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%.

                       

If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.

                       

The proportion of the payment that goes toward interest on a fully amortized loan increases over time.

 

 

QUESTION 6

Of the following investments, which would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero.

                       

Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments).

                       

Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).

                       

Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).

                       

Investment D pays $2,500 at the end of 10 years (just one payment).

                       

Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments

 

QUESTION 7

A 15-year bond has an annual coupon rate of 8%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 6%. Which of the following statements is CORRECT?

                       

The bond is currently selling at a price below its par value.

                       

If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.

                       

The bond should currently be selling at its par value.

                       

If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today.

                       

If market interest rates decline, the price of the bond will also decline.

 

QUESTION 8

 

Which of the following statements is CORRECT?

                       

Most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature.

                       

A sinking fund provision makes a bond more risky to investors at the time of issuance.

                       

Sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time.

                       

If interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price.

                       

Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued.

 

QUESTION 9

Bonds A and B are 15-year, $1,000 face value bonds. Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT?

                       

One year from now, Bond A's price will be higher than it is today.

                       

Bond A's current yield is greater than 8%.

                       

Bond A has a higher price than Bond B today, but one year from now the bonds will have the same price.

                       

Both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.

                       

Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price.

 

 

QUESTION 10

The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

                       

Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.

                       

Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.

                       

Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.

                       

Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase.

                       

Bond A's current yield will increase each year.

 

QUESTION 11

Assume that interest rates on 15-year noncallable Treasury and corporate bonds with different ratings are as follows:

 

T-bond = 7.72%          A = 9.64%

AAA = 8.72% BBB = 10.18%

 

The differences in rates among these issues were most probably caused primarily by:

                       

Tax effects.

                       

Default risk differences.

                       

Maturity risk differences.

                       

Inflation differences.

                       

Real risk-free rate differences.

 

QUESTION 12

A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is NOT CORRECT?

                       

The bond's yield to maturity is 9%.

                       

The bond's current yield is 9%.

                       

If the bond's yield to maturity remains constant, the bond will continue to sell at par.

                       

The bond's current yield exceeds its capital gains yield.

                       

The bond's expected capital gains yield is positive.

 

QUESTION 13

Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?

                       

The prices of both bonds will remain unchanged.

                       

The price of Bond A will decrease over time, but the price of Bond B will increase over time.

                       

The prices of both bonds will increase by 7% per year.

                       

The prices of both bonds will increase over time, but the price of Bond A will increase by more.

                       

The price of Bond B will decrease over time, but the price of Bond A will increase over time.

 

 

QUESTION 14

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to the CAPM?

                       

Stock Y's realized return during the coming year will be higher than Stock X's return.

                       

If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.

                       

Stock Y's return has a higher standard deviation than Stock X.

                       

If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.

                       

If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.

 

QUESTION 15

Which of the following statements is CORRECT?

                       

If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one.

                       

If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.

                       

Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.

                       

A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.

                       

If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

 

QUESTION 16

Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks?

                       

The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.

                       

The beta of the portfolio is less than the average of the betas of the individual stocks.

                       

The beta of the portfolio is equal to the average of the betas of the individual stocks.

                       

The beta of the portfolio is larger than the average of the betas of the individual stocks.

                       

The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.

 

QUESTION 17

Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true, assuming the CAPM is correct.

                       

In equilibrium, the expected return on Stock B will be greater than that on Stock A.

                       

When held in isolation, Stock A has more risk than Stock B.

                       

Stock B would be a more desirable addition to a portfolio than A.

                       

In equilibrium, the expected return on Stock A will be greater than that on B.

                       

Stock A would be a more desirable addition to a portfolio then Stock B.

 

 

QUESTION 18

Stocks A and B are quite similar: Each has an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?

                       

Portfolio P has a standard deviation that is greater than 25%.

                       

Portfolio P has an expected return that is less than 12%.

                       

Portfolio P has a standard deviation that is less than 25%.

                       

Portfolio P has a beta that is less than 1.2.

                       

Portfolio P has a beta that is greater than 1.2.

 

QUESTION 19

Which of the following statements is CORRECT?

                       

The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers.

                       

Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future.

                       

If investors become less risk averse, the slope of the Security Market Line will increase.

                       

If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.

                       

The slope of the SML is determined by the value of beta.

 

 

 

 

QUESTION 20

 

A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?

                       

$23.11

                       

$23.70

                       

$24.31

                       

$24.93

                       

$25.57

 

QUESTION 21

 

Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT?

                       

If one stock has a higher dividend yield, it must also have a lower dividend growth rate.

                       

If one stock has a higher dividend yield, it must also have a higher dividend growth rate.

                       

The two stocks must have the same dividend growth rate.

                       

The two stocks must have the same dividend yield.

                       

The two stocks must have the same dividend per share

 

QUESTION 22

If a firm's expected growth rate increased then its required rate of return would

                       

decrease.

                       

fluctuate less than before.

                       

fluctuate more than before.

                       

possibly increase, possibly decrease, or possibly remain constant.

                       

increase.

 

QUESTION 23

 

The required returns of Stocks X and Y are rX = 10% and rY = 12%. Which of the following statements is CORRECT?

                       

If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X.

                       

If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price.

                       

The stocks must sell for the same price.

                       

Stock Y must have a higher dividend yield than Stock X.

                       

If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.

 

 

QUESTION 24

Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $32.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate?

                       

6.01%

                       

6.17%

                       

6.33%

                       

6.49%

                       

6.65%

 

 

QUESTION 25

Which of the following statements is CORRECT?

                       

The preferred stock of a given firm is generally less risky to investors than the same firm's common stock.

                       

Corporations cannot buy the preferred stocks of other corporations.

                       

Preferred dividends are not generally cumulative.

                       

A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.

                       

Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.

 


Answer

FIN 534 quiz 3

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