FIN 303 Exam 3 Study Set
Compute the free cash flow to equity for a firm with the following conditions (each account is reported on a per share basis): Net Income - $14.10 Depreciation - $4.31 Proceeds from bond issue - $3.11 Total Debt Repayments - $0.19 Change in Net Working Capital - $0.00
$21.33
Blue Packaging Company (BPC) expects to pay a dividend of $1.28 in exactly one year. BPC has recently invested in multiple wealth increasing projects and expects its operating cash flow to increase dramatically for a few years. BPC expects a dividend growth rate of 50% during years 2, 3, and 4. After that high growth period, a normal growth rate of 3.1% will occur. BPC shareholders require a 14.7% return. The value of BPC stock is closest to:
$29.14 Explanation: First step is to determine the dividend stream up to the first dividend paid after the high growth period ends: D0= 0 D1= 1.28 D2= 1.28 × 1.50 = 1.92D3= 1.92 × 1.50 = 2.88 D4= 2.88 × 1.50 = 4.32 D5= 4.32 × 1.031 = 4.45 Second step is to compute the expected stock value at the time of the final high growth period dividend: Value4 =4.45/(0.147 - 0.031)= 38.36 Third step is to compute the present value of the dividend stream during the high growth period plus the expected stock price before the normal growth period begins (terminal value). CF0= 0; CF1= 1.28; CF2= 1.92; CF3= 2.88; CF4= 4.32 + 38.36; I = 14.7% Solve for NPV = 29.14
An issue of preferred stock pays an annual dividend of $4.29 while the firm's preferred shareholders require an 8.1% return. The value of this preferred stock is closest to:
$52.96
The Benson bond is a 1% coupon bond with semi-annual coupon payments that matures in 22 years. If the YTM for this bond is 3.5%, what is the value of the bond?
$618.65 Explanation: FV = $1,00,000 N= 44 I= 1.75% PMT= $5.00 PV= ???
Jocko observes the expected return for Delta Company stock is -5%. The market return and the risk-free return are 10% and 4%, respectively. According to CAPM, the beta for Delta is closest to:
-1.5
The North Equity Fund has a beta of 1.67 and a standard deviation of 22.6%. It has returned 13.8% during the past year when the return on one-year treasury bills has been 3.6%. The Sharpe Ratio of the North Equity Fund is closest to:
0.45 Explanation: Sharpe = (Portfolio Return - Risk Free Rate)/(Standard Deviation) Sharpe = (13.8 - 3.6)/22.6=0.45
Which of the following is(are) among the responsibilities of FINRA? 1. Educating investors. 2. Fostering market transparency. 3. Writing and enforcing rules governing the activities of all registered broker-dealer firms and registered brokers in the U.S. 4. Writing and enforcing rules governing the activities of all registered investment advisors.
1,2, and 3
Uncle Kevin invests $5,500 in AAA stock, $7,000 in BBB stock, and $7,500 in CCC stock. AAA, BBB, and CCC have expected returns of 12%, 8.5% and 7.3%, respectively. What is Uncle Kevin's weighted after tax return assuming he is in the 33% (combined federal and state) marginal tax bracket?
6.00% Explanation: His weighted return equals 9%, as indicated above. However, his after-tax weighted return equals 6% (9% x (1- 33% tax rate).
Arthur is considering purchasing a 12-year bond that is selling for $1,300. What is the current yield for this bond if it has an 8% coupon, paid semi-annually?
6.15%
Consider both the CAPM formula and weighted average portfolio beta calculations. Which of the following is correct for an asset with a negative beta? I. Negative beta assets are expected to return less than the riskless rate when the risk premium is positive. II. A negative beta asset can be combined with a positive beta asset to produce a zero beta portfolio. III. Negative beta assets do not provide any diversification benefits.
I and II Explanation: Negative beta assets are expected to return less than the riskless rate (when the return for the market is positive) but can be combined with positive beta assets to produce a zero beta portfolio.
Which of the following is/are correct concerning convertible bonds? I. Are likely to pay a lower yield than a comparable non-convertible bond. II. Are likely to pay a higher yield than a comparable non-convertible bond. III. Are more likely to be converted when a company's stock underperforms. IV. Are more likely to be converted when a company's stock outperforms.
I and IV Explanation: Since a conversion feature is valuable to bondholders, they are likely to provide a lower yield than a comparable non-convertible bond and it will be of greatest value as the stock rises or outperforms.
Which of the following statements correctly identify significant differences between modern portfolio theory (MPT) and behavior finance (BF)? I. MPT assumes all investors have perfect knowledge of investments while BF assumes investors work with incomplete knowledge. II. MPT assumes investors are averse to losses while BF assumes investors are averse to risk. III. MPT assumes investors price securities heuristically while BF assumes investors price securities rationally. IV. MPT assumes new information is quickly priced into the market while BF assumes price adjustments are not immediate and incomplete.
I and IV Explanation: Statements 1 & 4 are correct. Statements 2 & 3 reverse the assumptions between the two theories.
Which of the following statements is CORRECT regarding TVM Time Lines? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods. c. Time lines are useful for visualizing complex problems prior to doing actual calculations. d. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
c. Time lines are useful for visualizing complex problems prior to doing actual calculations. Explanations: Time lines can be constructed for all situations provided in the answers, and are useful for visualizing complex problems before doing calculations. Time line cash flows can be annuities, uneven cash flows, annual, quarterly, or even different time periods (i.e. monthly and quarterly).
Austin invested in the Very Value mutual fund 5 years ago. His returns were 25%, -5%, 10%, 0% and 50%, respectively. What is the difference between the arithmetic average and the geometric average return over the five years?
1.6%
TBT stock pays a $3 dividend, semi-annually, and has earning per share of $9. If the stock is currently trading at $60, what is the dividend yield percentage?
10.00%
Eugene is single and in the 32% federal and 3% state tax brackets. He is considering the purchase of a municipal bond, issued in a state other than his state of residence, with a YTM of 7%. What is Eugene's tax equivalent yield on the bond?
10.29% Explanation: The tax equivalent yield is calculated using the formula: [municipal rate/(1-tax bracket)]. Municipal bond interest is not subject to tax at the federal level, and not subject to tax at the state level if the bondholder is a resident of the state in which the issuing municipality is located. Eugene does not live in the state in which the issuing municipality is located so he has to pay state tax. Therefore, he will save a total of 32% (federal only) in taxes by purchasing the municipal bond. The tax equivalent yield is: 7/(1-.32) = 10.29%.
A large international financial institution is expected to pay a $10.16 dividend in one year. The growth rate is 4.9% and the institution's current market value is $181.34. The shareholders required return is closest to:
10.5%
Rick invested in the Hyper Growth mutual fund 5 years ago. His returns were 26%, -10%, 15%, 3% and 31%, respectively. What was the geometric average return over the five years?
12%
Troy is investing $48,000 in Fund A and $32,000 in Fund B. Fund A and Fund B have betas of 1.4 and 1.1, respectively. If the expected market return is 12% and the risk-free rate of return is 3%, what is the expected return for the portfolio using the CAPM?
14.52%. Explanation: CAPM = Rf + β(Rm - Rf) Weighted average beta:60% is invested in Fund A40% is invested in Fund B Portfolio beta = .60(1.4) + .4(1.1) = 1.28 Portfolio return = 3% + 1.28(12% - 3%) = 14.52% Alternative Calculation: Fund A: CAPM = 3% + 1.4(12% - 3%) = 15.6% Fund B: CAPM = 3% + 1.1(12% - 3%) = 12.9%Weighted average return:60% is invested in Fund A40% is invested in Fund B0.6(15.6%) + 0.4(12.9%) = 9.36 + 5.16 = 14.52
Callen is a young DPT and invests in the Bourgeois tech fund that has a beta of 2.0. If the expected market return is 11% and the risk-free rate of return is 4%, what return should Callen expect from the Fund?
18%
Fred bought 100 shares of Apple at $115 per share. One year later he sold the stock for $152 per share. During the year, Apple declared and paid dividends of $2 per share. What was Fred's holding period return?
34%
Hiral is considering the following AA rated bonds. Which of these has the most interest rate risk? A 10-year bond with a 4% coupon. A 10-year bond with a 3% coupon. A 15-year bond with a 3% coupon. A 20-year bond with a 3% coupon.
A 20-year bond with a 3% coupon.
Which would least likely be classified as an investment adviser by the Securities and Exchange Commission?
A financial firm that acts as a dealer in investment grade bonds. Explanation: Broker-dealers are explicitly excluded from being classified as advisers under the legal framework of the Investment Advisers Act. Individuals or firms that issue reports or offer investment advice, including asset allocation decisions, are considered to fit the definition of an investment adviser.
Which of the following statements is not correct? A puttable bond can be exchanged for equity shares of the issuing company. Callable bonds have higher YTMs than non-callable bonds with the same default risk and maturity. The YTM for a bond is the IRR (internal rate of return) of the cash flows that the investor earns if the bond is held to maturity. A bond that matures in ten years, has a 4% coupon rate, makes semi-annual coupon payments, and is selling in the market for $800 will pay the bondholder a semi-annual coupon amount of $20.
A puttable bond can be exchanged for equity shares of the issuing company. Explanation: A puttable bond contains an option that allows the bondholder to sell the bond back to the issuer at a predetermined price prior to the stated maturity of the bond. A convertible bond gives the option to convert to equity shares. The YTM for a bond is the IRR of the cash flows that the investor earns if the bond is held to maturity and if the cash flows are reinvested at the YTM rate. It is very unlikely that the YTM will be the actual return, unless the bond is a zero-coupon bond. Callable bonds will tend to have a higher YTM than non-callable bonds with the same default risk and maturity since there is more risk for the investor. The coupon rate is the rate of interest paid on the par value of a bond, not the market value of the bond. Par value is always $1,000. Therefore, the coupon payment equals $40 per year or $20 each coupon payment.
Which of the following reduces the number of outstanding shares and increases the share price proportionately?
A reverse stock split.
What is a distribution of additional shares to shareholders in lieu of cash?
A stock dividend.
An asset allocation strategy that is most likely to result in actual portfolio weights that can vary greatly from their original strategic weights is:
Buy and hold strategy. Explanation: Buy and hold implies the investor does not rebalance the portfolio weights even after significant swings in prices. This can result in weights that are substantially different than the beginning of period weights and is very likely to produce a portfolio with greater volatility than originally intended.
The level of risk tolerance is a measure of an investor's:
Ability and willingness to accept risk.
Ivan is considering purchasing a 20-year bond that is selling for $1,055. Which of the following is correct if this bond has a 3.75% coupon, paid semi-annually? All of the above. The current yield > YTM. The YTM < current yield. The coupon rate > current yield.
All of the above Explanation: For bonds selling at a premium, the relationship between the Coupon Rate (CR), YTM, and Current Yield (CY) is: CR > CY > YTM.
A municipal bond would least likely be classified as a revenue bond if it were issued for:
An upgrade to fire prevention facilities.
A firm has $5 billion outstanding in long-term bonds. The firm currently has sufficient cash flow to make the scheduled coupon payments but would struggle to make those payments in the future if a substantial weakening of the economy occurs. The most likely rating on these bonds is:
BBB
Which of the following is not one of Porter's five competitive forces used to evaluate the attractiveness of a specific industry?
Bargaining power of employee unions. Explanation: Bargaining power of employee unions is not one of Porter's Five Forces. Rivalry amont competitors, threat of new entrants, and substitute products are competitive forces. The remaining two competitive forces are bargaining power of buyers and bargaining power of suppliers.
According to the capital-asset pricing model (CAPM), a security's expected (required) return is equal to the risk-free rate plus a premium:
Based on the systematic risk of the security.
Ollie is considering two portfolios: 1) Portfolio A with a return of 10% and a standard deviation of 20% and 2) Portfolio B with a return of 6% and a standard deviation of 8%. Assuming the correlation between A and B is +0.2 and he invests 40% in A and 60% in B, what is the portfolio standard deviation?
Between 6% and 11%.
Which of the following statements about Treasury bills and commercial paper are correct? Neither of the choices provided are correct. Assuming the same maturity, yields on commercial paper will be higher than yields on T-bills. Both choices provided are correct. T-bills have less default risk than commercial paper
Both choices provided are correct. Explanation: T-bills are default risk free, while commercial paper has some, although minor, default risk. As a result of this potential default risk, commercial paper will have slightly higher yields.
Which of the following is NOT correct regarding the CAPM? Conceptually, the CAPM represents expected returns for various combinations of the risk-free rate of return and the market portfolio. The CAPM assumes all investors are rational and have uniform expectations about the risk-return relationship for investment alternatives. The CAPM assumes investors can borrow at the risk-free rate of return, as well as lend at the risk-free rate of return. CAPM is based on the notion that expected returns on individual stocks depends on their total risk levels.
CAPM is based on the notion that expected returns on individual stocks depends on their total risk levels.
The measure of "risk per unit of expected return" is most likely referred to as the:
Coefficient of variation.
Which of the following statements is most accurate? Firms with low PB ratios are value firms and tend to outperform high PB firms. The biggest drawback of using PCF ratio is its inability to address operating efficiency. Higher PEG ratios imply undervalued stocks. PCF is a preferred relative measure compared to PE.
Firms with low PB ratios are value firms and tend to outperform high PB firms. Explanation: Low PB stocks tend to outperform because they are identified as value stocks.
Investors are willing to pay a premium for predictable dividends because:
Dividends reduce uncertainty.
The piece of legislation whose purpose is to reduce the volatility in financial markets is most likely the:
Dodd Frank Act of 2010.
All of the following are correct regarding market capitalization-weighted indexes except:
Does not need to be modified over time as companies are added to or deleted from the index.
An asset allocation strategy that is most likely to result in the purchase of securities when prices rise is:
Dynamic Allocation Strategy Explanation: Dynamic allocation strategy allows the weights to follow market performance. Consequently, a bull market results in an increase in allocation to those securities rising in value.
Which of the following is NOT one of the primary responsibilities of the Federal Reserve?
Ensure consistent positive returns in the equity markets.
Max invests in a portfolio with a beta of zero. What is the portfolio's expected return?
Equal to the risk-free rate of return.
The beta of a portfolio is:
Equal to the weighted beta of the portfolio.
Uncle BJ, who lives in Carthage, Mississippi, invested in a Microsoft 10-year bond with a 2% coupon payment, paid semi-annually. Which of the following risks is he NOT subject to?
Exchange rate risk. Explanation: Uncle BJ's bond is subject to interest rate risk, default risk and reinvestment rate risk, but is not subject to exchange rate risk.
Increasing inflation rates and increasing interest rates would be characteristic of:
Expansion
Distinguish between fundamental and technical analysis.
Fundamental analysis is a form of economic analysis in which the basic fundamentals of a company are evaluated as part of a process of determining the intrinsic value of a firm or security. Fundamental analysis includes any relevant information that would impact the firm's profitability. Technical analysis is an asset allocation tool that uses historical asset prices and volume to make portfolio selection decisions. In technical analysis the intrinsic value, economic conditions, and firm profitability are not considered.
The higher the beta, the ____ of the security involved.
Greater the unavoidable risk.
A large firm that pays a substantial dividend and has several globally known brand names in the soft drink industry and trades on the NYSE would least likely to be characterized as a(n):
Growth Stock Explanation: Growth firms are those with high revenue, earnings, or cash flow expectations as compared to their competitors. A large firm that has been existence for more than one-half a century with branded product lines is not likely to be a high growth firm. It is certainly an income stock with the substantial dividend payment and is very likely a blue-chip stock. It could also be a defensive stock, one whose performance does not depend on economic growth.
When using a dividend discount model, the least likely included input variable is the:
Growth rate in the return on equity.
A financial analyst is least likely to use a free cash flow model to value a firm's equity if:
Growth rates in dividends fall gradually over time and are easily estimated.
Which of the following is/are not correct concerning bonds? I. Serial bonds have multiple maturity dates. II. Sinking fund bonds require the company to periodically redeem a portion of the bond prior to maturity. III. Zero coupon bonds are not subject to OID (original issue discount) rules.
II and III Explanation: Statements II and III are the incorrect statements. Sinking fund bonds require the company to periodically set aside funds into a trust to redeem the bonds at maturity, not prior to maturity. Zero coupon bonds are subject to OID rules and investors must pay taxes on imputed interest annually.
Which of the following would likely cause a bond to have a lower market value? (Hint: consider the inverse relationship between interest rates and bond prices; determine if each situation given would result in a higher or lower interest rate) I. The issuer's credit rating changed from A to AA. II. The issuer's credit rating changed from AA to A. III. The YTM of comparable securities rose. IV. The YTM of comparable securities declined.V. The bond included a call feature.
II, III and V. Explanation: If a company's credit rating improved (A to AA), investors would accept lower return and the market price of the bond would rise. If the YTM of comparable securities rose, investors would demand a higher return and the bond's price would decline. All other things equal, a callable bond will need to pay a higher return (or sell at a lower price) than a non-callable bond.
Which of the following is/are non-diversifiable risks? I. Industry risk. II. Unsystematic risk. III. Systematic risk. IV. Company risk.
III only
Which of the following statements about PE ratios is correct?
If the required return for shareholders decreases, it will cause the PE ratio to increase.
Four portfolio managers have generated superior performance against each of their benchmarks and the stock market in general. The manager least likely to replicate performance in the future is the one who:
Increases allocation to any stock that changes its corporate name. Explanation: Portfolio managers who use relative valuation or discounted cash flow techniques are much more likely to be able to replicate their superior performance than one who makes decisions based on superfluous variables, such as a name change.
Bonnie Brooks, CFA®, believes she has found a country whose financial markets exhibit pricing that reflects neither historical prices nor volume. The market is most likely:
Inefficient
Which of the following is an advantage of a moving average line?
It smooths out minor short-term variations in price changes. Explanation: A moving average line is used an indicator of long-term trends, smoothing out short-term price variations.
JuiceBox, Inc. has a market capitalization of $50 billion and is classified as a _________________.
Large-cap company.
A "defensive" stock would most likely have a "beta" that is:
Less than one
Security A has the following returns over four years: 4%, 7%, 0%, and -1%. What is the mean return and the standard deviation (sample) for Security A?
Mean of 2.5% and standard deviation of 3.7%.
Which of the following tools of technical analysis is used to assess investor sentiment?
Market Volume
Beta:
Measures systematic risk
A financial adviser manages an equity portfolio for an endowment fund, which has an 8.2% return objective. The adviser makes a strategic allocation recommendation that produces a return of 8.5% in an economy that has experienced a 2.9% rate of inflation. The advisor also creates her own benchmark for the fund which includes multiple indexes that have similar risk profiles of the securities in the fund. The benchmark return during the period is 8.9%. Is the endowment fund satisfied with the advisor's performance?
No, because the fund underperformed the benchmark. Explanation: While the fund did return more than the return objective, it still lagged the benchmark return. The fund is not likely to be satisfied with the relative performance, especially since the return objective includes a measure of inflation.
Which of the following is correct regarding a callable bond? The callable bond will have a lower YTM than a similar non-callable bond. The callable bond is more likely to be called when interest rates increase in an attempt to reduce interest expense. The callable bond is attractive due to its higher par value. None of the above.
None of the above
Perfectly correlated assets will most likely have correlation coefficients:
Of -1.0 and +1.0.
Now that you are taking FIN 303 you know that you should invest some money each month from now until you retire. What amount do you need to invest at the end of each month if you want to have $2,000,000 at the end of 35 years, and you can earn a rate of 7.5% (compounded monthly)? Show your calculator or Excel inputs for partial credit.
PV = 0, N = 35 x 12 = 420, I = 7.5/12 = .625, FV = 2,000,000, PMT = ? I need to invest $984.85/month to meet my goal!
Which of the following stages of the industry life cycle is characterized by limited competition and high profit margins?
Rapid Growth Explanation: In the rapid growth stage, the market is developed and there is substantial demand with limited competition, resulting in high profit margins.
Bass is considering two portfolios: 1) Portfolio A with a return of 13.7% and a standard deviation of 8% and 2) Portfolio B with a return of 7% and a standard deviation of 3%. Which of these two portfolios provides the least risk per unit of return?
Portfolio B with a Coefficient of Variation (CV) of .429 CV = standard deviation/expected/return Portfolio A CV = 8%/13.7% = .584 Portfolio B CV = 3%/7% = .429 Portfolio B has the lowest CV and the least risk per unit of return. This is the better portfolio to minimize risk.
Portfolio X has a weighted beta coefficient of 1.5 and Portfolio Y has a weighted beta coefficient of 0.8. Both portfolios are expected to earn the same weighted average expected return. With these assumptions, which of the following statements is correct? Portfolio X is preferred because it has a higher beta. Portfolio X is preferred because it has a higher standard deviation. Portfolio Y is preferred because it has a lower beta. Portfolio Y is preferred because it has a lower standard deviation.
Portfolio Y is preferred because it has a lower beta.
Consider the chart with the six portfolios and the efficient frontier. Which of the following statements is correct?
Portfolios H, F, and G have the same level of risk. Explanation: Choice a is incorrect because, while A, F, and B all have the same return, only Portfolio B is efficient. Portfolios B, C, and D are all efficient. Portfolios A, F, and G are all inefficient as there are other attainable portfolios with a higher return for the given level of risk. Portfolio H is unattainable.
The primary use of secondary equity markets is most likely to:
Provide marketability for investors to trade stocks.
A fixed-income money manager increases the duration of a portfolio beyond its strategic duration level because she expects a decline in yields. Over the next year, yields gradually fall and the manager outperforms the benchmark. The outperformance is most likely due to the:
Rate Anticipation Effect Explanation: The rate anticipation effect measures the return differential that can be attributed to deviations in the duration of the portfolio away from the benchmark duration. The rate anticipation effect is the result of a tactical shift away from the strategic duration to take advantage of short-term interest rate movements. Outperformance because of an anticipation of yield changes is a relatively short term effect.
A money manager generates a return of 11% when the benchmark returns 9%. The manager's asset allocation decisions underperform by 50 basis points. Which is most accurate? Asset allocation decisions helped the manager outperform the benchmark. The manager outperforms the benchmark by 250 basis points. The manager excelled in both asset allocation and security selection decisions. Security selection decisions outperform by 250 basis points.
Security selection decisions outperform by 250 basis points. Explanation: Total outperformance can be divided into asset allocation and security selection decisions. The total outperformance in this case is 200 basis points. If the manager underperformed in asset allocation by 50 basis points, the difference had to be made up in the security selection decision. Security selection therefore, had to be 250 basis points.
The intersection of the security market line and the y axis occurs at the:
Risk-free rate of return.
Maggie considers four potential securities with identical expected returns as part of her asset selection decision. Which security and which level of dependence with the current portfolio would most likely provide Maggie with the highest diversification benefits? Security 1 with a correlation coefficient of +1.0. Security 2 with a correlation coefficient of +0.32. Security 3 with a correlation coefficient of 0.00. Security 4 with a correlation coefficient of -0.38.
Security 4 with a correlation coefficient of -0.38. Explanation: Since the returns of the four potential securities are the same, the primary consideration is the risk element. The best security is the one with the lowest correlation, which is Security 4.
Assume that Dinah wants to add a security to her portfolio that will reduce the variability in the portfolio returns. Which of the following securities would you recommend if the correlations below are between each security and Dinah's portfolio? Security A: Correlation = -0.82. Security B: Correlation = -0.50. Security C: Correlation = +0.38. Security D: Correlation = +0.78.
Security A: Correlation = -0.82.
Which of the following would a financial adviser most likely identify has having the highest risk using the coefficient of variation? Security A with an expected return of 8% and a standard deviation of 9%. Security B with an expected return of 12% and a standard deviation of 14%. Security C with an expected return pf 5% and a standard deviation of 0%. Security D with an expected return of 15% and a standard deviation of 15%.
Security B with an expected return of 12% and a standard deviation of 14%.
A portfolio consists of 50% equity index fund and 50% fixed-income index fund. The portfolio will be reallocated using the constant weighting method. More details are shown below: Equity Index: Share: 1,000; Net Ass Value: $20; Total value: $20,000 Fixed-Income Index: Shares: 800; Net Ass Value: $25; Total Value: $20,000 The new allocation decision if the price of the Equity Fund changes to $22 and the price of the Fixed Income Fund changes to $30 is most likely to:
Sell 33 shares of Fixed-Income and purchase 46 shares of Equity. Explanation: To maintain a constant weighting allocation, $1,000 of Fixed-Income should be sold and $1,000 of Equity should be purchased.Sell 33 shares of Fixed-Income to receive $990 (33 × $30).Buy 46 shares of Equity to pay $1,012 (46 × $22).This produces a portfolio with approximately $23,000 in both assets, consistent with the strategic allocation.
If the Federal Reserve wants to increase interest rates, which of the following actions might it take?
Sell Gov. Securities
You just won the $1,000,000 lottery. You can receive a 20 year annuity of $50,000 per year at the end of each year (50,000*20 = 1,000,000) OR take a cash payout now of $500,000. If you have a required return of 7%, which is the better option? (Hint: You need to compare these two options at the same point in time, either in today's dollars or in future dollars 20 years from now.) Show your calculator or Excel inputs for partial credit.
Sidney, though your choice was correct, it looks like the entries for PV and FV were confused. PV of $500,000 = $500,000 (this is already in today's dollars) PV of $50,000 annuity: N = 20, I/Y = 7%, PMT = -50,000, FV = 0, PV = ?; PV = $529,700.71 If I require a 7% return, the annuity is the better choice.
A portfolio manager computes a relatively low price-to-book ratio for the small cap firms in the portfolio. The manager computes an intrinsic value of European indexes that match the current market value. Relative valuation by the manager indicates large cap price multiples are in line with their historical values. The manager currently has the following allocations: 20% small cap equities, 55% large cap equities, 20% European mid-cap equities, and 5% cash. A tactical decision to deviate from strategic weights would most likely include an increase in portfolio weights to:
Small Cap Equities Explanation: Low price-to-book value ratios are a good indication that shares are undervalued. A reasonable tactical response would be for the manager to increase the allocation to small cap equities. Since European stocks and large cap stocks are not undervalued, there is no compelling reason to increase their weights. Cash will likely remain at 5%.
Devon Baines is a board member with DDO Inc., a large pharmaceutical firm. At a recent meeting, the board votes to take over a smaller competitor whose shares trade in the OTC market and are priced at $50 per share. DDO will offer $75 per share and the offer will become public ten hours after the meeting. Baines decides to purchase shares in the target firm immediately after the meeting, but when he calls his broker to place the order, he is informed the price of the target firm is $72. The market is most likely:
Strong form Explanation: A market in which prices reflect all relevant information including private information is a strong form market. In this case, Baines was hoping to purchase at $50 but was only able to place the order when the price had risen to $72 per share, indicating that the price already reflected the new information about the takeover. This can only occur in a strong form market.
Bob owns a 10-year bond (Bond A) that is selling for $969. He finds another bond (Bond B) with identical characteristics that is priced at $922 and decides to sell Bond A and buy Bond B. What is this type of strategy called?
Substitution swap
Which of the following is NOT correct about TIPS? TIPS have maturities that do not exceed 20 years. The dollar amount of interest paid (coupon payment) on TIPS changes based on inflation and the changing principal amount of the TIPS. TIPS can be purchased on a competitive or noncompetitive basis. If deflation occurs over the life of the TIPS, then the investor receives the greater of the principal amount or the par value.
TIPS have maturities that do not exceed 20 years. Explanation: The interest rates on TIPS do not change. Instead, the principal amount changes based on inflation or deflation. This causes the dollar amount of interest paid to increase or decrease because the amount paid is based on the rate x the principal amount. TIPS are issued by the U.S. Treasury on both a competitive and noncompetitive basis. Maturities for TIPS can be as long as 30 years. Upon maturity, investors receive the greater of par value or principal value.
A financial analyst uses the 50-day trading history of a mid-cap stock to determine if the stock is undervalued. The analyst is most likely using:
Technical Analysis Explanation: Technical analysts use historical price or volume data to discover patterns or trends in pricing. If they find a trend, they purchase shares until the trend disappears.
Examples of income stocks least likely exclude:
Technology
Which of the following is correct regarding the CAPM? The CAPM assumes investors are not rational and have certain behavioral biases. The CAPM assumes investors have modest transaction costs (including taxes). The CAPM implies that the return of an investor equals the market premium magnified by the portfolio's beta plus the risk-free rate of return. CAPM believes that a portion of unsystematic risk remains even after diversification.
The CAPM implies that the return of an investor equals the market premium magnified by the portfolio's beta plus the risk-free rate of return. Explanation: Choice a is incorrect as CAPM assumes investors are rational, not irrational. Choice b is incorrect as CAPM assumes no transaction costs or taxes. Choice c is correct.
Which of the following is an index in which the price of the stocks in the index are added together and divided by an adjusted value?
The Dow Jones Industrial Index.
Which of the following is correct regarding a bond's YTM? The YTM is higher than the coupon rate when the bond is trading below $1,000. The rate equates the future cash flows to the price of the bond, assuming the coupon payments are reinvested at the coupon rate. The YTM will equal the coupon rate if the par value of the bond equals $1,000. The YTM is always higher than or equal to the coupon rate.
The YTM is higher than the coupon rate when the bond is trading below $1,000. Explanation: The YTM exceeds the coupon rate when the bond is trading at a discount and is lower than the coupon rate when the bond is trading at a premium. They will be equal when the bond is trading at par value, not when the par value equals $1,000. YTM equals the rate that equates the future cash flows to the price of the bond, assuming the coupon payments are reinvested at the YTM rate, not the coupon rate.
Brett is considering purchasing a 9-year bond that is pricing such that its YTM is 3%. Which of the following is correct if this bond has a 2.5% coupon, paid semi-annually?
The current yield is between 2.5% and 3%. Explanation: For bonds selling at a discount, the relationship between the Coupon Rate (CR), Yield to Maturity (YTM), and Currrent Yield (CY) is: CR < CY < YTM. In this case the CY is between the YTM and CR.
Which of the following will cause free cash flow to equity to increase?
The federal government decreases the tax rate on companies to attract more business to the U.S.
Discuss why investors choose equities to includes in their portfolios.
The main reason investors choose to include equities in their portfolios is because common equity returns have been significantly higher than returns for most other asset classes over a long period of time. While there is significant risk from investing in equities, the reward (return) is commensurate and compensates for this risk.
Ace, Inc. has net earnings of $3.6 billion this year. It has 600 million shares of common stock outstanding and it paid 75 cents per share per quarter this year. Which of the following is correct?
The retention ratio equals 50%.
Which of the following can be greatly reduced by diversification? Systematic risk. Market risk. Unsystematic risk. Systematic and unsystematic risk.
Unsystematic risk.
All of the following are correct regarding common stock ownership, except:
When a corporation dissolves, the common stockholders are the first to be paid from the assets of the company.
Which would most likely be classified as a primary market transaction?
Which would most likely be classified as a primary market transaction?
Which of the following statements is CORRECT regarding annuity payments? a. The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month. b. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity. c. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. d. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods. e. The cash flows for an annuity due must all occur at the ends of the periods.
a. The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month. Explanation: An annuity has equal payments that occur at regular intervals. Payments occur at the beginning of a period for an annuity due and at the end of a period for an ordinary annuity. Your textbook defines annuities with some payments at the beginning and some at the end of a period as a mixed annuity.
Which of the following should be considered when building a portfolio? Check all that apply. a. Market timing. b. The length of time available for your assets to earn returns. c. A need for liquid assets (cash). d. Credit card debt. e. Ability and willingness to take risks.
b. The length of time available for your assets to earn returns. c. A need for liquid assets (cash). e. Ability and willingness to take risk. Explanation: Time horizon, liquidity needs, and the ability and willingness to take risks are portfolio considerations along with return objectives and tax implications. Credit card debt is not a portfolio consideration but should be considered in the overall financial plan and may affect the ability to make greater portfolio contributions. Market timing is not a portfolio consideration and should not be considered as an investing strategy either. It is difficult to time the market, and this approach does not work out well for the average investor.
