FIN 334 Chapter 4
Congress considers a bill that would eliminate the mortgage interest deduction for individuals. For the housing industry, this is an example of A) tax risk. B) interest rate risk. C) business risk. D) event risk.
A
If the present value of an investment's benefits equals the present value of the investment's costs, then the investor would earn a A) return equal to the discount rate. B) negative rate of return. C) 0% rate of return. D) return greater than the discount rate.
A
Inflation tends to have a favorable impact on A) real estate. B) common stock. C) preferred stock. D) bonds.
A
Investor's are motivated to purchase an asset because of its A) expected returns. B) past returns. C) emotional benefits. D) all of the above.
A
Negative reaction to Netflix's change of billing plans is an example of A) liquidity risk. B) event risk. C) business risk. D) purchasing power risk.
A
The adage "the sooner one receives a return on a given investment, the better," reflects the financial concept known as the A) time value of money. B) total return concept. C) historical dividend theory. D) expected yield factor.
A
The risk-free rate is equal to the real rate of return plus A) an expected inflation premium. B) a risk premium. C) both an inflation and a risk premium. D) the prevailing prime rate.
A
The stated rate of interest is equal to the true rate of interest when A) interest is compounded annually and the period in questions is exactly 1 year. B) interest is compounded continuously over one or more years. C) interest is compounded annually over a period of several years. D) interest is discounted rather than compounded.
A
To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, you should enter the following variables into a financial calculator. A) N=3, i=5, PMT=1000 B) N=3, i=5, FV=3000 C) N=3, i=15, PMT=1000 D) N=1, i=5, PMT=3000
A
Which one of the following statements is correct concerning the time value of money? A) The future value of $1 at the end of two years is equal to $1 plus the first year's interest times 1 plus the annual interest rate. B) As the interest rate increases for any given year, the future value interest factor will decrease. C) The future value of $1 decreases with the passage of time. D) The future value interest factor is equal to zero if the interest rate is zero.
A
Which one of the following will tend to decrease the rate of return on an investment? A) elimination of a tax exemption relevant to the investment B) reduction in tax rates C) stabilization of inflation rates at a reasonably low level D) increased assurance of reinvestment rates at the desired rate of return
A
A holding period return is calculated by adding the current income to the capital gains and dividing this sum by the A) average investment value. B) beginning investment value. C) total income received. D) selling price of the investment.
B
Inflation tends to have a particularly negative impact on the price of A) real estate. B) bonds. C) gold. D) crude oil.
B
Liquidity risk is defined as the risk of A) having to trade a security in a broad market. B) not being able to sell an investment conveniently and at a reasonable price. C) having inflation erode the purchasing power of your investment. D) having declining price levels affect the reinvestment rate of your current income stream.
B
Over the long term, which one of the following has historically had the lowest average annual rate of return? A) small-company stocks B) long-term government bonds C) large-company stocks D) long-term corporate bonds
B
The closest approximation to the real, risk-free rate of interest is A) The short-term Treasury bill rate plus the inflation rate. B) The short-term Treasury bill rate minus the inflation rate. C) The 10 year Treasury bond rate minus the inflation rate. D) The 10 year Treasury bond rate minus the 1 year Treasury bill rate.
B
The holding period return (HPR) can appropriately be used to A) compare the yield on investments held for any time period. B) compare returns among investments that are held for the same period of time. C) isolate realized capital gains. D) determine the required reinvestment rate for long-term investments.
B
The stock of Plomb Co. falls sharply on news that its CEO has drowned in a boating accident while on vacation. This is an example of A) liquidity risk. B) event risk. C) accidental risk. D) flotation risk.
B
To determine the compounded annual rate of return on investments held for more than a year, investors typically use the present-value-based measure known as yield or A) holding period return. B) internal rate of return. C) inflation-adjusted return. D) simple return.
B
Which of the following factors will increase the risk level of an investment? I. a firm's decision to use a high percentage of debt financing II. an economic situation in which consumer prices are rising at a rapid rate III. the ability to trade the investment in a broad market rather than in a thin market IV. unstable currency values A) I and II only B) I, II and IV only C) II and IV only D) I, III and IV only
B
Which of the following statements are correct concerning present value? I. The present value interest factor for a single sum is always equal to or less than 1. II. The lower the discount rate for a given year, the smaller the present value interest factor. III. The further in time, the smaller the present value interest factor. IV. The present value is equal to the future value only when the stated interest rate is 1%. A) I and II only B) I and III only C) II and III only D) I, III and IV only
B
Which one of the following is an example of an annuity? A) the receipt of $50 in January, March, April, June, August, September and December B) the payment of $259 a month for three consecutive years C) the payment of $389 in January, $200 in February, and $200 in March D) the receipt of $100 a month for three months and then $150 a month for two months
B
A petroleum refinery in the Gulf region is forced to shut down for several months because of hurricane damage. This is an example of A) market risk. B) speculation. C) event risk. D) business risk.
C
An ordinary annuity has cash flows that occur at the ________ of each time period and are ________ in amount. A) beginning; constant B) beginning; variable C) end; constant D) end; variable
C
Most investors are risk-averse, which means they A) refuse to accept any financial risk. B) invest only in government insured securities. C) require an increase in return for any increase in risk. D) gain satisfaction from the excitement of risk.
C
The holding period is a useful way to compare investments because it considers A) the time value of money. B) only capital gains, but not income. C) both income and capital gains or losses. D) the relative size of investments being compared.
C
The risk that the rate of return on an investment will be less than expected due to factors that are independent of the investment, such as political, social or economic events, is called A) business risk. B) financial risk. C) market risk. D) liquidity risk.
C
Which of the following is(are) issue characteristics of an investment? I. type of investment such as stocks or bonds II. state of the economy III. coupon or dividend payments IV. time to maturity A) I and II only B) III only C) I, III and IV only D) I, II, III and IV
C
Which of the following should be considered when deciding among alternative investments? I. time value of money II. risks associated with each investment III. risk free rate of return IV. personal risk tolerance level A) I and II only B) III and IV only C) I, II and IV only D) I, II, III and IV
C
Which one following will lower required rates of return? A) higher rates of inflation B) higher risk premiums C) lower rates of inflation D) lower dividend yields
C
10) An investment paying 4% compounded quarterly will have a value at the end of one year equal to A) an investment paying 16% compounded annually at the end of 1 year. B) an investment paying 2% compounded semi-annually at the end of 1 year. C) an investment paying 4% compounded annually at the end of 4 years. D) an investment paying 1% compounded annually at the end of 4 years.
D
A capital loss is computed by A) subtracting the original cost of an investment from the proceeds received from the sale of that investment minus any income from the investment. B) subtracting the original cost of an investment from the proceeds received from the sale of that investment plus any income from the investment. C) subtracting the proceeds received from the sale of an investment from the original cost of the investment. D) subtracting the original cost of an investment from the proceeds received from the sale of that investment.
D
Each of the following investments produces the same rate of return. Which one has the greatest amount of risk? A) investment A with a standard deviation of 4% B) investment B with a standard deviation of 12% C) investment C with a standard deviation of 8% D) investment D with a standard deviation of 19%
D
If a stock is purchased at the beginning of a year, a single dividend is paid at the end of the year and the stock is sold immediately after the dividend has been received. In this case A) the internal rate of return is lower than the holding period return. B) the holding period return. is lower than the internal rate of return. C) it is not possible to calculate the internal rate of return. D) the internal rate of return equals the holding period return.
D
In which of the following circumstances would it be most appropriate to use the holding period return? A) to compare the capital gains on a house held for 8 years and a mutual fund held for 6 years B) to compare the calendar year performance of stocks purchased in March to stocks purchased in September C) to compare the dividend yield of stocks to the interest rate on bonds D) to compare the performance of several stocks, each of which was held throughout an entire year
D
Stocks in which of the following industries may be impacted by government actions? A) health care B) housing C) defense D) all of the above
D
The difficulty many investors experienced in selling mortgage based securities during the financial crisis of 2009 is an example of A) business risk. B) credit risk. C) market risk. D) liquidity risk.
D
The maximum rate of return that can be earned for a given rate of interest occurs when interest is compounded A) annually. B) daily. C) monthly. D) continuously.
D
The most predictable component of stock returns is A) capital gains. B) capital losses. C) inflation adjusted return. D) dividend income.
D
To compute the present value of $1,000 annuity received at the end of each of the next three years and discounted at the rate of 5% per year, you should use he following EXCEL command. A) ANN B) TVM C) RATE D) PV
D
When calculating the present value of either a future single sum or a future annuity, the applicable interest rate is usually called the A) yield to maturity. B) compound interest rate. C) internal rate of return. D) discount rate.
D
When computing an investment's yield using a financial calculator or spreadsheet such as Excel, which of the following should be entered as a negative number? A) the number of time periods B) dividend or interest payments C) the price at which the investment is sold D) the initial cost of the investment
D
When the rate of return is equal to the discount rate A) the present value of an investment's benefits must be greater than its cost. B) the cost of an investment equals the sum of its benefits. C) the cost of an investment equals the future value of its benefits. D) the cost of an investment equals the present value of its benefits.
D
Which of the following choices is in the correct order from less risk to more risk? A) corporate bonds, certificates of deposit, mutual funds that invest in stock, common stock B) certificates of deposit, corporate bonds, common stock, mutual funds that invest in stock C) certificates of deposit, mutual funds that invest in stock, common stock, corporate bonds D) certificates of deposit, corporate bonds, mutual funds that invest in stock, common stock
D
Which of the following internal characteristics should cause investors to expect the highest rate of return? A) a steady record of past dividends B) interest and principal guaranteed by the U.S. government C) a record of excellent management and consistent dividend payments D) poor management and excessive use of debt financing
D
Which of the following statements about the standard deviation are correct? I. The standard deviation is a measure of relative dispersion. II. Standard deviations should be in conjunction with expected returns to compare investments. III. The standard deviation is calculated by taking the square root of the variance. IV. The higher the standard deviation of an investment, the lower its risk. A) I and IV only B) II and III only C) I, III and IV only D) I, II and III only
D
An investment that has earned a high rate of return over the last 5 years will not necessarily continue to perform well in the future.
F
An ordinary annuity is defined as an annuity for which the cash flows occur at the beginning of each year or payment period.
F
Annual yield is a less meaningful measure of an investment's performance than holding period return if the holding period is other than 1 year.
F
Business risk is the risk associated with the amount of debt financing used by a firm.
F
Business risk resulting from uncertainty over a firm's earnings is a concern for stockholders, but not for debt holders.
F
Historical returns are of no use in estimating the risk of an investment.
F
Historically speaking, the standard deviation of returns on U.S. Treasury Bills is zero.
F
In the short term, stock prices tend to rise as inflation rises.
F
Investing in short-term debt is an effective strategy for managing the risk of falling interest rates.
F
Investments with lower standard deviations can be expected to produce higher rates of return.
F
Investors can be confidently predict future returns on an investment by studying its past performance.
F
Investors who limit themselves to risk free and low risk investments can avoid purchasing power risk.
F
It is not possible for the nominal risk-free rate of return to be lower than the rate of inflation.
F
Most investors are risk averse, meaning they will always be willing to sacrifice higher return if they can avoid risk.
F
The holding period return is an excellent method for comparing a short-term investment to a long-term investment.
F
The holding period return is especially useful comparing investments with unequal holding periods.
F
The net present value of an investment is computed by discounting cash flows at the internal rate of return.
F
The present value is equal to the future value multiplied by the 1 plus the interest rate.
F
The reluctance of Congress to tinker with tax rates and deductions has virtually eliminated tax risk for U.S. businesses.
F
The return that fully compensates for the risk of an investment is called the risk-free rate of return.
F
The standard deviation is computed by dividing the sum of the squared deviations by the number of observations.
F
The yield on an investment is the discount rate that produces a present value of benefits greater than the cost of the investment.
F
There is no limit to the increase in the true rate of interest as compounding becomes more frequent.
F
When using a financial calculator to compute the present value of a lump sum, the future value is entered as PMT.
F
Compound interest is interest paid not only on the initial investment but also on any interest accumulated in prior periods.
T
For a given stated rate of interest, a sum compounded monthly will earn more interest than a sum compounded annually.
T
If the discount rate is appropriate for the level of risk, a satisfactory investment will have a present value of benefits equal to or greater than than the present value of costs.
T
If the risk-free rate of return is less than the inflation rate, the real rate of return is negative.
T
If you own an investment providing periodic returns, your actual yield on the investment will depend on the reinvestment rate you are able to obtain.
T
In response to the same external force, the return on one investment may increase while the return on another investment may decrease.
T
Lower risk investments are associated with lower expected rates of return.
T
Meaningful measures of an investment's return must consider both income and capital gains.
T
One reason that the holding period return should not be used to compare long-term investments is that it does not consider the time value of money.
T
Risk can be defined as uncertainty concerning the actual return that an investment will generate.
T
Sydney invested $10,000 for an indefinite period at 5% per year. At the end of each year, she receives a a $500 check for interest earned. This type of account pays simple interest.
T
The financial concept of time value of money is dependent upon the opportunity to earn interest over time.
T
The greater the dispersion around an asset's expected return, the greater the risk.
T
The internal rate of return is the correct method to use when an investor wants to determine an investment's average annual yield.
T
The required return on a risky investment includes a real rate of return, an inflation premium and a risk premium.
T
The yield is the rate of return that causes a project to have a zero net present value.
T
The yield on an investment is equal to its internal rate of return.
T
To calculate the interest rate or growth rate using a spreadsheet or financial calculator, the present value and the future value most have opposite signs.
T
When using a financial calculator or electronic spreadsheet to calculate an investment's yield, the amount invested is expressed as a negative number.
T