Fin 3715- Exam 3

CHAP 8: Over-The-Counter Market

A securities market primarily comprised of dealers who buy and sell for their own inventories is referred to which type of market..

CHAP 7: early bond redemption

A sinking fund is managed by a trustee for which one of the following purposes

CHAP 8: Dividend Growth Model Example- If you expect the market rate of return to increase across the board on all equity securities, then you should also expect:

a decrease in all stock values.

CHAP 7: (7.1 EX)- All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to maturity.

a discount; less than

CHAP 8: Supernormal growth

a growth rate that is unsustainable over the long term.

CHAP 6: interest-only loan

a loan that calls for periodic interest payments and a lump sum principal payment

CHAP 6: amortized loan

a loan wherein each payment is equal in amount and includes both interest and principal; may have equal or increasing amounts applied to the principal from each loan payment.

CHAP 6: balloon loan

a loan wherein the regular payments, including both interest and principal amounts, are insufficient to retire the entire loan amount, which then must be repaid in one lump sum

CHAP 8: Preferred Stock

a type of equity security that has a fixed dividend and a priority status over other equity securities

CHAP 8: ECN

a website that allows individual investors to trade directly with one another

CHAP 7: (7.2 EX)- The Leeward Company just issued 15-year, 8 percent, unsecured bonds at par. These bonds fit the definition of which one of the following terms?

debenture

CHAP 7: (7.2 EX)- A $1,000 face value bond can be redeemed early at the issuer's discretion for $1,030, plus any accrued interest. The additional $30 is called..

call premium

CHAP 7: (7.5 EX)-A bond is quoted at a price of $989. This price is referred to as which one of the following?

clean price

CHAP 7: (7.4 EX)- Which one of the following risks would a floating-rate bond tend to have less of as compared to a fixed-rate coupon bond?

interest rate risk

CHAP 8: Dividend Yield

Computed by dividing next year's annual dividend by the current stock price

CHAP 6: Credit Risk

- U.S. Treasury securities are widely regarded to be risk-free 1. Credit risk is the risk of default, so that the bond's cash flows are not known with certainty - Corporations with higher default risk will need to pay higher coupons to attract buyers to their bonds

CHAP 7: (7.1/7.2 EX)-Decreasing the time to maturity..

...increases the price of a discount bond, all else constant.

CHAP 6: Note V. Coupon

1. "May 2013 maturity, $1000 par value" tells us that this is a note with a face value of $1000 and five years to maturity. 2. The phrase "2.2% coupon rate and semiannual coupons" tells us that the note pays a total of 2.2% of its face value each year in two equal semiannual installments.

CHAP 6: Risk-Free Interest Rates

1. Because a default-free zero-coupon bond that matures on date n provides a risk-free return over that period, the Law of One Price guarantees that the risk-free interest rate equals the yield to maturity on such a bond 2. We often refer to this as the risk-free interest rate for that period (n)

CHAP 6: Bond Prices Immediately After a Coupon Payment

1. Bond price = greater than the face value = above par or at a premium = coupon rate > YTM & coupon rate > current yield 2. Bond price is equal to face value = at par = coupan rate = YTM & market price = face value 3. Bond price is less than the face value = below par or at a discouny = coupon rate <YTM - Note that the bond price is higher, and hence the discount from its face value is smaller, when there is less time to maturity. - The discount shrinks because the yield has not changed, but there is less time until the face value will be received. - This example illustrates a more general property for bonds. - If a bond's yield to maturity does not change, then the rate of return of an investment in the bond equals its yield to maturity even if you sell the bond early.

CHAP 8: Disadvantages of Profitability Index

1. Breaks down when there is more than one constraint 2. Requires careful attention to make sure the constrained resource is completely utilized

CHAP 8: Mutually exclusive projects

1. Can't just pick the project with a positive NPV 2. The projects must be ranked and the best one chosen 3. Pick the project with the highest NPV!!!!!!!!!!!!!!!

CHAP 8: Advantages to using NPV

1. Corresponds directly to the impact of the project on the firm's value 2. Direct application of the Valuation Principle

CHAP 6: Interest Rate Risk and Bond Prices- Why bond prices change

1. Effect of time on bond prices is predictable, but unpredictable changes in rates also affect prices 2. Bonds with different characteristics will respond differently to changes in interest rates 3. Investors view long-term bonds to be riskier than short-term bonds 4. Bond prices are subject to the effects of both passage of time and changes in interest rates 5. Prices converge to face value due to the time effect, but move up and down because of changes in yields - bond is longer term to maturity = interest rate risk increases - bond has higher coupon payments = interest rate rick decreases - The bond with the smaller coupon payments is more sensitive to changes in interest rates. - Because its coupons are smaller relative to its par value, a larger fraction of its cash flows are received later. - later cash flows are affected more greatly by changes in interest rates, so compared to the 10% coupon bond, the effect of the interest change is greater for the cash flows of the 5% bond.

CHAP 8: Alternate Decision Rules

1. For most investments expenses are upfront and cash is received in the future 2. In these cases a low rate is best 3. When cash is upfront a high interest rate is best

CHAP 8: Disadvantages of IRR

1. Hard to Compute 2. Multiple IRRs lead to ambiguity 3. Cannot be used to choose among projects 4. Can be misleading if inflows come before outflows Kurtay Weaknesses: 1. In most cases IRR rule agrees with NPV for stand- alone projects if all negative cash flows precede positive cash flows 2. In other cases the IRR may disagree with NPV

CHAP 6: How do Interest Rate Changes and Bond Prices

1. If a bond sells at par the only return investors will earn is from the coupons that the bond pays 2. Therefore, the bond's coupon rate will exactly equal its yield to maturity 3. As interest rates in the economy fluctuate, the yields that investors demand will also change

CHAP 8: Disadvantages of using Payback

1. No guidance as to correct payback cutoff 2. Ignores cash flows after the cutoff completely 3. Not necessarily consistent with maximizing shareholder wealth Kurtay Weaknesses: 1. Ignores the time value of money 2. Ignores cash-flows after the payback period- BIGGEST WEAKNESS 3. Lacks a decision criterion grounded in economics

CHAP 6: Coupon bonds

1. Pay face value at maturity 2. make regular coupon interest payments 3. Two types of U.S. Treasury coupon securities are currently traded in financial markets: A. Treasury notes a. original maturities from one to ten years B. Treasury bonds b. original maturities of more than ten years - Coupon bonds may trade at a discount or at a premium - Most issuers of coupon bonds choose a coupon rate so that the bonds will initially trade at, or very close to, par - After the issue date, the market price of a bond changes over time

CHAP 8: Disadvantages to using NPV

1. Relies on an accurate estimate of the discount rate 2. Can be time-consuming to compute

CHAP 6: Bond Ratings

1. Several companies rate the creditworthiness of bonds A. Two best-known are Standard & Poor's and Moody's 2. These ratings help investors assess creditworthiness - Investment-grade bonds - Speculative bonds a. junk bonds b. high-yield bonds - The rating depends on: the risk of bankruptcy & bondholders' claim to assets in the event of bankruptcy Split rated bonds are called crossover bonds.

CHAP 8: Advantages of using Payback

1. Simple to compute 2. Favors liquidity

CHAP 8: Choosing Among Projects when Resources are Limited

1. Sometimes different investment opportunities demand different amounts of a particular resource 2. If there is a fixed supply of the resource so that you cannot undertake all possible opportunities, simply picking the highest-NPV opportunity might not lead to the best decision

CHAP 6: Bond certificate

1. Terms of the bond 2. Amounts and dates of all payments to be made.

CHAP 6: Return on a coupon bond comes from:

1. The difference between the purchase price and the principal value 2. Periodic coupon payments To compute the yield to maturity of a coupon bond, we need to know the coupon interest payments, and when they are paid.

CHAP 8:Modified Internal Rate of Return (MIRR)

1. Used to overcome problem of multiple IRRs 2. Computes the discount rate that sets the NPV of modified cash flows to zero 3. Possible modifications: a. Bring all negative cash flows to the present and incorporate into the initial cash outflow b. Leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project Questions to Ask: 1. Is it advisable to modify the cash flows? 2. It is not really an internal rate of return? 3. It does not solve some of the problems of IRR

CHAP 8: Advantages of Profitability Index

1. Uses the NPV to measure the benefit 2. Allows projects to be ranked on value created per unit of resource consumed

CHAP 6: Corporate Yield Curves

1. We can plot a yield curve for corporate bonds just as we can for Treasuries 2. The credit spread is the difference between the yields of corporate bonds and Treasuries 3. The shape of the yield curve keys us in on trends with the yield to maturity: a. If the yield curve is upward sloping, the yield to maturity decreases with the coupon rate of the bond. b. If the yield curve is downward sloping, the yield to maturity increases with the coupon rate of the bond. c. If the yield curve is flat, all zero-coupon and coupon-paying bonds will have the same yield, independent of maturities and coupon rates.

CHAP 6: Corporate Bond Yields

1. Yield to maturity of a defaultable bond is not equal to the expected return of investing in the bond 2. A higher yield to maturity does not necessarily imply that a bond's expected return is higher

CHAP 7: note

1. unsecured 2. maturity less than 10 years

CHAP 7: (7.1 EX)- Which one of the following bonds is the least sensitive to interest rate risk?

3-year; 6 percent coupon

CHAP 7: callable bond

A bond that can be paid off early at the issuer's discretion & generally have a sinking fund provision

CHAP 7: zero coupon

A bond that has only one payment, which occurs at maturity

CHAP 6: pure discount

A loan where the borrower receives money today and repays a single lump sum on a future date is called a(n) _____ loan; entire repayment of _______ loans is computed simply by computing a single future value.

CHAP 8: Specialist

A market maker who acts as a dealer in one or more securities on the floor of the NYSE

CHAP 6: Which one of the following statements related to annuities and perpetuities is correct?

A perpetuity comprised of $100 monthly payments is worth more than an annuity comprised of $100 monthly payments, given an interest rate of 12 percent,compounded monthly. AND The present value of a growing perpetuity will decrease if the discount rate is increased.

CHAP 7: pure time value of money

A.K.A. term structure of interest rates

CHAP 8: Broker

An agent who arranges a transaction between a buyer and a seller of equity securities

CHAP 8: Dealer

An agent who maintains an inventory from which he or she buys and sells securities

CHAP 8: Floor Trader.

An individual on the floor of the NYSE who owns a trading license and buys and sells for his or her personal account

CHAP 6: You are comparing two annuities which offer quarterly payments of $2,500 for five years and pay 0.75 percent interest per month. Annuity A will pay you on the first of each month while annuity B will pay you on the last day of each month. Which one of the following statements is correct concerning these two annuities?

Annuity B has a smaller present value than annuity A.

CHAP 6: Coupon rate

COUPONS- The promised interest payments of a bond. Set by the issuer and stated on the bond certificate By convention, expressed as an APR, so the amount of each coupon payment, CPN, is = CPN = (COUPON RATE * FACE VALUE)/ NUMBER OF COUPON PAYMENTS PER YEAR

CHAP 8: NPV Example- After saving $1,500 waiting tables, you are about to buy a 42-inch plasma TV. You notice that the store is offering "one-year same as cash" deal. You can take the TV home today and pay nothing until one year from now, when you will owe the store the $1,500 purchase price. If your savings account earns 5% per year, what is the NPV of this offer? Show that its NPV represents cash in your pocket.

Cash flows: $ 1,500 (today) -$ 1,500(in one year). The discount rate for calculating the present value of the payment in one year is your interest rate of 5%. You need to compare the present value of the cost ($1,500 in one year) to the benefit today (a $1,500 TV). NPV = +1500 - (1500/1.05) = 1500- (1,428.57)= $71.43. You could take $1,428.57 of the $1,500 you had saved for the TV and put it in your savings account. With interest, in one year it would grow to $1,428.57 * (1.05) = $1,500, enough to pay the store. The extra $71.43 is money in your pocket to spend as you like (or put toward the speaker system for your new media room).

CHAP 7: (7.7 EX)- A Treasury yield curve plots Treasury interest rates relative to...

MATURITY

CHAP 6: Spot interest rates

Default-free, zero-coupon yields

CHAP 8: Common Stock

Defined by the fact that it receives no preferential treatment in respect to either dividends or bankruptcy proceedings.

CHAP 8: Profitability Index

Definition- Prof. Index = Value Created/ Resource Consumed ==> NPV/ Resources Consumed. Rule- Rank projects according to their PI based on the constrained resource and move down the list accepting value-creating projects until the resources is exhausted. From ex. 8.6a: 1. Assign the resource to the projects in descending order according to the profitability index. 2. By ranking projects in terms of their NPV per engineer, we find the most value we can create, given our $300 million budget. 3. This ranking also shows us exactly what the budget constraint costs us

CHAP 8: The Payback Rule

Definition- The amount of time it takes to pay back the initial investment. Rule- Based on the notion that an opportunity that pays back the initial investment QUICKLY is the best idea. Accept the project if the payback period is less than a prespecified length of time- usually a few years, otherwise, turn it down. 1. Calculate the amount of time it takes to pay back the initial investment, called the payback period 2. Accept if the payback period is less than required 3. Reject if the payback period is greater than required The payback rule requires us to use an arbitrary cutoff period in summing the cash flows. The payback rule does not discount future cash flows- instead it simply sums the cash flows and compares them to a cash outflow in the present.

CHAP 8: The Internal Rate of Return Rule (IRR)

Definition- The interest rate sets the net present value of the cash flows equal to zero. the average return of the investment. Rule- Take any investment opportunity where IRR exceeds the opportunity cost of capital. Turn down any opportunity where IRR is less that opp. cost of capital 1. Picking the investment opportunity with the largest IRR can lead to a mistake 2. In general, it is dangerous to use the IRR in choosing between projects 3. Always rely on NPV

CHAP 8: Dividend Growth

Determines the present value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate

CHAP 8: Two-Stage Dividend Growth Model

Evaluates the current price of a stock based on the assumption a stock will__ grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely. G1 can be greater than R.

CHAP 6: Maturity Date

Final repayment date of the bond. Payments continue until this date. MATURITY - The specified date on which the principal amount of a bond is payable

CHAP 8: Dividend Growth Model Example- An increase in which of the following will increase the current value of a stock according to the dividend growth model? I. dividend amount II. number of future dividends, provided the current number is less than infinite III. discount rate IV. dividend growth rate

I, II, and IV ONLY. I. dividend amount II. number of future dividends, provided the current number is less than infinite IV. dividend growth rate

CHAP 7: bonds

I. Bonds provide tax benefits to issuers. II. The risk of a firm financially failing increases when the firm issues bonds. Bonds issued by the U.S. government: are considered to be free of default risk.

CHAP 7: (7.1 EX)-An 8 percent corporate bond that pays interest semi-annually was issued last year. Which two of the following most likely apply to this bond today if the current yield-to-maturity is 7 percent?

I. a structure as an interest-only loan IV. a market price that differs from the face value I & IV ONLY.

CHAP 8: Dividend Growth Model

I. assumes that dividends increase at a constant rate forever. II. can be used to compute a stock price at any point in time. III. can be used to value zero-growth stocks. IV. requires the growth rate to be less than the required return. The underlying assumption: A stock's value is equal to the discounted present value of the future cash flows which it generates.

CHAP 7: (7.4 EX)- Recently, you discovered a putable income bond that is convertible. If you purchase this bond, you will have the right to do which of the following?

I. force the issuer to repurchase the bond prior to maturity IV. convert the bond into equity shares I & IV ONLY

CHAP 7: (7.1 EX)- Which of the following increase the price sensitivity of a bond to changes in interest rates?

I. increase in time to maturity IV. decrease in coupon rate I & IV ONLY.

CHAP 6: Which of the following statements related to interest rates are correct? I. Annual interest rates consider the effect of interest earned on reinvested interest payments. II. When comparing loans, you should compare the effective annual rates. III. Lenders are required by law to disclose the effective annual rate of a loan to prospective borrowers. IV. Annual and effective interest rates are equal when interest is compounded annually.

II and IV only

CHAP 7: (7.2 EX)-Texas Foods has a 6 percent bond issue outstanding that pays $30 in interest every March and September. The bonds are investment grade and sell at par. The bonds are callable at a price equal to the present value of all future interest and principal payments discounted at a rate equal to the comparable Treasury rate plus 0.50 percent. Which of the following correctly describe the features of this bond?

II. "make whole" call price III. $1,000 face value IV. offer price of $1,000 II, III, & IV ONLY.

CHAP 7: (7.2 EX)-Which of the following are negative covenants that might be found in a bond indenture?

II. No debt senior to this issue can be issued. III. The company cannot lease any major assets without approval by the lender. ii & iii only.

CHAP 7: (7.1 EX)-A bond has a market price that exceeds its face value. Which of the following features currently apply to this bond?

II. premium price IV. yield-to-maturity that is less than the coupon rate II & IV ONLY

CHAP 7: (7.7 EX)- The taxability risk premium compensates bond holders for which one of the following?

a bond's unfavorable tax status

CHAP 8: Payback Rule Example- When choosing between two projects, assume a company chooses the one with the lowest payback period. 1. Project A has inflows of $1,000 for two years, an inflow of $8,000 in year 3, and an inflow of $1,000,000 in year four. Initial investment is $10,000. 2. Project B has inflows of $5,000 for four years with an initial investment of $10,000. Would the firm undertake the project under this rule?

In order to implement the payback rule, we need to know when the sum of the inflows from the project will equal the initial investment. For Project A: The sum of the cash flows from years 1 - 3 is $10,000. This will cover the initial investment of $10,000 at the end of year 3. For Project B: The sum of the cash flows from years 1 and 2 is $10,000. This will cover the initial investment of $10,000 at the end of year 2. Because the payback for Project B is faster than for Project A, Project B will be chosen, even though the 4th cash flow for Project A is very high!

CHAP 8: Payback Rule Example- Assume a company requires all projects to have a payback period of three years or less. The project has inflows of $1,000 for two years, an inflow of $12,000 in year three, and an initial investment of $10,000. Would the firm undertake the project under this rule?

In order to implement the payback rule, we need to know whether the sum of the inflows from the project will exceed the initial investment before the end of 3 years. The sum of the cash flows from years 1 through 3 is $14,000. This will cover the initial investment of $10,000. Because the payback is less than 3 years the project will be accepted.

CHAP 7: nominal rates

Interest rates that include an inflation premium

CHAP 8: NPV Example- After saving $2,500 waiting tables, you are about to buy a 50-inch LCD TV. You notice that the store is offering "one-year same as cash" deal. You can take the TV home today and pay nothing until one year from now, when you will owe the store the $2,500 purchase price. If your savings account earns 4% per year, what is the NPV of this offer? Show that its NPV represents cash in your pocket.

NPV = +2,500 - (1,500/1.04) = 2500 -(2403.85) = $96.15. You could take $2,403.85 of the $2,500 you had saved for the TV and put it in your savings account. With interest, in one year it would grow to $2,403.85 * (1.04) = $2,500, enough to pay the store. The extra $96.15 is money in your pocket to spend as you like.

CHAP 8: The NPV Decision Rule

NPV = PV (Benefits) - PV (Costs) OR the difference between the present value of an investment's benefits and the present value of its costs Most firms measure values in terms of Net Present Value-that is, in terms of cash today. Rule implies that we should: 1. Accept positive-NPV projects; accepting them is equivalent to receiving their NPV in cash today 2. Reject negative-NPV projects; accepting them would reduce the value of the firm, whereas rejecting them has no cost (NPV = 0)

CHAP 6: Zero-coupon bonds

Only two cash flows 1. The bond's market price at the time of purchase 2. The bond's face value at maturity Treasury bills are zero-coupon U.S. government bonds with maturity of up to one year Zero-coupon bonds always trade for a discount has more interest rate risk than a comparable coupon bond.

CHAP 6: You are comparing two investment options that each pay 5 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays three annual payments starting with $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options?

Option B has a higher present value at time zero than does option A.

CHAP 6: Yield to Maturity of a Coupon Bond

P= CPN * 1/y (1- [1/ (1 + y)^n]) + FV/ (1 + Y) ^n P = present value of all the periodic coupon payments + present value of the Face Value repayment using YTM (y)

CHAP 8: NPV Example- In exchange for $500 today, your firm will receive $550 in one year. If the interest rate is 8% per year....

PV(Benefit)= ($550 in one year) ÷ ($1.08 $ in one year/$ today) = $509.26 today= the amount you would need to put in the bank today to generate $550 in one year. SO NPV= $509.26 - $500 = $9.26 today. You should be able to borrow $509.26 and use the $550 in one year to repay the loan. This transaction leaves you with $509.26 - $500 = $9.26 today. As long as NPV is positive, the decision increases the value of the firm regardless of current cash needs or preferences.

CHAP 8: Advantages of IRR

Related to the NPV rule and usually yields the same (correct) decision

CHAP 8: Post

The counter area on the floor of the NYSE where a specialist operates

CHAP 7: spread

The difference between the price that a dealer is willing to pay and the price at which he or she will sell

CHAP 8: Crossover Point

The discount rate that makes the NPV of the two alternatives equal. 1. We can find the discount rate by setting the equations for the NPV of each project equal to each other and solving for the discount rate. In general, we can always compute the effect of choosing Project A over Project B as the difference of the NPVs. At the crossover point the difference is 0. 2. Just as the NPV of a project tells us the value impact of taking the project, so the difference of the NPVs of two alternatives tells us the incremental** impact of choosing one project over another. 3. The crossover point is the discount rate at which we would be indifferent between the two projects because the incremental value of choosing one over the other would be zero.

CHAP 6: Yield to Maturity of a Zero-Coupon Bond

The discount rate that sets the present value of the promised bond payments equal to the current market price of the bond. discount rate= YTM to find's bond's price at present value. Yield to Maturity of an n-Year Zero-Coupon Bond: 1 + YTM (n) = (FACE VALUE/ PRICE) ^ (1/n) YTM is the rate of return of buying the bond.

CHAP 6: interest rates

The effective annual rate equals the annual percentage rate when interest is compounded annually.

CHAP 6: stated interest rate

The interest rate that is quoted by a lender

CHAP 7: protective covenants

The items included in an indenture that limit certain actions of the issuer in order to protect bondholder's interests; are primarily designed to protect bondholders.

CHAP 8: Commission Broker.

The person on the floor of the NYSE who executes buy and sell orders on behalf of customers

CHAP 6: How is the principal amount of an interest-only loan repaid?

The principal is repaid in a lump sum at the end of the loan period.

CHAP 8: Capital Gains Yield

The rate at which a stock's price is expected to appreciate. The capital gains yield is the annual rate of change in a stock's price. (g) represents the capital gains yield as used in the dividend growth model Ex. High Country Builders currently pays an annual dividend of $1.35 and plans on increasing that amount by 2.5 percent each year. Valley High Builders currently pays an annual dividend of $1.20 and plans on increasing its dividend by 3 percent annually. Given this information, you know for certain that the stock of High Country Builders' has a higher ______ than the stock of Valley High Builders.

CHAP 8: Capital Gains Yield Example- Winston Co. has a dividend-paying stock with a total return for the year of -6.5 percent. Which one of the following must be true?

The stock has a negative capital gains yield.

CHAP 8: Order Flow

The stream of customer orders coming in to the NYSE trading floor

CHAP 8: Payback Rule Example- Assume Frederick's requires all projects to have a payback period of two years or less. The project has inflows of $28 million per year and an initial investment of $81.6 million. Would the firm undertake the project under this rule?

The sum of the cash flows from year 1 to year 2 is $28m x 2 = $56 million, this will not cover the initial investment of $81.6 million. Because the payback is > 2 years (3 years required $28 x 3 = $84 million) the project will be rejected.In this case, Fredrick's would have rejected a project that would have increased the value of the firm.

CHAP 6: Term

The time remaining until the repayment date

CHAP 6: relationship

Time and present value are inversely related, all else held constant.

CHAP 8: Logic of the NPV Decision Rule

When making an investment decision, take the alternative with the highest NPV, which is equivalent to receiving its NPV in cash today.

CHAP 7: asked price

You want to buy a bond from a dealer. Which one of the following prices will you pay?

CHAP 7: call-protected bond

a bond that cannot be called during a certain period of time.

CHAP 6: Face value

aka par value or principal amount. 1. Notional amount used to compute interest payments 2. Usually standard increments, such as $1000 3. Typically repaid at maturity A bond's coupon rate is equal to the annual interest divided by FACE VALUE

CHAP 6: You need $25,000 today and have decided to take out a loan at 7 percent for five years. Which one of the following loans would be the least expensive? Assume all loans require monthly payments and that interest is compounded on a monthly basis.

amortized loan with equal principal payments

CHAP 7: Treasury bonds

are generally issued as semi-annual coupon bonds

CHAP 7: "Cat" bonds

are primarily designed to help: insurance companies fund excessive claims.

CHAP 7: Real rates

as nominal rates that have been adjusted for INFLATION.

CHAP 7: (7.2 EX)- A bond that is payable to whomever has physical possession of the bond is said to be in:

bearer form.

CHAP 7: interest rate risk premium

compensation investors demand for accepting interest rate risk

CHAP 6: Which one of the following compounding periods will yield the smallest present value given a stated future value and annual percentage rate?

continuous

CHAP 7: (7.1 EX)- Mary just purchased a bond which pays $60 a year in interest. What is this $60 called?

coupon

CHAP 8: Voting Type Example- A company has two open seats, Seat A and Seat B, on its board of directors. There are 6 candidates vying for these 2 positions. There will be a single election to determine the winner of both open seats. As the owner of 100 shares of stock, you will receive one vote per share for each open seat. You decide to cast all 200 of your votes for a single candidate. What is this type of voting called?

cumulative

CHAP 7: (7.1 EX)- The Walthers Company has a semi-annual coupon bond outstanding. An increase in the market rate of interest will have which one of the following effects on this bond?

decrease the market price INCR. MKT RATE --> DECR MKT PRICE

CHAP 7: (7.7 EX)- Which one of the following risk premiums compensates for the possibility of nonpayment by the bond issuer?

default risk

CHAP 7: (7.5 EX)- Pete paid $1,032 as his total cost of purchasing a bond. This price is referred to as the:

dirty price

CHAP 6: A monthly interest rate expressed as an annual rate would be an example of which one of the following rates?

effective annual rate

CHAP 6: ordinary annuity

equal payments paid at regular intervals over a stated time period

CHAP 8: A FLOOR BROKER on the NYSE....

executes orders on behalf of a commission broker

CHAP 7: (7.1 EX)- Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment at maturity. What is the $1,000 called?

face value

CHAP 7: (7.2 EX)- Atlas Entertainment has 15-year bonds outstanding. The interest payments on these bonds are sent directly to each of the individual bondholders. These direct payments are a clear indication that the bonds can accurately be defined as being issued:

in registered form

CHAP 7: (7.1 EX)- As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:

increases at a decreasing rate

CHAP 7: (7.7 EX)- Which one of the following premiums is compensation for expected future inflation?

inflation

CHAP 7: (7.1 EX)-You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur?

long-term; zero coupon

CHAP 7: (7.4 EX)- Last year, you purchased a "TIPS" at par. Since that time, both market interest rates and the inflation rate have increased by 0.25 percent. Your bond has most likely done which one of the following since last year?

maintained a fixed real rate of return

CHAP 8: Secondary Market

market where outstanding shares of stock are resold

CHAP 8: Example- The owner of one of the 1,366 trading licenses for the NYSE

member

CHAP 7:(7.2 EX)- Last year, Lexington Homes issued $1 million in unsecured, non-callable debt. This debt pays an annual interest payment of $55 and matures 6 years from now. The face value is $1,000 and the market price is $1,020. Which one of these terms correctly describes a feature of this debt?

note

CHAP 7: Municipal bonds

pay interest that is federally tax-free.

CHAP 6: yield curve

plots the risk-free interest rate for different maturities. 1. These rates are the yields of risk-free zero-coupon bonds 2. Thus the yield curve in Chapter 5 is also called the zero-coupon yield curve 3.Shorter maturity = lower yield 4. longer maturity = higher yield

CHAP 8: Type of Market example- Callander Enterprises stock is listed on NASDAQ. The firm is planning to issue some new equity shares for sale to the general public. This sale will occur in which one of the following markets?

primary

CHAP 7: deferred call provision

prohibition which prevents bond issuers from redeeming callable bonds prior to a specified date

CHAP 7: collar of a floating-rate bond..

refers to the minimum and maximum: COUPON RATES

CHAP 8: Voting Type Example- You want to be on the board of directors of Wisely Foods. Since you are the only shareholder that will vote for you, you will need to own more than half of the outstanding shares of stock if you are to be elected to the board. What is the type of voting called that requires this level of stock ownership to be successfully elected under these conditions?

straight

CHAP 6: identify a British perpetuity

term? consol

CHAP 7: A "fallen angel" is a bond..

that has moved from investment grade to speculative grade.

CHAP 7: current yield

the annual interest on a bond divided by MARKET PRICE

CHAP 8: Dividends

the distributions to shareholders by a corporation

CHAP 8: SuperDOT

the electronic system used by the NYSE for directly transmitting orders to specialists

CHAP 6: annual percentage rate

the interest rate charged per period multiplied by the number of periods per year

CHAP 7: (7.7 EX)- The liquidity premium is compensation to investors for:

the lack of an active market wherein a bond can be sold for its actual value.

CHAP 7: indenture

the legal agreement between the bond issuer and the bondholders

CHAP 7: bid price

the price a dealer will pay to purchase a bond

CHAP 7: Fisher effect

the relationship between: REAL RATES, INFLATION RATES, AND NOMINAL RATES

CHAP 6: perpetuity

unending equal payments paid at equal time intervals

CHAP 8: Voting Type Example- You cannot attend the shareholder's meeting for Alpha United so you authorize another shareholder to vote on your behalf. What is the granting of this authority called?

voting by proxy

CHAP 7: (7.1 EX)- Currently, the bond market requires a return of 11.6 percent on the 10-year bonds issued by Winston Industries. The 11.6 percent is referred to as which one of the following?

yield to maturity