Finance

Everything else equal, the __________ the maturity of a bond and the __________ the coupon, the greater the sensitivity of the bond's price to interest rate changes. A. longer; higher B. longer; lower C. shorter; higher D. shorter; lower

B. longer; lower

b) Suppose that we need the above coupon bond for your cash requirements. However, due to some reasons, we cannot buy the coupon bond. Therefore, instead of the coupon bond, we decide to buy 1 year and 2 year zero coupon bond. If this alternative investment has the same cash flows as the coupon bond, how many bonds we need to buy (i.e., XX 1 year bonds and OO 2 year bonds)? What is the cost for this alternative bond investment?

Bond Year 1 Year 2 Coupon Bond 100 1100 1 year zeros: 1 2 year zeros: 11 100 1100 (= 100 x 11) Cost: (1154 in total) 98 1056(= 96 x 11)

A. You purchased a share of stock for $29. One year later you received $2.25 as dividend and sold the share for $28. Your holding-period return was _________. B. The holding-period return on a stock was 25%. Its ending price was $18, and its beginning price was $16. Its cash dividend must have been _________.

A. (28 - 29 + 2.25) / 29 = 0.0431 B. 0.25 = (18 - 16 + x) / 16 => x = 2

During the 1926-2013 period the geometric mean return on Treasury bonds was _________, if the arithmetic average is 5.40%. A. 5.07% B. 5.56% C. 9.34% D.11.43%

A. 5.07%

Which one of these statements is correct? A. Most long-term bond issues are referred to as unfunded debt. B. Bonds often provide tax benefits to issuers. C. The risk of a company financially failing decreases when the company issues bonds. D. All bonds are treated equally in a bankruptcy proceeding. E. A debenture is a senior secured debt.

B. Bonds often provide tax benefits to issuers.

The ______ measure of returns ignores compounding. A. geometric average B. arithmetic average C. IRR D. dollar-weighted

B. arithmetic average

The interest rate risk premium is the: A. additional compensation paid to investors to offset rising prices. B. compensation investors demand for accepting interest rate risk. C. difference between the yield to maturity and the current yield. D. difference between the market interest rate and the coupon rate. E. difference between the coupon rate and the current yield.

B. compensation investors demand for accepting interest rate risk.

Which one of the following methods of project analysis is defined as computing the value of a project based upon the present value of the project's anticipated cash flows? A. constant dividend growth model B. discounted cash flow valuation C. average accounting return D. expected earnings model E. internal rate of return

B. discounted cash flow valuation

Under the pure expectations hypothesis and constant real interest rates for different maturities, an upward-sloping yield curve would indicate __________________. A. expected increases in inflation over time B. expected decreases in inflation over time C. the presence of a liquidity premium D. that the equilibrium interest rate in the short-term part of the market is lower than the equilibrium interest rate in the long-term part of the market

B. expected decreases in inflation over time

Which one of the following applies to a premium bond? A. Yield to maturity > Coupon rate B. Coupon rate = Yield to maturity C. Coupon rate > Yield to maturity D. Unknown

C. Coupon rate > Yield to maturity

Rank the following from highest average historical standard deviation to lowest average historical standard deviation from 1926 to 2013. I. Small stocks II. Long-term bonds III. Large stocks IV. T-bills A. I, II, III, IV B. III, IV, II, I C. I, III, II, IV D. III, I, II, IV

C. I, III, II, IV

The historical yield spread between the AA bond and the AAA bond has been 25 basis points. Currently the spread is only 9 basis points. If you believe the spread will soon return to its historical levels, you should ________________________. A. buy the AA and short the AAA B. buy both the AA and the AAA C. buy the AAA and short the AA D. short both the AA and the AAA

C. buy the AAA and short the AA

If you are holding a premium bond, you must expect a _______ each year until maturity. If you are holding a discount bond, you must expect a _______ each year until maturity. (In each case assume that the yield to maturity remains stable over time.) A. capital gain; capital loss B. capital gain; capital gain C. capital loss; capital gain D. capital loss; capital loss

C. capital loss; capital gain

Floating-rate bonds have a __________ that is adjusted with current market interest rates. A. maturity date B. coupon payment date C. coupon rate D. dividend yield

C. coupon rate

During the 1986-2013 period, the Sharpe ratio was lowest for which of the following asset classes? A. small U.S. stocks B. large U.S. stocks C. long-term U.S. Treasury bonds D. equity world portfolio in U.S. dollars

C. long-term U.S. Treasury bonds

The complete portfolio refers to the investment in _________. A. the risk-free asset B. the risky portfolio C. the risk-free asset and the risky portfolio combined D. the risky portfolio and the index

C. the risk-free asset and the risky portfolio combined

A coupon bond that pays interest (coupon) semiannually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 6%. If the coupon rate is 8%, the intrinsic value of the bond today will be __________.

Coupon (semi annual) = (0.08 / 2) x 1000 = 40

A coupon bond that pays interest (coupon) semiannually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 6%. If the coupon rate is 8%, the intrinsic value of the bond today will be __________.

Coupon (semi annual) = (0.08 / 2) x 1000 = 40 P = (40/1 + 0.06/2) + (40/1 + 0.03^2) + ⋯ + (40/1 + 0.03^3) ⋅ + (1000 /1 + 0.03) = 1,085.30

A coupon bond that pays coupon of 4% annually has a par value of $1,000, matures in 5 years, and is selling today at $850. The actual yield to maturity on this bond is _________.

Coupon = 0.04 x 1000 = 40 r = 0.0773

Which one of the following increases the net present value of a project? A. an increase in the required rate of return B. an increase in the initial capital requirement C. a deferment of some cash inflows until a later year D. an increase in the after tax salvage value of the fixed assets E. a reduction in the final cash inflow

D. an increase in the after tax salvage value of the fixed assets.

You have $500,000 available to invest. The risk-free rate, as well as your borrowing rate, is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should _________. A. invest $125,000 in the risk-free asset B. invest $375,000 in the risk-free asset C. borrow $125,000 D.borrow $375,000 ( 6/8 x 500,000)

D. borrow $375,000 ( 6/8 x 500,000)

Asset A has an expected return of 20% and a standard deviation of 25%. The risk-free rate is 10%. What is the reward-to-variability ratio?

(0.2 - 0.1) / 0.25 = 0.4

Day Interiors is considering a project with the following cash flows. What is the IRR of this project? y0 = -114600 y1 = 35900 y2 = 50800 y3 = 45000

0 = -114600 + (35900/1+IRR) + (50800/1=IRR) + (45000/1+IRR)

The holding-period return on a stock was 32%. Its beginning price was $25, and its cash dividend was $1.50. Its ending price must have been ( ).

0.32 = (P - 25 + 1.50) / 25 P = 31.5

3. In the bond market, we find the following Treasury bonds and their prices. Bond price $980 $98 $96 Maturity 2 years 1 year 2 years Face value $1,000 $100 $100 Coupon rate 10% 0% 0% a) Compute the YTMs for the above three bonds.

980 = 0.1117 98 = 0.0204 96 = 0.0206

The primary difference between Treasury notes and bonds is ________. A. maturity at issue B. default risk C. coupon rate D. tax status

A. maturity at issue

Which one of the following bonds is the least sensitive to interest rate risk? A. 3-year; 4 percent coupon B. 3-year; 6 percent coupon C. 5-year; 6 percent coupon D. 7-year; 6 percent coupon E. 7-year; 4 percent coupon

B. 3-year; 6 percent coupon

The internal rate of return is defined as the: A. maximum rate of return a firm expects to earn on a project. B. rate of return a project will generate if the project in financed solely with internal funds. C. discount rate that equates the net cash inflows of a project to zero. D. discount rate which causes the net present value of a project to equal zero. E. discount rate that causes the profitability index for a project to equal zero.

D. discount rate which causes the net present value of a project to equal zero.

A zero coupon bond: A. is sold at a large premium. B. pays interest that is tax deductible to the issuer at the time of payment. C. can only be issued by the U.S. Treasury. D. has more interest rate risk than a comparable coupon bond. E. provides no taxable income to the bondholder until the bond matures.

D. has more interest rate risk than a comparable coupon bond.

Your investment has a 40% chance of earning a 15% rate of return, a 50% chance of earning a 10% rate of return, and a 10% chance of losing 3%. What is the standard deviation of this investment?

E(R) = 0.4 x 0.15 + 0.5 x 0.10 + 0.1 x (-0.03) = 0.1070 VAR(R) = 0.4 x (0.15 - 0.107)^2 + 0.5 x (0.10 - 0.107)^2 + 0.1 x (-0.03 - 0.107)^2 = 0.002641 STDEV(R) = VAR^(1/2) = 0.0514

What is the expected returns and standard deviation of the returns on a stock given the following information? STATE: BOOM NORMAL RECESSION PROBABILITY: 30% 65% 5% RATE OF RET.: 15% 12% 6%

E(r) = (0.30 × 0.15) + (0.65 × 0.12) + (0.05 × 0.06) = 0.126 Var = 0.30 (0.15 - 0.126)2 + 0.65 (0.12 - 0.126)2 + 0.05 (0.06 - 0.126)2 = 0.000414 Std dev = √0.000414 = 2.03 percent

There are two distinct discount rates at which a particular project will have a zero net present value. In this situation, the project is said to: A. have two net present value profiles. B. have operational ambiguity. C. create a mutually exclusive investment decision. D. produce multiple economies of scale. E. have multiple rates of return.

E. have multiple rates of return.

Florida, Inc., has identified the following two mutually exclusive projects: Year 0 1 2 3 4 Project A -29,000 14,400 12,300 9,200 5,100 Project B -29,000 4,300 9,800 15,200 16,800 What is the IRR for each of these projects? Using the IRR decision rule, which project should the company accept? If the required return is 11 percent, what is the NPV for each of these projects? Which project will the company choose if it applies the NPV decision rule?

IRR for A -29000 + 14400/(1+r) + 12300/(1+r)^2 +9200/(1+r)^3 + 5100/(1+r)^4 =0 R = 0.185 IRR for B -29000 +4300/(1+r) + 9800/(1+r)^2 +15200/(1+r)^3 + 16800/(1+r)^4 =0 R= 0.174 NPV for A -29000 +14400/(1+0.11) + 12300/(1+0.11)^2 +9200/(1+0.11)^3 + 5100/(1+0.11)^4 =4042.4 NPV for B -29000 +4300/(1+0.11) + 9800/(1+0.11)^2 +15200/(1+0.11)^3 + 16800/(1+0.11)^4 = 5008.5

What is the net present value of a project that has an initial cash outflow of $34,900 and the following cash inflows? The required return is 15.35 percent. y1=12500 y2=19700 y3=0 y4=10400

NPV= 34900 +(12500/1.1535) + (19700/(1.1535)^2) + (10400/(1.1535)^4) = 3383.25

Florida Enterprise has bonds on the market making annual payments, with the eight-year maturity, a par value of $1,000, and selling for $948. At this price, the bonds yield 5.9%. What must the coupon rate be on the bond? (a coupon rate is coupon payments over the face value)

P = $948 = C(PVIFA5.90%,8) + $1,000(PVIF5.90%,8) 948 = C/1 + 0.059) + (C/1.059^2) + ⋯ + ((C+ 1000)/1.059^8) Solving for the coupon payment, we get: C = $50.66 The coupon payment is the coupon rate times par value. Using this relationship, we get: Coupon rate = $50.66 / $1,000 Coupon rate = .0507, or 5.07%

Find the Payback Period and Discount Payback Period for both project A and project B. Required rate of return is 8% Year 0 1 2 3 4 Project A -80,000 15,000 20,000 45,000 40,000 Project B -80,000 45,000 20,000 15,000 40,000

Payback Period: A:3 B:3 Discount Payback Period: A: -80000+15000/1.08+20000/(1.08^2) +45000/(1.08^3) =-13241 40000/(1.08^4) =29401 13241/29401 =0.45 3.45yrs B: -80000+45000/1.08+20000/(1.08^2) +15000/(1.08^3) =--9279 40000/(1.08^4) =29401 9279/29401 = 0.315 3.315yrs

Bond X is a premium bond making semiannual payments. The bond pays a coupon rate of 8.5%, has a YTM of 7%, and has 13 years to maturity. Bond Y is a discount bond making semiannual payments. This bond pays a coupon rate of 7%, has a YTM of 8.5%, and has 13 years to maturity. What is the price of each bond today? If interest rates are unchanged, what do you expect the price of these bonds to be one year from now? In three years? In eight years? In 12 years? In 13 years? Illustrate your answers by graphing bond prices versus time to maturity.

X: P0 = $42.50(PVIFA3.5%,26) + $1,000(PVIF3.5%,26) = $1,126.68 P1 = $42.50(PVIFA3.5%,24) + $1,000(PVIF3.5%,24) = $1,120.44 P3 = $42.50(PVIFA3.5%,20) + $1,000(PVIF3.5%,20) = $1,106.59 P8 = $42.50(PVIFA3.5%,10) + $1,000(PVIF3.5%,10) = $1,062.37 P12 = $42.50(PVIFA3.5%,2) + $1,000(PVIF3.5%,2) = $1,014.25 P13 = $1,000 Y: P0 = $35(PVIFA4.25%,26) + $1,000(PVIF4.25%,26) = $883.33 P1 = $35(PVIFA4.25%,24) + $1,000(PVIF4.25%,24) = $888.52 P3 = $35(PVIFA4.25%,20) + $1,000(PVIF4.25%,20) = $900.29 P8 = $35(PVIFA4.25%,10) + $1,000(PVIF4.25%,10) = $939.92 P12 = $35(PVIFA4.25%,2) + $1,000(PVIF4.25%,2) = $985.90 P13 = $1,000

Samuelson Electronics has a required payback period of three years for all of its projects. Currently, the firm is analyzing two independent projects. Project A has an expected payback period of 2.8 years and a net present value of $6,800. Project B has an expected payback period of 3.1 years with a net present value of $28,400. Which projects should be accepted based on the payback decision rule? A. Project A only B. Project B only C. Both A and B D. Neither A nor B E. Answer cannot be determined based on the information given.

A. Project A only

The market risk premium is defined as __________. A. the difference between the return on an index fund and the return on Treasury bills B. the difference between the return on a small-firm mutual fund and the return on the Standard & Poor's 500 Index C. the difference between the return on the risky asset with the lowest returns and the return on Treasury bills D. the difference between the return on the highest-yielding and the return on the lowest-yielding asset

A. the difference between the return on an index fund and the return on Treasury bills

The reward-to-volatility ratio is given by _________. A. the slope of the capital allocation line B. the second derivative of the capital allocation line C. the point at which the second derivative of the investor's indifference curve reaches zero D. the portfolio's excess return

A. the slope of the capital allocation line

You are trying to determine whether to expand your business by building a new manufacturing plant. The plant has an installation cost of $12 million, which will be depreciated straight-line to zero over its four-year life. If the plant has projected net income of $1,854,300, $1,907,600, $1,876,000, and $1,329,500 over these four years, what is the project's average accounting return (AAR)?

AVG.BV = 12mil +0 /2 = 6mil AVG.NI = $1,854,300 + $1,907,600 + $1,876,000 + $1,329,500 /4 = 1,741,850 AAR =1741850/6mil =0.289

The arithmetic & geometric averages of -11%, 15%, and 20% are ________.

Arith: 1/3 x (-0.11 + 0.15 + 0.20) = 0.08 Geo: [(1-0.11)(1+0.15)(1+0.20)]^(1/3) - 1 = 0.0709

Compute the arithmetic and geometric averages of -12%, 20%, and 25%.

Arith: 1/3 x (-0.12 + 0.20 + 0.25) = 0.11 Geo: [(1-0.12)x(1+0.20)x(1+0.25)]^(1/3)-1 = 0.0970

To earn a high rating from the bond rating agencies, a company would want to have: I. A low times-interest-earned ratio II. A low debt-to-equity ratio III. A high quick ratio A. I only B. II and III only C. I and III only D. I, II, and III

B. II and III only

Both investors and gamblers take on risk. The difference between an investor and a gambler is that an investor _______. A. is normally risk neutral B. requires a risk premium to take on the risk C. knows he or she will not lose money D. knows the outcomes at the beginning of the holding period

B. requires a risk premium to take on the risk

The holding period return on a stock is equal to _________. A. the capital gain yield over the period plus the inflation rate B. the capital gain yield over the period plus the dividend yield C. the current yield plus the dividend yield D. the dividend yield plus the risk premium

B. the capital gain yield over the period plus the dividend yield

Using your work in question b), is there an arbitrage opportunity? If any, how can we transact for arbitrage? Compute the arbitrage profits. (for this question, we can assume that we can transact the coupon bond.)

Buy: coupon bond at 980 Sell: 1 x 1year zeros and 11 x 2year zeros at 1154 Profit: 1154 - 980 = 174