Finance Exam 2
If the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ____.
$1,220 Reason: Bond value = $320 + 900 = $1,220
Nasafi Lumber paid an annual dividend of $1.37 per share yesterday. Today, the company announced that future dividends will be increasing by 3 percent annually. If you require a return of 14.6 percent, how much are you willing to pay to purchase one share of this stock today?
$12.16 Excel: (Dividend * (1+Growth rate)) / (Required return - Growth rate)
Farm Machinery stock currently sells for $54.80 per share. The market required return is 14.2 percent while the company maintains a constant 3 percent growth rate in dividends. What was the most recent annual dividend per share paid on this stock?
$5.96 Step 1: Expected Dividend = Stock price * (required return - growth rate) Step 2 Most recent Div = Expected Dividend / ( 1 + Growth rate)
Fisher Effect
(1 + R) = (1 + r)(1+h) R = nominal rate r = real rate h = expected inflation rate
All else constant, which one of the following will result in the lowest present value of a lump sum?
8 percent interest for 10 years
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 of $100 monthly payments provided the discount rates are equal.
Which of the following is true about interest rate risk?
All else equal, the longer the time to maturity, the greater the interest rate risk. All else equal, the lower the coupon rate, the greater the interest rate risk.
Which one of the following compounding periods will yield the lowest effective annual rate given a stated future value at Year 5 and an annual percentage rate of 10 percent?
Annual
A bond that can be paid off early at the issuer's discretion is referred to as being which type of bond?
Callable
Real rates are defined as nominal rates that have been adjusted for which of the following?
Inflation
In actual practice, managers most frequently use which two types of investment criteria?
Internal rate of return and net present value
The term structure of interest rates tells us what _________ interest rate are on default-free, pure discount bonds of all maturities.
Nominal
How is an APR computed?
Rate per period × Number of periods per year
You own two bonds—one with a 5 percent coupon and one with a 6 percent coupon. Which one is more sensitive to interest rate risk, all other things being equal?
The bond with the 5 percent coupon rate is more sensitive.
Why does a bond's value fluctuate over time?
The coupon rate and par value are fixed, while market interest rates change
Which of these are required to calculate the current value of a bond?
Time remaining to maturity Par value Coupon rate Applicable market rate
Your credit card charges you .85 percent interest per month. This rate when multiplied by 12 is called the ____ rate.
annual percentage
An agent who arranges a transaction between a buyer and a seller of equity securities is called a:
broker
A corporate bond's yield to maturity ____.
can be greater than, equal to, or less than the bond's coupon rate changes over time
T-Notes
coupon debt with original maturity between one and ten years
T-Bonds
coupon debt with original maturity greater than ten years
The IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the:
crossover rate.
Andrew just calculated the present value of a $15,000 bonus he will receive next year. The interest rate he used in his calculation is referred to as the:
discount rate.
The longer the term, the (smaller/greater) the interest rate sensitivity.
greater
Longer-term bonds have (smaller/greater) interest rate sensitivity because a (smaller/larger) portion of a bond's value comes from the face amount.
greater, larger
Your aunt has promised to give you $5,000 when you graduate from college. You expect to graduate three years from now. If you speed up your plans to enable you to graduate two years from now, the present value of the promised gift will:
increase.
The relationship between bond prices and the market rate of interest is ____.
inverse; if the market rate of interest rises, bond prices will fall
Hayley won a lottery and will receive $1,000 each year for the next 30 years. The current value of these winnings is called the:
present value.
The degree of interest rate risk depends on ____.
the sensitivity of the bond's price to interest rate changes
A perpetuity is defined as:
unending equal payments paid at equal time intervals.
Current yield
•Bond's annual coupon payment divided by the bond current price. •Measures only cash income provided by the bonds as a percentage of bond price.
In general, a corporate bond's coupon rate ____,
changes in sync with market interest rates
You are comparing two annuities that offer regular payments of $2,500 for five years and pay .75 percent interest per month. You will purchase one of these today with a single lump sum payment. Annuity A will pay you monthly, starting today, while Annuity B will pay monthly, starting one month from today. Which one of the following statements is correct concerning these two annuities?
Annuity B has a smaller present value than Annuity A.
If you sell a bond with a coupon of 6 percent to a dealer when the market rate is 7 percent, which one of the following prices will you receive?
Bid price
Which one of following is the rate at which a stock's price is expected to appreciate?
Capital gains yield
You are trying to compare the present values of two separate streams of cash flows that have equivalent risks. One stream is expressed in nominal values and the other stream is expressed in real values. You decide to discount the nominal cash flows using a nominal annual rate of 8 percent. What rate should you use to discount the real cash flows?
Comparable real rate
Which of the following terms apply to a bond?
Coupon rate Time to maturity Par value
Municipal Securities
Debt of state and local governments Varying degrees of default risk, rated similar to corporate debt Interest received is tax-exempt at the federal level
Which one of the following actions will increase the present value of an amount to be received sometime in the future?
Decrease in the interest rate
A decrease in which of the following will increase the current value of a stock according to the dividend growth model?
Discount rate
What are the distributions of either cash or stock to shareholders by a corporation called?
Dividends
Caroline is going to receive a award of $20,000 six years from now. Jiexin is going to receive an award of $20,000 nine years from now. Which one of the following statements is correct if both individuals apply a discount rate of 7 percent?
In today's dollars, Caroline's award is worth more than Jiexin's.
Which of the following is true about a typical multiple-year bond's coupon?
It is a fixed annuity payment.
Which of the following are true about a bond's face value?
It is also known as the par value. It is the principal amount repaid at maturity.
What is an interest-only loan?
It's a loan in which the borrower pays interest periodically and repays the principal when the bond matures.
medium grade bond ratings
Moody's A and S&P A - capacity to pay is strong, but more susceptible to changes in circumstances Moody's Baa and S&P BBB - capacity to pay is adequate, adverse conditions will have more impact on the firm's ability to pay
High grade bond ratings
Moody's Aaa and S&P AAA - capacity to pay is extremely strong Moody's Aa and S&P AA - capacity to pay is very strong
Low grade
Moody's Ba and B S&P BB and B Considered possible that the capacity to pay will degenerate
Very low grade bond ratings
Moody's C (and below) and S&P C (and below) • income bonds with no interest being paid, or • in default with principal and interest in arrears
You are viewing a graph that plots the NPVs of a project against the various discount rates that could be applied to the project's cash flows. What is the name given to this graph?
NPV profile
Salazar's Salads is considering two projects. Project X consists of creating an outdoor eating area on the unused portion of the restaurant's property. Project Z would instead use that outdoor space for creating a drive-thru service window. When trying to decide which project to accept, the firm should rely most heavily on which one of the following analytical methods?
Net present value
Bui Bakery has a required payback period of two years for all of its projects. Currently, the firm is analyzing two independent projects. Project X has an expected payback period of 1.4 years and a net present value of $6,100. Project Z has an expected payback period of 2.6 years with a net present value of $18,600. Which project(s) should be accepted based on the payback decision rule?
Project X only
The term structure of interest rates includes all of the following basic components:
Real Rate of Interest, rate of inflation, Interest Rate Risk
Which one of the following statements concerning interest rates is correct?
The effective annual rate equals the annual percentage rate when interest is compounded annually.
Which one of these statements related to growing annuities and perpetuities is correct?
The present value of a growing perpetuity will decrease if the discount rate is increased.
Reyes has a dividend yield of 5.4 percent and a total return for the year of 4.8 percent. Which one of the following must be true?
The stock has a negative capital gains yield.
A premium bond that pays $60 in interest annually matures in seven years. The bond was originally issued three years ago at par. Which one of the following statements is accurate in respect to this bond today?
The yield to maturity is less than the coupon rate.
If you invest in a corporate bond, how many times can you expect, in general, to receive interest?
Twice a year
Which one of the following statements related to loan interest rates is correct?
When comparing loans you should compare the effective annual rates.
What is a corporate bond's yield to maturity (YTM)?
YTM is the prevailing market interest rate for bonds with similar features. YTM is the expected return for an investor who buys the bond today and holds it to maturity.
Gehle Corporation pays a constant annual dividend of $.63 per share. The stock is priced at $5.38 per share. If your required rate of return is 11 percent per year, should you buy the stock? Why or why not?
Yes; The stock has a present value of $5.73 per share. Excel: Divdend / Rate of Return
Bond yields (are/aren't) quoted like APRs
are
Protective covenants:
are primarily designed to protect bondholders.
The process of determining the present value of future cash flows in order to know their value today is referred to as:
discounted cash flow valuation.
The length of time a firm must wait to recoup, in present value terms, the money it has invested in a project is referred to as the:
discounted payback period.
When short-term rates are higher than long-term rates, we say it is __________________.
downward sloping
The actual interest rate on a loan that is compounded monthly but expressed as an annual rate is referred to as the _____ rate.
effective annual
An ordinary annuity is best defined as:
equal payments paid at the end of regular intervals over a stated time period.
Yield to Maturity
•The discount rate that equates the price of the bond with the discounted value of the coupons and face value. •A measure of rate of return that accounts to some extent for both current income and the price decrease/increase over the bond's life.
Net present value:
is the best method of analyzing mutually exclusive projects.
The reason that interest rate risk is greater for Blank______ term bonds than for Blank______ term bonds is that the change in rates has a greater effect on the present value of the Blank______ than on the present value of the Blank______.
long; short; face value; coupon payments
A company may decide to issue bonds with maturities of greater than 30 years in order to lock in (low/high) interest rates for a long time.
low
All other things being equal, the (lower/higher) the coupon rate, the greater the interest rate risk.
lower
Interest rates that include an inflation premium are referred to as:
nominal rates
The stream of customer orders coming in to the NYSE trading floor is called the:
order flow
The length of time a firm must wait to recoup the money it has invested in a project is called the:
payback period.
The information needed to compute a bond's yield to maturity includes the bond's ____, coupon rate, and maturity date.
price
T-bills
pure discount bonds with original maturity of one year or less
The pure time value of money is known as the:
term structure of interest rates.
Javangula Foods is considering two mutually exclusive projects and has determined that the crossover rate for these projects is 12.3 percent. Given this information, you know that:
the project that is acceptable at a discount rate of 12 percent should be rejected at a discount rate of 13 percent.
A project has a net present value of zero. Given this information:
the project's cash inflows equal its cash outflows in current dollar terms.
bond indenture
•Contract between the company and the bondholders that includes basic terms of the bonds, The total amount of bonds issued, description of property used as security, if applicable, Call provisions
Yield to call
•The discount rate that equates the bond's current price with its stream of promised cash flows until the expected Call date.
