FINANCE QUIZ 2

You just purchased a 15 year bond with an 11 percent annual coupon. The bond has a face value of $1,000 and a current yield of 10 percent. Assuming that the yield to maturity of 9.7072 percent remains constant, what will be the price of the bond 1 year from now?

$1,097 YTM = current yield + capital gain 9.7072 = 10% + capital gain, solve for capital gain. price now = annual coupon/current yield (1,000*.11)/.10 = $1,100 price in one year = price now x (1 + capital gain as a decimal)

Assume that a 15-year, $1,000 par value bond pays interest of $37.50 every 3 months. If you require a nominal annual rate of return of 12%, with quarterly compounding, how much should you be willing to pay for this bond (approximately)?

$1,207.5 N = 60 (15 years, payments every 3 months) I = 3 (12%, quarterly compounding) PMT = 37.50 FV = $1,000 OUTPUT = PV

Assume that McDonald's and Burger King have similar $1,000 par value bond issues outstanding. The bonds are equally risky. The Burger King bond has an annual coupon rate of 8 percent and matures 20 years from today. The McDonald's bond has a coupon rate of 8 percent, with interest paid semiannually, and it also matures in 20 years. If the nominal required rate of return, Kd, is 12 percent, semiannual basis, for both bonds, what is the difference in current market prices of the two bonds?

$17.53

Recently, Ohio Hospitals Inc. filed for bankruptcy. The firm was reorganized as American Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue to be put into effect. The issue has 10 years to maturity and a coupon rate of 10 percent, paid annually. The new agreement allows the firm to pay no interest for 5 years. Then, interest payments will be resumed for the next 5 years. Finally, at maturity (year 10), the principal plus the interest that was not paid during the first 5 years will be paid. However, no interest will be paid on the deferred interest. If the required annual return is 20 percent, what should the bonds sell for in the market today?

$362.44

Chips Inc. has two bond issues outstanding, and both sell for $701.22. The first issue has an annual coupon rate of 8% and 20 years to maturity. The second bond has an identical yield to maturity as the first bond, but only 5 years until maturity. Both bonds pay interest annually with par value of $1,000. What is the annual interest payment on the second bond?

$37.12 N = 20 PV = -701.22 PMT = 80 (8% of 1,000) FV = 1,000 OUTPUT = I use I found to calculate answer N = 5 I = 12 PV = -701.22 FV = 1,000 OUTPUT = PMT

Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with face value of $1,000, 15 years to maturity and a coupon rate of 8%, with interest paid semiannually. The required nominal rate on the debt has now risen to 16% per annum. What is the current value of this bond (approximately)?

$550

A zero coupon bond with a face value of $1,000 matures in 15 years. The bond has a yield to maturity of 7 percent. If an investor buys the bond at the beginning of the year, how much money in taxes will the investor have to pay on the zero coupon bond the first year. Assumer that the investor has a 25 percent marginal tax rate.

$6.34

Assume that you are considering the purchase of a $1,000 par value bond that pays interest of $70 each six months and has 10 years to go before it matures. If you buy this bond, you expect to hold it for 5 years and then to sell it in the market. You (and other investors) currently require a nominal rate of only 12 percent when you sell the bond due to a general decline in interest rates. How much should you be willing to pay for this bond?

$966.99

A 6-year bond which pays 8% interest semiannually sells at par ($1,000). Another 6-year bond of equal risk pays 8% interest annually. Both bonds are non-callable and have a face value of $1,000. What is the price of the bond which pays annual interest?

$992.64 N = 6 I = PMT =80 (8% of 1,000) FV = 1,000

A portfolio manager is holding the following investments. The manager plans to sell his holdings of Stock Y. The money from the sale will be used to purchase another $15 million of Stock X and another $5 million of Stock Z. The risk-free rate is 5 percent and the market risk premium is 5.5 percent. How many percentage points higher will the required return on the portfolio be after he completes this transaction (approximately)?

.39% find initial beta: add all invested amounts, then find total beta of old. risk free rate + (market risk premium * total beta of old). Change numbers according to changed stocks to find new number. subtract the two numbers to find final percentage

An analyst obtains the following information regarding two bonds. What is the duration difference between these two bonds?

0.05

Assume that the risk-free rate is 5.5 percent and the market risk premium is 6 percent. A money manager has $10 million invested in a portfolio that has a required return of 12 percent. The manager plans to sell $3 million of stock with a beta of 1.6 that is part of the portfolio. She plans to reinvest this $3 million into another stock that has a beta of 0.7. If she goes ahead with this planned transaction, what will be the required return of her new portfolio?

10.38% calculate current beta: required return = risk-free rate + (market risk premium)beta - solving for beta in this case calculate beta of remaining stocks: use beta found in part 1 (beta = (sold stocks/total stocks)(beta) + (remaining stocks/total stocks)X) - solve for X. calculate new portfolio's beta: (remaining stocks/total stocks)(X found above) + (sold stocks/total stocks)(second beta listed) new portfolios required return: risk-free rate + (market risk premium * new portfolio's beta)

Stock X, Stock Y, and the market have had the following returns over the past four years, The risk-free rate is 7 percent. The market risk premium is 5 percent. What is the required rate of return for a portfolio that consists of $14,000 invested in Stock X and $6,000 invested in Stock Y?

11.58%

Assume the city of Tampa sold an issue of $1,000 maturity value, tax-exempt (municipal bond), zero coupon bonds 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 10 percent, but with semiannual compounding. The bonds are now callable at a premium of 10 percent over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today?

12.37%

The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond is paid every six months, and the nominal annual yield is 14 percent. Given these facts, what is the annual coupon rate on this bond?

17% N = 20 (10 year, 6 month payments = 20) I = 7 (annual yield/ 2) PV = -1,158.91 FV = 1,000 OUTPUT = PMT multiply x2 to get annual number, then divide by $1,000 to find annual coupon rate

A portfolio manager is managing a $10 million portfolio. Currently the portfolio is invested in the following manner. Currently, the risk-free rate is 5 percent and the portfolio has an expected return of 10 percent. Assume that the market is in equilibrium so that expected returns equal required returns. The manager is willing to take on additional risk and wants to instead earn an expected return of 12 percent on the portfolio. Her plan is to sell Stock 1 and use the proceeds to buy another stock. In order to reach her goal, what should be the beta of the stock that the manager selects to replace stock 1?

2.60

The current risk-free rate is 6 percent and the market risk premium is 5 percent. Erika is preparing to invest $30,000 in the market and she wants her portfolio to have an expected return of 12.5 percent. Erika is concerned about bearing too much stand-alone risk; therefore, she will diversify her portfolio by investing in three different assets (two mutual funds and a risk-free security). The three assets she will be investing in are an aggressive growth mutual fund that had a beta of 1.6, an S&P 500 index fund with a beta of 1, and a risk-free security that has a beta of 0. She has already decided that she will invest 10 percent of her money in the risk-free asset. In order to achieve the desired expected return of 12.5 percent, what proportion of Erika's portfolio must be invested in the S&P 500 index fund?

23.33% AGMF = risk-free rate + (market risk premium* AGMF beta) S&P 500 = risk-free rate + (market risk premium *S&P 500 beta) expected return = .10(risk-free rate) + (.90-X)(AMGF) + X(S&P 500) solve for X

Bradley Hotels has a beta of 1.3, while Douglas Farms has a beta of 0.7. The required return on an index fund that holds the entire stock market is 12 percent. The risk free rate of interest is 7 percent. By how much does Bradley's required return exceed Douglas' required return?

3.0% entire stock market = risk free rate + (Rpm)1.0 solve for Rpm Ks = risk free rate + (RPM)beta of each the difference between the two is the answer

Currently the risk-free rate is 5 percent and the market risk premium is 6 percent. You have your money invested in three assets: an index fund that has a beta of 1.0, a risk-free security that has a beta of 0, and an international fund that has a beta of 1.5. You want 20 percent of your portfolio invested in the risk-free asset, and you want your overall portfolio to have an expected return of 11 percent. What portion of your overall portfolio should you invest in the international fund?

40%

You have $100 to invest in a portfolio. The portfolio is composed of a risky asset with an expected rate of return of 12 percent and a standard deviation of 15 percent and a Treasury bill with a rate of 5 percent. What percentage of your money should be invested in the risky asset to form a portfolio with an expected rate of return of 9 percent?

57%

A 15 year bond with a 10 percent semiannual coupon has a par value of $1,000. The bond may be called after 10 years at a call price of $1,050. The bond has a nominal yield to call of 6.5 percent. What is the bond's yield to maturity, stated on a nominal, or annual basis?

6.95%

You have been scouring the Wall Street Journal looking for stocks that are "good values" and have calculated expected returns for five stocks. Assume the risk-free rate (Krf) is 7 percent and the market risk premium (Km-Krf) is 2 percent. Which security would be the best investment?

7.06% calculate required return of each, whichever has the highest number is the best investment risk free rate + market risk premium (beta)

Assume that the State of Florida sold tax-exempt, zero coupon bonds with a $1,000 maturity value 5 years ago. The bonds had a 25 year maturity when they were issued, and there interest rate built into the issue was a nominal 8 percent, compounded semiannually. The bonds are now callable at a premium of 4 percent over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today?

9.01%

Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?

A reduction in market interest rates

You have developed the following data on three stocks. If you are a risk minimizer, you should choose stock __ if it is to be held in isolation and stock ___ if it is to be held as part of a well-diversified portfolio.

A, B. (smallest standard dev, smallest beta)

A highly risk-averse investor is considering the addition of an asset to a 10-stock portfolio. The two securities under consideration both have an expected return equal to 15 percent. However, the distribution of possible returns associated with Asset A has a standard deviation of 12 percent, while Asset B's standard deviation is 8 percent. Both assets are correlated with the market with equal to .75. Which asset should the risk-averse investor add to his/her portfolio?

Asset B

Which of the following statements is most correct?

Assume the the required rate of return on the market is currently km = 15%, and that km remains fixed at that level. If the yield curve has a steep upward slope, the calculated market risk premium would be larger if the 30-day T-bill rate were used as the risk-free rate than if the 30-year T-bond rate were used as Krf

You obtain the following information regarding three bonds. Assume you can buy or sell not more than one of each bond. Can you make an arbitrage here, and if so how much money will you earn?

Can earn approximately $14

The distributions of rates of return for companies AA and BB are given below. We can conclude from the above information that any rational risk-averse investor will add security AA to a well-diversified portfolio over security BB

False

HR corporation has a beta of 2.0, while LR corporation's beta is .5. the risk-free rate is 10 percent, and the required rate of return on an average stock is 15 percent. Now the expected rate of inflation built into Rf falls by 3 percentage points, while other components of the risk-free rate remain constant, the required return on the market falls to 11 percent, and the betas remain constant. When all of these changes are made, what will the different in the required returns on HR's and LR's stocks?

Khr/lr = (risk free rate - fall in percentage points) + (required return on the market - new risk free rate) beta of each

JRJ Corporation recently issued 10-year bonds at a price of $1,000. These bonds pay $60 in interest each 6 months. Their price has remained stable since they were issued, i.e., they still sell for $1,000. Due to additional financing needs, the firm wishes to issue new bonds that would have a maturity of 10 years, a par value of $1,000, and pay $40 interest every six months. If both bonds have the same yield, how many new bonds must JRJ issue to raise $2,000,000 cash?

N = 20 ( 10 x semiannual = 20) I = 6 (60 is 6% of 1,000) PMT = 40 FV = 1,000 divide number found by 2,000,000

You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6 months. If your nominal annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay for this bond?

N = 20 (10 years, 6 month payment = 20 payments) I = 5 (10% rate of return w/semiannual compounding = 10/2) PMT = 60 (interest payment) FV = 1,000 (face value) OUTPUT = PV

A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If your nominal annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond?

N = 40 (10 years, quarterly compounding = 40) I = 3 (12 / quarters = 3) PMT = 35 FV = 1,000

Which of the following statements is most correct?

None of the above statements is correct

Stock A has a beta of 1.2 and a standard deviation of 20 percent. Stock B has a beta of .8 and a standard deviation of 25 percent. Portfolio P is a $200,000 portfolio consisting of $100,000 invested in Stock A and $100,000 invested in stock B. Which of the following statements is most correct?

Portfolio P has a beta equal to 1.0

Stock A has an expected return of 10 percent and a standard deviation of 20 percent. Stock B has an expected return of 12 percent and a standard deviation of 30 percent. The risk-free rate is 5 percent and the market risk premium, Km - Krf, is 6 percent. Assume that the market is in equilibrium. Portfolio P has 50 percent invested in Stock A and 50 percent invested in Stock B. The returns of Stock A and Stock B are independent of one another. (That is, their correlation coefficient equals zero). Which of the following statements is most correct?

Statements A and B are correct.

In a portfolio of three different stocks, which of the following could not be true?

The beta of the portfolio is less than the beta of each of the individual stocks

Which of the following types of bond issues is the most price sensitive?

Zero coupon long term- bonds

Systematic risk is rewarded with a premium in the marketplace because

it is associated with market movements which cannot be eliminated through diversification

Duration is higher when

maturity is long but when market rates of interest and coupon rates are low

You hold a diversified portfolio consisting of a $10,000 investment in each of 20 different common stocks (i.e., your total investment is $200,000). The portfolio beta is equal to 1.2. You have decided to sell one of your stocks which has a beta equal to .7 for $10,000. You plan to use the proceeds to purchase another stock which had a beta equal to 1.4. What will be the beta of the new portfolio?

old portfolio beta = (1/20)(one stock beta) new beta = old portfolio beta + (1/20)(new beta)

Oakdale Funiture Inc. has a beta coefficient of .7 and a required rate of return of 15 percent. The market risk premium is currently 5 percent. If the inflation premium increases by 2 percentage points, and Oakdale acquires new assets that increase its beta by 50 percent, what will Oakdale's new required rate of return (assume that the inflation premium affects both the market return and the risk free rate the same way)?

required rate of return = Krf + (market risk premium * beta), solve for Krf, then add the inflation premium increase which equals new Krf. New beta = beta * 1.5 new required rate of return = new Krf + (market risk premium *new beta)

Assume the risk-free rate is 5 percent, and that the market risk premium is 7 percent. If a stock has a required rate of return of 13.75 percent, what is its beta?

required rate of return = risk-free rate + (market risk premium) beta