Financial Management Final Exam pt. 1

Shafer Corporation issued callable bonds. The bonds are most likely to be called if:

A. Interest rates decrease

Suppose interest rates have been at historically low levels the past two years. A reasonable strategy for bond investors during this time period would be to

B. invest in short term bonds to reduce interest rate risk

The yeild to maturity on a bond is...

C. The required rate of return on the bond

Aaron corporation has two bonds outstanding. Both bonds mature in 10 years, have a face value of $1,000 and have a yeild to maturity of 8%. One bond is a zero coupon bond and the other bond has coupon rate of 8%. Which of the following statements is true?

C. the zero coupon bond must sell for a lower price than the bond with an 8% coupon rate.

Which of the following statements is most correct?

D. Both B and C

John and Karen are both considering buying a corporate bond with a coupon rate of 8% , a face value of $1,000, and a maturity date of Jan 1, 2025. Which of the following statements is most correct?

D. John may determine a different value for a bond than Karen because each investor may have a different level of risk aversion, and hence a different required return

What is the expected rate of return on a bond that matures in 8 years, has a par value of $1,000, a coupon rate of 12%, and is currently selling for $976? Assume annual coupon payments.

Expected Rate of Return = (Annual Interest Payment + Annual Capital Gain) / Current Market Price First, let's calculate the annual interest payment: Annual Interest Payment = Coupon Rate * Par Value = 12% * $1,000 = $120 Next, let's calculate the annual capital gain: Annual Capital Gain = (Par Value - Current Market Price) / Years to Maturity = ($1,000 - $976) / 8 = $3 Now we can plug these values into the formula: Expected Rate of Return = ($120 + $3) / $976 = 0.1291 or 12.91% Therefore, the expected rate of return on the bond is approximately 12.91%, which is closest to option C.

What is the value of a bond that has a par value of $1,000, a coupon of $100 (annually), and matures in 12 years? Assume a required rate of return of 13%.

PV of coupon payment = Coupon payment / (1 + required rate of return)^t where t is the number of years until the payment is received. For a 12-year bond, there will be 12 coupon payments. The final payment will also include the par value of $1,000. PV = (100 / 1.13^1) + (100 / 1.13^2) + ... + (100 / 1.13^12) + (1000 / 1.13^12) PV = $822.47 Therefore, the value of the bond is $822.47.

. A corporate bond has a coupon rate of 9%, a yield to maturity of 11.1%, a face value of $1,000, and a market price of $850. Therefore, the annual interest payment is:

The annual interest payment is calculated as the coupon rate times the face value of the bond. Therefore, the annual interest payment on this bond is 9% × $1,000 = $90. So, the answer is (a) $90.

****A bond issued by Cornwallis, Inc. 15 years ago has a coupon rate of 7% and a face value of $1,000. The bond will mature in 10 years. What is the value (to the nearest dollar) to an investor with a required return of 10%?

The cash flows consist of annual interest payments of $70 (7% of $1,000) for the next 10 years, plus the face value of $1,000 received at maturity in 10 years. Using a financial calculator or a spreadsheet, we can find the present value of these cash flows using a discount rate of 10%. The result is: PV = $70 × (1 - 1/1.1^10)/0.1 + $1,000/1.1^10 PV = $70 × 6.145 + $385.54 PV = $826.19 Therefore, the value of the bond to an investor with a required return of 10% is approximately $826 (to the nearest dollar).

Alaska Power Company issued $1,000 bonds that have an annual coupon rate of 7.5%. The present market value of the bonds is $1,125. If the bonds have 15 years remaining until maturity, what is the current yield on Alaska Power Company bonds?

To calculate the current yield on the Alaska Power Company bonds, we need to divide the annual coupon payment by the current market value of the bond: Annual coupon payment = $1,000 x 7.5% = $75 Current yield = ($75 / $1,125) x 100% = 6.67% Therefore, the current yield on Alaska Power Company bonds is 6.67%, option (b).

****Emery Company just paid a dividend yesterday of $2.25 per share. The company's stock is currently selling for $60 per share, and the required rate of return on Emery Company stock is 15%. What is the growth rate expected for Emery Company dividends? (Round your answer to the nearest two decimal places.)

To calculate the growth rate expected for Emery Company dividends, we can use the Gordon Growth Model and rearrange the formula to solve for the growth rate (g): g = (D / P) - r Where: D = Dividend per share P = Stock price r = Required rate of return In this case, the dividend per share is $2.25, the stock price is $60, and the required rate of return is 15%. Plugging these values into the formula, we get: g = ($2.25 / $60) - 0.15 g = 0.0375 - 0.15 g = -0.1125 Therefore, the growth rate expected for Emery Company dividends is approximately -0.11, or -11%. ANSWER: D

The PDQ Company's common stock is expected to pay a $1.00 dividend in the coming year. If investors require a 15% return and the growth rate in dividends is expected to be 5%, what will the market price of the stock be?

To calculate the market price of the stock, we can use the Gordon Growth Model. The formula is as follows: P = D / (r - g) Where: P = Market price of the stock D = Dividend expected to be paid in the coming year r = Required rate of return g = Growth rate in dividends In this case, the dividend expected to be paid in the coming year is $1.00, the required rate of return is 15%, and the growth rate in dividends is 5%. Plugging these values into the formula, we get: P = $1.00 / (0.15 - 0.05) P = $1.00 / 0.10 P = $10.00 Therefore, the market price of the stock is expected to be $10.00. ANSWER: B

****A financial analyst expects KacieCo. to pay a dividend of $3 per share one year from today, a dividend of $3.50 per share in years two, and estimates the value of the stock at the end of year two to be $28. If your required return on KacieCo stock is 15%, what is the most you would be willing to pay for the stock today if you plan to sell the stock in two years?

To calculate the most you would be willing to pay for the stock today, you need to find the present value of the future cash flows (dividends and stock value) using the required return of 15%. The cash flows we have are as follows: Year 1: Dividend of $3 per share Year 2: Dividend of $3.50 per share + Stock value of $28 Using the formula for present value, we can calculate the present value of each cash flow and then sum them up. PV(Dividend Year 1) = $3 / (1 + 0.15) = $2.6087 PV(Dividend Year 2) = $3.50 / (1 + 0.15)^2 = $2.2689 PV(Stock Value Year 2) = $28 / (1 + 0.15)^2 = $20.2597 Now, we can calculate the present value of the cash flows: PV(Cash Flows) = PV(Dividend Year 1) + PV(Dividend Year 2) + PV(Stock Value Year 2) = $2.6087 + $2.2689 + $20.2597 = $25.1373 Therefore, the most you would be willing to pay for the stock today if you plan to sell it in two years is approximately $25.1373 per share.

Butler Corp paid a dividend today of $3.50 per share. The dividend is expected to grow at a constant rate of 8% per year. If Butler Corp stock is selling for $75.60 per share, the stockholders' expected rate of return is ________.

To calculate the stockholders' expected rate of return, we can use the dividend discount model (DDM) formula. The formula for the expected rate of return (Ke) is: Ke = (Dividend / Current Stock Price) + Growth Rate Given: Dividend (D0) = $3.50 per share Current Stock Price (P0) = $75.60 per share Growth Rate (g) = 8% or 0.08 Ke = (3.50 / 75.60) + 0.08 Ke = 0.0462 + 0.08 Ke = 0.1262 Converting the decimal to a percentage, the stockholders' expected rate of return is approximately 12.62%. Rounded to two decimal places, the correct option is: a. 12.63%

Swanson, Inc. bonds have a 10% coupon rate with semi-annual coupon payments. They have 12 and 1/2 years to maturity and a par value of $1,000. Compute the value of Swanson's bonds if investors' required rate of return is 8%

To calculate the value of Swanson, Inc. bonds, we need to find the present value of each semi-annual coupon payment and the present value of the face value of the bond at maturity, and then add them together. The semi-annual coupon payment is $50 (10% coupon rate divided by 2, multiplied by the $1,000 par value), and the bond will make 25 semi-annual coupon payments (12.5 years times 2). The present value of each semi-annual coupon payment can be calculated using the following formula: PV = PMT / (1 + r)^n where PV is the present value, PMT is the semi-annual coupon payment, r is the required rate of return divided by 2 (since it is a semi-annual payment), and n is the number of semi-annual periods until the payment is made. Using this formula, we can calculate the present value of each semi-annual coupon payment to be: PV = 50 / (1 + 0.04)^1 = $48.08 PV = 50 / (1 + 0.04)^2 = $46.23 PV = 50 / (1 + 0.04)^3 = $44.42 ... PV = 50 / (1 + 0.04)^24 = $11.91 Next, we need to calculate the present value of the face value of the bond at maturity. Since the bond has a par value of $1,000, the present value at maturity is simply $1,000. Finally, we can add up the present values of all the coupon payments and the present value of the face value of the bond at maturity to get the total value of the bond: Total value = $48.08 + $46.23 + $44.42 + ... + $11.91 + $1,000 Total value = $1,156.22 Therefore, the value of Swanson, Inc. bonds is $1,156.22 if investors' required rate of return is 8%. ANSWER: A

Nuray Corp. preferred stock pays a $.50 annual dividend. What is the value of the stock if your required rate of return is 10%?

To calculate the value of the preferred stock, we can use the formula for the present value of a perpetuity: Value = Dividend / Required Rate of Return In this case, the annual dividend is $0.50 and the required rate of return is 10%. Plugging these values into the formula, we get: Value = $0.50 / 0.10 Value = $5.00 Therefore, the value of the preferred stock is $5.00. ANSWER: C

You are considering the purchase of a common stock that paid a dividend of $1.00 yesterday. You expect this stock to have a growth rate of 20 percent for the next 3 years, resulting in dividends of D1=$1.20, D2=$1.44, and D3=$1.73. The long-run normal growth rate after year 3 is expected to be 8 percent (that is, a constant growth rate after year 3 of 8% per year forever). If you require a 12 percent rate of return, how much should you be willing to pay for this stock?

To calculate the value of the stock, we can use the dividend discount model (DDM) formula: P0 = D1 / (1+r)^1 + D2 / (1+r)^2 + D3 / (1+r)^3 + D3 * (1+g) / (r-g) * (1+r)^3 Where: P0 is the current price of the stock D1, D2, D3 are the expected dividends in years 1, 2, and 3 r is the required rate of return g is the long-run normal growth rate after year 3 Plugging in the given values: D1 = 1.20 D2 = 1.44 D3 = 1.73 r = 0.12 g = 0.08 P0 = 1.20 / (1+0.12)^1 + 1.44 / (1+0.12)^2 + 1.73 / (1+0.12)^3 + 1.73 * (1+0.08) / (0.12-0.08) * (1+0.12)^3 Simplifying the equation, we find: P0 = 1.20 / 1.12 + 1.44 / 1.12^2 + 1.73 / 1.12^3 + 1.73 * 1.08 / 0.04 * 1.12^3 Calculating the values, we get: P0 ≈ 1.0714 + 1.2165 + 1.3086 + 34.6607 Adding up these values, we find: P0 ≈ 38.2572 Rounded to the nearest dollar, the value of the stock is approximately $38. Therefore, the correct option is: a. $38.65

A $1,000 par value 12-year bond with a 9 percent coupon rate recently sold for $980. The yield to maturity is ________.

To calculate the yield to maturity (YTM) for this bond, we need to solve for the discount rate (i.e., the yield) that equates the present value of the bond's cash flows to its current market price. We know the following information: Face value (par value) of the bond: $1,000 Coupon rate: 9% (i.e., the annual coupon payment is $90) Years to maturity: 12 Market price: $980 the YTM is approximately 9.39%. Therefore, the answer is b. greater than 9 percent.

A corporate bond has a coupon rate of 9%, a face value of $1,000, a market price of $850, and the bond matures in 15 years. Therefore, the bond's yield to maturity is ________.

To calculate the yield to maturity of the bond, we need to solve for the interest rate in the present value formula, which is: PV = C/(1 + r)^1 + C/(1 + r)^2 + ... + C/(1 + r)^n + F/(1 + r)^n Where PV is the present value of the bond, C is the annual coupon payment, r is the yield to maturity, n is the number of years to maturity, and F is the face value of the bond. Plugging in the values given: PV = $850 C = $90 (9% of $1,000) n = 15 F = $1,000 $850 = $90/(1 + r/2)^1 + $90/(1 + r/2)^2 + ... + $90/(1 + r/2)^30 + $1,000/(1 + r/2)^30 Solving for r. r = 13.45% ANSWER: (d) 13.45%.

Halverson, Inc. just issued $1,000 par 20-year bonds. The bonds sold for $936 and pay interest semiannually. Investors require a rate of 7.00% on the bonds. What is the amount of the semi-annual interest payment on the bonds?

To find the amount of the semi-annual interest payment on the bonds, we can use the formula for calculating the coupon payment. The bond sold for $936, and the required rate of return (yield to maturity) is 7.00%. The bond pays interest semi-annually over a 20-year period, which corresponds to 40 semi-annual periods. Let's denote the semi-annual interest payment as C. Using the present value formula: PV = C × [(1 - (1 + r)^-n) / r] + FV / (1 + r)^n Substituting the given values: $936 = C × [(1 - (1 + 0.07 / 2)^-40) / (0.07 / 2)] + $1,000 / (1 + 0.07 / 2)^40 Solving this equation for C, we find: C ≈ $32.00 The semi-annual interest payment is approximately $32.00. Therefore, the correct answer is (c) $32.00.

Cranston Industries just issued $1,000 par 30-year bonds. The bonds sold for $1,107.20 and pay interest semi-annually. Investors require a rate of 7.75% on the bonds. What is the bonds' coupon rate? (Pro Tip from Sera, Don't round any data until the end)

To find the coupon rate of the bond, we can use the present value formula and solve for the coupon payment. The present value of the bond is given as $1,107.20, and the required rate of return (yield to maturity) is 7.75%. The bond pays interest semi-annually over a 30-year period, which corresponds to 60 semi-annual periods. Let's denote the coupon payment as C. Using the present value formula: PV = C × [(1 - (1 + r)^-n) / r] + FV / (1 + r)^n Substituting the given values: $1,107.20 = C × [(1 - (1 + 0.0775 / 2)^-60) / (0.0775 / 2)] + $1,000 / (1 + 0.0775 / 2)^60 Solving this equation for C, we find: C ≈ $37.539 The semi-annual coupon payment is approximately $37.539. To find the annual coupon rate, we multiply this amount by 2 (since there are two semi-annual periods in a year): Annual coupon rate = $37.539 × 2 = $75.078 Therefore, the bond's coupon rate is approximately $75.078 or 7.5078%. ANSWER: B

. SWH Corporation issued bonds on January 1, 2009. The bonds had a coupon rate of 4.5%, with interest paid semiannually. The face value of the bonds is $1,000 and the bonds mature on January 1, 2019. What is the yield to maturity for an SWH Corporation bond on January 1, 2013 if the market price of the bond on that date is $930?

To solve this problem, we can use the YTM formula and then solve for the interest rate that makes the present value of the bond equal to its market price: PV = (C / (1 + r/2)^n) + (C / (1 + r/2)^(n-1)) + ... + (C + FV / (1 + r/2)^(n-1)) where PV is the market price of the bond, C is the semiannual coupon payment, r is the YTM, n is the number of semiannual periods (20 in this case), and FV is the face value of the bond. Plugging in the given values, we get: 930 = (22.5 / (1 + r/2)^1) + (22.5 / (1 + r/2)^2) + ... + (22.5 + 1000 / (1 + r/2)^20) Using a financial calculator or spreadsheet software, we can solve for r using the I/Y (interest rate) function. The YTM is approximately 5.40%, so the ANSWER IS C.

****What is the value of a bond that matures in 5 years, has an annual coupon payment of $110, and a par value of $2,000? Assume a required rate of return of 7%.

Using the formula for the present value of a bond: PV = (C / r) x [1 - (1 / (1 + r)^n)] + (F / (1 + r)^n) Where PV is the present value of the bond, C is the annual coupon payment, r is the required rate of return (in decimal form), n is the number of periods until maturity, and F is the par value. Substituting the given values: PV = ($110 / 0.07) x [1 - (1 / (1 + 0.07)^5)] + ($2,000 / (1 + 0.07)^5) PV = ($1,571.43) x [1 - (1 / 1.40255)] + ($2,000 / 1.40255) PV = ($1,571.43) x 0.2846 + $1,426.28 PV = $446.04 + $1,426.28 PV = $1,872.32 Therefore, the value of the bond is approximately $1,872.32.

International Cruise Lines sold an issue of 15-year $1,000 par bonds to build new ships. The bonds pay 6.85% interest, semi-annually. Today's required rate of return is 8.35%. How much should these bonds sell for today? Round off to the nearest $1.

We can use the present value formula to calculate the current price of the bond: PV = C × [(1 - (1 + r)-n) / r] + FV / (1 + r)n where PV is the present value or current price of the bond, C is the semi-annual coupon payment, r is the required rate of return or yield to maturity, n is the total number of semi-annual periods, and FV is the face value or par value of the bond. In this case, C = 0.0685 × 1000 / 2 = $34.25 (semi-annual coupon payment), r = 0.0835 / 2 = 0.04175 (semi-annual required rate of return), n = 15 × 2 = 30 (total number of semi-annual periods) FV = $1000 (face value of the bond). PV = 34.25 × [(1 - (1 + 0.04175)^-30) / 0.04175] + 1000 / (1 + 0.04175)^30 PV = $935.71 Therefore, the bonds should sell for approximately $936 today (rounded off to the nearest $1). The answer is (c).

YTM Formula? What are the variables?

YTM = [C + (FV - PV) / n] / [(FV + PV) / 2] Where: C = Annual coupon payment FV = Face value of the bond PV = Present value (current market price) of the bond n = Number of years to maturity

Which of the following statements is true of a zero coupon bond?

a. The bond makes no coupon payments.

Which of the following changes will make the value of a stock go up, other things being held constant?

a. The required return decreases

The interest on corporate bonds is typically paid ________.

a. semi-annually.

A bond's yield to maturity depends upon all of the following except:

a. the individual investor's required return.

While checking the Wall Street Journal bond listings you notice that the price of an AT&T bond is the same as the price of a K-Mart bond. Based on this information you know that:

b. Both bonds have the same yield to maturity.

Preferred stock valuation usually treats the preferred stock as a ________.

b. perpetuity

The present value of the expected future cash flows of an asset represents the asset's ________.

c. intrinsic value

Zevo Corp. bonds have a coupon rate of 7%, a yield to maturity of 10%, a face value of $1,000, and mature in 10 years. Which of the following statements is most correct?

d. An investor who purchases the bond today will earn a return of 10% per year if he holds the bond until it matures.

Which of the following affect an asset's value to an investor? I. Amount of an asset's expected cash flow II. The riskiness of the cash flows III. Timing of an asset's cash flows IV. Investor's required rate of return

d. I, II, III, IV

Kilsheimer Company just paid a dividend of $4 per share. Future dividends are expected to grow at a constant rate of 6% per year. What is the value of the stock if the required return is 12%?

o calculate the value of the stock, we can use the Gordon Growth Model, also known as the Dividend Discount Model (DDM). The formula for the Gordon Growth Model is: V = D / (r - g) Where: V = Value of the stock D = Dividend per share r = Required rate of return g = Growth rate of dividends In this case, the dividend per share is $4, the required rate of return is 12%, and the growth rate of dividends is 6%. Plugging these values into the formula, we get: V = $4 / (0.12 - 0.06) V = $4 / 0.06 V = $66.67 ANSWER: C