Financial Systems midterm 2

You buy a stock of a firm that is expected to exhibit a growth rate of 5% into the indefinite future. Next year it will pay a dividend of 55¢. If the appropriate discount rate is 10%, what is the (fair) value of the stock? A. $11.55 B. $11 C. $5.5 D. $3.67

$11

Consider the two-period growth model for a firm. The first period lasts three years and the growth rate of dividends is 0% (no growth). The growth rate of dividends in the second period, which starts on year 3, is 6%. Assume that the dividend in year 1 is $1, and the appropriate discount rate is 13%. Find the value of this firm. A. $12.86 B. $17.50 C. $15.14 D. $9.84

$12.86

You have invested $1 in asset A and $1 in asset B. Asset A pays $5 if it is sunny in Lagos, Nigeria, and $2 if it is not. The probability that it is sunny in Lagos is 1/3. Asset B pays $11 if the NYSE goes up, and $9 if it does not. The probability that the NYSE goes up is ½. The expected payoff on your portfolio of A and B is: A. $10 B. $13.5 C. $12 D. $13

$13

An individual is offered to enter a game where she can earn $2,000 with probability 0.25, $5 with probability 0.25, and $500 with probability 0.5. The cost to play the game is P dollars. The individual is risk-neutral. What dollar amount P would leave the individual indifferent to entering the game? A. 835 B. $5 C. $751.25 D. none of the above

$751.25

A company issues a one-year, 2% coupon bond, paying $100 at maturity. There is a 3% probability that the company goes bankrupt before the end of the year; it will remain solvent with the complementary probability. The risk-free interest rate is 5%. Assume risk-neutral investors. Calculate the price of the corporate bond. A. $100 B. $97.14 C. $94.23 D. $90

$94.23

There are two risky stocks, A and B. The variance of returns for asset A is σA 2 = 0.04, and for B is σB 2 = 0.09. The covariance between A and B is σAB = -0.0168. The correlation coefficient is A. positive B. -0.28 C. -0.06 D. Cannot be calculated from the information given

-0.28

Consider an unbalanced coin. This coin is unbalanced because Heads comes up with probability 1/5, while Tails comes up with probability 4/5. Suppose you toss it twice. The probability of Heads coming up just once, either on the first or on the second toss, is: A. 0.16 B. 0.32 C. 0.50 4 D. 1

0.32

Assume you paid $30 for a firm's stock, that next period's dividend is $2, new investment is expected to yield 14% return and the retention rate of profits is 50%. Suppose that the price conforms to the one-period growth model with constant growth. Find the appropriate discount rate implied by the price of $30. A. 7% B. 6.67% C. 10.3% D. 13.67%

13.67%

A corporation issues a one-year, 5% coupon bond, paying $100 at maturity. The bond is risky, and sells at a price P=$92. The risk-free interest rate is 5%. The risk (or default) premium on this bond is: A. 0% B. 9.13% C. 14% D. Impossible to calculate with the information given

9.13%

Which of these $100 face value one-year coupon bonds will have the highest yield to maturity? A. A 6 percent coupon bond selling for $105 B. A 7 percent coupon bond selling for $100 C. A 1 percent coupon bond selling for $99. D. A 2 percent coupon bond selling for $101.

A 7 percent coupon bond selling for $100

We want to invest $200,000 in a portfolio composed of stock traded on the NYSE. Choose the statement that is most correct. A. If we have enough securities in the portfolio, then we can eliminate all risk. B. As we add securities to the portfolio, the average variance of the portfolio declines. C. As we add securities to the portfolio, the average variance of the portfolio increases. D. For any given portfolio we choose, the more money we invest, the lower the portfolio's risk.

As we add securities to the portfolio, the average variance of the portfolio declines

Which of the following best expresses the equation for holding period return? A. Current yield + coupon rate B. Yield to maturity - current yield C. Current yield + capital gain D. Coupon rate + capital gain

Current yield + capital gain

You have expected returns on five assets, and the variance-covariance matrix of those five assets. We invest $1 in a portfolio of those five assets. Choose the sentence that is most appropriate: 3 A. One can calculate the risk of the portfolio for any combination of those five assets. B. One can calculate the risk of the portfolio only if we spread the dollar equally across all five assets. C. One cannot calculate the risk of the portfolio because some information is missing. D. The risk of the portfolio will be zero if we include all five assets in it.

One can calculate the risk of the portfolio for any combination of those five assets.

You have a portfolio composed of two assets, A and B. Their risks are uncorrelated. The return on asset A depends on if the NYSE is "high" or "low." The return on asset B depends on if the weather is "sunny," "cloudy," or "rainy." What is the total number of possible outcomes for your portfolio? A. Five B. Two C. Six D. Three

Six

A multi-year coupon bond is issued at par. After a year, the yield to maturity climbed above the coupon rate. What happened to the price of the bond during that first year? A. The price of the bond did not change. B. The price of the bond rose above par. C. The price of the bond fell below par. D. The information give is insufficient to establish what happened to the price of the bond.

The price of the bond fell below par.

The interest-rate risk that is associated with bond investing: A. exists in particular if an investor plans to hold the bond to maturity. B. arises because of a mismatch between the investor's investment horizon and the maturity of the bond. C. is not at all reflected in the risk premium. D. can be eliminated by holding only consols.

arises because of a mismatch between the investor's investment horizon and the maturity of the bond.

The bond demand curve slopes downward because: A. at lower prices the reward for holding the bond increases. B. as bond prices fall so do yields. C. as bond prices fall bonds are less attractive. D. as bond prices rise yields increase.

at lower prices the reward for holding the bond increases.

Systematic risk: A. is the risk eliminated through diversification. B. represents the risk affecting a specific company. C. cannot be eliminated through diversification. D. is another name for risk unique to an individual asset.

cannot be eliminated through diversification.

Consider the market for bonds. If interest rates are expected to rise, the bond prices will: A. not change until interest rates actually change. B. fall, due to the demand for bonds decreasing. C. rise, as people seek capital gains. D. move in the same direction as the expected change in interest rates.

fall, due to the demand for bonds decreasing.

The greater the standard deviation of an investment the: A. lower the return. B. greater the risk. C. lower the risk. D. lower the risk and return.

greater the risk.

Borrowing to purchase an asset: A. increases expected return and the standard deviation by less than the leverage ratio. B. does not increase expected return, but does increases the standard deviation by the leverage ratio. C. increases expected return and standard deviation by the leverage ratio D. increases expected return and the standard deviation by twice the leverage ratio

increases expected return and standard deviation by the leverage ratio

Investing in a mutual fund made up of hundreds of stocks of different companies is an example of all of the following except: A. spreading risk. B. diversifying. C. risk reduction. D. increasing the variance of a portfolio

increasing the variance of a portfolio.

A risk-averse investor compared to a risk-neutral investor: A. will never take a risk, while the risk neutral investor will. B. will take the same risks as the risk neutral investor if the expected returns are equal. C. needs greater compensation for the same risk compared to the risk neutral investor. D. needs less compensation for the same risk compared to the risk neutral investor.

needs greater compensation for the same risk compared to the risk neutral investor.

The main reason for diversification for an investor is to: A. take advantage of the fact that returns of assets are perfectly positively correlated. B. take advantage of the fact that returns on assets are not perfectly correlated. C. lower transaction costs. D. gain from the greater returns that come from greater risk.

take advantage of the fact that returns on assets are not perfectly correlated.

If the U.S. government's borrowing needs increase (e.g. an increased budget deficit), in the bond market this would be seen as: A. the bond demand curve shifting right. B. a movement up the bond supply curve. C. the bond demand curve shifting left. D. the bond supply curve shifting right

the bond supply curve shifting right.

The risk spread (or premium) is: A. the difference between a bond's purchase price and selling price. B. the difference between the bond's yield and the yield on a U.S. Treasury bond of the same maturity. C. typically less than zero. D. assigned by a bond-rating agency on a monthly basis.

the difference between the bond's yield and the yield on a U.S. Treasury bond of the same maturity.

If an investment offered an expected payoff of $100 with $0 variance, you would know that: A. half of the time the payoff is $100 and the other half it is $0. B. the payoff is always $100. C. half of the time the payoff is $200 and the other half it is $0. D. half of the time the payoff is $200 and the other half it is $50.

the payoff is always $100.

An increase in expected inflation for any given nominal interest rate will cause: A. the real return to bondholders to decrease. B. a movement down the bond demand curve, but no change in the bond demand curve. C. the bond demand curve to shift right. D. the price of bonds to increase.

the real return to bondholders to decrease.

U.S. Treasury securities are considered to carry no risk spread because: A. they are the closest thing to default-risk free that an investor can obtain. B. the prices of U.S. Treasury bonds never change. C. the yields on U.S. Treasury bonds never change. D. the yields on U.S. Treasury bonds are always low.

they are the closest thing to default-risk free that an investor can obtain.

If the purchase price of a bond exceeds the face value, the yield to maturity: A. is greater than the coupon rate because the capital gain is positive. B. will equal the current yield. C. will be less than the coupon rate because the capital gain will be negative. D. will be greater than the current yield.

will be less than the coupon rate because the capital gain will be negative.

If the quantity of bonds demanded exceeds the quantity of bonds supplied, bond prices: A. would rise and yields would fall. B. would fall and yields would increase. C. will rise and yields will remain constant. D. will rise and yields would increase.

would rise and yields would fall.