Ch. 8, FINANCIAL MANAGEMENT FINAL ch 5,6,7,8,9,11 new 1

Midway through the life of an amortized loan, the percentage of the payment that represents interest could be equal to, less than, or greater than to the percentage that represents repayment of principal. The proportions depend on the original life of the loan and the interest rate. a. True b. False

A

Which of the following investments would have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same and is greater than zero. a. Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). b. Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments). c. Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments). d. Investment D pays $2,500 at the end of 10 years (just one payment). e. Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).

A

Which of the following statements is CORRECT? a. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity. b. If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%. c. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. d. The proportion of the payment that goes toward interest on a fully amortized loan increases over time. e. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.

A

You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? a. A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ. b. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD. c. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE. d. The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD. e. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.

A

If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year. a. True b. False

B

Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are useful for visualizing complex problems prior to doing actual calculations. c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. d. Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods. e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.

B

Which of the following statements is CORRECT? a. The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due. b. If a loan has a nominal annual rate of 8%, then the effective rate will never be less than 8%. c. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. d. The proportion of the payment that goes toward interest on a fully amortized loan increases over time. e. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.

B

Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years. b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant. c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year. e. The outstanding balance declines at a slower rate in the later years of the loan's life.

B

Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT? a. The monthly payments will decline over time. b. A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment. c. The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity. d. The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%. e. Exactly 10% of the first monthly payment represents interest.

B

Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT? a. The monthly payments will increase over time. b. A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment. c. The total dollar amount of interest being paid off each month gets larger as the loan approaches maturity. d. The amount representing interest in the first payment would be higher if the nominal interest rate were 7% rather than 10%. e. Exactly 10% of the first monthly payment represents interest.

B

You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment? a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000. b. The discount rate decreases. c. The riskiness of the investment's cash flows increases.

B

You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment? a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000. b. The discount rate increases. c. The riskiness of the investment's cash flows decreases. d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years. e. The discount rate decreases.

B

which of the following would be the most likely to lead to a higher level of interest rates in the economy B

B corporations set up their expansion plans and thus increase their demand for capital

The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3 year $150 annuity loan B

B if a loan has a nominal annual rate of 8%, then the effective rate will never be less than 8%

which of the following statements is most correct B

B the yield on a 2 yr corporate bond should always exceed the yield on a 2 yr treasury bond

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by a. Tax effects. B. Default and liquidity risk differences. c. Maturity risk differences. d. Inflation differences. e. Real risk-free rate differences

B. Default and liquidity risk differences.

A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT? a. The annual payments would be larger if the interest rate were lower. b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan. c. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower. d. The last payment would have a higher proportion of interest than the first payment. e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.

C

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? a. The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity. b. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage. c. A bank loan's nominal interest rate will always be equal to or less than its effective annual rate. d. If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%. e. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.

C

Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are not useful for visualizing complex problems prior to doing actual calculations. c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly. d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities. e. Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.

C

Which of the following statements is CORRECT? a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods. b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. c. The cash flows for an annuity due must all occur at the beginning of the periods. d. The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month. e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.

C

Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT? a. The periodic rate of interest is 1.5% and the effective rate of interest is 3%. b. The periodic rate of interest is 6% and the effective rate of interest is greater than 6%. c. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%. d. The periodic rate of interest is 3% and the effective rate of interest is 6%. e. The periodic rate of interest is 6% and the effective rate of interest is also 6%.

C

A $150,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT? a. The annual payments would be larger if the interest rate were lower. b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan. c. The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower. d. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher. e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.

D

A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT? a. The periodic interest rate is greater than 3%. b. The periodic rate is less than 3%. c. The present value would be greater if the lump sum were discounted back for more periods. d. The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually.

D

Which of the following investments would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero. a. Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments). b. Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments). c. Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments). d. Investment D pays $2,500 at the end of 10 years (just one payment). e. Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).

D

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? a. The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity. b. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage. c. A bank loan's nominal interest rate will always be equal to or greater than its effective annual rate. d. If an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%. e. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.

D

Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are not useful for visualizing complex problems prior to doing actual calculations. c. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. d. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. e. Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.

D

Which of the following statements is CORRECT? a. The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods. b. If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity. c. The cash flows for an annuity due must all occur at the ends of the periods. d. The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month. e. If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.

D

You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? a. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE. b. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD. c. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE. d. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD. e. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.

D

Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT? a. The periodic rate of interest is 2% and the effective rate of interest is 4%. b. The periodic rate of interest is 8% and the effective rate of interest is greater than 8%. c. The periodic rate of interest is 4% and the effective rate of interest is less than 8%. d. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%. e. The periodic rate of interest is 8% and the effective rate of interest is also 8%.

D

which of the following is correct? D

D if a bonds yield to maturity exceeds its coupon rate, the bonds price must be less than its maturity value

If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT? a. An upward-sloping yield curve would imply that interest rates are expected to be lower in the future. b.If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now. c. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond. D. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds. e. Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds

D. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.

A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT? a. The periodic interest rate is greater than 3%. b. The periodic rate is less than 3%. c. The present value would be greater if the lump sum were discounted back for more periods. d. The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually. e. The PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity.

E

Which of the following statements is CORRECT? a. A time line is not meaningful unless all cash flows occur annually. b. Time lines are not useful for visualizing complex problems prior to doing actual calculations. c. Time lines cannot be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly. d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities. e. Time lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.

E

Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years. b. Because the outstanding balance declines over time, the monthly payments will also decline over time. c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year. e. The outstanding balance declines at a faster rate in the later years of the loan's life

E

which of the following is correct? E

E Under the chapter 7 of the bankruptcy act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off claims against it according to the priority of the claims as spelled out in the Act

which of the following statements is CORRECT? E

E the pure expectations theory states that the maturity risk premium for long term treasury bonds is zero and that differences in interest rates across different treasury maturities are driven by expectations about future interest rates

A bond that had a 20-year original maturity with 1 year left to maturity has more price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates, and they cannot be called.)

FALSE

A bond that is callable has a chance of being retired earlier than its stated term to maturity. Therefore, if the yield curve is upward sloping, an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond.

FALSE

A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, companies call bonds if interest rates rise and do not call them if interest rates decline.

FALSE

A time line is not meaningful unless all cash flows occur annually.

FALSE

A time line is not meaningful unless all cash flows occur annually. a. True b. False

FALSE

A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation.

FALSE

All other things held constant, the present value of a given annual annuity increases as the number of periods per year increases.

FALSE

All other things held constant, the present value of a given annual annuity increases as the number of periods per year increases. a. True b. False

FALSE

As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).

FALSE

As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan). a. True b. False

FALSE

Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond.

FALSE

Because the maturity risk premium is normally positive, the yield curve must have an upward slope. If you measure the yield curve and find a downward slope, you must have done something wrong.

FALSE

Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value.

FALSE

Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value. a. True b. False

FALSE

Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating-rate debt shifts price risk to companies, it offers no advantages to corporate issuers.

FALSE

If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate.

FALSE

If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate. a. True b. False

FALSE

If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill.

FALSE

If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series.

FALSE

If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series. a. True b. False

FALSE

Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds.

FALSE

Midway through the life of an amortized loan, the percentage of the payment that represents interest must be equal to the percentage that represents repayment of principal. This is true regardless of the original life of the loan or the interest rate on the loan. a. True b. False

FALSE

One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather. If the weather is dark and stormy, the cost of money will be higher than if it is bright and sunny, other things held constant.

FALSE

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

FALSE

One of the four most fundamental factors that affect the cost of money as discussed in the text is the time preference for consumption. The higher the time preference, the lower the cost of money, other things held constant.

FALSE

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

FALSE

Some of the cash flows shown on a time line can be in the form of annuity payments but none can be uneven amounts.

FALSE

Some of the cash flows shown on a time line can be in the form of annuity payments but none can be uneven amounts. a. True b. False

FALSE

Starting to invest early for retirement reduces the benefits of compound interest.

FALSE

Starting to invest early for retirement reduces the benefits of compound interest. a. True b. False

FALSE

Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)

FALSE

Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.) a. True b. False

FALSE

Suppose the federal deficit increased sharply from one year to the next, and the Federal Reserve kept the money supply constant. Other things held constant, we would expect to see interest rates decline.

FALSE

T/F Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.

FALSE

T/F The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

FALSE

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) the skill level of the economy's labor force.

FALSE

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

FALSE

The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date.

FALSE

The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date. a. True b. False

FALSE

The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the smaller the percentage of the payment that will be a repayment of principal.

FALSE

The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the smaller the percentage of the payment that will be a repayment of principal. a. True b. False

FALSE

The present value of a future sum increases as either the discount rate or the number of periods per year increases, other things held constant. a. True b. False

FALSE

Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods.

FALSE

Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods. a. True b. False

FALSE

Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly

FALSE

Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly. a. True b. False

FALSE

When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage declines in the loan's later years.

FALSE

When a loan is amortized, a relatively high percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage declines in the loan's later years. a. True b. False

FALSE

You are considering 2 bonds that will be issued tomorrow. Both are rated triple B (BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10% coupon, neither can be called except for sinking fund purposes, and both are offered to you at their $1,000 par values. However, Bond SF has a sinking fund while Bond NSF does not. Under the sinking fund, the company must call and pay off 5% of the bonds at par each year. The yield curve at the time is upward sloping. The bond's prices, being equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would generally be expected to have a higher yield than Bond NSF.

FALSE

a

FALSE

If the treasury yield curve were downward sloping, the yield to maturity on a 10-year treasury coupon bond would be higher than that on a 1 - year T-bill

False

One of the four fundamental factors that effect the cost of money is time preference of consumption. the higher the time preference the lower the cost of money

False

because the maturity risk premium is normally positive, the yield curve must have an upward slope. if you measure the yield curve and find a downward slope, you must have done something wrong

False

one of the four fundamental factors that effect the cost of money is expected rate of inflation. If inflation is expected to be relatively high then interest rates will tend to be relatively low

False

since yield curves are based on a real risk free rate plus the expected rate of inflation, at any given time there can be only one yield curve and it applies to both corporate and treasury securities

False

suppose the federal deficit increased sharply from one year to the next and the federal reserve kept the money supply constant. other things help constant, we would expect to see interest rates decline

False

A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%.

TRUE

A time line is meaningful even if all cash flows do not occur annually.

TRUE

A time line is meaningful even if all cash flows do not occur annually. a. True b. False

TRUE

All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.

TRUE

All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases. a. True b. False

TRUE

An upward-sloping yield curve is often call a "normal" yield curve, while a downward-sloping yield curve is called "abnormal."

TRUE

As a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.

TRUE

As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan).

TRUE

As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan). a. True b. False

TRUE

Because the maturity risk premium is normally positive, the yield curve is normally upward sloping.

TRUE

Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.

TRUE

Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value. a. True b. False

TRUE

During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining.

TRUE

If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.

TRUE

If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate. a. True b. False

TRUE

If a firm raises capital by selling new bonds, it could be called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.

TRUE

If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.

TRUE

If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward-sloping yield curve.

TRUE

If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase.

TRUE

If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the present value of the same series.

TRUE

If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the present value of the same series. a. True b. False

TRUE

If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.

TRUE

If the required rate of return on a bond (rd) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)

TRUE

If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year.

TRUE

If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year. a. True b. False

TRUE

Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength.

TRUE

One of the four most fundamental factors that affect the cost of money as discussed in the text is the availability of production opportunities and their expected rates of return. If production opportunities are relatively good, then interest rates will tend to be relatively high, other things held constant.

TRUE

One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant.

TRUE

Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds.

TRUE

Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.

TRUE

Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond's face value.

TRUE

Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.

TRUE

Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts. a. True b. False

TRUE

Starting to invest early for retirement increases the benefits of compound interest.

TRUE

Starting to invest early for retirement increases the benefits of compound interest. a. True b. False

TRUE

Suppose Sally Smith plans to invest $1,000. She can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)

TRUE

Suppose Sally Smith plans to invest $1,000. She can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.) a. True b. False

TRUE

T/F Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0

TRUE

T/F The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

TRUE

The "yield curve" shows the relationship between bonds' maturities and their yields.

TRUE

The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak.

TRUE

The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.

TRUE

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation.

TRUE

The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the smaller the present value of a given lump sum to be received at some future date.

TRUE

The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the smaller the present value of a given lump sum to be received at some future date. a. True b. False

TRUE

The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present.

TRUE

The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the greater the percentage of the payment that will be a repayment of principal.

TRUE

The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the greater the percentage of the payment that will be a repayment of principal. a. True b. False

TRUE

The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant. a. True b. False

TRUE

The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond's remaining maturity.

TRUE

The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant.

TRUE

The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk."

TRUE

The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk," or "price risk."

TRUE

There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower.

TRUE

Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.

TRUE

Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods. a. True b. False

TRUE

Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly. a. True b. False

TRUE

When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage increases in the loan's later years.

TRUE

When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the early years, and the principal repayment's percentage increases in the loan's later years. a. True b. False

TRUE

You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.

TRUE

Because the maturity risk premium is normally positive the yield curve is normally upward sloping

True

During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation declining

True

If investors expect a zero rate of inflation, then the nominal rate of return on a very short term us treasury bond should be equal to the real risk-free rate r*

True

If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward sloping yield curve

True

If the demand curve for funds increased but supply curve remained constant we would expect to see the total amount of funds supplied and demand increase and interest rates in general tend to increase

True

If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future

True

One of the four most fundamental factors that affect the cost of money is the availability of production opportunities and their expected rates of return. if production opportunities are relatively good, then interest rates will tend to be relatively high

True

The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested is called reinvestment rate risk

True

an upward sloping yield curve is often call a "normal" yield curve, while a downward sloping yield curve is abnormal

True

one of the four fundamental factors that effect the cost of money is the risk inherent in a given security. the higher the risk the higher the securities required return

True

the federal reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak

True

the risk that interest rates will increase and that increase will to a decline in prices of outstanding bonds is called interest rate risk or price risk

True

the yield curve shows the relationship between bonds maturities and their yields

True

a

a

Which of the following statements is CORRECT? a. If a coupon bond is selling at par, its current yield equals its yield to maturity. b. If rates fall after its issue, a zero coupon bond could trade at a price above its maturity (or par) value. c. If rates fall rapidly, a zero coupon bond's expected appreciation could become negative. d. If a firm moves from a position of strength toward financial distress, its bonds' yield to maturity would probably decline. e. If a bond is selling at a premium, this implies that its yield to maturity exceeds its coupon rate.

a. If a coupon bond is selling at par, its current yield equals its yield to maturity.

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

a. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT? A

a. An index fund with beta = 1.0 should have a required return of 11%.

Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, and an 8% yield to maturity. Which of the following statements is CORRECT? a. Bond A's current yield is greater than that of Bond B. b. Bond A trades at a discount, whereas Bond B trades at a premium. c. Bond A's capital gains yield is greater than Bond B's capital gains yield. d. If the yield to maturity for both bonds remains at 8%, Bond A's price one year from now will be higher than it is today, but Bond B's price one year from now will be lower than it is today. e. If the yield to maturity for both bonds immediately decreases to 6%, Bond A's bond will have a larger percentage increase in value.

a. Bond A's current yield is greater than that of Bond B.

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

a. If a stock has a negative beta, its required return under the CAPM would be less than 5%.

A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT? a. If the yield to maturity remains at 8%, then the bond's price will decline over the next year. b. If the yield to maturity increases, then the bond's price will increase. c. The bond's current yield is less than 8%. d. If the yield to maturity remains at 8%, then the bond's price will remain constant over the next year. e. The bond's coupon rate is less than 8%

a. If the yield to maturity remains at 8%, then the bond's price will decline over the next year

A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT? a. If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price. b. If the yield to maturity remains constant, the bond's price one year from now will be higher than its current price. c. The bond's current yield is greater than 9%. d. The bond is selling below its par value. e. The bond is selling at a discount.

a. If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?

a. The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

a. The expected rate of return must be equal to the required rate of return; that is,

Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur?

a. The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

a. The required return on Portfolio P would increase by 1%.

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

a. The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.

Which of the following statements is CORRECT? A

a. The slope of the security market line is equal to the market risk premium.

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

a. The y-axis intercept would decline, and the slope would increase.

Which of the following statements is CORRECT? B

b. A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.

Which of the following statements is CORRECT? B

b. A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.

You observe the following information regarding Companies X and Y: • Company X has a higher expected return than Company Y. • Company X has a lower standard deviation of returns than Company Y. • Company X has a higher beta than Company Y. Given this information, which of the following statements is CORRECT?

b. Company X has a lower coefficient of variation than Company Y.

Which of the following statements is CORRECT? B

b. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

b. If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

b. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.

Which of the following statements is CORRECT? B

b. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

b. The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT?

b. The portfolio's expected return is 15%.

Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par? a. Adding a call provision. b. The rating agencies change the bond's rating from Baa to Aaa. c. Adding a sinking fund. d. Adding additional restrictive covenants that limit management's actions. e. Making the bond a first mortgage bond rather than a debenture

b. The rating agencies change the bond's rating from Baa to Aaa.

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?

b. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.

Assume that in recent years both expected inflation and the market risk premium (rM − rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?

b. The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT?

b. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.

You have the following data on three stocks: Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would 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.

c. B; A.

Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

c. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios.

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?

c. If Stock A's required return is 11%, then the market risk premium is 5%.

Which of the following statements is CORRECT? a. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value. b. Other things held constant, a corporation would rather issue noncallable bonds than callable bonds. c. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value. d. Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon. e. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.

c. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

c. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.

Which of the following statements is CORRECT? C

c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.

Which of the following events would make it more likely that a company would call its outstanding callable bonds? a. The company's bonds are downgraded. b. Market interest rates rise sharply. c. Market interest rates decline sharply. d. The company's financial situation deteriorates significantly. e. Inflation increases significantly.

c. Market interest rates decline sharply

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is +0.6. Portfolio P has 50% invested in Stock A and 50% invested in B. Which of the following statements is CORRECT?

c. Portfolio P has more market risk than Stock A but less market risk than B.

Over the past 87 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?

c. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

Over the past 88 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last? a. Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills. b. Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. c. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. d. U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. e. Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

c. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

c. Stock B.

Which of the following statements is CORRECT? C

c. Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future.

Which of the following statements is CORRECT? C

c. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

c. The beta of an "average stock," or "the market," can change over time, sometimes drastically.

In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false?

c. The beta of the portfolio is lower than the lowest of the three betas.

Which of the following statements is CORRECT? a. The total return on a bond during a given year is based only on the coupon interest payments received b. All else equal, a bond that has a coupon rate of 10% will sell at a discount if the required return for bonds of similar risk is 8%. c. The price of a discount bond will increase over time, assuming that the bond's yield to maturity remains constant. d. For a given firm, its debentures are likely to have a lower yield to maturity than its mortgage bonds. e. When large firms are in financial distress, they are almost always liquidated, whereas smaller firms are generally reorganized.

c. The price of a discount bond will increase over time, assuming that the bond's yield to maturity remains constant.

During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

c. The required return will fall for all stocks, but it will fall more for stocks with higher betas.

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

c. Your portfolio has a beta equal to 1.6, and its expected return is 15%.

Inflation, recession, and high interest rates are economic events that are best characterized as being

c. among the factors that are responsible for market risk.

Which of the following statements is CORRECT? a. One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the use of debt until the bonds mature. b. Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond. c. Once a firm declares bankruptcy, it must be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and legal fees. d. Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds. e. A firm with a sinking fund that gives it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.

d. . Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds.

The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT? a. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year. b. Bond A's current yield will increase each year. c. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity. d. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year. e. Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase.

d. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.

Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

d. Coefficient of variation; beta.

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

d. If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

d. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.

Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%. Which of the following statements is CORRECT? D

d. If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

d. If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2% RATIONALE: d is correct. The portfolio's beta is 1.08. Therefore, if the market risk premium increases by 2.0% the portfolio's required return will increase by 2.16%.

Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. Expected Standard Stock Return Deviation Beta A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT?

d. Portfolio ABC's expected return is 10.66667%.

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?

d. Portfolio P has a standard deviation that is less than 25%.

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT?

d. Portfolio P's expected return is equal to the expected return on Stock B.

Which of the following statements is CORRECT? a. Most sinking funds require the issuer to provide funds to a trustee, who saves the money so that it will be available to pay off bondholders when the bonds mature. b. Sinking fund provisions never require companies to retire their debt; they only establish "targets" for the company to reduce its debt over time. c. If interest rates have increased since a company issued bonds with a sinking fund, the company is less likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price. d. Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued. e. A sinking fund provision makes a bond more risky to investors at the time of issuance.

d. Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond has been issued.

Which of the following statements is CORRECT? D

d. The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

d. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.

Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed's actions would lead to a recession, and that led to an increase in the market risk premium, (rM − rRF). Under these conditions, with other things held constant, which of the following statements is most correct?

d. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.

Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return? a. Because of the call premium, the required rate of return would decline. b. There is no reason to expect a change in the required rate of return. c. The required rate of return would decline because the bond would then be less risky to a bondholder. d. The required rate of return would increase because the bond would then be more risky to a bondholder. e. It is impossible to say without more information.

d. The required rate of return would increase because the bond would then be more risky to a bondholder.

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines with the net effect being that the overall required return on the market, rM , remains constant. Which of the following statements is CORRECT?

d. The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B? Years Market Stock A Stock B 1 0.03 0.16 0.05 2 −0.05 0.20 0.05 3 0.01 0.18 0.05 4 −0.10 0.25 0.05 5 0.06 0.14 0.05

d. bA < 0; bB = 0.

Which of the following statements is CORRECT? E

e. A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

Which of the following statements is CORRECT? E

e. An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.

Which of the following statements is CORRECT? E

e. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

Which of the following statements is CORRECT? E

e. Assume that the required rate of return on the market, rM , is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

Assume that interest rates on 15-year noncallable Treasury and corporate bonds with different ratings are as follows: T-bond = 7.72% A = 9.64% AAA = 8.72% BBB = 10.18% The differences in rates among these issues were most probably caused primarily by: a. Maturity risk differences. b. Real risk-free rate differences. c. Tax effects. d. Inflation differences. e. Default risk differences.

e. Default risk differences.

Which of the following statements is CORRECT? E

e. During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

Which of the following statements is CORRECT? E

e. If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.

Which of the following statements is CORRECT? E

e. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

e. In equilibrium, the expected return on Stock A will be greater than that on B.

Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT?

e. Portfolio AC has a standard deviation that is less than 25%.

Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

e. Portfolio P has a beta of 1.0.

Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?

e. Portfolio P has the same required return as the market (rM ).

Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?

e. The required return on a stock with a positive beta < 1.0 will decline.

Which of the following statements is CORRECT? E

e. The slope of the security market line is equal to the market risk premium, (rM − rRF).

the four fundamental factors that effect the cost of money are

production opportunities time preference for consumption risk inflation

T/F the coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return

true