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FIN 730 EXAM 2 (All Terms)

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What is the price of a $1,000 face value bond if the quoted price is 102.1?

$1,021.00 Multiple 102.1 as percentage

Guggenheim, Inc. offers a 9.00 percent coupon bond with annual payments. The yield to maturity is 4.9 percent and the maturity date is 10 years. What is the market price of a $1,000 face value bond?

$1,318.13

Healthy Foods just paid its annual dividend of $1.45 a share. The firm recently announced that all future dividends will be increased by 2.8 percent annually. What is one share of this stock worth to you if you require a 14 percent rate of return?

$13.31 P0 = ($1.45 × 1.028)/(0.14 - 0.028) = $13.31

Molly is considering a project with cash inflows of $918, $867, $528, and $310 over the next four years, respectively. The relevant discount rate is 10 percent. What is the net present value of this project if it the start-up cost is $2,100?

$59.50

A 5.5% $1,000 bond matures in 7yrs, pays interest semiannually, and has a YTM of 6.23%. What is the current market price of the bond?

$959.09

A 5.5 percent $1,000 bond matures in seven years, pays interest semiannually, and has a yield to maturity of 6.23 percent. What is the current market price of the bond?

$959.09 1000 fv 62.3 iy 55 pmt 7 n compute pv

Wine and Roses, Inc. offers a 7.5 percent coupon bond with semiannual payments and a yield to maturity of 7.95 percent. The bonds mature in 15 years. What is the market price of a $1,000 face value bond?

$960.97

dividend: $1.45 increase 2.8% annually What is one share of stock worth if you require a 14% rate of return?

(1.45 x 1.028^6)/(0.14-0.028) = $15.279

Interest rate ____ are interest rate derivative instruments that are normally classified separately from interest rate swaps.

- caps - floors - collars

A financial institution may participate in the swaps markets by:

- serving as an intermediary by matching up parties that wish to engage in a swap. - engaging in swaps to reduce interest rate risk.

A proposed project requires an initial cash outlay of $849,000 for equipment and an additional cash outlay of $48,500 in year 1 to cover operating costs. During years 2 through 4, the project will generate cash inflows of $354,000 a year. What is the net present value of this project at a discount rate of 13 percent? Round your answer to the nearest whole dollar.

-$152,232

What is the net present value of a project with the following cash flows and a required return of 15 percent? Year Cash Flow 0 -$32,400 1 12,750 2 25,530 3 2,750

-$200.53

What is the net present value of a project with the following cash flows if the discount rate is 15 percent?

-$5,433.67

Market makers

-can execute stock option transactions for their customers. -can trade options for their own account. -are subject to the risk of losses from their positions in options. -benefit from the spread.

If a corporation hedges payables with currency call options, it will ____ if the value of the foreign currency is ____ than the exercise price when the payables are due.

1. exercise the option; greater 2. let the option expire; less

Speculators may be willing to write ____ options on foreign currencies they expect to ____ against the dollar.

1. put; strengthen 2. call; weaken

What is the profitability index for an investment with the following cash flows given a 7 percent required return? Year Cash Flow 0 -$22,000 1 8,200 2 10,500 3 9,900

1.13

A bond that pays interest annually yields a rate of return of 5.50 percent. The inflation rate for the same period is 4 percent. What is the real rate of return on this bond?

1.44 percent r = 1.0550 / 1.04 - 1 = 1.44

stock expected return: 18.18 risk free: 4.6 MRP: 9.3 What is the beta?

18.18 = 4.6 + X (9.3) 13.58 = X(9.3) X = 1.46

The Golden Goose is considering a project with an initial cost of $46,700. The project will produce cash inflows of $10,000 a year for the first two years and $12,000 a year for the following three years. What is the payback period?

4.23 years

beta: 1.46 expected return on market:13.9 risk free: 4.6 What is expected return on stock?

4.6 + 1.46(13.9-4.6) = 18.18

What is the internal rate of return on an investment with the following cash flows? Year Cash Flow 0 -$125,000 1 36,400 2 52,900 3 48,000

4.64 percent

The MerryWeather Firm wants to raise $19 million to expand its business. To accomplish this, the firm plans to sell 20-year, $1,000 face value zero-coupon bonds. The bonds will be priced to yield 4 percent. What is the minimum number of bonds the firm must sell to raise the $19 million it needs? Use annual compounding.

41,631 PV = $1,000 / 1.0420 = $456.39 Number of bonds = $19,000,000 / $456.39 = 41,631 bonds

The initial margin of a futures contract is typically between ____ percent of a futures contract's full value.

5 and 18

The 7 percent annual coupon bonds of IPO, Inc. are selling for $1,021. The bonds have a face value of $1,000 and mature in seven years. What is the yield to maturity?

6.62 percent 7 n -1,021 pv 70 pmt 1,000 fv solve for i/y 6.62

A bond has a $1,000 face value, a market price of $1,045, and pays interest payments of $80 every year. What is the coupon rate?

8.00 percent Coupon rate = $80/$1,000 = 8 percent

A six-year, semiannual coupon bond is selling for $991.38. The bond has a face value of $1,000 and a yield to maturity of 9.19 percent. What is the coupon rate?

9.00 percent

A firm is involved in an agreement in which it receives payments in periods when a market interest rate rises above an interest rate level specified in the agreement. This means that the firm has A) purchased an interest rate cap. B) sold an interest rate cap. C) purchased an interest rate floor. D) sold an interest rate floor.

Buyers of credit default swaps are most likely going to receive a payment from the seller of credit default swaps when the economy: A) is very weak. B) is stable. C) experiences high growth. D) experiences low inflation.

Financial institutions such as U.S. savings institutions and commercial banks traditionally had fewer interest rate-sensitive ___________ than ____________ and therefore were adversely affected by ____________ interest rates. A) assets; liabilities; increasing B) liabilities; assets; decreasing C) liabilities; assets; increasing D) none of the above

Lizard National Bank purchases a three-year interest rate cap for a fee of 2 percent of notional principal valued at $50 million, with an interest rate ceiling of 11 percent and LIBOR as the index representing the market interest rate. Assume that LIBOR is expected to be 9 percent, 12 percent, and 13 percent at the end of each of the next three years, respectively. 45. The total payments received (or paid) by Lizard, including the initial fee, are $______________. A) 500,000 B) 500,000 C) 1,500,000 D) 1,500,000 E) none of the above

Lizard National Bank purchases a three-year interest rate cap for a fee of 2 percent of notional principal valued at $50 million, with an interest rate ceiling of 11 percent and LIBOR as the index representing the market interest rate. Assume that LIBOR is expected to be 9 percent, 12 percent, and 13 percent at the end of each of the next three years, respectively. . The dollar amount to be received (or paid) by the seller of the interest rate cap based on the forecast of LIBOR assumed above over the three-year period is $__________. A) 500,000 B) 500,000 C) 1,500,000 D) 1,500,000 E) none of the above

A firm is involved in an agreement in which it makes payments in periods when a market interest rate rises above an interest rate level specified in the agreement. This means that the firm has A) purchased an interest rate cap. B) sold an interest rate cap. C) purchased an interest rate floor. D) sold an interest rate floor.

Hewitt Inc. has entered into an equity swap arrangement that allows it to swap a fixed interest rate of 8 percent in exchange for the rate of appreciation on the Dow Jones Industrial Average each year over a three-year period. The notional principal is $1 million. If the Dow depreciates by 1 percent, Hewitt will A) have to make a payment of $70,000. B) have to make a payment of $90,000. C) receive a payment of $70,000. D) receive a payment of $90,000. E) none of the above

If a U.S. institution in a forward swap would like to lock in the fixed rate that it will pay when the swap period begins, it is probably concerned that interest rates will ___________; the counterparty is likely adversely affected by ____________ interest rates. A) increase; increasing B) increase; declining C) decrease; declining D) decrease; increasing E) none of the above

____ risk is the risk that the position being hedged by a futures contract is not affected in the same manner as the instrument underlying the futures contract.

Basis

____ risk prevents the interest rate swap from completely eliminating a financial institution's exposure to interest rate risk.

Basis

MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76% Ronnie's Custom Cars purchased some fixed assets two years ago for $115,000. The assets are classified as 5-year property for MACRS. Ronnie is considering selling these assets now so he can buy some newer fixed assets which utilize the latest in technology. Ronnie has been offered $59,500 for his old assets. What is the net cash flow from the salvage value if the tax rate is 34 percent?

Book value = $115,000 × (1 - 0.20 - 0.32) = $55,200 Net cash flow = $59,500 - 0.34 × ($59,500 - $55,200) = $58,038.00

. A common maturity of a credit default swap contract is: A) one month B) three months C) five years D) 25 years

A _________________ swap involves an exchange of interest rate payments that does not begin until a specified future point in time. A) plain vanilla B) zero-coupon-for-floating C) forward D) seasoned vanilla E) putable

A firm is involved in an agreement in which it receives payments in periods when a market interest rate falls below an interest rate level specified in the agreement. This means that the firm has A) purchased an interest rate cap. B) sold an interest rate cap. C) purchased an interest rate floor. D) sold an interest rate floor.

The typical purchaser of an interest rate cap is a financial institution that is _________ affected by _________ interest rates. A) favorably; rising B) favorably; falling C) adversely; rising D) adversely; falling

The ____ is the most important exchange for trading options.

Chicago Board of Options Exchange (CBOE)

The annual interest divided by the face value of a bond is referred to as the:

Coupon rate

____ risk in a swap is typically not overwhelming because the affected party can simply discontinue its payments to the other party.

Credit

A firm is involved in an agreement in which it makes payments in periods when a market interest rate falls below an interest rate level specified in the agreement. This means that the firm has A) purchased an interest rate cap. B) sold an interest rate cap. C) purchased an interest rate floor. D) sold an interest rate floor.

A(n) _____________swap provides the party making the floating-rate payments with a right to terminate the swap. A) callable B) extendable C) plain vanilla D) putable E) none of the above

AIG's financial problems were attributed to: A) its weak returns on its investments in Treasury securities. B) its potential losses from its life insurance policies. C) fraud from avoiding taxes on its gains from credit default swaps. D) its potential losses from credit default swaps.

An interest rate collar represents the __________ of an interest rate cap and a simultaneous __________ of an interest rate floor. A) sale; sale B) sale; purchase C) purchase; purchase D) purchase; sale

Firms A and B have entered into an interest rate swap. On the first payment date, Firm A owes Firm B 12 percent of $10 million, and Firm B owes Firm A 14 percent of $10 million. Most likely, this transaction will be settled in what manner? A) Firm A will send Firm B $120,000 and Firm B will send Firm A $140,000 B) Firm B will send Firm A $120,000 and Firm A will send Firm B $140,000 C) Firm A will send Firm B $20,000 D) Firm B will send Firm A $20,000 E) none of the above

In a __________, a buyer makes periodic payments to a seller in exchange for protection against the possible default of debt securities specified in the contract. A) default option contract B) default futures contract C) bankruptcy contract D) credit default swap

Interest rate______________ are interest rate derivative instruments that are normally classified separately from interest rate swaps. A) caps B) floors C) collars D) all of the above

The Bank of Moronto has negotiated a plain vanilla swap in which it will exchange fixed payments of 10 percent for floating payments equal to LIBOR plus 0.5 percent at the end of each of the next three years. In the first year, LIBOR is 8 percent; in the second year, 9 percent; in the third year, LIBOR is 7 percent. What is the total net payment the Bank of Moronto makes over the three-year period if the notional principal is $10 million? A) 600,000 B) 600,000 C) 450,000 D) 450,000 E) none of the above

Which of the following is not a reason for financial institutions to engage in interest rate swaps? A) to reduce interest rate risk B) to act as an intermediary C) to act as a dealer in swaps D) all of the above are reasons for financial institutions to engage in swaps

Which of the following is not a typical provision of an interest rate swap? A) the notional principal value to which the interest rates are applied to determine the interest payments involved B) the fixed interest rate C) the floating interest rate D) the underwriter of the bond E) All of the above are provisions of an interest rate swap.

The common stock of The Garden of Eden is selling for $42 a share. The company pays a constant annual dividend and has a total return of 5.8 percent. What is the amount of the dividend?

D = 0.058 × $42 = $2.44

The Glass Ceiling paid an annual dividend of $2.20 per share last year. Management just announced that future dividends will increase by 2.8 percent annually. What is the amount of the expected dividend in year 5?

D5 = $2.20 × (1.028)5 = $2.53

Sun Lee's Furniture just purchased some fixed assets classified as 5-year property for MACRS. The assets cost $68,000. What is the amount of the depreciation expense for the first year? MACRS 5-year property Year Rate 1 20.00% 2 32.00% 3 19.20% 4 11.52% 5 11.52% 6 5.76%

Depreciation Year 1 = $68,000 × 0.2000 = $13,600 .

Reynolds Metals common stock is selling for $25 a share and has a dividend yield of 3.1 percent. What is the dividend amount?

Dividend = 0.031 × $25 = $0.78

A stock has a market price of $46.10 and pays a $2.40 annual dividend. What is the dividend yield?

Dividend yield = $2.40/$46.10 = 5.21 percent

A country that pegs its currency is still able to maintain complete control over its local interest rates. a. True b. False

False

_________ take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties on many transactions.

Hedgers; speculators

Which of the following statements is INCORRECT with respect to cross-hedging?

If the futures contract value is more volatile than the portfolio value, hedging will require a greater amount of principal represented by the futures contract

___________ involves the buying or selling of stock index futures with a simultaneous opposite position in the stocks that the index comprises.

Index arbitrage

A real rate of return is defined as a rate that has been adjusted for which one of the following?

Inflation

Based on the most recent survey information presented in your textbook, CFOs tend to use which two methods of investment analysis the most frequently?

Internal rate of return and net present value

In a swap arrangement, the most common index used for floating-rate payments would be the

London Interbank Offer Rate (LIBOR).

____ execute transactions desired by investors and trade stock options for their own account.

Market-makers

On which one of the following dates is the principal amount of a bond repaid?

Maturity date

Which of the following statements is incorrect?

Most financial institutions that anticipate that interest rate will move in an unfavorable direction to not hedge their positions.

The SPO needs to raise $2.2 million for an expansion project. The firm wants to raise this money by selling zero coupon bonds with a par value of $1,000 that matures in 20 years. The market yield on similar bonds is 8.8%. Hoe many bonds must the SPO sell to raise the money it needs? (semiannual compounding)

N=20*2 I/Y=8.8/2 FV=1,000 CPT PV= 178.64 # of bonds= 2,200,000/178.64 = 12,315 bonds

You are considering an investment for which you require a 14 percent rate of return. The investment costs $61,900 and will produce cash inflows of $26,000 for three years. Should you accept this project based on its internal rate of return? Why or why not?

No, because the IRR is 12.51 percent

Which one of the following is the rate of return an investor earns on a bond before adjusting for inflation?

Nominal rate

A debt-free firm has net income of $228,400, taxes of $46,200, and depreciation of $21,300. What is the operating cash flow?

Operating cash flow = $228,400 + $21,300 = $249,700

____ risk is the risk of losses as a result of inadequate management or controls.

Operational

__________ occurs when a firm does not have adequate controls to monitor the employees responsible for its futures positions and those employees take more speculative positions than the firm desires.

Operational risk

The Waffle House pays a constant annual dividend of $1.25 per share. How much are you willing to pay for one share if you require a 25 percent rate of return?

P = $1.25/0.25 = $5.00

Leslie's Unique Clothing Stores offers a common stock that pays an annual dividend of $3.00 a share. The company has promised to maintain a constant dividend. How much are you willing to pay for one share of this stock if you want to earn a 15.80 percent return on your equity investments?

P = $3.00 / 0.1580 = $18.99

Solar Energy, Inc. will pay an annual dividend of $1.85 next year. The company just announced that future dividends will be increasing by 2 percent annually. How much are you willing to pay for one share of this stock if you require a 14 percent return?

P0 = $1.85/(0.14 - 0.02) = $15.42

Horseshoe Stables is losing significant market share and thus its managers have decided to decrease the firm's annual dividend. The last annual dividend was $0.90 a share but all future dividends will be decreased by 10 percent annually. What is a share of this stock worth today at a required return of 15 percent?

P0 = ($0.90 × (1 - 0.10)/[0.15 - (-0.10] = $3.24

Michael's, Inc. just paid $2.00 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 4.40 percent. If you require a rate of return of 8.6 percent, how much are you willing to pay today to purchase one share of Michael's stock?

P0 = [$2.00 × (1 + 0.044)] / (0.086 - 0.044) = $49.71

River Rock, Inc. just paid an annual dividend of $2.80. The company has increased its dividend by 2.5 percent a year for the past 10 years and expects to continue doing so. What will a share of this stock be worth 6 years from now if the required return is 16 percent?

P6 = ($2.80 × 1.0257)/(0.16 - 0.025) = $24.65

It will cost $4,000 to acquire a small ice cream cart. Cart sales are expected to be $3,200 a year for five years. After the five years, the cart is expected to be worthless as that is the expected remaining life of the cooling system. What is the payback period of the ice cream cart?

Payback period = $4,000 / $3,200 = 1.25 years

Shoreline Foods pays a constant annual dividend of $1.60 a share and currently sells for $28.50 a share. What is the rate of return?

R = $1.60/$28.50 = 5.61 percent

The common stock of Sweet Treats is valued at $10.80 a share. The company increases its dividend by 8 percent annually and expects its next dividend to be $0.40 per share. What is the total rate of return on this stock?

R = ($0.40/$10.80) + 0.08 = 11.70 percent

Option trading is regulated by the

Securities and Exchange Commission.

____ of options can close out their positions at any time by ____ an identical option.

Sellers; purchasing

Generally speaking, bonds issued in the U.S. pay interest on a(n) _____ basis.

Semiannual

The ______ index can be used to measure risk-adjusted performance of a stock while controlling for the stock's volatility.

Sharpe

A 15-year old bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?

The bond's yield to maturity is greater than its coupon rate

To determine the present value of a bond that pays semiannual interest, which of the following adjustments should NOT be made to compute the price the bond?

The par value should be split in half

The Tattle Teller has a printing press sitting idly in its back room. The press has no market value to another printer because the machine utilizes old technology. The firm could get $250 for the press as scrap metal. The press is six years old and originally cost $148,000. The current book value is $2,570. The president of the firm is considering a new project and feels he can use this press for that project. What value, if any, should be assigned to the press as an initial cost of the new project?

The relevant cost is the opportunity cost of $250.

Which of the following is not an assumption underlying the Black-Scholes option-pricing model?

The world is risk-neutral.

Which of the following is not true with respect to market makers?

They are not subject to the risk of loss on their positions in options.

The sale of a call option on a stock the seller already owns is referred to as

a covered call.

A financial institution that wishes to reduce its exposure to the possibility of declining interest rates might use:

a long hedge.

A savings and loan association has longterm fixedrate mortgages financed by short- term funds. It hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid

a loss on the futures contracts more than offsets the favorable effect on the mortgage

According to the text, when a financial institution sells futures contracts on securities in order to hedge against a change in interest rates, this is referred to as

a short hedge.

The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 17 percent a year for the next 4 years and then decreasing the growth rate to 3 percent per year. The company just paid its annual dividend in the amount of $1.70 per share. What is the current value of one share of this stock if the required rate of return is 7.20 percent? a. $67.66 b. $69.36 c. $59.16 d. $78.12 e. $79.82

a. $67.66 P4 = ($1.70 × 1.174 × 1.03) / (0.072 - 0.03) = $78.12325 P0 = ($1.70 × 1.17) / 1.072 + ($1.70 × 1.172) / 1.0722 + ($1.70 × 1.173) / 1.0723 + ($1.70 × 1.174) / 1.0724 + $78.12325 / 1.0724 = $67.66

a. 11.70 percent R = ($0.40/$10.80) + 0.08 = 11.70 percent

The common stock of Eddie's Engines, Inc. sells for $27.51 a share. The stock is expected to pay $2.40 per share next year. Eddie's has established a pattern of increasing their dividends by 4.5 percent annually and expects to continue doing so. What is the market rate of return on this stock? a. 13.22 percent b. 5.55 percent c. 11.46 percent d. 8.72 percent e. 18.76 percent

a. 13.22 percent r = $2.40 / $27.51 + 0.045 = 13.22 percent

Assume interest rate parity exists. If the spot rate on the British pound is $2 and the 1-year British interest rate is 7 percent, and the 1-year U.S. interest rate is 11 percent, what is the pound's forward discount or premium? a. 3.74 percent premium b. 3.74 percent discount c. 3.60 percent premium d. 3.60 percent discount

a. 3.74 percent premium

A stock has a market price of $46.10 and pays a $2.40 annual dividend. What is the dividend yield? a. 5.21 percent b. 5.52 percent c. 5.78 percent d. 4.13 percent e. 4.84 percent

a. 5.21 percent Dividend yield = $2.40/$46.10 = 5.21 percent

A system whereby exchange rates are market determined without boundaries but subject to government intervention is called a. a dirty float. b. a free float. c. the gold standard. d. the Bretton Woods era.

a. a dirty float

Which of the following is most likely to provide currency forward contracts to their customers? a. commercial banks b. international mutual funds c. brokerage firms d. insurance companies

a. commercial banks

____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers. a. Commercial banks b. International mutual funds c. Insurance companies d. Pension funds e. All of the above

a. commercial banks

If the demand for British pounds ____, the pound will ____, other things being equal. a. increases; appreciate b. decreases; appreciate c. increases; depreciate d. B and C

a. increase; appreciate

If U.S. inflation suddenly becomes much higher than European inflation, the U.S. demand for European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces will place ____ pressure on the value of the euro. a. increase; decline; upward b. increase; decline; downward c. decrease; increase; upward d. decrease; increase; downward e. none of the above

a. increase; decline; upward

If British interest rates suddenly increase substantially relative to U.S. interest rates, the demand by U.S. investors for British pounds ____, the supply of British pounds to be sold in exchange for dollars ____, and the British pound will ____. a. increases; decreases; appreciate b. increases; decreases; depreciate c. decreases; increases; appreciate d. decreases; increases; depreciate e. none of the above

a. increases; decreases; appreciate

A system whereby one currency is maintained within specified boundaries of another currency or unit of account is a a. pegged system. b. free float. c. dirty float. d. managed float.

a. pegged system

The speculative risk of purchasing a ____ is that the foreign currency value ____ over time. a. put option; increases b. put option; decreases c. call option; increases d. futures contract; increases

a. put option; increases

If the spot rate ____ the exercise price, a currency ____ option would not be exercised. a. remains below; call b. remains below; put c. remains below; put d. A and B

a. reminds below; call

A speculator who expects the euro to depreciate might: a. sell euros forward and then purchase them in the spot market just before fulfilling the forward obligation. b. purchase euros forward and, when they are received, sell them in the spot market. c. purchase futures contracts on euros and, when the euros are received, sell them in the spot market. d. all of the above

a. sell euros forward and then purchase them in the spot market just before fulfilling the forward obligation.

____ forecasting involves the use of historical exchange rate data to predict future values. a. Technical b. Fundamental c. Market-based d. Mixed

a. technical

The typical purchaser of an interest rate cap is a financial institution that is ____ affected by ____ interest rates.

adversely; rising

Which of the following does not directly affect a call option premium?

analyst rating of the underlying instrument

Financial futures contracts on U.S. securities are ____ by nonU.S. financial institutions.

are commonly traded

Municipal Bond Index (MBI) futures

are settled in cash.

Financial institutions such as U.S. savings institutions and commercial banks traditionally had fewer interest rate-sensitive ____ than ____ and therefore were adversely affected by ____ interest rates.

assets; liabilities; increasing

Options on stock indexes representing non-U.S. stocks are ____; options exchanges have been established ____.

available; in numerous non-U.S. countries

Reynolds Metals common stock is selling for $25 a share and has a dividend yield of 3.1 percent. What is the dividend amount? a. $4.25 b. $0.78 c. $7.80 d. $0.31 e. $3.49

b. $0.78 Dividend = 0.031 × $25 = $0.78

b. $2.53 D5 = $2.20 × (1.028)5 = $2.53

b. $3.24 P0 = ($0.90 × (1 - 0.10)/[0.15 - (-0.10] = $3.24

Michael's, Inc. just paid $2.10 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 4.60 percent. If you require a rate of return of 8.8 percent, how much are you willing to pay today to purchase one share of Michael's stock? a. $24.96 b. $52.30 c. $16.39 d. $54.40 e. $26.15

b. $52.30 P0 = [$2.10 × (1 + 0.046)] / (0.088 - 0.046) = $52.30

Assume the following information. • Interest rate on borrowed euros is 5 percent annualized. • Interest rate on dollars loaned out is 6 percent annualized. • Spot rate is 1.10 euros per dollar (one euro = $0.909). • Expected spot rate in five days is 1.15 euros per dollar. • Fabrizio Bank can borrow 10 million euros. If Fabrizio Bank attempts to capitalize on the above information, its profit over the five-day period is a. 2,653,597.22 euros. b. 455,266.81 euros. c. 452,426.04 euros. d. none of the above

b. 455,266.81 euros

Which of the following statements is incorrect? a. Forward contracts are contracts typically negotiated with a commercial bank that allow the purchase or sale of a specified amount of a particular foreign currency at a specified exchange rate on a specified future date. b. The forward market is located in New York City. c. Many of the commercial banks that offer foreign exchange on a spot basis also offer forward transactions for the widely traded currencies. d. Forward contracts can hedge a corporation's risk that a currency's value may appreciate over time.

b. The forward market is located in New York City

Assume an equilibrium state in which European inflation and U.S. inflation are both 4 percent. If U.S. inflation suddenly decreased to 2 percent, the euro will ____ against the dollar by approximately ____ percent, according to purchasing power parity. a. appreciate; 2 b. depreciate; 2 c. appreciate; 4 d. depreciate; 4 e. none of the above

b. depreciate; 2

A(n) ____ in the supply of euros for sale will cause the euro to ____. a. increase; appreciate b. increase; depreciate c. decrease; depreciate d. none of the above

b. increase; depreciate

When a government influences factors, such as inflation, interest rates, or income, in order to affect currency's value, this is an example of a. direct intervention. b. indirect intervention. c. a freely floating system. d. a pegged system.

b. indirect intervention

If a commercial bank expects the euro to appreciate against the dollar, it may take a ____ position in euros and a ____ position in dollars. a. short; short b. long; short c. short; long d. long; long

b. long; short

At any given point in time, the price at which banks will buy a currency is ____ the price at which they sell it. a. higher than b. lower than c. the same as d. none of the above

b. lower than

In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.67. The Australian dollar (A$) is quoted for $0.62. What is the value of the Australian dollar in British pounds? a. A$2.69 b. £0.37 c. £2.69 d. A$0.37 e. none of the above

b. £0.37

With a(n) ______ strategy, funds are allocated to bonds with a short term to maturity and bonds with a long term to maturity. Thus, this strategy allocates some funds to achieving a relatively high return and other funds to cover liquidity needs.

barbell

Assume a U.S. savings institution funds its fixed-rate mortgages by attracting short-term deposits. If it engages in an interest rate swap, but the index on the swap does not move in perfect tandem with its cost of deposits, this reflects

basis risk.

The risk that the position being hedged by a futures position is not affected in the same manner as the instrument underlying the financial futures contract, is referred to as

basis risk.

The actions of numerous institutional investors to sell stock index futures instead of selling stocks to prepare for a market decline would likely cause the index futures price to be

below the prevailing stock prices.

When evaluating stock performance, _____ measures variability that is systematically related to market returns; ______ measures total variability of a stock's return

beta: standard deviation

Sellers (writers) of call options can offset their position at any point in time by

buying identical call options.

On an exchange, option trades can be executed

by a floor broker. electronically. by a market maker.

c. $15.42 P0 = $1.85/(0.14 - 0.02) = $15.42

The Waffle House pays a constant annual dividend of $1.25 per share. How much are you willing to pay for one share if you require a 25 percent rate of return? a. $6.63 b. $6.52 c. $5.00 d. $4.72 e. $6.83

c. $5.00 P = $1.25/0.25 = $5.00

Railway Cabooses just paid its annual dividend of $1.70 per share. The company has been reducing the dividends by 11.3 percent each year. How much are you willing to pay today to purchase stock in this company if your required rate of return is 12 percent? a. $8.73 b. $6.98 c. $6.47 d. $15.04 e. $8.12

c. $6.47 P0 = [$1.70 × [1 + (- 0.113)]] / [0.12 - (- 0.113)] = $6.47

If the spot rate of the British pound is $2, and the 180-day forward rate is $2.05, what is the annualized premium or discount? a. 2.5 percent discount b. 2.5 percent premium c. 10 percent premium d. 5 percent discount e. 5 percent premium

c. 5 percent premium

____ forecasting is usually based on either the spot rate or the forward rate. a. Technical b. Fundamental c. Market-based d. Mixed

c. Market-based

The ____ allowed for the devaluation of the dollar in 1971. a. Bretton Woods Agreement b. Louvre Accord c. Smithsonian Agreement d. none of the above

c. Smithsonian Agreement

Which of the following is not a difference between purchasing an option and purchasing a futures contract? a. The option requires that a premium be paid in addition to the price of the financial instrument. b. Owners of options can choose to let the option expire on the so-called expiration date without exercising it. c. The fulfillment of futures contracts is regulated by exchanges, while the fulfillment of options is not. d. All of the above are differences between purchasing an option and purchasing a futures contract.

c. The fulfillment of futures contracts is regulated by exchanges, while the fulfillment of options is not.

Which of the following statements is least correct regarding corporations involved in international business transactions? a. They may purchase currency put options to hedge future receivables denominated in a foreign currency. b. They may purchase currency call options to hedge future payables denominated in a foreign currency. c. They may purchase currency call options to hedge future receivables denominated in a foreign currency. d. They benefit from currency put options if the currency's value declines before the expiration date of the option.

c. They may purchase currency call options to hedge future receivables denominated in a foreign currency.

Currency futures contracts differ from forward contracts in that they a. are an obligation. b. are not an obligation. c. are standardized. d. can specify any amount and maturity date.

c. are standardized

The act of capitalizing on the discrepancy between the forward rate premium and the interest rate differential is called a. triangular arbitrage. b. locational arbitrage. c. covered interest arbitrage. d. interest rate parity.

c. covered interest arbitrage

The exchange rate between two foreign (nondollar) currencies is known as a(n): a. indirect dollar rate. b. forward rate. c. cross-exchange rate. d. derived exchange rate.

c. cross-exchange rate

If U.S. interest rates suddenly become much higher than European interest rates (and if it does not cause concern about higher inflation there), the U.S. demand for euros would ____, and the supply of euros to be exchanged for dollars would ____, other factors held constant. a.increase; increase b. increase; decrease c. decrease; increase d. decrease; decrease

c. decrease; increase

If a firm planning to hedge receivables is certain of the future direction a spot rate will move, and requires a tailor-made hedge in terms of amount and maturity date, it should use a a. call options contract traded on an exchange. b. futures contract traded on an exchange. c. forward contract. d. put options contract traded on an exchange

c. forward contract

In a(n) ____ exchange rate system, the foreign exchange market is totally free from government intervention. a. pegged b. dirty floating c. freely floating d. Bretton Woods e. none of the above

c. freely floating

The Bretton Woods Era was the era a. of free-floating exchange rates. b. of floating rates without boundaries, but subject to government intervention. c. in which governments maintained exchange rates within 1 percent of a specified rate. d. in which exchange rates were maintained within 10 percent of a specified rate.

c. in which governments maintained exchange rates within 1 percent of a specified rate.

Purchasing Power Parity suggests that the exchange rate will on average change by a percentage that reflects the ____ differential between two countries. a. income b. interest rate c. inflation d. tax

c. inflation

If the forward rate of a foreign currency ____ the existing spot rate, the forward rate will exhibit a ____. a. exceeds; discount b. is below; premium c. is below; discount d. A and B

c. is below; discount

Bank A asks $.555 for Swiss francs and Banks B and C are willing to pay $.557 for francs. An institution could capitalize on these differences by engaging in a. covered interest arbitrage. b. triangular arbitrage. c. locational arbitrage. d. witching hour arbitrage

c. locational arbitrage

Generally, a ____ home currency can ____ domestic economic growth. a. weak; dampen b. strong; stimulate c. strong; dampen d. A and B

c. strong; dampen

A ____ home currency can ____ domestic inflation. a. strong; increase b. weak; decrease c. strong; decrease d. A and B

c. strong; decrease

Which of the following is not a method of forecasting exchange rate volatility? a. using the volatility of historical exchange rate movements b. using a time series of volatility patterns in previous periods c. using the volatility of future exchange rate movements d. using the exchange rate's implied standard deviation

c. using the volatility of future exchange rate movements

Assume the following information. •Interest rate on borrowed euros is 5 percent annualized • Interest rate on dollars loaned out is 6 percent annualized • Spot rate for €0.83 per dollar (one € = $1.20) • Expected spot rate in five days is €0.85 per dollar • Alonso Bank can borrow €10 million What is the euro profit to Alonso Bank over the five-day period from shorting euros and going long on dollars? a. €200,311.11 b. €207,111.11 c. €201,555.56 d. none of the above

c. €201,555.56

A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified period of time.

call option

When the market price of the underlying security exceeds the exercise price, the

call option is in the money.

A ____ requires a premium above and beyond the price to be paid for the financial instrument.

call option, put option

A(n) ____ swap allows the party making fixed-rate payments to terminate the swap prior to maturity.

callable

An advantage of a ____ over other interest rate swaps is that the fixed-rate payer has the flexibility to avoid exchanging future interest payments.

callable swap

When a bank participates in a swap of fixed interest rate payments for floating-rate payments, or a swap of currencies, it

can match up two parties or can take a position in the swap.

Trading restrictions imposed on specific stocks or stock indices are referred to as

circuit breakers.

A $1,000 face value bond is currently quoted at 101.2. The bond pays semiannual payments of $28.50 each and matures in 6yrs. What is the coupon rate?

coupon rate = (28.5*2)/1,000 = 5.70%

In a ____, a buyer makes periodic payments to a seller in exchange for protection against the possible default of debt securities specified in the contract.

credit default swap

According to the text, a futures contract on one financial instrument to protect a position in a different financial instrument is known as

crosshedging.

An arrangement which enables firms to exchange currencies at periodic intervals is called a

currency swap.

The ____ is not a factor affecting the call option premium.

current price of futures contracts on the underlying instrument

Assume that a British pound put option has a premium of $.03 per unit, and an exercise price of $1.60. The present spot rate is $1.61. The expected future spot rate on the expiration date is $1.52. The option will be exercised on this date if at all. What is the expected per unit net gain (or loss) resulting from purchasing the put option? a. $.01 loss b. $.09 loss c. $.09 gain d. $.05 gain

d. $.05 gain

The Red Bud Co. pays a constant dividend of $1.50 a share. The company announced today that it will continue to do this for another 2 years after which time they will discontinue paying dividends permanently. What is one share of this stock worth today if the required rate of return is 7.1 percent? a. $3.00 b. $4.21 c. $1.61 d. $2.71 e. $1.66

d. $2.71 P0 = $1.50 / 1.071 + $1.50 / 1.0712 = $2.71

d. $24.65 P6 = ($2.80 × 1.0257)/(0.16 - 0.025) = $24.65

According to interest rate parity, if the interest rate in a foreign country is ____ than in the home country, the forward rate of the foreign country will have a ____. a. higher; discount b. lower; premium c. higher; premium d. A and B

d. A and B

The devaluation of a country's currency: a. makes foreign products more expensive for consumers in that country. b. increases foreign demand for that country's exports. c. can lead to deflation in that country. d. A and B

d. A and B

Which of the following statements is incorrect? a. Central banks often consider adjusting a currency's value to influence economic conditions. b. If the U.S. central bank wishes to stimulate the economy, it could weaken the dollar. c. A weaker dollar could cause U.S. inflation by reducing foreign competition. d. Direct intervention occurs when the central bank influences the factors that determine the dollar's value.

d. Direct intervention occurs when the central bank influences the factors that determine the dollar's value.

____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers. a. Pension funds b. International mutual funds c. Insurance companies d. Commercial banks e. None of the above

d. commercial banks

If European inflation suddenly becomes much higher than U.S. inflation, the U.S. demand for European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces will place ____ pressure on the value of the euro. a. increase; decline; upward b. increase; decline; downward c. decrease; increase; upward d. decrease; increase; downward e. none of the above

d. decrease; increase; downward

If the U.S. government imposed trade restrictions on U.S. imports, this would ____ the U.S. demand for foreign currencies, and would place ____ pressure on the values of foreign currencies (with respect to the dollar). a. increase; upward b. increase, downward c. limit; upward d. limit; downward

d. limit; downward

Which of the following is the least feasible strategy for a speculator who expects the Australian dollar to depreciate? a. sell Australian dollars forward and then purchase them in the spot market just before fulfilling the forward obligation b. sell futures contracts on Australian dollar; purchase Australian dollars in the spot market just before fulfilling the futures obligation c. purchase put options on Australian dollars, at some point before the expiration date, when the spot rate is less than the exercise price, purchase Australian dollars in the spot market and then exercise the put option d. purchase call options on Australian dollars; at some point before the expiration date, exercise the call option and then sell the Australian dollars received in the spot market e. All of the above are possible strategies for a speculator who expects the Australian dollar to depreciate.

d. purchase call options on Australian dollars; at some point before the expiration date, exercise the call option and then sell the Australian dollars received in the spot market

In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.65. The Australian dollar (A$) is quoted for $0.60. What is the value of the Australian dollar in British pounds? a. A$2.75 b. A$0.36 c. £2.75 d. £0.36 e. none of the above

d. £0.36

Speculators in futures contracts that normally close out their futures positions on the same day that the positions were initiated are referred to as

day traders.

The premium on an existing call option should ____ when the underlying stock price decreases.

decline

The premium on an existing call option should ____ when there is a reduction in the expected short term volatility of the stock price.

decline

The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of the stock price.

decline

The premium on an existing put option should ____ when the underlying stock price increases.

decline

A financial institution that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will ____ and the position in futures contracts will result in a ____.

decrease; gain

A financial institution that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will _____ and the position in the futures contracts will result in a _______

decrease; gain

If the prices of Treasury bonds ____, the value of an existing Treasury bond futures contract should

decrease; increase

The net present value:

decreases as the required rate of return increases.

The basis is the

difference between the price of a security and the price of a futures contract on the security.

If the Treasury issues an unusually large amount of bonds in the primary market, it places ____ on bond prices, and ____ on yields to be earned by investors that purchase bonds and plan to hold them to maturity.

downward pressure; upward pressure

e. $13.31 P0 = ($1.45 × 1.028)/(0.14 - 0.028) = $13.31

Leslie's Unique Clothing Stores offers a common stock that pays an annual dividend of $1.60 a share. The company has promised to maintain a constant dividend. How much are you willing to pay for one share of this stock if you want to earn a 10.20 percent return on your equity investments? a. $8.60 b. $16.32 c. $6.38 d. $11.80 e. $15.69

e. $15.69 P = $1.60 / 0.1020 = $15.69

The common stock of The Garden of Eden is selling for $42 a share. The company pays a constant annual dividend and has a total return of 5.8 percent. What is the amount of the dividend? a. $2.04 b. $6.81 c. $1.02 d. $3.70 e. $2.44

e. $2.44 D = 0.058 × $42 = $2.44

The Three Amigos Restaurant just paid an annual dividend of $4.20 per share and is expected to pay annual dividends of $4.40 and $4.50 per share the next two years, respectively. After that, the firm expects to maintain a constant dividend growth rate of 2 percent per year. What is the value of this stock today if the required return is 15 percent? a. $33.05 b. $29.61 c. $27.64 d. $30.66 e. $33.93

e. $33.93 P2 = ($4.50 × 1.02)/(0.15 - 0.02) = $35.31; P0 = [$4.40/1.15] + [($4.50 + $35.31)/1.152 = $33.93

Business Solutions, Inc. is expected to pay its first annual dividend of $1.00 per share three years from now. Starting in year 6, the company is expected to start increasing the dividend by 2 percent per year. What is the value of this stock today at a required return of 12 percent? a. $9.34 b. $8.29 c. $8.09 d. $9.03 e. $7.70

e. $7.70 P5 = ($1.00 × 1.02)/(0.12 - 0.02) = $10.20; P0 = [$1.00/1.123] + [$1.00/1.124] + [($1.00 + $10.20)/1.125] = $7.70

Shoreline Foods pays a constant annual dividend of $1.60 a share and currently sells for $28.50 a share. What is the rate of return? a. 5.39 percent b. 6.63 percent c. 6.91 percent d. 4.56 percent e. 5.61 percent

e. 5.61 percent R = $1.60/$28.50 = 5.61 percent

Beginning with an equilibrium situation, if European inflation suddenly ____ than U.S. inflation, this forced ____ pressure on the value of the euro. a. becomes much higher; upward b. becomes much higher; downward c. becomes much less; upward d. becomes much less; downward e. B and C

e. B and C

Which one of the following types of securities has no priority in a bankruptcy proceeding? a. Straight bond b. Senior debt c. Convertible bond d. Preferred stock e. Common stock

e. Common stock Refer to Section 7.2.

____ are not foreign exchange derivatives. a. Forward contracts b. Currency futures contracts c. Currency swaps d. Currency options a. all of the above are foreign exchange derivatives

e. all of the above are foreign exchange derivatives

The supply and demand for a currency are influenced by all of the following, except a. differential interest rates. b. differential inflation rates. c. direct government intervention. d. indirect government intervention. e. The supply and demand for a currency are affected by all of the above

e. the supply and demand for a currency are affected by all of the above

Stock index futures are priced ____ than the stock index itself.

either higher or lower

Which of the following can normally be found in quotations for stock options provided by the financial media?

exercise price, expiration date, and most recently quoted premium

A(n) ____ allows the party making fixed payments to extend the swap period.

extendable

What is the principal amount of a bond that is repaid at the end of the loan term called?

face value

The option on a callable swap would most likely be exercised if interest rates

fall.

Direct intervention is always extremely effective. a. True b. False

false

Exchange rates usually change precisely as suggested by the purchasing power parity (PPP) theory. a. True b. False

false

Financial institutions rarely use the forward market. a. True b. False

false

Fundamental forecasting has been found to be consistently superior to the other forecasting techniques. a. True b. False

false

Purchasing power parity suggests that the forward rate premium (or discount) should be about equal to the differential in interest rates between the countries of concern. a. True b. False

false

The euro is presently pegged to the British pound in order to stabilize international payments between European countries. a. True b. False

false

The forward rate is the exchange rate for immediate delivery. a. True b. False

false

The forward rate premium is dictated by the national income differential of the two currencies. a. True b. False

false

The forward rate premium reflects the percentage by which the spot rate exceeds the forward rate on an annualized basis. a. True b. False

false

The indirect exchange rate specifies the value of the currency in U.S. dollars. a. True b. False

false

The pegged exchange rate system is no longer used by any countries. a. True b. False

false

The potential benefits from using foreign exchange derivatives are independent of the expected exchange rate movements. a. True b. False

false

Assume that a bank obtains most of its funds from large CDs with a one-year maturity. Its assets are in the form of loans with rates that adjust every six months. The bank would be ____ affected if interest rates increase. To partially hedge its position, it could ____ futures contracts.

favorably; purchase

A(n) ______ is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specific price and date

financial future contract

A(n) ____ is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date.

financial futures contract

A common maturity of a credit default swap contract is:

five years

A plain vanilla swap enables firms to exchange ____ for ____.

fixed rate payments; variable interest rate payments

If a firm negotiates a plain vanilla swap, it will provide ____ payments in exchange for ____ payments.

fixed-rate; floating-rate

A ____ swap involves an exchange of interest rate payments that does not begin until a specified future point in time.

forward

A(n) ____ swap involves an exchange of interest payments over a swap period that does not begin until a specified future point in time.

forward

For a bond of a given par value, the higher the investor's required rate of return is above the coupon rate, the

greater is the discount on the price

The ____, the lower the premium on a put option, other things being equal.

higher the existing price of the security relative to the exercise price

The greater the volatility of the underlying stock, the ____ the call option premium and the ____ the put option premium.

higher; higher

The longer the time to maturity, the ____ the call option premium and the ____ the put option premium.

higher; higher

Assuming the same expiration date, an option with a ____ exercise price has a ____ call option premium and a ____ put option premium.

higher; lower; higher

The premium on an existing put option should ____ when there is a increase in the expected short-term volatility of the stock price.

increase

The premium on an existing put option should ____ when there is an increase in the expected short-term volatility of the stock price.

increase

When stock portfolio managers use dynamic asset allocation by purchasing call options on a stock index, they ____ their exposure to stock market conditions.

increase

A(n) _____ in the expected level of inflation results in _____ pressure on bond prices.

increase ; downward

If a U.S. institution in a forward swap would like to lock in the fixed rate that it will pay when the swap period begins, it is probably concerned that interest rates will ____; the counterparty is likely adversely affected by ____ interest rates.

increase; declining

An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and places ____ pressure on Treasury bond futures prices.

increase; higher; downward

If speculators believe interest rates will ____, they would consider ____ a Tbill futures contract today.

increase; selling

If speculators believe interest rates will _______, they would consider ______ a T bill futures contract today.

increase; selling

Assume that speculators had purchased a futures contract at the beginning of the year.If the price of a security represented by a futures contract ____ over the year, then these speculators would likely have purchased the futures contract for ____ than they can sell it for.

increased; less

Assume a financial institution has rate-sensitive liabilities and rate-sensitive assets. If this institution negotiates a rate-capped swap, its ____ payments will be capped, and it will ____ an up-front premium in exchange for the cap.

inflow; receive

An equity swap involves the exchange of

interest payments for payments linked to the degree of change in a stock index.

Dynamic asset allocation

involves the switching between risky and lowrisk investments by institutional investors over time in response to changing expectations.

When a bond's yield to maturity is less than the bond's coupon rate, the bond:

is selling at a premium.

Buyers of credit default swaps are most likely going to receive a payment from the seller of credit default swaps when the economy:

is very weak.

The advantage of a rate-capped interest rate swap to a party exchanging fixed payments for floating payments (relative to a plain vanilla swap) is that

it receives an up-front fee.

AIG's financial problems during the credit crisis were attributed to:

its potential losses from credit default swaps.

Using a(n) ____ strategy, investors allocate funds evenly to bonds in each of several different maturity classes.

laddered

Which of the following is not an advantage of having derivative securities such as swaps traded on an exchange instead of over the counter?

less standardarized contracts, allowing contracts to be tailored to the parties' specific needs

Covered call writing ____ the upside potential return and ____ the risk of an investment in stock.

limits; decreases

The ____, the higher the call option premium, other things being equal.

longer the maturity of the option

The prices of _____ coupon bonds and bonds with __________ maturities are most sensitive to changes in the required rate of return.

low; long

The profits of a financial institution with interestrate sensitive liabilities and interest rateinsensitive assets are ____ with hedging than without hedging if interest rates decrease.

lower

The use of financial leverage

magnifies the positive returns of futures contracts. magnifies losses of futures contracts. *BOTH*

Financial leverage, when used in association with a futures contract, ____ the positive returns and ____ losses.

magnifies; magnifies

A savings institution has long-term fixed rate mortgages supported by short-term funds. A put option on Treasury bond futures could be used to (ignore the premium paid for the option when you answer this question)

maintain its interest rate spread if interest rates rise, and increase its spread if interest rates fall.

in a period when interest rates are expected to rise, ____ institutions will want a fixed-for-floating swap, and the fixed rate specified on interest rate swaps will be ____ under these conditions.

many; higher

A put option is "out of the money" when the

market price of the security exceeds the exercise price.

A call option is "in the money" when the

market price of the underlying security exceeds the exercise price.

Financial institutions with ____ interest rate-sensitive liabilities than assets are ____ affected by rising interest rates.

more; adversely

In crosshedging, if the futures contract value is ____ volatile than the portfolio value, hedging will require a ____ amount of principal represented by the futures contracts.

more; greater

If there are ____ traders with buy offers than sell offers for a particular contract, the futures price will ____ until this imbalance is removed.

more; rise

When a stock index option is exercised, the cash payment is equal to a specified dollar amount

multiplied by the difference between the index level and the exercise price.

Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities?

net present value

The dividend yield is defined as:

next year's expected cash dividend divided by the current market price per share.

The dividend yield is defined as:

next year's expected cash dividend divided by the current market price per share. Refer to Section 7.1.

An interest rate swap agreement indicates the ____ value, which represents the principal amount to which interest rates are applied to determine the interest payments involved.

notional

Currency futures may be purchased to hedge ____ or to capitalize on the expected ____ of that currency against the dollar.

payables; appreciation

Companies with international trade can hedge ____ by ____ currency futures.

payables; buying

Speculators in futures contracts that normally maintain the futures position that they initiate for extended periods of time (such as weeks or months) are referred to as

position traders.

Corporations involved in international business transactions can ____ to hedge future ____.

purchase currency put options; receivables

Assume a corporation is receiving a large amount of funds in the near future. The company plans to use the funds to purchase municipal bonds. Also assume that the company is concerned that interest rates decrease before the purchase date, which would make the municipal bonds more expensive. In order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates decrease, the futures contract will generate a ____.

purchase; gain

An interest rate collar represents the ____ of an interest rate cap and a simultaneous ____ of an interest rate floor.

purchase; sale

A firm is involved in an agreement in which it receives payments in periods when a market interest rate rises above an interest rate level specified in the agreement. This means that the firm has

purchased an interest rate cap.

A firm is involved in an agreement in which it receives payments in periods when a market interest rate falls below an interest rate level specified in the agreement. This means that the firm has

purchased an interest rate floor.

Speculators who anticipate a decline in interest rates may consider ____ a ____ option on Treasury bond futures.

purchasing; call

When the exercise price exceeds the market price of the underlying security, the

put option is in the money.

Speculators purchase currency ____ on currencies they expect to ____ against the dollar.

put options; weaken

A ____ swap allows the party making floating-rate payments to terminate the swap prior to maturity.

putable

The common stock of Eddie's Engines, Inc. sells for $28.11 a share. The stock is expected to pay $3.00 per share next year. Eddie's has established a pattern of increasing their dividends by 5.1 percent annually and expects to continue doing so. What is the market rate of return on this stock?

r = $3.00 / $28.11 + 0.051 = 15.77 percent

A ____ swap involves the exchange of fixed-rate payments for floating-rate payments that are capped.

rate-capped

The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to:

recoup its initial cost.

When stock portfolio managers use dynamic asset allocation by writing call options on a stock index, they ____ their exposure to stock market conditions.

reduce

Savings institutions participate in the swap market primarily to

reduce interest rate risk.

Financial institutions primarily use interest rate swaps in a way that will ____ exposure to interest rate risk and ____ potential returns.

reduce; reduce

A plain vanilla swap is especially beneficial when interest rates are expected to

rise consistently.

the option on a putable swap would most likely be exercised if interest rates

rise.

The most likely users of plain vanilla swaps would be

savings institutions.

If a financial institution expects that the market value of its municipal bonds will decline because of economic conditions, it could hedge its position by ____ futures contracts on ____.

selling; a Municipal Bond Index

If the coupon rate equals the required rate of return, the price of the bond =

should be equal to its par value

A stock's beta can be measured from the estimate of the _____ using regression analysis

slope coefficient

If a futures contract is more volatile than the portfolio value, the amount of principal represented by the futures contracts to hedge the portfolio is ____ the market value of the securities

smaller than

A firm is involved in an agreement in which it makes payments in periods when a market interest rate rises above an interest rate level specified in the agreement. This means that the firm has

sold an interest rate cap.

A firm is involved in an agreement in which it makes payments in periods when a market interest rate falls below an interest rate level specified in the agreement. This means that the firm has

sold an interest rate floor.

According to the text, any political aspects that prevent a counterparty on a swap from meeting its payment obligations represent

sovereign risk.

Systemic risk reflects the risk that a particular event could

spread adverse effects among several firms or among financial markets.

Long-term equity anticipations (LEAPS) represent

stock options with longer terms to expiration than the more traditional stock options.

A cost that should be ignored when evaluating a project because that cost has already been incurred and cannot be recouped is referred to as which type of cost?

sunk

Hedgers

take positions in futures to reduce their exposure to future movements in interest

The limitation of the dividend discount model are more pronounced when valuing stocks

that retain most of their earnings

Interest rate futures are not available on

the S&P 500 index.

The market risk premium is:

the return of the market in excess of the risk-free rate

The net gain or loss on a futures contract for a stock index that is not closed out is the difference between the futures price when the initial position was created and the futures price at

the settlement date

The net gain or loss on a futures contract for a stock index that is not closed out is based on the difference between the futures price when the initial position was created and the futures price at

the settlement date.

The advantage of a rate-capped interest rate swap (relative to a plain vanilla swap) to a party exchanging floating payments for fixed payments is that

there is a maximum limit set on the interest payments it will provide.

Floor traders

trade futures contracts for their own account.

A country that pegs its currency does not have complete control over its local interest rates, as its interest rates must be aligned with the interest rates of the currency to which it is tied. a. True b. False

true

A country that pegs its exchange rate to another exchange rate does not have complete control over its interest rates. a. True b. False

true

A speculator who expects a foreign currency to appreciate could purchase the currency forward and, when received, sell it in the spot market. a. True b. False

true

Central bank intervention can be overwhelmed by market forces and may not always succeed in reversing exchange rate movements. a. True b. False

true

Currency futures contracts are standardized, whereas forward contracts are more flexible and can specify whatever amount and maturity date are desired. a. True b. False

true

If the quoted cross rate between two foreign currencies is not aligned with the two corresponding exchange rates, investors can profit from triangular arbitrage. a. True b. False

true

In reality, exchange rates do not always change as suggested by purchasing power parity. a. True b. False

true

The Smithsonian Agreement allowed for a devaluation of the dollar and for a widening of the boundaries within which currencies were allowed to fluctuate. a. True b. False

true

The following information refers to Fresno Bank and Champaign Bank. In Euros: Fresno Bank $1.002 (bid rate) $1.009 (ask rate) Champaign Bank $0.997 (bid rate) $1.000 (ask rate) Based on this information, locational arbitrage would be profitable. a. True b. False

true

The indirect exchange rate is always the reciprocal of the direct exchange rate. a. True b. False

true

The primary advantage of currency options over forward and futures contracts is that they provide a right rather than an obligation to purchase or sell a particular currency at a specified price within a given period. a. True b. False

true

When countries experience substantial net outflows of funds, they commonly use indirect intervention by raising interest rates to discourage excessive outflows of funds and therefore limit any downward pressure on the value of their currency. a. True b. False

true

When the Federal Reserve attempt to lower interest rates by increasing the U.S. money supply, it puts upward pressure on the value of the dollar. a. True b. False

true

If security prices fully reflect all market-related information (such as historical price pattern) but do not full reflect all other public information, security markets are

weak-form efficient

Put options are typically used to hedge

when portfolio managers are mainly concerned with a temporary decline in a stock's value.

Assume that corporate bond portfolio managers are concerned about the possibility of many bond defaults resulting from a future recession. A short position in Treasury bond futures ____ an effective hedge against the default risk. A short position in Treasury bill futures ____ an effective hedge against the default risk.

would not be; would not be

If an investment is producing a return that is equal to the required return, the investment's net present value will be:

FIN 730 EXAM 2 (All Terms)

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