FIN3403-exam2
What is the clean price of a 1000 par value bond with a 12 % coupon, payable semiannually, if the bonds dirty price is 1050 and the next semiannual coupon payment is due in 4 months?
$1030
Scott Corporation does not pay dividends. The PE ratio for its industry is 13.3, and Scott's EPS were $1.47. At what price should Scott's stock trade?
$19.55
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6 percent?
$5.94 NPV= -95+(107/1.06) = $5.94
A bond pays annual interest payments of $50, has a par value of $1000, and a market price of $1200. How is the coupon rate computed?
$50/$1,000
Dusty Corporation has an issue of preferred stock that pays a dividend of 7% of its state value, which of $100. Which of the following would be a commonly used name for the preferred stock?
$7 preferred
If a project has multiple internal rates of return, which of the following methods should be used?
-MIRR -NPV
What are some features of the OTC market of bonds?
-OTC dealers are connected electronically -The OTC has no designated physical location
What are the two unique features of a US federal government bond?
-US treasury issues are exempt from state income taxes -US treasury issues are considered to be default free
How is a zero coupon bond different from a conventional bond?
-ZC make no interest payments -ZC bonds have always been issued at a discount
A benchmark PE ratio can be determined using:
-a company own historical PEs -the PEs of similar companies
The NYSE differs from the NASDAQ primarily bc the NYSE has:
-an auction market -a physical location -specialist
Which three components determine the shape of the term structure of interest rates?
-inflation premium -real interest rate -interest rate risk premium
Which of the following is usually a right of common shareholders?
-the right to a proportional share of dividends paid -voting rights
Which of the following are usually included in a bond's indenture?
-the total amount of bonds issued -the repayment arrangements
What are some reasons why the bond market is so big?
-various state and local governments also participate in the bond market -many corporations have multiple bond issues outstanding -federal government borrowing activity in the bond market is enormous
What will your aftertax yield be on a corporate bond that is currently priced to yield 7% percent if you are in the 25 percent tax bracket?
.07 X (1-.25)= 5.25%
If you are holding a municipal bond that is trading at par to yield 6%, how much will your after-tax yield change if your income tax bracket increases from 15% to 20%. Assume there are no state or local taxes
0%
What are the weaknesses of the payback method?
1. Time value of money principles are ignored 2. Cash flows received after the payback period are ignored 3. the cutoff date is arbitrary
What is the effective annual yield for a bond that pays interest semiannually and has a quoted yield to maturity of 10 percent?
10.25%
What is the price of a US Treasury bond listed at 122 if the par value is $5000?
5000 X 122%= $6100
If an investment appreciates by 7 percent while the rate of inflation is 2%, what is the nominal rate of return?
7%
When an investor sells a bond to a dealer, the price paid by the dealer is known as the ____.
Bid price
Match each one of these bonds with their characteristics
CAT bond: protects insurance companies from natural disasters Convertible bond: can be exchanged for shares of stock Put bond: owner can force issuer to repay prior to maturity at a stated price Structured note: based on financial securities, commodities, or currencies
Matthews Company has two classes of common stock, and each share represents the same proportion of ownership in the company. Class A has 2 votes for each share. Class B has one vote per share. Which class is more valuable?
Class A
How has TRACE improved transparency in the corporate bond market?
Corporate bond dealers are now required to report trade info through TRACE
Is a company required to pay preferred dividends?
No; the company may defer dividends on preferred stock; however they can not pay dividends to common shareholders until preferred dividends are paid
The formula for valuing a constant growth stock is:
P0=D1/(R-g)
The IRR rule can lead to bad decisions when ____ or ____.
Projects are mutually exclusive, cash flows are not conventional.
What is the equation of the nominal rate of return?
R= r + h
Which is the largest security market in the world in terms of trading volume?
The US Treasuries market
What is the asked price?
The asked price is the price at which a dealer is willing to sell
What is the difference between a bonds "clean price" and its "dirty price"?
The clean price excludes interest accrued since the last coupon payment, while the dirty price includes accrued interest.
What does the clean price of a bond represent?
The quoted price, which excludes interest accrued since the last coupon date
A bond has a quoted price of $984.63, a face value of $1000, a semi-annual coupon of $20, and a maturity of 10 years. Match its current yield and its YTM below.
YTM= 4.19% Current Yield= 4.06%
What is a premium bond?
a bond that sells for more than face value
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:
a target average accounting return
The PI rule for an independent project is to ___ the project if the PI is greater than 1.
accept
What are municipal bonds?
bonds that have been issued by state or local government
Secondary markets in sukuk are extremely illiquid bc most sukuk are:
bought and held to maturity
A person who brings buyers and sellers together is called a(n) _____.
broker
Capital ___ is decision-making process for accepting and rejecting projects
budgeting
The ___ can be interpreted as the capital gains yield.
constant growth rate
If the liquidity of a bond increases then the bond's yield will _____.
decrease
All esle constant, the dividend yield will increase if the stock price ___.
decreases
What is a discount bond?
discount bonds are bonds that sell for less than face value
The constant-growth model infers that ____.
dividends change at a constant rate
Which one of the following is true about dividend growth patterns?
dividends may grow at a constant rate
Which of the following represents the valuation of stock using a zero-growth model?
dividends/discount rate
The price of a share of common stock is equal to the present value of all ___ future dividends.
expected
Cumulative voting means board members are elected one at a time, with each shareholder casting his or her allotted votes for each seat on the board.
false
For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.
false
Investing more money in a project is a guarantee of greater profits.
false
The profitability index is calculated by dividing the PV of the ____ cash flows by the initial investments
future
One requirement of the dividend growth model is:
g<R
In an inflationary environment, the nominal rate will be ___ the real rate.
greater than
The value of a firm is the function of its ___ rate and its ___ rate.
growth; discount
A humped term structure of interest rates indicates that interest rates are expected to _____ as the time to maturity increases.
increase and then decline
When interest rates in the market fall, bond values are likely to increase because the present value of the bond's remaining cash flows ____.
increases
IRR continues to be very popular in practice, partly because:
it gives a rate of return rather than a dollar value
If a $1000 par value bond is trading at a discount, it means that the market value of the bond is ____ $1000
less than
A zero-coupon bond is a bond that ___
makes no interest payments
WinWin Corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?
no minority shareholder would have enough votes to win any seat on the board
The constant growth formula calculate the stock price:
one year prior (year t) to the first dividend payment(Dvt+1)
If a given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ____ rate.
real
According to the basic IRR rule, we should:
reject a project if the IRR is less than the required return
The NYSE member who acts as a dealer in a small number of securities is called a(n) _____.
specialist
Mota Motors has eight directors on its board, two of whom go up for election each year. This is an ex of a:
staggered board
In which of the following scenarios would IRR always recommend the wrong decision?
start CF= 1000 End CF= -2000
The goal of many successful organizations is a(n) ___ rate of growth in dividends.
steady
The payback period rule ___ a project if it has a payback period that is less than or equal to a particular cutoff date.
suggests accepting
Why does a bond's value fluctuate over time?
the coupon rate and par value are fixed, while market interest rates change
When the stock being valued does not pay dividends,
the dividend growth model can still be used
What does the AAA rating assigned by S&P mean?
the firm is in a strong position to meet its debt obligations
If you own corporate bonds, you will be concerned about interest rate risk as it affects ___.
the market price of the bonds
If a $1000 par value bond is trading at a premium, the bond is
trading for more than $1000 in the market
The US government borrows money by issuing
treasury bills treasury notes treasury bonds
IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects.
true
In general, the price that is paid for a bond will exceed its quoted price.
true
It can be advantageous to have a staggered board bc it provides "institutional memory"
true
The crossover rate is the rate at which the NPV's of 2 projects are equal.
true
Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:
zero
If the growth rate (g) is zero, the capital gains yield is ___.
zero
The default risk premium refers to the extra compensation demanded by investors for the possibility that the issuer might ___.
not make all the promised payments
When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:
one vote per share held
Initial public offerings of stock occur in the ___ market.
primary
Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If Projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?
project beta
A bond's yield to maturity considers the total interest earnings and the change in the bond's price while the current yield considers ____.
the annual coupon payment and the bond price
Which quote, asked or bid, would an investor be expected to pay to a dealer if he or she was buying a bond from the dealer?
the asked price
Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?
the bid price the asked price
Which of the following entities declares a dividend?
the board of directors
The amount by which the call price exceeds the par value of the bond is called:
the call premium
The IRR is the discount rate that makes the NPV of a project equal to ____.
zero
As a general rule, which of the following are true of debt and equity?
-equity represents an ownership interest -the max reward for owning debt is fixed
Which of the following are reasons why it is more difficult to value common stock than it is to value bonds?
-the life of a common stock is essentially forever -the rate of return required by the market is not easily observed -common stock cash flows are not known in advance
What is the nominal rate of return on an investment?
it is the rate that has not been adjusted for inflation
If the rate of inflation is 3 percent and the real rate of return is 9 percent, the nominal rate is approximately ___ percent.
12
Use your calculator to find the YTM on a 20 year, $1000 par value bond that pays coupons of 4.5% semi-annually and currently sells for $1104.89
3.75%
If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes
5%
What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?
9.70%
What is the PI for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12 percent?
=((80/1.12)+(20/1.12^2))/30=2.91
What information do we need to determine the value of stock using the zero-growth model?
-discount rate -annual dividend amt
Preferred stock has preference over common stock in the:
-distribution of corporate assets -payment of dividends
Which of the following are expected cash flows to investors in stocks?
-dividends -capital gains
Which of the following are advantage(s) of AAR?
-easy to compute -needed info is always available
Which of the following are mutually exclusive investments?
2 different choices for the assembly lines that will make the same product, & a restaurant or gas station on the same piece of land.
Saxon Company is considering a project that will generate NI of $50,000 in Year 1, $75,000 in Year 2, and $90,000 in Year 3. The cost of the project is $700,000, and this cost will be depreciated to $0 in the 3 years of the investment. What is their AAR?
20.48%
At what tax rate will you be indifferent between a muni that yields 7 percent and a comparable corporate bond yielding 9 percent? assume no state taxes
22.2%
In general, a corporate bond's coupon rate _____.
is fixed until the bond matures
One common reason for having two classes of common stock with different voting rights is:
it is easier for insiders such as founding families to maintain control of the company
Which of the following occurs in the primary market>
newly-issued stocks are initially sold
The point at which the NPV profile crosses the vertical axis is the:
sum of the cash flows of the project
Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.
true
If you invest in a corporate bond, how many times can you expect, in general, to receive interest?
twice a year
When valuing a stock, the advantage to considering the stock price in the distant future (rather than a more near-term price) as a cash flow is that:
when discounted to present value, a stock price in the distant future is nearly zero
When the US government wants to borrow money for the long-term(more than one year) it issues:
-treasury notes -treasury bonds
The bid-ask spread represents the ____.
Dealers profit
In which way(s) is preferred stock like a bond?
-preferred stock sometimes has a sinking fund, giving it a set maturity like bonds -some preferred stock has credit ratings, like bonds -preferred shareholders receive a stated value if the firm liquidates, like bondholder -preferred shareholders receive a stated dividend, similar to interest on a bond
Which six factors determine the yield on a bond?
-real rate of return -interest rate risk -expected future inflation -liquidity -default risk -taxability
Which of the following variables are required to calculated the value of a bond?
-remaining life of bond -coupon rate -market yield
Which of the following projects is acceptable if the average accounting return is required to be at least 20%?
-restaurant: average income = $450,000, Average book value= $2,180,000 -book store: average income= $140,000, Average book value= $600,000
Which of the following institutions issue bonds that are traded in the bond market?
-state governments -public corporations -federal government
Which of the following are common protective covenants?
-the firm cannot merge with any other firm -The firm must limit dividends to equity holders -The firm must maintain working capital at or above a specified level
Which of the following are features of municipal bonds?
-the interest on municipal bonds is exempt from federal taxes -they are issued by the state and local governments
Arrange the steps involved in the discounted payback period in order starting with the first step.
1. discount the cash flows using the discount rate 2. add the discounted cash flows 3. accept if the discounted payback period is less than pre-specified number of years.
What will happen to the default risk premium during periods of economic uncertainty?
it will increase
The reason that interest rate risk is greater for ____ term bonds than for ____ term bonds is that the change in rates has a greater effect on the present value of the ___ than on the present value of the ____.
long; short; face value; coupon payments
Why is the bond market less transparent than the stock market?
many bond transactions are negotiated privately
Most voting in large corporations is done by proxy bc:
most small shareholders do not attend the annual meeting
Fundamentally, the business of the NYSE is to attract and process ____.
order flow
What is the price of a stock if its dividend a year from now is expected to be $3.20, the discount rate is 9 percent, and the constant rate of growth is 5 percent?
p0= 3.20/(.09-.05)=$80
This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively
payback method
The amount of time needed for the cash flows from an investment to pay for its initial cost is the
payback period
In capital budgeting, the net ____ determines the value of a project to the company
present value
What is the total return for a stock that currently sells for $100, pays a dividend in one year of $2, and has a constant growth rate of 8 percent?
10%
What is a bond's current yield?
=annual coupon payment/ current price
A corporate bond's yield to maturity ____.
-changes over time -can be greater than, equal to, or less than the bond's coupon rate
NASDAQ has which of these features?
-computer network of securities dealers -multiple market system
Which of the following terms apply to a bond?
-coupon rate -time to maturity -par value
Which of these is included in the calculation of a bond's yield to maturity?
-current price -coupon rate -par value
All junk bonds typically have which of these features?
-high probability of default -less than investment-grading rating
What are three important features of Treasury notes and bonds?
-highly liquid -taxable -default free
Which three of the following are common shapes for the term structure of interest rates?
-humped -downward sloping -upward sloping
Which of the following are features of common stock?
-it has no special preference in bankruptcy -it generally has voting rights -it has no special preference in receiving dividends
Which of the following are true about a bond's face value?
-it is also known as the par value -it is the principal amt repaid at maturity
When cash flows are conventional, NPV is ____.
-negative for discount rates above the IRR -positive for discount rates below the IRR -equal to zero when the discount rate equals the IRR
According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada?
-net present value -internal rate of return
Three special case patterns of dividend growth include:
-non-constant growth -zero growth -constant growth
How significant is the real rate of return in determining the shape of the term structure of interest rates?
-not very significant -less significant than inflation
How is investing in US Treasury bonds different from investing in corporate bonds?
-treasury bonds have no default risk -interest from US Treasuries is exempt from taxes at the state level but corporate interest is not
Which of these correctly identify differences between US Treasury bonds and corporate bonds?
-treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer -treasury bonds are considered free of default risk while corporate bonds are exposed to default risk -treasury bonds are issued by the US government while corporate bonds are issued by corporations
What are the weaknesses of the discounted payback period?
1. loss of simplicity as compared to the payback method 2. exclusion of some cash flows 3. arbitrary cutoff date
Place the following bonds in order of security as defined in the US.
1. mortgage bonds 2. debentures
The three attributes of NPV are that it:
1. uses all the cash flows of a project 2. uses cash flows 3. discounts the cash flows properly
What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?
10%
Will is deciding whether or not to buy Dang corporation stock, whose current price is $54.95. Dang paid a dividend of $2.17 this year. Will estimates that dividends will grow very quickly, at a rate of 12%, for the next four years. After that, he expects the dividend growth rate to fall to 5%. Should Will buy the stock if his required rate of return is 10%
Yes; using the two stage growth model, the stock's value is $58.06
A project should be ___ if its NPV is greater than zero.
accepted
Payback period tells the time it takes to break even in an ___ sense. Discounted payback period tells the time it takes to break even in an ___ or financial sense
accounting; economic
How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the projects lifetime
an increase in the size of the first cash inflow will decrease the payback period, all else held constant
Suppose Bob owns 20 shares and Vikki owns 30 shares in Good Company, and there are five members of the board of directors. Under which voting arrangement can Bob assure himself of a board member that represents his interest?
cumulative voting
Someone who maintains an inventory of stocks and buys and sells those stocks is known as a ___.
dealer
The MIRR function eliminates multiple IRRs and should replace NPV
false
The discounted payback rule has an objective benchmark to use in decision-making.
false
A PE ratio that is based on estimated future earnings is known as a ____ PE ratio.
forward
An asset's value is determined by the present value of its ____ cash flows.
future
A bond with a BBB rating has a ____ than a bond with an A rating.
higher risk of default
An ______ project does not rely on the acceptance or rejection of another project
independent
The present value of all cash flows (after the initial investment) is divided by the ____ to calculate the profitability index.
initial investment
The most important alternatives to NPV is the ___ method.
internal rate of return
The point at which the NPV profile crosses the horizontal axis is the:
internal rate of return
Stock price reporting has increasingly moved from traditional print media to the ___ in recent years.
internet
Which of the following is true about a multi-year typical bond's coupon?
it is a fixed annuity payment
What is a real rate of return?
it is a rate of return that has been adjusted for inflation
What is the definition of a bonds time to maturity?
it is the number of years until the face value is due to be repaid
A market is considered transparent if ____.
its prices and trading volume are easily observed
