Finance 311 Exam #3

Constant dividend equation

P0 = D / R

A profitability index of 1.1 implies that for every $1 of investment, we create an additional $__ in value

$.10

Relevant cash flows for bond valuation:

- Coupon payments (annuity) - Par value (lump sum)

Municipal Securities

- Debt of state and local governments. - Varying degrees of default risk, rated similar to corporate debt. - Interest received is tax-exempt at the federal level.

For any evaluation we need to:

- Define future cash flows. - Determine the appropriate discount rate. - Find the PV of the future cash flows.

Supernormal growth

- Dividend growth is not consistent initially, but settles down to constant growth eventually. - The price is computed using a multistage model.

Decision criteria when evaluating capital budgeting decisions

- Does the decision rule adjust for the time value of money? - Does the decision rule adjust for risk? - Does the decision rule provide information on whether we are creating value for the firm?

Inverted Yield Curve

- Downward-sloping. - Long-term yields are lower than short term yields.

Payback Method Advantages

- Easy to understand and compute - Simple to use - Adjusts for uncertainty of later cash flows - Biased toward liquidity Quickly frees up cash for other projects

Payback Method Disadvantages

- Ignores the time value of money - Risk is not considered - Requires an arbitrary cutoff point - Ignores cash flows beyond the cutoff date - Biased against long-term projects, such as research and development, and new projects

Discounted Payback Advantages

- Includes time value of money - Easy to understand - Does not accept negative estimated NPV investments when all future cash flows are positive - Biased towards liquidity

Xerox issued $75 million of 8.25% preferred stock at $50 per share. What is the is the fixed, annual dividend per share?

$4.125

Dividends are fixed either as a dollar amount or as a _ of par value.

%

The Fisher Effect equation:

(1 + R) = (1 + r)(1 + h) where R = nominal rate r = real rate h = expected inflation rate

Foreign Bonds

- Bonds issued by foreign governments or by foreign corporations. - Exposed to exchange rate risk.

Zeros

- Bonds that pay only par value at maturity; no coupons.

Profitability Index Advantages

- Closely related to NPV, generally leading to identical decisions - Easy to understand and communicate - May be useful when available investment funds are limited

Common Stock

- Control of the firm. - No fixed maturity date (infinite) - Receive dividend payments and capital gains.

Real Rate of Return

- The nominal rate of return minus the inflation rate. - Represents a change in purchasing power.

Moody's Ba/B and S&P's BB/B represent a capacity to pay that is? What grade are these considered?

- There is a possibility that the capacity to pay will degenerate. - Low grade.

Normal Yield Curve

- Upward-Sloping. - Long-term yields are higher than short-term yields.

Which of the following is not one of the six factors used to determine the yield on a bond? - Interest rate risk - Voting rights - Real rate of return - Default risk - Liquidity - Expected future inflation - Taxability

- Voting rights

Appropriate discount rate factors:

- YTM - Rate that similar bonds would pay in the market. - Required return on the bond.

Moody's Baa and S&P BBB represent a capacity to pay that is? What grade are these considered?

- adequate, adverse conditions will have more impact on the firm's ability to pay. - Medium grade.

Moody's A and S&P A represent a capacity to pay that is? What grade are these considered?

- strong, but more susceptible to changes in circumstances. - Medium grade.

T-Bill

A short-term debt obligation (discount bond) backed by the U.S. government with a maturity of less than one year.

NPV ______ cash flows properly. A) discounts B) compounds

A) discounts

A limitation of bond ratings is that they ____. A) focus exclusively on default risk B) change every day C) focus on both default risk and interest rate risk D) are generated by the issuing corporations, not an external independent agency

A) focus exclusively on default risk

Default Risk Premium (DRP)

Compensation for the possibility that the issuer may not pay the interest or repay the principal.

T-Note

Coupon debt with original maturity between one and ten years.

True or False: An all equity firm can still go bankrupt merely due to debt.

False

True or False: Common stockholders do not vote for the board of directors.

False

True or False: Debtors have an ownership interest.

False

True or False: For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.

False

True or False: Opportunity costs can be ignored when determining the financial feasibility of a project.

False

True or False: The MIRR function eliminates multiple IRRs and should replace NPV.

False

True or false: A bond's value is not affected by changes in the market rate of interest.

False

True or false: The inflation premium will be higher if the rate of inflation is low.

False

True or false: The real rate of return will generally be higher than the nominal rate of return.

False

Profitability Index (PI)

Measures the benefit per unit cost, based on the time value of money. - This measure can be very useful in situations in which we have limited capital.

Reinvestment Risk

Occurs because the company will be reinvesting the coupon payments it receives.

A zero-growth stock pays a dividend of $2 per share and has a discount rate of 10%. What will the stock's price be? A) 12.29 B) 1.81 C) 20.00

Po = $2/.10 = C) 20.00

Internal Rate of Return (IRR)

Rate of return that makes the present value of the future cash flows equal to the initial costs of the investment. - Similar to NPV.

Voting Rights

Right to vote for the firm you are invested in board of directors.

Yield to Maturity (YTM)

The interest rate required in the market on a bond.

If you know the price of one bond, you can estimate its YTM and use that to find the price of a second bond. True or False?

True

Shariah does not permit the charging or paying or interest. True or False?

True

Current Yield =

annual coupon / current price

Coupon Rate Equation

annual coupon/face value

Dividend payments are not considered a business expense; therefore, they (are/are not) tax deductible.

are not

In financial markets the difference between the ____ price and the ask price is known as the spread.

bid

Default risk probability (is/is not) reflected in bond ratings.

is

If YTM is less than the coupon rate, then par value is (less than/greater than) the bond price.

less than

Limited Liability

liability is limited to the amount of the owners' investment.

Priority is (lower/higher) than debt and preferred. It is (lower/higher) than common stock.

lower, higher

Hybrid securities are like common stock as they have no fixed ______.

maturity

Long-term bonds have (more/less) interest rate risk than short-term bonds.

more

Low coupon bonds have more or less reinvestment rate risk?

more

With nonconventional cash flows, there is a possibility that more than one discount rate will make the NPV of an investment zero. This is called the _______ rates of return problem.

multiple

By ignoring time value, the payback period rule may incorrectly accept projects with a _______ (positive/negative) NPV.

negative

Bonds of similar risk (and maturity) will be priced to yield about the same return. Does the coupon rate matter?

no

If a given set of cash flows is expressed in _____ terms and discounted at the _______ rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the real rate. Listen to the complete question

nominal, nominal

When voting for the board of directors, the number of votes a shareholder is entitled to is usually _____ vote per share held.

one

A stock with dividend priority over common stock is called a ______ stock.

preferred

Net ______ value is a measure of how much value is created or added today by undertaking an investment.

present

Interest Rate Risk is also called

price risk

With ______ voting, the directors are elected one at a time and the only way to guarantee a seat is to own 50 percent plus one share.

straight

Investment firms that are active participants in stocks assigned to them are called _______ liquidity providers.

supplemental

Yield curve is the graphical representation of what?

term structure

IRR is based entirely on

the estimated cash flows and is independent of interest rates found elsewhere.

A government bond is also called a

treasury

Debentures

unsecured bonds

Common stock is a (fixed/variable) income security.

variable

Moody's Aa and S&P AA represent a capacity to pay that is ____ _____ and are considered what grade?

very strong, high-grade

Moody's C (and below) and S&P's C (and below) are? What grade are these considered?

- Income bonds with no interest being paid or in default with principal and interest in arrears. - Very low grade.

Corporate Bond

- Issued by corporations. - Higher risk than government bonds.

Which six factors determine the yield on a bond? - Liquidity - Default risk - Interest rate risk - Expected future inflation - Taxability - Voting rights - Real rate of return

- Liquidity - Default risk - Interest rate risk - Expected future inflation - Taxability - Real rate of return

Profitability Index Disadvantages

- May lead to incorrect decisions in comparisons of mutually exclusive investments

Discounted Payback Disadvantages

- May reject positive NPV investments - Requires an arbitrary cutoff point - Ignores cash flows beyond the cutoff point - Biased against long-term projects, such as R&D and new products

Factors that effect Bond Yields

- Real rate of interest. - Expected future inflation premium. - Interest rate risk premium. - Default risk premium. - Taxability premium. - Liquidity premium.

Mortgage Bonds

- Secured by real property, usually land or buildings.

Optional provisions in a bond indenture:

- Sinking fund - Call features

Junk Bonds

- Speculative or below-investment grade bonds. - Rated BB and below.

A bond indenture outlines:

- The basic terms of the bond(s). - The total amount of bonds issued. - A description of property used as security, if applicable. - Details of protective covenants.

If you buy a share of stock, you can receive cash in two ways:

- The company pays dividends. - You sell your shares, either to another investor in the market or back to the company.

Constant dividend growth

- The firm will increase the dividend by a constant percent every period. - The price is computed using the growing perpetuity model.

Constant dividend (zero growth)

- The firm will pay a constant dividend forever. - This is like preferred stock. - The price is computed using the perpetuity formula.

Three special case patterns of dividend growth include _____. - discounted growth - zero growth - fast growth - constant growth - negative growth - nonconstant growth

- zero growth - constant growth - nonconstant growth

You should take on projects with a PI >

1

Three MIRR Approaches

1. Discounting approach - discount all negative cash flow to t=0, add to initial cost and find IRR of these cash flows 2. Reinvestment approach - compound all future cash flows to t=n (last year of the project) and then find IRR of initial cost (PV) and the FV of all future cash flows calculated earlier 3. Combination approach - Discount all negative cash flows to the present (PV) - Compound all positive cash flows to the future (FV) - Find the IRR of these 2 cash flows.

Suppose: Dividends grow at a high growth rate for a few years and then will grow at a constant rate thereafter. In this scenario, how would you determine the stock price?

1. Find future cash flows during nonconstant growth period 2. Use constant growth formula to determine the value of the stock in the year dividend growth slows to a normal level (this is a future cash flow, stock price at this point in time) 3. Use TVM to find the value of all future dividends as well as the future stock price (computed in step 2). Discount at appropriate discount rate (do not use a growth rate)

Capital Budgeting Decision Rules

1. Net Present Value 2. The Payback Rule 3. The Discounted Payback 4. The Profitability Index 5. The Internal Rate of Return

Difficulties in valuing stocks:

1. cash flows are not explicit. 2. life is forever. 3. market rate is not easily observed.

Which of the following entities declares a dividend? A) The CFO B) The board of directors C) The management of the company D) Existing shareholders

B) The board of directors

Convertible Bond

A bond that can be swapped for a fixed number of shares of stock anytime before maturity at the holder's option.

Bond

A contract between two parties: one is the investor and the other is a company or a government agency.

A bond pays annual interest payments of $50, has a par value of $1,000, and a market price of $1,200. How is the coupon rate computed? A) $50/$1,000 B) $50/($1,200 - 1,000) C) $50/[($1,000 + 1,200)/2] D) $50/$1,200

A) $50/$1,000

Which one of these correctly specifies the relationship between the nominal rate and the real rate? A) (1 + R) = (1 + r) × (1 + h) B) (1 + h) = (1 + R) × (1 + r) C) (1 + r) = (1 + R) × (1 + h) D) R = r + h

A) (1 + R) = (1 + r) × (1 + h)

Which of the following are expected cash flows to investors in stocks? Select all that apply: A) Dividends B) Capital gains C) Interest D) Fees

A) Dividends B) Capital gains

What are some reasons why the bond market is so big? Select all that apply: A) Federal government borrowing activity in the bond market is enormous. B) Various state and local governments also participate in the bond market. C) Corporations are required to raise more money from bonds than from stocks. D) Many corporations have multiple bond issues outstanding.

A) Federal government borrowing activity in the bond market is enormous. B) Various state and local governments also participate in the bond market. D) Many corporations have multiple bond issues outstanding.

Which of the following are features of common stock? Select all that apply: A) It has no special preference in receiving dividends. B) It generally has voting rights. C) It receives interest semi-annually. D) It receives dividends every quarter. E) It has no special preference in bankruptcy.

A) It has no special preference in receiving dividends. B) It generally has voting rights. E) It has no special preference in bankruptcy.

If a project has multiple internal rates of return, which of the following methods should be used? Select all that apply: A) MIRR B) IRR C) NPV

A) MIRR C) NPV

Which one of the following is the most important source of risk from owning bonds? A) Market interest rate fluctuations B) Mergers C) Loss of a bond certificate D) Coupon interest rate fluctuations

A) Market interest rate fluctuations

What are the cash flows involved in the purchase of a 5-year zero coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent. A) Pay $800 today and receive $1,000 at the end of 5 years B) Pay $800 today and receive $1,250 at the end of five years C) Pay $800 today, receive $50 every year for 5 years, and receive $1,000 at the end of 5 years D) Pay $800 today and receive $800 plus $250 at the end of 5 years

A) Pay $800 today and receive $1,000 at the end of 5 years

What are three important features of Treasury notes and bonds? A) Taxable B) Highly liquid C) Default-free D) Tax-free

A) Taxable B) Highly liquid C) Default-free

What are the advantages of the payback period method for management? Select all that apply: A) The payback period method is ideal for short projects. B) It allows lower level managers to make small decisions effectively. C) The payback period adjusts for the discount rate. D) The payback period method is easy to use.

A) The payback period method is ideal for short projects. B) It allows lower level managers to make small decisions effectively. D) The payback period method is easy to use.

What does the clean price for a bond represent? A) The quoted price, which excludes interest accrued since the last coupon date. B) The quoted price plus interest accrued since the last coupon date. C) The original issue price plus interest accrued since the last coupon date. D) The original issue price

A) The quoted price, which excludes interest accrued since the last coupon date.

Which of the following are usually included in a bond's indenture? Select all that apply: A) The total amount of bonds issued B) The repayment arrangements C) The bond's rating D) The names of the bondholders

A) The total amount of bonds issued B) The repayment arrangements

Why does a bond's value fluctuate over time? A) A bond's value does not fluctuate over time B) The coupon rate and par value are fixed, while market interest rates change C) The coupon rate varies, while market interest rates are fixed D) A bond's par value changes over time

B) The coupon rate and par value are fixed, while market interest rates change

Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds? Select all that apply: A) Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. B) Treasury bonds are issued by the US government while corporate bonds are issued by corporations. C) Treasury bonds do not offer any tax benefits to investors but corporate bonds do. D) Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer.

A) Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. B) Treasury bonds are issued by the US government while corporate bonds are issued by corporations. D) Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer.

How is investing in U.S. Treasury bonds different from investing in corporate bonds? Select all that apply: A) Treasury issues have no default risk. B) U.S. Treasury bonds have longer maturities than corporate bonds. C) Interest from U.S. Treasuries is exempt from all taxation while corporate bond interest is taxable at all levels. D) Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not.

A) Treasury issues have no default risk. D) Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not.

Someone who maintains an inventory of stocks and buys and sells those stocks is known as a ____. A) dealer B) retailer C) speculator C) broker

A) dealer

The assumption of constant growth infers that _________. A) dividends change at a constant rate B) the real interest rate remains constant C) stock prices remain constant

A) dividends change at a constant rate - The constant-growth model infers that dividends grow at a constant rate.

The profitability index is calculated by dividing the PV of the _________ cash flows by the initial investment. A) future B) positive C) previous

A) future

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. A) real B) inflation C) nominal D) cross

A) real

The trading of existing shares occurs in the ______ market. A) secondary B) primary C) tertiary D) federal

A) secondary

The NYSE member who acts as a dealer in a small number of securities is called a(n) _____. A) specialist B) floor trader C) member D) floor broker

A) specialist

The goal of many successful organizations is a(n) ______ rate of growth in dividends. A) steady B) zero C) erratic D) negative

A) steady

Most of the time, a floating-rate bond's coupon adjusts ____. A) with a lag to some base rate B) with a lead to some base rate C) dramatically D) on a continual basis

A) with a lag to some base rate

The IRR is the discount rate that makes the NPV of a project equal to ______. A) zero B) the terminal book value of the project's fixed assets C) the payback period D) the project's initial cost

A) zero

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: A) zero B) positive C) negative

A) zero - The internal rate of return is the rate that makes NPV = 0. Because Capital's IRR is equal to its required rate, the NPV must be zero.

Decision Rule for payback period method

Accept if the payback period is less than some preset limit.

Decision Rule for a discounted payback period

Accept the project if it pays back on a discounted basis within the specified time.

Put Bond

Allows the holder to force the issuer to buy back the bond at a stated price.

Catastophe (CAT) Bonds

Allows the issuer to receive funding from the bond only if specific conditions, such as an earthquake or tornado, occur. If an event protected by the bond activates a payout to the insurance company, the obligation to pay interest and repay the principal is either deferred or completely forgiven.

Claim on Income

As a shareholder you have a right to any earnings of the company after all other obligations are met.

Claim on Assets

As a shareholder you have residual claim to a firm's assets in a case of liquidation.

NASDAQ has which of these features? Select all that apply: A) Single DMM system B) Computer network of securities dealers C) Multiple market maker system D) Physical trading floor

B) Computer network of securities dealers C) Multiple market maker system

What is the equation to find a bond's current yield? A) Current yield = Annual coupon/Par value B) Current yield = Annual coupon payment/Current price C) Current yield = Current price/Face value D) Current yield = Annual coupon/Face value

B) Current yield = Annual coupon payment/Current price

What information do we need to determine the value of stock using the zero-growth model? Select all that apply: A) Capital gain amount B) Discount rate C) Annual dividend amount D) Future stock price

B) Discount rate C) Annual dividend amount

As a general rule, which of the following are true of debt and equity? Select all that apply: A) Debt and equity represent the same financial claims B) Equity represents an ownership interest C) Creditors generally have voting power D) The maximum reward for owning debt is fixed

B) Equity represents an ownership interest D) The maximum reward for owning debt is fixed

A benchmark PE ratio can be determined using: Select all that apply: A) the constant-growth model B) a company's own historical PEs C) Bank of Canada estimates D) the PEs of similar companies

B) a company's own historical PEs D) the PEs of similar companies

The main reason it is important to distinguish between debt and equity is that the benefits and risks _____. A) are similar B) are different C) never change

B) are different

A person who brings buyers and sellers together is called a(n) ______. A) lawyer B) broker C) dealer D) investor

B) broker

Capital ______ is the decision-making process for accepting and rejecting projects. A) structure B) budgeting C) spending D) relevance

B) budgeting

A zero-growth model for stock valuation is distinguished by a ____. A) zero stock price at Year 0 B) constant dividend amount C) constant discount rate D) negative dividend growth rate

B) constant dividend amount - A zero-growth model for stock valuation is distinguished by a constant (no growth) dividend amount.

The three attributes of NPV are that it: Select all that apply: A) doesn't rely on a discount rate. B) discounts the cash flows properly. C) uses cash flows. D) uses all the cash flows of a project.

B) discounts the cash flows properly. C) uses cash flows. D) uses all the cash flows of a project.

Preferred stock has preference over common stock in the _____. Select all that apply: A) number of votes given B) distribution of corporate assets C) portfolios of individual investors D) payment of dividends

B) distribution of corporate assets D) payment of dividends

The basic NPV investment rule is: Select all that apply: A) accept a project if the discount rate is above zero. B) if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference C) accept a project if the NPV is greater than zero. D) accept a project if the NPV is less than zero. E) reject a project if its NPV is less than zero.

B) if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference C) accept a project if the NPV is greater than zero. E) reject a project if its NPV is less than zero.

The payback period can lead to incorrect decisions if it is used too literally because it ____. A) ignores the initial cost B) ignores cash flows after the cutoff date C) uses an arbitrary discount rate D) includes all the cash flows for every project

B) ignores cash flows after the cutoff date

The federal government can raise money from financial markets to finance its deficits by ___. A) raising taxes B) issuing bonds C) requesting foreign aid D) issuing stocks

B) issuing bonds

For a project with conventional cash flows, the NPV is ______ if the required return is less than the IRR, and it is ______ if the required return is greater than the IRR. A) negative, positive B) positive, negative C) positive, positive D) negative, negative

B) positive, negative - For a project with conventional cash flows, the NPV is positive if the required return is less than the IRR, and it is negative if the required return is greater than the IRR.

Mota Motors has eight directors on its board, two of whom go up for election each year. This is an example of a: A) managed board B) staggered board C) voting rights board D) proxy board

B) staggered board

When the stock being valued does not pay dividends, A) the dividend growth model can not be used. B) the dividend growth model can still be used.

B) the dividend growth model can still be used. - The analyst must assume that, at some point in the company's future, it begins paying dividends. (Though this assumption can be considered far-fetched, the process is still valid if the assumption is made. Therefore, the model can be used and the answer is "true.")

If you own corporate bonds, you will be concerned about interest rate risk as it affects ____. A) the time to maturity B) the market price of the bonds C) coupon rates D) the par value of the bonds

B) the market price of the bonds

Eurobonds

Bonds denominated in one country's currency but sold to residents of other countries. (borrowing overseas)

Dividends received by corporations have a minimum __ exclusion from taxable income. A) 30% B) 50% C) 70% D) There are no exclusions from taxable income for corporations.

C) 70%

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 interests? A) Minority voting B) Straight voting C) Cumulative voting

C) Cumulative voting - Under cumulative voting, Bob would have 20 X 5 = 100 votes to cast. He could cast all 100 shares for a candidate of his choice, assuring the candidate of a seat on the board. Vikki would have a total of 30 X 5 = 150 shares, and there is no way to distribute her shares over five candidates such that each had more than 100 votes.

Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period? A) Modified internal rate of return B) Average accounting return C) Discounted payback period D) Payback period

C) Discounted payback period

Which one of the following is true about dividend growth patterns? A) Dividends always grow at a constant rate. B) Dividends never grow. C) Dividends may grow at a constant rate. D) Dividends always grow at a differential rate.

C) Dividends may grow at a constant rate.

Which of the following occurs in the primary market? A) Issuers repurchase shares B) Outstanding shares are resold C) Newly-issued stocks are initially sold D) Shareholders gift shares to charities

C) Newly-issued stocks are initially sold

The present value of all cash flows (after the initial investment) is divided by the ______ to calculate the profitability index. A) internal rate of return B) discount rate C) net present value D) initial investment

D) initial investment

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? A) Corporations always have one board member designated to protect the interests of minority shareholders. B) Each minority shareholder would have one preferred board member. C) No minority shareholder would have enough votes to win any seat on the board. D) Minority shareholders don't vote in such an arrangement.

C) No minority shareholder would have enough votes to win any seat on the board.

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively. A) Net present value B) Average accounting return C) Payback method D) Internal rate of return

C) Payback method

Which of the following are mutually exclusive investments? Select all that apply: A) A restaurant or a gas station on opposite corners. B) Two computer systems - one for the administrative office and one for the security cameras. C) Two different choices for the assembly lines that will make the same product. D) A restaurant or a gas station on the same piece of land.

C) Two different choices for the assembly lines that will make the same product. D) A restaurant or a gas station on the same piece of land.

The internal rate of return is a function of ____. A) the cost of debt incurred by a project B) the market interest rate C) a project's cash flows D) a project's opportunity costs

C) a project's cash flows

A project should be __________ if its NPV is greater than zero. A) delayed B) rejected C) accepted

C) accepted

Secondary markets in sukuk are extremely illiquid because most sukuk are: A) legally suspect B) subject to religious interpretation C) bought and held to maturity D) riskier than other bond issues

C) bought and held to maturity

The IRR rule can lead to bad decisions when _____ or _____. Select all that apply: A) NPV is positive B) payback period is less than two years. C) cash flows are not conventional D) projects are mutually exclusive

C) cash flows are not conventional D) projects are mutually exclusive

A bond with exotic features is often called a _____ bond. A) angel B) bird C) cat D) dog

C) cat

Stock price reporting has increasingly moved from traditional print media to the ______ in recent years. A) radio B) ticker tape machine C) internet D) network newscasts

C) internet

A zero coupon bond is a bond that ____. A) produces no taxable income B) is sold at a premium C) makes no interest payments D) has no market value

C) makes no interest payments

In capital budgeting, the net ______ determines the value of a project to the company. A) sales B) future value C) present value D) income

C) present value - Net present value is the value a project will add to a company today.

The Fisher effect decomposes the nominal rate into: A) the inflation rate and the yield to maturity B) the real rate and the yield to maturity C) the inflation rate and the real rate

C) the inflation rate and the real rate

Benefit of MIRR over IRR

Can produce a single number with specific rates for borrowing and reinvestment.

_______ budgeting is the decision-making process for accepting and rejecting projects.

Capital

T-Bond

Coupon debt with original maturity greater than ten years.

Sukuk Bonds

Created to meet a demand for assets that comply with Shariah, or Islamic law.

Which of the following is not a difference between debt and equity? A) Unlike dividend omissions to equity holders, unpaid debt obligations can lead to bankruptcy B) Equity represents ownership interest while debt does not C) A corporation's interest payments on debt are tax deductible, but the dividends it pays to equity holders are not D) Equity is publicly traded while debt is not

D) Equity is publicly traded while debt is not

Preferred stock are usually sold for ___ per share: A) $25 B) $50 C) $100 D) It is typically any of the above amounts

D) It is typically any of the above amounts

The formula for valuing a constant growth stock is _____. Multiple choice question. A) P = D1/(R − g)2 B) P = D1 − g/R C) R = P − D1/g D) P0 = D1/(R − g)

D) P0 = D1/(R − g)

Which of the following is an example of an opportunity cost? A) Money spent on advertising to take advantage of opportunities in the market B) Lowering taxes by increasing depreciation expenses C) Sales revenue lost due to new competitors entering the market D) Rental income likely to be lost by using a vacant building for an upcoming project

D) Rental income likely to be lost by using a vacant building for an upcoming project

Which is the largest security market in the world in terms of trading volume? A) The U.S. corporate bond market B) The U.S. derivatives market C) The U.S. stock market D) The U.S. Treasuries market

D) The U.S. Treasuries market

In general, a corporate bond's coupon rate ____, A) changes every year B) changes in sync with market interest rates C) decreases as a bond nears maturity D) is fixed until the bond matures

D) is fixed until the bond matures

A zero coupon bond is a bond that ____. A) produces no taxable income B) is sold at a premium C) has no market value D) makes no interest payments

D) makes no interest payments

When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows: A) one vote for every 100 shares held B) one vote per proxy C) one vote per shareholder D) one vote per share held

D) one vote per share held

Initial public offerings of stock occur in the ____ market. A) futures B) commodities C) secondary D) primary

D) primary

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. A) inflation B) cross C) nominal D) real

D) real

Opportunity costs are classified as: A) variable costs B) fixed costs C) irrelevant costs D) relevant costs

D) relevant costs

Modified Internal Rate of Return (MIRR)

Differentiates itself from IRR in that the reinvestment rate for the cash flows is determined by the evaluator. It is the interest rate that compares the future value of the cash flows with the cost of the project.

True or false: 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 - Cumulative voting means that each shareholder may distribute votes however he or she wishes. If there are four seats on the board and the shareholder owns 20 shares, he or she can cast 80 votes for one board member.

NPV and IRR will generally give us the same decision. What are the two exeptions?

Nonconventional cash flows - cash flow signs change more than once Mutually exclusive projects - Initial investments are substantially different (issue of scale) - Timing of cash flows is substantially different

How to find bond prices on Excel:

PRICE(Settlement,Maturity,Rate,Yld,Redemption, Frequency,Basis) YIELD(Settlement,Maturity,Rate,Pr,Redemption, Frequency,Basis) - Settlement and maturity need to be actual dates. - The redemption and Pr need to be input as % of par value.

PI =

PV of Inflows / PV of Outflows

Bond Value =

PV of coupons + PV of par OR PV of annuity + PV of lump sum

Using the payback period rule will bias toward accepting which type of investment? Short-term investment or Long-term investment

Short-term investment

Income Bond

Similar to conventional bonds, except that coupon payments depend on company income.

Preemptive Rights

Stockholders may share proportionally in an new stock issues.

Face (par) Value

The amount that will be repaid at the end of the loan.

Coupon Rate

The interest rate that a bond issuer will pay to a bondholder.

Bond Maturity

The number of years until the face value is paid.

Nominal Rate of Return

The quoted rate of interest that does not account for inflation.

Term Structure

The relationship between time to maturity and yields, all else equal.

Interest Rate Risk

The risk that arises for bond owners from fluctuating interest rates.

Indenture

The written agreement between the corporation and the lender detailing the terms of the debt issue.

Sukuk Bonds are typically bought and held to maturity, and are extremely illiquid. True or False?

True

True or False: Creditors do not have voting rights.

True

True or False: Dividends are not a liability of the firm, and stockholders have no legal recourse if dividends are not paid.

True

True or False: Dividends are not considered a cost of doing business and are not tax deductible.

True

True or False: Excess debt can lead to financial distress and bankruptcy.

True

True or False: In regards to debt, Interest is considered a cost of doing business and is tax deductible.

True

True or False: Some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.

True

True or False: When purchasing equity in a company, you have an ownership interest.

True

True or false: Equity represents an ownership interest.

True

True or false: Interest earned on Treasury notes and bonds is taxable

True

True or false: The major difference between Western financial practices and Islamic law is that Islamic law does not permit charging or paying interest.

True

Subordinated debentures

Unsecured "junior" debt.

Intrinsic Value

V0 , the present value of a firm's expected future net cash flows discounted by the required rate of return.

As with bonds, the price of the stock is the present value of these expected ____ _____.

cash flows

Net present value is the difference between the market value of a project and its ___.

cost

The _______ rate depends on the risk characteristics of the bond when issued.

coupon

The ______ rate is the rate at which the NPVs of two projects are equal.

crossover

The _____ yield is the bond's annual coupon divided by its price.

current

As interest rates increase, bond prices (increase/decrease)?

decrease

As interest rates increase, present values (increase/decrease)?

decrease

Reinvestment risk can happen when a decline in interest rates (increase/decrease) the return earned on coupons that are reinvested in the future.

decrease

Zero bonds are also called

deep discount bonds or original issue discount bonds (OIDs)

An NYSE member who acts as a dealer in particular stocks is called a _______ market maker.

designated

A ______ is a payment by a corporation to shareholders, made in either cash or stock.

dividend

Common stock has no special preference either in receiving ______ or in bankruptcy.

dividends

If YTM = coupon rate, then par value (equals/does not equal) bond price.

equals

A situation in which taking one investment prevents the taking of another is called a mutually ______ investment decision.

exclusive

Moody's Aaa and S&P AAA represent a capacity to pay that is _________ _____ and are considered what grade?

extremely strong, high-grade

A treasury is debt issued by the

federal government

Hybrid securities are like debt as preferred dividends are _____.

fixed

With _______-rate bonds, the coupon payments are adjustable.

floating

An NYSE member who executes customer buy and sell orders is called a ______ broker.

floor

If YTM is greater than coupon rate, then par value is (greater than/not greater than) bond price.

greater than

Accept the project if the IRR is?

greater than the required return

Junk bonds are also called

high-yield bonds.

The taxation of dividends received by individuals depends on the ______ period.

holding

Decline in bond price can happen when interest rates (increase/decrease)

increase

The written agreement between the corporation and the lender detailing the terms of the debt issue is the ______.

indenture

The ______ premium is the portion of a nominal interest rate that represents compensation for expected future _______.

inflation, inflation

The Fisher Effect defines the relationship between?

real rates, nominal rates and inflation.

The payback period method allows lower management to make ______ (smaller/larger), everyday financial decisions effectively.

smaller

In a ______ board, only a fraction of the directorships are up for election at any one time.

staggered

Treasury bills and principle-only treasury strips or examples of

zeros

Computing a discounted payback period

• Compute the present value of each cash flow and then determine how long it takes to pay back on a discounted basis. • Compare to a specified required period. • Discounted payback period - length of time until the present value of the accumulated cash flows equal the original investment.

Net Present Value Advantages

• Considers all of the cash flows in the computation • Uses the time value of money • Provides the answer in dollar terms, which is easy to understand • Usually provides a similar answer to the IRR computation

Internal Rate of Return Advantages

• Considers all of the cash flows in the project • Uses time value of money • Knowing a return is intuitively appealing • If the IRR is high enough, you may not need to estimate a required return, which is often a difficult task • Usually provides a similar answer to the NPV computation

Net Present Value Disadvantages

• Requires the use of the time value of money, thus a bit more difficult to compute • Projects that differ by orders of magnitude in cost are not obvious in the NPV final figure

Internal Rate of Return Disadvantages

• Uses the firm's required rate of return for comparison purposes. • Unusually high numbers can often occur when a significant amount of the project's cash flows occur early in the life of the project. • May result in multiple answers (nonconventional cash flows) • May lead to incorrect decisions in comparisons of mutually exclusive investments