Finance Exam 3

Bonds generally have a maturity date while preferred stocks do not.

True

If a bond has a market value that is higher than its par value, then the required return on the bond must be less than the bond's coupon rate.

True

The par value of a corporate bond indicates the payment that the issuer promises to make to the bondholder at maturity.

True

Total risk equals systematic risk plus unsystematic risk.

True

A mortgage bond is secured by a lien on real property.

True

An example of a Eurobond is a bond issued in Asia by a U.S. Corporation with interest and principal payments made in U.S. dollars.

True

Beta is a measurement of the relationship between a security's returns and the general market's returns.

True

The benefits of diversification occur as long as the investments in a portfolio are not perfectly positively correlated.

True

The realized rate of return, or holding period return, is equal to the holding period dollar gain divided by the price at the beginning of the period.

True

Variation in the rate of return of an investment is a measure of the riskiness of that investment

True

Stock A has the following returns for various states of the economy: State of the Economy Probability Stock A's Return Recession 10% -30% Below Average 20% -2% Average 40% 10% Above Average 20% 18% Boom 10% 40% Estimate Stock A's standard deviation of returns . Hint: First Calculate the Expected Return then calculate the standard deviation. A) 10%. B) 14%. C) 17%. D) 20%

(-.3-.082)^2(.2)+(-.02-.082)^2(.2)+(.1-.082)^2(.4)... Square answer to get standard dev

Stock A has the following returns for various states of the economy: Stock A's expected return is State of the Economy Probability Stock A's Return Recession 10% -30% Below Average 20% -2% Average 40% 10% Above Average 20% 18% Boom 10% 40% A)5.4%. B) 7.2%. C) 8.2%. D) 9.6%

(.1x-.3)+(.2x-.02)+(.4x.1) ... .082

Wildings, Inc. common stock has a beta of 1.2. If the risk-free return is 4% and the market risk premium is 9%, what is the required return on Wildings' stock? A) 10.0% B) 12.0% C) 13.8% D) 14.8%

.04 + (.90)(1.2)

Assume that you have $165,000 invested in a stock whose beta is 1.25, $85,000 invested in a stock whose beta is 2.35, and $235,000 invested in a stock whose beta is 1.11. What is the beta of your portfolio? A) 1.37 B) 2.01 C) 1.85 D) 1.57

165000/ (Sum of Inv) 85000/ (Sum of Inv) 235000/ (Sum of Inv) (.34x1.25)+(.175x2.35)+(.485x1.11) = 1.37

Which of the following is true of a zero coupon bond? A) The bond makes no coupon payments. B) The bond sells at a premium prior to maturity. C) The bond has a zero par value. D) The bond has no value until the year it matures because there are no positive cash flows.

A) The bond makes no coupon payments.

ND Electric Company issues $1000 bonds that have an annual coupon rate of 6.5%. The present market value of the bonds is $1,225. If the bonds have 17 years remaining until maturity, what is the current yield on ND Electric Company?

A: Current yield = Annual interest x (Coupon payment) / Price

Valley Manufacturing Inc. just issued $1000 par 20-year bond. The bonds sold for $758.18 and pay interest semiannually. Investors require a rate of 9% on the bonds. What is the bonds' coupon rate?

A: Step 1: FV = $1000 N = 20 x 2 = 40 periods PV = -758.18 I/Y = 9% / 2 = 4.5% CPT, PMT = $31.85 Step 2: (Interest Payment) = 31.85 = 1000 x CR / 2 6

Which of the following statements concerning junk bonds is MOST correct? A) A rational investor will always prefer a AAA-rated bond to a junk bond. B) Junk bonds have higher interest rates than AAA-rated bonds because of the higher risk. C) Junk bonds may also be called low-yielding securities. D) Junk bonds are priced higher than AAA-rated bonds because junk bonds are more risky.

B) Junk bonds have higher interest rates than AAA-rated bonds because of the higher risk.

The capital asset pricing model A) provides a risk-return trade- off in which risk is measured in terms of the market volatility. B) provides a risk-return trade- off in which risk is measured in terms of beta. C) measures risk as the coefficient of variation between security and market rates of return. D) depicts the total risk of a security.

B) provides a risk-return trade- off in which risk is measured in terms of beta.

PBJ Corporation issued on January 1, 2006. The bonds had a coupon rate of 5.5% with interest paid semiannually. The face value of the bonds is $1000 and the bonds mature on January 1, 2021. What is the yield to maturity for a PBJ Corp bond on January 1, 2012 if the market price of the bond on that date is $950?

B: Coupon PMT = 1000 X 5.5 / 2 = 27.5 FV = 1000 PV = -950 N = 9 x 2 = 18 CPT, 1/Y = 3.12 x 2 = 6.23

The Johnson Corporation issues a bond which has a coupn rate of 10.20%, a yield to maturity of 10.55%, a face value of $1000, and a market price of $850. Therefore, the annual interest payment is

B: Periodic Coupon Payment = Par Value x Coupon rate/ m 1000 x 10.02%

A bond will sell at a premium (above par value) if A: the mrkt value of the bond is greater than the discount rate of the bond B: Investor's current required rate of return is below the coupon rate of the bond C: current mrkt interest rates are moving in the same direction as the bond values D: the economy is in a recession

B: Premium bond: PV (Current selling price) > Par value True when: YTM (1/Y) < Coupon rate (CR)

If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, which would have the highest yield to maturity, everything else equal? A) the debenture B) the mortgage bond C) the subordinated debenture D) all of the above

C) the subordinated debenture

A corporate bond has a coupon rate of 9%, a face value of $1000, a market price of $850, and the bond matures in 15 years. Therefore, the bonds yield to maturity is?

C. 11.1% To get PMT: 1000 x 9% = 90 FV = 1000 N = 15 I/Y = ? PMT = 90 PV = -850

Which of the following affect an asset's value to an investor? I)Amount of an asset's expected cash flow, II)The riskiness of the cash flows ,III)Timing of an asset's cash flows , IV)Investor's required rate of return A) I, II, III B) I, III, IV C) I, II, IV D) I, II, III, IV

D) I, II, III, IV

Which of the following measures the average relationship between a stock's returns and the market's returns? A) coefficient of validation B) standard deviation C) geometric regression D) beta coefficient

D) beta coefficient

Beta is a statistical measure of A) unsystematic risk. B) total risk. C) the standard deviation. D) the relationship between an investment's returns and the market return.

D) the relationship between an investment's returns and the market return.

Bart's Moving Company bonds have a 11% coupon rate. Interest is paid semiannually. The bonds have a par value of $1000 and will mature 8 years from now. Compute the value of Bart's Moving Company bonds if investors required rate of return is 9.5%

D. $1082.75 To get PMT: 11% x 1000 / 2 = 55 N = 8 x 2 = 16 I/Y = 9.5% / 2 = 4.75 PV = ? PMT = 55 FV = 1000

You are considering investing in Ford Motor Company. Which of the following are examples of diversifiable risk? I. Risk resulting from possibility of a stock market crash. II. Risk resulting from uncertainty regarding a possible strike against Ford. III. Risk resulting from an expensive recall of a Ford product. IV. Risk resulting from interest rates decreasing. A) I only B) I and IV C) I, II, III, IV D) II, III

D. II, III

A bond rating of "BB" indicates that the company's financial position is above average and hence the default risk on the bonds is very low.

False

Adding stocks to a bond portfolio will increase the riskiness of the portfolio because stocks have higher standard deviations of returns than bonds.

False

Because risk is measured by variability of returns, how long we hold our investments does not matter very much when it comes to reducing risk.

False

In the case of insolvency, the claims of debt are honored prior to those of common stock and after those of preferred stock.

False

If a bond is selling below its face value, then its yield to maturity must be less than the bond's coupon rate

False: Current selling price (PV) < Par value its a discount bond

If you hold a portfolio made up of the following stocks: Investment Value Beta Stock X $4,000 1.5 Stock Y $5,000 1.0 Stock Z $1,000 0.5 What is the beta of the portfolio? A) 1.33 B) 1.24 C) 1.15 D) 1.00

Find weight of each 4000/ (4000+5000+1000) = .4 5000/ (4000+5000+1000) = .5 1000/ (4000+5000+1000) = .1 Calculate Portfolio (.4x1.5)+(.5x1)+(.1x.5) = 1.15

What is the value of a bond that matures in 17 years, makes an annual coupon payment of $50, and has a par value of $1000. Assume a required rate of return of 5.90%?

PV = ? FV = 1000 N = 17 I/Y = 5.9% PMT = 50

The prices for the National Gasworks Corporation for the second quarter of 2012 are given below. The price of the stock on April 1, 2012 was $130. Find the holding period return for an investor who purchased the stock on April 1, 2012 and sold it the last day of June 2012. Month End Price April $125 May 138.5 June 132.75 A)-4.2% B)-3.7% C) 2.1% D) 3.7%

Price @ end of period + Dividend - Price @ beginning / Price at beginning 132.75 + 0 - 130/ 130 = .021

The rate on T-bills is currently 2%. Environment Help Company stock has a beta of 1.5 and a required rate of return of 17%. According to CAPM, determine the return on the market portfolio. A) 27.5% B) 19.0% C) 14.0% D) 12.0%

RROR= Risk free rate + (Rm - .02)(1.5) .17=.02+(Rm-.02)(1.5) .17-.02=1.5Rm-.03 .15+.03=1.5Rm .18/1.5 = .12

Assume that an investment is forecasted to produce the following returns: a 20% probability of a 12% return; a 50% probability of a 16% return; and a 30% probability of a 19% return. What is the standard deviation of return for this investment? A) 5.89% B) 16.1% C) 2.43% D) 15.7%

Step 1: Get expected return (Probability x return) Step 2: Estimate variance (Return x expected return total)^2 (Probability)

Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities.

True

Convertible bonds are debt securities that can be converted into a firm's stock at a specified price.

True

Diversifying among different kinds of assets is called asset allocation.

True

Restrictive provisions in bond indentures agreements are designed to protect bondholders and lessen the agency problem between bondholders and stockholders

True

The CAPM designates the risk-return trade-off existing in the market, where risk is defined in terms of beta.

True

The T-bill return is used in the CAPM model as the risk-free rate.

True

Subordinated debentures are more risky than unsubordinated debentures because the claims of subordinate debenture holders are less likely to be honored in the event of liquidation

True: Bondholders enjoy seniority in claims on assets and income of a corporation over its shareholders

To determine the periodic interest payments (or coupon payments) that a bond makes, multiply the bond's stated coupon rate by its par value and divide by the number of coupon payments per year

True: periodic coupon payments (or interest payment) = Par value x Coupon rate/ m