401 Final Exam

If the present value of $250 expected one year from today is $200, what is the one-year discount rate?

1 + r = 250/200 = 1.25; r = 25%.

If the abnormal return for a stock during the first week is +5 percent and +3 percent during the second week, what is the abnormal return for the two-week period?

Abnormal return = (1.05)(1.03) − 1 = 8.15%.

Analysis of 60 monthly rates of return on United Futon common stock indicates a beta of 1.50 and an alpha of -0.25% per month. A month later, the market is up by 5.5%, and United Futon is up by 6.5%. What is Futon's abnormal rate of return?

Abnormal stock return = Actual stock return - Expected stock return Abnormal stock return = Actual stock return - (α + β × Return on market index) Abnormal stock return = 0.065 - (-0.0025 + 1.50 × 0.055) Abnormal stock return = -0.015, or -1.50%

Analysis of 60 monthly rates of return on United Futon common stock indicates a beta of 1.45 and an alpha of −0.2% per month. A month later, the market is up by 5%, and United Futon is up by 6%. What is Futon's abnormal rate of return?

Abnormal stock return = Actual stock return − Expected stock return Abnormal stock return = Actual stock return − (α + β × Return on market index) Abnormal stock return = 0.06 − (−0.002 + 1.45 × 0.05) Abnormal stock return = −0.0105, or −1.05%

Insurance companies face the following problem(s):

Administrative costs, Adverse selection and moral hazard

A business plan generally contains a description of I) the proposed products; II) the potential market; III) the underlying technology; IV) resources needed

All of these

Firms regularly use the following to reduce risk: I) currency options II) interest-rate options III) commodity options

All of these

The following are advantages of shelf registration I) securities can be issued in dribs and drabs without incurring excessive transaction costs; II) securities can be issued on short notice; III) security issues can be timed to take advantage of market conditions

All of these

The following are sensible reasons for a firm to engage in hedge transactions: I) to reduce the risk of financial distress; II) to reduce the fluctuations in its income; III) to mitigate agency costs

All of these

How much will you have at the end of 19 years if you invest $190 today at 11% annually compounded?

Annual compounding: Ct = PV × (1 + r)t C19 = $190 × 1.1119 C19 = $1,380.04

A four-year bond has an 8 percent coupon rate and a face value of $1,000. If the current price of the bond is $878.31, calculate the yield to maturity of the bond (assuming annual interest payments).

Use trial and error method: (80/1.12) + (80/(1.12^2)) + (80/(1.12^3)) + (1080/(1.12^4)) = $870.51. Therefore, yield to maturity is 12 percent. Or use a financial calculator: PV = -878.31; N = 4; PMT = 80; FV = 1,000. Compute I = 12%. Financial calculator affords the most precise answer

A firm owns a building with a book value of $150,000 and a market value of $250,000. If the firm uses the building for a project, then its opportunity cost, ignoring taxes, is

$250,000

Two bonds have the same maturity, risk rating, and face value, but have different coupon rates. The bond with a lower coupon rate will have a longer duration. t/F

True

The type of the risk that can be eliminated by diversification is called

Unique risk

The dividend yield reported on finance.yahoo.com is calculated as follows:

(dividend/closing stock price).

Proper treatment of inflation in NPV calculations involves

discounting nominal cash flows by the nominal discount rate and discounting real cash flows by the real discount rate

A conglomerate is a firm that

diversifies across several unrelated businesses

The opportunity cost of capital for a risky project is:

the expected rate of return on a security of similar risk as the project.

Put-call parity can be used to show

the precise relationship between put and call option prices, given equal exercise prices and equal expiration dates.

When a firm hedges a risk, it

transfers the risk to someone else

Generally, initial public offerings (IPOs) are

under priced

The correlation coefficient measures the

degree to which the returns of two stocks move together.

According to the data, venture capital funds earn an average annual rate of return of about

17%

Spin-offs are not taxed if the shareholders of the parent company are given at least

80% of the shares in the new company

What are non-conventional cash flows?

A combination of cash outflows and inflows

Which type of situation best represents "gambling for redemption"?

A firm on the verge of bankruptcy invests all available funds in a high-risk, low-NPV project in order to attempt to save itself.

Which of the following entities likely has the highest cost of financial distress?

A pharmaceuticals development company

The underwriter accepts responsibility only to try to sell the issue.

Best Efforts

How much will you have if you invest at 11% continuously compounded?

Continuous compounding: Ct = PV × ert C19 = $190 × e0.11 × 19 C19 = $1,536.13

If you invest $105 at an interest rate of 10%, how much will you have at the end of five years?

Ct = PV × (1 + r)t C5 = $105 × 1.105 C5 = $169.10

You have invested $65,000 at 7%. After paying the above school fees, how much would remain at the end of the five years?

Ct = PV × (1 + r)t Ct = ($65,000 − 53,302.57) × 1.075 Ct = $16,406.26

Suppose the beta of Microsoft is 1.13, the risk-free rate is 3 percent, and the market risk premium is 8 percent. Calculate the expected return for Microsoft.

E(R) = 3 + 1.13(8) = 12.04%.

How would an increase in the interest rate effect the present value of an annuity problem (all other variables remain the same)?

Decrease the Present Value

How would a decrease in the interest rate effect the future value of a lump sum, single amount problem (all other variables remain the same)?

Decrease the future value

Weak-form efficiency implies that past stock returns

Do not help predict future returns

A 10-year bond is issued with a face value of $1,000, paying interest of $60 a year. If interest rates increase shortly after the bond is issued answer the following:What happens to the bond's coupon rate?

Does not change

You are given the following data for year 1: Revenues = 100; Fixed costs = 30; Total variable costs = 50; Depreciation = $10; Tax rate = 21 percent. Calculate the after-tax cash flow for the project for year 1.

EBT = (100 − 30 − 50 − 10) = 10. T = 10(0.21) = 2.10. CF1 = 10 − 2.1 + 10 = $17.9.

Company X has a P/E ratio of 10 and a stock price of $50 per share. Calculate earnings per share of the company.

EPS = 50/10 = $5

Universal Air is a no-growth firm and has two million shares outstanding. It expects to earn a constant $20 million per year on its assets. If it has no debt, all earnings are paid out as dividends, and the cost of capital is 10 percent, calculate the current price per share of the stock.

EPS = DPS = 20,000,000/2,000,000 = $10 per share; P0 = 10/0.10 = $100/share.

The act of buying or selling the underlying asset via the option contract is called _______________ the option.

Exercising

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 16 percent and a standard deviation of returns of 20 percent. The risk-free asset has an interest rate of 4 percent. Calculate the expected return on the resulting portfolio.

Expected return = 2(16) − (4) = 28%.

Informational efficiency in financial markets results in stock prices being

Fairer

A 10-year bond is issued with a face value of $1,000, paying interest of $60 a year. If interest rates increase shortly after the bond is issued answer the following: what happens to the bonds price

Falls

A European option may be exercised anytime up to and including the expiration date. t/F

False

An investor who wants to sell his stock immediately should enter a limit order. t/f

False

Electronic Communications Network refers to the automated ticker tape on the New York Stock Exchange. t/f

False

If interest rates rise, bond duration rise also. T/F

False

Longer-maturity bonds necessarily have longer duration T/F

False

Managers, shareholders, and the firm's debtholders have identical information about the value of the firm. T/F

False

The bid price is always greater than the ask price t/F

False

The duration of any bond is the same as its maturity T/F

False

The longer a bond's duration, the lower its volatility. (Volatility = modified duration.) T/F

False

The sale of shares by a large investor usually takes place in the primary market. t/f

False

The Solar Calculator Company proposes to invest $5 million in a new calculator-making plant. Fixed costs are $2 million per year. A solar calculator costs $5 per unit to manufacture and sells for $20 per unit. If the plant lasts for three years and the cost of capital is 12 percent, what is the break-even level (i.e., NPV = 0) of annual sales? (Assume that revenues and costs occur at the end of each year. Assume no taxes.) Round to the nearest 1,000 units.

First, find the annual cash flow that justifies a $5 million investment using the equivalent annual cost (EAC) method. The 3-year annuity factor @ 12% equals 2.40183127. EAC = 5,000,000/2.40183127 = 2,081,745 million. The plant must net this amount of cash flow each year. Given $2 million of annual fixed costs, let X = the annual sales rate: (X) (20 − 5) − 2,000,000 = 2,081,745; X = (4,081,745/15) = 272,117 units or about 272,000 units.

The Hammer Company proposes to invest $6 million in a new type of hammer-making equipment. The fixed costs are $0.5 million per year. The equipment will last for five years. The manufacturing cost per hammer is $1 and each hammer sells for $6. The cost of capital is 20 percent. Calculate the break-even (i.e., NPV = 0) sales volume per year. (Ignore taxes. Round to the nearest 1,000.)

First, find the annual cash flow that justifies a $6 million investment using the equivalent annual cost (EAC) method. The 5-year annuity factor @ 20 percent equals 2.9906. EAC = 6/2.9906 = 2 million. The equipment must net this amount of cash flow each year. Given $0.5 million of annual fixed costs, let X = the annual sales rate. X (6 − 1) − 500,000 = 2,000,000. X = 2,500,000/5 = 500,000 units.

A leasing contract calls for an immediate payment of $105,000 and nine subsequent $105,000 semiannual payments at six-month intervals. What is the PV of these payments if the annual discount rate is 8%?

First, find the semiannual rate that is equivalent to the annual rate: 1 + r = (1 + r / 2)2 1.08 = (1 + r / 2)2 r / 2 = 1.080.5 - 1 r = 0.039230, or 3.9230% PV = C0 + C × ((1 / r) - {1 / [r(1 + r)t]}) PV = $105,000 + $105,000 × ((1 / 0.039230) - {1 / [0.039230(1 + 0.039230)9]}) PV = $888,454.65

Which of the following statements about forwards, futures, and options is correct?

Forward contracts and futures contracts are economically similar, but vary greatly in how they are traded.

The variables in a present value of a lump sum problem include all of the following, except:

Free Cash Flow

In 2018, Beta Corporation earned gross profits of $710,000. a. Suppose that Beta was financed by a combination of common stock and $1.15 million of debt. The interest rate on the debt was 10%, and the corporate tax rate in 2018 was 21%. How much profit was available for common stockholders after payment of interest and corporate taxes?

Gross profits $ 710,000 Interest on debt (10% on $1.15 million) 115,000 Earnings before taxes $ 595,000 Tax (21%) 124,950 Funds available to common stockholders $ 470,050

In 2018, Beta Corporation earned gross profits of $710,000. Now suppose that instead of issuing debt, Beta was financed by a combination of common stock and $1.15 million of preferred stock. The dividend yield on the preferred was 8%, and the corporate tax rate was still 21%. Recalculate the profit available for common stockholders after payment of preferred dividends and corporate taxes

Gross profits $ 710,000 Tax (21%) 149,100 Net income $ 560,900 Preferred dividend (8% on $1.15 million) 92,000 Funds available to common stockholders $ 468,900

Who first developed portfolio theory?

Harry Markowitz

Which of the following is a statement of semistrong form efficiency? I) Stock prices will adjust immediately to public information. II) Stock prices reflect all information. III) Stock prices will adjust to newly published information after a long time delay.

I Only

All else equal, an increase in fixed costs I) increases the break-even point based on NPV; II) increases the accounting break-even point; III) decreases the break-even point based on NPV; IV) decreases the accounting break-even point

I and II only

If the efficient market hypothesis holds, investors should expect I) to receive a fair price for their security II) to earn a normal rate of return on their investments III) to be able to pick stocks that will outperform the market

I and II only

The United States is considered to have a market-based financial system because I) stock market capitalization, as a percentage of GDP, is relatively high; II) bank loans, as a percentage of GDP, are relatively low; III) the United States has thousands of banks and insurance companies

I and II only

Predictable cycles in stock price movements I) tend to persist for a long time; II) tend to self-destruct as soon as investors recognize them; III) never appear, since stock returns change randomly

II only

The capital structure of the firm can be defined as I) the firm's mix of different debt securities; II) the firm's mix of different securities used to finance assets; III) the market imperfection that the firm's managers can exploit

II only

The main advantage of debt financing for a firm is: I) no SEC registration is required for bond issues; II) interest expenses are tax deductible; III) unlevered firms have higher value than levered firms

II only

In the principal-agent framework, the ultimate principals are I) managers; II) board of directors; III) shareholders; IV) governments

III Only

Which of the following observations would provide evidence against the strong form of efficient market theory? I) Mutual fund managers do not on average make superior returns. II) In any year approximately 50% of all pension funds outperform the market. III) Managers who trade in their own firm's stocks make superior returns.

III only

one of the biggest challenges for the Net Present Value method is:

Identifying the appropriate discount rate to use

The $42 million lottery prize that you have just won actually pays out $3.0 million a year for 20 years. The interest rate is 12.0%. What is the present value if the first payment comes immediately?

If each cashflow arrives one year earlier, then you can simply compound the PV calculated in part a by (1 + r) → $22.41 million × (1.12) = $25.10 million

When a firm has the opportunity to add a project that will utilize excess factory capacity (that is currently not being used), which costs should be used to help determine if the added project should be undertaken?

Incremental Costs

The ultimate owners of a publicly traded corporation are

Individuals

For long-term U.S. government bonds, which risk concerns investors the most?

Interest rate risk

The study of behavioral finance has best helped explain which of the following investor behaviors?

Investors are generally too slow to update their beliefs in the face of new evidence

The largest and best documented LBO of the 1980s was

KKR acquiring RJR Nabisco

Which of the following are methods by which a company's structure can be modified?

LBOs, privatizations, spin-offs and carve-outs, and bankruptcies

What has been the average annual real rate of interest on Treasury bills over the past 117 years (from 1900 to 2017)?

Less than 2%

If a firm's management leads a leveraged buyout transaction, then the transaction is called a(an)

MBO

How does modified internal rate of return (MIRR) differ from IRR?

MIRR reduces the number of sign changes in a cash flow sequence.

In order to calculate the tax shields provided by debt, the tax rate used is the

Marginal corporate tax rate

Assume Boeing has about 10.3 billion shares outstanding and the stock price is $37.10. Also, assume the P/E ratio is about 18.3. Calculate the approximate market capitalization for GE.

Market capitalization = (10.3)(37.10) = $382.13 billion.

Which of the following is included in the Fama-French three-factor model?

Market factor, book-to-market factor, and size factor.

Normal and lognormal distributions are completely specified by their

Mean and Standard deviation

Which of the following is NOT an advantage to calculating and reporting economic depreciation?

Most firms can easily calculate economic depreciation.

All of the following are commonly cited reasons for using the Internal Rate of Return, except:

Multiple IRR allow the company to choose the best one when evaluating projects

What is the present value of $1,000 to be received in 12 years invested at a rate of 8%?

N = 12 I/YR = 8 PMT = $0 FV = $1,000 PV = ??? = $397

What is the future value of $1,000 invested for 15 years at a rate of 5%?

N = 15 I/YR = 5 PV = $1,000 PMT = $0 FV = ??? = $2,079

After completing a project analysis, an analyst should rely on which tool to make a final recommendation on the project?

NPV

A small business received a five-year $1,000,000 loan at a subsidized rate of 3 percent per year. The firm will pay 3 percent annual interest payment each year and the principal at the end of five years. If market interest rates on similar loans are 6 percent per year, what is the NPV of the loan? (Ignore taxes.)

NPV = +1,000,000 − [((30,000/1.06) + ... + (30,000/(1.065)) + (1,000,000/(1.065))] = 126,371.

An investment costs $1,668 and pays $230 in perpetuity. If the interest rate is 14%, what is the NPV?

NPV = C / r − investment NPV = $230 / 0.14 − $1,668 NPV = −$25.14

The combination approach for calculating the Modified Internal Rate of Return (MIRR) differs because:

Negative cash flows are discounted back and positive cash flows are compounded forward.

Suppose that you buy a two-year 8.8% bond at its face value. What will be your total nominal return over the two years if inflation is 3.8% in the first year and 5.8% in the second?

Nominal 2-year return: 1.0882 − 1 = 0.1837, or 18.37%

If markets are efficient, which of the following investors should achieve superior returns over time? I)Mutual fund managers who manage other people's money for a living II)Investors who choose stocks by throwing darts at a list of stocks in the financial pages of a newspaper III)Analysts who spend considerable time evaluating the best stocks to buy

Non or these options

Ms. Kraft owns 50,000 shares of the common stock of Copperhead Corporation with a market value of $2 per share, or $100,000 overall. The company is currently financed as follows: Market Value Common stock (8 million shares) $ 16 million Short-term loans $ 2 million Copperhead now announces that it is replacing $1 million of short-term debt with an issue of common stock. What percent of the firm does Ms. Kraft currently own?

Ownership percent = shares owned / total shares Ownership percent = 50,000 / 8m Ownership percent = 0.00625, or 0.625%

The following are measures used by firms when making capital budgeting decisions except

P/E Ratio

World-Tour Co. has just now paid a dividend of $2.83 per share (Div0); its dividends are expected to grow at a constant rate of 6 percent per year forever. If the required rate of return on the stock is 16 percent, what is the current value of the stock, after paying the dividend?

P0 = (2.83 × 1.06)/(0.16 - 0.06) = 30.

Casino Inc. expects to pay a dividend of $3 per share at the end of year 1 (Div1) and these dividends are expected to grow at a constant rate of 6 percent per year forever. If the required rate of return on the stock is 18 percent, what is the current value of the stock today?

P0 = Div1/(r − g) = (3/(0.18 − 0.06)) = 25.

Pharmecology just paid an annual dividend of $1.35 per share. It's a mature company, but future EPS and dividends are expected to grow with inflation, which is forecasted at 2.75% per year. The nominal cost of capital is 9.5%. What is Pharmecology's current stock price?

P0 = [DIV0 × (1 + g)] / (r − g) P0 = [$1.35 × (1 + 0.0275)] / (0.095 − 0.0275) P0 = $20.55

A 26-year German government bond (bund) has a face value of €300 and a coupon rate of 5% paid annually. Assume that the interest rate (in euros) is equal to 7.60% per year. What is the bond's PV?

PV = (0.05 × €300) × ((1 / 0.076) − {1 / [0.076 × (1 + 0.076)26]}) + €300 / (1 + 0.076)26 PV = €212.65

A 11-year German government bond (bund) has a face value of €150 and a coupon rate of 6% paid annually. Assume that the interest rate (in euros) is equal to 6.10% per year. What is the bond's PV?

PV = (0.06 × €150) × ((1 / 0.061) − {1 / [0.061 × (1 + 0.061)11]}) + €150 / (1 + 0.061)11 PV = €148.82

A three-year bond with 10 percent coupon rate and $1,000 face value yields 8 percent. Assuming annual coupon payments, calculate the price of the bond.

PV = (100/1.08) + (100/(1.08^2)) + (1100/(1.08^3)) = $1,051.54. Alternatively, using a financial calculator, PMT = 100; FV = 1,000; N = 3; I = 8. Compute: PV = 1,051.54.

The $42 million lottery prize that you have just won actually pays out $3.0 million a year for 20 years. The interest rate is 12.0%. If the first payment comes after 1 year, what is the present value of your winnings?

PV = C × ((1 / r) - {1 / [r(1 + r)t]}) PV = $3.0 million × ((1 / 0.12) - {1 / [0.12(1.12)20]}) PV = $22.41 million

You have to pay $13,000 a year in school fees at the end of each of the next five years. If the interest rate is 7%, how much do you need to set aside today to cover these bills?

PV = C((1 / r) - {1 / [r(1 + r)t]}) PV = $13,000((1 / 0.07) - {1 / [0.07(1.07)5]}) PV = $53,302.57

A common stock will pay a cash dividend of $3 next year. After that, the dividends are expected to increase indefinitely at 3% per year. If the discount rate is 14%, what is the PV of the stream of dividend payments?

PV = C1 / (r − g) PV = $3 / (0.14 − 0.03) PV = $27.27

The cost of a new automobile is $11,000. If the interest rate is 4%, how much would you have to set aside now to provide this sum in four years?

PV = Ct / (1 + r)t PV = $11,000 / 1.044 PV = $9,402.85

If the cost of capital is 10%, what is the PV of $222 paid in year 12?

PV = Ct / (1 + r)t PV = $222 / 1.1012 PV = $70.74

David and Helen Zhang are saving to buy a boat at the end of nine years. If the boat costs $28,000 and they can earn 8% a year on their savings, how much do they need to put aside at the end of years 1 through 9?

PV = Ct / (1 + r)t PV = $28,000 / 1.089 PV = $14,006.97 C = PVA / ((1 / r) − {1 / [r(1 + r)t]}) C = $14,006.97 / ((1 / 0.08) − {1 / [0.08(1 + 0.08)9]}) C = $2,242.23

What is the present value of a six-year, $5,000 per year annuity at a discount rate of 10 percent?

PV = [(1/0.10) - (1/((0.10)(1.10^6)))] × 5,000 = 21,776.30.

The 8.3%, fifteen-year bond yields 6.3%. If this yield to maturity remains unchanged, what will be its price one year hence? Assume annual coupon payments and a face value of $1,000

PV15-year = (0.083 × $1,000) × ((1 / 0.063) − {1 / [0.063(1 + 0.063)15]}) + $1,000 / 1.06315 PV15-year = $1,190.49 PV14-year = (0.083 × $1,000) × ((1 / 0.063) − {1 / [0.063(1 + 0.063)14]}) + $1,000 / 1.06314 PV14-year = $1,182.49

Which of the following investment rules may not use all possible cash flows in its calculations?

Payback period

The variable that you are solving for in a present value of a lump sum problem is:

Present Value

Learn and Earn Company is financed entirely by common stock that is priced to offer a 20 percent expected return. If the company repurchases 50 percent of the stock and substitutes an equal value of debt yielding 8 percent, what is the expected return on its common stock after refinancing?

RE = 0.2 + (0.5/0.5)(0.20 − 0.08) = 0.32 = 32%.

Suppose that you buy a two-year 8.8% bond at its face value. What will be your total real return?

Real 2-year return: (1.088 / 1.038) × (1.088 / 1.058) − 1 = 0.0779, or 7.79%

Suppose that you buy a two-year 8.8% bond at its face value.Now suppose that the bond is a TIPS. What will be your total 2-year real and nominal returns?

Real 2-year return: (1.088 × 1.038) × (1.088 × 1.058) − 1 = 0.3000, or 30.00% Nominal 2-year return: 1.0882 − 1 = 0.1837, or 18.37%

The two-year interest rate is 11.2% and the expected annual inflation rate is 5.6%.If the expected rate of inflation suddenly rises to 7.6%, what does Fisher's theory say about how the real interest rate will change?

Real rate does not change

The following are agency problems associated with capital budgeting:

Reduced effort, perks or private benefits, empire building, entrenching investments and avoiding risk

The type of bonds where the identities of bond owners are recorded and the coupon interest payments are sent automatically are called

Registered bonds

A 10-year bond is issued with a face value of $1,000, paying interest of $60 a year. If interest rates increase shortly after the bond is issued answer the following: What happens to the bond YTM

Rises

Some issues are not registered but can be traded freely among qualified institutional buyers.

Rule 144A

Firms looking to raise funds will file registration statements with the

Securities and Exchange Commission (SEC).

If you sold a wheat futures contract for $3.75 per bushel and the contract ended at $3.60, what is your profit per bushel? (Ignore transaction costs.)

Sell at $3.75 and buy back at $3.60; net profit = 0.15/bushel.

In November 2017, Treasury 3 7/8s of 2041 offered a semiannually compounded yield to maturity of 3.00%. Recognizing that coupons are paid semiannually, calculate the bond's price. Assume face value is $1,000

Semiannual discount rate = 0.0300 / 2 = 0.0150, or 1.50% Number of time periods = (2041 − 2017) × 2 = 48 PV = [(0.03875 × $1,000) / 2] × ((1 / 0.0150) − {1 / [0.0150 × (1 + 0.0150)48]}) + $1,000 / (1 + 0.0150)48 PV = $1,148.94

The yield to maturity on a bond is really its internal rate of return. T/F

True

In carve-out transactions:

Shares of the new company are sold in a public offering

Several tranches of the same security may be sold under the same registration. (A "tranche" is a batch, a fraction of a larger issue.)

Shelf Registration

One can best describe the term structure of interest rates as the relationship between

Spot interest rates and time

Consider a bond with a face value of $1,000, an annual coupon rate of 6 percent, a yield to maturity of 8 percent, and 10 years to maturity. This bond's duration is

Step 1: N = 10; PMT = 60; FV = 1,000; I = 8. Compute PV = 865.80. Step 2: Duration = [1(55.56) + 2(51.44) + 3(47.63) + 4(44.10) + 5(40.83) + 6(37.81) + 7(35) + 8(32.42) + 9(30.01) + 10(490.99)]/(865.80) = 7.6 years.

A bond has a face value of $1,000, an annual coupon rate of 7 percent, yield to maturity of 10 percent, and 20 years to maturity. The bond's duration is

Step 1: N = 20; PMT = 70; FV = 1,000; I = 10. Compute PV = 744.59. Step 2: Duration = [((1)(70)/1.1) + ((2)(70)/1.1^2) + . . . + ((20)(1070)/1.1^20)]/744.59 = 10 years.

Assuming that bonds are sold at a fair price, the benefits from the interest tax shield go to the

Stockholders of the firm

The gains from LBOs typically derive from

Tax saving because of high debt servicing Loss in the value to bondholders Improved performance because of incentive to managers and employees

Which of the following investment rules has the value additivity property?

The Net present Value Method

The variable that you are solving for in a present value of an annuity problem is:

The Present Value

In which country do financial markets play the most important role as sources of corporate funding?

The United States

A conglomerate discount refers to which circumstance?

The market value of the whole conglomerate is less than the sum of the value of the parts.

One would expect a stock with a beta of zero to have a rate of return equal to

The risk-free rate

Which of the following statements about the relationship between interest rates and bond prices is true?

There is an inverse relationship between bond prices and interest rates, and the price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates (assuming that the coupon rate is the same for both).

Suppose a business takes out a $7,000, five-year loan at 6 percent that will be paid annually with a single, fixed payment each period. How much will be the annual payment?

Total Amount = C × [(1 − 1/(1 + r)t)/r] $7,000 = C × [(1 - 1/(1 + .06)5)/.06] $7,000 = C × [(1 - 1/1.3382)/.06] $7,000 = C × [.2527/.06] C = $7,000 / 4.2121 C = $1,661.88

(1 + rnominal) = (1 + rreal)(1 + inflation rate). T/F

True

A United States Treasury "strip" is a zero-coupon bond. T/F

True

A call option gives its owner the opportunity to buy a stock at a specified price that is generally called the exercise price. A put option gives its owner the opportunity to sell stock at a specified price. Options that can be exercised only at maturity are called European options. T/F

True

A corporation has a legal existence of its own and is based on "articles of incorporation." t/F

True

Behavioral finance deals with the idea that individual investors have built-in biases and misconceptions that can drive prices away from fair values. T/F

True

Consider the impact of inflation risk on the term structure of interest rates. If investors become more wary of inflation, one would expect to observe a steeper, more upwards sloping, term structure of interest rates. T/F

True

For firms with relatively high levels of debt, the company cost of capital is the cost of equity of the firm. T/F

True

Generally, an industry beta, calculated from a portfolio of companies in the same industry, is more accurate than a beta estimate for a single company. T/F

True

If a stock's returns follow a random walk pattern, then one should expect to calculate a statistically insignificant autocorrelation coefficient, calculated between each successive day's stock returns. T/F

True

In a completely competitive market, security prices follow a random walk. T/F

True

In an efficient market, investors will not pay others what they can do equally well themselves. T/F

True

One calculates the weighted average cost of capital (WACC), on an after-tax basis, as WACC = (rD) (1 − TC ) (D/V) + (rE) (E/V), where V = D + E. T/F

True

Other things equal, the lower the bond coupon, the higher its volatility. T/F

True

Price changes are independent of one another and follow a "random walk". Efficient markets dictate that stock price changes must be random and unpredictable. T/F

True

The U.S. Treasury issues inflation-indexed bonds known as TIPS. t/f

True

For $10,000, you can purchase a five-year annuity that will pay $2,358.65 per year for five years. The payments occur at the beginning of each year. Calculate the effective annual interest rate implied by this arrangement.

Using a financial calculator: N = 5; PV = -10,000; PMT = 2358.65; FV = 0. Compute: I = 9.0% [Calculator setting: BEGIN (BGN)].

Which of the following statements is generally true of venture capital (VC) firms?

VCs generally provide management advice and contacts in addition to capital.

Equity investment in start-up private companies is called

Venture Capital

One calculates the after-tax weighted average cost of capital (WACC) as

WACC = rD (1 − TC)(D/V) + rE (E/V); (where V = D + E).

One can use the profitability index most usefully for which situation?

When capital rationing exists

If an investment project (normal project) has an IRR equal to the cost of capital, the NPV for that project is

Zero

One should determine the after-tax weighted average cost of capital by

adding the weighted average after-tax cost of debt to the weighted average cost of equity.

The important point(s) to remember while estimating the cash flows of a project

are cash flow is relevant, always estimate cash flows on an incremental basis, and be consistent in the treatment of inflation.

If a stock were overpriced, it would plot

below the security market line

Investors indicate to the underwriter how many shares they would like to buy in a new issue and these indications are used to help set the price.

bodybuilding

A factor in APT is a variable that

correlates with the returns of risky assets in a systematic manner.

The cost of capital is the same as the cost of equity for firms that are financed

entirely by equity

In order to test the semistrong form of the efficient-market hypothesis, researchers have mostly relied on the

estimation of the serial correlation coefficients (autocorrelations) for securities and markets. measurement of how rapidly security prices adjust to different news items. measurement of the performance of technical trading strategies over the years.

The owner of a regular exchange-listed put-option on a stock

has the right to sell 100 shares of the underlying stock at the exercise price.

The value of a put option at expiration equals the

higher of the exercise price minus market price of the share and zero.

The following are sources of financing for corporations:

households, financial institutions, and other corporations.

The free-rider problem, when referring to monitoring of the firms' performance, often results in

ineffective monitoring by the shareholders, monitoring being delegated by shareholders to boards of directors, and no monitoring by a large number of small individual investors.

The main advantage of the payback rule is that it

is simple to use

The valuation of a common stock today primarily depends on

its expected future dividends and its discount rate.

In order to test the weak form of the efficient-market hypothesis, researchers have used the following methods except

measurement of how rapidly security prices adjust to different news items

The current market value of a previously purchased machine proposed for use in a project is an example of a(n)

opportunity cost.

The variables in a future value of a lump sum problem include all of the following, except:

payments and volatility

An efficient portfolio

provides the highest expected return for a given level of risk and provides the least risk for a given level of expected return.

The IRR is defined as

the discount rate that makes the NPV equal to zero

Pharmecology just paid an annual dividend of $1.35 per share. It's a mature company, but future EPS and dividends are expected to grow with inflation, which is forecasted at 2.75% per year. The nominal cost of capital is 9.5%. What would be Pharmecology's current stock price using forecasted real dividends and a real discount rate?

r = (1 + R) / (1 + h) − 1 r = (1 + 0.095) / (1 + 0.0275) − 1 r = 0.0657, or 6.57% In real terms, g equals 0, so DIV1 equals DIV0. P0 = DIV0 / r P0 = $1.35 / 0.0657 P0 = $20.55

Super Computer Company's stock is selling for $100 per share today. It is expected that-at the end of one year-it will pay a dividend of $6 per share and then be sold for $114 per share. Calculate the expected rate of return for the shareholders.

r = (114 + 6 - 100)/100 = 20%.

The two-year interest rate is 11.2% and the expected annual inflation rate is 5.6%. What is the expected real interest rate?

r = 1.112 / 1.056 - 1 r = 0.0530, or 5.30%

A firm is unlevered and has a cost of equity capital of 9 percent. What is the cost of equity if the firm becomes levered at a debt-equity ratio of 2? The expected cost of debt is 7 percent. (Assume no taxes.)

rE = 9 + 2(9 − 7) = 13%.

The two-year interest rate is 11.2% and the expected annual inflation rate is 5.6%.If the expected rate of inflation suddenly rises to 7.6%, what will be the new nominal rate?

rNominal = 1.0530 × 1.076 - 1 rNominal = 0.1331, or 13.31%

A privatization is a

sale of a government-owned company to private investors

The simplest way to divest an asset is to

sell it

The price for immediate delivery of a commodity is called the

spot price

Suppose that a lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages. He finds that he can "beat the market" by short selling the stock of firms that will be sued. This hypothetical finding would violate the

strong-form hypothesis of market efficiency

Generally, hedging transactions are

zero-NPV transaction