Business Finance Exam 2

The price sensitivity of a bond increases in response to a change in the market rate of interest as the:

coupon rate decreases and the time to maturity increases.

You purchase a bond with an invoice price of $1,119. The bond has a coupon rate of 6.25 percent, a face value of $1,000, and there are four months to the next semiannual coupon date. What is the clean price of this bond?

$1,108.58 Accrued interest = (.0625)($1,000)(1/2)(2/6) Accrued interest = $10.42 Clean price = $1,119 − 10.42 Clean price = $1,108.58

You borrow money today at 6.65 percent, compounded annually, and repay the principal and interest in one lump sum of $12,800 two years from today. How much are you borrowing?

$11,253.52 PV = $12,800/1.06652 PV = $11,253.52

Shore Hotels just paid an annual dividend of $1.50 per share. The company will increase its dividend by 7 percent next year and will then reduce its dividend growth rate by 2 percentage points per year until it reaches the industry average of 3 percent dividend growth, after which the company will keep a constant growth rate forever. What is the price of this stock today given a required return of 14 percent?

$14.85 P2 = [$1.50(1.07)(1.05)(1.03)]/(.14 − .03) P2 = $15.78 P0 = [$1.50(1.07)]/1.14 + {[$1.50(1.07)(1.05)] + $15.78}/1.142 P0 = $14.85

A firm has a current EPS of $1.63 and a benchmark PE of 11.7. Earnings are expected to grow 2.6 percent annually. What is the target stock price in one year?

$19.57 P1 = $1.63(1.026)(11.7) P1 = $19.57

You are seeking a fixed-rate mortgage of $195,000 with a term of 30 years. Your bank quotes an APR of 6.2 percent, compounded monthly. You can only afford monthly payments of $1,000, so you offer to pay off any remaining loan balance at the end of the loan term in the form of a single balloon payment. What will be the amount of the balloon payment?

$202,828.59 PVA = $1,000[(1 − {1/[1 + (.062/12)](30)(12)})/(.062/12)] PVA = $163,273.58 Remaining principal in today's dollars = $195,000 − 163,273.58 Remaining principal in today's dollars = $31,726.42 FV = $31,726.42(1 + .062/12)(30)(12) FV = $202,828.59

Jones Stoneware has a liability of $75,000 due four years from today. The company is planning to make an initial deposit today into a savings account and then deposit an additional $10,000 at the end of each of the next four years. The account pays interest of 4.5 percent. How much does the firm need to deposit today for its savings to be sufficient to pay this debt?

$27,016.84 FVA = $10,000[(1.0454 − 1)/.045] FVA = $42,781.91 Additional FV needed = $75,000 − 42,781.91 Additional FV needed = $32,218.09 Initial deposit = $32,218.09/1.0454 Initial deposit = $27,016.84

JL Co. stock currently sells for $64 per share and the required return is 12 percent. The total return is evenly divided between the capital gains yield and the dividend yield. What is the current dividend per share if it's the company's policy to always maintain a constant growth rate in its dividends?

$3.62 Dividend yield = .12/2 Dividend yield = .06, or 6% D1 = .06($64) D1 = $3.84 D0 = $3.84/1.06 D0 = $3.62

Jensen Shipping currently has an EPS of $2.31, a benchmark PE of 13.5, and an earnings growth rate of 2.3 percent. What is the target share price 4 years from now?

$34.15 P4 = $2.31(1.0234)(13.5) P4 = $34.15

Your grandfather left you an inheritance that will provide an annual income for the next 20 years. You will receive the first payment one year from now in the amount of $2,500. Every year after that, the payment amount will increase by 5 percent. What is your inheritance worth to you today if you can earn 7.5 percent on your investments?

$37,537.88 GAPV = $2,500{[1 −(1.05/1.075)20]/(.075 − .05)} GAPV = $37,537.88

A newly issued 10-year, $1,000, zero coupon bond just sold for $311.05. What is the implicit interest, in dollars, for the first year of the bond's life? Assume semiannual compounding.

$38.53 Bond price0 = $311.05 = $1,000/(1 + r/2)(10)(2) r = .120257, or 12.0257% Bond price1 = $1,000/(1 + .120257/2)(9)(2) Bond price1 = $349.58 Implicit interest = $349.58 − 311.05 Implicit interest = $38.53

Nu-Tek has preferred stock outstanding that pays a cumulative $1.50 dividend per quarter. This company has not paid any of its dividends for the past two quarters. How much must be paid as a dividend for each share of preferred stock if the company plans to pay a dividend to its common shareholders this upcoming quarter?

$4.50 Required preferred dividend = 3($1.50) Required preferred dividend = $4.50

A preferred stock pays an annual dividend of $5.20. What is one share of this stock worth today if the rate of return is 10.44 percent?

$49.81 PV = $5.20/.1044 PV = $49.81

A one-time gift to your college will provide $25,000 in scholarship funds next year with that amount increasing by 2 percent annually thereafter. If the discount rate is 5.5 percent, what is the current value of this perpetual gift?

$714,285.71 GPPV = $25,000/(.055 − .02) GPPV = $714,285.71

Al obtained a mortgage of $195,000 at 5.25 percent for 15 years. How much of the second monthly payment is applied to interest?

$850 $195,000 = C({1 - [1/(1 + .0525/12)(15)(12)]}/(.0525/12)) C = $1,567.56 InterestMonth 1 = $195,000(.0525/12) InterestMonth 1 = $853.13 PrincipalMonth 1 = $1,567.56 − 853.13 PrincipalMonth 1 = $714.43 InterestMonth 2 = ($195,000 − 714.43)(.0525/12) InterestMonth 2 = $850.00

Whistle Stop pays a constant annual dividend of $4 on its stock. The company will maintain this dividend for the next 3 years and will then cease paying dividends forever. What is the current price per share if the required return on this stock is 15.6 percent?

$9.04 P0 = $4[1 − (1/1.1563)]/.156 P0 = $9.04

A 1-year loan of $15,000 is quoted at 6.7 percent plus 3 points. This loan is to be repaid in one lump sum. What is the actual cost of this loan?

10.00 percent Loan amount received = $15,000(1 − .03) Loan amount received = $14,550 Loan repayment amount = $15,000(1.067) Loan repayment amount = $16,005 $16,005 = $14,550(1 + r)1 r = .1000, or 10.00%

The Friendly Bank wants to earn an EAR of 12 percent on its consumer loans. The bank uses daily compounding. What rate is the bank most apt to quote on these loans?

11.33 percent APR = 365(1.121/365 − 1) APR = .1133, or 11.33%

What is the EAR of 18.9 percent compounded continuously?

20.80 percent EAR = e.189 − 1 EAR = .2080, or 20.80%

You grandfather invested $16,600 years ago to provide annual payments of $700 a year to his heirs forever. What is the rate of return?

4.22 percent r = $700/$16,600 r = .0422, or 4.22%

Al is retired and his sole source of income is his bond portfolio. Although he has sufficient principal to live on, he only wants to spend the interest income and thus is concerned about the purchasing power of that income. Which one of the following bonds should best ease Al's concerns?

5-year TIPS

Suppose the real rate is 3.45 percent and the inflation rate is 2.2 percent. What rate would you expect to earn on a Treasury bill?

5.73 percent R = [1.0345(1.022)] − 1 R = .0573, or 5.73%

On this date last year, you borrowed $3,900. You have to repay the loan with a lump sum payment of $6,000 six years from now. What is the interest rate?

6.35 percent r = ($6,000/$3,900)1/7 − 1 r = .0635, or 6.35%

Bare Trees United issued 20-year bonds 3 years ago at a coupon rate of 8.5 percent. The bonds make semiannual payments. If these bonds currently sell for 91.4 percent of par value, what is the YTM?

9.53 percent $914 = $42.50({1 − [1/(1 + r)(17)(2)]}/r) + $1,000/(1 + r)(17)(2) To solve for r, use trial-and-error, a financial calculator, or a computer. Enter: 34 −$914 $42.50 $1,000 N I/Y PV PMT FV Solve for: 4.766 YTM = 2(4.766%) YTM = 9.53%

Which one of the following is the price at which a dealer will sell a bond?

Asked price

A bond that can be paid off early at the issuer's discretion is referred to as being which type of bond?

Callable

Which one of following is the rate at which a stock's price is expected to appreciate?

Capital gains yield

What is the model called that determines the market value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate?

Constant-growth model

Which one of the following applies to a premium bond?

Coupon rate > Current yield > Yield to maturity

A decrease in which of the following will increase the current value of a stock according to the dividend growth model?

Discount rate

An agent who arranges a transaction between a buyer and a seller of equity securities is called a:

broker

A sinking fund is managed by a trustee for which one of the following purposes?

Early bond redemption

A securities market primarily composed of dealers who buy and sell for their own inventories is referred to which type of market?

Over-the-counter

Ernst & Frank stock is listed on NASDAQ. The firm is planning to issue some new equity shares for sale to the general public. This sale will definitely occur in which one of the following markets?

Primary

Project X has cash flows of $8,500, $8,000, $7,500, and $7,000 for Years 1 to 4, respectively. Project Y has cash flows of $7,000, $7,500, $8,000, and $8,500 for Years 1 to 4, respectively. Which one of the following statements is true concerning these two projects given a positive discount rate? (No calculations needed)

Project X has both a higher present and a higher future value than Project Y.

A $1,000 face value bond can be redeemed early at the issuer's discretion for $1,030, plus any accrued interest. The additional $30 is called the:

call premium.

A call-protected bond is a bond that:

cannot be called at this point in time

Which one of the following statements correctly defines a time value of money relationship?

Time and present value are inversely related, all else held constant.

Kurt has researched T-Tek and believes the firm is poised to vastly increase in value. He has decided to purchase T-Tek bonds as he needs a steady stream of income. However, he still wishes that he could share in the firm's success along with the shareholders. Which one of the following bond features will help him fulfill his wish?

Warrant

Which one of these equations applies to a bond that currently has a market price that exceeds par value?

Yield to maturity < Coupon rate

Supernormal growth is a growth rate that:

is unsustainable over the long term.

DLQ Inc. bonds mature in 12 years and have a coupon rate of 6 percent. If the market rate of interest increases, then the:

market price of the bond will decrease.

The annual dividend yield is computed by dividing ________ annual dividend by the current stock price.

next year's

The secondary market is best defined as the market:

where outstanding shares of stock are resold.

You have been purchasing $12,000 worth of stock annually for the past eight years and now have a portfolio valued at $87,881. What is your annual rate of return?

− 2.54 percent FVA = $87,881 = $12,000{[(1 + r)8 − 1]/r} r = −.0254, or −2.54%