Corporate Finance Exam 2

Swanson, Inc. bonds have a 10% coupon rate with semi-annual coupon payments. They have 12 and 1/2 years to maturity and a par value of $1,000. Compute the value of Swanson's bonds if investors' required rate of return is 8%.

$1,156.22

Assume that Brady Corp. has an issue of 18-year $1,000 par value bonds that pay 7% interest, annually. Further assume that today's required rate of return on these bonds is 5%. How much would these bonds sell for today? Round off to the nearest $1.

$1,233.79

Unsystematic Risk

(company unique risk, diversifiable risk) is a risk that affects only a specific firm

Systematic Risk

(market risk, undiversifiable risk) is a risk that affects all firms

Three Important relationships with Bonds

1. bond value and required rate of return, negative associated 2. premium bond, par value, discount bond 3. Long-term bonds have greater interest rate risk than short-term bonds

Alaska Power Company issued $1,000 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 Alaska Power Company bonds?

5.3%

What is the yield to maturity of a corporate bond with 13 years to maturity, a coupon rate of 8% per year, a $1,000 par value, and a current market price of $1,250? Assume semi-annual coupon payments.

5.3%

Beta is a statistical measure of

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

Of the following different types of securities, which is typically considered most risky?

Common stocks of small companies

Last National Bank is offering you a loan at 10%; payments on the loan are to be made monthly. Credit Onion is offering you a loan where payments are to be made semi-annually; the rate on the loan is also 10%. Local Bank down the street is also offering a loan at 10% where the payments are made quarterly. Which loan has the lowest annual cost?

Credit Onion's loan

You are considering buying some stock in Continental Grain. Which of the following are examples of non-diversifiable risks? I. Risk resulting from a general decline in the stock market. II. Risk resulting from a possible increase in income taxes. III. Risk resulting from an explosion in a grain elevator owned by Continental. IV. Risk resulting from a pending lawsuit against Continental.

I and II

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.

II, III

Which of the following investments is clearly preferred to the others for an investor who is not holding a well-diversified portfolio? k: expected rate of return; σ: risk Investment k σ A 18% 20% B 20% 20% C 20% 22%

Investment B

Market prices comparisons

Market Price < required rate of return... sell Market Price > required rate of return... buy Market Price = required rate of return... fairly priced

Changes in the general economy, like changes in interest rates or tax laws represent what type of risk?

Market risk

Which of the following statements is most correct concerning diversification and risk?

Risk-averse investors often choose companies from different industries for their portfolios because the correlation of returns is less than if all the companies came from the same industry.

You must add one of two investments to an already well- diversified portfolio. Security A Security B Expected Return = 14% Expected Return = 14% SD of SD of Returns = 15.8% Returns = 19.7% Beta = 1.8 Beta = 1.5 If you are a risk-averse investor, which one is the better choice?

Security B

Which of the following is the slope of the security market line?

the market risk premium

Two bonds are identical except for their maturity. The bonds have a coupon rate that is greater than their yield to maturity. Which of the following is true when comparing the two bonds?

The longer maturity bond has a greater premium (is priced farther above par).

Judge whether the statement is true or​ false: "The​ holding-period rate of return is the return an investor would receive from holding a security for a designated period of​ time." True or False?

True

Treasury bills are​ risk-free assets because they have a​ short-term maturity​ date, their price is less​ volatile, and there is no chance of default on them.

True

If you were to use the standard deviation as a measure of investment risk, which of the following has historically been the least risky investment?

U.S. Treasury bills

YTM comparisons

YTM < required rate of return... sell YTM > required rate of return... buy YTM = required rate of return... fairly priced

You determine that XYZ common stock has an expected return of 24%. XYZ has a Beta of 1.5. The risk-free rate is 5%, and the market expected return is 15%. Which of the following is most likely to happen?

You and other investors will buy up XYZ stock and its price will rise.

Should you sell the bond or continue to own​ it? ​(Select the best choice​ below.)

You should sell the bond because the​ bond's yield to maturity is lower than your expected rate of return and thus it is overvalued.

Portfolio risk is typically measured by ________ while the risk of a single investment is measured by ________.

beta; standard deviation

Stock A has an expected return of 12% with a standard deviation of 8%. If returns are normally distributed, then approximately two-thirds of the time the return on stock A will be

between 4% and 20%.

Investment A has an expected return of 15% per year, while investment B has an expected return of 12% per year. A rational investor will choose

investment A if A and B are of equal risk.

A bond will sell at a discount (below par value) if

investor's current required rate of return is above the coupon rate of the bond.

If market interest rates decline

long-term bonds will rise in value more than short-term bonds.

What is the name of additional compensation required for assuming greater​ risk?

risk premium

Stock A has a beta of 1.2 and a standard deviation of returns of 18%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the market risk premium increases, then

the required return on stock B will increase more than the required return on stock A.