Exam 2
Grossnickle Corporation issued 20-year, noncallable, 7.4% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity? $1,281.57 $1,000.85 $1,013.05 $1,220.55 $1,196.13
$1,220.55
Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 5.00%, based on semiannual compounding. What is the bond's price? $1,235.47 $976.02 $1,457.85 $1,050.15 $1,359.01
$1,235.47
Goode Inc.'s stock has a required rate of return of 11.50%, and it sells for $29.00 per share. Goode's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend, D0? $0.95 $1.38 $1.37 $1.22 $1.06
$1.22
A share of common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 14.2%, what is the stock price? $12.70 $11.98 $14.61 $10.66 $12.10
$11.98
Nachman Industries just paid a dividend of D0 = $3.75. Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What is the best estimate of the stock's current market value? $144.04 $135.11 $127.47 $151.68 $130.01
$127.47
Kedia Inc. forecasts a negative free cash flow for the coming year, FCF1 = -$10 million, but it expects positive numbers thereafter, with FCF2 = $34 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14.0%, what is the firm's total corporate value, in millions? $335.10 $275.00 $319.14 $289.47 $303.95
$289.47
Francis Inc.'s stock has a required rate of return of 10.25%, and it sells for $87.50 per share. The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-end dividend, D1? $3.72 $2.79 $4.65 $3.16 $3.90
$3.72
Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $2.00 per share. If the required return on this preferred stock is 6.5%, at what price should the stock sell? $30.77 $32.92 $38.15 $23.38 $27.38
$30.77
A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 8.2%. What is the stock's current price? $27.39 $29.02 $32.61 $38.80 $27.07
$32.61
You have been assigned the task of using the corporate, or free cash flow, model to estimate Petry Corporation's intrinsic value. The firm's WACC is 10.00%, its end-of-year free cash flow (FCF1) is expected to be $70.0 million, the FCFs are expected to grow at a constant rate of 5.00% a year in the future, the company has $200 million of long-term debt and preferred stock, and it has 30 million shares of common stock outstanding. What is the firm's estimated intrinsic value per share of common stock? $48.80 $34.40 $36.80 $49.60 $40.00
$40.00
Ryngaert Inc. recently issued noncallable bonds that mature in 15 years. They have a par value of $1,000 and an annual coupon of 5.7%. If the current market interest rate is 7.0%, at what price should the bonds sell? $1,040.28 $802.25 $1,013.84 $775.81 $881.60
$881.60
Ackert Company's last dividend was $4.00. The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (rs) is 12.0%. What is the best estimate of the current stock price? $87.00 $95.61 $89.87 $80.31 $104.21
$95.61
Bae Inc. is considering an investment that has an expected return of 45% and a standard deviation of 10%. What is the investment's coefficient of variation? Do not round your intermediate calculations. Round the final answer to 2 decimal places. 0.22 0.27 0.20 0.26 0.23
0.22
Bill Dukes has $100,000 invested in a 2-stock portfolio. $62,500 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta? Do not round your intermediate calculations. Round the final answer to 2 decimal places. 1.14 0.90 1.44 1.20 1.56
1.20
Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 21.5% and a beta of 1.70. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock? Do not round your intermediate calculations. 13.98%; 1.28 12.29%; 1.48 12.41%; 1.56 12.05%; 1.25 9.40%; 1.34
12.05%; 1.25
Taggart Inc.'s stock has a 50% chance of producing a 36% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return? Do not round your intermediate calculations. 15.86% 15.71% 15.40% 12.01% 14.01%
15.40%
5-year Treasury bonds yield 4.4%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year T-bonds is 0.4%. There is no liquidity premium on these bonds. What is the real risk-free rate, r*? 2.10% 2.39% 2.21% 2.58% 1.91%
2.10%
Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 4.10%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. 4.20 4.49 3.82 3.57 4.41
4.20
Company A has a beta of 0.70, while Company B's beta is 1.45. The required return on the stock market is 9.00%, and the risk-free rate is 2.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.) Do not round your intermediate calculations. 5.06% 5.01% 4.71% 4.30% 4.25%
5.06%
Sadik Inc.'s bonds currently sell for $1,300 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)? 5.10% 5.31% 4.94% 6.00% 4.30%
5.31%
Dothan Inc.'s stock has a 25% chance of producing a 16% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return? Do not round your intermediate calculations. 4.51% 5.50% 4.68% 4.29% 6.38%
5.50%
Gray Manufacturing is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $27.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate? 6.01% 5.54% 6.07% 6.91% 5.95%
5.95%
Porter Inc's stock has an expected return of 12.50%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 2.00%, what is the market risk premium (Rm-Rf)? Do not round your intermediate calculations. 10.50% 8.48% 7.98% 8.40% 6.80%
8.40%
Radoski Corporation's bonds make an annual coupon interest payment of 7.35% every year. The bonds have a par value of $1,000, a current price of $920, and mature in 12 years. What is the yield to maturity on these bonds? 6.83% 9.53% 8.10% 7.25% 8.44%
8.44%
Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 5.90%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. 9.27% 8.91% 7.29% 9.00% 10.35%
9.00%
Cooley Company's stock has a beta of 1.28, the risk-free rate is 2.25%, and the market risk premium (Rm-Rf) is 5.50%. What is the firm's required rate of return? Do not round your intermediate calculations. 9.29% 9.94% 10.96% 8.55% 11.52%
9.29%
Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 7.00%. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. 9.50% 11.59% 7.70% 7.41% 8.46%
9.50%
Adams Enterprises' noncallable bonds currently sell for $910. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity? 7.34% 9.66% 8.60% 9.95% 11.21%
9.66%
Which of the following factors would be most likely to lead to an increase in nominal interest rates? Households reduce their consumption and increase their savings. A new technology like the Internet has just been introduced, and it increases investment opportunities. There is a decrease in expected inflation. The economy falls into a recession. The Federal Reserve decides to try to stimulate the economy
A new technology like the Internet has just been introduced, and it increases investment opportunities.
Which of the following statements is CORRECT? A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return. Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio. A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.
A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.
A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT? The prices of both bonds will decrease by the same amount. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. The prices of both bonds would increase by the same amount. One bond's price would increase, while the other bond's price would decrease. The prices of the two bonds would remain constant.
Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.
Which of the following would be most likely to lead to a higher level of interest rates in the economy? Households start saving a larger percentage of their income. Corporations step up their expansion plans and thus increase their demand for capital. The level of inflation begins to decline. The economy moves from a boom to a recession. The Federal Reserve decides to try to stimulate the economy.
Corporations step up their expansion plans and thus increase their demand for capital.
Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%The differences in these rates were probably caused primarily by: Tax effects. Default and liquidity risk differences. Maturity risk differences. Inflation differences. Real risk-free rate differences.
Default and liquidity risk differences.
Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows: T-bond = 7.72% A = 9.64%AAA = 8.72% BBB = 10.18% The differences in rates among these issues were most probably caused primarily by: Real risk-free rate differences. Tax effects. Default risk and liquidity differences. Maturity risk differences. Inflation differences.
Default risk and liquidity differences.
A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, companies call bonds if interest rates rise and do not call them if interest rates decline. True False
False
Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more price risk if you purchased a 30-day bond than if you bought a 30-year bond. True False
False
One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant. True False
False
The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation. True False
False
Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT? If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's. Stock B must have a higher dividend yield than Stock A. Stock A must have a higher dividend yield than Stock B. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.
If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's.
Which of the following statements is CORRECT? If the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. If the maturity risk premium (MRP) equals zero, the Treasury bond yield curve must be flat. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. If the expectations theory holds, the Treasury bond yield curve will never be downward sloping. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.
If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.
A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT? If market interest rates decline, the price of the bond will also decline. The bond is currently selling at a price below its par value. If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today. The bond should currently be selling at its par value. If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today.
If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.
Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.) Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns. Stock B has a higher required rate of return than Stock A. Portfolio P has a standard deviation of 22.5%. More information is needed to determine the portfolio's beta. Portfolio P has a beta of 1.0.
Portfolio P has a beta of 1.0.
For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true? The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. The beta of the portfolio is less than the weighted average of the betas of the individual stocks. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. The beta of the portfolio is larger than the weighted average of the betas of the individual stocks.
The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.
Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks? The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change. The expected return of your portfolio is likely to decline. The diversifiable risk will remain the same, but the market risk will likely decline. Both the diversifiable risk and the market risk of your portfolio are likely to decline. The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.
The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT? The yield curve should be downward sloping, with the rate on a 1-year bond at 6%. The interest rate today on a 2-year bond should be approximately 6%. The interest rate today on a 2-year bond should be approximately 7%. The interest rate today on a 3-year bond should be approximately 7%. The interest rate today on a 3-year bond should be approximately 8%
The interest rate today on a 3-year bond should be approximately 7%.
Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT? In equilibrium, long-term rates must be equal to short-term rates. An upward-sloping yield curve implies that future short-term rates are expected to decline. The maturity risk premium is assumed to be zero. Inflation is expected to be zero. Consumer prices as measured by an index of inflation are expected to rise at a constant rate.
The maturity risk premium is assumed to be zero.
In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t 1)%, where t is the number of years until the bond matures. Given this information, which of the following statements is CORRECT? The yield on 2-year Treasury securities must exceed the yield on 5-year Treasury securities. The yield on 5-year Treasury securities must exceed the yield on 10-year corporate bonds. The yield on 5-year corporate bonds must exceed the yield on 8-year Treasury bonds. The yield curve must be "humped." The yield curve must be upward sloping.
The yield curve must be upward sloping.
Which of the following statements is CORRECT? The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond. The real risk-free rate should increase if people expect inflation to increase.
The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities. True False
True
According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio. True False
True
Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away. True False
True
Because the maturity risk premium is normally positive, the yield curve is normally upward sloping. True False
True
If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward sloping yield curve. True False
True
Junk bonds are high-risk, high-yield debt instruments. They are often used to finance leveraged buyouts and mergers, and to provide financing to companies of questionable financial strength. True False
True
One of the four most fundamental factors that affect the cost of money as discussed in the text is the availability of production opportunities and their expected rates of return. If production opportunities are relatively good, then interest rates will tend to be relatively high, other things held constant. True False
True
Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. True False
True
The "yield curve" shows the relationship between bonds' maturities and their yields. True False
True
The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak. True False
True
The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation. True False
True
If in the opinion of a given investor a stock's expected return exceeds its required return, this suggests that the investor thinks the stock is experiencing supernormal growth. the stock should be sold. Correct! the stock is a good buy. management is probably not trying to maximize the price per share. dividends are not likely to be declared.
the stock is a good buy.
Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.90%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places. 7.16 8.83 6.63 7.42 8.04
8.83
