FIN 301 CH 2-4 MC--MINE
39) All of the following are typically advantages of private placements EXCEPT A) speed. B) reduced flotation costs. C) financial flexibility. D) the possibility of future SEC registration.
Answer: D
17) Given the rate information in the table below, estimate the nominal rate for a AA-rated corporate bond. Assume a liquidity premium of 8 basis points. Identify as part of your answer the inflation risk premium, the default risk premium, the maturity premium, and the liquidity premium. 3-month T-bills 2.00% 30-year Treasury bonds 5.00% AA-rated corp. bonds 8.00% Inflation Rate 1.00%
Answer:k* = 2.0% - 1.0% = 1.0% IRP = 1.0% DRP = 8.0% - 5.0% = 3.0% MP = 5.0% - 2.0% = 3.0% LP = .08% (given) K = 1.0% + 1.0% + 3.0% + 3.0% + .08% = 8.08%
16) Given the anticipated rate of inflation (i) of 1.7% and the real rate of interest (R) of 1.4%, find the nominal rate of interest (r).
Answer:r = R + i + Ri r = .014 + .017 + (.014)(.017) r = .031 + .000238 = .031238 r = 3.12%
19) The current rate of return on a one-year U.S. Government security is 3%. The rate of return on a two-year U.S. Government security is 5%. According to the expectations theory, what is the return on a one-year U.S. Government security purchased one year from today?
Answer: $1,000 × 1.03 = $1,030 at the end of year one $1,000 × (1.05)2 = $1,102.50 at the end of two years $1,102.50 - $1,030 = $72.50 interest needed in year 2 $72.50/$1,030 = 7.04%
10) You are considering an investment in a AAA-rated U.S. corporate bond but you are not sure what rate of interest it should pay. Assume that the real risk-free rate of interest is 1.0%; inflation is expected to be 1.5%; the maturity risk premium is 2.5%; and, the default risk premium for AAA rated corporate bonds is 3.5%. What rate of interest should the U.S. corporate bond pay? A) 8.5% B) 6.0% C) 5.0% D) 2.5%
Answer: A
14) Which of the following represents the correct ordering of returns over the period 1926 to 2014 (from lowest to highest return)? A) Treasury bills, long-term government bonds, long-term corporate bonds, common stocks B) common stocks, long-term government bonds, long-term corporate bonds, Treasury bills C) Treasury bills, common stocks, long-term corporate bonds, long-term government bonds D) long-term corporate bonds, Treasury bills, long-term government bonds, common stocks
Answer: A
15) The ________ is the premium to compensate for the price change expected to occur over the life of the bond or investment instrument. A) inflation-risk premium B) maturity premium C) real risk-free interest rate premium D) default-risk premium
Answer: A
15) The basic format of an income statement is A) Sales - Expenses = Profits. B) Income - Expenses = EBIT. C) Sales - Liabilities = Profits. D) Assets - Liabilities = Profits.
Answer: A
16) During the period 1990 to 2014, the average yield on 3-month U.S. Treasury bills was 3.04%, the average inflation rate was 2.64%, the average yield on 30-year Treasury bonds was 5.49%, and the average return on 30-year Aaa-rated corporate bonds was 6.35%. The real risk-free short-term interest rate is A) 0.40 B) 2.13 C) 2.97 D) 4.76
Answer: A
19) Suppose the following rates are averages for banks in your area: interest checking accounts pay 1%, savings accounts pay 2%, and one-year certificates of deposit pay 3%. All accounts are federally insured by the FDIC. The difference in rates can be explained mainly by A) liquidity premiums. B) default risk premiums. C) maturity premiums. D) inflation risk premiums.
Answer: A
20) When a company repurchases its own common stock, it is likely that A) the stock price will increase because the company views the stock as undervalued. B) the stock price will decrease because the company is creating artificial demand for its stock. C) the stock price will remain the same as this is simply an internal transaction. D) the board of directors will be fired for incompetence.
Answer: A
20) Which of the following statements is false? A) Brokers purchase securities for their own account. B) Most corporate bond trading takes place over the counter. C) Broker-dealers stand ready to buy and sell specific securities at selected prices. D) none of the above
Answer: A
21) Investment firms, such as Goldman Sachs, assist the transfer of capital by A) facilitating indirect transfers from savers (investing public) to borrowers (corporations needing capital). B) selling indirect securities to savers and using the funds to buy common stock for corporations needing funds. C) selling direct securities. D) selling common stock for corporate clients in the secondary market.
Answer: A
23) If a corporation wants a guarantee that all of its shares of stock will be sold, it should use which of the following distribution methods? A) competitive bid purchase B) privileged subscription with no standby agreement C) commission or best-efforts contract D) direct sale
Answer: A
33) ExxonMobil generates about $50 billion in cash annually from its operations and invests about half of that on new exploration. Therefore, ExxonMobil is an example of a(n) A) savings surplus unit. B) savings deficit unit. C) investment banker. D) financial intermediary.
Answer: A
36) Common examples of financial intermediaries include all of the following EXCEPT A) Venture Capital Firms. B) Life Insurance Companies. C) Pension Funds. D) Mutual Funds.
Answer: A
36) Which of the following is an advantage of using private placements for debt? A) reduced costs from the elimination of the registration statement for the SEC, investment-banking underwriting fees and distribution costs B) lower interest costs C) fewer and less burdensome restrictive covenants D) the possibility of future SEC registration
Answer: A
37) John calls his stockbroker and instructs him to purchase 100 shares of Microsoft Corporation common stock. This transaction occurs in the A) secondary market. B) primary market. C) credit market. D) futures market.
Answer: A
41) All of the following securities are sold in money markets EXCEPT A) common stock. B) commercial paper. C) 3-month U.S. Treasury bills. D) 6-month certificates of deposit.
Answer: A
43) All of the following are benefits of organized stock exchanges EXCEPT A) increased stock price volatility. B) continuous markets. C) fair security prices. D) easier access to new capital for business expansion.
Answer: A
43) The costs associated with issuing securities to the public can be high. Some types of securities have greater expenses associated with them than others. Which of the following is the most costly security to issue? A) common stock B) corporate bonds C) preferred stock D) all of the above
Answer: A
44) The stock market with the most stringent listing requirements is the A) New York Stock Exchange (NYSE). B) NASDAQ Stock Market. C) American Stock Exchange (AMEX). D) All organized exchanges have the same listing requirements in order to make trading fair for all investors.
Answer: A
45) Bill is a public accountant auditing Expo Corporation. Based on information in Expo's confidential records, Bill recommends the purchase of Expo stock to his brother. A) Bill is involved in insider trading prohibited by the SEC. B) Bill's brother has no direct connection to Expo Corporation and therefore his purchase of the stock is not prohibited by insider trading laws. C) Bill is not an insider because he is not an officer or employee of Expo Corporation D) If Bill told a non-relative who purchases Expo stock, no insider trading laws would be violated.
Answer: A
47) A commitment fee is A) an amount paid on the unused portion of a loan in a private placement. B) an amount paid by an investment banker to ensure the sale of securities. C) paid by investors to guarantee that a company will borrow from them. D) paid by bondholders to secure the right to convert bonds into common stock.
Answer: A
47) An example of a primary market transaction is A) a new issue of common stock by AT&T. B) a sale of some outstanding common stock of AT&T by an investor. C) AT&T repurchasing its own stock from a stockholder. D) all of the above
Answer: A
48) An example of a primary market transaction involving a money-market security is A) a new issue of a security with a very short maturity. B) a new issue of a security with a very long maturity. C) the transfer of a previously-issued security with a very short maturity. D) the transfer of a previously-issued security with a very long maturity.
Answer: A
50) Financial intermediaries A) offer indirect securities. B) include the national and regional stock exchange. C) usually are underwriting syndicates. D) constitute the various secondary markets.
Answer: A
55) In August 2004, Google first sold its common stock to the public at $85 per share and raised $1.76 billion. This is an example of A) a primary market transaction. B) a secondary market transaction. C) a venture capital firm transaction. D) a money-market transaction.
Answer: A
6) Which of the following securities will likely have the highest maturity risk premium? A) U.S. Treasury bond maturing in 2027 B) Bbb-rated corporate bond maturing in 2020 actively traded on a major exchange C) Aaa-rated corporate bond maturing in 2015 not actively traded D) U.S. Treasury bill
Answer: A
23) The yield curve in 2009 was very low, with short-term rates close to zero and long-term rates below 5 percent. What factors contributed to such low interest rates?
Answer: Answer: In response to the banking and economic crises, the U.S. Government undertook policies to reduce interest rates in an attempt to stimulate economic activity. In addition, the recession caused a decrease in the demand for borrowed funds, and investors, scared off by large declines in the stock market, moved money into safer U.S. Treasury securities. Increasing Treasury prices mean lower yields.
15) Which of the following represents the correct ordering of standard deviation of returns over the period 1926 to 2014 (from highest to lowest standard deviation of returns)? A) Treasury bills, long-term corporate bonds, long-term government bonds, common stocks B) common stocks, long-term government bonds, long-term corporate bonds, Treasury bills C) Treasury bills, long-term government bonds, long-term corporate bonds, common stocks D) Treasury bills, long-term government bonds, common stocks, long-term corporate bonds
Answer: B
18) Which of the following securities will likely have the highest default risk premium? A) U.S. Treasury bond maturing in 2027 B) Bbb-rated corporate bond maturing in 2020 actively traded on a major exchange C) Aaa-rated corporate bond maturing in 2015 not actively traded D) U.S. Treasury bill
Answer: B
25) Spandra Electronics wants to raise money by selling stock. After talking to several investment banking firms, Spandra decides to hire Goldman Sachs to sell 5 million shares of its common stock. Goldman sells 4.5 million shares and returns the rest to Spandra. This is an example of A) a privileged subscription with a standby agreement. B) a commission or best-efforts agreement. C) a privileged subscription with a standby agreement. D) a competitive bid purchase.
Answer: B
29) Which of the following statements about investment banking in the United States is MOST correct? A) Investing banking is dominated by a few, very large, stand-alone investment banking firms, such as Bear Stearns. B) The investment banking industry is dominated by large banks that are also investment bankers. C) The top five banks involved in investment banking account for less than 25% of the industry's total market share. D) The investment banking industry became more competitive following the financial crisis in 2007 and 2008.
Answer: B
33) A "Dutch auction" was used by Google to raise money in 2004. A Dutch auction involves A) selling bonds in Europe. B) allowing investors to submit bids saying how many shares they'd like to buy and at what price. C) allowing investment banking firms to submit bids on how many shares they are willing to sell and at what price. D) hiring a Dutch firm to sell a company's securities at auction.
Answer: B
35) Which of the following statements concerning private placements is MOST correct? A) Private placements do not involve investment bankers. B) Although not selling the securities to the public, investment bankers may provide advice on the evaluation of prospective buyers and the terms of sale for private placements. C) Private placements are limited to stocks, not bonds. D) More than half of all private placements are sold to federal, state, or local governments or government agencies.
Answer: B
39) General Motors raises money by selling a new issue of common stock. This transaction occurs in A) the secondary market. B) the capital market. C) the money market. D) the futures market.
Answer: B
41) Private placements usually have several advantages associated with them, but also tend to suffer from specific disadvantages. Which of the following is a disadvantage of a private placement when compared to other methods of selling new securities? A) strictly standardized features/terms B) higher interest costs C) reduced flotation costs D) avoidance of registration with the SEC
Answer: B
42) Which of the following would NOT normally be considered a "flotation cost"? A) underwriter's spread B) dividends C) legal fees D) printing and engraving expenses
Answer: B
46) Capital market instruments include A) negotiable certificates of deposit. B) corporate equities. C) commercial paper. D) Treasury bills.
Answer: B
57) Capital market transactions include which of the following? A) any security that is purchased from a brokerage firm that is well capitalized B) common stock of a public corporation C) all securities that are purchased in the open market D) U.S. Treasury bills
Answer: B
10) What was the average annual rate of return on long-term government bonds (30-year Treasury bonds) during the period 1990 to 2014? A) 4.14% B) 5.88% C) 5.49% D) 7.82%
Answer: C
11) What is the term for a graphical representation of the relationship between interest rates and the maturities of debt securities? A) term curve B) maturity chart C) yield curve D) inflationary expectations
Answer: C
11) What was the average annual rate of return on long-term corporate bonds during the period 1926 to 2014? A) 8.3% B) 6.5% C) 6.10% D) 7.00%
Answer: C
12) What was the average annual rate of return on common stocks during the period 1926 to 2014? A) 15.4% B) 18.6% C) 10.1% D) 9.5%
Answer: C
13) A "normal" yield curve is A) downward sloping. B) downward sloping, then upward sloping. C) upward sloping. D) upward sloping, then downward sloping.
Answer: C
13) Company A and Company B both report the same level of sales and net income. Therefore, A) both A and B will report the same Earnings Per Share. B) both A and B will report the same Gross Profit Margin. C) both A and B will report the same Net Profit Margin. D) both A and C are true.
Answer: C
14) The A corporation has an operating profit margin of 20%, operating expenses of $500,000, and financing costs of $15,000. Therefore, A) the corporation's gross profit margin is less than 20%. B) the corporation's net profit margin is greater than 20%. C) the corporation's gross profit margin is greater than 20%. D) the corporation's gross profit margin is equal to 20% because gross profit is not affected by operating expenses or financing costs.
Answer: C
14) Which of the following premiums is NOT factored into the price of a long-term Treasury bond? A) a real risk-free interest rate B) a maturity premium C) a default-risk premium D) an inflation-risk premium
Answer: C
17) Which of the following securities will likely have the highest liquidity premium? A) U.S. Treasury bond maturing in 2027 B) Bbb-rated corporate bond maturing in 2020 actively traded on a major exchange C) Aaa-rated corporate bond maturing in 2015 not actively traded D) U.S. Treasury bill
Answer: C
24) Reynolds, Inc. needs to raise $5 million by selling common stock. Reynolds sells 1 million shares of stock at $5 each to Goldman Sachs, who then is responsible for selling the shares to investors. This is an example of a A) privileged subscription. B) standby agreement. C) negotiated purchase. D) commission or best-efforts agreement.
Answer: C
30) The investment banker performs what three basic functions? A) underwriting, distributing, and regulating B) underwriting, advising, and price-pegging C) underwriting, distributing, and advising D) underwriting, distributing, and negotiating
Answer: C
30) Which of the following statements is an example of a futures market transaction? A) An investor purchases 100 shares of IBM hoping to sell it in two years for a profit. B) A company purchases an option to buy 1000 barrels of oil anytime between now and the end of the year. C) A company agrees to purchase 1000 barrels of oil for delivery in six months at a price of $70 per barrel. D) An executive has a portion of his current year salary deferred until he retires.
Answer: C
31) General Electric (GE) has been a public company for many years with its common stock traded on the New York Stock Exchange. If GE decides to sell 500,000 shares of new common stock, the transaction will be describe as A) an initial public offering. B) a secondary market transaction because GE common stock has been trading for years. C) a seasoned equity offering because GE has sold common stock before. D) a money-market transaction because GE raises new money to fund its business.
Answer: C
31) When an investment banking firm "underwrites" an issue of securities, the firm is performing which of the following? A) agreeing to market the securities to investors for a fee B) giving legal advice to the firm that is issuing the securities C) offering to purchase the securities from the firm, thereby assuming the risk of resale to investors D) agreeing to provide insurance that the firm's securities will sell for a price that is established by the firm
Answer: C
34) Three ways that savings can be transferred through the financial markets include all of the following EXCEPT A) direct transfer of funds. B) indirect transfer using the investment banker. C) indirect transfer using the venture capital firm. D) indirect transfer using the financial intermediary.
Answer: C
38) A life insurance company purchases $1 billion of corporate bonds from premiums collected on its life insurance policies. Therefore A) the corporate bonds are indirect securities and the life insurance policies are direct securities. B) the corporate bonds are indirect securities and the life insurance policies are indirect securities. C) the corporate bonds are direct securities and the life insurance policies are indirect securities. D) the corporate bonds are direct securities and the life insurance policies are direct securities.
Answer: C
40) Advantages of private placements do NOT include which of the following? A) more financing flexibility B) lower flotation costs C) investor protection through extensive regulation D) funds which are available more quickly than through a public offering
Answer: C
40) Which of the following is an example of both a capital market and a primary market transaction? A) The U.S. Government sells 3-month Treasury bills. B) Microsoft common stock owned by an individual investor is sold to another investor. C) Ford Motor Company sells a new issue of common stock to raise funds through a public offering. D) No transactions occur in both primary and capital markets at the same time.
Answer: C
42) Which of the following is an advantage of organized stock exchanges? A) increased stock price volatility B) screening companies to ensure only low risk stocks are sold C) providing a continuous market D) Only profitable companies may issue new securities on an organized exchange.
Answer: C
5) A basis point is equal to A) one percent. B) one-tenth of one percent. C) one-hundredth of one percent. D) one-half of one percent.
Answer: C
51) The telecommunications system that provides a national information linkup among brokers and dealers operating in the over-the-counter market is called A) NCIS. B) NSQA. C) NASDAQ. D) NASQ.
Answer: C
53) Which of the following refers to all institutions and procedures that provide for transactions in short-term debt instruments generally issued by borrowers with very high credit ratings? A) capital market B) commercial banks C) money market D) stock market
Answer: C
58) Prices of securities that are traded on the organized exchanges are determined by A) a "bid" and "ask" negotiation process amongst brokers who hold these securities in their own account. B) the Securities Exchange Commission. C) a continuous auction process reflecting the sentiments of buyers and sellers. D) the sellers of the securities.
Answer: C
60) The Securities and Exchange Commission (SEC) A) regulates only initial public offerings, or IPOs. B) regulates only primary market transactions to ensure investors are provided with adequate and accurate information on new securities. C) regulates both primary and secondary markets. D) regulates initial public offerings, but not seasoned equity offerings, in the primary market.
Answer: C
61) The New York Stock Exchange (NYSE) is A) an automated electronic trading platform. B) an auction market with face-to-face trading on the floor of the stock exchange in addition to automated, electronic trading. C) a hybrid market, allowing for face-to-face trading on the floor of the stock exchange in addition to automated, electronic trading. D) primarily a futures market.
Answer: C
7) The one-year interest rate is 4%. The interest rate for a two-year security is 6%. According to the unbiased expectations theory, the one-year interest rate one year from now must be equal to A) 5.00%. B) 8.00%. C) 8.04%. D) 10.00%.
Answer: C
7) The real rate of return is the return earned above the A) default risk premium. B) risk-adjusted return. C) inflation risk premium. D) variability of returns measured by standard deviation.
Answer: C
8) The one-year interest rate is 4%. The interest rate for a two-year security is 6%. The one-year interest rate one year from now is 8.34%. According to the liquidity preference theory, the risk premium for the second one-year investment is A) 0.50%. B) 0.34%. C) 0.30%. D) 1.66%.
Answer: C
9) What was the average annual rate of return on 3-month U.S. Treasury bills during the period 1990 to 2014? A) 2.15% B) 4.23% C) 3.04% D) 5.68%
Answer: C
9) You are considering an investment in a U.S. Treasury bond but you are not sure what rate of interest it should pay. Assume that the real risk-free rate of interest is 1.0%; inflation is expected to be 1.5%; the maturity risk premium is 2.5%; and, the default risk premium for AAA rated corporate bonds is 3.5%. What rate of interest should the U.S. Treasury bond pay? A) 8.5% B) 6.0% C) 5.0% D) 2.5%
Answer: C
12) Which of the following is NOT a valid theory that attempts to explain the shape of the term structure of interest rates? A) the unbiased expectations theory B) the liquidity preference theory C) the market segmentation theory D) the Fisher Effect theory
Answer: D
13) Over the period 1926 to 2014, the standard deviation of returns has been the greatest for which of the following? A) Treasury bills B) corporate bonds C) government bonds D) common stocks
Answer: D
16) Rogue Industries reported the following items for the current year: Sales = $3,000,000; Cost of Goods Sold = $1,500,000; Depreciation Expense = $170,000; Administrative Expenses = $150,000; Interest Expense = $30,000; Marketing Expenses = $80,000; and Taxes = $300,000. Rogue's gross profit is equal to A) $770,000. B) $1,070,000. C) $1,100,000. D) $1,500,000.
Answer: D
22) A corporation sells securities to an investment banking firm on January 1st. The next day an international oil crisis causes stock prices to drop dramatically. The corporation is immune from the drop in price of its stock due to which function of the investment banking firm? A) hedging B) distributing C) reinsurance D) underwriting
Answer: D
26) Activities of the investment banker include A) assuming the risk of selling a security issue. B) selling new securities to the ultimate investors. C) providing advice to firms issuing securities. D) all of the above
Answer: D
27) The investment banker does NOT underwrite the securities to be issued in which of the following? A) initial public offering B) primary market transaction C) firm commitment D) best efforts
Answer: D
28) Which of the following relationships is true regarding the costs of issuing the following securities? A) common stock > bonds > preferred stock B) preferred stock > common stock > bonds C) bonds > common stock > preferred stock D) common stock > preferred stock > bonds
Answer: D
32) Investment banking firms offer to facilitate the sale of securities to the public in a variety of ways. Which of the following methods guarantees the corporation with a pre-determined price for the securities? A) a best efforts basis B) a commission basis C) a competitive bid D) an underwriting
Answer: D
32) Money-market instruments include A) common stock. B) preferred stock. C) T-bonds. D) T-bills.
Answer: D
34) Commercial banks that also provide investment banking services are called A) conglomerate banks. B) multi-purpose banks. C) investment enhanced banks. D) universal banks.
Answer: D
35) A wealthy private investor providing a direct transfer of funds is called A) a venture capitalist. B) an investment banker. C) a financial intermediary. D) an angel investor.
Answer: D
37) Which of the following statements is MOST correct concerning flotation costs? A) Flotation costs are the same for common stock, preferred stock and bonds because they reflect mainly printing costs and legal fees. B) Flotation costs are generally higher for bonds rather than stocks because the dollar amounts involved are much higher, allowing for economies of scale. C) Flotation costs as a percentage of gross proceeds increase as the size of the security issue increases. D) Flotation costs are higher for common stocks than for preferred stocks and bonds due to the higher level of risk associated with owning common stock.
Answer: D
38) Private placements are A) limited to debt securities. B) limited to equity securities. C) available for both debt and equity securities, but the market is dominated by equity issues. D) especially appealing to new, small, and medium-sized companies.
Answer: D
4) The nominal interest rate is 7% and the expected inflation rate is 2%. Based on the Fisher effect, the real rate of interest is A) 5.0%. B) 6.86%. C) 5.1%. D) 4.9%.
Answer: D
44) The Sarbanes-Oxley Act of 2002, in order to protect investors, requires a higher level of accountability for which of the following groups? A) corporate officers B) public accountants C) boards of directors D) all of the above
Answer: D
45) The Sarbanes-Oxley Act of 2002 holds all of the following groups strictly accountable in a legal sense for any instances of misconduct EXCEPT A) company officers. B) outside members of the board of directors. C) lawyers. D) investors.
Answer: D
46) The Sarbanes-Oxley Act, or SOX A) holds corporate advisors strictly accountable in a legal sense for any instances of misconduct. B) pretexts the interests of shareholders by providing greater protection against accounting fraud and financial misconduct. C) reduces the cost of financial reporting by standardizing reporting requirements. D) accomplishes both A and B.
Answer: D
49) An example of a secondary market transaction involving a capital market security is A) a new issue of a security with a very short maturity. B) a new issue of a security with a very long maturity. C) the transfer of a previously-issued security with a very short maturity. D) the transfer of a previously-issued security with a very long maturity.
Answer: D
52) Insurance companies invest in the "long-end" of the securities market by purchasing securities with longer maturities. In which of the following instruments would an insurance company be least likely to invest most of its assets? A) corporate stocks B) corporate bonds C) mortgages D) commercial paper
Answer: D
54) Which of the following is NOT a benefit provided by the existence of organized security exchanges? A) providing a continuous market B) establishing and publicizing fair security prices C) helping businesses raise new capital D) standardization of all debt agreements
Answer: D
56) Money-market transactions include which of the following? A) any security that is paid for with cash B) 30-year U.S. Treasury bonds C) all securities paid for with the proceeds of a money-market account D) securities that have a maturity of less than one year
Answer: D
59) Prices of securities that are traded in the Over-the-Counter Markets are determined by A) the Federal Trade Commission. B) a continuous modified auction process. C) the buyers of these securities. D) a "bid" and "ask" negotiation process of broker-dealers of these securities.
Answer: D
6) The prime lending rate is the base rate on A) mortgage loans. B) home equity loans. C) auto loans. D) corporate loans.
Answer: D
8) The risk premium would be greater for an investment in an oil and gas exploration in unproven fields than an investment in preferred stock because A) oil and gas exploration investments have a greater variability in possible returns. B) the preferred stock is more liquid. C) the inflation rate would vary more with oil and gas exploration investments. D) both A and B
Answer: D
21) Examine the securities below and identify the security with the highest liquidity premium, the highest default risk premium, and the highest maturity premium. a. 30-year U.S. Government Treasury bond maturing in 2025 b. 25-year Bbb-rated corporate bond maturing in 2030, actively traded on the New York Exchange c. 10-year Aaa-rated corporate bond maturing in 2020, thinly traded on a regional exchange d. 3-month U.S. Treasury bill
Answer: The 10-year Aaa-rated corporate bond has the highest liquidity premium because it is not actively traded and may be difficult to turn into cash on short notice. The Bbb-rated corporate bond has the highest default risk premium. The U.S. Government securities are virtually default risk free, and the other corporate bond is Aaa rated. The 25-year Bbb-rated corporate bond maturing in 2030 has the highest maturity premium. Although the Treasury bond had a longer maturity when issued, currently the 25-year Bbb bond has the longest time left to maturity.
18) An investor buys a 20-year Bbb-rated corporate bond with a nominal annual rate of return of 10%. The average inflation rate is expected to be 2%. The default risk premium is expected to be 5% and the maturity premium is 4%. Calculate the real rate of interest.
Answer: krf = k* + IRP + (k* × IRP) 10% = k* + 2% + (k* × 2%) 8% = 1.02 k* 7.84% = k*
22) Given the anticipated rate of inflation (i) of 2.13% and the real rate of interest (R) of 3.1%, find the nominal rate of interest (r).
Answer: r = R + i + Ri r = .031 + .0213 + (.031)(.0213) r = .0523 + .0006603 r = .05296 = 5.3%
21) If provided the nominal rate of interest (r) of 7.4% and the anticipated rate of inflation (i) of 4.5%, what is the real rate of interest (R)?
Answer: r = R + i + Ri .074 = R + .045 + (.045)(R) .074 - .045 = 1.045R .029 = 1.045R R = .02775 = 2. 78%
20) The date today is January 1, 2010. A one-year security maturing on 1/1/11 yields 3%. A two-year security maturing on 1/1/12 yields 6%. A three-year security maturing on 1/1/13 yields 11%. Calculate the expected annual return on a two-year security beginning 1/1/11 and maturing on 1/1/13.
Answer:$1,000 × (1.11)3rd power = $1,367.63 at the end of three years (1/1/13) $1,000 × (1.03) = $1,030 at the end of one year (1/1/11) $1,367.63 - $1,030 = $337.63 to be earned on two-year security from 1/1/11 to 1/1/13 $1,030 × (1 + k)2nd power = $1,367.63 k = ($1,367.63/$1,030).5 - 1 = 15.23%
