FIN300 Test #2
Omega Inc. is converting a $1,000 convertible bond with a conversion ratio of 50 into 50 shares of common stock. The conversion price is:
$20
A $1,000 convertible bond with a conversion ratio of 25 can be converted into 25 shares of common stock. The conversion price is:
$40
Alpha Inc. is evaluating three independent projects for investment - Project A, Project B, and Project C using the net present value (NPV) approach. The net present value (NPV) of Project A is $11,250, Project B is $31,650, and Project C is $4,500. Assume that Alpha has sufficient capital invest in all the prjects. An efficient financial manager will take the capital budgeting decision in such a manner that the shareholders' wealth will increase by ________.
$42,900
A share of perpetual preferred stock pays an annual dividend of $10 per share, If investors require a 15 percent rate of return, what should be the price of this preferred stock?
$66.67
A few years ago, Tangerine Technology issued a bond that has a face value equal to $1,000 and pays investors $20 interest every six months. The bond has eight years remaining until maturity. If an investor requires and 8 percent rate of return to invest in this bond, what is the maximum price he or she should be willing to pay to purchase the bond? (Round the answer to two places of the decimal).
$766.95
A firm's total investment in an investment fund is $2 million. The amount invested in Stocks A, B, C, and D are 1.50, 0.50, 1.25, and 0.75 respectively. Calculate the beta of the investment fund.
0.91
Beige Infotech plans to issue bonds with a par value of $1,000 and 12 years to maturity. These bonds will pay $50 interest every 6 months. Current market conditions are such that the bonds will be sold to net $874.50. Which of the following is the yield to maturity (YTM) of an issue that a broker would quote to an investor is ? (Round the answer to the nearest whole number.)
12%
A stock has a beta coefficient equal to 1.20. The risk premium associated with the market is 9%, and the risk-free rate is 5%. Application of the capital asset pricing model indicates that the stock's appropriate return should be _______.
15.8%
An investor is planning to invest in the stock of Zync Corporation. The probability of the return being 12% if 0.25, 15.0% is 0.10, and 18.0% is 0.65. Given the probability distributions, what is the expected rate of return for the investment?
16.20%
The risk-free rate is 4%, the market risk premium is 6%, and the market return is 10%. Stock A's beta is 2.1 and the standard deviation of its returns is 62.5%. What should be the stock's expected rate of return to make the investor indifferent toward buying or selling the stock? (Round off the answer to two decimal places.)
16.60%
Oakdale Furniture Inc. has a beta coefficient of 0.7 and a required rate of return of 15%. The market risk premium is currently 5%. If the inflation premium increases by 2 percentage points and Oakdale acquires new assets which increase its beta by 50%, what will Oakdale's new required rate of return be?
18.75%
A firm has a EBIT of $30 million, a total invested capital of $104 million, and an average cost of funds of 15%. The firm has a marginal tax rate of 40% and 8.5 million shares of the firm are outstanding. what is the EVA of the firm?
2.40 million
The standard deviation of the return on Stock Y is 47.5%, and the expected return from the stock is 16%. Calculate the coefficient of variation of the stock. (Round your answer to two decimal places.)
2.97
Sam is considering investing a part of his savings in the stock of Simmons Corporation. For the stock of Simmons Corporation, the probability of the return being 15% is 0.3, 10% is 0.5, and 20% is 0.2. Compute the standard deviation of the returns on the stock with the given information. (Round your answer to three decimal places.)
3.905%
The risk-free rate is 2.80%, and the expected market return is 4.00%. The expected return on Security X is 7.50%, what is the beta of the security?
3.92
Trueware's preferred stock currently has a market price equal to $120 per share. If the dividend paid on this stock is $8.25 per share, what is the required rate of return investors are demanding from Truware's preferred stock?
6.88%
Chi Corporation's beta (a measure of its systematic risk) is 0.91 and the required rate of return on its stock is 15.60%. If the market return is 16.25 percent, what is the risk-free rate of return
9.03%
Which of the following is considered as a Yankee stock?
A German stock traded in the US
Identify the correct statement about risk-reward relationship.
A nondiversifiable risk is rewarded with additional returns.
The risk of which of the following portfolios is equal to the market risk?
A portfolio with a beta of 1.0
Which of the following statements is true of a project with larger early cash inflows?
A project with larger early cash inflows provides more funds for reinvestment in the early years.
Which of the following statements is true of a required rate of return?
A required rate of return is the discount rate the IRR must exceed for a project to be considered acceptable.
_________ enable investors to participate in the international financial markets without having to bear risks.
American Depository Receipts (ADRs)
Which of the following statements is true of a project with net present value (NPV) of zero?
An NPV of zero signifies that the projects required rate of return is equal to its internal rate of return.
The next expected dividend for Stock B is $3, and the current price of the stock is $18. Its earnings, dividends, and price can be expected to grow at a constant rate of 5% per year. The risk free rate is 4%, the market risk premium is 7%, and the stock's beta is 3.2. Based on the given information, which of the following statements is correct?
An investor should not buy this stock because its expected return is 21.67%, and its required rate of return is 26.40%.
The expected returns for Stocks A, B, C, and D are 10%, 14%, 16%, and 17% respectively. The corresponding standard deviations for these stocks are 18%, 16%, 20%, and 28% respectively. Based on their coefficients of variation, which of the securities is least risky for an investor? Assume all investors are risk-averse and the investments will be held in isolation.
B
The risk-free rate of return is 5%, and the market return is 8%. The betas of Stocks A, B, C, and D, are 0.62, 0.90, 1.30, and 1.45, respectively. The espected rates of return for Stocks A, B, C, and D are 6.2%, 7.7%, 9.5%, and 10.5% respectively. An investor will be indifferent towards buying or selling which of the above stocks?
B
Identify the risk which is irrelevant for the purpose of determining the risk premium of a security
Business risk
Which of the following is true about the call provision?
Call provisions state that the company must pay an amount grater than the par value of the preferred stock.
The price of a stock has increased by $10. Which of the folowing is a probable reason for the increase in stock price?
Decrease in the expected rate of return
Which of the following is included in diversifiable risk?
Default risk
Which of the following statements is true of semiannual compounding/
Each interest payment is half as large as the annual interest payment
The ______ is based on the concept that the earnings generated by a compnay must be sufficient to compensate investors who provide funds.
Economic value added (EVA)
A stock issued in Japan, traded in Germany is known as _______.
Euro stock
Any debt sold in a country other than the one in whose currency it is denominated is referred to as:
Eurodebt
a deposit in a foreign bank that is denominated in U.S. dollars is called a:
Eurodollar deposit
__________ are backed by government's ability to tax its citizens.
General obligation bonds
Which of the following is true about the change in the price of a stock?
If investors expect their investments to generate lower future cash flows, then prices should fall.
Which of the following statements about the various types market and firm-specific risks is true?
Inflation risk is a relevant risk
Which os the following loans requires the principal amounts to be repaid in several payments during the lives of the loans?
Installment loans
Which of the following risks is relevant for the purpose of determining the risk premium of a security?
Liquidity risk
Which of the following results from a higher risk and a more restricted market for lower-grade bonds?
Lower-grade bonds offer higher returns than high-grade bonds
A portfolio's beta coefficient is measure of its _________.
Market risk
Which of the following risks is referred to as relevant risk?
Market risk
Identify the pair of risks where both the components are referring to the same kind of risk.
Market risk and nondiversifiable risk
Which of the following capital budgeting methods is used if the projects being evaluated have multiple internal rates of return?
Modified internal rate or return method
Which of the following methods determines the acceptability of a project based on the greatest value addition to the firm?
Net Present value (NPV) method
Which of the following capital budgeting techniques has experienced the greatest increase in usage by firms since the 1970's?
Net present value
Which of the following methods gives a direct measure of the dollar benefit on a present value basis to the firm's shareholders?
Net present value (NPV) method
A capital budgeting project should be accepted if its NPV is:
Positive after discounting all the cash inflows and outflows for the project
Which of the following is a good indicator of the value of a stock?
Price earnings ratio
Par value, maturity value, face value, and ___________ are used interchangeably to designate the borrowed amount that must be repaid by the borrower.
Principal value
Azure Inc. is evaluating two mutually exclusive projects - Project A and Project B. The initial cash outflow is $20,000 for each project. Project A results in cash inflows of $12,500 every year for two years. Project B results in cash inflows of $26,000 in the second year. The required rate of return of Azure Inc. is 10%. Based on the net present value approach, Azure Inc. should invest in:
Project A only
What action should a firm take when the price of its common stock is undervalued?
Repurchase shares of common stock
_______ are used to raise funds for projects that will generate revenues that contribute to payment of interest and repayment of debt.
Revenue bonds
Identify the correct statement about various kinds of risk.
Standard deviation is the measure of total risk, whereas beta is the measure of systematic risk.
The standard deviations of Stocks A, B, C, and D are 12.5%, 8.0%, 20.2%, and 15.3%, respectively. The betas for the stocks are 1.0, 0.5, 2.4, and 3.0 respectively. According to the given information, which of the stock would be considered riskiest in a diversified portfolio of investments?
Stock D, because it has the highest beta
What does a stock's payback period of 12 indicate?
The P/E ratio of the stock is 12
Which of the following is required to compute the internal rate of return (IRR) of a project?
The cash inflows and cash outflows for the project
Which of the following statements is true of the discounted payback period method?
The discounted payback period uses present value of cash flows to compute payback period.
Which of the following is a limitation of the net present value (NPV) method over the internal rate of return (IRR) method of capital budgeting?
The net present value (NPV) method contains no information about the amount of capital at risk.
Which of the following statements is true of semiannual compounding?
The number of payments is twice the number of years in a bond's term
Which of the following statements is true of a project with a negative net present value (NPV)?
The projects's required rate of return would exceed the internal rate of return (IRR).
If investors of a stock conclude that the inflation rate is going to decrease, which of the following changes would occur?
The risk fee rate of return would decrease
Stock Q has a beta equal to 1.6 and Stock P has a beta equal to 0.8. Based on this information, according to the capital asset pricing model (CAPM), which of the following statements is correct?
The risk premium associated with Stock Q, RPq, should be two times the risk premium associated with Stock P,RPp.
The expected value of a company's stock is $18. The investors expect that the stock will generate a future cash flow of 8% instead of 5%. What will be the impact on the stock price of the firm, because of the change in the expected cash flow?
The stock price will increase
Which of the following is true about a fully diversified portfolio?
The unsystematic risk of a fully diversified portfolio is zero.
Which of the following statements about diversification or reduction of risk is correct?
The weaker the positive correlation two stocks exhibit, the more risk can be reduced when they are combined in a portfolio.
An example of a short-term debt instrument is a:
Treasury bond.
Which of the following statements is true of the internal rate of return (IRR) method?
Using the IRR method could lead to investment decisions that increase wealth but do not maximize it.
Which of the following statements about a change in the average investor's risk aversion and its impact on the required rate of return is correct?
When the average investor's aversion to risk changes, investments with higher beta coefficients experience greater changes in their required rates of return than investments with lower betas
A(n) _______ is a stock issued by a foreign company that is traded in the United States.
Yankee stock
The average rate of return earned on a bond if it is held until the first call date is called the:
Yield To Call
When investors purchase preferred stock, they generally expect to receive _____
a constant dividend
The recovery of a project's initial investment on a present value basis prior to the end of the project's useful life results in ______.
a positive net present value (NPV)
Which of the following securities is similar to bonds (debt) in some respects, but similar to common stock in other respects?
a preferred stock
Which of the following is true about the convertibility provision of a preferred stock?
a preferred stock can be converted into a common stock
In a given average beta portfolio, replacing an existing investment with a higher beta investment, will lead to _________.
an increase in the required rate of return of the portfolio
A trustee represents the:
bondholders
Changes in a firm's bond rating affect both the firm's ability to ______ as well as the ________.
borrow long-term capital; cost of such funds
Most corporate bonds contain a call provision, which gives the issuing firm the right to:
call in the bonds for redemption.
The computation for a bond's yield to call (YTC) is different from that for its yield to maturity (YTM) because the ______ of the bond is substituted for the maturity (par) value.
call price
A provision in a bond contract that gives the issuer the right to recall the bond and repay it prior to the stated maturity date is referred to as a(n):
call provision
The growth rate of a stock, g, represents the stock's:
capital gains rate (yield)
Which of the following best describes American depository receipts (ADRs)?
certificates created by organizations such as banks; they represent ownership in stocks of foreign companies that are held in trust by banks located in countries where the stocks are traded.
With reference to an investment, risk refers to the _____.
chance of actual returns being the same as expected
Which of the following is a type of promissory note issued by large, financially sound firms?
commercial paper
Which of the following shor-term debts is issued in denominations of $100,000 by large, financiially sound firms?
commercial paper
At the time a bond is issued, the _______ generally is set at a level that will cause the market price of the bond to equal its par value.
coupon rate
A protective feature on a preferred stock that requires preferred dividends previously not paid to be disbursed before any common stock dividends can be paid are known as a ______.
cumulative provision
The greater a bond's ___________, the greater the risk premium associated with the bond.
default risk
Reduction of stand-alone risk of an individual investment, measured by the standard deviation of its returns, by combining it with other investments in a portfolio is called _________.
diversification
The rate of return an investor expects to earn on a stock consists of the expected growth rate, or capital gains yield, that is associated with the stock and the _________ generated by the stock.
dividend yield
The mean value of the probability distribution of possible returns from an investment is known as the investment's __________.
expected rate of return
Loans from one bank to another bank are called:
federal funds
a corporate bond's fixed coupon rate of interest results in:
fixed interest payments
A conversion feature permits a bondholder (investor) to exchange, or convert, the bond into shares of the company's common stock at _______.
fixed price
Since many Eurocredits are very large, the lending bank:
forms a loan syndicate to help raise the needed funds
The holders of a ______ class of stock will not receive dividends until the company establishes its earning power by building up retained earnings to a designated level.
founders' shares
When computing a project's modified internal rate of return (MIRR), its terminal value is determined by computing the _____.
future value of the expected cash inflows
One reason a lower-grade bond offers higher returns than a high-grade bond is that a lower-grade bond:
has a higher risk and a more restricted market than a high-grade bond.
When are preferred stockholders given the right to vote for directors?
if the company has not paid the preferred dividend for a specified period
The value of a bond is determined by computing the present value of the ______ and the present value of the _______.
interest payments; maturity value
The point where the NPV profile on a graph that shows the net present values for a project at various discount rates crosses the X
internal rate of return
According to the CAPM, __________.
investors should expect to be rewarded for only the systematic risk associated with an individual investment, the systematic risk being measured by the beta coefficient.
The coupon rate on a bond is set immediately before the bond is issued by the firm so that the bond's:
issuing price equals its face (par) value
Which of the following statements is true about a fully-diversified portfolio?
it has systematic risk, but no unsystematic risk
Which of the following is true about proxy?
it involves the transfer of the right to vote to a second party by means of an instrument.
If the market interest rates are greater than the coupon interest rate of a bond, the market value of the bond will be:
less than the maturity value of the bond
Systematic risk includes ____________.
liquidity risk
Which of the following bond values fluctuates continuously during the life of a bond?
market value
When the __________ value of debt is the same as its face value, it is said to be selling at __________ value.
market; par
Standard deviation of the returns on a stock is __________.
measure of the tightness, or variability, of a set of returns
Federal funds are borrowed by banks from other banks with excess reserves to:
meet the reserve requirements of the Federal Reserve.
A bond secured by tangible (real) assets is termed a ____________ bond.
mortgage
If two projects are of equal size and have the same life, then the ______ and the ______ will always lead to the same project selection decision.
net present value (NPV), modified internal rate of return (MIRR)
A firm has the right to handle a sinking fund by randomly calling for redemption a certain percentage of the bonds each year at _________ value
par
The _______ establishes the amount due to the preferred stockholders in the event the firm is liquidated
par value
As per the _______ method of capital budgeting, it is better to recover the cost of (investment in) a project sooner rather than later.
payback period
The length of time required to recover the original cost of an investment is known as the investment's _____.
payback period
Capital budget is an outline of _________.
planned expenditures on fixed assets
A _______ gives existing stockholders the right to purchase shares of new issues of a firm's common stock on a pro rata basis
preemptive right
The _______ is stated as a percentage of par value
preferred dividend
The call provision is applicable to which of the following types of stock?
preferred stock
Which of the following securities gives the right to vote for directors if the company does not pay the dividend for a specified period?
preferred stock
which of the following types of security can be converted into a common stock?
preferred stock
A bond that has a market value greater than its par value is called a ______ bond.
premium
the value of a bond is calculated by computing the ______ of all expected future cash flows.
present value
The value of a stock is determined by computing the _____ of all of the ______ the stock is expected to generate in the future.
present value; dividends
_________ risk and _________ risk tend to offset each other.
price; reinvestment
A(n) _________ is the discount rate that forces the present value of a project's expected cash flows to equal its initial cost-- that is, the rate where the project's net present value equals zero.
project's internal rate of return
A project's traditional payback period is defined as the expected number of years required to _____.
recover the original investment
The principal value of debt:
represents the amount owed to the lender, which must be repaid.
Investors that demand higher rates of return to invest in higher-risk securities are known as _________.
risk-averse investors
According to CAPM, the risk premium for any investment is the return that is generated in excess of the ________.
risk-free rate of return
Other things held constant, if the expected inflation rate increases, the new security market line (SML) would _________.
shift up
A provision that facilitates the orderly retirement of a bond issue is a:
sinking fund
The total, or stand-alone risk associated with a stock is determined by the _________.
standard deviation of the stock's returns
The total risk associated with an investment can be divided into ________.
systematic risk and diversifiable risk
The x-axis of the SML indicates the ____.
systematic risk of security as measured by it beta coefficient
The future value of the cash inflows is called the
terminal value
Alpha Corporation's bond with a face value of $1,000 is currently selling at a discount in the financial markets. If the bond's yield to maturity is 12.5%, _______
the bond's coupon rate of interest will be less than 12.5%
The percentage rate of return on a bond consists of the current yield plus:
the capital gains yield
The net present value (NPV) method assumes that ______.
the cash flows from a project can be reinvested at the firm's required rate of return
A constant growth model is meaningless when ________.
the expected growth rate is greater then the required rate of return
For a risk-averse investor, all other things held constant, the higher a security's risk, ______.
the higher the return investors demand, and thus the less they are willing to pay for the investment.
Reinvested cash flows will earn a lower rate of return if:
the interest rate declines
Identify a limitation of the internal rate of return (IRR) method of capital budgeting.
the internal rate of return (IRR) can give multiple internal rates of returns (IRRs) for one project.
In evaluating independent projects, if a project is acceptable using the internal rate of return (IRR) method, then _____.
the net present value (NPV) method will also show that it is acceptable
Suppose the interest rate on a 10%, 12 year, 0 coupon bond with a $1,000 face value falls from 10% to 8%. which of the following is true of the value of the bond?
the present value of the bond at 8% is $397.11
The value of a firm increases if _______.
the present value of the cash inflows of a project is greater then its cost
If two mutually exclusive capital budgeting projects have positive NPVs, then ____.
the project with the highest NPV should be purchased
As investors' risk aversion increases _______.
the risk premium increases and the slope of SML becomes steeper
A trustee guarantees that:
the terms of the bond indenture are carried out.
The smaller the value of the standard deviation of the returns of an investment, _________.
the tighter the probability distribution, and the lower the total risk associated with the investment
To compute a project's traditional payback period (PB), the _______ cash flows that it is expected to generate during its life are used; to compute a project's discounted payback period (DPB), the _______ of the cash flows that it is expected to generate during its life are used.
unadjusted; present value
The coefficient of variation is calculated ______.
by dividing the standard deviation of the returns by the expected return.
How can a firm include a maturity option with a preferred stock issue?
by including a call provision with a sinking fund
The portion of the total return on a bond attributed to the annual interest that the bond pays is called the ______ yield.
current
Which of the following mathematical expressions computes current yield?
current yield = bond yield - capital gains yield
As the principal value of a debt is repaid at the maturity date, it is referred to as the ________ value.
maturity
The date on which the principal amount of a debt is due is referred to as the:
maturity date
By including a call provision with a sinking fund, a firm essentially adds a _______ to the preferred stock.
maturity option
When economic conditions change, a bond that sold at par when it was issued will sell for more or less than par after its issue, depending on the relationship between the bond's _____ and the bond's _______.
prevailing market rates; coupon rate
The ___________ must be repaid at some point during the life of the debt.
principal value of debt.
A listing of all possible returns on an investment, with a chance of occurrence assigned to each return is known as _____.
probability distribution
When will a firm repurchase shares of its common stock in the financial markets?
the management wants to gain more ownership control of the firm
