Finance Exam 3
supplemental liquidity providers (SLPs)
Investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (i.e., offering to either buy or sell). They trade purely for their own accounts.
You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur?
Long-term, zero coupon
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
Nasdaq Level 1
designed to provide a timely, accurate source of price quotations.
A decrease in which of the following will increase the current value of a stock according to the dividend growth model?
discount rate
Nasdaq Level 3
for market makers only -allows Nasdaq dealers to enter or change their price quote information.
Which one of the following represents the capital gains yield as used in the dividend growth model?
g
When using the two-stage dividend growth model:
g1 can be greater than R.
As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:
increases at an decreasing rate.
Nominal rates
interest rates or rates of return that have NOT been adjusted for inflation
real rates
interest rates or rates of return that have been adjusted for infaltion.
Bonds and interest rates
inverse relationship
Supernormal growth is a growth rate that
is unsustainable over the long term.
The current yield is defined as the annual interest on a bond divided by the:
market price
GEO Inc. has paid annual dividends of $.41, $.47, and $.53 a share over the past three years, respectively. The company expects to now maintain a constant dividend. At a discount rate of 14.4 percent, what is the current value per share?
p0=.53/.144=3.68
Global Logistics just announced it is increasing its annual dividend to $1.68 next year and will increase that dividend by 1.85 percent annually thereafter. How much will one share of this stock be worth ten years from now if the required rate of return is 12.8 percent?
p=D0(1+g)/R-g ($1.68(1+.0185)^10/(.128-.0185)= $18.43
National Trucking has paid an annual dividend of $1 per share on its common stock for the past 15 years and is expected to continue paying a dollar a share long into the future. Given this, one share of the firm's stock is:
priced the same as a $1 perpetuity.
What six components make up a bond's yield?
real rate of interest, expected future inflation, interest rate risk, default risk, taxability, lack of liquidity.
Dividend Growth Model
requires the growth rate to be less than the required return.
inside quotes
the highest bid quotes and the lowest ask quotes for a nasdaq-listed security
dirty price of bond
the price of a bond including accrued interest, AKA as the full or invoice price. This is the price the buyer actually pays.
Yield to Maturity (YTM)
the rate required in the market on a bond.
term structure of interest rates
the relationship between nominal interest rates on default-free, pure discount securities and time to maturity; that is, the pure time value of money
Fisher effect
the relationship between nominal returns, real returns, and inflation R=(1+r)*(1+h)
Coupon
the stated interest payment made on a bond.
indenture
the written agreement between the corporation and the lender detailing the terms of the debt issue
Government Bonds
bonds issued by the government; have no default risk and issues are exempt from state income taxes.
floating rate bonds
bonds with interest rates that change with current interest rates otherwise available in the economy
The common stock of Water Town Mills pays a constant annual dividend of $2.25 a share. What is one share of this stock worth at a discount rate of 16.2 percent?
$2.25/.162=$13.89
Debt vs. Equity
-Creditors generally receive the first claim on the firm's cash flow. -Shareholder's equity is the residual difference between assets and liabilities.
Home Services common stock offers an expected total return of 14.56 percent. The last annual dividend was $2.27 a share. Dividends increase at a constant 2.1 percent per year. What is the dividend yield?
.1456-.012=.1246=12.46%
Gee-Gee common stock returned a nifty 21.6 percent rate of return last year. The dividend amount was $.25 a share which equated to a dividend yield of 1.01 percent. What was the rate of price appreciation for the year?
20.59% g=.216-.0101= .2059
You own one share of a cumulative preferred stock that pays quarterly dividends. The firm has recently suffered some financial setbacks and has failed to pay the last two dividends. However, new funding has been arranged and the firm intends to restore all dividends, both common and preferred, this quarter. As a preferred shareholder, you should expect to receive the equivalent of ________ quarter(s) of dividends when the next dividend is paid.
3
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
3(1.50)=$4.50
zero coupon bond
A bond that makes no coupon payments and is thus priced at a deep discount.
Dividend yield
A stock's expected cash dividend divided by its current price.
What are bid and ask prices?
Bid: price dealer quotes to buy security Ask: price dealer quotes to sell a security
A bond that can be paid off early at the issuer's discretion is referred to as being which type of bond?
Callable bond
Allison just received the semiannual payment of $35 on a bond she owns. Which term refers to this payment?
Coupon rate because a periodic payment is received against pre-defined coupon rates.
Jason's Paints just issued 20-year, 7.25 percent, unsecured bonds at par. These bonds fit the definition of which one of the following terms?
Debenture; -Unsecured bonds issued by companies are called debentures. These debentures carry a fixed rate of coupon payments. These coupon payments are paid at regular intervals specified in the indenture.
A discount bond's coupon rate is equal to the annual interest divided by the:
Face value
Bert owns a bond that will pay him $45 each year in interest plus $1,000 as a principal payment at maturity. What is the $1,000 called?
Face value
Who can access Level 3 of NASDAQ's information?
NASDAQ market makers
designated market maker (DMM)
NYSE members who act as dealers in particular stocks. Formerly known as "specialists"
floor brokers
NYSE members who execute customer buy and sell orders
Three Corners Markets paid an annual dividend of $1.42 a share last month. Today, the company announced that future dividends will be increasing by 1.3 percent annually. If you require a return of 14.6 percent, how much are you willing to pay to purchase one share of this stock today?
P0 = [$1.42(1.013)]/(.146 − .013)P0 = $10.82
Dee's made two announcements concerning its common stock today. First, the company announced that the next annual dividend will be $1.58 a share. Secondly, all dividends after that will decrease by 1.15 percent annually. What is the value of this stock at a discount rate of 15.5 percent?
P0=$1.58/(.155-(-.0115) =$9.49
Sweatshirts Ltd. is downsizing. The company paid an annual dividend of $4.20 last year and has announced plans to lower the dividend by 25 percent each year. Once the dividend amount becomes zero, the company will go out of business. You have a required rate of return of 18 percent on this particular stock. What are your shares in this firm worth today on a per share basis?
P0=D0(1+g)/(R-g) P0=4.20(1-.25)/(.18-(-.25))=$7.33
Currently, a firm has a benchmark PE of 11.7 and an EPS of $3.20. Earnings are expected to grow 3.2 percent annually. What is the implicit rate of return?
P0=EPS(PE) P0=$3.20(11.7)=$37.44 P1=$3.20(1+.032)(11.70=$38.638 R=38.638-37.44/37.44=.0320=3.30%
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?
P4=$2.32(1+.023)^4*13.5=$34.15
The current dividend yield on CJ's common stock is 1.89 percent. The company just paid an annual dividend of $1.56 and announced plans to pay $1.70 next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on this stock?
R= stock%+[(Div2-Div1)/Div1)] .0189+[(1.70-1.56)/(1.56)]=.1086=10.86%
The common stock of Dayton Repair sells for $47.92 a share. The stock is expected to pay $2.28 per share next year when the annual dividend is distributed. The company increases its dividends by 1.65 percent annually. What is the market rate of return on this stock?
R=D1/P0+g R= (2.28/47.92)+.0165=6.41%
Which one of the following statements is correct?
Stocks can have negative growth rates.
Coupon rate
The annual coupon divided by the face value of a bond.
A $1,000 par value corporate bond that pays $60 annually in interest was issued last year. Which one of these would apply to this bond today if the current price of the bond is $996.20?
The current yield exceeds the coupon rate. coupon rate = 60/1000 = 6% Bond is traded below its par as price is lower than 1000 and its discount bond Current yield = coupon amount/Price = 60/996.20 = 6.02%
capital gains yield
The dividend growth rate, or the rate at which the value of an investment grows.
clean price of bond
The price of a bond net of accrued interest; this is the price that is typically quoted.
face value (par value)
The principal amount of a bond that is repaid at the end of the term.
Maturity
The specified date on which the principal amount of a bond is paid. -once the bond has been issued, the number of years to maturity declines as time goes by.
World Travel has 7 percent, semiannual, coupon bonds outstanding with a current market price of $1,023.46, a par value of $1,000, and a yield to maturity of 6.72 percent. How many years is it until these bonds mature?
To solve for N first find the I/Y: (6.72/2)=3.36 and PMT: 35 next use cal i/y= 3.36, PV=-1,023.46, FV=1,000, PMT=35 -N= 25.02 now divide N by 2 25.02/2=12.53
The 7 percent bonds issued by Modern Kitchens pay interest semiannually, mature in eight years, and have a $1,000 face value. Currently, the bonds sell for $987. What is the yield to maturity?
To solve for R use a calculator first find PMT o Fin CAl N=8*2,PV=-987, FV=1,000 PMT=$35 Next find I/Y N=16, PV=-987,PMT=35,FV=1,000 I/y= 3.608% Now since the interest is semiannual multiply I/Y by two. 3.608% * 2=7.22%
You cannot attend the shareholder's meeting for Alpha United so you authorize another shareholder to vote on your behalf. What is the granting of this authority called?
Voting by proxy
Upward sloping
When long-term rates are higher than short-term rates, which of the following shapes will the term structure of interest rates usually have?
downward sloping
When short-term rates are higher than long-term rates
Which one of these equations applies to a bond that currently has a market price that exceeds par value?
YTM, < Coupon rate
All else constant, a bond will sell at ________ when the coupon rate is ________ the yield to maturity.
a discount; less than
treasury yield curve
a plot of the yields on treasury notes and bonds relative to maturity
nasdaq level 2
allows users to view price quotes from all Nasdaq market makers. -allows access to inside quotes -available on the web for usually a small fee
note
an unsecured debt, usually with a maturity under 10 years.