Finance Test 2

The greater the default risk, the higher the default risk premium. a. True b. False

a. True

The term structure of interest rates shows: a. How taxes impact the after tax rate of return on securities. b. How interest rates change over time. c. How securities that are similar in every other way but have different maturities have different yields. d. The relationship between default risk and return.

c. How securities that are similar in every other way but have different maturities have different yields.

A bond will sell at a discount if which of the following happened? a. Market interest rates became negative. b. Taxes increased. c. Interest rates rose above coupon rate. d. The bond was redeemed.

c. Interest rates rose above coupon rate.

Which of the following statements is true regarding real and nominal interest rates? a. Nominal interest rates are the real interest rate minus inflation b. Real interest rates are nominal interest rates plus inflation c. Real interest rates are nominal interest rates minus inflation d. Real interest rates are the ones you see in the market

c. Real interest rates are nominal interest rates minus inflation

The coupon rate refers to: a. The true market price of bond. b. The rate at which a bond price changes. c. The interest rate a bond pays. d. The rate at which investors buy a bond.

c. The interest rate a bond pays.

Quantitative easing came about because which policy was not working properly? a. Fiscal Policy b. Exchange Rate Policy. c. Trade Policy. d. Monetary Policy.

d. Monetary Policy.

Question Workspace Check My Work Which of the following statements is NOT CORRECT? a. The dividend yield is the percentage of how much of the stock's return is received as dividends. b. The capital gains yield is the annual percentage of a stock's change in price. c. The total return is equal to the dividend yield plus the capital gains yield. d. The capital gains yield is calculated as the dollar amount of the year's dividend payments divided by the current stock price. e. The dividend yield, the capital gains yield, and the total return are three key components of the Discounted Dividend Model.

d. The capital gains yield is calculated as the dollar amount of the year's dividend payments divided by the current stock price.

Coupon payments in finance refer to: a. Interest payment from owning a bond. b. Discounts paid to buyers. c. Dividends paid by stocks or equities. d. Admissions into a financial market.

a. Interest payment from owning a bond.

The key difference between investment grade bonds and junk bonds are: a. Liquidity risk. b. Default risk. c. Length to maturity. d. Prepayment risk.

b. Default risk.

Question Workspace Check My Work An inverted yield curve occurs when: a. Longer term bonds pay higher yields than shorter term bonds. b. Short term bonds pay higher yields than longer term bonds. c. Tax free bonds pay a higher yield than taxable bonds. d. Corporate bonds pay higher yields than government bonds.

d. Corporate bonds pay higher yields than government bonds.

The Beta of a stock measures: a. How the stock price moves relative to interest rate movements. b. How much dividends the corporation has paid in the past. c. How many times the stock has split. d. How the stock price moves relative to the rest of the market.

d. How the stock price moves relative to the rest of the market.

Which of the following statements is NOT CORRECT? a. For the discounted dividend model, you need to know the firm's dividend payments, the dividend growth rate, and the discount rate, or required rate of return. In addition, the model assumes that the firm will only be around for a finite period. The model cannot handle the assumption that there are an infinite number of dividend payments. b. To arrive at an estimate of the growth rate used in the discounted dividend model that determines how much dividends are expected to change each year, one looks at the company's history and likely future performance. c. The discounted dividend model calculates what the value of the stock price today should be, so we can then compare that value to the stock's current market price to determine whether to purchase, sell, or hold the stock. d. The discount rate, or required rate of return, used in the discounted dividend model reduces the values of future dividend payments to calculate their present values—which are used in arriving at the value of the stock price today. e. The discounted dividend model deals with a fundamental question in finance—the value or worth of a stock.

a. For the discounted dividend model, you need to know the firm's dividend payments, the dividend growth rate, and the discount rate, or required rate of return. In addition, the model assumes that the firm will only be around for a finite period. The model cannot handle the assumption that there are an infinite number of dividend payments.

A stock with a Beta of more than one: a. Has experienced price changes that are more volatile than the over market. b. Will reduce the overall volatility of a stock portfolio. c. Has paid out more than the rate of inflation. d. Has paid more dividends than the average stock in the market.

a. Has experienced price changes that are more volatile than the over market.

A bond will sell at a premium if which of the following happened? a. Interest rates fell below coupon rate. b. Tax rates increased. c. The borrower defaulted. d. The stock market increased.

a. Interest rates fell below coupon rate.

Question Workspace Check My Work The weights in the expected rate of return calculation must sum to equal: a. One. b. One hundred. c. The current real market interest rate. d. The expected rate of return.

a. One.

Which of the following statements is CORRECT? a. There are 2 different ways to calculate a bond's return. The main difference is with the life-span of the bond. If an issuer can call its bonds early, the relevant return calculation is the yield to call. However, if an issuer cannot call its bonds, the relevant return calculation is the yield to maturity. b. The yield to call is the return calculated on a bond that is held to maturity. c. The yield to maturity is the return calculated on a bond that is held until it is called, which is a shorter period than the bond's original life. d. The main difference between the yield to call and the yield to maturity calculations is that the dollar coupon payment differs on a callable bond than on a non-callable bond.

a. There are 2 different ways to calculate a bond's return. The main difference is with the life-span of the bond. If an issuer can call its bonds early, the relevant return calculation is the yield to call. However, if an issuer cannot call its bonds, the relevant return calculation is the yield to maturity.

Can the real interest rate ever be negative?

a. Yes

Nominal interest rate shows you a more accurate rate of return than the real interest rate. a. True b. False

b. False

The goal of quantitative easing is to: a. Increase the price of gold. b. Increase liquidity in financial markets. c. Increase interest rates. d. Push down the price of real estate.

b. Increase liquidity in financial markets.

If interest rates fall, the risk with a fixed rate instrument is that: a. Price of the financial instrument will fall rapidly. b. It will be paid off before maturity. c. Default risk will become counter cyclical. d. The real interest rate may increase very rapidly.

b. It will be paid off before maturity.

Who, generally, benefits for a fixed interest rate bond if market interest rates are falling? a. Governments because it collects more in tax revenue. b. Lenders or holders of bonds. c. Equity holders. d. Borrowers or bond issuers.

b. Lenders or holders of bonds.

Who tends to issue junk bonds? a. Foreign governments. b. Local governments in the United States. c. Financially troubled firms. d. The Federal Reserve.

c. Financially troubled firms.

Which of the following statements is CORRECT? a. The realized rate of return is denoted simply as a lower-case r. It represents a statistical calculation of what will happen with the stock's future return. b. The required rate of return is denoted simply as a lower-case r with a straight line on top. This rate of return doesn't represent speculation about a stock's future return but represents the actual return you receive from the stock. c. The required return represents the return an investor requires to invest in the stock; the expected return is based on a statistical calculation of what will happen with the future value of the stock; and the realized rate of return is the actual, historic return earned on the stock. d. The actual values of the expected rate of return, the required rate of return, and the realized rate of return must be identical for financial markets to operate. e. None of the statements above are correct.

c. The required return represents the return an investor requires to invest in the stock; the expected return is based on a statistical calculation of what will happen with the future value of the stock; and the realized rate of return is the actual, historic return earned on the stock.

Which of the following statements is NOT CORRECT? a. When a bond's coupon rate is equal to the market interest rate, the bond will sell for its face value, or what is known as selling at par. b. When a bond's coupon interest rate is less than the market interest rate, the bond will sell at a value less than its par value and is known as a discount bond. c. When the market interest rate is higher than the coupon interest rate, the bond price rises above the par value and is called a premium bond. d. Bonds are basically loans, so they usually make regular interest payments to the bondholders. The percentage of this interest payment relative to the bond's face value is called the coupon interest rate. e. For a fixed-rate bond, the coupon interest rate is set for the life of the bond. Unlike a fixed-rate bond's coupon interest rate, the market interest rate changes throughout the life of the bond and has a huge impact on the bond's price.

c. When the market interest rate is higher than the coupon interest rate, the bond price rises above the par value and is called a premium bond.

Question Workspace Check My Work The default risk premium is an important contributor in determining what happens to which of the following? a. Exchange rates b. Inflation rate c. Bond maturity date d. Market interest rates

d. Market interest rates

In calculating the expected rate of return, the expected returns in each state are weighted by: a. The time it takes to earn that return. b. The after tax rate of return earned. c. The rate of return expected. d. The probability of that state occurring.

d. The probability of that state occurring.

The term structure of interest rates is shown graphically with the: a. PE ratio curve. b. Market return curve. c. Beta curve analysis. d. Yield Curve.

d. Yield Curve.

Question Workspace Check My Work Diversification is a fundamental investment tool. Which of the following is a key to diversification? a. Variety—Invest in a wide range of financial products. b. Correlation—Look at investments that are not closely correlated, meaning that their values don't tend to move in the same direction at the same time. c. Quantity—There's no such thing as a diminishing return to diversification, so you should invest in the maximum number of investments as possible. If you can invest in thousands of different investments within your portfolio, you should. d. Statements a, b, and c are all correct. e. Statements a and b are correct.

e. Statements a and b are correct.