Managerial Finance Exam 2

True

1. Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value.

False

10. If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series.

False

100. As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).

$821.69

102. Suppose you are buying your first condo for $145,000, and you will make a $15,000 down payment. You have arranged to finance the remainder with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal interest rate, with the first payment due in one month. What will your monthly payments be?

Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued.

104. Which of the following statements is CORRECT?

Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.

105. Which of the following statements is CORRECT?

True

107. All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.

$299,574

109. You inherited an oil well that will pay you $25,000 per year for 25 years, with the first payment being made today. If you think a fair return on the well is 7.5%, how much should you ask for it if you decide to sell it?

The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.

110. Which of the following statements is CORRECT?

The cash flows for an annuity due must all occur at the beginning of the periods.

111. Which of the following statements is CORRECT?

True

112. You are considering 2 bonds that will be issued tomorrow. Both are rated triple B (BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10% coupon, neither can be called except for sinking fund purposes, and both are offered to you at their $1,000 par values. However, Bond SF has a sinking fund while Bond NSF does not. Under the sinking fund, the company must call and pay off 5% of the bonds at par each year. The yield curve at the time is upward sloping. The bond's prices, being equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would generally be expected to have a higher yield than Bond NSF.

1.31%

113. Niendorf Corporation's 5-year bonds yield 8.00%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Niendorf's bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t − 1) × 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf's bonds?

6.21%

114. Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. 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?

False

15. The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) the skill level of the economy's labor force.

True

16. An upward-sloping yield curve is often call a "normal" yield curve, while a downward-sloping yield curve is called "abnormal."

True

17. Your uncle Camilo says that if you start to invest early for retirement increases the benefits of compound interest.

True

19. The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present.

False

21. 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.

Market interest rates decline sharply

22. Which event would make it more likely that a company would call its outstanding callable bonds in the future?

False

23. If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill.

True

24. One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant.

8.95%

25. What's the rate of return you would earn if you paid $950 for a perpetuity that pays $85 per year?

You hold two bonds, a 10-year, zero coupon, issue and a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from its current level, the zero coupon bond will experience the larger percentage decline.

26. Which of the following statements is CORRECT?

True

29. The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk," or "price risk."

False

30. A time line is not meaningful unless all cash flows occur annually.

$881.60

31. Tuvidaquita Inc. issued noncallable bonds that mature in 15 years. Assume 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?

$301.10

32. Last year Rocco Corporation's sales were $225 million. If sales grow at 6% per year, how large (in millions) will they be 5 years later?

$20,352

33. What is the PV of an ordinary annuity with 10 payments of $2,700 if the appropriate interest rate is 5.5%?

False

34. 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.

3.80%

35. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

6.60%

36. Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 4.10%. 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.

6.812%

37. The real risk-free rate is 3.55%, inflation is expected to be 3.15% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond?

$23,261

38. You want to quit your job and return to school for an MBA degree 3 years from now, and you plan to save $7,000 per year, beginning immediately. You will make 3 deposits in an account that pays 5.2% interest. Under these assumptions, how much will you have 3 years from today?

True

39. Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.

Default and liquidity risk differences

40. 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:

False

41. If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.

True

43. 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.

False

44. One of the four most fundamental factors that affect the cost of money as discussed in the text is the time preference for consumption. The higher the time preference, the lower the cost of money, other things held constant.

$240.08

45. Jordan has $125 today. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?

$3883.27

47. How much would $100, growing at 5% per year, be worth after 75 years?

$5,000

48. What's the present value of a perpetuity that pays $250 per year if the appropriate interest rate is 5%?

7.17%

49. Adams Enterprises' noncallable bonds currently sell for $1,120. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity?

$2364.24

50. You deposit $1,000 today in a savings account that pays 3.5% interest, compounded annually. How much will your account be worth at the end of 25 years?

$18,369

51. You want to go to Europe 5 years from now, and you can save $3,100 per year, beginning one year from today. You plan to deposit the funds in a mutual fund that you think will return 8.5% per year. Under these conditions, how much would you have just after you make the 5th deposit, 5 years from now?

$605,183

52. Your aunt is about to retire, and she wants to sell some of her stock and buy an annuity that will provide her with income of $50,000 per year for 30 years, beginning a year from today. The going rate on such annuities is 7.25%. How much would it cost her to buy such an annuity today?

True

53. 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.

$537.78

55. Find the following problem in finance, how much would $20,000 due in 50 years be worth today if the discount rate were 7.5%?

False

56. If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase.

7.70%

57. Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 3.10%, 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, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

False

59. Time lines cannot be constructed for annuities unless all the payments occur at the end of the periods.

True

6. 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.

False

62. Some of the cash flows shown on a time line can be in the form of annuity payments but none can be uneven amounts.

False

63. Starting to invest early for retirement reduces the benefits of compound interest.

True

64. Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond's face value.

True

65. Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

False

66. A zero coupon bond is a bond that pays no interest and is offered (and initially sells) at par. These bonds provide compensation to investors in the form of capital appreciation.

True

67. Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.

True

68. 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.

6.00%

69. Suppose the U.S. Treasury offers to sell you a bond for $747.25. No payments will be made until the bond matures 5 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond at the offer price?

5.24%

7. A bond intermediary banker offers to sell you a Treasury note for $3,000. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $5,000. What interest rate would you earn if you bought this bond at the offer price?

False

71. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.

5.70%

72. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross- product terms, i.e., if averaging is required, use the arithmetic average.

True

73. If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.

False

74. 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.

7.14%

75. Malko Enterprises' bonds currently sell for $1,050. They have a 6-year maturity, an annual coupon of $75, and a par value of $1,000. What is their current yield?

False

76. One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather. If the weather is dark and stormy, the cost of money will be higher than if it is bright and sunny, other things held constant.

$1781.53

77. Suppose you have $1,500 and plan to purchase a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures?

False

78. The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

$16,112

8. You want to quit your job and go back to school for a law degree 4 years from now, and you plan to save $3,500 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. Under these assumptions, how much will you have 4 years from today?

True

80. As a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.

$1105.69

81. Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 8.4% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

5.35%

82. Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 2.25%, 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.

True

83. Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.

True

84. The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond's remaining maturity.

False

85. If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the present value of the same series.

True

87. The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk."

True

88. Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.

True

89. A time line is meaningful even if all cash flows do not occur annually.

True.

9. If a firm raises capital by selling new bonds, it could be called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.

If a coupon bond is selling at par, its current yield equals its yield to maturity.

91. Which of the following statements is CORRECT?

False

92. Floating-rate debt is advantageous to investors because the interest rate moves up if market rates rise. Since floating- rate debt shifts price risk to companies, it offers no advantages to corporate issuers.

The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.

93. You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?

$1618.62

94. What's the future value of $1,200 after 5 years if the appropriate interest rate is 6%, compounded monthly?

Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.

95. Which of the following statements is CORRECT?

20-year, zero coupon bond.

97. Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?

Maturity risk premiums could help to explain the yield curve's upward slope.

98. Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that

The yield on a 10-year bond would be less than that on a 1-year bill.

99. If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?

False

A bond that had a 20-year original maturity with 1 year left to maturity has more price risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates, and they cannot be called.)

True

During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining.