Chapter 7 Concepts
The current yield exceeds the coupon rate.
A $1,000 par value corporate bond that pays $45 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 $989.42?
Decrease
A (decrease/increase) in the size of the first cash inflow will decrease the payback period, all else held constant.
Call Premium
A bond has a face value of $1,000. It can be redeemed early at the issuer's discretion for $1,015, plus any accrued interest. The additional $15 is called the:
A discount
A bond's YTM will exceed its current yield when the bond is selling at ____.
Interest Earnings Only
A bond's yield to maturity considers the interest earnings and the change in the bond's price while the current yield considers ____.
- can be greater than, equal to, or less than the bond's coupon rate - remains fixed over the life of the bond
A corporate bond's yield to maturity ____.
Discount Rate
A decrease in which of the following will increase the current value of a stock according to the dividend growth model?
R = $7.95/$48.89 R = .1626, or 16.26%
A preferred stock pays an annual dividend of $7.95 and sells for $48.89 per share. What is the rate of return?
D = .0840($63.60) D = $5.34
A preferred stock sells for $63.60 per share and provides a return of 8.40 percent. What is the amount of the dividend per share?
Accepted
A project should be __________ if its NPV is greater than zero.
Constant dividend amount
A zero-growth model for stock valuation is distinguished by a ____.
The target average accounting return
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds _____.
Decreases
All else constant, the dividend yield will increase if the stock price ____.
Changes in interest rates cause changes in bond prices.
As an investor in the bond market, why should you be concerned about changes in interest rates?
Increases at a decreasing rate
As the maturity of a bond increases, interest rate risk ____.
R(3) = [(3 − 1)/(13 − 1)](.118) + [(13 − 3)/(13 − 1)](.126)R(3) = .1247, or 12.47%
Based on the past 13 years, Valdez Interiors common stock has yielded an arithmetic average rate of return of 12.6 percent. The geometric average return for the same period was 11.8 percent. What is the estimated return on this stock for the next three years according to Blume's formula?
A sinking fund provision
Callable bonds generally have....
High standard deviation, large risk premium
Generally speaking, which of the following best correspond to a wide frequency distribution?
- A conventional bond pays periodic interest whiles zeros make no interest payments. - Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeros must be offered at a discount from par
How is a conventional bond different from a zero coupon bond?
at 99.5 percent of face value plus any accrued interest
If a $1,000 face value U.S. Treasury bond is quoted at 99.5, then the bond can be purchased _____.
Less than
If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ______ $1,000.
Is highly risky
If the dispersion of returns on a particular security is very spread out from the security's mean return, the security ____.
12%
If the rate of inflation is 3 percent and the real rate of return is 9 percent, the nominal rate is approximately ____ percent.
0% Interest income from munis is exempt from federal income tax.
If you are holding a municipal bond that is trading at par to yield 6 percent, by how much will your aftertax yield change if your income tax bracket increases from 15 percent to 20 percent. Assume there are no state or local taxes
5%
If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes.
Greater Than
In an inflationary environment, the nominal rate will be _________ the real rate.
All else equal, corporate bonds have a higher pretax yield.
In general, which will have a higher pretax yield, a municipal bond or a corporate bond?
Preferred shareholders receive a stated value if the firm liquidates, like bondholders. Preferred shareholders receive a stated dividend, similar to interest on a bond. Preferred stock sometimes has a sinking fund, giving it a set maturity like bonds. Some preferred stock has credit ratings, like bonds.
In which way(s) is preferred stock like a bond?
15000/8500 = 1.8 years
It will cost $15,000 to acquire a used food truck that is expected to produce cash inflows of $8,500 per year for five years. After the five years, the truck is expected to be worthless. What is the payback period?
Reject; The project never pays back on a discounted basis. PV = $47,000/1.1522 + $198,000/1.1523 + $226,000/1.1524 PV = $293,248.02 The project should be rejected because the PV of the cash inflows is less than the initial cost.
JJ's is reviewing a project with a required discount rate of 15.2 percent and an initial cost of $309,000. The cash inflows are $47,000, $198,000, and $226,000 for Years 2 to 4, respectively. Should the project be accepted based on discounted payback if the required payback period is 2.5 years?
Strong
Kate Corporation has discovered a very secret new product, but hasn't yet announced the discovery to the public. If the stock price reacts before the announcement (assuming no corporate "leaks"), the market is _____ form efficient.
Capital gains yield = [($17,000/500) − $25.20]/$25.20 Capital gains yield = .349, or 34.9%
Last year, you purchased 500 shares of Ayala, Incorporated, stock for $25.20 per share. You have received a total of $400 in dividends and $17,000 in proceeds from selling the shares. What is your capital gains yield on this stock?
Greater; Larger
Longer-term bonds have ________ interest rate sensitivity because a ________ portion of a bond's value comes from the face amount.
is the best method of analyzing mutually exclusive projects.
Net present value:
Inflation
One of the components of the nominal rate of return is the compensation for the _______ effect on the original investment.
2.16
One year ago, you purchased a stock at a price of $43.20 per share. The stock pays quarterly dividends of $.18 per share. Today, the stock is selling for $45.36 per share. What is your capital gain on this investment?
Geometric; 2.50
Over the past four years, Preston's investment account earned annual returns of 6.5 percent, −24 percent, 12.5 percent, and 21.2 percent. To determine the compound annual growth rate of the investment account, he should use the ________ average of ________ percent.
1. Mortgage Bond 2. Debenture
Place the following bonds in order of security as defined in the United States:
Like
Preferred shareholders receive a stated value if the firm liquidates, _______ bondholders.
100
Preferred shares have a stated liquidating value, typically $_____ per share.
Payback
Ruba is training her newest coworker, Justin, in the art of project analysis. To get started, Ruba will assign Justin responsibility for analyzing all projects with an initial cost of less than $1,000. Which method is Ruba most apt to ask Justin to employ in making his initial recommendations?
The GE bond will lose more because it has a longer maturity.
Suppose you own a 30-year bond issued by GE and a 2-year bond issued by PG with identical coupon rates and par values. Which bond will you decrease in value more as interest rates rise?
Real
T-bills do not show negative returns, though the returns are sometimes lower than the inflation rate, resulting in a negative _______ return.
Inflation
The CPI is the most commonly used measure of...
Crossover Rate
The IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the:
False
True or false: A bond's value is not affected by changes in the market rate of interest.
True
True or false: In general, the stock market is more transparent than the real estate market.
Bonds that are issued with a very low coupon rate.
What are original issue discount bonds?
Pay $800 today and receive $1,000 at the end of 5 years
What are the cash flows involved in the purchase of a 5-year zero coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent.
$5,000 × 122%
What is the formula to determine the price of a U.S. Treasury bond listed at 122 if the par value is $5,000?
$900 1,000 * .90
What is the price of a U.S. Treasury bond that is listed at 90 if the par value is $1,000?
Bid Price
When an investor sells a bond, the price received by a dealer is always the ____.
Increases
When interest rates in the market fall, bond values are likely to increase because the present value of the bond's remaining cash flows ____.
Yes
When the stock being valued does not pay dividends, can the dividend growth model still be used?
short-term rates are higher than long-term rates
When the term structure of interest rates is downward sloping, ____.
Lower Than
When using trial and error to compute the yield to maturity (YTM) for a 6 percent coupon bond that trades at a premium, the process can be shortened if the initial guess is ____ 6 percent.
Discounted Payback Period
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
Stock Market
Which is more transparent, the stock market or the bond market?
- The mean return - The standard deviation of returns
Which of the following are needed to describe the distribution of stock returns?
It is a fixed annuity payment
Which of the following is true about a typical multiple-year bond's coupon?
Modified internal rate of return that exceeds the required return
Which one of the following is a project acceptance indicator given an independent project with conventional cash flows?
Coupon rate = Current yield = Yield to maturity
Which one of the following relationships applies to a par value bond?
U.S. Treasury bills had an annual return in excess of 10 percent in three or more years.
Which one of the following statements is a correct reflection of the U.S. financial markets for the period 1926-2019?
Corporate shareholders may receive a tax break on a portion of their dividend income.
Which one of the following statements related to corporate dividends is correct?
The IRR is equal to the required return when the net present value is equal to zero.
Which one of the following statements related to the internal rate of return (IRR) is correct?
Discounted payback is biased towards short-term projects.
Which one of these statements related to discounted payback is correct?
- Upward Sloping - Humped - Downward Sloping
Which three of the following are common shapes for the term structure of interest rates?
Reward to Risk
The Sharpe ratio measures ___.
Project A should be rejected and Project B should be accepted.
The Square Box is considering two independent projects with an initial cost of $18,000 each. The cash inflows of Project A are $3,000, $7,000, and $10,000 for Years 1 to 3, respectively. The cash inflows for Project B are $3,000, $7,000, and $15,000 for Years 1 to 3, respectively. The required return is 12 percent and the required discounted payback period is 3 years. Based on discounted payback, which project(s), if either, should be accepted?
Current
The _______ yield does not include the capital gain from the price discount, whereas the YTM does include it.
Yield to Maturity
The bond market requires a return of 6.2 percent on the 15-year bonds issued by Mingwei Manufacturing. The 6.2 percent is referred to as the:
As of the date the first dividend payment (Dt +1) is received (year t + 1)
The constant growth formula calculates the stock price:
Issuing Bonds
The federal government can raise money from financial markets to finance its deficits by ___.
Small-company stocks have lost as much as 50 percent and gained as much as 100 percent in a single year.
The historical record for the period 1926-2019 supports which one of the following statements?
A project's cash flows
The internal rate of return is a function of ____.
Tedious to compute without the use of either a financial calculator or a computer.
The internal rate of return is:
The aftertax salvage value of the fixed assets increases.
The net present value of a project will increase if:
Dividends
The price of a share of common stock is equal to the present value of all expected future
NPV
The profitability index is most closely related to which one of the following?
Nominal
The rates on financial securities are generally quoted as _____ rates.
Face Value; Coupon Payments
The reason that interest rate risk is greater for long term bonds than for short term bonds is that the change in rates has a greater effect on the present value of the ____ than on the present value of the ____.
where outstanding shares of stock are resold.
The secondary market is best defined as the market:
Growth; Discount
The value of a firm is the function of its ______ rate and its _______ rate.
Negative
There is a(n) ______ relationship between market interest rates and bond values.
Generally issued as semiannual coupon bonds.
Treasury bonds are:
P4 = $.75/.138 P4 = $5.4348 P0 = $.25/1.1383 + ($.25 + 5.4348)/1.1384 P0 = $3.56
Whitmarsh Hotels pays no dividend at the present time. Starting in Year 3, the firm will pay a dividend of $.25 per share for two years. After that, the company plans on paying a constant $.75 per share annual dividend indefinitely. How much should you pay per share to purchase this stock today at a required return of 13.8 percent?
The board of directors
Who declares a dividend?
Semistrong
You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor often comments on the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient.
All other things being equal, the lower the coupon rate, the greater the interest rate risk. (5%)
You own two bonds—one with a 5 percent coupon and one with a 6 percent coupon. Which one is more sensitive to interest rate risk, all other things being equal?