exam 2 fin311

Ryngaert Inc. recently issued noncallable bonds that mature in 15 years. They have 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?

$881.60

Dothan Inc.'s stock has a 25% chance of producing a 16% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return? Do not round your intermediate calculations.

5.50%.

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

true

Morin Company's bonds mature in 8 years, have a par value of $1,000, and make an annual coupon interest payment of $65. The market requires an interest rate of 6.1% on these bonds. What is the bond's price?

$1,024.74

Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 5.00%, based on semiannual compounding. What is the bond's price?

$1,235.47

Which of the following statements is CORRECT?

The slope of the security market line is equal to the market risk premium (MRP) (rm - rfr).

Because the maturity risk premium is normally positive, the yield curve must have an upward slope. If you measure the yield curve and find a downward slope, you must have done something wrong.

false

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

true

When a new issue of stock is brought to market, it is the marginal investor who determines the price at which the stock will trade.

true

A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 8.2%. What is the stock's current price?

$32.61

The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company's beta is 1.90, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company's current stock price, P0?

$9.89

Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.88. Stock Investment Beta A $50,000 0.50 B $50,000 0.80 C $50,000 1.00 D $50,000 1.20 Total $200,000 If Jill replaces Stock A with another stock, E, which has a beta of 1.45, what will the portfolio's new beta be? Do not round your intermediate calculations.

1.11

Bill Dukes has $100,000 invested in a 2-stock portfolio. $62,500 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta? Do not round your intermediate calculations. Round the final answer to 2 decimal places.

1.20

Sadik Inc.'s bonds currently sell for $1,300 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)?

5.31%

Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?

Adding a call provision.

Which of the following statements is CORRECT?

An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

If markets are in equilibrium, which of the following conditions will exist?

Each stock's expected return should equal its required return as seen by the marginal investor.

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

If a stock has a negative beta, its required return under the CAPM would be less than 5%.

Which of the following statements is CORRECT, other things held constant?

If expected inflation increases, interest rates are likely to increase.

Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? X Y Price $30 $30 Expected growth (constant) 6% 4% Required return 12% 10%

One year from now, Stock X's price is expected to be higher than Stock Y's price.

Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

Portfolio P has a beta of 1.0.

Suppose the U.S. Treasury issued $50 billion of short-term securities and sold them to the public. Other things held constant, what would be the most likely effect on short-term securities' prices and interest rates?

Prices would decline and interest rates would rise.

Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Beta 1.10 0.90 Constant growth rate 7.00% 7.00%

Stock A must have a higher dividend yield than Stock B.

Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return?

The required rate of return would increase because the bond would then be more risky to a bondholder.

Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds.

false

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.

false

Preferred stock is a hybrid--a sort of cross between a common stock and a bond--in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.

false

Suppose the federal deficit increased sharply from one year to the next, and the Federal Reserve kept the money supply constant. Other things held constant, we would expect to see interest rates decline.

false

The corporate valuation model cannot be used unless a company pays dividends.

false

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

false

If in the opinion of a given investor a stock's expected return exceeds its required return, this suggests that the investor thinks

the stock is a good buy.

A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%.

true

A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms.

true

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

true

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

true

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.

true

Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

true

Diversification will normally reduce the riskiness of a portfolio of stocks.

true

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

true

For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.

true

If a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

true

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*.

true

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.

true

One of the four most fundamental factors that affect the cost of money as discussed in the text is the availability of production opportunities and their expected rates of return. If production opportunities are relatively good, then interest rates will tend to be relatively high, other things held constant.

true

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.

true

Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the firm's total corporate value.

true

Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.

true

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

true

The "yield curve" shows the relationship between bonds' maturities and their yields.

true

The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

true

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.

true

The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value.

true

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

true

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."

true

The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

true

There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower.

true

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

true

Malko Enterprises' bonds currently sell for $1,020. They have a 6-year maturity, an annual coupon of $75, and a par value of $1,000. What is their current yield?

7.35%

Radoski Corporation's bonds make an annual coupon interest payment of 7.35% every year. The bonds have a par value of $1,000, a current price of $920, and mature in 12 years. What is the yield to maturity on these bonds?

8.44%

Which of the following factors would be most likely to lead to an increase in nominal interest rates?

A new technology like the Internet has just been introduced, and it increases investment opportunities.

Which of the following statements is CORRECT?

If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield is zero.

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72%; AAA = 8.72%; A = 9.64%; BBB = 10.18% The differences in these rates were probably caused primarily by:

Default and liquidity risk differences.

Assuming the pure expectations theory is correct, which of the following statements is CORRECT?

If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.

A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?

If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today .

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.

Which of the following events would make it more likely that a company would call its outstanding callable bonds?

Market interest rates decline sharply.

Consider the following information for three stocks, A, B, and C. The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. S ER SD B A 10% 20% 1.0 B 10% 10% 1.0 C 12% 12% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT?

Portolio ABC's expected return is 10.66667%.

A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT?

The bond's expected capital gains in zero.

A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?

The bond's yield to maturity is great than its coupon rate.

If the pure expectations theory holds, which of the following statements is CORRECT?

The maturity risk premium would be zero.

Which of the following statements is CORRECT?

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

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?

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

Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?

This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

Your portfolio has a beta equal to 1.6, and its expected return is 15%.

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.

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.)

false

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.

false

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

false

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.

false

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.

false

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.

false

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.

false