FIN 3060 TEST 2
ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?
$60 in interest at the end of each year for 10 years and a $1,000 repayment of principal at the end of 10 years.
Suppose a firm's dividends are expected to grow at a rate of 15% (g1) for 3 years (t) then stabilize at 5% (g2) forever. If the firm just paid a $2.00 (D0) dividend and the discount rate is 10% (r), what is the value of a share of the firm's stock in year 3 (P3 )? (Do not round your intermediate calculation.)
$63.88 HOW? D3 = D0 x (1+g1)t = $2 x (1.15)3 = $3.04 D4 = D3 x (1+g2) = $3.04 x 1.05 = $3.19 P3 = D4/(r-g2 ) = $3.19/(.10 - .05) = $63.88
Which of the following is the formula for the future value of an annuity factor?
((1+r)t−1r)
Which of the following is the general formula for the EAR when m is the number of times interest is compounded in a year?
(1+quoted rate/m)m - 1
The formula for the present value of an annuity due is:
(1+r)×(PV of an ordinary annuity)
To find the present value of an annuity of $100 per year for 10 years at 10% per year using the tables, find a present value factor of 6.1446 and multiply it by ______.
100
Which of the following spreadsheet functions will result in the correct answer for the below annuity problem: You plan to deposit $100 per year for the next 10 years in an account paying 8 percent. How much will you have in this annuity?
= FV(.08,10,-100,0)
Which of the following spreadsheet functions will calculate the $614.46 present value of an ordinary annuity of $100 per year for 10 years at 10% per year?
=PV(0.10,10,-100,0,0)
The interest rate charged per period multiplied by the number of periods per year is equal to ____ on a loan
APR
Which of the following are cash flows to investors in stocks?
Capital gains Dividends
As an investor in the bond market, why should you be concerned about changes in interest rates?
Changes in interest rates cause changes in bond prices.
Which of the following processes can be used to calculate the future value of multiple cash flows?
Compound the accumulated balance forward one year at a time Calculate the future value of each cash flow first and then sum them
P1 = (__ + P2)/(1 + R)
D2
What information do we need to determine the value of a stock using the zero growth model?
Discount rate Dividend
In the dividend growth model, the expected return for investors comes from which two sources?
Dividend Yield Growth rate
Which of the following represents the valuation of stock using a zero growth model?
Dividend/Discount rate = D/R
Which one of the following is true about dividend growth patterns?
Dividends may grow at a constant rate.
Which of the following is the appropriate spreadsheet function to convert a quoted rate of 12% compounded quarterly to an EAR?
EFFECT(0.12,4)
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
When calculating annuity present values using a financial calculator, the ___ is left blank
FV
True or false: The annual percentage rate (APR) is calculated as the interest rate charged per period on a loan divided by the number of periods per year.
False
True or false: To find the annuity future value factor, you only need the cash flows and the discount rate.
False
True or false: When using a financial calculator to find the number of payments, the PMT value should be entered as a positive.
False
Which of the following is not a way to amortize a loan?
Fixed interest payments only
More frequent compounding leads to:
Higher EARs
What does the dirty price represent?
It includes the quoted price and accrued interest
What is a real rate of return?
It is a percentage change in buying power. It is a rate of return that has been adjusted for inflation.
What is a bond's accrued interest?
It is interest that has been earned but not yet received by the current bondholder
What is the nominal rate of return on an investment?
It is the actual percentage change in the dollar value of an investment unadjusted for inflation.
What is the bid price?
It is the price at which a dealer is willing to buy securities. It is the price an investor will receive if he sells a bond to a dealer.
What does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately.
Which one of the following is the most important source of risk from owning bonds?
Market interest rate fluctuations
When using a financial calculator to find the number of payments, the PMT value should be entered as a
Negative
This type of growth describes a company that grows quickly at first, then slower in future years.
Non-constant
Which of the following variables is NOT required to calculate the value of a bond?
Original issue price of bond
What is the formula for the present value of a growing perpetuity where C1 is the net cash flow, R is the required return and g is the growth rate?
P = C1/(R-g)
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.
Pay $800 today and receive $1,000 at the end of 5 years
What is the equation for approximating the nominal rate of return? R = the nominal rate of interest r = the real rate of interest h = the inflation rate
R = r + h
What does historical data suggest about the nature of short-term and long-term interest rates?
Sometimes short-term rates are higher and sometimes long-term rates are higher.
Which of the following are reasons that make valuing a share of stock more difficult than valuing a bond?
Stock has no set maturity Dividends are unknown and uncertain The required rate of return is unobservable
Which of the following ratios might be used to estimate the value of a stock?
The Price/Earnings ratio The Price/Sales ratio
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
As a general rule, which of the following are true of debt and equity?
The maximum reward for owning debt is fixed. Equity represents an ownership interest.
What does the clean price for a bond represent?
The quoted price excluding accrued interest
What are the three components that influence the Treasury yield curve?
The real rate of return The interest rate risk premium Expected future inflation
Which of the following are usually included in a bond's indenture?
The repayment arrangements the total amount of bonds issues
Which of the following are rights of common stock holders?
The right to share proportionally in any common dividends paid. The right to share proportionally in any residual value in the event of liquidation. The right to vote on matters of importance.
Which of the following are true of bonds?
They are issued by both corporations and governments They are normally interest-only loans
Junk bonds have the following features:
They are rated below investment grade bonds
In the Excel setup of a loan amortization problem, which of the following occurs?
To find the principal payment each month, you subtract the dollar interest payment from the fixed payment. The payment is found with = PMT(rate, nper, -pv, fv).
True or false: Interest rates can be quoted in various ways.
True
True or false: The perpetuity present value can be found using the perpetual cash flow and the discount rate.
True
What is a corporate bond's yield to maturity (YTM)?
YTM is the expected return for an investor who buys the bond today and holds it to maturity. YTM is the prevailing market interest rate for bonds with similar features.
Which of the following is a perpetuity?
a constant stream of cash flows forever
A bond's coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
Which of the following is the simplest form of loan?
a pure discount loan
Which of the following are bonds that have actually been issued?
a put bond a convertible bond a CoCo bond
To find the total bond value, add the present value of the amount paid at maturity to the _____ of the annual coupon payments.
annuity PV
An annuity with payments beginning immediately rather than at the end of the period is called an _________.
annuity due
If bonds for AT&T are quoted at 115, they can be purchased:
at 115% of par value plus accrued interest
If a $1,000 face value U.S. Treasury bond is quoted at 99.5, then the bond can be purchased _____.
at 99.5 percent of face value plus any accrued interest
With typical interest-only loans, the entire principal is:
at some point in the future
An annuity due is a series of payments that are made ____.
at the beginning of each period
A provision in the bond indenture giving the issuing company the option to repurchase the bonds before maturity is termed a _________________.
call provision
A corporate bond's yield to maturity:
changes over time is usually not the same as a bond's coupon rate
The effective annual rate (EAR) takes into account the ______ of interest that occurs within a year
compounding
Three special case patterns of dividend growth discussed in the text include:
constant growth non-constant growth zero growth
A bond's ____ payment is a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
coupon
The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?
coupon rate time to maturity
Which of the following terms apply to a bond?
coupon rate time to maturity par value
What four variables are required to calculate the value of a bond?
coupon rate yield to maturity par value time remaining to maturity
If unpaid preferred dividends must be "caught up" before any common dividends can be paid, they are called _________ dividends.
cumulative
Someone who maintains an inventory of stocks and buys and sells those stocks is known as a ____.
dealer
the bid-ask spread represents the ___.
dealers profit
When interest rates in the market rise, we can expect the price of bonds to ____.
decrease
All else constant, the dividend yield will increase if the stock price ____.
decreases
Preferred stock has preference over common stock in the:
distribution of corporate assets payment of dividends
One step in calculating an EAR is to ___ the quoted rate by the number of times that the interest is compounded.
divide
The constant-growth model assumes that _________.
dividends change at a constant rate
Assume interest is compounded monthly. The ___ annual rate will express this rate as though it were compounded annually.
effective
the ___ annual rate is the interest rate expressed as if it were compounded once per year.
effective
In almost all multiple cash flow calculations, it is implicitly assumed that the cash flows occur at the _____ of each period.
end
Spreadsheet functions used to calculate the present value of multiple cash flows assume, by default, that all cash flows occur at the Blank______ of the period.
end
The price of a share of common stock is equal to the present value of all ______ future dividends.
expected
For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.
false
True or false: A PE ratio that is based on estimated future earnings is called a regressive PE ratio.
false
True or false: Bond ratings are concerned only with the possibility of price changes.
false
True or false: Common stock has a set maturity.
false
True or false: If the interest rate is greater than zero, the value of an annuity due is always less than an ordinary annuity.
false
True or false: The annuity due calculation assumes cash flows occur evenly throughout the period.
false
True or false: The annuity present value factor equals one minus the discount rate all divided by the present value factor.
false
True or false: The effective annual rate is the interest rate expressed in terms of the interest payment made each period
false
True or false: The effective annual rate is the interest rate expressed in terms of the interest payment made each period.
false
True or false: The interest rate charged per period divided by the number of periods per year.
false
True or false: The payment for an annuity can be calculated using the annuity present value, the present value factor, and the interest rate.
false
True or false: Using the spreadsheet formula to convert a quoted rate (or an APR) to an effective rate, use the formula NOMINAL(effect_rate, npery).
false REAL FORMULA: ISEFFECT(nominal_rate, npery).
Which of the following are ways to amortize a loan?
fixed interest payments only
A limitation of bond ratings is that they ____.
focus exclusively on default risk
If the interest rate is greater than zero, the value of an annuity due is always ______ an ordinary annuity.
greater than
The value of a firm is derived using the firm's ______ rate and its _______ rate.
growth; discount
A bond with a BB rating has a ______ than a bond with an BBB rating.
higher risk of default
"Inside Quotes" represent the _________ and the ________.
highest bid price; lowest ask price
When interest rates in the market fall, bond values will increase because the present value of the bond's remaining cash flows ____.
increases
A perpetuity is a constant stream of cash flows for a(n) ______ period of time.
infinite
The nominal rate is found by adding the _____ and the real rate of return.
inflation
A key difference between interest payments and dividend payments is?
interest is tax deductible dividends are not tax deductible
When finding the present or future value of an annuity using a financial calculator, the ______ ______ should be entered as a percentage.
interest rate
An ordinary annuity consists of a(n) ________ stream of cash flows for a fixed period of time.
level
A zero-coupon bond is a bond that ____.
makes no interest payments
A simple way to amortize a loan is to have the borrower pay the interest each period plus some fixed amount. This approach is common with ____ term business loans
medium
The annuity present value factor equals one ____ the present value factor all divided by the discount rate.
minus
Which of the following could not be evaluated as annuities or annuities due?
monthly electric bills tips to a waiter
Which of the following are real-world examples of annuities?
mortgages, leases, pension
Bonds issued by state and local governments are called _______ ______.
municipal bonds
You are solving a present value equation using a financial calculator and are given the number of years for compounding. This should be entered as the _____ value on the financial calculator.
n
If a company's growth for Years 1 through 3 is 20% but stabilizes at 5% beginning in Year 4, its growth pattern would be described as _______.
non-constant
Using an Excel spreadsheet to solve for the payment in an amortized loan, enter the number of periods as the ___ value
nper
The present value of an annuity due is equal to the present value of a(an) ______ annuity multiplied by (1+ r).
ordinary
equity represents a ___ interest of a firm
ownership
the ____ for an annuity can be calculated using the annuity present value, the present value factor, and the discount rate.
payment
C/r is the formula for the present value of a(n) ____.
perpetuity
The present value formula for a(n) ______ is PV = C/r, where C is the constant and regularly timed cash flow to infinity, and r is the interest rate.
perpetuity
the ___ present value can be found using the perpetual cash flow and the discount rate
perpetuity
The formula for the ______ value interest factor of an annuity is: [1- 1/(1+r)τ]/r.
present
When entering variables in a spreadsheet function (or in a financial calculator), the "sign convention" can be critical to achieving a correct answer. The sign convention says that outflows are negative values; inflows are positive values. For which variables is this a consideration?
present value payment future value
Amortization is the process of paying off loans by regularly reducing the _______
principal
he original amount of a loan is termed the loan ___________.
principal
hat are the two major forms of long-term debt?
private issue public issue
A part of the indenture limiting certain actions during the term of the loan are termed ________.
protective covenants
If you borrow $15,000 today at 5% annual interest to be repaid in one year as a lump sum, this is termed a _______________ .
pure discount loan
Compounding during the year can lead to a difference between the ___ rate and the effective rate
quoted
EAR = (1 _______+ rate/m)m − 1
quoted or stated
P0 = (D1 + P1)/(1 + __)
r
The term structure of interest rates examines the ____.
relationship between short-term and long-term interest rates
Using a benchmark PE ratio against current earnings yields a forecasted price called a _______ price.
target
If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?
the 10-year bond
The general formula for______ is (1 + quoted rate/m)m − 1.
the EAR
Bond ratings are based on the probability of default risk, which is the risk that ___.
the bond's issuer may not be able make all the required payments
The dividend yield is determined by dividing the expected dividend (D1) by:
the current price (Po)
The term structure of interest rates describes ________.
the pure time value of money the relationship between nominal rates and time to maturity
The degree of interest rate risk depends on ____.
the sensitivity of the bond's price to interest rate changes
Because of ______ and ______, interest rates are often quoted in many different ways.
tradition; legislation
The formula for the future value of an annuity factor is [(1+r)t -1]/r.
true
True or false: A put bond allows the holder to force the issuer to buy the bond back at a stated price.
true
True or false: An ordinary annuity consists of a level stream of cash flows for a fixed period of time.
true
True or false: Current yield = Annual coupon payment/Price
true
True or false: Low-grade bonds may not be rated by major rating agencies.
true
True or false: The annuity present value of an amount C is calculated as C multiplied by {1-[1/(1+r)t]}/r .
true
True or false: To find the future value of multiple cash flows, calculate the future value of each cash flow first and then sum them
true
True or false: To find the future value of multiple cash flows, calculate the future value of each cash flow first and then sum them.
true
True or false: Total return is calculated by adding the dividend yield and the capital gains yield.
true
True or false: When calculating the present value of an annuity using the financial calculator, you enter the cash flows of the annuity in the PMT key.
true
True or false: In general, the price that is paid for a bond will exceed its quoted price.
true bc Invoice price = Dirty price = Quoted price + Accrued interest.
The first cash flow at the end of Week 1 is $100, the second cash flow at the end of Month 2 is $100, and the third cash flow at the end of Year 3 is $100. This cash flow pattern is a(n) ______ type of cash flow.
uneven
When long-term rates are higher than short-term rates, which of the following shapes will the term structure of interest rates usually have?
upward sloping
Most of the time, a floating-rate bond's coupon adjusts ____.
with a lag to some base rate
If the growth rate (g) is zero, the capital gains yield is ____.
zero
The cash flows of an annuity due are the same as those of an ordinary annuity except that there is an extra cash flow at Time ____
zero