FIN 355 Book Problems for Exam 1
CH 2 Suppose that short term yield bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after tax yield if your tax bracket is? a.0% b.10% c.20% d.30%
0% gives the greatest yield
CH 10 Zero-coupon bond
A bond paying no coupons, that sells at a discount, and provides only a payment of Par value at maturity.
CH 10 Equipment obligation bond
A bond whose specific collateral to cover the possibility of the firm defaulting, takes the form of equipment.
CH 3 What are the differences between a stop-loss over, a limit sell order, and a market order?
A stop order is a trade is not to be executed unless stock hits a price limit. The stop-loss is used to limit losses when prices are falling. An order specifying a price at which an investor is willing to buy or sell a security is a limit order, while a market order directs the broker to buy or sell at whatever price is available in the market.
CH 2 Why are higher tax bracket investors more inclined to invest in municipal binds than are low-bracket investors?
Although municipal bonds are lesser yield they offer higher tax bracket investors the perk of federal tax exemption, meaning the income received from interest on the municipal bonds does not get taxed in their high level tax bracket. High tax bracket gets higher interest income from using municipal bonds than net interest income from other types of bonds.
CH 3 What is the difference between an IPO and an SEO?
An IPO is the first time a formerly privately-owned company sells stock to the general public. A seasoned issue is the issuance of stock by a company that has already undergone an IPO.
CH 2 Describe alternative ways that an investor may add positions in international equity to his/her portfolio?
An investor may use a depository receipt to buy or sell international equity. An American Depository Receipt is a certificate traded in the US market that represents ownership of an international company.
CH 1 Difference between asset allocation and security selection
Asset allocation is the allocation of an investment portfolio across broad asset classes. Security selection is the choice of specific securities within each asset class
CH 2 Why are corporations more apt to hold preferred stock then other potential investors?
Because 70% of the income received by the corporation is tax free and only 30% is taxable.
CH 2 Why are money market securities sometimes referred to as cash equivalents?
Because they are short tern in nature, have high liquidity, and can be converted into cash quickly with less cost.
CH 10 Original-issue discount bond
Bonds that are issued intentionally, with low coupon rates, that cause the bond to sell at a discount from Par value. (Ex. Zero Coupon Bond)
CH 3 Where would an illiquid security in a developing country most likely trade? -Broker markets -Electronic crossing networks -Electronic limit-order markets
Broker markets
CH 2 What are the key differences between common stock, preferred stock, and corporate bonds?
Common stock is an ownership share in a publicly held corporation. Common shareholders have voting rights and may receive dividends. Preferred stock represents nonvoting shares in a corporation, usually paying a fixed stream of dividends. While corporate bonds are long-term debt issued by corporations, the bonds typically pay semi-annual coupons and return the face value of the bond at maturity.
CH 10 Eurobond
Denominated in one currency, usually that of the issuer, but sold in other national markets.
CH 15 The following price quotations are for exchange-listed options on Primo Corporation common stock. Company Strike Expiration Call Put Primo 61.12 55 Feb 7.25 0.48 With transaction costs ignored, how much would a buyer have to pay for one call option contract. Assume each contract is for 100 shares.
Each contract is for 100 shares: $7.25 × 100 = $725
CH 1 What are the differences between equity and fixed-income securities?
Equity is a lower-priority claim and represents an ownership share in a corporation, whereas fixed-income (debt) security is a higher-priority claim but does not have an ownership interest. Fixed-income (debt) security pays a specified cash flow at pre-contracted time intervals until the last payment on the maturity date. Equity has an indefinite life.
CH 2 What features of money market securities distinguish them from other fixed-income securities?
Fixed-income securities are securities that pay interest or dividend at a fixed rate such as preferred stocks or bonds. Money market securities differ in three ways: They are short term(under 1 year) in nature, They are highly marketable securities with less credit risk, They are very safe as they are highly liquid.
CH 10 Convertible bond
Give Bond holders an option to exchange each bond for a specified number of shares of common stock of the firm.
CH 15 You purchase one Facebook October 160 put contract for a premium of $5.35. What is your maximum possible profit? Assume each contract is for 100 units.
If the stock price drops to zero, you will make $160 − $5.35 per stock, or $154.65. Given 100 units per contract, the total potential profit is $15,465.
CH 2 What is meant by Limited Liability?
In the case of bankruptcy a firms shareholders are held responsible. Shareholders assets cannot be claimed and the liability is limited to the shares.
CH 1 What are the key differences between investment banks and commercial banks?
Investment banking involves, among other activities, underwriting new security issues and providing advice on mergers and acquisitions, whereas commercial banking primarily involves taking deposits and making loans.
Ch 2 What is meant by the LIBOR rate? The Federal Funds rate?
LIBOR stands for London Inter Bank Offer Rate where banks with enormous amount of funds lend to other banks in London to make adjustments in mortgage rates and is calculated on 10 different currencies on the basis of 15 different borrowings in 1 year and is published daily. Federal Funds Rate. Every bank is required to put a certain amount of funds in the Federal Bank and that amount depends on the amount deposited by customers into each bank. Banks that are short on funds can borrow from banks that have an excess of funds at a specified interest rate.
CH 10 Indexed bond
Make payments that are tied to a general price index. or the price of a particular commodity. (Ex. TIPS)
CH 3 Why have average trade sizes declined in recent years?
Many large investors seek anonymity for fear that their intentions will become known to other investors. Large block trades attract the attention of other traders. By splitting large transactions into smaller trades, investors are better able to retain a degree of anonymity
CH 3 How do margin trades magnify both the upside potential and downside risk of an investment portfolio?
Margin is a type of leverage that allows investors to post only a portion of the value of the security they purchase. As such, when the price of the security rises or falls, the gain or loss represents a much higher percentage, relative to the actual money invested.
CH 2 How does a municipal revenue bond differ from a general obligation bonds? Which would you expect to have a lower yield to maturity?
Municipal Revenue Bonds are repayments that depend upon specific projects and are more risky. General Obligation Bonds have revenues that depend on an agreement between bondholder and issuer and are less risky. The greater the risk and ROI of the project the higher the yield to maturity.
CH 1 Why do financial assets show up as a component of household wealth, but not of national wealth? Why do financial assets still matter for the material well-being of an economy?
National wealth is a measurement of the real assets used to produce GDP in the economy. Financial assets are claims on those assets held by individuals. Financial assets owned by households represent their claims on the real assets of the issuers, and thus show up as wealth to households. Their interests in the issuers, on the other hand, are obligations to the issuers. At the national level, the financial interests and the obligations cancel each other out, so only the real assets are measured as the wealth of the economy. The financial assets are important since they drive the efficient use of real assets and help us allocate resources, specifically in terms of risk return trade-offs.
CH 10 Serial bond
One bond issue that does not require a sinking fund in which the firm sells bonds with staggered maturity dates.
CH 15 Why do you think the most actively traded options tend to be the ones that are near the money?
Options at the money have the highest time premium and thus the highest potential for gain. Since they highest potential gain is at the money, the logical conclusion is that they will have the highest volume. A common phrase used by traders is "avoid the cheaps and the deeps." Cheap options are those with very little time premium. Deep options are those that are way out of or in the money. None of these provide profit opportunities.
CH 15 We said that options can be used either to scale up or reduce overall portfolio risk. What are some examples of risk-increasing and risk-reducing options strategies? Explain each.
Options provide numerous opportunities to modify the risk profile of a portfolio. The simplest example of an option strategy that increases risk is investing in an 'all options' portfolio of at the money options (as illustrated in the text). The leverage provided by options makes this strategy very risky, and potentially very profitable. An example of a risk-reducing options strategy is a protective put strategy. Here, the investor buys a put on an existing stock or portfolio, with exercise price of the put near or somewhat less than the market value of the underlying asset. This strategy protects the value of the portfolio because the minimum value of the stock-plus-put strategy is the exercise price of the put.
CH 1 What reforms to the financial system might reduce its exposure to systemic risk?
Passed in 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act proposes several mechanisms to mitigate systemic risk. The act attempts to limit the risky activities in which the banks can engage and calls for stricter rules for bank capital, liquidity, and risk management practices, especially as banks become larger and their potential failure becomes more threatening to other institutions. The act seeks to unify and clarify the lines of regulatory authority and responsibility in government agencies and to address the incentive issue by forcing employee compensation to reflect longer-term performance. It also mandates increased transparency, especially in derivatives markets.
CH 3 A market order has: -Price uncertainty but not execution uncertainty -Both price uncertainty and execution uncertainty -Execution uncertainty but not price uncertainty
Price uncertainty but not execution uncertainty
CH 1 What are the differences between real and financial assets?
Real assets are assets used to produce goods and services (land, building, equipment) Financial assets are claims on real assets or the income generated by them (cash, loans, stocks)
CH 10 Junk bond
Speculative grade bond (not good), a bond rated BB or lower by S&P or Ba by Moody's, or an unrated Bond. Also known as "high yield" bonds.
CH 2 Preferred stock yields often are lower than yields on bonds of the same quality because of: -Marketability -Risk -Taxation -Call protection
Taxation
CH 3 What are some different components of the effective costs of buying or selling shares of stock?
The effective price paid or received for a stock includes items such as bid-ask spread, brokerage fees, commissions, and taxes (when applicable). These reduce the amount received by a seller and increase the cost incurred by a buyer
CH 15 An investor buys a call at a price of $5.60 with an exercise price of $51. At what stock price will the investor break even on the purchase of the call? (Round your answer to 2 decimal places.)
The price has to be at least as much as the sum of the exercise price and the premium of the option to break even: $51 + $5.60 = $56.60
CH 1 What is the difference between a primary asset and a derivative asset?
The primary asset has a claim on the real assets of a firm, whereas a derivative asset provides a payoff that depends on the prices of a primary asset but not the claim on real assets.
CH 3 What is the difference between a primary and secondary market?
The primary market is the market where newly-issued securities are sold, while the secondary market is the market for trading existing securities. After firms sell their newly-issued stocks to investors in the primary market, new investors purchase stocks from existing investors in the secondary market
CH 3 How do security dealers earn their profits?
The primary source of income for a securities dealer is the bid-ask spread. This is the difference between the price at which the dealer is willing to purchase a security and the price at which they are willing to sell the same security.
CH 2 Which of the following correctly describes a repurchase agreement? -The sale of a security with the commitment to repurchase the same security at a specified future date and designated price. -The sale of a security with the commitment to repurchase the same security at a future date left unspecified, at designated price. -The purchase of a security with a commitment to purchase more of the same security at a specified future date
The sale of a security with the commitment to repurchase the same security at a specified future date and designated price. "Overnight borrowing."
CH 10 Catastrophe bond
These bonds are a way to transfer "catastrophe risk" from insurance companies to the capital markets.
CH 2 What are the major components of the money market? (TCCBER)
Treasury Bills, Certificates of Deposit, Commercial Paper, Bankers Acceptance, Eurodollars and Repos.
CH 1 The average rate of return on investments in large stocks has outpaced that on investments in Treasury bills by about 7% since 1926. Why, then, does anyone invest in Treasury bills?
Treasury bills serve a purpose for investors who prefer a low-risk investment. The lower average rate of return compared to stocks is the price investors pay for predictability of investment performance and portfolio value.
CH 3 What is the role of an underwriter? A prospectus?
Underwriters purchase securities from the issuing company and resell them. A prospectus is a description of the firm and the security it is issuing.
CH 2 Why do most professionals consider the Wilshire 5000 a better index of the performance of the broad stock market than the Dow Jones Industrial Average?
W5000 is way bigger and contains almost all of the stocks in the U.S therefore it is a better indicator of the current market trends. The DJIA is at most, 30 of the largest stocks in the U.S
CH 3 In what circumstances are private placements more likely to be used than public offerings?
When a firm is a willing buyer of securities and wishes to avoid the extensive time and cost associated with preparing a public issue, it may issue shares privately.
CH 10 Samurai bond
Yen dominated bonds, sold in Japan, by non-Japanese issuers.
You establish a straddle on Walmart using September call and put options with a strike price of $58. The call premium is $4.65 and the put premium is $5.40. a. What is the most you can lose on this position? (Input the amount as positive value. Round your answer to 2 decimal places.) b. What will be your profit or loss if Walmart is selling for $65 in September? (Input the amount as positive value. Round your answer to 2 decimal places.) c. At what stock prices will you break even on the straddle? (Input your answers from highest to lowest to receive credit for your answers. Round your answers to 2 decimal places.) Break even prices $ and $
a. 10.05 (4.65+5.4) b. 3.05 (65-58 = 7 , 10.05-7) c.68.05 and 47.95
CH 1 Suppose that in a wave of pessimism, housing prices fall by 10% across the entire economy. (LO 1-2) a. Has the stock of real assets of the economy changed? b. Are individuals less wealthy? c. Can you reconcile your answers to ( a ) and ( b )?
a. No. The real estate in existence has not changed, only the perception of its value has. b. Yes. The financial asset value of the claims on the real estate has changed, and thus the balance sheet of individual investors has been reduced. c. The difference between these two answers reflects the difference between real and financial asset values. Real assets still exist, yet the value of the claims on those assets or the cash flows they generate do change. Thus, there is the difference.
CH 1 Lanni Products is a start-up computer software development firm. It currently owns computer equipment worth $30,000 and has cash on hand of $20,000 contributed by Lanni's owners. For each of the following transactions, identify the real and/or financial assets that trade hands. Are any financial assets created or destroyed in the transaction? (LO 1-2) a. Lanni takes out a bank loan. It receives $50,000 in cash and signs a note promising to pay back the loan over three years. b. Lanni uses the cash from the bank plus $20,000 of its own funds to finance the development of new financial planning software. c. Lanni sells the software product to Microsoft, which will market it to the public under the Microsoft name. Lanni accepts payment in the form of 5,000 shares of Microsoft stock. d. Lanni sells the shares of stock for $25 per share and uses part of the proceeds to pay off the bank loan.
a. The bank loan is a financial liability for Lanni. Lanni's IOU is the bank's financial asset. The cash Lanni receives is a financial asset. The new financial asset created is Lanni's promissory note held by the bank. b. The cash paid by Lanni is the transfer of a financial asset to the software developer. In return, Lanni gets a real asset, the completed software. No financial assets are created or destroyed. Cash is simply transferred from one firm to another. c. Lanni sells the software, which is a real asset, to Microsoft. In exchange Lanni receives a financial asset, 5,000 shares of Microsoft stock. If Microsoft issues new shares in order to pay Lanni, this would constitute the creation of new financial asset. d. In selling 5,000 shares of stock for $125,000, Lanni is exchanging one financial asset for another. In paying off the IOU with $50,000, Lanni is exchanging financial assets. The loan is "destroyed" in the transaction, since it is retired when paid.
CH 1 For each transaction, identify the real and/or financial assets that trade hands. Are any financial assets created or destroyed in the transaction? a. Toyota takes out a bank loan to finance the construction of a new factory. b. Toyota pays off its loan. c. Toyota uses $10 million of cash on hand to purchase additional inventory of spare auto parts.
a. Toyota creates a real asset—the factory. The loan is a financial asset that is created in the transaction. b. When the loan is repaid, the financial asset is destroyed but the real asset continues to exist. c. The cash is a financial asset that is traded in exchange for a real asset, inventory.
CH 1 What are some approaches to solving agency problems?
corporate governance mechanisms, such as the design of executive compensation, oversight by the Board, and monitoring from the institutional investors