FIN 780 Exam 2
Consider a bond which pays 7% semiannually and has 8 years to maturity. The market requires an interest rate of 8% on bonds of this risk. What is this bond's price?
941.74
method for computing the stock price of a non dividend paying firm with external financing needs
free cash flows
Stock A has a variance of .1428 while Stock B's variance is .0910. The covariance of the returns for these two stocks is -.0206. What is the correlation coefficient? A. -.1505 B. -.1146 C. -.1480 D. -.1643 E. -.1807
E. -.1807
-The return an investor in a security receives is _____ _____ the cost of the security to the company that issued it.
Equal to
Which of the following is not a difference between debt and equity?
Equity is publicly traded while debt is not
-The period of time before and after an IPO when communication with the public is limited is known as the _____ period.
Quiet.
Historically, the real return on Treasury bills has been:
Quite low
(Q) The next dividend payment by ECY, Inc., will be $3.20 per share. The dividends are anticipated to maintain a growth rate of 6 percent, forever. If ECY stock currently sells for $63.50 per share, what is the required return? what is the dividend yield? What is the expected capital gains yield?
R = 11.04%, CGY = 6%
what is the relationship between firms and PE ratios?
is is generally assumed that similar firms have similar PE ratios
what is enterprise value equal to?
market value of equity + market value of debt - cash
distribution of stock returns can be described by the __ and __
mean return and sd of returns
which technique for capital budgeting is the most complex
monte carlo simulation
NASDAQ has a
multiple market maker system computer network of securities dealers
Dividend Growth
value of an asset is the PV of its expected future cash flows
Bonds issued by state and local governments are called __ ___
municipal bonds
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 Ibbotson-Sinquefield data shows that ___________.
-Long term corporate bonds had less risk or variability than stocks -US T-bills had the lowest risk or variability
Studying market history can reward us by demonstrating that:
-On average, investors will earn a reward for bearing risk -The greater the potential reward is, the greater the risk
A firm has 15,000 shares of stock outstanding. The expected net income is $50,000 of which 40% will be used to pay dividends and repurchase shares. Income is expected to grow by 10% and the required return is 14%. What is the price per share?
$33.33
the __ method is ideal for firms with limited funds that have a need for a quick turn around of their capital
payback
-Which of the following are tax-deductible to the firm?
Coupon interest paid on bonds.
what is the expected dividend yield?
Div/ stock price
-If a firm issues no debt, its average cost of capital will equal _____.
Its cost of equity.
The risk premium is computed by ______ the average return for the investment.
subtracting the average return on the U.S. Treasury bill from
The true risk of any investment comes from ____________.
surprises
-If the annual stock market returns for Barry Company were 19 percent, and -8 percent, what was the arithmetic mean for those 3 years?
([19 + 13 + -8]/3 =) 8%
diversification is possible as long as correlation doesnt equal
+1
PV0
= C1/r = C1/(r-g)
-WACC was used to compute the following project NPVs: Project A = $100, Project B = -$50, Project C = -$10, Project D = $40. Which projects should the firm accept?
A and D
What is a premium bond?
A bond that sells for more than face value
Bond prices decrease
As interest rates increase
-Assets A and B each have an expected return of 10 percent. Asset A has a standard deviation of 12 percent while Asset B has a standard deviation of 13 percent. Which asset would a rational investor choose?
Asset A (A is better as it offers the same return at a lower level of risk)
What is a bonds accrued interest
It is interest that has been earned but not yet received by the current bondholder
What is the asked price?
It is the price at which an investor can buy a bond It is the price at which dealer is willing to sell a particular security
Which of the following are true about a bonds face value?
It is the principal amount repaid at maturity It is also known as the par value
-What is the definition of expected return?
It is the return that an investor expects to earn on a risky asset in the future.
What does a Treasury yield curve show?
It shows the yield for different maturities of Treasury notes and bonds
What does the Treasury Yield Curve show?
It shows the yield for different maturities of Treasury notes and bonds
A market is considered transparent if?
It's prices and trading volume are easily observed
-Average returns can be calculated:
Two different ways.
Market risk Unsystematic risk
What are the two components of risky return (U) in the total return equation?
They both measure how two random variables are related
What do covariance and correlation measure?
The variance will decrease
What is the impact on the variance of a two-asset portfolio if the covariance between the two securities is negative?
The risk-free rate
What is the intercept of the security market line (SML)?
PE ratio is negatively related to the
firm's discount rate stocks risk
A zero coupon bond is a bond that
makes no interest payments
what is one objection to the PV analysis of stocks?
that investors are shortsighted
The relationship between nominal rate, real rates and inflation is called ___
the Fisher Effect
To determine the appropriate required return for an investment, we can use _________________.
the Security Market Line
what is order flow?
the flow of customer orders to buy and sell stocks
what method is most helpful when computing the stock price of a non-dividend paying firm with external financing needs?
the free cash flow model
what is the value of a firm's common stock to an investor?
the present value of all of the expected future dividends
which market do initial public offerings occur in?
the primary market
firm is more apt to the option to expand when
the project is a success
A capital gain occurs when:
the purchase price is less than the selling price
What is the intercept of the security market line (SML)?
the risk-free rate
when share repurchases are involved, what must you compute before calculating the stock price per share?
the total present value of all outstanding shares
when share repurchases take place, what must you calculate before finding stock price per share?
the total present value of all outstanding shares
conceptually, how are the dividend discount model, the comparables method, and the free cash flow model related?
they are mutually consistent and can all be used to determine the value of a share of stock
what is the NYSE's goal?
to generate as much liquidity as possible, which makes it easier for ordinary investors to quickly buy and sell at prevailing prices
(T/F) a capital gain on a stock is counted as part of the total return whether or not the gain is realized from selling the stock.
true
What two factors determine a stock's total return?
unexpected risk & expected return
The average squared difference between the actual return and the average return is called the:
variance.
correlation ___ over time
varies
what are electronic communications networks? (ECNs)
websites that allow investors to trade directly with one another; buy and sell orders are transmitted to the NASDAQ and displayed along with the market maker bid and ask prices; increase liquidity and competition
what is straight voting?
when directors are elected one at a time; the only way to guarantee a seat is to own 50% plus one share, which guarantees you will win every seat
-The rate used to discount project cash flows is known as the _____.
• Cost of capital • Discount rate • Required return
-Which of the following are components used in the construction of the WACC?
• Cost of preferred stock • Cost of common stock • Cost of debt
-Which of the following are ways to make money by investing in stocks?
• Dividends • Capital gains
-Which of the following are examples of systematic risk?
• Future rates of inflation • Regulatory changes in tax rates.
-As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
• It may eventually be almost totally eliminated. • It is likely to decrease.
Bond Pricing Theorm
Bonds of similar risk(and Maturity) will be priced to yield about the same return, regardless of the coupon rate. If you know the price of one bond, you can estimate its YTM and use that to find the price of the second bond.
What are municipal bonds?
Bonds that have been issued by state or local governments
-_____ were a bright spot for U.S. investors during 2008.
Bonds.
The primary purpose of portfolio diversification is to: A. increase returns and risks. B. eliminate all risks. C. eliminate asset-specific risk. D. eliminate systematic risk. E. lower both returns and risks.
C. Eliminate asset-specific risk.
Weisbro and Sons common stock sells for $21 a share and pays an annual dividend that increases by 5% annually. The market rate of return on this stock is 9%. What is the amount of the last dividend paid by Weisbro and Sons? Multiple Choice $.77 $.80 $.84 $.87 $.88
$.80
$1,000; $35 : Because the bond is selling at par, its price is equal to the face value of $1,000. Since the bond pays coupon seminually, coupon = $1,000 * 7% / 2 = $35
A bond with a 7 percent coupon that pays interest semi-annually and is priced at par will have a market price of _____ and interest payments in the amount of _____ each.
-Which of the following is true?
A company can deduct interest paid on debt when computing taxable income.
The NYSE trades both electronically and face-two-face, which makes it ___.
A hybrid market
Which rating means that a firm is in a strong position to meet its debt obligations?
AAA
above
According to the CAPM, a security is considered underpriced when its expected return plots ___ the SML.
When its expected return plots below the SML
According to the CAPM, when is a security considered overpriced?
-Some risk adjustment to a firm's WACC or projects of differing risk, even if it is subjective, is probably:
Better than no risk adjustment.
What are cash flows to investors in stocks?
Capital Gains Dividends
A portfolio consists of Stocks A and B and has an expected return of 11.6 percent. Stock A has an expected return of 17.8 percent while Stock B is expected to return 8.4 percent. What is the portfolio weight of Stock A? A. 29.87% B. 61.98% C. 32.58% D. 34.04% E. 67.42%
D. 34.04%
Risk that affects at most a small number of assets is called _____ risk. A. portfolio B. non-diversifiable C. market D. unsystematic E. total
D. Unsystematic
__ act as two sided dealers in particular stocks
DMM
_______ act as two-sided dealers in particular stocks.
DMMs
An agent who buys and sells securities from inventory is called a:
Dealer
When interest rates in the market rise, we can expect the price of bonds to __
Decrease
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: a. Default and liquidity risk differences. b. Maturity risk differences. c. Inflation differences. d. Tax effects. e. Real risk-free rate differences
Default and liquidity risk differences.
Net investment is equal to the total investment minus ____.
Depreciation
State of Economy Probability ofState of Economy Portfolio ReturnIf State Occurs Recession .16 − .10 Normal .52 .12 Boom .32 .32
E(R) = .16(−.10) + .52(.12) + .32(.32) E(R) = .1488, or 14.88%
-The CAPM formula is:
E(RE)=Rf+B(E(RM)-Rf)
T/F: Immunization is an active form of bond management
False
-An important advantage to a firm raising equity internally is not having to pay _____.
Flotation costs.
PE Ratio
PPS/EPS
when share repurchases are involved, you must compute the __ before the stock price per share
PV of the outstanding shares
What is the present value of the annual interest payments on a 20 year, $1000 par value bond with a 5% coupon paid annually, if the yield on similar bonds is 10%?
PV= (.05 X $1000) X (1-1/1.10^20) .10 = $425.68
Initial public offerings of stock occur in the ____ market.
Primary
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 rate are higher
A member of the NYSE acting as a dealer in one or more securities on the exchange floor is called a:
Specialist
-The systematic risk principle argues that the market does not reward risks:
That are borne unnecessarily.
If you are holding two identical bonds except that one matures in 10 years and the other matures in 5 years, which bonds price will be more sensitive to interest rate risk?
The 10 year bond
0
The historical market risk premium for equities has been ______.
The sensitivity of a bonds price to interest rate changes in dependent in which of the following two variables?
Time to maturity Coupon rate
-An advertisement used after the registration waiting period to announce a new securities issue is called a _____.
Tombstone
Which one of the following types of securities has tended to produce the lowest real rate of return for the period 1926 through 2011?
U.S. Treasury bills
Which are the two unique features of a US federal government bond?
US Treasury issues are considered to be default free US Treasury issues are exempt from state income taxes
-If a cash offer is a public offer, a(n) _____ is usually involved.
Underwriter
when dealing with the history of capital market returns, an average stock market return is useful because it: a) is the best estimate of any one years stock market return during the specified period b) guarantees the long-term future rate of return c) simplifies detailed market data d) accurately forecasts future short-run returns
a + c
what features does the NASDAQ have?
a computer network of securities dealers and a multiple market maker system
PI rule for an independent project is to ___ if PI > 1
accept
what are DMMs?
act as dealers in particular stocks, maintaining a two-sided market continually updating bid and ask prices; ensures there is always a buyer or seller available, thereby promoting market liquidity
what is the formula for dividend yield?
dividend / stock price
if you buy 40 shares of BP stock at $35 per share, your total investment in BP is
$1400 = 40 x 35
If your total dollar return was $7 and your dividend was $2, then the price change on your stock must have been ____
$5 = 7-2
-What is the expected return on a security with a beta of 1.2 if the risk-free rate is 4 percent and the expected return on the market is 12 percent?
13.6%
-Suppose you buy a share of stock for $100. At the end of one year the stock price is $114 and a $1 dividend is paid. If you do not sell the stock, your total annual return is _____.
15%
Suppose you buy a share of stock for $100. At the end of one year the stock price is $144 and a $1 dividend is paid. If you do not sell the stock, your total annual return is _________.
15%
If the dividend received next year is $2, the discount rate is 10%, and the stock is currently priced at $25, the constant growth rate must be ____ percent.
2
Bonds used in Ibbotson SBBI long-term U.S. government bond portfolio had maturities of ___ years.
20
what is the approximate standard deviation of the returns on an average stock?
50%
-The probability of an outcome being within + or - one standard deviation to the mean in a normal distribution is approximately ____ percent.
68
If the arithmetic average return is 10% and the variance of returns is 0.05, find the approximate geometric mean
7.5
-The probability of an outcome being within + or - two standard deviations of the mean in a normal distribution is approximately _____ percent.
95
If the covariance of Stock A with Stock B is .20, then what is the covariance of Stock B with Stock A? A. .20 B. .80 C. 5 D. 4 E. -1.20
A. .20
There is a 10 percent probability the economy will boom and a 20 percent probability it will fall into a recession. Stock A is expected to return 15 percent in a boom, 9 percent in a normal economy, and lose 14 percent in a recession. Stock B should return 10 percent in a boom, 6 percent in a normal economy, and 2 percent in a recession. Stock C is expected to return 5 percent in a boom, 7 percent in a normal economy, and 8 percent in a recession. What is the standard deviation of a portfolio invested 20 percent in Stock A, 30 percent in Stock B, and 50 percent in Stock C? A. .6% B. .9% C. 1.8% D. 2.2% E. 4.9%
D. 2.2%
An efficient set of portfolios is comprised of: A. a complete opportunity set. B. the portion of the opportunity set located below the minimum variance portfolio. C. only the minimum variance portfolio. D. the dominant portion of the opportunity set. E. only the maximum return portfolio.
D. The dominant portion of the opportunity set.
Winslow, Inc. stock is currently selling for $40 a share. The stock has a dividend yield of 3.8%. How much dividend income will you receive per year if you purchase 500 shares of this stock?
Dividend income = $40 × .038 × 500 = $760
The total dollar return on a stock is the sum of the ____________ and the __________.
Dividends; Capital gains
-Sigma Corporation consists of two divisions: A and B. Division A is riskier than Division B. if Sigma Corporation uses the firm's overall WACC to evaluate both Divisions' projects, which Division will probably not receive enough resources to fund all of its potentially profitable project?
Division B
Enterprise value is equal to the market value of a firm's equity plus the market value of a firm's debt ____.
Minus cash
-What is the required return on a stock (RE), according to the constant dividend growth model, if the growth rate (g) is zero?
Re= D1/P0
If you are holding two identical bonds, except that one matures in 10 year and the other matures in 5 years, which bonds price will be more sensitive to interest rate risk?
The 10 year bond
A stock has a beta of 1.33 and an expected return of 13.1%. A risk-free asset currently earns 4.45% (a) What is the expected return on a portfolio that is equally invested in the two assets? (b) If a portfolio of the two assets has a beta of 0.93, what are the portfolio weights? (c) If a portfolio of the two assets has an expected return of 12.3 percent, what is its beta? (d) If a portfolio of the two assets has a beta of 2.53, what are the portfolio weights?
a). Expected return 8.78 % b). Weight of the stock 0.6992 Weight of the risk-free asset 0.3008 c). Beta 1.21 d). Weight of the stock 1.9023 Weight of the risk-free asset -0.9023
YTM=coupon rate
par value=bond price
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? a. $1,220.48 b. $1,190.71 c. $1,133.34 d. $1,161.67 e. $1,105.69
$1,105.69
Sqeekers Co. issued 11-year bonds a year ago at a coupon rate of 8.9 percent. The bonds make semiannual payments and have a par value of $1,000. If the YTM on these bonds is 7.2 percent, what is the current bond price?
$1,119.72 rate: 7.2%/2 nper: (11-1)*2 pmt: -1000*8.9%/2 fv: -1000 cmpt pv
What is the value (price) of a 5 year 7.4% coupon bond selling to yield 5.6%, assuming the coupon payments are made semiannually?
$1077.56
You bought one share of stock for $100 and received a 2$ dividend. If the price of the stock rose to $103, then your total dollar return would be _____.
$5 103-100+2 = 5
Name two features of municipal bonds:
1. They are exempt from federal taxes 2. They are issued by state and local government's
what are the three patterns of dividend growth?
1. zero growth 2. constant growth 3. differential growth
-What is the expected return for a security if the risk-free rate is 5 percent, the expected return on the market is 9 percent, and the security's beta is 1.5?
11%
-What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4 percent and the expected return on the market is 12 percent?
13.6%
Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%? a. 20-year, zero coupon bond. b. 20-year, 10% coupon bond. c. 20-year, 5% coupon bond. d. 1-year, 10% coupon bond. e. 10-year, zero coupon bond
20-year, zero coupon bond.
urnips and Parsley common stock sells for $31.65 a share at a market rate of return of 9.5%. The company just paid their annual dividend of $1.20. What is the rate of growth of their dividend? Multiple Choice 5.2% 5.5% 5.9% 6.0% 6.3%
B. 5.5%
The term for the number of years until the face value of a bond is due to be paid is:
Bond's time to maturity
The standard deviation of a portfolio will tend to increase when: A. a risky asset in the portfolio is replaced with U.S. Treasury bills. B. one of two stocks related to the airline industry is replaced with a third stock that is unrelated to the airline industry. C. the portfolio concentration in a single cyclical industry increases. D. the weights of the various diverse securities become more evenly distributed. E. short-term bonds are replaced with Treasury Bills.
C. The portfolio concentration in a single cyclical industry increases.
Zelo stock has a beta of 1.23. The risk-free rate of return is 2.86 percent and the market rate of return is 11.47 percent. What is the amount of the risk premium on Zelo stock? A. 9.47% B. 12.60% C. 11.54% D. 10.59% E. 12.30%
D. 10.59%
Stock M has a beta of 1.2. The market risk premium is 7.8 percent and the risk-free rate is 3.6 percent. Assume you compile a portfolio equally invested in Stock M, Stock N, and a risk-free security that has a portfolio beta equal to the overall market. What is the expected return on the portfolio? A. 11.2% B. 10.8% C. 10.4% D. 11.4% E. 11.7%
D. 11.4%
6.value: 10.00 points Suppose you know that a company's stock currently sells for $64 per share and the required return on the stock is 14 percent. You also know that the total return on the stock is evenly divided between a capital gains yield and a dividend yield. If it's the company's policy to always maintain a constant growth rate in its dividends, what is the current dividend per share? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Current dividend per share $
Dividend yield % is a % of the total stock per share price P0 = D0 (1+g) / [R-g] = D1 / [R-g] 14% = Capital gains yield + dividend yield = 7% + 7% g = 0.07 7% =D1 = 0.07x64= 4.48 P0 = 64 Dividend yield = D1 = D0 (1+g) = 4.48=D0(1.07) D0 = 4.48/1.07 D0 = *4.19*
-With the _____ method of issuing securities, the underwriter determines the offer price based on submitted bids.
Dutch auction underwriting.
The principle of diversification tells us that: A. concentrating an investment in two or three large stocks will eliminate all of your risk. B. concentrating an investment in three companies all within the same industry will greatly reduce your overall risk. C. spreading an investment across five diverse companies will not lower your overall risk at all. D. spreading an investment across many diverse assets will eliminate all of the risk. E. spreading an investment across many diverse assets will eliminate idiosyncratic risk.
E. Spreading an investment across many diverse assets will eliminate idiosyncratic risk.
The price earnings ratio is found by dividing the current price per share by last year's _____.
Earnings per share
-if the firm is all-equity, the discount rate is equal to the firm's cost of _____ capital.
Equity
-True or false: Systematic risk will impact all securities in every portfolio equally.
FALSE (While it is possible, it is highly unlikely that systematic risk such as changes in interest rates will affect all firms equally.)
Long-term bonds have greater interest rate sensitivity because a large portion of a bonds value comes from the $1000 _______ ________.
Face amount.
What are the effects of staggering the elections for the board of directors?
Increased prevention of minority shareholder control of the board Improved continuity on the board of directors Decreased likelihood of a successful takeover attempt
In general, a corporate bonds coupon rate?
It's fixed until the bond matures.
9.value: 10.00 points Lohn Corporation is expected to pay the following dividends over the next four years: $17, $13, $12, and $7.50. Afterward, the company pledges to maintain a constant 5 percent growth rate in dividends forever. If the required return on the stock is 15 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Current share price $
P0 = D0 (1+g) / [R-g] = D1 / [R-g] P4 = D5 / [R-g] = (7.50x1.05) / [.15-.05] = 7.875/.1 = 78.75 Fv 4 = Stock price + Dividend = 78.75 + 7.50 = 86.25 Fv 3 = dividend = 12 Fv 2 = dividend = 13 Fv 1 = dividend = 17 FV 83.25, I/Y = 15%, N = 4, CPT PV = 49.31 FV 12, I/Y = 15%, N = 3, CPT PV = 7.89 FV 13, I/Y = 15%, N = 2, CPT PV = 9.83 FV 17, I/Y = 15%, N = 1, CPT PV = 14.78 sum = current share price= *$81.81*
What four variables are required to calculate the value of a bond?
Par value Coupon rate Time remaining to maturity Yield to maturity
A no-dividend firm can still pay off for an investor by ___.
Paying high dividends in the future. Being acquired in the future
9.30% Cacluate YTM on current bond and they will be equal
Pembroke Co. wants to issue new 20-year bonds for some much-needed expansion projects. The company currently has 10% coupon bonds on the market that sells for $1,063, makes semiannual payments and matures in 20 years. What coupon rate should the company set on its new bonds if it wants them to sell at par?
(Q) Ayden, Inc., has an issue of preferred stock outstanding that pays a $5.90 dividend every year, in perpetuity. If this issue currently sells for $87 per share, what is the required return?
R = 6.78%
Common stock is generally identified by its lack of special preference in ____.
Receiving dividends Bankruptcy
-A document required by the SEC for new public issues that contains the issuing firm's financial information, financial history, and details of the existing business is known as the _____.
Registration statement
-If an all-equity firm discounts a project's cash flows with the firm's overall weighted average cost of capital even though the project's beta is less than the firm's overall beta, it is possible that the project might be:
Rejected, when it should be accepted.
Which of the following variables are required to calculate the value of a bond? Check all that apply. -original issue price of bond - remaining life of bond -market yield -coupon rate
Remaining life of bond, market yield, coupon rate.
Which of the following are usually included in the bond's indenture? -The bond's rating -The names of the bondholders -The repayment arrangements -The total amount of bonds issued
Repayment arrangements and total amount of bonds issued.
The arithmetic average rate of return measures the _______________.
Return in an average year over a given period
-The arithmetic average rate of return measures the _____.
Return in an average year over a given period.
4.03 %
Suppose a stock had an initial price of $62 per share, paid a dividend of $2.50 per share during the year, and had an ending share price of $72. What was the dividend yield?
Suppose you own a risky asset with an expected return of 12% and a standard deviation of 20%. If the returns are normally distributed, the approximate probability of receiving a return greater than 32% is approximately:
Z = (32 - 12)/20 = 1; 32 is 1 standard deviation above the mean. The probability of being within 1 standard deviation is approximately 68%; therefore, probability above the mean is approximately 32%/2 = 16%
You have identified a 3.5% coupon Treasury Bond with 4 years left to maturity. The quoted price is $962.81 a. Calculate the bond's current yield b. Calculate the bond's Yield to Maturity (YTM)
a. 3.63% b. 4.53%
All of the following can be used as passive bond management techniques except: a. Forecasting interest rates b. Buy and hold c. Indexing d. Immunization e. All of the above
a. Forecasting interest rates
which of the following positive financial events occurred in the us in 2008? a) inflation was only 5% b) T-bills had positive returns c) long-term bonds had positive returns d) corporate bonds rose 15%
b + c
All of the following are components of interest rates except: a. Riskless rate b. Return premium c. Time factor d. Risk premium e.All are factors
b. Return premium
common stock is generally identified by its lack of special preferences in
bankruptcy receiving dividends
what does common stock lack special preference in?
bankruptcy payouts and receiving dividends
a __ market is characterized by declining stock prices
bear
why do many states have mandatory cumulative voting?
because straight voting freezes out minority shareholders
the dividend yield for a one-year period is equal to the annual dividend amount divided by the
beginning stock price
no dividend firm can still pay off an investor by
being acquired in the future paying dividends in the future
the geometric rate of return takes _____ into account.
compounding
The appropriate discount rate to use to evaluate a new project is the _________.
cost of capital
Which of the following is true concerning duration? a. Duration is negatively related to a bond's coupon rate b. Duration is positively related to maturity c. Duration is a good measure of the impact on bond prices for large changes in interest rates d. A & B e. A& C
d. A & B
the value of stock is equal to the
discounted PV of the (sum of next period's dividend + net period's stock price) and the discounted PV of all future dividends
P0
dividend/(discount rate - growth rate)
cash flows to investors in stocks are
dividends and capital gains
what are SLPs?
essentially investment firms that agree to be active participants in stocks assigned to them; their job to regularly mae a one sided market purely for their own accounts
what do floor brokers do?
execute trades for customers, trying to get the best price possible
A floor broker is a NYSE member who:
executes orders on behalf of a commission broker.
The price of a share of common stock is equal to the present value of all _____ future dividends.
expected
the Ibbotson SBBI small stock portfolio includes the bottom _______ of NYSE listed stocks.
fifth
A PE ratio that is based on estimated future earnings is known as a ________PE ratio.
forward
Systematic risk will _______ when securities are added to a portfolio.
not charge
total variable costs are directly related to
number of output
variable cost PER UNIT is not related to
number of units produced
NASDAQ has what features?
o Computer network of securities dealers o Multiple market maker system
What are the three basic patterns of dividend growth?
o Constant growth o Zero growth o Differential growth
What three are common methods used to compute stock values?
o Dividend Discount model o Free cash flow model o Comparable method
Earning next year are a function of which factors?
o Earnings this year o Return on retained earnings o Retained earnings this year
The term structure of interest examines the _______.
relationship between short-term and long-term interest rates
The excess return you earn by moving from a relatively risk-free investment to a risky investment is called the:
risk premium.
trading of existing shares is in the __ market
secondary
what is the effect of cumulative voting?
to permit minority participation
what is the formula for net investment?
total investment - depreciation
-To estimate a firm's equity cost of capital using the CAPM, we need to know the _____.
• Market risk premium • Risk-free rate • Stock's beta
-The available evidence indicates that there are pronounced cycles in which of the following?
• The number of IPOs • The degree of IPO underpricing.
Bond ratings are based on the probability of default risk which is the risk that
the bonds issuer may not be able to make all the required payments
what is the rate at which a stock's price is expected to appreciate or depreciate?
the capital gains yield
monte carlo simulation analyzes
the expected NPV by determining a probability distribution for each variable
how is the market cap calculated?
the number of shares outstanding * current stock price / share
In predicting the expected future return of the market, one of the dangers is that:
the past is not indicative of the future and the past period measured is too short to get a reasonable estimate of the future.
A portfolio can be described by its portfolio weights which are defined as _________________.
the percentage of dollars invested in each asset
What is the value (price) of a zero-coupon bond that matures in 20 years and is selling to yield 7.6%?
$224.96
You have decided that you would like to own some shares of GH Corp. but need an expected 12.5% rate of return to compensate for the perceived risk of such ownership. What is the maximum you are willing to spend per share to buy GH stock if the company pays a constant $3.40 annual dividend per share? Multiple Choice $26.04 $26.87 $27.20 $28.29 $29.59
$27.20 3.40/ 12.5% = 27.2
The model that correctly specifies the relationship between the nominal rate and the real rate is: R = the nominal rate r = the real rate
(1 + R ) = (1 + r) x (1+h)
Say you own an asset that had a total return last year of 11.7 percent. If the inflation rate last year was 6.9 percent, what was your real return?
(1 + inflation) ( 1 + real return) = (1 + total return) (1 + 6.9%)( 1 + real return) = (1 + 11.7%) (1 + real return) = (1 + 11.7%) / (1 + 6.9%) = 1.0449 Real Return = 1.0449 - 1 = 0.0449 = 4.49%
Which of the following are examples of unsystematic risk? -labor strikes -the expected rate of inflation next year -changes in management -changes in federal tax code
-labor strikes -changes in management
if the risk premium of stock JKL is 5% while the standard deviation is 10%, then the sharpe ratio equals
.5 = .05/.1
You buy a stock for $50. Its price rises to $55, and it pays a $2 dividend in a year. You do NOT sell the stock. Your capital gains yield is ________.
10%
Weisbro and Sons common stock sells for $21 a share and pays an annual dividend that increases by 5% annually. The market rate of return on this stock is 9%. What is the amount of the last dividend paid by Weisbro and Sons?
$0.80 $21 = [D0 x (1 + 0.05)]/(0.09 - 0.05)
$100 at the end of each year forever at 10% per year is worth how much today?
$1,000
You invest in a bond paying 6% interest paid semiannually with a fae value of $1,000. The bond matures in 8 years and current market rates are 5%. What is the current value of the bond?
$1,065.28
Winslow and Daughters just paid their annual dividend of $2.20 a share. They recently announced that all future dividends will be increased by 2 percent annually. What is one share of this stock worth to you if you require a 14 percent rate of return?
$18.70 Work: Current price=D1/(Required return-Growth rate) =(2.2*1.02)/(0.14-0.02) =18.70
-A firm needs to raise $950,000 but will incur flotation costs of 5 percent. How much will it pay in flotation costs?
$50,000
-If you buy 100 shares of ABC stock at $5 per share, your total investment is _____?
$500
-A company has a borrowing rate of 15 percent and a tax rate of 30 percent. What is its aftertax cost of debt?
10.5%
-If the risk premium of stock JKL is 5 percent while the standard deviation is 10 percent, then the Sharpe ratio equals _____.
(.05/.10 =) .5
-What is the return on a portfolio that consists of: $50,000 in an index fund, $30,000 in a bond fund, and $20,000 in a foreign stock fund? The expected returns are 7 percent, -3 percent, and 18 percent, respectively.
(.5 X 7% + .3 X -3% + .2 X 18% =) 6.2%
-If the arithmetic return is 10% and the variance of returns is 0.05, find the approximate geometric mean.
(0.10 - ½ X 0.05 =) 7.5%
-Marks Company believes that there is a sixty percent chance of a recession and a forty percent chance of a boom. In the case of recession, the company expects to earn a 2% return. In the case of a boom, the company expects to earn 22%. What is the Marks Company's expected return?
(0.6*0.0+0.4*0.22)=0.10
-What will your capital gain be if you hold 40 shares of BP stock and the stock price rises from $27 to $40 a share?
(40 X [$40 - 27] =) $520
how can the price of a stock at the end of one year be calculated?
(Div2 + P2) / 1 + discount rate
___________ risk is reduced as more securities are added to the portfolio.
- Diversifiable - Unsystematic - Unique
Martha's Vineyard recently paid a $3.60 annual dividend on its common stock. The dividend increases at an average rate of 4.5% per year. The stock is currently selling for $57.88 a share. What is the rate of return on the stock?
11.0% $57.88 = [$3.60 x (1 + 0.045)] / (R - 0.045)
Which of the following statements are true about variance? - Standard deviation is the square root of variance - Computation of variance requires the use of a computer - Variance is a measure of the squared deviations of a security's return from its expected return - Variance measures a security's expected return over many periods
- Standard deviation is the square root of variance - Variance is a measure of the squared deviations of a security's return from its expected return
Which of the following are true?
- T-bills sometimes outperform common stocks. - Common stocks frequently experience negative returns.
Non-Constant Growth Dividend Model
- assume that dividends will grow at different rates in the foreseeable future and then will grow at a constant rate after. Steps: estimate dividends, find perpetuity of constant growth, discount the dividends back
Key Assumptions of MMA
- comparable firms have future CF expectations and risks similar to the firm being valued
Constant Growth Dividend Model
- dividends grow at a constant rate, g, forever. Value of a growth stock = PV of a growing perpetuity. P0 =Div1/(r-g), where Div1= Div0(1 + g), Pt = D_t+1/(r-g)
Zero Growth Dividend Model
- dividends remain at the same level forever (ex: preferred stock with fixed dividends and infinite life. Like a perpetuity.) P0 = Dividend / r
Stock Ownership Cash flows
- dividends, capital gains
Expected Return Constant Growth
- expected rate of return = expected dividend yield + expected capital gain yield
Free Cash Flow Approach
- find market value (MV) of an entire firm using free cash flows and weighted average cost of capital
Price Earnings Ratio
- indicated the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company's earnings. AKA price multiplier because it shows how much investors are willing to pay per dollar of earnings.
Expected Return Zero Growth
- infer expected return of a precerred stock or zero growth stocks given price. P = D1/P0
A corporate bond's yield to maturity:
- is usually not the same as a bond's coupon rate - changes over time
The risk of owning an asset comes from:
- unanticipated events - surprises
The rates of return in the Ibbotson-Sinquefield studies are not adjusted for which of the following?
-Inflation -Taxes
Arrange the following investments from highest to lowest return based on what our study of capital market history has revealed about risk premiums.
-Small company -Long-term -U.S. treasury bills
Which of the following are common protective covenants? -The firm cannot merge with any other firm -The firm is pledge assets to other lenders -The firm must limit dividends to equity holders -The firm must maintain working capital at or above a specified level -The firmest issue additional long-term debt within a specified.
-The firm cannot merge with any other firm -The firm must limit dividends to equity holders -The firm must maintain working capital at or above a specified level
The Ibbotson-Sinquefield data presents returns from 1925 to the recent past for:
-US T-Bills, -Large cap stocks -Small cap stocks
Three special case patterns of dividend growth discussed in the text include:
-constant growth -zero growth -non-constant growth
Preferred stock has preference over common stock in the:
-payment of dividends -distribution of corporate assets
If security ABC has a beta of 1. and security XYZ has a beta of 1, what is the beta of a portfolio that is equally invested in both securities?
1.25
Standard deviation measures _____ risk while beta measures ____ risk. A. total; systematic B. nondiversifiable; diversifiable C. unsystematic; total D. unsystematic; systematic E. total; unsystematic
A. total; systematic
The expected return on the market
According to the capital asset pricing model, what is the expected return on a security with beta of 1?
-The best way to include flotation costs is to _____.
Add them to the initial investment.
a discount; higher than
All else constant, a bond will sell at _____ when the yield to maturity is _____ the coupon rate.
decreases; decreases.
All else constant, as the market price of a bond increases the current yield _____ and the yield to maturity _____
A portfolio has 45 percent of its funds invested in Security One and 55 percent invested in Security Two. Security One has a standard deviation of 6 percent. Security Two has a standard deviation of 12 percent. The securities have a coefficient of correlation of .62. What is the portfolio variance? A. .006946 B. .007295 C. .007157 D. .008104 E. .007506
B. .007295
If a stock portfolio is well diversified, then the portfolio variance: A. will equal the variance of the most volatile stock in the portfolio. B. may be less than the variance of the least risky stock in the portfolio. C. must be equal to or greater than the variance of the least risky stock in the portfolio. D. will be a weighted average of the variances of the individual securities in the portfolio. E. will be an arithmetic average of the variances of the individual securities in the portfolio.
B. May be less than the variance of the least risky stock in the portfolio.
When an investor sells Avon, the price received is always the?
Bid price
Stock K is expected to return 12.4 percent while the return on Stock L is expected to be 8.6 percent. You have $10,000 to invest in these two stocks. How much should you invest in Stock L if you desire a combined return from the two stocks of 11 percent? A. $3,511 B. $4,209 C. $3,684 D. $2,907 E. $3,415
C. $3,684
74. Stock A has a beta of 1.2, Stock B's beta is 1.46, and Stock C's beta is .72. If you invest $2,000 in Stock A, $3,000 in Stock B, and $5,000 in Stock C, what will be the beta of your portfolio? A. 1.008 B. 1.014 C. 1.038 D. 1.067 E. 1.127
C. 1.038
This type of bond protects insurance companies from natural disasters.
CAT bond
-Dividends paid to common stockholders _____ be deducted from the payer's taxable income for tax purposes.
Cannot
The rate at which a stock's price is expected to appreciate (or depreciate) is called the _____ yield.
Capital Gains
-WACC is used to discount _____ _____.
Cash flows
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
A corporate bond's yield to maturity
Changes over time Is usually not the same as bonds coupon rate
A member of the New York Stock Exchange who executes buy and sell orders from customers once transmitted to the exchange floor is called a:
Commission Broker
-The average return on the stock market can be used to _____.
Compare stock returns with the returns on other securities.
The separation principle states that an investor will: A. choose between any efficient portfolio and a riskless asset to generate the desired expected return. B. choose a portfolio from the efficient set based on individual risk tolerance. C. never choose to invest in a riskless asset due to the low expected rate of return. D. combine a riskless asset with the tangency portfolio based on their risk tolerance level. E. combine a riskless asset with the minimum variance portfolio based on their risk tolerance level.
D. Combine a riskless asset with the tangency portfolio based on their risk tolerance level.
Someone who maintains an inventory of stocks and buys and sells those stocks is known as a ____.
Dealer
-Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio:
Declines
You purchased 300 shares of stock at a price of $37.23 per share. Over the last year, you have received total dividend income of $351. What is the dividend yield?
Dividend per share = $351 ÷ 300 = $1.17; Dividend yield = $1.17 ÷ $37.23 = 3.14%
Which one of the following represents valuation of stock using a zero-growth model?
Dividend/Discount rate
what is the expected return formula?
E(r) = dividend yield + capital gains yield
What is the difference between debt and equity?
Equity is publicly traded while debt is not.
-The _____ rate of return is the difference between risky returns and risk-free returns.
Excess.
A firm may choose to forgo dividends today if growth opportunities are ____.
High
A bond with a BBB rating has a (higher or lower) risk than a bond with an A rating.
Higher risk of default
In a stock price quote, the ask price is _____ the bid price
Higher than
-What is systematic risk?
It is a risk that pertains to a large number of assets.
What is a risk premium?
It is additional compensation for taking risk, over and above the risk-free rate
-What is a risk premium?
It is additional compensation for taking risk, over and above the risk-free rate.
What is the definition of a bonds time to maturity?
It is the number of years until the face values are paid off
Experience more Price risk
Long-term bonds with low coupon rates
In an inflationary environment, reported earnings are ____ if a firm uses LIFO rather than FIFO accounting.
Lower
What are two components of risky return in the total return equation?
Market risk & unsystematic risk
Bonds are classified based on the collateral provided to protect bondholders in case of default. Which of the following are unseccured forms of debt?
Notes Debentures (in the US)
What are some features of the OTC market for bonds?
OTC dealers are connected electronically The OTC has no designated physical location
-When is a new issue usually priced?
On the effective date of the registration statement.
Which of the following terms apply to a bond?
Par value Coupon rate Time to maturity
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 ____ value than on the present value of the ____________ payments.
Par, coupon
What are the cash flows involved in the purchase of 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%?
Pay $800 today and receive $1000 at the end of 5 years
-Variance is measured in _____, while standard deviation is measured in _____.
Percent squared; percent
If its YTM is less than its coupon rate, a bond will sell at a (blank), and increases in market interest rates will (blank).
Premium; decrease this premium
The voting procedure where a shareholder grants authority to another individual to vote his or her shares is called _____ voting.
Proxy
-A project should only be accepted if its return is above what is _____.
Required by investors
-The CAPM can be used to estimate the _____.
Required return on equity.
The ratio of this year's retained earnings to net income is called the _____ ratio.
Retention
When estimating the growth rate, g, with the constant-growth stock valuation model, it is assumed that the ______ ratio stays the same.
Retention
The market in which previously issued securities are traded among investors is called the _____ market.
Secondary
The trading of existing shares occurs in the ____ market.
Secondary
Which bond is not greatly affected by small changes in interest rates? Choose short-term or long-term.
Short term
Experience more reinvestment rate risk
Short-term bonds with high coupon rates
P1
Stock price in one year
P0
Stock price today
This type of bond is based on financial securities, commodities, or currencies.
Structured note
Which of the following is commonly used to measure inflation
The Consumer Price Index (CPI)
The relationship between nominal rates, real rates and inflation is called _______.
The Fisher Effect
expected; unexpected
The ______ return is equal to the ______ return and a(n) ______ part of the return. actual;
The price at which the dealer is willing to sell is called:
The ask price
-Which of the following methods for calculating the cost of equity ignores risk?
The dividend growth model.
increases; increases
The expected return on the market will increase if the risk-free rate _________ or if the market risk premium _____.
-What is the expected return on a security with beta of 1?
The expected return on the market.
remain unchanged
The expected returns of the existing securities in your portfolio ______ when new securities are added to the portfolio
Heginbotham Corp. issued 15-year bonds two years ago at a coupon rate of 8.5 percent. The bonds make semiannual payments. If these bonds currently sell for 106 percent of par value, what is the YTM?
The yield to maturity is given by rate function in excel as =rate(nper,pmt,pv,fv) where nper = 15 * 2 = 30 semiannual periods pmt = 0.085 *1000 = 85/2 = 42.5 pv = 1060 FV =1000 Hence semiannual yield = rate(30,42.5,-1060,1000) = 3.9069% Hence annual yield = 3.9069*2 = 7.8139% = 7.81%
The US government borrows money by issuing:
Treasury notes & bonds
T/F: Convexity estimates better than duration the economic life of the bond (the impact of changing interest rates on bond prices for large changes in interest rates)
True
covariance correlation
Two ways to measure the relationship between the returns of two securities are ______ and ______.
-Which new issue cost results from a stock initially being sold for less than its true value?
Underpricing
-In the 1999-2000 time period, companies missed out on $63 billion because of _____.
Underpricing.
-A Dutch auction underwriting is also known as a(n) _____.
Uniform price auction.
The dollar value of the world stock market capitalization, from largest to smallest is:
United States, Europe, Japan, United Kingdom
-An initial public offering (IPO) is also referred to as a(n) _____.
Unseasoned new issue.
true
Unsystematic risk is eliminated in a well-diversified portfolio of securities
If you wish to create a portfolio of stocks, what is the required minimum number of stocks?
You must invest in stocks of at least 2 corporations
-If you wish to create a portfolio of stocks, what is the required minimum number of stocks?
You must invest in stocks of more than one corporation.
to realize a capital loss if you sold the bond at the market price today.
You own a bond that has a 7 percent coupon and matures in 12 years. You purchased this bond at par value when it was originally issued. If the current market rate for this type and quality of bond is 7.5 percent, then you would expect:
If the growth rate (g) is zero, the capital gains yield is _____.
Zero
-If a stock has returns of 10 percent and 20 percent over 2 years, the geometric average rate of return can be calculated by _____.
[(1.10)(1.20)]^2-1
what is the formula for price per share?
[(dividend payout ratio x NI)/(discount - growth)]/# shares outstanding
Unsystematic Idiosyncratic Unique
____ risk is reduced as more securities are added to the portfolio
coupon rate
annual interest payment as a percentage of face value
the Ibbotson SBBI data presents returns from 1948 to the recent past for: a) high-yield bonds b) municipal bonds c) small-company stocks d) us treasury bills e) large-company stocks
c + d + e
how to calculate expected return on a portfolio using beta
calculate the average beta between individual securities and plug the average into the CAPM formula
What is a bond's current yield?
current yield = annual coupon payment / current price
as depreciation expense increases, taxes and NI will ___ while investment cash flows will ___
decrease increase
if inflation rate increases, the nominal rate will
increase
when estimating equivalent annual costs, ____ cash flows should be used
real because comparing projects with different lives, so inflation could be different in later years when the shorter project is already done
Which one of the following is a correct ranking of securities based on their volatility over the period of 1926 to 2011? Rank from highest to lowest.
small company stocks, large company stocks, long-term corporate bonds
Bond rating 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
-Which of the following are true?
• Common stocks frequently experience negative returns. • T-bills sometimes outperform common stocks.
-The growth rate of dividends can be found using:
• Historical dividend growth rates • Security analysts' forecasts
-Arrange the following investments from highest to lowest return based on what our study of capital market history has revealed about risk premiums.
• Small-company common stock • Long-term corporate bonds • U.S. Treasury bills
-The risk of owning an asset comes from:
• Surprises • Unanticipated events
-The Ibbotson-Sinquefield data show that over the long-term _____.
• T-bills, which had the lowest risk, generated the lowest return • Small-company stocks had the highest risk level • Small-company stocks generated the highest average return
-Which of the following are examples of information that may impact the risky return of a stock?
• The Fed's decision on interest rates at their meeting next week. • The outcome of an application currently pending with the Food and Drug Administration.
-What are the two components of unexpected return (U) in the total return equation?
• The unsystematic portion • The systematic portion
-Arrange the following investments in ascending order from lowest historical risk premium to highest historical risk premium:
• U.S. Treasury Bills • Long-term corporate bonds • Large-company stocks • Small-company stocks
-The Ibbotson-Sinquefield data presents returns from 1925 to the recent past for:
• US T-bills • Large-cap stocks • Small-cap stocks
-Which of the following are explanations of underpricing?
• Underpricing is a kind of insurance for the investment banks. • Underpricing occurs with smaller issues in order to attract investors.
If the quoted interest rate is 2% per month (12 months in a year), what is the APR?
24%
Over the period of 1926 to 2011, the average rate of inflation was _____%.
3.1
What excel function 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)
A bond with a 7% coupon that pays interest semi-annually and is priced at par will have a market price of _____ and interest payments in the amount of _____ each. Multiple Choice $1,007; $70 $1,070; $35 $1,070; $70 $1,000; $35 $1,000; $70
A bond with a 7 percent coupon that pays interest semi-annually and is priced at par will have a market price of _____ and interest payments in the amount of _____ each. A. $1,007; $70B. $1,070; $35C. $1,070; $70D. $1,000; $35E. $1,000; $70Answer: (D ) Interest payment: 1,000 x (.07/2) = 35
The two polar cases when estimating R for individual securities are:
A firm whose growth rate is equal to or above R A firm paying no dividends
More volatility in returns produces _____ difference between the arithmetic and geometric averages.
A larger.
The expected return will increase to 19% from 11%.
A security has a beta of 1, the market risk premium is 8 percent, and the risk-free rate is 3 percent. What will happen to the expected return if the beta doubles?
-Barry Corporation expects free cash flow of $110 thousand at the end o the year, and steady growth from here on. Its WACC is 12% and its expected growth rate is 5%. What is the value of Barry Corporation today?
$1,571,429
-Including the preferred stock in the WACC adds the term:
(P/V)XRp
As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
- It may eventually be almost eliminated - It is likely to decrease
What does variance measure?
- It measures the riskiness of a security's returns - It measures the spread of the sample of returns
Which of the following are examples of systematic risk? -future rates of inflation -labor strikes -regulatory changes in tax rates -an increase in competition in the industry
-future rates of inflation -regulatory changes in tax rates
Your portfolio has a beta of 1.18. The portfolio consists of 20% U.S. Treasury bills, 30% in stock A, and 50% in stock B. Stock A has a risk-level equivalent to that of the overall market. What is the beta of stock B? Multiple Choice .55 1.10 1.24 1.60 1.76
1.60
-Suppose the risk-free rate is 5 percent, the market rate of return is 10 percent, and beta is 2. Find the required rate of return using the CAPM.
15%
-The calculation of a portfolio beta is similar to the calculation of:
A portfolio's expected return.
The risk premium for an individual security is computed by: A. multiplying the security's beta by the market risk premium. B. multiplying the security's beta by the risk-free rate of return. C. adding the risk-free rate to the security's expected return. D. dividing the market risk premium by the quantity (1 + Beta). E. dividing the market risk premium by the beta of the security.
A. Multiplying the security's beta by the market risk premium.
A stock with a beta of zero would be expected to have a rate of return equal to: A. the risk-free rate. B. the market rate. C. the prime rate. D. the market rate less the risk-free rate. E. zero.
A. The risk-free rate.
I, III, and IV only
American Fortunes is preparing a bond offering with an 8 percent coupon rate. The bonds will be repaid in 10 years. The company plans to issue the bonds at par value and pay interest semiannually. Given this, which of the following statements are correct? I. The initial selling price of each bond will be $1,000. II. After the bonds have been outstanding for 1 year, you should use 9 as the number of compounding periods when calculating the market value of the bond. III. Each interest payment per bond will be $40. IV. The yield to maturity when the bonds are first issued is 8 percent.
A website that allow investors to trade directly with one another is called ____
An ECN
You would like to combine a highly risky stock with a beta of 2.6 with U.S. Treasury bills in such a way that the risk level of the portfolio is equivalent to the risk level of the overall market. What percentage of the portfolio should be invested in Treasury bills? A. 57.91% B. 61.54% C. 50.00% D. 38.46% E. 42.09%
B. 61.54%
-The dividend yield for a 1-year period is equal to the annual dividend amount divided by the _____.
Beginning stock price.
-Economic Value Added (EVA) uses the weighted average cost of capital to determine if value is:
Being created or destroyed
One year ago, you purchased a stock at a price of $60 a share. Today, you sold the stock and realized a total return of 30%. Your capital gain was $8 a share. What was your dividend yield on this stock?
Capital gains yield = $8 ÷ $32 = 25%; Dividend yield = 30% - 25% = 5%
A form of equity which receives no preferential treatment in either the payment of dividends or in bankruptcy distributions is called _____ stock.
Common
-You have estimated the following returns for Companies X and Y: Company Return in recession Return in Boom X -3% 20% Y -8% 30% If Boom and Recession have an equal probability of occurring, what is the expected return on a portfolio consisting of 80% Company X and 20% Company Y?
Company X Expected return is 0.085 Company Y Expected return is 0.11 Expected return on the portfolio is 9%
-With the_____ method of selecting a syndicate, the issuing firm offers its securities to the highest biding underwriter.
Competitive offer
-The geometric rate of return takes ______ into account.
Compounding.
The expected return on a portfolio: A. can be greater than the expected return on the best performing security in the portfolio. B. can be less than the expected return on the worst performing security in the portfolio. C. is independent of the performance of the overall economy. D. is limited by the returns on the individual securities within the portfolio. E. is an arithmetic average of the returns of the individual securities when the weights of those securities are unequal.
D. Is limited by the returns on the individual securities within the portfolio.
The linear relation between an asset's expected return and its beta coefficient defines the: A. reward-to-risk ratio. B. covariance line. C. characteristic line. D. security market line. E. market risk premium.
D. Security market line
The market risk premium is computed by: A. adding the risk-free rate of return to the inflation rate. B. adding the risk-free rate of return to the market rate of return. C. subtracting the risk-free rate of return from the inflation rate. D. subtracting the risk-free rate of return from the market rate of return. E. multiplying the risk-free rate of return by the market beta.
D. Subtracting the risk-free rate of return from the market rate of return.
-When new securities are added to a portfolio, the total unsystematic risk portion of that portfolio is most likely to _____.
Decrease.
In the dividend discount model, the expected return for investors comes from which two sources?
Dividend Yield Growth Rate
Div1
Dividend at end of Year 1
-One method for estimating the cost of equity is based on the _____ model.
Dividend growth
One year ago, you purchased a stock at a price of $33. The stock pays quarterly dividends of $.60 per share. Today, the stock is worth $35.2 per share. What is the total amount of your dividend income to date from this investment?
Dividend income = $.60 × 4 = $2.40
The range of possible correlations between two securities is defined as: A. 0 to +1. B. 0 to-1. C. ≧ 0. D. ≦ 1. E. +1 to -1.
E. +1 to -1.
Suppose you observe the following situation: Security Pete Corp: Beta = 1.80 Expected Return = 0.190 Security Repete Co. Beta = 1.49 Expected Return = 0.163
Expected return on market = 12.03% Risk-free rate = 3.32%
-The second lesson from studying capital market history is that risk is:
Handsomely rewarded
-What does the security market line depict?
It is a graphical depiction of the capital asset pricing model. It shows the relationship between expected return and beta.
What is a real rate of return?
It is a rate return that has been adjusted to remove inflation It is a percentage change in buying power An inflation rate measures changes in buying power
What is unsystematic risk?
It is a risk that affects a single asset or a small group of assets
Which term applies to the granting of authority by a shareholder to someone else to case their votes?
Proxy
Name three institutions that issue bonds that are traded in the bond market.
Public corporations, the federal government, state governments.
-Other companies that specialize only in projects similar to the project your firm is considering are called. ____.
Pure plays
Return Rate
R = (D1/P0) + g
The determinants of a firm's growth rate include which factors?
Return on retained earnings The retention ratio
-The Sharpe ratio measures _____.
Reward to risk.
Lower than 6.5% YTM= 3.88% Effective annual rate= 3.92% ((1+0.0194)^2))-1
Suppose that the bond with a 6.5% coupon rate and semiannual coupons, has a face value of $1000, 3 years to maturity and is selling for $1073.44 (asked Price). Without calculation, will the yield by more or less than 6.5% Calculate the YTM? What is the effective annual yield on this bond?
Which of the following are usually included in a bonds indenture?
The total amount of bonds issued The repayment arrangements
How are the unsystematic risks of two different companies in two different industries related?
There is no relationship
Name three important features of treasury notes and bonds:
They are highly liquid, default-free, and taxable on the state or local level but not the federal level.
Which of the following are true of bonds?
They are interest only loans They are issued by both corporations and governments They are the major form of corporate debt
Junk bonds have the following features
They have high probability of default They pay a high rate of interest They are rated below investment grade bonds
A firm decides to raise money by issuing 5 million bonds with a par value of $5000 each for 10 years at a coupon rate of 7%. At the time of issue the bonds were sold for $5500 each. But with the par value of the bonds be in five years?
They will be the par value of $5000.
True or false: all else equal, the longer the time to maturity, the greater the interest rate risk.
True
When a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means that the market:
already knew about most of the news item
what is the most difficult corporation type for these formulas to predict stock price for?
companies who do not pay cash dividends
the average return of the stock market can be used for
compare stock returns with returns of other securities
the average return on the stock market can be used to
compare stock returns with the returns on other securities
two mutually exclusive projects can be evaluated correctly by
comparing the incremental IRR to the discount rate comparing the NPV of the two projects examining the NPV of the incremental cash flows NOT just comparing the IRRs
Bourdon Software has 10.4 percent coupon bonds on the market with 16 years to maturity. The bonds make semiannual payments and currently sell for 108 percent of par. What is the current yield on the bonds? Current yield % What is the YTM? YTM % What is the effective annual yield? Effective annual yield %
coupon rate: 10.4 maturity (years): 16 price % of par: 108% price: 108%*1000=1080 coupon: 104%*1000=104 current yield: 10% (coupon/price) N= years *2 = 32 I/Y=? PV=-1080* PMT=104/2=52 FV=1000 4.71*2=9.42 --> YTM EAR = (1 + 0.0471)^2-1 = 9.64 *important to enter as a negative number
what does the constant-growth model assume?
dividends change at a constant rate
what dividends are provided by constant growth dividends?
dividends grow at a rate of g per period; steady growth rather than level payments
Assuming a bond portfolio manager is managing against an index with a duration of 4.5 years. If the manager believes interest rates will rise, which of the following will be the manager's best move: a. Create a portfolio with a duration of 6.3 years b. Create a portfolio with a duration of 5.4 years c. Create a portfolio with a duration of 4.5 years d. Create a portfolio with a duration of 4.0 years e. Create a portfolio with a duration of 3.5 years
e. Create a portfolio with a duration of 3.5 years
how are earnings impacted when a firm uses LIFO over FIFO in an inflationary environment?
earnings are lower
what is the formula for next year's earnings?
earnings next year = earnings this year + RE + return on RE
earnings next year are a function of
earnings this year return on retained earnings retained earnings this year
the _____ risk premium on common stocks represents the additional return from bearing risk.
equity
Find constant growth rate
g = discount rate - (D1/P0)
proxy
granting the authority of another SH to use your vote
we should accept a project if the IRR is ___ than the discount rate
greater
what is a potential beneficial purpose of staggering?
it provides institutional memory, or continuity on the board of directors - can be important for firms with significant long-range plans and projects
present value break even point is better than accounting break even because
it takes into consideration the opportunity cost of the initial investment
The PE ratio is negatively related to the ______.
o Stock's risk o Firms discount rate
optimal portfolios
offer the lowest risk for a given level of return offer the highest level of return for a given level or risk provide the best risk-reward trade off
the discount rate is often referred to as
opportunity cost
retention ratio
ratio of this years retained earnings to net income
capital ____ occurs when a firm doesnt have enough funds for all of its positive NPV project
rationing
one objection to PV analysis for stock is that investors are
short sided; investors wont look past their time horizon of owning the stock
characteristics line for a security shows
shows a security's variance of returns shows a security's return in relation to the market's return
beta measures __ risk
systematic
Locate the Treasury issue in Figure 7.4 maturing in February 2029. Assume a par value of $10,000. What is its coupon rate? What is its bid price in dollars? What was the previous day's asked price in dollars?
the coupon rate is 5.250% bid price = [par value x bid quote] =[10,000*1.233594 (/or 123.3594%)] = $12,335.94 asked price = [par value*(asked price-change)] =[10000*(123.3594%-(-0.7031%))] =$12,406
The Zolo Co. just declared that it is increasing its annual dividend from $1.00 per share to $1.25 per share. If the stock price remains constant, then:
the dividend yield will increase
the frequency distribution of stock returns displays
the frequency of occurrence for each rate of range various ranges of return on x axis
coupon
the interest payments paid to the bondholder
a stock that pays a constant annual dividend will have what kind of market price change?
the market price will decrease when the market rate increases (NOT SURE CHECK QUIZ Q5)
the square of the standard deviation is equal to
variance
-What can we say about the dividends paid to common and preferred stockholders?
• Dividends to preferred stockholders are fixed. • Dividends to common stockholders are not fixed
T/F: A strategy that bond investors typically use if they believe that interest rates will fall is to shorten their duration
False
T/F: For a coupon paying bond the duration will always be longer than the time to maturity
False
T/F: The duration of a bond is negatively related to the maturity
False
True or False: A well-diversified portfolio will eliminate all risks.
False
maximize expected return and minimize risk
From an investor's perspective, an optimal portfolio will ___.
An asset's value is determined by the present value of its _____ cash flows.
Future
-Which, of the following is a conclusion that can be drawn regarding market efficiency from capital market history?
Future market prices are hard to predict based on publicly available information.
-True or false: A capital gain on a stock is counted as part of the total return whether or not the gain is realized from selling the stock.
TRUE (An unrealized gain is treated the same as a realized gain when computing the total return.)
Which of the following are features of municipal bonds?
They are issued by state and local governments The interest on municipal bonds is, in some cases, exempt from state taxes in the state of issue The interest on municipal bonds in exempt from federal taxes
Capital market history shows us that the average return relationship from lowest to highest between securities is:
Treasury bills, government bonds, corporate bonds, large common stocks, small company stocks.
Three vehicles the US government issues to borrow money:
Treasury notes, treasury bonds, and treasury bills.
-What does WACC stand for?
Weighted Average Cost of Capital
Correlation is related to covariance. Correlation measures the interrelationship between the returns of two securities.
Which of the following statements are true about correlation?
Systematic, or market risk
Which one of the following types of risk is not reduced by diversification?
Systematic, or market, risk
Which type of risk does not change as we add more securities to a portfolio?
the excess rate of return: a) can occasionally be negative b) is generally positive over the long term c) can never be negative for more than a 1-year period
a + b
a frequency distribution of stock returns displays: a) various ranges of returns on the horizontal axis b) the standard deviation of all data points c) the average of all data points d) the frequency of occurrence for each rate of return range
a + d
the average excess return on common stocks is called the _____ risk premium.
equity
More frequent compounding leads to:
higher EARs
A bond with a BBB rating has a _______ than a bond with an A rating.
higher risk of default
NYSE trades electronically and face to face making it a
hybrid market
how is the dividend yield calculated?
next year's expected cash dividend / current stock price
-Capital gain on a stock results from _____.
An increase in stock price.
The expected return on HiLo stock is 14.08 percent while the expected return on the market is 11.5 percent. The beta of HiLo is 1.26. What is the risk-free rate of return? A. .41% B. 2.01% C. .69% D. 1.58% E. 1.62%
D. 1.58%
Estimation of firm's value
Industry value * EBITDA
16.13%
Suppose a stock had an initial price of $62 per share, paid a dividend of $2.50 per share during the year, and had an ending share price of $72. What is the capital gains yield?
-Which of the following variables is NOT required when using the CAPM to compute the cost of equity capital?
The rate of inflation.
yield to maturity
The rate of return required by investors in the market for owning a bond is called the:
what is the dividend discount model formula?
V = D / (1 + k) ^ t
-The square of the standard deviation s equal to the _____.
Variance
-Financing from wealthy individuals or private investment groups is referred to as _____.
Venture
Percentage returns are more convenient than dollar returns because they:
apply to any amount invested
the risk of an individual security depends on the security's
covariance with the market
Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio:
declines
Davis Corp bonds have a 15-year maturity, a 7% coupon (paid semiannually), and par value of $1,000. The market interest rate (rd) is 6%, based on semiannual compounding. What is the bond's price?
$1,098
Wilbert's Clothing Stores just paid a $1.25 annual dividend. The company has a policy whereby the dividend increases by 2% annually. You would like to purchase 100 shares of stock in this firm but realize that you will not have the funds to do so for another three years. If you desire a 12% rate of return, how much should you expect to pay for 100 shares when you can afford to buy this stock? Ignore trading costs.
$1,353 P3 = [$1.25 x (1 + 0.02)^4] / (0.12 - 0.02) P3 is purchase cost = $13.53 x 100 shares
The Reading Co. has adopted a policy of increasing the annual dividend on their common stock at a constant rate of 3.5% annually. The last dividend they paid was $0.95 a share. What will the company's dividend be in five years? Multiple Choice $.90 $.93 $1.03 $1.13 $1.23
$1.13
The Reading Co. has adopted a policy of increasing the annual dividend on their common stock at a constant rate of 3.5% annually. The last dividend they paid was $0.95 a share. What will the company's dividend be in five years?
$1.13 D6 = $0.95 x (1.03^6)
If you buy 100 shares of ABC stock at $5 per share, your total investment is ____________.
$500
You bought 100 shares of stock at $20 each. At the end of the year, you received a total of $400 in dividends, and your stock was worth $2,500 total. What was your total dollar capital gain and total dollar return?
$CG = $2,500 - $2,000 = $500; $Total Return = CG + DIV = $500 + $400 = $90
-Including preferred stock in the WACC adds the term:
(P/V)Rp
-One year ago, Ernie purchased shares of RTF common stock for $100 a share. Today the stock paid a dividend of $1 per share. If the stock currently sells for $114 per share, what is Ernie's total return?
([114 + 1 + 100]/100 = .15 =) 15%
-If you buy a stock for $50. After one year, its price rises to $55, and it pays a $2 dividend. You do not sell the stock. Your capital gains yield is _____.
([55 - 50]/50 =) 10%
What will your after-tax you'll be on a corporation bond that is currently priced to yield 7% if you are in the 25% tax bracket?
(yield) X (1 - tax rate) .07 X (1 - .25) .07 X .75 = 5.25
Which of the following are examples of a portfolio? - Investing $100,000 in a combination of stocks and bonds - Investing $100,000 in a combination of US and Asian stocks - Investing $100,000 to buy 100 shares of the best performing stock on the NYSE - Investing $100,000 in the stocks of 50 publicly traded corporations
- Investing $100,000 in a combination of stocks and bonds - Investing $100,000 in a combination of US and Asian stocks - Investing $100,000 in the stocks of 50 publicly traded corporations
Which of the following ratios might be used to estimate the value of a stock?
-The Price/Earnings Ratio -The Price/Sales Ratio
In the dividend growth model, the expected return for investors comes from which two sources?
-dividend yield and growth rate -capital gains yield
Name six factors that determine the yield on a bond.
-expected future inflation -default risk -Real rate of return -taxability -interest rate risk - liquidity
if the risk premium of stock MNO is 10% and the standard deviation is 40%, what is the sharpe ratio?
.25 = .1/.4
-By definition, what is the beta of the average asset equal to?
1
what are the two key differences between the NYSE and the NASDAQ?
1. the NASDAQ is a computer network and has no physical location where trading takes place 2. the NASDAQ has a multiple market maker system rather than a DMM system
in practice, which models have which uses?
1. the dividend discount model is useful for firms paying steady dividends 2. the comparables model is useful for firms with similar growth opportunities 3. the free cash flow model is helpful for non-dividend paying firms with external financing needs
Winston Enterprises has a 15-year bond issue outstanding that pays a 9 % coupon. The bond is currently priced at $894.60 and has a par value of $1,000. Interest is paid semiannually. What is the yield to maturity? Multiple Choice 8.67% 10.13% 10.16% 10.40% 10.45%
10.40%
(Q) The common stock of Eddie's Engines, Inc. sells for $25.71 a share. The stock is expected to pay $1.80 per share one year from today when the annual dividend is distributed. Eddie's has established a pattern of increasing its dividends by 4% annually and expects to continue doing so. What is the market rate of return on this stock?
11%
What is the expected return for a security if the risk-free rate is 5%, the expected return on the market is 9%, and the security's beta is 1.5?
11% 5+1.5(9-5)=11%
You agree to repay $1,200 in 2 weeks for a $1,000 payday loan. What is your EAR assuming that there are 52 weeks in a year?
11,347.55%
Martha's Vineyard recently paid a $3.60 annual dividend on its common stock. This dividend increases at an average rate of 4.5% per year. The stock is currently selling for $57.88 a share. What is the rate of return on the stock? Multiple Choice 6.5% 7.5% 8.5% 9.0% 11.0%
11.0%
Palmer Company had the following returns: 2009: 12% 2010: 10% 2011: -8% 2012: 4% 2013: 22% What is the standard deviation of Palmer's return?
11.04%
What is the current yield on $1000 par value bond that sells for $900 with the coupon rate is 10%?
11.11%. Current yield equals annual amount divided by PV (aka Price of bond). First myltiply .10 X $1000 to get payment. It's already annualized at $100. So, $100/$900= .11111 =11.11%
-What is the expected return of a portfolio consisting of stocks A and B if the expected return is 10 percent for A and 15 percent for B? Assume you are equally invested in both the stocks.
12.5%
Bet'R Bilt Bikes just announced that their annual dividend for this coming year will be $1.42 a share and that all future dividends are expected to increase by 2.5% annually. What is the market rate of return if this stock is currently selling for $14.20 a share? Multiple Choice 9.5% 10.0% 12.5% 13.5% 15.0%
12.5%
What is the expected return of a portfolio consisting of Stocks A and B if the expeted return is 10% for A and 15% for B? Assume you are equally invested in both the stocks.
12.5%
Bet'R Bilt Bikes just announced that their annual dividend for this coming year will be $1.42 a share and that all future dividends are expected to increase by 2.5% annually. What is the market rate of return if this stock is currently selling for $14.20 a share?
12.5% $14.20 = $1.42 / (R - 0.025)
-The weighted average of the standard deviation of the assets in Portfolio C is 12.9%. Which of the following is a possible value for the standard deviation of the portfolio?
12.9% & 10.9% (The standard deviation of a portfolio is less than or equal to the weighted average of the standard deviations of the assets in the portfolio.)
-A firm's capital structure consists of 30 percent debt and 70 percent equity. Its bonds yield 10 percent, pretax, its cost of equity is 16 percent, and the tax rate is 40 percent. What is its WACC
13%
The risk-free rate of return is 3.5% and the market risk premium is 7.5%. What is the expected rate of return on a stock with a beta of 1.28? Multiple Choice 9.12% 10.24% 13.10% 14.24% 15.36%
13.10%
One year ago, Ernie purchased shares of RTF common stock for $100 a share. Today the stock paid a dividend of $1 per share. If the stock currently sells for $114 per share, what is Ernie's total return?
15% (114-100+1)/100 = 15%
One year ago, Ernie purchased shares of RTF common stock for $100 a share. Today the stock paid a dividend of $1 per share. If the stock currently sells for $114 per share, what is Ernie's total return?
15% = (114 - 100 + 1) / 100
Kurt's Adventures, Inc. stock is quite cyclical. In a boom economy, the stock is expected to return 30% in comparison to 12% in a normal economy and a negative 20% in a recessionary period. The probability of a recession is 15%. There is a 30% chance of a boom economy. The remainder of the time the economy will be at normal levels. What is the standard deviation of the returns on Kurt's Adventures, Inc. stock? Multiple Choice 10.05% 12.60% 15.83% 17.46% 25.04%
15.83%
If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent, then the probability of earning a return greater than 15 percent is about _____ percent.
16
The Lo Sun Corporation offers a 6% bond with a current market price of $875.05. The yield to maturity is 7.34%. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond matures? Multiple Choice 16 years 18 years 24 years 30 years 36 years
16 years
-If stock ABC as a mean return of 10 percent with a standard deviation of 5 percent, then the probability of earning a return greater than 15 percent is about _____ percent.
16%
-If the risk-free rate is 4 percent, an all-equity firm's beta is 3, and the market risk premium is 6 percent, what is the firm's cost of capital?
16%
The enterprise value of a firm will be $ _____ million if the EV/EBITDA ratio for the industry is 8 and it has an EBITDA of $20million.
160
If an all-equity firm's beta is 2, the risk-free rate is 3%, and the historical market risk premium is 7%, what is the firm's cost of capital?
17%
a share of common stock currently sells for $100 and will pay a dividend of $2 at the end of the year. if the price is expected to increase to $113 at the end of one year, what is the stock's current dividend yield?
2% = 2/100
A firm has three open seats on its board of directors and has 10,000 shares outstanding. How many shares must you control to ensure your election to the board if each share receives one vote and voting is cumulative?
2,501 [10,000/(3 +1)]
-If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent, then the probability of earning a negative return is approximately _____ percent.
2.5
the probability of a return being more than two standard deviations below the mean in a normal distribution is approximately _____ percent.
2.5
If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent, then the probability of earning a negative return is approximately ___ percent.
2.5 = .05/2
-The probability of an outcome being TWO STANDARD DEVIATIONS BELOW the mean in a normal distribution is approximately _____ percent.
2.5 (The probability of an outcome being two standard deviations below the mean in a normal distribution is approximately 2.5 percent. This is true because there is a 95% probability that it is within two standard deviations of the mean. Because the normal distribution is symmetric, there must be a 0.05/2=0.025 probability of the outcome being 2 standard deviations below or above the mean.)
the probability of a return being more than two SD below the mean in a normal distribution is
2.5%
McCue Inc.'s bonds currently sell for $1,250. They pay a $90 annual coupon, have a 25-year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? (Subtract the YTC from the YTM; it is possible to get a negative answer.) a. 2.62% b. 2.88% c. 3.83% d. 3.48% e. 3.17%
2.62%
Joline Enterprises just paid their annual dividend of $1.40. The stock is selling for $12.48 a share and has a required return of 14 percent. What is the growth rate of the dividend?
2.78 percent Dividend Growth = Year X Dividend / (Year X - 1 Dividend) - 1
long-term corporate bonds is a portfolio of high-quality corporate bonds with _____-year maturities.
20
-When 100 securities are included, the standard deviation of a portfolio of risky assets falls to about:
20% (When 100 securities are included, the standard deviation of a portfolio of risky assets falls to about 20%. It only takes 10 securities to reduce a portfolio's standard deviation to about 23.7%)
7.value: 10.00 points Moraine, Inc., has an issue of preferred stock outstanding that pays a $3.15 dividend every year in perpetuity. If this issue currently sells for $92 per share, what is the required return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Required return %
3.15/92 = *3.42%*
the 94.5% confidence interval for the historical standard error for the true us equity risk premium should be within _____ % to _____%.
3.4; 11
A stock pays an $.80 dividend and has a market price of $20.40 a share. What is the dividend yield?
3.92 percent (0.80/20.40) * 100 = 3.92156 -> 3.92
The probability of an outcome being within one standard deviation of the mean in a normal distribution is approximately _________ percent.
68
the probability of a return being within one standard deviation of the mean in a normal distribution is approximately _______ percent.
68
What is the arithmetic average return for a stock that has annual returns of 8%, 2%, and 11% for the past 3 years?
7%
If an investment appreciates by 7% while the rate of inflation is 2%, what is the nominal rate of return?
7%. The nominal rate is the observed rate, in this case the appreciation is the observed rate. It includes inflation. (P 223)
Dyl Inc.'s bonds currently sell for $1,040 and have a par value of $1,000. They pay a $65 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to maturity (YTM)? a. 5.78% b. 6.39% c. 6.71% d. 6.09% e. 7.05%
7.05%
Sadik Inc.'s bonds currently sell for $1,180 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)? a. 6.98% b. 6.63% c. 7.35% d. 8.12% e. 7.74%
7.74%
A General Co. bond has an 8 % coupon and pays interest annually. The face value is $1,000 and the current market price is $1,020.50. The bond matures in 20 years. What is the yield to maturity? Multiple Choice 7.79% 7.82% 8.00% 8.04% 8.12%
7.79%
-John's portfolio consists of $1,200 worth of Chi Corporation common stock and $400 worth of Lambda Corporation common stock, Lambda's portfolio weight is 25%, and Chi's portfolio weight is:
75% (*must equal 1.00)
the long-run average risk premium for large-company common stocks for the period 1926 to 2014 was:
8.6%
ou have a portfolio consisting solely of stock A and stock B. The portfolio has an expected return of 11.2%. Stock A has an expected return of 12% while stock B is expected to return 7%. What is the portfolio weight of stock A? Multiple Choice 46% 54% 58% 64% 84%
84% ".112" = [.12 × x] + [.07 × (1 - x)] = .12x + .07 - .07x; .042 =.05x; x = 84%
Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bond is 7.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now? a. 8.16% b. 7.75% c. 8.59% d. 7.36% e. 9.04%
9.04%
The rate of return on the common stock of Flowers by Flo is expected to be 14 percent in a boom economy, 8 percent in a normal economy, and only 2 percent in a recessionary economy. The probabilities of these economic states are 20 percent for a boom, 70 percent for a normal economy, and 10 percent for a recession. What is the variance of the returns? A. .001044 B. .001280 C. .001863 D. .002001 E. .002471
A. .001044
Stock S is expected to return 12 percent in a boom, 9 percent in a normal economy, and 2 percent in a recession. Stock T is expected to return 4 percent in a boom, 6 percent in a normal economy, and 9 percent in a recession. There is a 10 percent probability of a boom and a 25 percent probability of a recession. What is the standard deviation of a portfolio which is comprised of $4,500 of Stock S and $3,000 of Stock T? A. 1.4% B. 1.9% C. 2.6% D. 5.7% E. 7.2%
A. 1.4%
BPJ stock is expected to earn 14.8 percent in a recession, 6.3 percent in a normal economy, and lose 4.7 percent in a booming economy. The probability of a boom is 20 percent while the probability of a normal economy is 55 percent. What is the expected rate of return on this stock? A. 6.23% B. 6.72% C. 6.81% D. 7.60% E. 8.11%
A. 6.23%
The amount of systematic risk present in a particular risky asset, relative to the systematic risk present in an average risky asset, is called the particular asset's: A. beta coefficient. B. reward-to-risk ratio. C. total risk. D. diversifiable risk. E. Treynor index.
A. Beta coefficient
The correlation between Stocks A and B is computed as the: A. covariance between A and B divided by the standard deviation of A times the standard deviation of B. B. standard deviation A divided by the standard deviation of B. C. standard deviation of AB divided by the covariance between A and B. D. variance of A plus the variance of B divided by the covariance of AB. E. square root of the covariance of AB.
A. Covariance between A and B divided by the standard deviation of A times the standard deviation of B.
The beta of a security is calculated by dividing the: A. covariance of the security return with the market return by the variance of the market. B. correlation of the security return with the market return by the variance of the market. C. variance of the market by the covariance of the security return with the market return. D. variance of the market return by the correlation of the security return with the market return. E. covariance of the security return with the market return by the correlation of the security and market returns
A. Covariance of the security return with the market return by the variance of the market.
The intercept point of the security market line is the rate of return which corresponds to: A. the risk-free rate of return. B. the market rate of return. C. a value of zero. D. a value of 1.0. E. the beta of the market.
A. The risk-free rate of return.
-The discount rate for the firm's projects equals the cost of capital for the firm as a whole when _____.
All projects have the same risk as the current firm.
The returns on your portfolio over the last 5 years were -5%, 20%, 0%, 10% and 5%. What is the arithmetic average return?
Arithmetic average = (-5 + 20 + 0 + 10 + 5)/5 = 6%
What are the arithmetic and geometric average returns for a stock with annual returns of 5%, 8%, -3%, and 16%?
Arithmetic average = (.05 + .08 - .03 + .16) ÷ 4 = 6.5%; Geometric return = (1.05 × 1.08 × .97 × 1.16).25 - 1 = 6.28%
A stock had returns of 8%, -2%, 4%, and 16% over the past four years. What is the standard deviation of this stock for the past four years?
Average return = (.08 - .02 + .04 + .16) ÷ 4 = .065; Total squared deviation = (.08 - .065)2 + (-.02 - .065)2 + (.04 - .065)2 + (.16 - .065)2 = .000225 + .007225 + .000625 + .009025 = .0171; Standard deviation = √(.0171 ÷ (4 - 1) = √.0057 = .075498 = 7.5%
A portfolio contains two securities and has a beta of 1.08. The first security comprises 54 percent of the portfolio and has a beta of 1.27. What is the beta of the second security? A. .79 B. .86 C. .62 D. .82 E. .93
B. .86
The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is referred to as the: A. market rate of return. B. market risk premium. C. systematic return. D. total return. E. real rate of return.
B. Market risk premium.
Stock A has a beta of .68 and an expected return of 8.1 percent. Stock B has a 1.42 beta and expected return of 13.9 percent. Stock C has a 1.23 beta and an expected return of 12.4 percent. Stock D has a 1.31 beta and an expected return of 12.6 percent. Stock E has a .94 beta and an expected return of 9.8 percent. Which one of these stocks is correctly priced if the risk-free rate of return is 2.5 percent and the market risk premium is 8 percent? A. Stock A B. Stock B C. Stock C D. Stock D E. Stock E
B. Stock B
Which one of the following statements is correct concerning the standard deviation of a portfolio? A. The greater the diversification of a portfolio, the greater the standard deviation of that portfolio. B. The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio. C. Standard deviation is used to determine the amount of risk premium that should apply to a portfolio. D. The standard deviation of a portfolio is equal to the geometric average standard deviation of the individual securities held within that portfolio. E. The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.
B. The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio.
What are crossover bonds?
Bonds that have both an investment grade and a junk bond rating
A portfolio has 38 percent of its funds invested in Security C and 62 percent invested in Security D. Security C has an expected return of 8.47 percent and a standard deviation of 7.12 percent. Security D has an expected return of 13.45 percent and a standard deviation of 16.22 percent. The securities have a coefficient of correlation of .89. What are the portfolio rate of return and variance values? A. 11.09%; .124031 B. 11.56%; .127620 C. 11.56%; .015688 D. 10.87%; .014308 E. 10.87%; .127620
C. 11.56%; .015688
Kali's Ski Resort, Inc. stock is quite cyclical. In a boom economy, the stock is expected to return 30 percent in comparison to 12 percent in a normal economy and a negative 20 percent in a recessionary period. The probability of a recession is 15 percent while there is a 30 percent chance of a boom economy. The remainder of the time, the economy will be at normal levels. What is the standard deviation of the returns? A. 10.05% B. 12.60% C. 15.83% D. 17.46% E. 25.04%
C. 15.83%
There is a 25 percent probability the economy will boom; otherwise, it will be normal. Stock Q is expected to return 18 percent in a boom and 9 percent otherwise. Stock R is expected to return 9 percent in a boom and 5 percent otherwise. What is the standard deviation of a portfolio that is invested 40 percent in Stock Q and 60 percent in Stock R? A. .7% B. 1.4% C. 2.6% D. 6.8% E. 8.1%
C. 2.6%
RTF stock is expected to return 10.6 percent if the economy booms and only 4.2 percent if the economy goes into a recessionary period. The probability of a boom is 55 percent while the probability of a recession is 45 percent. What is the standard deviation of the returns on RTF stock? A. 4.03% B. 2.97% C. 3.18% D. 3.69% E. 5.27%
C. 3.18%
Which one of the following is an example of unsystematic risk? A. the inflation rate increases unexpectedly B. the federal government lowers income taxes C. an oil tanker runs aground and spills its cargo D. interest rates decline by one-half of one percent E. the GDP rises by .5 percent more than anticipated
C. An oil tanker runs aground and spills its cargo
Which of these are squared values? A. variance, correlation, and covariance B. variance and beta C. covariance and variance D. correlation, beta, variance E. covariance and correlation
C. Covariance and variance
The capital market line: A. and the characteristic line are two terms describing the same function. B. intersects the feasible set at its midpoint. C. has a vertical intercept at the risk-free rate of return. D. has a horizontal intercept at the market beta. E. lies tangent to the opportunity set at its minimum point.
C. Has a vertical intercept at the risk-free rate of return.
As we add more diverse securities to a portfolio, the ____ risk of the portfolio will decrease while the _____ risk will not. A. total; unsystematic B. systematic; unsystematic C. total; systematic D. systematic; total E. unsystematic; total
C. Total; systematic
A stock with an actual return that lies above the security market line has: A. more systematic risk than the overall market. B. more risk than warranted based on the realized rate of return. C. yielded a higher return than expected for the level of risk assumed. D. less systematic risk than the overall market. E. yielded a return equivalent to the level of risk assumed.
C. Yielded a higher return than expected for the level of risk assumed.
You just sold 200 shares of Langley, Inc. stock at a price of $38.75 a share. Last year you paid $41.50 a share to buy this stock. Over the course of the year, you received dividends totaling $1.64 per share. What is your capital gain on this investment?
Capital gain = ($38.75 - $41.50) × 200 = -$550 (capital loss)
If you buy a stock for $10 and later sell it for $16, you will have a ___________.
Capital gain of $6
-If you buy a stock for $10 and later sell it for $16, you will have a _____.
Capital gain of $6.
-The total dollar return is the sum of dividends and _____.
Capital gains or losses.
Stock A is expected to return 12 percent in a normal economy and lose 7 percent in a recession. Stock B is expected to return 8 percent in a normal economy and 2 percent in a recession. The probability of the economy being normal is 80 percent and the probability of a recession is 20 percent. What is the covariance of these two securities? A. .004203 B. .004115 C. .003280 D. .003876 E. .003915
D. .003876
The variance of Stock A is .0036, the variance of the market is .0059, and the covariance between the two is .0026. What is the correlation coefficient? A. .8776 B. .1224 C. .5010 D. .5642 E. .4918
D. .5642
The risk-free rate of return is 3.68 percent and the market risk premium is 7.84 percent. What is the expected rate of return on a stock with a beta of 1.32? A. 9.17% B. 9.24% C. 13.12% D. 14.03% E. 14.36%
D. 14.03%
Stock A has a beta of .69 and an expected return of 9.27 percent. Stock B has a 1.13 beta and an expected return of 11.88 percent. Stock C has a 1.48 beta and an expected return of 15.31 percent. Stock D has a beta of .71 and an expected return of 8.79 percent. Lastly, Stock E has a 1.45 beta and an expected return of 14.04 percent. Which one of these stocks is correctly priced if the risk-free rate of return is 3.6 percent and the market rate of return is 10.8 percent? A. Stock A B. Stock B C. Stock C D. Stock D E. Stock E
D. Stock D
Which three of the following common shapes for the term structure of interest rates? -v-shaped -downward sloping -upward sloping -humps
Downward sloping, upward sloping, and humped. (P 226)
State of Economy Probability of State of Economy Portfolio Return If State Occurs Recession .30 − .15 Boom .70 .25
E(R) = .30(−.15) + .70(.25) E(R) = .1300, or 13.00%
The common stock of CTI has an expected return of 14.48 percent. The return on the market is 11.6 percent and the risk-free rate of return is 3.42 percent. What is the beta of this stock? A. .95 B. 1.49 C. 1.31 D. 1.42 E. 1.35
E. 1.35
76. Your portfolio has a beta of 1.18 and consists of 15 percent U.S. Treasury bills, 30 percent Stock A, and 55 percent Stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of Stock B? A. .55 B. 1.10 C. 1.24 D. 1.40 E. 1.60
E. 1.60
The variance of a portfolio comprised of many securities is primarily dependent upon the: A. variances of the securities held within the portfolio. B. beta of the portfolio. C. portfolio's correlation with the market. D. covariance between the overall portfolio and the market. E. covariances between the individual securities.
E. Covariances between the individual securities.
The slope of an asset's security market line is the: A. reward-to-risk ratio. B. portfolio weight. C. beta coefficient. D. risk-free interest rate. E. market risk premium.
E. Market risk premium
According to the capital asset pricing model, the expected return on a security is: A. negatively and non-linearly related to the security's beta. B. negatively and linearly related to the security's beta. C. positively and linearly related to the security's variance. D. positively and non-linearly related to the security's beta. E. positively and linearly related to the security's beta.
E. Positively and linearly related to the security's beta.
7.value: 10.00 points Treasury bills are currently paying 6 percent and the inflation rate is 3.3 percent. What is the approximate real rate of interest? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Approximate real rate % What is the exact real rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Exact real rate %
FISHER EFFECT --nominal rate is like interest rate or rate of return (1+R)=(1+r)(1+h) (1+ nominal rate)=(1+ real rate )(1+ expected inflation rate) a. approximate real rate = 6-3.3 = *2.7%* b. exact real rate (1+ nominal rate)=(1+ *real rate* )(1+ expected inflation rate) (1+ *real rate* )=(1+ nominal rate) / (1+ expected inflation rate) real rate = (1.06)(1.033) - 1 = 0.02614 = *2.61%*
-In an efficient market, firms should expect to receive _____ value for securities they sell.
Fair
True or False: Since the CAPM equation can be used only for individual securities, it cannot be used with portfolios.
False
True or false: zero coupon bond make interest payments.
False
Ture or false: All classes of stock issued by a firm must have equal voting rights.
False
-An investment bank that underwrites a security issue by buying the securities for less than the offering price and accepting the risk that the securities won't sell is using the _____ method.
Firm commitment
A member of the NYSE who tries to anticipate price fluctuations and buys and sells accordingly for his or her personal account is called a(n):
Floor Trader
-The costs associated with new issues are known as _____.
Flotation costs.
3%
For every 3% movement in the market, the market must move by:
-Historically, the real return on Treasury bills has been:
Quite low
A stock has an expected return of 12.9 percent and a beta of 1.15, and the expected return on the market is 11.9 percent. Required: What must the risk-free rate be?
Risk-free rate 5.23%
If the expected return on the market is 16%, then using the historical risk premium on large stocks of 8.6%, the current risk-free rate is:
Risk-free rate = 16% - 8.6% = 7.4%
-True or false: The existence of traders attempting to beat the market is a necessary precondition for markets to become efficient.
TRUE (without such professional traders, prices would fail to reflect all relevant information)
Rate of Return If State Occurs State of Probability of Economy State of Economy Stock A Stock B Recession .19 .10 − .14 Normal .60 .13 .15 Boom .21 .18 .32
The expected return of an asset is the sum of each return times the probability of that return occurring. So, the expected return of each stock asset is: E(RA) = .19(.10) + .60(.13) + .21(.18) E(RA) = .1348, or 13.48% E(RB) = .19(−.14) + .60(.15) + .21(.32) E(RB) = .1306, or 13.06% To calculate the standard deviation, we first need to calculate the variance. To find the variance, we find the squared deviations from the expected return. We then multiply each possible squared deviation by its probability, then add all of these up. The result is the variance. So, the variance and standard deviation of each stock is: σA2 =.19(.10 − .1348)2 + .60(.13 − .1348)2 + .21(.18 − .1348)2 σA2 = .00067 σA = .000671/2 σA = .0259, or 2.59% σB2 =.19(−.14 − .1306)2 + .60(.15 − .1306)2 + .21(.32 − .1306)2 σB2 = .02167 σB = .021671/2 σB = .1472, or 14.72%
What are the portfolio weights for a portfolio that has 122 shares of Stock A that sell for $32 per share and 102 shares of Stock B that sell for $22 per share?
The portfolio weight of an asset is the total investment in that asset divided by the total portfolio value. First, we will find the portfolio value, which is: Total value = 122($32) + 102($22) Total value = $6,148 The portfolio weight for each stock is: WeightA = 122($32)/$6,148 WeightA = .6350 WeightB = 102($22)/$6,148 WeightB = .3650
face value
The principal amount of a bond that is repaid at the end of the loan term is called the bond's:
-The standard deviation is _____.
The square root of the variance.
This ensures that that the sum of the deviations is a positive number.
Why are the deviations of returns squared when computing variance?
What is the beta of the risk-free asset?
Zero
10.value: 10.00 points Bond X is a premium bond making semiannual payments. The bond pays a coupon rate of 10 percent, has a YTM of 8 percent, and has 20 years to maturity. Bond Y is a discount bond making semiannual payments. This bond pays a coupon rate of 8 percent, has a YTM of 10 percent, and also has 20 years to maturity. The bonds have a $1,000 par value. What is the price of each bond today? (Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.) Price of Bond X $ Price of Bond Y $ If interest rates remain unchanged, what do you expect the price of these bonds to be one year from now? In 10 years? In 15 years? In 19 years? In 20 years? (Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.) Price of bond Bond X Bond Y One year $ 10 years $ 15 years $ 19 years $ 20 years $
a. price of bond x $ fv = 1,000 n = 20*2 = 40 i = 8/2 = 4 pmt = (1,000*0.1)/2 = 50 cpt, *pv bond x = 1,197.92* price of box y $ i = 10/2 = 5 pmt = (1,000*0.08)/2 = 40 cpt, *pv bond y= 828.71* b. BOND X: 1 yr => n = (20-1) x 2 = 38; cpt, *pv = 1,193.68* 10 yrs => n = (20-10) x 2 = 20; cpt, *pv = 1,1,35.90* 15 yrs => n = (20-15) x 2 = 10; cpt, *pv = 1,081.11* 19 yrs => n = (20-19) x 2 = 2; cpt, *pv = 1,018.86* 20 yrs => n = 0; cpt, *pv = 1,000* BOND Y: (change i = 5 & pmt = 40... then repeat n's from above^) 1 yr => n = 38; cpt, *pv = 831.32* 10 yrs => n = 20; cpt, *pv = 875.38* 15 yrs => n = 10; cpt, *pv = 922.78* 19 yrs => n = 2; cpt, *pv = 981.41* 20 yrs => n = 0; cpt, *pv = 1,000*
Assume the following bond characteristics: Duration: 4.54 years Current bond price: $1000 YTM: 9.5% Estimated change in interest rates: expect rates to decline by 30 basis points or .30% a. Calculate the bond's modified duration b. Calculate the expected price of the bond
a. 4.33 years b. ?
NPV is positive when discount rates are ___ IRR
below negative for discount rates > IRR indifferent for discount rates = IRR
for a diversified investor, what is the best way to measure systematic risk of an individual security?
beta
in a stock quote price, the ask price is __ than the bid price
higher because this is what people are willing to accept for the purchase of stock
investors who are risk averse demand ___
higher compensation for taking on risk
A bond with a BBB rating has a ___ than a bond with an A rating.
higher risk of default
the __ period rate return is the rate of return over some arbitrary investment period
holding
the _____ period rate of return is simply the rate of return over some arbitrary investment period.
holding
probability distribution in context of sales is
identifying various level of sales and assigning a probability of occurrence to each level
synergy will __ sale of existing products
increase
investors cant have a portfolio not in the feasible set because they cannot
increase the SD of securities lower the return of securities increase the correlation between securities
Stock prices fluctuate from day to day because of:
information flow
risky return is affected by
information that will be revealed in the near future, not historical information
why do no pay out stocks sell at positive prices?
investors speculate on capital returns if the firm is sold investors count on future dividends
FCF
is the amount of active cash that could be hypothetically paid out to debt/equity holders from a company (find PV of each CF)
Over the period of 1926 through 2011, the annual rate of return on _____ has been more volatile than the annual rate of return on _____.
large company stocks; long-term corporate bonds
more volatility in returns produces a ___ difference between arithmetic and geometric averages
larger
the Ibbotson data showed that long term corporate bonds had ___ than stocks
less risk or variability
An ordinary annuity consists of a(n) ______ stream of cash flows for a fixed period of time.
level
financial break even point is
level of sales before a project loses money on a net present value basis
a long term high quality bond portfolio will include
long term corp bonds gov of canada bonds long term provincial bonds
in an inflationary environment, reported earnings are ____ if they use LIFO rather than FIFO accounting
lower
in a stock price quote, the number of shares outstanding multiplied by the current price is known as
market cap
5.value: 10.00 points DMA Corporation has bonds on the market with 18.5 years to maturity, a YTM of 7.9 percent, and a current price of $1,067. The bonds make semiannual payments and have a par value of $1,000. What must the coupon rate be on these bonds? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Coupon rate %
n=18.5*2 = 37 i=7.9/2 = 3.95 pv= -1,067 fv=1,000 cpt, *pmt=42.97539* ^ SEMIANNUAL PAYMENT IN $ To calculate coupon % per year: (*42.975398* x 2) / 1,000 => *8.60%*
3.value: 10.00 points Essary Enterprises has bonds on the market making annual payments, with nine years to maturity, a par value of $1,000, and selling for $966. At this price, the bonds yield 6.8 percent. What must the coupon rate be on the bonds? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Coupon rate %
n=9 fv=1,000 pv= -966 i=6.8 cpt, pmt=62.82577 62.8577/1,000 = *6.28%*
Earnings next year are a function of which factors?
o Earnings this year o Return on retained earnings o Retained earnings this year
The price earnings (PE) ratio is a function of which three factors?
o Growth opportunities o Accounting practices o Risk level
Which of the following are cash flows to investors in stocks?
o Interest o Capital Gains o Dividends
When enterprise value is calculated, cash is subtracted from the market value of debt and equity because ____.
o Many firms hold more cash than necessary o An EV ratio should reflect the ability of productive assets to create cash flow
Preferred stock has which of these features?
o Preference over common stock in a liquidation o Dividend payment preference
Common stockholders generally have which rights?
o Right to vote on key issues such as merger o Right to share proportionally in dividends paid o Right to share proportionally in residual assets in a liquidation
The entire principal of an interest-only loan is the:
original loan amount
(Q) Handy Depot's stock currently sells for $50 per share. The expected dividend is $1.50 and this dividend is expected to grow at a constant annual rate of 10%. What is Handy Depot's expected return?
r = 13%
Inflation Cross-Product An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. If the real risk-free rate is 3% and inflation is expected to be 12% each of the next 4 years, what is the yield on a 4-year security with no maturity, default, or liquidity risk? (Hint: Refer to "The Links Between Expected Inflation and Interest Rates: A Closer Look." on Page 200.) Round your answer to two decimal places.
r* = 3%; IP4 = 12%; MRP = DRP = LP = 0; rRF4 = ? rRF4 =(1 + r*)(1 + IP4) - 1 = (1.03)(1.12) - 1 = 0.1536 = 15.36%.
With typical interest-only loans, the entire principal is:
repaid at some point in the future
firms growth rate =
retention ratio * return on retained earnings
arithmetic average measures the
return in an average year over a given period
the arithmetic average rate of return measures the
return in an average year over a given period
normal return
return that shareholders predict or expect
sharpe ratio
risk premium of asset / sd
The excess return required from a risky asset over that required from a risk-free asset is called the:
risk premium.
T bills over a long period of time had the lowest ___, generating the lowest ___
risk, return
A stock has an expected return of 14 percent, its beta is 1.65, and the expected return on the market is 11.2 percent. What must the risk-free rate be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
risk-free rate = 6.89%
the incremental IRR is used to account for the problem of __ when evaluating project cash flows
scale
The variance of returns is computed by dividing the sum of the:
squared deviations by the number of returns minus one
in the Ibbotson study, the large-company common stock portfolio is based on the _____.
standard & poor's composite index
the sharpe ratio is the stocks excess return (risk premium) divided by its ______.
standard deviation
what dividends are provided by stocks with differential growth?
stocks grow at multiple rates for fixed number of periods, meaning that stock price is calculated as the sum of several annuity calculations
A portfolio of large company stocks would contain which one of the following types of securities?
stocks of firms included in the S&P 500 index
using the Ibbotson SBBI yearbook, year-by-year real returns can be calculated by
subtracting the annual inflation rate from the annual historical rate of return
the geometric average rate of return is approximately equal to:
the arithmetic mean minus half the variance
in a stock price quote, how are the bid and ask prices related?
the ask price is higher than the bid price
The dividend yield is determined by dividing the expected dividend (D1), by:
the current price
In estimating the future equity risk premium, it is important to include assumptions about:
the future risk environment and the amount of risk aversion of future investors
the determinants of a firm's growth rate include which factors?
the retention ratio and return on retained earnings
what is a preemptive right?
the right to share proportionately in any new stock sold - the company must offer new stock to its existing shareholders before offering it to the general public
On average, for the period 1926 through 2011:
the risk premium on long-term corporate bonds has exceeded the risk premium on long-term government bonds.
According to the capital asset pricing model (CAPM), what is the expected return on a security with a beta of zero?
the risk-free rate of return
if the dispersion of returns on a security are very spread out from the mean, then
the security is highly risky
The degree of interest rate risk depends on _
the sensitivity of the bond's price to interest rate changes
what is the purpose of preemptive rights?
to give the stockholder the opportunity to protect his/her proportionate ownership in the corporation
expected total revenues =
total market * market share * price per unit
what is the impact on the variance of a two asset portfolio if the covariance is negative?
variance will decrease because as one asset declines it will be offset by the other increasing
managers should focus their attention on the variable that ___ during a sensitivity analysis
when changed, has the largest deviation from NPV
You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.12 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?
βP = 1 = (1/3)(0) + (1/3)(1.12) + (1/3)(x) x = 1.88
-According to the CAPM, which of the following events would affect the return on a risky asset?
• A change in the yield on T-bills • A strengthening of the country's currency • Federal reserve actions that affect economy.
-Which of the following are true about the venture capital (VC) market?
• Access to venture capital is very limited • Personal contacts are important in gaining access to the VC market.
-In an efficient market:
• Assets are priced at the present value of their future cash flows. • All investments have NPV=0
-To apply the dividend growth model to a particular stock, you need to estimate the _____.
• Dividend yield for the next period • Growth rate
-Which of the following are examples of unsystematic risk?
• Labor strikes • Changes in management
The common stock of Energizer's pays an annual dividend that is expected to increase by 10% annually. The stock commands a market rate of return of 12% and sells for $55.00 a share. What is the expected amount of the next dividend to be paid on Energizer's common stock? Multiple Choice $.90 $1.00 $1.10 $1.21 $1.33
$1.10
The common stock of Energizer's pays an annual dividend that is expected to increase by 10% annually. The stock commands a market rate of return of 12% and sells for $55.00 a share. What is the expected amount of the next dividend to be paid on Energizer's common stock?
$1.10 $55.00 = D1/(0.12 - 0.10)
One year ago, you purchased a stock at a price of $32.50. The stock pays quarterly dividends of $.40 per share. Today, the stock is worth $34.60 per share. What is the total amount of your dividend income to date from this investment?
$1.60 Dividend income = $.40 × 4 = $1.60
-If you receive a $2 dividend per share on your 100 shares, your total income is _____.
$200
What will your capital gain be if you hold 40 shares of BP stock and the stock price rises from $27 to $40 a share?
$520
What is the maximum capital loss that you can incur if you bought 200 shares of TP Inc. for $32?
$6,400
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
-What are the after-tax earnings for HU Corporation if it reports $200 in revenue, $90 in operating expenses, has a tax rate of 30% and pays $20 in interest on its bonds?
$63
What is the Future Value of $100 deposited each year for 2 years beginning next year, then $200 deposited for the next two years if you can earn 6% per year?
$643.46
Suppose you paid $1,200 loan off by paying principal each year plus 10% yearly interest. How much is the SECOND interest payment?
$80
why is cash subtracted from the market value of debt and equity?
1. because an EV ratio should reflect the ability of productive assets to create cash flow 2. many firms hold more cash than necessary
what are the three different types of license holders?
1. designated market makers (DMMs) 2. floor brokers 3. supplimental liquidity providers (SLPs)
(Q) Siblings, Inc., is expected to maintain a constant 6.4 percent growth rate in its dividends, indefinitely. If the company has a dividend yield of 4.3 percent, what is the required return on the company's stock?
10.7%
If the rate of inflation is 3% and the real rate of return is 9%, the nominal rate is approximately __ percent
12
Over the period of 1926 to 2011, small company stocks had an average return of ____%.
16.5
-If a firm has multiple projects, each project should be discounted using _____.
A discount rate commensurate with a project's risk
Assuming inflationary environment, a firm that uses LIFO accounting will have ____ PE ratio than an equivalent firm using FIFO accounting.
A higher
A bond that sells for more than face value is what type of bond?
A premium bond
2.5%
A stock had returns of 14 percent, 16 percent, and 9 percent for the past 3 years. Based on these returns, what is the probability that this stock will earn at least 20.22 percent in any one given year?
what are cash flows to investors in stocks?
dividends and capital gains
what are the cash flows to investors in stocks?
dividends and capital gains
constant growth model assumes that
dividends change at a constant rate
What is the value of a stock if next year's dividend is $6, the discount rate is 11 % and the constant rate of growth is 3%?
$75
In an efficient market:
- All investments have NPV=0 - Assets are priced at the present value of their future cash flows
-If a security's expected return is equal to the expected return on the market, its beta must be _____.
1
what is the retention ratio formula?
1 + g = retention ratio * return on retained earnings
two main benefits of performing a sensitivity analysis
1. reduces the false sense of security by giving a range of values for NPV instead of just one 2. identifies the variable that has the most effect on the NPV
if stock GHI has an initial price of $100. two years later the price is $132. what is GHI's geometric mean rate of return?
14.89% = (132/100)^(1/2) - 1
-The standard deviation for large-company stock returns from 1926-2010 is:
20.2%
If you are in the 20% federal income tax bracket, what is you after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes
5% Interest income from munis is exempt from federal income tax
If the variance of a portfolio is 0.0025, what is the standard deviation?
5% or 0.05
7%
A reasonable estimate for the US equity risk premium is
The systematic risk of the market is measured by a: A. beta of 1.0. B. beta of zero. C. standard deviation of 1.0. D. standard deviation of zero. E. variance of 1.0.
A. Beta of 1.0.
-If the market changes and stock prices instantly and fully reflect new information, which time path does such a change exhibit?
An efficient market reaction.
unsystematic diversifiable
Another name for idiosyncratic risk is ______ risk. unsystematic
How much can a corporation expect to receive per bond if it sells ten-year zero coupon bonds with a face value of $1000 if the market rate of interest is 9%?
Answer: $414.64 Zero coupon bonds use semi annual compounding: $1000/[1 + (.09/2)] ^20 (Make N=20 because there are 20 periods in a 10 year semi-annual bond)
-Percentage returns are more convenient than dollar returns because they _____.
Apply to any amount invested.
Which one of the following is an example of a non-diversifiable risk? A. a well-respected president of a firm suddenly resigns B. a well-respected chairman of the Federal Reserve Bank suddenly resigns C. a key employee suddenly resigns and accepts employment with a key competitor D. a well-managed firm reduces its work force and automates several jobs E. a poorly managed firm suddenly goes out of business due to lack of sales
B. A well-respected chairman of the Federal Reserve Bank suddenly resigns
-Flotation costs are costs incurred to _____.
Bring new security issues to the market.
An agent who arranges a trade between a buyer and a seller is called a:
Broker
A security that is fairly priced will have a return _____ the security market line. A. below B. on or below C. on D. on or above E. above
C. On
Your portfolio is comprised of 30 percent of Stock X, 50 percent of Stock Y, and 20 percent of Stock Z. Stock X has a beta of .64, Stock Y has a beta of 1.48, and Stock Z has a beta of 1.04. What is the portfolio beta? A. 1.01 B. 1.05 C. 1.09 D. 1.14 E. 1.18
D. 1.14
A portfolio consists of three stocks. There are 540 shares of Stock A valued at $24.20 share, 310 shares of Stock B valued at $48.10 a share, and 200 shares of Stock C priced at $26.50 a share. Stocks A, B, and C are expected to return 8.3 percent, 16.4 percent, and 11.7 percent, respectively. What is the expected return on this portfolio? A. 12.50% B. 11.67% C. 12.78% D. 12.47% E. 11.87%
D. 12.47%
5.value: 10.00 points Tell Me Why Co. is expected to maintain a constant 4 percent growth rate in its dividends indefinitely. If the company has a dividend yield of 5.8 percent, what is the required return on the company's stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Required return %
Dividend yield = D1 / P0 = 0.058 R = D1 / P0 + g = 0.058 + 0.04 = *9.8%*
Today, you sold 200 shares of SLG, Inc. stock. Your total return on these shares is 12.5%. You purchased the shares one year ago at a price of $28.50 a share. You have received a total of $280 in dividends over the course of the year. What is your capital gains yield on this investment?
Dividend yield = $280 ÷ (200 × $28.50) = 4.91%; Capital gains yield = 12.5% - 4.91% = 7.59%
-The two potential ways to make money as a stockholder are through _____ and capital appreciation.
Dividends
Given the following information, what is the expected return on a portfolio that is invested 30 percent in both Stocks A and C, and 40 percent in Stock B?
E(RBoom) = (0.30 × 0.078) + (0.40 × 0.236) + (0.30 × 0.184) = 0.1730 E(RNormal) = (0.30 × 0.091) + (0.40 × 0.154) + (0.30 × 0.137) = 0.1300 E(RRecession) = (0.30 × 0.118) + (0.40 × -0.123) + (0.30 × 0.064) = 0.0054 E(RPortfolio) = (0.05 × 0.1730) + (0.85 × 0.1300) + (0.10 × 0.0054) = 11.97 percent
website that allows investors to trade directly with one another is called
ECN
Consider the following information: Probability of State of Economy: Recession = 0.32 Boom = 0.68 Portfolio Return if state occurs: Recession = -0.17 Boom = 0.23 Calculate the expected return. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Expected Return = 10.20%
The NYSE's goal is to _____.
Generate as much liquidity as possible
A stock had returns of 6%, 13%, -11%, and 17% over the past four years. What is the geometric average return for this time period?
Geometric average = (1.06 × 1.13 × .89 × 1.17).25 - 1 = 5.7%
When a floor broker "works" an order, they are trying to _____.
Get their client the best possible price
The ____ can be interpreted as the capital gains yield.
Growth rate
The total annual returns on large company common stocks averaged 12.3% from 1926 to 2011, small company stocks averaged 17.4%, long-term government bonds averaged 5.8%, while Treasury Bills averaged 3.8%. What was the average risk premium earned by long-term government bonds, and small company stocks respectively?
Long Term Government = 5.8% - 3.8% = 2.0%; Small Stocks = 17.5% - 3.8% = 13.7%
A stock has an expected rate of return of 8.3% and a standard deviation of 6.4%. Which one of the following best describes the probability that this stock will lose 11% or more in any one given year?
Lower bound of 99% probability range = .083 - (3 × .064) = -.109 = -10.9%; Probability of losing 11% or more is less than 0.5%
Why is the bond market less transparent than the stock market?
Many bond transactions are negotiated privately
NASDAQ differs from NYSE primarily because NASDAQ has ____.
No physical location
This type of growth describes a company that grows quickly first, then slower in the future years.
Non-constant
(Q) The Starr Co. just paid a dividend of $2.15 per share on its stock. The dividends are expected to grow at a constant rate of 5 percent per year, indefinitely. If investors require a return of 11 percent on the stock, what is the current price? What will the price be in three years? In 15 years?
P0 = $37.63 P3 = $43.56 P15 = $78.22
(Q) Storico Co. just paid a dividend of $3.85 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the required return on Storico stock is 13 percent, what will a share of stock sell for today?
P0 = $65.46
market risk
Systematic risk is sometimes referred to as:
The owner of this bond can force issuer to repay prior to maturity at a stated price.
Put bond
Mona Corporation has a variance of returns of 343, while Scott Company has a variance of returns of 898. Which company's actual returns vary more from their mean return?
Scott Company
-Mona Corporation has a variance of returns of 343, while Scott Corporation has a variance of returns of 898. Which company's actual returns vary more from their mean return?
Scott Corporation
$4,980
Six months ago, you purchased 2,000 shares of ABC stock for $25.83 a share. You have received dividend payments equal to $0.50 a share. Today, you sold all of your shares for $27.82 a share. What is your total dollar return on this investment?
-It would be useful to understand how the _____ of the risk premium on a risky asset is determined.
Size
-Geometric averages are _____ arithmetic averages.
Smaller than
-Which of the following is commonly used to measure inflation
The Consumer Price Index (CPI)
What does a bond's rating reflect?
The ability of the firm to repay its debt and interest on time
current yield
The annual coupon payment of a bond divided by its market price is called the:
Par value (face value)
The principle amount of a bond that is repaid at the maturity of the bond
-The market for venture capital refers to:
The private financial marketplace for new or distressed firms.
How is the real rate of return different from the nominal rate of return?
The real rate of return excludes inflation from the nominal rate.
Which of the following are usually included in a bond's indenture? -The repayment arrangements -The name of bondholders -The bonds rating -The total amount of bonds issued
The repayment arrangements and the total amount of bonds issued.
-According to the CAPM, what is the expected return on a stock if its beta is equal to zero?
The risk-free rate
-What is the intercept of the security market line (SML)?
The risk-free rate (Beta is the independent variable and is plotted on the x-axis. The intercept is the risk-free rate)
-According to the capital asset pricing model (CAPM), what is the expected return on a security with a beta of zero?
The risk-free rate of return.
-If a firm uses its overall cost of capital to discount cash flows from higher risk projects. It will accept _____ projects.
Too many high-risk
Six months ago, you purchased 1,200 shares of ABC stock for $21.20 a share. You have received dividend payments equal to $.60 a share. Today, you sold all of your shares for $22.20 a share. What is your total dollar return on this investment?
Total dollar return = ($22.20 - $21.20 + $.60) × 1,200 = $1,920
A year ago, you purchased 300 shares of IXC Technologies, Inc. stock at a price of $10.05 per share. The stock pays an annual dividend of $.10 per share. Today, you sold all of your shares for $29.32 per share. What is your total dollar return on this investment?
Total dollar return = ($29.32 - $10.05 + $.10) × 300 = $8,811
-If your total dollar return was $7 and your dividend was $2, then the price change on your stock must have been _____.
Total dollar return is the sum of the capital gain and the dividend. Because the dividend was $2 and the total dollar return was $7, the capital gain must have been $5.
T/F: The price you actually pay to purchase a bond will generally exceed the clean price
True
T/F: The yield to maturity is defined as the promised return an investor will receive from a bond purchased at the current market price and held to maturity
True
To a false: all else equal, the lower the coupon rate, the greater the interest rate risk.
True
True or false junk bonds are rated less than investment-grade rating?
True
True or false junk bonds have a high probability of default.
True
True or false: a conventional bond pays periodic interest while zeros make no interest payments.
True
True or false: conventional bonds can sell at par, and a discount from par, or at a premium over par while zeros can not.
True
The efficient markets hypothesis contends that _________ capital markets such as the NYSE are efficient.
Well-organized
-The efficient markets hypothesis contends that _____ capital markets such as the NASDAQ are efficient.
Well-organized.
8.50% 8.27%
What are the arithmetic and geometric average returns for a stock with annual returns of 13 percent, 9 percent, -3 percent, and 15 percent?
It means that, on average, if the returns of stock A are positive, the returns of stock B will be negative.
What does it mean if the returns of two stocks, A and B, are negatively correlated?
It is the return that shareholders predict or expect.
What is a normal return?
capital gain in $
difference in new stock price - old stock price * number of shares owned
if a stock has returns of 10% and 20% over 2 years, the geometric average rate of return can be calculated by
[(1.10)(1.20)]^.5 - 1
which of the following are needed to describe the distribution of stock returns? a) the standard deviation of returns b) the mean return c) the variety of returns d) the life span of the stock
a + b
the Ibbotson SBBI data show that over the long-term: a) T-bills, which have the lowest risk, generated the lowest return b) small-company stocks had the highest risk level c) long-term corporate bonds had the lowest risk d) large-company stocks generated the highest average return e) small-company stocks generated the highest average return
a + b + e
the rates of return in the Ibbotson SBBI yearbook are not adjusted for which of the following? a) taxes b) bond coupons c) dividends d) transaction costs
a + d
which of the following are true about the stock performance of other countries in 2008? a) Russia's stock prices fell by more than 50% b) china's stock prices actually went up by 5% c) india's stock prices only fell by 20% d) Iceland's stock prices fell by over 90%
a + d
A bonds coupon payment is:
a fixed amount of interest that is paid annually or semiannually by the issuer to its bondholders
what is a proxy?
a grant of authority by a shareholder to someone else to vote his/her shares; convenient
what dividends are provided by zero growth dividends?
a level dividend stream with no growth from period to period
The calculation of a portfolio beta is similar to the calculation of:
a portfolio's expected return
what kind of market price will a stock that pays a constant annual dividend have?
a price that decreases when the market rate of return increases
what type of growth describes a company that grows quickly at first buy slower in later years?
differential growth
a firm should replace a machine when the ____ costs are less than the ___ costs
annual costs of new machine are less than annual costs of current machine
The return earned in an average year over a multi-year period is called the _____ average return.
arithmetic
the __ mean is the best estimate for next year's return
arithmetic
the ___ avg is used to find the mean of a frequency distribution
arithmetic
geometric average is practically equal to the ___
arithmetic average - half of the variance
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
some important characteristics of normal distribution is that it is: a) very bumpy b) symmetrical c) skewed to the right d) bell-shaped
b + d
what is the formula for a firm's growth rate?
g = retention ratio x ROE
the excess rate of return is
generally positive over long term but can occasionally be negative
The average compound return earned per year over a multi-year period is called the _____ average return.
geometric
value of a firm is a function of its __ rate and __ rate
growth and discount
When computing the expected return on a portfolio of stocks the portfolio weights are based on the: A. number of shares owned in each stock. B. price per share of each stock. C. market value of the total shares held in each stock. D. original amount invested in each stock. E. cost per share of each stock held.
C. Market value of the total shares held in each stock.
The characteristic line graphically depicts the relationship between the: A. beta of a security and the return on the security. B. arithmetic average beta of the securities in a portfolio and the weighted average beta of those securities. C. return on a security and the return on the market. D. beta of a security and the return on the market. E. beta of a security and the corresponding beta of the market.
C. Return on a security and the return on the market.
Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk. A. idiosyncratic B. diversifiable C. systematic D. asset-specific E. total
C. Systematic
Which one of the following is the best example of systematic risk? A. the price of lumber declines sharply B. airline pilots go on strike C. the Federal Reserve increases interest rates D. a hurricane hits a tourist destination E. people become diet conscious and avoid fast food restaurants
C. The Federal Reserve increases interest rates
Which one of these conditions must exist if the standard deviation of a portfolio is to be less than the weighted average of the standard deviations of the individual securities held within that portfolio? A. β< 1 B. Rm> 1 C. ρ< 1 D. β = 0 E. ρ >1
C. ρ< 1
a positive capital gain on a stock results from
an increase in price
the _____ mean is the best estimate of next years returns.
arithmetic
It is a risk that pertains to a large number of assets.
What is systematic risk?
11%
What is the expected return for a security if the risk-free rate is 5 percent, the expected return on the market is 9 percent, and the security's beta is 1.5?
13.6%
What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4 percent and the expected return on the market is 12 percent?
The market-risk premium
What is the slope of the security market line (SML)?
It is a risk that affects a single asset or a small group of assets.
What is unsystematic risk?
A measure of the squared deviations of a security's return from its expected return
What is variance?
It can increase or decrease.
What will happen to the risk of a portfolio composed of two securities as more dollars are invested in the riskier asset?
what is an over the counter (OTC) market?
a securities market largely characterized by dealers who buy and sell securities for their own inventories
even though depreciation is a noncash expense, it affects cash flows because
it affects how much is paid in taxes which is a cash outflow
how is preferred stock different from common stock?
it has a preference over common stock in the payment of dividends and in the distribution of corporate assets in the event of liquidation
IPOs of stock occur in the ___ market
primary
Amortization is the process of paying off loans by regularly reducing the _______.
principal
4.value: 10.00 points Heginbotham Corp. issued 10-year bonds two years ago at a coupon rate of 8.4 percent. The bonds make semiannual payments. If these bonds currently sell for 105 percent of par value, what is the YTM? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) YTM %
pv = 1,000*1.05 => -1,050 fv = 1000 n = # of periods = 2(10-2) = 16 pmt = 1,000*(0.084/2) = 42 cpt, *i=3.77790* ^ THIS IS THE SEMIANNUAL PAYMENT % *3.77790* x 2 => *7.56%*
the goal of many successful organizations is a __ rate of growth in dividends
steady
what is the PE ratio negatively related to?
stock's risk and the firm's discount rate
all real estate is depreciated on a
straight line basis
over the long term, small company common stocks showed
the highest average return the highest risk
basic output of monte carlo simulation
distribution of each future cash flow per year
dividend yield
dividend amount / beginning stock price
Most of the time, a floating-rate bond's coupon adjusts _________.
with a lag to some base rate
-In reality, most firms cover the equity portion of their capital spending with _____.
Internally generated cash flow.
-.05/(.45 × .30) = -.37
If the covariance between stocks C and D is -.05, what is the correlation between these stocks? Assume the standard deviation of returns is .45 for Stock C and .30 for Stock D.
-2% to 22%
If the expected return is 10 percent and the standard deviation is 12 percent, what is the range of returns that will occur about 68 percent of the time?
-If the variance of a portfolio is .0025, what is the standard deviation?
5%
-What is the arithmetic average return for a mutual fund that reported a return of 5% every year for the last 3 years?
5%
what is the arithmetic average return for a mutual fund that reported a return of 5% every year for the last 3 years?
5% = (5% + 5% + 5%)/3
A stock you are interested in paid a dividend of $1 last year. The anticipated growth rate in dividends and earnings is 25% for the next 2 years before settling down to a constant 5% growth rate. The discount rate is 12%. Calculate the expected price of the stock.
$21.04 Price = $1.00(1.25)/1.12 + $1.25(1.25)/1.2544 + [$1.5625(1.05)/(0.12-0.05)]/1.2544 = $21.04
Retention Ratio
Growth rate percent/return on equity
sharpe measures __ to __
reward to risk
maximum capital loss from purchasing shares
initial cost
Match each information type to the form of market efficiency that identifies that type of information as being quickly and accurately reflected in stock prices.
- All information > strong form efficiency - All public information > semi-strong form efficiency - Historical stock prices > weak form efficiency
Some important characteristics of the normal distribution are that it is:
- Bell-shaped - Symmetrical
The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables? - Time to maturity - Coupon Rate - Par Value - Bond Rating
- Time to maturity - Coupon Rate
-What is variance?
A measure of the squared deviations of a security's return from its expected return.
-Based on the capital asset pricing model (CAPM) there is generally _____ relationship between beta and the expected return on a security.
A positive.
-When a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means that the market:
Already knew about most of the news item.
Which of these are required to calculate the current value of a bond? Check all that apply. -applicable market rate -coupon rate -par value -Price at the time of bond issue -Time remaining to maturity
Applicable market rate Coupon rate Par value Time remaining to maturity
What are the arithmetic and geometric average returns for a stock with annual returns of 4%, 9%, -6%, and 18%?
Arithmetic average = (.04 + .09 - .06 + .18) ÷ 4 = 6.25%; Geometric return = (1.04 × 1.09 × .94 × 1.18).25 - 1 = 5.89%
A stock has returns of 3%, 18%, -24%, and 16% for the past four years. Based on this information, what is the 95% probability range for any one given year?
Average return = (.03 + .18 - .24 + .16) ÷ 4 = .0325; Total squared deviation = (.03 - .0325)2 + (.18 - .0325)2 + (-.24 - .0325)2 + (.16 - .0325)2 = .00000625 + .02175625 + .07425625 + .01625625 = .112275; Standard deviation = √(.112275 ÷ (4 - 1) = √.037425 = .19346 = 19.346%; 95% probability range = 3.25% ± (2 × 19.346%) = -35.4 to 41.9%
A stock had returns of 7%, 9%, -3%, and 5% over the past four years. What is the standard deviation of this stock for the past four years?
Average return = (.07 + .09 - .03 + .5) ÷ 4 = .045; Standard deviation = √{(.07 - .045)2 + (-.09 - .045)2 + (-.03 - .045)2 + (.05 - .045)2 }/(4 - 1) = 0.06656 = 6.7%
You have a sample of returns observations for the Malta Stock Fund. The 4 returns are 7.25%, 5.6%, 12.5%, 1.0%. What is the average return and variance of these returns?
Average return = (.0725 + .056 + .125 + .01)/4 = .2635/4 = .065875 = 6.6%; Variance = [(7.25 - 6.6)2 + (5.6 - 6.6)2 + (12.5 - 6.6)2 + (1 - 6.6)2]/3 = 67.5925/3 = 22.53
A stock had returns of 8%, 14%, and 2% for the past three years. Based on these returns, what is the probability that this stock will earn at least 20% in any one given year?
Average return = (.08 + .14 + .02) ÷ 3 = 8%; Total squared deviation = (.08 - .08)2 + (.14 - .08)2 + (.02 - .08)2 = .00 + .0036 + .0036 = .0072; Standard deviation = √(.0072 ÷ (3 - 1) = .06 = 6%; Upper end of the 95% probability range = 8% + (2 × 6%) = 20%; Probability of earning at least 20% in any one year is 2.5%
The long term inflation rate average was 3.2% and you invested in long term corporate bonds over the same period which earned 6.1%. What was the average risk premium you earned?
Average risk premium = 6.1% - 3.2% = 2.9%
Correlation is expressed as the symbol: A. α. B. ρ. C. β. D. c. E. є.
B. ρ
The historical market risk premium for equities has been positive. The historical market return for equities has been significantly higher (more than 5%) than the risk-free rate.
Based on historical data, which of the following are true about the market risk premium?
a positive
Based on the capital asset pricing model (CAPM) there is generally ___ relationship between beta and the expected return on a security.
-How can a positive relationship between the expected return on a security and its beta be justified?
Because the difference between the return on the market and the risk-free rate is likely to be positive.
The dividend yield for a 1-year period is equal to the annual dividend amount divided by the _____________.
Beginning stock price
-In the _____ method of issuing securities, the underwriting syndicate avoids the risk of unsold securities.
Best efforts
-If you are forecasting a few decades in the future you should calculate the expected return using:
Blume's formula
A portfolio is entirely invested into BBB stock, which is expected to return 16.4 percent, and ZI bonds, which are expected to return 8.6 percent. 48 percent of the funds are invested in BBB and the rest in ZI. What is the expected return on the portfolio? A. 13.64% B. 14.36% C. 12.34% D. 14.20% E. 11.69%
C. 12.34%
The voting procedure whereby shareholders may cast all of their votes for one member of the board is called _____ voting.
Cumulative
What is bonds current yield?
Current yield = annual coupon payment / current price
Why is the current yield an incorrect measure of a bond's total return?
Current yield is an incorrect measure of total return because unlike realized return, it doesn't take into account all cash flows made until maturity
-The minimum required return on a new project when its risk is similar to that of projects the firm currently owns is known as the:
Cost of capital
DMA Corporation has bonds on the market with 19.5 years to maturity, a YTM of 6.6 percent, and a current price of $1,043. The bonds make semiannual payments and have a par value of $1,000. What must the coupon rate be on these bonds?
Coupon Amount = pmt(rate,nper,pv,fv) Coupon Amount = pmt(6.6%/2,19.5*2,-1043,1000) Coupon Amount = $ 34.98 Coupon rate = Coupon Amount*2/Face Value Coupon rate = 34.98*2/1000 Coupon rate = 7.00% Calculator: N=
Which of these is included in the calculation of a bonds yield to maturity? Check all that apply. -coupon rate -current price -par value -Number bonds issued
Coupon rate, current price, and par value.
-A Green Shoe provision is used to _____.
Cover excess demand and oversubscription.
10.value: 10.00 points Synovec Co. is growing quickly. Dividends are expected to grow at a rate of 25 percent for the next three years, with the growth rate falling off to a constant 4 percent thereafter. If the required return is 10 percent, and the company just paid a dividend of $2.95, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Current share price $
D0 = 2.95 D1 = 2.95 x 1.25 = 3.69 D2 = 3.69 x 1.25 = 4.61 D3 = 4.61 x 1.25 = 5.76 P3 = D3 (1+g) / [R-g] = 5.76 x (1.04) / [.1-.04] = 5.99 / .06 = 99.83 Fv 3 = Stock price + Dividend = 99.83 + 5.76 = 105.59 Fv 2 = dividend = 4.61 Fv 1 = dividend = 3.69 N = 3, I/Y = 10%, FV = 105.59, CPT PV = 79.33 N = 2, I/Y = 10%, FV = 4.61, CPT PV = 3.81 N = 1, I/Y = 10%, FV = 3.69, CPT PV = 3.35 sum = current share price = *$86.49*
If the liquidity of a bond increases than the bonds you will what?
Decrease.
All else constant, the dividend yield will increase if the stock price ______.
Decreases
A firms bond rating sheds light on its ____________ risk.
Default
Winslow, Inc. stock is currently selling for $60 a share. The stock has a dividend yield of 2.5%. How much dividend income will you receive per year if you purchase 800 shares of this stock?
Dividend income = $60 × .025 × 800 = $1,200
What type of growth describes a company that grows quickly at first but then grows slower in later years?
Differential growth
You purchased 200 shares of stock at a price of $36.72 per share. Over the last year, you have received total dividend income of $322. What is the dividend yield?
Dividend per share = $322 ÷ 200 = $1.61; Dividend yield = $1.61 ÷ $36.72 = 4.4%
Payments made by a corporation to its shareholders in the form of either cash or shares of stock are called:
Dividends
The two potential ways to make money as a stockholder are through ____________ and capital appreciation.
Dividends
A portfolio is comprised of 100 shares of Stock A valued at $22 a share, 600 shares of Stock B valued at $17 each, 400 shares of Stock C valued at $46 each, and 200 shares of Stock D valued at $38 each. What is the portfolio weight of Stock C? A. 46.87% B. 48.09% C. 42.33% D. 45.27% E. 47.92%
E. 47.92%
Which one of the following would indicate a portfolio is being effectively diversified? A. an increase in the portfolio beta B. a decrease in the portfolio beta C. an increase in the portfolio rate of return D. an increase in the portfolio standard deviation E. a decrease in the portfolio standard deviation
E. A decrease in the portfolio standard deviation
What is the appropriate Excel function to convert a quoted rate of 12% compounded quarterly to an EAR?
EFFECT(0.12,4)
The price of a share of common stock is equal to the present value of the ____ future dividends.
Expected
8.value: 10.00 points An investment offers a total return of 17 percent over the coming year. Janice Yellen thinks the total real return on this investment will be only 13 percent. What does Janice believe the inflation rate will be over the next year? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Inflation rate %
FISHER EFFECT --nominal rate is like interest rate or rate of return (1+R)=(1+r)(1+h) (1+ nominal rate)=(1+ real rate )(1+ *expected inflation rate*) inflation rate = (1+nominal)(1+real)-1 = (1.17)(1.13) - 1 = 0.03540 = *3.54%* is the inflation rate
9.value: 10.00 points Say you own an asset that had a total return last year of 11.2 percent. If the inflation rate last year was 5.9 percent, what was your real return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Real return %
FISHER EFFECT --nominal rate is like interest rate or rate of return (1+R)=(1+r)(1+h) (1+ nominal rate)=(1+ real rate )(1+ expected inflation rate) (1+ *real rate* )=(1+ nominal rate) / (1+ expected inflation rate) real = (1.112) / (1.059) - 1 = 0.05005 = *5.00%* is the real rate
-According to a study by Lee, Lockhead, Ritter and Zhao, direct expenses across all offerings are _____ for equity offers than for debt offers.
Greater
The value of a firm is the function of its ____ rate and its _____ rate.
Growth; discount
The prices for IMB over the last 3 years are given below. Assuming no dividends were paid, what was the 3-year holding period return? Given the following information: Year 1 return = 10%, Year 2 return = 15%, Year 3 return = 12%.
HPR = (1.10) (1.15) (1.12) = 1.4168 - 1 = 41.68%
The second lesson from studying capital market history is that risk is:
Handsomely rewarded
Because the difference between the return on the market and the risk-free rate is likely to be positive.
How can a positive relationship between expected return on a security and its beta be justified?
The standard deviation on small company stocks: I. is greater than the standard deviation on large company stocks. / II. is less than the standard deviation on large company stocks. / III. had an average value of about 33% for the period 1926 to 2011. / IV. had an average value of about 20% for the period 1926 to 2011.
I and III only
Which of the following statements are correct concerning the variance of the annual returns on an investment? I. The larger the variance, the more the actual returns tend to differ from the average return. / II. The larger the variance, the larger the standard deviation. / III. The larger the variance, the greater the risk of the investment. / IV. The larger the variance, the higher the expected return.
I, II, III, and IV
Which of the following statements concerning the standard deviation are correct? I. The greater the standard deviation, the lower the risk. / II. The standard deviation is a measure of volatility. / III. The higher the standard deviation, the less certain the rate of return in any one given year. / IV. The higher the standard deviation, the higher the expected return.
II, III, and IV only
The total rate of return earned on a stock is comprised of which two of the following? I. current yield II. yield to maturity III. dividend yield IV. capital gains yield
III and IV only Dividend Yield & Capital Gains Yield
+5 to 25
If the expected return of a portfolio is 15 percent and the standard deviation of the portfolio is 10 percent, then the 68 percent probability range is ____ percent.
When finding the present value or future value of an annuity using a spreadsheet (excel), the _______ should be entered as a decimal.
interest rate
It is equal to 0.
If a security's expected return is equal to the risk-free rate of return, and the market-risk premium is greater than zero, what can you conclude about the value of the security's beta based on CAPM?
Junk bonds typically have what rating?
If rated at all, they're rated below BBB grade.
σp= .0025.5= .05, or 5%
If the variance of a portfolio is .0025, what is the standard deviation?
0.1243
If the variance of a security is 0.01545, what is the standard deviation?
epsilon
In the return equation, the unsystematic risk is denoted by:
-Dividends are the _____ component of the total return from investing in a stock.
Income
-If the variance of a portfolio increases, then the portfolio standard deviation will _____.
Increase
Why do no-payout stocks sell at positive prices?
Investors speculate on capital returns if the firm is sold. Investors count on future dividends.
-If the dispersion of returns on a particular security is very spread out from the security's mean return, the security _____.
Is highly risky
-Finding a firm's overall cost of equity is difficult because:
It cannot be observed directly.
-What is unsystematic risk?
It is a risk that affects a single asset or a small group of assets.
8.9%
Last year, you purchased a stock at a price of $68.00 a share. Over the course of the year, you received $2.80 in dividends and inflation averaged 3.3 percent. Today, you sold your shares for $73.50 a share. What is your approximate real rate of return on this investment?
Which of the following may increase the yield in corporate bonds as compensation to investors but will not impact Treasury bond yields?
Liquidity premium Default risk premium
In a stock price quote, the number of shares outstanding multiplied by the current price per share is known as the _____.
Market cap
Which on of the following is the most important source of risk from owning bonds?
Market interest rate fluctuation
What is the most important source of risk from owning bonds?
Market interest rate fluctuations
Which of the following events would make it more likely that a company would call its outstanding callable bonds? a. The company's bonds are downgraded. b. The company's financial situation deteriorates significantly. c. Market interest rates rise sharply. d. Market interest rates decline sharply. e. Inflation increases significantly.
Market interest rates decline sharply.
-The most appropriate weights to use in the WACC are the _____ weights.
Market value
The owner of a NYSE trading license is called a(n) _____ of the exchange.
Member
Bond provide a portfolio with all of the following except: a. Income b. Risk reduction through less volatility than stocks c. More expected growth than all stock portfolio d. They provide all of the above e. It depends on the maturity of the bond
More expected growth than all stock portfolio
A firm with growth opportunities should sell for ____ a firm without growth opportunities.
More than
-There is _____ correlation between the unsystematic risk of two companies from different industries.
NO
How significant is the real rate of return in determining the shape of the term structure of interest rates?
Not very significant and also less significant than inflation.
-The year 2008 was:
One of the worst years for stock market investors in U.S. history.
The year 2008 was:
One of the worst years for stock market investors in US history
___ refers to the stream of customers' orders to buy and sell stock.
Order flow
Which of the following variables is NOT required to calculate the value of a bond?
Original issue price of bond
-In the world of star-up ventures, OPM stands for _____.
Other people's money
Which one of the following statements is correct?
Over time, the average unexpected return will be zero.
4.value: 10.00 points Caan Corporation will pay a $3.02 per share dividend next year. The company pledges to increase its dividend by 5.5 percent per year indefinitely. If you require a return of 10 percent on your investment, how much will you pay for the company's stock today? (Do not round intermediate calculations. Round your answer to 2 decimal places, e.g., 32.16.) A) Stock price $
P0 = D0 ( 1 + g) / [R - g] = D1 / [R - g] A) Stock price = P0 = 3.02 / (.1 - .055) = *67.11*
8.value: 10.00 points Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will pay a $14 per share dividend 10 years from today and will increase the dividend by 8 percent per year thereafter. If the required return on this stock is 14 percent, what is the current share price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
P0 = D0 (1+g) / [R-g] = D1 / [R-g] P9 = D10 / [R-g] = 14 / [.14-.08] = 14 / 0.06 = 233.33 FV = 233.33 I = 14 N = 9 CPT, PV = *$71.75*
What is the beta of a portfolio comprised of the following securities? Stock Amount Invested Security Beta A $5,000 1.64 B $6,000 1.75 C $8,500 1.00
Portfolio value = $5,000 + $6,000 + $8,500 = $19,500 βPortfolio = [($5,000 / $19,500) × 1.64] + [($6,000 / $19,500) × 1.75] + [($8,500 / $19,500) × 1.00] = 1.395
What are the portfolio weights for a portfolio that has 165 shares of Stock A that sell for $90 per share and 140 shares of Stock B that sell for $106 per share? (Round your answers to 4 decimal places)
Portfolio weight: Stock A 0.5002 Stock B 0.4998
-If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be:
Positive
-Normally, the excess rate of return on risky assets is _____.
Positive
Normally, the excess rate of return is _____.
Positive
-The security market line (SML) shows that the relationship between a security's expected return and its beta is _____.
Positive.
-A red herring is another name for a _____.
Preliminary prospectus
3.value: 10.00 points The next dividend payment by Halestorm, Inc., will be $1.56 per share. The dividends are anticipated to maintain a growth rate of 4 percent forever. The stock currently sells for $29 per share. What is the dividend yield? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) A) Dividend yield % What is the expected capital gains yield? (Enter your answer as a percent.) B) Capital gains yield %
R = D1 / P0 + g Required return = (Dividends / Selling Price Now) + (Growth rate or Capital gains yield) A) Dividend yield = D1 / P0 = Div per share / Current price per share = 1.56 / 29 = *5.38%* B) Capital gains yield = g = *4%*
what is the formula for required return, or R?
R = Div/ stock price + g
2.value: 10.00 points The next dividend payment by Halestorm, Inc., will be $1.72 per share. The dividends are anticipated to maintain a growth rate of 4 percent forever. If the stock currently sells for $33 per share, what is the required return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) A) Required return %
R = [D0 ( 1 + g) / P0] + g R = [D1/P0] + g A) R = 1.72/33 + .04 = 0.0921 = *9.21%*
-The formula for calculating the cost of equity capital that is based on the dividend discount model is:
RE = D1/P0 + g
We can estimate the anticipated return on current retained earnings by using the historical ____ _____ ___.
Return on Equity
The electronic system used by the NYSE which enables orders to be transmitted directly to a specialist is called the _____ system.
SuperDOT
-The cost of capital is an appropriate name since a project must earn enough to pay those who _____ the capital.
Supply
-Palmer Company had the following returns: 2009 12% 2010 10% 2011 -8% 2012 4% 2013 22% What is the STANDARD DEVIATION of Palmer's returns?
Square root of variance = 11.04%
The returns on your portfolio over the last 5 years were -5%, 20%, 0%, 10% and 5%. What is the standard deviation of your return?
Standard Deviation = √[(-.05 - .06)2 + (.20 - .06)2 + (0 - .06)2 + (.10 - .06)2 + (.05 - .06)2]/4 = √.0370/4 = √.00925 = .09617 = 9.62%
The goal of many successful organizations is a(n) ____ rate of growth in dividends.
Steady
Which is more transparent, the stock market or the bond market?
Stock market
The voting procedure where you must own fifty percent plus one of the outstanding shares of stock to guarantee that you will win a seat on the board of directors is called _____ voting.
Straight
-Kate corporation has discovered a very secret new product, but hasn't yet announced the discover to the public. If the stock price reacts before the announcements (assuming no corporate "leaks"), the market is:
Strong form efficient
-A normal distribution has a _____ shape.
Symmetrical
_____________ risk is the only risk important to the well diversified investor.
Systematic
-Which type of risk does not change as we add more securities to a portfolio?
Systematic or market, risk
-Which type of risk is unaffected by adding securities to a portfolio?
Systematic risk
-Which one of the following types of risk is not reduced by diversification?
Systematic risk cannot be diversified away. Or market risk
not change
Systematic risk will ____ when securities are added to a portfolio.
False
Systematic risk will impact all securities in every portfolio equally.
-When an investor is diversified only _____ risk matters
Systematic.
-True or false: It is possible for the unsystematic risk of a portfolio to be reduced to practically zero.
TRUE
-True or false: The most difficult part of the underwriting process for an initial public offering is determining the correct offer price.
TRUE
-Blume's formula combines
The arithmetic average return and the geometric average return.
-The geometric average rate of return is approximately equal to _____.
The arithmetic mean minus half of the variance.
Which two prices can be found in the Wall Street Journal's daily Treasury bond listing?
The bid price and the asked price.
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? a. The bond's yield to maturity is above 9%. b. The bond's current yield is less than its expected capital gains yield. c. If the bond's yield to maturity declines, the bond will sell at a discount. d. The bond's current yield is above 9%. e. The bond's expected capital gains yield is zero.
The bond's expected capital gains yield is zero.
The amount by which the call price exceeds the par value of the bond is called?
The call premium
What does a call provision allow the issuer to do? In what interest rate environment is the bond most likely to be called by the issuer?
The call provision allows the issuer to call or buy back the bond from the bondholder. They are most likely to call it when there is a premium and interest rates are lowering
What does the AAA rating assigned by S&P mean?
The firm is in a strong position to meet its debt obligations
Why does a bond's value fluctuate overtime?
The coupon rate and par value are fixed, while market interest rates change.
Amram Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not convertible, not callable, and has no sinking fund. Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the second bond, the convertible, callable bond with the sinking fund, to have it sell initially at par? a. The rate should be over 8%. b. The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%. c. The rate should be slightly greater than 6%. d. The rate should be over 7%. e. The coupon rate should be exactly equal to 6%.
The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%.
-A security has a beta of 1, the market risk premium is 8 percent, and the risk-free rate is 3 percent. What will happen to the expected return if the beta doubles?
The expected return will increase to 19% from 11%.
σA × σB
The formula for computing the correlation of the returns on Stocks A and B is equal to the Cov(RA,RB) divided by _____.
Which one of the following is a correct statement concerning risk premium?
The greater the volatility of returns, the greater the risk premium
-The difference between the price the issuer receives and the offering price is_____.
The gross spread.
positive
The historical market risk premium for equities has been ______.
What are the three components that influence the Treasury yield curve?
The interest rate risk premium The real rate of return Expected inflation
-A company must file a registration statement with the SEC unless:
The issue is less than $5 million.
-What is the slope of the security market line (SML)?
The market-risk premium
A limitation of bond rating is that they
focus exclusively on default risk
the square root of the variance
The standard deviation is ___.
.is less than one
The standard deviation of a portfolio of two securities will be less than the weighted average of the standard deviation of the two securities when the correlation between the two securities
less than +1.
The standard deviation of the S&P 500 index is likely less than the weighted average of the individual securities in the index because the correlations between pairs of the securities are likely ____.
Eight months ago, you purchased 400 shares of Winston, Inc. stock at a price of $54.90 a share. The company pays quarterly dividends of $.50 a share. Today, you sold all of your shares for $49.30 a share. What is your total percentage return on this investment?
Total percentage return = ($49.30 - $54.90 + $.50 + $.50) ÷ $54.90 = -8.4% (loss)
When share repurchases are involved, you must compute the _____ before computing the stock price per share.
Total present value of all outstanding shares
Market Multiples Approach -
find a comparable firm that should be valued similarly to your firm along various financial metrics and apply it to your company
Which three of the following are common shapes for the term structure of interest rates?
Upward sloping Humped Downward sloping
In general, which shape does the term structure of interest rates usually have?
Upward slopping
-A distribution tends to have a smooth shape when the number of observations is _____.
Very large
It measures the spread of the sample of returns. It measures the riskiness of a security's returns.
What does variance measure?
1.5
What is Stock B's beta if the covariance between stock B and the market is 3.75, and variance of the market is 2.5?
It is additional compensation for taking risk, over and above the risk-free rate.
What is a risk premium?
Actual Return = Normal return + Risky return
What is the equation for the return on a company's stock?
what is the most useful application of the constant growth formula?
for stocks that are mature and can reasonably guarantee sustainable dividend growth
-One of the disadvantages of using historical returns to estimate the market risk premium is that the past may not be a good guide to the future:
When economic conditions change quickly.
does not matter
When expressing covariance between two securities, the ordering of variables:
The Fed's decision on interest rates at their meeting next week The outcome of an application currently pending with the Food and Drug Administration.
Which of the following are examples of information that may impact the risky return of a stock?
The returns will be positively correlated over time. The returns will move in the same direction (i.e. positive) but not by the same magnitude.
Which of the following are likely to be true if we observe the returns of two stocks in the same industry, such as Pfizer and Merck?
The variances of stocks A and B The covariance between stocks A and B The market value, in dollars, of the investments in stocks A and B
Which of the following are needed in order to compute the variance of a portfolio consisting of two stocks, A and B?
Because unsystematic risk should be eliminated through diversification
Why can an investor holding a well-diversified portfolio of securities ignore the unsystematic risk of individual securities?
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
A bond has a quoted price of $984.36, a face value of $1000, semi-annual coupon of $20, and a maturity of 10 years. Match its current yield and it's YTM below. YTM Current Yield 4.06% 4.19%
YTM= CY=
incremental IRR calculation
calculate the difference in CF from large project - small project and then solve for IRR
what is the most useful implementation of the zero growth formula?
calculating preferred stock dividends
Unsystematic risk:
can be effectively eliminated by portfolio diversification
the total dollar return is the sum of dividends and
capital gains or losses
there is a __ relationship between risk and expected return
direct
1.value: 10.00 points Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose a German company issues a bond with a par value of €1,000, 25 years to maturity, and a coupon rate of 7.9 percent paid annually. If the yield to maturity is 9 percent, what is the current price of the bond? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Price €
fv=1000 n=25 pmt= 1000*.079 = 79 i=9 cpt, *pv=891.95*
A symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation is the _____ distribution.
normal
what is the primary market?
shares of stock are first brought to the market and sold to investors
geometric averages are usually _____ arithmetic averages
smaller than
what is a dealer?
someone who maintains an inventory and stands ready to buy and sell at any time
The standard deviation is the _______ of the variance.
square root
what is the secondary market?
where existing shares are traded among investors
bull market
where stock prices are rising
-A good source for bond quotes is:
www.finra.org/marketdata
is there any advantage to using the EV/EBITDA ratio over the PE ratio to compare stock prices?
yes, as companies in the same industry may differ by leverage, which has a lower impact on EV/EBITDA than it does on PE
If the growth rate (g) is zero, the capital gains yield is ________.
zero
if the growth rate is zero, what is the capital gains yield?
zero
-A firm is exposed to both systematic and unsystematic risks. Which of the following are examples of systematic risks?
• An increase in the corporate tax rate • An increase in the Federal funds rate
the price of XYZ stock rises from $10 to $15. if you own 100 shares, your capital gain is
$500 = (15-10) x 100
Unsystematic risk will affect:
- firms in a single industry - a specific firm
in 2015, the us stock market represented about _________% of the world stock market capitalization.
57.7
Because of _______ and ______, interest rates are often quoted in many different ways.
tradition; legislation
What will happen to a bonds time to maturity as the years go by?
It will decline
-Stock prices fluctuate from day to day because of:
Information flow
-Which of the following are important considerations when choosing between venture capitalists?
• Financial strength • Style • Exit strategy
-In the Ibbotson-Sinquefield studies, long-term corporate bonds have which of the following characteristics?
• High quality • 20-year maturities.
-When dealing with the history of capital market returns, an average stock market return is useful because it _____.
• Is the best estimation of any one year's stock market return during the specified period. • Simplifies detailed market data.
-What does variance measure?
• It measures the dispersion of the sample of returns. • It measures the riskiness of a security's return. *Variance measures the dispersion of the sample of returns.
-The WACC is the minimum return a company needs to earn to satisfy _____,
• Its stockholders • Its bondholders
-The Ibbotson-Sinquefield data shows that _____.
• Long-term corporate bonds had less risk or variability than stocks. • U.S. T-bills had the lowest risk or variability
-A firm's cost of debt can be _____.
• Obtained by talking to investment bankers • Obtained by checking yields on publicly traded bonds • Estimated easier than its cost of equity.
Studying market history can reward us by demonstrating that:
• On average, investors will earn a reward for bearing risk • The greater the potential reward is, the greater the risk.
-Preferred stock
• Pays dividends in perpetuity • Pays a constant dividend.
Grossnickle Corporation issued 20-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity? a. $1,232.15 b. $1,142.03 c. $1,113.48 d. $1,171.32 e. $1,201.35
$1,232.15 Par value = Maturity value = FV $1,000 Coupon rate 7.5% Years to maturity = N 19 Required rate = I/YR 5.5% (Coupon rate)(Par value) = PMT $75 PV $1,232.15
Dumb Mistakes, Inc., stock is selling for $13.07 a share based on a 13 percent rate of return. What is the amount of the annual dividend the firm just paid if the growth rate of the dividends is 3.5 percent?
$1.20
if you invested $100 and made a total dollar return of $10 over the course of the year, your year-end total cash would be
$110 = 100 + 10
Six months ago, you purchased 100 shares of stock in ABC Co. at a price of $43.89 a share. ABC stock pays a quarterly dividend of $.10 a share. Today, you sold all of your shares for $45.13 per share. What is the total amount of your capital gains on this investment?
$124.00 Capital gains = ($45.13 - $43.89) × 100 = $124
The Value of a 20 year zero coupon bond when the market required rate of return of 9% semiannual is
$171.93
-Palmer Company had the following returns: 2009 12% 2010 10% 2011 -8% 2012 4% 2013 22% What is the VARIANCE of Palmer's returns?
0.0122
Palmer Company had the following returns: 2009: 12% 2010: 10% 2011: -8% 2012: 4% 2013: 22% What is the variance of Palmer's returns?
0.0122
-A firm has a target debt-equity ratio of 0.5, but it plans to finance a new project with all the debt. What debt-equity ratio should be used when calculating the project's flotation costs?
0.5
how many votes will guarantee you a seat as a director?
1 / (N + 1) percent of the stock plus one share, where N = the number of director openings available
the treasury bills used in the Ibbotson SBBI yearbook had maturities of:
1 month
holding period return formula
1+R * 1+R .... -1
Which of these correctly identify differences between Treasury bonds and corporate bonds? Check all that apply. -Treasury bonds are issued by the US government will corporate bonds are issued by corporations. -Treasury bonds do not offer any tax benefits to investors but corporate bonds do. -Treasury bonds offered to certain tax benefits to investors the corporate bonds cannot offer. -Treasury bonds are free of default risk while corporate bonds are exposed to default risk.
1,3,4
Look at the frequency distribution in Figure 12.9 and rank the following ranges of stock returns in order from highest to lowest frequency.
1. 20%-30% 2. 10%-20% 3. 0-10% 4. -10%-0
What are the 4 steps of computation of variance?
1. Calculate the expected return 2. Calculate the deviation of each return from the expected return 3. Square each deviation 4. Calculate the average squared deviation
-A firm's capital structure consists of 40 percent debt and 60 percent equity. The aftertax yield on debt is 2.5 percent and the cost of equity is 15 percent. The project is about as risky as the overall firm. What discount rate should be used to estimate the project's net present value?
10%
-If a preferred stock pays a dividend of $2 per year and is selling for $20, its yield is:
10%
-MNO preferred stock pays a dividend of $2 per year and has a price of $20. If MNO's tax rate is 40 percent, the required rate of return on its preferred stock is _____ percent.
10%
What is the coupon rate on a bond that has a par value of $1000, a market value of $1100, and a coupon interest payment of $100 per year?
10%
What is the total return for a stock that currently sells $100, pays a dividend in one year of $2, and has a constant growth rate of 8%?
10%
What is the total return for a stock that currently sells for $100, is expected to pay a dividend in one year of $2, and has a constant growth rate of 8%?
10% R=(2/100)+0.08
What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?
10% (Coupon rate=$100/$1,000=10%)
You buy a stock for $50. Its price rises to $55, and it pays a $2 dividend. You do not sell the stock. Your capital gains yield is
10% = (55 - 50) / 50
A 12-year, 5% coupon bond pays interest annually. The bond has a face value of $1,000. What is the change in the price of this bond if the market yield rises to 6% from the current yield of 4.5%? Multiple Choice 11.11 % decrease 12.38 % decrease 12.38 % increase 14.13 % decrease 14.13 % increase
12.38 % decrease
NASDAQ differs from NYSE bc
has a multiple market maker system and no physical location both have an electronic system and dealers
If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent, then the probability of earning a return greater than 15% is about _______%.
16 = Prob (R>15%) = (1-.68)/2
You own the following portfolio of stocks. What is the portfolio weight of stock C? Number Price Multiple Choice 30.8% 37.4% 42.3% 45.2% 47.9%
30.8%
Shares of common stock of the Samson Co. offer an expected total return of 12%. The dividend is increasing at a constant 8% per year. The dividend yield must be:
4% 0.12 = (D1/P0) + 0.08 D1/P0 is dividend yield
hares of common stock of the Samson Co. offer an expected total return of 12%. The dividend is increasing at a constant 8% per year. The dividend yield must be: Multiple Choice - 4%. 4%. 8%. 12%. 20%
4%.
Taussig Corp.'s bonds currently sell for $1,150. They have a 6.35% annual coupon rate and a 20-year maturity, but they can be called in 5 years at $1,067.50. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds? a. 4.20% b. 3.99% c. 3.42% d. 3.79% e. 3.60%
4.20%
A firm with an 8 percent dividend growth rate and return on equity of 20% must have a retention ratio of ______ percent.
40
If Joan owns 100 shares of ABC company and the company is electing 4 directors, under cumulative voting, Joan would usually have _____ votes.
400
If you are in the 20% tax bracket, what is your after-tax yield on a par value municipal bond yielding 5%? Ignore state and local taxes.
5%. Interest income from the Muni is exempt from the federal income tax so the after-tax yield equals the before tax yield.
The bonds issued by Jensen & Son bear a 5 % coupon, payable semiannually. The bond matures in 8 years and has a $1,000 face value. Currently, the bond sells at par. What is the yield to maturity? Multiple Choice 4.87% 4.97% 5.00% 5.09%
5.00%
What will your aftertax yield be on a corporate bond that is currently priced to yield 7% if you are in the 25 percent tax bracket?
5.25% (.07x(1-.25)=5.25%)
going back to 1802, the us historical risk premium is, on average, about ________ %.
5.4
Turnips and Parsley common stock sells for $31.65 a share at a market rate of return of 9.5%. The company just paid their annual dividend of $1.20. What is the rate of growth of their dividend?
5.5% $31.65 = [$1.20 x (1+g)]/(0.95 - g)
What is the after-tax yield on a US treasury bond using 7% if you are in the 20% tax bracket?
5.6% .07 X (1- 0.2) = 5.6%
The capital gains yield plus the dividend yield on a security is called the:
total return
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? a. 6.52% b. 6.85% c. 6.21% d. 7.19% e. 5.90%
5.90%
The Inferior Goods Co. stock is expected to earn 13% in a recession, 7% in a normal economy, and lose 6% in a booming economy. The probability of a boom is 20% while the probability of a normal economy is 55% and the chance of a recession is 25%. What is the expected rate of return on this stock? Multiple Choice 5.00% 5.90% 6.80%
5.90%
-Consider the following two assets: Asset Expected return Beta X 5.8% 0.8 Y 14.2% 1.8 If the risk free rate is 1%, what is the reward-to-risk ration for Asset X?
6.0%
The average annual return on long-term corporate bonds for the period of 1926 to 2011 was ________%
6.4
Baker Industries pays a constant annual dividend of $.80 a share and currently sells for $12.50 a share. What is the rate of return?
6.40 percent Work: Rate of return = Annual Dividend / Current Price * 100 = $ 0.80 / $ 12.50 * 100 = 6.40%
What is the total return for a stock currently sells for $108, pays a dividend in one year of $3.20, and has a constant growth rate of 3.5 percent?
6.46%
what is the arithmetic average return for a stock that had annual returns of 8%, 2%, and 11% for the past 3 years?
7% = (8 + 2 + 11)/3
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? a. 7.14% b. 8.68% c. 8.27% d. 7.50% e. 7.88%
7.14% PV $1,050 PMT $75 Current yield = 7.14%
From 1900 to 2010, the US ranked ____ when compared internationally in terms of highest equity risk premium.
7th
If the annual stock market returns for Berry Company were 19 percent, 13 percent, and -8 percent, what was the arithmetic mean for those 3 years?
8%
If the annual stock market returns for Berry Company were 19 percent, 13 percent, and -8 percent, what was the arithmetic mean for those 3 years?
8% = (.19 + .13 - .08) / 3
If the rate of inflation is 3% and the real rate of return is 5%, the nominal rate is approximately what percent?
8% To find nominal rate simply add inflation to the real rate.
Calculate the Yield to Call on the following bond: Bond maturity: 10 years Call date: 3 years Coupon rate: 8% Current price: $1,050.00 Call price: $1,075.00
8.3%
On objection to the present value analysis of stocks is that investors ____.
Are shortsighted
Present value decreases
As interest rates increase
R
Discount rate
An efficient market is one in which any change in available information will be reflected in the company's stock price ____________.
Immediately
negative
In a two-asset portfolio, a ________ covariance of returns between the two securities will lead to a reduction in the variance of the portfolio.
Nominal rates are called "nominal" because they have not been adjusted for _____________.
Inflation
Which three components determine the shape of the term structure of interest rates?
Inflation premium, real interest rate, and interest rate risk premium.
-An efficient market is one that fully reflects all available _____.
Information.
The main trading floor at the NYSE is known as ____.
The big room
what are some important lessons from the 2008 financial crisis? a) investors should invest all of their funds in T-bills b) diversification is important c) the stock market is risky d) the risk premium going forward will probably be lower
b + c
which of the following are true? a) on average, T-bills outperform common stock b) common stocks frequently experience negative returns c) T-bills sometimes outperform common stocks
b + c
sensitivity analysis is also known as __ and __
bop - best, optimistic, pessimistic what if
the equivalent annual cost method for deciding between two machines applies only if
both machines are being replaced
what is a broker?
brings buyers and sellers together but does not maintain an inventory
how can a no-dividend firm still pay off for an investor?
by being acquired in the future or by paying high dividends in the future
all else constant, dividend yield will increase when stock price
decreases
You own a stock portfolio invested 30 percent in Stock Q, 30 percent in Stock R, 30 percent in Stock S, and 10 percent in Stock T. The betas for these four stocks are .82, 1.20, 1.21, and 1.38, respectively. What is the portfolio beta? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
portfolio beta = 1.11
If investors are risk adverse, it is reasonable to assume that the only risk premium for the stock market will be:
positive
The standard deviation for a set of stock returns can be calculated as the:
positive square root of the variance.
return of two stocks in the same industry will be
positively correlated move in the same direction but not same magnitude
the sharpe ratio measures
reward to risk
assumptions related to __ and ___ are critical for forecasting future US equity premiums
risk aversion of future investors and future risk enviroment
assumptions related to the _____ are critical for forecasting future us equity premiums.
risk aversion of future investors and the future risk environment
two components of expected return of the market
risk free rate and risk premium
PE ratio is a function of
risk level accounting practices growth opportunities
discount rate assigned to a project represents
risk of the project and the opportunity cost to the investor
-Which of the following statements are true about variances?
• Standard deviation is the square root of variance. • Variance is a measure of the squared deviations of a security's return from its expected return.
-Possible explanations of the drop in a stock's price after an announcement of a new equity issue are that the announcement is an indication that _____.
• The firm has too much debt • Management believes the firm is overvalued.
-The SML approach required estimates of:
• The market risk premium • The beta coefficient
-What are the two components of the expected return on the market (Rm)?
• The risk-free rate (Rt) • The risk premium
-Whether a firm obtains capital by debt or equity financing depends on:
• The size of the firm • The firm's life-cycle • The firm's growth prospects
-What two factors determine a stock's total return?
• Unexpected return • Expected return
when evaluating mutually exclusive projects, the PI has a problem with evaluating
scale
The general formula for _________ is (1+quoted rate/m)^(m) - 1.
the EAR
True
It is possible for the unsystematic risk of a portfolio to be reduced to practically zero.
One share of Kilo, Inc., stock is selling for $43.60 a share. The company pays a constant annual dividend and has a rate of return of 8 percent. What is the amount of Kilo's dividend?
$3.49 Work: Price = dividend / R 43.60 = Dividend / 0.08 Dividend = 43.60 x 0.08 = 3.488 or 3.49
A corporate bonds yield to maturity can do two things:
1. Change over time 2. Can't be greater than, equal to, or less than the bonds coupon rate
-Dang's Donuts has EBIT of $25,432, depreciation of $1,500, and a tax rate of 18%. The company will not be changing its net working capital, but plans a capital expenditure of $6,324. What is Dang's adjusted cash flow from assets?
$16,030.24
If you receive a $2 dividend per share on your 100 shares, your total dividend income is _____________.
$200
what will the dividend income be on 1000 shares of XYZ stock if XYZ distributes a $.20 per share dividend?
$200 = .2 x 1000
if you receive a $2 dividend per share on your 100 shares, your total dividend income is
$200 = 2 x 100
A stock you are interested in paid a dividend of $1 last year. The anticipated growth rate in dividends and earnings is 25% for the next 2 years before settling down to a constant 5% growth rate. The discount rate is 12%. Calculate the expected price of the stock. Multiple Choice $15.38 $20.50 $21.04 $22.27 $26.14
$21.04 Price = $1.00(1.25)/1.12 + $1.25(1.25)/1.2544 + [$1.5625(1.05)/(.12-.05)]/1.2544 = $21.04
What is the price of a stock at the end of one year (P1), if the dividend for year 2 (D2), is $5, the price for year 2 (P2) is $20, and the discount rate is 10%?
$22.73
You have decided that you would like to own some shares of GH Corp. but need an expected 12.5% rate of return to compensate for the perceived risk of such ownership. What is the maximum you are willing to spend per share to buy GH stock if the company pays a constant $3.40 annual dividend per share?
$27.20 P0 = $3.40 / 0.125
Denver Deelights is expected to pay their first annual dividend three years from now. That payment will be $.50 a share. Starting in year four, the company will increase the dividend by 4 percent per year. The required return is 12 percent. What is the value of this stock today?
$4.98 Work: =(0.5*1.04)/(0.12-0.04) =$6.5 =0.5/1.12^3+6.5/1.12^3 =4.98 approx.
You bought one share of stock for $100 and received a $2 dividend. If the price of the stock rose to $103, then your total dollar return would be _____.
$5 = 103 - 100 + 2
A year ago, you purchased 300 shares of IXC Technologies, Inc. stock at a price of $9.03 per share. The stock pays an annual dividend of $.10 per share. Today, you sold all of your shares for $28.14 per share. What is your total dollar return on this investment?
$5,763 Total dollar return = ($28.14 - $9.03 + $.10) × 300 = $5,763
The price of a stock drops from $50 to $40 per share. If you own 50 shares, your total capital loss is ___________.
$500 (2500-2000)
the price of a stock drops from $50 to $40 per share. if you own 50 shares, your total capital loss is
$500 = (40-50) x 50
if you buy 100 shares of ABC stock at $5 per share, your total investment is
$500 = 100 x 5
-UCL and LEV have earnings before interest and taxes of $110, LEV also has $20 of interest expense. Both companies are taxed at 30 percent, ULC's aftertax earnings are _____, which is _____ than LEV's aftertax earnings.
$77; $14 greater
What is the price of a stock if its dividend a year from now is expected to be $3.20, the discount rate is 9 percent, and the constant rate of growth is 5 percent.
$80
Mr. Money, Inc., announced yesterday that their next annual dividend will be $1.40 and that future dividends will be increasing by 3 percent annually. How much are you willing to pay for one share of this stock if your required return is 18 percent?
$9.33
A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now? a. $906.86 b. $953.36 c. $884.19 d. $977.20 e. $930.11 First find the YTM at this time, then use the YTM with the other data to find the bond's price 5 years hence. Par value $1,000 Coupon rate 8.50% Value in 5 years: N 25 N20 PV $925 I/YR 9.28% PMT $85 PMT$85 FV $1,000 FV $1,000 I/YR 9.28% PV $930.11
$930.11
Wine and Roses, Inc. offers a 7% coupon bond with semiannual payments and a yield to maturity of 7.73%. The bonds mature in 10 years. What is the market price of a $1,000 face value bond? Multiple Choice $943.28 $949.80 $1,108.16 $1,401.26 $1,401.86
$949.80
You bought 100 shares of stock at $20 each. At the end of the year, you received a total of $400 in dividends, and your stock was worth $2,500 total. What was your total return?
$Invest = $20(100) = $2,000; $Return = ($2,500 + $400 - $2,000)/$2,000 = .45 = 45%
Excelsior share are currently selling for $25 each. You bought 200 shares one year ago at $24 and received dividend payments of $1.50 per share. What was your total rate of return?
% Total Return = [($25 + $1.50)/$24] - 1 = .1041667 = 10.42%
Excelsior shares are currently selling for $25 each. You bought 200 shares one year ago at $24 and received dividend payments of $1.50 per share. What was your percentage capital gain this year?
%CG = ($25 - $24)/$25 = .04167 = 4.17%
-You bought one share of stock for $100 and received a $2 dividend. If the price of the stock rose to $103, then your total dollar return would be _____.
($103 - 100 + 2 =) $5
-A share of common stock currently sells for $100 and will pay a dividend of $2 at the end of the year. If the price is expected to increase to $113 at the end of one year, what is the stock's current dividend yield?
($2/$100) = 2%
What are the 3 components that influence the Treasury Yield Curve?
1. The real rate of return 2. Expected Inflation 3. The interest rate risk premium
(Q) Fifth National Bank just issued some new preferred stock. The issue will pay an annual dividend of $10 in perpetuity, beginning seven years from now. If the market requires a return of 5.6 percent on this investment, how much does a share of preferred stock cost today?
(A) $128.77
(Q) Yesterday, Railway Cabooses paid its annual dividend of $1.20 per share. The company has been reducing the dividends by 10% each year. How much are you willing to pay to purchase stock in this company if your required rate of return is 14%?
(A) $4.5
(Q) Mortgage Instruments Inc. is expected to pay dividends of $1.03 one year from today. The company just paid a dividend of $1. This growth rate is expected to continue. How much should be paid for Mortgage Instruments stock today if the appropriate discount rate is 5%?
(A) $51.50
(Q) Let's calculate the P/E ratio for Wal-Mart Stores Inc. (NYSE:WMT), as of November 14, 2017 when the company's stock price closed at $91.09. The company's profit for the fiscal year ended January 31, 2017 was $13.64 billion and its number of shares outstanding is 3.1 billion.
(A) Its EPS can be calculated as $13.64 billion / 3.1 billion = $4.40. Wal-Mart's P/E ratio is, therefore, $91.09/$4.40 = 20.70.
(Q) The Germinating Flower Co. has earnings of $1.75 per share. The benchmark PE for the company is 18. What stock price would you consider appropriate? What if the benchmark PE were 21?
(A) P = Benchmark PE ratio × EPS • So, with a PE ratio of 18, we find: P = 18($1.75) = $31.50 •With a PE ratio of 21, we find: P = 21($1.75) = $36.75
(Q) Lohn Corporation is expected to pay the following dividends over the next four years: $10, $7, $6, and $2.75. Afterwards, the company pledges to maintain a constant 5 percent growth rate in dividends forever. If the required return on the stock is 13 percent, what is the current share price?
(A)$42.31
(Q) Mineral Water, Inc., will pay a quarterly dividend per share of $.80 at the end of each of the next 12 quarters. Thereafter, the dividend will grow at a quarterly rate of 1 percent, forever. The appropriate rate of return on the stock is 10 percent, compounded quarterly. What is the current stock price?
(A)$48.26
How is an APR computed?
(Rate per period X Number of periods in a year) - 1
-The price of a stock drops from $50 to $40 per share. If you own 50 shares, your total capital loss is _____.
([$40 - 50] X 50 =) $500
Which of the following is not a difference b/w debt and equity? - Unlike dividend omissions to equity holders, unpaid debt obligations can lead to bankruptcy - Equity is publicly traded while in debt - Equity represents ownership interest while debt does not - A corporation's interest payments on debt are tax deductible, but the dividends it pays to equity holders are not
- Equity is publicly traded while in debt
Which of the following are real-world examples of annuities? - Mortgages - Common Stock dividends - Leases - Preferred stock dividends - Pensions
- Mortgages - Leases - Preferred stock dividends - Pensions
Which of the following are examples of information that may impact the risky return of a stock? - The outcome of an application currently pending with the Food and Drug administration - The trend in sales growth over the last 10 years - Last year's income as a percentage of sales and gross fixed assets - The Fed's decision on interest at their meeting next week
- The outcome of an application currently pending with the Food and Drug administration - The Fed's decision on interest at their meeting next week
The systematic risk principle argues that the market does not reward risks:
- that are borne unnecessarily - that are diversifiable
The term structure of interest rates describes _________.
- the pure value of money - the relationship between nominal rates and time to maturity
Which of the following terms apply to a bond? - time to maturity - coupon rate - dividend yield - par value
- time to maturity - coupon rate - par value
the diversification benefits of holding a portfolio are maxed at what correlation
-1
the range of returns for a large stock portfolio, within 2 standard deviations, is ____.
-28.1 and +52.3%
Which of the following are cash flows to investors in stocks?
-Capital Gains -Dividends
What information do we need to determine the value of a stock using the zero growth model?
-Dividend -Discount rate
Arrange the following investments in ascending order from lowest historical risk premium to highest historical risk premium.
1. U.S. Treasury bills 2. Long-term corporate bonds 3. Large-company stocks 4. Small-company stock
a stock's PE ratio is likely a function of what 3 factors?
1. growth opportunities (high growth = high PE) 2. risk (low risk = high PE) 3. accounting practices (conservative practices = high PE)
what two basic effects does staggering have?
1. it makes it more difficult for a minority to elect a director when there is cumulative voting because there are fewer directors to be elected at one time 2. it makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors
what are the four main issues with the dividend discount model?
1. most dividends pay stocks quarterly 2. why should you pay for dividends you will never receive? 3. what if a stock doesn't pay dividends? 4. how can we actually employ the formula, forecasting all future dividends?
shareholders usually have what rights?
1. the right to share proportionally in dividends paid 2. the right to share proportionately in assets remaining after liabilities have been paid in a liquidation 3. the right to vote on stockholder matters of great importance, such as a merger
what are some important characteristics of dividends?
1. unless a dividend is declared by the board, it is not a liability to the corporation 2. the payment of dividends is not a business expense 3. dividends received by individual shareholders are taxable
what are the solutions to the four issues with the dividend discount model?
1. we assume annual payments purely for simplicity 2. you receive future dividend payments when you sell your stock 3. stocks all pay dividends eventually 4. use DDM 3 different ways
-If security ABC has a beta of 1.5 and security of XYZ has a beta of 1, what is the beta of a portfolio that is equally invested in both securities?
1.25
Brown Enterprises' bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80, and a par value of $1,000. What is their current yield?
7.80%
John's portfolio consists of $1,200 worth of Chi Corporation common stock and $400 worth of Lambda Corporation common stock. Lambda's portfolio weight is 25%, and Chi's portfolio weight is:
75% 100%-25% 0r $1,200/$1,600
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? a. $817.12 b. $838.07 c. $881.60 d. $859.56 e. $903.64
881.60
the probability of an outcome being within two standard deviations of the mean in a normal distribution is approximately _______ percent.
95
Consider a bond which pays 7% semiannually and has 8 years to maturity. The market requires an interest rate of 8% on bonds of this risk. What is this bond's price? Multiple Choice $942.50 $911.52 $941.74 $1,064.81 None of the above.
= $941.74 N = 16 I/Y = 4 PMT = 35 FV = 1,000 PV = ???
Value of Common Stock
= MV0 - debt - preferred stock, P0 = value of common stock / # of shares outstanding
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
−27.4 to 37.9
A stock has returns of 3 percent, 17 percent, −17 percent, and 18 percent for the past 4 years. Based on this information, what is the 95 percent probability range for any one given year?
1.value: 10.00 points The Jackson-Timberlake Wardrobe Co. just paid a dividend of $1.30 per share on its stock. The dividends are expected to grow at a constant rate of 4 percent per year indefinitely. Investors require a return of 14 percent on the company's stock. What is the current stock price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) A) Current price $ What will the stock price be in three years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) B) Stock price $ What will the stock price be in 12 years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) C) Stock price $ HintsReferenceseBook & Resources Hint #1
A) P1 = D(1+g) / [R-g] PV = 1.30 x (1.04) / [.14 - 4] = *13.52* B) PV = 13.52 I / Y = 4 N = 3 CPT, *FV = 15.21* C) N = 12 CPT, *FV = 21.65*
(Q) Dozier Corp. is a fast-growing supplier of office products. •FCF1=-$20M, FCF2=$30M, FCF3=$40M, after that FCF is expected to grow at a constant rate 7%, WACC=13% a.What is the firm's value today? b.Suppose Dozier has $100M of debt, no preferred stock, and 10M shares of outstanding. What is your estimate of the price per share?
A) $527.89m B) Value of common equity = $427.89m, Price/share = $42.79
You desire a portfolio beta of 1.1. Currently, your portfolio consists of $100 invested in Stock A with a beta of 1.4 and $300 in Stock B with a beta of .6. You have another $400 to invest and want to divide it between Stock C with a beta of 1.6 and a risk-free asset. How much should you invest in the risk-free asset to obtain your desired beta? A. $50 B. $100 C. $125 D. $350 E. $300
A. $50
Unsystematic risk: A. can be effectively eliminated through portfolio diversification. B. is compensated for by the risk premium. C. is measured by beta. D. cannot be avoided if you wish to participate in the financial markets. E. is related to the overall economy.
A. Can be effectively eliminated through portfolio diversification.
-What is risk premium?
It is the additional compensation for taking risk, over and above the risk-free rate.
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? a. The rating agencies change the bond's rating from Baa to Aaa. b. Adding additional restrictive covenants that limit management's actions. c. Adding a call provision. d. Making the bond a first mortgage bond rather than a debenture. e. Adding a sinking fund.
Adding a call provision.
-Match each information type to the form of market efficiency that identifies that type of information as being quickly and accurately reflected in stock prices.
All information -strong form of efficiency all public information -semistrong form of efficiency historical information -weak form of efficiency.
-When a dollar in the future is discounted to the present it is worth less because of the time value o money, but when a news item is discounted, it means that the market:
Already knew
Treasury bills are currently paying 7 percent and the inflation rate is 2.7 percent. What is the approximate real rate of interest? What is the exact real rate?
Apx.RealRateOfInterest = bill rate - inflation rate 7% - 2.70% = 4.3 RealRateof Return = (1+bill rate)/(1+inflation rate)-1 (1+7%)/(1+2.70%)-1 = 0.04187 of 4.187%, rounded to 4.19%
What are the arithmetic and geometric average returns for a stock with annual returns of 21%, 8%, -32%, 41%, and 5%?
Arithmetic average = (.21 + .08 - .32 + .41 + .05) ÷ 5 = 8.6%; Geometric return = (1.21 × 1.08 × .68 × 1.41 × 1.05).20 - 1 = 5.6%
Kids Toy Co. has had total returns over the past five years of 0%, 7%, -2%, 10%, and 12%. What was the arithmetic average return on this stock?
Arithmetic average = (0 + 7 - 2 + 10 + 12)/5 = 5.40%
A stock had returns of 8%, 39%, 11%, and -24% for the past four years. Which one of the following best describes the probability that this stock will NOT lose more than 43% in any one given year?
Average return = (.08 + .39 + .11 - .24) ÷ 4 = 8.5%; Total squared deviation = (.08 - .085)2 + (.39 - .085)2 + (.11 - .085)2 + (-.24 - .085)2 = .000025 + .093025 + .000625 + .105625 = .1993; Standard deviation = √.1993 ÷ (4 - 1) = √.06643333 = 25.7747%; Lower bound of the 95% probability range = 8.5% - (2 × 25.7747%) = -43.05; Probability of NOT losing more than 43% in any given year is 97.5%.
A stock had returns of 11%, 1%, 9%, 15%, and -6% for the past five years. Based on these returns, what is the approximate probability that this stock will earn at least 23% in any one given year?
Average return = (.11 + .01 + .09 + .15 - .06) ÷ 5 = 6%; Total squared deviation = (.11 - .06)2 + (.01 - .06)2 + (.09 - .06)2 + (.15 - .06)2 + (-.06 - .06)2 = .0025 + .0025 + .0009 + .0081 + .0144 = .0284; Standard deviation = √(0.284 ÷ (5 - 1) = √.0071 = .084; Upper end of the 95% probability range = .06 + (2 × .084) = 22.8%; Probability of earning more than 23% in any one year is just slightly less than 2.5%
Over the past five years, a stock produced returns of 14%, 22%, -16%, 2%, and 10%. What is the probability that an investor in this stock will NOT lose more than 8% nor earn more than 21% in any one given year?
Average return = (.14 + .22 - .16 + .02 + .10) ÷ 5 = 6.4%; Total squared deviation = (.14 - .064)2 + (.22 - .064)2 + (-.16 - .064)2 + (.02 - 0.064)2 + (.10 - .064)2 = .005776 + .024336 + .050176 + .001936 + .001296 = .08352; Standard deviation = √.08352 ÷ (5 - 1) = √.02088 = 14.45%; 68% probability range = 6.4% ± 14.45% = -8.05% to 20.85%; Answer is 68%.
The return pattern on your favorite stock has been 5%, 8%, -12%, 15%, 21% over the last five years. What has been your average return and holding period return over the last 5 years?
Average return = (5 + 8 - 12 + 15 + 21)/5 = 37/5 = 7.4%; HPR = [(1.05)(1.08)(.88)(1.15)(1.21)] - 1 = (1.3886) - 1 = .3886 = 38.9%
What is the inflation premium?
It is the additional return demand by investors to compensate for expected inflation
The expected return on a portfolio is best described as ____ average of the expected returns on the individual securities held in the portfolio. A. an arithmetic B. a weighted C. a compounded D. a geometric E. a minimum
B) A weighted
94. You want to design a portfolio has a beta of zero. Stock A has a beta of 1.69 and Stock B's beta is also greater than 1. You are willing to include both stocks as well as a risk-free security in your portfolio. If your portfolio will have a combined value of $5,000, how much should you invest in Stock B? A. $2,630 B. $0 C. $2,959 D. $3,008 E. $1,487
B. $0
There is a 15 percent probability the economy will boom; otherwise, it will be normal. Stock G should return 15 percent in a boom and 8 percent in a normal economy. Stock H should return 9 percent in a boom and 6 percent otherwise. What is the variance of a portfolio consisting of $3,500 in Stock G and $6,500 in Stock H? A. .000209 B. .000247 C. .002098 D. .037026 E. .073600
B. .000247
Stock S is expected to return 12 percent in a boom and 6 percent in a normal economy. Stock T is expected to return 20 percent in a boom and 4 percent in a normal economy. There is a 40 percent probability that the economy will boom; otherwise, it will be normal. What is the portfolio variance if 30 percent of the portfolio is invested in Stock S and 70 percent is invested in Stock T? A. .002220 B. .004056 C. .006224 D. .008080 E. .098000
B. .004056
Stock A is expected to return 14 percent in a normal economy and lose 21 percent in a recession. Stock B is expected to return 11 percent in a normal economy and 5 percent in a recession. The probability of the economy being normal is 75 percent with a 25 percent probability of a recession. What is the covariance of these two securities? A. .007006 B. .006563 C. .005180 D. .007309 E. .006274
B. .006563
What is the inflation premium?
It is the additional return demanded by investors to compensate for expected inflation
Zoom stock has a beta of 1.46. The risk-free rate of return is 3.07 percent and the market rate of return is 11.81 percent. What is the amount of the risk premium on Zoom stock? A. 8.09% B. 12.76% C. 9.59% D. 10.25% E. 17.24%
B. 12.76%
Stock A has an expected return of 17.8 percent, and Stock B has an expected return of 9.6 percent. However, the risk of Stock A as measured by its variance is 3 times that of Stock B. If the two stocks are combined equally in a portfolio, what would be the portfolio's expected return? A. 13.37% B. 13.70% C. 15.75% D. 12.41% E. 14.55%
B. 13.70%
You would like to combine a risky stock with a beta of 1.87 with U.S. Treasury bills in such a way that the risk level of the portfolio is equivalent to the risk level of the overall market. What percentage of the portfolio should be invested in the risky stock? A. 54.15% B. 53.48% C. 55.09% D. 52.91% E. 54.67%
B. 53.48%
There is a 20 percent probability the economy will boom, 70 percent probability it will be normal, and a 10 percent probability of a recession. Stock A will return 18 percent in a boom, 11 percent in a normal economy, and lose 10 percent in a recession. Stock B will return 9 percent in boom, 7 percent in a normal economy, and 4 percent in a recession. Stock C will return 6 percent in a boom, 9 percent in a normal economy, and 13 percent in a recession. What is the expected return on a portfolio which is invested 20 percent in Stock A, 50 percent in Stock B, and 30 percent in Stock C? A. 7.40% B. 8.25% C. 8.33% D. 9.45% E. 9.50%
B. 8.25%
The combination of the efficient set of portfolios with a riskless lending and borrowing rate results in the: A. capital market line which shows that all investors will only invest in the riskless asset. B. capital market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio. C. security market line which shows that all investors will invest in the minimum variance portfolio. D. security market line which shows that all investors will invest only in the riskless asset. E. characteristic line which shows that all investors will invest in the same combination of securities.
B. Capital market line which shows that all investors will invest in a combination of the riskless asset and the tangency portfolio.
Which one of these best describes steps of the separation principle? A. Determine the beta that best fits an investor's risk tolerance level and then determine which assets can be combined to create a portfolio that matches that beta. B. Determine the tangency point between the risk-free rate and the efficient set of risky assets and determine how to combine the tangency point portfolio with risk-free assets to match the investor's risk tolerance level. C. Determine the appropriate beta for an individual investor and then determine the most efficient set of risky assets that falls below that beta level. D. From a pool of assets determine which pairs of assets have the lowest covariances and then determine how to combine these pairs into a portfolio that matches the investor's preferred beta. E. Determine an investor's risk tolerance level and then determine which portfolio rate of return best fits that level of risk tolerance.
B. Determine the tangency point between the risk-free rate and the efficient set of risky assets and determine how to combine the tangency point portfolio with risk-free assets to match the investor's risk tolerance level.
A dominant portfolio within an opportunity set that has the lowest possible level of risk is referred to as the: A. efficient frontier. B. minimum variance portfolio. C. upper tail of the efficient set. D. tangency portfolio. E. optimal covariance portfolio.
B. Minimum variance portfolio.
If the correlation between two stocks is -1, the returns on the stocks: A. generally move in the same direction. B. move perfectly opposite to one another. C. are unrelated to one another. D. have standard deviations of equal size but opposite signs. E. totally offset each other producing a rate of return of zero.
B. Move perfectly opposite to one another.
You are comparing Stock A to Stock B. Stock A will return 9 percent in a boom and 4 percent in a recession. Stock B will return 15 percent in a boom and lose 6 percent in a recession. The probability of a boom is 60 percent with a 40 percent chance of a recession. Given this information, which one of these two stocks should you prefer and why? A. Stock A; because it has a higher expected return and appears to be more risky than Stock B B. Stock A; because it has a higher expected return and appears to be less risky than Stock B C. Stock A; because it has a slightly lower expected return but appears to be significantly less risky than Stock B D. Stock B; because it has a higher expected return and appears to be just slightly more risky than Stock A E. Stock B; because it has a higher expected return and appears to be less risky than Stock
B. Stock A; because it has a higher expected return and appears to be less risky than Stock B
If you are forecasting a few decades in the future you should calculate the expected return using:
Blume's formula
-What is an uncertain or risky return?
It is the portion of return that depends on information that is currently unknown.
The stock of Martin Industries has a beta of 1.43. The risk-free rate of return is 3.6 percent and the market risk premium is 9 percent. What is the expected rate of return? A. 11.32% B. 14.17% C. 16.47% D. 17.48% E. 18.03%
C. 16.47%
You recently purchased a stock that is expected to earn 12.6 percent in a booming economy, 8.9 percent in a normal economy and lose 5.2 percent in a recessionary economy. Each economic state is equally likely to occur. What is your expected rate of return on this stock? A. 6.47% B. 8.90% C. 5.43% D. 7.65% E. 7.01%
C. 5.43%
historically, there is a ______ relationship between risk and expected return in the financial markets.
direct
The measure of beta associates most closely with: A. idiosyncratic risk. B. the risk-free return. C. systematic risk. D. unexpected risk. E. unsystematic risk.
C. Systematic risk.
Which one of the following statements is correct concerning the expected rate of return on an individual stock given various states of the economy? A. The expected return is a geometric average where the probabilities of the economic states are used as the exponential powers. B. The expected return is an arithmetic average of the individual returns for each state of the economy. C. The expected return is a weighted average where the probabilities of the economic states are used as the weights. D. The expected return is equal to the summation of the values computed by dividing the expected return for each economic state by the probability of the state. E. As long as the total probabilities of the economic states equal 100 percent, then the expected return on the stock is a geometric average of the expected returns for each economic state.
C. The expected return is a weighted average where the probabilities of the economic states are used as the weights.
Six months ago, you purchased 100 shares of stock in ABC Co. at a price of $43.26 a share. ABC stock pays a quarterly dividend of $.10 a share. Today, you sold all of your shares for $46.71 per share. What is the total amount of your capital gains on this investment?
Capital gains = ($46.71 - $43.26) × 100 = $345
One year ago, you purchased a stock at a price of $32 a share. Today, you sold the stock and realized a total return of 25%. Your capital gain was $6 a share. What was your dividend yield on this stock?
Capital gains yield = $6 ÷ $32 = 18.75%; Dividend yield = 25% - 18.75% = 6.25%
-When a company declares a dividend, shareholders generally receive _____.
Cash
A zero-growth model for stock valuation is distinguished by a ____.
Constant dividend amount
This type of bond can be exchanged for shares of stock.
Convertible bond
You purchased 300 shares of Deltona, Inc. stock for $44.90 a share. You have received a total of $630 in dividends and $14,040 in proceeds from selling the shares. What is your capital gains yield on this stock?
Cost = 300 × $44.90 = $13,470; Capital gains yield = ($14,040 - $13,470) ÷ $13,470 = 4.23
-If an analyst's forecast for a firm's earnings growth is 7 percent, and its dividend yield is 3 percent, its cost of equity will be _____.
Cost of equity = Dividend yield + growth rate = 3% + 7% = 10%
You want to compile a $1,000 portfolio which will be invested in Stocks A and B plus a risk-free asset. Stock A has a beta of 1.2 and Stock B has a beta of .7. If you invest $300 in Stock A and want a portfolio beta of .9, how much should you invest in Stock B? A. $700.00 B. $268.40 C. 300.00 D. $771.43 E. $608.15
D. $771.43
You have a $1,250 portfolio which is invested in Stocks A and B plus a risk-free asset. $350 is invested in Stock A which has a beta of 1.36 and Stock B has a beta of .84. How much needs to be invested in Stock B if you want a portfolio beta of .95? A. $803 B. $951 C. $782 D. $847 E. $791
D. $847
Stock A has an expected return of 12 percent and a variance of .0203. The market has an expected return of 11 percent and a variance of .0093. What is the beta of Stock A if the covariance of Stock A with the market is .0137. A. .68 B. .76 C. 1.55 D. 1.47 E. 1.32
D. 1.47
The stock of Big Joe's has a beta of 1.38 and an expected return of 16.26 percent. The risk-free rate of return is 3.42 percent. What is the expected return on the market? A. 7.60% B. 8.04% C. 9.30% D. 12.72% E. 12.16%
D. 12.72%
The market has an expected rate of return of 9.8 percent. The long-term government bond is expected to yield 4.5 percent and the U.S. Treasury bill is expected to yield 3.4 percent. The inflation rate is 3.1 percent. What is the market risk premium? A. 2.2% B. 3.3% C. 5.3% D. 6.4% E. 6.7%
D. 6.4%
The economy has a 10 percent chance of booming, 60 percent chance of being normal, and 30 percent chance of going into a recession. A stock is expected to return 16 percent in a boom, 11 percent in a normal, and lose 8 percent in a recession. What is the standard deviation of the returns? A. 5.80% B. 7.34% C. 8.38% D. 9.15% E. 9.87%
D. 9.15%
The expected return on a stock that is computed using economic probabilities is: A. guaranteed to equal the actual average return on the stock for the next five years. B. guaranteed to be the minimal rate of return on the stock over the next two years. C. guaranteed to equal the actual return for the immediate twelve month period. D. a mathematical expectation based on a weighted average and not an actual anticipated outcome. E. the actual return you will receive.
D. A mathematical expectation based on a weighted average and not an actual anticipated outcome.
You have plotted the monthly returns for two securities for the past five years on the same graph. The pattern of the movements of each of the two securities generally rose and fell to the same degree in step with each other. This indicates the securities have: A. no correlation with each other. B. a weak negative correlation. C. a strong negative correlation. D. a strong positive correlation. E. a weak positive correlation.
D. A strong positive correlation.
Assume you are looking at an opportunity set representing many securities. Where would the minimum variance portfolio be located in relation to this set? A. at the lowest point of the set B. in the exact center of the set C. at the far-right point of the set D. at the far-left point of the set E. at the highest point of the set
D. At the far-left point of the set
You have a portfolio comprised of two risky securities. This combination produces no diversification benefit. The lack of diversification benefits indicates the returns on the two securities: A. are too low for their level of risk. B. move perfectly opposite of one another. C. are too large to offset. D. move perfectly in sync with one another. E. are completely unrelated to one another.
D. Move perfectly in sync with one another.
-Historically, there is a(n) _____ relationship between risk and expected return in the stock market.
Direct
Historically, there is a(n) ________________ relationship between risk and expected return in the stock market.
Direct
What information do we need to determine the value of stock using the zero-growth model?
Discount rate Annual dividend amount
Which of these factors are used in predicting stock values using the dividend discount model?
Discount rate Growth
The stock valuation model that determines the current stock price by dividing the next annual dividend amount by the excess of the discount rate less the dividend growth rate is called the _____ model.
Dividend Growth
(Q) If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium. A. The expected return on the stock is 5% a year. B. The stock's dividend yield is 5%. C. The price of the stock is expected to decline in the future. D. The stock's required return must be equal to or less than 5%. E. The stock's price one year from now is expected to be 5% above the current price.
E
You recently purchased a stock that is expected to earn 25 percent in a booming economy, 14 percent in a normal economy, and lose 5 percent in a recessionary economy. There is a 23 percent probability of a boom, a 62 percent chance of a normal economy, and a 15 percent chance of a recession. What is your expected rate of return on this stock?
E(R) = (0.23 × 0.25) + (0.62 × 0.14) + (0.15 × -0.05) = 0.1368 = 13.68 percent
invest $19,000 and have a portfolio expected return of 12.3%. You are considering two securities, A and B. Stock A has an expected return of 15.6%and B has an expected return of 10.3%. How much should you invest in Stock A if you invest the balance in Stock B?
E(RP) = 0.123 = 0.156x + 0.103(1 - x) x = 0.377358 InvestmentA = 0.377358 × $19,000 = $7,170
The common stock of Flavorful Teas has an expected return of 14.4%. The return on the market is 10% and the risk-free rate of return is 2.5%. What is the beta of this stock? Multiple Choice .65 1.09 1.32 1.59 1.68
E(r) = .144 = .025 + b × (.10 - .025); .119 = .075b; b 1.5866666 = 1.59
You are considering purchasing stock S. This stock has an expected return of 12 percent if the economy booms, 8 percent if the economy is normal, and 3 percent if the economy goes into a recessionary period. The overall expected rate of return on this stock will: A. be equal to one-half of 8 percent if there is a 50 percent chance of an economic boom. B. vary inversely with the growth of the economy. C. increase as the probability of a recession increases. D. be independent of the probability of each economic state occurring. E. increase as the probability of a boom economy increases.
E. Increase as the probability of a boom economy increases.
What is the bid prices?
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
What are three components that influence the Treasury yield curve?
Expected inflation The interest rate risk premium The real rate of return
Consider the following information: State of Economy Probability of State Recession .20 -.09 Normal .45 .11 Boom .35 .30 Calculate the expected return?
Expected return 13.65%
A stock has a beta of 1.22, the expected return on the market is 12 percent, and the risk-free rate is 4 percent. What must the expected return on this stock be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Expected return = 13.76%
-What is the equation for the capital asset pricing model?
Expected return on security = Risk-free rate + Beta X (Return on market - Risk-free rate)
You own a portfolio that is 25% invested in Stock X, 40% in Stock Y, and 35% in Stock Z. The expected returns on these three stocks are 10%, 13%, and 15%, respectively. Required: What is the expected return on the portfolio?
Expected return on the portfolio 12.95%
-True or false: A well-diversified portfolio will eliminate all risks.
FALSE
-True or false: Projects should always be discounted at the firm's overall cost of capital.
FALSE
-True or false: Since the CAPM equation can be used only for individual securities, it cannot be used with portfolios.
FALSE
You have $11,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 10 percent and Stock Y with an expected return of 7.5 percent. If your goal is to create a portfolio with an expected return of 8.8 percent, how much money will you invest in Stock X and Stock Y?
Here we are given the expected return of the portfolio and the expected return of each asset in the portfolio and are asked to find the weight of each asset. We can use the equation for the expected return of a portfolio to solve this problem. Since the total weight of a portfolio must equal 1 (100%), the weight of Stock Y must be one minus the weight of Stock X. Mathematically speaking, this means: E(RP) = .088 = .1wX + .075(1 − wX) We can now solve this equation for the weight of Stock X as: .088 = .1wX + .075 − .075wX .013 = .025wX wX = .52 So, the dollar amount invested in Stock X is the weight of Stock X times the total portfolio value, or: Investment in X = .52($11,000) = $5,720 And the dollar amount invested in Stock Y is: Investment in Y = (1 − .52)($11,000) = $5,280
The capital gains yield can be found by finding the difference between the ending stock price and the initial stock price and dividing it by the _______________.
Initial stock price
-The capital gains yield can be found by finding the difference between the ending stock price and the initial stock price and dividing it by the ____.
Initial stock price.
A bonds you to maturity considers the interest earnings in the change in the bonds price while the current yield considers what?
Interest earnings only
EBITDA measures earnings before _____.
Interest, depreciation, amortization
-If a security's expected return is equal to the risk-free rate of return, and the market-risk premium is greater than zero, what can you conclude about the value of the security's beta based on CAPM?
It is equal to 0. E(RT) = RT + βT(RM --R¬¬T) = RT βT = 0
What will happen to a bond's time to maturity as the years go by?
It will decline
What will happen to the default risk premium during periods of economic uncertainty?
It will increase.
-If the firm issued so much debt that its equity was valueless, its average cost of capital would equal _____.
Its cost of debt.
If a $1000 par value bond is trading at a discount, it means that the market value of the bond is (equal to, less than, or more than) $1000.
Its market value is less than $1000.
-An investment will have a negative NPV when its expected return is _____ _____ what the financial markets offer for the same risk.
Less than
-An agreement in an underwriting contract that prohibits insider shares from being sold immediately following a IPO is called a _____ period.
Lockup
Which bond comes first in order of security as defined in the US: -Debentures -Mortgage bonds
Mortgage bonds are first, debentures our second.
You must know the discount rate to apply ___ and ___
NPV and IRR
There is a(n) ________________ relationship between market interest rates and bond values.
Negative
(Q) Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because the firm needs to plow back its earnings to fuel growth. The company will pay a $15 per share dividend 10 years from today and will increase the dividend by 5.5 percent per year thereafter. If the required return on this stock is 13 percent, what is the current share price?
P0 = $66.58
You own a portfolio that has $2,500 invested in Stock A and $3,500 invested in Stock B. If the expected returns on these stocks are 10 percent and 13 percent, respectively, what is the expected return on the portfolio? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.
Portfolio expected return = 11.75%
A _____ is a form of equity security that has a stated liquidating value.
Preferred Stock
Bond X is a premium bond making semiannual payments. The bond pays a coupon rate of 7 percent, has a YTM of 5 percent, and has 11 years to maturity. Bond Y is a discount bond making semiannual payments. This bond pays a coupon rate of 5 percent, has a YTM of 7 percent, and also has 11 years to maturity. The bonds have a $1,000 par value. What is the price of each bond today? (Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.) Price of Bond X $ Price of Bond Y $ If interest rates remain unchanged, what do you expect the price of these bonds to be one year from now? In two years? In six years? In 10 years? In 11 years? (Do not round intermediate calculations. Round your answers to 2 decimal places, e.g., 32.16.) Price of bond Bond X Bond Y One year $ $ Two years $ $ Six years $ $ 10 years $ $ 11 years $ $
Price of Bond X: N=11*2, I/Y=5%/2, PMT=70/2, FV=1000 ---> N=22, I/Y=2.5, PMT=35, FV=1000 CPT PV = 1167.65 Price of Bond Y: N=11*2, I/Y=7%/2, PMT=50/2, FV=1000 ---> N=22, I/Y=3.5, PMT=25, FV=1000 CPT PV = 848.33 Price of Bond X after 1 year: after 1 year = 11-1 or N=10*2 N=20, I/Y=2.5, PMT=35, FV=1000 CPT PV = 1155.89 Price of Bond Y after 1 year: after 1 year = 11-1 or N=10*2 N=20, I/Y=3.5, PMT=25, FV=1000 CPT PV = 857.88 Price of Bond X after 2 years: after 2 years = 11-2 or N=9*2 N=18, I/Y=2.5, PMT=35, FV=1000 CPT PV = 1143.53 Price of Bond Y after 2 years: after 2 years = 11-2 or N=9*2 N=18, I/Y=3.5, PMT=25, FV=1000 CPT PV = 868.10 Price of Bond X after 6 years: after 6 years = 11-6 or N=5*2 N=10, I/Y=2.5, PMT=35, FV=1000 CPT PV = 1087.52 Price of Bond Y after 6 years: after 6 years = 11-6 or N=5*2 N=10, I/Y=3.5, PMT=25, FV=1000 CPT PV = 916.83 Price of Bond X after 10 years: after 10 years = 11-10 or N=1*2 N=2, I/Y=2.5, PMT=35, FV=1000 CPT PV = 1019.27 Price of Bond Y after 10 years: after 10 years = 11-10 or N=1*2 N=2, I/Y=3.5, PMT=25, FV=1000 CPT PV = 981.00 Price of Bond X after 11 years: after 11 years = 11-11 or N=0*2 N=0, I/Y=2.5, PMT=35, FV=1000 CPT PV = 1000.00 Price of Bond Y after 11 years: after 11 years = 11-11 or N=0*2 N=0, I/Y=3.5, PMT=25, FV=1000 CPT PV = 1000.00
The market in which new securities are originally sold to investors is called the _____ market.
Primary
-Your total year-end value from a one-year investment equals the initial investment plus the total dollar return. It also equals the _____.
Proceeds from the stock sale plus dividends.
A part of the indenture limiting certain actions during the term of the loan are termed ____
Protective covenants
-The market risk premium is defined as:
RM - Rf
A rate of return that has been adjusted for inflation:
Real rate of return
What are the three components of the treasury of curve?
Real rate of return, expected future inflation, and the interest rate risk premium.
If a given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ___________ rate.
Real rate.
A stock had the following prices and dividends. What is the geometric average return on this stock? Year 1 price = $23.19 Year 2 price = $24.90/Dividend = $0.23 Year 3 price = $23.18/Dividend = $0.24 Year 4 price = $24.86/Dividend = $0.25
Return for year 2 = ($24.90 - $23.19 + $.23) ÷ $23.19 = 8.3657%; Return for year 3 = ($23.18 - $24.90 + $.24) ÷ $24.90 = -5.9438%; Return for year 4 = ($24.86 - $23.18 + $.25) ÷ $23.18 = 8.3261%; Geometric return = (1.083657 × .940562 × 1.083261).3333 - 1 = 3.4%
The market portfolio of common stocks earned 14.7% in one year. Treasury bills earned 5.7%. What was the real risk premium on equities?
Risk premium = 14.7% - 5.7% = 9.0%
Both Bond Sam and Bond Dave have 9 percent coupons, make semiannual payments, and are priced at par value. Bond Sam has four years to maturity, whereas Bond Dave has 15 years to maturity. If interest rates suddenly rise by 2 percent, what is the percentage change in the price of Bond Sam and Bond Dave? Percentage change in price of Bond Sam % Percentage change in price of Bond Dave % If rates were to suddenly fall by 2 percent instead, what would be the percentage change in the price of Bond Sam and Bond Dave? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Percentage change in price of Bond Sam % Percentage change in price of Bond Dave %
SAM: YTM=9 N= 4*2=8 I/Y=9/2=4.5 PMT = 9%*1000, 90/2=45 FV=1000 CPT PV = 1000 YTM=11 N= 4*2=8 I/Y=11/2=5.5 PMT = 9%*1000, 90/2=45 FV=1000 CPT PV = 936.65 change in price = (63.35)* --> 1000-936.65 change in percentage -6.3* --> 63.35/1000 * make sure to put (-) if it is negative YTM=7 N= 4*2=8 I/Y=7/2=3.5 PMT = 9%*1000, 90/2=45 FV=1000 CPT PV = 1068.74 change in price = 68.74 --> 1068.74-1000 change in percentage 6.9 --> 68.74/1000 DAVE: YTM=9 N= 15*2=30 I/Y=9/2=4.5 PMT = 9%*1000, 90/2=45 FV=1000 CPT PV = 1000 YTM=11 N= 15*2=30 I/Y=11/2=5.5 PMT = 9%*1000, 90/2=45 FV=1000 CPT PV = 854.66 change in price = (145.34)* --> 1000-854.66 change in percentage -14.5* --> 145.34/1000 * make sure to put (-) if it is negative YTM=7 N= 15*2=30 I/Y=7/2=3.5 PMT = 9%*1000, 90/2=45 FV=1000 CPT PV = 1183.92 change in price = 183.92 --> 1183.92-1000 change in percentage 18.4 --> 183.92/1000
What are the portfolio weights for a portfolio that has 132 shares of Stock A that sell for $42 per share and 112 shares of Stock B that sell for $32 per share? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., .1616.)
Stock A 0.6074 Stock B 0.3926
what is the formula for the value of a common stock with constant growth dividends?
Stock price = Div/(R-g)
what is the formula for the value of a common stock with zero growth dividends?
Stock price = Div/R
What is the slope of the security market line (SML)?
The market-risk premium
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
greater than 6 percent but less than 7 percent
The newly issued bonds of the Wynslow Corp. offer a 6 percent coupon with semiannual interest payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be:
coupon
The stated interest payment, in dollars, made on a bond each period is called the bond's:
The sensitivity of a bonds price to interest rate changes in dependent on which of the following two variables?
Time maturity Coupon rate
-What is the equation for total return as a function of expected and unexpected returns?
Total return = Expected return + Unexpected return
T/F: For a zero coupon bond, duration= time to maturity
True
T/F: Over the life of the bond, its prices will converge to its face value
True
T/F: The duration of a bond is negatively related to the coupon rate of interest
True
T/F: The duration of a bond is negatively related to the yield to maturity
True
All relevant information available to shareholders
What does a normal return depend upon?
The return that an individual expects to earn over the next period.
What is expected return?
045/(.3 × .2) = .75
What is the correlation of returns between stocks A and B based on the following information? The standard deviation of returns is .30 for A and .20 for B and the covariance between A and B's returns is .045.
Zero
What is the covariance for two securities with returns that are unrelated to each other?
.5 × 7% + .3 × -3% + .2 × 18% = 6.2%
What is the return on a portfolio that consists of: $50,000 in an index fund, $30,000 in a bond fund, and $20,000 in a foreign stock fund? The expected returns are 7 percent, -3 percent, and 18 percent, respectively.
The death of the CEO of a publicly traded corporation Management fraud leading to significant losses
Which of the following are examples of idiosyncratic risk?
Regulatory changes in tax rates Future rates of inflation
Which of the following are examples of systematic risk?
The actual return can be higher or lower than the expected return. The expected return can be calculated as the average of the returns in previous periods. The expected return reflects an estimate that can be based on sophisticated forecasts of future outcomes.
Which of the following statements are true about expected return?
how is common stock generally identified?
by its lack of special preference in receiving dividends and bankruptcy payouts
what can growth rate be interpreted as?
capital gains yield, or the rate at which the value of the investment grows
When a company declares a dividend, shareholders generally receive _____________.
cash
what is the impact of having multiple classes of stock?
classes are created with unequal voting rights
all else constant, the dividend yield will increase if the stock price does what?
decreases; as stock price increases, the ratio between dividend value and stock price decreases
how does depreciation affect OCF?
depreciation reduces taxable income and taxes and increases OCF
scenario analysis
determines the impact on NPV of a set of events relating to a specific scenario
company that grows quickly at first and then slows down in growth has what type of growth
differential
The constant-growth model assumes that ___________.
dividend change at a constant rate
The interest rate expressed as if it were compounded once per year is called the _______.
effective annual rate
how do most trades on the NYSE occur?
electronically without human intervention
The primary purpose of portfolio diversification is to:
eliminate asset-specific risk
avg excess return (risk premium) for stocks is called
equity risk premium
Suppose the real rate is 4% and the inflation rate is 5.6 percent. What rate would you expect to see on a treasury bill?
from fisher equation (1+R) = (1+r) * (1+h) R = (1+0.04) * (1+0.056) - 1 R = 1.098 - 1 R = 0.09824 R = 9.8%
2.value: 10.00 points A Japanese company has a bond outstanding that sells for 90 percent of its ¥100,000 par value. The bond has a coupon rate of 4.9 percent paid annually and matures in 20 years. What is the yield to maturity of this bond? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Yield to maturity %
fv=100,000 pv=100,000*.9=> -90,000 pmt=100,000*.049 = 4,900 n=20 cpt, *i=5.75%*
If the interest rate is greater than zero, the value of an annuity due is always ______ an ordinary annuity.
greater than
what factors are used in predicting stock values using the dividend discount model?
growth and the discount rate
what is the most important of the 3 factors influencing the PE ratio?
growth opportunities
the ___ can be interpreted as the capital gains yield
growth rate
in the dividend discount model, the expected return for investors comes from what two sources
growth rate and dividend yield
The value of a firm is derived using the firm's _______ rate and its ______ rate.
growth; discount
what is the purpose of having multiple classes of stock?
has to do with control of the firm; management can raise equity capital by issuing nonvoting/limited-voting stock while maintaining control
if investors have homogenous expectations, then they will
have similar estimates about the risk and return attributes of individual securities
how should a firm with growth opportunities sell compared to a firm without growth opportunities?
higher
when enterprise value is calculated, cash is subtracted from market value of debt and equity because
many firms hold more cash than necessary an EV ratio should reflect the ability of productive assets to create cash flow
why is cash subtracted when enterprise value is calculated?
many firms hold more cash than necessary, and an EV ratio should reflect the ability of PRODUCTIVE assets to create cash flow
the __ method is best suited for smaller projects
payback
6.value: 10.00 points Yan Yan Corp. has a $2,000 par value bond outstanding with a coupon rate of 4.4 percent paid semiannually and 18 years to maturity. The yield to maturity on this bond is 4.7 percent. What is the price of the bond? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Price $
n = 18*2 = 36 i = 4.7/2 = 2.35 pmt = 2,000*0.022 = 44 fv = 2,000 cpt, *pv = 1,927.66*
how are electronic trades made?
orders to buy and sell are submitted to the exchange; orders are compared by a computer and whenever there is a match the orders are executed with no human intervention
Estimates using the arithmetic average will probably tend to _____ values over the long-term while estimates using the geometric average will probably tend to _____ values over the short-term.
overestimate; underestimate
YTM< coupon rate
par value is greater than the bond price, selling at a premium
YTM> coupon rate
par value is less than the bond price, selling at a discount
When entering variables in an Excel 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?
payment future value present value
firms that pay zero growth dividends are considered what?
perpetuities
Based on the period of 1926 through 2011, _____ have tended to outperform other securities over the long-term.
small company stocks
Which of the following types of risk is not reduced by diversification? -unique risk -asset-specific risk -systematic risk -unsystematic risk
systematic risk
Using a benchmark PE ratio against current earnings yields a forecast price called a _____ price.
target
what is the underlying assumption of the dividend growth model?
that a stock is worth the present value of the future income provided by the stock
what does the gordon growth model assume?
that dividends grow at a constant rate of g% forever, meaning that price also grows at g% forever
when estimating g with the constant growth valuation model, what ratio is assumed to stay the same?
the retention ratio
variance measures
the squared deviations of actual returns from expected returns -measures the riskiness of security's returns -measures the spread of the sample of returns
what is cumulative voting?
the total number of votes that each shareholder may cast is determined by multiplying the number of shares owned by the number of directors to be elected; directors are all elected at once
what is a device by which mandatory cumulative voting can have a minimized impact?
to stagger the voting for the board of directors so that only a fraction of the directorships are up for election, meaning it takes a larger percentage to guarantee a seat
what happens in a hybrid market?
trading takes place both electronically and face-to face