FIN223 Midterm 2 (Chapters 6, 7, 8, 9, 10)
Kale Inc. forecasts the free cash flows (in millions) shown below. Assume the firm has zero non-operating assets. If the weighted average cost of capital is 11.0% and FCF is expected to grow at a rate of 5.0% after Year 2, then what is the firm's total corporate value (in millions)? Do not round intermediate calculations. Years: 1, 2 Free Cash Flow: -$50, $145
$2,132
A stock just paid a dividend of D 0 = $1.50. The required rate of return is r s = 9.0%, and the constant growth rate is g = 4.0%. What is the current stock price?
$31.20
A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is r s = 10.5%, and the expected constant growth rate is g = 8.6%. What is the stock's current price?
$39.47
Whited Inc.'s stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 3.50% per year. The required rate of return on the stock, r s, is 11.50%. What is the stock's expected price 5 years from now?
$41.87
You must estimate the intrinsic value of Noe Technologies' stock. The end-of-year free cash flow (FCF 1) is expected to be $23.50 million, and it is expected to grow at a constant rate of 7.0% a year thereafter. The company's WACC is 10.0%, it has $125.0 million of long-term debt plus preferred stock outstanding, and there are 15.0 million shares of common stock outstanding. Assume the firm has zero non-operating assets. What is the firm's estimated intrinsic value per share of common stock? Do not round intermediate calculations.
$43.89
The Francis Company is expected to pay a dividend of D 1 = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 0.85, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company's current stock price? Do not round intermediate calculations.
$46.73
Suppose Boyson Corporation's projected free cash flow for next year is FCF 1 = $250,000, and FCF is expected to grow at a constant rate of 6.5%. Assume the firm has zero non-operating assets. If the company's weighted average cost of capital is 11.5%, then what is the firm's total corporate value?
$5,000,000
Ryan Enterprises forecasts the free cash flows (in millions) shown below. Assume the firm has zero non-operating assets. The weighted average cost of capital is 13.0%, and the FCFs are expected to continue growing at a 5.0% rate after Year 3. What is the firm's total corporate value (in millions)? Do not round intermediate calculations. Years: 1, 2, 3 FCF: -$15, $10, $55
$532.97
Janice Cosmetics has a constant dividend growth rate of 5% and just paid a dividend of $5.00. If the required rate of return is 15%, what will the stock sell for one year from now?
$55.13
Molen Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of $4.00 per share. If the required return on this preferred stock is 6.5%, then at what price should the stock sell?
$61.54
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 7.7%, at what price should the bonds sell?
$825.63
A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $825. If the yield to maturity remains at its current rate, what will the price be 5 years from now?
$835.17
Morin Company's bonds mature in 8 years, have a par value of $1,000, and make an annual coupon interest payment of $65. The market requires an interest rate of 6.7% on these bonds. What is the bond's price?
$987.92
Crockett Corporation's 5-year bonds yield 6.35%, and 5-year T-bonds yield 4.45%. The real risk-free rate is r* = 3.80%, the default risk premium for Crockett's bonds is DRP = 1.00% versus zero for T-bonds, the liquidity premium on Crockett's bonds is LP = 0.90% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) 0.1%, where t = number of years to maturity. What inflation premium (IP) is built into 5-year bond yields?
0.25%
Roenfeld Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock? Do not round your intermediate calculations. State of the Economy Boom 0.14 25% Probability of State Occurring Normal 0.50 15% Stock's Expected Return Recession 0.36 5%
0.5250
Kelly Inc's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.70%. The real risk-free rate is r* = 2.5%, the default risk premium for Kelly's bonds is DRP = 0.40%, the liquidity premium on Kelly's bonds is LP = 2.4% versus zero on T-bonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium (MRP) on all 5-year bonds?
0.70%
Listed below are some provisions that are often contained in bond indentures. Which of these provisions, viewed alone, would tend to reduce the yield to maturity that investors would otherwise require on a newly issued bond?
1, 3, 4, 6
Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 5.80% per year. What is the real risk-free rate of return, r*? The cross-product term should be considered , i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places.)
1.13%
Suppose the rate of return on a 10-year T-bond is 4.05%, the expected average rate of inflation over the next 10 years is 2.0%, the MRP on a 10-year T-bond is 0.9%, no MRP is required on a TIPS, and no liquidity premium is required on any Treasury security. Given this information, what should the yield be on a 10-year TIPS? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
1.15%
Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 3.00%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
1.15%
Keys Corporation's 5-year bonds yield 6.10% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the liquidity premium for Keys' bonds is LP = 0.5% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Keys' bonds?
1.20%
Cheng Inc. is considering a capital budgeting project that has an expected return of 23% and a standard deviation of 30%. What is the project's coefficient of variation? Do not round your intermediate calculations. Round the final answer to 2 decimal places.
1.30
Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 7.10%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds?
1.55%
Kay Corporation's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay's bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Kay's bonds?
1.80%
Suppose a company has preferred 5%, $100 par value preferred stock that is currently selling for $50 a share. What rate of return do investors require?
10%
Suppose your company is financed 20% with debt and 80% with common stock. If the cost of new borrowing will be 5% and the cost of equity is 12%, what is the cost of capital to your company if the applicable tax rate is 30%?
10.3%
Stock A's stock has a beta of 1.30, and its required return is 15.25%. Stock B's beta is 0.80. If the risk-free rate is 2.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.) Do not round your intermediate calculations.
10.44%
Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 7.90%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.
10.88
Trahan Lumber Company hired you to help estimate its cost of capital. You obtained the following data: D 1 = $1.25; P 0 = $20.00; g = 5.00% (constant); and F = 6.00%. What is the cost of equity raised by selling new common stock?
11.65%
What is the effective annual rate of 12% compounded quarterly?
12.55%
O'Brien Inc. has the following data: r RF = 5.00%; RP M = 6.00%; and b = 1.50. What is the firm's cost of equity from retained earnings based on the CAPM?
14.00%
Company A has a beta of 0.70, while Company B's beta is 1.00. The required return on the stock market is 9.00%, and the risk-free rate is 2.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.) Do not round your intermediate calculations.
2.03%
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.)
2.62%
Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?
20-year, zero coupon bond.
Taggart Inc.'s stock has a 50% chance of producing a 46% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return? Do not round your intermediate calculations.
20.40%
5-year Treasury bonds yield 6.1%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year T-bonds is 0.4%. There is no liquidity premium on these bonds. What is the real risk-free rate, r*?
3.80%
Adams Enterprises' noncallable bonds currently sell for $1,480. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity?
4.14%
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?
4.20%
Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 4.40%. 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? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.
4.80
Gray Manufacturing is expected to pay a dividend of $1.25 per share at the end of the year (D 1 = $1.25). The stock sells for $22.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate?
4.94%
If a United States Savings bond can be purchased for $29.50 and has a maturity value of $100 at the end of 25 years, what is the annual rate of return on the bond?
5 percent
If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 11.9%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?
5.30%
Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 2.80%. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
5.30%
Cooley Company's stock has a beta of 0.60, the risk-free rate is 2.25%, and the market risk premium is 5.50%. What is the firm's required rate of return? Do not round your intermediate calculations.
5.55%
Janice Cosmetics has a constant dividend growth rate of 5% and just paid a dividend of $5.00. If the required rate of return is 15%, what will the stock sell for one year from now?
55.13
Keenan Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,085. What is the bond's nominal yield to call?
6.10%
Sadik Inc.'s bonds currently sell for $1,250 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)?
6.28%
Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.10%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond. What is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.
6.40
Malko Enterprises' bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $75, and a par value of $1,000. What is their current yield?
6.52%
Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D 1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $87.50 a share. The before-tax cost of debt is 7.50%, and the tax rate is 25%. The target capital structure consists of 45% debt and 55% common equity. What is the company's WACC if all the equity used is from retained earnings? Do not round your intermediate calculations.
7.13%
A company's perpetual preferred stock currently sells for $105.00 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?
8.02%
You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained earnings is 10.50%, and the tax rate is 25%. The firm will not be issuing any new stock. What is Quigley's WACC? Round final answer to two decimal places. Do not round your intermediate calculations.
8.08%
To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $875, and has a par value of $1,000. If the firm's tax rate is 25%, what is the component cost of debt for use in the WACC calculation? Do not round your intermediate calculations.
8.09%
Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.60%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
8.10%
Bosio Inc.'s perpetual preferred stock sells for $102.50 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC?
8.64%
You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 11.50%. The firm will not be issuing any new stock. What is its WACC?
8.70%
Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 4.20%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
8.80%
Porter Inc's stock has an expected return of 13.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 2.00%, what is the market risk premium? Do not round your intermediate calculations.
9.00%
The real risk-free rate is 3.05%, inflation is expected to be 5.95% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, i.e., if averaging is required, use the arithmetic average, what is the equilibrium rate of return on a 1-year Treasury bond?
9.00%
Daves Inc. recently hired you as a consultant to estimate the company's WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,000.00. (2) The company's tax rate is 25%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC? Do not round your intermediate calculations.
9.32%
Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 6.60%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
9.70%
Kollo Enterprises has a beta of 1.02, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return? Do not round your intermediate calculations.
9.79%
Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 6.60%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Include the cross-product term, i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places.)
9.90%
If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value?
A 10-year zero coupon bond.
Which of the following bonds has the greatest price risk?
A 10-year, $1,000 face value, zero coupon bond.
Duval Inc. uses only equity capital, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept?
A Division A project with an 11% return.
Which of the following factors would be most likely to lead to an increase in nominal interest rates?
A new technology like the Internet has just been introduced, and it increases investment opportunities.
Which of the following statements is CORRECT?
A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.
An annuity is defined as:
A set of level cash flows occuring each time period for a specific fixed length of time.
Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?
Adding a call provision.
Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?
Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.
Which of the following statements is CORRECT?
All else equal, bonds with larger coupons have less price risk than bonds with smaller coupons.
Which of the following statements is CORRECT?
All else equal, if a bond's yield to maturity increases, its price will fall.
You have the following data on three stocks: Stock: A, B, C Standard Deviation: 20%, 10%, 12% Beta: 0.59, 0.61, 1.29 If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.
B; A.
Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year.
Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, an 8% yield to maturity, and are noncallable. Which of the following statements is CORRECT?
Bond A's current yield is greater than that of Bond B.
A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?
Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.
You observe the following information regarding Companies X and Y: —Company X has a higher expected return than Company Y. —Company X has a lower standard deviation of returns than Company Y. —Company X has a higher beta than Company Y. Given this information, which of the following statements is CORRECT?
Company X has a lower coefficient of variation than Company Y.
Which of the following would be most likely to lead to a higher level of interest rates in the economy?
Corporations step up their expansion plans and thus increase their demand for capital.
Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by:
Default and liquidity risk differences.
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:
Default risk and liquidity differences.
The cost of external equity capital raised by issuing new common stock (r e) is defined as follows, in words: "The cost of external equity equals the cost of equity capital from retaining earnings (r s), divided by one minus the percentage flotation cost required to sell the new stock, (1 - F)."
False
Which of the following statements is CORRECT?
If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield is zero.
Which of the following statements is CORRECT?
If a coupon bond is selling at par, its current yield equals its yield to maturity.
Which of the following statements is CORRECT?
If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.
Which of the following statements is CORRECT?
If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.
A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?
If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.
Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or corvertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT?
If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have a lower yield than Long's bonds.
Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?
If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?
If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.
The required returns of Stocks X and Y are r X = 10% and r Y = 12%. Which of the following statements is CORRECT?
If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher expected growth rate.
Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)
If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?
If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
Which of the following statements is CORRECT?
If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.
A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?
If the yield to maturity remains at 8%, then the bond's price will decline over the next year.
A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?
If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.
A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity. Which of the following statements is CORRECT?
If the yield to maturity remains constant, the price of the bond will decline over time.
Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.
In equilibrium, the expected return on Stock A will be greater than that on B.
Which of the following statements is CORRECT?
Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds.
Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?
Increase the percentage of debt in the target capital structure.
If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?
Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
Which of the following events would make it more likely that a company would call its outstanding callable bonds?
Market interest rates decline sharply.
Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that
Maturity risk premiums could help to explain the yield curve's upward slope.
Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that
Maturity risk premiums could help to explain the yield curve's upward slope.
Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?
Portfolio P has a standard deviation that is less than 25%.
Suppose the U.S. Treasury issued $50 billion of short-term securities and sold them to the public. Other things held constant, what would be the most likely effect on short-term securities' prices and interest rates?
Prices would decline and interest rates would rise.
LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?
Project B, which is of below-average risk and has a return of 8.5%.
Which of the following statements is CORRECT?
Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued.
Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?
Some class or classes of common stock are entitled to more votes per share than other classes.
Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? Stock: A, B Price: $25, $25 Expected growth (constant): 10%, 5% Required return: 15%, 15%
Stock A's expected dividend at t = 1 is only half that of Stock B.
A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?
The bond's yield to maturity is greater than its coupon rate.
A stock is expected to pay a year-end dividend of $2.00, i.e., D 1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, then which of the following statements is CORRECT?
The company's expected stock price at the beginning of next year is $9.50.
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?
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%.
Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?
The interest rate today on a 3-year bond should be approximately 7%.
Which of the following statements is CORRECT?
The market price of a bond will always approach its par value as its maturity date approaches, provided the bond's required return remains constant.
Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?
The maturity risk premium is assumed to be zero.
If the pure expectations theory holds, which of the following statements is CORRECT?
The maturity risk premium would be zero.
Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT?
The portfolio's expected return is 15%.
Which of the following statements is CORRECT?
The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm's common stock.
You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?
The price of Bond A will decrease over time, but the price of Bond B will increase over time.
Which of the following statements is CORRECT?
The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.
Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return?
The required rate of return would increase because the bond would then be more risky to a bondholder.
Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?
The required return on a stock with a positive beta < 1.0 will decline.
During the coming year, the market risk premium (r M - r RF), is expected to fall, while the risk-free rate, r RF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?
The required return will fall for all stocks, but it will fall more for stocks with higher betas.
Which of the following statements is CORRECT?
The slope of the security market line is equal to the market risk premium.
Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:
The y-axis intercept would decline, and the slope would increase.
If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?
The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat.
Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?
The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities.
If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?
The yield on a 10-year bond would be less than that on a 1-year bill.
The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT?
The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?
This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.
If the expected dividend growth rate is zero, then the cost of external equity capital raised by issuing new common stock (r e) is equal to the cost of equity capital from retaining earnings (r s) divided by one minus the percentage flotation cost required to sell the new stock, (1 - F). If the expected growth rate is not zero, then the cost of external equity must be found using a different formula.
True
Which of the following statements is CORRECT?
Under Chapter 7 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the sale proceeds must be used to pay off claims against it according to the priority of the claims as spelled out in the Act.
Which of the following statements is CORRECT?
When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.
Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?
Your portfolio has a beta equal to 1.6, and its expected return is 15%.
Inflation, recession, and high interest rates are economic events that are best characterized as being
among the factors that are responsible for market risk.
You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B? Years: 1, 2, 3, 4, 5 Market: 0.03, -0.05, 0.01, -0.10, 0.06 Stock A: 0.16, 0.20, 0.18, 0.25, 0.14 Stock B: 0.05, 0.05, 0.05, 0.05, 0.05
bA < 0; bB = 0.
For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure.
re > rs > WACC > rd.
If a given investor believes that a stock's expected return exceeds its required return, then the investor most likely believes that
the stock is a good buy.
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 9.5% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
$1,000.00
Grossnickle Corporation issued 20-year, noncallable, 7.1% 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?
$1,185.72
Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going interest rate (r d) is 5.30%, based on semiannual compounding. What is the bond's price?
$1,200.05
