FIN406: from midterm to final

When valuing a stock, an overestimated terminal growth rate can not be noticed if the earnings ratio is also higher. a. True b. False

False

If a firm follows a low-investment-rate plan (applies a low plow back ratio), its dividends will be higher now and lower in the future than a firm that follows a high-reinvestment-rate plan. a. True b. False

True

If the currency of your country is appreciating, the result should be to decrease in exports and to increase in imports. a. True b. False

True

If the interest rate on debt is lower than ROA, then a firm will increase the ROE by increasing the use of debt in the capital structure.

True

In a multi-stage growth model, the majority of the value can be found in the terminal growth rate. a. True b. False

True

In periods of inflation, accounting depreciation is understated relative to replacement cost, and real economic income is overstated.

True

According to Peter Lynch, a rough rule of thumb for security analysis is that the growth rate should be equal to the P/E ratio. a. True b. False

True

Arbitrage and low-risk economic profit can occur if the law of one price is violated. True False

True

Common size financial statements make it easier to compare firms of different sizes.

True

Food producers, pharmaceutical firms, and public utilities are examples of defensive industries. a. True b. False

True

Forward rates differ from future short rates because they are imperfect forecasts. True False

True

Increases in the money supply will cause demand for investment and consumption goods to increase in the short run and cause prices to increase in the long run. a. True b. False

True

Inflation is the rate at which the general level of prices is increasing, and rates are high when the economy is considered to be "overheated." a. True b. False

True

Other things being equal, a low dividend-payout ratio would be most consistent with a relatively high growth rate of firm earnings. a. True b. False

True

The dividend discount model includes capital gains implicitly. a. True b. False

True

The expectations theory of the term structure of interest rates states that forward rates are determined by investors' expectations of future interest rates. True False

True

The firm has a substantial amount of old plant and equipment best explains a ratio of sales/average net fixed assets that exceeds the industry average.

True

The income statement is a summary of the profitability of the firm over a period of time, such as a year.

True

The intrinsic value is defined as the present value of all cash proceeds to the investor in the stock. a. True b. False

True

To create a common size balance sheet, multiply all items on the balance sheet by total assets.

False

Treasury STRIPS are extremely risky securities. True False

False

Siri had a FCFE of $1.5M last year and has 3.0M shares outstanding. Siri's required return on equity is 12%, and WACC is 9.8%. If FCFE is expected to grow at 8% forever, the intrinsic value of Siri's shares is

$13.50 FCFE/share (D0)= amount $ in shares / number of shares $1.5/3.0 = $0.50 / share Stock price = (D0 * (1 + growth rate)) / (ROE - growth rate) = (0.5 * 1.08) / (0.12 - 0.08) = $13.5000

SI International had a FCFE of $122.1M last year and has 12.43M shares outstanding. SI's required return on equity is 11.3%, and WACC is 9.8%. If FCFE is expected to grow at 7.0% forever, the intrinsic value of SI's shares is

$244.4328 FCFE/share = 122.1 mil / 12.43 mil = 9.8230/share Stock price = (D0 * (1 + growth rate)) / (ROE - growth rate) = (9.8230*1.07) / (0.113-0.07) = 244.4328

See Candy had an FCFE of $7.2M last year and has 3.2M shares outstanding. See's required return on equity is 10.6%, and WACC is 9.3%. If FCFE is expected to grow at 6.5% forever, the intrinsic value of See's shares is

$58.4463 FCFE/share (D0)= amount $ in shares / number of shares 7.2/3.2 = 2.2500 Stock price = (D0 * (1 + growth rate)) / (ROE - growth rate) = (2.25 * 1.065) / (0.106 - 0.065) = 2.3963 / 0.0410 = 58.4463

Gray Matter has a balance sheet that lists $85 million in assets, $45 million in liabilities, and $40 million in common shareholders' equity. It has 1,600,000 common shares outstanding. The replacement cost of the assets is $115 million. Shares currently trading for $90 in the stock market. What is Gray Matter's market value per share?

$90 per share We do not set the market value, the buying and selling on the market determines it.

Bluelight Music Studio, Inc. is expected to have an EBIT of $1.2M this year. Stingy Corporation is in the 21% tax bracket, will report $133,000 in depreciation, will make $76,000 in capital expenditures, and will have a $24,000 increase in net working capital this year. Calculate Bluelight Music Studio, Inc.'s FCFF.

$981,000 EBIT = 1.2 million minus: Tax @ 21% = 0.21*1,200,000= 252,000 1,200,000-252,000= 948,000 add: depreciation = 133,000 minus: capital exp. = 76,000 minus: increase in working cap. = 24,000 948,000 + 133,000 - 76,000 - 24,000 = FCFF = 981,000

A coupon bond that pays interest semi-annually has a par value of $1,000, matures in five years, and has a yield to maturity of 10%. The intrinsic value of the bond today will be ________ if the coupon rate is 13%.

-1,115.826 N = 5*2 = 10 i/y = 0.10/2 = 0.05 or 5% pv = ? pmt = 1000*0.13 = 130/2 = 65 fv = 1000

Using semi-annual compounding, a 15-year 3% coupon bond that has a par value of $1,000 and a required return of 8% would be priced at approximately

-567.6992 N = 15*2 = 30 I/Y = 8%/2 = 4 PV = ? PMT = 1000*0.03 = 30/2 = 15 FV = 1000 *compute in calculator)

A coupon bond that pays interest annually has a par value of $1,000, matures in five years, and has a yield to maturity of 10%. The intrinsic value of the bond today will be ______ if the coupon rate is 6%.

-848.3685 n = 5 i/y = 10 pv = ? pmt = 1000*6% = 60 fv = 1000

A coupon bond that pays interest semi-annually is selling at a par value of $1,000, matures in seven years, and has a coupon rate of 5.6%. The yield to maturity on this bond is __________.

0.056 N = 7*2 = 14 I/Y = ? PV = -1000 PMT = 1000 *0.056 = 56/2 = 28 FV = 1000 i/y = 2.8%*2 = 0.056 or 5.6%

Blue Sky Airlines has an expected ROE of 12%. Determine the dividend growth rate if the company elects to pay 40% of its earnings in the form of dividends. (Enter as a decimal).

0.072 Growth = (ROE) * (1 - payout ratio) = (0.12)*(1-0.4) = 0.072

A firm has a (net profit/pretax profit) ratio of 0.6, a leverage ratio of 2, a (pretax profit/EBIT) of 0.6, an asset turnover ratio of 2.5, a current ratio of 1.5, and a return on sales ratio of 4%. The firm's ROE is

0.072 Return on Equity = (net profit/pretax profit)* (pretax profit ratio/EBIT)* (return on sale ratio)*asset turnover ratio*leverage ratio = 0.6*0.6*0.04*2.5*2 = 0.072

A coupon bond pays annual interest, has a par value of $1,000, matures in four years, has a coupon rate of 8.5%, and has a yield to maturity of 8.65%. The current yield on this bond is ________

0.085 current yield = PMT/FV PMT = 1000*0.085 = 85 =85/1000 = 0.085

A firm has an ROA of 14%, a debt/equity ratio of 0.8, a tax rate of 35%, and the interest rate on the debt is 10%. The firm's ROE is

0.1118 ROA = 14% Cost of debt aka the interest rate on debt (k) = 10% Debt/Equity ratio = 0.8 Tax rate = 35% ROE = [ROA + (ROA - k)*DE] * (1 - tax rate) = [0.14 + (0.14-0.1)*0.8] * (1 - 0.35) = 0.1118

A coupon bond that pays interest of $100 annually has a par value of $1,000, matures in five years, and is selling today at a $75 discount from par value. The yield to maturity on this bond is___________.

0.1208 or 12.08% *yield to maturity is solving for I/Y* N = 5 I/Y = ? PV = -1000 - 75 = -925 PMT = 100 FV = 100 *solve in calc.*

The financial statements of Barnes Tool and Equipment, LLC are given below. Barnes Tool and Equipment, LLC Income Statement (2021) Sales/8,000,000 Cost of goods sold/5,260,000 Gross profit/2,740,000 Selling & administrative expenses/1,500,000 Operating profit/1,240,000 Interest expense/140,000 Income before tax/1,100,000 Tax expense/440,000 Net income/660,000 Balance Sheet/2021/2020 Cash/200,000/50,000 Accounts receivable/1,200,000/950,000 Inventory/1,840,000/1,500,000 Total current assets/3,240,000/2,500,000 Fixed assets/3,200,000/3,000,000 Total assets/6,440,000/5,500,000 Accounts Payable/800,000/720,000 Bank loan/600,000/100,000 Total current liabilities/1,400,000/820,000 Bond payable/900,000/1,000,000 Total liabilities/2,300,000/1,820,000 Common stock (130,000 shares)/300,000/300,000 Retained earnings/3,840,000/3,380,000 Total liabilities & equity/6,440,000/5,500,000 Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Barnes Tool and Equipment, LLC. The firm's return on sales ratio for 2021 is _____.

0.155 return on sales or profit margin = EBIT/sales EBIT = income before taxes + interest expense EBIT = 1,100,000 + 140,000 = 1,240,000/8,000,000 return on sales = 0.155

No Limit Rockets, LLC is expected to pay a dividend of $3.50 in the coming year. Dividends are expected to grow at a rate of 12% per year. The risk-free rate of return is 3%, and the expected return on the market portfolio is 13%. The stock is trading in the market today at a price of $75.00. What is the market-capitalization rate for No Limit Rockets, LLC? (Enter as a decimal)

0.1667 market capitalization rate = (dividend in year 1/stock price) + growth rate = (3.50/75.00) + 0.12 = 0.1667 *if another question asks "What is the approximate beta of Risk Metrics's stock?" then Required return = Risk free rate + Beta * (Expected return of market portfolio - Risk free rate)

The financial statements of Barnes Tool and Equipment, LLC are given below. Barnes Tool and Equipment, LLC Income Statement (2021) Sales/8,000,000 Cost of goods sold/5,260,000 Gross profit/2,740,000 Selling & administrative expenses/1,500,000 Operating profit/1,240,000 Interest expense/140,000 Income before tax/1,100,000 Tax expense/440,000 Net income/660,000 Balance Sheet/2021/2020 Cash/200,000/50,000 Accounts receivable/1,200,000/950,000 Inventory/1,840,000/1,500,000 Total current assets/3,240,000/2,500,000 Fixed assets/3,200,000/3,000,000 Total assets/6,440,000/5,500,000 Accounts Payable/800,000/720,000 Bank loan/600,000/100,000 Total current liabilities/1,400,000/820,000 Bond payable/900,000/1,000,000 Total liabilities/2,300,000/1,820,000 Common stock (130,000 shares)/300,000/300,000 Retained earnings/3,840,000/3,380,000 Total liabilities & equity/6,440,000/5,500,000 Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Barnes Tool and Equipment, LLC. The firm's quick ratio for 2021 is

1 quick ratio = (cash + marketable securities + receivables)/current liabilities stuff in parenthesis is = current assets - inventory = 3,240,000 - 1,840,000 = 1,400,000/1,400,000 = 1

Two firms, Kappa and Delta, both produce coat hangers. The price of the coat hangers is $1.50 each. Firm Kappa has total fixed costs of $750,000 and variable costs of 50¢ per coat hanger. Firm Delta has total fixed costs of $400,000 and variable costs of 30¢ per coat hanger. The corporate tax rate is 21%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the before-tax profit of firm Kappa will be

1,250,000 Total revenue = # of unites * selling price Total cost = fixed cost + (variable cost per unit * # of units) Before tax profit = TR - TC TR = 2,000,000*1.5 = 3,000,000 TC = 750,000 + (0.5 * 2,000,000) = 1,750,000 BTP = 3,000,000 - 1,750,000 = 1,250,000

Two firms, Kappa and Delta, both produce coat hangers. The price of the coat hangers is $1.50 each. Firm Kappa has total fixed costs of $750,000 and variable costs of 50¢ per coat hanger. Firm Delta has total fixed costs of $400,000 and variable costs of 50¢ per coat hanger. The corporate tax rate is 21%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy enters a recession, the total cost of firm Kappa will be $_________.

1,450,000 Total cost = fixed cost + (variable cost per unit * # of units) TC = 750,000 + (.50 * 1,400,000) = 1,450,000

Two firms, Kappa and Delta, both produce coat hangers. The price of the coat hangers is $1.50 each. Firm Kappa has total fixed costs of $750,000 and variable costs of 50¢ per coat hanger. Firm Delta has total fixed costs of $400,000 and variable costs of 30¢ per coat hanger. The corporate tax rate is 21%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the total cost of firm Kappa will be $________.

1,750,000 Total cost = fixed cost + (variable cost per unit * # of units) TC = 750,000 + (0.50 * 2,000,000) = 1,750,000

The financial statements of Barnes Tool and Equipment, LLC are given below. Barnes Tool and Equipment, LLC Income Statement (2021) Sales/8,000,000 Cost of goods sold/5,260,000 Gross profit/2,740,000 Selling & administrative expenses/1,500,000 Operating profit/1,240,000 Interest expense/140,000 Income before tax/1,100,000 Tax expense/440,000 Net income/660,000 Balance Sheet/2021/2020 Cash/200,000/50,000 Accounts receivable/1,200,000/950,000 Inventory/1,840,000/1,500,000 Total current assets/3,240,000/2,500,000 Fixed assets/3,200,000/3,000,000 Total assets/6,440,000/5,500,000 Accounts Payable/800,000/720,000 Bank loan/600,000/100,000 Total current liabilities/1,400,000/820,000 Bond payable/900,000/1,000,000 Total liabilities/2,300,000/1,820,000 Common stock (130,000 shares)/300,000/300,000 Retained earnings/3,840,000/3,380,000 Total liabilities & equity/6,440,000/5,500,000 Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Barnes Tool and Equipment, LLC. The firm's market-to-book value for 2021 is ___________.

1.3299 Market to book value ratio: *book value is the share holder equity per year* *the book value per share is the avg. in this case* Book value per share = (common stock + retained earnings)/# of shares = price per share/ book value per share Common stock + retained earnings (of 2021 and 2020)/ 2 = 300,000+300,000+3,840,000+3,380,000 = 7,820,000/2 average = 3,910,000 3,910,000/130,000 shares = 30.0769 M-to-BV = 40/30.0769 = 1.3299

A firm has a P/E ratio of 12, an ROE of 13%, and a market-to-book value of

1.56 ROE = 13% P/E ratio = 12 ROE = Net income / Book value of shareholders equity P/E = (price per share)/(EPS per share) or = market capitalization/net income 12 = Price/Net Income Price = 12*Net Income (equation 1) 0.13 = Net Income/Book Value of shareholders equity Book Value = Net Income/0.13 (equation 2) Now Market/Book Value = 12 Net Income/Net Income/0.13 Market/ Book Value = 12 * 0.13 Market/ Book Value = 1.56 Hence market to book value is 1.56

A convertible bond has a par value of $1,000 and a current market value of $950. The current price of the issuing firm's stock is $20, and the conversion ratio is 40 shares. The bond's conversion premium is ___________.

150 Bond conversion premium = current price of bond - current price of stock * conversion ratio = 950 - 20 * 40 = 950 - 800 = 150

The financial statements of Barnes Tool and Equipment, LLC are given below. Barnes Tool and Equipment, LLC Income Statement (2021) Sales/8,000,000 Cost of goods sold/5,260,000 Gross profit/2,740,000 Selling & administrative expenses/1,500,000 Operating profit/1,240,000 Interest expense/140,000 Income before tax/1,100,000 Tax expense/440,000 Net income/660,000 Balance Sheet/2021/2020 Cash/200,000/50,000 Accounts receivable/1,200,000/950,000 Inventory/1,840,000/1,500,000 Total current assets/3,240,000/2,500,000 Fixed assets/3,200,000/3,000,000 Total assets/6,440,000/5,500,000 Accounts Payable/800,000/720,000 Bank loan/600,000/100,000 Total current liabilities/1,400,000/820,000 Bond payable/900,000/1,000,000 Total liabilities/2,300,000/1,820,000 Common stock (130,000 shares)/300,000/300,000 Retained earnings/3,840,000/3,380,000 Total liabilities & equity/6,440,000/5,500,000 Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Barnes Tool and Equipment, LLC. The firm's current ratio for 2021 is

2.3143 current ratio = current assets / current liabilities = 3,240,000/1,400,000 = 2.3143

Two firms, Kappa and Delta, both produce coat hangers. The price of the coat hangers is $1.50 each. Firm Kappa has total fixed costs of $750,000 and variable costs of 50¢ per coat hanger. Firm Delta has total fixed costs of $400,000 and variable costs of 30¢ per coat hanger. The corporate tax rate is 21%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the tax of firm Kappa will be

262,500 Total revenue = # of unites * selling price Total cost = fixed cost + (variable cost per unit * # of units) Before tax profit = TR - TC Tax of firm = BTP * corp. tax rate TR = 2,000,000*1.5 = 3,000,000 TC = 750,000 + (0.5 * 2,000,000) = 1,750,000 BTP = 3,000,000 - 1,750,000 = 1,250,000 Tax = 1,250,000 * 0.21 = 262,500

Two firms, Kappa and Delta, both produce coat hangers. The price of the coat hangers is $1.50 each. Firm Kappa has total fixed costs of $750,000 and variable costs of 50¢ per coat hanger. Firm D has total fixed costs of $400,000 and variable costs of 30¢ per coat hanger. The corporate tax rate is 21%. If the economy is strong, each firm will sell 2,000,000 coat hangers. If the economy enters a recession, each firm will sell 1,400,000 coat hangers. If the economy is strong, the total revenue of firm Kappa will be

3,000,000 Total revenue = # of unites * selling price TR = 2,000,000 * 1.50 = 3,000,000

Two firms, Alpha and Beta, both produce widgets. The price of the widgets is $1 each. Firm A has total fixed costs of $500,000 and variable costs of 50¢ per widget. Firm Beta has total fixed costs of $240,000 and variable costs of 75¢ per widget. The corporate tax rate is 21%. If the economy is strong, each firm will sell 1,200,000 widgets. If the economy enters a recession, each firm will sell 1,100,000 widgets. If the economy enters a recession, the after-tax profit of Firm Alpha will be

39,500 Total revenue = # of unites * selling price Total cost = fixed cost + (variable cost per unit * # of units) Before tax profit = TR - TC Tax of firm = BTP * corp. tax rate After tax profit = BTP - tax on firm TR = 1,100,000 * 1 = 1,100,000 TC = 500,000 + (0.5 * 1,100,000) = 1,050,000 BTP = 1,100,000 - 1,050,000 = 50,000 Tax = 50,000 * 0.21 = 10,500 ATP = 50,000 - 10,500 = 39,500

The financial statements of Barnes Tool and Equipment, LLC are given below. Barnes Tool and Equipment, LLC Income Statement (2021) Sales/8,000,000 Cost of goods sold/5,260,000 Gross profit/2,740,000 Selling & administrative expenses/1,500,000 Operating profit/1,240,000 Interest expense/140,000 Income before tax/1,100,000 Tax expense/440,000 Net income/660,000 Balance Sheet/2021/2020 Cash/200,000/50,000 Accounts receivable/1,200,000/950,000 Inventory/1,840,000/1,500,000 Total current assets/3,240,000/2,500,000 Fixed assets/3,200,000/3,000,000 Total assets/6,440,000/5,500,000 Accounts Payable/800,000/720,000 Bank loan/600,000/100,000 Total current liabilities/1,400,000/820,000 Bond payable/900,000/1,000,000 Total liabilities/2,300,000/1,820,000 Common stock (130,000 shares)/300,000/300,000 Retained earnings/3,840,000/3,380,000 Total liabilities & equity/6,440,000/5,500,000 Note: The common shares are trading in the stock market for $40 each. Refer to the financial statements of Barnes Tool and Equipment, LLC. The firm's average collection period for 2021 is

49.0469 average collection period: *meaning it takes the company ___ days to collect from the debt outstanding* Days sales in receivables = (avg. accounts receivables/annual sales)*365 (1,200,000+950,000)/2 = 1,075,000 1,075,000/8,000,000 = 0.1344 * 365 = 49.0469

Suppose that all investors expect that interest rates for the 4 years will be as follows: Year Forward Interest Rate 0. 3% (today) 1. 4% 2. 5% 3. 6% What is the price of a 3-year zero-coupon bond with a par value of $1,000?

889.0785 Price of 3-Year Zero Coupon Bond = Par Value/[(1+ Year 0 Forward Interest Rate)*(1+Year 1 Forward Interest Rate)*(1+Year 2 Forward Interest Rate)] = 1000/[(1+0.03)*(1+0.04)*(1+0.05)] = 889.0785

According to the expectations theory, what is the expected forward rate in the third year? A) 9.00% B) 11.19% C) 7.00% D) 7.33% E) None of the options are correct.

9.00% Logic: 881.68/808.88-1 = 9% Elaboration: Forward rate in Year 1: 1000 / 943.40 - 1 = 6% Year 2: 943.40 / 881.68 - 1 = 7% Year 3: 881.68 / 808.88 - 1 = 9% Year 4: 808.88 / 742.09 - 1 = 9%

The statement of cash flows provides a snapshot of the financial condition of the firm at a particular time.

False

A firm has a market-to-book value ratio that is equivalent to the industry average and an ROE that is less than the industry average, which implies the firm is more likely to avoid insolvency in the short run than other firms in the industry.

False

A peak is only a feature of geography and not an investment term. a. True b. False

False

An example of a highly cyclical industry is the tobacco industry. a. True b. False

False

An inverted yield curve implies that long-term interest rates are higher than short-term interest rates. True False

False

An upward-sloping yield curve is a flat yield curve. True False

False

Assume the U.S. government was to decide to increase the budget deficit. Holding all else constant, will cause interest rates and government borrowing to decrease. a. True b. False

False

Bond stripping and bond reconstitution offer opportunities for huge losses; which can occur if the law of one price is violated. True False

False

Book value per share is the amount of money per common share that could be realized by breaking up the firm, selling the assets, repaying the debt, and distributing the remainder to shareholders. a. True b. False

False

Classifying firms into groups, such as countercyclical, provides an alternative to the industry life cycle. a. True b. False

False

Dividend discount models and P/E ratios are used by statistical analysts to try to find mispriced securities. a. True b. False

False

GDP refers to the difference between government spending and government revenues. a. True b. False

False

High P/E ratios tend to indicate that a company will grow slowly , ceteris paribus. a. True b. False

False

High present value of growth opportunities most likely will correspond with high asset turnover.

False

If the interest rate on debt is higher than ROA, a firm will increase the ROE by increasing the use of debt in the capital structure.

False

Investors want high plowback ratios whenever k > ROE. a. True b. False

False

Market value per share is equal to common shareholders' equity divided by common shares outstanding. a. True b. False

False

Supply-side economics is concerned with government spending and, tax levels, monetary policy. and fiscal policy. a. True b. False

False

Technical analysts are analysts who use information concerning the current and prospective profitability of a firm to assess the firm's fair market value. a. True b. False

False

The forward yield curve is created from stripped treasuries. True False

False

The goal of fundamental analysts is to find securities with high market capitalization rates. a. True b. False

False

The growth in per-share FCFE of Ewing Oil, LLC. is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years. After this five-year period, the growth in per share FCFE is expected to be 3% per year, indefinitely. The required rate of return on Ewing Oil, LLC. is 11%. Ewing Oil just paid a per-share FCFE of $2.50. Determine how much the stock should be worth today.

NPV = 36.1029 (incorrect) *REFER TO FIN406 WEEK 2 Uneven cash flows pt. 2 video*

An upward-sloping yield curve a. may be an indication that interest rates are expected to increase. b. may incorporate a liquidity premium. c. may reflect the confounding of the liquidity premium with interest rate expectations. d. All of the options are correct. e. None of the options are correct.

One of the problems of the most commonly used explanation of term structure, the expectations hypothesis, is that it is difficult to separate out the liquidity premium from interest rate expectations. maybe: b. may incorporate a liquidity premium. but not A or C

A trough is a transition from a contraction in the business cycle to the start of an expansion. a. True b. False

True

A top-down analysis of a firm starts with the global economy. a. True b. False

True

The level of real income of a firm can be distorted by the reporting of depreciation and interest expense. During periods of high inflation, the level of reported depreciation tends to overstate income, and the level of interest expense reported tends to understate income.

True

The structure of interest rates is the relationship between the interest rate on a security and its time to maturity. True False

True

The yield curve shows at any point in time the relationship between the yield on a bond and the time to maturity on the bond. True False

True

To create a common-size income statement, divide all items on the income statement by total revenue.

True

Over a period of 30 years or so, in managing investment funds, Benjamin Graham used the approach of investing in the stocks of companies where the stocks were trading at less than their working capital value. The average return from using this strategy was approximately a. 20%. b. 5%. c. 10%. d. 15%. e. None of the options are correct.

a. 20%. Although Graham said in 1976 that markets were so efficient that one could not expect to identify undervalued securities consistently, as he had done throughout his career, he continued to find this one variable useful.

The required rate of return on equity is the most appropriate discount rate to use when applying a ______ valuation model. a. FCFE b. DDM c. P/E d. FCEF or DDM e. FCEF

a. FCFE The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity.

Which of the following combinations will result in a sharply-increasing yield curve? a. Increasing future expected short rates and increasing liquidity premiums b. Decreasing future expected short rates and increasing liquidity premiums c. Increasing future expected short rates and decreasing liquidity premiums d. Increasing future expected short rates and constant liquidity premiums e. Constant future expected short rates and increasing liquidity premiums

a. Increasing future expected short rates and increasing liquidity premiums Both of the forces will act to increase the slope of the yield curve.

If you wish to compute economic earnings and are trying to decide how to account for inventory, a. LIFO is better than FIFO. b. FIFO and LIFO are equally good. c. FIFO is better than LIFO. d. FIFO and LIFO are equally bad. e. None of the options are correct.

a. LIFO is better than FIFO. LIFO reflects the current cost of goods sold and thus is a better determinant of economic earnings.

In the dividend discount model, which of the following are not incorporated into the discount rate? a. Return on assets b. Expected inflation rate c. Risk premium for stocks d. Real risk-free rate

a. Return on assets The real risk-free rate, risk premium for stocks, and expected inflation rate are incorporated into the discount rate used in the dividend discount model.

________ is equal to the total market value of the firm's common stock divided by (the replacement cost of the firm's assets less liabilities). a. Tobin's Q b. Liquidation value per share c. Market value per share d. Book value per share e. None of the options are correct.

a. Tobin's Q Reason: Book value per share is assets minus liabilities divided by number of shares. Liquidation value per share is the amount a shareholder would receive in the event of bankruptcy. Market value per share is the market price of the stock.

A CDS is an acronym for a credit default swap. a. True b. False

a. True

A credit default swap is an insurance policy on the default risk of federal government and corporate bonds and loans. a. True b. False

a. True

Accrued interest must be paid by the buyer of the bond and remitted to the seller of the bond. a. True b. False

a. True

The current yield on a bond is equal to annual interest payment divided by the current market price. a. True b. False

a. True

If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows), a. arbitrage would probably occur. b. arbitrage would probably not occur. c. the FED would adjust interest rates. d. None of the options are correct.

a. arbitrage would probably occur. If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows) arbitrage would probably occur.

The value of a Treasury bond should a. be equal to the sum of the value of STRIPS created from it. b. be less than the sum of the value of STRIPS created from it. c. be greater than the sum of the value of STRIPS created from it. d. All of the options are correct.

a. be equal to the sum of the value of STRIPS created from it. The value of a Treasury bond should be equal to the sum of the value of STRIPS created from it.

When a bond indenture includes a sinking fund provision, a. bondholders may lose because their bonds can be repurchased by the corporation at below-market prices. b. firms must establish a cash fund for future bond redemption. c. firms must establish a cash fund for future bond redemption, and bondholders always benefit because principal repayment on the scheduled maturity date is guaranteed. d. bondholders always benefit because principal repayment on the scheduled maturity date is guaranteed.

a. bondholders may lose because their bonds can be repurchased by the corporation at below-market prices. A sinking fund provisions requires the firm to redeem bonds over several years, either by open market purchase or at a special call price from bondholders. This can result in repurchase in advance of scheduled maturity at below-market prices.

Fundamental analysis uses a. earnings and dividends prospects. b. earnings, dividend prospects, and price momentum. c. price momentum. d. earnings, dividend prospects, and relative strength. e. relative strength.

a. earnings and dividends prospects. Reason: Relative strength and price momentum are technical, not fundamental, tools.

TIPs are a. government bonds with par value linked to the general level of prices. b. government bonds with coupon rates linked to the general level of prices. c. securities formed from the principal payments only of government bonds. d. securities formed from the coupon payments only of government bonds. e. zero-coupon government bonds.

a. government bonds with par value linked to the general level of prices. Treasury Inflation Protected Securities (TIPS) are bonds whose par value adjusts according to the general level of prices. This changes coupon payments, but not the stated coupon rate.

Bond analysts might be more interested in a bond's yield to call if a. interest rates are expected to fall. b. the bond's yield to maturity is insufficient. c. the firm has called some of its bonds in the past. d. interest rates are expected to rise. e. the investor only plans to hold the bond until its first call date.

a. interest rates are expected to fall. If interest rates fall the firm is more likely to call the issue and refinance at lower rates. This is similar to an individual refinancing a home. The student has to think through each of the reasons given and make the connection between falling rates and the motivation to refinance.

If the economy were going into a recession, an attractive industry to invest in would be the a. medical services and construction industries. b. construction industry. c. automobile and construction industries. d. automobile industry. e. medical services industry.

a. medical services and construction industries Reason: Medical services are necessities and thus perform about the same regardless of the business cycle. Automobile and construction industries are cyclical and perform poorly during recessions.

Ceteris paribus, the price and yield on a bond are a. negatively related b. not related c. sometimes positively and sometimes negatively related d. positively related e. indefinitely related

a. negatively related Bond prices and yields are inversely related.

The most recently issued Treasury securities are called a. on the run. b. off the run. c. on the market. d. off the market. e. None of the options are correct.

a. on the run The most recently issued Treasury securities are called on the run.

The most appropriate discount rate to use when applying a FCFE valuation model is the a. required rate of return on equity. b. risk-free rate. c. WACC d. None of the options are correct

a. required rate of return on equity. The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity.

If the economy is shrinking, firms with low operating leverage will experience a. smaller decreases in profits than firms with high operating leverage. b. similar decreases in profits as firms with high operating leverage. c. larger decreases in profits than firms with high operating leverage. d. no change in profits.

a. smaller decreases in profits than firms with high operating leverage. Reason: As sales decrease, firms with high operating leverage spread these fixed costs over fewer units and thus decrease profits.

If the economy is growing, firms with low operating leverage will experience a. smaller increases in profits than firms with high operating leverage. b. similar increases in profits as firms with high operating leverage. c. higher increases in profits than firms with high operating leverage. d. no change in profits.

a. smaller increases in profits than firms with high operating leverage. Reason: As sales increase, firms with high operating leverage spread these fixed costs over more units and thus increase profits.

A preferred stock will pay a dividend of $7.50 in the upcoming year and every year thereafter; i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth DDM to calculate the intrinsic value of this preferred stock. a. $56.25 b. $7.50 c. $64.12 d. $0.75 e. None of the options are correct.

b. $7.50 7.50/.10 = 75.00.

A CDO is an acronym for collateralized debenture originator. a. True b. False

b. False

Mortgage-backed CDOs were a disaster in 2007 because super-prime they were formed by pooling super-prime mortgages, home prices declined, the mortgages were variable rate loans, and interest rates decreased. a. True b. False

b. False

The asset behind a Mortgage-backed CDOs is the individual's personal income. a. True b. False

b. False

The bond market consists of many investors on any given day. a. True b. False

b. False

The current yield on a bond is equal to the internal rate of return. a. True b. False

b. False

Who popularized the dividend discount model, which is sometimes referred to by his name? a. Frederick Macaulay b. Myron Gordon c. Harry Markowitz d. Burton Malkiel e. Marshall Blume

b. Myron Gordon The dividend discount model is also called the Gordon model.

Of the following five investments, ________ is (are) considered the safest. a. U.S. agency issues b. Treasury bills c. corporate bonds d. Treasury bonds e. commercial paper

b. Treasury bills Only Treasury issues are insured by the U.S. government; the shorter-term the instrument, the safer the instrument.

The most appropriate discount rate to use when applying a FCFF valuation model is the a. risk-free rate. b. WACC. c. required rate of return on equity or risk-free rate, depending on the debt level of the firm. d. required rate of return on equity. e. None are correct

b. WACC reason: The most appropriate discount rate to use when applying a FCFF valuation model is the WACC.

The on the run yield curve is a. a plot of yield as a function of maturity for zero-coupon bonds. b. a plot of yield as a function of maturity for recently-issued coupon bonds trading at or near par. c. a plot of yield as a function of maturity for corporate bonds with different risk ratings. d. a plot of liquidity premiums for different maturities.

b. a plot of yield as a function of maturity for recently-issued coupon bonds trading at or near par. The on the run yield curve is a plot of yield as a function of maturity for recently issued coupon bonds trading at or near par.

A zero-coupon bond is one that a. pays interest to the investor based on the general level of interest rates rather than at a specified coupon rate. b. effectively has a zero-percent coupon rate. c. is analyzed primarily by focusing ("zeroing in") on the coupon rate. d. is issued by state governments because they don't have to pay interest. e. pays interest to the investor without requiring the actual coupon to be mailed to the corporation.

b. effectively has a zero-percent coupon rate. Zero-coupon bonds pay no interest. Investors receive the face value at maturity.

Comparability problems arise because a. inflation may affect firms differently due to accounting conventions used. b. firms may use different generally accepted accounting principles, and inflation may affect firms differently due to accounting conventions used. c. financial analysts do not know how to compare financial statements. d. firms may use different generally accepted accounting principles, and financial analysts do not know how to compare financial statements. e. firms may use different generally accepted accounting principles.

b. firms may use different generally accepted accounting principles, and inflation may affect firms differently due to accounting conventions used. Firms often select specific generally accepted accounting principles for the desired effect on the financial statements. The analyst must make adjustments in order to compare firms using different account techniques. Often firms adopt specific techniques to offset the negative effects of inflation on the firm.

If the economy is growing, firms with high operating leverage will experience a. similar increases in profits as firms with low operating leverage. b. higher increases in profits than firms with low operating leverage. c. smaller increases in profits than firms with low operating leverage. d. no change in profits. e. none of the options are correct.

b. higher increases in profits than firms with low operating leverage. Reason: As sales increase, firms with high operating leverage spread these fixed costs over more units and thus increase profits.

The yield to maturity on a bond is a. based on the assumption that any payments received are reinvested at the coupon rate. b. the discount rate that will set the present value of the payments equal to the bond price. c. below the coupon rate when the bond sells at a discount and equal to the coupon rate when the bond sells at a premium.

b. the discount rate that will set the present value of the payments equal to the bond price. The yield to maturity on a bond is the discount rate that will set the present value of the payments equal to the bond price.

The "real," or inflation-adjusted, exchange rate is a. the balance of trade. b. the purchasing-power ratio. c. the budget deficit. d. unimportant to the U.S. economy. e. none of the options are correct.

b. the purchasing-power ratio Reason: The ratio of one country's purchasing power to another's is called the "real," or inflation-adjusted, exchange rate and is an important measure of the relative costs of domestic versus foreign goods.

Which of the financial statements recognizes only transactions in which cash changes hands? a. Income statement b. Statement of cash flows c. Balance sheet and income statement d. Balance sheet e. All of the options are correct.

c. Balance sheet and income statement The Balance Sheet and Income Statement are based on accrual accounting methods. Revenues and expenses are recognized when they are incurred regardless of whether cash is involved.

WACC is the most appropriate discount rate to use when applying a ______ valuation model. a. FCFE b. P/E c. FCFF d. FCFF or DDM, depending on the debt level of the firm, e. DDM

c. FCFF The most appropriate discount rate to use when applying a FCFF valuation model is the WACC.

To earn a high rating from the bond-rating agencies, a firm should have a. a low times-interest-earned ratio and a high quick ratio. b. a low debt-to-equity ratio. c. a low debt-to-equity ratio and a high quick ratio. d. a low times-interest-earned ratio. e. a high quick ratio.

c. a low debt-to-equity ratio and a high quick ratio. High values for the times interest and quick ratios and a low debt to equity ratio are desirable indicators of safety.

A rapidly growing GDP indicates a(n) ______ economy with ______ opportunity for a firm to increase sales. a. expanding; little b. stable; no c. expanding; ample d. stagnant; ample e. stagnant; little

c. expanding; ample Reason: GDP is a measure of the productive output of the country and indicates the opportunities firms have to expand sales.

Many stock analysts assume that a mispriced stock will a. return to its intrinsic value within a few days. b. never return to its intrinsic value. c. gradually approach its intrinsic value over several years. d. immediately return to its intrinsic value. e. none of the options are correct

c. gradually approach its intrinsic value over several years. Many analysts assume that mispricing may take several years to gradually correct.

During periods of inflation, the use of FIFO (rather than LIFO) as the method of accounting for inventories causes a. higher incomes taxes and lower ending inventory. b. lower ending inventory. c. higher incomes taxes. d. higher reported sales. e. None of the options are correct.

c. higher incomes taxes. In inflationary periods, the use of FIFO causes overstated earnings, which result in higher taxes.

According to the expectations hypothesis, an upward-sloping yield curve implies that a. interest rates are expected to remain stable in the future. b. interest rates are expected to decline in the future. c. interest rates are expected to increase in the future. d. interest rates are expected to decline first, then increase. e. interest rates are expected to increase first, then decrease.

c. interest rates are expected to increase in the future. An upward sloping yield curve is based on the expectation that short-term interest rates will increase.

The average duration of unemployment and changes in the consumer price index for services are a. coincidental economic indicators b. leading economic indicators c. lagging economic indicators d. composite economic indicators

c. lagging economic indicators Reason: These indicators (C) lag the general economy and are indicators that the economy is about to change directions.

If the economy is shrinking, firms with high operating leverage will experience a. smaller decreases in profits than firms with low operating leverage. b. similar decreases in profits as firms with low operating leverage. c. larger decreases in profits than firms with low operating leverage. d. no change in profits.

c. larger decreases in profits than firms with low operating leverage. Reason: As sales decrease, firms with high operating leverage spread these fixed costs over fewer units and thus decrease profits.

The stock price index and new orders for non-defense capital goods are a. lagging economic indicators. b. not useful as economic indicators. c. leading economic indicators. d. coincidental economic indicators.

c. leading economic indicators Reason: Contracts and orders for plant and equipment are indicative of future economic times and thus are leading economic indicators. The stock price index is one of the best leading economic indicators, a reflection of market efficiency.

A perpetuity growth rate that is higher than the combined population growth and inflation rate might cause what result? a. lower terminal value b. increased discount rate c. over-priced stock d. under-priced stock

c. over-priced stock reason: If the "g" in the perpetuity growth formula is higher than expected, the denominator is lower than the stock is overpriced.

Proceeds from a company's sale of stock to the public are included in a. par value. b. retained earnings. c. par value and additional paid-in capital. d. additional paid-in capital. e. All of the options are correct.

c. par value and additional paid-in capital. When a stock is sold, the par value goes into the Par account and any amount above the par value goes into the Additional Paid-in Capital account.

The P/E ratio that is based on a firm's financial statements and reported in the newspaper stock listings is different from the P/E ratio derived from the dividend discount model (DDM) because a. They are not different—this is a "trick" question. b. the prices reported are not accurate. c. the DDM uses different earnings measures in the denominator. d. the DDM uses a different price in the numerator. e. the people who construct the ratio from financial statements have inside information.

c. the DDM uses different earnings measures in the denominator. Both ratios use the same numerator—the market price of the stock. But P/Es from financial statements use the most recent past accounting earnings, while the DDM uses expected future economic earnings.

A bond will sell at a discount when a. the coupon rate is less than the current yield, and the current yield is greater than the yield to maturity. b. the coupon rate is greater than yield to maturity. c. the coupon rate is less than the current yield, and the current yield is less than yield to maturity. d. the coupon rate is greater than the current yield, and the current yield is greater than yield to maturity.

c. the coupon rate is less than the current yield, and the current yield is less than yield to maturity. In order for the investor to earn more than the current yield, the bond must be selling for a discount. Yield to maturity will be greater than current yield as investor will have purchased the bond at discount and will be receiving the coupon payments over the life of the bond.

A firm has a higher quick (or acid test) ratio than the industry average, which implies a. the firm has a higher P/E ratio than other firms in the industry. b. the firm has a higher P/E ratio than other firms in the industry, and the firm is more likely to avoid insolvency in the short run than other firms in the industry. c. the firm is more likely to avoid insolvency in the short run than other firms in the industry, and the firm may be less profitable than other firms in the industry. d. the firm is more likely to avoid insolvency in the short run than other firms in the industry. e. the firm may be less profitable than other firms in the industry.

c. the firm is more likely to avoid insolvency in the short run than other firms in the industry, and the firm may be less profitable than other firms in the industry. Current assets earn less than fixed assets; thus, a firm with a relatively high level of current assets may be less profitable than other firms. However, its high level of current assets makes it more liquid.

The yield curve is a component of a. the Dow Jones Industrial Average. b. the consumer price index. c. the index of leading economic indicators. d. the producer price index. e. the inflation index.

c. the index of leading economic indicators. Since the yield curve is often used to forecast the business cycle, it is used as one of the leading economic indicators.

One of the problems with attempting to forecast stock market values is that a. the earnings multiplier approach can only be used at the firm level. b. dividend-payout ratios are highly variable. c. the level of uncertainty surrounding the forecast will always be quite high. d. None of the options are correct. e. there are no variables that seem to predict market return.

c. the level of uncertainty surrounding the forecast will always be quite high. reason: Although some variables such as market dividend yield appear to be strongly related to market return, the market has great variability and so the level of uncertainty in any forecast will be high.

Earnings management is a. when management makes changes in the operations of the firm to ensure that earnings do not increase too rapidly. b. when management makes changes in the operations of the firm to ensure that earnings do not decrease too rapidly. c. the practice of using flexible accounting rules to improve the apparent profitability of the firm. d. when management makes changes in the operations of the firm to ensure that earnings do not increase or decrease too rapidly.

c. the practice of using flexible accounting rules to improve the apparent profitability of the firm. Reason: Earnings management is the practice of using flexible accounting rules to improve the apparent profitability of the firm

Industrial production refers to a. the difference between government spending and government revenues. b. the amount of personal disposable income in the economy. c. the total manufacturing output in the economy. d. the total production of goods and services in the economy.

c. the total manufacturing output in the economy Reason: Industrial production is a measure of the productive output of the manufacturing sector of the economy.

Historically, P/E ratios have tended to be a. uncorrelated with any macroeconomic variables, including inflation rates. b. higher when inflation has been high. c. uncorrelated with inflation rates but correlated with other macroeconomic variables. d. lower when inflation has been high.

c. uncorrelated with inflation rates but correlated with other macroeconomic variables. reason: P/E ratios have tended to be lower when inflation has been high, reflecting the market's assessment that earnings in these periods are of "lower quality," i.e., artificially distorted by inflation, and warranting lower P/E ratios.

When computing yield to maturity, the implicit reinvestment assumption is that the interest payments are reinvested at the a. coupon rate. b. current yield. c. yield to maturity at the time of the investment. d. prevailing yield to maturity at the time interest payments are received. e. the average yield to maturity throughout the investment period.

c. yield to maturity at the time of the investment. In order to earn the yield to maturity quoted at the time of the investment, coupons must be reinvested at that rate.

The bond indenture includes a. the par value of the bond. b. the maturity date of the bond. c. the coupon rate of the bond. d. All of the options are correct.

d. All of the options are correct. The bond indenture includes the coupon rate, par value, and maturity date of the bond, as well as any other contractual features.

Which of the following is not a type of international bond? a. Yankee bonds b. Bulldog bonds c. All of the options are international bonds. d. Elton bonds e. Samurai bonds

d. Elton bonds Samurai bonds, Yankee bonds, and bulldog bonds are mentioned in the textbook.

Which of the following is the best measure of the floor for a stock price? a. Book value b. Market value c. Tobin's Q d. Liquidation value e. Replacement cost

d. Liquidation value reason: If the firm's market value drops below the liquidation value the firm will be a possible takeover target. It would be worth more liquidated than as a going concern.

Which of the following are possible explanations for the term structure of interest rates? a. The expectations theory b. The liquidity preference theory c. Modern portfolio theory d. The expectations theory and the liquidity preference theory

d. The expectations theory and the liquidity preference theory The expectations theory and the liquidity preference theory are theories that have been proposed to explain the term structure.

If the expected ROE on reinvested earnings is equal to k, the multistage DDM reduces to a. V0 = (Expected EPS in year 1)/ k. b. V0 = (Market return in year 1)/ k. c. V0 = (Treasury bond yield in year 1)/ k.. d. V0 = (Expected dividend yield in year 1)/ k.

d. V0 = (Expected dividend yield in year 1)/ k. If ROE = k, no growth is occurring; b = 0; EPS = DPS. If the expected ROE on reinvested earnings is equal to k, then in such case V0= (expected dividend yield in year 1)/k.

At issue, coupon bonds typically sell a. below par value. b. above par value. c. at a value unrelated to par. d. at or near par value.

d. at or near par value If the investment banker has appraised the market and the quality of the bond correctly, the bond will sell at or near par (unless interest rates have changed very dramatically and very quickly around the time of issuance).

GAAP allows a. minimal leeway to manage earnings. b. no leeway to manage earnings. c. earnings management if it is beneficial in increasing stock price. d. considerable leeway to manage earnings. e. none are correct

d. considerable leeway to manage earnings.

______ is a measure of what the firm would have earned if it didn't have any obligations to creditors or tax authorities. a. Net Income b. Net Sales c. Non-operating Income d. Earnings before interest and taxes e. Operating Income

d. earnings before interest and taxes Taxes and interest expense are subtracted from EBIT to find Net Income. If there are no taxes and no interest expense EBIT would equal Net Income.

Economic value added (EVA) is also known as a. accounting value added. b. excess capacity. c. residual income. d. excess income. e. value of assets.

d. excess income. Stern Stewart, a consulting firm that works extensively with EVA, introduced this term.

Low P/E ratios tend to indicate that a company will _______, ceteris paribus. a. grow quickly b. P/E ratios are unrelated to growth. c. grow at the same speed as the average company d. grow slowly e. None of the options are correct.

d. grow slowly reason: Investors pay for growth; hence a relatively high P/E ratio for growth firms. The price/earnings ratio, also called the P/E ratio, tells investors how much a company is worth. The P/E ratio simply the stock price divided by the company's earnings per share for a designated period like the past 12 months. The price/earnings ratio conveys how much investors will pay per share for $1 of earnings.

Assume that the Federal Reserve decreases the money supply. This action will cause _______ to decrease. a. trade balance b. unemployment rate c. interest rates d. investment in the economy

d. investment in the economy Reason: Decreasing the money supply is an economic contraction strategy, resulting in a decreased output of the economy.

The yield curve a. is a graphical depiction of term structure of interest rates. b. is usually depicted for U.S. Treasuries in order to hold risk constant across maturities and yields. c. is usually depicted for corporate bonds of different ratings. d. is a graphical depiction of term structure of interest rates and is usually depicted for U.S. Treasuries in order to hold risk constant across maturities and yields. e. is a graphical depiction of term structure of interest rates and is usually depicted for corporate bonds of different ratings.

d. is a graphical depiction of term structure of interest rates and is usually depicted for U.S. Treasuries in order to hold risk constant across maturities and yields. The yield curve (yields vs. maturities, all else equal) is depicted for U.S. Treasuries more frequently than for corporate bonds, as the risk is constant across maturities for Treasuries.

Common size income statements make it easier to compare firms a. in different industries. b. that use different inventory valuation methods (FIFO vs. LIFO). c. with different degrees of leverage. d. of different sizes.

d. of different sizes. Common size income statements make it easier to compare firms of different sizes.

The most widely used monetary tool is a. altering the discount rate. b. altering marginal tax rates. c. altering the reserve requirements. d. open-market operations. e. None of the options are correct.

d. open market operations Reason: The Federal Reserve's open market operations are the most widely used and most effective monetary tool for influencing interest rates.

Since 1955, Treasury bond yields and earnings yields on stocks have been a. negatively correlated. b. identical. c. uncorrelated. d. positively correlated.

d. positively correlated reason: The earnings yield on stocks equals the expected real rate of return on the stock market, which should be equal to the yield to maturity on Treasury bonds plus a risk premium, which may change slowly over time.

A declining GDP indicates a(n) ______ economy with ______ opportunity for a firm to increase sales. a. expanding; ample b, stagnant or shrinking; ample c. expanding; little d. stagnant or shrinking; little e. stable; no

d. stagnant or shrinking; little Reason: GDP is a measure of the productive output of the country and indicates the opportunities firms have to expand sales.

A firm's earnings per share increased from $10 to $12, dividends increased from $4.00 to $4.80, and the share price increased from $80 to $90. Given this information, it follows that a. the firm increased the number of shares outstanding. b. the firm had a decrease in dividend-payout ratio. c. the required rate of return decreased. d. the stock experienced a drop in the P/E ratio.

d. the stock experienced a drop in the P/E ratio. Reason: $80/$10 = 8; $90/$12 = 7.5

Debt securities are often called fixed-income securities because a. they were the first type of investment offered to the public which allowed them to "fix" their income at a higher level by investing in bonds. b. the government fixes the maximum rate that can be paid on bonds. c. they are held predominantly by older people who are living on fixed incomes. d. they promise either a fixed stream of income or a stream of income determined by a specific formula. e. they pay a fixed amount at maturity.

d. they promise either a fixed stream of income or a stream of income determined by a specific formula. This definition is given in the chapter's introduction. It helps the student understand the nature of bonds.

Collateralized bonds a. rely on the general earning power of the firm for the bond's safety. b. are backed by specific assets of the issuing firm. c. All of the options are true. d. are backed by specific assets of the issuing firm and are generally considered the safest variety of bonds. e. are considered the safest variety of bonds.

e. are considered the safest variety of bonds. Collateralized bonds are considered the safest variety of bonds because they are backed by specific assets of the firm, rather than relying on the firm's general earning power.

The pure yield curve can be estimated a. by using zero-coupon Treasuries. b. by using stripped Treasuries if each coupon is treated as a separate "zero." c. by using corporate bonds with different risk ratings. d. by estimating liquidity premiums for different maturities. e. by using zero-coupon Treasuries and by using stripped Treasuries if each coupon is treated as a separate "zero."

e. by using zero-coupon Treasuries and by using stripped Treasuries if each coupon is treated as a separate "zero." The pure yield curve is calculated using stripped or zero-coupon Treasuries.

An example of a liquidity ratio is a. fixed asset turnover. b. current ratio. c. acid test or quick ratio. d. fixed asset turnover and acid test or quick ratio. e. current ratio and acid test or quick ratio.

e. current ratio and acid test or quick ratio. Both current ratio and acid test or quick ratio are measures of liquidity; A relates to fixed assets.

The dollar value of a firm's return in excess of its opportunity costs is called its a. return margin. b. excess return. c. profitability measure. d. prospective capacity. e. economic value added.

e. economic value added. Economic value added measures the success of the firm relative to its return on projects vs. the rate investors could earn themselves in the capital markets. EVA = ROA − k × capital invested.

Most corporate bonds are traded a. over the counter by bond dealers linked by a computer quotation system. b. by the issuing corporation. c. on a formal exchange operated by the American Stock Exchange. d. on a formal exchange operated by the Philadelphia Stock Exchange. e. on a formal exchange operated by the New York Stock Exchange.

e. on a formal exchange operated by the New York Stock Exchange. Most corporate bonds are traded in a loosely organized network of bond dealers linked by a computer quote system. Only a small proportion is traded on the New York Exchange.

A coupon bond is a bond that a. can always be converted into a specific number of shares of common stock in the issuing company. b. always sells at par value. c. None of the options are correct. d. does not pay interest on a regular basis but pays a lump sum at maturity. e. pays interest on a regular basis (typically every six months).

e. pays interest on a regular basis (typically every six months). A coupon bond will pay the coupon rate of interest on a regular basis unless the firm defaults on the bond. Convertible bonds are specific types of bonds.

An inverted yield curve is one a. with a hump in the middle. b. constructed by using convertible bonds. c. that is relatively flat. d. that plots the inverse relationship between bond prices and bond yields. e. that slopes downward.

e. that slopes downward. An inverted yield curve occurs when short-term rates are higher than long-term rates.

The bonds of Amazon have received a rating of "B" by Moody's. The "B" rating indicates a. the bonds are insured or junk bonds. b. the bonds are referred to as "high-yield" bonds. c. the bonds are insured. d. the bonds are junk bonds. e. the bonds are "high-yield" or junk bonds.

e. the bonds are "high-yield" or junk bonds. B ratings are risky bonds, often called junk bonds (or high-yield bonds by those marketing such bonds).