Finance

The present value of $100 paid annually at year-end for 20 years at 10% per year is

$851.36 100[(1/0.10) − (1/(0.10(1.10)20))] = 851.36.

Compound growth means that value increases after t periods by

(1 + growth rate)^t

The interest payments to the bondholder are called the ______. par maturity face coupon

Coupon The Coupon rate is the annual payment on a bond, expressed as a percentage of face value.

Using the dividend discount model for a no-growth stock, what is the value of a stock that pays a $3 dividend and has a discount rate of 10%?

DIV1/r = $3/0.1 = $30

A bank offers a savings account with an APR of 9% with monthly compounding. What is the effective annual interest rate of this investment?

EAR = (1 + 0.09/12)12 − 1 = 9.38%

The type of market efficiency that asserts that investors cannot earn superior returns through a study of information available to other investors is ______. semi-strong-form efficiency hulk-form efficiency weak-form efficiency strong-form efficiency

semi-strong-form efficiency

The type of market efficiency that asserts that no investor, including firm insiders, can earn superior returns is

strong-form efficiency

The return on a bond that sells at a premium is ___ than the current yield greater less

Less A bond priced above its face value is said to sell at a premium (premium bond). Investors who buy the premium bond face a capital loss over the life of the bond, since the bond will be redeemed at its original (face) value. Bond priced below face value sells at a discount and is known as a discount bond. Investors receive a capital gain over the life of the bond, so the return on the discount bond is greater than the coupon rate. Bond priced at face value (par) is known as a par bond. Its return equals the coupon rate.

The U.S. Treasury issues ______, which adjust nominal cash flows based on the consumer price index TIPS MBS NPV SOX

TIPS Treasury Inflation-Protected Securities (TIPS) are inflation-indexed bonds that adjust nominal cash flows based on changes in the consumer price index.

A market "bubble" is characterized by stock prices that are at levels in excess of what would be justified by expected dividends and earnings. In short, the market is seriously overpriced for some class of stocks.

True

True or false: The nominal interest rate can be defined as an interest rate quoted today by a financial institution on a loan or investment, such as an APR or a periodic rate

True

A measure of return that takes account of both coupon payments and change in a bond's value over its life is a standard measure known as Blank______. bond rate current rate of interest yield to maturity current yield

Yield to maturity

An amortization schedule includes Blank______. closing balance principal paid total interest interest paid year total payment opening balance

closing balance principal paid interest paid year total payment opening balance

At a rate of interest of 10% (r), the present value (PV) of $100 will ______ as the time period (t)

decrease, increase Present value will decrease as the time period increases. This follows the time value of money concept that a dollar today is worth more than a dollar tomorrow.

Present value is calculated using a ______ calculation.

discounted cash flow

A change in interest rate has the greatest effect on the present value of ______. current cash flows short-term cash flows distant cash flows

distant cash flows

The payment made when a bond matures is called the bond's ______. face value personal value coupon value end value

face value

When the coupon rate of a bond is equal to the current interest rate, the bond will sell for ______. less than face value a discount face value more than face value

face value (also known as principal or par value)

The plowback ratio is defined as the ______. fraction of earnings retained by the firm fraction of earnings paid out as dividends fraction of earnings required to pay back debt

fraction of earnings retained by the firm

If interest rates fall, the rate of return on a bond will be ______ the yield to maturity. greater than less than equal to

greater than

The firm's growth rate if it plows back a constant fraction of earnings, maintains a constant return on equity, and keeps its debt ratio constant is the firm's ______. sustainable growth rate payout ratio plowback ratio targeted growth rate

sustainable growth rate

The type of market efficiency that asserts that investors cannot make superior returns by searching for patterns in past returns is

weak-form efficiency

A plot drawn to show the relationship between bond yields and maturity is known as the ______. total revenue curve break-even point yield curve total cost curve

yield curve

The discount rate that makes the present value of the bond's payments equal to its price is known as the ______. current yield current rate of interest yield to maturity bond rate

yield to maturity -Takes into account both coupon payments and change in a bond's value over its life

Helena Handbaskets expects to pay a dividend of $0.50 at year-end and expects that dividend to grow at a rate of 6% per year thereafter. If investors require a 15% return on Helena's stock, what should the current share price be? $3.33 $6.00 $5.56 $5.89

$0.50/(0.15 − 0.06) = $5.56.

A dollar invested today at 7.5% interest compounded annually will be worth Blank______ one year from now.

$1.075 Reason: FV = $1.00(1 + 0.075)^1.

A dollar invested today at 8.0% simple annual interest will be worth ______ three years from now

$1.24 Reason: With simple interest, the bank calculates interest only on the principal investment: $1.00 + $0.08 + $0.08 + $0.08 = $1.24. Do not confuse this with compound interest, which computes interest earned on interest.

A dollar invested today at 8.0% interest compounded annually will be worth ______ three years from now.

$1.2597 Reason: FV = $1.00(1 + 0.08)^3.

You put $100 in the bank now, $200 in the bank a year from now, and $300 in the bank in 2 years. How much money will you have available 3 years from now if you earn a 7.5% rate of interest? (Calculate the future value of this stream of cash flows.

$100 × (1.075)^3 + $200 × (1.075)^2 + $300 × (1.075) = $677.85.

You will receive $100 in 1 year, $200 in 2 years, and $300 in 3 years. If you can earn a 7.5% rate of interest, what is the present value of this stream of cash flows? (Please note that you receive nothing immediately—there is no initial payment) $487.50 $512.33 $507.58 $608.98

$100/(1.075)^1 + $200/(1.075)^2 + $300/(1.075)^3 = $507.58.

Today you deposit $1000 in an account paying 6% interest. At the end of years 1, 2, and 3, you will deposit $100 in that account. What is the present value of that stream of cash flows? $1,237.40 $1,376.32 $1.111.12 $1,267.30

$1000 + $100/(1.06)^1 + $100/(1.06)^2 + $100/(1.06)^3 = $1,267.30.

Today you deposit $1000 in an account paying 6% interest. At the end of years 1, 2, and 3, you will deposit $100 in that account. How much will you have at the end of year 4? $1,599.94 $1,527.99 $1,493.94 $1,399.44

$1000*(1.06)^4 + $100*(1.06)^3 + $100*(1.06)^2 + $100*(1.06)^3= $1599.94

A company issues a $5,000 bond that matures in 5 years with a coupon rate of 6% and a current interest rate of 6%. The bond will sell for $5020 $5000 $4998 $4980

$5000 When the bond coupon rate and the interest rate are the same, the bond will sell for face value.

Which of the following is the correct formula for the discount factor? 1/(1 + r)^t 1/(1 + r) 1/(1 + r) × t (1 + r)

1/(1 + r)^t

Marley Corporation's bonds have 4 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 5%. If the price of the bond is $841.51, the yield to maturity is ______. (Use trial and error to calculate yield) 12% 8% 10% 5%

10% First, calculate the coupon payment: $1,000 × 0.05 = $50. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $841.51. You will see that by doing trial and error on the 4 given yields in the multiple choice question (5%, 8%, 10%, and 12%), the correct yield is 10%: $841.51 = $50/(1 + 0.1) + $50/(1 + 0.1)^2+ $50/(1 + 0.1)^3+ $1,050/(1.1)^4. $1000*1.05=1050

In 2013, the CPI was about 2.5 times its level in 1981. If the cost of one semester of college was $5,000 in 1981, what should the nominal cost of a semester of college be in 2013, assuming the real price is constant? 10,000 12,000 2,000 12,500

12,500 2.5x5000=12500

What is the future value of $100 invested for 4 years at 10% interest? 140 144 146.41 145.54

146.41 FV=$100*(1+r)^1 =$100(1+.1)^4=146.41

Your neighborhood bank is offering investors a money market account that pays 3.5% interest on deposits. If the current annual rate of inflation is 1.2%, how much is the exact real rate for this account? 2.80% 3.05% 2.30% 2.27%

2.27% [1.035/1.012] -1 = 2.27% Real rate of interest equation: [Nominal / inflation rate] -1 = real interest rate

In 2013, the CPI was about 2.5 times its level in 1981. If the cost of one semester of college was $5,000 in 1981, what should the nominal cost of a semester of college be in 2013, assuming the real price is constant?

2.5 × $5000 = $12,500

An individual invested $1,000 in a bond with a coupon payment of $12. The price of the bond increased to $1,400. What is the rate of return on this bond? 40% 71.4% 12% 41.2%

41.2% Rate of return = (coupon income + price change)/investment = ($12 + $400)/$1,000 = 0.412 or 41.2%.

Mortor's Corporation sold 6 year bonds for $1,072.62, with a face value of $1,000 and a coupon rate of 8%. The annual yield to maturity is 6% 6.5% 7% 7.5%

6.5% $1072.62= $80/(1 + 0.065) + $80/(1 + 0.065)^2+ $80/(1 + 0.065)^3+ $80/(1 + 0.065)^4+ $80/(1 + 0.065)^5+ $1,080/(1 + 0.065)^6 1000*1.08=$1080

If the nominal rate of interest is 10% and the rate of inflation is 3%, the real interest rate is

6.8% 1 + real interest rate = (1 + 0.1)/(1 + 0.03) = 1.068 − 1 = 0.068 or 6.8%.

The rate quoted by Big Bank on a car loan is 8%. The annual rate of inflation is currently 1.5%. What is the approximate real interest rate paid by the consumer on this loan? 6.5% 9.5% 12% 8%

8%-1.5%= 6.5% The equation used to determine the approximate real interest rate is: Nominal interest rate - inflation rate

The present value of an annuity of $1 per period is called the Blank______. interest rate annuity payment perpetuity annuity factor

Annuity factor

Marley Corporation's bonds have 4 years left to maturity. Interest is paid annually, and the bonds have a $1,000 par value and a coupon rate of 5%. If the price of the bond is $841.51, the yield to maturity is Blank______. (Use trial and error to calculate yield) 8% 12% 5% 10%

First, calculate the coupon payment: $1,000 × 0.05 = $50. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $841.51. You will see that by doing trial and error on the 4 given yields in the multiple choice question (5%, 8%, 10%, and 12%), the correct yield is 10%: $841.51 = $50/(1 + 0.1) + $50/(1 + 0.1)^2+ $50/(1 + 0.1)^3+ $1,050/(1.1)^4.

Mortor's Corporation sold 6 year bonds for $1,072.62, with a face value of $1,000 and a coupon rate of 8%. The annual yield to maturity is Blank______. 7% 7.5% 6% 6.5%

First, calculate the coupon payment: $1,000 × 0.08 = $80. Next, discount the payments at each yield to determine the appropriate yield that gives a bond price of $1,072.62. You will see that by doing trial and error on the 4 given yields in the multiple choice question (6%, 6.5%, 7%, and 7.5%), the correct yield is 6.5%: $1,072.62 = $80/(1 + 0.065) + $80/(1 + 0.065)^2+ $80/(1 + 0.065)^3+ $80/(1 + 0.065)^4+ $80/(1 + 0.065)^5+ $1,080/(1 + 0.065)^6.

Find the future value of an annuity of $100 per year for 10 years at 10% per year.

First, find the PV by using the 10 year annuity factor: PV = $100 × 10 year annuity factor = $100 × [1/0.1 − 1/0.1x(1.1)10]= $614.46. To find the future value, multiply $614.46 x (1.1)10= $1,593.75.

The value in t years of an investment made today at interest rate r is called the ______ of your investment. future value compound value present value simple value

Future Value

In 2013, the CPI was about 2.5 times its level in 1981. If the price of a pack of cigarettes was $1.00 in 1981 and $5.00 in 2013, then the real price has ______ since 1981. The inflation-adjusted price today should be ______ if there had been no real growth in the price of a pack. increased; $5.00 is the same as; $2.50 is less than; $5.00 increased; $2.50

Increased; $2.50 In 2013, the CPI was about 2.5 times its level in 1981. If the price of a pack of cigarettes was $1.00 in 1981 and $5.00 in 2013, then the real price has increased since 1981. The inflation-adjusted price today should be $2.50 if there had been no real growth in the price of a pack.

Because the ______ rate is uncertain, so is the ______ rate of interest offered on bonds.

Inflation, real

The increased change in value that occurs because longer maturity investments are affected more by interest rate changes than are shorter maturity investments is called ______ risk. reinvestment rate default interest rate maturity

Interest rate risk The increased change in value that occurs because longer maturity investments are affected more by interest rate changes than are shorter maturity investments is called interest rate risk. reinvestment rate: The risk that the rate of interest changes, ex: when debt is rolled over(continued on) default: Risk of non-payment of principal and interest as they fall due (not being able to pay)

Which type of interest rate is generally quoted for loans and by banks and other financial institutions? nominal Treasury real

Nominal It sets the actual number of dollars you will be paid with no offset for suture inflation

______ dollars refer to the actual number of dollars of the day, whereas Blank______ dollars refer to the amount of purchasing power.

Nominal, real Current, constant

Which of the following is the correct equation for the present value of an annuity with regular payment C for t periods at interest rate r? PV = C[1/r − 1/r(1 + r)t] PV = C/rt PV = C/r PV = C/(1 + r)t − C/r

PV = C[1/r − 1/r(1 + r)t]

If the interest rate (r) increases, what will happen to the present value (PV) over time? PV will increase PV will decline

PV will decline.

The price of a bond is equal to the PV(coupon) minus PV(face value) FV(coupon) plus FV(face value) PV(coupon) plus PV(face value) FV(coupon) minus FV(face value)

PV(coupon) plus PV(face value)

The current value of an amount to be received at some time in the future, computed based on a certain interest rate and for a certain time period, is called

Present Value

Even when the yield curve of a long-term bond is upward-sloping, some investors prefer short-term bonds. Which of the following reasons would explain why this statement is true? Long-term investors cannot profit if interest rates fall. Prices of long-term bonds fluctuate more than prices of short-term bonds. Prices of short-term bonds fluctuate more than prices of long-term bonds. Short-term investors can profit if interest rates rise.

Prices of long-term bonds fluctuate more than prices of short-term bonds. Short-term investors can profit if interest rates rise.

Which type of price refers to the purchasing power of money? current nominal real

Real Current and nominal both refer to the actual numbers of dollars of the day Constant and real both refer to the amount of purchasing power

Which of the following statements are true regarding the present value of a stream of cash payments? Real cash payments should be discounted using a real interest rate. Nominal cash payments should be discounted using a nominal interest rate. Nominal cash payments may be discounted using a real or nominal rate. Real cash payments may be discounted using a real or nominal rate.

Real cash payments should be discounted using a real interest rate. Nominal cash payments should be discounted using a nominal interest rate. Remember: Current (nominal) collar cash flows must discounted by the nominal interest rate Real (constant) cash flows must be discounted by the real interest rate.

In addition to paying a dividend, a firm can return cash to its equity investors through a ______. stock repurchase IPO new bond issue

Stock repurchase

Interest Rate Risk

The changes in value of securities due to changes in interest rates. Interest rates and bond prices move in opposite directions. When interest rates fall, the cash flows are discounted at a lower rate and bond prices rise. (and vice versa) Lower interest rates mean bond value will increase. **Interest rate changes from day to day and these changes affect the PV of the coupon payments, but not the payments themselves. When interest rates increase, the price of the bond decreases which means the yield will be higher for the new bond. Now, people who had old bonds are earning a less return than they can get now.

The payout ratio is defined as ______. the proportion of earnings needed to acquire a new firm the proportion of earnings to be paid out to employees the proportion of earnings to be paid out as dividends the proportion of earnings to be reinvested in the firm

The portion of earnings to be paid out as dividends

The real interest rate can be defined as

The real change in value of an investment (or real cost of a loan) after adjustment for inflation.

If the interest rate is greater than zero, the present value of an annuity due is always ______ an ordinary annuity. equal to greater than less than

greater than Cash flows for annuities due always come one period earlier than the corresponding cash flows for ordinary annuities. Therefore, each is discounted for one less period, and the present value for the annuity due increases by a factor of (1 + r) over that of the ordinary annuity.

A firm that is experiencing rapid ______ may see its free cash flow be zero or negative since it is reinvesting all of its earnings into new investments.

growth

The _____ on government bonds provide a benchmark for all interest rates

interests rates

Stock repurchases are an attractive alternative to dividends because _____. stock repurchases are less costly than paying a dividend dividend calculations are more difficult to make investors interpret dividends as repeated cash distributions

investors interpret dividends as repeated cash distributions

The return on a bond that sells at a premium is ___ (less/more) than the current yield

less

If interest rates rise, the rate of return on a bond will be Blank______ the yield to maturity. equal to less than greater than

less than

What is the future value of a series of $2,000 end-of-year 85,471 deposits into an IRA account paying 5% interest, over a period of 35 years? Use your financial calculator

n = 35, i = 5, PV = 0, PMT = 2,000, compute FV = 180,640.61

Companies that grow rapidly for several years before settling down to a stable growth rate should use the_________ growth model for stock valuation.

non-constant growth

A stock that pays out a perpetual stream of constant dividends can be valued as a(n) ______. perpetuity long-term bond annuity constant growth stock

perpetuity

The present value formula for a(n) Blank______ is PV = C/r, where C is the constant and regularly timed cash flow to infinity, and r is the interest rate. annuity growing annuity perpetuity growing perpetuity

perpetuity

The present value of an annuity due is equal to the Blank______. present value of an ordinary annuity × r present value of an ordinary annuity × (1 + r) present value of an ordinary annuity + (1 − r) present value of an ordinary annuity/(1 + r)

present value of an ordinary annuity × (1 + r)

The expected rate of return for a stock whose next dividend is "DIV1," that has a required rate of return "r" and expects to grow its future dividends at a rate of "g" is Blank______. r = g r = DIV1/P0 r = (DIV1/P0) + g r = DIV1 + P0/g

r = (DIV1/P0) + g