Finance Test #2

How are the cash flows of a coupon bond different from an amortizing loan?

A coupon bond pays interest over the life of the bond and returns the principal at the end of the term. Thus the cash flows are smaller over the life of the bond with a lump-sum payment at the end. In contrast, an amortizing loan has identical cash flows over its life with a part of the cash flow going toward interest and the balance as return of principal.

What care, if any, should be taken regarding the sign of the cash flows while drawing the timeline and associated cash flows of a coupon bond?

A typical coupon bond will have the first cash flow in the opposite direction as compared to all the rest of the cash flows over its life. The first cash corresponds to the issuer borrowing the money, while all the rest of the cash flows are payments by the issuer to the bondholder either in the form of interest or principal

How are the cash flows of a zero-coupon bond different from those of a coupon bond?

A zero-coupon bond has only two cash flows over its life. The first one is associated with the issues borrowing the money and the second when the issuer returns the principal. A coupon bond, on the other hand, has several cash flows over its life. The first cash flow of both these types of bonds, zero-coupon and coupon are similar as they denote the issuer borrowing the money. However, for a coupon bond the subsequent cash flows over its life correspond to the interest payment promised by the issuer with a final payment equal to the return of principal.

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 10 years. The bond certificate indicates that the stated coupon rate for this bond is 8.2% and that the coupon payments are to be made semiannually. Assuming the appropriate YTM on the Sisyphean bond is 7.3%, then the price that this bond trades for will be closest to ________.

A) $1063 A) FV = $1000 I = 3.65 (7.3/2) PMT = $41 N = 20 (10 × 2) Compute PV = 1063.10

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 7.5% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: Assuming that Lutherʹs bonds are rated AAA, their price will be closest to ________.

A) $1064 A) FV = $1,000 PMT = $75 N = 10 I = 6.60 Compute PV = $1064.40

A small business repairs its store. The builders charge them $130,000 which will be paid back in monthly installments over three years at 6.80% APR. The builders will reduce this rate to 6.30% APR if they pay $2600 up front. By approximately how much will this reduce the monthly loan repayments?

A) $109 A) The first step is to calculate the monthly payment using a present value (PV) of $130,000 monthly interest rate of 6.80/12 = 0.566667 %, and 36 periods, which = $4002.15 ; the second step is to use that monthly payment using a monthly interest rate of 6.30/12 = 0.525000 % and a PV of $130,000 - $2600 = $127,400 to calculate the payment = $3893.10 . The difference of the two = $4002.15 - $3893.10 = $109.05

A stock is expected to pay $1.25 per share every year indefinitely and the equity cost of capital for the company is 8.4%. What price would an investor be expected to pay per share ten years in the future?

A) $14.88 A) P0 = $1.25 / 0.084 = $14.88

A Xerox DocuColor photocopier costing $44,000 is paid off in 60 monthly installments at 6.90% APR. After three years the company wishes to sell the photocopier. What is the minimum price for which they can sell the copier so that they can cover the cost of the balance remaining on the loan?

A) $19,433 A) The first step is to calculate the monthly payment using a present value (PV) of $44,000 monthly interest rate of 6.90/12% = 0.575000 %, and 60 periods, which = $869.18 ; the second step is to use that monthly payment to calculate the present value (PV) of 24 months remaining payment keeping the interest rate unchanged.

JRN Enterprises just announced that it plans to cut its dividend from $3.00 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRNʹs dividends were expected to grow indefinitely at 4% per year and JRNʹs stock was trading at $25.50 per share. With the new expansion, JRNʹs dividends are expected to grow at 8% per year indefinitely. Assuming that JRNʹs risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to ________.

A) $19.32 A) Two steps. Step 1: Solve for rE: rE = Div1 / P0 + g = $3.00 /$25.50 + 0.04 = 0.15765 or 15.77% Step 2: Solve for new stock price: P0 = Div1 / (rE - g) = $1.50 /(0.15765 - 0.08) = $19.32

Rylan Industries is expected to pay a dividend of $5.70 year for the next four years. If the current price of Rylan stock is $31.27 , and Rylanʹs equity cost of capital is 12%, what price would you expect Rylanʹs stock to sell for at the end of the four years?

A) $21.96 A) Using a financial calculator, PV = -31.27 , PMT = 5.70, n = 4, I = 12; Calculate FV = $21.9

A small foundry agrees to pay $220,000 two years from now to a supplier for a given amount of coking coal. The foundry plans to deposit a fixed amount in a bank account every three months, starting three months from now, so that at the end of two years the account holds $220,000 . If the account pays 12.5% APR compounded monthly, how much must be deposited every three months?

A) $24,602 A) Calculate the EAR = 13.2416 %; calculate APR with quarterly compounding = 12.6307 %; calculate the payment for 8 quarters with $220,000 as future value (FV).

Coolibah Holdings is expected to pay dividends of $1.20 every six months for the next three years. If the current price of Coolibah stock is $22.60 , and Coolibahʹs equity cost of capital is 18%, what price would you expect Coolibahʹs stock to sell for at the end of three years?

A) $28.87 A) Using a financial calculator, PV = -$22.60 , PMT = $1.20, n = 6, I = 18% / 2; calculate FV = $28.87 .

Credenza Industries is expected to pay a dividend of $1.70 at the end of the coming year. It is expected to sell for $62 at the end of the year. If its equity cost of capital is 9%, what is the expected capital gain from the sale of this stock at the end of the coming year?

A) $3.56 A) P0 using the capital gain rate formula = ($1.70 + $62) / (1 + 0.09) = $58.44 ; Capital gain = P1 - P0 = $62 - $58.44 = $3.56

The present value (PV) of receiving $1100 per year with certainty at the end of the next three years is closest to ________.

A) $3010 A) PV = $1100 / (1 + 0.050) + $1100 / (1 + 0.048)2 + $1100 / (1 + 0.046)3 = 3010.33

Liam had an extension built onto his home. He financed it for 48 months with a loan at 5.00% APR. His monthly payments were $770 . How much was the loan amount for this extension?

A) $33,436 A) Calculate the PV annuity of $770 for 48 months at 5.00/12 = 0.416667 %, which = $33,436 .

What is the present value (PV) of an investment that pays $100,000 every year for four years if the interest rate is 5% APR, compounded quarterly?

A) $353,818 A) Calculate EAR = 5.0945 %; Calculate PV Annuity = $353,818

Von Bora Corporation (VBC) is expected to pay a $3.00 dividend at the end of this year. If you expect VBCʹs dividend to grow by 6% per year forever and VBCʹs equity cost of capital to be 13%, then the value of a share of VBS stock is closest to ________.

A) $42.86 A) P0 = Div1 / (rE - g) = $3.00 / (0.13 - 0.06) = $42.86

A bank lends some money to a business. The business will pay the bank a single payment of $176,000 in ten yearsʹ time. How much greater is the present value (PV) of this payment if the interest rate is 9% rather than 8%?

A) $7178 A) PV of $180,000 at 8% for 10 years = $81,522.05 ; PV of $180,000 at 9% for 10 years = $74,344.30 ; difference = $7177.75

A stock is expected to pay $0.70 per share every year indefinitely. If the current price of the stock is $18.90 , and the equity cost of capital for the company that released the shares is 7.9%, what price would an investor be expected to pay per share five years into the future?

A) $8.86 A) P0 = $0.70 / 0.079 = $8.86

What must be the price of a $10,000 bond with a 6.1% coupon rate, semiannual coupons, and five years to maturity if it has a yield to maturity of 10% APR?

A) $8494.26 A) Using FV = $10,000 , periods to maturity = 10, PMT = 305.00 , and periodic discount rate = 5.0% per period, calculate PV = $8494.26 .

A company issues a ten-year $1,000 face value bond at par with a coupon rate of 6.1% paid semiannually. The YTM at the beginning of the third year of the bond (8 years left to maturity) is 8.1%. What is the new price of the bond?

A) $883.91 A) FV = 1000 PMT = 30.5 N = 16 I = 4.05 Solve for PV

A firm issues 5-year bonds with a coupon rate of 4.7%, paid semiannually. The credit spread for this firmʹs 5-year debt is 1.2%. New 5-year Treasury notes are being issued at par with a coupon rate of 5.1%. What should the price of the firmʹs outstanding 5-year bonds be if their face value is $1,000?

A) $932.28 A) Calculate the PV of the bond with FV = $1,000, YTM = 3.150 %, PMT = 23.50 , and N = 10, which = $932.28 .

In 2009, U.S. Treasury yielded 0.1%, while inflation was 2.7%. What was the real rate in 2009?

A) -2.6% A) 0.1% - 2.7% = -2.6%

A construction company takes a loan of $1,531,000 to cover the cost of a new grader. If the interest rate is 6.75% APR, and payments are made monthly for five years, what percentage of the outstanding principal does the company pay in interest each month?

A) 0.56% A) The percentage of outstanding principal paid is the monthly periodic interest rate = 6.75/12 = 0.56%.

The credit spread of the BBB corporate bond is closest to ________.

A) 0.8% A) 5.8% - 5.0% (BBB Yield - risk-free yield) = 0.8%

A company has stock which costs $41.50 per share and pays a dividend of $2.50 per share this year. The companyʹs cost of equity is 7%. What is the expected annual growth rate of the companyʹs dividends?

A) 0.98%

The credit spread of the B corporate bond is closest to ________.

A) 1.4% A) 6.1% - 4.7% (B Yield - risk-free yield) = 1.4%

Kirkevue Industries pays out all its earnings as dividends and has a share price of $27. In order to expand, Kirkevue announces it will cut its dividend payments from $2.15 to $1.75 per share and reinvest the retained funds. What is the growth rate that should be achieved on the reinvested funds to keep the equity cost of capital unchanged?

A) 1.48%

A risk-free, zero-coupon bond with a $5000 face value has 15 years to maturity. The bond currently trades at $3750 . What is the yield to maturity of this bond?

A) 1.936% A) YTM = (Face Value / Price)1/n - 1; YTM = ($5000 / $3750 )1/15 - 1 = 1.936%

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 5.6% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: Assuming that Lutherʹs bonds receive a AA rating, the number of bonds that Luther must issue to raise the needed $25 million is closest to ________.

A) 27,848 A) FV = $1,000 PMT = $56.00 N = 10 I = 7.06% Compute PV Total number of bonds = $25,000,000 / $897.74 = 27,848

What is the coupon rate of an eight-year, $10,000 bond with semiannual coupons and a price of $9006.6568 , if it has a yield to maturity of 6.5%?

A) 4.888% A) Using FV = $10,000 , periods to maturity = 16, and discount rate = 3.25%, calculate PMT = $244.4000 ; annual coupon payment = $244.4000 × 2 = $488.8000 ; coupon rate = 4.888 %.

The yield to maturity for the three -year zero-coupon bond is closest to ________.

A) 5.40% A) Yield = (100/price)(1/n) - 1 = (100/85.40 )(1/3) - 1 = 0.054 or 5.40%

A homeowner has a $227,000 home with a 20-year mortgage, paid monthly at 6.60% APR. After five years he receives $50,000 as an inheritance. If he pays this $50,000 toward his mortgage along with his regular payment, by approximately how many years will it reduce the amount of time it takes him to pay off his mortgage?

A) 5.5 years A) The first step is to calculate the monthly payment using a present value (PV) of $227,000 , monthly interest rate of 6.60/12 = 0.55%, and 240 periods, which = $1705.842 ; the second step is to use that monthly payment to calculate the balance at the end of five years, which = $194,594.353 ; next step is to reduce this balance by $50,000 to the new outstanding balance of $144,594.353 ; now calculate the number of months required to pay off this balance, which = 114.45 ; the last step is to calculate the difference between 180 - 114.45 = 65.55 , when divided by 12 gives 5.5 years.

Luther Industries has a dividend yield of 4.5% and a cost of equity capital of 10%. Luther Industriesʹ dividends are expected to grow at a constant rate indefinitely. The growth rate of Lutherʹs dividends is closest to ________.

A) 5.5% A) rE = Div1 / P0 + g 0.1 = 0.045 + g, so g = 5.5%

The lowest effective rate of return you could earn on any of these investments is closest to ________.

A) 6.3830% A) EAR (A) = (1 + APR / m)m - 1 = (1 + 0.063830 /1)1 - 1 = 6.3830% EAR (B) = (1 + APR / m)m - 1 = (1 + 0.062116 /365)365 - 1 = 6.4080% EAR (C) = (1 + APR / m)m - 1 = (1 + 0.062834 /4)4 - 1 = 6.4330% EAR (D) = (1 + APR / m)m - 1 = (1 + 0.062744 /12)12 - 1 = 6.4580%

What is the real interest rate given a nominal rate of 8.9% and an inflation rate of 1.9%?

A) 6.9% A) (0.089 ) / (1+ 0.019 ) - 1 = 0.06869 ;real rate = 6.869%

The effective annual rate (EAR) for a loan with a stated APR of 8% compounded monthly is closest to ________.

A) 8.30% A) EAR = (1 + APR / m)m - 1 = (1 + 0.08/12)12 - 1 = 0.0830 or 8.30%.

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 7.0% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: What rating must Luther receive on these bonds if they want the bonds to be issued at par?

A) A A) FV = $1,000 PMT = $70 N = 10 I = 7.00% (yield for A rating) Compute PV = $1,000.00.

Which of the following statements is FALSE regarding profitable and unprofitable growth?

A) If a firm wants to increase its share price, it must diversify.

The table above shows the rate of return (APR) for four investment alternatives. Which offers the highest EAR?

A) Investment A A) Calculate the EAR for each; A = 6.0%; B = 5.99%; C = 5.96%; D = 5.86%.

Which alternative offers you the lowest effective rate of return?

A) Investment A A) EAR (A) = (1 + APR / m)m - 1 = (1 + 0.069030 /1)1 - 1 = 6.9030% EAR (B) = (1 + APR / m)m - 1 = (1 + 0.066992 /365)365 - 1 = 6.9280% EAR (C) = (1 + APR / m)m - 1 = (1 + 0.067787 /4)4 - 1 = 6.9530% EAR (D) = (1 + APR / m)m - 1 = (1 + 0.067643 /12)12 - 1 = 6.9780%

Which of the following will NOT increase a companyʹs dividend payments?

A) It can issue more shares

Which of the following is a limitation of the dividend-discount model?

A) It cannot handle negative growth rates.

What is the effective annual rate (EAR)?

A) It is the interest rate that would earn the same interest with annual compounding.

In an effort to maintain price stability, it is expected that the European Central Bank will raise interest rates in the future. Which of the following is the most likely effect of such an action on short-term and long-term interest rates in Europe?

A) Long-term interest rates will tend to be higher than short-term interest rates.

Why, in general, do investment opportunities offer a rate greater than that offered by U.S. Treasury securities for the same horizon?

A) Most investment opportunities bear far greater risk than those offered by U.S. Treasury securities.

Given the above term structure of interest rates, which of the following is most likely in the future? Option I. Interest rates will fall. Option II. Economic growth will slow. Option III. Long-term rates will rise relative to short term rates.

A) Option I only

Why is the yield to maturity of a zero-coupon, risk-free bond that matures at the end of a given period the risk-free interest rate for that period?

A) Since such a bond provides a risk-free return over that period, the Law of One Price guarantees that the risk-free interest rate equals the yield to maturity.

Which of the following situations would result in lowering of interest rates by the banking authority of a country?

A) The economy is slowing down

Assume your current mortgage payment is $900 per month. If you begin to pay $1,000 per month (with the extra $100 per month going to principal), which of the following will be TRUE?

A) The mortgage balance will decrease faster with $1,000 monthly payment compared to $900 monthly payments.

Which of the following statements is FALSE of the dividend-discount model?

A) We cannot use the dividend-discount model to value the stock of a firm with rapid or changing growth.

When computing a present value, which of the following is TRUE?

A) You should adjust the discount rate to match the interval between cash flows.

A corporation issues a bond that generates the above cash flows. If the periods are of 3 -month intervals, which of the following best describes that bond?

A) a 15-year bond with a notional value of $5000 and a coupon rate of 4.6% paid quarterly

Which of the following bonds is trading at a premium?

A) a five-year bond with a $2,000 face value whose yield to maturity is 7.0% and coupon rate is 7.2% APR paid semiannually

Which of the following bonds will be least sensitive to a change in interest rates?

A) a ten-year bond with a $2,000 face value whose yield to maturity is 5.8% and coupon rate is 5.8% APR paid semiannually

Which of the following is NOT a way that a firm can increase its dividend?

A) by increasing its retention rate

Which of the following best describes the annual percentage rate?

A) the quoted interest rate which, considered with the compounding period, gives the effective interest rate

A bond certificate includes ________.

A) the terms of the bond

How do we handle a situation when both compounding period and cash flow interval are given to us but both are less than a year and not equal to each other?

Additional care should be taken when the compounding period is given to us and it does not equal the cash flow interval. This requires some additional steps in computing the applicable interest rate. The compounding interval has to match the cash flow interval to enable transformation to present value (PV) or future value (FV). In most cases, it should be possible to achieve this by calculating the effective annual rate from the given compounding interval and subsequently calculating the annual percentage rate and periodic interest rate for the cash flow interval.

Everything else remaining same, under what situation will APR and EAR be equal?

An APR will equal EAR only with annual compounding assuming everything else remains same.

A home buyer buys a house for $2,155,000 . She pays 20% cash, and takes a fixed-rate mortgage for ten years at 7.70% APR. If she makes semi-monthly payments, which of the following is closest to each of her payment?

B) $10,311.34 B) Calculate bimonthly payment when PV of ordinary annuity = $1,724,000 , periodic interest = 7.70/24%, and number of periods = 240.

What is the coupon payment of a 25-year $1000 bond with a 4.5% coupon rate with quarterly payments?

B) $11.25 B) $1000 × 0.045 / 4 = $11.25

Two years ago you purchased a new SUV. You financed your SUV for 60 months (with payments made at the end of the month) with a loan at 6.15% APR. Your monthly payments are $388.05 and you have just made your 24th monthly payment on your SUV. Assuming that you have made all of the first 24 payments on time, then the outstanding principal balance on your SUV loan is closest to ________.

B) $12,727 B) First we need the monthly interest rate = APR / m = 0.0615 / 12 = 0.005125 or 0.5125 %. Now: I = 0.5125 FV = 0 N = 36 (remaining payments 60 - 24 = 36) PMT = 388.05 Compute PV = $12,727.23 .

You are purchasing a new home and need to borrow $260,000 from a mortgage lender. The mortgage lender quotes you a rate of 6.80% APR for a 30-year fixed rate mortgage. The mortgage lender also tells you that if you are willing to pay two points, they can offer you a lower rate of 6.50% APR for a 30-year fixed rate mortgage. One point is equal to 1% of the loan value. So if you take the lower rate and pay the points, you will need to borrow an additional $5200 to cover points you are paying the lender. Assuming you pay the points and borrow from the mortgage lender at 6.50%, then your monthly mortgage payment (with payments made at the end of the month) will be closest to ________.

B) $1676 B) First we need the monthly interest rate = APR / m = 0.0650 / 12 = 0.005417 or 0.5417 %. Now: PV = 265,200 (2 points) I = 0.5417 FV = 0 N = 360 (30 years × 12 months) Compute PMT = $1676.24

Shown above is information from FINRA regarding one of Bank of Americaʹs bonds. How much would the holder of such a bond earn each coupon payment for each $100 in face value if coupons are paid semiannually?

B) $2.15 B) 100 × 4.300% = $4.30; $4.30 / 2 = $2.15

Two years ago you purchased a new SUV. You financed your SUV for 60 months (with payments made at the end of the month) with a loan at 5.95% APR. Your monthly payments are $386.19 and you have just made your 24th monthly payment on your SUV. The amount of your original loan is closest to ________.

B) $20,000 B) First we need the monthly interest rate = APR / m = 0.0595 / 12 = 0.004958 or 0.4958 %. Now: I = 0.4958 FV = 0 N = 60 PMT = $386.19 Compute PV = $20,000

The Sisyphean Company has a bond outstanding with a face value of $5000 that matures in 10 years. The bond certificate indicates that the stated coupon rate for this bond is 8.9% and that the coupon payments are to be made semiannually. How much will each semiannual coupon payment be?

B) $222.5 B) Coupon payment = (coupon rate × face value)/number of coupons per year = (0.089 × 5000 ) / 2 = $222.5

Your firm needs to invest in a new delivery truck. The life expectancy of the delivery truck is five years. You can purchase a new delivery truck for an upfront cost of $240,000 , or you can lease a truck from the manufacturer for five years for a monthly lease payment of $4800 (paid at the end of each month). Your firm can borrow at 7.80% APR with quarterly compounding. The present value (PV) of the lease payments for the delivery truck is closest to ________.

B) $238,132 B) First we need to calculate the monthly discount rate for the lease arrangement. EAR = (1 + APR / m)m - 1 = (1 + 0.078 / 4)4 - 1 = 0.08031 or 8.031% Monthly rate = (1 + EAR)(1/12) - 1= (1 + 0.08031 )(1/12) - 1 = 0.006458 = 0.6458% Now we can apply the PVA formula to calculate the PV of the lease or by calculator: I = 0.6458 N = 60 (5 years × 12 months/yr) FV = 0 PMT = $4800 Compute PV = $238,132 .

Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be $641 million. The firmʹs equity cost of capital is 11%. Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares. If Aaronʹs earnings are expected to grow at a constant 7% per year, what is Aaronʹs share price?

B) $24.96 B) P0 = (0.5 × $641 million) / (0.11 - 0.07) = $8012.5 million; Price per share = $8012.5 million / 321 million = $24.96

Sinclair Pharmaceuticals, a small drug company, develops a vaccine that will protect against Helicobacter pylori, a bacteria that is the cause of a number of diseases of the stomach. It is expected that Sinclair Pharmaceuticals will experience extremely high growth over the next three years and will reinvest all of its earnings in expanding the company over this time. Earnings were $1.10 per share before the development of the vaccine and are expected to grow by 40% per year for the next three years. After this time, it is expected that growth will drop to 5% and stay there for the expected future. Four years from now Sinclair will pay dividends that are 75% of its earnings. If its equity cost of capital is 12%, what is the value of a share of Sinclair Pharmaceuticals today?

B) $25.78

Consider a zero-coupon bond with $100 face value and 15 years to maturity. If the YTM is 7.4%, this bond will trade at a price closest to ________.

B) $34.27

A bond has a $10,000 face value, ten years to maturity, and 8% semiannual coupon payments. What would be the expected difference in this bondʹs price immediately before and immediately after the next coupon payment?

B) $400 B) The expected difference in this bondʹs price will be $400 since the bond pays semiannual coupon of $400 .

What is the coupon payment of a 15-year $10,000 bond with a 9% coupon rate with semiannual payments?

B) $450 B) $10,000 × 0.09/2 = $450

You are considering purchasing a new automobile with the upfront cost of $25,000 or leasing it from the dealer for a period of 60 months. The dealer offers you 4.00% APR financing for 60 months (with payments made at the end of the month). Assuming you finance the entire $25,000 through the dealer, your monthly payments will be closest to ________.

B) $460 B) First we need the monthly interest rate = APR / m = 0.0400 / 12 = 0.003333 or 0.3333 %. Now: PV =$25,000 I = 0.3333 FV = 0 N = 60 Compute PMT = $460.41

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 10 years. The bond certificate indicates that the stated coupon rate for this bond is 8.0% and that the coupon payments are to be made semiannually. Assuming the appropriate YTM on the Sisyphean bond is 11.1%, then the price that this bond trades for will be closest to ________.

B) $816 B) FV = 1000 I = 5.55 (11.1/2) PMT = $40 ($80/2) N = 20 (10 × 2) Compute PV = 815.54

The current zero-coupon yield curve for risk-free bonds is shown above. What is the price of a zero-coupon, four-year, risk-free bond of $100?

B) $87.99 B) Price = (Face value) / (1 + YTM)N; Price = ($100) / (1 + 3.25%)4 = $87.99.

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 6.0% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: Assuming that Lutherʹs bonds receive a AA rating, the price of the bonds will be closest to ________.

B) $941 B) FV = $1,000 PMT = $60.00 N = 10 I = 6.83 Compute PV = $941

A 20-year bond with a $1,000 face value was issued with a yield to maturity of 4.3% and pays coupons semi-annually. After ten years, the yield to maturity is still 4.3% and the clean price of the bond is $959.71 . After three more months go by, what would you expect the dirty price to be?

B) $969.21 B) FV = $1,000, PV = -959.71 , n = 20, i = 2.15%, solve for PMT. PMT = $19.00 , so coupon rate per 6 month period = 1.90%. Accrued interest for three months = $19.00 /2= $9.50 , so dirty price = $959.71 + $9.50 = $969.21 .

Gremlin Industries will pay a dividend of $1.90 per share this year. It is expected that this dividend will grow by 4% per year each year in the future. The current price of Gremlinʹs stock is $23.50 per share. What is Gremlinʹs equity cost of capital?

B) 12%

The above table shows the yields to maturity on a number of two-year, zero-coupon securities. What is the credit spread on a two-year, zero-coupon corporate bond with a B rating?

B) 2.0%

What is the yield to maturity of a(n) eight-year, $5000 bond with a 4.4% coupon rate and semiannual coupons if this bond is currently trading for a price of $4723.70 ?

B) 5.26% B) Using FV = $5000 , periods to maturity = 16, PMT = 110.00 , and PV = $4724 , calculate discount rate = 2.6275% per period; 2.6275 × 2 = 5.255%.

Joseph buys a Hummer for $59,000 , financing it with a five-year 7.60% APR loan paid monthly. He decides to pay an extra $50 per month in addition to his monthly payments. Approximately how long will he take to pay off the loan under these conditions?

B) 57.07 months B) The first step is to calculate the monthly payment using a present value (PV) of $59,000 , monthly interest rate of 7.60/12 = 0.633333 %, and 60 periods, which = $1185.04 ; the second step is to add $50 to this monthly payment giving the new monthly payment of $1235.04 ; the last step is to calculate the time required to pay off the loan = 57.0740 months.

Elinore is asked to invest $5100 in a friendʹs business with the promise that the friend will repay $5610 in one year. Elinore finds her best alternative to this investment, with similar risk, is one that will pay her $5508 in one year. U.S. securities of similar term offer a rate of return of 7%. What is the opportunity cost of capital in this case?

B) 8% B) $5508 - $5100 = $408 ; $408 / $5100 = 0.08 or 8%

If the current inflation rate is 2.0%, then the nominal rate necessary for you to earn a(n) 7.3% real interest rate on your investment is closest to ________.

B) 9.4% B) nominal = (1 + inflation)(1 + real) - 1 = (1 + 0.073 )(1 + 0.02) - 1 = 0.0945or 9.4%

You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $1.25 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 13% and their equity cost of capital is 15%. The expected growth rate for KTIʹs dividends is closest to ________.

B) 9.8% B) g = Retention rate × Return on new investment = ($5 - $1.25 ) / $5 × 0.13 = 0.0975 or 9.8%

Suppose that when these bonds were issued, Luther received a price of $972.42 for each bond. What is the likely rating that Lutherʹs bonds received?

B) BBB B) FV = $1,000 PMT = $70 N = 10 PV = -$972.42 Compute I = 7.4% which is the BBB rating yield.

Which of the following statements regarding bonds and their terms is FALSE?

B) By convention, the coupon rate is expressed as an effective annual rate

Which of the following models directly values all of the firmʹs equity, rather than a single share? I. Dividend-discount model II. Total payout model III. Discounted cash flow model

B) II only

The above screen shot above from Google Finance shows the price history of Progenics, a pharmaceutical company. In the time period shown, Progenics released information that an intravenously-administered formulation of their leading product had failed in a Phase III clinical trial. In which of the months shown in the price history is this most likely to have occurred?

B) March 2008

Which of the following is/are TRUE? I. The EAR can never exceed the APR. II. The APR can never exceed the EAR. III. The APR and EAR can never be equal.

B) Only II is true.

Which of the following formulas is INCORRECT?

B) PN = (rE - g) × DivN+1

Which of the following statements regarding bonds and their terms is FALSE?

B) Prior to its maturity date, the price of a zero-coupon bond is always greater than its face value.

Five years ago you took out a 30-year mortgage with an APR of 6.5% for $200,000. If you were to refinance the mortgage today for 20 years at an APR of 4.25%, how much would your monthly payment change by?

B) The monthly payment will decrease by $104.79 B) Current Mortgage Payment: P/Y = 12, N = 360, I/Y = 6.5, PV = $200,000, Solve for PMT = $1,264.14 Current Mortgage Balance: P/Y = 12, N = 300, I/Y = 6.5, PMT = $1,264.14, Solve for PV = $187,221.9 New Mortgage Payment: P/Y = 12, N = 240, I/Y = 4.25, PV = $187,222.54, Solve for PMT = $1,159.35 Current Payment - New Payment = $1,159.35- $1,264.14 = -$104.79

A $1000 bond with a coupon rate of 6.2% paid semiannually has eight years to maturity and a yield to maturity of 8.3%. If interest rates rise and the yield to maturity increases to 8.6%, what will happen to the price of the bond?

B) The price of the bond will fall by $15.78 . B) Using FV = $1000 , periods to maturity = 16, PMT = 31.00 , and discount rate = 4.15%, calculate PV = $878.9937 ; Using FV = $1000 , periods to maturity = 16, PMT = 31.00 , and discount rate = 4.30%, calculate PV = $863.2168 ; difference = $878.9937 - $863.2168 = $15.7769 .

Which of the following statements regarding bonds and their terms is FALSE?

B) The yield to maturity of a bond is the discount rate that sets the future value (FV) of the promised bond payments equal to the current market price of the bond.

Which of the following statements is FALSE?

B) Total return equals earnings multiplied by the dividend payout rate.

Which of the following statements regarding bonds and their terms is FALSE?

B) Unlike the case of bonds that pay coupons, for zero-coupon bonds, there is no formula to solve for the yield to maturity.

A corporate bond makes payments of $9.67 every month for ten years with a final payment of $2009.67. Which of the following best describes this bond?

B) a 10-year bond with a face value of $2,000 and a coupon rate of 5.8% with monthly payments B) $9.67 × 12 / (2,009.67 - 9.67) = 5.802%

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 5 years. The bond certificate indicates that the stated coupon rate for this bond is 8.1% and that the coupon payments are to be made semiannually. Assuming the appropriate YTM on the Sisyphean bond is 10.6%, then this bond will trade at ________.

B) a discount B) As the coupon rate of 8.1% is less than the YTM of 10.6% on the bonds, so they will trade at a discount.

The above information is for a corporate bond issued by the Markel Corporation. What sort of bond is this?

B) an investment grade bond

You placed an order to purchase stock where you specified the maximum price you were willing to pay. This type of order is known as a ________.

B) limit order

Which of the following accounts has the highest EAR?

B) one that pays 1.0% per month B) Calculate the EAR for each choice and pick the highest: A = 11.09 %; B= 12.68 %; C = 9.60%; D = 9.95%.

What is the dirty price of a bond?

B) the bondʹs actual cash price

What, typically, is used to calculate the opportunity cost of capital on a risk-free investment?

B) the interest rate on U.S. Treasury securities with the same term

The yield curve is typically ________.

B) upward sloping

In which of the following situations would it not be appropriate to use the following formula: PV = C0 + C1/(1 + r) + C2/(1 + r)2 + . . . . + Cn/(1 + r)n when determining the present value (PV) of a cash flow stream?

B) when short-term and long-term interest rates vary widely

The above screen shot from Google Finance shows the basic stock information for Logitech International SA (USA) after the close of business on August 22, 2008. What is the difference between the opening and closing price of the stock on this date?

C) $0.24 C) $26.30 - $26.06 = $0.24

A mining company needs to raise $100 million in order to begin open -pit mining of a coal seam. The company will fund this by issuing 30-year bonds with a face value of $1,000 and a coupon rate of 6.5%, paid annually. The above table shows the yield to maturity for similar 30-year corporate bonds of different ratings. If the companyʹs bonds are rated A, what will be their selling price?

C) $1054.48 C) Calculate the PV of the bond with FV = $1,000, YTM = 6.1%, PMT = 65.00 , and N = 30, which = $1054.48

A $50,000 new car loan is taken out with the terms 12% APR for 48 months. How much are monthly payments on this loan?

C) $1316.69 C) Calculate the PMT when PV of ordinary annuity = $50,000 , periodic interest = 12/12%, and number of periods = 48.

Howard is saving for a holiday. He deposits a fixed amount every month in a bank account with an EAR of 14.7%. If this account pays interest every month then how much should he save from each monthly paycheck in order to have $14,000 in the account in four yearsʹ time?

C) $220 C) First calculate the APR using an EAR of 14.7% and monthly compounding, which comes to 13.7937 %. Then using a periodic rate of 13.7937 /12, calculate the payment over 48 months that gives a future value (FV) of $14,000 , which is $110.15.

You are purchasing a new home and need to borrow $380,000 from a mortgage lender. The mortgage lender quotes you a rate of 5.75% APR for a 30-year fixed rate mortgage. The mortgage lender also tells you that if you are willing to pay two points, they can offer you a lower rate of 5.45% APR for a 30-year fixed rate mortgage. One point is equal to 1% of the loan value. So if you take the lower rate and pay the points, you will need to borrow an additional $7600 to cover points you are paying the lender. Assuming you do not pay the points and borrow from the mortgage lender at 5.75%, then your monthly mortgage payment (with payments made at the end of the month) will be closest to ________.

C) $2218 C) First we need the monthly interest rate = APR / m = 0.0575 / 12 = 0.004792 or 0.4792 %. Now: PV = $380,000 (no points) I = 0.4792 FV = 0 N = 360 (30 years × 12 months) Compute PMT = $2217.58 .

Matilda Industries pays a dividend of $2.10 per share and is expected to pay this amount indefinitely. If Matildaʹs equity cost of capital is 9%, which of the following would be closest to Matildaʹs stock price?

C) $23.33 C) PV0 = $2.10 / 0.09 = $23.33

Corey buys 10 Tufflift 4-post, 4.5-ton car hoists for his parking garage at a total cost of $432,000 . He finances this with a five-year loan at 7.80% APR with monthly payments. After he has made the first 20 payments, how much is the outstanding principal balance on his loan?

C) $306,206 C) The first step is to calculate the monthly payment using a present value (PV) of $432,000 , monthly interest rate of 7.80/12 = 0.650000 %, and 60 periods, which = $8718.11 ; the second step is to use that monthly payment to calculate the present value (PV) of 40 months keeping the interest rate unchanged, which = $306,206.10 .

A truck costing $111,000 is paid off in monthly installments over four years with 8.10% APR. After three years the owner wishes to sell the truck. What is the closest amount from the following list that he needs to pay on his loan before he can sell the truck?

C) $31,195 C) The first step is to calculate the monthly payment using a present value (PV) of $111,000 monthly interest rate of 8.10/12 = 0.675000 %, and 48 periods, which = $2715.05 ; the second step is to use that monthly payment to calculate the present value (PV) of 12 months remaining payment keeping the interest rate unchanged.

Valorous Corporation will pay a dividend of $1.75 per share at this yearʹs end and a dividend of $2.35 per share at the end of next year. It is expected that the price of Valorousʹ stock will be $41 per share after two years. If Valorous has an equity cost of capital of 9%, what is the maximum price that a prudent investor would be willing to pay for a share of Valorous stock today?

C) $38.09 C) Using a financial calculator, CF0 = 0,CF1 = 1.75,CF2 = (41 + 2.35) = 43.35 ; calculate NPV at I = 9%, equals $38.09 .

Drew receives an inheritance that pays him $54,000 every three months for the next two years. Which of the following is closest to the present value (PV) of this inheritance if the interest rate is 8.9% (EAR)?

C) $392,957 C) First calculate the APR with quarterly compounding, which equals 8.62%; then using a periodic interest rate of 8.62/4%, calculate the present value (PV) of an annuity of $54,000 for eight periods.

Shown above is information from FINRA regarding one of Caterpillar Financial Servicesʹ bonds. How much would the holder of such a bond earn each coupon payment for each $100 in face value if coupons are paid annually?

C) $4.00 C) $97.05 × 4% = $4.00

You expect that Bean Enterprises will have earnings per share of $2 for the coming year. Bean plans to retain all of its earnings for the next three years. For the subsequent two years, the firm plans on retaining 50% of its earnings. It will then retain only 25% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 20% per year. If Beanʹs equity cost of capital is 10%, then the price of a share of Beanʹs stock is closest to ________.

C) $41.36

Sunnyfax Publishing pays out all its earnings and has a share price of $37. In order to expand, Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds. Once the funds are reinvested, they are expected to grow at a rate of 13%. If the reinvestment does not affect Sunnyfaxʹs equity cost of capital, what is the expected share price as a consequence of this decision?

C) $52.38

An investor holds a Ford bond with a face value of $5000 , a coupon rate of 8.5%, and semiannual payments that matures on January 15, 2029. How much will the investor receive on January 15, 2029?

C) $5212.50 C) $5000 + $5000 × 0.085 /2 = $5212.5

A risk-free, zero-coupon bond has 15 years to maturity. Which of the following is closest to the price per $1000 of face value that the bond will trade at if the YTM is 6.1%?

C) $553.15 C) Price = (Face value) / (1 + YTM)N. Price = ($1000 ) / (1 + 6.1%)10 = $553.15

You are considering purchasing a new automobile with the upfront cost of $26,000 or leasing it from the dealer for a period of 48 months. The dealer offers you 2.80% APR financing for 48 months (with payments made at the end of the month). Assuming you finance the entire $26,000 through the dealer, your monthly payments will be closest to ________.

C) $573 C) First we need the monthly interest rate = APR / m = 0.0280 / 12 = 0.002333 or 0.002333 %. Now: PV = $26,000 I = 0.2333 FV = 0 N = 48 Compute PMT = $573.20 .

You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $2.50 of these earnings to shareholders in the form of a dividend. KTIʹs return on new investments is 14% and their equity cost of capital is 11%. The value of a share of KTIʹs stock today is closest to ________.

C) $62.50 C) g = Retention rate × Return on new investment = ($5 - $2.50 )/$5 × 0.14 = 0.07 or 7% P0 = Div1 / (rE - g) = $2.50 / (0.11 - 0.07) = $62.50

Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the end of the year to be $960 million. The firmʹs equity cost of capital is 9%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittendenʹs earnings are expected to grow at a constant 3% per year, what is Chittendenʹs share price?

C) $7.47 C) P0 = (0.3 × $960 million) / (0.09 - 0.03) = $4800 million; Price per share = $4800 million / 643 million = $7.47

An investor buys a property for $608,000 with a 25-year mortgage and monthly payments at 8.10% APR. After 18 months the investor resells the property for $667,525 . How much cash will the investor have from the sale, once the mortgage is paid off?

C) $71,521 C) The first step is to calculate the monthly payment using a present value (PV) of $608,000 , monthly interest rate of 8.10/12 = 0.675000 %, and 300 periods, which = $4732.9906 ; the second step is to use that monthly payment to calculate the present value (PV) of 282 months keeping the interest rate unchanged which = $596,004.59 ; finally calculate the difference between $667,525 - $596,004.59 = $71,520.55 .

A homeowner has five years of monthly payments of $1400 before she has paid off her house. If the interest rate is 6% APR, what is the remaining balance on her loan?

C) $72,416 C) Calculate PV of the ordinary annuity of $1400 paid per month at a periodic interest rate of 6 /12 = 0.500000 % over 60 months = $72,416 .

What must be the price of a $1000 bond with a 5.8% coupon rate, annual coupons, and 20 years to maturity if YTM is 7.8% APR?

C) $800.68 C) Using FV = $1000 , periods to maturity = 20, PMT = $58.00 , and discount rate = 7.8% per period, calculate PV = $800.68

The above table shows the yields to maturity on a number of three-year, zero-coupon securities. What is the price per $100 of the face value of a three-year, zero-coupon corporate bond with a BBB rating?

C) $82.55 C) Calculate the PV of the bond with FV = $100, YTM = 6.6%, and N = 3, which = $82.55 .

Avril Synchronistics will pay a dividend of $1.20 per share this year. It is expected that this dividend will grow by 3% each year in the future. What will be the current value of a single share of Avrilʹs stock if the firmʹs equity cost of capital is 16%?

C) $9.23

The Sisyphean Companyʹs common stock is currently trading for $25.50 per share. The stock is expected to pay a $2.80 dividend at the end of the year and the Sisyphean Companyʹs equity cost of capital is 10%. If the dividend payout rate is expected to remain constant, then the expected growth rate in the Sisyphean Companyʹs earnings is closest to ________.

C) -0.98% C) P0 = Div1 / (rE - g) = $25.50 = $2.80 / (0.1 - g),so g = -0.0098 or -0.98%

A company issues a ten-year $1,000 face value bond at par with a coupon rate of 6.7% paid semiannually. The YTM at the beginning of the third year of the bond (8 years left to maturity) is 8.1%. What was the percentage change in the price of the bond over the past two years?

C) -8.13% C) The new price would be $918.73 . ($918.73 - $1000)/1000 = -8.13%

Your firm needs to invest in a new delivery truck. The life expectancy of the delivery truck is five years. You can purchase a new delivery truck for an upfront cost of $300,000 , or you can lease a truck from the manufacturer for five years for a monthly lease payment of $6000 (paid at the end of each month). Your firm can borrow at 8.00% APR with quarterly compounding. The monthly discount rate that you should use to evaluate the truck lease is closest to ________.

C) 0.6623% C) EAR = (1 + APR / m)m - 1 = (1 + 0.08/4)4 - 1 = 0.08243 or 8.243% Monthly rate = (1 + EAR)(1/12) - 1= (1 + 0.08243 )(1/12) - 1 = 0.006623 = 0.6623%

A pottery factory purchases a continuous belt conveyor kiln for $68,000 . A 6.3% APR loan with monthly payments is taken out to purchase the kiln. If the monthly payments are $765.22 , over what term is this loan being paid?

C) 10 years C) Calculate N when PV of ordinary annuity = $68,000 , periodic interest = 6.3/12%, and monthly payments = $765.22 . N = 156 periods; years = 13 years.

A 10% APR with quarterly compounding is equivalent to an EAR of ________.

C) 10.38% C) EAR = (1 + 0.10 / 4)4 - 1 = 10.38%

A round lot consists of how many shares?

C) 100

The effective annual rate (EAR) for a loan with a stated APR of 11% compounded quarterly is closest to ________.

C) 11.46% C) EAR = (1 + APR / m)m - 1 = (1 + 0.11/4)4 - 1 = 0.1146 or 11.46%

Jumbuck Exploration has a current stock price of $3.00 and is expected to sell for $3.15 in one yearʹs time, immediately after it pays a dividend of $0.28 . Which of the following is closest to Jumbuck Explorationʹs equity cost of capital?

C) 14.33% C) $0.28 + $3.15 - $3.00 = $0.43 ; cost of capital = $0.43 /$3.00 = 14.33%

Luther Industries needs to raise $25 million to fund a new office complex. The company plans on issuing ten-year bonds with a face value of $1,000 and a coupon rate of 7.3% (annual payments). The following table summarizes the YTM for similar ten-year corporate bonds of various credit ratings: Assuming that Lutherʹs bonds receive a AAA rating, the number of bonds that Luther must issue to raise the needed $25 million is closest to ________.

C) 23,724 C) FV = $1,000 PMT = $73.00 N = 10 I = 6.55 Compute PV = $1053.79 . Total number of bonds = $25,000,000 / $1053.79 = 23,723.89 .

The current zero-coupon yield curve for risk-free bonds is shown above. What is the risk-free interest rate on a 4-year maturity?

C) 3.25%

A ten-year, zero-coupon bond with a yield to maturity of 4% has a face value of $1000 . An investor purchases the bond when it is initially traded, and then sells it four years later. What is the rate of return of this investment, assuming the yield to maturity does not change?

C) 4.00%

The effective annual rate (EAR) for a savings account with a stated APR of 5% compounded daily is closest to ________.

C) 5.13% C) EAR = (1 + APR / m)m - 1 = (1 + 0.05 / 365)365 - 1 = 0.0513 or 5.13%

A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 6%, what should be the coupon rate offered if the bond is to trade at par?

C) 6%

The highest effective rate of return you could earn on any of these investments is closest to ________.

C) 6.1610% C) EAR (A) = (1 + APR / m)m - 1 = (1 + 0.060860 /1)1 - 1 = 6.0860% EAR (B) = (1 + APR / m)m - 1 = (1 + 0.059320 /365)365 - 1 = 6.1110% EAR (C) = (1 + APR / m)m - 1 = (1 + 0.059997 /4)4 - 1 = 6.1360% EAR (D) = (1 + APR / m)m - 1 = (1 + 0.059936 /12)12 - 1 = 6.1610%

A bank pays interest semiannually with an EAR of 13%. What is the periodic interest rate applicable semiannually ?

C) 6.30% C) First convert the EAR to APR with semiannually compounding, which equals 12.60 %; now divide this by 2 to get the periodic interest rate = 6.30%.

What is the yield to maturity of a one-year, risk-free, zero-coupon bond with a $10,000 face value and a price of $9400 when released?

C) 6.383% C) Calculate the discount rate that equates $10,000 to $9400 in one year. 1 + YTMn = (Face value / price)1/n. YTMn = 6.383%

What is the yield to maturity of a ten-year, $10,000 bond with a 5.4% coupon rate and semiannual coupons if this bond is currently trading for a price of $9207.93 ?

C) 6.49% C) Using FV = $10,000 , periods to maturity = 20, PMT = 270.00 , and PV = $9207.93 , calculate discount rate = 3.2445% per period; 3.2445 × 2 = 6.489%.

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in five years. The bond certificate indicates that the stated coupon rate for this bond is 8.5% and that the coupon payments are to be made semiannually. Assuming that this bond trades for $1081.73 , then the YTM for this bond is closest to ________.

C) 6.56% C) FV = $1000 PMT = $42.50 ($85 / 2) N = 10 (5 × 2) PV = -$1081.73 Compute I = 3.2783 × 2 = 6.5565 %.

A bank offers a loan that will requires you to pay 7% interest compounded monthly . Which of the following is closest to the EAR charged by the bank?

C) 7.23% C) EAR = {(1 + APR) / m}m - 1; EAR = {(1 + 0.07) / 12}12 - 1; 0.0723 × 100 = 7.23%

A house costs $148,000 . It is to be paid off in exactly ten years, with monthly payments of $1737.54 . What is the APR of this loan?

C) 7.25% C) Calculate the periodic interest rate when PV of ordinary annuity = $148,000 , number of months = 120, and monthly payments = $1737.54 ; the periodic interest rate = 0.60%, which multiplied by 12 gives an APR = 7.25%.

Consolidated Insurance wants to raise $35 million in order to build a new headquarters. The company will fund this by issuing 10-year bonds with a face value of $1,000 and a coupon rate of 6.3%, paid semiannually. The above table shows the yield to maturity for similar 10-year corporate bonds of different ratings. Which of the following is closest to how many more bonds Consolidated Insurance would have to sell to raise this money if their bonds received an A rating rather than an AA rating?

C) 781 bonds C) Calculate the PV of the bond with FV = $1,000, YTM = 3.2%, PMT = 31.50 , and N = 20, which = $992.70 ; thus, the number of bonds sold if AA rating = 35,257.49 bonds; Calculate the PV of the bond with FV = $1,000, YTM = 3.35%, PMT = 31.50 , and N = 20, which = 971.19 ; thus, the number of bonds sold if A rating = 36,038.43 bonds; hence, the difference = 781 bonds.

An investor purchases a 30-year, zero-coupon bond with a face value of $5000 and a yield to maturity of 8.4%. He sells this bond ten years later. What is the rate of return on his investment, assuming yield to maturity does not change?

C) 8.40%

Which of the following statements is true of bond prices?

C) A rise in interest rates causes bond prices to fall.

Lloyd Industries raised $28 million in order to upgrade its roller kiln furnace for the production of ceramic tiles. The company funded this by issuing 15-year bonds with a face value of $1,000 and a coupon rate of 6.2%, paid annually. The above table shows the yield to maturity for similar 15-year corporate bonds of different ratings issued at the same time. When Lloyd Industries issued their bonds, they received a price of $962.63. Which of the following is most likely to be the rating these bonds received?

C) BBB C) Calculate the YTM of the bond with FV = $1,000, PMT = 62, and N = 15, which = 6.6%; the table shows that the bonds received a BBB rating.

Inflation is calculated as the rate of change in the _______.

C) Consumer Price Index

Which of the following will be a source of cash flows for a shareholder of a certain stock? I. Sale of the shares at a future date II. The firm in which the shares are held paying out cash to shareholders in the form of dividends III. The firm in which the shares are held increasing the total number of shares outstanding through a stock split

C) I and II

Given that the inflation rate in 2006 was about 3.24%, while a short-term municipal bond offered a rate of 2.9%, which of the following statements is correct?

C) Investors in these bonds were able to buy less at the end of the year than they could have purchased at the start of the year.

An animator needs a laptop for audio/video editing, and notices that he can pay $2600 for a Dell XPS laptop, or lease from the manufacturer for monthly payments of $75 each for four years. The designer can borrow at an interest rate of 14% APR compounded monthly. What is the cost of leasing the laptop over buying it outright?

C) Leasing costs $145 more than buying. C) Using a periodic rate of 14% / 12 per month, calculate the present value (PV) of an annuity of $75 for 48 months; then subtract $2600 to calculate the difference in costs.

How are investors in zero-coupon bonds compensated for making such an investment?

C) Such bonds are purchased at a discount, below their face value.

Which of the following statements is FALSE?

C) The highest interest rate for a given horizon is the rate paid on U.S. Treasury securities.

Which of the following statements regarding bonds and their terms is FALSE?

C) The only cash payments the investor will receive from a zero-coupon bond are the interest payments that are paid up until the maturity date.

Why are the interest rates of U.S. Treasury securities less than the interest rates of equivalent corporate bonds?

C) U.S. Treasury securities are widely regarded to be risk-free.

Which of the following bonds will be most sensitive to a change in interest rates if all bonds have the same initial yield to maturity?

C) a 20-year bond with a $1,000 face value whose coupon rate is 5.8% APR paid semiannually

Which of the following bonds is trading at par?

C) a bond with a $1,000 face value trading at $1,000

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 5 years. The bond certificate indicates that the stated coupon rate for this bond is 10.0% and that the coupon payments are to be made semiannually. Assuming the appropriate YTM on the Sisyphean bond is 7.5%, then this bond will trade at ________.

C) a premium C) As the coupon rate of 10.0% is more than the YTM of 7.5% on the bonds, so the bonds will trade at a premium.

A(n) 12% APR with monthly compounding is closest to ________.

C) an EAR of 12.68% C) EAR = {(1 + 0.12) / m}m - 1 = 12.68 %.

What is the shape of the yield curve and what expectations are investors likely to have about future interest rates?

C) inverted; lower

A bank offers an account with an APR of 5.8% and an EAR of 5.88%. How does the bank compound interest for this account?

C) semiannual compounding C) Using an APR = 5.8%, calculate the EAR for the compounding periods given in each choice: A = 5.97%; B = 5.96%; C = 5.88%; D = 5.8%.

A university issues a bond with a face value of $5000 and a coupon rate of 4.41% that matures on July 15, 2018. The holder of such a bond receives coupon payments of $110.25 . How frequently are coupon payments made in this case?

C) semiannually

Based upon the information provided in the table above, you can conclude ________.

C) that the yield curve is downward sloping

The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 15 years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon payments are to be made semiannually. How much are each of the semiannual coupon payments? Assuming the appropriate YTM on the Sisyphean bond is 8.8%, then at what price should this bond trade for?

Coupon payments = (coupon rate × face value) / number of coupons per year = (.08 × $1,000) / 2 = $40 FV = 1,000 I = 4.4% (8.8/2) PMT = $40 ($80/2) N = 30 (15 × 2) Compute PV = $934.07

Which of the following best shows the timeline for cash flows from a five-year bond with a face value of $2,000, a coupon rate of 5.0%, and semiannual payments?

D

Which of the following yield curves would most likely predict a downturn in the economy?

D

Five years ago you took out a 30-year mortgage with an APR of 6.20% for $206,000 . If you were to refinance the mortgage today for 20 years at an APR of 3.95%, how much would you save in total interest expense?

D) $100,251 D) Current Mortgage Payment: P/Y = 12, N = 360, I/Y = 6.20,PV = $206,000 , Solve for PMT = 1261.69 Current Mortgage Balance: P/Y = 12, N = 300, I/Y = 6.20, PMT = 1261.69 , Solve for PV = $192,159.69 Total of Remaining Payments on Current Mortgage = 300 × $1261.69 = $378,505.83 New Mortgage Payment: P/Y = 12, N = 240, I/Y = 3.95, PV = $192,159.69 , Solve for PMT = $1159.39 Total Payments on New Mortgage: 240 × $1159.39 = $278,254.41 Difference in Total of Payments = $378,505.83 - $278,254.41 = $100,251

A firm issues two-year bonds with a coupon rate of 6.7%, paid semiannually. The credit spread for this firmʹs two-year debt is 0.8%. New two-year Treasury notes are being issued at par with a coupon rate of 3.1%. What should the price of the firmʹs outstanding two-year bonds be per $100 of face value?

D) $105.34 D) Calculate the PV of the bond with FV = $100, YTM = 1.95%, PMT = 3.35, and N = 4 which = $105.34 .

A five-year bond with a $1,000 face value has a yield to maturity is 5.0% and itʹs coupon rate is 6.0% paid annually. The dirty price of this bond exactly 6 months after its second coupon payment is closest to ________.

D) $1057.23 D) Calculate the clean price right after second coupon payment using FV = $1,000. YTM = 5.0%, PMT = 60, and N = 3; clean price = $1027.23 ; accrued interest six months after last coupon is $30; dirty price = $1027.23 + $30 = $1057.23 .

Growth Industries presently pays an annual dividend of $1.20 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowthʹs equity cost of capital is 10%, then the value of a share of NoGrowthʹs stock is closest to ________.

D) $12.00 D) P0 = Div1 / (rE - g) = $1.20 / (0.1 - 0) = $12.00

A $52,000 loan is taken out on a boat with the terms 3% APR for 36 months. How much are the monthly payments on this loan?

D) $1512.22 D) Calculate the PMT when PV of ordinary annuity = $52,000 , periodic interest = 3/12%, and number of periods = 36.

Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If Owenʹs equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend?

D) $16.00 D) (1 + 0.12) × $15.00 = $16.80 ; $16.80 - $0.80 = $16.00

Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in the coming year. It decides to retain 10% of these earnings in order to lease new aircraft. The return on this investment will be 25%. If its equity cost of capital is 11%, what is the expected share price of Jumbo Transport?

D) $21.18

The table above shows the interest rates available from investing in risk-free U.S. Treasury securities with different investment terms. What is the present value (PV) of cash flows from an investment that yields $6000 at the end of each year for the next four years?

D) $22,639 D) PV of $11,000 at 1.8% for 1 year = $5893.91 ; PV of $11,000 at 2.25% for 2 years = $5710.89 ; PV of $11,000 at 2.30% for 3 years = $5604.34 ; PV of $11,000 at 2.66% for 4 years = $5401.90 ; sum of these four PVs = $22,638.99 .

A stock is expected to pay $2.60 per share every year indefinitely and the equity cost of capital for the company is 11%. What price would an investor be expected to pay per share next year?

D) $23.64 D) P0 = $2.60 / 0.11 = $23.64

Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that this dividend will grow by 5% per year each year in the future. What will be the current value of a single share of Spacefoodʹs stock if the firmʹs equity cost of capital is 12%?

D) $34.29

The above screen shot from Google Finance shows the basic stock information for Kraft Foods Inc. after the close of the stock market on May 30, 2008. What is the highest that the stock has traded at in the last 12 months?

D) $35.29

Consider a zero-coupon bond with a $1000 face value and 10 years left until maturity. If the YTM of this bond is 10.2%, then the price of this bond is closest to ________.

D) $379 D) FV = 1000 I = 10.2 PMT = 0 N = 10 Compute PV = FV (1 + i)N = 1000 (1 + 10.200 )10 = 378.60

A risk-free, zero-coupon bond with a face value of $10,000 has 15 years to maturity. If the YTM is 6.1%, which of the following would be closest to the price this bond will trade at?

D) $4114 D) Price = (Face value) / (1 + YTM)N. Price = ($10,000 ) / (1 + 6.1%)15 = $4114

Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0 million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to repurchase shares. If Sultanʹs earnings are expected to grow by 5% per year, these payout rates do not change, and Sultanʹs equity cost of capital is 10%, what is Sultanʹs share price?

D) $60.00 D) P0 = (0.6 × $6.0 million) / (0.1 - 0.05) = $72 million; P0 = $72 million / 1.2 million = $60.00

The above screen shot from Google Finance shows basic stock information for PepsiCo. If you owned 1600 shares of PepsiCo for the period shown, how much would you have earned in dividend payments?

D) $688.00 D) 1600 × $0.43 = $688.00

Valence Electronics has 213 million shares outstanding. It expects earnings at the end of the year of $800 million. Valence pays out 40% of its earnings in total15% paid out as dividends and 25% used to repurchase shares. If Valenceʹs earnings are expected to grow by 7% per year, these payout rates do not change, and Valenceʹs equity cost of capital is 9%, what is Valenceʹs share price?

D) $75.12 D) P0 = (0.4 × $800 million) / (0.09 - 0.07) = $16,000 million; Price per share = $16,000 million / 213 million = $75.12

The table above shows the interest rates available from investing in risk-free U.S. Treasury securities with different investment terms. If an investment offers a risk-free cash flow of $100,000 in two yearsʹ time, what is the present value (PV) of that cash flow?

D) $95,647 D) Using FV = $100,000 , find the present value (PV) at 2.25% for 2 years.

he net present value (NPV) of an investment that costs $4320 and pays $1600 certain at the end of one, three, and five years is closest to ________.

D) -$114.21 D) NPV = -4320 + 1600 / (1.05)1 +1600 / (1.046)3 + 1600 / (1.045)5 = -$114.21

In 2007, interest rates were about 4.5% and inflation was about 2.8%. What was the real interest rate in 2007?

D) 1.65% D) 1.045 / 1.028 = 1.0165; real rate = 1.65%

A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 8%, which of the following coupon rates will cause the bond to be issued at a premium?

D) 10%

A 12% APR with bi-monthly compounding is equivalent to an EAR of ________.

D) 12.62% D) EAR = {(1 + 0.12) / 6}6 - 1 = 12.62%

Michael has a credit card debt of $75,000 that has a 12% APR, compounded monthly. The minimum monthly payment only requires him to pay the interest on his debt. He receives an offer for a credit card with an APR of 4% compounded monthly. If he rolls over his debt onto this card and makes the same monthly payment as before, how long will it take him to pay off his credit card debt?

D) 122 months D) The first step is to calculate the minimum monthly payment using the debt balance of $75,000 and 12% APR compounded monthly, which = $75,000 × 12% / 12 = $750 . The second step is to use the same $750 as payment, and using a discount rate of 4%/12, calculate the number of months required to pay off the present value (PV) of $75,000 , which = 122 months.

The Busby Corporation had a share price at the start of the year of $26.10 , paid a dividend of $0.59 at the end of the year, and had a share price of $29.50 at the end of the year. Which of the following is closest to the rate of return of investments in companies with equal risk to The Busby Corporation for this period?

D) 15% D) $29.50 + $0.59 - $26.10 = $3.99 ; $3.99 / $26.10 = 15.29 %; rounded to 15%

A stock is bought for $23.00 and sold for $27.00 one year later, immediately after it has paid a dividend of $1.50. What is the capital gain rate for this transaction?

D) 17.39% D) Capital gain rate = (P1 - P0) / P0 = ($27.00 - $23.00 ) / $23.00 = 17.39%

The above table shows the price per $100-face value bond of several risk-free, zero-coupon bonds. What is the yield to maturity of the two year, zero-coupon, risk-free bond shown?

D) 2.85% D) Calculate the discount rate that equates $100 to $94.53 in two years. 1 + YTMn = (Face value / price)1/n. YTMn = 2.85%

Consider an investment that pays $1900 certain at the end of each of the next four years. If the investment costs $6650 and has a net present value (NPV) of $142.31 , then the four year risk-free interest rate is closest to ________.

D) 4.51% D) NPV = 142.31 = -6650 + 1900 / (1.05)1 + 1900 / (1.048)2 + 1900 / (1.046)3 +1900 / (1 + x)4 6650 + 142.31 - 1900 / (1.05)1 + 1900 / (1.048)2 + 1900 / (1.046)3 = 1900 / (1 + x)4 X = 0.0451 or 4.51%

Consider a zero-coupon bond with a $1000 face value and 15 years left until maturity. If the bond is currently trading for $431 , then the yield to maturity on this bond is closest to ________.

D) 5.77% D) FV = 1000 PV = -431 PMT = 0 N = 15 Compute I = 5.7714 %.

the current inflation rate is 3.6% and you have an investment opportunity that pays 10.9%, then the real rate of interest on your investment is closest to ________.

D) 7.0% D) (1 + nominal rate) = (1 + inflation rate)(1 + real rate) real interest rate = 1 + nominal rate 1 + inflation rate - 1 = 0.070463 or 7.05%

Ursula wants to buy a $19,000 used car. She has savings of $2,000 plus an $800 trade-in. She wants her monthly payments to be about $282 . Which of the following loans offers monthly payments closest to $282 ?

D) 7.8% APR for 72 months D) Calculate N when PV of ordinary annuity = $19,000 - $2,000 - $800 = $16,200 , periodic interest = 7.8/12%, and monthly payments = $282 .

Your firm needs to invest in a new delivery truck. The life expectancy of the delivery truck is five years. You can purchase a new delivery truck for an upfront cost of $350,000 , or you can lease a truck from the manufacturer for five years for a monthly lease payment of $7000 (paid at the end of each month). Your firm can borrow at 9.00% APR with quarterly compounding. The effective annual rate on your firmʹs borrowings is closest to ________.

D) 9.31% D) EAR = (1 + APR / m)m - 1 = (1 + 0.0900 /4)4 - 1 = 0.09308 or 9.31%

A bond has five years to maturity, a $1000 face value, and a 5.5% coupon rate with annual coupons. What is its yield to maturity if it is currently trading at $846.11 ?

D) 9.51% D) Using FV = $1000 , periods to maturity = 5, PMT = 55.00 , and PV = $846.11 , calculate discount rate = 9.5089% per period.

The Sisyphean Company has a bond outstanding with a face value of $5000 that reaches maturity in 8 years. The bond certificate indicates that the stated coupon rate for this bond is 8.2% and that the coupon payments are to be made semiannually. Assuming that this bond trades for $4541.53 , then the YTM for this bond is closest to ________.

D) 9.9% D) FV = $5000 PMT = $205 ($410/2) N = 16 (8 × 2) PV = -$4541.53 Compute I = 4.9426 × 2 = 9.8852 %.

The price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a BBB rating is closest to ________.

D) 93.90 D) Assuming face value of the coupon is $100, P = $100 / (1 + 6.5 / 100) = 93.90

The price (expressed as a percentage of the face value) of a one-year, zero-coupon corporate bond with a AAA rating is closest to ________.

D) 94.61 D) Assuming face value of the coupon is $100, P = $100 / (1 + 5.7 / 100) = 94.61

Which of the following statements is FALSE?

D) According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.

Which of the following is true about the face value of a bond?

D) All of the above are true.

A bond is currently trading below par. Which of the following must be true about that bond?

D) B or C above

Emma runs a small factory that needs a vacuum oven for brazing small fittings. She can purchase the model she needs for $180,000 up front, or she can lease it for five years for $4,200 per month. She can borrow at 7% APR, compounded monthly. Assuming that the oven will be used for five years, should she purchase the oven or should she lease it?

D) Buy, since the present value (PV) of the lease is $32,108 more than the cost of the oven. D) Calculate PV lease payments = $212,108; subtract $180,000 to get $32,108.

Which of the following statements is FALSE about dividend payout and growth?

D) During periods of high growth, it is not unusual for firms to pay out 100% of their earnings to shareholders in the form of dividends

Which of the following statements is FALSE?

D) For a risk-free project, the opportunity cost of capital will typically be greater than the interest rate of U.S. Treasury securities with a similar term

Which of the following statements is FALSE?

D) Fundamentally, interest rates are determined by the Federal Reserve.

Which alternative offers you the highest effective rate of return?

D) Investment D D) EAR (A) = (1 + APR / m)m - 1 = (1 + 0.062200 /1)1 - 1 = 6.2200% EAR (B) = (1 + APR / m)m - 1 = (1 + 0.060583 /365)365 - 1 = 6.2450% EAR (C) = (1 + APR / m)m - 1 = (1 + 0.061277 /4)4 - 1 = 6.2700% EAR (D) = (1 + APR / m)m - 1 = (1 + 0.061204 /12)12 - 1 = 6.2950%

When the costs of an investment come before that investmentʹs benefits, what will be the effect of a rise in interest rates on the attractiveness of that investment to potential investors?

D) It will make it less attractive, since it will decrease the investmentʹs net present value (NPV).

The above screen shot from Google Finance shows the basic stock information for Logitech International SA (USA). What is Logitech International SA (USA)ʹs ticker symbol?

D) LOGI

Which of the following statements is FALSE about interest rates?

D) The annual percentage rate indicates the amount of interest including the effect of compounding.

Which of the following reasons for considering long-term loans inherently more risky than short-term loans is most accurate?

D) The loan values are very sensitive to changes in market interest rates.

Which of the following would be LEAST likely to lower the interest rate that a bank offers a borrower?

D) The loan will be for a long period of time.

A $5000 bond with a coupon rate of 5.7% paid semiannually has ten years to maturity and a yield to maturity of 6.4%. If interest rates fall and the yield to maturity decreases by 0.8%, what will happen to the price of the bond?

D) The price of the bond will rise by $293.50 . D) Using FV = $5000 periods to maturity = 20, PMT = $142.50 , and discount rate = 6.4/2%, calculate PV = $4744.3939 ; Using FV = $5000 , periods to maturity = 20, PMT = $142.50 , and discount rate = 5.6/2% , calculate PV = $5037.8909 ; difference = $5037.8909 - $4744.3939 = $293.4969 .

Historically, why were high inflation rates associated with high nominal interest rates?

D) The real interest rate needs to be high enough so that individuals can expect their savings to have greater purchasing power in the future than in the present

Which of the following best illustrates why a bond is a type of loan?

D) When an investor buys a bond from an issuer, the investor is giving money to the issuer, with the assurance that it will be repaid at a date in the future.

Which of the following statements regarding bonds and their terms is FALSE?

D) When prices are quoted in the bond market, they are conventionally quoted in increments of $1,000.

Which of the following bonds will be most sensitive to a change in interest rates?

D) a 30-year bond with a $1,000 face value whose yield to maturity is 5.5% and coupon rate is 6.4% APR paid annually

If the yield to maturity of all of the following bonds is 6%, which will trade at the greatest premium per $100 face value?

D) a bond with a $1,000 face value, five years to maturity and 6.3% annual coupon payments

What are dividend payments?

D) a share of the profits paid to each shareholder on the basis of the number of shares they hold

Which of the following best describes a bond rated by Standard & Poorʹs and Moody as B?

D) generally lacks the characteristics of a desirable investment

Which of the following computes the growth in purchasing power?

D) growth of money / growth of prices

Which of the following risk-free, zero-coupon bonds could be bought for the lowest price?

D) one with a face value of $1,000, a YTM of 5.9%, and 20 years to maturity A) Price = $1,000 / (1 + 4.8%)5 = $791 B) Price = $1,000 / (1 + 3.2%)8 = $777 C) Price = $1,000 / (1 + 6.8%)10 = $518 D) Price = $1,000 / (1 + 5.9%)20 = $318 (lowest price)

Which of the following formulas is INCORRECT?

D) rE = (Div1 / P0) - g

What role do dividends play in stock investing?

Dividends are periodic payments given out by the firm to shareholders. It is not necessary for a firm to declare dividends, but mature firms tend to pay out dividends.

A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor.

FALSE

Before it matures, the price of any bond is always less than its face value.

FALSE

Bond traders generally quote bond yields rather than bond prices, since yield to maturity depends on the face value of the bond.

FALSE

For a free-risk investment, the opportunity cost of capital will generally be more than the interest rate offered by U.S. Treasury securities with a similar term.

FALSE

Joe borrows $100,000 and agrees to repay the principal, plus 7% APR interest compounded monthly, at the end of three years. Joe has taken out an amortizing loan.

FALSE

Prior to its maturity date, the price of a zero-coupon bond is its face value.

FALSE

Stocks that do not pay a dividend must have a value of $0.

FALSE

The annual percentage rate indicates the amount of interest, including the effect of any compounding.

FALSE

The coupon value of a bond is the face value of the bond.

FALSE

The credit spread of a bond shrinks if it is perceived that the probability of the issuer defaulting increases.

FALSE

The real interest rate is the rate of growth of oneʹs purchasing power due to money invested.

FALSE

The term opportunity in opportunity cost of capital comes from the fact that any worthwhile opportunity for investment will have a cost: the risk to the capital invested.

FALSE

Treasury bonds have original maturities from one to ten years, while Treasury notes have original maturities of more than ten years.

FALSE

When there are large numbers of people looking to save their money and there is little demand for loans, one would expect interest rates to be high.

FALSE

Assuming that this bond trades for $1,035.44, then the YTM for this bond is equal to ________.

FV = $1,000 PMT = 40 (80 / 2) N = 30 (15 × 2) PV = -$1,035.44 Compute I = 3.8 × 2 = 7.6 or 7.6%

You are in the process of purchasing a new automobile that will cost you $25,000. The dealership is offering you either a $1,000 rebate (applied toward the purchase price) or 3.9% financing for 60 months (with payments made at the end of the month). You have been pre-approved for an auto loan through your local credit union at an interest rate of 7.5% for 60 months. Should you take the $1,000 rebate and finance through your credit union or forgo the rebate and finance through the dealership at the lower 3.9% APR?

Financing through credit union: First we need the monthly interest rate = APR / m = 0.075 / 12 = 0.00625 or 0.625%. Now: PV=$24,000 (25,000 - 1,000 rebate) I = 0.625 FV = 0 N = 60 Compute PMT = $480.91. Financing through dealership: First we need the monthly interest rate = APR / m = 0.039 / 12 = 0.00325 or 0.325%. Now: PV = $25,000 (no rebate) I = 0.325 FV = 0 N = 60 Compute PMT = $459.29 Since 459.29 < 480.91, go with the dealership financing and forgo the rebate.

What is the relationship between the growth rate and the cost of equity implied in the dividend-discount model?

For the dividend-discount model equation to be viable, the growth rate should be smaller than the cost of equity because the model becomes meaningless if the growth rate is equal to or greater than the cost of equity.

What care, if any, should be taken when cash flows occur in periodicities that are shorter than a year (e.g., quarterly or monthly cash flows)?

In the real world, cash flows can occur with any periodicity but interest rates are generally quoted in annual terms. As such, when cash flows occur at a shorter than annual time interval the interest rates have to be modified to correspond to the cash flow interval. One way to do that is to match the compounding period equal to cash flow interval.

Assuming everything else remains unchanged, how does a firmʹs decision to increase its dividend-payout ratio affect its growth rate?

Increasing dividend-payout ratio will decrease the retention rate, thereby decreasing the growth rate.

What is a major assumption about growth rate in the dividend-discount model?

It is assumed that the growth rate used in the dividend-discount model be constant in the future.

What issues should one be careful of when calculating the bond price from its yield to maturity using the time value of money (TVM) keys of a financial calculator?

It is quite simple to transfer the bond cash flow timeline to a financial calculator. Care has to be taken when using the TVM keys in understanding that the last cash flow, i.e., the return of principal by the issuer, is automatically augmented by the last coupon payment and no special steps are needed for that.

How can the dividend-discount model handle changing growth rates?

Most firms have high growth rate during the early part of their existence, which gradually tapers to the steady-state growth rate. We cannot apply the formula during the period while the growth rate is changing. We can only apply it once the growth rate has stabilized to a constant rate.

How can the financial calculator be used to calculate the price of a coupon bond from its yield to maturity?

Most popular financial calculators can help compute the price of a coupon bond in several ways. Two such ways may be using ʹtime value of money (TVM) keys and cash flow (CF) keys.

What is the net present value (NPV) of an investment that costs $2,500 and pays $1,000 at the end of one, three, and five years?

NPV = -$2,500 + $1,000 / (1.05)1 + $1,000 / (1.046)3 + $1,000 / (1.045)5 = $128.62

You are purchasing a new home and need to borrow $325,000 from a mortgage lender. The mortgage lender quotes you a rate of 6.5% APR for a 30-year fixed rate mortgage (with payments made at the end of each month). The mortgage lender also tells you that if you are willing to pay one point, they can offer you a lower rate of 6.25% APR for a 30-year fixed rate mortgage. One point is equal to 1% of the loan value. So if you take the lower rate and pay the points, you will need to borrow an additional $3,250 to cover points you are paying the lender. Assuming that you do not intend to prepay your mortgage (pay off your mortgage early), are you better off paying the one point and borrowing at 6.25% APR or just taking out the loan at 6.5% without any points?

Pay the points! Points (6.25% APR) First we need the monthly interest rate = APR / m = 0.0625 / 12 = 0.00520833 or 0.5208%. Now: PV = $328,250 ($325,000 + 1 point) I = 0.5208 FV = 0 N = 360 (30 years × 12 months) Compute PMT = $2,021.01 No Points (6.5% APR) First we need the monthly interest rate = APR / m = 0.065 / 12 = 0.005417 or 0.5417%. Now: PV = $325,000 (no points) I = 0.5417 FV = 0 N = 360 (30 years × 12 months) Compute PMT = $2,054.22 Since $2,021.01 < $2,054.22, pay the points!

A bond is said to mature on the date when the issuer repays its notional value.

TRUE

A bond will trade at a discount if its coupon rate is less than its yield to maturity.

TRUE

A firm can either pay its earnings to its investors, or it can keep them and reinvest them.

TRUE

Bonds with a high risk of default generally offer high yields.

TRUE

Forecasting dividends requires forecasting the firmʹs earnings, dividend payout rate, and future share count.

TRUE

Market forces determine interest rates based ultimately on the willingness of individuals, banks, and firms to borrow, save, and lend.

TRUE

Quality adjustments to changes in the CPI most often result in reductions to the inflation rate calculated from it.

TRUE

The Valuation Principle states that the value of a stock is equal to the present value (PV) of both the dividends and future sale price of that stock which the investor will receive.

TRUE

The only cash payment an investor in a zero-coupon bond receives is the face value of the bond on its maturity date.

TRUE

The opportunity cost of capital is the best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted.

TRUE

The ownership in a corporation is divided into shares of stock, which carry rights to a share in the profits of the firm through future dividend payments.

TRUE

When you borrow money, the interest rate on the borrowed money is the price you pay to be able to convert your future loan payments into money today.

TRUE

What is the general relationship between the absolute values of APR and EAR for an investment?

The APR of a project will either equal its EAR or be smaller than EAR. The APR will equal EAR with annual compounding for all other compounding intervals the APR will be smaller than EAR.

How are interest and return of principal handled in an amortizing loan payment?

The amount of periodic payments, generally monthly, for most amortizing loans is held constant such that a part goes toward paying interest on the outstanding balance and the rest toward return of principal. Thus this ratio keeps changing over the life of the loan. Initially, when the principal is highest, a major part of the loan goes toward paying interest and a smaller part toward returning the principal. However, as the loan progresses the interest component of the payment increases and the principal component decreases till the loan is fully paid off.

What is the implied assumption about interest rates when using the built-in functions of a financial calculator to calculate the present value (PV) of an annuity?

The built-in functions for present value of ordinary annuity in a financial calculator assume that interest rates are the same for every maturity on the yield curve.

What is the implied assumption about interest rates when the equation to calculate the present value (PV) of perpetuity is used?

The equation for computation of present value of perpetuity assumes that the interest rates are the same for every maturity on the yield curve.

Which of the following would be LEAST likely to lower the interest rate that a bank offers a​ borrower?

The loan will be for a long period of time.

Can the nominal interest rate ever be negative? Can the real interest rate ever be negative? Explain.

The nominal interest rate can never be negative since by just holding your money you are earning a 0% return (no negative) on your money. The real rate, however, can be negative anytime that the inflation rate exceeds the nominal rate.

What issues should one be careful of when calculating the bond price from its yield to maturity using the cash flow (CF) keys of a financial calculator?

There are two issues that one has to be careful about when using the CF keys in computing the price of coupon bonds from its yield to maturity. Since the coupon payments are generally identical over the life of the bond, it might be prudent to use the frequency key while entering this cash flow. That is the first pitfall to be aware of as the frequency to be entered into the calculator has to be reduced by one to account for the last coupon payment that gets added to the return of principal. Similarly, the last cash flow has to be the sum of principal and the last coupon payment.

What care, if any, should be taken regarding the timing of the cash flows while drawing the timeline and associated cash flows of a coupon bond?

There are two issues that one has to be careful of in marking the timing of cash flows associated with a coupon bond. The first is to be cognizant of the periodicity of the coupon payment, as most coupons are not paid annually. The second is to make sure that the return of principal at the end of the life also has a last coupon payment associated with it.

After examining the yield curve, what predictions do you have about interest rates in the future? About future economic growth and the overall state of the economy?

This is an inverted yield curve, which implies that interest rates should be falling in the future. An inverted yield curve is often interpreted as a negative forecast for economic growth. Since each of the last six recessions in the United States were preceded by a period with an inverted yield curve it could be a leading indicator of a future recession.

Under what situation should the clean price, dirty price, and the price calculated by the basic annuity and present value (PV) equations for a bond be equal?

Typically, while drawing the timeline for bond cash flows, the price calculated is the price on the date of coupon payment. Even on this date there would be a pre-coupon payment price and a post-coupon payment price. The clean price, dirty price and the price calculated by the annuity and present value (PV) equations converge to a single price right after the coupon has detached from the bond and paid to the holder.

Under what situation can a zero-coupon bond be selling at par to its face value?

Unlike a coupon bond, a zero-coupon bond does not have a periodic cash flow with one lump-sum payment of the face value at its maturity. Consequently, a zero-coupon bond will be always selling at a price less than its face value and can never sell at par with its face value. If it does then the time value of money concepts will be violated, which never happens.

Under what situation can a zero-coupon bond be selling at a premium?

Unlike a coupon bond, a zero-coupon bond does not have a periodic cash flow with one lump-sum payment of the face value at its maturity. Consequently, a zero-coupon bond will be always selling at a price less than its face value. If it does then the time value of money concepts will be violated, which never happens.

How do we decide on opportunity cost when we have several opportunities that need to be foregone?

We rank all the foregone opportunities, and opportunity cost is the second best opportunity that we forego. Thus we select the best opportunity and rank all the alternative opportunities and use the cost of the second best opportunity as opportunity cost.

Is it possible to analyze cash flows that occur in time intervals that are not exactly equal to a year?

Yes, in real world cash flows may be between any intervals. They may be shorter than a year or longer than a year. Additional care needs to be taken in both cases. For cash flows that have an interval longer than one year, one should be careful to show the years with zero cash flows. Alternately, for those with shorter than a year, one should be careful about modifying the interest rate to match the time interval.

Can the dividend-discount model handle negative growth rates?

Yes, the dividend-discount model can handle negative growth rates. The model works as long as growth rate is smaller than the cost of equity and negative growth rate is smaller than the cost of equity.

Which of the following bonds is trading at a​ premium?

a five-year bond with a​ $2,000 face value whose yield to maturity is​ 7.0% and coupon rate is​ 7.2% APR paid semiannually

Treasury bonds have original maturities from one to ten​ years, while Treasury notes have original maturities of more than ten years.

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