FINC Exam 2

Interest rate risk

Interest rate risk arises from fluctuating interest rates, and the degree of interest rate risk a bond has depends on its sensitivity to interest rate changes The longer the time to maturity, the greater the interest rate risk

bond value

present value of the coupons + present value of the face amount

Unsystematic risk

(also called diversifiable risk, unique risk, or asset-specific risk) is a risk that affects at most a small number of assets (For Example, the announcement of an oil strike by a company)

systematic risk

(also called nondiversifiable risk or market risk) influences many assets (For Example, uncertainties about general economic conditions, such as G D P, interest rates, or inflation).

Risk-free rate

Rf, is the y-intercept of the SML

Which average return should you use when forecasting future wealth levels?

- Geometric average tells you what you actually earned per year on average, compounded annually, while the arithmetic average tells you what you earned in atypical year - If you know the true arithmetic average return, then this is what you should use in your forecast - If you are using estimates of arithmetic and geometric returns, the arithmetic average return is probably too high for longer periods and the geometric average is probably too low for shorter periods.

What would happen to the value of these three bond if the required rate of return remained 10%?

At maturity, the value of any bond must equal its par value If Rd remains constant: The value of a premium and would decrease over time, until it reached $1,000 The value of a discount bound would increase over time, until it reached $1,000 the value of a par bond stays at $1,000

Werden Drilling offers 5.5 percent coupon bonds with semiannual payments and a yield to maturity of 7 percent. The bonds mature in 10 years. What is the market price per bond if the face value is $1,000? a. $893.41 b. $894.65 c. $937.63 d. $671.36 e. $1,114.20

a. $893.41

A 13-year, 6 percent coupon bond pays interest semiannually. The bond has a face value of $1,000. What is the percentage change in the price of this bond if the market yield to maturity rises to 5.7 percent from the current rate of 5.5 percent? a. -1.79% b. -1.38% c. -11.64% d. 1.79%

a. -1.79%

A stock experienced returns of 5 percent, −17 percent, and 15 percent during the last three years. What is the standard deviation of the stock's returns for the three-year period? a. 16.37% b. 13.37% c. 48.86% d. 5.98% e. 2.68%

a. 16.37%

The 30-year, 5.5 percent bonds issued by Modern Kitchens pay interest semiannually, mature in four years, and have a $1,000 face value. Currently, the bonds sell for $1,020.66. What is the yield to maturity? a. 4.92% b. 4.41% c. 2.46% d. 2.68% e. 5.39%

a. 4.92%

The ________ explains the relationship between the expected return on a security and the level of that security's systematic risk. a. capital asset pricing model b. time value of money equation c. unsystematic risk equation d. market performance equation e. expected risk formula

a. capital asset pricing model

Long-term bonds...

are more sensitive to interest rate changes, and hence have more price risk

portfolio weights

are percentages of portfolio's total value invested in a particular asset

Worthy Ware pays a constant dividend of $1.46 per share. The company announced today that it will continue to pay the dividend for another 2 years and then in Year 3 it will pay a final liquidating dividend of $15.25 per share. What is one share of this stock worth today at a required return of 18.5 percent? a. $12.92 b. $11.44 c. $12.07 d. $13.09 e. $14.20

b. $11.44

You own 850 shares of Bennett Trading stock valued at $53.15 per share. What is the dividend yield if your total annual dividend income is $1,256? a. 2.67% b. 2.78% c. 1.83% d. 2.13% e. 2.54%

b. 2.78%

A stock had annual returns of 7 percent, −28 percent, 13 percent, and 23 percent for the past four years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent. a. 3.75; 17.46 b. 3.75; 1.72 c. 17.75; 4.27 d. 17.75; 17.46 e. 3.75; 4.27

b. 3.75; 1.72

You recently purchased a stock that is expected to earn 12 percent in a booming economy, 6.5 percent in a normal economy, and lose 1.5 percent in a recessionary economy. The probability of a booming economy is 14 percent while the probability of a normal economy is 65 percent. What is your expected rate of return on this stock? a. 6.22% b. 5.59% c. -2.24% d. 0.35% e. 5.67%

b. 5.59%

discount bond

bod sells for less than face value

Premium bond

bond that sells for more than face value

Fazekas Companies is preparing to pay annual dividends of $1.48, $1.60, and $1.75 per share over the next three years, respectively. After that, the annual dividend will be $1.90 per share indefinitely. What is this stock worth to you per share if you require a return of 14.6 percent? a. $11.22 b. $12.21 c. $12.32 d. $11.47 e. $12.03

c. $12.32

You are purchasing a 15-year, zero coupon bond. The yield to maturity is 6.85 percent and the face value is $1,000. What is the current market price? Assume semiannual compounding. a. $406.67 b. $408.18 c. $364.11 d. $321.50 e. $358.47

c. $364.11

Petropoulos Resorts common stock sells for $58.49 per share and pays an annual dividend that increases by 1.3 percent annually. The market rate of return on this stock is 12.6 percent. What is the amount of the last dividend paid? a. $6.60 b. $5.86 c. $6.52 d. $6.98 e. $5.64

c. $6.52

Nasafi Lumber paid an annual dividend of $1.37 per share yesterday. Today, the company announced that future dividends will be increasing by 3 percent annually. If you require a return of 14.6 percent, how much are you willing to pay to purchase one share of this stock today? a. $11.81 b. $13.53 c. $9.67 d. $12.16 e. $9.38

d. $12.16

Olivares, Incorporated, bonds mature in 17 years and have a coupon rate of 5.4 percent. If the market rate of interest increases, then the: a. coupon rate will also increase b. current yield will decrease c. yield to maturity will be less than the coupon rate d. market price of the bond will decrease e. coupon payment will increase

d. market price of the bond will decrease

Vanessa purchased a stock one year ago and sold it today for $3.15 per share more than her purchase price. She received a total of $2.60 per share in dividends. Which one of the following statements is correct in relation to this investment? a. the dividend yield is expressed as a percentage of the par value b. the capital gain would have been less had Vanessa not received the dividends c. the total dollar return per share iOS $.55 d. the capital gains yield positive e. the dividend yield is greater than the capital gains yield

d. the capital gains yield positive

Total return (rs)

dividend yield + capital gains yield

Schwartz Imports just paid an annual dividend of $2.69 per share and is expected to increase that amount by 5.2 percent per year. If you are planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of security is 12.6 percent at the time of your purchase? a. $38.24 b. $36.35 c. $40.93 d. $22.46 e. $40.23

e. $40.23

Suppose a stock had an initial price of $30 per share, paid a dividend of $5 per share during the year, and had an ending share price of $33.40. What was the capital gains yield? a. 10.2% b. 16.7% c. 4.2% d. 15.0% e. 11.3%

e. 11.3%

If the economy is normal, the stock of Flores Corporation is expected to return 12 percent. If the economy falls into a recession, the stock's return is projected at a negative 3.5 percent. The probability of a normal economy is 76 percent. What is the standard deviation of the returns on this stock? a. 43.82% b. 12.35% c. 8.28% d. 2.88% e. 6.62%

e. 6.62%

You own a portfolio that has $1,720 invested in Stock A and $3,470 invested in Stock B. The expected returns on these stocks are 13.7 percent and 8.0 percent, respectively. What is the expected return on the portfolio? a. 9.20% b. 10.23% c. 12.18% d. 7.13% e. 9.89%

e. 9.89%

Principle diversification

implies some of the riskiness with individual assets can beeliminated by forming portfolios. Unsystematic risk is essentially eliminated by diversification, so a portfolio with many assets has almost no unsystematic risk.

portfolio

is a group of assets such as stocks and bonds held by an investor

Security market line (SML)

is a positively sloped, straight line displaying the relationship between expected return and beta (expected return on the y-axis and beta on the x-axis) - All the assets in the market must plot on the SM

Coupon rate

is the annual coupon divided by the face value of the bond

Geometric average return

is the average compounded return earned per year over a multiyear period

Variance

is the average squared difference between the actual return and the average return

Capital asset pricing model (CAPM)

is the equation showing the relationship betweenexpected return and beta

Standard deviation

is the positive square root of the variance - measures total, or stand-alone, risk - larger SD is associated with a wider probability distribution of returns - the larger SD is, the lower the probability that actual returns will be close to expected returns

Arithmetic average return

is the return earned in an average year over a multiyear period

Maturity

is the specified date on which the principal amount of a bond is paid

Coupon

is the stated interest payment made on a bond

Face value

or par value, is the principal amount of a bond that is repair at the end of the term

Yield to maturity

or yield, which is the rate required in the market on a bond