finc303 exam2

Three $1,000 face value, 10-year, noncallable, bonds have the same amount of risk, hence their YTMs are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

. Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year

A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?

. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.

29. Which of the following statements is CORRECT?

. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.

If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?

. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.

. Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that

. Maturity risk premiums could help to explain the yield curve's upward slope.

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

. The beta of an "average stock," or "the market," can change over time, sometimes drastically

36. Which of the following statements is CORRECT?

. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.

Which of the following statements is CORRECT?

. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.

A bond trader observes the following information: • The Treasury yield curve is downward sloping. • Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds. • Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields.

A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.

Which of the following factors would be most likely to lead to an increase in nominal interest rates

A new technology like the Internet has just been introduced, and it increases investment opportunities

Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Price $25 $40 Expected growth 7% 9% Expected return 10% 12%

A's expected dividend is $0.75 and B's expected dividend is $1.20 A = P0 = D1 /(r − g) = D1 = P0 (r) − P0(g) = $0.75 B = P0 = D1/(r − g) = D1 = P0 (r) − P0(g) = $1.20

59. Which of the following statements is CORRECT?

An investor can eliminate virtually all diversifiable risk if he or she holds a very large, welldiversified portfolio of stocks.

Which of the following would be most likely to lead to a higher level of interest rates in the economy?

Corporations step up their expansion plans and thus increase their demand for capital.

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%

Default and liquidity risk differences.

If markets are in equilibrium, which of the following conditions will exist?

Each stock's expected return should equal its required return as seen by the marginal investor Statement is true, because if the expected return does not equal the required return, then markets are not in equilibrium and buying/selling will occur until the expected return equals the required return

47. Which of the following statements is CORRECT?

Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve

Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT?

If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's if the required return for Stock A is higher than that of Stock B, and if the dividend yield for Stock A is lower than Stock B's, the growth rate for Stock A must be higher to offset this

33. Which of the following statements is CORRECT?

If a coupon bond is selling at par, its current yield equals its yield to maturity, and its expected capital gains yield is zero

Which of the following statements is CORRECT, other things held constant?

If expected inflation increases, interest rates are likely to increase

A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?

If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today

Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT?

If one stock has a higher dividend yield, it must also have a lower dividend growth rate

. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?

If the pure expectations theory holds, the Treasury yield curve must be downward sloping.

49. Which of the following statements is CORRECT?

If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future

Which of the following statements is CORRECT?

If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market

Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that

Maturity risk premiums could help to explain the yield curve's upward slope.

Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? X Y Price $30 $30 Expected growth (constant) 6% 4% Required return 12% 10%

One year from now, Stock X's price is expected to be higher than Stock Y's price.

Which of the following statements is CORRECT?

Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock

27. Which of the following statements is CORRECT?

Sinking fund provisions sometimes turn out to adversely affect bondholders, and this is most likely to occur if interest rates decline after the bond was issued

Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?

Some class or classes of common stock are entitled to more votes per share than other classes

Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Price $25 $25 Expected growth (constant) 10% 5% Required return 15% 15%

Stock A's expected dividend at t = 1 is only half that of Stock B. Price $25 $25 g 10% 5% r 15% 15% Div. Yield = r − g = 5% 10% D1 = P(Div Yield) = $1.25 $2.50

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

Stock B.

Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? X Y Price $25 $25 Expected dividend yield 5% 3% Required return 12% 10%

Stock X pays a higher dividend per share than Stock Y Dividend = Yield × Price: X dividend = $1.25 Y dividend = $0.75 Stock X has a dividend yield of 5% versus a dividend yield of 3% for Y

55. Which of the following statements is CORRECT?

Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period

54. Which of the following statements is CORRECT?

The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.

A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = −5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

The company's expected stock price at the beginning of next year is $9.50. Note that P0 = $2/(0.15 + 0.05) = $10. That price is expected to decline by 5% each year, so P1 must be $10(0.95) = $9.50. Therefore, answer e is correct, while the others are all false.

Which of the following statements is CORRECT?

The constant growth model takes into consideration the capital gains investors expect to earn on a stock.

Which of the following statements is NOT CORRECT?

The corporate valuation model discounts free cash flows by the required return on equity.

. Amram Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not convertible, not callable, and has no sinking fund. Alternatively, Amram could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Amram would have to pay on the second bond, the convertible, callable bond with the sinking fund, to have it sell initially at par?

The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%.

Which of the following statements is CORRECT, assuming stocks are in equilibrium?

The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield

Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?

The maturity risk premium is assumed to be zero.

Which of the following statements is CORRECT?

The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm's common stock

Which of the following statements is CORRECT?

The preferred stock of a given firm is generally less risky to investors than the same firm's common stock

44. Which of the following statements is CORRECT?

The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.

Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return?

The required rate of return would increase because the bond would then be more risky to a bondholder

The expected return on Natter Corporation's stock is 14%. The stock's dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT?

The stock price is expected to be $54 a share one year from now P1 = P0 (1 + g) = $54. Therefore, d is correct.

Which of the following statements is CORRECT?

The stock valuation model, P0 = D1/(rs − g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate

Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT? Expected dividend, D1 $3.00 Current Price, P0 $50 Expected constant growth rate 6.0%

The stock's expected dividend yield and growth rate are equal. The correct answer choice is b. One could quickly calculate the dividend yield and see that it equals the growth rate, but here are some numbers that provide more information. D1 $3.00 D1/P0 6.0% P0$50.00 rX12.0%

. If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.

The stock's price one year from now is expected to be 5% above the current price

If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?

The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat.

If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?

The yield on a 10-year bond would be less than that on a 1-year bill

Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Required return 10% 12% Market price $25 $40 Expected growth 7% 9%

These two stocks must have the same dividend yield A B Expected return 10% 12% Expected growth 7% 9% Dividend yield 3% 3%

Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?

This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.

Which of the following statements is CORRECT?

To implement the corporate valuation model, we discount projected free cash flows at the weighted average cost of capital.

Which of the following statements is CORRECT?

You hold two bonds, a 10-year, zero coupon, issue and a 10-year bond that pays a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from its current level, the zero coupon bond will experience the larger percentage decline.

42. Assuming the pure expectations theory is correct, which of the following statements is CORRECT?

a. If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.

34. Which of the following statements is CORRECT?

a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.

. A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT?

a. The bond's expected capital gains yield is zero.

Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?

a. The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities.

33. Which of the following statements is CORRECT?

a. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.

26. Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?

b. Adding a call provision.

A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?

b. If the yield to maturity remains at 8%, then the bond's price will decline over the next year.

45. Which of the following statements is CORRECT?

b. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT?

b. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.

31. Which of the following statements is CORRECT?

c. All else equal, if a bond's yield to maturity increases, its price will fall.

You have the following data on three stocks: Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well diversified portfolio.

c. B; A.

. Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are noncallable, are as follows: T-bond = 7.72% A = 9.64% AAA = 8.72% BBB = 10.18% The differences in rates among these issues were most probably caused primarily by:

c. Default and liquidity risk differences.

. Which of the following events would make it more likely that a company would call its outstanding callable bonds?

c. Market interest rates decline sharply.

A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?

c. The bond's yield to maturity is greater than its coupon rate.

. You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?

c. The price of Bond A will decrease over time, but the price of Bond B will increase over time.

Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?

d. A 10-year zero coupon bond.

Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

d. Coefficient of variation; beta.

Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT?

d. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have a lower yield than Long's bonds.

Suppose the U.S. Treasury issued $50 billion of short-term securities and sold them to the public. Other things held constant, what would be the most likely effect on short-term securities' prices and interest rates?

d. Prices would decline and interest rates would rise.

. Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?

d. The interest rate today on a 3-year bond should be approximately 7%.

43. If the pure expectations theory holds, which of the following statements is CORRECT?

d. The maturity risk premium would be zero.

Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?

e. 20-year, zero coupon bond.

56. Which of the following statements is CORRECT?

e. During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct

e. In equilibrium, the expected return on Stock A will be greater than that on B.

The real risk-free rate of interest is expected to remain constant at 3% for the foreseeable future. However, inflation is expected to increase steadily over the next 30 years, so the Treasury yield curve has an upward slope. Assume that the pure expectations theory holds. You are also considering two corporate bonds, one with a 5-year maturity and one with a 10-year maturity. Both have the same default and liquidity risks. Given these assumptions, which of these statements is CORRECT

e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.

. In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t − 1)%, where t is the number of years until the bond matures. Given this information, which of the following statements is CORRECT?

e. The yield curve must be upward sloping.

An increase in a firm's expected growth rate would cause its required rate of return to

possibly increase, possibly decrease, or possibly remain constant

The preemptive right is important to shareholders because it

protects the current shareholders against a dilution of their ownership interests.

. For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

the expected future return must be equal to the required return.

If in the opinion of a given investor a stock's expected return exceeds its required return, this suggests that the investor thinks

the stock is a good buy