FP13 Quiz Questions

Which of the following methods can be used in determining the basis in a mutual fund when the shares were acquired at different times? Specific identification First in, first out (FIFO) Average cost method

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Which of the following statements best describes Eurodollars?

B) U.S. dollar-denominated deposits at banks outside the United States -in millions maturity less than six months

Which of the following statements best describes banker's acceptances?

Banker's acceptances are typically traded at a discount from their face value in the secondary market. Eurodollars are U.S. dollar-denominated deposits at banks outside the United States.

The segment of the security trading marketplace that allows for institutional investors to trade with other institutional investors outside of normal trading hours is known as

The fourth market

which of the following is considered to be both liquid and marketable?

U.S. Treasury bills are both liquid and marketable. Passbook savings accounts are liquid but not marketable. Neither blue-chip stocks nor antique jewelry is assured of being both liquid and marketable.

Indifference curves, which represent the risk-reward trade-off that the investor is willing to make, will -cross the efficient frontier in two locations. -lie tangent to the efficient frontier. -will not intersect the efficient frontier.

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Which of the following is a risk involved in an investment in undeveloped land? -The land may be adversely rezoned. -The investor may not be able to obtain permits to build on the land. -Access to the investor's land may be restricted by adjacent landowners. -The anticipated population growth may not occur.

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A 7% coupon bond pays interest semiannually and has a duration of 12 (computed using semiannual compounding) and a maturity of 25 years. The bond sells for $1,100 and has a YTM of 6.2%. If the YTM is expected to increase by 50 basis points, by what percentage can the price of the bond be expected to change?

-12 (0.005/1.031)= -0.0582

Which of the following statements describes the purpose of holding cash and cash equivalents? They provide a totally risk-free investment that can safeguard the asset values of a retired individual. They supply highly liquid investments that provide funds for financial emergencies.

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Harry purchased 100 shares of MNL common stock five years ago at a cost of $4,300. The stock paid the following dividends: At the time the fifth-year dividend was paid, Harry sold the stock for $8,900. What was Harry's average annual compound rate of return (IRR) on MNL stock?

4,300+/-, CFj 180CFj 180CFj 200CFj 225CFj 230+8,900=, CFjSHIFT, IRR/YR(answer = 19.21%

Which of these statements best describes the concept of bond duration?

Duration is the average weighted time it takes the bondholder to receive the interest and principal payments from a bond in present value dollars.

Klaus Copenhagen's objective is to receive income, and he is considering a preferred stock with a $1.50 dividend that is currently trading at $25. What would be the approximate price movement of this preferred stock if interest rates were to rise 1%?

First, determine what the current interest rate is, $1.50 ÷ $25 = 0.06. Now, determine the percentage price movement if interest rates climb 1%—$1.50 ÷ 0.07 = $21.43. This is a decline of $3.57, or 14.28%.

Kevin owns a $1,000 par value corporate bond with three years remaining until maturity. This bond is currently trading for $1,020.91. The bond has a coupon rate of 4.5% (annual coupon payments) and a current YTM of 3.75%. What is the duration of this bond?

For year 1, FV = 45, I/YR = 3.75, N = 1, solve for PV(43.37) For year 2, change N to 2 without clearing your calculator and solve for PV(41.81xyears2). For year 3, FV = 1,045, I/YR = 3.75, N = 3, solve for PV.(935.73xyears3)=2807.9 add all three together Divide the sum in the last column ($2,934.18) by the total PV/market price of the bond ($1,020.91) to derive the duration of 2.8741 years.

When analyzing various investment alternatives, investors would generally choose which of these?

The answer is an investment exhibiting a high positive skewness and a leptokurtic distribution. Investments exhibiting high positive skewness have a larger than average number of positive price movements. Also, investments exhibiting a leptokurtic distribution have more observations clustered closely around the mean, resulting in a lower variance. Investors prefer a large number of positive returns with low risk.

What is the downside risk of a 6% coupon convertible bond currently trading at $1,040 with a maturity of 12 years and a conversion value of $950? The current interest rate on comparable debt is 7.5%.

The downside risk of a convertible bond is the difference between the market price and its investment value. To determine the investment value, calculate what the bond would be worth based just on interest rates. HP 10bII+: 1000 FV, 30 PMT, 12 × 2 = 24 N, 7.5 ÷ 2 = I/YR, solve for PV = $882.66. The current market price of the bond is $1,040, so $1,040 - $882.66 = $157.33. The conversion value, which is higher ($950), is not relevant in determining downside risk.

Assume a $1,000 par value bond with 3 years until maturity is currently trading for $1,027.23. The bond has a coupon rate of 6% (annual coupon payments) and a current YTM of 5%. The bond has a duration of 2.51 years. Calculate what the new market price for the bond would be if the YTM changed from 5% to 4.5%.

The new price of the bond should be $1,041.23. FV = 1,000 PMT = 60 I/YR = 4.5 N = 3 Solve for PV = -1,041.2345, or $1,041.23

Assume a 3-year, $1,000 par value corporate bond is currently trading for $959.53. The bond has a coupon rate of 4% (paid once per year) and a yield to maturity of 5.50%. Calculate the duration for this bond.

To solve for the PV of a given CF (example Year 1): FV = 40, N = 1, PMT = 0, 5.5 = I/YR, solve for PV. -year 2 just change Y=2 (multiple by 2 for denominator) -year 3 change fv to 1040 N=3 (multiple answer by 3) Divide the sum in the last column (2,766.83) by the total PV/market price of the bond (959.53) to derive the duration of 2.8835 years.

An investor considering investing in a particular security is more concerned with

expected return

Your client has just opened a margin account with your brokerage firm and purchased 500 shares of stock for $60 per share. The firm has a 55% initial margin and 35% maintenance margin policy. Calculate the stock price at which your client will receive a margin call.

he client will receive a margin call when the price of the stock drops to $41.54, calculated as follows: margin call = ($60 × 0.45) ÷ (1 - 0.35) margin call = $27.00 ÷ 0.65 = $41.5385, or $41.54

Limited partnerships are distinguished by which of the following? The general partner controls the business activities of the partnership. The limited partners participate in the business venture with limited liability. The general partner determines when distributions are made to the limited partners. The limited partners may have difficulty selling their interests.

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.A convertible bond has a 6.5% coupon rate, interest is paid semiannually, and the bond matures in five years. Comparable debt currently yields 7.5%. The bond is convertible into common stock at $25 per share. The current price of the stock is $28, and the current price of the convertible bond is $1,050. What is the investment value of the bond?

10, N 7.5 ÷, 2 I/YR 32.5, PMT 1000, FV Solve for PV = -958.94, or $958.94.

You are considering purchase of a stock that is currently selling for $23 and pays a dividend of $1.15 per share. The dividend is expected to grow at a rate of 15% per year for the next three years. After that, the dividend is expected to grow at a constant rate of 8%. Your required return is 13%. The maximum price you should pay for this stock is

13 I/YR 0CF0 1.3225CF1 1.5209CF2 1.7490 + 37.7784CF3 29.7559 SHIFT, NPV The 37.7784 is calculated from the constant growth DDM, starting at the end of the third year: [1.7490(1.08)] ÷ (0.13 - 0.08) = 37.7784

n investor holding a Treasury bill as of the date of maturity includes

An investor holding a Treasury bill as of the date of maturity includes the amount of the discount as ordinary income. An investor who sells the bill before maturity includes as ordinary income only a portion of the acquisition discount based on the total time he held the bill. The remaining portion is capital gain income.

All of the following statements correctly describe certificates of deposit (CDs) except

CDs typically pay a fixed interest rate, with higher interest rates offered for longer-term certificates.

A money market mutual fund manager recently purchased negotiable, short-term, unsecured promissory notes issued by a number of large corporations for the portfolio. Select the type of investment the money manager purchased.

Commercial paper is usually issued in denominations of $100,000 or more and is a substitute for short-term bank financing. Commercial paper is normally sold at a discount and is rated for quality by a rating service.

Frank sells short 300 shares of XYZ stock at $40. He then buys back the stock for $10,000. XYZ stock paid a dividend of $1.25 per share before he covered the short sale. Calculate his net gain or loss.

Frank is responsible for paying the dividend to the investor who lent the stock. Proceeds: $12,000 Cost: (10,000) Gain: $2,000 Less dividend payment: (375) Net gain: $1,625

Assume YC1 is an inverted yield curve and one year later all interest rates have decreased to where the new yield curve, YC2, is a normal yield curve. Which of the following provides information that can be interpreted from these yield curves?

Market interest rates have decreased from YC1 to YC2. When market rates decrease, duration increases, because market interest rates and duration are inversely related. Treasury bills are short-term debt and Treasury bonds are long-term debt. When an inverted yield curve changes to a normal yield curve, short-term rates will decline more than long-term rates. An inverted yield curve normally occurs when inflation is high and the Fed fights inflation by raising short-term interest rates above long-term interest rates.

Identify which of the following statements pertaining to the various types of money market investments is CORRECT. -Commercial paper offers higher yields than T-bills. -Eurodollars are U.S. dollar-denominated deposits at banks outside of the United States. -Banker's acceptances are short-term drafts drawn by a private company on a major bank to finance imports and exports. -T-bills are subject to default risk and a lack of marketability.

Only statement IV is incorrect. T-bills are not subject to default risk and exhibit a high degree of marketability. As a result, the 90-day T-bill is often used as a proxy for the risk-free investment.

Calculate the present value of a five-year bond with a coupon rate of 5.50% (paid semiannually) if similar quality bonds are currently yielding 4.35%.

The answer is $1,051.18. The present value of the bond is $1,051.18, calculated as follows: N = 10 (5 × 2); I/YR = 2.175 (4.35% ÷ 2); PMT = 27.50 (5.50% × 1,000 ÷ 2); FV = 1,000; solve for PV = 1,051.18, or $1,051.18.

Ronald owns a Hydro Industries 7% convertible bond. The bond is convertible into 30 shares of Hydro Industries, which is currently trading at $43 per share. The investment value of the bond is $980, and the current market price of the bond is $1,433. What is the conversion value of Larry's bond?

The answer is $1,290. Conversion value = conversion ratio × market price of common stock, or 30 × $43 = $1,290.

Chuck Johnson owns a convertible bond that has a conversion price of $40 per share and a coupon of 5.5%. Interest is paid semiannually. The current market price of the stock is $41 per share. The investment value of the bond is $940, and the bond currently sells for a market price of $1,120. What is the downside risk of this bond?

The answer is $180. The downside risk of a convertible bond is the dollar or percentage decline from the current market price of the convertible bond to the investment value of the bond: $1,120 - $940 = $180.

LOK stock is currently paying an annual dividend of $2.15 per share, which is expected to grow at a constant rate of 2% annually. Calculate the price for the stock if an investor's required rate of return is 10%.

The answer is $27.41. Using the constant growth dividend discount model, the stock has an intrinsic value of $27.41, calculated as follows: [$2.15 × (1 + 0.02)] ÷ (0.10 - 0.02) = $2.1930 ÷ 0.08 = $27.41.

Carly purchased $80,000 of JEM stock for $40 per share utilizing her margin account. She used $40,000 in her money market fund plus she borrowed $40,000 from her broker. She acquired a total of 2,000 shares of JEM stock. JEM stock is currently trading at $39.65 per share. Calculate the stock price that Carly would receive a margin call from her broker. Assume a maintenance margin requirement of 35% and an initial margin requirement of 50%.

The answer is $30.77. Carly would receive a margin call when the stock fell to $30.77 per share. Margin call = [(1 − initial margin percentage) ÷ (1 − maintenance margin)] × purchase price of the stock = [(1 - 0.50) ÷ (1 - 0.35)] × 40 = 30.7692, or $30.77.

Amelia is considering buying shares of HSO stock valued at $50 per share. She forecasts the stock to trade in excess of $75 per share over the next three years. During this time, she expects to receive annual dividends of $4.50 per share. Given a 10% required rate of return, calculate the intrinsic value of the stock.

The answer is $45.00. The intrinsic value of the stock is $45, using the perpetuity dividend discount model, calculated as follows: $4.50 ÷ 0.10 = $45.

Ellen Hyson purchased a BB rated convertible bond of TCD Corporation that has a 10% coupon and matures in nine years. Comparable debt (BB rated, nine years to maturity) yields 12%. The bonds are convertible at $32 per share of common stock, and the current market price of TCD common stock is $25. What is the conversion value of this bond?

The answer is $781.25. The conversion value = conversion ratio × market price of common stock. Therefore, the conversion value equals ($1,000 ÷ $32) × $25 = $781.25.

LJM Corporation has a bond issue with a coupon rate of 8% and seven years remaining until maturity. Assuming a par value of $1,000 and semiannual coupon payments, calculate the intrinsic value of the bond if current market conditions justify a 10% required rate of return.

The answer is $901.01. The intrinsic value of LJM's bond is $901.01, calculated as follows: N = 14 (7 × 2); I/YR = 5 (10% ÷ 2); PMT = 40 (8% × $1,000 ÷ 2); FV = 1,000; solve for PV = 901.01, or $901.01.

Calculate the estimated change in the price of a bond with a present value of $987.56 and Macaulay duration of 4.8 years when its YTM changes from 7% to 6%

The answer is +4.49%. Given the inverse relationship between bond prices and market interest rates, the price of the bond must increase by 4.49%, calculated as follows: ΔP/P = -4.8 × [(0.06 - 0.07) ÷ (1 + 0.07)] = 0.0449, or 4.49%.

Calculate the estimated change in the price of a bond with a present value of $987.56 and Macaulay duration of 4.8 years when its YTM changes from 7% to 6%.

The answer is +4.49%. Given the inverse relationship between bond prices and market interest rates, the price of the bond must increase by 4.49%, calculated as follows: ΔP/P = -4.8 × [(0.06 - 0.07) ÷ (1 + 0.07)] = 0.0449, or 4.49%.

ABC Corporation has a P/E ratio of 5.00 and an expected growth rate in earnings for the next year of 9.5%. Assuming an investor's required rate of return is 12%, calculate the firm's PEG ratio.

The answer is 0.5263. Calculate the firm's PEG ratio as follows: 5.00 ÷ (0.095 × 100) = 0.5263. After calculating this ratio, it then would be compared to ABC Corporation's peers to determine whether a purchase is warranted.

Stock TTY has a mean return of 11% and a standard deviation of 5%. What is the probability of a return of less than 6%, assuming a normal distribution of returns?

The answer is 16%. The probability of Stock TTY returning more than 11% is 50%. Additionally, the probability that the stock's return lies within one standard deviation of the mean is 68%. Because the distribution is symmetric, there is a 34% chance that returns will be between 6% and 11%. Therefore, the probability of a return less than 6% is 16% (100% − 50% − 34%).

Brantley recently purchased a new video game system on his credit card. Assuming the nominal annual percentage rate (APR) is 14.95% (compounded daily), calculate the effective annual rate (EAR).

The answer is 16.12%. The effective annual rate on his credit card is 16.12%, calculated as follows: EAR = [1 + (0.1495 ÷ 365)]365 - 1 = 0.1612, or 16.12%.

Jonathan purchased 500 shares of CPM stock for $12 per share. At the end of the first year, he made another purchase of 500 shares at a stock price of $12 per share. At the end of the third year, he sold all of the stock for $17 per share. In addition, the stock paid a dividend of 0.35 per share at the end of each year. Calculate the dollar-weighted return to Jonathan over the three-year period.

The answer is 17.46%. Jonathan earned a dollar-weighted rate of return of 17.46% on CPM stock over the three-year period, calculated as follows: CF0 = −12 × 500 = −6,000 CF1 = (−12 × 500) + (0.35 × 500) = −5,825 CF2 = (0.35 × 1,000) = 350 CF3 = (0.35 × 1,000) + (17 × 1,000) = 17,350 Solve for the internal rate of return (IRR/YR) = 17.4626, or 17.46%

Nancy bought 50 shares of ABC stock for $50 per share. She made additional purchases at the end of each of the following years: Year 1: 10 shares at $52 per share Year 2: 10 shares at $53 per share Year 3: 10 shares at $45 per share ABC stock has not paid any dividends during her holding period. At the end of Year 4, the stock is trading for $55 per share. Which of the following is Nancy's return over the past four years on ABC stock (assume she sells the stock for the current trading price)?

The answer is 2.95%. The dollar-weighted return is calculated as follows: CF0 (2,500) [50 × $50] CF1 (520) [10 × $52] CF2 (530) [10 × $53] CF3 (450) [10 × $45] CF4 4,400 [80 × $55] Solve for IRR/YR = 2.95%

JEM Technologies, Inc. has assets of $500 million and $50 million in liabilities. For the past year the company earned $125 million, and paid out $50 million in dividends. Calculate the company's return on equity (ROE).

The answer is 28%. $500,000,000 - $50,000,000 = $450,000,000 in equity. $125,000,000 profit ÷ $450,000,000 equity = 0.2778, or 28% ROE.

The conversion value of a convertible bond with a conversion ratio of 25, a conversion price of $40, and a market price of the underlying stock of $32 is

The conversion value is the value if converted and is determined by multiplying the market price of the underlying stock by the conversion ratio: $32 × 25 = $800

Darla, a U.S. citizen and resident of Georgia, owns a 5% coupon corporate bond, a 4% coupon State of Georgia municipal bond, and a 3% coupon U.S. Treasury note. Darla's marginal state income tax rate is 6% and federal tax rate is 24%. If Darla invested equal amounts in each of the three bonds, what is her after-tax rate of return on the portfolio?

The answer is 3.26%. Because the corporate bond is taxable by the state and the federal government, its after-tax return is 3.5% [5% × (1 - 0.30)]. The State of Georgia municipal is not taxable by either government entity. The Treasury note is taxable by the federal government; therefore, its after-tax return is 2.28% [3% × (1 - 0.24)]. Averaging the three rates equals 3.26% [(3.5% + 4% + 2.28%) ÷ 3].

Calculate the weighted average yield to maturity (YTM) for Frank's bond portfolio.

The answer is 8.66%. Referring to the yield curve, Treasuries with 10-year terms are yielding 8.5%, and Treasuries with 20-year terms are yielding 9.0%. Frank has $25,000 in 10-year-term bonds and $12,000 in 20-year-term bonds. Thus, Frank's bond portfolio has a weighted YTM of 8.66%, calculated as follows: [($25,000 × 8.5%) + ($12,000 × 9.0%)] ÷ $37,000 = 8.66%.

calculate the weighted average yield to maturity (YTM) for Frank's bond portfolio.

The answer is 8.66%. Referring to the yield curve, Treasuries with 10-year terms are yielding 8.5%, and Treasuries with 20-year terms are yielding 9.0%. Frank has $25,000 in 10-year-term bonds and $12,000 in 20-year-term bonds. Thus, Frank's bond portfolio has a weighted YTM of 8.66%, calculated as follows: [($25,000 × 8.5%) + ($12,000 × 9.0%)] ÷ $37,000 = 8.66%.

Jack experienced returns in his growth mutual fund over the last five years of 2%, 5.5%, -9%, 18%, and 26%. Calculate both the arithmetic and geometric means for this series of returns.

The answer is Arithmetic mean = 8.50%; geometric mean = 7.80%. Arithmetic mean: [(2% + 5.5% − 9% + 18% + 26%) ÷ 5] = 8.50%. Geometric mean: PV = -1; FV = (1 + 0.02)(1 + 0.055)(1 - 0.09)(1 + 0.18)(1 + 0.26) = 1.4559; N = 5; solve for I/YR = 7.80%.

Which of these are characteristics of foreign currency exchange? -When a strong foreign currency is converted into U.S. dollars, more dollars are received than if the foreign currency had stayed stable or declined. -An increase in the supply of a currency results in its devaluation. -A U.S. investor in foreign assets would want the U.S. dollar to strengthen against foreign currencies after the assets are purchased. -When the U.S. dollar weakens against a foreign currency, the total return increases to a U.S. investor holding stocks denominated in that currency.

The answer is I, II, and IV. When an investor has money invested in a foreign stock, the investor should want the dollar to decline relative to the foreign currency so that a currency gain occurs in addition to the security gain. Currencies are subject to the same supply/demand rules that apply to goods and services and to the money supply. Increasing supply results in decreasing price of the currency.

Choose the CORRECT statements regarding convexity relationships.

The answer is II and IV. Convexity has an inverse relationship with coupon rate and a direct relationship with term to maturity. The higher the coupon, the lower the convexity. The longer the maturity the greater the convexity.

DIV Corporation's current market value is $50 million, with 2 million shares outstanding. The board of directors votes to pay a stock dividend of 10%. Which of the following statements is CORRECT?

The answer is II and IV. DIV Corporation's overall market value will remain unchanged at $50 million, with 2.2 million shares outstanding. The stock price per share will be adjusted downward to $22.73 ($50,000,000 ÷ 2,200,000).

An investor is deciding whether to make an investment in LKJ stock, which has a standard deviation of 4.3% and an expected return of 13%, or FDS stock, which has a standard deviation of 5.6% and an expected return of 10.5%. Using the coefficient of variation (CV), which of the following is the preferable investment choice?

The answer is LKJ, with a CV of 0.3308. The CV is calculated by dividing the standard deviation of an asset by its expected return. For LKJ, the CV is 0.3308 (0.043 ÷ 0.13). For FDS, the CV is 0.5333 (0.056 ÷ 0.105). Using only this information, the investor may choose to select the asset with the lower CV, which in this case, is the LKJ stock.

Which statement regarding the concepts of modern portfolio theory (MPT) is NOT correct?

The answer is Markowitz used risk (as measured by beta) and expected return as the basis for determining appropriate assets or portfolios. Harry Markowitz's theory uses standard deviation as a measure of portfolio risk.

Mysterious Company stock has a mean return of 9% and a standard deviation of 3%. Based on this information, which of the following statements is CORRECT?

The answer is Mysterious Company is unlikely to experience a negative return. With a normal probability distribution, 68% of the returns fall within one standard deviation of the mean, 95% within two standard deviations, and 99% within three standard deviations. Therefore, Mysterious Company has less than a 0.5% chance of experiencing a negative return.

If a mutual fund's beta and standard deviation are expected to decrease in the future, its average annual return and the market average annual return are expected to remain the same, and the risk-free rate is expected to remain constant, which of the following shows the real effect this would have on the following performance measures?

The answer is Option D. A decrease in the risk level decreases the denominator of the Sharpe ratio, while the numerator stays constant, thereby increasing the Sharpe ratio. The decreased risk level, as measured by beta, decreases the expected return for the fund, while the actual portfolio return remains constant, thereby increasing the alpha. Increase alpha increase sharpe ratio

RNO Mutual Fund invests in domestic debt and equity securities. The fund's current bond holdings are valued at $63 million, and its equity holdings are valued at $85 million. RNO currently has 3 million outstanding shares; although it is not limited in the number of shares it may sell. Which of these statements is CORRECT?

The answer is RNO shares are priced at $49.33 per share. Because RNO invests in both bonds and equities, it is not a money market mutual fund. RNO's shares are valued at NAV, calculated as follows: ($63 million + $85 million) ÷ 3 million shares = $49.33 per share. Mutual fund shares are sold and redeemed directly by the mutual fund company and do not trade on the major exchanges. RNO is an example of an open-end investment company.

Sam holds a considerable amount of both Series EE and Series HH savings bonds. He is nearing retirement and likes the fact that his Series HH bonds pay interest semiannually and would like to exchange most of his Series EE bonds for Series HH bonds to increase his cash flow. Choose which of these statements regarding such an exchange is CORRECT.

The answer is Series EE bonds may no longer be exchanged for Series HH bonds. Until September 2004 (when Series HH bonds were no longer issued by the Treasury), the exchange of EE bonds for HH bonds was a popular way of continuing the income tax deferral on the accrued interest portion of the EE bonds. Such changes are no longer possible.

Larry's 401(k) plan has experienced returns over the past five years of -10%, 15.55%, -5.87%, 12.75%, and 14.85%. What are both the arithmetic and geometric means for this series of returns?

The answer is arithmetic mean = 5.45%; geometric mean = 4.85%. Arithmetic mean: [(-0.10 + 0.155 - 0.0587 + 0.1275 + 0.1485) ÷ 5] = 0.0545, or 5.45%. Geometric mean: PV = -1; FV = (1 - 0.10)(1 + 0.155)(1 - 0.0587)(1 + 0.1275)(1 + 0.1485) = 1.2671; N = 5; solve for I/YR = 4.8485, or 4.85%.

According to Markowitz, an investor's optimal portfolio is determined when the investor's

The answer is highest indifference curve is tangent to the efficient frontier. The optimal portfolio for an investor is determined as the point when the investor's highest indifference curve is tangent to the efficient frontier.

If a bond is immunized against interest rate risk, a dollar decline in the bond's price, resulting from rising interest rates, will be approximately offset by a dollar increase in the

The answer is income from coupons reinvested over the investment horizon. By investing in bonds that have a duration equal to the investor's investment time horizon, any bond price/value changes caused by interest rate fluctuations will be approximately offset by changes in the interest earned on the reinvested coupons.

FER stock has a current dividend of $0.75 per share that has been growing at a rate of 1.25% per year. If an investor's required rate of return is 15% and the stock is currently selling for $6.34 per share, determine whether the investor should purchase the stock.

The answer is no, the stock is overvalued based on the constant growth dividend discount model. Based on the constant growth dividend discount model, the intrinsic value of the stock is $5.52, calculated as follows: [0.75 × (1 + 0.0125)] ÷ (0.15 - 0.0125) = 0.7594 ÷ 0.1375 = 5.5227, or $5.52. Because FER is currently trading at a price of $6.34 per share, it is overvalued, and the investor should not buy the stock.

Which of the following statements regarding indifference curves is CORRECT?

The answer is represent all points where an investor is equally satisfied with the risk/return trade-off. Indifference curves express an individual's preference regarding two items - risk and return. The more risk averse an investor is, the steeper the slope is for that investor's indifference curve. Conversely, the less risk averse an investor is, the flatter the slope for that investor's indifference curve.

Assume that the yield curve currently is shaped as shown in YC1 (normal), and you anticipate it will be shaped as shown in YC2 (inverted) one year from now.

The answer is sell short-term bonds and buy long-term bonds. When a yield curve is inverted, a financial planner should consider purchasing long-term securities to lock in rates for a long period of time—in anticipation of lower yields in the future. Such a move might also result in a capital gain on the investment as bond prices rise.

The security market line (SML)

The answer is shows a security's expected return as a function of its systematic risk. The security market line (SML) shows the relationship between the rate of return and systematic risk (beta). Thus, the SML depicts a security's expected return as a function of its systematic risk. The intersection between the efficient frontier and a line from the risk-free rate depicts all the optimal portfolios composed of a combination of the market portfolio and the risk-free asset. The market portfolio is the only optimal portfolio comprised solely of risky securities.

Wendy traveled to France and converted U.S. dollars into euros when the exchange rate was USD 1.42 for each euro. When Wendy returned from France, she had some euros left over and converted them back into U.S. dollars. At that time, one dollar was worth .77 euros. Wendy wants to know if she made or lost money on the euros she exchanged back into U.S. dollars. You inform her that

The answer is the dollar has strengthened, and she lost money. When she returned, she would have preferred the euro to strengthen against the dollar; that way, she could have received more dollars.

CAL stock has a current annual dividend of $1.25 that has been growing at a constant rate of 4.5% per year. Assuming the stock is currently selling for $40, and your required rate of return is 7.5%, should you buy the stock at today's price?

The answer is yes, because the stock is undervalued. On the basis of the constant growth dividend discount model, the intrinsic value of CAL stock is $43.54, calculated as follows: V = [$1.25 × (1 + 0.045)] ÷ (0.075 - 0.045) V = $1.30625 ÷ 0.03 V = $43.54 Because CAL stock is currently selling for $40 per share, it is undervalued in the secondary market and worthy of a purchase.

Select the market designed to facilitate the initial sale of securities to the public.

primary

Marcy may add 100 shares of LKM corporation stock to her investment portfolio. The stock recently paid a dividend of $1.85 per share. The dividend is expected to grow at a constant rate of 2.25% per year. Her required rate of return is 7%. The stock is currently trading for $35.75 per share. Determine whether she should purchase the stock and why.

the answer is yes, the stock is undervalued based on an intrinsic value of $39.82. Using the constant growth dividend discount model, the intrinsic value of the stock is $39.82. V = ($1.85 × 1.0225) ÷ (0.07 - 0.0225) V = 1.8916 ÷ 0.04750 V = 39.8232, or $39.82 Based on this value, the stock is undervalued relative to its price in the secondary market.