F300 Exam 2

As applied to mortgage loans, which of the following statements is FALSE?

Advertised rates are EARS.

Which of the following statements is true about variance?

All of the Above: The larger the variance, the greater the dispersion; Variance is essentially the variability from the average; Variance describes how spread out a set of numbers or a value is around its mean or average;

Suppose you depost money in a CD at the bank, which of the following statements is TRUE

The bank is technically renting money from you with a promise to repay that money with interest

The phrase "Price to rent money" is sometimes used to refer to

interest rates

For most stocks, the correlation coefficient with other stocks is ____________.

positive

Stocks are different from bonds because _________________.

stocks, unlike bods, represent residual ownership.

_________ is risk that can not be diversified away

systematic risk

The 2 major components of the interest rate that cause rates to vary across different investment opportunities or loans are

the default premium and the maturity premium

The primary benefit of diversification is

Reduction in Risk

The __________ is the intercept of the Security Market Line.

Risk - free rate

Zero - coupon US Government bonds are known as

STRIPS

Assuming that stocks represent most industries, the number of stocks necessary to eliminate nearly all unsystematic risk varies from

20 to 30

Which of the below is NOT a major component of interest rates?

Historical Interest Rates

Real Rate of your Reward for Saving:

Interest Rate - Inflation Rate

Investors want to

Minimize risk & Maximize return

_______________ has to do with the speed and accuracy of processing a buy or sell order at the best available price.

Operational efficiency

When the ___ is less than the yield to maturity, the bond sells at a/the ___ the par value.

coupon rate; discount to

The ____________ is the interest rate printed on the bond

Coupon Rate

The "Truth in Savings Law" requires banks to advertise their rates on investments such as CDs and savings accounts as Annual Percentage Yields (APY).

TRUE

The HPR is the return measured from the initial purchase to the final sale of the investment without regard to the length of time the investment is held.

TRUE

The dividend models appeal to a fundamental concept of asset pricing - that the value of an asset is determined by the future cash flow to which the owner is entitled while holding the asset, and required rate of return for the cash flow

TRUE

We assign a very low probability of default to the US treasury and thus assume that all Treasury bills will be paid in full at maturity and thus have zero default premium.

TRUE

The difference between the price and the par value of a zero - coupon bond represents _______________.

The accumulated interest over the life of the bond.

Which of the following statements is FALSE?

The longer the loan, the greater the risk of nonpayment and the lower the interest rate the lender demands.

Diversification is

not putting all of your eggs in one basket, a common investment strategy, spreading wealth over a variety of investment opportunities

Why does the monthly payment plan have less total cash outflow each year?

as more payments are made year year, the principal is repaid quickly and thus the interest expense is less.

Bonds are different from stocks because ________

bonds promise fixed payments for the length of their maturity

The __________ compensates the investor for the additional risk that the loan will not be paid in full

default premium

The terms ___________ & ___________ mean the same thing

diversifiable risk; unsystematic risk

The value of a financial asset is the _____________.

present value of all of the future cash flows that will be received.

Correlation is a standardized measure of how stocks perform relative to one another in different states of the economy, and has a range of

-1.0 to +1.0

Treasury Bills have a beta of

0

MicroMedia Inc $1000 par value bonds are selling for $1265. Which of the following statements is TRUE?

All of the Above; The bonds are selling at a premium to the par value, the coupon rate is greater than the yield to maturity, the bond market currently requires a rate (yield) less than the coupon rate

You wish to diversify your single - security portfolio in a way that will maximize your reduction in risk. Which of the following securities should you add to your portfolio?

Alpha Company stock that has a correlation coefficient of -0.25 with your current portfolio

When interest rates are stated or given for loan repayments, it is assumed that they are ______________ unless specifically stated otherwise.

Annual Percentage Rates

If we know the dividend stream, the future price of the stock, the future selling date of the stock & the required return, we can price the stock just as we priced _____________.

Bonds

A company selling a bond is ________ money.

Borrowing

Dividend models suggest that the value of a financial asset is determined by future cash flows. A problem arises, however, in that future cash flows may be difficult to predict as to ______________ of these cash flows

Both the timing and the amount

Shaky Company has just issued a 5 year bond with a yield of 9%; Stable Company has issued an identical 5 year bond but with a yield of 7%. Why did the market demand a higher return from Shaky?

Companies with poor financials tend to compensate investors for the default risk by issuing bonds with higher yields.

_____________ means that the percentage increase in the dividend is the same each year.

Constant growth

Ben has just purchased a long-term government bond and expects to make a 7% return. Donna has just purchased a stock in a new start up company but expects to make a 20% return. Why does Donna expect a higher return?

Donna is expecting a higher return on the stock due to both the maturity premium and default premium.

_______________ refers to how quickly information is reflected in the available prices for trading

Informational efficiency

Real Rate + Inflation Rate =

Nominal Rate

The Fisher Effect involves which of the items below

Nominal Rate, the real rate & inflation rate

MicroMedia INC $1000 par value bonds are selling for $832. Which of the following statements is TRUE?

None of the Following are True: The coupon rate is greater than the TYM, The bonds are selling at a premium to the par value, the bonds must have more than six years to maturity

To determine the interest paid by compounding period, we take the advertised annual percentage rate and simply divide it by the ________ to get the appropriate periodic interest rate.

Number of Compounding periods per year

A typical practice of many companies is to distribute part of the earnings to shareholders through:

Quarterly Cash Dividends

For purposes of maximum portfolio diversification, which of the following would provide the greatest diversification?

Security C with a correlation coefficient of -0.50

What is the EAR if the APR is 10.52% and compounding is daily?

Slightly above 11.09%

What is the EAR if the APR is 5% and compounding is quarterly?

Slightly above 5.09%

An annual percentage rate must be converted to the appropriate periodic rate when compounding is more frequent than once per year.

TRUE

Differences in borrowing rates can generally be explained by the level of risk of the investment or loan and by the length of the investment or loan.

TRUE

If the par value of a bond is equal to the bond price, then we know the YTM is equal to the coupon rate.

TRUE

Stocks with higher standard deviation are riskier

TRUE

When pricing a zero- coupon bond, the convention is to use the semiannual pricing formula rather than the annual pricing formula.

TRUE

When quoting rates on loans, the "Truth in Lending Law" requires the bank to state the rate as an APR, effectively understanding the true cost of the loan when interest is computed more often than once a year.

TRUE

Zero Coupon Bonds are priced at deep discounts.

TRUE

Nominal Interest Rates are the sum of 2 major components:

The Real Interest Rate & Expected Inflation

The U.S. government offers 2 bonds: one selling to yield 6.5% and the other to yield 8.5%. Why would one bond sell for a lower yield if the originator is the same?

The difference between the yields of the US government bonds is due to the maturity premium of the investments.

Which of the following is FALSE?

The payment of cash dividends to shareholds is a deductible expense for the company

Why would we want to assume a constant growth to dividends if we seldom see a firm with this type of pattern?

We really want to estimate a series of future dividends and can only do this if we have a growth rate.

The __________ is a market derived interest rate used to discount the future cash flows of the bonds.

Yield to Maturity

Assume that you are willing to postpone consumption today and buy a certificate of deposit at your local bank, your reward for postponing consumption implies that at the end of the year:

You will be able to buy more goods and services

An investors total investment set may be referred to as

a financial portfolio

The Security Market Line has ______________.

a positive slope

Stocks differ from bonds because:

all of the above; (1) Bond cash flows are known while stock cash flows are uncertain (2) Firms pay bond cash flows prior to paying taxes, while stock cash flows are after tax (3) the ending par value of a bond is known at purchase while the ending value of a share of stock is unknown at purchase.

The measure of systematic risk is called

beta

Strong - form efficiency markets theory proclaims that __________________.

current prices reflect the price and volume history of the stock, all publicly available information and all private information

A beta of 1.0 is the beta of the _________, while a beta of 0.0 is measure for a ________.

market; risk - free security

APRs must be converted to the appropriate periodic rates when compounding is ______________.

more frequent than once a year.

The frequency of default on a home loan is ______________ the frequency of default on a credit card.

much lower than

Most U.S. corporate and government bonds choose to make ____________ coupon payments

semiannual

The type of risk that can be diversified away is called

unsystematic risk

A more risky stock has a higher ________.

variance and standard deviation

In _______________, current prices reflect the price history and trading volume of the stock. It is of no use to chart historical stock prices to predict future stock prices such that you can identify mispriced stocks and routinely outperform the market.

weak - form efficient markets