FIN 301

The two major forms of long-term debt are , _______ issue and privately placed.

public

When assuming nonconstant growth in dividends, to avoid the problem of having to forecast and discount an infinite number of dividends, we must require that the dividends _____.

start growing at a constant rate sometime in the future

The goal of many successful organizations is a(n) ______ rate of growth in dividends.

steady

In case of default:

subordinated debt holders must give preference to other specified creditors

Bond ratings are based on the probability of default risk, which is the risk that ___.

the bond's issuer may not be able make all the required payments

Equity represents an ownership interest

true

Most corporate bonds pay coupon interest payments times per year.

twice

If you invest in a corporate bond, how many times can you expect, in general, to receive interest?

twice a year

The idea for ____-stage growth is that the dividend will grow at a rate of g1 for t years and then grow at a rate of g2 thereafter, forever.

two

If the growth rate (g) is zero, the capital gains yield is ____.

zero

With ____-rate bonds, the coupon payments are adjustable.

floating

An asset's value is determined by the present value of its ______ cash flows.

future

One requirement of the dividend growth model is _____.

g < R

Why does a bond's value fluctuate over time?

the coupon rate and par value are fixed, while market interest rates change

When the stock being valued does not pay dividends,

the dividend growth model can still be used.

Bond yields (are/aren't) quoted like APRs.

are

A _______provision allows the company to repurchase or "_______" part or all of the bond issue at stated prices over a specified period.

call call

A _______ is an unsecured bond, for which no specific pledge of property is made.

debenture

The price of a share of common stock is equal to the present value of all ______ future dividends.

expected

The value of a firm is the function of its ______ rate and its _______ rate.

growth , discount

A bond with a BBB rating has a ______ than a bond with an A rating.

higher risk of default

Place the following bonds in order of security as defined in the United States:

mortgage bonds debentures

In general, a corporate bond's coupon rate ____,

is fixed until the bond matures

Interest on municipal bonds (is/isn't) federally taxed.

isn't

The federal government can raise money from financial markets to finance its deficits by ___.

issuing bonds

Which of the following is true about a typical multiple-year bond's coupon?

it is a fixed annuity payment

What is the definition of a bond's time to maturity?

it is the number of years until the face value is due to be repaid

What is an interest-only loan?

it's a loan in which the borrower pays interest periodically and repays the principal when the bond matures

Three special case patterns of dividend growth include _____.

non-constant growth constant growth zero growth

When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as follows:

one vote per share held

The constant growth formula calculates the stock price:

one year prior (year t) to the first dividend payment (Dt +1)

A share of common stock can be valued by determining the _____value of its future cash flows.

present

A bond pays annual interest payments of $50, has a par value of $1,000, and a market price of $1,200. How is the coupon rate computed?

$50 / $1000

The U.S. government borrows money by issuing:

- Treasury bills - Treasury bonds - Treasury notes

Which of the following are features of common stock?

It has no special preference in receiving dividends. It has no special preference in bankruptcy. It generally has voting rights.

WinWin Corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?

No minority shareholder would have enough votes to win any seat on the board.

Which is the formula used to estimate a stock price based on the benchmark PE?

Pt = Benchmark PE ratio × EPSt

What is a premium bond?

a bond that sells for more than face value

A benchmark PE ratio can be determined using:

a company's own historical PEs the PEs of similar companies

Protective covenants are classified into two types:________- and_________- covenants.

affirmative negative

A firm's bond rating sheds light on its _________ risk.

default

What is a discount bond?

discount bonds are bonds that sell for less than the face value

If the present value of the interIf the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ____.

$1,220

Dusty Corporation has an issue of preferred stock that pays a dividend of 7 percent of its state value, which is $100. Which of the following would be a commonly used name for that preferred stock?

$7 preferred

What is the value of a bond if the present value of interest cash flows is $200 and the present value of the par value to be received when the bond matures is $750?

$950

If a zero-dividend stock is purchased for $80 and sold one year later for $84, the 1-year return can be found using the formula ______.

(84/80) - 1

How is a conventional bond different from a zero coupon bond?

- Conventional bonds can sell at par, at a discount from par, or at a premium over par while zeros must be offered at a discount from par - A conventional bond pays periodic interest whiles zeros make no interest payments.

If you invest in a bond that is rated AAA by S&P, you can be reasonably assured that your investment has very little default risk.

- High probability of default - Less than investment-grade rating

How is investing in U.S. Treasury bonds different from investing in corporate bonds?

- Interest from U.S. Treasuries is exempt from taxes at the state level but corporate interest is not. - Treasury issues have no default risk.

As a general rule, which of the following are true of debt and equity?

- The maximum reward for owning debt is fixed - Equity represents an ownership interest

As a general rule, which of the following are true of debt and equity?

- The maximum reward for owning debt is fixed - Equity represents an ownership interest

false: If you invest in junk bonds, there is a high likelihood that you will earn a very high return.

- They are issued by state and local governments. - The interest on municipal bonds is exempt from federal taxes.

Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?

- Treasury bonds offer certain tax benefits to investors that corporate bonds cannot offer. - Treasury bonds are considered free of default risk while corporate bonds are exposed to default risk. - Treasury bonds are issued by the US government while corporate bonds are issued by corporations.

What is a corporate bond's yield to maturity (YTM)?

- YTM is the expected return for an investor who buys the bond today and hold it to maturity - YTM is the prevailing market interest rate for bonds with similar features

How is a zero coupon bond different from a conventional bond?

- Zero coupon bonds are always issued at a discount. - Zero coupon bonds make no interest payments.

A corporate bond's yield to maturity ____.

- changes over time - can be greater than, equal to, or less than the bond's coupon rate

Which of these are required to calculate the current value of a bond?

- coupon rate - applicable market rate - time remaining to maturity - par value

Which of the following terms apply to a bond?

- par value - coupon rate - time to maturity

Which of the following variables are required to calculate the value of a bond?

- remaining life of bond - coupon rate - market yield

If you are holding a municipal bond that is trading at par to yield 6 percent, by how much will your aftertax yield change if your income tax bracket increases from 15 percent to 20 percent. Assume there are no state or local taxes

0%

In terms of time to maturity, U.S. Treasury notes and bonds have initial maturities ranging from ___ years.

2-30

If you are in the 20 percent tax bracket, what is your aftertax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes.

5%

What are municipal bonds?

Bonds that have been issued by state or local governments

What are crossover bonds?

Bonds that have both an investment grade and a junk bond rating

Match each one of these bonds with their characteristic.

CAT bond ----->Protects insurance companies from natural disasters Convertible bond ----->Can be exchanged for shares of stock Put bond -----> Owner can force issuer to repay prior to maturity at a stated price Structured note ----->Based on financial securities, commodities, or currencies

The amount by which the call price exceeds the par value of the bond is called the _____.

Call premium

Which of the following are reasons why it is more difficult to value common stock than it is to value bonds? Common stock cash flows are not known in advance The rate of return required by the market is not easily observed. The life of a common stock is essentially forever. All bond and stock cash flows are guaranteed to be paid.

Common stock cash flows are not known in advance The rate of return required by the market is not easily observed. The life of a common stock is essentially forever.

What are the federal income tax implications of receiving $50 in interest income from a municipal bond versus a corporate bond?

Only the interest on the corporate bond will be taxed.

The formula for valuing a constant growth stock is _____.

P0 = D1 / (R - g)

What is the formula to determine the price of a stock at the end of one year (P1) if the dividend for Year 2 (Div2) is $10, the price for Year 2 (P2) is $15, and the discount rate is 8 percent?

P1 = (10 + 15) / 1.08

What is the formula to determine the price of a stock at the end of one year (P1) if the dividend for Year 2 (Div2) is $5, the price for Year 2 (P2) is $20, and the discount rate is 10 percent?

P1 = (5 + 20) / 1.10

Match the following terms relating to stock valuation: P1 D1 R R0

P1 = price in one year D1 = dividend in one year R = discount rate P0 = price today

What are the cash flows involved in the purchase of a 5-year zero coupon bond that has a par value of $1,000 if the current price is $800? Assume the market rate of interest is 5 percent.

Pay $800 today and receive $1,000 at the end of 5 years

In which way(s) is preferred stock like a bond?

Preferred shareholders receive a stated dividend, similar to interest on a bond. Some preferred stock has credit ratings, like bonds. Preferred shareholders receive a stated value if the firm liquidates, like bondholders. Preferred stock sometimes has a sinking fund, giving it a set maturity like bonds.

What is the formula to determine the total return for a stock that currently sells for $100, pays a dividend in one year of $2, and has a constant growth rate of 8 percent?

R = (2 / 100) + 0.08

What does a bond's rating reflect?

The ability of the firm to repay its debt and interest on time

What does the AAA rating assigned by S&P mean?

The firm is in a strong position to meet its debt obligations.

What information do we need to determine the value of stock using the zero-growth model?

annual dividend amount discount rate

The main reason it is important to distinguish between debt and equity is that the benefits and risks _____.

are different

When a corporation or government wishes to borrow money from the public on a long-term basis, it usually does so by issuing or selling debt securities that are generically called

bonds

Matthews Company has two classes of common stock, and each share represents the same proportion of ownership in the company. Class A has 2 votes for each share. Class B has one vote per share. Which class is more valuable?

class A

The ______ can be interpreted as the capital gains yield.

constant growth rate

A bond's ______ rate is the stated interest payment made on a bond.

coupon

If a bond is rated Baa by Moody's and BB by Standard & Poor's, the bond will be regarded as a(n) _____ bond.

crossover

Suppose Bob owns 20 shares and Vikki owns 30 shares in Good Company, and there are five members of the board of directors. Under which voting arrangement can Bob assure himself of a board member that represents his interests?

cumulative voting

The dividend growth model determines the current price of a stock as its dividend next period (multiplied/divided) by the discount rate (less/plus) the dividend growth rate.

dividend less

The price of a share of common stock is equal to the present value of all expected future

dividends

Which of the following represents the valuation of stock using a zero-growth model?

dividends / discount rate

Which one of the following is true about dividend growth patterns?

dividends may grow at a constant rate

If you were classified as a high income/high tax bracket investor, you might find municipal bonds an attractive investment because ____.

income from municipal bonds is exempt from federal taxes

When interest rates in the market fall, bond values are likely to increase because the present value of the bond's remaining cash flows ____.

increases

The written agreement between the corporation and the lender detailing the terms of the debt issue is the

indenture

If a $1,000 par value bond is trading at a discount, it means that the market value of the bond is ______ $1,000.

less than

A zero coupon bond is a bond that ____.

makes no interest payments

A bond's time to ____ is the number of years until the face value is due to be repaid.

maturity

A share of common stock is (less/more) difficult to value in practice than a bond.

more

Most voting in large corporations is done by proxy because _____.

most small shareholders do not attend the annual meeting

When applying two-stage growth, in the second stage, g2 _____.

must be less than R

There is a(n) ______ relationship between market interest rates and bond values. Multiple choice question.

negative

How is an APR computed?

rate per period x number of periods per year

The main reason for considering nonconstant growth in dividends is to allow for _____ growth rates over _____.

supernormal; some finite length of time

Which of the following are common protective covenants?

- the firm must limit dividends to equity holders - the firm cannot merge with any other firm - the firm must maintain working capital at or above a specified level

Which of the following is not a difference between debt and equity?

Equity is publicly traded while debt is not

If the market rate of interest rises, the value of the bond will (fall/rise).

fall

True or false: A bond's value is not affected by changes in the market rate of interest.

false

The interest from a municipal bond is exempt from ____ income taxes.

federal

The dividend yield is determined by dividing the expected dividend (D1) by _____.

the current price (P0)

What does a Moody's bond rating of C typically indicate?

the issuer is in default

If a $1,000 par value bond is trading at a premium, the bond is _____.

trading for more than $1000 in the market

Most of the time, a floating-rate bond's coupon adjusts ____.

with a lag to some base rate