FIN 301 Exam 3

risk premium

= expected return - risk free rate

What is the model called that determines the market value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate?

Constant growth model

Municipal Securities

Debt of state and local governments Varying degrees of default risk, rated similar to corporate debt Interest received is tax-exempt at the federal level.

Which one of the following rights is never directly granted to all shareholders of a publicly held corporation?

Determining the amount of the dividend to be paid per share

Unsystematic risk

Diversifiable (Business Risk), eliminate, Labor strikes, part shortages, etc.

Supernormal growth

Dividend growth is not consistent initially, but settles down to constant growth eventually. The price is computed using a multistage model.

Treasury Securities

Federal government debt that is considered to carry a risk-free rate of return T-bills - pure discount bonds with original maturity of one year or less T-notes - coupon debt with original maturity between one and ten years T-bonds - coupon debt with original maturity greater than ten years

Which of the following statements regarding unsystematic risk is accurate?

It can be effectively eliminated by portfolio diversification.

Systematic risk

Non-Diversifiable (Market Risk), can't eliminate GDP, inflation, interest rates, etc.

Bond Values

Over time, interest rates change in the marketplace, but the cash flows from a bond remain the same; as a result, the value of the bond will fluctuate

With respect to returns, which one of the following statements is accurate?

Over time, the average unexpected return will be zero.

perpetuity formula

P0 = D / R

Bond Value

PV of coupons + PV of par

Premium Bond

Price above par value

Discount bond

Price below par value

To calculate the expected risk premium on a stock, one must subtract the ________ from the stock's expected return.

Risk free rate

If a poorly-diversified portfolio becomes well diversified, we would expect the portfolio's:

Standard deviation will decrease

Based on the capital asset pricing model (CAPM), which of the following should earn the highest risk premium?

Stock with a beta of 1.24

Constant dividend growth

The firm will increase the dividend by a constant percent every period. The price is computed using the growing perpetuity model.

Constant dividend (i.e., zero growth)

The firm will pay a constant dividend forever. This is like preferred stock. The price is computed using the perpetuity formula.

________ risk is measured using the standard deviation.

Total

Assume the current market price of a bond exceeds its par value. Which one of these equations applies?

Yield to maturity < Coupon rate

Coupon rate

annual coupon divided by face value

When calculating a firm's weighted average cost of capital, the capital structure weights:

are based on the market values of the outstanding securities.

Zero coupon bonds

are bonds that make no coupon payments and are thus initially priced at a deep discount

Bonds issued by the U.S. government:

are considered to be free of default risk.

Of the options listed below, which is the best measure of systematic risk?

beta

A ________ is the market's measure of systematic risk.

beta of 1

Market Price (PV)

current price of the bond in the market

Maturity date

date that bond matures and the par value is paid

Par value (FV)

face value or principal amount, repaid at maturity, stated in values of $100, $1,000, $10,000, $100,000, etc.

Total coupon payments (N)

frequency of coupon payments each year times the number of years to bond maturity

Yield or Yield to maturity (I/Y)

internal rate of return required in the market for the bond. Rate required for the present value of all the future cash flows of the bond (face value and coupon payments) to equal the current bond price

As the market rate of interest increases, then....

market price of the bod will decrease

The cost of preferred stock is equivalent to the:

rate of return on a perpetuity.

Coupon (PMT)

stated interest payment

To determine a firm's cost of capital, one must include:

the returns currently required by both debtholders and stockholders.

Features of preferred stock

• Dividends Stated dividend that must be paid before dividends can be paid to common stockholders Dividends are not a liability of the firm, and preferred dividends can be deferred indefinitely. Most preferred dividends are cumulative - any missed preferred dividends have to be paid before common dividends can be paid. • Preferred stock generally does not carry voting rights.

Features of common stock

• Voting Rights • Proxy voting • Classes of stock: A and B impacting voting rights • Other Rights Share proportionally in declared dividends Share proportionally in remaining assets during liquidation Preemptive right - first shot at new stock issue to maintain proportional ownership if desired