FIN3403 exam 2
A benchmark PE ration can be determined using
1) a company's own historian PEs 2) the PEs of similar companies
What is the price of a U.S Treasury bond that is listed at 90 if the par value is $1,000?
900 1,000 x .90=900
Structured note
Based on financial securities, commodities, or currencies
Most voting in large corporations is done by proxy because:
Most small shareholders do not attend the annual meeting. This is because it is inconvenient and they have a fairly small stake in the decisions made
The two most important stock markets in the U.S are the NYSE and the
NASDAQ
Symbol for discount rate
R
Which is more transparent, the stock market or the bond market?
The stock market
Place the following bonds in order of security as defined in the U.S
1) Mortgage bonds 2) Debentures
Three special case patterns of dividend growth include:
1) Non-constant growth 2) Constant growth 3) zero growth
Which of the following projects is acceptable if the average accounting return is required to be at least 20%?
1) Restaurant: Average income= $450,000, Average book value= $2,180,000 2) Book store: Average income= $140,000, Average book value= $600,000
What are the advantages of the payback period method for management?
1) the payback period method is ideal for short projects 2) The payback period method is easy to use 3) It allows lower level managers to make small decisions effectively
Which of the following is usually a right of common shareholders?
1) the right to a proportional share of dividends paid 2) Voting rights 3) the right to purchase a proportional share of new stock issued
Which of the following are weaknesses of the payback method?
1) time value of money principles are ignored 2) the cutoff date is arbitrary 3) cash flows received after the payback period are ignored
The three attributes of NPV are that it
1) uses cash flows 2) discounts the cash flows properly 3) uses all the cash flows of a project
What will happen to the default risk premium during periods of economic uncertainty?
it will increase
the amount of time needed for the cash flows from an investment to pay for its initial cost is the
payback period
You expect the following dividends from ABC Stock: Year 1: $3.00 Year 2: $2.00 Year 3: $1.00 You expect that from year 4 onward, the dividend will grow at a constant 3% growth rate. If your required rate of return is 7%, what is your estimate for the current stock price?
$26.39 3/1.07 + 2/1.07^2+(1+1(1.03)/(0.07-0.03))/1.07^3= 26.39
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107. and a discount rate of 6%?
$5.94
Amy took out a mortgage of $100,000 at 4.5% with monthly payments for 30 years. What is her payment to principal and interest each month?
$506.69
Dusty Corporation has an issue of preferred stock that pays a dividend of 7% of its state value, which is $100. Which of the following would be a commonly used name for that preferred stock?
$7 preferred The preferred stock would often be called by its dividend amount, so it would be called "$7 preferred"
What are some features of the OTC market for bonds?
-OTC dealers are connected electronically -The OTC has no designated physical location
What does the dirty price represent?
It includes the quoted price and interest accrued since the last coupon payment
What is a real rate of return?
It is a rate of return that has been adjusted for inflation
What does the clean price for a bond represent?
The quoted price, which excludes interest accrued since the last coupon date
What is a corporate bond's yield to maturity?
YTM is the expected return for an investor who buys the bond today and holds it to maturity YTM is the prevailing market interest rate for bonds with similar features
A bond has a quoted price of $984.63, a face value of $1,000, a semi-annual coupon of $20, and a maturity of 10 years. Match its current yield and its YTM below
YTM= 4.19% Current yield= 4.06%
The internal rate of return is a function of
a projects cash flows
If a $1,000 face value U.S Treasury bond is quoted at 99.5, then the bond can be purchased
at 99.5 percent of the face value plus any accrued interest
A zero-growth model for stock valuation is distinguished by a ______
constant dividend amount
Discounted payback period tells the time it takes to break even in an _____ or financial sense
economic
The price of a share of common stock is equal to the present value of all ______ future dividends
expected
A humpted term structure of interest rates indicates that interest rates are expected to ___________ as the time to maturity increases
increase and then decline
Initial public offerings of stock occur in the ________ market
primary secondary is the market for existing shares trading between investors
The IRR rule can lead to bad decisions when ______ or ________
projects are mutually exclusive cash flows are not conventional
npv accounts for the size of the project and thus mitigates the effects of
scale
The NYSE member who acts as a dealer in a small number of securities is called a
specialist
Suppose a bond's clean price is $1,050 and the bond currently has accrued interest of $30. What is the dirty price?
$1,080
The NYSE differs from the NASDAQ primarily because the NYSE has:
1) physical location 2) specialists 3) an auction market
Convertible bond
can be exchanged for shares of stock
The largest number of NYSE members are registered as
commission brokers
Which of the following are true about a bond's face value?
It is also known as the par value It is the principal amount repaid at maturity
Is a company required to pay preferred dividends?
No; the company may defer dividends on preferred stock; however they can not pay dividends to common shareholders until preferred dividends are paid
What is the difference between a bond's "clean price" and its "dirty price"?
The clean price excludes interest accrued since the last coupon payment, while the dirty price includes accrued interest
Which of the following are reasons why it is more difficult to value common stock than it is to value bonds?
1) the life of a common stock is essentially forever 2) Common stock cash flows are not known in advance 3) The rate of return required by the market is not easily observed
The degree of interest rate depends on
the sensitivity of the bond's price to interest rate changes
A market is considered transparent if
its prices and trading volume are easily observed
Which of these are required to calculate the current value of a bond?
-par value -time remaining to maturity -coupon rate
The basic NPV investment rule is:
-reject a project if its NPV is less than zero -accept a project if its NPV is greater than zero -if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference
Which of the following are usually included in a bond's indenture?
-the total amount of bonds issued -the repayment arrangements
What is 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%?
10% R=($2/$100)+.08=.10, or 10%
What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?
10% Coupon rate= $100/$1,000
What is the current yield on a $1,000 par value bond that sells for $900 if the coupon rate is 10 percent?
11.11%
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 Under cumulative voting, Bob would have 20 x 5= 100 votes to cast. He could cast all 100 shares for a candidate of his choice, assuring the candidate of a seat on the board. Vikki would have a total of 30 x 5= 150 shares, and there is no way to distribute her shares over five candidates such that each had more than 100 votes
Symbol for dividend in one year
D1
The constant-growth model infers that __________.
Dividends change at a constant rate
When voting for the board of directors, the number of votes a shareholder is entitled to is general determined as follows:
One vote per share held
Fundamentally, the business of the NYSE is too attract and process ______.
Order flow
Symbol for price today
P0
Secondary markets in sukuk are extremely illiquid because most sukuk are
bought and held to maturity
A _________ maintains an inventory of stocks and buys and sells those stocks
dealer
Someone who maintains an inventory of stocks and buys and sells those stocks is known as
dealer A dealer is sort of like a retailer in stocks, but with a different name (and no shelves).
The bid-ask spread represents the
dealer's profit
When the US government wants to borrow money for the long-term (more than one year) it issues
treasury notes treasury bonds
True or false: two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing
true
Capital Corp is considering a project whose internal rate of return is 14%. If Capital's rate of return is 14%, the projects NPV is?
zero
What are some reasons why the bond market is so big?
-Federal government borrowing activity in the bond market is enormous -Various state and local governments also participate in the bond market -Many corporations have multiple bond issues outstanding
A corporation issues 50k bonds at 1000 each. The bonds mature in 5 years and have a coupon rate of 7%. What will the total annual interest expense be for the corporation?
3.5 million 50k x 1k x .07=3.5 million
Use your calculator to find the YTM on a 20 yr, $1000 par value bond that pays coupons of 4.5% semi-annually and currently sells for $1104.89
3.75 enter 40 for N (2 payments per years for 20 yrs), 22.5 for coupon (.045x1000)/2, -1104 for PV and 1000 for FV. Solve for I/Y and multiply by 2
What is the price of a U.S Treasury bond listed at 122 if the par value is $5,000?
6,100 5,000 x 1.22= 6,100
What will your aftertax yield be on a corporate bond that is currently trading at par and yielding 8 percent if you are in the 20 percent tax bracket?
6.4%
What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?
9.70%
True or false: The crossover rate is the rate at which the NPVs of two projects are equal
True
True or false: The near stock price is relevant to the current stock price; however, its value is included in discounted value of the distant stock price
True
What are municipal bonds?
Bonds that have been issued by state or local governments
The profitability index is calculated by dividing the PV of the _______ cash flows by the initial investment.
Future
What is the nominal rate of return on an investment?
It is the actual percentage change in the dollar value of an investment
If a project has multiple internal rates of return, which of the following methods should be used?
NPV and MIRR
Which of the following terms apply to a bond?
Par value, coupon rate, and time to maturity
Which is the largest security market in the world in terms of trading volume
The U.S Treasuries market
What is the asked price?
The asked price is the price at which the dealer is willing to sell
Which has a higher value, the bid price or the asked price quote?
The asked price quote is higher
What is the bid price?
The bid is the price at which a dealer is willing to buy securities
Why does a bond's value fluctuate over time?
The coupon rate and par value are fixed, while market interest rates change
Which of the following are features of municipal bonds?
They are issued by state and local governments The interest on municipal bonds is exempt from federal taxes
True or false: the price you actually pay to purchase a bond will generally exceed the clean price.
True
Saxon Company is considering a project that will generate net income of $50,000 in Year, $75,000 in Year 2, and $90,000 in Year 3. The cost of the project is $700,000 and this cost will be depreciated to zero in the three years of the investment. What is their average accounting return?
20.48% The average net income is (50,000 75,000 90,000)/3=71,670. The average book value of the investment is (700,000+0)/2=350,000. The average accounting return is 71,670/350,000=20.48%
Which of the following occurs in the primary market? 1) shareholders gift shares to charities 2) outstanding shares are resold 3) newly-issued stocks are initially sold 4) issuers repurchase shares
3) newly-issued stocks are initially sold
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:
A target average accounting return According to the average accounting return rule, a project is acceptable if its average accounting return exceeds a target average accounting return
How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project's lifetime.
An increase in the size of the first cash inflow will decrease the payback period, all else constant.
Which of these are required to calculate the current value of a bond? Check all that apply.
Applicable market rate Coupon rate Par value Time remaining to maturity
Which one of the following is true about dividend growth patterns?
Dividends may grow at a constant rate
True or false: Investing more money in a project is a guarantee of greater profits.
False
Mota Motors has eight directors on its board, two of whom go up for election each year. This is an example of a:
Staggered board In a staggered board, only a fraction of the directorships are up for election at any one time.
Which of the following institutions issue bonds that are traded in the bond market?
State governments, the federal government, and public corporations
A PE ratio that is based on estimated future earnings is known as a ___________ PE ratio
forward
One requirement of the dividend growth model is:
g<R For the dividend growth model to be useful, the long-term growth rate must be smaller than the discount rate
The IRR will always recommend that the ending cash flow is _______ than the starting cash flow
greater
The value of a firm is the function of its ______ rate and its _______ rate
growth; discount
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
When cash flows are conventional, NPV is _____ if the discount rate is above the IRR
negative
The constant growth formula calculates the stock price
one year prior (year t) to the first dividend payment (D t+1)
Put bond
owner can force issuer to repay prior to maturity at a stated price
Which of these is included in the calculation of a bond's yield to maturity?
par value current price coupon rate
the capital budgeting method allows lower management to make smaller, everyday financial decisions effectively
payback method
The ______ method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment
payback method The payback method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment. NPV includes all cash flows and discounts them at the required rate of return
According to the basic IRR rule, we should:
reject a project if the IRR is less than the required return
The point at which the NPV profile crosses the vertical axis is the:
sum of the cash flows of the project
Which of the following entities declares a dividend?
the board of directors
The dividend yield is determined by dividing the expect dividend (D1) by
the current price (P0)
When the stock being valued does not pay dividends,
the dividend growth model can still be used The analyst must assume that, at some point in the company's future, it begins paying dividends. (Though this assumption an be considered far-fetched, the process is still valid if the assumption is made. Therefore, the model can be used and the answer is "true.")
If the growth rate (g) is zero, the capital gains yield is ________
zero
What is the after-tax yield on a US treasury bond using 7% if you are in the 20% tax bracket?
5.6% .07 X (1- 0.2) = 5.6%
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 cannot. A conventional bond pays periodic interest whiles zeros make no interest payments
A person who brings buyers and sellers together is called a _______
broker
Capital _________ is decision making process for accepting and rejecting projects
budgeting
A corporate bond's yield to maturity_______
changes over time and can be greater than, equal to, or less than the bond's coupon rate
All else constant, the dividend yield will increase if the stock price _______
decreases The dividend yield is D/P, so when the denominator decreases, the ratio increases
Arrange the steps involved in the discounted payback period in order starting with the first step:
1) Discount the cash flows using the discount rate 2) add the discounted cash flows 3) accept if the discounted payback period is less than some pre-specified number of years
When cash flows are conventional, NPV is _____
1) negative for discount rates above the IRR 2) Equal to zero when the discount rate equals the IRR 3) Positive for discount rates below the IRR
Preferred stock has preference over common stock in the:
1) payment of dividends 2) distribution of corporate assets Preferred stock has preference over common stock in the payment of dividends
If the rate of inflation is 3 percent and the real rate of return is 9 percent, the nominal rate is approx.
12%
Companies must pay interest to _______________ first
bondholders If they do not pay, they will be in default, which could have serious consequences
Scott Corporation does not pay dividends. The PE ratio for its industry is 13.3, and Scott's EPS were $1.47. At what price should Scott's stock trade?
$19.55
Which of the following are common protective covenants?
-The firm cannot merge with any other firm -The firm must limit dividends to equity holders -The firm must maintain working capital at or above a specified level
If you are holding a municipal bond that is trading at par to yield 6%, by how much will your after-tax yield change if your income tax bracket increases from 15% to 20%. Assume there are no state or local taxes
0%
Which of the following are mutually exclusive investments? 1) A restaurant or a gas station on the same piece of land 2) Two different choices of the assembly lines that will make the same product 3) Two computer systems- one for administrative office and one for the security cameras 4) A restaurant or a gas station on opposite corners
1) A restaurant or a gas station on the same piece of land 2) Two different choices of the assembly lines that will make the same product
What information do we need to determine the value of stock using the zero-growth model?
1) Annual dividend amount 2) Discount rate
Which of the following are expected cash flows to investors in stocks?
1) capital gains 2) Dividends
True or false: the discounted payback rule has an objective benchmark to use in decision making
False: the discounted payback period rule is somewhat arbitrary-corporate financial managers determine the number of years to beat
What are three important features of Treasury notes and bonds?
Highly liquid, default-free, and taxable
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
All junk bonds typical have which of these features?
Less than investment-grade rating High probability of default
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the U.S and Canada?
Net present value and internal rate of return
Symbol for prince in one year
P1
In capital budgeting, the net _______ determines the value of a project to the company.
Present value
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 gov't while corporate bonds are issued by the corporations
True or false: Some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return
True: whenever subsequent cash flows are both negative and positive, multiple internal rates of return will occur
The PI rule for an independent project is to ______ the project is the PI is greater than 1
accept
The payback period rule suggests _____ a project if it has a payback period that is less than or equal to a particular cutoff date
accepting If a projects payback period is less than or equal to a particular cutoff date, the payback period rule suggests accepting it.
Payback period tells the time it takes to break even in an ____ sense
accounting
In the dividend discount model, the expected return for investors comes from which two sources?
1) Dividend Yield 2) Growth Rate The expected rate of return for stock investors is the dividend yield plus the growth rate (or capital gains yield)
Which of the following is a feature of common stock?
1) It has no special preference in receiving dividends 2) It generally has voting rights 3) It has no special preference in bankruptcy
In which ways is preferred stock like a bond?
1) Some preferred stock has credit ratings, like bonds 2) Preferred shareholders receive a stated dividend, similar to interest on a bond 3) Preferred shareholders receive a stated value if the firm liquidates, like bondholders 4) Preferred stock sometimes has a sinking fund, giving it a set maturity like bonds
What are advantages of AAR?
1) easy to compute 2) needed information is always available
The discounted payback period has which of these weaknesses?
1) exclusion of some cash flows 2) Loss of simplicity as compared to the payback method 3) Arbitrary cutoff date
NASDAQ has which of these features? 1) multiple market maker system 2) Physical trading floor 3) Single DMM system 4) Computer network of securities dealers
1) multiple market maker system 4) computer network of securities
How has TRACE improved transparency in the corporate bond market?
Corporate dealers are now required to report trade information through TRACE
Will is deciding whether or not to buy Dang Corporation stock, whose current price is $54.95. Dang paid a dividend of $2.17 this year. Will estimates that dividends will grow very quickly, at a rate of 12%, for the next four years. After that, he expects the dividend growth rate to fall to 5%. Should Will buy the stock if his required rate of return is 10%?
No; using the two stage growth model, the stock value is $9.08 P0=2.17(1.12)/(0.10-0.12) x [1-(1.12/1.10)^4]+[2.17(1.12)^4(1.05)/(0.10-0.05)]/1.10^4= $58.06 Note the first part of the equation is growing annuity that starts next year at a value of $2.17*(1.12) and grows at 12% for four years. The second part is the value at time 4 discounted for four periods
Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If Projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?
Project Beta
An ________ project does not rely on the acceptance or rejection of another project
independent
The present value of all cash flows after the initial investment is divided by the _____ to calculate the profitability index
initial investment
What is the most important alternative to the NPV method?
internal rate of return (IRR)
Stock price reporting has increasingly moved from traditional print media to the _____ in recent years
internet
In general, a corporate bond's coupon rate
is fixed until the bond matures
IRR continues to be very popular in practice, partly because:
it gives a rate of return rather than a dollar value
One reason corporations use staggered boards is that
it makes takeover attempts less likely to be successful
The reason that the interest rate risk is greater for _______ term bonds than for _______ term bonds is that the change in rates has a greater effect on the present value of the _________ than on the present value of the __________
long short face value coupon payments
All else held constant, the yield on a highly liquid bond will be _________ the yield on a illiquid bond
lower than
Cat bond
protect insurance companies from natural disasters
When valuing a stock, the advantage to considering the stock price in the distant future (rather than a more near-term price) as a cash flow is that:
when discounted to present value, a stock in the distant future is nearly zero.