FINANCE 2
The total return on a stock is equal to
Capital gains yield + Dividend yield.
Which one of the following measures the interrelationship between two securities?
Covariance
Unsystematic risk
can be effectively eliminated through portfolio diversification.
The rate at which a stock's price is expected to appreciate (or depreciate) is called the __________ yield.
capital gains
What does the spread between the bid and asked bond prices represent?
Dealer's profit
According to finance professionals, which one of these factors has the biggest impact on a firm's PE ratio?
Growth opportunities
Maddon Corporation stock currently sells for $76 per share. The market requires a return of 9 percent on the firm's stock. If the company maintains a constant 2.5 percent growth rate in dividends, what was the most recent dividend per share paid on the stock?
P0 = $76 = D0(1 + g)/(R − g) Solving this equation for the dividend gives us: D0 = $76(.09 − .025)/(1.025) D0 = $4.82
Antiques R Us is a mature manufacturing firm. The company just paid a dividend of $10.15, but management expects to reduce the payout by 4 percent per year indefinitely. If you require a return of 15 percent on this stock, what will you pay for a share today?
P0 = D0(1 + g)/(R − g) P0 = $10.15(1 − .04)/[(.15 − (−.04)] P0 = $51.28
Douglas, Inc., is expected to maintain a constant 4.2 percent growth rate in its dividend indefinitely. If the company has a dividend yield of 6 percent, what is the required return on the company's stock?
R = Dividend yield + Capital gains yield R = .060 + .042 R = .1020, or 10.20%
Kate, an individual investor, sold 500 shares of Hewn Furniture stock on Monday. Levy, another individual investor, purchased those shares, although he never met Kate. You know for certain that this trade occurred in which market?
Secondary market
Based on the period 1926-2018, which category of securities has outperformed all the other categories?
Small-Company stocks
What conclusion should you draw from the performance of stocks and bonds over the period 1926-2018?
Stocks are riskier than bonds.
__________ bonds pay interest that is taxed only at the federal level.
Treasury
Alejandro has a portfolio with a beta of 1.42 but wants to lower his investment risk. Adding which one of the following securities to his portfolio will most assuredly lower the risk of the portfolio?
U.S. Treasury bills
Multiple classes of stock are primarily created to
allow certain shareholders to retain control of a firm.
Bonds issued by the U.S. government
are considered default-free.
Protective covenants
are primarily designed to protect bondholders from future actions of the bond issuer.
Corporate dividends
are taxed at the personal level even though they are paid from after-tax income.
Pan Systems' bonds bear a coupon rate of 4.2 percent, payable annually. The bonds mature in 7.5 years, sell at par, and have a $1,000 face value. What is the yield to maturity?
4.20% No math is required; since the bonds sell at par, the yield to maturity will equal the coupon rate.
Which one of the following statements concerning dealers and brokers in the financial markets is correct?
A broker never assumes ownership of the securities being traded.
Well-diversified portfolios have negligible
unsystematic risks.
Turnips and Parsley common stock sells for $31.65 a share at a market rate of return of 9.5%. The company just paid their annual dividend of $1.20. What is the rate of growth of their dividend?
5.5% $31.65 = [$1.20 x (1+g)]/(0.95 - g)
The primary purpose of portfolio diversification is to
eliminate security-specific risk.
In a stock market report, the open price represents the
first trade of the day.
If the bondholder has any rights that can force repayment of the bond prior to maturity, the bond
has a put provision.
Assume a discount bond has a few years until maturity and a positive yield. All else constant, the bond's yield to maturity is
inversely related to the bond's market price.
The owner of preferred stock
is entitled to a distribution of income prior to distribution to the common shareholders.
When computing the expected return on a portfolio of stocks, the portfolio weights are based on the
market value of the total shares held in each stock.
Hentges Co. pays a constant annual dividend of $2.50 per share and has 1,000 shares of common stock outstanding. The company
must declare each annual dividend before it becomes an actual liability.
The yield to maturity on a bond is the rate
of return currently required by the market.
A security that is fairly priced will have a return that lies __________ the security market line.
on
The excess return you earn by moving from a relatively risk-free investment to a risky investment is called the
risk premium
A stock with a beta of zero would be expected to have a rate of return equal to
the risk-free rate.
The capital gains yield plus the dividend yield on a security is called the
total return
Wilbert's Clothing Stores just paid a $1.25 annual dividend. The company has a policy whereby the dividend increases by 2% annually. You would like to purchase 100 shares of stock in this firm but realize that you will not have the funds to do so for another three years. If you desire a 12% rate of return, how much should you expect to pay for 100 shares when you can afford to buy this stock? Ignore trading costs.
$1,353 P3 = [$1.25 x (1 + 0.02)^4] / (0.12 - 0.02) P3 is purchase cost = $13.53 x 100 shares
Which one of the following is an example of systematic risk?
A well respected chairperson of the Federal Reserve suddenly resigns.
A stock with an actual return that lies above the security market line has
yielded a higher return than expected for the level of risk assumed.
You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.38 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?
βP = 1.0 = 1/3(0) + 1/3(1.38) + 1/3(βX) Solving for the beta of Stock X, we get: βX = 1.62
A portfolio has a beta of 1.27. The portfolio consists of 25 percent U.S. Treasury bills, 38 percent Stock A, and 37 percent Stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of Stock B?
βRisk-free = 0 βMarket = 1 1.27 = (.25 × 0) + (.38 × 1.0) + (.37 × βB) βB = 2.41
You have a two-stock portfolio with an expected return of 11.7 percent. Stock A has an expected return of 13.8 percent while Stock B is expected to return 9.2 percent. What is the portfolio weight of Stock A?
.117 = .138xA + .092(1 − xA) xA = .5435, or 54.35%
One year ago, you purchased a stock at a price of $47.26 a share. Today, you sold the stock and realized a total return of 9.8 percent. Your capital gain was $3.68 a share. What was your dividend yield on this stock?
2.01% Capital gains yield = $3.68 / $47.26 = 7.79% Dividend yield = 9.8% − 7.79% = 2.01%
You have decided that you would like to own some shares of GH Corp. but need an expected 12.5% rate of return to compensate for the perceived risk of such ownership. What is the maximum you are willing to spend per share to buy GH stock if the company pays a constant $3.40 annual dividend per share?
3.40/ .125 = 27.20
Which one of the following would tend to indicate that a portfolio is being effectively diversified?
A decrease in the portfolio standard deviation
A stock had returns of 8%, 39%, 11%, and -24% for the past four years. Which one of the following best describes the probability that this stock will NOT lose more than 43% in any one given year?
Average return = (.08 + .39 + .11 - .24) ÷ 4 = 8.5%; Total squared deviation = (.08 - .085)2 + (.39 - .085)2 + (.11 - .085)2 + (-.24 - .085)2 = .000025 + .093025 + .000625 + .105625 = .1993; Standard deviation = √.1993 ÷ (4 - 1) = √.06643333 = 25.7747%; Lower bound of the 95% probability range = 8.5% - (2 × 25.7747%) = -43.05; Probability of NOT losing more than 43% in any given year is 97.5%.
Wine and Roses, Inc. offers a 7% coupon bond with semiannual payments and a yield to maturity of 7.73%. The bonds mature in 10 years. What is the market price of a $1,000 face value bond?
N= 10*2= 20 I/Y= 7.73/2= PV= ??? PMT= 70/2=35 FV= 1000 PV= -949.80
Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose a German company has a bond outstanding with a par value of €1,000, 15 years to maturity, and a coupon rate of 7.3 percent paid annually. If the yield to maturity is 8.4 percent, what is the current price of the bond?
N= 15 I/Y = 8.4 PV = ??? PMT = +73 FV= -1000 PV= 908.10
Winston Enterprises has a 15-year bond issue outstanding that pays a 9 % coupon. The bond is currently priced at $894.60 and has a par value of $1,000. Interest is paid semiannually. What is the yield to maturity?
N= 15*2= 30 I/Y= ?? PV= -894.60 PMT= 90 FV= 1000 I/Y= 5.21468*2= 10.40%
A stock has had returns of 8 percent, 26 percent, 18 percent, −14 percent, 26 percent, and −6 percent over the last six years. What are the arithmetic and geometric average returns for the stock?
The arithmetic average return is the sum of the known returns divided by the number of returns, so: Arithmetic average return = (.08 + .26 + .18 − .14 + .26 − .06)/6 Arithmetic average return = .0967, or 9.67% Geometric average return = [(1 + R1) × (1 + R2) × ... × (1 + RT)]1/T − 1Geometric average return = [(1 + .08)(1 + .26)(1 + .18)(1 − .14)(1 + .26)(1 − .06)]1/6 − 1 Geometric average return = .0855, or 8.55%
A stock report contains the following information: P/E 18.6, closing price 17.28, dividend .65, net change .17, and an ask of 17.35 × 200. Which one of the following statements is correct given this information?
The closing price on the previous trading day was $17.11.
Suppose a stock had an initial price of $70 per share, paid a dividend of $2.30 per share during the year, and had an ending share price of $82. What was the dividend yield and the capital gains yield?
The dividend yield is the dividend divided by the beginning of the period price, so: Dividend yield = $2.30/$70 Dividend yield = .0329, or 3.29% And the capital gains yield is the increase in price divided by the initial price, so: Capital gains yield = ($82 − 70)/$70 Capital gains yield = .1714, or 17.14%
A stock quote shows a last price of 41.18, a P/E of 16, and a net change of −.38. Based on this information, which one of the following statements is correct?
The earnings per share are equal to 1/16th of $41.18.
A year ago, you purchased 300 shares of IXC Technologies, Inc. stock at a price of $9.05 per share. The stock pays an annual dividend of $.12 per share. Today, you sold all of your shares for $29.14 per share. What is your total dollar return on this investment?
Total dollar return = ($29.14 - $9.05 + $.12) × 300 = $6,063
All else constant, a coupon bond that is selling at a premium, must have
a yield to maturity that is less than the coupon rate.
A bond with both a face value and a market value of $1,000 is called a __________ bond.
par value
The standard deviation for a set of stock returns can be calculated as the
positive square root of the variance.
According to the capital asset pricing model, the expected return on a security is
positively and linearly related to the security's beta.
A __________ is a form of equity security that has a stated liquidating value.
preferred stock
The principle of diversification tells us that
spreading investment portfolio's holdings across many diverse securities will lower the portfolio's level of risk.
The variance of returns for a portfolio of stocks is computed by dividing the sum of the
squared deviations by (the number of returns minus one).
The voting procedure where you must control 50 percent plus one of the outstanding shares of stock to guarantee that you will win a seat on the board of directors is called __________ voting.
straight
The risk premium is computed by __________ the average rate of return for an investment.
subtracting the average return on U.S. Treasury bills from
The equity risk premium for an individual security is computed by
multiplying the security's beta by the market risk premium.
The term structure of interest rates reflects the
pure time value of money for various lengths of time.
The average annual compound return earned per year over a multiyear period is called the __________ average return.
geometric
The written, legally binding agreement between a corporate borrower and its lenders detailing all of the terms of a bond issue is called the
indenture.
Assume two securities are negatively correlated. If these two securities are combined into an equally weighted portfolio, the portfolio standard deviation must be
less than the weighted average of the standard deviations of the individual securities.
Which formula computes the actual real rate of return on an investment?
r = (1 + R ) / (1 + h) − 1
The increase you realize in buying power as a result of owning a bond is referred to as the __________ rate of return.
real
The overall level of interest rates is primarily affected by the
real rate.
If there is no diversification benefit derived from combining two risky stocks into one portfolio, then the
returns on the two stocks must move perfectly in sync with one another.
Two of the primary differences between a corporate bond and a Treasury bond with identical maturity dates are related to
taxes and potential default.
Aleksov Brothers common stock sells for $36.60 a share and pays an annual dividend that increases by 1.8 percent annually. The market rate of return on this stock is 14.7 percent. What is the amount of the last dividend paid?
$36.60 = (D0 × 1.018)/(.147 − .018) D0 = $4.64
You just sold 500 shares of stock for $33.20 per share. One year ago, you purchased the stock for $38.92 per share and have received dividends totaling $.65 per share. What is your total capital gain in dollars?
Capital gain = ($33.20 − $38.92) × 500 = −$2,860
Which one of the following represents the portion of a stock's rate of return that is attributable to the growth rate of the dividends?
Capital gains yield
Stuart Software has 11.2 percent coupon bonds on the market with 20 years to maturity. The bonds make semiannual payments and currently sell for 108.4 percent of par. a. What is the current yield on the bonds? b.What is the YTM of the bonds? c.What is the effective annual yield?
Current yield = Annual coupon payment/PriceCurrent yield = $112/$1,084 Current yield = .1033, or 10.33% N= 20*2= 40 I/Y = ??? PV =-1084 PMT = 112/2 FV= 1000 I/Y= 5.104 *2= 10.21% 2nd -> 2: NOM= 10.21 C/Y= 2 EFF=?? EFF= 10.41%
The Reading Co. has adopted a policy of increasing the annual dividend on their common stock at a constant rate of 3.5% annually. The last dividend they paid was $0.95 a share. What will the company's dividend be in five years?
D5 = 0.95*(1 + 0.035)^5 = 1.13
Which one of the following transactions occurs in the primary market?
Delta, Inc., sold new Delta stock to David
Which one of the following values cannot be negative?
Dividend Yield
You purchased 100 shares of stock at a price of $35.72 per share. Over the last year, you have received total dividend income of $312. What is the dividend yield?
Dividend per share = $312 ÷ 100 = $3.12; Dividend yield = $3.12 ÷ $35.72 = 8.73%
Today, you sold 200 shares of SLG, Inc. stock. Your total return on these shares is 12.5%. You purchased the shares one year ago at a price of $28.50 a share. You have received a total of $280 in dividends over the course of the year. What is your capital gains yield on this investment?
Dividend yield = $280 ÷ (200 × $28.50) = 4.91%; Capital gains yield = 12.5% - 4.91% = 7.59%
Shares of Halva Corp. stock offer an expected total return of 14.6 percent. What is the dividend yield if the dividend increases by 2.8 percent annually?
Dividend yield = 14.6% − 2.8% = 11.8%
Which one of these statements is correct?
During the 1930s (the Great Depression), long-term government bonds produced a relatively stable rate of return relative to large-company stocks.
Consider the following information: State of Economy || Probability ofState of Economy || Rate of Return If State Occurs Recession Recession, .20 , -.14 Normal, .45, .10 Boom, .35, .36 Calculate the expected return.
E(R) = .20(−.14) + .45(.10) + .35(.36) E(R) = .1430, or 14.30%
You have $26,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 15 percent and Stock Y with an expected return of 11 percent. If your goal is to create a portfolio with an expected return of 13.68 percent, how much money will you invest in Stock X and Stock Y?
E(RP) = .1368 = .15XX + .110(1 − XX) We can now solve this equation for the weight of Stock X as: .1368 = .15XX + .110 − .110XX. 0268 = .040XX XX = .6700 So, the dollar amount invested in Stock X is the weight of Stock X times the total portfolio value, or: Investment in X = .6700($26,000) Investment in X = $17,420 And the dollar amount invested in Stock Y is: Investment in Y = (1 − .6700)($26,000) Investment in Y = $8,580
A stock has an expected return of 12.2 percent, the risk-free rate is 4 percent, and the market risk premium is 10 percent. What must the beta of this stock be?
E(Ri) = .122 = .040 + .10βi βi = .82
A stock has an expected return of 14.5 percent, its beta is 1.60, and the expected return on the market is 11 percent. What must the risk-free rate be?
E(Ri) = .145 = Rf + (.110 − Rf)(1.60) .145 = Rf + .17600 − 1.60Rf Rf = .0517, or 5.17%
A stock has a beta of 1.02, the expected return on the market is 12 percent, and the risk-free rate is 3 percent. What must the expected return on this stock be?
E(Ri) = Rf + [E(RM) − Rf] × βi Substituting the values we are given, we find: E(Ri) = .030 + (.12 − .030)(1.02) E(Ri) = .1218, or 12.18%
The risk-free rate of return is 3.5 percent and the market risk premium is 7.5 percent. What is the expected rate of return on a stock with a beta of 1.43?
E(r) = .035 + 1.43(.075) = .142, or 14.2%
Ballou stock is quite cyclical. In a boom economy, the stock is expected to return 34 percent in comparison to 13 percent in a normal economy and a negative 22 percent in a recessionary period. The probability of a recession is 15 percent while the chance of a boom is 4 percent. What is the standard deviation of the returns this stock?
E(r) = .04(.34) + .81(.13) + .15(−.22) = .0859 σ = [.04(.34 − .0859)2 + .81(.13 − .0859)2 + .15(−.22 − .0859)2].5 = .1349, or 13.49%
The Mehdi Co. stock is expected to earn 5.5 percent in a recession, 10 percent in a normal economy, and lose 1.5 percent in a booming economy. The probability of a boom is 12 percent while the probability of a normal economy is 60 percent. What is the expected rate of return on this stock?
E(r) = .12(−.015) + .60(.10) + (1 − .12 − .60).055 = .0736, or 7.36%
The common stock of Flavorful Teas has an expected return of 14.4%. The return on the market is 10% and the risk-free rate of return is 2.5%. What is the beta of this stock?
E(r) = .144 = .025 + b × (.10 - .025); .119 = .075b; b 1.5866666 = 1.59
What is the expected return on a portfolio which is invested 20% in stock A, 50% in stock B, and 30% in stock C? Boom: 20% probability; 18% A; 9% B; 6% C Normal: 70% probability; 11% A; 7% B; 9% C Recession: 10% probability; -10% A; 4% B; 13% C
E(r)Boom = (.20 × .18) + (.50 × .09) + (.30 × .06) = .036 + .045 + .018 = .099 E(r)Normal = (.20 × .11) + (.50 × .07) + (.30 × .09) = .022 + .035 + .027 = .084 E(r)Bust = (.20 × -.10) + (.50 × .04) + (.30 × .13) = -.020 + .020 + .039 = .039 E(r)Portfolio = (.20 × .099) + (.70 × .084) + (.10 × .039) = .02376 + .0588 + .0039 = .0825 = 8.25%
What is the variance of a portfolio consisting of $3,500 in stock G and $6,500 in stock H. Boom; 15% probability; 15% G; 9%H Normal; 85% probability; 8% G; 6%H
E(r)Boom = [$3,500 ÷ ($3,500 + $6,500) × .15)] + [$6,500 ÷($3,500 + $6,500) × .09) = .0525 + .0585= .111 E(r)Normal = [$3,500 ÷($3,500 + $6,500) × .08)] + [$6,500 ÷($3,500 + $6,500) × .06) = .028 + .039= .067 E(r)Portfolio = (.15 × .111) + (.85 × .067) = .01665 + .05695 = .0736VarPortfolio = [.15 × (.111 - .0736)2] + [.85 × (.067 - .0736)2] = .000209814 + .000037026 = .00024684 = .000247
Suppose a portfolio had an arithmetic average annual return of 9 percent during a 4-year period. Which one of these statements must be true regarding this portfolio for the period?
If the standard deviation of the portfolio is greater than zero, then the geometric average portfolio return is less than 9 percent.
Assume the risk-free rate and the market risk premium are both positive. Trevor currently owns a portfolio consisting of risky and risk-free securities. The portfolio has an expected return of 11.2 percent, a standard deviation of 16.2 percent, and a beta of 1.21. He has decided that he would prefer a higher expected return. Which one of these actions should he take?
Increase the portfolio weight of the risky assets without affecting the total portfolio value
NASDAQ has which one of these features?
Multiple market maker system
A year ago, Jasper Inc. sold 20-year bonds at par with a coupon rate of 4.5 percent and semiannual payments. The face value of each bond is $1,000 and the yield to maturity is now 5.6 percent. What is the current value of each bond?
N= (20-1)*2 = 38 I/Y= 5.6/2= PV= ??? PMT= 45/2= FV= -1000 PV= 872.35
A General Co. bond has an 8 % coupon and pays interest annually. The face value is $1,000 and the current market price is $1,020.50. The bond matures in 20 years. What is the yield to maturity?
N= 20 I/Y= ?? PV= -1020.50 PMT= 80 FV= 1000 I/Y= 7.79%
Qin Corp. issued 20-year bonds 2 years ago at a coupon rate of 8.3 percent. The bonds make semiannual payments. If these bonds currently sell for 104 percent of par value, what is the YTM?
N= 36 I/Y = ?? PV = -1040 PMT = 83/2 FV= 1000 I/Y= 3.940%
Lei Corporation has bonds on the market with 23.5 years to maturity, a YTM of 7 percent, a par value of $1,000, and a current price of $1,051. The bonds make semiannual payments. What must the coupon rate be on these bonds?
N= 47 I/Y = 7/2= 3.5 PV = -1051 PMT = ??? FV= 1000 PMT= $37.23
Cavo Corp. has 9 percent coupon bonds making annual payments with a YTM of 8.3 percent. The current yield on these bonds is 8.65 percent. How many years do these bonds have left until they mature?
N= ??? I/Y = 8.3 PV =-1040.46 PMT = 90 FV= 1000 N= 8.2
The Lo Sun Corporation offers a 6% bond with a current market price of $875.05. The yield to maturity is 7.34%. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond matures?
N= ??? I/Y= 7.34/2= PV= -875.05 PMT= 60/2=30 FV= 1000 N= 32 /2= 16 N=16
Consider a bond which pays 7% semiannually and has 8 years to maturity. The market requires an interest rate of 8% on bonds of this risk. What is this bond's price?
N=16 I/Y=4 PMT=35 FV=$1000 PV=?=$941.74
You are comparing the returns of two portfolios for a 10-year period. Portfolio I has a lower dispersion of returns and a higher average rate of return than Portfolio II. Given this, what do you know with certainty?
Portfolio I has a lower standard deviation than Portfolio II.
You own the following portfolio of stocks. What is the portfolio weight of stock C? Number Price A; 100 shares; $22/share B; 600 shares; $17/share C; 400 shares; $46/share D; 200 shares; $38/share
Portfolio weight C = (400 × $46) ÷ [(100 × $22) + (600 × $17) + (400 × $46) + (200 × $38)] = $18,400 ÷ $38,400 = 47.9%
Which one of the following statements concerning preferred stock is correct?
Preferred shareholders may be granted voting rights if preferred dividend payments remain unpaid.
A stock you are interested in paid a dividend of $1 last year. The anticipated growth rate in dividends and earnings is 25% for the next 2 years before settling down to a constant 5% growth rate. The discount rate is 12%. Calculate the expected price of the stock.
Price = $1.00(1.25)/1.12 + $1.25(1.25)/1.2544 + [$1.5625(1.05)/(.12-.05)]/1.2544 = $21.05
The Vineyard recently paid an annual dividend of $2.78. This dividend increases at 1.65 percent per year and currently sells for $42.19 a share. What is the rate of return?
R = $2.78 × 1.0165/$42.19 + .0165 R = .0835, or 8.35%
Tookies Tacos' next annual dividend will be $4.26 a share and all later dividends are expected to increase by 4.4 percent annually. What is the rate of return if this stock is currently selling for $48.74 a share?
R = ($4.26/$48.74) + .044 R = .1314, or 13.14%
The next dividend payment by Zone, Inc., will be $2.16 per share. The dividends are anticipated to maintain a growth rate of 5 percent forever. If the stock currently sells for $44 per share, what is the required return?
R = (D1/P0) + gR = ($2.16/$44.00) + .05R = .0991, or 9.91%
Ollie, Inc., has an issue of preferred stock outstanding that pays a dividend of $4.75 every year in perpetuity. If this issue currently sells for $98 per share, what is the required return?
R = D/P0 R = $4.75/$98 R = .0485, or 4.85%
Treasury bills are currently paying 8 percent and the inflation rate is 3.5 percent. a.What is the approximate real rate of interest? b.What is the exact real rate?
R = r + h Approximate r = .08 − .035 Approximate r = .045, or 4.50% Exact r = [(1 + .08)/(1 + .035)] − 1Exact r = .0435, or 4.35%
Which one of the following formulas is used to estimate a firm's growth rate?
Retention ratio × ROE
stock had the following prices and dividends. What is the geometric average return on this stock? Year 1 price = $23.19 Year 2 price = $24.90/Dividend = $0.23 Year 3 price = $23.18/Dividend = $0.24 Year 4 price = $24.86/Dividend = $0.25
Return for year 2 = ($24.90 - $23.19 + $.23) ÷ $23.19 = 8.3657%; Return for year 3 = ($23.18 - $24.90 + $.24) ÷ $24.90 = -5.9438%; Return for year 4 = ($24.86 - $23.18 + $.25) ÷ $23.18 = 8.3261%; Geometric return = (1.083657 × .940562 × 1.083261).3333 - 1 = 3.4%
The Cricket Co. just paid a dividend of $1.40 per share on its stock. The dividends are expected to grow at a constant rate of 5 percent per year indefinitely. Investors require a return of 12 percent on the company's stock. a.What is the current stock price? b.What will the stock price be in 3 years? c.What will the stock price be in 9 years?
So the price of the stock today is: P0 = D0(1 + g)/(R − g) P0 = $1.40(1.05)/(.12 − .05) P0 = $21.00 P3 = D3(1 + g)/(R − g) P3 = D0(1 + g)4/(R − g) P3 = $1.40(1.05)4/(.12 − .05) P3 = $24.31 P9 = D9(1 + g)/(R − g) P9 = D0(1 + g)10/(R − g) P9 = $1.40(1.05)10/(.12 − .05) P9 = $32.58
Assume Stocks A and B have had identical stock prices every day for the past three years. Stock A pays a dividend but Stock B does not. Which one of these statements applies to these stocks for the last three years?
Stock A's total return has been higher than Stock B's every year.
You own a portfolio that has $3,200 invested in Stock A and $4,200 invested in Stock B. If the expected returns on these stocks are 12 percent and 15 percent, respectively, what is the expected return on the portfolio?
The expected return of a portfolio is the sum of the weight of each asset times the expected return of each asset. The total value of the portfolio is: Total value = $3,200 + 4,200 Total value = $7,400 So, the expected return of this portfolio is: E(RP) = ($3,200/$7,400)(.12) + ($4,200/$7,400)(.15) E(RP) = .1370, or 13.70%
Probability of State of Economy .20 .57 .23 Rate of Return if State Occurs : Stock A: .05 .08 .13 Stock B: -.20 .09 .26 a.Calculate the expected return for the two stocks. b.Calculate the standard deviation for the two stocks.
The expected return of an asset is the sum of each return times the probability of that return occurring. So, the expected return of each stock asset is: E(RA) = .20(.05) + .57(.08) + .23(.13) E(RA) = .0855, or 8.55% E(RB) = .20(−.20) + .57(.09) + .23(.26) E(RB) = .0711, or 7.11% σA^2 = .20(.05 − .0855)2 + .57(.08 − .0855)Z^2 + .23(.13 − .0855)^2 σA^2 = .00072 σA = .00072^1/2 σA = .0269, or 2.69% σB2 = .20(−.20 − .0711)^2 + .57(.09 − .0711)^2 + .23(.26 − .0711)^2 σB^2 = .02311 σB = .02311^1/2 σB = .1520, or 15.20%
A portfolio consists of five securities that have individual betas of 1.72, .67, 1.37, 1.53, and .49. You do not know the portfolio weight of each security. What do you know with certainty?
The portfolio beta will be less than 1.72 and greater than .49.
What are the portfolio weights for a portfolio that has 132 shares of Stock A that sell for $42 per share and 112 shares of Stock B that sell for $32 per share?
The portfolio weight of an asset is the total investment in that asset divided by the total portfolio value. First, we will find the portfolio value, which is: Total value = 132($42) + 112($32) Total value = $9,128 The portfolio weight for each stock is: XA = 132($42)/$9,128 XA = .6074 XB = 112($32)/$9,128 XB = .3926
Suppose a stock had an initial price of $88 per share, paid a dividend of $2.10 per share during the year, and had an ending share price of $96. Compute the total percentage return. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
The return of any asset is the increase in price, plus any dividends or cash flows, all divided by the initial price. The return of this stock is: R = [($96 − 88) + 2.10]/$88R = .1148, or 11.48%
Which one of the following types of securities has tended to produce the lowest real rate of return for the period 1926-2018?
U.S. Treasury bills
All else constant, a bond will sell at __________ when the yield to maturity is __________ the coupon rate.
a discount; higher than
You plotted the monthly rate of return for two securities against time for the past 48 months. If the pattern of the movements of these two sets of returns rose and fell together the majority, but not all, of the time, then the securities have
a strong positive correlation.
You've observed the following returns on Bennington Corporation's stock over the past five years: 15 percent, −6 percent, 18 percent, 14 percent, and 10 percent. a.What was the arithmetic average return on the company's stock over this five-year period? b-1.What was the variance of the company's stock returns over this period? b-2.What was the standard deviation of the company's stock returns over this period?
a.To find the average return, we sum all the returns and divide by the number of returns, so: Average return = (.15 − .06 + .18 + .14 + .10)/5 Average return = .102, or 10.2% b.Using the equation to calculate variance, we find: Variance = 1/4[(.15 − .102)2 + (−.06 − .102)2 + (.18 − .102)2 + (.14 − .102)2 + (.10 − .102)2] Variance = .00902 So, the standard deviation is: Standard deviation = .009021/2 Standard deviation = .0950, or 9.50%
The return earned in a typical year during a multiyear period is called the __________ average return.
arithmetic
The systematic risk of the market is assigned a
beta of 1.
Systematic risk is measured by
beta.
A dealer will buy at the __________ price and sell at the __________ price.
bid; ask
An agent who arranges security transactions among investors without maintaining an inventory of their own is called a
broker
Based on the dividend growth model, an increase in investors' required rate of return will
cause the market values of all stocks to decrease, all else held constant.
The beta of a security is calculated by dividing the
covariance of the security with the market by the variance of the market.
The correlation between stocks A and B is equal to the
covarianceAB divided by the product of the standard deviations of A and B.
The voting procedure whereby shareholders may cast all their votes for one candidate for the board of directors is called __________ voting.
cumulative
A market participant who buys and sells securities from their own inventory is called a
dealer
The __________ premium is that portion of a nominal interest rate or bond yield that represents compensation for the possibility of nonpayment by the bond issuer.
default risk
Sophia owns shares of stock in Torrid Design and wants to be elected to the company's board of directors. There are 100,000 shares of stock outstanding and each share is granted one vote for each open position on the board. Presently, the company is voting to elect two new directors. Sophia can be assured of her election
if cumulative voting applies and she owns one-third of the shares, plus one additional share.
Interest rate risk __________ as the time to maturity increases.
increases at a decreasing rate
A discount bond has a coupon rate that
is less than the bond's yield to maturity.
The expected return on a portfolio
is limited by the returns on the individual securities within the portfolio.
If a stock portfolio is well diversified, then the portfolio variance
may be less than the variance of the least risky stock in the portfolio.
A symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation is the __________ distribution.
normal
The market in which new securities are originally sold to investors is called the __________ market.
primary
The parts of an indenture that protect the interests of the lender by limiting certain actions that a company might take during the term of the loan are called
protective covenants.
The voting procedure where a shareholder grants authority to another individual to vote his/her shares is called __________ voting.
proxy
The market risk premium is computed by
subtracting the risk-free rate of return from the market rate of return.
Interest rate risk increases as
the coupon payment decreases.
The standard deviation of a portfolio will tend to increase when
the portfolio concentration in a single cyclical industry increases.
The intercept point of the security market line is the rate of return that corresponds to
the risk-free rate.
Last year, Kennedi purchased a fixed-rate, 10-year bond at par that has a coupon rate of 4.2 percent. If the current market rate for this type and quality of bond is 4.5 percent, then she should expect
to realize a capital loss if she sells the bond at today's market price
The value of a 20 year zero-coupon bond with a $1,000 face value when the market required rate of return of 8% (compounded semiannually) is ___.
$1,000/(1.040)40 = $208.29 N= 20*2= 40 I/Y= 8/2= 4 PV= ??? PMT= 0 FV= 1000 PV= 208.29
A bond with a 7% coupon that pays interest semi-annually and is priced at par will have a market price of _____ and interest payments in the amount of _____ each.
$1,000; $35
Ernst Electrical increases its annual dividend by 1.8 percent annually. The stock commands a market rate of return of 18 percent and sells for $19.07 a share. What is the expected amount of the next dividend?
$19.07 = D1/(.18 − .018) D1 = $3.09
Given a normal distribution, assume you want to earn a rate of return that plots more than three standard deviations above the mean. What is your probability of earning such a return in any one year?
.14 percent or less
A stock has returns of 3%, 18%, -24%, and 16% for the past four years. Based on this information, what is the 95% probability range for any one given year?
Average return = (.03 + .18 - .24 + .16) ÷ 4 = .0325; Total squared deviation = (.03 - .0325)2 + (.18 - .0325)2 + (-.24 - .0325)2 + (.16 - .0325)2 = .00000625 + .02175625 + .07425625 + .01625625 = .112275; Standard deviation = √(.112275 ÷ (4 - 1) = √.037425 = .19346 = 19.346%; 95% probability range = 3.25% ± (2 × 19.346%) = -35.4 to 41.9%
A stock had returns of 8 percent, 13 percent, and −3 percent for the past three years. Based on these returns, what is the approximate probability that this stock will earn at least 14.19 percent in any one given year?
Average return = (.08 + .13 − .03)/3 = .06 σ = {[(.08 − .06)2 + (.13 − .06)2 + (−.03 − .06)2]/(3 − 1)}.5 = .0819 Upper end of the 68.26% probability range = .06 + .0819= .1419, or 14.19% Approximate probability of earning at least 14.19% = (100% − 68.26%)/2 = 15.87%
A stock had returns of 8%, -2%, 4%, and 16% over the past four years. What is the standard deviation of this stock for the past four years?
Average return = (.08 - .02 + .04 + .16) ÷ 4 = .065; Total squared deviation = (.08 - .065)2 + (-.02 - .065)2 + (.04 - .065)2 + (.16 - .065)2 = .000225 + .007225 + .000625 + .009025 = .0171; Standard deviation = √(.0171 ÷ (4 - 1) = √.0057 = .075498 = 7.5%
Over the long-term, which one of the following is a correct statement concerning risk premium?
Stocks tend to have a higher risk premium than bonds.
You own a stock portfolio invested 35 percent in Stock Q, 30 percent in Stock R, 20 percent in Stock S, and 15 percent in Stock T. The betas for these four stocks are .79, 1.17, 1.18, and 1.35, respectively. What is the portfolio beta?
The beta of a portfolio is the sum of the weight of each asset times the beta of each asset. So, the beta of the portfolio is: βP = .35(.79) + .30(1.17) + .20(1.18) + .15(1.35) βP = 1.07
Which one of the following statements is correct concerning the standard deviation of a portfolio?
The standard deviation of a portfolio could potentially be lowered by changing the weights of the securities in the portfolio.
What is the beta of a portfolio comprised of the following securities?Amount Security Stock A; $2,000 invested; 1.20 Beta Stock B; $3,000 invested; 1.46 Beta Stock C; $5,000 invested; .72 Beta
ValuePortfolio = $2,000 + $3,000 + $5,000 = $10,000 BetaPortfolio = ($2,000 ÷ $10,000 × 1.20) + ($3,000 ÷ $10,000 × 1.46) + ($5,000 ÷ $10,000 × .72) = .24 + .438 + .36 = 1.038