Finance 3770 Midterm II Concept

12) Preferred stock and common stock issued by the same firm will have the same required return because the riskiness of the firm's cash flows is the same for both securities.

False

2) In terms of risk, preferred stock is safer than common stock because it has a prior claim on assets and income.

True

26) You are considering buying some stock in Continental Grain. Which of the following are examples of non-diversifiable risks?

A) I. Risk resulting from a general decline in the stock market. II. Risk resulting from a possible increase in income taxes.

10) At 6 percent compounded monthly, how long will it take to triple your money?

A) 221 months

1) The expected rate of return from an investment is equal to the expected cash flows divided by the initial investment.

True

10) Common stock does not mature.

True

10) Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities.

True

10)The par value of a corporate bond indicates the payment that the issuer promises to make to the bondholder at maturity.

True

11) Bondholders and preferred stockholders can be viewed as creditors, whereas the common stockholders are the true owners of the firm.

True

11) Total risk equals systematic risk plus unsystematic risk.

True

11)If a bond sells for its par value, the coupon interest rate and yield to maturity are equal.

True

12) The required rate of return for an asset is equal to the risk-free rate plus a risk premium.

True

12)To determine the periodic interest payments that a bond makes, multiply the bond's stated coupon rate by its par value and divide by the number of coupon payments per year.

True

13) Diversifying among different kinds of assets is called asset allocation.

True

13) In theory, shareholders select the board of directors, but in reality, management effectively selects the directors.

True

14) In general, common stock and preferred stock are both valued by calculating the present value of all expected future cash flows, using the required return as the discount rate.

True

14)Junk bonds are also called high-yield bonds.

True

15)The expected yield on junk bonds is higher than the yield on AAA-rated bonds because of the higher default risk associated with junk bonds.

True

16) Small company stocks have historically had higher average annual returns than large company stocks, and also a higher risk premium.

True

17) According to the CAPM, for each unit of Beta an asset's required rate of return increases by the market's risk premium.

True

17)Market value of a bond is expected to be higher than its liquidation value.

True

18)A common protective provision in a bond indenture is the limitation of dividends on the issuing firm's common stock.

True

19)A firm's bond rating would be favorably affected if they have low financial leverage (debt).

True

2)Convertible bonds are debt securities that can be converted into a firm's stock at a prespecified price.

True

3) Beta represents the average movement of a company's stock returns in response to a movement in the market's returns.

True

3)A mortgage bond is secured by a lien on real property.

True

4) At an annual interest rate of 9%, an initial sum of money will double approximately every 8 years.

True

4) The amount of the preferred stock dividend is generally fixed either as a dollar amount or as a percentage of the par value.

True

4) The benefits of diversification occur as long as the investments in a portfolio are not perfectly positively correlated.

True

5) A stock with a beta of 1 has systematic or market risk equal to the "typical" stock in the marketplace.

True

5) Preferred stock is riskier than long-term debt because its claim on assets and income come after those of bonds.

True

5) The present value of a deferred annuity (e.g., an annuity that starts 10 years from today) can be calculated in two steps: (1) calculate the present value of the annuity, and (2) calculate the present value of the amount determined in step (1

True

6) Beta is a measurement of the relationship between a security's returns and the general market's returns.

True

6)Bonds generally have a maturity date while preferred stocks do not.

True

7) The Beta of a T-bill is zero.

True

7) The future value of an annuity due is greater than the future value of an otherwise identical ordinary annuity.

True

8) A preferred stock that pays an annual dividend of $10, has a par value of $100, and has a required return of 5% will be valued at $200.

True

8) A well-diversified portfolio typically has systematic risk equal to about 40% of the portfolio's total risk.

True

8) If we invest money for 10 years at 8 percent interest, compounded semiannually, we are really investing money for 20 six-month periods, and receiving 4 percent interest each period.

True

8)The value of a bond is inversely related to changes in the investor's present required rate of return.

True

9) A certificate of deposit that pays 9.8% compounded monthly is better than a similar certificate of deposit that pays 10% compounded only once per year.

True

9) Preferred stock is less risky than common stock, but more risky than debt.

True

9)If a bond has a market value that is higher than its par value, then the required return on the bond must be less than the bond's coupon rate.

True

13) You have two very similar investment options with same level of risks. Investment A brings in $5,000 every year for 7 years. Investment B brings in 56,000 in 7 years. What is the interest rate implicit in these two investment options?

A) More than 15%

20)Which of the following bond provisions will make a bond more desirable to investors, other things being equal?

A) The bond is convertible.

45)Which of the following is true of a zero coupon bond?

A) The bond makes no coupon payments.

25) A typical measure for the risk-free rate of return is the

A) U.S. Treasury Bill rate.

25)If a firm were to experience financial insolvency, the legal system provides an order of hierarchy for the payment of claims. Assume that a firm has the following outstanding securities: mortgage bonds, common stock, debentures, and preferred stock. Rank the order in which investors that own mortgage bonds would have their claim paid?

A) first

21)Progressive Corporation issued callable bonds. The bonds are most likely to be called if

A) interest rates decrease.

25) Which of the following features, or benefits, belong to a firm's common stockholders?

A) limited liability B) ownership of the firm C) voting rights D) all of the above***

31)The interest on corporate bonds is typically paid

A) semiannually.

47)While checking the Wall Street Journal bond listings you notice that the price of an AT&T bond is the same as the price of a K-Mart bond. Based on this information you know that

A) the bond with the lower coupon rate will have the lower current yield.

29) Stock A has a beta of 1.2 and a standard deviation of returns of 18%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the market risk premium increases, then

A) the required return on stock B will increase more than the required return on stock A.

20) Most preferred stocks have a feature that requires all past unpaid preferred dividend payments be paid before any common stock dividends can be paid. What is the name of this feature?

B) cumulative

23) Changes in the general economy, like changes in interest rates or tax laws represent what type of risk?

B) market risk

15) Preferred stock valuation usually treats the preferred stock as aA) capital asset.

B) perpetuity.

27) What is the name given to the equation that financial managers use to measure an investor's required rate of return?

B) the capital asset pricing model

24)If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, everything else equal (such as coupon rate, maturity, etc.) which would sell for the greatest price?

B) the mortgage bond

19) Nogrowth Corporation expects their dividend to stay at $0.50 per share each year into the foreseeable future. Therefore

B) the value of the stock can be estimated as $0.50 divided by an investor's required rate of return.

48)Speculative, or non-investment-grade, bonds have an S&P bond rating of

C) BB or less.

12) Last National Bank is offering you a loan at 10%; payments on the loan are to be made monthly. Credit Onion is offering you a loan where payments are to be made semiannually; the rate on the loan is also 10%. Local Bank down the street is also offering a loan at 10% where the payments are made quarterly. Which loan has the lowest annual cost?

C) Credit Onion's loan

27)Which of the following is FALSE concerning bonds?

C) Debentures are secured by specific assets other than real estate.

50)Charlie Corporation has two bonds outstanding. Both bonds mature in 10 years, have a face value of $1,000, and have a yield to maturity of 8%. One bond is a zero coupon bond and the other bond has a coupon rate of 8%. Which of the following statements is true?

C) The zero coupon bond must sell for a lower price than the bond with an 8% coupon rate.

22)Which of the following statements is true regarding convertible bonds?

C) These bonds are convertible into common stock of the issuing firm at a prespecified price.

36) Portfolio risk is typically measured by ________ while the risk of a single investment is measured by ________.

C) beta; standard deviation

38)In the present value bond valuation model, risk is generally incorporated into the

C) discount rate or required return.

24) The minimum rate of return necessary to attract an investor to purchase or hold a security is referred to as the

C) investor's required rate of return.

28)The present value of the expected future cash flows of an asset represents the asset's

C) price/intrinsic value.

23)If a corporation were to choose between issuing a debenture, a mortgage bond, or a subordinated debenture, which would have the highest yield to maturity, everything else equal?

C) the subordinated debenture

39)Fred and Ethel are both considering buying a corporate bond with a coupon rate of 8%, a face value of $1,000, and a maturity date of January 1, 2025. Which of the following statements is MOST correct?

D) Fred may determine a different value for a bond than Ethel because each investor may have a different level of risk tolerance, and hence a different required return

38) Which of the following investments is clearly preferred to the others for a risk-averse investor?

D) cannot be determined without additional information

24) Consider the following four types of payments that could be made by a normal operating firm: interest, common dividends, income taxes, and preferred dividends. Compared to the other payments mentioned, where would you rank common dividend payments in terms of the order of payment if the firm is liquidating?

D) fourth

33) Beta is a statistical measure of

D) the relationship between an investment's returns and the market return.

34) Beginning with an investment in one company's securities, as we add securities of other companies to our portfolio, which type of risk declines?

D) unsystematic risk

1) Preferred stock is referred to as a hybrid security because it has many characteristics of both common stock and bonds.

True

13)Unlike market value, the intrinsic value of an asset is estimated independently of risk.

False

14) Asset allocation is not recommended by financial planners because mixing different types of assets, such as stocks with bonds, makes it more difficult to track performance and adjust portfolios to changing market conditions.

False

15) Adding stocks to a bond portfolio will increase the riskiness of the portfolio because stocks have higher standard deviations of returns than bonds.

False

16)If two bonds have the same yield to maturity, they also have the same current yield.

False

2) Actual returns are always less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value.

False

2) An investment earning simple interest is preferred over an investment earning compound interest because the simplicity adds value.

False

3) $10,000 invested at 10% per year for 5 years earns interest equal to $6,105.10; therefore, $10,000 invested at 10% per year for 10 years will earn interest equal to $12,210.20 (2 times $6,105.10).

False

3) Public perception and reputation do not affect stock prices, which are strictly a function of dividends and required returns.

False

4)In general, interest on bonds may be deferred until a later date at the discretion of management, making debt financing more appealing to corporate managers.

False

5)Other things held equal, a bond with a call provision is worth more to investors than a bond without a call provision.

False

6) If a firm does not have enough money to pay any common stock dividends, it is technically in default to the common shareholders.

False

6) When repaying an amortized loan, the interest payments increase over time due to the compounding process.

False

7) ABC Corp 5% preferred stock with a par value of $100 and a market price of $125 will pay an annual dividend this year of $12 per share.

False

7)Debentures are expected to have a lower yield than secured bonds because the debentures are more risky and therefore less desirable.

False

9) Because risk is measured by variability of returns, how long we hold our investments does not matter very much when it comes to reducing risk

False

1 )Subordinated debentures are more risky than unsubordinated debentures because the claims of subordinated debenture holders are less likely to be honored in the event of liquidation.

True

1) A timeline identifies the timing and amount of a stream of cash flows, along with the interest rate it earns

True