Finance Exam 3

Which one of the following statements is correct? a) The risk-free rate represents the change in purchasing power b) Any return greater than the inflation rate represents the risk premium c) Historical real rates of return must be positive d) Nominal rates exceed real rates by the amount of the risk-free rate e) Given a positive rate of inflation, the real rate must be less than the nominal rate

E

Which one of the following types of stock is defined by the fact that it receives no preferential treatment in respect to either dividends or bankruptcy proceedings? A. Dual class. B. Cumulative. C. Non cumulative. D. Preferred. E. Common.

E

Which one of the following bonds is the least sensitive to interest rate risk? Multiple Choice 3-year; 4 percent coupon 3-year; 6 percent coupon Correct 5-year; 6 percent coupon 7-year; 6 percent coupon 7-year; 4 percent coupon

2

Bonds issued by the U.S. government: Multiple Choice are considered to be free of interest rate risk. generally have higher coupons than comparable bonds issued by a corporation. are considered to be free of default risk. Correct pay interest that is exempt from federal income taxes. are called "munis."

3

A decrease in which of the following will increase the current value of a stock according to the dividend growth model? Multiple Choice Dividend amount Number of future dividends, provided the total number of dividends is less than infinite Dividend growth rate Discount rate Correct Both the discount rate and the dividend growth rate

4

Which one of the following applies to a premium bond? Yield to maturity > Current yield > Coupon rate Coupon rate = Current yield = Yield to maturity Coupon rate > Yield to maturity > Current yield Coupon rate < Yield to maturity < Current yield Coupon rate > Current yield > Yield to maturity

5

The valuation of preferred stock is most similar to A. a common stock with no growth in dividends. B. a common stock with a constant growth in dividends. C. a common stock with a nonconstant growth in dividends. D. a certificate of deposit. E. None of the answers above are correct

A

Valencia Corporation has a capital structure that includes bonds, preferred stock, and common stock.Which of the following rights have most likely been granted to the preferred shareholders?I. right to share in company profits prior to other shareholdersII. right to elect the corporate directorsIII. right to vote on proposed mergersIV. right to all residual income after the common dividends have been paid a) I only b) I and IV only c) I and III only d) II, III, and IV only e) I, II, III, and IV

A

Which of the following is a true statement? A. Preferred stockholders have a residual claim to income. B. Bondholders may force a corporation into bankruptcy for failure to make interest payments. C. Common stockholders are legally entitled to some dividend. D. Coupons on most corporate bonds are cumulative. E. Common stockholders always earn a positive return on their investment

B

foreign bonds

Bonds issued by foreign governments or by foreign corporations

municipal bonds

Bonds issued by state and local governments

Based on the dividend growth model, if you expect the market rate of return to increase across the boardon all equity securities then you should also expect:a) An increase in all stock values b) All stock values to remain constant c) A decrease in all stock values d) Dividend-paying stocks to maintain a constant price while non-dividend paying stocks decreasein value e) Dividend-paying stocks to increase in price while non-dividend paying stocks remain constant invalue

C

Buxbaum Corporation is preparing a bond offering with a coupon rate of 6 percent, paid semiannually,and a face value of $1,000. The bonds will mature in 10 years and will be sold at par. Given this, whichone of the following statements is correct?a) The bonds will become discount bonds if the market rate of interest declines b) The bonds will pay 10 interest payments of $60 each c) The bonds will sell at a premium if the market rate is 5.5 percent d) The bonds will initially sell for $1,030 each e) The final payment will be in the amount of $1,060

C

Dixie South currently pays an annual dividend of $1.46 a share and plans on increasing that amount by 2.75 percent annually. Northern Culture currently pays an annual dividend of $1.42 a share and plans on increasing its dividend by 3.1 percent annually. Given this information, you know for certain that the stock of Northern Culture has a higher ______ than the stock of Dixie South. A. Market price. B. Dividend yield. C. Capital gains yield. D. Total return. E. Real return.

C

The two - stage dividend growth model evaluates the current price of a stock based on the assumption a stock will: A. Pay an increasing dividend for a period of time and then cease paying dividends altogether. B. Increase the dividend amount every other year. C. Pay a constant dividend for the first two quarters of each year and then increase the dividend the last two quarters of each year. D. Grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely. E. Pay increasing dividends for a fixed period of time, cease paying dividends for a period of time, and then commence paying increasing dividends for an indefinite period of time.

D

A project has a net present value of zero. Given this information: Multiple Choice the project has a zero percent rate of return. the project requires no initial cash investment. the project has no cash flows. the summation of all of the project's cash flows is zero. the project's cash inflows equal its cash outflows in current dollar terms.

E

Javangula Foods is considering two mutually exclusive projects and has determined that the crossover rate for these projects is 12.3 percent. Given this information, you know that: Multiple Choiceneither project will be accepted if the discount rate is less than 12.3 percent.both projects have a negative NPV at discount rates greater than 12.3 percent.both projects provide an internal rate of return of 12.3 percent.both projects have a zero NPV at a discount rate of 12.3 percent.the project that is acceptable at a discount rate of 12 percent should be rejected at a discount rate of 13 percent.

E

The length of time a firm must wait to recoup, in present value terms, the money it has invested in a project is referred to as the: Multiple Choice net present value period. internal return period. payback period. discounted profitability period. discounted payback period.

E

A project has a discount rate of 15.5 percent, an initial cost of $109,200, an inflow of $56,400 in Year 1,and an inflow of $75,900 in Year 2. Your boss requires that every project return a minimum of $1.06 forevery $1 invested. Based on this information, what is your recommendation on this project?a) Accept the project because the profitability index (PI) is 0.97 b) Reject the project because the profitability index (PI) is 0.97 c) Accept the project because the profitability index (PI) is 1.03 d) Reject the project because the profitability index (PI) is 1.01 e) Reject the project because the profitability index (PI) is 1.03

b

NPV Advantages and Disadvantages

considers all of cash flows in the computation uses the time value of money easy to understand since its dollar return disadvantages takes more time to compute cash flow timing is somewhat important

Corporate Bonds

long-term debt issued by private corporations typically paying semiannual coupons and returning the face value of the bond at maturity

Assume a project is independent and has financing-type cash flows (i.e. positive cash flows). Which oneof these statements is correct? a) The internal rate of return (IRR) cannot be used to determine the acceptability of the project b) The project is acceptable if the required return exceeds the internal rate of return (IRR) c) The project is acceptable only if the NPV is zero or negative d) The project's required rate of return will always be negative e) The project is acceptable if the internal rate of return (IRR) is negative

b

The Fisher effect _____________. * a. States that nominal interest rates are equal to the real interest rates plus the expected inflation rate b. States that nominal interest rates are equal to real interest rates minus the expected inflation rate c. Predicts that as the expected inflation rate rises, so do nominal interest rates d. Predicts that as the expected inflation rate rises, real interest rates fall

b

We accept projects with a positive NPV because it means that ____________.I. We have recovered all our costsII. We are creating value for our shareholdersIII. The project's expected return exceeds the required returnIV. Initial costs are recovered quickly allowing the firm to invest in more projects A. I only B. II only C. II and III only D. III and IV only E. II, III and IV only

c

Payback Advantages and Disadvantages

Advantages easy to compute adjust for uncertainty of later cash flows Biased toward liquidity: Quickly frees up cash for other projects Disadvantages Ignores the time value of money Requries an arbitay cut off date ignores cash flows beyond the cut off date Based against long term project

IRR Advantages and Disadvantages

Advantages: - Shows return on each dollar invested - Allows us to compare return to required rate of return Disadvantages: -Incorrectly assumes that money is reinvested at the IRR rate -May conflict with NPV analysis -Possible multiple IRRs or No IRRs for a project

T bills Treasury Notes Treasury Bonds

Short term medium long term

Probability Index

advantages closely related to NPV, generally leading to identical decision may be useful when avabile investment funds are limited disadvantages May lead to incorrect decision in comparison of mutually exclusive investment