Finance Mid term
Which of the following statements about annuities are true?
-An annuity is a series of equal payments made at fixed intervals for a specified number of periods. -Ordinary annuities make fixed payments at the beginning of each period for a certain time period.
Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 8.4% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
1,105.69
McCue Inc.'s bonds currently sell for $1,250. They pay a $90 annual coupon, have a 25-year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bonds' YTM and its YTC? (Subtract the YTC from the YTM; it is possible to get a negative answer.)
2.62%
If all interest rates in the economy fall by 1%, which of the following bonds would have the greatest percentage increase in value?
20-year, zero coupon bond
Which of the following is an example of an annuity?
A job contract that pays a regular monthly salary for three years
Which of the following factors tend to encourage management to act in their stockholders' best interests?
A reasonable compensation package sufficient to attract and retain able managers Direct intervention by shareholders Firing managers who do not perform well Threat of a hostile takeover
Ordinary annuity
A series of equal cash flows that are paid or received at regular intervals, such as a day or a month, is called an annuity.
Which of the following statements about business organizations is CORRECT?
A significant risk in starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.
Amortized loan
An amortized loan is one that is repaid with payments that are composed of both the interest owed on the loan and a portion of the loan's principal. In contrast, a zero-interest loan is one on which interest is not charged and the payments made to repay the loan will consist only of principal.
Eric wants to invest in government securities that promise to pay $1,000 at maturity. The opportunity cost (interest rate) of holding the security is 9.60%. Assuming that both investments have equal risk and Eric's investment time horizon is flexible, which of the following investment options will exhibit the lower price?
An investment that matures in six years
Of the following actions, which one is most likely to reduce conflicts of interest between managers and stockholders?
Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.
Bethany is planning to start a business. Why might she choose to operate her business as a corporation rather than as a proprietorship or a partnership?
Corporations generally find it easier to raise large amounts of capital.
Interest rates on 20-year Treasury and corporate bonds with different ratings, all noncallable, are as follows: T-bond = 6.32% A = 8.46% AAA = 7.78% BBB = 9.28% The differences in rates among these issues were most probably caused by:
Default and liquidity risk differences.
Which is TRUE about business organizations?
Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations even though corporate earnings are subject to double taxation.
There is a direct relationship between bond ratings and the required rate of return on bonds; that is, the higher the rating, the higher is the required rate of return.
FALSE
Simple Interest FV formula
FV= PV+(PV*I*N)
Compound Interest FV formula
FV=PV*(1+I) ^n
After the end of the second year and all other factors remaining equal, a future value based on compound interest will never exceed the future value based on simple interest.
False
Which of the following statements about legal and ethical issues is CORRECT?
If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.
Which of the following statements about bond price risk is CORRECT, assuming that all else is equal?
Long-term bonds have less reinvestment risk than short-term bonds.
Which of the following is true about present value calculations?
Other things remaining equal, the present value of a future cash flow decreases if the investment time period increases.
A 20-year, annual coupon bond with one year left to maturity has the same price risk as a 10-year, annual coupon bond with one year left to maturity. Both bonds are of equal risk, have the same coupon rate, and the prices of the two bonds are equal.
TRUE
A typical sales forecast will usually be based on recent historical trends and events as well as on forecasts of economic prospects.
TRUE
If the dividend payout ratio is 100%, all ratios are held constant, and the firm is operating at full capacity, then any increase in sales will require additional financing.
TRUE
Annual percentage rate
The annual percentage rate (APR) is the cost of borrowed funds as quoted by lenders and paid by borrowers, in which the interest required is expressed as a percentage of the principal borrowed. This rate does not reflect the effects of compounding if interest is earned more than once per year.
Of the following policy changes, which would be the most likely to REDUCE potential conflicts of interest between stockholders and managers?
The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.
Eagle Enterprises Inc. can issue a 20-year bond with a 6% annual coupon at par. This bond is not convertible, not callable, and has no sinking fund. On the other hand, Eagle Enterprises could issue a 20-year bond that is convertible into common equity, may be called, and has a sinking fund. Which of the following most accurately describes the coupon rate that Eagle Enterprises would have to pay on the second bond, the convertible, callable bond with the sinking fund, to have it sell initially at par?
The coupon rate could be less than, equal to, or greater than 6%, depending on the specific terms set, but in the real world the convertible feature would probably cause the coupon rate to be less than 6%.
Time value of money
The financial concept that maintains that the timing of a receipt or payment of a cash flow will affect its value is called the time value of money (TVM). The time value of money illustrates that, due to its capacity to earn interest, a cash flow received today is worth more than an identical cash flow to be received on a future date. The exact current value of a future cash flow is a function of the magnitude of the future cash flow, the return required by the owner (recipient) of the cash flow, and when in the future the cash flow will occur.
Opportunity cost of funds
The interest rate that represents the return on an investor's best available alternative investment of comparable (equal) risk is the investor's opportunity cost of funds.
Which of the following investments that pay will $19,000 in 14 years will have a higher price today?
The security that earns an interest rate of 7.00%.
All other factors being equal, both the simple interest and the compound interest methods will accrue the same amount of earned interest by the end of the first year.
True
Everything else held constant, an account that earns compound interest will grow more quickly than an otherwise identical account that earns simple interest.
True
Maximizing the firm's expected profits for the current year does not necessarily maximize the stockholders' wealth for the current year.
True
For any given maturity
a given percentage point increase in the interest rate causes a smaller dollar capital loss than the capital gain stemming from an identical decrease in the interest rate.
Perpetuity
a series of equal cash flows that are expected to continue forever. A perpetuity can be considered to be a special type of annuity.
From a borrower's point of view
interest paid on bonds is tax deductible.
Annuity due
is the name given to a series of equal cash flows that occur at the beginning of each of the equally spaced intervals (such as daily, monthly, annually, and so on).
Discounting
is the process of calculating the present value of a cash flow to be received or paid in the future. Compounding, which is the process of determining the future, or terminal, value of a current cash flow, is the opposite of discounting.
A 20-year zero-coupon bond has
less reinvestment risk than a 20-year coupon bond.
Family Traditions Home Fashions would call its outstanding callable bonds if _____.
market investment rates decline sharply
Amortization schedule
reports the amount of principle and the amount of interest that make up each payment made to repay a loan by the end of its regular term.
Future value
represents the amount to which a current (present) value will grow over a given period of time when compounded at a given rate of interest.
The primary financial objective is
stockholder wealth maximization, which is the maximization of stock price.
Price sensitivity
that is, the change in price due to a given change in the required rate of return—increases as a bond's maturity increases.
