Finance Test 3

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You are trying to determine the appropriate price to pay for a share of common stock. If you purchase this stock, you plan to hold it for 1 year. At the end of the year you expect to receive a dividend of $5.50 and to sell the stock for $154. The appropriate rate of return for this stock is 16 percent. What should the current price of this stock be?

137.50

On January 1, 2016, the price of a stock is 42.50, whereas on December 31, 2016, the price of the stock is 48.78. Determine the capital gain yield of the stock

14.78%

On January 1, 2016, the price of a stock is 42.50, whereas on December 31, 2016, the price of the stock is 48.78. Determine the capital gain yield of the stock.

14.78%

A $1,000 par value bond sells for $1,216. It matures in 20 years, has a 14 percent coupon, pays interest semiannually, and can be called in 5 years at a price of $1,100. The bond's yield to maturity is: (Round the answer to two decimal places.)

11.26%.

Alpha's preferred stock currently has a market price equal to $80 per share. If the dividend paid on this stock is $6 per share, what is the required rate of return investors are demanding from Alpha's preferred stock?

7.5%

O'Brien Ltd.'s outstanding bonds have a $1,000 par value, and they mature in 25 years. Their nominal yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $850. What is the bond's nominal (annual) coupon interest rate?

7.70%

The variance of the returns of Stock X is 62.5%, and the expected return from the stock is 18%. Calculate the coefficient of variation of the stock. (Round your answer to two decimal places.)

0.44 [The coefficient of variation is a standardized measure of the risk per unit of return.]

On January 1, 2016, the price of a stock is 42.50, whereas on December 31, 2016, the price of the stock is 48.78. Determine the capital gain yield of the stock.

14.78%

A stock has a beta coefficient, β, equal to 1.20.The risk premium associated with the market is 9 percent, and the risk-free rate is 5 percent. Application of the capital asset pricing model indicates that the stock's appropriate return should be _____.

15.8%

Commercial paper is a type of:

promissory note

Corporate bonds can often be redeemed for cash at the bondholder's option. This type of bond is called a :

putable bond.

Municipal bonds are issued by:

state and local governments

The conversion feature of a bond permits:

the bondholder to exchange the bonds with a company's common stock.

A debt is said to be selling at par when:

the market value is equal to the face value of the debt

The P/E ratio gives an indication of _____

the payback period of a stock

The P/E ratio gives an indication of _____.

the payback period of a stock

The face value of a debt is:

the principal value written on the face, or outside cover, of a debt contract

Lower-grade bonds offer higher returns than high-grade bonds because of:

their higher risk and more restricted market.

A bond that pays no annual interest and is sold at a discount below its par value is called a:

zero coupon bond.

A firm has an EBIT of $22 million, total invested capital of $74 million, and the average cost of funds of 12%. The firm has a marginal tax rate of 35% and 4.2 million shares of the firm are outstanding. What is the EVA of the firm?

$5.42 million

A share of common stock has a current price of $82.50 and is expected to grow at a constant rate of 10 percent. If you require a 14 percent rate of return, what is the current dividend on this stock?

$3.00

Which of the following types of bonds protects a bondholder against increases in interest rates?

Floating-rate bonds

A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If an investor's simple annual required rate of return is 12 percent with quarterly compounding, how much should the investor be willing to pay for this bond? (Round the answer to two decimal places.)

$1,115.57

Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If an investor requires a simple annual rate of return of 12 percent with quarterly compounding, how much should the investor be willing to pay for this bond? (Round the answer to two decimal places.)

$1,207.57

What is the risk of investing money in American depository receipts (ADRs)?

Risks associated with the corporations in which the investments are made

A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock

$43.97

The last dividend on Spirex Corporation's common stock was $4.00, and the expected growth rate is 10 percent. If you require a rate of return of 20 percent, what is the highest price you should be willing to pay for this stock?

$44.00

In order to accurately assess the capital structure of a firm, it is necessary to convert its balance sheet figures to a market value basis. KJM Corporation's balance sheet as of today is as follows: Long-term debt (bonds, at par)$10,000,000Preferred stock2,000,000Common stock ($10 par)10,000,000Retained earnings 4,000,000Total debt and equity$26,000,000 The bonds have a 4.0% coupon rate, payable semiannually, and a par value of $1,000. They mature exactly 10 years from today. The yield to maturity is 12%, so the bonds now sell below par. What is the current market value of the firm's debt?

$5,412,032

$5.42 million

The perpetual preferred stock pays an annual dividend of $6 per share. If investors require a 12 percent rate of return, the price of this preferred stock should be closest to:

$50.00

Assume that an investor wishes to purchase a 20-year bond with a maturity value of $1,000 and semiannual interest payments of $40. If the investor requires a 10 percent simple yield to maturity on this investment, what is the maximum price she should be willing to pay for the bond? (Round the answer to the nearest whole number.)

$828

Rick bought a bond when it was issued by Macroflex Corporation 14 years ago. The bond, which has a $1,000 face value and a coupon rate equal to 10 percent, matures in six years. Interest is paid every six months; the next interest payment is scheduled for six months from today. If the yield on similar risk investments is 14 percent, the current market value (price) of the bond is: (Round the answer to two decimal places.)

$841.15.

Assume Alice is considering buying the bond described below: Years to maturity = 10 Par value = $1,000 Annual coupon rate = 8 percent annually, with interest being paid every 6 months. If Alice expects to earn a 10 percent rate of return on this bond, the most she should pay for the bond is closest to:

$875.38

D. J. Masson Inc. recently issued noncallable bonds that mature in 10 years. They have a par value of $1,000 and an annual coupon of 5.5%. If the current market interest rate is 7.0%, at what price should the bonds sell?

$894.65

An investor is contemplating the purchase of a 20-year bond that pays $50 interest every six months. The investor plans to hold the bond only for 10 years, at which time she will sell it in the marketplace. She requires a 12 percent annual return but believes the market will require only an 8 percent return when she sells the bond 10 years from now. Assuming she is a rational investor, how much should she be willing to pay for the bond today? (Round the answer to two decimal places.)

$927.68

Devine Divots issued a bond a few years ago. The bond has a face value equal to $1,000 and pays investors $30 interest every six months. The bond has eight years remaining until maturity. If an investor requires a 7 percent rate of return to invest in this bond, what is the maximum price the investor should be willing to pay to purchase the bond? (Round the answer to two decimal places.)

$939.53

Darren has the option of investing in either Stock A or Stock B. The probability of the return of Stock A being 25% is 0.45, 14% is 0.25, and 4% is 0.30. The probability of the return of Stock B being 30% is 0.30, 9% is 0.25, and 2% is 0.30. Given the probability distributions for the two investments, what is the expected rate of return for Stock A and Stock B?

15.95%; 11.85%

The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond is paid every six months, and the simple annual yield is 14 percent. Given this information, the annual coupon rate on the bond is:

17%

The risk-free rate is 4%, the market risk premium is 8%, and the market return is 12%. Stock Y's beta is 1.85 and the standard deviation of its returns is 60%. What should be the stock's expected rate of return to make the investor indifferent toward buying or selling the stock?

18.80%

If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J?

2.0

Cold Boxes Corporation has 100 bonds outstanding with a maturity value of $1,000. The required rate of return on these bonds is currently 10 percent, and interest is paid semiannually. The bonds mature in 5 years, and their current market value is $768 per bond. The annual coupon interest rate is:

4%.

Which of the following portfolios would have no diversification benefits?

A portfolio consisting of two perfectly positively correlated stocks

Certificates representing ownership in stocks of foreign companies, which are held in a trust bank located in the country the stock is traded are called _____

American depository receipts

Certificates representing ownership in stocks of foreign companies, which are held in a trust bank located in the country the stock is traded are called _____.

American depository receipts

Which of the following events would make it less likely for a company to choose to call its outstanding callable bonds?

An increase in interest rates

Garvin Enterprises' bonds currently sell for $1,150. They have a 6-year maturity, an annual coupon of $85, and a par value of $1,000. What is their current yield?

Current yield = coupon /price = 85/1,150 = 7.39%

The expected returns for Stocks A, B, C, D, and E are 7%, 10%, 12%, 25%, and 18% respectively. The corresponding standard deviations for these stocks are 12%, 18%, 15%, 23%, and 15% respectively. Based on their coefficients of variation, which of the securities is least risky for an investor? Assume all investors are risk-averse and the investments will be held in isolation.

Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest being paid semiannually. The required simple rate of return on this debt has now risen to 16 percent. What is the current value of this bond? (Round the answer to the nearest whole number.)

Each interest payment is only one-fourth of the annual payment, but the coupon payments are made four times in a year. [550]

The constant growth Dividend Discount Model (DDM) may be written as _____.

P0 = D1/(rs - g)

Steve Brickson currently has an investment portfolio that contains four stocks with a total value equal to $80,000. The portfolio has a beta (β) equal to 1.4. In order to earn higher returns, Steve wants to invest an additional $20,000 in a stock that has β equal to 2.4. After Steve adds the new stock to his portfolio, what will the portfolio's beta be?

Portfolio beta = ((($80,000 / ($20,000 + $80,000)) × 1.4) + ((($20,000 / ($20,000 + $80,000)) × 2.4) = 1.6.

Which of the following is a feature of a preferred stock?

Preferred stockholders are entitled to dividends that are expressed as a percentage of the stated par value of the preferred stock.

The interest rate on a 10 percent, 10-year zero-coupon bond with a $1,000 face value falls from 8 percent to 7 percent. Which of the following is true of the value of the bond? (Round the answer to two decimal places.)

The present value of the bond at 7 percent is $508.34.

The perpetual preferred stock pays an annual dividend of $6 per share. If investors require a 12 percent rate of return, the price of this preferred stock should be closest to:

The price of the preferred stock is $50, calculated by dividing $6 by 12 percent.

Stock A has a beta (β) equal to 2.1 and Stock B has a beta equal to 0.7. Based on this information, according to the capital asset pricing model (CAPM), which of the following statements is correct?

The risk premium associated with Stock A, RPA, should be three times the risk premium associated with Stock B, RPB.

Which of the following statements about the security market line (SML) and investor's risk aversion is correct?

The steeper the slope of the line, the greater the average investor's risk aversion, and thus the greater the return investors require as compensation for risk.

The current expected value of a stock is $32. If investors demand a higher rate of return of 10% instead of the 8% rate of return, what will the impact on the stock price of the firm be?

The stock price will decrease.

Consider two bond issues, Issue A and Issue B, that are identical in all respects except Issue A is callable. Which of the following is TRUE?

The yield to maturity (YTM) for Issue A will be greater than the YTM for Issue B.

Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10.65 percent currently have a yield to maturity (YTM) equal to 15.25 percent. Based on this information, it is understood that BB&C's bonds must currently be selling at _____ in the financial markets

a discount

The computation for the yield to call (YTC) is the same as that for the yield to maturity (YTM), except that we substitute the _____ of the bond for the maturity (par) value.

call price

A preferred stock can be exchanged for a certain number of shares of common stock at the _____.

conversion price

A(n) _____ can be exchanged for shares of equity at the owner's discretion.

convertible bond

Omega Software Corporation's bond with a face value of $1,000 is currently selling at a premium in the financial markets. If the bond's yield to maturity is 11.5 percent, then the bond's:

coupon rate of interest will be greater than 11.5 percent.

The greater a bond's default risk, the greater the:

default risk premium (DRP) associated with the bond.

The preferred dividend is generally stated as a percentage of the _____.

par value

The market for a stock is said to be in equilibrium when the _____.

expected return on the stock is equal to its required return

When using the Dividend Discount Model, assuming that growth (g) will remain constant, under which of the following circumstances will the dividend yield be equal to the required return on a common stock (rs)?

g = 0

Other things held constant, if investors become less risk averse, the new security market line (SML) would _____.

have a less steep slope

The percentage rate of return that investors earn on a bond consists of a(n):

interest yield plus a capital gains yield.

The expected rate of return of an investment _____.

is the mean value of the probability distribution of possible returns

The _____ of a bond fluctuates continuously during its life.

market value

The _____ of a bond fluctuates continuously during its life.

market value

A debt backed by some form of specific property is known as a:

mortgage bond.

The preferred dividend is generally stated as a percentage of the _____.

par value

Stock X's beta is 2.1. The risk-free rate is 6%, and the market return is 13%. The expected rate of return of Stock X is 15.5%. On the basis of this information, which of the following statements is true?

An investor should not buy Stock X because its expected rate of return is less than the required rate of return.

The risk-free rate of return is 4%, and the market return is 10%. The betas of Stocks A, B, C, D, and E are 0.85, 0.75, 1.20, 1.35, and 0.5 respectively. The expected rates of return for Stocks A, B, C, D, and E are 7%, 9%, 9.5%, 12.1%, and 14% respectively. Which of the above stocks would an investor be indifferent towards buying or selling?

Which of the following is an advantage of convertible bonds?

Investors can choose to hold the company's bonds or convert the bonds into its stock.

What does a P/E ratio of 10 indicate?

It would take 10 years for an investor to recover his or her initial investment.

What is the formula to calculate P/E ratio?

Market price per share ÷ Earnings per share

The constant growth Dividend Discount Model (DDM) may be written as _____

P0 = D1/(rs - g)

Which of the following is included in the call provision of a preferred stock?

Preferred stock can be redeemed by incorporating a maturity option to a preferred stock issue

The standard deviation of the returns of Stock A is 45.85%, and the standard deviation of the returns of Stock B is 52.7%. Which of the following statements about the stocks is correct?

Stock A has tighter probability distribution, and hence lower total risk.

The present value of the bond at 7 percent is $508.34.

The current expected value of a stock is $32. If investors demand a higher rate of return of 10% instead of the 8% rate of return, what will the impact on the stock price of the firm be?

The stock price will decrease.

A bond differs from a term loan in that:

a bond has a high issuance cost.

Omega Software Corporation's bond with a face value of $1,000 is currently selling at a premium in the financial markets. If the bond's yield to maturity is 11.5 percent, then the bond's

coupon rate of interest will be greater than 11.5 percent.

What is the term for a protective feature on a preferred stock that requires preferred dividends previously not paid to be disbursed before any common stock dividends can be paid?

cumulative dividends

Other things held constant, if the expected inflation rate decreases, and at the same time investors become more risk averse, the Security Market Line (SML) would shift _____.

down and have a steeper slope

The current market interest rate declines from 10 percent to 8 percent. Due to interest rate reinvestment risk, the bondholders will:

earn a lower return on the reinvested cash flows.

Omega Inc. holds a 12-year bond that has a 12 percent coupon rate and a marginal tax rate of 40 percent. It is currently selling for $1,000, which is the bond's face value. If interest is paid semiannually, the bond's yield to maturity is:

equal to 12 percent.

The larger the standard deviation of returns of an investment, _____.

greater is the chance that the realized return will differ significantly from the expected return

The sinking fund provision requires a firm to:

retire a portion of the bond issue each year.

If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be:

selling at a premium; i.e., the bond's market price should be greater than its face value.

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