Financial Exam 3 Study Guide

One year ago, you purchased a 6 percent coupon bond with a face value of $1,000 when it was selling for 98.6 percent of par. Today, you sold this bond for 101.2 percent of par. What is your total dollar return on this investment?

$86

What is the beta of the following portfolio? Stock Value Beta M $18,400 .97 N $6,320 1.04 O $32,900 1.23 P $11,850 .88

1.08 Portfolio value = $18,400 + 6,320 + 32,900 + 11,850 = $69,470 Beta = ($18,400/$69,470)(.97) + ($6,320/$69,470)(1.04) + ($32,900/$69,470)(1.23) + ($11,850/$69,470)(.88) = 1.08

Connor Corp. has large amount of data that they are trying to analyze from the last 15 years. They have an arithmetic sales growth average of 12% and a geometric average growth of 9%. Using Blume's formula, what would the forecast sales growth be for the next five years?

11.14%

Use the following returns for X and Y. Year X Y 1 22.7% 29.1% 2 -17.7 -4.7 3 10.7 31.1 4 21.4 -16.4 5 5.7 35.1 Calculate the average returns for X and Y. Calculate the variances for X and Y. Calculate the standard deviations for X and Y

Calculate the average returns for X and Y. [.227 − .177 + .107 + .214 + .057]5=.0856, or 8.56%X¯=[Σi=1Nxi]/N=[.227⁢ − .177⁢ + .107⁢ + .214⁢ + .057]5=.0856,⁢ or 8.56% 14.84% Calculate the variances for X and Y. .026679 .055899 Calculate the standard deviations for X and Y 16.33% 23.64%

Suppose a stock had an initial price of $87 per share, paid a dividend of $1.60 per share during the year, and had an ending share price of $102. Compute the percentage total return Dividend yield Capital gains yield

Compute the percentage total return R = [($102 - 87) + 1.60] / $87R = .1908, or 19.08% Dividend yield Dividend yield = $1.60 / $87Dividend yield = .0184, or 1.84% Capital gains yield Capital gains yield = ($102 - 87) / $87Capital gains yield = .1724, or 17.24%

The risk-free rate of return is 5.4 percent and the market risk premium is 13 percent. What is the expected rate of return on a stock with a beta of 1.6?

E(R) = .054 + 1.60(.13)E(R) = .2620, or 26.20%

You recently purchased a stock that is expected to earn 21 percent in a booming economy, 16 percent in a normal economy, and lose 5 percent in a recessionary economy. There is 20 percent probability of a boom, 65 percent chance of a normal economy, and 15 percent chance of a recession. What is your expected rate of return on this stock?

E(R) = .20(.21) + .65(.16) + .15(-.05)E(R) = .1385, or 13.85%

The common stock of Flavorful Teas has an expected return of 23.92 percent. The return on the market is 16 percent and the risk-free rate of return is 2.8 percent. What is the beta of this stock?

E(R) = .2392 = .028 + β(.160 − .028).2112 = .132β β = 1.60

When attempting to forecast for extremely long intervals, such as 50 years, it is best to use:

Expected Return Averages

True or False: The arithmetic average tells you what you actually earned per year on average, whereas the geometric average tells you what you earned in a typical year.

False

Farmer's Supply is considering opening a clothing store, which would be a new line of business for the firm. Management has decided to use the cost of capital of a similar clothing store as the discount rate to evaluate this proposed expansion. Which one of the following terms describes this evaluation approach?

Pure play approach

Countess Corp. is expected to pay an annual dividend of $4.33 on its common stock in one year. The current stock price is $71.51 per share. The company announced that it will increase its dividend by 3.50 percent annually. What is the company's cost of equity?

R(E) = ($4.33/$71.51) + .0350 R(E) = .0956, or 9.56%

The stock in Bowie Enterprises has a beta of 1.24. The expected return on the market is 11.20 percent and the risk-free rate is 2.82 percent. What is the required return on the company's stock?

R(E) = .0282 + 1.24(.1120 − .0282) R(E) = .1321, or 13.21%

Diversifying a portfolio across various sectors and industries might do more than one of the following. However, this diversification must do which one of the following?

Reduce the portfolio's unique risks

On a particular risky investment, investors require an excess return of 7 percent in addition to the risk-free rate of 4 percent. What is this excess return called?

Risk Premium

Assume the securities markets are strong form efficient. Given this assumption, you should expect which one of the following to occur?

The price of each security in that market will frequently fluctuate

Take It All Away has a cost of equity of 10.81 percent, a pretax cost of debt of 5.45 percent, and a tax rate of 35 percent. The company's capital structure consists of 77 percent debt on a book value basis, but debt is 37 percent of the company's value on a market value basis. What is the company's WACC?

WACC = .63(10.81%) + .37(5.45%)(1 − .35) WACC = 8.12%

You own the following portfolio of stocks. What is the portfolio weight of Stock C? Stock # of Shares Price per Share A 120 $33 B 760 29 C 450 53 D 240 52

Weight of C = (450 × $53)/[(120 × $33) + (760 × $29) + (450 × $53) + (240 × $52)]Weight of C = $23,850/$62,330 Weight of C = .3826

A portfolio consists of $13,400 in Stock M and $18,900 invested in Stock N. The expected return on these stocks is 8.50 percent and 11.60 percent, respectively. What is the expected return on the portfolio?

Weight of M = $13,400/($13,400 + 18,900) Weight of M = .4149 Portfolio expected return = .4149(8.5%) + (1 - .4149)(11.6%) Portfolio expected return = 10.31%

Which one of the following represents the minimum rate of return a firm must earn on its assets if it is to maintain the current value of its securities?

Weighted average cost of capital

The capital asset pricing model:

considers the relationship between the fluctuations in a security's returns versus the market's returns.

An increase in a levered firm's tax rate will:

decrease the firm's cost of capital.

A firm that uses its weighted average cost of capital as the required return for all of its investments will:

increase the risk level of the firm over time.

The lower the standard deviation of returns on a security, the _____ the expected rate of return and the _____ the risk.

lower; lower

An efficient capital market is best defined as a market in which security prices reflect which one of the following?

-Current inflation -Risk Premium -The historical arithmetic rate of return (All this information is true to to this question)

The standard deviation measures the _____ of a security's returns over time

Volatility

If the financial markets are efficient then:

stock prices should respond only to unexpected news and events.

One year ago, you purchased 600 shares of a stock. This morning you sold those shares and realized a total return of 3.1 percent. Given this information, you know for sure the:

sum of the dividend yield and the capital gains yield is 3.1 percent.

For a risky security to have a positive expected return but less risk than the overall market, the security must have a beta:

that is > 0 but < 1