FINC exam 3

Morin Company's bonds mature in 8 years, have a par value of $1,000, and make an annual coupon interest payment of $65. The market requires an interest rate of 6.1% on these bonds. What is the bond's price?

$1,024.74 N 8 I/YR 6.1% PMT $65 FV $1,000 Solve for PV: $1,024.74

The Francis Company is expected to pay a dividend of D1 = $1.25 per share at the end of the year, and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The company's beta is 1.70, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is the company's current stock price?

$17.01. (use the CAPM equation to find the required rate of return for Francis Company's stock) D1 $1.25 b 1.70 rRF 4.00% RPM 5.50% g 6.00% rS = rRF + b(RPM) = 13.35% P0 = D1/(rS - g). $17.01

Mooradian Corporation's free cash flow during the just-ended year (t = 0) was $250 million, and its FCF (free cash flow) is expected to grow at a constant rate of 5.0% in the future. If the weighted average cost of capital is 12.5%, what is the firm's market value of operations, in millions

$3,500 FCF0 $250 g 5.0% WACC 12.5% FCF1 = FCF0(1 + g) = $262.50 MV of operations = FCF1/(WACC - g) =. $3,500.00

Based on the corporate valuation model, Wang Inc.'s total corporate value is $750 million. Its balance sheet shows $100 million notes payable, $200 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm's market value of equity, in millions?

$450 Use the following equation from Slide 27 of the Chapter 9 PowerPoint slides: Market Value of Equity = Market Value of Operations + Market Value of Non-operating Assets - Market Value of Debt and Preferred Stock. Assuming that the book value of debt is close to its market value, the total market value of the company's equity is: Market value of operations $750 Notes payable -$100 Long-term debt -$200 Value of equity = $450 The book value of equity figures are irrelevant for this problem.

The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company's beta is 1.90, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company's current stock price, P0

$9.89 The difference between this question and the previous one is that here you're given D0. So you have to use D0 to figure out what D1 is and then plug D1 into the discounted dividend model equation. D0 $0.75 b 1.90 rRF 4.0% RPM 5.0% g 5.5% D1 = D0(1 + g) = $0.7913 rS = rRF + b(RPM) = 13.50% P0 = D1/(rS - g) $9.89

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 10.7% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

$901.80 Par value $1,000 Coupon rate 9.5% Periods/year 2 Yrs to maturity 20 Periods = Yrs to maturity Periods/year 40 Required rate 10.7% Periodic rate = Required rate / 2 = I/YR. 5.35% PMT per period = Coupon rate/2 Par value. $47.50 Maturity value = FV $1,000 Solve for PV: $901.80

T/F: If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.

TRUE

T/F: If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward sloping yield curve

TRUE

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Gamma Corp at $10 a share and adding it to your portfolio. Gamma has an expected return of 21.5% and a beta of 1.70. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Gamma stock? Do not round your intermediate calculations

12.05%; 1.25 The key here is that the expected return and the beta of the new portfolio are just weighted averages: Old portfolio return = 11% Old portfolio beta = 1.2 Gamma Corp's return = 21.5% Gamma Corp's beta = 1.7 Percentage of portfolio that consists of Gamma stock = $ in Gamma / ($ in Old portfolio + $ in Gamma) = $10,000 / ($10,000 + $90,000) = $10,000/$100,000 = 10% (So now you know that the weights are 0.1 in Gamma Corp stock, and 0.9 in the Old portfolio.) Plug in those weights to get the new portfolio's expected return and beta: New expected portfolio return = rp = (0.1 × 21.5%) + (0.9 × 11%) = 12.05% New expected portfolio beta = bp = (0.1 × 1.70) + (0.9 × 1.20) = 1.25

Keenan Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,045. What is the bond's nominal yield to call?

5.59% First, use the given data to find the bond's current price. Then use that price to find the YTC. Coupon rate. 8.25% YTM 6.50% Maturity 15 Yrs to call 6 Par value. $1,000 Call price $1,045 Periods/year. 2 Determine the bond's price PMT/period $41.25 N 30 I/YR 3.25% FV $1000.00 PV = Price. $1166.09 Yrs to call. 6 Call price. $1,045 Determine the bond's YTC N 12 PV. $1,166.09 PMT. $41.25 FV $1,045.00 I/YR. 2.80% Nom. YTC. 5.59%

Porter Inc's stock has an expected return of 12.50%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 2.00%, what is the market risk premium? Do not round your intermediate calculations.

8.40% Use the CAPM to determine the market risk premium with the given data.

Cooley Company's stock has a beta of 1.28, the risk-free rate is 2.25%, and the market risk premium is 5.50%. What is the firm's required rate of return? Do not round your intermediate calculations

9.29% (Use CAPM formula)

Which of the following statements is CORRECT? All else equal, high-coupon bonds have less reinvestment risk than low-coupon bonds. All else equal, long-term bonds have less price risk than short-term bonds. All else equal, low-coupon bonds have less price risk than high-coupon bonds. All else equal, short-term bonds have less reinvestment risk than long-term bonds. All else equal, long-term bonds have less reinvestment risk than short-term bonds.

All else equal, long-term bonds have less reinvestment risk than short-term bonds.

Which of the following statements is CORRECT? An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

You have the following data on three stocks: Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

B; A.- When held in isolation, the measure of risk we are concerned with is the standard deviation. The lower the better, so you would want to choose Stock B since it has the lowest standard deviation. However, when held as part of a well-diversified portfolio, the measure of risk that we are concerned with is beta. Again, the lower the better, so you would choose Stock A since it has the lowest beta.

Dothan Inc.'s stock has a 25% chance of producing a 16% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return? Do not round your intermediate calculations.

Conditions Prob. Return Prob. × Return Good 0.25 16.0% 4.00% Average 0.50 12.0% 6.00% Poor 0.25 -18.0% -4.50% = 1.00 = 5.50% Expected return

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by:

Default and liquidity risk differences

T/F: . If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill.

FALSE

T/F: A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, companies call bonds if interest rates rise and do not call them if interest rates decline.

FALSE

T/F: Because the maturity risk premium is normally positive, the yield curve is normally upward sloping.

TRUE

Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT? If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's. Stock B must have a higher dividend yield than Stock A. Stock A must have a higher dividend yield than Stock B. If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B's. Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.

If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B's. Statement a is true, because if the required return for Stock A is higher than that of Stock B, and if the dividend yield for Stock A is lower than Stock B's, the growth rate for Stock A must be higher to offset this.

Which of the following statements is CORRECT? If the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. If the maturity risk premium (MRP) equals zero, the Treasury bond yield curve must be flat. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping. If the expectations theory holds, the Treasury bond yield curve will never be downward sloping. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.

If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.

T/F: For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return

TRUE

T/F: From an investor's perspective, a firm's preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer's standpoint, these risk relationships are reversed: bonds are the most risky for the firm, preferred is next, and common is least risky.

TRUE

Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT? A B Price $25 $25 Expected growth (constant) 10% 5% Required return 15% 15% ​ Stock A's expected dividend at t = 1 is only half that of Stock B. Stock A has a higher dividend yield than Stock B. Currently the two stocks have the same price, but over time Stock B's price will pass that of A. Since Stock A's growth rate is twice that of Stock B, Stock A's future dividends will always be twice as high as Stock B's. The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.

Stock A's expected dividend at t = 1 is only half that of Stock B. Statement A is correct, because if both stocks have the same price and the same required return, and A's growth rate is twice that of B, then A's dividend and dividend yield must be half that of B. This point is illustrated with the following example. A B Price $25 $25 g 10%. 5% rs 15% 15% Div. Yield = rs - g = 5% 10% D1= P0*(Div Yield) = $1.25 $2.50

T/F: Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

TRUE

T/F: Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse

TRUE

T/F: The Y-axis intercept of the SML (security market line) represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

TRUE

T/F: The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

TRUE

T/F: The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond's remaining maturity.

TRUE

T/F: There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower

TRUE

T/F: When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk

TRUE

T/F: You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.

TRUE- Use your financial calculator to solve for I, which is the rate of return on this bond. N = 10, PV = -$800, PMT = $100, and FV = $1000. The bond's expected return (YTM) is 13.81%, which exceeds your 12% required return, so buy the bond.

A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT? The bond's expected capital gains yield is zero. The bond's yield to maturity is above 9%. The bond's current yield is above 9%. If the bond's yield to maturity declines, the bond will sell at a discount. The bond's current yield is less than its expected capital gains yield.

The bond's expected capital gains yield is zero If the bond is selling at par, we know that its coupon rate is equal to the prevailing market interest rate. Coupon rate = YTM. Both are 9% (you can plug values into a financial calculator to verify this). The current yield is 9% (this is just the coupon payment divided by the current price, which is 90/1000). There are no expected capital gains (you paid $1000 for the bond, and you expected to get back that same amount 10 years from now since the par value is also $1000). Thus, A is the correct answer

A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT? The company's current stock price is $20. The company's dividend yield 5 years from now is expected to be 10%. The constant growth model cannot be used because the growth rate is negative. The company's expected capital gains yield is 5%. The company's expected stock price at the beginning of next year is $9.50.

The company's expected stock price at the beginning of next year is $9.50 Note that P0 = $2/(0.15 + 0.05) = $10. That price is expected to decline by 5% each year, so P1 must be $10(0.95) = $9.50. Therefore, answer e is correct, while all the others are false.

Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return? Because of the call premium, the required rate of return would decline. There is no reason to expect a change in the required rate of return. The required rate of return would decline because the bond would then be less risky to a bondholder. The required rate of return would increase because the bond would then be more risky to a bondholder. It is impossible to say without more information.

The required rate of return would increase because the bond would then be more risky to a bondholder. Call provisions are bad for the bondholder. Thus, a callable bond would have to offer additional compensation (that is, a higher rate of return) to entice an investor to be willing to hold the bond.

During the coming year, the market risk premium (rM - rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT? The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. The required return on all stocks will remain unchanged. The required return will fall for all stocks, but it will fall more for stocks with higher betas. The required return for all stocks will fall by the same amount. The required return will fall for all stocks, but it will fall less for stocks with higher betas.

The required return will fall for all stocks, but it will fall more for stocks with higher betas.

The expected return on Natter Corporation's stock is 14%. The stock's dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT? The stock's dividend yield is 7%. The stock's dividend yield is 8%. The current dividend per share is $4.00. The stock price is expected to be $54 a share one year from now. The stock price is expected to be $57 a share one year from now.

The stock price is expected to be $54 a share one year from now. P1 = P0(1 + g) = $54. Therefore, D is correct. P1 = $54.00. A and B are false because the dividend yield is actually 14 - 8 = 6%.

Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT? Expected dividend, D1 $3.00 Current Price, P0 $50 Expected constant growth rate. 6.0% ​ The stock's required return is 10%. The stock's expected dividend yield and growth rate are equal. The stock's expected dividend yield is 5%. The stock's expected capital gains yield is 5%. The stock's expected price 10 years from now is $100.00.

The stock's expected dividend yield and growth rate are equal.

Which of the following statements is CORRECT? The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond. The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5-year AAA-rated corporate bond. The following represents a "possibly reasonable" formula for the maturity risk premium on bonds: MRP = -0.1%(t), where t is the years to maturity.

The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.