Intermediate Finance Exam 1
$200 at the end of each year forever at 10% is worth how much today?
$2,000
What is the value of a bond if the present value of interest cash flows is $200 and the present value of the face value to be received when the bond matures is $150?
$350
Which of the following will result in a lower present value?
-A higher interest rate -More risk -More time
What information is needed to compute a bond's yield to maturity?
-Time to maturity -Coupon rate -The bond's current price
The sensitivity of a bond's price to interest rate changes is dependent on which of the following two variables?
-Time to maturity of the bond -The bond's coupon rate
The opportunity cost of capital reflects
-the risk of the investment -the opportunity cost to the investor
The present value for a(n) _____ is PV = C/r, where C is the constant and regularly timed cash flow to infinity, and r is the interest rate. A. perpetuity B. growing perpetuity C. growing annuity D. annuity
A. perpetuity
A bond that makes just one cash payment, the price of which can be used to determine spot rates, is called a: A. strip bond B. premium bond C. discount bond D. face value bond
A. strip bond
The general formula for the _____ is (1+r/m)^m - 1. A. SAIR B. EAR C. APR
B. EAR (effective annual rate) The EAR takes into account compounding while APR does not.
True or false: A bond's price is not affected by changes in the market rate of interest.
B. False
What is a bond's current yield? A. It is the coupon rate. B. It is the annual coupon payment divided by the bond's price. C. It is the difference between the current bond price and face value.
B. It is the annual coupon payment divided by the bond's price.
Which one of the following is the most important source of risk from owning bonds? A. Loss of a bond certificate B. Market interest rate fluctuations C. Mergers D. Coupon interest rate fluctuations
B. Market interest rate fluctuations
Which of the following is the correct formula for the 1-period present value? A. PV = FV/r B. PV = FV(1+r) C. PV = FV * (1+r)
B. PV = FV (1+r)
How are TIPS different from traditional bonds? A. Promised payments are specified in nominal terms. B. Promised payments are specified in real terms. C. Investors can choose to receive payments in real terms or nominal terms.
B. Promised payments are specified in real terms. (Treasury-Inflation Protected Securities)
A perpetuity is a constant stream of cash flows for a(n) _____ period of time. A. random B. infinite C. finite D. undetermined
B. infinite
If the term structure of interest rates is upward-sloping, then A. short-term rates are higher than long-term rates B. long-term rates are higher than short-term rates C. there is no relationship between short-term and long-term rates D. long-term rates equal short-term rates
B. long-term rates are higher than short-term rates
Inflation will _____ the real return on a bond. A. randomize B. reduce C. have no effect on D. increase
B. reduce
Which compounding interval will result in the lowest future value assuming everything else is held constant? A. continuous B. quarterly C. daily D. annual
D. annual
How is the future value of $100 invested today for 3 years at 10 percent annual interest compounded?
FV = $100(1.10)^3
Which of the following is the multi-period formula for compounding a present value into a future value?
FV = C0 * (1+r)^n
The future value formula is
FV=C0(1+r)^n
In an inflationary environment, the nominal rate will be _____ the real rate.
greater than
When inflation is highly uncertain investors will require _____ expected rates of return in order to lend long.
high
Assume you own a bond currently valued at $989. If the market rate of interest drops, the bond's current market price will _____.
increase
The federal government can raise money from financial markets to finance its deficits by:
issuing bonds
A dollar received one year from today has ___ value than a dollar received today.
less
C/r is the formula for the present value of a(n) _______.
perpetuity
The term structure of interest rates examines the:
relationship between short-term and long-term interest rates
The owners of a corporation are called _____
shareholders
The primary responsibility of financial managers is to increase the value of _____
the existing shares of stock
The expectations theory of the term structure states that a series of short-maturity bonds must offer _____ expected return as an investment in a single long-maturity bond.
the same
A bond's yield to maturity is:
the total yield or expected return on a bond that is held until it matures
If a $1000 face value bond is trading at a premium, the bond is:
trading for more than $1000 in the market
Semiannual compounding means that interest is paid _____ per year.
two times
What is the present value of an ordinary annuity that pays $100 per year for three years if the interest rate is 10% per year?
$248.69
What is the present value of $100 in 10 years at a continuously compounded rate of 10 percent?
$36.79 *keyword continuously compounded, not regularly compounded (100/e^.1*10)
If you invest in a $1000 corporate bond that has a 9 percent coupon and makes semi annual payments, you can expect to receive _____ each six months.
$45 every 6 months
ABC Co. issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?
$60 in interest at the end of each year for 10 years and a $1000 repayment of principal at the end of 10 years
What is the real value of an expected bond payment of $1000 in 10 years if the rate of inflation is expected to be 5%?
$613.91 (1000/(1.05)^10)
The cost of a new automobile is $10,000. If the interest rate is 5%, how much would you have to set aside now to provide this sum in five years?
$7,835.26
If the interest rate is 10% per year, then what is the present value (PV) of $100 received one year from today?
$90.91 (100/1.10)
A corporate bond's yield to maturity:
- is usually not the same as a bond's coupon rate - changes over time
A corporate bond's yield:
-Changes over time -Is usually not the same as a bond's coupon rate
What information is needed to compute a bond's yield to maturity?
-Coupon rate -The bond's current price -Time to maturity
What four variables are required to calculate the value of a bond?
-Face value -Yield -Coupon rate -Time remaining to maturity
Which of the following are true about a bond's face value?
-It is amount repaid when the bond matures. -Face value is fixed and does not change with interest rate changes.
All junk bonds typically have which of these features?
-Less than investment-grade rating -High probability of default
Which of the following terms apply to a bond?
-Maturity -Face value -Principal
Which of the following will result in a lower present value for a given future cash flow?
-More risk -More time -A higher interest rte
If the PV of $139 is $125, what is the discount factor?
.8992 (125/132)
If you earn 8 percent a year compounded annually for 7 years on a $1000 present value, your future value will be
1,713.82 1000(1.08)^7
What is the coupon rate on a bond that has a par value of $1000, a market value of $1100, and a coupon interest payment of $100 per year?
10%
What is the real rate of return if the nominal rate is 7 percent and the rate of inflation is 2 percent?
4.90% (1.07/1.02) -1
The rates on financial securities are generally quoted as: A. nominal rates B. static rates C. real rates D. trade rates
A. nominal rates
When the term structure of interest rates is downward sloping, _____. A. short-term rates are higher than long-term rates B. there is no relationship between short-term and long-term rates C. short-term rates are lower than long-term rates D. short-term rates equal long-term rates
A. short-term rates are higher than long-term rates
Bond ratings are based on the probability of default risk, which is the risk that ___. A. the bond's issuer may not be able to make all the required payments B. inflation may increase in the short term C. the bond's interest rates may change unexpectedly D. the bond's maturity may change
A. the bond's issuer may not be able to make all the required payments
A TIPS bondholder will not know: A. the size of expected payments in nominal terms B. how the nominal payment will be adjusted for inflation C. the size of expected payments in real terms D. whether payment will be made or not
A. the size of expected payments in normal terms
Which of the following is true about a growing annuity? A. The cash grows at an irregular rate. B. The cash grows for a finite period. C. The cash grows for an infinite period. D. The cash flow grows at a constant rate.
B. The cash grows for a finite period. & D. The cash flow grows at a constant rate.
Which one of the following is a real asset? A. a share of stock B. a factory C. a corporate bond
B. a factory
The percentage change in bond price for a 1 percentage-point change in yield is measured by: A. Macaulay duration B. modified duration C. the yield curve D. spot rates
B. modified duration
According to the basic investment rule for NPV, a firm should _____. A. accept a project if the discount rate is greater than zero B. reject a project if NPV is less than zero C. accept a project if the NPV is greater than zero D. reject a project if the discount rate is greater than zero
B. reject a project if NPV is less than zero & C. accept a project if the NPV is greater than zero
If you own corporate bonds, you will be concerned about interest rate as it affects _____. A. the time to maturity B. the market price of the bonds C. coupon rates D. the par value of the bonds
B. the market price of the bonds
Bond A has a 5 percent coupon and will mature in 5 years whereas Bond B has a 7 percent coupon rate and will mature in 2 years. Which bond's value will be more impacted by a change in interest rates?
Bond A
Duration measures: A. the difference between short-term and long-term bonds B. face value received at maturity C. average time to maturity D. spot rates in the term structure
C. average time to maturity
The YTM will be greater than the current yield if A. bonds were purchased at par value B. bonds were purchased at a premium C. bonds were purchased at a discount D. YTM cannot be greater than current yield
C. bonds were purchased at a discount
A bond with a BBB rating has a ___ than a bond with an A rating. A. longer duration B. shorter duration C. higher risk of default D. lower risk of default
C. higher risk of default
The relationship between bond prices and the market rate of interest is _____. A. positive during the initial years and negative during the later years B. non-existent; there is no specific relationship between bond price and market rates C. inverse; if the market rate of interest rises, bond prices will fall
C. inverse; if the market rate of interest rises, bond prices will fall
The _____ states that the same commodity must sell at the same price in a well-functioning market. A. spot rate laws B. laws of supply and demand C. law of one price D. arbitrage principle
C. law of one price
Expected inflation, risk, and expectations of changes in future interest rates all impact the shape of the: A. bond ratings B. expectations theory C. term structure D. duration curve
C. term structure
What is the nominal rate of return on an investment? A. It is the rate of return earned in excess of the average rate earned by similar investments. B. It is the percentage change in the dollar value of an investment adjusted for inflation. C. It is the average rate of return earned by similar investments. D. It is the actual percentage change in the dollar value of an investment.
D. It is the actual percentage change in the dollar value of an investment.
If bonds for GE are quoted at 90, they can be purchased: A. at 90% of current market price B. for $900 C. for $90 per bond D. at 90% of face value
D. at 90% of face value
A traditional (non-growing) annuity consists of a(n) _____ period of time. A. uneven B. random C. infinite D. fixed
D. fixed
The term structure of interest rates examines the: A. changes in bond values over time B. relationship between coupon rates and market yield C. relationship between face value and market price D. relationship between short-term and long-term interest rates
D. relationship between short-term and long-term interest rates
What is a discount bond?
Discount bonds are bonds that sell for less than the face value
True or false. Small changes in the interest rate do not really matter when dealing with millions or billions of dollars over 30 or 40 years.
False
True or false: Corporate debt is typically less risky than sovereign debt.
False
True or false: The real rate of return will generally be higher than the nominal rate of return.
False
Which of the following is true about a typical multi-year bond's coupon?
It is a fixed payment made yearly and at bond maturity.
What is the bond's current yield?
It is the annual coupon payment divided by the bond's price
NPV =
PV - investment
What is the difference between a premium bond and a discount bond?
Premium bonds sell for more than the face value while discount rates sell for less than the face value.
What does historical data suggest about the nature of short-term and long-term interest rates?
Sometime short-term rates are higher and sometimes long-term rates are higher.
If you are holding two identical bonds, except that one matures in 10 years and one matures in 5 years, which bond's price will be more sensitive to interest rates?
The 10-year bond
Suppose you own a 30-year bond issue by GE and a 2-year bond issued by PG with identical coupon rates and face values. Which bond will you lose more money on as interest rates rise?
The GE bond will lose more because it has a longer maturity.
Assume you own a bond that was issued by a blue-chip company. If the market rate of interest rises, what will happen to the price of your bond?
The bond price will fall.
You own two bonds-one with a 5 percent coupon and one with a 6 percent coupon. Which one is more sensitive to interest rate risk, all other things being equal?
The bond with the 5 percent coupon rate is more sensitive.
Why is the YTM of a discount bond greater than the bond's current yield?
The current yield does not include the capital gain from the price discount from face value.
Which of the following is true regarding long-duration and short-duration bonds?
The prices of long-duration bonds are more volatile than short-duration bonds.
What does empirical data indicate about the relationship between nominal interest rates and the rate of inflation?
There is a positive relationship between interest rates and inflation.
Why is a dollar received today worth more than a dollar received in the future?
Today's dollar can be invested, yielding a greater amount in the future.
True or false: If you invest in a bond that is rated AAA by S&P, you can be reasonably assured that your investment has very little default risk.
True
True or false: In well-functioning markets, arbitrage opportunities are eliminated almost instantaneously by investors who try to take advantage of them.
True
Financial assets:
a share of stock, a personal IOU, the balance in a firm's checking account, a corporate bond
When trying to find the total present value of a stream of cash flows over a number of years, you should _____ the present values of the individual cash flows.
add
The conflict of interest between an agent and a principal is called a(n)
agency problem
A fixed stream of cash flows that ends after a specified number of years is called a(n)
annuity
Which term applies to the mixture of debt and equity maintained by a firm?
capital structure
The effective annual rate (EAR) takes into account the _____ of interest that occurs within a year.
compounding
One example of a perpetuity is a British _____.
consol (a bond)
If interest rates go up, the present value of a perpetuity will _____.
decrease
When interest rates in the market rise, we can expect the price of bonds to _____.
decrease
At an annual interest rate of 10 percent, what is the present value of a perpetuity growing at 4 percent per year if next year's cash flow is $6?
$100
PV = C/(r-g) is the formula for the present value of a _____.
growing perpetuity
If you increase the risk level of a project, the discount rate should _____ which will _____ the project's present value.
increase; decrease
What are some of the implications of the time value of money concepts?
-A dollar tomorrow is worth less than a dollar today -A dollar today is worth more than a dollar tomorrow.
Which of the following are annuities?
-Annual installment loan payments -Yearly lease payments
When a corporation is formed, it is granted which of the following rights?
-Form contracts -Legal powers to sue -Borrow and lend money They have unlimited life.
A good financial decision will do which of the following?
-Increase market value of shareholders' equity -Increase the value of the firm's existing stock
e^.09 equals
1.094
If the cost of capital is 9%, what is the PV of $374 paid in year 9?
172.20
Real assets:
A trademark, a factory, undeveloped land, an experienced and hardworking sales force
If you invest $1000 and the present value of the expected cash inflows is $1300, then the NPV is _____. A. +$300 B. $2300 C. -$300 D. $1300
A. +$300
Which of the following is true about a growing annuity? A. The cash flows grow for a finite period B. The cash flows grow at an irregular rate C. The cash flows grow at a constant rate D. The cash flows grow for an infinite period
A. The cash flows grow for a finite period & C. The cash flows grow at a constant rate
Which one of the following is a financial asset? A. Undeveloped land B. A share of stock C. A factory
B. a share of stock
An annuity is a series of payments that are made _____. A. 1 year hence B. at the beginning of each period C. 1 year in the past D. any time in the future
B. at the beginning of each period
There is no limit to how frequently interest could be paid. Where payments are spread evenly and continuously throughout the year we say the interest rate is _____ compounded. A. effectively B. continuously C. annually D. perpetually
B. continuously
The federal government taxes which of the following? A. shareholder dividends but not corporate earnings B. corporate earnings and shareholder dividends C. corporate earnings but not shareholder dividends D. neither corporate earnings nor shareholder dividends
B. corporate earnings and shareholder dividends
Another name for the rate of return is the _____ rate. A. federal funds B. discount C. inflation D. money market
B. discount
Which of the following will increase wealth? A. a negative NPV B. a zero NPV C. a positive NPV
C. a positive NPV
The annual percentage rate is the annual interest rate without consideration of A. dividing B. discounting C. compounding D. multiplying
C. compounding
The idea behind _____ is that interest is earned on interest. A. rebounding B. simplification C. compounding D. reinsurance
C. compounding
Assume interest is compounded monthly. The ___ annual rate will express this rate as though it were compounded annually. A. nominal B. stated C. effective D. implicit
C. effective (EAR)
A growing annuity has a(n) _____. A. infinite number of constant cash flows B. infinite number of growing cash flows C. finite number of growing cash flows D. finite number of level cash flows
C. finite number of growing cash flows
The future value of $100 at 10% compounded semiannually is _____ than the future value of $100 compounded annually. A. less than B. equal to C. greater than
C. greater than
With _____, shareholders cannot be held personally responsible for a corporation's debt. A. articles of incorporation B. bylaws C. limited liability D. unlimited liability
C. limited liability
In a shareholder-manager relationship, who is the agent? A. neither shareholders nor managers B. shareholders C. managers D. both shareholders and managers
C. managers
Present value represents what an amount of money promised or expected in the future is worth _____. A. next month B. last year C. today D. next year
C. today
What is the formula for the present value of a growing perpetuity?
C/(r-g)
A corporation must write _____ that set out the purpose of the business and how it is to be governed. A. legal will B. an indenture agreement C. a partnership agreement D. articles of incorporation
D. articles of incorporation
_____ budgeting is the process of making and managing expenditures on long-term assets. A. Conventional B. Optional C. Performance-based D. Capital
D. capital
A bad financial decision is defined as a decision that _____ owners' wealth. A. increases B. maximizes C. does not affect D. decreases
D. decreases
Find the future value of an annuity of $100 per year for 10 years at 10 percent per year.
$1,593.75
What is the future value of $100 compounded for 50 years at 10 percent annual interest?
$11,739.09 (or 100 * 1.10^50)
Assume $100 earns a stated 10 percent rate compounded quarterly. What will the value of the $100 be after one year?
$110.38
If you invest $100 at 10 percent for year for 2 years, your future value will be
$121
If you invest $100 at 10 percent per year for 3 years, your future value with annual compounding will be _____.
$133.10
What is the present value of a perpetuity of $100 per year if the annual interest rate is 10% and the growth rate is 6% per year?
$2500 (.10-.6 = .04 , 100/.04 = 2500)
What is the present value of $100 in 10 years at a continuously compounded rate of 10 percent?
$36.79
If the future value is $500 in 1 year and the interest rate is 12 percent per year, what is the present value?
$446.43 (500/1.12)
A growing annuity has a(n) _____.
finite number of growing cash flows
If an interest rate is greater than zero, the value of an annuity due is always _____ an ordinary annuity.
greater than
If the interest rate is greater than zero, the value of an annuity due is always _____ an ordinary annuity.
greater than
Companies usually buy _____ assets. These include both tangible assets such as _____ and intangible assets such as _____. To pay for these assets, they sell _____ assets such as _____. The decision about which assets to buy is usually termed the _____ or _____ decision. The decision about how to raise the money is usually termed the _____ decision.
real; executive airplanes; brand names; financial; bonds; investment; capital budgeting; financing
How is net present value (NPV) computed?
NPV = PV - investment
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%? (Be sure to record the initial investment as a negative number)
$5.94 (-$95 + $107/1.06)
Assume 12 percent annual interest is compounded semiannually on a $500 investment. What will that investment be worth after 1 year?
$561.80
You have to pay $12,000 a year in school fees at the end of each of the next six years. If the interest rate is 8%, how much do you need to set aside today to cover these bills?
$7,562.04
If the interest rate is 10% per year, then what is the present value of $100 received one year from today?
$90.91 (100/1.10)
Which of the situations will increase wealth? A. An initial cost of $1000 and a PV of future cash flows of $1,001 B. An initial cost of $1000 and a PV of future cash flows of $1,001 C. Cost of $1000 and a PV of future cash flows of $900 D. An initial cost of $1,000 and a PV of future cash flows of $999
A. An initial cost of $1000 and a PV of future cash flows of $1,001 & B. An initial cost of $1000 and a PV of future cash flows of $1,001
Which of the following represents an infinite and constant stream of cash flows? A. a perpetuity B. a growing annuity C. a growing perpetuity D. an annuity
A. a perpetuity
The costs incurred due to a conflict of interest between stockholders and management are called _____ costs. A. agency B. sunk C. opportunity D. hidden
A. agency
A _____ is a legal entity owned by its shareholders. A. corporation B. partnership C. limited liability partnership D. government agency
A. corporation
Since ____ and ownership are separated, a corporation's life is unlimited A. management B. taxation C. profitability D. debt
A. management
The goal of a for-profit business is to _____ the value of existing owners' equity. A. maximize B. minimize C. dilute D. maintain
A. maximize
The return that can be earned on investment opportunities available to investors in financial markets is called the _____ cost of capital A. opportunity B. market C. sunk D. comparison
A. opportunity
The rate of return that a company's shareholders could get by investing on their own at the same level of risk as one of the firm's projects is referred to as _____. A. the opportunity cost of capital B. the bargain rate of return C. a variable cost D. a sunk cost
A. the opportunity cost of capital
What is the main goal of financial management? A. to maximize current market value B. to maximize current profits C. to minimize expenses D. to maximize market share
A. to maximize current market value
One of the most basic principles of finance is that rational individuals prefer to receive a dollar _____ than a dollar _____. A. tomorrow; today B. today; yesterday C. today; tomorrow
C. today; tomorrow
We can imagine the financial manager doing several things on behalf of the firm's stockholders. But in well-functioning capital markets, shareholders will vote for only one of the following goals. A. Modify the firm's investment plan to help shareholders achieve a particular time pattern of consumption. B. Choose high or low risk assets to match shareholders' risk preferences. C. Help balance shareholders' checkbooks. D. Make shareholders as wealthy as possible by investing in real assets.
D. Make shareholders as wealthy as possible by investing in real assets.