Introduction to Finance Exam 2 Study guide

Assume that you have just won $5,000,000 in the lottery and will receive $250,000 per year for the next 20 years. How much is your prize worth today if the interest rate is 8%?

$2,454,525

You wish to save $500,000 in the next 25 years. You notice that a corporate bond fund that earns about 11 percent per year and decide to invest in it. How much must you save each year to obtain your goal?

$4,370.13

How much must be invested today to have $1,000 in two years if the interest rate is 5%?

$907.00

Which of the following would increase the future value of an amount?

An increase in the interest rate An increase in the amount An increase in the time until future value is to be received All of the above

Which of the following has a "residual claim" on the firm's resources?

Common shareholders

If a bond is selling at par value, which of the following would be the same as its coupon rate?

Current Yield Yield to Maturity Market Interest Rate Correct Answer All of the above

Convertible bonds allow the issuing company to convert outstanding bonds to shares of common stock when the company deems necessary.

False

Holding all other variables constant, an increase in the discount rate would increase a present value.

False

Scholars almost universally support technical analysis because it uses detailed statistical analysis to make predictions.

False

The liquidity preference theory says that the yield curve should be upward sloping because lenders generally prefer long-term loans.

False

The return on a share of stock is based on the expected dividend plus the projected selling price, all divided by the projected selling price.

False

The technical analyst forecasts a company's cash flows to arrive at value. The fundamental analyst relies on past price patterns repeating themselves.

False

The term knom represents the effective annual rate of interest.

False

The time value of money means that a dollar today is worth less than a dollar at any time in the future.

False

Which of the following best describes maturity risk?

If interest rates increase, bonds with long maturities will decrease in price more than bonds with short maturities.

Holding all other variables constant, which of the following will DECREASE the risk of a bond to the investor?

Increase in restrictive covenants Change in bond rating from B to BBB Secured with specific assets of the firm Both a & c Correct! All of the above

____ are traded in capital markets.

Long-term bonds and stocks

____ markets deal in short-term securities having maturities of one year or less.

Money

Which of the following is associated with the Sarbanes-Oxley Act?

PCAOB now monitors the activities of public accounting firms.

If the interest rate is 6%, which expression will determine the appropriate price to pay for a business that you expect to earn $5,000 in each of the next ten years and be sold for $25,000 in the eleventh year.

PV = $5,000[PVFA6,10] + $25,000[PVF6,11]

A five-year corporate bond would initially be issued in which market?

Primary market

Which of the following is not a characteristic of a call option?

Right to sell

*Stocks and bonds are traded in separate markets, and interest rates are set in bond (debt) markets. Why then does there seem to be an inverse relationship between the movements of stock prices and interest rates (they move in opposite directions)?

There is an inverse relationship between the movements of the stock process and interest rates, as interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. This is due to the discount rate, the larger the discount rate the more price of the bond will decrease but, as coupon rates increase, the bond will increase.

A principal dissimilarity between bonds and stocks is the lack of a contractual agreement to pay dividends to stockholders, whereas bondholders are guaranteed their interest payment.

True

Bond prices respond to changes in the market rate of interest by moving in a direction opposite to the change.

True

Bond ratings are the primary measure of default risk.

True

Both the timing and the amount of cash flows that come from an investment determine its desirability.

True

Holding all other variables constant, as the return on a preferred stock increases, the value of the stock decreases.

True

Money market securities are generally more liquid than capital market securities.

True

Registered bonds require that the names of owners be registered with a transfer agent. Bearer bonds belong to the person who possesses them.

True

The dividend yield is the annual dividend divided by the current stock's price.

True

The efficient market hypothesis asserts that because of quick and efficient dissemination of information, the prices of stocks reflect all publicly available information.

True

The future cash flows associated with stock ownership consists of dividends and price appreciation.

True

The interest rate is the price of money.

True

The present value of a stock's projected future cash flows is what the share is worth today.

True

The present value of an annuity is equal to the sum of the present values of each of the cash flows in the annuity.

True

The term coupon originated long ago when coupons were attached to bonds. When interest was due a bondholder would clip off a coupon and send it to the bond issuing company which would return an interest payment.

True

Valuation is a systematic process through which we establish the prices at which stocks and bonds should sell.

True

​Debt securities issued by the federal government do not compensate investors for liquidity risk.

True

​When applying the Constant Growth Model, the required return must be greater than the rate of growth otherwise the results will be meaningless.

True

Which of the following statements is not correct?

When a bond's yield to maturity is greater than the coupon rate, the bond sells above par.

Which of the following is most correct?

When coupon rates exceed market rates, bonds will sell at a premium. Bonds will always sell at par when the coupon rate equals the market rate. Both a. and d. are correct.

Which of the following describes the relationship between changes in market interest rates and the market value of bonds?

When interest rates increase, bond prices decrease. When interest rates decrease, bond prices increase. Both c. and d. are correct.

An unapproved prospectus is called:

a red herring.

The principle behind time value of money is based on the fact that:

a sum of money in hand today is worth more than the same sum in the future. a sum of money in the future is worth less than the same sum in hand today. Correct! a and c

When a loan is amortized over a five year term, the:

amount of interest paid is reduced each year.

A red herring is:

an unapproved prospectus.

The SOX now requires _____ to certify that they believe in their own financial reports.

analysts

Effective annual rates decrease as ____ decrease:

annual percentage rates number of compounding periods quoted rates Correct! All of the above

The present value factor (PVF) and the future value factor (FVF) are related:

as reciprocals.

Opportunity cost is the:

benefit that would have been available from the next best use of money.

When interest rates change, bond yields adjust through:

changes in price.

The practice that gives minority stockholders a chance to elect at least one director is called:

cumulative voting.

The individual on the exchange floor who supervises trading in a stock and ensures that the market remains orderly is called a(n):

designated market maker.

The process of finding present values is frequently called:

discounting.

The primary function of financial markets is to:

facilitate the movement of cash from savers to companies that need money.

The cash flow projected in a perpetuity is defined as a:

future value of an annuity.

If a series of equal payments is received regularly at the end of the year, and each is deposited immediately at the same interest rate, the ____ is the sum of all the payments and all the interest earned at the end of the series.

future value of an ordinary annuity

When interest rates move up or down, bond prices move:

in the opposite direction. in the opposite direction and further the longer is the term until maturity. a and c

If a bond rating lowers, one can expect the bond's current yield to ____.

increase

If a bond rating lowers, one can expect the bond's yield to maturity to ____.

increase

Maturity risk exists because the prices of longer-term bonds fluctuate more in response to:

interest rate changes.

The price of a stock today can be determined by:

kPo= D1+(P1-Po).

In general, price changes due to a given interest rate change will be:

larger as the term of the bond extends farther in time. smaller as the maturity date nears. b and c

Capital markets deal in:

long -term debt and stock.

Maturity risk exists because:

long-term bond prices fluctuate more than short-term bond prices when interest rates change.

Preemptive rights allow stockholders to:

maintain their proportionate ownership of corporations.

Financial markets have the basic function of:

matching savers and users of funds.

In the ____ market, the firm receives the proceeds from the sale of its securities.

over-the-counter secondary fully integrated Correct! none of the above

Established through the Securities Exchange Act of 1934, the Securities and Exchange Commission is charged with the responsibility to:

oversee financial market activities. enforce the laws preventing certain manipulative and deceptive behavior. a and c

In order to "go public," a company must take all of the following actions except:

prepare a "red herring" and file it with the Commerce Department.

The ____value of an imbedded annuity is moved back in time as an amount.

present

A cash flow projected today for a specific period of time is a:

present value of a single sum.

In general, dividends are paid:

quarterly

The maturity risk premium reflects a preference by many lenders for:

shorter maturities.

A growth rate that exceeds the market return is called:

supernormal growth.

The efficient market hypothesis:

supports the validity of neither technical nor fundamental analysis.

A security's value is equal to:

the present value of its expected cash flows.

A seasoned equity offering refers to:

the sale of new shares of an existing stock.

Employee stock options are most similar to:

warrants.