Exam 2 Finance 3100
You are considering an investment in a Third World bank account that pays a nominal annual rate of 18%, compounded monthly. If you invest $5,000 at the beginning of each month, how many months would it take for your account to grow to $280,000? Round fractional months up.
41
Which of the following statements best describes Kholdy Enterprises' bond? a. This bond is a discount bond since its price is less than its par value of $1,000. b. This bond is a premium bond since its price is greater than its par value of $1,000. c. This bond is a par value bond since its price is equal to its par value of $1,000.
a
You plan to invest in bonds that pay 6.0%, compounded annually. If you invest $10,000 today, how many years will it take for your investment to grow to $25,000?
a. 15.73
Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM - rRF), equals 4%. Which of the following statements is CORRECT?
a. If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.
Which of the following statements is correct? a. Other things held constant, a 10-year bond has more reinvestment risk than a 30-year bond. b. If you need a specific amount of money at a specific future date, you could invest in a number of different kinds of bonds, but the one type of bond that you should avoid is a zero coupon bond, because such bonds do not pay any interest. c. If you need a specific amount of money at a specific future date, you should be concerned about price risk, but you do not need to be concerned about reinvestment risk.
a. Other things held constant, a 10-year bond has more reinvestment risk than a 30-year bond.
A $150,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?
a. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.
Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?
a. The required return on a stock with a positive beta < 1.0 will decline.
Select one of the choices below that best completes the following sentence: If an investor sold long-term bonds and used the proceeds to purchase short-term bonds, this would increase the investor's exposure to ________ risk and decrease the investor's exposure to ________ risk. a. reinvestment; price b. price; reinvestment c. default; reinvestment d. price; default e. liquidity; reinvestment
a. reinvestment; price
Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant? a. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit. b. A bank loan's nominal interest rate will always be equal to or less than its effective annual rate. c. The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity. d. If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%. e. A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
b
Which of the following statements is TRUE? a. A deposit will grow faster if simple interest rather than compound interest is paid. b. Compound interest means that interest in future periods is earned on the interest earned in the past, whereas under simple interest, interest is earned only on the original investment. c. It would be better to both lend and borrow money at a rate of 6%, simple interest, rather than at a rate of 6%, compound interest.
b
Last year Rocco Corporation's sales were $175 million. If sales grow at 6% per year, how large (in millions) will they be 5 years later?
b. $234.19
Sue now has $280. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?
b. $537.77
Your child's orthodontist offers you two alternative payment plans. The first plan requires a $3,500 immediate up-front payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the monthly payment plan?
b. 24.05%
Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, an 8% yield to maturity, and are noncallable. Which of the following statements is CORRECT?
b. Bond A's current yield is greater than that of Bond B.
Which of the following statements is FALSE? a. Cash flows do not have to occur for every period shown on the time line. A lump sum cash flow can be depicted as easily as annuities on a time line. b. Time lines put verbal information into a diagram that is useful for seeing the cash flows that occur, when they occur, and the interest rate used in the analysis. c. The FV as shown on a time line is always the cash flow at Time = 1. d. Time lines can show cash flows that occur over years, quarters, or any other periods. e. Time lines typically show dollars below the line and years above the line.
c
Suppose you borrowed $27,000 at a rate of 9.0% and must repay it in 4 equal installments at the end of each of the next 4 years. How large would your payments be?
c. $8,334.05
Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)
c. Portfolio P has a beta of 1.0.
Suppose an Exxon Corporation bond will pay $4,500 ten years from now. If the going interest rate on safe 10-year bonds is 5.60%, how much is the bond worth today?
d. $2,609.60
Which of the following events would make it more likely that a company would call its outstanding callable bonds?
d. Market interest rates decline sharply.
An investor is considering buying one of two 10-year, $1,000 face value, noncallable bonds: Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, and the YTM is expected to remain constant for the next 10 years. Which of the following statements is CORRECT?
d. One year from now, Bond A's price will be higher than it is today.
Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed's actions would lead to a recession, and that led to an increase in the market risk premium, (rM - rRF). Under these conditions, with other things held constant, which of the following statements is most correct?
d. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.
Which of the following statements is CORRECT? a. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used. b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond. c. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate. d. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond. e. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.
e
Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?
e. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios.
Butcher Company plans to issue bonds to raise $10 million to finance expansion. It could use 10-year mortgage bonds backed by the firm's fixed assets, 10-year debentures that are not backed by any specific assets but are backed by the firm's general earning power, or 10-year subordinated debentures that would be subordinated to all of the firm's other debt. If it uses mortgage bonds, they would be rated A by Moody's and S&P, and their market interest rate would be 7.5%. Given this information, which of the following statements is most correct?
e. Given the 7.5% interest rate on the mortgage bonds, the plain debentures might carry an interest rate of 8.0% and the subordinated debentures a rate of 8.5%.
A stock with a beta equal to -1.0 has zero systematic (or market) risk.
false
A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.
false
If a firm goes bankrupt and must be liquidated, and if less money is available than the balance sheet values of bonds, preferred stock, and common equity, then some security holders will receive less than the book values of their investments. The priority system under our bankruptcy laws allocates funds first to preferred stock because of its preference, then to bonds, and then to common stockholders (only if there are funds left over after paying preferred stockholders and bondholders). True or false?
false
Income bonds pay interest only if the issuing company actually earns the indicated interest. Thus, these securities cannot bankrupt a company, and this makes them safer from an investor's perspective than regular bonds.
false
Most bonds are owned by and traded among large financial institutions, and it is relatively easy for bond dealers to arrange the transfer of large blocks of bonds among the millions of large and small bondholders on the exchanges rather than the over-the counter market. True or false?
false
The higher the positive correlation between two assets' returns, the greater is the risk reduction from holding them in a portfolio. True or false?
false
We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.
false
A 20-year bond with a 6% coupon rate can have a par value of any amount that is a multiple of $1,000. The issuer will make payments of 6% of the par value each year, generally with one-half of the annual amount paid each 6 months. Bonds may include a sinking fund, which means that some of the bonds must be paid off each year rather than at maturity. Also, many bonds include a call provision, which gives the issuer the right to pay off the bonds prior to their stated maturity. True or false?
true
A lender should prefer to lend at a rate of 10% with semiannual compounding, but a borrower would prefer a loan with a rate of 10%, annual compounding. True or false?
true
A stock's price is simply the current market price, and it is easily observed for publicly traded companies. By contrast, intrinsic value, which represents the "true" value of the company's stock, cannot be directly observed and must instead be estimated. True or false?
true
As a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.
true
Assume Lei's bonds paid interest annually rather than semiannually. You could find the value of these bonds, in a market where the going nominal annual rate on semiannual payment bonds is 7%, by finding the effective annual rate, which is 7.1225%, and then discounting the annual bond's cash flows by this effective rate. The annual payment bonds would have a value of $1,352.72 versus $1,374.17. True or false?
true
Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.
true
Betas can be found by plotting stocks' returns on the vertical axis and the returns on an index like the S&P 500 on the horizontal axis, and then calculating the slope of the resulting regression line. This slope is the stock's beta coefficient. The steeper the slope, the larger the beta and the riskier the stock. True or false?
true
Firms can use different classes of common stock to meet specific needs of the company. Founders' shares are one such class. They are shares owned by the firm's founders that enable them to maintain control over the company without having to own a majority of stock. True or false?
true
Foreign bonds are issued by a foreign government or a foreign corporation. An additional risk exists when bonds are denominated in a currency other than that of the investor's home currency. True or false?
true
If a firm raises capital by selling new bonds, it could be called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.
true
If all investors were completely indifferent to risk, i.e., if they had no aversion to risk at all, then the SML would plot as a horizontal line. True or false?
true
If the market interest rate remains at 5% for the next 29 years, and if Leggio's credit rating remains constant, then the price of its bonds will decrease gradually over time and be exactly $1,000 at maturity. True or false?
true
If the required rate of return on a bond (rd) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)
true
If two assets are held in a portfolio, the assets will generally be less risky than if they were held in isolation. True or false?
true
If two assets are perfectly positively correlated, then their returns will move up and down exactly in sync with one another. True or false?
true
If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year.
true
If you plotted the returns of a company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.
true
In response to concerns about the CAPM's validity, some researchers have developed models that include more explanatory variables than just beta. While these models are promising, the basic CAPM is still the most widely used method for estimating required rates of returns on stocks. True or false?
true
Is the following statement true or false? There is a fundamental trade-off between risk and return: to entice investors to take on more risk, you have to provide them with higher expected returns.
true
Is this statement true or false? A rational person should choose to receive cash flows from an annuity due of $1,000 per year rather than from a similar ordinary annuity.
true
Is this statement true or false? If one set up time lines for an ordinary annuity of $1,000 per year for 3 years and a 3-year, $1,000 annuity due, the primary difference between the two time lines is that the $1,000 payments for the annuity due would begin at t = 0 and end at t = 2, whereas the ordinary annuity's payments would begin at t = 1 and end at t = 3.
true
Is this statement true or false? If you calculated the value of an ordinary annuity, you could find the value of the corresponding annuity due by multiplying the FV of the ordinary annuity by (1 + I), because this would take into account that each annuity due payment occurs one year earlier.
true
People differ with regard to their willingness to bear risks. However, if two stocks have the same expected rate of return, then most individuals would prefer the less risky to the more risky stock. This is called risk aversion. True or false?
true
Preferred stock is a "hybrid" security. Preferreds typically pay a fixed dividend, so they are a fixed-income security like a bond. However, the directors can omit the preferred dividend without throwing the company into bankruptcy. True or false?
true
Proxy fights are attempts by a person or group that wants to take over control of a firm by getting the firms' stockholders to give their voting proxies to the new group. True or false?
true
Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.
true
Suppose the standard deviation of expected returns for a given corporate project is quite high, and the project's returns are also highly correlated with returns on the firm's other assets. This suggests that the project is quite risky. However, if the project is not perfectly positively correlated with returns on other stocks in the market, then the project's true risk to stockholders might not be very large. True or false?
true
The Security Market Line (SML) shows the relationship between stocks' required rates of return (measured on the vertical axis) and their betas (measured on the horizontal axis). The vertical axis intercept is the required rate of return on a riskless asset, and the required rate of return associated with b = 1.0 is the required rate of return on "the market." The difference between the required rate of return on the market and that on the riskless asset (rM - rRF) is defined as the "market risk premium." The steeper the SML, the larger the market risk premium, and the greater the average investor's aversion to risk. True or false?
true
The coefficient of variation is a better measure of risk if one is comparing assets that have substantially different expected returns, because it shows the amount of risk per unit of expected return. True or false?
true
The interest paid on a municipal bond, otherwise known as a muni, is generally exempt from federal income taxes. Therefore, the coupon rate on these bonds is considerably lower than a corporate bond of equivalent risk. True or false?
true
The preemptive right is the right of current stockholders to buy new shares in an amount that will maintain their proportionate ownership in the firm. True or false?
true
The probability distribution for a stock would list the stock's set of possible returns and the probability of each return. We could use this data to find both the stock's expected rate of return and the standard deviation of that return, which is one measure of risk. True or false?
true
The value of a share of common stock depends on the cash flows it is expected to provide, and those flows consist of two elements: (1) the dividends the investor receives each year while he or she holds the stock and (2) the price received when the stock is sold. The final price includes the original price paid plus an expected capital gain. True or false?
true
The value of a share of stock can be estimated by using the PV of future dividends. An alternative valuation procedure, called the "corporate valuation model," calls for finding the expected future free cash flows, discounting those cash flows at the weighted average cost of capital, summing the PVs of the free cash flows, subtracting the market values of debt and preferred to calculate the value of the common equity, and then dividing by the number of shares outstanding to find the value of a share of common stock. In theory, the two methods should produce the same stock price. Is this statement true or false?
true
To estimate the value of a nonconstant growth stock, we can estimate the value of each dividend during the period of nonconstant growth, find the PVs of these dividends, find the value of the stock at the horizon date, find the PV of the horizon value, and then sum these PVs to find the value of the stock today. True or false?
true
Two key sections of the Bankruptcy Act are Chapter 7, which relates to liquidating firms and allocating the proceeds among its creditors, and Chapter 11, which deals with reorganizing businesses that are thought to be worth more as operating enterprises than they would bring in from liquidation of firms' assets. Troubled firms' managements generally try to reorganize, but if no feasible reorganization plan can be developed, then the bankruptcy judge will order liquidation. True or false?
true
Under an amortized loan, the periodic payments are all equal. However, the fraction of the payment that represents interest declines over time. True or false?
true