Exam 2 (FINC514)

The ______ an asset's probability distribution, the lower its risk. Three useful measures of stand-alone risk are standard deviation, coefficient of variation, and the Sharpe ratio.

tighter

It follows that over a given time period, investments with _____ Sharpe ratios performed better, because they generated higher _______ excess returns per unit of risk.

higher higher

In addition, the yield spread between corporate and Treasury bonds is _______ the longer the maturity.

larger

Higher-beta stocks are expected to have lower required returns.

False

Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? - The yield on U.S. Treasury securities always remains static. - In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity.

In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity.

______ is the risk of a decline in a bond's value due to an increase in interest rates. This risk is higher on bonds that have long maturities than on bonds that will mature in the near future.

Reinvestment

_____ is the symbol that represents the cost of raising capital through retained earnings in the weighted average cost of capital (WACC) equation.

Rs

DCF The DCF approach for estimated the cost of retained earnings, rs, is given as follows:

Rs= R*hat*s = D1/P0 + Expected gL

Dividends are fixed

debt

So, the larger the federal ______ , other things held constant, the _______ the level of interest rates.

deficit higher

An average stock's beta is _______ 1 because an average-risk stock is one that tends to move up and down in step with the general market.

equal to

The CAPM states that any stock's required rate of return is _______ the risk-free rate of return plus a risk premium that reflects only the risk remaining ______ diversification.

equal to after

No tax adjustments are made when calculating the cost of preferred stock.

equity

If interest rates rise, then the value of the bond ______; however, if interest rates fall, then the value of the bond ______.

falls rises

The market risk component of the total portfolio risk can be reduced by randomly adding stocks to the portfolio.

false

When returns on Stock A increase, returns on Stock B also increase. In general, this would mean that Stocks A and B are positively correlated.

True

Yield curves of highly liquid assets will be lower than yield curves of relatively illiquid assets.

True

The risk in a portfolio will increase if more stocks that are negatively correlated with other stocks are added to the portfolio.

false

The rate at which the firm has borrowed in the past is _______ because we need to know the cost of ______ capital. For these reasons, the _______ on outstanding debt (which reflects current market conditions) is a better measure of the cost of debt than the _________ .

irrelevant new yield to maturity coupon rate

Most individuals hold stocks in portfolios. The risk of a stock held in a portfolio is typically _____ the stock's risk when it is held alone. Therefore, the risk and return of an individual stock should be analyzed in terms of how the security affects the risk and return of the portfolio in which it is held.

lower than

The firm's primary financial objective is to _______ shareholder value. To do this, companies invest in projects that earn _______ their cost of capital.

maximize more than

In November 2006, Citigroup's stock (NYSE: C) was trading at $49.59. Following the credit crisis of 2007-2008 and by the end of October 2009, Citigroup's stock price had plummeted to $4.27. Several banks went under, and others saw their stock prices lose more than 60% of their value. Based on your understanding of stock prices and intrinsic values, which of the following statements is true? - A stock's market price is based only on true investor returns. - A stock's intrinsic value is based on true risk in the company.

- A stock's intrinsic value is based on true risk in the company.

Based on this example, which of the following statements is true? - Classified shares are not issued with the purpose of providing super voting rights to a certain class of investors. - Classified shares are issued to provide super voting rights to a certain class of investors.

- Classified shares are issued to provide super voting rights to a certain class of investors.

The cost of issuing new common stock is calculated the same way as the cost of raising equity capital from retained earnings. - False: Flotation costs need to be taken into account when calculating the cost of issuing new common stock, but they do not need to be taken into account when raising capital from retained earnings. - True: The cost of retained earnings and the cost of new common stock are calculated in the same manner, except that the cost of retained earnings is based on the firm's existing common equity, while the cost of new common stock is based on the value of the firm's share price net of its flotation cost.

- False: Flotation costs need to be taken into account when calculating the cost of issuing new common stock, but they do not need to be taken into account when raising capital from retained earnings.

Which of the following would be included in the calculation of total invested capital? - Notes payable - Taxes payable - Accounts payable - Responses a and c would be included in the calculation of total invested capital. - None of the above would be included in the calculation of total invested capital.

- Notes payable

You invest $100,000 in 40 stocks, 20 bonds, and a certificate of deposit (CD). To which kind of risk will you primarily be exposed? - Stand-alone risk - Portfolio risk

- Portfolio risk

Which of the following describe the reason(s) why maximization of intrinsic stock value benefits society? Check all that apply. - Successful companies higher more employees. - Successful companies can avoid raising external funds in the financial markets. - Most investors prefer companies that can raise prices beyond reasonable levels. - Stock price maximization requires efficient, low-cost businesses.

- Successful companies higher more employees. - Stock price maximization requires efficient, low-cost businesses.

_________ and accruals, which arise spontaneously from operations when capital budgeting projects are undertaken, are not included as part of investor-supplied capital because they do not come directly from investors.

Accounts payable

Chapter 9

Chapter 9

he expected rate of return on a portfolio equals the weighted average of the expected returns on the assets held in the portfolio. A portfolio's risk _____ calculated as the weighted average of the individual stock's standard deviations; the portfolio's risk is generally _______ because diversification ______ the portfolio's risk.

Isn't smaller lowers

A stock that is more volatile than the market will have a beta of more than 1.0.

True

Stock A's beta is 1.0; this means that the stock moves in the same direction and magnitude as the market.

True

Common stock dividends ______ specified by contract—they depend on the firm's earnings. Two models are used to estimate a stock's intrinsic value: the discounted dividend model and the corporate valuation model.

are not

This relationship between risk and return indicates that investors are risk _____ ; investors dislike risk and require ______ rates of return as an inducement to buy riskier securities.

averse higher

The _____________ is the interest rate that a firm pays on any new debt financing.

before tax cost of debt

Chapter 10

chapter 10

The _________ model is an alternative model used to value a firm, especially one that does not pay dividends or is privately held.

corporate valuation

This model calculates the firm's _________ , and then finds their present values at the firm's weighted average cost of capital to determine a firm's value.

free cash flows

A stock with a beta ________ 1 is considered to have high risk, while a stock with beta _______ 1 is considered to have low risk.

greater than less than

If a portfolio consists of two stocks that are perfectly _______ correlated then the portfolio is riskless because the stocks' returns move counter cyclically to each other.

negatively

Stand-alone risk is the risk an investor would face if he or she held only _____ . No investment should be undertaken unless its expected rate of return is high enough to compensate for its perceived _________ . The expected rate of return is the return expected to be realized from an investment; it is calculated as the ________

one asset perceived weighted average

Some argue that retained earnings should be "free" because they represent money that is left over after dividends are paid. While it is true that no direct costs are associated with retained earnings, this capital still has a cost, a(n) _______ cost.

opportunity

Common stock represents the ______ in a firm, and is valued as the present value of its expected future ______ stream.

ownership dividend

The capital asset pricing model (CAPM) explains how risk should be considered when stocks and other assets are held in ________.

portfolios

A stock's contribution to the market risk of a well-diversified portfolio is called _______ risk. It can be measured by a metric called the beta coefficient, which calculates the degree to which a stock moves with the movements in the market.

relevant

A _________ represents the additional compensation investors require for bearing risk; it is the difference between the expected rate of return on a given risky asset and that on a less risky asset. An asset's risk can be considered in two ways: On a stand-alone basis and in a portfolio context.

risk premium

A portfolio's risk is not equal to the weighted average of the individual stocks' standard deviations.

true

The CAPM estimate of rs is equal to the risk-free rate, rRF, plus a risk premium that is equal to the risk premium on an average stock, (rM - rRF), scaled up or down to reflect the particular stock's risk as measured by its beta coefficient, bi. This model assumes that a firm's stockholders _______ diversified, but if they are _______ diversified, then the firm's true investment risk would not be measured by _________ and the CAPM estimate would ________ the correct value of rs.

well not well beta understate

The ________ on the company's _________-term debt is generally used to calculate the cost of debt because, more often than not, the capital is being raised to fund _______ -term projects.

yield to maturity long long

Over the past several years, Germany, Japan, and Switzerland have had lower interest rates than the United States due to lower values of this premium.

Inflation premium (IP)

This premium is added when a security lacks marketability, because it cannot be bought and sold quickly without losing value.

Liquidity risk premium (LP)

As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because interest rate changes are uncertain, this premium is added as a compensation for this uncertainty.

Maturity risk premium (MRP)

Suppose that a firm is facing an upward-sloping yield curve and needs to borrow money to invest in production. Does this mean that the firm should consider borrowing only at short-term rates? - Yes, using short-term financing will give the firm the lowest possible interest rate over the life of the project. - No, an upward-sloping yield curve means that the firm will get a lower interest rate if it uses long-term financing. - No, the firm needs to take the volatility of short-term rates into account.

No, the firm needs to take the volatility of short-term rates into account.

If the inflation rate was 3.00% and the nominal interest rate was 4.60% over the last year, what was the real rate of interest over the last year? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average.

The nominal interest rate consists of the real rate of interest and inflation. In this case, the nominal interest rate is 4.60%, and the inflation rate is 3.00%. So the real rate of interest is 4.60% - 3.00% = 1.60%.

The yield curve for a BBB-rated corporate bond is expected to be above the US Treasury bond yield curve.

True

A bond's ________ gives the issuer the right to call, or redeem, a bond at specific times and under specific conditions.

call provision

A bond issuer is said to be in ______ if it does not pay the interest or the principal in accordance with the terms of the indenture agreement or if it violates one or more of the issue's restrictive covenants.

default

f the government borrows money, this ______ the demand for funds and ______ interest rates.

increases increases

The contract that describes the terms of a borrowing arrangement between a firm that sells a bond issue and the investors who purchase the bonds is called the _______ .

indenture

Because interest rates can and do occasionally rise, all long-term bonds, even Treasury bonds, have an element of risk called _______ rate risk.

interest

Some bonds have sinking ______ provisions which require the issuer to systematically retire a portion of the bond issue each year.

sinking fund

Bridge Bonds Series A Dated 7-15-2005 4.375% Due 7-15-2055 @100.00 What is the maturity date of this bond? - 7-15-2005 - 7-15-2055

- 7-15-2055

Based on your understanding of bond ratings and bond-rating criteria, which of the following statements is true? - During an economic recession and in a pessimistic environment, the yield spread between US government bonds and corporate bonds could be higher than during good economic times. - During a period of economic growth and in an optimistic environment, the yield spread between US government bonds and corporate bonds could be higher than during an economic recession and a pessimistic environment.

- During an economic recession and in a pessimistic environment, the yield spread between US government bonds and corporate bonds could be higher than during good economic times.

What type of bonds are these? - Municipal bonds - Corporate bonds - Treasury bonds

- Municipal bonds

Which of the following are most likely to have higher yields? - Convertible bonds - Nonconvertible bonds

- Nonconvertible bonds

New York City issued a general obligation bond for a canal in 1812. It was the first formal debt instrument with a fixed repayment schedule issued by a city. Who is the issuer of the bonds? - The New York City government - Federal Reserve Bank of New York - Bank of New York

- The New York City government

Yield to maturity (YTM) is the rate of return expected from a bond held until its maturity date. However, the YTM equals the expected rate of return under certain assumptions. Which of the following is one of those assumptions? - The bond is callable. - The probability of default is zero.

- The probability of default is zero.

Which of the following statements about Treasury bonds is the most accurate? - Treasury bonds are completely riskless. - Treasury bonds have a very small amount of default risk, so they are not completely riskless. - Treasury bonds are not completely riskless, since their prices will decline when interest rates rise.

- Treasury bonds are not completely riskless, since their prices will decline when interest rates rise.

Chapter 6

Chapter 6

Chapter 7

Chapter 7

Chapter 8

Chapter 8

________ bonds are exchangeable at the option of the holder for the issuing firm's common stock. Bonds can be issued with warrants giving the holder the option to purchase the firm's stock for a stated price, thereby providing a capital gain if the stock's price rises.

Convertible

These bonds are traded in the bond markets based on investors' belief that the issuer will not default on the repayment. These bonds have no collateral and usually offer higher yields.

Debentures

This is the difference between the interest rate on a US Treasury bond and a corporate bond of the same profile—that is, the same maturity and marketability.

Default risk premium (DRP)

Government policy doesn't influence the allocation of capital and the level of interest rates.

False

If the Fed injects a huge amount of money into the markets, inflation is expected to decline, and long-term interest rates are expected to rise.

False

The pure expectations theory assumes that a one-year bond purchased today will have the same return as a one-year bond purchased five years from now.

False The pure expectations theory assumes that the maturity risk premium is zero (MRP = 0). This suggests that investing consecutively in short-term bonds will provide the same return as a long-term bond.

______ pay interest only if the firm has earnings, while an indexed (purchasing power) bond bases interest payments on an inflation index to protect the holder from inflation.

Income

It is calculated by adding the inflation premium to r*.

Nominal risk-free rate (Rrf)

______ risk is the risk that a decline in interest rates will lead to a decline in income from a bond portfolio. This risk is obviously high on callable bonds.

Price

_______ bonds contain a provision that allows holders to sell them back to the company prior to maturity at a prearranged price.

Putable

This is the rate on short-term US Treasury securities, assuming there is no inflation.

Real risk-free rate (r*)

These bonds are backed by real estate holdings and equipment, and if a company goes bankrupt, the collateral can be sold off to compensate for the default. These bonds, more so than other collateralized securities, have prior claims over assets.

Senior mortgage bonds

These bonds have a claim on assets only after senior debt has been paid in full.

Subordinated debentures

______ bonds pay no annual interest but are sold at a ________ par, thus compensating investors in the form of capital appreciation.

Zero coupon discount below

A(n) _______ yield curve is downward sloping and indicates that investors expect inflation to decrease. The shape of the yield curve depends on expectations about future inflation and the effects of maturity on bonds' risk.

abnormal

A company is more likely to call its bonds if they are able to replace their current high-coupon debt with less expensive financing. A bond is more likely to be called if its price is _____ par—because this means that the going market interest rate is less than its coupon rate.

at

An original issue discount (OID) bond is any bond originally offered at a price _____ par value.

below

A(n) _______ is a long-term contract under which a borrower agrees to make payments of interest and principal on specific dates

bond

A _______ provision gives the issuer the right to redeem the bonds under specified terms prior to their normal maturity date, although not all bonds have this provision.

call

The prices of long-term bonds ______ whenever interest rates rise.

decline

To account for the effects related to both a bond's maturity and coupon, many analysts focus on a measure called _____ , which is the weighted average of the time it takes to receive each of the bond's cash flows.

duration

Bonds can be _____ bonds with a constant coupon rate over the life of the bond, or they can be _______ -rate bonds with a coupon rate that varies over time depending on the level of interest rates.

fixed floating

If the coupon interest rate remains constant from the time of issue until the bond matures, then the bond is called a _______ bond.

fixed-rate

Default means that a borrower will not make scheduled interest or principal payments, and it affects the market interest rate on a bond. The _______ the bond's risk of default, the higher the market rate. The average default risk premium varies over time, and it tends to get ________ when the economy is weaker and borrowers are more likely to have a hard time paying off their debts.

greater larger

A(n) _______ yield curve occurs when interest rates on intermediate-term maturities are higher than rates on both short- and long-term maturities.

humped

For fixed-rate bonds it's important to realize that the value of the bond has a(n) _______ relationship to the level of interest rates.

inverse

The initial effect would be to cause short-term rates to decline; however, a _______ money supply might lead to an increase in expected future inflation, which would cause long-term rates to rise even as short-term rates fell. The reverse is true when the Fed ______ the money supply.

larger tightens

A liquid asset can be converted to cash quickly at a "fair market value." Real assets are generally ________ liquid than financial assets, but different financial assets vary in their liquidity. Assets with higher trading volume are generally _______ liquid. The average liquidity premium varies over time.

less more

Therefore, a _______ premium, which is higher the longer the term of the bond, is included in the required interest rate.

maturity

This occurs because longer-term corporate bonds have _______ default and liquidity risk than shorter-term bonds, and both of these premiums are ________ in Treasury bonds.

more absent

The interest rate on debt, r, is equal to the real risk-free rate plus an inflation premium plus a default risk premium plus a liquidity premium plus a maturity risk premium. The interest rate on debt, r, is also equal to the ______ risk-free rate plus a default risk premium plus a liquidity premium plus a maturity risk premium.

nominal

The term structure of interest rates describes the relationship between long- and short-term rates. When these data are plotted, the resulting graph is called a yield curve. A(n) ______ yield curve is upward sloping because investors charge higher rates on longer-term bonds, even when inflation is expected to remain constant.

normal

The _____ value of a bond is its stated face value or maturity value, and its coupon interest rate is the stated annual interest rate on the bond. The maturity date is the date on which the par value must be repaid.

par

Longer maturity bonds have high _____ risk but low _____ risk, while higher coupon bonds have a higher level of _______ risk and a lower level of ______ risk.

price reinvestment reinvestment price

Although investing in short-term T-bills preserves one's _________, the interest income provided by short-term T-bills is ______ stable than the interest income on long-term bonds.

principle less

Because sinking fund provisions facilitate their orderly retirement, bonds with these provisions are regarded as being _________ so they will have ________ coupon rates than similar bonds without these provisions.

safer lower

There are four main types reflecting who the issuers are: _______ , corporate, state and local government, and foreign. Each type differs with respect to _____ and expected return. All have some common characteristics even though they may have different contractual features.

treasury risk

If the demand for funds decline, which typically happens during a recession, interest rates _____

will decline

Suppose the real risk-free rate and inflation rate are expected to remain at their current levels throughout the foreseeable future. Consider all factors that affect the yield curve. Then identify which of the following shapes that the US Treasury yield curve can take. Check all that apply. - Inverted yield curve - Upward-sloping yield curve - Downward-sloping yield curve

- Inverted yield curve - Upward-sloping yield curve - Downward-sloping yield curve

If U.S. businesses and individuals buy more goods from abroad than they sell (more imports than exports), the U.S. is running a foreign trade ______, which must be financed.

deficit

If the government spends more than it takes in as taxes, it runs a _____, which must be covered by additional borrowing or by printing money.

deficit

The mathematics of bond valuation imply a predictable relationship between the bond's coupon rate, the bondholder's required return, the bond's par value, and its intrinsic value. These relationships can be summarized as follows: •When the bond's coupon rate is equal to the bondholder's required return, the bond's intrinsic value will equal its par value, and the bond will trade at par. •When the bond's coupon rate is greater than the bondholder's required return, the bond's intrinsic value will _______ its par value, and the bond will trade at a premium. •When the bond's coupon rate is less than the bondholder's required return, the bond's intrinsic value will be less than its par value, and the bond will trade at ________ .

exceed a discount

If the government prints money, the result will be ______, which will _______ interest rates.

increased increased

The Federal Reserve Board controls the money supply. To stimulate the economy, the Fed ______ the money supply.

increases

While long-term bonds are heavily exposed to _______ rate risk, short-term bills are heavily exposed to _______ risk.

interest reinvestment

A bond's ________ refers to its face value and the amount of money that the issuing entity borrows and promises to repay on the maturity date.

par value

The __________ theory states that the shape of the yield curve depends on investors' expectations about future interest rates. The theory assumes that bond traders establish bond prices and interest rates strictly on the basis of expectations for future interest rates and that they are indifferent to maturity because they don't view long-term bonds as being riskier than short-term bonds.

pure expectations

During _________ , short-term rates decline more sharply than long-term rates because (1) the Fed operates mainly in the short-term sector, so the Fed's intervention has the strongest effect there; (2) Long-term rates reflect the average expected inflation rate over the next 20 to 30 years and this expectation doesn't change much due to the level of current inflation. So, short-term rates are ________ volatile than long-term rates.

recessions more

sound financial policy calls for using a mix of long- and short-term debt as well as equity to position the firm so that it can survive in any interest rate environment. The firm's optimal financial policy depends on the nature of the firm's assets—the easier its assets can be sold, the more feasible it is for the firm to use ________ debt. Consequently, it is logical for a firm to finance current assets with _________ term debt and to finance fixed assets with ________ -term debt.

short short long

The real risk-free rate of interest may be thought of as the interest rate on ________ U.S. Treasury securities in an inflation-free world. A Treasury Inflation Protected Security (TIPS) is free of most risks, and its value increases with inflation. Short-term TIPS are free of default, maturity, and liquidity risks and of risk due to changes in the general level of interest rates. However, they are not free of changes in the real rate. Our definition of the risk-free rate assumes that, despite the recent downgrade, Treasury securities have no meaningful default risk.

short term

A bond contract feature that requires the issuer to retire a specified portion of the bond issue each year is called a ___________

sinking fund provision

Each of the following factors affects the weighted average cost of capital (WACC) equation. Which of the following factors are outside a firm's control? Check all that apply. - The general level of stock prices - The effect of the tax rate on the cost of debt in the weighted average cost of capital equation - The firm's capital budgeting decision rules

- The general level of stock prices - The effect of the tax rate on the cost of debt in the weighted average cost of capital equation

True or False: Assuming all else is equal, the shorter a bond's maturity, the more its price will change in response to a given change in interest rates. - False - True

- True

The default risk on Walmart's short-term debt will be higher than the default risk on its long-term debt.

False

There is a price for each type of capital; however, the price remains constant due to foreign investment.

False

Which tend to be more volatile, short- or long-term interest rates?

Short-term interest rates

During the credit crisis of 2008, investors around the world were fearful about the collapse of real estate markets, shaky stock markets, and illiquidity of several securities in the United States and several other nations. The demand for US Treasury bonds increased, which led to a rise in their price and a decline in their yields.

True

The _______ cost of debt is used in calculating the WACC because we are interested in maximizing the value of the firm's stock, and the stock price depends on ________ cash flows.

after tax after tax

The firm's after-tax earnings belong to its stockholders, and these earnings serve to compensate them for the use of their capital. The earnings can either be paid out in the form of dividends to stockholders who could have invested this money in alternative investments or retained for reinvestment in the firm. Therefore, the firm needs to earn at least as much on any earnings retained as the stockholders could earn on alternative investments of comparable risk.

correct

Risk is an important concept affecting security prices and rates of return. Risk is the chance that some unfavorable event will occur, and there is a trade-off between risk and return. The higher an investment's risk, the ______ the return required to induce investors to purchase the asset.

higher

A premium-Select-pardiscountpremiumCorrect 7 of Item 1 bond is one that sells above its par value. This situation occurs whenever the going rate of interest is below the coupon rate. Over time its value will ______ approaching its maturity value at maturity. A par value bond is one that sells at par; the bond's coupon rate is equal to the going rate of interest. Normally, the coupon rate is set at the going market rate the day a bond is issued so it sells at par initially.

decrease

The cost of common equity is based on the rate of return that investors require on the company's common stock. New common equity is raised in two ways: (1) by retaining some of the current year's earnings and (2) by issuing new common stock. Equity raised by issuing stock has a(n) ______ cost, re, than equity raised from retained earnings, rs, due to flotation costs required to sell new common stock.

higher

It is also high on short-term bonds because the shorter the bond's maturity, the fewer the years before the relatively high old-coupon bonds will be replaced with new low-coupon issues. Which type of risk is more relevant to an investor depends on the investor's _______, which is the period of time an investor plans to hold a particular investment.

investment horizon

In reality, most stocks are ______ correlated but not perfectly. So, combining stocks into portfolios reduces risk but does not completely eliminate it. This illustrates that ________ can reduce risk, but not completely eliminate risk.

positively diversification

If the returns of the stocks are perfectly _____ correlated then the stocks' returns would move up and down together and the portfolio would be exactly as risky as the individual stocks. In this situation, diversification would be completely _______ for reducing risk

positively useless

Business conditions influence interest rates. During a ________ , the demand for money and the inflation rate tend to fall and the Fed tends to ________ the money supply to stimulate the economy.

recession increase

As a result, there is a tendency for interest rates to decline during ________.

recessions

The coefficient of variation is a better measure of stand-alone risk than standard deviation because it is a standardized measure of risk per unit; it is calculated as the __________ divided by the expected return. The coefficient of variation shows the risk per unit of return, so it provides a more meaningful risk measure when the expected returns on two alternatives are not ______

standard deviation identical

Countries with strong balance sheets and declining budget deficits tend to have lower interest rates.

True

If inflation is expected to decrease in the future and the real rate is expected to remain steady, then the Treasury yield curve is downward sloping. (Assume MRP = 0.)

True

The Federal Reserve's ability to use monetary policy to control economic activity in the United States is limited because US interest rates are highly dependent on interest rates in other parts of the world.

True

The interest rate in each market is the point where the supply and demand curves for capital intersect.

True

The supply curve in each market is upward sloping, which indicates that investors are willing to supply more capital the higher the interest rate they receive on their capital.

True

The larger the trade ________ , the higher the tendency to borrow, so U.S. interest rates become highly dependent on interest rate levels abroad. Consequently, this interdependency ________ the Fed's ability to use monetary policy to control U.S. economic activity.

deficit constrains

If reliable inputs for the CAPM are not available as would be true for a closely held company, analysts often use a subjective procedure to estimate the cost of equity. Empirical studies suggest that the risk premium on a firm's stock over its own bonds generally ranges from 3 to 5 percentage points. The equation is shown as: rs = Bond yield + Risk premium. Note that this risk premium is ________ the risk premium given in the CAPM. This method doesn't produce a precise cost of equity, but does provide a ballpark estimate.

different

A ________ bond is one that sells below its par value. This situation occurs whenever the going rate of interest is above the coupon rate. Over time its value will ______ approaching its maturity value at maturity.

discount increase

The __________ model values a common stock as the present value of its expected future cash flows at the firm's required rate of return on equity. Variations of this model are used to value constant growth stocks, zero growth stocks, and nonconstant growth stocks.

discounted dividend

Portfolio risk can be broken down into two types. _____ risk is that part of a security's risk associated with random events. It can be eliminated by proper diversification and is also known as company-specific risk.

diversification

You can estimate the value of a company's stock using models such as the corporate valuation model and the dividend discount model. Which of the following companies would you choose to evaluate if you were using the discounted dividend model to estimate the value of the company's stock? - A company that has been distributing a portion of their earnings every quarter for the past six years. - A company that is in a high-growth stage and plans to retain all its earnings for the next few years to support its growth.

- A company that has been distributing a portion of their earnings every quarter for the past six years.

Generally, investors would prefer to invest in assets that have: - A higher-than-average expected rate of return given its perceived risk. - A lower-than-average expected rate of return given its perceived risk.

- A higher-than-average expected rate of return given its perceived risk.

A financial planner is examining the portfolios held by several of her clients. Which of the following portfolios is likely to have the smallest standard deviation? - A portfolio consisting of about three randomly selected stocks from different sectors. - A portfolio containing only Microsoft stock. - A portfolio containing Microsoft, Apple, and Google stock.

- A portfolio consisting of about three randomly selected stocks from different sectors.

Larry Nelson holds 1,000 shares of General Electric (GE) common stock. As a stockholder, he has the right to be involved in the election of its directors, who are responsible for managing the company and achieving the company's objectives. True or False: Larry can invest in another company that is selling class A stocks to the public, and class B shares will be retained by company insiders. This will help the founders maintain control in the company. - True - False

- True

True or False: It is free for a company to raise money through retained earnings, because retained earnings represent money that is left over after dividends are paid out to shareholders. - False - True

- True

True or False: To segment the rights to which certain common shareholders are entitled, companies often separate common equity into more than one class of shares called classified stock. - True - False

- True

When are issuers more likely to call an outstanding bond issue? - When interest rates are lower than they were when the bonds were issued - When interest rates are higher than they were when the bonds were issued

- When interest rates are lower than they were when the bonds were issued

Its contribution to the portfolio's market risk is measured by a stock's ________, which shows the extent to which a given stock's returns move up and down with the stock market.

beta coefficient

If the firm cannot invest retained earnings to earn at least rs, it should pay those funds to its stockholders and let them invest directly in stocks or other assets that will provide that return. There are three procedures that can be used to estimate the cost of retained earnings: the Capital Asset Pricing Model (CAPM), the Bond-Yield-Plus-Risk-Premium approach, and the Discounted Cash Flow (DCF) approach.

correct

Two important terms when discussing _____ are correlation and correlation coefficient. Correlation is the tendency of two variables to move together, while correlation coefficient is a measure of the degree of relationship between two variables.

diversification

So, the cost of capital is often referred to as the _______ rate. When calculating the weighted average cost of capital (WACC), our concern is with capital that must be provided by ________—interest-bearing debt, preferred stock, and common equity.

hurdle investors

Companies issue bonds, preferred stock, and common equity to raise capital to invest in capital budgeting projects. Capital is a necessary factor of production, and like any other factor, it has a cost. This cost is equal to the __________ required return on the applicable security. The rates of return that investors require on bonds, preferred stocks, and common equity represent the costs of those securities to the firm. Companies estimate the required returns on their securities, calculate a weighted average of the costs of their different types of capital, and use this average cost for capital budgeting purposes.

marginal investor's

On the other hand, ______ risk is the risk that remains in a portfolio after diversification has eliminated all company-specific risk. Standard deviation is not a good measure of risk when a stock is held in a portfolio. A stock's relevant risk is the risk that remains once a stock is in a diversified portfolio.

market

Because of their additional default and liquidity risk, corporate bonds yield more _______ Treasury bonds with the same maturity.

more than

A firm's before-tax cost of debt, rd, is the interest rate that the firm must pay on _________ debt. Because interest is tax deductible, the relevant cost of ______ debt used to calculate a firm's WACC is the ________ cost of debt, rd(1 - T).

new new after tax

It is important to emphasize that the cost of debt is the interest rate on ________ debt, not _______ debt because our primary concern with the cost of capital is its use in capital budgeting decisions.

new outstanding

The firm's cost of retained earnings can be estimated using the CAPM equation as follows:

rs = rRF + (RPM)bi = rRF + (rM - rRF)bi

The Sharpe ratio compares the asset's realized excess return to its _________ over a specified period. Excess returns measure the amount that investment returns are above the risk-free rate — so investments with returns equal to the risk-free rate will have a ______ Sharpe ratio

standard deviation zero

If a stock's expected return plots on or above the SML, then the stock's return is ______ to compensate the investor for risk. If a stock's expected return plots below the SML, the stock's return is _______ to compensate the investor for risk.

sufficient insufficient

This generally means that the US borrows from nations with export ________.

surplus

Remember, a bond's coupon rate partially determines the interest-based return that a bond _____ pay, and a bondholder's required return reflects the return that a bondholder _______ to receive from a given investment.

will would like

If the Federal Reserve tightens credit, which decreases the supply of funds, interest rates ______

will increase