Fin 3403 Exam 2

What is the current yield on 1,000 par value bond that sells for 900 if the coupon rate is 10%

(.10*1,000)/900 = 11.11

If you are in the 20 percent tax bracket, what is your after-tax yield on a par value municipal bond yielding 5 percent? Ignore state and local taxes.

5% ( interest income from a muni is exempt from federal income tax so the after-tax yield equals the before tax yield)

A bond pays annual interest payments of 50, has a par value of 1,000 and a market price of 1,200. How is the coupon rate computed?

50/1000

The three attributes of NPV are that it:

Discounts the cash flows properly Uses all the cash flows of a project Uses cash flows

In the dividend discount model, the expected return for investors from which two sources?

Dividend yield Growth rate

The discounted payback period has which of the following weaknesses?

Exclusion of some cash flows Arbitrary cutoff date Loss of simplicity as compared to the payback method

Cumulative voting means board members are elected one at a time, with each shareholder casting his or her allotted votes for each seat on the board

False

Investing more money in a project is a guarantee of greater profits

False

The MIRR function eliminates multiple IRRs and should replace NPV

False

The most important alternative to the NPV if the __ method

Internal rate of return

A market is considered transparent if

Its prices and trading volume at easily observed

NASDAQ has which of these features?

Multiple market maker system Computer network of securities dealers

the US government borrows many by issuing:

Treasury bonds, treasury bills, treasury notes

Two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing

True

The goal of many successful organization is an ___ rate of growth in dividends

steady

Will is deciding whether or not to buy Dang Corporation stock, whose current price is 54.95. Dang paid a dividend of 2.17 this year. Will estimate that dividends will grow very quickly, at a rate of 12% for the next four years. After that, he expects the dividend growth rate to fall to 5%. Should Will buy the stock if his required rate of return is 10%?

Yes; using the two stage growth model, the stock value is 58.06

When an investor sells a bond, the price received is always the ___.

bid price

What are municipal bonds?

bonds that have been issued by state or local governments

Secondary markets in sukuk are extremely illiquid because most sukuk are:

brought and held to maturity

Capital ___ is the decision-making process for accepting and rejecting projects

budgeting

The amount by which the call price exceeds the par value of the bond is called

call premium

The IRR rule can lead to bad decisions when __ or ___.

cash flows are not conventional Projects are mutually exclusive

If the liquidity of a bond increases then the bond's yield will

decrease

All else constant, the dividend yield will increase if the stock price ____

decreases

What are the three important features of treasury notes and bonds?

default-free, highly liquid, taxable

NPV __ cash flows properly

discounted

The constant-growth model infers that

dividends change at a constant rate

which three of the following are common shapes for the term structure of interest rates?

downward sloping, upward sloping, humped

The price of common stock is equal to the present value of all __ future dividends

expected

An __ project does not rely on the acceptance or rejection of another project

independent

The point at which the NPV profile crosses the horizontal axis is the:

internal rate of return

IRR continues to be popular in practice, partly because:

it gives a rate of return rather than a dollar value

Which of the following is true about a multi-year typical bond's coupon?

it is a fixed annuity payment

Which of the following are true about a bond's face value?

it is also known as the par value it is the principle amount repaid at maturity

Which of the following are advantages of AAR?

it is easy to compute needed information is always available

A zero- coupon is a bond that

makes no interest payments

When cash flows are conventional, NPV is ___ if the discount rate is above the IRR

negative

Which of the following occurs in the primary market?

newly-issued stocks at initially sold

When voting for the board of directors, the number of votes a shareholders is entitled to is generally determined as follows:

one vote per share held

Fundamentally, the business of the NYSE is to attract and process __.

order flow

Cat bond

protects insurance companies form natural disasters

If a given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ___ rate.

real

If given set of cash flows is expressed in nominal terms and discounted at the nominal rate, the resulting present value will be the same as if the cash flows were expressed in real terms and discounted at the ___ rate

real

According to the basic IRR rule, we should

reject a project if the IRR is less than the required return

The payback period rule __ a project it if has a payback period that is less than or equal to a particular cutoff date.

suggests accepting

The point at which the NPV profile crosses the vertical axis is the:

sums of the cash flows of the project

Which quote, asked or bid, would you expect to pay if you were buying a bond?

the asked price

Which of the following are common protective covenants

the firm must maintain working capital at or above a specified level the firm must limit dividends to equity holders the firm cannot merge with any other firm

Which of the following are features of municipal bonds?

the interest on municipal bonds is exempt from federal taxes they are issued by state and local government

Which of these included in the calculation of a bond's yield to maturity?

current price, coupon rate, par value

What six factors determines the yield on a bond?

liquidity, expected future inflation, real rate of return, interest rate risk, default risk, and taxability

The NYSE differs from the NASDAQ primarily because the NYSE has:

physical location specialists an auction market

Capital Corp. is considering a project who internal rate of return is 14%. If capital required return is 14%, the NPV is:

zero

The IRR is the discount rate that makes the NPV of a project equal to ___.

zero

How is a zero coupon bond different form a conventional bond?

zero coupon bonds make no interest payments zero coupon bonds are always issued at a discount

The __ can be interpreted as the capital gains yield

constant growth rate

How is a conventional bond different from a zero coupon bond?

conventional bonds can sell at par, at a discount from par, or at a premium over par value while zeroes can not A conventional bond pays periodic whiles zeroes make no interest payments

Which of the following variables are required to calculate the value of a bond?

coupon rate, market yield, remaining life of bond

The profitability index is calculated by dividing the PV of the ___cash flows by the initial investment

future

The present value of all cash flows after initial investment is divided by the __ to calculate the profitability index

initial investment

The present value of all cash flows after the initial investment is divided by the ___ to calculate the profitability index

initial investment

Stock price reporting has increasingly moved from traditional print media to the __ in recent years

internet

The relationship between bond prices and the market rate of interest is

inverse, if the market rate of interest rises, bond prices will fall

The reason that interest rate is greater for __ term bonds than for__ term bonds is that the change in rates has a greater effect on the present value of the ___ than on the present value of the __.

long; short; face value; coupon payments

Why is the bond market less transparent than the stock market?

many bonds transactions are negotiated privately

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively

payback method

The amount of time needed for the cash flows from an investment to pay for its initial cost is the

payback period

If the IRR is greater than the ___ ___, we should accept the project

required return

If the IRR os greater than the __ __, we should accept the project

required return

NPV accounts for the size of the project and thus mitigates the effects of

scale

All junk bonds typically have which of these features?

Less than investment-grade rating. High probability of default

All else held constant, the yield on a highly liquid bond will be __ the yield on a illiquid bond

Lower than

If a project has multiple internal rates of return, which of the following methods should be used

NPV MIRR

Preferred stock preference over common stock in the:

Payments of dividends Distribution of corporate assets

The PI rule for an independent project is to __ the project if the PI is greater than 1.

accept

A project should be ___ if its NPV is greater than zero

accepted

What is the bid price

the bid is the price at which a dealer is willing to buy securities

Which of the following entities declares a dividend

the board of directors

When the stock being valued does not pay dividends,

the dividend growth model can still be used

issuing bonds

the federal government can raise money from financial markets to finance its deficits by?

How is the real rate of return different from the nominal rate of return?

the real rate of return excludes inflation from the nominal rate

Which if the following are usually included in a bond's indenture?

the repayment arrangements the total amount of bonds issued

The US government borrows money by issuing:

treasury bonds, treasury bills, treasury notes

What is a real rate of return?

It is a rate of return that has been adjusted for inflation

At what tax rate will you be indifferent between a muni that yields 7 percent and a comparable corporate bond yielding 9 percent? assume no state taxes.

1-.07/.09= 22.2%

Which of the following is a feature of common stock?

It has no special preference in bankruptcy It generally have voting rights It has no special preference in receiving dividends

If the present value of the interest payments on a bond is 320 and the present value of the par value to be paid at maturity is 900, the total value of the bond must be__.

1220

Scott corporation does not pay dividends. The PE ratio for its industry is 13.3 and Scott's EPS were 1.47. At what price should Scott's stock trade?

19.55 =(13.3*1.47)

If you purchase a bond costing 1,143 with a par value of 1,000 that pays a semi-annual coupon of 5%, how much will each coupon payment be?

25

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 these bonds?

60 in interest at the end of each for 10 years and a 1,000 repayment of principle at the end of 10 years.

if an investment appreciates by 7 percent while the rate of inflation is 2 percent, what is the nominal rate of return?

7 percent

Payback period tells the time it takes to break even in an ___ sense. Discounted payback tells the time it takes to break even in an __ or financial sense.

Accounting Economic

The discounted payback rule has an objective benchmark to use in decision-making.

False

Which of these correctly identify differences between U.S. Treasury bonds and corporate bonds?

They are default-free, they are taxable, and they are highly liquid

Which of the following are weaknesses of the payback method?

Time value of money principles are ignored Cash flows received after the payback period are ignored The cutoff date is arbitrary

Some projects such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return

True

The crossover rate is the rate at which the NPVs of two projects are equal

True

When valuing a stock, the advantage to considering the stock price in the distant future (rather than a more near term price) as a cash flow is that:

When discounted to present value, a stock price in the distant future is nearly zero

A benchmark PE ratio can be determined using:

a company's own historical PEs The PEs of similar companies

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

a target average accounting return

A firm decides to raise money by issuing 5 million bonds with a par value of 5,000 each for 10 years at a coupon rate of 7 percent. At the time of the issue, the bonds were sold for 5,500 each. What will the par value of the bonds be in year 5?

5,000 per bond

If the rate of inflation is 3 percent and the real rate of return is 5 percent, the nominal rate is approximately __ percent

8 percent

As an investor in the bond market, why should you be concerned about changes in interest rates?

changes in interest rate cause changes in bond prices

The largest number of NYSE members are registered as ___.

commission brokers

A zero growth model for stock valuation is distinguished by a ___

constant dividend amount

For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed

false

one requirement of the dividend growth model is:

for the dividend growth model to be useful, the long term rate must be smaller than the discount rate

The value of the firm is the function of its __ rate and its __ rate

growth; discount

A bond yield to maturity considers the interest earnings and the change in the bonds price while the current yield considers __.

interest earnings only

What is the nominal rate of return on an investment?

it is the actual percentage change in the dollar value of an investment

What is the definition of a bond's time to maturity?

it is the number of years until the face value is due to be repaid

What will happen to the default risk premium during periods of economic uncertainty?

it will increase

What is an interest-only loan?

it's a loan which the borrower pays interest periodically and repays the principle when the bond matures

what are some reasons why the bond market is so big?

many corporations have multiple bond issues outstanding various state and local governments also participate in the bond market federal government borrowing activity in the bond market is enormous

Place the following bonds in order of security as defined in the US.

mortgage bonds Debentures

Put bond

owner can force issuer to repay prior to maturity at a stated price

which of these is included in the calculation of a bond's yield to maturity?

par value, current price, coupon rate

Three special case patterns of dividend growth include:

zero growth constant growth non constant growth

what is the coupon rate on a bond that has a par value of 1,000, a market value of 1,100 and a coupon interest payment of 100 per year?

10% (100/1000)

What is the value of stock if next year's dividend is 6, the discount is 11 and the constant rate of growth is 3 percent?

75 = 6/(.11-.03)

Structured notes

Based on financial securities, commodities, or currencies

A corporate bond's yield to maturity

Changes over time can be greater than, equal to, or less than the bond's coupon rate

A PE ratio that is based on estimated future earnings is known as ___ PE ratio.

Forward

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 percent?

NPV= -95+(107/1.06)= 5.94

WinWin corporation has five board members, and each shareholder gets one vote per share. The company uses a straight board voting procedure. How does this arrangement affect minority shareholders?

No shareholder would have enough votes to win any seat on the board, so minority shareholders interests would not be necessarily be protected

When cash flows are conventional, NPV is

Positive for discount rate below the IRR Negative for discount rates above the IRR Equal to zero when the discount rate equals the IRR

In which ways is preferred stock like a bond?

Preferred shareholders receive a stated value if the firm liquidates, like bondholders Some preferred stock has credit ratings, like bonds Preferred shareholders receive a stated dividend, similar to interest on a bond Preferred stock sometimes has a sinking fund, giving it a set maturity like bonds

Which two prices can be found in the Wall street journal daily treasury bond listing?

The asked priced The bid price

Which of the following are reasons why it is more difficult to value common stock than it is to value bonds?

The life of a common stock is essentially forever The rate of return required by the market is not easily observed Common stock cash flows are not known in advance

Which of the following is usually a right to common shareholder

The right to purchase a proportional shares of new stock issued Voting rights The right to a proportional share of dividends paid

A bond has a quoted price of 984.63 a face value of 1,000 a semi-annual of 20 and a maturity of 10 years. Match its current yield to its YTM below.

YTM = 4.19 Current yield = 4.06

What is a corporate bond's yield to maturity

YTM is the prevailing market interest rate for bonds with similar features YTM is the expected return for an investor who buys today and holds it to maturity

Convertible bond

can be exchanged for shares of stock

Which of the following are expected cash flows to investors in stocks?

capital gains, and dividends