FIN 3403 exam 2 definitions

Which of the following statements is true of zero coupon bonds? Entry field with correct answer A. Zero coupon bonds have no coupon payments over its life and only offer a single payment at maturity. B. Zero coupon bonds sell well below their face value (at a deep discount) because they offer no coupons. C. The most frequent and regular issuer of zero coupon securities is the U.S. Treasury Department. D. All of the above are true.

D. All of the above are true.

Which one of the following statements is true of a bond's yield to maturity? Entry field with correct answer A. The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond. B. It is the annual yield that the investor earns if the bond is held to maturity, and all the coupon and principal payments are made as promised. C. A bond's yield to maturity changes daily as interest rates increase or decrease. D. All of the above are true.

D. All of the above are true.

Preferred stock resembles a bond because Entry field with correct answer A. preferred stock do not have a retirement date. B. dividends on preferred stock increase over time. C. dividends on preferred stock reduce a firm's tax obligation. D. preferred stock pays fixed dividends which is similar to the interest paid on bonds.

D. preferred stock pays fixed dividends which is similar to the interest paid on bonds.

The constant growth dividend model would be useful to determine the value of all, but which of the following firms? Entry field with correct answer A. A firm whose expected sales, profits, and dividends are fluctuating. B. A firm whose earnings and dividends are declining at a fairly steady rate. C. A firm whose earnings and dividends are growing at a fairly steady rate. D. A firm whose sales, profits, and dividends are growing at an annual average compound rate of 5 percent.

A. A firm whose expected sales, profits, and dividends are fluctuating.

Which of the following investors should be willing to pay the highest price for an asset? Entry field with correct answer A. An investor with a diversified portfolio. B. An investor who is not completely diversified. C. An investor who is so risk-averse that he does not recognize the benefits of diversification. D. An investor with a single-asset portfolio.

A. An investor with a diversified portfolio.

Why is there a limit to the benefits of diversification? Entry field with correct answer A. Diversification cannot eliminate market risk. B. Diversification cannot eliminate firm-specific risk. C. Diversification cannot eliminate unique risk. D. Diversification cannot eliminate unsystematic risk.

A. Diversification cannot eliminate market risk.

Which of the following statements about preferred stock is FALSE? Entry field with correct answer A. Failure to pay dividends on preferred stocks will result in a default. B. Preferred stock has a lower-priority claim on the firm's assets than the firm's creditors in the event of default. C. Preferred stock has a higher-priority claim on the firm's assets than the common stock. D. Preferred stock typically pays a fixed dividend.

A. Failure to pay dividends on preferred stocks will result in a default.

Which of the following statements is NOT true about common stock? Entry field with correct answer A. Owners of common stock are guaranteed dividend payments by the firm. B. Common-stock holders have the right to vote on the election of the board of directors of their company. C. Common-stock holders have limited liability toward the obligations of the corporation. D. Common stock is considered to have no fixed maturity.

A. Owners of common stock are guaranteed dividend payments by the firm.

Which of the following statements is NOT true about preferred stock? Entry field with correct answer A. Preferred stockholders are not guaranteed dividend payments by the firm. B. Preferred stock dividends are paid by the issuer with after-tax dollars. C. Preferred stock holders have limited voting privileges relative to common-stock owners. D. Preferred stock represents ownership in the firm.

A. Preferred stockholders are not guaranteed dividend payments by the firm.

Given the historical information in the chapter, which of the following investment classes had the highest average return? A. Small U.S. Stocks B. Intermediate-Term Government Bonds C. Long-Term Government Bonds D. Large U.S. Stocks

A. Small U.S. Stocks

Which of the following is the most typical example of a zero-growth dividend stock? Entry field with correct answer A. The preferred stock of a utility company. B. The common stock of a firm in the information technology industry. C. The common stock of a firm in the biotechnology industry. D. The common stock of a firm in the health care industry.

A. The preferred stock of a utility company.

The price of a bond is calculated by: Entry field with correct answer A. adding the present value of the principal payment and the present value of coupon payments. B. discounting the difference between the principal payment and the coupon payments. C. discounting the sum of coupon payments and principal. D. subtracting the present value of principal payment from the present value of coupon payments.

A. adding the present value of the principal payment and the present value of coupon payments.

When analyzing a firm's cost of debt, we are typically interested in Entry field with correct answer A. the cost of the debt on the date that the analysis is being completed. B. the coupon rate on the firm's bonds. C. the cost of the debt and cost of preferred stock on the date that the analysis is being completed. D. none of the above.

A. the cost of the debt on the date that the analysis is being completed.

The Capital Asset Pricing Model (CAPM) measures Entry field with correct answer A. the expected rate of return of an asset. B. the systematic risk level of an asset. C. the risk-free rate of return. D. the realized rate of return of an asset.

A. the expected rate of return of an asset.

In order for a firm to estimate its cost of debt capital by observing the price of its debt instruments, Entry field with correct answer A. the firm must depend on markets being reasonably efficient. B. the debt must be privately held by the firm. C. the beta of the debt must be greater than the beta of the firm's equity. D. none of the above.

A. the firm must depend on markets being reasonably efficient.

The current cost of debt to use when estimating a firm's WACC is the _____. Entry field with correct answer A. yield to maturity on its outstanding bonds B. coupon rate on its outstanding bonds C. the yield to call on its outstanding bonds D. none of the above

A. yield to maturity on its outstanding bonds

If John buys a 5-year bond with a 9% coupon rate paid semiannually and $1000 par value for $925, his yield to maturity would be closest to: Round to two decimal places. Entry field with correct answer A. 9.65%. B. 10.99%. C. 5.49%. D. 8.50%.

B. 10.99%.

Which of the following statements is true? Entry field with correct answer A. If market interest rates rise, bond prices will rise. B. If market interest rates rise, a 10-year bond will fall in value more than a 1-year bond. C. If market interest rates rise, a 1-year bond will fall in value more than a 10-year bond. D. For a given change in market interest rates, the prices of higher-coupon bonds change more than the prices of lower-coupon bonds.

B. If market interest rates rise, a 10-year bond will fall in value more than a 1-year bond.

Which of the following statements is true? Entry field with correct answer A. The constant growth dividend model can be used effectively to value the common shares of a mixed growth stock. B. In order for the constant growth dividend model to properly value a firm's common stock, R must be greater than g. C. From a practical perspective, the growth rate in the constant growth dividend model must be greater than the sum of the long-term rate of inflation and the long-term real growth rate of the economy. D. In order for the constant growth dividend model to properly value a firm's common stock, g must be greater than R.

B. In order for the constant growth dividend model to properly value a firm's common stock, R must be greater than g.

Which of the following statements is true about the general dividend valuation model? Entry field with correct answer A. It implies that the value of a firm's common stock can be determined only if the expected future dividends are infinite. B. It implies that the underlying value of a share of stock is determined by the market's expectations of the future dividends that the firm will generate. C. It implies that the value of a growth stock can be determined by forecasting the future price of the stock. D. The model cannot be used to calculate the value of a common stock unless the dividends exceed the firm's expected growth rate.

B. It implies that the underlying value of a share of stock is determined by the market's expectations of the future dividends that the firm will generate.

Which of the following statements is true about growth stocks? Entry field with correct answer A. These are stocks of firms that grow their sales at above-average rates and are expected to do so for a length of time. B. These are stocks of firms that grow their earnings at above-average rates and are expected to do so for a length of time. C. They generally pay dividends during their fast growth phase. D. None of the above.

B. These are stocks of firms that grow their earnings at above-average rates and are expected to do so for a length of time.

When estimating the cost of debt capital for a firm, we are primarily interested in Entry field with correct answer A. the weighted average cost of capital. B. the cost of long-term debt. C. the coupon rate of the debt. D. none of the above.

B. the cost of long-term debt.

Most of the risk-reduction benefits from diversification can be achieved in a portfolio consisting of Entry field with correct answer A. 5 to 10 assets. B. 10 to 15 assets. C. 15 to 20 assets. D. 20 to 25 assets.

C. 15 to 20 assets.

Which of the following is the best measure of the systematic risk in a portfolio? Entry field with correct answer A. Variance B. Standard deviation C. Beta D. Covariance

C. Beta

Which of the following are the three simplifying assumptions that cover most stock growth patterns? Entry field with correct answer A. Dividends remain constant over time, dividends grow at a constant rate, and dividends are equal to zero. B. Dividends have a zero-growth rate, dividends grow at a varying rate, and dividends are equal to zero. C. Dividends remain constant over time, dividends grow at a constant rate, and dividends have a mixed growth pattern. D. None of the above.

C. Dividends remain constant over time, dividends grow at a constant rate, and dividends have a mixed growth pattern.

The cost of equity is equal to the: Entry field with correct answer A. Risk the company incurs when financing. B. Cost of retained earnings plus dividends. C. Rate of return required by stockholders. D. Expected market return.

C. Rate of return required by stockholders.

Which of the following statements regarding variance is true? Entry field with correct answer A. Variance is a measure of total risk. B. Variance can be negative. C. Variance is a measure of the uncertainty surrounding an outcome. D. Variance is the square root of standard deviation.

C. Variance is a measure of the uncertainty surrounding an outcome.

A bond pays a coupon interest rate of 7.5 percent. The market rate on similar bonds is 8.4 percent. The bond will sell at _____. Entry field with correct answer A. book value B. par C. a discount D. a premium

C. a discount

A firm can be viewed as Entry field with correct answer A. a collection of debt instruments financing it. B. a portfolio of all individual projects in the industry, each with its own risks, cost of capital, and returns. C. a portfolio of individual projects, each with its own risks, cost of capital, and returns. D. a collection of equity shares comprising it.

C. a portfolio of individual projects, each with its own risks, cost of capital, and returns.

One reason why firms issue convertible bonds is that, the bonds can be sold for: Entry field with correct answer A. lower prices with higher interest rates. B. lower prices with lower interest rates. C. higher prices with lower interest rates. D. higher prices with higher interest rates.

C. higher prices with lower interest rates.

A benefit of a callable bond is the: Entry field with correct answer A. issuer may sell it for a higher price. B. issuer may replace it with a bond that has a higher coupon rate. C. issuer may replace it with a bond that has a lower coupon rate. D. bondholder may sell it for a higher price.

C. issuer may replace it with a bond that has a lower coupon rate.

Preferred stock is sometimes treated like a debt security because: Entry field with correct answer A. legally preferred stock is a debt security. B. preferred dividends are deductible from taxable income just like interest payments on bonds. C. preferred dividend payments are similar to bond interest payments and are fixed in nature regardless of the firm's earnings. D. preferred stock holders receive a residual value and not a stated value.

C. preferred dividend payments are similar to bond interest payments and are fixed in nature regardless of the firm's earnings.

Investors should care only about systematic risk because they can eliminate unsystematic risk by holding a diversified portfolio. Investors care only about _____. Entry field with correct answer A. total risk B. diversifiable risk C. systematic risk D. business-specific risk

C. systematic risk

The two components of total risk associated with an investment are _____. Entry field with correct answer A. variance and standard deviation B. short-term risk and long-term risk C. systematic risk and diversifiable risk D. covariance and correlation

C. systematic risk and diversifiable risk

Which of the following is true of risk and expected returns? Entry field with correct answer A. If two investments have the same expected return, investors prefer the riskier alternative. B. The expected return on an investment is independent of the associated risk. C. The expected return on an investment is inversely proportional to the associated risk. D. Higher the risk, higher the expected returns on an investment.

D. Higher the risk, higher the expected returns on an investment.

In order to use a firm's WACC to evaluate its future project's cash flows, which of the following must hold? Entry field with correct answer A. The project will be financed with the same proportion of debt and equity as the firm. B. The systematic risk of the project is the same as the overall systematic risk of the firm. C. The project should have conventional cash flows. D. The project will be financed with the same proportion of debt and equity as the firm, and the systematic risk of the project is the same as the overall systematic risk of the firm.

D. The project will be financed with the same proportion of debt and equity as the firm, and the systematic risk of the project is the same as the overall systematic risk of the firm.

Which of the following statements is correct? A. When choosing between two investments that have the same level of risk, investors prefer the investment with the lower return. B. The greater the risk associated with an investment, the lower the return investors expect from it. C. If two investments have the same expected return, investors prefer the riskiest alternative. D. When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.

D. When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.

Although the CAPM is theoretically the correct model to use when estimating the expected rate of return on an investment, it is difficult to apply in practice because Entry field with correct answer A. firms do not issue publicly traded shares for each individual project. B. individual project betas are almost impossible to be determined. C. analysts do not have a way to directly estimate the returns related to each individual project. D. all of the above.

D. all of the above.

The cost of capital is: Entry field with correct answer A. the required rate of return for new projects that have risk that is similar to that of the overall firm. B. the rate of return a firm earns on its investments to satisfy the required rate of return for the firm's investors. C. the opportunity cost of using funds on projects. D. all of the above.

D. all of the above.

A portfolio with a level of systematic risk that is the same as that of the market has a beta that is Entry field with correct answer A. less than the beta of the risk-free asset. B. less than zero. C. equal to one. D. equal to zero.

D. equal to one.

A bond will sell at a premium when its coupon interest rate: Entry field with correct answer A. is lower than the market interest rate on similar bonds. B. varies more than the market interest rate on similar bonds. C. equals the market interest rate on similar bonds. D. exceeds the market interest rate on similar bonds.

D. exceeds the market interest rate on similar bonds.

In regard to interest rate risk, short-term bonds: Entry field with correct answer A. and longer-term bonds have the same amount of interest rate risk because their coupon interest rates are fixed. B. and longer-term bonds have no interest rate risk because their coupon interest rates are fixed. C. have more interest rate risk than longer-term bonds. D. have less interest rate risk than longer-term bonds.

D. have less interest rate risk than longer-term bonds.

Based on the CAPM, the relationship between the expected return of an asset and its systematic risk is _____. Entry field with correct answer A. exponential B. inverted C. logarithmic D. linear

D. linear

The normal distribution is described by its _____. Entry field with correct answer A. probability and return B. median and kurtosis C. variance and covariance D. mean and standard deviation

D. mean and standard deviation

Diversification provides a benefit to investors when the investor Entry field with correct answer A. finds the security with the optimal expected rate of return. B. selects two or more securities whose returns are better than the average market return. C. buys only risk-free Treasury securities. D. selects two or more securities whose returns are not highly correlated with each other.

D. selects two or more securities whose returns are not highly correlated with each other.