Finance test #2
Which of the following securities has the highest priority with regard to the distribution of both earnings and proceeds from the liquidation of assets of a firm?
corporate bonds
what is risk return
increase in potential return with an increase in risk
On January 3, 2016, the stock price of a firm was $25 and on January 4, 2016, it reduced to $19. Which of the following is a probable reason for the decrease in the stock price?
increased rate of return
The terms and conditions of a bond are set forth in its
indenture
Per Standard & Poor's Corporation (S&P), a bond whose rating is BBB is considered:
investment grade with medium investment risk.
yield to call
is the average rate of return earned on a bond ifit is held until the first call date.
High-risk, high-yield bonds used to finance mergers, leveraged buyouts, and troubled companies are referred to as
junk bonds
Which one of the following is not a risk factor for investing in international stocks?
management risk
stock valuation ratio (P/E)
market price per share of common stock/ earnings per share Higher P/E Stock is overvalued(Compared with industry) Investor pay more for the company's earnings Growth stock Lower P/E Stock is undervalued(Compared with industry) Investor pay less for the company's earnings Value stock
The Blank Space of a bond fluctuates continuously during its lif
market value
A debt is said to be selling at par, when the _____ of the debt is equal to the _____.
market value; face value of the debt
what is return?
money made or lost on an investment over some period, normally expressed in percentage, net returns or gross returns
YTM is the average annual rate of return earned on abond if it is held to maturity.
n=20 I/y=? PV=-875 PMT=40 FV=1000 I/Y = 5% is the six-month rate or return.• YTM = 5% × 2 = 10% = Annual rate of return
Suppose that the bond can be called in four (4) yearsat a call price of $1,080.
n=8 I/y? PV=-875 PMT=40 FV= 1080 output=6.87 YTC = 6.87 x 2 = 13.74%
Which of the following securities can be converted into common stock?
preferred stock
Which of the following types of securities is referred to as a hybrid security?
preferred stock
A bond that can be redeemed for cash at the bondholder's option is called a(n)
puttable bond
A portfolio is made up of Stocks A, B, C, and D in theproportion of 20%, 30%, 25%, and 25% respectively. Thenondiversifiable risks of the stocks as measured by their betasare 0.4, 1.2, 2.5, and 1.75 for Stock A, B, C, and D respectively.The expected returns of the stocks are 12%, 24%, 30%, and 28%respectively. Measure the beta of the portfolio
1.5. (0.20×0.4)+(0.30×1.2)+(0.25×2.5)+(0.25×1.75)
Isabel invested in four-stock portfolio; she invested 20 percent of her money in Stock A, 30 percent of her money in Stock B, 25 percent of her money in Stock C, and 25 percent of her money in Stock D. The betas for Stock A, B, C, and D are 0.4, 1.2, 2.5, and 1.75, respectively, and their expected returns are 12 percent, 24 percent, 30 percent, and 28 percent, respectively. What is the beta of Isabel's portfolio?
1.50. Stock A: 0.20×0.40 Stock B: 0.30×1.2 Stock C: 0.25×2.5 Stock D: 0.25×1.75. ADD together
Tony's Pizzeria plans to issue bonds with a par value of$1,000 and 10 years to maturity. These bonds will pay$45 interest every 6 months. Current market conditionsare such that the bonds will be sold at net $937.79. Whatis the yield to maturity (YTM) of the issue as a brokerwould quote it to an investor? (Round the answer to thenearest whole number.)
10%
The beta coefficient of Zed Corporation is equal to 0.7 and the required rate of return on the stock equals 12%. If the expected return on the market is 12.5%, what is the risk-free rate of return?
10.83%. 0.12=x+0.7(0.125-x) solve for x
Let's say a portfolio combines two assets: X and Y. The weight of Asset X in the portfolio is 50%, and the weight of Asset Y is 50%. The standard deviation of return for Asset X is 21% and 8% for Asset Y. The correlation coefficient of returns of Asset X and Asset Y is 0.0058. What is the standard deviation of this portfolio?
11.26% (0.5 × 0.5 × 0.21 × 0.21) + (0.5 × 0.5 × 0.08 × 0.08) + (2 × 0.5 × 0.21 × 0.5 × 0.08 × 0.0058) = 0.012674 Square Root of 0.012674 = 0.11257 or 11.26%
A $1,000 par value bond sells for $1,216. It matures in 20 years, has a 14 percent coupon, pays interest semiannually, and can be called in 5 years at a price of $1,100. Calculate the bond's yield to maturity.
11.26%. Solving for I/Y Inputs: N = 40; PV = −1,216; PMT = 70; FV = 1,000 Output: I = 5.6307%, or 5.63% per six months; YTM = 5.63% × 2 = 11.26%
A stock has a beta coefficient, β, equal to 1.20.The riskpremium associated with the market is 9 percent, and the risk-free rate is 5 percent. Application of the capital asset pricingmodel indicates that the stock's appropriate return should be_____.
15.8%. =0.09+1.2*(0.09-0.05)
A stock has a beta coefficient, β, equal to 1.20. The risk premium associated with the market is 9%, and the risk-free rate is 5%. Application of the CAPM indicates that the stock's appropriate return should be Blank Space.
15.8%. ER = 0.05 + [1.2 × (0.09)] = 0.05 + 0.108 = 0.158 or 15.8%
A stock has a beta coefficient, β, equal to 1.20. The risk premium associated with the market is 9 percent, and the risk-free rate is 5 percent. Application of the capital asset pricing model indicates that the stock's appropriate return should be _____.
15.8%. Expected Return=Risk-Free Rate+β×(Market Risk Premium) Given: Beta (ββ) = 1.20 Market Risk Premium = 9% (0.09 as a decimal) Risk-Free Rate = 5% (0.05 as a decimal). =5%+(1.2*9%)
The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond is paid every six months, and the simple annual yield is 14 percent. From the given information, calculate the annual coupon rate on the bond.
17%. Solving for PMT Inputs: N = 20; I = 7; PV = −1,158.91; FV = 1,000 Output: PMT = $85.00 (Semiannual PMT) Annual coupon rate = ($85 × 2) / $1,000 = 17.00%
The risk-free rate is 5%, the market risk premium is 8%, and the market return is 13%. Stock Y's beta is 1.85 and the standard deviation of its returns is 62.5%. What should be the stock's expected rate of return to make the investor indifferent toward buying or selling the stock?
19.80 (0.05+(1.85*0.08)
If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J?
2.0 =((0.13-0.07)/(0.1-0.07))
If the risk-free rate is 7%, the expected return on the market is 10%, and the expected return on Security J is 13%, what is the beta of Security J?
2.0 The required rate of return on the stock (Ri). The risk-free rate of return (Rf). The expected return on the market (Rm). β= (0.13-0.07)/(0.1-0.07)
What is the standard deviation of ABC Inc.'s monthly stock price returns if the last six months' monthly returns were 1.5%, 3.2%, 5.9%, 4.4%, 7.6%, and 0.5%?
2.67% standard deviation in excel
Three years ago, you invested $10,000 in the sharesof ABC Corp. Each year, the company distributeddividends to its shareholders. During the period, yourtotal income was $300. Today, you sold your sharesfor $12,000, and you want to deter-mine theannualized HPR of your investment.
23%
What is a holding period of return for an investor, who bought a stock three years ago at $73 and received $5 in dividends over the investment period, if the stock is now trading at $85.
23.28% HPR= 5+(85-73)/73=
A share of common stock has a current price of $82.50and is expected to grow at a constant rate of 10 percent. Ifyou require a 14 percent rate of return, what is the currentdividend on this stock?
3
How many types of probability distribution are there for skewness in general?
3
Peng Corporation has 100 bonds outstanding with a maturity value of $1,000. The required rate of return on these bonds is currently 10%, and interest is paid semiannually. The bonds mature in five years, and their current market value is $768 per bond. The annual coupon interest rate is
3.99%
Cold Boxes Corporation has 100 bonds outstanding with amaturity value of $1,000. The required rate of return onthese bonds is currently 10 percent, and interest is paidsemiannually. The bonds mature in 5 years, and theircurrent market value is $768 per bond. The annual couponinterest rate is: (Round the answer to the nearest wholenumber.)
4% Solve for PMT N=10, I/Y=5, PV=-768, FV=1000, =20*2(make annually), 40/1000
If the dividend on stock today is $2.40 and is expected togrow at 4% constantly. If the required rate of return is 10%,what is the value of the current stock price?If the stock is currently trading at $50.00, is this stock agood buy?
41.60
An investor is holding a stock that has been volatile withreturns significantly year-over-year. The initial investmentwas $1,000 in stock ABC, and it returned the following: Year 1- 15% returns, Year 2-160% returns, Year 3 (-30% returns, year 4 -20% returns What are the arithmetic and geometric annual returns ofStock A for four years and the balance of investment atthe end of Year 4?
42.25%, 25.9%, $2511.60
Four years ago, you invested $10,000 in the shares of ABC Corp. Each year, the company distributed dividends to its shareholders. During the period, your total income was $300. Today, you sold your shares for $12,000. What is the annualized HPR of your investment?
5.31% HPR = (300 + [12,000 − 10,000])/10,000. Annualized HPR=(1+0.23)^1/4−1=
What is the geometric return(compound annualized return) of Stock ABC for six years? Year 1- 10% return Year 2 -8% return Year 3- 35% return Year 4 20% return Year 5 -15% return
5.69 Geometric return = [(1+0.10)*(1-0.08)*(1+0.35)*(1+0.20)*(1-0.15)]1/6-1
What is a holding period of return for an investor, who bought a stock a year ago at $55 and received $2 in dividends over the year, if the stock is now trading at $85?
58.18%. HPR = (2 + [85 − 55])/55 = 0.5818
Antonio's Pizzeria plans to issue bonds with a par value of $1,000 and 10 years to maturity. These bonds will pay $45 interest every six months. Current market conditions are such that the bonds will be sold at net $937.79. What is the YTM of the issue as a broker would quote it to an investor?
9.998%
Beta Coefficient,
: A measure of the extent to which the returns on agiven stock move with the stock market, whichrepresents an "average" stock. The entire market is extremely well diversified(theoretically perfectly diversified), because itincludes all investments
annualized her equation
=(1+holding period return)^1/t-1
HPR
=income return + price return
importance of bond ratings
A bond's rating is an indication of its default risk. Most bonds are purchased by institutional investorswho are legally restricted to investment-gradesecurities (Baa or higher). Changes in ratings affect a firm's ability to borrow long-term capital and the cost of using that capital.
arithmetic return
A calculation in which the mean equals the average of the annual percentage changes in capital appreciation plus dividend distributions.
bond(debt)
A loan to a firm, a government, or an individual Short term to long term Global bond market is larger than global stockmarket
Which of the following portfolios would have no diversification benefits?
A portfolio consisting of two perfectly positively correlated stocks.
Which of the following statements is true about a zerocoupon bond?
A zero coupon bond is issued at a substantial discountbelow its par value
Which one of the following is not a reason to invest in stocks?
receive income
Which one of the following is not an example of an affirmative covenant?
reduce taxes
The chance of receiving an actual return that differs from the one that is expected is called
risk
If the yield to maturity (the market rate of return) of a bond is less than its coupon rate, the bond should be:
selling at a premium; i.e., the bond's market price should be greater than its face value.
The _____ of an investment is a measure of the tightness, or variability, of its set of returns.
standard deviation of the returns
annualized hpr
the equivalent rate of return per year
A debt is said to be selling at par when:
the market value is equal to the face value of the debt.
The face value of a debt is:
the principal value written on the face, or outside cover, of a debt contract.
The greater the variability of the possible returns on an investment,
the riskier the investment
holding period return
total return from an asset over a period of time, gains/losses compared to the initial investment
A higher duration usually implies that a bond has higher interest rate risk.
true
Along with skewness, kurtosis is widely used to measure extreme measures in statistics.
true
Alpha may be positive or negative
true
FM refers to international countries that are expected to become future EM. They tend to be even less developed, have higher levels of risk than EM, have little market liquidity, and only marginally developed market systems.
true
Investment grade bonds refer to higher-rated bonds that investors consider then safer and more stable investments. Investment grade bonds contain "AAA" to "BBB-" ratings for S&P's rating scale and "Aaa" to "Baa3" ratings for Moody's rating scale
true
Investors usually buy undervalued stocks for profit because they believe the stock prices of those companies will go up in the future. On the other hand, they tend to sell overvalued stocks to avoid loss because they believe the stock prices of those companies will generally decrease in the future.
true
Investors who try to profit from increases in the bond price are usually interested in buying a bond currently trading at discount.
true
Regardless of the size of the coupon payment, the price of a bond moves in the opposite direction to interest rate movements. For example, if interest rates rise, bond prices fall.
true
The P/S ratio shows how much the market values every dollar of the company's sales or revenue. Analysts use this ratio when valuing growth stocks that have yet to turn a profit or have suffered a temporary setback.
true
The SGM is to value a stock that is expected to have higher-than-normal growth in dividend payments for some period in the future, the supernormal growth period. The dividends are expected to go back to normal with a constant growth after the supernormal growth period.
true
Stocks that have common characteristics such as high dividend yield, low Price-to-Book (P/B) ratio, and a low Price-to-Earnings (P/E) ratio traditionally called _____.
value stocks
Stocks that have common characteristics, such as high dividend yield, low P/B ratio, and a low P/E ratio, are traditionally called Blank Space.
value stocks
portfolio return
weighted average return on the stocks held in the portfolio
A bond that pays no annual interest and is sold at a discount below its par value is called a
zero-coupon bond
The expected returns for Stocks A, B, C, D, and E are 7 percent, 10 percent, 12 percent, 25 percent, and 18 percent, respectively. The corresponding standard deviations for these stocks are 12 percent, 18 percent, 15 percent, 23 percent, and 15 percent, respectively. Which one of the securities should a risk-averse investor purchase if the investment will be held in isolation (by itself)?
E Sharpe Ratio=((Expected Return −Risk −Free Rate / Standard Deviation ) E= 18%/15%=1.2 highest one
valuation of bonds
Face Value, Par Value The amount of money the firm borrows andpromises to repay at some future date (maturity). Coupon Payment The specified number of dollars of interest paideach period on a bond, generally each six months.
If there are frequent deposit and withdrawal transactions in your investment account, which type of return calculation you should use to correctly calculate your investment return?
MWR
large-cap company
Market Capitalization more than $10 billion 93% of the total US stock markets Stable / Well-established More transparent Higher dividends
What is the formula to calculate the P/E ratio?
Market price per share, EPS
Correlation Coefficient,
Measures the degree of relationship between twovariables. Positively correlated stocks (p > 0) have rates ofreturn that consistently move in the same direction. Negatively correlated stocks (p < 0) have rates ofreturn that consistently move in opposite directions.
medium/small-cap company
Mid-cap company Market Capitalization between $2 and $10 billion More risker than large-cap Higher expected return Small-cap company Market Capitalization between $300 million to $2 billion Less access to capital due to unstable cash flow More volatile than mid- or large-cap stocks
yield curve
Normal Yield Curve Inverted Yield Curve Flat Yield Curve
Which one of the following is not an example of the absolute valuation method under the DCF model?
P/E ratio
Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If an investor requires a simple annual rate of return of 12 percent with quarterly compounding, how much should the investor be willing to pay for this bond?
$1207.57. Inputs: N = 60; I = 3; PMT = 37.50; FV = 1,000 PV of lump sum amount in excel
Rick bought a bond when it was issued by MacroflexCorporation 14 years ago. The bond, which has a $1,000face value and a coupon rate equal to 10 percent, maturesin six years. Interest is paid every six months; the nextinterest payment is scheduled for six months from today. Ifthe yield on similar risk investments is 14 percent, thecurrent market value (price) of the bond is: (Round theanswer to two decimal places.
$841.15 PV of ordinary annuity N=6, I/Y=14%, PMT 100, FV= 1000
An investor just purchased a 10-year, $1,000 par value bond. The coupon rate on this bond is 8% annually, with interest being paid every six months. If the investor expects to earn a 10% simple rate of return on this bond, how much should she pay for it?
$875.38
bond value
PV of coupons + PV of par PV of annuity + PV of lump sum
convertible feature
Permits the bondholder to convert the bond intoshares of common stock at a fixed price. One-way conversion—investors cannot convert thestocks back to bonds.
If a bond's YTM exceeds its coupon rate, the bond's
Price must be less than its par value.
changes in stock prices
Prices move opposite to changes in rates of return. Prices move in the same direction as changes incash flows expected from the stock in the future.
preferred stock features
Priority to Assets and Earnings- Interest > Preferred Dividend > Common Stock Dividend Convertibility- Preferred stock => Common Stock Preferred stock generally is nonvoting stock. Sinking Fund Provision- Call for the repurchase and retirement No specified maturity date
An investor just purchased a 10-year, $1,000 par valuebond. The coupon rate on this bond is 8 percent annually,with interest being paid every 6 months. If the investorexpects to earn a 10 percent simple rate of return on thisbond, how much should she pay for it? (Round theanswer to two decimal places.)
$875.38
Sinking Fund—
a required annual payment designed topay off a bond or preferred stock issue Firms handle a sinking fund in one of two ways: Call in for redemption a certain percentage of thebonds each year. Buy the required amount of bonds in the openmarket.
A(n) Blank Space can be exchanged for shares of equity at the owner's discretion.
convertible bond
The annualized return and standard deviation of REITsare 7.1% and 23.1%, respectively. If we assume 1-yearannual risk-free rate was 0.10%, what is the Sharpe ratioof the REITs?
0.303
A share of common stock has a current price of $82.50 and isexpected to grow at a constant rate of 10 percent. If you requirea 14 percent rate of return, what is the current dividend on thisstock?
$3. =(82.5*(0.14-0.1))/(1+0.1)
A share of common stock has a current price of $82.50 and is expected to grow at a constant rate of 10 percent. If you require a 14 percent rate of return, what is the current dividend (D0) on this stock?
$3.00. x(1+0.10)/(0.14-0.10)=82.50. 27.5x=82.50
A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock? (Round intermediate calculations to two decimal places.)
$43.96 check excel in yellow box
A firm expects to pay dividends at the end of each of thenext four years of $2.00, $1.50, $2.50, and $3.50. Ifgrowth is then expected to level off at 8 percent, and ifyou require a 14 percent rate of return, how muchshould you be willing to pay for this stock?
$43.97
The last dividend on Spirex Corporation's common stockwas $4.00, and the expected growth rate is 10 percent.If you require a rate of return of 20 percent, what is thehighest price you should be willing to pay for this stock?
$44
The last dividend on Spirex Corporation's common stock was$4.00, and the expected growth rate is 10 percent. If you requirea rate of return of 20 percent, what is the highest price youshould be willing to pay for this stock?
$44. GGM(dividend discount) 4.00×1.10. Then 4.40/(0.20-0.10)
The last dividend on Spirex Corporation's common stock was $4.00, and the expected growth rate is 10 percent. If you require a rate of return of 20 percent, what is the highest price you should be willing to pay for this stock?
$44.00
The last dividend on J Ho Corporation's common stock was $4.00, and the expected growth rate is 10%. If you require a rate of return of 20%, what is the highest price you should be willing to pay for this stock?
$44.00. 4* (1 + 0.1) = 4.4, 4.4/0.20-0.10
A share of perpetual preferred stock pays an annual dividend of $6 per share. If investors require a 12% rate of return, what should be the price of this preferred stock?
$50 6/0.12
Assume that an investor wishes to purchase a 20-year bondwith a maturity value of $1,000 and semiannual interestpayments of $40. If the investor requires a 10 percentsimple yield to maturity on this investment, what is themaximum price she should be willing to pay for the bond?(Round the answer to the nearest whole number.)
$828, N=40, Y/I=10/2, FV=1000, PMT=40, PV of lump sum amount
Assume that an investor wishes to purchase a 20-year bond with a maturity value of $1,000 andsemiannual interest payments of $40. If the investorrequires a 10 percent simple yield to maturity on thisinvestment, what is the maximum price she should bewilling to pay for the bond? (Round the answer to thenearest whole number.)
$828. =(1000*POWER(1.05,-40)+(40*(1-POWER(1.05,-40))/0.05))
What is the MWR if you started investing in a mutual fund with $1,500 five years ago? Each year you added $500 to increase your investment amount for the first four years. Then you sold the entire balance of your investment for $3,150 in the fifth year.
-2.93%, irr formula
absolute valuation method
Intrinsic valuation method Discounted cash flow Using projected or future cash flows- Dividend, cash flow, earnings Predicting accurate growth rate, discount rate might bedifficult.
Sharpe ratio formula
Actual return - risk free rate divded by standard deviation
Market risk : systematic risk
Affects all securities
Certificates representing ownership in stocks of foreign companies, which are held in a trust bank located in the country the stock is traded are called Blank Space.
American depository receipts
gordon growth model
Assume that dividend grows at a constant rate in thefuture for an infinite time. v0= D1/k-g v= current value of stock d1= dividend in one period from now k=estimated cost of equity g= constant growth rate of the company's dividends for an infinite time
Sharpe ration
Average return of an investment earned in excess of therisk-free rate per unit of total risk(Standard Deviation)
The Concept of Beta
B = 0.5: stock is only half as volatile, or risky, as theaverage stock. B = 1.0: stock has the same systematic risk as theaverage stock (same as the market). B = 2.0: stock is twice as risky as the average stock.
corporate bonds by rating
Investment Grade Bonds Lower risk Lower yield Interest rate risk High-Yield(Junk) Bonds High risk Higher yield Credit risk
basic valuation
Based on "The Time Value of Money" concepts, weknow that the value of anything is based on thepresent value of the cash flows the asset is expectedto produce in the future.
relative valuation method
Based on the value of similar assets of companies Begins with analyzing financial statement/ratios Compare with other firms in same industry/sector Ratios P/E ratio P/S ratio P/B ratio
long term-bond
Bonds(Public Debt)- A long-term contract where a borrower agrees tomake payments of interest during the life of the loanand then repay the principal amount borrowed at theend of the life of the bond.
Which of the following is true about a growth stock?
It generally pays little or no dividends because the firm retains most of its earnings to fund developmental opportunities.
coefficient of variation formula
CV= Risk/return
coefficient of variation
Calculated as the standard deviation divided by theexpected return. Useful where investments differ in risk and expectedreturn
bond contract features
Call Provision—a provision in a bond contract that givesthe issuer the right to redeem the bonds under specifiedterms prior to the normal maturity date. Refunding—retiring an existing bond issue using theproceeds of a newly issued bond.
systematic risk
Changes in macroeconomic environment Impact the entire financial market Non-diversifiable, market risk
Risk Reduction
Combining stocks that are not perfectly positivelycorrelated will reduce the portfolio risk throughdiversification. A portfolio risk is reduced as the number of stocksin the portfolio increases. Lower correlation of stocks in a portfolio, the lowerthe portfolio's risk.
Types of stock
Common Stock Owners of the corporation Voting rights Higher rates of return Preferred Stock Hybrid security Bonds and Stock Higher dividend yields
dividend discount model
Company's current stock price is the sum of alldiscounted future cash flows Gordon Growth Model Supernormal Growth Model No Dividend Payments Growth Model
Which one of the following is not a common characteristic of large-cap stocks?
Large-cap companies are riskier than small-cap companies.
bond yield
Current (interest) yield + Capital gains yield
The following shows two investments you made in different period. In which investment do you yield a higher result? What was annualized HPR for that investment? Four years ago, you invested $10,000 in the shares of DEF Corp. The company has not paid any dividends during the period as its business has struggled due to recession. Today, you sold your shares for $12,000. Five years ago, you invested $20,000 in the shares of GHY Corp. Each year, the company distributed dividends to its shareholders. During the period, your total income was $1,200. Today, you sold your shares for $23,000
DEF Corp; 4.66% First Find each companies HPR then Annualized HPR and compare DEF Corp HPR = (12,000 − 10,000)/10,000 = 0.20 or 20% Annualized HPR=(1+0.2)^1/4−1=0.0466 or 4.66 GHY Corp HPR = (23,000 − 20,000 + 1,200)/20,000 = 0.21 or 21% Annualized HPR=(1+0.21)^1/5−1=0.0389 or 3.89
debt chara
Debt Characteristics Principal Value = Face Value = Par Value Coupon Rate- Interest Payments Maturity Date Yield Bond Price Priority to Assets and Earnings
common stock features
Dividends- No legal obligation to pay dividends. No specific maturity date. Voting Rights Priority to Assets and Earnings- Interest > Preferred Dividend > Common StockDividend Preemptive Rights
Currency risk : systematic risk
Due to currency exchange risk
Purchasing power risk : systematic risk
Due to inflation
Which of the following statements about beta is correct?
Firms with greater systematic risk volatilities than the market have betas that are greater than 1.0, and firms with smaller systematic risk volatilities than the market have betas that are less than 1.0.
Which of the following types of bonds protects a bondholder against increases in interest rates?
Floating-rate bonds
Which one of the followings is not a bond-rating agency?
Goldman sachs
types of bonds
Government Bond- Treasury bonds are issued by the U.S. Treasury Corporate Bond Municipal Bonds- Issued by states, cities, school districts, public airports. Tax-free investment Mortgage-Backed Securities
why invest in stocks?
Grow your assets Stocks have gone up Inflation hedge
valuing stocks with non constant growth- example
Growth Rate Year 1 - 3 = 20% Year 4 = 5%(Constant) Dividend at period 0 = $1.00 Required Rate of Return = 15% What is the value of the stock? $15.1985
growth/value and dividend
Growth stock- Above average growth Low or no dividend High P/E and P/B Value stock- Trade at lower price relative to its fundamentals High dividend yield Low P/E and P/B
Which of the following is true about the payment of dividends by a firm?
Growth stocks pay little or no dividends and instead retain most of their earnings each year.
supernormal growth model
Higher Growth- Dividend grows at a higher rate for certain period Constant Growth- Dividend growth stays at a constant rate
Interest rate risk: systematic risk
Higher interest rate => Lower valuation
interest rate risk on a bond
Interest Rate Price Risk The risk of changes in bond prices to whichinvestors are exposed due to changing interestrates. Interest Rate Reinvestment Rate Risk The risk that income from a bond portfolio will varybecause cash flows have to be reinvested atcurrent (perhaps lower) market rates.
risk-return
Increase in potential return with an increase in risk Low levels of uncertainty, low potential return High levels of uncertainty, high potential return
bonds by coupon and interest rate
Inflation Protected(Indexed) Bond A bond with interest payments that are based onan inflation index; helps protect the bondholderfrom inflation. Floating-rate bonds The bond's rate "floats" with market interest ratesrather than with the inflation rate. Zero (or Very Low) Coupon Bonds Bonds that pay no annual interest; sold at adiscount below par.
10% Coupon, 8% current INT, 14-year, $1,000Bonds Compounded Semi-annually
Pv n= 28 I/y= 4 PV=? PMT=50 FV= 1000
Reinvestment risk : systematic risk
Related to interest rate risk
measure of risk
Standard Deviation how much an investment's returns vary from its averagereturn. Measure of Volatility => Risk
stock
Stock? Equity? Stock = Equity Proportional Ownership- Assets and Earnings Stock Exchange- Buy and sell Outperform other assets in the long-term
portfolio beta coefficients
The beta of any set of securities is the weighted average of the individual securities' betas
Which of the following statements is true of a bond?
The maturity date of a bond is contractually fixed.
The conversion ratio is
The number of shares of stock that the bondholder receives upon conversion.
capital asset pricing model
The relationship between systematic risk and expectedreturn for risky assets. The expected return should beequal to the risk-free return plus a risk premium thatreflects the asset's systematic risk.
Stock A has a beta coefficient (β) equal to 2.1, and Stock B has a beta coefficient (β) equal to 0.7. According to the capital asset pricing model (CAPM), which of the following statements is correct?
The risk premium associated with Stock A, RPA, should be three times the risk premium associated with Stock B, RPB.
Which of the following statements about correlation is correct?
The weaker the positive correlation two stocks exhibit, the more risk can be reduced when they are combined in a portfolio.
stock valuation
Theoretical/intrinsic value of company Undervalued or overvalued Absolute valuation vs. relative valuation
short-term bond
Treasury Bills- Discounted securities issued by U.S. government tofinance operations. Federal Funds Rate- Overnight loans from one bank to another. (RequiredReserve) Target interest rate set by the Federal Open MarketCommittee. Money Market Mutual Funds- Pooled funds that are invested in money market instruments and managed by investment companies.
risk
Uncertainty of actual returns will differ from anexpected outcome Probability of an adverse outcome for an investor
unsystematic risk
Unique to specific securities Diversifiable risk =Diversified portfolio will reduce unsystematic risks Business risk =Specific business, industry, management Financial risk =Capital structure Default Risk = Not able to service its debts
changes in bond values over time
Whenever the going rate of interest, rd, equals the couponrate, a bond will sell at its par value An increase in interest rates will cause the price of anoutstanding bond to fall; a decrease in interest rates willcause the price to rise. The market value of a bond will always approach its parvalue as its maturity date approaches, provided the firmdoes not go bankrupt.
yield to maturity
YTM is the average rate of return earned on a bond ifit is held to maturity.
In a given portfolio, replacing an existing investment with a lower beta investment results in Blank Space.
a decrease in the required rate of return of the portfolio
If a preferred stock issue has a conversion feature, the stock can be converted into _____.
common stock
compounded annual growth rate (geometric return)
compounding factor= (1+R1)* (1+ R2)*.....
YTM equation
average rate of return earned on a bond if it is held to maturity
Which of the following is a measure of the extent to which the returns on a given stock move with the stock market?
beta coefficient
A HPR makes it possible to compare investment results in different time periods.
false
A bond's value will increase when interest rates increase.
false
A typical common stock issue has a maturity period of 10 years.
false
Beta = Covariance (Ka, Km)/Standard Deviation (Km)
false
For stocks, the vertical axis of the style box displays market capitalization and is divided into four company size indicators: large, medium, small, and micro. The horizontal axis shows growth, core, and value styles.
false
Geometric return is a measure of the performance of an investment. It is calculated by finding the rate of return that will set the present values of all cash flows equal to the value of the initial investment.
false
HPR consists of three parts: income return, price return, and bonus return.
false
If ABC tech co. is trading at a P/E of 35 while thetechnology industry is trading at a P/E of 30, the ABCstock is considered undervalued.
false
If we view P/E ratios as measures of payback, all elseequal, higher earnings multipliers are better.
false
P/B ratio considers that a stock's market value (i.e., stock price) is a backward-looking metric that reflects a company's future cash flows, while the book value of equity is an accounting measure based on the historic cost.
false
Private firms must meet the SEC's strict filing requirements that are required for public companies.
false
Systematic risk is diversifiable, so it is an investment's relevant risk. Unsystematic risk is nondiversifiable risk and, therefore, not relevant.
false
The GGM takes a perpetual constant dividend growth rate assumption. This model is ideal for companies with no dividend payments, fluctuating dividend growth rates, or irregular dividend payments.
false
The Sharpe ratio is the average return of an investment earned in excess of the risk-free rate per unit of the systematic risk, beta.
false
The total percentage exposure of the portfolio does not always add up to 100%.
false
Which of the following types of bonds protect a bondholder against increases in interest rates?
floating-rate bonds
The larger the standard deviation of returns on an investment, the _____.
greater the chance that its realized return will differ significantly from its expected return
