Financial Markets and Institutions- Exam 2

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Bonds that are transferred into principal-only and interest-only securities are called

"stripped" bonds.

A 12 percent coupon rate bond makes semi-annual interest rate payments. Par value is $1,000. The bond matures in 10 years. The required rate of return is 10 percent. Use any of the following information to find the current price. PVIFAi=12 percent,n=10=5.6502 PVIFi=12 percent,n=10=.3220 PVIFAi=10 percent,n=20=8.5136 PVIFAi=5 percent,n=20=12.4622 PVIFi=5 percent,n=20=.3769 PVIFi=6 percent,n=10=.5584

$1,125

Morgan Robbins, a private investor, would like to purchase a bond that has a par value of $1,000, pays $80 at the end of each year in coupon payments, and has 10 years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Mr. Robbins pay for the bond?

$1,147.20

Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as Tarzac is 15. Tarzac is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzac requires a return of 12 percent. The estimated stock price of Tarzak today should be __________ using the adjusted dividend discount model.

$116.41

Baywa has an outstanding bond that has a coupon rate of 8.3%. What is the market price of this bond if it pays interest semi-annually, has 15 years to maturity, and the current required rate of return is 9% on bonds of similar quality?

$943

Give several examples of short-term debt instruments, such as federal funds market and commercial paper. Explain how these instruments are valued, what economic factors affect their valuations and price movements?

- CD's - bank loans - T-Bills - Commercial Paper These instruments are valued by

A newly issued T-bill with a $10,000 par value sells for $9,750, and has a 90-day maturity. What is the discount?

10.00 percent

Jarrod King, a private investor, purchases a Treasury bill with a $10,000 par value for $9,645. One hundred days later, Jarrod sells the T-bill for $9,719. What is Jarrod's expected annualized yield from this transaction?

2.80 percent

A firm has a current stock price of $15.32. The firm's annual dividend is $1.14 per share. The firm's dividend yield is

7.44 percent.

Jim Carrey, a private investor, purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Mr. Carrey will hold the bonds until maturity. Thus, he will earn a return of __________ percent.

9

17) Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as Tarzac is 15. Tarzac is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzac requires a return of 12 percent. The estimated stock price of Tarzak today should be __________ using the adjusted dividend discount model.

A $116.41

25) Which of the following is true of money market instruments?

A Their yields are highly correlated over time.

Which of the following is a money market security?

A commercial paper

11) If interest rates suddenly ____________, those existing bonds that have a call feature are __________ likely to be called.

A decline; more

13) If the coupon rate ______ the required rate of return, the price of a bond _____ par value.

A equals; equals

As a result of more favorable economic conditions, there is a(n) ____ demand for loanable funds, causing an ____ shift in the demand curve.

A increased; outward

Other things being equal, foreign governments and corporations would demand ____ U.S. funds if their local interest rates were lower than U.S. rates. Therefore, for a given set of foreign interest rates, foreign demand for U.S. funds is ____ related to U.S. interest rates.

A less; inversely

Those financial markets that facilitate the flow of short-term funds are known as

A money markets.

Which of the following is a nondepository financial institution?

A mutual funds

If all other characteristics are similar, ____ would have to offer

A taxable securities; a higher before-tax yield than tax-exempt securities

Which of the following is not an example of an organized exchange?

A the Over-The-Counter Market

7) Which of the following is not a money market instrument?

ALL OF THESE ARE: banker's acceptance commercial paper negotiable CDs repurchase agreements

Which of the following is not a money market instrument?

All of the above are money market instruments.

2) Morgan Robbins, a private investor, would like to purchase a bond that has a par value of $1,000, pays $80 at the end of each year in coupon payments, and has 10 years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Mr. Robbins pay for the bond?

B $1,147.20

10) Jim Carrey, a private investor, purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Mr. Carrey will hold the bonds until maturity. Thus, he will earn a return of __________ percent.

B 9

16) Initial public offerings (IPOs) tend to occur more frequently during bearish stock markets.

B False

15) The ____________________is a value-weighted index of stock prices of 500 large U.S. firms.

B Standard and Poor's 500

24) T-bills and commercial paper are sold

B at a discount from par value.

In general, securities with ____ characteristics will offer ____ yields.

B favorable; lower

As the supply of funds in the banking system ____, the federal funds rate ____ along with other interest rates.

B increases; declines

20) Firms assume ______ risk when they issue preferred stock than when they issue bonds. The payment of dividends on preferred stock ______ be omitted without the firm being forced into bankruptcy.

B less; can

1) When two securities have the same expected cash flows, the value of the ___________ security will be higher then the value of the _____________ security.

B low-risk; high-risk

The Fisher effect states that the

B nominal interest rate equals the expected inflation rate plus the real rate of interest.

The yield offered on a debt security is ____ related to the prevailing risk-free rate and ____ related to the security's risk premium.

B positively; positively

21) The prevailing price per share divided by the firm's earnings per share is known as the

B price-earnings ratio.

If research showed that all investors attempt to purchase securities that perfectly match their time in which they will have available funds, this would specifically support the argument made by the

B segmented markets theory.

6) At any given time, the yield on commercial paper is ______ the yield on a T-bill with the same maturity.

B slightly higher than

9) Municipal general obligation bonds are ______. Municipal revenue bonds are ______.

B supported by the municipal government's ability to tax; supported by revenue generated from the project

Holding other factors such as risk constant, the relationship between the maturity and annualized yield of securities is called the

B term structure of interest rates.

19) Bonds that are transferred into principal-only and interest-only securities are called

C "stripped" bonds

An investor's tax rate is 30 percent. What must the before-tax yield on a security be to have an after-tax yield of 11 percent?

C 15.71 percent

23) A firm has a current stock price of $15.32. The firm's annual dividend is $1.14 per share. The firm's dividend yield is

C 7.44 percent.

3) If bond portfolio managers expect interest rates to increase in the future, they would likely ______ their holdings of bonds now, which could cause the prices of bonds to ______ as a result of their actions.

C decrease; decrease

If economic expansion is expected to decrease, the demand for loanable funds should ____ and interest rates should

C decrease; decrease

The equilibrium interest rate

C equates the aggregate demand for funds with the aggregate supply of loanable funds.

8) Which money market transaction is most likely to represent a loan from one commercial bank to another?

C federal funds

14) The price of short-term bonds are commonly ______ those of long-term bonds

C less volatile than

The required return to implement a given business project will be ____ if interest rates are lower. This implies that businesses will demand a ____ quantity of loanable funds when interest rates are lower.

C lower; greater

With regard to monetary policy, which of the following is under direct control of the Federal Reserve's Board of Governors?

C revise reserve requirements for depository institutions

18) If the returns of two stocks are perfectly correlated, then

C their correlation coefficient should equal 1.0.

Assume that the reserve requirements ratio is 15%. An initial injection of $150 million could result in a maximum change in the money supply of

D $1 billion.

12) A 12 percent coupon rate bond makes semi-annual interest rate payments. Par value is $1,000. The bond matures in 10 years. The required rate of return is 10 percent. Use any of the following information to find the current price. PVIFAi=12 percent,n=10=5.6502 PVIFi=12 percent,n=10=.3220 PVIFAi=10 percent,n=20=8.5136 PVIFAi=5 percent,n=20=12.4622 PVIFi=5 percent,n=20=.3769 PVIFi=6 percent,n=10=.5584

D 1,125

5) A newly issued T-bill with a $10,000 par value sells for $9,750, and has a 90-day maturity. What is the discount?

D 10.00 percent

4) Jarrod King, a private investor, purchases a Treasury bill with a $10,000 par value for $9,645. One hundred days later, Jarrod sells the T-bill for $9,719. What is Jarrod's expected annualized yield from this transaction?

D 2.80 percent

The term structure of interest rates defines the relationship

D between maturity and yield.

If markets were ____, investors could use available information ignored by the market to earn abnormally high returns.

D inefficient

Which of the following is currently a main role of the Federal Reserve's Board of Governors?

D regulating commercial banks controlling monetary policy

22) Sudden favorable news about the performance of a firm will make investors believe that the firm's stock is __________at its prevailing price.

D undervalued

According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term funds, there would be ____ pressure on the supply of short-term funds provided by investors and ____ pressure on the yield of long-term securities.

D upward; upward

Assume that today, the annualized two-year interest rate is 12 percent, and the one-year interest rate is 9 percent. A three-year security has an annualized interest rate of 14 percent. What is the one-year forward rate two years from now

E none of the above

If issuers of securities (borrowers) and investors suddenly expect interest rates to decrease, their actions to benefit from their expectations should cause

E none of the above

Initial public offerings (IPOs) tend to occur more frequently during bearish stock markets.

False

Fight to Quality

Flight to quality refers to the herd-like behavior of investors to shift out of risky assets during financial downturns or bear markets. This often occurs with a shift out of stocks and into bonds, where bonds are seen as relatively more safe and thus higher "quality" during rough economic patches

How does a municipal revenue bond differ from a general obligation bond?

General obligation, or GO, bonds are backed by the general revenue of the issuing municipality, while revenue bonds are supported by a specific revenue source, such as income from a toll road, hospital, or higher-education system.

Discuss some features of bonds, including sinking fund, call premium, and subordinated debentures. Explain why bondholders often prefer a sinking fund provision in a bond issue. How can it affect the risk and return on bonds?

Sinking Fund: A sinking-fund provision is a requirement that the firm retire a certain amount of the bond issue each year. This reduces the payments necessary at maturity and therefore can reduce the risk of investors. Call Premium: Call premium is the dollar amount over the par value of a callable debt security that is given to holders when the security is redeemed early by the issuer. Subordinate Debentures: A class of unsecured bond that, in the event of liquidation, is prioritized lower than other classes of debt. In essence, a subordinated debenture bond is an unsecured loan, which has no collateral. Prefer/ affect risk and return: A sinking fund provision is used to reduce the amount owed on the maturity date and hence reduce the risk that the borrower will default on the bond issue. Also, a sinking fund provision may add liquidity to a bond issue if the company satisfies its sinking fund obligation by buying bonds in the open market.

The ____________________is a value-weighted index of stock prices of 500 large U.S. firms

Standard and Poor's 500

Which of the following is true of money market instruments?

Their yields are highly correlated over time.

T-bills and commercial paper are sold

at a discount from par value

If interest rates suddenly ____________, those existing bonds that have a call feature are __________ likely to be called.

decline; more

If bond portfolio managers expect interest rates to increase in the future, they would likely ______ their holdings of bonds now, which could cause the prices of bonds to ______ as a result of their actions.

decrease; decrease

If the coupon rate ______ the required rate of return, the price of a bond _____ par value.

equals; equals

Which money market transaction is most likely to represent a loan from one commercial bank to another?

federal funds

The price of short-term bonds are commonly ______ those of long-term bonds

less volatile than

Firms assume ______ risk when they issue preferred stock than when they issue bonds. The payment of dividends on preferred stock ______ be omitted without the firm being forced into bankruptcy

less; can

When two securities have the same expected cash flows, the value of the ___________ security will be higher then the value of the _____________ security.

low-risk; high-risk

The prevailing price per share divided by the firm's earnings per share is known as the

price-earnings ratio

At any given time, the yield on commercial paper is ______ the yield on a T-bill with the same maturity.

slightly higher than

Municipal general obligation bonds are ______. Municipal revenue bonds are ______.

supported by the municipal government's ability to tax; supported by revenue generated from the project

municipal bonds

tax-exempt bonds issued by state and local governments §Are sold at a discount from par value, and the gain is the difference between par value and the price paid

If the returns of two stocks are perfectly correlated, then

their correlation coefficient should equal 1.0

Sudden favorable news about the performance of a firm will make investors believe that the firm's stock is __________at its prevailing price.

undervalued


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