Fire 311 chapt 8.2-10 (final)
Which of the following is generally NOT a characteristic of a bond? A) Voting rights B) Par value C) Claims on assets and income D) Indenture
A) Voting rights
A stock currently sells for $63 per share, and the required return on the stock is 10%. Assuming a growth rate of 5%, calculate the stock's last dividend paid. A) $1 B) $3 C) $5 D) $7
B) $3
The expected rate of return on a share of common stock whose dividends are growing at a constant rate (g) is which of the following? A) (D1 + g)/Vc B) D1/Vc + g C) D1/g D) D1/Vc
B) D1/Vc + g
If current market interest rates rise, what will happen to the value of outstanding bonds? A) It will rise. B) It will fall. C) It will remain unchanged. D) There is no connection between current market interest rates and the value of outstanding bonds.
B) It will fall.
The shareholder can cast all votes for a single candidate or split them among various candidates through A) proxy fights. B) cumulative voting. C) call provisions. D) majority voting.
B) cumulative voting.
If a stock has a much higher than normal P/E ratio, investors probably expect A) slow growth in earnings. B) rapid growth in earnings. C) large increases in the price of the stock. D) a declining stock price.
B) rapid growth in earnings.
Mango Company bonds pay a semiannual coupon rate of 6.4%. They have eight years to maturity and face value, or par, of $1,000. Compute the value of Mango bonds if investors' required rate of return is 5%. A) $1,090.48 B) $883.66 C) $1,006.83 D) $950.00
C) $1,006.83
An issue of common stock currently sells for $40.00 per share, has an expected dividend to be paid at the end of the year of $2.00 per share, and has an expected growth rate to infinity of 5% per year. The expected rate of return on this security is A) 5%. B) 10.25%. C) 13.11%. D) 10%.
D) 10%.
Which of the following statements about bonds is true? A) As the maturity date of a bond approaches, the market value of a bond will become more volatile. B) Long-term bonds have less interest rate risk than do short-term bonds. C) Bond prices move in the same direction as market interest rates. D) If market interest rates are above a bond's coupon interest rate, then the bond will sell below its par value.
D) If market interest rates are above a bond's coupon interest rate, then the bond will sell below its par value.
As investors' required rate of return on a bond increases, the value of the bond increases also.
FALSE
Bond ratings measure the interest rate risk of a given bond issue.
FALSE
Bonds cannot be worth less than their book value.
FALSE
Bonds with a longer time to maturity have less interest rate risk.
FALSE
Common stockholders are essentially creditors of the firm.
FALSE
Dry Seal plans to issue bonds to expand operations. The bonds will have a par value of $1,000, a 10-year maturity, and a coupon interest rate of 9%, paid semiannually. Current market conditions are such that the bonds will be sold to net $937.79. The yield-to-maturity of these bonds is 10%.
FALSE
Generic, Inc. has bonds outstanding that mature in 20 years. The bonds have $1,000 par value, pay interest annually at a rate of 10%, and have a current selling price of $875.25. The current yield on the bonds is 11.63%.
FALSE
In the event of bankruptcy, preferred stockholders and common stockholders have the same claim on the firm's assets.
FALSE
Investment grade bonds are rated BB or lower.
FALSE
The stockholder's expected rate of return consists of a dividend yield and interest.
FALSE
You purchased Photon, Inc. bonds exactly one year ago today for $875. During the latest year, you received $65 in interest on the bonds. The current yield on these bonds is 6.5%.
FALSE
The return for the market during the next period is expected to be 11.5%; the risk-free rate is 2.5%. Calculate the required rate of return for a stock with a beta of 1.5.
K = 2.5% + 1.5(11.5% - 2.5%) = 16%
The higher a firm's P/E ratio, the more optimistic investors feel about the firm's growth prospects.
TRUE
You can purchase one share of Sumter Company common stock for $80 today. You expect the price of the common stock to increase to $85 per share in one year. The company pays an annual dividend of $3.00 per share. What is your expected rate of return for Sumter stock?
$80.00 = + $80.00 (1 + R) = $88.00 (1 + R) = = $1.10 R = .10
Walmart's current earnings per share of $5.02 are expected to grow at a rate of 17% per year for the next few years. Using a P/E ratio of 13.46, what is a reasonable value for a share of Walmart Stock.
A reasonable value for Walmart would be $5.02(1.17)(13.46)=$79.06 per share.
Terminator Bug Company bonds have a 14% coupon rate. Interest is paid semiannually. The bonds have a par value of $1,000 and will mature 10 years from now. Compute the value of Terminator bonds if investors' required rate of return is 12%. A) $1,114.70 B) $1,149.39 C) $894.06 D) $1,000.00v
A) $1,114.70
Zorba's is a small chain of restaurants whose stock is not publicly traded. The average P/E ratio for similar restaurant chains is 16.5; the P/E ratio for the S&P 500 Index is 15.2. This year's earnings were $1.21 per share and next year's earnings are forecasted at $1.46 per share. A reasonable price for a share of Zorba's stock is A) $24.09. B) $19.96. C) $20.23. D) $16.50.
A) $24.09.
The GAP's most recent earnings per share were $1.75. Analysts forecast next year's earnings per share at $1.88. If the appropriate P/E ratio is 15, a share of GAP stock should be valued at A) $28.20. B) $26.25. C) $27.23. D) $8.57.
A) $28.20.
What is the value of a preferred stock that pays a $2.10 dividend to an investor with a required rate of return of 6% (round your answer to the nearest $1)? A) $35 B) $23 C) $17 D) $21
A) $35
You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today? Round to the nearest $.01. A) $36.65 B) $91.23 C) $51.55 D) $74.82
A) $36.65 1.80 * 1.12 / (.175 - .12)= 2.016/.055 = 36.65
UVP preferred stock pays $5.00 in annual dividends. If your required rate of return is 13%, how much will you be willing to pay for one share? A) $38.46 B) $26.26 C) $65.46 D) $46.38
A) $38.46 5/.13 = 38.46
You are evaluating the purchase of Cellars, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12% for the next three years. You plan to hold the stock for three years and then sell it. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Calculate the present value of the expected dividends. A) $4.91 B) $5.40 C) $9.80 D) $6.80
A) $4.91
Fris B. Corporation stock is currently selling for $42.86. It is expected to pay a dividend of $3.00 at the end of the year. Dividends are expected to grow at a constant rate of 3% indefinitely. Compute the required rate of return on FBC stock. A) 10% B) 33% C) 7% D) 4.3%
A) 10% step 1: 3.00 / 42.86 + 3% step 2: 7% + 3% = 10%
A $1,000 par value bond with a 12% coupon rate currently selling for $825 has a current yield of A) 14.55%. B) 12.44%. C) 7.27%. D) 5.61%.
A) 14.55%.
Blue's Chips Inc. has a $1,000 par value bond that is currently selling for $1,300. It has an annual coupon rate of 7%, paid semiannually, and has nine years remaining until maturity. What is the annual yield to maturity on the bond? (Round to the nearest whole percentage.) A) 3.15% B) 1.57% C) 3.12% D) 6.24%
A) 3.15%
An issue of preferred stock currently sells for $52.50 per share and pays a constant annual expected dividend of $2.25 per share. The expected return on this security is A) 4.29%. B) 0.04%. C) 8.33%. D) 13.33%.
A) 4.29%.
If a company has a return on equity of 25% and wants a growth rate of 10%, how much of ROE should be retained? A) 40% B) 50% C) 60% D) 70%
A) 40% .10/.25 = 40%
Davis Gas & Electric issued preferred stock in 1985 that had a par value of $50. The stock pays a dividend of 7.875%. Assume that shares are currently selling for $62.50. What is the preferred stockholder's expected rate of return? Round to the nearest 0.01%. A) 6.30% B) 7.88% C) 10.25% D) 5.02%
A) 6.30%
What is the expected rate of return on a bond that pays a coupon rate of 9% paid semi-annually, has a par value of $1,000, matures in five years, and is currently selling for $1071? A) 7.28% B) 8.40% C) 3.64% D) 4.21%
A) 7.28%
You are considering the purchase of Hytec bonds that were issued 14 years ago. When the bonds were originally sold, they had a 30-year maturity and a 14.375% coupon interest rate that is payable semiannually. The bond is currently selling for $1,508.72. What is the yield to maturity on the bonds? A) 8.50% B) 14.38% C) 11.11% D) 7.67%
A) 8.50%
Which of the following statements about bonds is true? A) If market interest rates are below a bond's coupon interest rate, then the bond will sell above its par value. B) Long-term bonds have less interest rate risk than do short-term bonds. C) Bond prices move in the same direction as market interest rates. D) As the maturity date of a bond approaches, the market value of a bond will become more volatile.
A) If market interest rates are below a bond's coupon interest rate, then the bond will sell above its par value.
If current market interest rates fall, what will happen to the value of outstanding bonds? A) It will rise. B) It will fall. C) It will remain unchanged. D) There is no connection between current market interest rates and the value of outstanding bonds.
A) It will rise.
The largest market stock exchange in the U.S. is A) NYSE. B) Nasdaq. C) AMEX. D) the CBOT.
A) NYSE.
Quirk Drugs sold an issue of 30-year, $1,000 par value bonds to the public that carry a 10.85% coupon rate, payable semiannually. It is now 10 years later, and the current market rate of interest is 9.00%. If interest rates remain at 9.00% until Quirk's bonds mature, what will happen to the value of the bonds over time? A) The bonds will sell at a premium and decline in value until maturity. B) The bonds will sell at a discount and rise in value until maturity. C) The bonds will sell at a premium and rise in value until maturity. D) The bonds will sell at a discount and fall in value until maturity.
A) The bonds will sell at a premium and decline in value until maturity.
Which of the following statements about bonds is true? A) The market value of a bond moves in the opposite direction of market interest rates. B) As the maturity date of a bond approaches, the market value of a bond will become more volatile. C) Long-term bonds are less risky than short-term bonds. D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value. E) None of the above.
A) The market value of a bond moves in the opposite direction of market interest rates.
Which of the following statements about zero coupon bonds is FALSE? A) When the bonds mature, the issuing firm is faced with a small cash outflow relative to the cash inflow the firm receives when the bonds are initially issued. B) Zero coupon bonds have lower interest rate risk than bonds with high coupons. C) Zero coupon bonds are an extremely popular way for corporations to borrow money. D) Most zero coupon bonds in the U.S. are government issues.
A) When the bonds mature, the issuing firm is faced with a small cash outflow relative to the cash inflow the firm receives when the bonds are initially issued.
An example of a primary market transaction is A) a new issue of stock by Evergreen Solar. B) a purchase of Microsoft stock on Nasdaq. C) Target repurchasing some its own stock from an investor. D) a sale of IBM stock on the NYSE.
A) a new issue of stock by Evergreen Solar.
CEOs naming friends to the board of directors and paying them more than the norm is an example of the A) agency problem. B) preemptive right. C) majority voting feature. D) proxy fights.
A) agency problem.
A bond has a coupon rate of 6% paid semi-annually, a par value of $1,000, and matures tomorrow. The bond will sell for A) approximately $1,030 . B) approximately $1,000. C) approximately $1,060. D) The price cannot be estimated without knowing the market rate of interest.
A) approximately $1,030 .
Expected cash flow for a preferred stock primarily consists of A) dividend payments. B) changes in the price of the stock. C) interest payments. D) both A and B.
A) dividend payments.
An decrease in the ________ will increase the value of preferred stock. A) expected rate of return B) life of the investment C) dividend paid D) both A and C
A) expected rate of return
Eurobonds are A) issued in a country different from the one in whose currency the bond is denominated. B) issued only in Europe. C) the European equivalent of a junk bond. D) none of the above.
A) issued in a country different from the one in whose currency the bond is denominated.
Preferred stock is similar to common stock in that A) it has no fixed maturity date. B) the nonpayment of dividends can bring on bankruptcy. C) dividends are limited in amount. D) both carry voting rights.
A) it has no fixed maturity date.
Acme Consolidated has a return on equity of 12%. If Acme distributes 60% of earnings as dividends, its expected growth rate will be A) new 4.80%. B) 7.20%. C) 12%. D) 6%.
A) new 4.80%. 12 ( 1-.60) = 4.80%
Bond ratings directly affect a bond's A) spread over the Treasury yield. B) coupon rate. C) maturity date. D) call provisions.
A) spread over the Treasury yield.
If the market price of a bond increases, then A) the yield to maturity decreases. B) the coupon rate increases. C) the yield to maturity increases. D) none of the above.
A) the yield to maturity decreases.
RAH Inc. is not publicly traded, but the P/E ratios of it's 4 closest competitors are 15, 15.3, 15.7, and 16.5. RAH's current earnings per share are $1.50. They are expected to grow at 6% for the next few years. What is a reasonable price for a share of RAH stock?
An appropriate P/E ratio would be an average of the 4 competitors: (15 + 15.3 + 15.7 + 16.5)/4 = 15.625. A reasonable price would be $1.50(1.06)(15.625) = $24.84.
Applebee sold an issue of 30-year, $1,000 par value bonds to the public. The coupon rate of 8.75% is payable annually. It is now five years later, and the current market rate of interest is 7.25%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1. A) $715 B) $1,171 C) $1,225 D) $697
B) $1,171
ABC, Inc. just paid a dividend of $2. ABC expects dividends to grow at 10%. The return on stocks like ABC, Inc. is typically around 12%. What is the most you would pay for a share of ABC stock? A) $100 B) $110 C) $120 D) $130
B) $110 2*1.10 / (.12-.10) = 110
Marshall Manufacturing has common stock which paid a dividend of $1.00 a share last year. You expect the stock to grow at 5% per year. If the appropriate rate of return on this stock is 12%, how much are you willing to pay for the stock today? A) $13.00 B) $15.00 C) $17.00 D) $19.00
B) $15.00 1.00 * 1.05/ (.12-.05) = 15
Little Feet Shoe Co. just paid a dividend of $1.65 on its common stock. This company's dividends are expected to grow at a constant rate of 3% indefinitely. If the required rate of return on this stock is 11%, compute the current value of per share of LFS stock. A) $20.63 B) $21.24 C) $15.00 D) $55.00
B) $21.24 (1.65)(1.03)/ (.11-.03)= 21.24
An investor is contemplating the purchase of common stock at the beginning of this year and to hold the stock for one year. The investor expects the year-end dividend to be $2.00 and expects a year-end price for the stock of $40. If this investor's required rate of return is 10%, then the value of the stock to this investor is A) $36.36. B) $38.18. C) $33.06. D) $34.88.
B) $38.18. 2+40 /1.10 = 38.18
Marshall Manufacturing has a bond outstanding that was issued 20 years ago at a coupon rate of 9%. The $1,000 par value bond pays interest semiannually and was originally issued with a term of 30 years. If today's interest rate is 14%, what is the value of the bond today? A) $654.98 B) $735.15 C) $814.42 D) $941.87
B) $735.15
The Fisher effect can be expressed mathematically as A) ( nominal rate)= (the real rate of interest) ( the inflation rate). B) (1+ the nominal rate)= (1+the real rate of interest) (1 + the inflation rate). C) the nominal rate)= the real rate of interest + the inflation rate). D) the real rate of interest= the nominal rate - the inflation rate).
B) (1+ the nominal rate)= (1+the real rate of interest) (1 + the inflation rate).
Green Corp.'s preferred stock is selling for $20.83. If the company pays $2.50 annual dividends, what is the expected rate of return on its stock? A) 8.33% B) 12.00% C) 2.50% D) 20.00%
B) 12.00% 2.50/20.83 = 12.00
Home Depot stock is currently selling for $75 per share. Next year's dividend is expected to be $1.56; next year's earnings per share are expected to be $4.16. Home Depot's P/E ratio is A) .055. B) 18. C) 2.14. D) 48.
B) 18.
Marjen, Inc. just paid a dividend of $5. Marjen stock currently sells for $73.57. The return on stocks like Marjen, Inc. is around 10%. What is the implied growth rate of dividends. A) 1% B) 3% C) 5% D) 7%
B) 3%
You are considering the purchase of Miller Manufacturing, Inc.'s common stock. The stock is selling for $21.00 per share. The next dividend is expected to be $2.10, and you expect the dividend to keep growing at a constant rate. If the stock is returning 15%, calculate the growth rate of dividends. A) 3% B) 5% C) 8% D) 10%
B) 5%
You paid $865.50 for a corporate bond that has a 6.75% coupon rate. What is the bond's current yield? A) 8.375% B) 7.800% C) 15.001% D) 6.667%
B) 7.800%
Apple stock is now selling for $460 per share. The P/E ratio based on current earnings is 10.98 and the P/E ratio based on expected earnings is 10.16. The expected growth rate in Apples earnings must be A) 2.39%. B) 8.07%. C) -7.5%. D) 5.5%.
B) 8.07%.
Which of the following statements is true? A) A bond that has a rating of AA is considered to be a junk bond. B) A bond will sell at a premium if the prevailing required rate of return is less than the bond's coupon rate. C) A zero coupon is a bond that is secured by a lien on real property. D) The legal document that describes all of the terms and conditions of a bond issue is called a debenture agreement.
B) A bond will sell at a premium if the prevailing required rate of return is less than the bond's coupon rate.
Preferred stock is similar to a bond in which of the following ways? A) Preferred stock always contains a maturity date. B) Both investments provide a fixed income. C) Both contain a growth factor similar to common stock. D) None of the above.
B) Both investments provide a fixed income.
Which of the following statements about bonds is true? A) Bond prices move in the same direction as market interest rates. B) If market interest rates change, long-term bonds will fluctuate more in value than short-term bonds. C) Long-term bonds are less risky than short-term bonds. D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value. E) None of the above.
B) If market interest rates change, long-term bonds will fluctuate more in value than short-term bonds.
Which of the following statements concerning preferred stock is correct? A) Preferred stock generally is more costly to the firm than common stock. B) Most issues of preferred stock have a cumulative feature. C) Preferred dividend payments are tax-deductible. D) Preferred stock is a riskier form of capital to the firm than bonds.
B) Most issues of preferred stock have a cumulative feature.
Cassel Corp. bonds pay an annual coupon rate of 10%. If investors' required rate of return is now 8% on these bonds, they will be priced at A) par value. B) a premium to par value. C) a discount to par value. D) cannot be determined from information given.
B) a premium to par value.
The nominal interest rate A) does not include inflation. B) includes inflation and the real rate of interest. C) ignores the Fisher effect. D) is the rate at which banks lend money to other banks.
B) includes inflation and the real rate of interest.
Common shareholders have a claim on the company's assets A) at any time, equal to the value of their shares. B) only after the claims of debtholders and preferred shareholders have been satisfied. C) after the claims of the preferred shareholders have been satisfied, but before the debt holders. D) never. Common shareholders have no claim on the company's assets.
B) only after the claims of debtholders and preferred shareholders have been satisfied.
Edison Power and Light has an outstanding issue of cumulative preferred stock with an annual fixed dividend of $2.00 per share. It has not paid the preferred dividend for the last 3 years, but intends to pay a dividend on the common stock in the coming year. Before Edison can pay a dividend on the common stock A) preferred shareholders may cast all their votes for a single director. B) preferred shareholders must receive dividends totaling $8.00 per share. C) preferred shareholders must receive $2.00 per share. D) will not necessarily receive any dividend.
B) preferred shareholders must receive dividends totaling $8.00 per share.
The holder of a non-amortizing bonds A) receives no periodic interest payments. B) receives the full par value of the bond when it matures. C) receives shares of common stock rather than cash interest payments. D) receives periodic payments that consist of both interest and principal.
B) receives the full par value of the bond when it matures.
A decrease in the ________ will cause an increase in common stock value. A) growth rate B) required rate of return C) last paid dividend D) both B and C
B) required rate of return
McDonald's stock currently sells for $103. It's expected earnings per share are $5.50. The average P/E ratio for the industry is 24. If investors expected the same growth rate and risk for McDonald's as for an average firm in the same industry, it's stock price would A) stay about the same. B) rise. C) fall. D) there is not enough information.
B) rise.
A $1,000 par value bond is currently listed as selling at 92 1/8. This means A) that you can buy the bond for $92.125. B) that you can buy the bond for $921.25. C) that if you purchase the bond today, you will receive $921.25 when the bond matures. D) none of the above.
B) that you can buy the bond for $921.25.
When a bond's coupon rate is higher than the required rate of return, the bond A) will sell at a discount from par. B) will sell at a premium over par. C) may sell at either a discount or a premium. D) will sell at par value.
B) will sell at a premium over par.
Tri State Pickle Company preferred stock pays a perpetual annual dividend of 2 1/2% of its par value. Par value of TSP preferred stock is $100 per share. If investors' required rate of return on this stock is 15%, what is the value of per share? A) $37.50 B) $15.00 C) $16.67 D) $6.00
C) $16.67
The retail analyst at Morgan-Sachs values stock of the GAP at $38.00 per share. They are using the average industry "forward" P/E ratio of 17. Their forecasted earnings per share for next year is A) $0.54. B) $1.50. C) $2.24. D) There is not enough information calculate earnings per share.
C) $2.24.
WSU Inc. is a young company that does not yet pay a dividend. You believe that the company will begin to pay dividends 5 years from now, and that the company will then be worth $50 per share. If your required rate of return on this risky stock is 20%, what is the stock worth today? A) $40 B) $10 C) $20.09 D) $0.00
C) $20.09 FV: 50 PMT: 0 N:5 I:20 *PV: 20.09
You are evaluating the purchase of Charbridge, Inc. common stock which currently pays no dividend and is not expected to do so for many years. Because of rapidly growing sales and profits, you believe the stock will be worth $51.50 in 3 years. If your required rate of return is 16%, what is the stock worth today? A) $59.74 B) $51.25 C) $32.99 D) $0.00 because stocks that do not pay dividends have no value.
C) $32.99 FV: 51.50 N: 3 I:16 Pmt: 0 *PV: 32.99
Murky Pharmaceuticals has issued preferred stock with a par value of $100 and a 5% dividend. The investors' required yield is 10%. What is the value of a share of Murky preferred? A) $100 B) $75 C) $50 D) $25
C) $50
Six years ago, Colt, Inc. sold an issue of 30-year, $1,000 par value bonds. The coupon rate of 5.25% is payable annually. Investors presently require a rate of return of 8.375%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1. A) $1,050 B) $932 C) $681 D) $1,111
C) $681
Sacramento Light & Power issued preferred stock in 1998 that had a par value of $85. The preferred stock pays a dividend of 5.75%. Investors require a rate of return of 6.50% today on this stock. What is the value of the preferred stock today? Round to the nearest $1. A) $100 B) $85 C) $75 D) $16
C) $75
What is the value of a bond that has a par value of $1,000, a coupon rate of $80 (annually), and matures in 11 years? Assume a required rate of return of 11%, and round your answer to the nearest $10. A) $320.66 B) $1,011.00 C) $813.80 D) $790.79
C) $813.80
You are considering a portfolio of three stocks with 30% of your money invested in company X, 45% of your money invested in company Y, and 25% of your money invested in company Z. If the betas for each stock are 1.22 for company X, 1.46 for company Y, and 1.03 for company Z, what is the portfolio beta? A) 1.24 B) 1.00 C) 1.28 D) 1.33
C) 1.28
Green Company's common stock is currently selling at $24.00 per share. The company recently paid dividends of $1.92 per share and projects growth at a rate of 4%. At this rate, what is the stock's expected rate of return? A) 4.08% B) 8.00% C) 12.00% D) 8.80%
C) 12.00% (1.92 + 1.04/24) + .04 = 12.32 ~12%
What is the yield to maturity of a nine-year bond that pays a coupon rate of 20% per year, has a $1,000 par value, and is currently priced at $1,407? Assume annual coupon payments. A) 21.81% B) 6.14% C) 12.28% D) 11.43%
C) 12.28%
Solitron Manufacturing Company preferred stock is selling for $14. If it has a yearly dividend of $1, what is your expected rate of return if you purchase the stock at its market price (round your answer to the nearest .1%). A) 25.0% B) 14.2% C) 7.1% D) 9.3%
C) 7.1%
Petrified Forest Skin Care, Inc. pays an annual perpetual dividend of $1.70 per share. If the stock is currently selling for $21.25 per share, what is the expected rate of return on this stock. A) 36.13% B) 12.5% C) 8.0% D) 13.6%
C) 8.0%
(Starting chapt 10) The XYZ Company, whose common stock is currently selling for $40 per share, is expected to pay a $2.00 dividend in the coming year. If investors believe that the expected rate of return on XYZ is 14%, what growth rate in dividends must be expected? A) 5% B) 14% C) 9% D) 6%
C) 9% 40= 2/14% = 9%
Aurand, Inc. has outstanding bonds with an 8% annual coupon rate paid semiannually. The bonds have a par value of $1,000, a current price of $904, and will mature in 14 years. What is the annual yield to maturity on the bond? A) 15.80% B) 10.47% C) 9.24% D) 7.90% E) 4.62%v
C) 9.24%
Which of the following companies is most likely to trade on the New York Stock Exchange? A) Dell B) Genzyme Transgenics C) Coca Cola D) Tata Motors
C) Coca Cola
Which investor incurs the greatest risk? A) Mortgage bondholder B) Preferred stockholder C) Common stockholder D) Debenture bondholder
C) Common stockholder
Which of the following exchanges has the strictest listing requirements? A) AMEX B) Nasdaq C) NYSE D) OTC
C) NYSE
Piercing Publishers recently issued preferred stock with a fixed annual dividend of $3.00 per share. Investors require a 5% return on similar preferred stock issues. The stock is currently selling for $65. Is the stock a good buy? A) Yes, as it is undervalued $5. B) Yes, as it is undervalued $10. C) No, as it is overvalued $5. D) No, as it is overvalued $10.
C) No, as it is overvalued $5.
What allows common stockholders the right to cast a number of votes equal to the number of directors being elected? A) The majority voting provision B) The casting feature C) The cumulative voting provision D) The proxy method
C) The cumulative voting provision
Which of the following formulas is appropriate to find the value of preferred stock with a fixed dividend? A) Value of preferred stock = Annual Preferred Stock Dividend (1 + growth rate)/Market's Required Yield on Preferred Stock B) Value of preferred stock = Annual Preferred Stock Dividend (1 + growth rate)/Market's Required Yield on Preferred Stock - growth rate C) Value of preferred stock = Annual Preferred Stock Dividend/Market's Required Yield on Preferred Stock D) Value of preferred stock = Annual Preferred Stock Dividend/Investor's Required Yield on Preferred Stock
C) Value of preferred stock = Annual Preferred Stock Dividend/Market's Required Yield on Preferred Stock
Which of the following statements is true? A) When investors' required rate of return equals the bond's coupon rate, then the market value of the bond may be selling at par value. B) When investors' required rate of return exceeds the bond's coupon rate, then the market value of the bond will be greater than par value. C) When investors' required rate of return is less than the bond's coupon rate, then market value of the bond will be greater than par value. D) When investors' required rate of return is less than the bond's coupon rate, then the market value of the bond will be less than par value.Which of the following statements is true?
C) When investors' required rate of return is less than the bond's coupon rate, then market value of the bond will be greater than par value.
KDP's most recent dividend was $2.00 per share and is selling today in the market for $70. The dividend is expected to grow at a rate of 7% per year for the foreseeable future. If the market return is 10% on investments with comparable risk, should you purchase the stock? A) No, because the stock is overpriced $1.33. B) No, because the stock is overpriced $3.33. C) Yes, because the stock is underpriced $1.33. D) Yes, because the stock is underpriced $3.33.
C) Yes, because the stock is underpriced $1.33.
Government bonds have lower yield to maturity than do corporate bonds of the same maturity because the ________ premium is lower for government bonds. A) interest rate risk B) inflation C) default D) maturity
C) default
An issue of common stock currently sells for $50.00 per share, has an expected dividend to be paid at the end of the year of $2.50 per share, and has an expected growth rate to infinity of 5% per year. If investors' required rate of return for this particular security is 12% per year, then this security is A) overvalued and offering an expected return higher than the required return. B) undervalued and offering an expected return higher than the required return. C) overvalued and offering an expected return lower than the required return. D) undervalued and offering an expected return lower than the required return.
C) overvalued and offering an expected return lower than the required return.
Common stockholders are essentially A) creditors of the firm. B) managers of the firm. C) owners of the firm. D) all of the above.
C) owners of the firm.
The P/E ratio is calculated by dividing A) the current stock price by stockholders' equity. B) total assets by net income. C) the current stock price by earnings per share. D) the current stock price by operating cash flow per share.
C) the current stock price by earnings per share
The yield on a corporate bond with a 20 year maturity would include A) only the real rate of interest and expected inflation. B) the risk-free rate multiplied by 1+ default rate. C) the risk-free rate plus a default risk premium, a liquidity risk premium and a maturity risk premium. D) the real rate of interest, the expected inflation rate and a default risk premium.
C) the risk-free rate plus a default risk premium, a liquidity risk premium and a maturity risk premium.
What is the value of a bond that matures in three years, has an annual coupon payment of $110, and a par value of $1,000? Assume a required rate of return of 11%, and round your answer to the nearest $10. A) $970 B) $1,330 C) $330 D) $1,000
D) $1,000
The required rate of return on TKF preferred has fallen from 5.75% at the time of issue to the present rate of 5%. The stock now sells for $115. What was the original price? A) $75.61 B) $132.25 C) $114 D) $100
D) $100
You are considering the purchase of common stock that just paid a dividend of $6.50 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 18%. How much should you expect to pay for this stock? A) $86 B) $94 C) $108 D) $121 E) $242
D) $121 6.50 * 1.12 / (.18-.12) = 120.833 ~121
World Wide Interlink Corp. has decided to undertake a large project. Consequently, there is a need for additional funds. The financial manager plans to issue preferred stock with an annual dividend of $5 per share. The stock will have a par value of $30. If investors' required rate of return on this investment is currently 20%, what should the preferred stock's market value be? A) $10 B) $15 C) $20 D) $25
D) $25
A firm just paid $2.00 on its common stock and expects to continue paying dividends, which are expected to grow 5% each year, from now to infinity. If the required rate of return for this stock is 9%, then the value of the stock is A) $50.00. B) $40.00. C) $54.50. D) $52.50.
D) $52.50. (2*1.05) /( .09-.05) = 2.1/.04 = 52.5
A share of common stock just paid a dividend of $3.25 per share. The expected long-run growth rate for this stock is 18%. If investors require a rate of return of 24%, what should the price of the stock be? A) $57.51 B) $62.25 C) $71.86 D) $63.92
D) $63.92 3.25 * 1.18 / (.24-.18) = 63.916
Marble Corporation's ROE is 17%. Their dividend payout ratio is 20%. The last dividend, just paid, was $2.58. If dividends are expected to grow by the company's sustainable growth rate indefinitely, what is the current value of Marble common stock if its required return is 18%? A) $14.33 B) $18.27 C) $47.67 D) $66.61
D) $66.61
Butler, Inc.'s return on equity is 17% and management retains 75% of earnings for investment purposes. Based on this information, what will be the firm's growth rate? A) 4.25% B) 22.67% C) 44.12% D) 12.75%
D) 12.75% .17*.75 = 12.75%
Brookline, Inc. just sold an issue of 30-year bonds for $1,107.20. Investors require a rate of return on these bonds of 7.75%. The bonds pay interest semiannually. What is the coupon rate of the bonds? A) 7.750% B) 11.072% C) 9.375% D) 8.675%
D) 8.675%
Which of the following factors will influence a firm's P/E ratio? A) The investors' required rate of return B) Firm investment opportunities C) General market conditions D) All of the above
D) All of the above
Which of the following statements is true? A) Preferred stockholders are entitled to dividends before common stockholders can receive dividends. B) Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not pay back the investment. C) The market value of preferred stock, like bonds, will usually fluctuate in value primarily as the result of market rates of interest. D) All of the above.
D) All of the above.
Which of the following provisions is unique to preferred stockholders and usually NOT available to common stockholders? A) Cumulative dividends feature B) Voting rights C) Fixed dividend D) Both A and C
D) Both A and C therefore, cumulative dividends and fixed dividends
You are thinking about purchasing 1,000 shares of stock in the following firms: Number of Shares Firm's Beta Firm A 100 0.75 Firm B 200 1.47 Firm C 200 0.82 Firm D 600 1.60 If you purchase the number of shares specified, then the beta of your portfolio will be: A) 1.16. B) 1.35. C) 1.00. D) Cannot be determined without knowing the stock prices.
D) Cannot be determined without knowing the stock prices.
________ gives minority shareholders more power to elect board of directors. A) Preemptive right B) Majority voting C) Proxy fights D) Cumulative voting
D) Cumulative voting
A small, newly listed technology company is most likely to be listed on A) AMEX. B) NYSE. C) Nasdaq National Markets. D) Nasdaq Capital Markets.
D) Nasdaq Capital Markets.
Which of the following bond types has the greatest risk for investors? A) Debentures B) Mortgage bonds C) Floating rate bonds D) Subordinated debentures
D) Subordinated debentures
Horizon Communications stock pays a fixed annual dividend of $3.00. Because of lower inflation, the market's required yield on this preferred stock has gone from 12% to 10%. As a result A) Horizon's dividend decreased by 6 cents. B) The value of Horizon's preferred increased by $3.00. C) The value of Horizon's preferred decreased by $5.00. D) The value of Horizon's preferred increased by $5.00.
D) The value of Horizon's preferred increased by $5.00.
Common stockholders expect greater returns than bondholders because A) they have no legal right to receive dividends. B) they bear greater risk. C) in the event of liquidation, they are only entitled to receive any cash that is left after all creditors are paid. D) all of the above.
D) all of the above.
Listing requirements for the New York Stock Exchange include A) profitability. B) market value. C) breadth of ownership. D) all of the above.
D) all of the above.
A bond investor seeking capital gains should purchase A) bonds with short maturity dates when interest rates are expected to rise. B) bonds with distant maturity dates when interest rates are expected to rise. C) bonds with short maturity dates when interest rates are expected to decline. D) bonds with distant maturity dates when interest rates are expected to decline.
D) bonds with distant maturity dates when interest rates are expected to decline.
Junk bonds A) pay little or no interest. B) are commonly used to finance municipal waste disposal facilities. C) are issued by the U. S. Treasury Department. D) have yields that are considerably higher than those of the highest rated bonds.
D) have yields that are considerably higher than those of the highest rated bonds.
A(n)________ is used to outline the issuing company's contractual obligations to bondholders. A) mortgage B) debenture C) bond rating D) indenture
D) indenture
Profitable companies often prefer to issue debt rather than preferred stock because A) debt creates less risk for the company. B) interest payments are fixed but preferred shareholders expect dividends to grow. C) preferred shares dilute the voting rights of common shareholders but bonds do not. D) interest on debt is deductible for tax purposes, but preferred dividends are not.
D) interest on debt is deductible for tax purposes, but preferred dividends are not.
As interest rates, and consequently investors' required rates of return, change over time, the ________ of outstanding bonds will also change. A) maturity date B) coupon interest payment C) par value D) price
D) price
If the ROE on a new investment is less than the firm's required rate of return A) the investment increases the firm's value. B) the investment leaves the firm's value unchanged. C) the effect on the firm's value is unpredictable. D) the investment reduces the firm's value.
D) the investment reduces the firm's value.
The discount rate used to value a bond is A) the coupon interest rate. B) determined by the issuing company. C) fixed for the life of the bond. D) the market rate of interest.v
D) the market rate of interest.
A bond with a face value of $1,000 has annual coupon payments of $100 and was issued seven years ago. The bond currently sells for $1,085, has eight years left to maturity. This bond's ________ must be less than 10%. A) current yield B) coupon rate C) current yield and coupon rate D) yield to maturity and current yield
D) yield to maturity and current yield
You are considering the purchase of Wahoo, Inc. The firm just paid a dividend of $4.20 per share. The stock is selling for $115 per share. Security analysts agree with top management in projecting steady growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for stocks of this type is 17.5%. If you were to purchase and hold the stock for three years, what would the expected dividends be worth today? A) $12.60 B) $9.21 C) $17.12 D) $15.55 E) $11.46
E) $11.46
A bond's "spread" refers to the difference between it's Moody's rating and its Standard & Poors rating.
FALSE
A security with a beta of zero has a required rate of return equal to the overall market rate of return.
FALSE
Large, established technology companies such as Apple, Dell, Intel and Microsoft all trade on the NYSE.
FALSE
Maturity risk and liquidity risk are equivalent terms.
FALSE
Miller Motorworks has a $1,000 par value, 8% annual coupon bond with interest payable semiannually with a remaining term of 15 years. The annual market yield on similar bonds is 6%. This bond will at a discount from par.
FALSE
P/E ratios found in published sources or on the internet are always computed by dividing the next period's expected earnings into the current price of the stock.
FALSE
Preferred stock cannot be retired.
FALSE
Pursuant to the Fisher Effect, the real interest rate is exactly equal to the nominal interest rate less the rate of inflation.
FALSE
Shorter-term bonds have greater interest rate risk than do longer-term bonds.
FALSE
So long as a bond sells for an amount above its par value, the coupon interest rate and yield to maturity remain equal.
FALSE
Stock valuation is more precise than bond valuation as stock cash flows are more certain.
FALSE
The NASDAQ trading floors are located in New York City.
FALSE
The P/E ratio is the market price of a share of stock divided by book equity per share.
FALSE
The higher the bond rating, the more default risk associated with the bond.
FALSE
The higher the investor's required rate of return, the higher the P/E ratio will be.
FALSE
To determine the value of a share of preferred stock, the discount rate used is the annual dividend percent.
FALSE
When inflation rates go up, bond prices go up as well.
FALSE
Is the following common stock priced correctly? If no, what is the correct price? Price = $26.25 Required rate of return = 13% Dividend year 0 = $2.00 Dividend year 1 = $2.10
Growth rate = 5% Vcs = 2.10 /(.13 - .05)= $26.25 The stock is priced correctly.
Determine the rate of return on a preferred stock that costs $50 and pays a $6 per share dividend.
K = Div = 6 = 12% Vg 50
Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1 and grows at a rate of 5%.
Kcs = + 5% = 10% + 5% = 15%
Why are longer-term bonds more sensitive to changes in interest rates than shorter-term bonds?
Longer-term bonds are more price-sensitive to changes in interest rates because there are more cash flows remaining whose values are affected by the change. Since shorter-term bonds have fewer cash flows remaining, price sensitivity to change in interest rates will be lower. In addition, as the bond gets closer to maturity, the present value of the maturity payment gets less and less volatile. Duration is a measure of how responsive a bond's price is to changing interest rates. Duration is higher for long-term bonds than for short-term bonds.
BCD's $1,000 par value bonds currently sell for $798.50. The coupon rate is 10%, paid semiannually. If the bonds have five years before maturity, what is the yield to maturity or expected rate of return?
N=10, PV=-798.50, PMT=50, FV=1000, solve for i=8.00 semi-annual rate, 8.00% × 2 = 16%
Given the following information, determine the market value of EAO Company bonds. Par value $1,000 Coupon rate 10% Years to maturity 6 Market rate 8% Interest paid semiannually
N=12, i=4, PMT=50, FV=1000, solve for PV=-1093.85 Price = $1,093.85
Calculate the value of a bond that is expected to mature in 13 years with a $1,000 face value. The interest coupon rate is 8%, and the required rate of return is 10%. Interest is paid annually.
N=13, i=5, PMT=80, FV=1000, solve for PV=.-1116.90 Price = $1,116.90
DAH, Inc. has issued a 12% bond that is to mature in nine years. The bond had a $1,000 par value, and interest is due to be paid semiannually. If your required rate of return is 10%, what price would you be willing to pay for the bond?
N=18, i=5, PMT=60, FV=1000, solve for PV=.-1116.90 Price = $1,116.90
If you are willing to pay $1,392.05 for a 15-year, $1,000 par value bond that pays 10% interest semiannually, what is your expected rate of return?
N=30, PV=-1,392.05, PMT=50, FV=1000, solve for i=2.99 semi-annual rate, 2.99 % × 2 = 6%
The market price of a 20-year, $1,000 bond that pays 9% interest semiannually is $774.31. What is the bond's yield to maturity?
N=40, PV=-774.31, PMT=45, FV=1000, solve for i=6.00 semi-annual rate, 6.00 × 2 = 6%
Draper Company's common stock paid a dividend last year of $3.70. You believe that the long-term growth in the dividends of the firm will be 8% per year. If your required return for Draper is 14%, how much are you willing to pay for the stock?
P0 =$66.60
Discuss two reasons why preferred stock would be viewed as less risky than common stock to investors.
Preferred stockholders are paid before common stockholders in the event of bankruptcy. Common stockholders, as the residual owners of a corporation, would receive any monies remaining after bondholder and preferred stock claims are satisfied. Preferred dividends are paid before common stock dividends in the normal course of business. In the event that a preferred dividend is not paid, it accumulates and dividends in arrears must be paid before any common stock dividends can be declared. Common shareholders take the risk that they will not receive dividends. The magnitude of the cash flows from preferred is also known where it is not known for common stock. Because cash flows are more certain, preferred stock would be considered less risky to the investor.
The common stock of Cranberry, Inc. is selling for $26.75 on the open market. A dividend of $3.68 is expected to be distributed, and the growth rate of this company is estimated to be 5.5%. If Richard Dean, an average investor, is considering purchasing this stock at the market price, what is his expected rate of return?
R = (D/V) + g R = ($3.68/$26.75) + .055 R = 19.26%
Security A has an expected rate of return of 22% and a beta of 2.5. Security B has a beta of 1.20. If the Treasury bill rate is 2.0%, what is the expected rate of return for security B?
RA = RF + BA(Rm - Rf) .22 = .02 + 2.5 (Rm - .02) .20 = 2.5 (Rm - .02) = 2.5 Rm - .05 .25 = 2.5 Rm .10 = Rm RB = Rf + BB(Rm - Rf) RB = .02 + 1.20(.10 - .02) RB = .116 or 11.6%
Tannerly Worldwide's common stock is currently selling for $48 a share. If the expected dividend at the end of the year is $2.40 and last year's dividend was $2.00, what is the rate of return implicit in the current stock price?
Rc = 2.40/48 + (2.40 - 2.00)/2.00 = .05 + .20 = 25%
AA & Co. has a beta of .656. If the expected market return is 13.2% and the risk-free rate is 5.7%, what is the appropriate required return of AA & Co. using the CAPM model?
Required Rate of Return = Risk-Free Rate + (Market Return - Risk-Free Rate) × Beta = 5.7% + (13.2% - 5.7%) × 0.656 = 10.62%
Texon's preferred stock sells for $85 and pays $11 each year in dividends. What is the required rate of return?
Required rate of return = 0.129
A AAA rated bond's yield to maturity will be very close to it's expected yield.
TRUE
A basis point is equal to one hundredth of a percentage point.
TRUE
A block trade is a trade involving 10,000 or more shares by a single holder.
TRUE
A bond issued by Pomme Computers has a coupon rate of #5 paid semi-annually. If the market's required rate of return on this bond is also 3%, the bond will sell at par value.
TRUE
A bond's value equals the present value of interest and principal the owner will receive.
TRUE
A company may issue multiple classes of preferred stock.
TRUE
As market interest rates increase, bond prices decrease.
TRUE
As the maturity date of a bond approaches, the bond's market value approaches its par value.
TRUE
As the time to maturity increases, the maturity premium increases.
TRUE
Bonds that sell at a discount have a coupon rate lower than the market interest rate.
TRUE
Common stock represents a claim on residual income.
TRUE
Convertible bonds can be exchanged for the issuing firm's common stock at a price specified at the time of issue.
TRUE
Cumulative voting gives each share of stock a number of votes equal to the number of directors being elected to the board.
TRUE
Debentures are unsecured long-term debt.
TRUE
Eurobonds are bonds issued in a country different from the one in whose currency the bond is denominated.
TRUE
In addition to stocks in individual companies, the AMEX conducts trading in such securities as ETFs and options.
TRUE
Lambda Co. has bonds outstanding that mature in 10 years. The bonds have $1,000 par value, pay interest annually at a rate of 9%, and have a current selling price of $1,125. The yield to maturity on the bonds is less than 9%.
TRUE
Long-term government bonds are not without maturity risk.
TRUE
The better the bond rating, the lower the rate of return demanded in the capital markets.
TRUE
The cumulative dividend feature is necessary to protect the rights of preferred stockholders.
TRUE
The current yield of a bond will equal its coupon rate when the bond is selling at par value.
TRUE
The expected rate of return implied by a given market price equals the required rate of return for investors at the margin.
TRUE
The growth rate of future earnings is determined by return on equity and the profit-retention rate.
TRUE
The longer the time to maturity, the more sensitive a bond's price to changes in market interest rates.
TRUE
The sensitivity of a bond's value to changing interest rates depends on both the bond's time to maturity and its pattern of cash flows.
TRUE
The stock valuation model D1/(Rc - g) requires Rc > G.
TRUE
The value of preferred shares is affected by changes in interest rates.
TRUE
Trading on the Nasdaq is done electronically and does not require a physical location.
TRUE
When bankruptcy occurs, the claims of the common shareholders may go unsatisfied.
TRUE
When referring to bonds, expected rate of return and yield to maturity are often used interchangeably.
TRUE
Zero coupon bonds are disadvantageous to the issuing firm if interest rates fall.
TRUE
Compare and contrast current yield and yield to maturity.
The current yield is a measure of the one-year return on a bond if purchased today. The current yield is calculated by taking a bond's annual coupon payment and dividing by its market price. Yield to maturity measures the return on a bond if it is held to maturity. The yield to maturity is that discount rate that would make the present value of the expected future cash flows exactly equal to the market price at time of calculation. In an efficient market, the yield to maturity will reflect the market rate of interest and required return of bondholders.
What elements determine what the yield to maturity will be for a bond?
The starting point is the risk free rate, a rate for a bond with no risks. A short term treasury bill reflects the risk free rate. The risk free rate comprises the real rate of return plus an inflation premium, so that the investor can earn the real return. If one knows the nominal risk free rate and the inflation rate, one can determine the real rate through the Fisher effect. When there is a possibility of default, the investor must receive a default premium to reflect that risk. Finally, there is the risk that the yield to maturity of the bond may change over the life of the bond, possibly lowering its value. This risk is reflected by the investor adding a maturity premium to the required return. In summary, the yield to maturity will be the real return, plus premiums for inflation, default, and maturity.
Briefly discuss why there is no reason to believe that the market will reward investors with additional returns for assuming unsystematic risk.
Through diversification, risk can be lowered without sacrificing returns. The market rewards investors for the systematic risk that cannot be eliminated through proper asset allocation in a diversified portfolio.
You are considering the purchase of AMDEX Company stock. You anticipate that the company will pay dividends of $2.00 per share next year and $2.25 per share the following year. You believe that you can sell the stock for $17.50 per share two years from now. If your required rate of return is 12%, what is the maximum price that you would pay for a share of AMDEX Company stock?
Vc = $2.00 PVIF12%,1 + $19.75 PVIF12%,2 = ($2.00)(.893) + ($19.75)(.797) = $17.53
Given the anticipated rate of inflation (i) of 6.13% and the real rate of interest (R) of 7.56%, what is the true inflation premium?
We know the inflation premium to equal i + iR or = 0.0613 + (.0613)(.0756) = 6.59%
Explain why an increase in the inflation rate will cause the yield to maturity on a bond to increase.
When the inflation rate increases, it means that the risk free rate of return will increase. This happens because investors need to make some real return, even on a risk free investment. This means that in order to keep the real rate of return constant, when the inflation rate goes up, the nominal interest rate goes up as well. Consequently, to maintain the same real rate of return, the nominal rate must go up, which in turn raises the required return, or yield to maturity.
Garvin, Inc.'s bonds have a par value of $1,000. The bonds pay semiannual interest of $40 and mature in five years. a. How much would you pay for Garvin bonds if your required rate of return is 10%? b. How much would you pay if your required rate of return is 8%?
a. N=10, i=5, PMT=40, FV=1000, solve for PV=-922.78 Price = $922.78 b. Price = $1,000
Miller/Hershey's preferred stock is selling at $54 on the market and pays an annual dividend of $4.20 per share. a. What is the expected rate of return on the stock? b. If an investor's required rate of return is 9%, what is the value of the stock for that investor? c. Considering the investor's required rate of return, does this stock seem to be a desirable investment?
a. R = D/V R = $4.20/54 R = 7.78% b. V = D/R V = $4.20/.09 V = $46.66 c. No, it is not a desirable investment.
If provided the nominal rate of interest (r) of 14.2% and the anticipated rate of inflation (i) of 5.5%, what is the real rate of interest (R)?
r = R + i + iR .142 = R + .055 + (.055)(R) .142 - .055 = 1.055R + .055 - .055 .087 = 1.055R R = 8.2%
Given the anticipated rate of inflation (i) of 6.3% and the real rate of interest (R) of 4.7%, find the nominal rate of interest (r).
r = R + i + iR r = .047 + 0.63 + (.063)(.047) r = 11.3%
Colby & Company bonds pay semiannual interest of $50. They mature in 15 years and have a par value of $1,000. The market rate of interest is 8%. The market value of Colby bonds is (round to the nearest dollar) A) $1,173. B) $743. C) $1,000. D) $827.
A) $1,173.
On average, when the overall market changes by 10%, the stock of Veracity Communications changes 12%. What is Veracity's beta? A) 1.2 B) 8.33% C) 12% D) Insufficient information is provided
A) 1.2
The rate on six-month T-bills is currently 5%. Andvark Company stock has a beta of 1.69 and a required rate of return of 15.4%. According to CAPM, determine the return on the market portfolio. A) 11.15% B) 6.15% C) 17.07% D) 14.11%
A) 11.15%
Hefty stock has a beta of 1.2. If the risk-free rate is 7% and the market risk premium is 6.5%, what is the required rate of return on Hefty? A) 14.8% B) 14.4% C) 12.4% D) 13.5%
A) 14.8%
Which of the following has a beta of zero? A) A risk-free asset B) The market C) A high-risk asset D) Both A and B
A) A risk-free asset
Which of the following is a good measure of the relationship between an investment's returns and the market's returns? A) The beta coefficient B) The standard variation C) The CPI D) The S&P 500 Index
A) The beta coefficient
Which of the following features allows a borrower to redeem or repurchase a bond issue before its maturity date? A) The call provision B) Convertibility C) Floating rate D) The priority of claims
A) The call provision
The security market line (SML) relates risk to return, for a given set of market conditions. If risk aversion increases, which of the following would most likely occur? A) The market risk premium would increase. B) Beta would increase. C) The slope of the SML would increase. D) The SML line would shift up.
A) The market risk premium would increase.
You are thinking of adding one of two investments to an already well diversified portfolio. Security A: Expected return= 12% Stand dev of returns= 20.9% Beta= .8 Security B: Expected return= 12% Stand dev of returns= 10.1% Beta= 2 If you are a risk-averse investor A) security A is the better choice. B) security B is the better choice. C) either security would be acceptable. D) cannot be determined with information given.
A) security A is the better choice.
The interest on corporate bonds is typically paid A) semiannually. B) annually. C) quarterly. D) monthly.
A) semiannually.
A stock's beta is a measure of its A) systematic risk. B) unsystematic risk. C) company-specific risk. D) diversifiable risk.
A) systematic risk.
If you hold a portfolio made up of the following stocks: Investment Value Beta Stock A $2,000 1.5 Stock B $5,000 1.2 Stock C $3,000 .8 What is the beta of the portfolio? A) 1.17 B) 1.14 C) 1.32 D) Can't be determined from information given
B) 1.14
Your broker mailed you your year-end statement. You have $25,000 invested in Dow Chemical, $18,000 tied up in GM, $36,000 in Microsoft stock, and $11,000 in Nike. The betas for each of your stocks are 1.55 for Dow, 1.12 for GM, 2.39 for Microsoft, and .76 for Nike. What is the beta of your portfolio? A) 1.46 B) 1.70 C) 2.60 D) 0.41
B) 1.70 (25000*1.55+18000*1.12+36000*2.39+11000*0.76)/(25000+18000+36000+11000) =(25000*1.55+18000*1.12+36000*2.39+11000*0.76)/(25000+18000+36000+11000) = 1.70
Davis & Davis issued $1,000 par value bonds at 102. The bonds pay 12% interest annually and mature in 30 years. The market rate of interest is (round to the nearest hundredth of a percent) A) 12.00%. B) 11.71%. C) 10.12%. D) 11.29%.
B) 11.71%.
Use info from above: The required rate of return for Firm A is A) 8%. B) 12%. C) 16%. D) Cannot be determined with information given.
B) 12%.
use info from above: Firm B's risk premium is A) 2.66%. B) 4.8%. C) 6.3%. D) 8.1%.
B) 4.8%.
Marjen stock has a required return of 20%. The expected market return is 15%, and the beta of Marjen's stock is 1.5. Calculate the risk-free rate.' A) 4% B) 5% C) 6% D) 7%
B) 5%
The Blackburn Group has recently issued 20-year, unsecured bonds rated BB by Moody's. These bonds yield 443 basis points above the U.S. Treasury yield of 2.76%. The yield to maturity on these bonds is A) 4.43%. B) 7.19%. C) 12.23%. D) mortgage bonds.
B) 7.19%.
Changes in the general economy, such as changes in interest rates or tax laws, represent what type of risk? A) Firm-specific risk B) Market risk C) Unsystematic risk D) Diversifiable risk
B) Market risk
You are considering investing in Ford Motor Company. Which of the following is an example of diversifiable risk? A) Risk resulting from the possibility of a stock market crash B) Risk resulting from uncertainty regarding a possible strike against Ford C) Risk resulting from an expected recession D) Risk resulting from interest rates decreasing
B) Risk resulting from uncertainty regarding a possible strike against Ford
Which of the following is generally used to measure the market when calculating betas? A) The Dow Jones Industrial Average B) The Standard & Poors 500 Index C) The Value Line Quantam Index D) The Case Schiller Housing Index
B) The Standard & Poors 500 Index
A $1,000 par value 10-year bond with a 10% coupon rate recently sold for $900. The yield to maturity A) is 10%. B) is greater than 10%. C) is less than 10%. D) cannot be determined.
B) is greater than 10%.
Sterling Corp. bonds pay 10% annual interest and are selling at 97. The market rate of interest A) is less than 10%. B) is greater than 10%. C) equals 10%. D) cannot be determined.
B) is greater than 10%.
The market risk premium is measured by A) beta. B) market return less risk-free rate. C) T-bill rate. D) standard deviation.v
B) market return less risk-free rate.
A stock with a beta greater than 1.0 has returns that are ________ volatile than the market, and a stock with a beta of less than 1.0 exhibits returns which are ________ volatile than those of the market portfolio. A) more, more B) more, less C) less, more D) less, lessv
B) more, less
The capital asset pricing model: A) provides a risk-return trade-off in which risk is measured in terms of the market returns. B) provides a risk-return trade-off in which risk is measured in terms of beta. C) measures risk as the correlation coefficient between a security and market rates of return. D) depicts the total risk of a security.
B) provides a risk-return trade-off in which risk is measured in terms of beta.
Advantages to borrowing in the private market include A) less restrictive covenants. B) reduced initial costs. C) lower interest costs. D) avoiding future SEC registration.
B) reduced initial costs.
All of the following affect the value of a bond EXCEPT A) investors' required rate of return. B) the recorded value of the firm's assets. C) the coupon rate of interest. D) the maturity date of the bond.
B) the recorded value of the firm's assets.
Provide an intuitive discussion of beta and its importance for measuring risk.
Beta is an important measure that indicates the systematic risk of a given investment. Since systematic risk cannot be diversified away, investors are compensated for taking this risk. Beta compares the market risk of a particular investment with the market risk of the market, and the risk premium necessary for a stock is directly proportional to the risk premium for the market as a whole. When the risk premium is added to the risk free rate, this results in the required return for the stock.
Caldwell, Inc. sold an issue of 30-year, $1,000 par value bonds to the public. The bonds carry a 10.85% coupon rate and pay interest semiannually. It is now 12 years later. The current market rate of interest on the Caldwell bonds is 8.45%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1. A) $751 B) $1,177 C) $1,220 D) $976
C) $1,220
Bell Weather, Inc. has a beta of 1.25. The return on the market portfolio is 12.5%, and the risk-free rate is 5%. According to CAPM, what is the required return on this stock? A) 20.62% B) 9.37% C) 14.37% D) 15.62%
C) 14.37% 5 + 1.25* (12.5-5) = 14.375
The expected return on the market portfolio is currently 11%. Battmobile Corporation stockholders require a rate of return of 23.0%, and the stock has a beta of 2.5. According to CAPM, determine the risk-free rate. A) 17.5% B) 2.75% C) 3.0% D) 9.2%
C) 3.0%
The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The return on the market portfolio is 12%, and the risk-free rate is 2.5%. According to CAPM, what is the risk premium on a stock with a beta of 1.0? A) 12.00% B) 22.33% C) 9.5% D) 14.5%
C) 9.5% 12-2.5= 9.5
Which of the following statements is true? A) A stock with a beta less than zero has no exposure to systematic risk. B) A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0. C) A stock with a beta less than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0. D) A stock with a beta less than 1.0 has higher nondiversifiable risk than a stock with a beta of 1.0.
C) A stock with a beta less than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.
Which of the following is NOT an example of systematic risk? A) Inflation B) Recession C) Management risk D) Interest rate risk
C) Management risk
You are going to invest all of your funds in one of three projects with the following distribution of possible returns: Project 1: Stand dev= 12% Prob= 50% chance, Return= 20% Prob= 50% chance, Return= -4% Project 2: Stand Dev 19.5% Probability: Return: 30% Chance 30% 40% Chance 10% 30% Chance -20% Project 3: Stand Dev 12% Probability: Return: 10% Chance 30% 40% Chance 15% 40% Chance 10% 10% Chance -21% If you are a risk-averse investor, which one should you choose? A) Project 1 B) Project 2 C) Project 3
C) Project 3 -E(R) for Project 1 = (0.5) * (0.2) + (0.5) * (-0.04) + (0.3) * (-0.2) = 0.1 - 0.02 - 0.06 = 0.02 or 2% E(R) for Project 2 = (0.3) * (0.3) + (0.4) * (0.1) = 0.09 + 0.04 = 0.13 or 13% E(R) for Project 3 = (0.1) * (0.3) + (0.4) * (0.15) + (0.4) * (0.1) + (0.1) * (-0.21) = 0.03 + 0.06 + 0.04 - 0.021 = 0.109 or 109% Standard deviation for Project 1 = 12% Standard deviation for Project 2 = 19.5% Standard deviation for Project 3 = 12% For risk averse investors, Project 3 is suitable since E(R) ie. expected return is more and standard deviation is less.
What type of risk can investors reduce through diversification? A) All risk B) Systematic risk only C) Unsystematic risk only D) Uncertainty
C) Unsystematic risk only
Which of the following statements is true? A) Systematic, or market, risk can be reduced through diversification. B) Both systematic and unsystematic risk can be reduced through diversification. C) Unsystematic, or company, risk can be reduced through diversification. D) Neither systematic nor unsystematic risk can be reduced through diversification.Which of the following statements is true?
C) Unsystematic, or company, risk can be reduced through diversification.
The market (systematic) risk associated with an individual stock is most closely identified with the A) variance of the returns of the stock. B) variance of the returns of the market. C) beta of the stock. D) standard deviation of the stock.
C) beta of the stock.
The appropriate measure for risk according to the capital asset pricing model is A) the standard deviation of a firm's cash flows. B) alpha. C) beta. D) probability of correlation.
C) beta.
Currently, the expected return on the market is 12.5% and the required rate of return for Alpha, Inc. is 12.5%. Therefore, Alpha's beta must be A) less than 1.0. B) greater than 1.0. C) equal to 1.0. D) unknown based on the information provided.]
C) equal to 1.0.
(Starting chapter 9) The par value of a bond A) never equals its market value. B) is determined by the investor. C) generally is $1,000. D) is never returned to the bondholder.
C) generally is $1,000.
The detailed legal agreement between a bond's issuer and its trustees is known as the A) collateral agreement. B) call provision. C) indenture. D) covenant.
C) indenture.
The yield to maturity on a bond A) is fixed in the indenture. B) is lower for higher-risk bonds. C) is the required return on the bond. D) is generally equal to the coupon interest rate.v
C) is the required return on the bond.
Bonds with ratings lower than Standard & Poor's BBB or Moody's Baa are classified as A) in default. B) investment grade. C) not investment grade. D) medium quality.
C) not investment grade.
Advantages of privately placing debt include all of the following EXCEPT A) speed. B) reduced placement costs. C) restrictive covenants. D) flexibility.
C) restrictive covenants.
Investment risk is A) the probability of achieving a return that is greater than what was expected. B) the probability of achieving a beta coefficient that is less than what was expected. C) the probability of achieving a return that is less than what was expected. D) the probability of achieving a standard deviation that is less than what was expected.
C) the probability of achieving a return that is less than what was expected.
The risk-return relationship for each financial asset is shown on A) the capital market line. B) the New York Stock Exchange market line. C) the security market line. D) none of the above.
C) the security market line.
MI has a $1,000 par value, 30-year bond outstanding that was issued 20 years ago at an annual coupon rate of 10%, paid semiannually. Market interest rates on similar bonds are 7%. Calculate the bond's price. A) $956.42 B) $1,000.00 C) $1,168.31 D) $1,213.19
D) $1,213.19
Use info from above: Firm A's risk premium is A) 4%. B) 6%. C) 8%. D) 10%.
D) 10%.
Huit Industries' common stock has an expected return of 11.4% and a beta of 1.2. If the expected risk-free return is 3%, what is the expected return for the market (round your answer to the nearest .1%)? A) 7.7% B) 9.6% C) 10.0% D) 11.4%
D) 11.4%
Given the capital asset pricing model, a security with a beta of 1.5 should return ________, if the risk-free rate is 3% and the market return is 11%. A) 16.5% B) 14.0% C) 14.5% D) 15.0%
D) 15.0% 3 + 1.5*(11-3)= 15
What is the expected rate of return on a bond that matures in seven years, has a par value of $1,000, a coupon rate of 14%, and is currently selling for $911? Assume annual coupon payments. A) 7.81% B) 15.36% C) 15.61% D) 16.22%
D) 16.22%
Tanzlin Manufacturing's common stock has a beta of 1.5. If the expected risk-free return is 2% and the expected return on the market is 14%, what is the expected return on the stock? A) 13.5% B) 21.0% C) 16.8% D) 20.0%
D) 20.0% 2 + 1.2*(14-2)= 20
Use the following information to answer the following question(s). Market 1: Firm A beta : 1.25 Firm B beta: 0.6 Market Return 10% Risk Free Rate 2% The market risk premium is A) 2%. B) 4%. C) 6%. D) 8%.
D) 8%.
Siebling Manufacturing Company's common stock has a beta of .8. If the expected risk-free return is 2% and the market offers a premium of 8% over the risk-free rate, what is the expected return on Siebling's common stock? A) 7.8% B) 13.4% C) 14.4% D) 8.4%
D) 8.4% Expected return - Risk free rate+ Beta*( market return- Risk free rate) =2+.8*(8)= 8.4%
You hold a portfolio with the following securities: Security Percent of Portfolio Beta Return X Corporation 20% 1.35 14% Y Corporation 35% .95 10% Z Corporation 45% .75 8% Compute the expected return and beta for the portfolio. A) 10.67%, 1.02 B) 9.9%, 1.02 C) 34.4%, .94 D) 9.9%, .94
D) 9.9%, .94
The security market line (SML) relates risk to return, for a given set of market conditions. If expected inflation increases, which of the following would most likely occur? A) The market risk premium would increase. B) Beta would increase. C) The slope of the SML would increase. D) The SML line would shift up.
D) The SML line would shift up.
Corporate debt can be privately placed with A) union pension funds. B) life insurance companies. C) state pension funds. D) all of the above
D) all of the above
On any given day, a bond can be issued at A) a discount. B) a premium. C) par. D) all of the above.
D) all of the above.
The issuance of bonds to raise capital for a corporation A) magnifies the returns to the stockholders. B) increases risk to the stockholders. C) is a cheaper form of capital than the issuance of common stock. D) all of the above.
D) all of the above.
The beta of ABC Co. stock is the slope of A) the security market line. B) the characteristic line for a plot of returns on the S&P 500 versus returns on short-term Treasury bills. C) the arbitrage pricing line. D) the line of best fit for a plot of ABC Co. returns against the returns of the market portfolio for the same period.
D) the line of best fit for a plot of ABC Co. returns against the returns of the market portfolio for the same period.
Beta is a statistical measure of A) hyperbolic. B) total risk. C) the standard deviation. D) the relationship between an investment's returns and the market return.
D) the relationship between an investment's returns and the market return.
A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.
FALSE
A stock with a beta of 1.0 would on average earn the risk-free rate.
FALSE
Betas for individual stocks tend to be stable.
FALSE
If investors became more risk averse The SML would shift downward and the slope of the SML would fall.
FALSE
Increasing a portfolio from 2 stocks to 4 stocks will reduce risk more than increasing a portfolio from 10 stocks to 12 stocks.
FALSE
Long-term bonds issued by large, established corporations are commonly used to estimate the risk-free rate.
FALSE
Stocks with higher betas are usually more stable than stocks with lower betas.
FALSE
The current yield is the average rate of interest a bond will from the time of purchase until it matures.
FALSE
The debenture is the legal agreement between the firm issuing a bond and the bond trustee who represents the bondholders.
FALSE
The market beta changes frequently with economic conditions.
FALSE
The market rewards assuming additional unsystematic risk with additional returns.
FALSE
The par value of a corporate bond indicates the level of interest payments that will be paid to investors.
FALSE
The security market line (SML) intercepts the Y axis at the risk-free rate.
FALSE
Total risk equals unique security risk times systematic risk.
FALSE
Asset A has a required return of 18% and a beta of 1.4. The expected market return is 14%. What is the risk-free rate? Plot the security market line.
K = Krf + (Km - Krf)b 18% = X + (14% - X)1.4 18% - X =19.6% - 1.4X .4X = 1.6% X = 4% = Risk - free Rate = Krf
A conversion feature confers the option of redeeming a bond for the company's stock rather than cash
TRUE
Any unsecured long-term debt instrument is a debenture.
TRUE
Beta is a measurement of the relationship between a security's returns and the general market's returns.
TRUE
If investors expected inflation to increase in the future, the SML would shift up, but the slope would remain the same.
TRUE
If the issuing company becomes insolvent, the claims of the bondholders are honored before those of preferred stockholders.
TRUE
It is impossible to eliminate all risk through diversification
TRUE
On average, the market rewards assuming additional systematic risk with additional returns.
TRUE
The CAPM designates the risk-return tradeoff existing in the market, where risk is defined in terms of beta.
TRUE
The S&P 500 Index is commonly used to estimate the market rate of return.
TRUE
The security market line can drawn by connecting the risk-free rate and the expected return on the market portfolio.
TRUE
U. S. Treasury bills can be used to approximate the risk-free rate
TRUE
Unsystematic risk can be eliminated through diversification.
TRUE
