## 113 terms

### Which of the following factors would be most likely to lead to an increase in interest rates in the economy?

Most businesses decide to modernize and expand their manufacturing capacity, and to install new equipment to reduce labor costs.

### Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?

Corporations step up their expansion plans and thus increase their demand for capital.

### Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds. Assuming the announcement was not expected, what effect, other things held constant, would that have on bond prices and interest rates?

Prices would decline and interest rates would rise.

### Which of the following statements is most correct?

Sarbanes-Oxley prohibits auditors from providing consulting services to the companies they audit.

### Which of the following statements is most correct?

Sarbanes-Oxley requires the CEO sign and certify the company's financial statements.

### Which of the following statements is most correct?

A market is transparent when accurate information is available to all market participants.

### Which of the following statements is most correct?

EVA is a measure of the firm's true profitability.

### Which of the following statements is most correct?

(b) and (c) are correct.: Stock is valuable only because it generates cash flows for the investor. , Managers can affect firm value by changing the riskiness of its cash flows.

### Which of the following statements is most correct?

A firm's fundamental value is the present value of its future free cash flows.

###
Given the following information, determine which beta coefficient for Stock A is consistent with equilibrium:

rA = 11.3%; rRF = 5%; rM = 10%

1.26

### The tighter the probability distribution of expected future returns, the smaller the risk of a given investment as measured by the standard deviation.

True

### The coefficient of variation, calculated as the standard deviation divided by the expected return, is a standardized measure of the risk per unit of expected return.

True

### Assume that the risk-free rate is 5% and the market risk premium is 6%. What is the require rate of return on a stock that has a beta of 1.2?

12.2%

###
Historical rates of return for the market and for Stock A are given below:

Year || Market || Stock A

1 || 6.0% || 8.0%

2 || -8.0 ||3.0

3 || -8.0 ||-2.0

4 ||18.0 ||12.0

If the required return on the market is 11 percent and the risk-free rate is 6 percent, what is the required return on Stock A, according to CAPM/SML theory?

8.27%

###
Assume that a new law is passed which restricts investors to holding only one asset. A risk-averse investor is considering two possible assets as the asset to be held in isolation. The assets' possible returns and related probabilities (i.e., the probability distributions) are as follows:

Asset X || Asset Y

P || r || P || r

0.10|| -3% || 0.05 || -3%

0.10|| 2 || 0.10 || 2

0.25 || 5 || 0.30 || 5

0.25 || 8 || 0.30 || 8

0.30 || 10 || 0.25 || 10

Which asset should be preferred?

Asset Y, since its coefficient of variation is lower and its expected return is higher.

### A stock has an expected return of 12.25 percent. The beta of the stock is 1.15 and the risk-free rate is 5 percent. What is the market risk premium?

6.30%

###
The returns of United Railroad Inc. (URI) are listed below, along with the returns on "the market":

Year || Market || URI

1 || -14% || -9%

2 || 16 || 11

3 || 22 || 15

4 || 7 || 5

5 || -2 || -1

what is the beta value of (URI) ?

0.667

### The tighter the probability distribution of expected future returns, the smaller the risk of a given investment as measured by the standard deviation.

True

### When investors require higher rates of return for investments that demonstrate higher variability of returns, this is evidence of risk aversion.

True

### If investors expected inflation to increase in the future, and they also become risk averse, what could be said about the change in the Security Market Line (SML)?

The SML would shift up and the slope would increase.

### Which of the following statements is CORRECT?

The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94.

### Which of the following statements is CORRECT?

Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time.

### Which of the following are the factors for the Fama-French model?

The excess market return, a size factor, and a book-to-market factor.

### For markets to be in equilibrium (that is, for there to be no strong pressure for prices to depart from their current levels),

The expected rate of return must be equal to the required rate of return

### In a portfolio of three different stocks, which of the following could NOT be true?

The beta of the portfolio is less than the betas of each of the individual stocks.

### Assume an economy in which there are three securities: Stock A with rA = 10% and sA = 10%; Stock B with rB = 15% and sB = 20%; and a riskless asset with rRF = 7%. Stocks A and B are uncorrelated (rAB = 0). Which of the following statements is most CORRECT?

The expected return on the investor's portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (SD) that is between 10% and 20%.

### Assume that you hold a well-diversified portfolio that has an expected return of 12.0% and a beta of 1.20. You are in the process of buying 100 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 15.0% and a beta of 2.00. The total value of your current portfolio is $9,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock? [rp; bp]

12.30%; 1.28

###
The returns on the market, the returns on United Fund (UF), the risk-free rate, and the required return on the United Fund are shown below. Assuming the market is in equilibrium and that beta can be estimated with historical data, what is the required return on the market, rM?

Year|| Market|| UF

2003|| -9%|| -14%

2004|| 11%|| 16%

2005|| 15%|| 22%

2006|| 5%|| 7%

2007|| -1%|| -2%

rRF: 7.00%; rUnited: 15.00%

12.33%

### If you plotted the returns of Selleck & Company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.

True

### If the returns of two firms are negatively correlated, then one of them must have a negative beta.

True

### It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm are negative.

True

### Arbitrage pricing theory is based on the premise that more than one factor affects stock returns, and the factors are specified to be (1) market returns, (2) dividend yields, and (3) changes in inflation.

False

### Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?

A reduction in market interest rates.

### A bond has an annual 11 percent coupon rate, an annual interest payment of $110, a maturity of 20 years, a face value of $1,000, and makes annual payments. It has a yield to maturity of 8.83 percent. If the price is $1,200, what rate of return will an investor expect to receive during the next year?

8.83%

### Consider a $1,000 par value bond with a 7 percent annual coupon. The bond pays interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10 percent?

8.46%

### You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6 months. If your nominal annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay for this bond?

$1,124.62

### A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If your nominal annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond?

$1,115.57

### If a firm raises capital by selling new bonds, the buyer is called the "issuing firm," and the coupon rate is generally set equal to the required rate.

False

### A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates.

False

### Many bond indentures allow the company to acquire bonds for a sinking fund either by purchasing bonds in the market or by a lottery administered by the trustee for the purchase of a percentage of the issue through a call at face value.

True

### A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells) at par, therefore providing compensation to investors in the form of capital appreciation.

False

### A junk bond is a high risk, high yield debt instrument typically used to finance a leveraged buyout or a merger, or to provide financing to a company of questionable financial strength.

True

### Restrictive covenants are designed so as to protect both the bondholder and the issuer even though they may constrain the actions of the firm's managers. Such covenants are contained in the bond's indenture.

True

### A corporate bond matures in 14 years. The bond has an 8 percent semiannual coupon and a par value of $1,000. The bond is callable in five years at a call price of $1,050. The price of the bond today is $1,075. What are the bond's yield to maturity and yield to call?

YTM = 7.14%; YTC = 7.05%

### You just purchased a 15-year bond with an 11 percent annual coupon. The bond has a face value of $1,000 and a current yield of 10 percent. Assuming that the yield to maturity of 9.7072 percent remains constant, what will be the price of the bond 1 year from now?

$1,097

### Most studies of stock market efficiency suggest that the stock market is highly efficient in the weak form and reasonably efficient in the semistrong form. Based on these findings which of the following statements are correct?

Information you read in The Wall Street Journal today cannot be used to select stocks that will consistently beat the market.

### Which of the following statements is false?

Going public establishes a true market value for the firm and ensures that a liquid market will always exist for the firm's shares.

### The expected rate of return on the common stock of Northwest Corporation is 14 percent. The stock's dividend is expected to grow at a constant rate of 8 percent a year. The stock currently sells for $50 a share. Which of the following statements is most correct?

The stock price is expected to be $54 a share in one year.

### A share of common stock has just paid a dividend of $2.00. If the expected long-run growth rate for this stock is 15 percent, and if investors require a 19 percent rate of return, what is the price of the stock?

$57.50

### Waters Corporation has a stock price of $20 a share. The stock's year-end dividend is expected to be $2 a share (D1 = $2.00). The stock's required rate of return is 15 percent and the stock's dividend is expected to grow at the same constant rate forever. What is the expected price of the stock seven years from now?

$28

### A share of preferred stock pays a dividend of $0.50 each quarter. If you are willing to pay $20.00 for this preferred stock, what is your nominal (not effective) annual rate of return?

10%

### Given the following information, calculate the expected capital gains yield for Chicago Bears Inc.: beta = 0.6; rM = 15%; rRF = 8%; D1 = $2.00; P0 = $25.00. Assume the stock is in equilibrium and exhibits constant growth.

4.2%

### The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares sold by the firm. This right protects current stockholders against both dilution of control and dilution of value.

True

### When a corporation's shares are owned by a few individuals who are associated with the firm's management, we say that the stock is "closely held."

True

### A publicly owned corporation is simply a company whose shares are held by the investing public, which may include other corporations and institutions.

True

### A proxy is a document giving one party the authority to act for another party, typically the power to vote shares of common stock. A proxy can be an important tool relating to control of the firm.

True

### Management's basic, overriding goal is to create ___________ for _____________

Value ; Stockholders

###
If businesses are successful and earn above-normal ___________, this will attract ___________,

which will eventually drive prices down, so the main long-term beneficiary is the ____________.

profits;competition;consumer

###
Free cash flow (FCF) is: ___________ minus___________ ________ minus ___________ minus

________________.

Sales-(Operating Cost + Operating Taxes + Required investments in operating

capital).

### The fundamental value of a firm is the present value of its expected ________________.

free cash flows

###
The weighted average cost of capital is the average return required by ________________ and

________________.

shareholders, creditors

###
A(n) ________________ relationship arises whenever one or more individuals (the principals)

hire another individual or organization (the agent) to act on their behalf, delegating decisionmaking authority to that agent

agency

###
Potential agency problems exist between a firm's shareholders and its ________________ and

also between managers and ________________

managers; creditors (or debtholders)

###
Executive compensation contracts typically have three components, ________________ ,

________________ , and ________________ .

annual salary; bonus; options

### ________________ allow managers to purchase stock at some future time at a given price

Executive stock options

###
A(n) ________________ is the acquisition of a company over the opposition of its

management

hostile takeover

###
A relatively new measure of managerial performance, ___________________________ is being

used by more and more firms to tie executive compensation to stock wealth maximization

economic value added

###
. A potential ________________ arises whenever the manager of a firm owns less than 100

percent of the firm's common stock.

agency problem

###
If reliable, accurate information is available to all market participants, then we are said to have

________________ .

market transparency

### The Sarbanes-Oxyley Act of 2000 was designed to address ___________________________

corporate fraud

###
The value of an investment made overseas will depend on what happens to exchange rates, and

this is known as ________________ risk.

exchange rate

###
Changes in ______________________________ and _______________________ _ can cause

exchange rates to fluctuate.

relative inflation; country risk

###
The types of actions that help a firm maximize stock price are generally not directly beneficial to

society. True or False

False

###
Which of the following factors tend to encourage management to pursue stock price

maximization as a goal?

a) Shareholders link management's compensation to company performance

b) Managers' reactions to the threat of firing and hostile takeovers.

c) Managers do not have goals other than stock price maximization.

d) Statement a and b are correct.

e) Statement a, b and c are correct.

d

###
Ripken Iron Works faces the following probability distribution:

State of Probability of Stock's Expected Return

the Economy State Occurring if this State Occurs

Boom 0.25 25%

Normal 0.50 15

Recession 0.25 5

What is the coefficient of variation on the company's stock? (Assume that the standard deviation is

calculated using the probability statistic.)

0.47

###
The returns of United Railroad Inc. (URI) are listed below, along with the returns on "the

market":

Year URI Market

1 −14% −9%

2 16 11

3 22 15

4 7 5

5 −2 −1

If the risk-free rate is 9 percent and the required return on URI's stock is 15 percent, what is the required

return on the market? Assume the market is in equilibrium. (Hint: Think rise over run.)

13%

###
Historical rates of return for the market and for Stock A are given below:

Year Market Stock A

1 6.0% 8.0%

2 −8.0 3.0

3 −8.0 −2.0

4 18.0 12.0

If the required return on the market is 11 percent and the risk-free rate is 6 percent, what is the required

return on Stock A, according to CAPM/SML theory?

8.27%

###
If you plotted the returns of Selleck & Company against those of the market and found that

the slope of your line was negative, the CAPM would indicate that the required rate of return

on Selleck's stock should be less than the risk-free rate for a well-diversified investor,

assuming that the observed relationship is expected to continue in the future.

True

### If the returns of two firms are negatively correlated, then one of them must have a negative beta.

True

###
It is possible for a firm to have a positive beta, even if the correlation between its returns and

those of another firm are negative

True

###
The CAPM is a multi-period model which takes account of differences in securities' maturities, and

it can be used to determine the required rate of return for any given level of systematic risk.

False

###
For markets to be in equilibrium (that is, for there to be no strong pressure for prices to depart

from their current levels),

The expected rate of return must be equal to the required rate of return; that is, rˆ = r .

###
Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true

about these securities? (Assume market equilibrium.)

The expected return on Stock A should be greater than that on Stock B.

### Which of the following statements is CORRECT?

Tests have shown that the betas of individual stocks are unstable over time, but that the betas

of large portfolios are reasonably stable over time.

### Which of the following are the factors for the Fama-French model?

The excess market return, a size factor, and a book-to-market factor.

###
Assume that you hold a well-diversified portfolio that has an expected return of 12.0% and a

beta of 1.20. You are in the process of buying 100 shares of Alpha Corp at $10 a share and

adding it to your portfolio. Alpha has an expected return of 15.0% and a beta of 2.00. The total

value of your current portfolio is $9,000. What will the expected return and beta on the

portfolio be after the purchase of the Alpha stock?

12.30%; 1.28

###
The returns on the market, the returns on United Fund (UF), the risk-free rate, and the required

return on the United Fund are shown below. Assuming the market is in equilibrium and that

beta can be estimated with historical data, what is the required return on the market, rM?

Year Market UF

2003 -9% -14%

2004 11% 16%

2005 15% 22%

2006 5% 7%

2007 -1% -2%

rRF: 7.00%; rUnited: 15.00%

12.33%

###
A 12-year bond pays an annual coupon of 8.5 percent. The bond has a yield to maturity of 9.5

percent and a par value of $1,000. What is the bond's current yield?

9.14%

###
A bond matures in 12 years, and pays an 8 percent annual coupon. The bond has a face value of

$1,000, and currently sells for $985. What is the bond's current yield and yield to maturity?

Current yield = 8.12%; yield to maturity = 8.20%

###
Palmer Products has outstanding bonds with an annual 8 percent coupon. The bonds have a par

value of $1,000 and a price of $865. The bonds will mature in 11 years. What is the yield to

maturity on the bonds?

10.09%

###
A 20-year bond with a par value of $1,000 has a 9 percent annual coupon. The bond currently

sells for $925. If the bond's yield to maturity remains at its current rate, what will be the price of

the bond 5 years from now?

$ 933.09

###
A corporate bond with a $1,000 face value pays a $50 coupon every six months. The bond will

mature in ten years, and has a nominal yield to maturity of 9 percent. What is the price of the

bond?

$1,065.04

###
A bond with a $1,000 face value and an 8 percent annual coupon pays interest semiannually. The

bond will mature in 15 years. The nominal yield to maturity is 11 percent. What is the price of

the bond today?

$ 781.99

###
A corporate bond matures in 14 years. The bond has an 8 percent semiannual coupon and a par

value of $1,000. The bond is callable in five years at a call price of $1,050. The price of the

bond today is $1,075. What are the bond's yield to maturity and yield to call?

YTM = 7.14%; YTC = 7.05%

###
A corporate bond has a face value of $1,000, and pays a $50 coupon every six months (i.e., the

bond has a 10 percent semiannual coupon). The bond matures in 12 years and sells at a price of

$1,080. What is the bond's nominal yield to maturity?

8.90%

###
You have just been offered a $1,000 par value bond for $847.88. The coupon rate is 8 percent,

payable annually, and annual interest rates on new issues of the same degree of risk are 10

percent. You want to know how many more interest payments you will receive, but the party

selling the bond cannot remember. Can you determine how many interest payments remain?

15

###
A corporate bond which matures in 12 years, pays a 9 percent annual coupon, has a face value of

$1,000, and a yield to maturity of 7.5 percent. The bond can first be called four years from now.

The call price is $1,050. What is the bond's yield to call?

6.73%

###
An 8 percent annual coupon, noncallable bond has ten years until it matures and a yield to

maturity of 9.1 percent. What should be the price of a 10-year noncallable bond of equal risk

which pays an 8 percent semiannual coupon? Assume both bonds have a par value of $1,000.

$ 941.09

###
Kennedy Gas Works has bonds which mature in 10 years, and have a face value of $1,000. The

bonds have a 10 percent quarterly coupon (i.e., the nominal coupon rate is 10 percent). The

bonds may be called in five years. The bonds have a nominal yield to maturity of 8 percent and a

yield to call of 7.5 percent. What is the call price on the bonds?

$1,048.34

###
Given the following information, calculate the expected capital gains yield for Chicago Bears

Inc.: beta = 0.6; rM = 15%; rRF = 8%; D1 = $2.00; P0 = $25.00. Assume the stock is in equilibrium

and exhibits constant growth.

4.2%

###
Conner Corporation has a stock price of $32.35 per share. The last dividend was $3.42 (i.e., D0 =

$3.42). The long-run growth rate for the company is a constant 7 percent. What is the

company's capital gains yield and dividend yield?

Capital gains yield = 7.00%; Dividend yield = 11.31%.

###
Grant Corporation's stock is selling for $40 in the market. The company's beta is 0.8, the market

risk premium is 6 percent, and the risk-free rate is 9 percent. The previous dividend was $2 (i.e.,

D0 = $2) and dividends are expected to grow at a constant rate. What is the growth rate for this

stock?

8.38%

###
An increase in a firm's expected growth rate would normally cause the firm's required rate of

return to

Possibly increase, possibly decrease, or possibly remain unchanged.

###
The probability distribution for rM for the coming year is as follows:

Probability rM

0.05 7%

0.30 8

0.30 9

0.30 10

0.05 12

If rRF = 6.05% and Stock X has a beta of 2.0, an expected constant growth rate of 7 percent, and

D0 = $2, what market price gives the investor a return consistent with the stock's risk?

$42.38

### Which of the following statements is most correct?

Weak-form market efficiency implies that recent trends in stock prices would be of no use in

selecting stocks.