Finance Exam 2

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101 terms · Exam 2 Question Pool

Stacy purchased a stock last year and sold it today for $3 a share more than her purchase price. She received a total of $0.75 in dividends. Which one of the following statements is correct in relation to this investment?

The capital gains yield is positive

Which one of the following correctly describes the dividend yield?

next year's annual dividend divived by today's stock price

Which of the following statements is correct in relation to a stock investment?
I. The capital gains yield can be positive, negative, or zero.
II. The dividend yeild can be positive, negative, or zero.
III. The total return can be postive, negative, or zero.
IV. Neither the dividend yeild nor the total return can be negative.

I and III only

You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?

expected return

Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total. Which one of the following terms most applies to Suzie's investments?

portfolio

Steve has invested in twelce different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which one of the following?

portfolio weight

Which one of the following is a risk that applies to most securities?

systematic

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent?

unsystematic

The principle of diversification tells us that:

spreading an investment across many diverse assets will eliminate some of the total risk

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.

systematic risk principle (only answer with "risk")

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset?

beta

Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas?

security market line

Which one of the following is represented by the slope of the security market line?

market risk premium

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?

capital asset pricing model (CAPM)

The expected risk premium on a stock is equal to the expected return on the stock minus the:

risk-free rate

Standard deviation measures which type of risk?

total

The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:

market value of the investment in each stock

The expected return on a portfolio considers which of the following factors?
I. percentage of the portfolio invested in each individual security
II. projected states of the economy
III. the performance of each security given various economic states
IV. probability of occurrence for each state of the economy

All four of them

The expected return on a portfolio:
I. can never exceed the expected return of the best performing security in the portfolio.
II. must be equal to or greater than the expected return of the worst performing security in the portfolio.
III. is independent of the unsystematic risks of the individual securities held in the portfolio.
IV. is independent of the allocation of the portfolio amongst individual securities.

can never exceed the expected return of the best performing security in the portfolion; must be equal to or greater than the expected return of the worst performing security in the portfolio; and is independent of the unsystematic risks of the individual securities held in the portfolio

If a stock portfolio is well diversified, then the portfolio variance:

may be less than the variance of the least risky stock in the portfolio

The standard deviation of a portfolio:

can be less than the standard deviation of the least risky security in the portfolio

The standard deviation of a portfolio:

can be less than the weighted average of the standard deviations of the individual securities held in that portfolio

Which one of the following statements is correct?
A. The unexpected return is always negative
B. The expected return minus the unexpected return is equal to the total return
C. Over time, the average return is equal to the unexpected return
D. The expected return includes the surprise portion of the news announcements
E. Over time, the average unexpected return will be zero

E. Over time, the average unexpected return will be zero

Which one of the following is an example of systematic risk?

investors panic causing security prices around the globe to fall precipitously

Unsystematic risk:

can be effectively eliminiated by portfolio diversification

Which one of the following is an example of unsystematic risk?

consumer spending on entertainment decreased nationally

Which one of the following is least apt to reduce the unsystematic risk of a portfolio?

reducing the number of stocks held in the portfolio

Which one of the following statements related to risk is correct?

The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio

Which one of the following risks is irrelevant to a well-diversified investor?

unsystematic risk

Which of the following are examples of diversifiable risk?
I. earthquake damages an entire town
II. federal government imposes a $100 fee on all business entities
III. employment taxes increase nationally
IV. toymakers are required to improve their safety standards

Earthquakes and toys

Which of the following statements are correct concerning diversifiable risks?

Can be eliminated by investing in thirty unrelated securities; there is no reward for accepting diviersifiable risks; diversifiable risks are generally associated with an individual firm or industry

Which one of the following is the best example of a diversifiable risk?

a firms sales decrease

Which of the following statements concerning risk are correct?
I. Nondiversifiable risk is measured by beta.
II. The risk premium increases as diversifiable risk increases.
III. Systematic risk is another name for nondiversifiable risk.
IV. Diversifiable risks are market risks you cannot avoid.

I and III

The primary purpose of portfolio diversification is to:

eliminate asset-specific risk

Which one of the following indicates a portfolio is being effectively diversified?

a decrease in the portfolio standard deviation

Systematic risk is measured by:

beta

Which one of the following is most directly affected by the level of systematic risk in a security?

expected rate of return

Which one of the following statements is correct concerning a portfolio beta?

A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio

The systematic risk of the market is measured by:

a beta of 1.0

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset?
I. assets standard deviation
II. assets beta
III. risk-free rate of return
IV. market risk premium

assets beta; market risk premium

Total risk is measured by _____ and systematic risk is measured by _____.

standard deviation; beta

The intercept point of the security market line is the rate of return which corresponds to:

the risk-free rate

A stock with an actual return that lies above the security market line has:

a higher return than expected for the level of risk assumed

The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant stock has 3 percent less systematic risk than the market and has an actual return of 12 percent. This stock:

underpriced

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?

reward-to-risk ratio

The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A has a beta of 0.82 and stock B has a beta of 1.29. This information implies that:

either stock A is overpriced or stock B is underpriced, or both

The market risk premium is computed by:

subtracting the risk-free rate of return from the market rate of return

The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free asset is referred to as the:

risk premium

The _____ of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly.

risk premium

The capital asset pricing model (CAPM) assumes which of the following?
I. a risk-free asset has no systematic risk.
II. beta is a reliable estimate of total risk.
III. the reward-to-risk ratio is constant.
IV. the market rate of return can be approximated.

I, III, and IV

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:

market risk premium and the amount of systematic risk inherent in the security

Which one of the following should earn the most risk premium based on CAPM?
A. diversified portfolio with returns similar to the overall market
B. stock with a beta of 1.38
C. stock with a beta of 0.74
D. U.S. Treasury bill
E. portfolio with a beta of 1.01

stock with a beta of 1.38

What is the model called that determines the present value of a stock based on its next annual dividend, the dividend growth rate, and the applicable discount rate?

dividend growth

Which one of the following is computed by dividing next year's annual dividend by the current stock price?

dividend yield

Which one of following is the rate at which a stock's price is expected to appreciate?

capital gains yield

What are the distributions to shareholders by a corporation called?

dividends

Which one of the following is a type of equity security that has a fixed dividend and a priority status over other equity securities?

preferred stock

An increase in which of the following will increase the current value of a stock according to the dividend growth model?
I. dividend amount
II. number of future dividends, provided the current number is less than infinite
III. discount rate
IV. dividend growth rate

I, II, and IV

High Country Builders currently pays an annual dividend of $1.35 and plans on increasing that amount by 2.5 percent each year. Valley High Builders currently pays an annual dividend of $1.20 and plans on increasing its dividend by 3 percent annually. Given this information, you know for certain that the stock of High Country Builders' has a higher ______ than the stock of Valley High Builders.

capital gains yield

The dividend growth model:
I. assumes that dividends increase at a constant rate forever.
II. can be used to compute a stock price at any point in time.
III. can be used to value zero-growth stocks.
IV. requires the growth rate to be less than the required return.

I, II, III, and IV

Which one of the following is an underlying assumption of the dividend growth model?

A stock's value is equal to the discounted present value of the future cash flows which it generates

Answer this question based on the dividend growth model. If you expect the market rate of return to increase across the board on all equity securities, then you should also expect:

a decrease in all stock values

Which one of the following statements is correct?

The capital gains yield is the annual rate of change in a stock's price

Supernormal growth is a growth rate that:

Is unsustainable over the long term

Which one of the following represents the capital gains yield as used in the dividend growth model?

g

Winston Co. has a dividend-paying stock with a total return for the year of -6.5 percent. Which one of the following must be true?

The stock has a negative capital gains yield

The two-stage dividend growth model evaluates the current price of a stock based on the assumption a stock will:

groq at a fixed rate for a period of time after which it will grow at a different rate indefinitely

Which one of the following sets of dividend payments best meets the definition of two-stage growth as it applies to the two-stage dividend growth model?

dividend payments which increase by 10 percent per year for 5 years followed by dividends which increase by 3 percent annually thereafter

Mary just purchased a bond which pays $60 a year in interest. What is this $60 called?

a coupon

Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment at maturity. What is the $1,000 called?

face value

A bond's coupon rate is equal to the annual interest divided by which one of the following?

face value

The specified date on which the principal amount of a bond is payable is referred to as which one of the following?

maturity

Currently, the bond market requires a return of 11.6 percent on the 10-year bonds issued by Winston Industries. The 11.6 percent is referred to as which one of the following?

yield to maturity

The current yield is defined as the annual interest on a bond divided by which one of the following?

market price

An indenture is:

the legal agreement between the bond issuer and the bondholders

Atlas Entertainment has 15-year bonds outstanding. The interest payments on these bonds are sent directly to each of the individual bondholders. These direct payments are a clear indication that the bonds can accurately be defined as being issued:

in registered form

A bond that is payable to whomever has physical possession of the bond is said to be in:

bearer form

A bond is quoted at a price of $989. This price is referred to as which one of the following?

clean price

A Treasury yield curve plots Treasury interest rates relative to which one of the following?

maturity

Which one of the following risk premiums compensates for the possibility of nonpayment by the bond issuer?

default risk

The liquidity premium is compensation to investors for:

the lack of an active market wherein a bond can be sold for its actual value

A bond has a market price that exceeds its face value. Which of the following features currently apply to this bond?
I. discounted price
II. premium price
III. yield-to-maturity that exceeds the coupon rate
IV. yield-to-maturity that is less than the coupon rate

II and IV

All else constant, a bond will sell at _____ when the coupon rate is _____ the yield to maturity.

a discount; less than...

The Walthers Company has a semi-annual coupon bond outstanding. An increase in the market rate of interest will have which one of the following effects on this bond?

decrease the market price

Which of the following are characteristics of a premium bond?
I. coupon rate < yield-to-maturity
II. coupon rate > yield-to-maturity
III. coupon rate < current yield
IV. coupon rate > current yield

II and IV only

Which of the following relationships apply to a par value bond?
I. coupon rate < yield-to-maturity
II. current yield = yield-to-maturity
III. market price = call price
IV. market price = face value

II and IV

Which one of the following relationships is stated correctly?

Decreasing the time to matuerity increases the price of a discount bond, all else constant

Green Roof Inns is preparing a bond offering with a 6 percent, semiannual coupon and a face value of $1,000. The bonds will be repaid in 10 years and will be sold at par. Given this, which one of the following statements is correct?

the bonds will sell at a premium if the market rate is 5.5 percent

A newly issued bond has a 7 percent coupon with semiannual interest payments. The bonds are currently priced at par value. The effective annual rate provided by these bonds must be:

greater than 7 percent

Which of the following increase the price sensitivity of a bond to changes in interest rates?
I. increase in time to maturity
II. decrease in time to maturity
III. increase in coupon rate
IV. decrease in coupon rate

I and IV

Which one of the following bonds is the least sensitive to interest rate risk?

3-year; 6 percent coupon

As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:

increases at a decreasing rate

You own a bond that has a 6 percent annual coupon and matures 5 years from now. You purchased this 10-year bond at par value when it was originally issued. Which one of the following statements applies to this bond if the relevant market interest rate is now 5.8 percent?

you will realize a capital gain on the bond if you sell it today

You expect interest rates to decline in the near future even though the bond market is not indicating any sign of this change. Which one of the following bonds should you purchase now to maximize your gains if the rate decline does occur?

long-term; zero coupon

A 6 percent, annual coupon bond is currently selling at a premium and matures in 7 years. The bond was originally issued 3 years ago at par. Which one of the following statements is accurate in respect to this bond today?

the yield-to-maturity is less than the coupon rate

Which one of the following statements concerning bond ratings is correct?

Split rated bonds are called crossover bonds

Bonds issued by the U.S. government:

are considered to be free of default risk

Municipal bonds:

pay interest that is federally tax-free

A zero coupon bond:

has more interest rate risk than a comparabel coupon bond

A 6-year, $1,000 face value bond issued by Taylor Tools pays interest semiannually on February 1 and August 1. Assume today is October 1. What will the difference, if any, be between this bond's clean and dirty prices today?

two months' interest

Today, June 15, you want to buy a bond with a quoted price of 98.64. The bond pays interest on January 1 and July 1. Which one of the following prices represents your total cost of purchasing this bond today?

dirty price

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