Finance Exam 1

Created by marye753 

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Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse. (T or F)

TRUE

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0. (T or F)

TRUE

One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM.(T or F)

TRUE

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio. (T or F)

TRUE

If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the low standard deviation. (T or F)

TRUE

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio. (T or F)

FALSE

If the returns of two firms are negatively correlated, then one of them must have a negative beta. (T or F)

TRUE

Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky. (T or F)

TRUE

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away. (T or F)

TRUE

Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return. (T or F)

FALSE

Since the market return represents the expected return on an average stock, the market return reflects a certain amount of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is required to compensate stock investors for assuming an average amount of risk. (T or F)

TRUE

A call provision gives bondholders the right to demand, or "call for," repayment of a bond. Typically, companies call bonds if interest rates (rise / decline) and do not call them if interest rates (rise / decline.)

rise, decline

The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining _____________ and then discounting them back to the _____________.

future cash flows, present

If the required rate of return on a bond (rd) is (greater / less) than its coupon interest rate and will remain above that rate, then the market value of the bond will always be (above / below) its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)

greater, below

A 10-year corporate bond has an annual coupon of 9%. The bond is currently selling at par ($1,000). Which of the following statements is CORRECT?

a. The bond's expected capital gains yield is zero.

Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?
a. 10-year, zero coupon bond.
b. 20-year, 10% coupon bond.
c. 20-year, 5% coupon bond.
d. 1-year, 10% coupon bond.
e. 20-year, zero coupon bond.

e. 20-year, zero coupon bond.

Morin Company's bonds mature in 8 years, have a par value of $1,000, and make an annual coupon interest payment of $65. The market requires an interest rate of 8.2% on these bonds. What is the bond's price?

903.04

Malko Enterprises' bonds currently sell for $1,050. They have a 6-year maturity, an annual coupon of $75, and a par value of $1,000. What is their current yield?

7.14%

Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 8.4% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?

$1,105.69

A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now?

$930.11

If we are given a periodic interest rate, a monthly rate for example, we can find the nominal annual rate by ____________ the __________ rate by the _______________.

Multiplying, periodic rate, the number of periods per year.

Your bank account pays a 6% nominal rate of interest, which is compounded quarterly.
Therefore the periodic rate of interest is ______ and the effective rate of interest is greater than _____.

6/4
1.5%, 6%

The "yield curve" shows the relationship between bonds' ______________ and their____________.

maturities, yields

If the Treasury yield curve were downward sloping, would the yield to maturity on a 10-year Treasury coupon bond would be higher or lower than that on a 1-year T-bill ?

lower

If the pure expectations theory is correct, would a downward sloping yield curve indicates that interest rates are expected to increase or decrease in the future ?

decrease

Assume that the rate on a 1-year bond is now 4%, but all investors expect 1-year rates to be 6% one year from now and then to rise to 7% two years from now. What is the interest rate on a 3 year bond ? Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero.

(4+6+7)/3
=5.67%

The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. What is the equilibrium rate of return on a 1-year Treasury bond?

3.05+2.5 = 5.80%

EAR or EEF%

= (1+Inom/M)^M-1

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