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FIN 331 TEST 2

Terms in this set (65)

Foreign bonds are issued by a foreign government or a foreign corporation. An additional risk exists when bonds are denominated in a currency other than that of the investor's home currency. True or false?
a. True
b. False
true
The interest paid on a municipal bond, otherwise known as a muni, is generally exempt from federal income taxes. Therefore, the coupon rate on these bonds is considerably lower than a corporate bond of equivalent risk. True or false?
a. True
b. False
true
Coupon payments in finance refer to:
a. Discounts paid to buyers.
b. Admissions into a financial market.
c. Dividends paid by stocks or equities.
d. Interest payment from owning a bond.
d. Interest payment from owning a bond.
The coupon rate refers to:
a. The rate at which a bond price changes.
b. The rate at which investors buy a bond.
c. The interest rate a bond pays.
d. The true market price of bond.
c. The interest rate a bond pays.
Who, generally, benefits for a fixed interest rate bond if market interest rates are falling?
a. Equity holders.
b. Governments because it collects more in tax revenue.
c. Lenders or holders of bonds.
d. Borrowers or bond issuers
c. Lenders or holders of bonds.
If interest rates fall, the risk with a fixed rate instrument is that:
a. It will be paid off before maturity.
b. The real interest rate may increase very rapidly.
c. Default risk will become counter cyclical.
d. Price of the financial instrument will fall rapidly.
a. It will be paid off before maturity.
A 20-year bond with a 6% coupon rate can have a par value of any amount that is a multiple of $1,000. The issuer will make payments of 6% of the par value each year, generally with one-half of the annual amount paid each 6 months. Bonds may include a sinking fund, which means that some of the bonds must be paid off each year rather than at maturity. Also, many bonds include a call provision, which gives the issuer the right to pay off the bonds prior to their stated maturity. True or false?
a. True
b. False
true
A bond will sell at a premium if which of the following happened?
a. The stock market increased.
b. Interest rates fell below coupon rate.
c. The borrower defaulted.
d. Tax rates increased.
b. Interest rates fell below coupon rate.
A bond will sell at a discount if which of the following happened?
a. Market interest rates became negative.
b. The bond was redeemed.
c. Taxes increased.
d. Interest rates rose above coupon rate.
d. Interest rates rose above coupon rate.
Kholdy Enterprises' outstanding bonds mature in 6 years, have a par value of $1,000, and make an annual coupon payment of $60. The market yield on the bond is currently 10%. What is the bond's price?
a. $1,125.00
b. $1,089.93
c. $1,000.00
d. $ 825.79
e. $ 967.55
d. $ 825.79
Which of the following statements best describes Kholdy Enterprises' bond? (bonds price was $825.79)
a. This bond is a premium bond since its price is greater than its par value of $1,000.
b. This bond is a par value bond since its price is equal to its par value of $1,000.
c. This bond is a discount bond since its price is less than its par value of $1,000.
c. This bond is a discount bond since its price is less than its par value of $1,000.
Wald Inc.'s bonds currently sell for $1,120 and have a par value of $1,000. They pay an $85 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,050. What is their YTM?
a. 5.95%
b. 7.08%
c. 6.71%
d. 6.49%
e. 7.34%
e. 7.34%

N=20
PV=$1,120
FV= $1,000
PMT= $85

CPT I/Y
Wald Inc.'s bonds currently sell for $1,120 and have a par value of $1,000. They pay an $85 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,050. What is their YTC?
a. 7.34%
b. 5.95%
c. 7.08%
d. 6.49%
e. 6.71%
d. 6.49%

N=5
PV=$1,120
FV=$1,050
PMT=$85

CPT I/Y
Wald Inc.'s bonds currently sell for $1,120 and have a par value of $1,000. They pay an $85 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,050. What return would an investor most likely earn, if interest rates remain at current levels for the foreseeable future?
a. 6.49%
b. 7.34%
c. 5.95%
d. 7.08%
e. 6.71%
a. 6.49%
Leggio Inc. issued bonds with a 30-year maturity one year ago. The bonds have a 6% coupon, make one payment per year, and sold at their $1,000 par value at issue because the going market rate at the time was 6%. Now, one year later, the market rate has declined from 6% to 5%. At what price should Leggio's bonds now sell?
a. $1,209.10
b. $1,000.00
c. $1,067.54
d. $1,151.41
e. $ 911.22
d. $1,151.41
If the market interest rate remains at 5% for the next 29 years, and if Leggio's credit rating remains constant, then the price of its bonds will decrease gradually over time and be exactly $1,000 at maturity. True or false?
a. True
b. False
true
Lei Corporation's bonds have a 30-year maturity, a 10% semiannual coupon ($50 coupon payments are made every six months), a face value of $1,000, and cannot be called. The going nominal annual interest rate (rd) for similar semiannual payment bonds of equivalent risk is 7%. What is the bond's price?
a. $1,146.33
b. $1,000.00
c. $ 957.49
d. $1,454.06
e. $1,374.17
e. $1,374.17
Assume Lei's bonds paid interest annually rather than semiannually. You could find the value of these bonds, in a market where the going nominal annual rate on semiannual payment bonds is 7%, by finding the effective annual rate, which is 7.1225%, and then discounting the annual bond's cash flows by this effective rate. The annual payment bonds would have a value of $1,352.72 versus $1,374.17. True or false?
a. True
b. False
true
Select one of the choices below that best completes the following sentence: If an investor sold long-term bonds and used the proceeds to purchase short-term bonds, this would increase the investor's exposure to ________ risk and decrease the investor's exposure to ________ risk.
a. price; reinvestment
b. default; reinvestment
c. liquidity; reinvestment
d. reinvestment; price
e. price; default
d. reinvestment; price
Which of the following statements is correct?
a. If you need a specific amount of money at a specific future date, you should be concerned about price risk, but you do not need to be concerned about reinvestment risk.
b. If you need a specific amount of money at a specific future date, you could invest in a number of different kinds of bonds, but the one type of bond that you should avoid is a zero coupon bond, because such bonds do not pay any interest.
c. Other things held constant, a 10-year bond has more reinvestment risk than a 30-year bond.
c. Other things held constant, a 10-year bond has more reinvestment risk than a 30-year bond.
The key difference between investment grade bonds and junk bonds are:
a. Prepayment risk.
b. Liquidity risk.
c. Default risk.
d. Length to maturity.
c. Default risk.
Who tends to issue junk bonds?
a. The Federal Reserve.
b. Local governments in the United States.
c. Foreign governments.
d. Financially troubled firms.
d. Financially troubled firms.
utcher Company plans to issue bonds to raise $10 million to finance expansion. It could use 10-year mortgage bonds backed by the firm's fixed assets, 10-year debentures that are not backed by any specific assets but are backed by the firm's general earning power, or 10-year subordinated debentures that would be subordinated to all of the firm's other debt. If it uses mortgage bonds, they would be rated A by Moody's and S&P, and their market interest rate would be 7.5%. Given this information, which of the following statements is most correct?
a. Given the 7.5% interest rate on the mortgage bonds, the plain debentures might carry an interest rate of 8.0% and the subordinated debentures a rate of 8.5%.
b. The subordinated debentures would be rated highest, probably AA.
c. Since bond ratings are highly subjective, information about the rating and interest rate on the A-rated bond tells us nothing about how the two types of debentures would be rated, or about their likely interest rates.
d. Given the 7.5% interest rate on the mortgage bonds, the subordinated debentures might carry an interest rate of 8.0% and the plain debentures a rate of 8.5%.
e. The debentures would be rated highest, probably AA.
a. Given the 7.5% interest rate on the mortgage bonds, the plain debentures might carry an interest rate of 8.0% and the subordinated debentures a rate of 8.5%.
Two key sections of the Bankruptcy Act are Chapter 7, which relates to liquidating firms and allocating the proceeds among its creditors, and Chapter 11, which deals with reorganizing businesses that are thought to be worth more as operating enterprises than they would bring in from liquidation of firms' assets. Troubled firms' managements generally try to reorganize, but if no feasible reorganization plan can be developed, then the bankruptcy judge will order liquidation. True or false?
a. True
b. False
true
Most bonds are owned by and traded among large financial institutions, and it is relatively easy for bond dealers to arrange the transfer of large blocks of bonds among the millions of large and small bondholders on the exchanges rather than the over-the counter market. True or false?
a. True
b. False
false
Is the following statement true or false? There is a fundamental trade-off between risk and return: to entice investors to take on more risk, you have to provide them with higher expected returns.
a. True
b. False
true
People differ with regard to their willingness to bear risks. However, if two stocks have the same expected rate of return, then most individuals would prefer the less risky to the more risky stock. This is called risk aversion. True or false?
a. True
b. False
true
The probability distribution for a stock would list the stock's set of possible returns and the probability of each return. We could use this data to find both the stock's expected rate of return and the standard deviation of that return, which is one measure of risk. True or false?
a. True
b. False
true
The coefficient of variation is a better measure of risk if one is comparing assets that have substantially different expected returns, because it shows the amount of risk per unit of expected return. True or false?
a. True
b. False
true
Investment X has a 25% chance of producing a 20% return, a 50% chance of producing a 15% return, and a 25% chance of producing a return of -5%. What is X's expected return?
a. 10.15%
b. 11.25%
c. 9.33%
d. 9.65%
e. 10.69%
b. 11.25%
Investment X has a 25% chance of producing a 20% return, a 50% chance of producing a 15% return, and a 25% chance of producing a return of -5%. What's Investment X's standard deviation?
a. 10.7%
b. 9.6%
c. 9.3%
d. 8.8%
e. 11.4%
b. 9.6%
Investment X has a 25% chance of producing a 20% return, a 50% chance of producing a 15% return, and a 25% chance of producing a return of -5%. What's Investment X's coefficient of variation?
a. 1.07
b. 0.93
c. 1.26
d. 0.85
e. 1.18
d. 0.85
In calculating the expected rate of return, the expected returns in each state are weighted by:
a. The probability of that state occurring.
b. The rate of return expected.
c. The time it takes to earn that return.
d. The after tax rate of return earned.
a. The probability of that state occurring.
The weights in the expected rate of return calculation must sum to equal:
a. The current real market interest rate.
b. One.
c. The expected rate of return.
d. One hundred.
one
The Beta of a stock measures:
a. How the stock price moves relative to the rest of the market.
b. How the stock price moves relative to interest rate movements.
c. How many times the stock has split.
d. How much dividends the corporation has paid in the past.
a. How the stock price moves relative to the rest of the market.
A stock with a Beta of more than one:
a. Has paid more dividends than the average stock in the market.
b. Will reduce the overall volatility of a stock portfolio.
c. Has experienced price changes that are more volatile than the over market.
d. Has paid out more than the rate of inflation.
c. Has experienced price changes that are more volatile than the over market.
If two assets are perfectly positively correlated, then their returns will move up and down exactly in sync with one another. True or false?
a. True
b. False
true
If two assets are held in a portfolio, the assets will generally be less risky than if they were held in isolation. True or false?
a. True
b. False
true
The higher the positive correlation between two assets' returns, the greater is the risk reduction from holding them in a portfolio. True or false?
a. True
b. False
false
Betas can be found by plotting stocks' returns on the vertical axis and the returns on an index like the S&P 500 on the horizontal axis, and then calculating the slope of the resulting regression line. This slope is the stock's beta coefficient. The steeper the slope, the larger the beta and the riskier the stock. True or false?
a. True
b. False
true
A 2-stock portfolio that contains $40,000 of GE stock with a beta of 1.25 and $60,000 of Duke Energy stock with a beta of 0.60 would have a beta of 0.86. What would be the portfolio's beta, if the owner rebalanced the portfolio so that it contained $80,000 of GE and $20,000 of Duke Energy stock?
a. 1.00
b. 0.91
c. 1.17
d. 0.77
e. 1.12
1.12
The Security Market Line (SML) shows the relationship between stocks' required rates of return (measured on the vertical axis) and their betas (measured on the horizontal axis). The vertical axis intercept is the required rate of return on a riskless asset, and the required rate of return associated with b = 1.0 is the required rate of return on "the market." The difference between the required rate of return on the market and that on the riskless asset (rM - rRF) is defined as the "market risk premium." The steeper the SML, the larger the market risk premium, and the greater the average investor's aversion to risk. True or false?
a. True
b. False
true
If all investors were completely indifferent to risk, i.e., if they had no aversion to risk at all, then the SML would plot as a horizontal line. True or false?
a. True
b. False
true
Which of the following relationships would induce someone to purchase stock?
a. r = =
b. > r
c. > r
d. >
e. r >
r^>r
Suppose a stock has a beta of 1.3, the risk-free rate is 6.0%, and the market risk premium is 4.5%. If the stock's beta falls to 1.0 but the other two variables remain unchanged, by how much would the stock's required rate of return decline?
a. 1.35%
b. 2.28%
c. 1.71%
d. 0.88%
e. 0.62%
a. 1.35%
In response to concerns about the CAPM's validity, some researchers have developed models that include more explanatory variables than just beta. While these models are promising, the basic CAPM is still the most widely used method for estimating required rates of returns on stocks. True or false?
a. True
b. False
true
Suppose the standard deviation of expected returns for a given corporate project is quite high, and the project's returns are also highly correlated with returns on the firm's other assets. This suggests that the project is quite risky. However, if the project is not perfectly positively correlated with returns on other stocks in the market, then the project's true risk to stockholders might not be very large. True or false?
a. True
b. False
true
Proxy fights are attempts by a person or group that wants to take over control of a firm by getting the firms' stockholders to give their voting proxies to the new group. True or false?
a. True
b. False
true
The preemptive right is the right of current stockholders to buy new shares in an amount that will maintain their proportionate ownership in the firm. True or false?
a. True
b. False
true
Firms can use different classes of common stock to meet specific needs of the company. Founders' shares are one such class. They are shares owned by the firm's founders that enable them to maintain control over the company without having to own a majority of stock. True or false?
a. True
b. False
true
A stock's price is simply the current market price, and it is easily observed for publicly traded companies. By contrast, intrinsic value, which represents the "true" value of the company's stock, cannot be directly observed and must instead be estimated. True or false?
a. True
b. False
true
In calculating the expected rate of return, the expected returns in each state are weighted by:
a. The time it takes to earn that return.
b. The after tax rate of return earned.
c. The probability of that state occurring.
d. The rate of return expected.
c. The probability of that state occurring.
The weights in the expected rate of return calculation must sum to equal:
a. One hundred.
b. The expected rate of return.
c. One.
d. The current real market interest rate.
c. one
The value of a share of common stock depends on the cash flows it is expected to provide, and those flows consist of two elements: (1) the dividends the investor receives each year while he or she holds the stock and (2) the price received when the stock is sold. The final price includes the original price paid plus an expected capital gain. True or false?
a. True
b. False
true
Investors expect Bae Corporation to pay a dividend of D1 = $1.50 and to grow at a constant rate of 7% per year. The stock sells at a price of $25. What is Bae's expected dividend yield?
a. 8.0%
b. 6.0%
c. 4.0%
d. 5.0%
e. 7.0%
b. 6.0%
Investors expect Bae Corporation to pay a dividend of D1 = $1.50 and to grow at a constant rate of 7% per year. The stock sells at a price of $25. What is Bae's expected capital gains yield?
a. 7.0%
b. 4.0%
c. 5.0%
d. 6.0%
e. 8.0%
a. 7.0%
Investors expect Bae Corporation to pay a dividend of D1 = $1.50 and to grow at a constant rate of 7% per year. The stock sells at a price of $25. What is Bae's expected total rate of return?
a. 12.0%
b. 14.0%
c. 13.0%
d. 11.0%
e. 10.0%
c. 13.0%
Vara Technologies' is expected to pay a dividend of $2.00 per share one year from today. Vara's required rate of return is rs = 11%. If the expected growth rate is 5%, at what price should the stock sell?
a. $36.79
b. $33.33
c. $34.16
d. $35.89
e. $35.02
b. $33.33
Vara Technologies' is expected to pay a dividend of $2.00 per share one year from today. Vara's required rate of return is rs = 11%. What would Vara's price be if the expected growth rate were g = 0%?
a. $17.28
b. $16.85
c. $16.43
d. $18.18
e. $17.73
d. $18.18
To estimate the value of a nonconstant growth stock, we can estimate the value of each dividend during the period of nonconstant growth, find the PVs of these dividends, find the value of the stock at the horizon date, find the PV of the horizon value, and then sum these PVs to find the value of the stock today. True or false?
a. True
b. False
true
Silva Motors just paid a dividend of $2.00, i.e., D0 = $2.00. The dividend is expected to grow by 100% during Year 1, by 50% during Year 2, and then at a constant rate of 5% thereafter. If Silva's required rate of return is rs = 12%, what is the value of the stock today?
a. $80.10
b. $82.36
c. $74.24
d. $76.15
e. $78.20
a. $80.10
The value of a share of stock can be estimated by using the PV of future dividends. An alternative valuation procedure, called the "corporate valuation model," calls for finding the expected future free cash flows, discounting those cash flows at the weighted average cost of capital, summing the PVs of the free cash flows, subtracting the market values of debt and preferred to calculate the value of the common equity, and then dividing by the number of shares outstanding to find the value of a share of common stock. In theory, the two methods should produce the same stock price. Is this statement true or false?
a. True
b. False
true
Calvert Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, Calvert doesn't pay any dividends and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Calvert's stock. The pension fund manager has estimated Calvert's free cash flows for the next 3 years as follows: $1.2 million, $2.5 million, and $4.1 million. After the third year, free cash flow is projected to grow at a constant 5%. Calvert's WACC is 10%, the market value of its debt and preferred stock totals $10.9256 million, and it has 2.5 million shares of common stock outstanding. What is an estimate of Calvert's price per share?
a. $30.07
b. $24.00
c. $20.25
d. $28.37
e. $17.50
b. $24.00
Preferred stock is a "hybrid" security. Preferreds typically pay a fixed dividend, so they are a fixed-income security like a bond. However, the directors can omit the preferred dividend without throwing the company into bankruptcy. True or false?
a. True
b. False
true
If a firm goes bankrupt and must be liquidated, and if less money is available than the balance sheet values of bonds, preferred stock, and common equity, then some security holders will receive less than the book values of their investments. The priority system under our bankruptcy laws allocates funds first to preferred stock because of its preference, then to bonds, and then to common stockholders (only if there are funds left over after paying preferred stockholders and bondholders). True or false?
a. True
b. False
false
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