50 terms

# EXAM2

###### PLAY
Which of the following statements regarding a 15-year (180-month) \$125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)
The outstanding balance declines at a faster rate in the later years of the loan's life
Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT
A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal, than for the first monthly payment
Steve and Ed are cousins who were both born on the same day, and both turned 25 today. Their grandfather began putting \$2,500 per year into a trust fund for Steve on his 20th birthday, and he just made a 6th payment into the fund. The grandfather (or his estate's trustee) will make 40 more \$2,500 payments until a 46th and final payment is made on Steve's 65th birthday. The grandfather set things up this way because he wants Steve to work, not be a "trust fund baby," but he also wants to ensure that Steve is provided for in his old age.

Until now, the grandfather has been disappointed with Ed, hence has not given him anything. However, they recently reconciled, and the grandfather decided to make an equivalent provision for Ed. He will make the first payment to a trust for Ed today, and he has instructed his trustee to make 40 additional equal annual payments until Ed turns 65, when the 41st and final payment will be made. If both trusts earn an annual return of 8%, how much must the grandfather put into Ed's trust today and each subsequent year to enable him to have the same retirement nest egg as Steve after the last payment is made on their 65th birthday?
\$3,726
Which of the following investments would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero
Investment D pays \$2,500 at the end of 10 years (just one payment
Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price
10-year zero coupon bond.
You want to quit your job and return to school for an MBA degree 3 years from now, and you plan to save \$7,000 per year, beginning immediately. You will make 3 deposits in an account that pays 5.2% interest. Under these assumptions, how much will you have 3 years from today?
\$23,261
BEGIN Mode
N 3
I/YR 5.2%
PV \$0.00
PMT \$7,000
FV \$23,261
How much would \$5,000 due in 25 years be worth today if the discount rate were 5.5%?
\$1,311.17
Response Feedback: N 25
I/YR 5.5%
PMT \$0
FV \$5,000
PV \$1,311.17
How much would \$5,000 due in 25 years be worth today if the discount rate were 5.5%?
\$1,311.17
Response Feedback: N 25
I/YR 5.5%
PMT \$0
FV \$5,000
PV \$1,311.17
You want to go to Europe 5 years from now, and you can save \$3,100 per year, beginning one year from today. You plan to deposit the funds in a mutual fund that you think will return 8.5% per year. Under these conditions, how much would you have just after you make the 5th deposit, 5 years from now?
\$18,369
Response Feedback: N 5
I/YR 8.5%
PV \$0.00
PMT \$3,100
FV \$18,369
Starting to invest early for retirement increases the benefits of compound interest.
T
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
The bond's expected capital gains yield is zero.
The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant.
Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.
What is the present value of the following cash flow stream at a rate of 12.0%?
0 1 2 3 4
CFs: \$0 \$1,500 \$3,000 \$4,500 \$6,000
PV of CFs: \$0 \$1,339 \$2,392 \$3,203 \$3,813
\$10,747
PV = \$10,747 Found by summing individual PVs.
Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
F
Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return?
The required rate of return would increase because the bond would then be more risky to a bondholder.
Sinking funds are provisions included in bond indentures that require companies to retire bonds on a scheduled basis prior to their final maturity. Many indentures allow the company to acquire bonds for sinking fund purposes by either (1) purchasing bonds on the open market at the going market price or (2) selecting the bonds to be called by a lottery administered by the trustee, in which case the price paid is the bond's face value.
T
Which of the following statements is CORRECT?
If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.
Suppose you inherited \$275,000 and invested it at 8.25% per year. How much could you withdraw at the beginning of each of the next 20 years?
\$26,357.92
Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT?
A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.
You have a chance to buy an annuity that pays \$5,000 at the beginning of each year for 5 years. You could earn 4.5% on your money in other investments with equal risk. What is the most you should pay for the annuity?
\$22,938
Response Feedback: BEGIN Mode
N 5
I/YR 4.5%
PMT \$5,000
FV \$0.00
PV \$22,938
Sue now has \$125. How much would she have after 8 years if she leaves it invested at 8.5% with annual compounding?
\$240.08
Response Feedback: N 8
I/YR 8.5%
PV \$125
PMT \$0
FV \$240.08
The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond?
5.80%
Which of the following statements is CORRECT?
All else equal, bonds with larger coupons have less price risk than bonds with smaller coupons.
Which of the following statements is CORRECT?
Reinvestment risk is lower, other things held constant, on long-term than on short-term bonds.
Which of the following statements is CORRECT?
The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.
At a rate of 6.5%, what is the future value of the following cash flow stream?
0 1 2 3 4
CFs: \$0 \$75 \$225 \$0 \$300
FV of CFs: \$0 \$91 \$255 \$0 \$300
\$645.80
Found by summing individual FVs
Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?
20-year, zero coupon bond.
Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?
You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper that you can buy a \$1,000 par value bond for \$800. The coupon rate is 10% (with annual payments), and there are 10 years before the bond will mature and pay off its \$1,000 par value. You should buy the bond if your required return on bonds with this risk is 12%.
T
Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.
T
Which of the following statements is CORRECT?
The present value of a 3-year, \$150 annuity due will exceed the present value of a 3-year, \$150 ordinary annuity.
Five years ago, Weed Go Inc. earned \$1.50 per share. Its earnings this year were \$3.20. What was the growth rate in earnings per share (EPS) over the 5-year period?
16.36%
Response Feedback: N 5
PV \$1.50
PMT \$0
FV \$3.20
I/YR 16.36%
You are considering 2 bonds that will be issued tomorrow. Both are rated triple B (BBB, the lowest investment-grade rating), both mature in 20 years, both have a 10% coupon, neither can be called except for sinking fund purposes, and both are offered to you at their \$1,000 par values. However, Bond SF has a sinking fund while Bond NSF does not. Under the sinking fund, the company must call and pay off 5% of the bonds at par each year. The yield curve at the time is upward sloping. The bond's prices, being equal, are probably not in equilibrium, as Bond SF, which has the sinking fund, would generally be expected to have a higher yield than Bond NSF.
F
Which of the following statements is CORRECT?
If a loan has a nominal annual rate of 8%, then the effective rate will never be less than 8%.
Suppose you inherited \$275,000 and invested it at 8.25% per year. How much could you withdraw at the end of each of the next 20 years?
\$28,532
Response Feedback: N 20
I/YR 8.25%
PV \$275,000
FV \$0.00
PMT \$28,532
The price sensitivity of a bond to a given change in interest rates is generally greater the longer the bond's remaining maturity.
T
A U.S. Treasury bond will pay a lump sum of \$1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?
The PV of the \$1,000 lump sum has a smaller present value than the PV of a 3-year, \$333.33 ordinary annuity.
Which of the following statements is CORRECT?
Time lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year.
False
Moon Software Inc. is planning to issue two types of 25-year, noncallable bonds to raise a total of \$6 million, \$3 million from each type of bond. First, 3,000 bonds with a 10% semiannual coupon will be sold at their \$1,000 par value to raise \$3,000,000. These are called "par" bonds. Second, Original Issue Discount (OID) bonds, also with a 25-year maturity and a \$1,000 par value, will be sold, but these bonds will have a semiannual coupon of only 6.25%. The OID bonds must be offered at below par in order to provide investors with the same effective yield as the par bonds. How many OID bonds must the firm issue to raise \$3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.
4,562
Niendorf Corporation's 5-year bonds yield 8.00%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Niendorf's bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) ´ 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf's bonds?
2.00%
Your subscription to Investing Wisely Weekly is about to expire. You plan to subscribe to the magazine for the rest of your life, and you can renew it by paying \$85 annually, beginning immediately, or you can get a lifetime subscription for \$850, also payable immediately. Assuming that you can earn 6.0% on your funds and that the annual renewal rate will remain constant, how many years must you live to make the lifetime subscription the better buy?
14.33

BEGIN Mode
Interest rate (I/YR) 6.0%
Annual cost (PMT) \$85
Number of payments made (N) 14.33
What is the present value of the following cash flow stream at a rate of 8.0%?
What is the present value of the following cash flow
stream at a rate of 8.0%?

0 1 2 3
CFs: \$750 \$2,450 \$3,175 \$4,400
9,233

PV of CFs: \$750 \$2,269 \$2,722 \$3,493

PV = \$9,233 Found by summing individual PVs.
PV = \$9,233
Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.
T
Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 2.15%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
2.00
What's the future value of \$1,200 after 5 years if the appropriate interest rate is 6%, compounded monthly?
1,618.62
Response Feedback: Years 5
Periods/Yr 12
Nom. I/YR 6.0%

N = Periods 60
PMT \$0
I/Period 0.5%
PV \$1,200 Could be found using a calculator, the equation, or Excel.
FV \$1,618.62 Note that we must first convert to periods and rate per period
Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?
The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities.
A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?
If the yield to maturity remains constant, the bond's price one year from now will be lower than its current price.
Suppose you borrowed \$14,000 at a rate of 10.0% and must repay it in 5 equal installments at the end of each of the next 5 years. How much interest would you have to pay in the first year?
\$1,400.00
Keenan Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon, semiannual payments, and a \$1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of \$1,120. What is the bond's nominal yield to call?
6.53%