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The proper goal of the financial manager should be to maximize the firm's expected profit, since this will add the most wealth to each of the individual shareholders (owners) of the firm. a. b. True False

Goal of firm Answer: b Diff: E . If a firm has a single owner, we may say that the proper goal of a financial manager would be to maximize the firm's earnings per share. a. b. True False

Managerial incentives Answer: b Diff: E . Performance shares are dollar bonuses awarded to managers on the basis of corporate performance. a. b. True False

Agency Answer: b Diff: E . If a firm's stock price falls during the year, this indicates that the firm's managers are not acting in shareholders' best interests. a. b. True False

Agency Answer: a Diff: E . An agency problem exists between stockholders and managers. A second agency problem arises between stockholders and creditors. a. b. True False

Agency Answer: b Diff: E . An agency relationship exists when one or more persons hire another person to perform some service but withhold decision-making authority from that person. a. b. True False

Social welfare and finance Answer: b Diff: E . The goal of maximizing stock price is a detriment to society in that few of the actions that result in maximization of stock price also benefit society. a. True

b.

False

Social welfare and finance Answer: a Diff: E . If a firm's managers want to maximize stock price it is in their best interests to operate efficient, low-cost plants, develop new and safe products that consumers want, and maintain good relationships with customers, suppliers, creditors, and the communities in which they operate. a. b. True False

Medium: Managerial incentives Answer: a Diff: M . In a competitive marketplace, if managers deviate too far from making decisions that are consistent with stockholder wealth maximization, they risk being disciplined by the market. Part of this discipline involves the threat of being taken over by groups who are more aligned with stockholder interests. a. b. True False

Hostile takeovers Answer: b Diff: M . A hostile takeover is a method of seizing control of a company and involves an action taken against the opposition of incumbent management. However, this action is typically motivated by a desire to control the firm's assets and is rarely motivated by a low share price. a. b. True False

Multiple Choice: Conceptual Easy: Goal of firm Answer: d Diff: E . The primary goal of a publicly-owned firm interested in serving its stockholders should be to a. b. c. d. e. Maximize expected total corporate profit. Maximize expected EPS. Minimize the chances of losses. Maximize the stock price per share. Maximize expected net income.

Agency Answer: d Diff: E . Which of the following statements is most correct?

a. Compensating managers with stock can reduce the agency problem between stockholders and managers. b. Restrictions are included in credit agreements to protect bondholders from the agency problem that exists between bondholders and stockholders. c. The threat of a takeover can reduce the agency problem between bondholders and stockholders. d. Statements a and b are correct. e. All of the statements above are correct. Agency Answer: a Diff: E . Which of the following work to reduce agency conflicts between stockholders and bondholders? a. b. c. d. Including restrictive covenants in the company’s bond contract. Providing managers with a large number of stock options. The passage of laws which make it easier for companies to resist hostile takeovers. Statements b and c are correct. e. All of the statements above are correct.

Agency Answer: d Diff: E . Which of the following actions are likely to reduce the agency problem between stockholders and managers? a. b. c. d. e. Congress passes a law that severely restricts hostile takeovers. A manager receives a lower salary but receives additional shares of the company’s stock. The board of directors has become more vigilant in its oversight of the company’s management. Statements b and c are correct. All of the statements above are correct.

Agency Answer: b Diff: E . Which of the following actions are likely to reduce agency conflicts between stockholders and managers? a. b. c. d. e. Paying managers a large fixed salary. Increasing the threat of corporate takeover. Placing restrictive covenants in debt agreements. All of the statements above are correct. Statements b and c are correct.

Managerial incentives Answer: e Diff: E . Which of the following mechanisms is used to motivate managers to act in the interests of shareholders? a. b. c. d. e. Bond covenants. The threat of a takeover. Executive stock options. Statements a and b are correct. Statements b and c are correct.

Stock is valuable only because it generates cash flows for the investor. A stock’s fundamental value is the value it would have if all accurate. d. or managers may operate in their own personal best interests. e. b. d. long-term price Answer: a Diff: M N . Management should work to maximize the stock’s short-term value. Which of the following statements is most correct? a. b. Agency Answer: c Diff: M . (b) and (c) are correct. Free cash flows are called “free” because the cost of capital for these cash flows is zero. c. c. e. d. Short-term vs. Intrinsic value Answer: b Diff: M N . c. The agency conflicts between bondholders and stockholders can be reduced with the use of bond covenants. All of the statements above are false. b. As long as managers stay within the law. (a) and (b) are correct. e. Agency conflicts between stockholders and managers are not really a problem when outsiders (i. An agency relationship exists when one or more persons hire another person to perform some service but withhold decision-making authority from that person. pertinent information were available to the market. there are no effective controls that stockholders can implement to control managerial decision making. A stock’s market price is usually greater than its intrinsic value. non-managers) own shares in a corporation.Medium: Valuation Answer: e Diff: M N . Management can’t manipulate the short-term price because it is determined in the marketplace. Managers may operate in stockholders' best interests.e. c. Managers can affect firm value by changing the riskiness of its cash flows. A stock’s intrinsic value is usually greater than its market price. d. pertinent information were available to the market.. A stock’s intrinsic value is its book value. A stock’s short-term price and long-term price are the same. Which of the following statements is most correct? a. A stock’s market price is the marginal investor’s intrinsic value. Agency Answer: d Diff: M . e. Which of the following statements is most correct? a. b. Which of the following statements is most correct? a. A stock’s short-term value is the value it would have if all accurate. A stock’s intrinsic value is its market value.

Managers are granted performance shares. A company declares bankruptcy.000. but uses the money instead to repurchase stock. Statements b and c are correct. b. Which of the following statements is most correct? a. The threat of takeover is one way in which the agency problem between stockholders and managers can be alleviated. c.000. e. but instead of being liquidated. Anti-pollution laws are unnecessary because firms will choose not to pollute because that is in their best interests. A principal hires another individual to perform some service. An agent takes unobserved actions on his own behalf. A moral hazard problem arises when: a. A company borrows $1. d.000 worth of executive stock options. . d. Firms that try to maximize their stock values will tend to lay off employees to cut costs. c. b. A group of institutional stockholders votes to oust management.000 for investment in equipment. b. Managerial compensation can be structured to reduce agency problems between stockholders and managers. A CEO is awarded $100. Which of the following is an example of a moral hazard? a. Firms that try to maximize their stock values will raise the prices of their products.000. Agency Answer: d Diff: M . c. b. d. EVA .. Which of the following statements is most correct? a. a. All of the statements above are correct. One of the ways in which firms can mitigate or reduce agency problems between bondholders and stockholders is by increasing the amount of debt in the capital structure. e. Goal of firm Answer: e Diff: M . e. d. Answer: c Diff: M Which of the following statements is most correct? EVA is a measure of the value added to customers. The government should allow monopolies to operate without regulation so that they may maximize their shareholders’ wealth. which he exercises two years later for $1. gouging customers and driving them away. e. Stockholders have to incur costs to make managers act to maximize stock price. Newly-privatized firms generally hire more employees. c. A CEO orders the headquarters moved just so he can have a nicer office. Agency Answer: a Diff: M . it is reorganized and one set of bondholders who are owed $10 million accept $3 million in payment for the debt. Firms borrow money from bondholders.

Sarbanes-Oxley requires company executives to disclose their fraudulent activities “in a timely and accurate manner. True . EVA is a measure of the firm’s true profitability. Sarbanes-Oxley established a new Federal agency. c. e. c. we can construct a payoff matrix of expected returns. e. A transparent market has few regulations. d. A market is transparent when everyone knows who the person is that they are trading with.b. c. d. e. Which of the following statements is most correct? a. Sarbanes-Oxley made it illegal for company executives to trade on insider information. Sarbanes-Oxley Answer: d Diff: M N . Transparency Answer: b Diff: M . EVA is a measure of management compensation. Payoff matrix Answer: a Diff: E . Sarbanes-Oxley requires the Securities Exchange Commission to audit public companies’ financial statements. Which of the following statements is most correct? a. multiplying each outcome or "state" by its respective probability of occurrence for a particular stock. A transparent market has many opportunities for trading on insider information. a. Sarbanes-Oxley prohibits auditors from providing consulting services to the companies they audit. d. Sarbanes-Oxley requires the Chairman of the Board of Directors to sign and certify the company’s financial statements. Which of the following statements is most correct? a. A market is transparent when trading is inexpensive.” Sarbanes-Oxley Answer: e Diff: M N . EVA is a measure of the value added to management. A market is transparent when accurate information is available to all market participants. Sarbanes-Oxley requires that auditors maintain extensive records to document that their consulting and auditing services for a given company are not conflicting. c. b. Sarbanes-Oxley prohibited investment banks from allowing their analysts to make recommendations on stocks the investment banks do business with. e. Sarbanes-Oxley requires the CEO sign and certify the company’s financial statements. to audit public companies’ financial statements. b. EVA is a measure of stock price. b. d. the Public Company Auditing Board. Sarbanes-Oxley requires that either the CEO or CFO hand-deliver the annual and quarterly financial statements to the SEC. If we develop a weighted average of the possible return outcomes.

a. b. False Risk comparisons Answer: a Diff: E . Companies should deliberately increase their risk relative to the market only if the actions that increase the risk also increase the expected rate of return on the firm's assets by enough to completely compensate for the higher risk. a. True False Risk and expected return Answer: a Diff: E . One key result of applying the Capital Asset Pricing Model is that the risk and return of an individual security should be analyzed by how that security affects the risk and return of the portfolio in which it is held. b. True False Coefficient of variation Answer: a Diff: E . b. True False CAPM and risk Answer: a Diff: E . the smaller the risk of a given investment as measured by the standard deviation. calculated as the standard deviation divided by the expected return. a. a. The coefficient of variation. The coefficient of variation is a better measure of risk than the standard deviation if the expected returns of the securities being compared differ significantly. True False Risk aversion Answer: a Diff: E . this is evidence of risk aversion. a. False Standard deviation Answer: a Diff: E . When investors require higher rates of return for investments that demonstrate higher variability of returns. b. a. The tighter the probability distribution of expected future returns. is a standardized measure of the risk per unit of expected return. True False CAPM and risk Answer: a Diff: E . True b.b. b.

b. the greater the benefits of the additional portfolio diversification. The realized portfolio return is the weighted average of the relative weights of securities in the portfolio multiplied by their respective expected returns. True False Portfolio return Answer: b Diff: E . b. True False Portfolio risk Answer: b Diff: E . Thus. the relevant risk is an individual stock's contribution to the overall riskiness of the portfolio. True False Beta coefficient Answer: a Diff: E . True False Market risk Answer: b Diff: E . b. a. True False Market risk Answer: a Diff: E . and it will definitely have a beta which is greater than 1.. a. not the isolated risks of individual stocks. a. a. True False Portfolio risk Answer: b Diff: E . When adding new securities to an existing portfolio. a. investors are primarily concerned with portfolio risk. Portfolio diversification reduces the variability of the returns on each security held in the portfolio. a. A security's beta measures its nondiversifiable (or market) risk relative to that of most other securities. b. Diversifiable risk. According to the Capital Asset Pricing Model.0. the higher or more positive the degree of correlation between the new securities and those already in the portfolio. A stock with above average market risk will tend to be more volatile than an average stock. can be lowered by adding more stocks to a portfolio. Market risk refers to the tendency of a stock to move with the general stock market. which is measured by beta. b. b. .

b. a. If investors become more averse to risk. a. b. and if it is expected to remain constant. Businesses earn returns for security holders by purchasing and operating physical assets. b. True False Medium: .a. b. If its market risk is known. the analyst has sufficient information to specify the firm's required return. True False Changes in beta Answer: b Diff: E . b. a. The relevant risk of any physical asset must be measured in terms of its effect on the risk of the firm's securities. SML . A stock's beta is more relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only one stock. True False SML and risk aversion Answer: a Diff: E . True False Physical assets Answer: a Diff: E . the slope of the Security Market Line (SML) will increase. The required return on a firm's common stock is determined by the firm's market risk. True False Required returnAnswer: b Diff: E . b. b. True False Answer: b Diff: E The slope of the SML is determined by the value of beta. a. a. a. True False Beta coefficient Answer: a Diff: E . A firm cannot change its beta through any managerial decision because betas are completely market determined.

b. That is. the standard deviation is not always an adequate measure of risk. a. the coefficient of variation will always allow an investor to properly compare the relative risks of any two securities. a. True False Portfolio risk Answer: a Diff: M . b. Risk aversion is a general dislike for risk and a preference for certainty. while Portfolio B has 100 securities. Because of differences in the expected returns of different securities. True False Coefficient of variation Answer: b Diff: M . a. the standard deviation. True False Risk aversion Answer: b Diff: M . but it is possible for Portfolio A to be less risky. Risk aversion implies that some securities will go unpurchased in the market even if a large risk premium is paid to investors. However. it is always larger than its square root. we should soon observe an increase in demand for the investment. Portfolio A has but one security. exceeds its required rate of return. b. and the price will likely increase until a price is established that equates the expected return with the required return.Variance Answer: b Diff: M . as seen by the marginal investor. Because of diversification effects. Variance is a measure of the variability of returns and since it involves squaring each deviation of the required return from the expected return. True False Answer: b Diff: M Portfolio risk . a. a. investors would be willing to give up a risk premium of return in order to obtain a lower return with certainty. b. we would expect Portfolio B to have the lower relevant risk. a. b. True False Expected returnAnswer: a Diff: M . True False Risk premium and risk aversion Answer: a Diff: M . If the expected rate of return for a particular investment. b.

When a firm makes bad managerial judgements or has unforeseen negative events happen to it that affect its returns. a. these random events are unpredictable and therefore cannot be diversified away by the investor. True False Correlation coefficient and risk Answer: b Diff: M . a. b. the resulting portfolio can have less risk than either security held alone. True False Reducing portfolio risk Answer: a Diff: M .. we know that Portfolio B will have the lower market risk. True False Portfolio risk and beta Answer: b Diff: M . b. True False Portfolio risk and return Answer: b Diff: M . It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio. Even if the correlation between the returns on two different securities is perfectly positive. while Portfolio B has 100 securities. True False Company-specific risk Answer: b Diff: M .2 30% -10% Normal 0. The distributions of rates of return for Companies AA and BB are given below: State of Probability of Economy State Occurring AA BB Boom 0.6 10 5 Recession 0. that is. b. b. Portfolio B will have the lower beta. Because of diversification. a. While the portfolio return is a weighted average of realized security returns. portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio. Portfolio A has but one security.2 -5 50 We can conclude from the above information that any rational risk-averse investor will add Security AA to a well-diversified portfolio over Security BB. a. a. b. if the securities are combined in the correct unequal proportions.

If the price of money increases due to greater anticipated inflation. b. True False Beta coefficient Answer: a Diff: M . he or she can. Betas used in the CAPM. a. True False Changes in beta Answer: a Diff: M . We will generally find that the beta of a diversified portfolio is more stable over time than the beta of a single security. b. True False CAPM Answer: a Diff: M . True False Portfolio beta Answer: a Diff: M . a. a. b. I should increase the beta of my portfolio.tion. Any change in beta is likely to affect the required rate of return on a security. Although rRF will increase. are always subject to changes in future volatility and this is a limitation on the use of the CAPM. through diversifica. the risk-free rate will reflect this fact. If I know for sure that the market will have a positive return over the next year. A portfolio with a beta of minus 2 has the same degree of risk to its holder. If an investor buys enough stocks. although we are limited in most cases to using past data in applying it. to maximize my rate of return. b. it is possible that the SML required rate of return for a stock will . True False Diversification effects Answer: a Diff: M . However. The CAPM is built on expected conditions. the holder of either portfolio could lower his or her risk exposure by buying some "normal" stocks. a. eliminate all of the non-market risk inherent in owning stocks. a.. b. calculated using historical data. which implies that a change in beta will likely have an impact on the security's price. a. relative to the market. but as a general rule it will not be possible to eliminate all market risk. True False CAPM and inflation Answer: b Diff: M . as a portfolio with a beta of plus 2. b.

the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor. As a result. assuming that the observed relationship is expected to continue into the future. e. Since the market return represents the return on an average stock. and if you found that the slope of the regression line was negative. The slope and intercept of this line cannot be controlled by the financial manager. a. that return carries risk with it. When company-specific risk has been diversified. d. a. True False SML Answer: b Diff: M . b. The Y-axis intercept of the SML indicates the return on the individual asset when the realized return on an average stock (beta = 1. (Assume that beta remains constant. Risk refers to the chance that some unfavorable event will occur. there exists a market risk premium which is the amount over and above the risk-free rate that is required to compensate an investor for assuming an average amount of risk. The SML relates required returns to firms' market risk. c.0 has zero market risk. b. True False Multiple Choice: Conceptual Easy: Risk concepts Answer: e Diff: E . Which of the following statements is most correct? a. True False SML Answer: a Diff: M .0) is zero. If you plotted the returns of a given stock against those of the market. and a probability distribution is completely described by a listing of the likelihood of unfavorable events. b. b. b. a. .rRF) will decrease. A stock with a beta of -1. Portfolio diversification reduces the variability of returns on an individual stock.decrease because the market risk premium (rM . True False Market risk premium Answer: a Diff: M .) a. the inherent risk that remains is market risk which is constant for all securities in the market.

e. which of the following statements is most correct? a. b. Portfolio risk and return Answer: a Diff: E . Company X has a lower coefficient of variation. e. Statements a and b are correct. The portfolio’s standard deviation is 20 percent. The expected return on Stock A will be greater than that on Stock B. e. Company X has a lower standard deviation than Company Y. b. Higher beta stocks have a higher required return. Company X is a better stock to buy. The portfolio’s beta is less than 1. Stock B would be a more desirable addition to a portfolio than Stock A. and a beta of 1. Company-specific risk can be diversified away. e. Beta coefficient Answer: d Diff: E . Answer: b Diff: E . Company X has a higher beta than Company Y. Answer: a Diff: E Which of the following statements is incorrect? The slope of the security market line is measured by beta. Statements a and b are correct. a standard deviation of 20 percent. Given this information. d. d. c. When held in isolation. Statements a. Stock A would be a more desirable addition to a portfolio than Stock B. SML The portfolio’s expected return is 15 percent. d. Stock A and Stock B each have an expected return of 15 percent. d. Stock A has a beta of 1.6. the correlation coefficient is 0. You observe the following information regarding Company X and Company Y: • • • Company X has a higher expected mean return than Company Y. The expected return on Stock B will be greater than that on Stock A. c.Risk measures Answer: a Diff: E . Which of the following statements must be true about these securities? (Assume the market is in equilibrium.2. b. The returns of the two stocks are not perfectly correlated.2. Two securities with the same stand-alone risk can have different betas.) a. You have put together a portfolio which is 50 percent Stock A and 50 percent Stock B. Which of the following statements is most correct? a. and c are correct. c.5 and Stock B has a beta of 0. a. c. b. The market risk premium is affected by attitudes about risk. Company X has more company-specific risk. SML . Stock A has greater risk than Stock B. b.5. All of the statements above are correct.

000 invested in Stock A and $100. None of the above statements is correct. b. Statements a and c are correct. Portfolio P has a standard deviation of 22. c. SML Answer: c Diff: E . Stock B has a higher required rate of return than stock A. b.5 percent. if the portfolio contained all publicly traded stocks.. d. and if that risk is expected to remain constant. c.0. e. The slope of the security market line is the market risk premium. Stock B has a beta of 0. Statements a and c are correct. Indeed.2 and a standard deviation of 20 percent. e. d. Portfolio diversification reduces the variability of the returns on the individual stocks held in the portfolio. Which of the following statements is most correct? a. d. If the systematic risk is known. Portfolio P has a beta equal to 1. Portfolio P is a $200. A stock's beta is less relevant as a measure of risk to an investor with a well diversified portfolio than to an investor who holds only that one stock. SML. or market) risk relative to that of an average stock. If an investor buys enough stocks. Risk analysis and portfolio diversification Answer: d Diff: E . its required rate of return will be unaffected by changes in the market risk premium.000 invested in Stock B. e. he or she can. A stock with a negative beta must have a negative required rate of return. Which of the following statements is most correct? a. Medium: . The slope of the security market line is beta. b. A security's beta measures its nondiversifiable (systematic. eliminate virtually all of the non¬market (or company-specific) risk inherent in owning stocks.000 portfolio consisting of $100. through diversification. e.8 and a standard deviation of 25 percent. c. If you double a company’s beta its required return more than doubles. b. d. (rM – rRF). The required return on a firm's common stock is determined by its systematic (or market) risk. Statements a and b are correct. then no other information is required to specify the firm's required return. and beta Answer: e Diff: E . Stock A has a beta of 1. Which of the following statements is most correct? a. If a stock’s beta doubles its required rate of return must double.) a. Statements b and c are correct. If a stock has a beta equal to 1. c. The slope of the security market line is beta. CAPM. it would be riskless.0. Which of the following statements is most correct? (Assume that the required return is determined by the Security Market Line.

15 0. B B. is 5 percent.29 Beta If you are a risk minimizer. you should choose Stock _____ if it is to be held in isolation and Stock _____ if it is to be held as part of a well-diversified portfolio.2 and $300. that is. Assume that required returns are based on the CAPM. Assume that investors become increasingly risk averse. is 6 percent and the market risk premium. Portfolio return Answer: b Diff: M . e. = r. assume that the risk-free rate and expected inflation remain the same. a. B SML and risk aversion Answer: e Diff: M . b. that is.000 invested in a stock that has a beta of 1. rRF. The past realized rate of return must be equal to the expected rate of return. d. The portfolio’s required return is less than 11 percent. c. Which of the following statements is most correct? a. For markets to be in equilibrium. A.20 1. The expected rate of return must be equal to the required rate of return.8.0.000 invested in a stock that has a beta of 0. d. You have developed the following data on three stocks: Stock A B C Standard Deviation 0.25 0. The required rate of return will decline for stocks that have betas less than 1. rM will remain the same. that is. r = . Answers a and b are correct.79 0. c. e. The required rate of return must equal the realized rate of return. c. = r = . that is. for there to be no strong pressure for prices to depart from their current levels.Market equilibrium Answer: a Diff: M . Which of the following is most likely to occur? a. a. All three of the statements above must hold for equilibrium to exist. The required rate of return for each stock in the market will increase by an amount equal to the increase in the market risk premium. r = . (rM – rRF). Risk aversion Answer: b Diff: M . A C. so that the market risk premium increases. Also. Your $1 million portfolio consists of $700. e. that is. d. None of the statements above is correct. A C. b. None of the statements above is correct. . A A. The risk-free rate.61 0. b. The required rate of return on the market.

Portfolio risk and beta Answer: c Diff: M . None of the above (that is. c. Which of the following statements is most correct? . Portfolio risk Answer: e Diff: M . the required return on your portfolio will increase by more than 2 percentage points. b. but not necessarily at the same time).2. Stock A has a beta = 0.6. Which of the following statements is most correct? a. which of the following could not be true? a. If the market risk premium remains unchanged but expected inflation increases by 2 percentage points. If market participants become more risk averse.b. e. d. while Stock B has a beta = 1. the required return on your portfolio will increase by more than 2 percentage points. All of the answers above are correct. In a portfolio of three different stocks. Answers b and c are correct. An equally weighted portfolio of Stock A and Stock B will have a beta less than 1. b. Market participants are able to eliminate virtually all market risk if they hold a large diversified portfolio of stocks. Which of the following statements is most correct? a. e. the required return on Stock B will increase more than the required return for Stock A. your portfolio’s expected return should equal the expected return on the market. Portfolio risk and return Answer: c Diff: M . Stock B’s required return is double that of Stock A’s. d. which is 11 percent.8. If the risk-free rate remains unchanged but the market risk premium increases by 2 percentage points. The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isola¬tion. c. It is possible to have a situation where the market risk of a single stock is less than that of a well diversified portfolio. d. Portfolio risk and beta Answer: e Diff: M . d. e. e. If the stock market is efficient. Answers a and c are correct. The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. c. c. None of the above answers is correct. they all could be true. Answers a and c are correct.specific risk if they hold a large diversified portfolio of stocks. Market participants are able to eliminate virtually all company. The beta of the portfolio is less than the beta of each of the individual stocks. b. The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas.

you should invest some of your money in each stock in the market. Diversifiable risk. then. and high interest rates are economic events which are characterized as a. . Beta coefficient Answer: a Diff: M . d. Jane’s portfolio has a larger amount of company-specific risk since she is holding more stocks in her portfolio. c. Company-specific risk that can be diversified away. Jack has the same amount of money invested in a single stock with a beta equal to 1. One could also construct a scatter diagram of returns on the stock versus those on the market. if there were 10. b. c. c. Statements b and d are correct. i. d. If you add enough randomly selected stocks to a portfolio. then. Which of the following statements is most correct? a. Jane holds a large diversified portfolio of 100 randomly selected stocks and the portfolio’s beta = 1.6 and a standard deviation of 20 percent. If you formed a portfolio which included a large number of low beta stocks (stocks with betas less than 1. and use it as beta. Jane has a higher required rate of return. d. If a stock did have a beta of 1.0). Market risk Answer: b Diff: M .. Inflation. Which of the following statements is most correct? a. recession. The beta coefficient of a stock is normally found by running a regression of past returns on the stock against past returns on a stock market index. Diversifiable risk can be eliminated by forming a large portfolio. yet you wanted to minimize the riskiness of your portfolio as measured by its beta. Portfolio diversification Answer: c Diff: M . Unsystematic risk that can be diversified away. e. b. but normally even highly diversified portfolios are subject to market risk. It is theoretically possible for a stock to have a beta of 1.2. b. according to the CAPM theory. estimate the slope of the line of best fit. at least in theory.0. e. None of the statements above is correct.a.0. so the portfolio would have a relatively low degree of risk.e. Statements b and c are correct. Market risk. Each of the individual stocks in her portfolio has a standard deviation of 20 percent. Jane’s portfolio has less market risk since it has a lower beta. the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio. you can completely eliminate all the market risk from the portfolio. since she is more diversified.0 but greater than -1.000 traded stocks in the world. its required rate of return would be equal to the riskless (default-free) rate of return. Systematic risk that can be diversified away. If you were restricted to investing in publicly traded common stocks. rRF. the least risky portfolio would include some shares in each of them. b. e.

profits. Sometimes a security or project does not have a past history which can be used as a basis for calculating beta. is in the business of collecting past-due accounts for other companies. e.05 0. Which of the following is not a difficulty concerning beta and its estimation? a. Collections Inc. c.6. because it does so much better than most other companies when the economy is weak. Collections' revenues. Statements a and c are true. All of the statements above are true.18 0.05 -0.25 0.e.c. Market Stock A Stock B 0. d.0. bB = 0 bA = 0.10 0.05 -0. i. e. You have developed data which give (1) the average annual returns on the market for the past five years. bB = 0 bA < -1. Your 1-stock portfolio would be even less risky if the stock had a negative beta. say 2. which of the possible answers best describes the historical betas for A and B? Years 1 2 3 4 5 a. Beta coefficient Answer: d Diff: M . Which of the following statements is most correct? a.05 0. b. Suppose you are managing a stock portfolio. c. This suggests that Collections Inc. bB = 1 bA > +1.14 0.16 0.05 0. and stock price tend to rise during recessions. If you found a stock with a zero beta and held it as the only stock in your portfolio. d. i. bB = 1 Beta coefficient Answer: c Diff: M .01 0. Beta coefficient Answer: a Diff: M . The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.20 0. Suppose the returns on two stocks are negatively correlated.e.. e.. and you have information which leads you to believe that the stock market is likely to be very strong in the immediate future. you would by definition have a riskless portfolio. One has a beta of 1.03 0. If these data are as follows. . you are confident that the market is about to rise sharply. while the other has a beta of -0.06 0. You should sell your high beta stocks and buy low beta stocks in order to take advantage of the expected market move. The returns on the stock with the negative beta will be negatively correlated with returns on most other stocks in the market.05 bA > 0. b. bB = -1 bA < 0.2 as determined in a regression analysis. d. Statements a and b are true.'s beta should be quite high. and (2) similar information on Stocks A and B. it is a collection agency.

Down and keep same slope. Down and have steeper slope. SML. The slope of the SML is determined by the value of beta. c. d. b. Answer: e Diff: M Which of the following statements is most correct? a. b. other things held constant. Statements a and c are true. (1) if the expected inflation rate decreases. the stock's expected return will increase by 3 percent. Sometimes. sometimes drastically. If investors become less risk averse. Answers a. Answer: b Diff: M Which of the following statements is most correct about a stock which has a beta = 1. the Security Market Line would shift a. The SML relates required returns to firms' market risk. c." or "the market. b. c. An increase in expected inflation could be expected to increase the required return on a riskless asset and on an average stock by the same amount. Other things held constant. d. and you found that the slope of the regression line was negative." can change over time. SML . c. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.2? a. e. A graph of the SML would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis. Up and have less steep slope. the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor. If you plotted the returns of a given stock against those of the market. and (2) investors become more risk averse. SML Answer: a Diff: M . and c are correct. b. If the market risk premium increases by 3 percent the stock's expected return will increase by less than 3 percent. e. the calculated beta will be drastically different than the "true" or "expected future" beta. b. Up and keep same slope. SML . the slope of the Security Market Line will increase. during a period when the company is undergoing a change such as toward more leverage or riskier assets. d. and portfolio risk Answer: a Diff: M . If expected inflation increases 3 percent. Down and have less steep slope. The beta of an "average stock. Which of the following statements is most correct? a. d. assuming that the observed relationship is expected to continue on into the future. CAPM.b. The slope and intercept of this line cannot be controlled by the financial manager. If the stock's beta doubles its expected return will double. . Answers b and c are correct. e.

then the new security market line would have a steeper slope. d. but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.. but normally even highly diversified portfolios are subject to market (or systematic) risk.5. you can completely eliminate all the market risk from the portfolio. e. stocks with higher standard deviations of returns will have higher expected returns. and the theory has been confirmed beyond any reasonable doubt. Answers b and c are correct. this portfolio will have more market risk than a single stock with a beta = 0. If investors became more averse to risk. If a stock has a negative beta. A portfolio with a large number of randomly selected stocks will have less market risk than a single stock which has a beta equal to 0. Which of the following statements is most correct? . The CAPM has been thoroughly tested. the portfolio's expected return would be a weighted average of the stocks' expected returns. b. b. If you form a large portfolio of stocks each with a beta greater than 1. and c are correct. CAPM and required returns Answer: d Diff: M . Portfolio risk and SML Answer: e Diff: M . e. Which of the following statements is most correct? a. e.e. b. Company-specific (or unsystematic) risk can be reduced by forming a large portfolio. and beta Answer: e Diff: M . If two "normal" or "typical" stocks were combined to form a 2-stock portfolio. its expected return must be negative.8. c. If you add enough randomly selected stocks to a portfolio. All of the statements above are correct. CAPM. an equally weighted portfolio of the two stocks will have a variance which is less than that of the individual stocks.c. Portfolio return. d. c. Which of the following statements is most correct? a. Answers a. c. b. then the required rate of return will also double. If investors became more risk averse. Both statements a and b are correct. d. Risk analysis and portfolio diversification Answer: e Diff: M . None of the statements above is correct. According to the CAPM. then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on highbeta stocks. d. If the returns from two stocks are perfectly positively correlated (i. If the beta of a company doubles.0. Which of the following statements is most correct? a. the correlation coefficient is +1) and the two stocks have equal variance. e. We would observe a downward shift in the required returns of all stocks if investors believed that there would be deflation in the economy.

the required return on low beta stocks will decline. Expectations for inflation are not reflected anywhere in this equation. d. because each of the elements in the equation is determined exclusively by the market. All of the statements above are correct. Assume that the required rate of return on the market. even in the long run. If you selected a group of stocks whose returns are perfectly positively correlated. then the two mutual funds would both have betas of 1. market participants become more risk averse. Since the holder of the 1-stock portfolio is exposed to more risk. . not by the type of actions a company's management can take. d. Answer: d Diff: T Which of the following statements is most correct? a. each of which had a beta of 1. the calculated market risk premium would be larger if the 30-day T-bill rate were used as the risk-free rate than if the 30-year Tbond rate were used as rRF.0. Statements a and b are true. b. assuming the stocks are all equally risky. c. It is possible to have a situation where the market risk of a single stock is less than the market risk of a portfolio of stocks. An investor who holds just one stock will be exposed to more risk than an investor who holds a portfolio of stocks.0. e. d.0 and thus would be equally risky from an investor's standpoint. If the yield curve has a steep upward slope. If investors become more risk averse. c. Which of the following statements is most correct? a. on average. he or she can expect to earn a higher rate of return to compensate for the greater risk. then you could end up with a portfolio for which none of the unsystematic risk is diversified away. there is nothing a financial manager can do to change his or her company's cost of capital. Statements a and c are true. and Mutual Fund B held equal amounts of 10 stocks with betas of 1. c. but the required return on an average risk stock will not change.a. The market risk premium will increase if. Statements a and b are correct. According to CAPM theory. rM. Assume that the required rate of return on the market is currently rM = 15%. even indirectly. SML . If the yield curve were upward-sloping. If the required rate of return is given by the SML equation as set forth in Statement a. Tough: CAPM Answer: c Diff: T . If Mutual Fund A held equal amounts of 100 stocks. e. but rRF remains constant. is given and fixed. b. the required rate of return on high beta stocks will rise. b.rRF)bi. and that rM remains fixed at that level. then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. and because of that the text notes that the CAPM may not be strictly correct. the required rate of return on a given stock can be found by use of the SML equation: ri = rRF + (rM .

1.0% 2. c. determine which beta coefficient for Stock A is consistent with equilibrium: rA = 11.0% 15. the market has averaged a 14 percent annual return over the last six years. rM = 10% . The risk-free rate is 10 percent. d.2. The Mars’s beta is 1. what will be the difference in the required returns on HR's and LR's stocks? a. c.5% 5. Calculate the required rate of return for Mars Inc. d.4% 6. and Mars has averaged a 14. the real risk-free rate remains constant.4 return over the last six years. HR Corporation has a beta of 2.6% 16. c. c.0.0. b. and its realized rate of return has averaged 15 percent over the last 5 years. e. d.5. Mercury has a beta of 2.2% 14. e. and d are false. 15% 16% 17% 18% 20% CAPM and required return Answer: e Diff: E .. the expected return on the market is 11. b. the required return on the market falls to 11 percent.6% 13.e. and the required rate of return on an average stock is 15 percent. a. the rate on a T-bill is 4 percent. Now the expected rate of inflation built into rRF falls by 3 percentage points.2% Required returnAnswer: d Diff: E . and the betas remain constant. Multiple Choice: Problems Easy: Required returnAnswer: a Diff: E . b.’s stock. assuming that investors expect a 5 percent rate of inflation in the future. The real risk-free rate is equal to 3 percent and the market risk premium is 5 percent. e. When all of these changes are made. b. rRF = 5%.0% Beta coefficient Answer: b Diff: E .3%. while LR Corporation's beta is 0. a.5 percent. Given the following information.5% 4. Statements a. 12. Calculate the required rate of return for Mercury Inc. the rate on a long-term T-bond is 6 percent.

You have decided to sell one of your stocks which has a beta equal to 0.000). bp = 2. what is its beta? a. b. d. If a stock has a required rate of return of 13.28 = 12.75 percent.32 Market risk premium Answer: d Diff: E . your total investment is $200. and a total value of $9.15 and the risk-free rate is 5 percent. You hold a diversified portfolio consisting of a $10.250 1.2.333 Portfolio return Answer: b Diff: E .96 Portfolio beta Answer: b Diff: E . bp = 1. b. What will be the beta of the new portfolio? a. c.0%.0%.0.86 1. bp = 1. c.2. You plan to use the proceeds to purchase another stock which has a beta equal to 1.284 1.26 1. bp = 1. a beta of 1.35 Beta coefficient Answer: a Diff: E . b. The beta of the stock is 1. e. c. c.2%. b.7 for $10. bp = 1. You plan to increase your portfolio by buying 100 shares of AT&E at $10 a share.60 1.8%.25 percent. 0. The portfolio beta is equal to 1. 1. AT&E has an expected return of 20 percent with a beta of 2. = 20. What is the market risk premium? .000.25 1. What will be the expected return and the beta of your portfolio after you purchase the new stock? a.10 0.a.e.235 1.4.80 1. You are an investor in common stock. A stock has an expected return of 12.40 = 14.000 investment in each of 20 different common stocks (i.0%. d.00 = 12. and that the market risk premium is 7 percent. Assume that the risk-free rate is 5 percent.000. 1.. d. e. e. e.35 1. d. and you currently hold a well-diversified portfolio which has an expected return of 12 percent.20 = 13.165 1.37 1.

5. e. since the expected returns are the same. since its expected return is higher.00% 20%.50% 12%. b.25 8 0.a.30% 6. Asset X. since its coefficient of variation is lower and its expected return is higher. since its standard deviation is lower.2 10% 2 0. what is the expected return and the standard deviation of returns for Security J? State Pi rJ _____ ____ ____ 1 0.50% 15. d. Asset X. A riskaverse investor is considering two possible assets as the asset to be held in isolation. d.10 2 0. 15%.30% 7. 1..16% 15%. b. since its beta is probably lower. b. Assume that a new law is passed which restricts investors to holding only one asset.10 -3% 0.30 8 0. e. 6. Expected returnAnswer: c Diff: M . 5. Given the following probability distribution.e.25 5 0.00% 6. Asset Y.2 20 a. 10. Asset Y. e. Either one.30 10 Asset Y r 0. the probability distributions) are as follows: Asset X P r 0. The assets' possible returns and related probabilities (i.10 2 0.00% Required returnAnswer: c Diff: M .6 15 3 0.25 10 P Which asset should be preferred? a. c. 3. d. c.30 5 0.05 -3% 0. c.18% 15%.25% Medium: Expected returnAnswer: e Diff: M .

and Oakdale acquires new assets which increase its beta by 50 percent. What will be the new beta of the portfolio? a. a lead mining stock whose b is equal to 1.20 1. c.. +50% e. What would be the percentage change in the return on the stock.0. and $50.000 investment in each of 20 different common stocks.00% CAPM and required return Answer: d Diff: M . Oakdale Furniture Inc. c. e.0. You are holding a stock which has a beta of 2. e. If the inflation premium increases by 2 percentage points.10 1.000 invested in a stock which has a beta = 1. 1. +30% c. You hold a diversified portfolio consisting of a $5.0 and is currently in equilibrium. for $5. 13. b.000 of stock in a steel company whose b is equal to 2. +40% d. Your portfolio consists of $100.2.25% 17.80% 18.7 and a required rate of return of 15 percent.8.33% 16. if the return on an average stock increased by 30 percent while the risk-free rate remained unchanged? a. The market risk premium is currently 5 percent. b. Last year this portfolio had a required rate of return of 13 percent.50% 22.000 invested in a stock which has a beta = 1. +20% b.14% 7.000 invested in a stock which has a beta = 0. b.14% 11. c. d. and the return on an average stock is 10 percent.22 1. has a beta coefficient of 0.15 Portfolio beta Answer: c Diff: M .15. What is the portfolio's current required rate of return? a. $150. The risk-free rate is 7 percent.25% Portfolio beta Answer: b Diff: M .12 1. The required return on the stock is 15 percent. what will be Oakdale's new required rate of return? a.75% 15. The portfolio beta is equal to 1. You have decided to sell one of your stocks. +60% Required returnAnswer: c Diff: M .45% 15. d.8. This year nothing has changed except for the fact that the market risk premium has increased by 2 percent (two percentage points).000 net and to use the proceeds to buy $5. 5. e. d.

25 5 What is the coefficient of variation on the company's stock? (Assume that the standard deviation is calculated using the probability statistic. and $25.) . 6. she wants the fund's expected return to be 13. 1. Ripken Iron Works faces the following probability distribution: State of the Economy Boom 0.0% None of the answers above is correct. She wants to invest these funds in a variety of stocks. Coefficient of variation Answer: b Diff: M .50 2.50 Recession Probability of Stock’s Expected Return State Occurring if this State Occurs 25% 15 0. Walter Jasper currently manages a $500. what should be the average beta for the new stocks added to the portfolio? a.8% 5. b. What is the required rate of return on the investor's portfolio? a..000. d. e. 1.45 1. e.33 1. A mutual fund manager has a $200.2. After making these additional investments. e. c.67 1. d. b.000 in funds soon.35 1.50. If Walter wants the required return on the new portfolio to be 11.000 from a new client.000 portfolio with a beta = 1.000 portfolio.87 Portfolio beta Answer: e Diff: M .000 in stock B which has a beta of 0. Assume that the riskfree rate is 6 percent and that the market risk premium is also 6 percent.25 Normal 0. What should be the average beta of the new stocks added to the portfolio? a.000 in stock A which has a beta of 1.75 percent. An investor is forming a portfolio by investing $50. The risk-free rate is 4 percent and the return on the market is 9 percent. The existing portfolio has a required return of 10.8% 7. b. The return on the market is equal to 6 percent and Treasury bonds have a yield of 4 percent. The manager expects to receive an additional $50.6% 6. d.10 1.64 1.00 1.5 percent.90. c.5 percent. c.80 Portfolio return Answer: a Diff: M . He is expecting to receive an additional $250.000.

16 Beta coefficient Answer: a Diff: M .62 0. The risk-free rate is 6 percent and .334 3. b.20 -10 0.10 -60% 0. The following probability distributions of returns for two stocks have been estimated: Probability 0. e.000 invested in a stock which has an estimated beta of 1.3 6 Stock A Stock B 5% 4 3 What is the coefficient of variation for the stock that is less risky (assuming you use the coefficient of variation to rank riskiness).) a. b.2.201 2. 3.4 8 0.66 5.10 Probability of Stock’s Expected Return State Occurring if this State Occurs 0. c.47 0. An analyst has estimated how a particular stock’s return will vary depending on what will happen to the economy: State of the Economy Recession Below Average Average Above Average Boom 0. a.3 12% 0. d. and another $15. b.67 0.19 0.71 Coefficient of variation Answer: c Diff: M . An investor has $5.121 2. 2. e.000 invested in the stock of the company for which she works. e. d.a.40 15 0.20 40 90 What is the coefficient of variation on the company’s stock? (Use the population standard deviation to calculate the coefficient of variation.472 3.06 0. 0.54 0.28 0. c. d.727 Coefficient of variation Answer: c Diff: M . c.

e. c. b. the real risk-free rate remains constant.) . by how much will the required return on Stock X exceed that on Stock Y? a.6. d. 3.7.000) portfolio is 15 percent.) is 2 percent.0 Market return Answer: d Diff: M .8 1.the market risk premium is also 6 percent. Which security would be the best investment? (Assume you must choose just one. along with the returns on "the market": Year URI 1 -14% 2 16 3 22 4 7 5 -2 Market -9% 11 15 5 -1 If the risk-free rate is 9 percent and the required return on URI's stock is 15 percent.20% 4. c. The risk-free rate is 7 percent.6 1. Now the expected rate of inflation built into rRF rises by 1 percentage point. what is the required return on the market? Assume the market is in equi¬librium. 1. while Company Y's beta is 0. the required return on the market rises to 14 percent.75% 4.) a. Company X has a beta of 1. The investor calculates that the required rate of return on her total ($20.82% 5. The returns of United Railroad Inc. You have been scouring The Wall Street Journal looking for stocks that are "good values" and have calculated the expected returns for five stocks.40% 5. After all of these changes have been reflected in the data. (URI) are listed below. and the required rate of return on an average stock is 12 percent. 4% 9% 10% 13% 16% CAPM and required return Answer: d Diff: M . e. Assume the risk-free rate (rRF) is 7 percent and the market risk premium ( . b. d.9 2. d.75% Expected and required returns Answer: b Diff: M . What is the beta of the company for which she works? a.7 1. c. e. b. and betas remain constant. (Hint: Think rise over run.

06% c.29% 11. c.000 500.000 Beta 0. e. The risk-free rate.6 1. A money manager is holding the following portfolio: Stock 1 2 3 4 Amount Invested $300.000.50 CAPM and beta coefficient Answer: d Diff: M . rM. 9.000 D 5. The investor holds the following stocks: Stock Amount Invested $2. A money manager is managing the account of a large investor.0 1.50% 1. What is Stock D’s estimated beta? a. is 14 percent. What would be the portfolio’s required rate of return following this change? a.154 Tough: Portfolio required return Answer: a Diff: T .026 2.389 1. is 7 percent and the return on the market.01% b.000 0. rRF. b. b.256 1. 11. The manager would like to sell all of her holdings of Stock 1 and use the proceeds to purchase more shares of Stock 4.000 500. c. 7.Expected Return Beta a.5 percent.40 ??? A The portfolio’s required rate of return is 17 percent.000 Estimated Beta 1. 13.000 300.10 1. 5.000. 8.63% 10.87 2. d.80 B 5.8 The risk-free rate is 6 percent and the portfolio’s required rate of return is 12.52% 14.33% . e.00 -0. d.4 1.04% d.05% 12.000 C 3.70 0.67 0.429 2.000.000.74% e. 1.

0 -2. c.46 15.25% 7.0 If the required return on the market is 11 percent and the risk-free rate is 6 percent. Historical rates of return for the market and for Stock A are given below: Year Market Stock A 1 6.Financial Calculator Section Multiple Choice: Problems Easy: Coefficient of variation Answer: b Diff: E . are given below: Year Market Countercyclical Year 1 -2.0% 8.80 1. e. 6.0% 2 -8.27% 10.79% 8.0 3.69 4. c.57% 7. Below are the stock returns for the past five years for Agnew Industries: Year 1 2 3 4 5 Stock Return 22% 33 1 -12 10 What was the stock’s coefficient of variation during this five-year period? (Use the population standard deviation to calculate the coefficient of variation.22 CAPM and required return Answer: a Diff: M .0% 8. e.0 4 18. what is the required return on Stock A.00% 6.72 0. d.0% . according to CAPM/SML theory? a.0 12. Medium: CAPM and required return Answer: e Diff: M .) a. d.0 3 -8. b. Some returns data for the market and for Countercyclical Corp. b.

b. and the market risk premium is 4 percent.. what is the portfolio's standard deviation? a. d.66% 1.0 The required return on the market is 14 percent. Here are the expected returns on two stocks: Returns Probability X Y 0. d.25% 2.8 20 15 0.64% 3.1% 10. c.5% 13.00% Portfolio standard deviation Answer: a Diff: M .1 40 20 If you form a 50-50 portfolio of the two stocks.0 -8. what is the difference between J's expected and required rates of return? a. and the risk-free rate is 8 percent. 3.0 3. What is the required return on Countercyclical Corp. e.0 18.42% 4.5% 20.4% 16.Year 2 Year 3 Year 4 12. The realized returns for the market and Stock J for the last 4 years are given below: Year Market Stock J 1 10% 5% 2 15 0 3 -5 14 4 0 10 An average stock has an expected return of 12 percent. 0. 8.00% 11. e. c.1 -20% 10% 0.0 -7. If Stock J's expected rate of return as viewed by a marginal investor is 8 percent. c. b.76% 14. according to CAPM/SML theory? a.0% Expected and required returns Answer: c Diff: M . d.58% 8.72% . b.0 21.

67% Beta coefficient Answer: a Diff: E .68% 11. even if the correlation between the returns of it and another firm are negative. the rise-over-run calculation results in a ratio. If all the observation points for the security's returns and the market's returns do not fall on a straight line then the ratio is subject to change. d. True False .000 invested in Stock Y? a. c. In estimating a security's beta coefficient. Stock Y. a. b.58% 12.e. True False Linearity and beta Answer: a Diff: E . a. a. b. The market risk premium is 5 percent. 9. If the returns of two firms are negatively correlated. b. e.000 invested in Stock X and $6.94% 10.0 has zero systematic (or market) risk. b. True False Beta coefficient Answer: a Diff: E . and the market have had the following returns over the past four years. a. then one of them must have a negative beta. Stock X. A stock with a beta equal to -1.41% 13. True False Beta coefficient Answer: b Diff: E .36% Portfolio return Answer: c Diff: M . What is the required rate of return for a portfolio which consists of $14. Year 1 2 3 4 Market X Y 11% 10% 12% 7 4 -3 17 12 21 -3 -2 -5 The risk-free rate is 7 percent. 5. b. It is possible for a firm to have a positive beta.

b. a. True False Answer: b Diff: E The slope of the SML is determined by the value of beta. In portfolio analysis. b. b. a. a. SML . The slope and intercept of this line are not controllable by the financial manager. True False Medium: CAPM Answer: b Diff: M . The Capital Asset Pricing Model (CAPM) is a multi-period model which takes account of differences in securities’ maturities. a. and it can be used to determine the required rate of return for any given level of systematic risk. True False SML Answer: a Diff: E . True False Portfolio risk Answer: a Diff: E . We will almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security. assuming that the observed relationship is expected to continue in the future. b. despite the fact that we are interested in ex ante (future) data. we often use ex post (historical) returns and standard deviations. a. If you plotted the returns of Selleck and Company against those of the market and found that the slope of your line was negative. a. SML True False Answer: b Diff: M . b. True False Portfolio beta Answer: b Diff: M . the CAPM would indicate that the required rate of return on Selleck should be less than the risk-free rate for a well-diversified investor. b.SML Answer: a Diff: E . The SML relates required returns to firms’ syste¬matic (or market) risk.

61 0. if held in isolation and Stock if held as part of Risk measures Answer: d Diff: E .15 0. The Y-axis intercept of the SML indicates the return on the individual asset when the realized return on an average (b = 1) stock is zero.25 0. True False Multiple Choice: Conceptual Easy: Risk aversion Answer: b Diff: E . True False Arbitrage Pricing Theory Answer: b Diff: M . C. a.20 1. C. e.79 0. A. B. you would choose Stock a well-diversified portfolio. A. d. A. You have developed the following data on three stocks: Stock A B C Standard Deviation 0. True False Risk aversion Answer: a Diff: M .29 Beta As a risk minimizer. c.21 will be greater than the return required on an asset whose standard deviation is 0.. and (3) changes in inflation. A. (2) dividend yield. However. If investors are risk averse. b. b. b. Arbitrage Pricing Theory is based on the premise that more than one factor affects stock returns. B. The factors are (1) market returns.10. if assets are held in portfolios. we can conclude that the required rate of return associated with an asset held in isolation whose standard deviation is 0. it is possible that the required return could be higher on the low standard deviation stock. Which is the best measure of risk for an asset held in isolation? Which is the best measure for an asset held in a diversified portfolio? . a. a. C. a. B. b.

Which of the following is not a difficulty concerning beta and its estimation? a. beta. beta. d.. correlation coefficient. c. e. b.5. d. Sometimes.” or “the market. during a period when the company is undergoing a change such as toward more leverage or riskier assets. betas. c. Beta. The beta of the portfolio is less than the beta of each of the individual stocks. b. d.” can change over time. Portfolio risk and return Answer: c Diff: E . b. Beta. The beta of an “average stock. d.e. sometimes drastically. Stock A has greater risk than Stock B. When held in isolation. the calculated beta will be drastically different than the “true” or “expected future” beta. Beta coefficient Answer: d Diff: E . Sometimes a security or project does not have a past history which can be used as a basis for calculating beta. which of the following could not be true? a. The beta of the portfolio is greater than the beta of one or two of the individual stocks’ None of the above (i. All of the statements above are potentially serious problems. Variance. Stock A would be a more desirable addition to a portfolio than Stock B. c. correlation coefficient. b. Which of the following statements must be true about these securities? (Assume market equilibrium. You have developed data which give (1) the average annual returns of the market for the past five years and (2) similar information on Stocks A and B. variance.) a. e. If these data are as follows. Stock B would be a more desirable addition to a portfolio than Stock A. they all could be true. Stock A has a beta of 1. The expected return on Stock B will be greater than that on Stock A. isolation. c. Standard deviation. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. The riskiness of the portfolio is less than the riskiness of each of the stocks held in The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. Medium: Beta coefficient Answer: d Diff: M . Coefficient of variation. but not necessarily at the same time). Beta coefficient Answer: c Diff: E . e.5 and Stock B has a beta of 0. e. In a portfolio of three different stocks. which of the possible answers best describes the historical beta for A and B? .a. The expected return on Stock A will be greater than that on Stock B.

c. “Characteristic line” is another name for the Security Market Line. The distance of the plot points from the characteristic line is a measure of the stock’s market risk. that is. .05 0. Tests of the CAPM Answer: e Diff: M . b. bA = 0. The required rate of return must equal the realized rate of return. None of the above statements is correct. None of the above statements is correct. The distance of the plot points from the characteristic line is a measure of the stock’s diversifiable risk. Market Stock A Stock B 0.18 0. All three of the above statements must hold for equilibrium to exist.25 0. bB = 0. The past realized rate of return must be equal to the expected rate of return. Which of the following statements is most correct? a. d. e. b. for there to be no strong pressure for prices to depart from their current levels). For markets to be in equilibrium (that is. that is. . The slope of the CML is ( M – rRF)/bM. M are inefficient. The slope of the characteristic line is the stock’s standard deviation. Which of the following statements is most correct? . Characteristic line Answer: e Diff: M . d. e.Years 1 2 3 4 5 a. that is. a. e. The expected rate of return must be equal to the required rate of return. that is.06 0.10 0.05 0.03 0.05 -0. bA < -1.14 0. e. c. Answer: e Diff: M Which of the following statements is most correct? a.16 0.01 0. .05 bA > 0.05 0. c. bB = 0. d. b. bB = -1. bA > +1. The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio. CML . The characteristic line is the regression line that results from plotting the returns on a particular stock versus the returns on a stock from a different industry. c. b. Market equilibrium Answer: a Diff: M . d.20 0. bA < 0. bB = 1.05 -0. bB = 1. .

and c are correct.6 and the typical R2 for a portfolio is about 0. d.94. d. c. but that the betas of large portfolios are reasonably stable over time. The excess market return. c. b.10 1.6. e.3 and the typical R2 for a portfolio is about 0. The typical R2 for a stock is about 0. The typical R2 for a stock is about 0. A debt factor. The excess market return.6.a. The excess market return. Tests have shown that the risk/return relationship appears to be linear.94. The excess market return. e. a debt factor.2. b. You hold a diversified portfolio consisting of a $5. Statements a and b are correct. e. The portfolio beta is equal to 1. and a book-to-market factor. Which of the following statements is most correct? a.17 1.0). Multiple Choice: Problems Easy: Portfolio beta Answer: b Diff: E . Richard Roll has argued that it is not even possible to test the CAPM to see if it is correct.02 Portfolio return Answer: b Diff: E . Fama-French Model Answer: a Diff: M . Tests have shown that the betas of individual stocks are unstable over time. e. b. and a debt.3 and the typical R2 for a portfolio is about 0. What is the new beta of the portfolio? a. You plan to buy 100 shares of AT&E at $10 a share. a size factor. an industrial production factor. You have decided to sell a lead mining stock (b = 1. and a book-to-market factor. You are an investor in common stock and currently hold a well-diversified portfolio which has an expected return of 12 percent with a beta of 1. Which of the following are the factors for the Fama-French model? a. The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.22 1. The typical R2 for a stock is about 0. b.3. and a book-to-market factor.12 1. 1. but the slope of the relationship is less than that predicted by the CAPM.0) at $5.000 net and use the proceeds to buy a like amount of a steel company stock (b = 2.12. d. d. a size factor. c. The typical R2 for a stock is about 0. a size factor. . b. and a book-to-market factor. c. Statements a. Beta calculation Answer: c Diff: M .000 investment in each of 20 different common stocks.94 and the typical R2 for a portfolio is about 0.

000 1. b. The funds’ assets are as follows: Stock A B C D Investment Beta $ 200. bp = 1.AT&E has an expected return of 20 percent with a beta of 2.000. Calculate the required rate of return for Mercury.00 rp = 12.000 1. The real risk-free rate is equal to 3 percent and the market risk premium is 5 percent.50 300. and its realized rate of return has averaged 15 percent over the last 5 years.0%. .000 -0. e. e. The total value of your current portfolio is $9. bp = 2. What will be the percentage change in the required return on the stock if the required return on an average stock increases by 30 percent while the risk-free rate is unchanged? Your stock has a beta of 2. assuming that investors expect a 5 percent rate of inflation in the future. c. Consider the following information and then calculate the required rate of return for the Scientific Investment Fund.8%. What will be the expected return and beta of the portfolio after the purchase of the new stock? a.000 0. Mercury has a beta of 2. d. bp = 1.32 Required returnAnswer: d Diff: E .25 1.50 500.20 rp = 13.0. bp = 1.0%. 15% 16% 17% 18% None of the above Medium: Required returnAnswer: c Diff: M . The required rate of return on the stock is 15 percent when the required return on an average stock is 10 percent. a. a. bp = 1. d.75 The market required rate of return is 15 percent and the risk-free rate is 7 percent.0. c. rp = 20. d. Inc. b. +20% +30% +40% +50% +60% Required returnAnswer: c Diff: M . c.2%.28 rp = 12. e.000..40 rp = 14. You are holding a stock which is currently in equilibrium. b.0%.

71 16.70 12.a.25% 17. d. e.0% 13. Oakdale Furniture. along with the returns on the market: Year 2002 2003 2004 2005 2006 URI -14% 16 22 7 -2 Market -9% 11 15 5 -1 If the risk-free rate is 9 percent and the required return on URI’s stock is 15 percent.10% 2 -3. what will be Oakdale’s new required rate of return? a. d. 14. (URI) are listed below.90 3 21. (Hint: Think rise over run.7 and a required rate of return of 15 percent.1% 12. b. The returns of United Railroad. c. e. 4% 9% 10% 13% 16% Beta and base year sensitivity Answer: a Diff: M .20 .) a.50% 22. what is the required return on the market? Assume the market is in equilibrium.3% Required returnAnswer: c Diff: M . e. c.7% 10. what is the difference in the calculated beta coefficient of Stock Q when Year 1 and Year 2 data are used as compared to Year 2 and Year 3 data? Year Stock Q Market 1 6. c.3% 15. Inc. b. Inc.30% 6. The market risk premium is currently 5 percent. has a beta coefficient of 0. b.75% 15.80% 18. 13. Given the following returns on Stock Q and "the market" during the last three years. If we expect the inflation premium to increase by 2 percentage points and Oakdale to acquire assets which will increase its beta by 50 percent. d.00% Market return Answer: d Diff: M .

b.a. a. If a firm raises capital by selling new bonds. 9. A 20-year original maturity bond with 1 year left to maturity has more interest rate risk than a 10-year original maturity bond with 1 year left to maturity. True . in the real world. True False Mortgage bond Answer: a Diff: E ." and the coupon rate is generally set equal to the required rate. (Assume that the bonds have equal default risk and equal coupon rates. be subject to much more interest rate risk if you purchased a 30-day bond than if you bought a 30-year bond. For bonds. Because short-term interest rates are much more volatile than long-term rates. may be found by determining future cash flows and then discounting them back to the present. b. Typically. a. True False Interest rate risk Answer: b Diff: E . b. b.17 1. a. debentures have higher interest rates than mortgage bonds primarily because the mortgage bonds are backed by assets while debentures are unsecured. a. the buyer is called the "issuing firm. e. True False Bond prices and interest rates Answer: a Diff: E . The market value of any real or financial asset. c. b. bonds.) a. price sensitivity to a given change in interest rates generally increases as years remaining to maturity increases.06 6. d.23 0. a. you would.56 Discounted cash flows Answer: b Diff: E . or art work. True False Interest rate risk Answer: b Diff: E .81 0. True False Issuing bonds Answer: b Diff: E . including stocks. b.

or "call for. True False Sinking fund Answer: a Diff: E . a. A call provision gives bondholders the right to demand. a. Typically. True b. 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. or to provide financing to a company of questionable financial strength. True False Call provision Answer: b Diff: E . b.b. a. False Debt coupon rate Answer: a Diff: E . high yield debt instrument typically used to finance a leveraged buyout or a merger. therefore providing compensation to investors in the form of capital appreciation. a. because when rates rise the bondholder can get the principal amount back and reinvest it elsewhere at higher rates. A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells) at par." repayment of a bond. True False Floating rate debt Answer: a Diff: E . A junk bond is a high risk. The motivation for floating rate bonds arose out of the costly experience of the early 1980s when inflation pushed interest rates to very high levels causing sharp declines in the prices of long-term bonds. a firm will have to pay a higher coupon rate on a subordinated debenture than on a second mortgage bond. b. calls are exercised if interest rates rise. True False Answer: a Diff: E Bond ratings and required returns . a. a. True False Zero coupon bond Answer: b Diff: E . b. Other things equal. b. b. False Junk bond Answer: a Diff: E .

b. if the yield curve is upward sloping. You have just noticed in the financial pages of the local newspaper that you can buy a $1.000 par value bond for $800. at which time its market value will equal its par value.) a. and required returns increase as the ratings get lower. Therefore. b. a. A bond with a $100 annual interest payment with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9 percent and would sell for a discount if interest rates were greater than 11 percent. b. The required return is lowest for AAA-rated bonds. The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds.. an outstanding callable bond should have a lower yield to maturity than an otherwise identical noncallable bond. a. True False Medium: Bond value Answer: a Diff: M . b. True False Prices and interest rates Answer: a Diff: M . a. True False . There is an inverse relationship between bond ratings and the required return on a bond. True False Callable bond Answer: b Diff: M . with annual interest payments. the market value of that bond will always be below its par value until the bond matures. a. b. and there are 10 years to maturity. a. True False Bond value . If the required rate of return on a bond is greater than its coupon interest rate (and rd remains above the coupon rate). If the coupon rate is 10 percent.annual payment Answer: a Diff: M . True False Bond premiums and discounts Answer: a Diff: M . (Accrued interest between interest payment dates should not be considered when answering this question. A bond that is callable has a chance of being retired earlier than its stated term to maturity. other things equal and held constant. b. you should make the purchase if your re¬quired return on investments of this type is 12 percent.

000 par value. both mature in 20 years. Floating rate debt shifts interest rate risk to companies and thus has no advantages for issuers. b. which has the sinking fund. and both are offered to you at their $1. You are considering two bonds. True False Bond ratings Answer: a Diff: M . True False Income bond Answer: b Diff: M . a. As inflation increases the value of the bond increases and the issuer is responsible for the accumulated value which may become much greater than the original face value. Floating rate debt is advantageous to investors because the interest rate moves up if market rates rise. a. This is probably not an equilibrium situation. True False Sinking fund Answer: b Diff: M . True False Floating rate debt Answer: b Diff: M . 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. b. a. both have a 10 percent coupon. True .Indexed bond Answer: b Diff: M . a. b. Income bonds pay interest only when the amount of the interest is actually earned by the company. b. these securities cannot bankrupt a company and this makes them safer than regular bonds. would generally be expected to have a higher yield than Bond Y. Such covenants are contained in the bond's indenture. A firm with a low bond rating faces a more severe penalty when the Security Market Line (SML) is relatively steep than when it is not so steep. a. An indexed bond has its value tied to an inflation index. a. Bond X has a sinking fund while Bond Y does not. Thus. b. However. as Bond X. Both are rated double A (AA). True False Restrictive covenants Answer: a Diff: M .

All of the statements above are correct. d. All else equal. False Multiple Choice: Conceptual Easy: Interest rates Answer: e Diff: E . for a given change in the required rate of return. the yield to maturity that would exist without such a call provision will generally be _________________ the YTM with it. Answers c and d are correct. Other things held constant. b. longer. than unrelated to Bond coupon rate Answer: c Diff: E . e. All of the following may serve to reduce the coupon rate that would otherwise be required on a bond issued at par. e. higher than lower than the same as either higher or lower. b. Statements a and c are correct. the the time to maturity. depending on the level of call premium. Answers a and b are correct. b. Interest rate and reinvestment risk Answer: e Diff: E . c. smaller. smaller. except a . b. Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds? a. c. One of the basic relationships in interest rate theory is that. longer. if a bond indenture contains a call provision. An increase in the call premium. All else equal. greater. larger.b. Answers a. e. the the change in price. shorter. d. long-term bonds have more interest rate risk than short term bonds. higher coupon bonds have more reinvestment risk than low coupon bonds. c. Callable bond Answer: a Diff: E . a. A reduction in market interest rates. e. d. All else equal. The company's bonds are downgraded. d. Call provision Answer: b Diff: E . a. Which of the following statements is most correct? a. short-term bonds have more reinvestment risk than do long-term bonds. and c are correct. shorter. other things held constant. c. b.

a. b. c. d. e.

Sinking fund. Restrictive covenant. Call provision. Change in rating from Aa to Aaa. None of the answers above (all may reduce the required coupon rate).

Bond concepts Answer: a Diff: E . Which of the following statements is most correct? a. b. c. d. e. All else equal, if a bond’s yield to maturity increases, its price will fall. All else equal, if a bond’s yield to maturity increases, its current yield will fall. If a bond’s yield to maturity exceeds the coupon rate, the bond will sell at a premium over par. All of the answers above are correct. None of the answers above is correct.

Bond concepts Answer: c Diff: E . Which of the following statements is most correct? a. If a bond’s yield to maturity exceeds its annual coupon, then the bond will be trading at a premium. b. If interest rates increase, the relative price change of a 10-year coupon bond will be greater than the relative price change of a 10-year zero coupon bond. c. If a coupon bond is selling at par, its current yield equals its yield to maturity. d. Both a and c are correct. e. None of the answers above is correct. Bond concepts Answer: e Diff: E . A 10-year corporate bond has an annual coupon payment of 9 percent. The bond is currently selling at par ($1,000). Which of the following statements is most correct? a. b. c. d. e. The bond’s yield to maturity is 9 percent. The bond’s current yield is 9 percent. If the bond’s yield to maturity remains constant, the bond’s price will remain at par. Both answers a and c are correct. All of the answers above are correct.

Sinking fund Answer: e Diff: E . Which of the following statements is most correct? a. Sinking fund provisions do not require companies to retire their debt; they only establish “targets” for the company to reduce its debt over time. b. Sinking fund provisions sometimes work to the detriment of bondholders – particularly if interest rates have declined over time. c. If interest rates have increased since the time a company issues bonds with a sinking fund provision, the company is more likely to retire the bonds by buying them back in the open market, as opposed to calling them in at the sinking fund call price. d. Statements a and b are correct.

e.

Statements b and c are correct.

Sinking fund provision Answer: d Diff: E . Which of the following statements is most correct? a. Retiring bonds under a sinking fund provision is similar to calling bonds under a call provision in the sense that bonds are repurchased by the issuer prior to maturity. b. Under a sinking fund, bonds will be purchased on the open market by the issuer when the bonds are selling at a premium and bonds will be called in for redemption when the bonds are selling at a discount. c. The sinking fund provision makes a debt issue less risky to the investor. d. Both statements a and c are correct. e. All of the statements above are correct. Types of debt Answer: e Diff: E . Which of the following statements is most correct? a. b. c. d. e. Junk bonds typically have a lower yield to maturity relative to investment grade bonds. A debenture is a secured bond which is backed by some or all of the firm’s fixed assets. Subordinated debt has less default risk than senior debt. All of the statements above are correct. None of the statements above is correct.

Medium: Bond yield Answer: b Diff: M . Which of the following statements is most correct? a. Rising inflation makes the actual yield to maturity on a bond greater than the quoted yield to maturity which is based on market prices. b. The yield to maturity for a coupon bond that sells at its par value consists entirely of an interest yield; it has a zero expected capital gains yield. c. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss. d. The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm enters bankruptcy. e. All of the statements above are false. Bond yield Answer: c Diff: M . Which of the following statements is most correct? a. The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B. b. If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity. c. If a coupon bond is selling at par, its current yield equals its yield to maturity. d. Both a and b are correct. e. Both b and c are correct.

Price risk Answer: c Diff: M . Assume that all interest rates in the economy decline from 10 percent to 9 percent. Which of the following bonds will have the largest percentage increase in price? a. b. c. d. e. A 10-year bond with a 10 percent coupon. An 8-year bond with a 9 percent coupon. A 10-year zero coupon bond. A 1-year bond with a 15 percent coupon. A 3-year bond with a 10 percent coupon.

Price risk Answer: c Diff: M . Which of the following has the greatest price risk? a. A 10-year, $1,000 face value, 10 percent coupon bond with semiannual interest payments. b. A 10-year, $1,000 face value, 10 percent coupon bond with annual interest payments. c. A 10-year, $1,000 face value, zero coupon bond. d. A 10-year $100 annuity. e. All of the above have the same price risk since they all mature in 10 years. Price risk Answer: c Diff: M . If the yield to maturity decreased 1 percentage point, which of the following bonds would have the largest percentage increase in value? a. b. c. d. e. A 1-year bond with an 8 percent coupon. A 1-year zero-coupon bond. A 10-year zero-coupon bond. A 10-year bond with an 8 percent coupon. A 10-year bond with a 12 percent coupon.

Price risk Answer: a Diff: M . If interest rates fall from 8 percent to 7 percent, which of the following bonds will have the largest percentage increase in its value? a. b. c. d. e. A 10-year zero coupon bond. A 10-year bond with a 10 percent semiannual coupon. A 10-year bond with a 10 percent annual coupon. A 5-year zero coupon bond. A 5-year bond with a 12 percent annual coupon.

Bond concepts Answer: e Diff: M . Which of the following statements is most correct? a. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond. b. Other things held constant, a corporation would rather issue noncallable bonds than callable bonds. c. Reinvestment rate risk is worse from a typical investor's standpoint than interest rate risk.

000 par value.d. The price of a discount bond will increase over time. Which of the following statements is most correct? a. If a bond is selling for a premium. If a coupon bond is selling at par. Which of the following statements is most correct? a. its current yield equals its yield to maturity. If a 10-year.000 par. zero coupon bond were issued at a price which gave investors a 10 percent rate of return. c. c. All of the statements above are correct. Bond concepts Answer: b Diff: M . and if interest rates then dropped to the point where rd = YTM = 5%. then we would probably observe an immediate increase in bond prices. Bond concepts Answer: b Diff: M . Bond concepts Answer: e Diff: M . b. a bond that has a coupon rate of 10 percent will sell at a discount if the required return for a bond of similar risk is 8 percent. Both b and c are correct. Which of the following statements is most correct? a. d. If rates fall after its issue. a bond that has a coupon rate of 10 percent will sell at a discount if the required return for a bond of similar risk is 8 percent. this implies that the bond’s yield to maturity exceeds its coupon rate. Statements a and c are correct. The market value of a bond will always approach its par value as its maturity date approaches. we could be sure that the bond would sell at a premium over its $1. Bond concepts Answer: d Diff: M . c. e.000 par value. d. a zero coupon bond could trade for an amount above its par value. e. All else equal. All else equal. Which of the following statements is most correct? a. The total return on a bond for a given year consists only of the coupon interest payments received. The total yield on a bond is derived from interest payments and changes in the price of the bond. . If a 10-year. $1. Statements b and c are correct. assuming that the bond’s yield to maturity remains constant over time. None of the statements above is correct. e. zero coupon bond were issued at a price which gave investors a 10 percent rate of return.000 par. $1. e. we could be sure that the bond would sell at a discount below its $1. All of the statements above are correct. b. d. b. provided the issuer of the bond does not go bankrupt. and if interest rates then dropped to the point where rd = YTM = 5%. If the Federal Reserve unexpectedly announces that it expects inflation to increase.

Two bonds have the same maturity and the same coupon rate. c. Therefore. the bond which is callable will have a higher yield to maturity than the bond which is noncallable. Debentures generally have a higher yield to maturity relative to mortgage bonds. a 20-year bond that is callable after 5 years will have an expected life that is probably shorter.000. one is callable and the other is not.050 and the bond’s face value is $1. The actual life of a callable bond will be equal to or less than the actual life of a noncallable bond with the same maturity date. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate. d. The bond’s current yield is greater than 10 percent. the required rate of return will be lower on the callable bond. and certainly no longer. b. Therefore. The bond is selling at a price below par. Statements a and b are correct. Which of the following statements is most correct? a. if the yield curve is upward sloping. than an otherwise similar noncallable 20-year bond.b. d. other things held constant. c. d. 10 percent bond should sell at a higher price than an otherwise similar noncallable bond. Which of the following statements is most correct? a. However. Two bonds have the same maturity and the same coupon rate. Callable bond Answer: b Diff: M . Statements a and b are false. Answers b and c are correct. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used. d. Answers a and c are correct. None of the above answers is correct. A 10-year bond has a 10 percent annual coupon and a yield to maturity of 12 percent. Therefore. e. e. . A noncallable 20-year bond will generally have an expected life that is equal to or greater than that of an otherwise identical callable 20-year bond. assuming other characteristics are similar. Both answers a and c are correct. Moreover. The bond can be called in 5 years at a call price of $1. c. c. Callable bond Answer: d Diff: M . investors should require a lower rate of return on the callable bond than on the noncallable bond. b. Bond concepts Answer: d Diff: M . The bond’s yield to call is less than 12 percent. If there are two bonds with equal maturity and credit risk. Distant cash flows are generally riskier than near-term cash flows. A callable 10-year. However. the interest rate risk faced by investors is greater the longer the maturity of a bond. e. Which of the following statements is most correct? a. one is callable and the other is not. Further. b. callable bonds expose investors to less interest rate risk than noncallable bonds. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.

A company is planning to raise $1. Other things held constant. d. these securities cannot bankrupt a company and this makes them safer to investors than regular bonds.000 is raised as a first mortgage bond on the new plant and $500. All of the above statements are false.Types of debt Answer: c Diff: M .000 as debentures. the cost of the debt would be lower if the debt is in the form of a fixed rate bond rather than a floating rate bond. the cost of the debt would be lower if the debt is in the form of a bond rather than a term loan. d. If debt is used to raise the million dollars. a 1-year bond will have a higher (i. b. Miscellaneous concepts Answer: b Diff: M . d. b. If debt is used to raise the million dollars.. A 10-year 10 percent coupon bond has less reinvestment rate risk than a 10-year 5 percent coupon bond (assuming all else equal). All of the statements above are false. If debt is used to raise the million dollars..000 to finance a new plant. The price of a 20-year 10 percent bond is less sensitive to changes in interest rates (i.000 bond with $100 annual interest payments with five years to maturity (not expected to default) would sell for a discount if interest rates were below 9 percent and would sell for a premium if interest rates were greater than 11 percent. Answers a.e. One disadvantage of zero coupon bonds is that issuing firms cannot realize the tax savings from issuing debt until the bonds mature. the interest rate on the first mortgage bond would be lower than it would be if the entire $1 million were raised by selling first mortgage bonds. better) bond rating than a 20-year bond. e. Miscellaneous concepts Answer: b Diff: M . e. Which of the following statements is most correct? a. Miscellaneous concepts Answer: e Diff: M . Which of the following statements is most correct? a. A firm with a sinking fund payment coming due would generally choose to buy back bonds in the open market. b. Which of the following statements is most correct? a. but $500. . e. c. and c are correct statements. All else equal. c. Which of the following statements is most correct? a. if the price of the bond exceeds the sinking fund call price. b. The total return on a bond for a given year arises from both the coupon interest payments received for the year and the change in the value of the bond from the beginning to the end of the year. The company would be especially anxious to have a call provision included in the indenture if its management thinks that interest rates are almost certain to rise in the foreseeable future. c. callable bonds should have a lower yield to maturity than noncallable bonds.000. Thus. Income bonds pay interest only when the amount of the interest is actually earned by the company. A $1.e. has lower interest rate price risk) than the price of a 5-year 10 percent bond.

e. e. Assuming that both bonds are held to maturity and are of equal risk. Interest rate risk Answer: a Diff: M . c. 2-year Treasury bond with a 15 percent annual coupon. then its current yield will be less than its yield to maturity. c.e. Statements a and b are correct. None of the answers above is correct. d. b. e. All treasury securities have a yield to maturity of 7 percent--so the yield curve is flat. 15-year Treasury bond with a 12 percent annual coupon. 15-year zero coupon Treasury bond. then you would expect to earn the yield-to-maturity. The bond’s yield to maturity is less than 10 percent. . d. c. If a callable bond is trading at a premium. e. If the yield to maturity on all Treasuries were to decline to 6 percent. the bond’s price will be the same one year from Statements a and c are correct. c. a bond selling for more than par with ten years to maturity will have a lower current yield and higher capital gain relative to a bond that sells at par. If a bond sells for less than par. A 12 percent coupon bond which matures in 7 years. A 7 percent coupon bond which matures in 9 years. If a bond sells at par. A 20-year bond with semiannual interest payments has higher price risk (i. 10 percent coupon bonds. d. 10-year zero coupon bonds have higher reinvestment rate risk than 10-year.b. b. You just purchased a 10-year corporate bond that has an annual coupon of 10 percent. Answers a and c are correct. which of the following bonds would have the largest percentage increase in price? a. A 9 percent coupon bond which matures in 10 years. c. Which of the following statements is most correct? a. Which of the following Treasury bonds will have the largest amount of interest rate risk (price risk)? a.. A 7 percent coupon bond which matures in 12 years. Which of the following statements is most correct? a. Interest rate risk Answer: a Diff: M . interest rate risk) than a 5-year bond with semiannual interest payments. Current yield and yield to maturity Answer: a Diff: M . 2-year zero coupon Treasury bond. b. now. then its yield to maturity is less than its coupon rate. A 10 percent coupon bond which matures in 10 years. d. d. The bond sells at a premium above par. 12-year Treasury bond with a 10 percent annual coupon. The bond’s current yield is greater than 10 percent. Current yield and yield to maturity Answer: e Diff: M . b. If the bond’s yield to maturity stays constant.

b. b. Answers a and c are correct. e. An indenture is a bond that is less risky than a subordinated debenture. e. The expected return on a corporate bond is always less than its promised return when the probability of default is greater than zero. senior debt will generally have a lower yield to maturity than subordinated debt. bonds. If a company increases its debt ratio. If a company is retiring bonds for sinking fund purposes it will buy back bonds on the open market when the coupon rate is less than the market interest rate. secured debt is considered to be less risky than unsecured debt. d. None of the answers above is correct. d. c. d. A bond sinking fund would be good for investors if interest rates have declined after issuance and the investor’s bonds get called. b. All of the statements above are correct. All else equal. None of the answers above is correct. c. e. All of the answers above are correct. Statements a and c are correct. c. Both a and c are correct. c.e. senior debt has less default risk than subordinated debt. Corporate bonds and default risk Answer: c Diff: M . d. this is likely to reduce the default premium on its existing All else equal. bonds. Default risk Answer: d Diff: M . Mortgage bonds have less default risk than debentures. Default risk Answer: b Diff: M . The expected return on corporate bonds will generally exceed the yield to maturity. this is likely to reduce the default premium on its existing All else equal. e. An indenture is a bond that is less risky than a subordinated debenture. Both a and b are correct. All of the answers above are correct. Which of the following statements is most correct? a. b. Sinking funds and default risk Answer: d Diff: M . Which of the following statements is most correct? . Which of the following statements is most correct? a. Which of the following statements is correct? a. If a company increases its debt ratio. Which of the following statements is most correct? a. Tough: Bond yields and prices Answer: b Diff: T .

d. b. a 5 percent coupon bond would have less interest rate risk than a 10 percent coupon bond. Bond concepts Answer: e Diff: T . but all 10-year bonds have the same interest rate risk. e. e. If a bond's yield to maturity exceeds its coupon rate. d. reinvestment rate risk Answer: c Diff: T . For any given maturity. c. the same yield to maturity. All else equal. A 10-year bond would have more reinvestment rate risk than a 5-year bond. e. c. Zero coupon bonds have more interest rate risk than any other type bond. c. a given percentage point increase in the interest rate causes a smaller dollar capital loss than the capital gain stemming from an identical decrease in the interest rate. c. Which of the following statements is most correct? a. but all 10-year bonds have the same reinvestment rate risk. From a borrower's point of view. Interest vs. an increase in interest rates will have a greater effect on the prices of long-term bonds than it will on the prices of short-term bonds. If their maturities were the same. the bond's price must be less than its maturity value. assume other things are held constant. a 5 percent coupon bond would have more interest rate risk than a 10 percent coupon bond. If a bond's yield to maturity exceeds its coupon rate. None of the answers above is correct. d. e. d. a given percentage point increase in the interest rate (rd) causes a larger dollar capital loss than the capital gain stemming from an identical decrease in the interest rate. . A 10-year bond would have more interest rate risk than a 5-year bond. the bonds should sell for the same price regardless of the bond's coupon rate. All else equal. A 20-year zero coupon bond has less reinvestment rate risk than a 20-year coupon bond. even perpetuities. a. Bond concepts Answer: b Diff: T . that is. Answers b and c are correct. an increase in interest rates will have a greater effect on higher-coupon bonds than it will have on lower-coupon bonds. the change in price due to a given change in the required rate of return. If their maturities were the same. Answers a and c are correct. Which of the following is not true about bonds? In all of the statements. b. Which of the following statements is most correct? a.a. Price sensitivity. All of the statements above are correct. An increase in interest rates will have a greater effect on a zero coupon bond with 10 years maturity than it will have on a 9-year bond with a 10 percent annual coupon. the bond's current yield must also exceed its coupon rate. If two bonds have the same maturity. For a given bond of any maturity. increases as a bond's maturity increases. interest paid on bonds is tax-deductible. and the same level of risk. b. b.

1. d. 3. 6 1. 2. The bond may have a sinking fund. The bond may be made convertible. 6 1. each viewed alone. 4. 6 Weighted average cost of debt Answer: e Diff: T . 6 1. c. By an iron-clad provision in its charter. 3. the firm's total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. b. 2. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds. the greater the risk of. 4. b. 4. The higher the percentage of total debt represented by mortgage bonds. a face value of $1. but the result might well be such that the firm's total interest charges would not be affected materially by the mix between the two. an annual coupon rate of 10 percent. The higher the percentage of total debt represented by debentures. 5. 6 1. we could be absolutely certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of debentures. e. the higher the firm’s total dollar interest charges will be. If you require a 9 percent nominal . and hence the interest rate on.000. Suppose a new company decides to raise its initial $200 million of capital as $100 million of common equity and $100 million of long-term debt. we cannot tell for sure how. 4. 4. 5. Multiple Choice: Problems Easy: Bond value . Which of the above provisions. we could be absolutely certain that the firm's total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds. Fixed assets may be used as security. and semiannual interest payments. Interest rates on the two types of bonds would vary as their percentages were changed.semiannual payment Answer: c Diff: E . would tend to reduce the yield to maturity investors would otherwise require on a newly issued bond? a. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds. 3. 3. The bond may have restrictive covenants in its indenture. 5. 4. e. d.Bond indenture Answer: d Diff: T . In this situation. consequently. c. the company can never borrow any more money. and. Assume that you wish to purchase a bond with a 30-year maturity. 2. 6. The bond may have a call provision. or whether. the debentures. The bond may be subordinated to other classes of debt. the riskier both types of bonds will be. 3. Which of the following statements is most correct? a. Listed below are some provisions that are often contained in bond indentures: 1.

It has a yield to maturity of 8.49 $1.semiannual payment Answer: e Diff: E .19 $1. b.35 $1. how much should you be willing to pay for this bond? a. A bond has an annual 11 percent coupon rate. a face value of $1.000. an annual interest payment of $110.102. b.000 face value bond that pays interest of $60 every 6 months. and makes annual payments. d.63 Yield to maturity Answer: b Diff: E .yield to maturity on this investment. If your nominal annual required rate of return is 10 percent with semiannual compounding. what is the maximum price you should be willing to pay for the bond? . e. c. c. e. You intend to purchase a 10-year. c.50 $1.96.431.086.33% 8. -0.83 percent. c.76 $1.62 Bond value . what rate of return will an investor expect to receive during the next year? a.000 and makes semiannual interest payments of $40. d. b. If you require a 10 percent nominal yield to maturity on this investment.semiannual payment Answer: d Diff: E .74 $1. $1.17% 11.00% None of the above Bond value .83% 9. $905.200. what is the annual nominal yield to maturity on the bond? a. a maturity of 20 years.31 $1.124. d. d. e. b. e. If the price is $1.106. A bond has an annual 8 percent coupon rate. Assume that you wish to purchase a 20-year bond that has a maturity value of $1.15 $ 957.103.000. If the price is $934. and makes semiannual payments. a maturity of 10 years.149. $ 826. what is the maximum price you should be willing to pay for the bond? a. a face value of $1. 8% 9% 10% 11% 12% Return on a bond Answer: b Diff: E .

00% 8. c. c. e. an annual coupon payment of $80.36 $1. Unfortunately. Consider a $1.391.000 par value bond with a 7 percent annual coupon.37% Risk premium on bonds Answer: c Diff: E . If your nominal annual required rate of return is 12 percent with quarterly compounding.7% 9. b. how much should you be willing to pay for this bond? a. b. Rollincoast Incorporated issued BBB bonds two years ago that provided a yield to maturity of 11.051.2% 10. A $1.8% 8.46% 7. the next interest payment would have been due in 1 year). The bond pays interest annually. e.000 par value bond pays interest of $35 each quarter and will mature in 10 years. and a par value of $1.00% 8. e. The creditors. The current risk premium on BBB bonds versus government bonds is half what it was two years ago. What is the current yield on the bond assuming that the required return on the bond is 10 percent? a.52% 8. These bonds have 8 years remaining to maturity.5 percent. c. have agreed to a postponement of the next 4 interest payments (otherwise. Long-term risk-free government bonds were yielding 8.115.57 $1. d. d. including yourself.annual payment Answer: d Diff: M . There are 9 years remaining until maturity.a. 7. b. b. $ 941.000. e. d. Euler is on the brink of bankruptcy.7 percent at that time. You are the owner of 100 bonds issued by Euler. then at what rate should Rollincoast expect to issue new bonds? a.2% 12.8 percent. d.00 $ 825.49 Current yield Answer: b Diff: E . c. 10. If the risk-free long-term governments are currently yielding 7. Ltd. The .quarterly payment Answer: c Diff: E .25 $1.9% Medium: Bond value . $619 $674 $761 $828 $902 Bond value .

c.000.000.semiannual payment Answer: d Diff: M . e.000 cash? . The postponed payments will accrue interest at an annual rate of 6 percent. What is the present value of each bond? a. c. with interest paid semiannually. what would be the largest equal annual amounts she could withdraw for two years. d. Their price has remained stable since they were issued.000.580 Bond value .783 $ 550 $ 450 Bond value . $538. d. and soon thereafter she became engaged to Sam Spade. two payments.654 $25. b. If both bonds have the same yield. Interest on these bonds is paid annually on December 31 of each year..e. and they will then be paid as a lump sum at maturity 8 years hence. $13. e. e.e. The 2 percent annual coupon bonds mature in exactly twenty years. a par value of $1.273 $1.708 $12. how many new bonds must JRJ issue to raise $2. Marie Snell recently inherited some bonds (face value $100. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent. for Years 5 through 8.000 $7.annual payment Answer: a Diff: M . If Marie sells her bonds now and puts the proceeds into an account which pays 10 percent compounded annually. the firm wishes to issue new bonds that would have a maturity of 10 years.84 $266. and new annual coupon bonds with similar risk and maturity are currently yielding 12 percent. The required rate of return on these bonds.000.21 $426. JRJ Corporation recently issued 10-year bonds at a price of $1. b. considering their substantial risk. c. $1. Due to a number of lawsuits related to toxic wastes. is now 28 percent. the first payment today and the second payment one year from today)? a.semiannual payment Answer: b Diff: M .remaining interest payments.305 $14.98 Bond value . Due to additional financing needs. i.73 $384. What is the current value of this bond? a. beginning today (i. a University of Florida marketing graduate. d. will be made as scheduled.. they still sell for $1.255 $29. b. a major chemical manufacturer has recently experienced a market reevaluation. These bonds pay $60 in interest each six months.88 $249. and pay $40 in interest every six months.000) from her father. Sam wants Marie to cash in the bonds so the two of them can use the money to "live like royalty" for two years in Monte Carlo. The required nominal rate on this debt has now risen to 16 percent.

e.115.000 par value bond that pays interest of $70 each six months and has 10 years to go before it matures. it is necessary to convert its balance sheet figures to a market value basis. b. is as follows: Long-term debt (bonds. $1.semiannual payment Answer: d Diff: M . but you expect the market to require a nominal rate of only 12 percent when you sell the bond due to a general decline in interest rates.71 $1.quarterly payment Answer: b Diff: M . d. $ 821.24 Bond value . $1.000 5.6748 and 0. $ 800 $ 926 $1. b. 60 periods are 27. In order to accurately assess the capital structure of a firm. respectively.000 face value bond pays interest of $37.025 $1. you expect to hold it for 5 years and then to sell it in the market. b. You (and other investors) currently require a nominal annual rate of 16 percent. compounded quarterly. Assume that you are considering the purchase of a $1. $ 842.207.85 Bond value .358.000 par value bond with a 10 percent coupon. d. how much should she pay for the bond? a. c. Your client has been offered a 5-year.596 3.57 $ 986.275 Bond value . c.a.1697.120. e. c. with quarterly compounding. If you require a nominal annual rate of return of 12 percent.92 $1.000 4.00 $1. d. at par) $10.400 2. c.216 $ 981 Market value of bonds Answer: a Diff: M .000.quarterly payment Answer: b Diff: M .43 $1. e.26 $ 966.359.000 . b. how much should you be willing to pay for this bond? (Hint: The PVIFA and PVIF for 3 percent. If you buy this bond.99 $ 731. Assume that a 15-year. 2. Interest on this bond is paid quarterly. e. d. KJM Corporation's balance sheet as of today.81 $1. If your client is to earn a nominal rate of return of 12 percent.) a. How much should you be willing to pay for this bond? a.50 every 3 months.

Cold Boxes Ltd.097 $1. e. and a par value of $1. and their current market value is $768 per bond.000 Retained earnings 4. b.000 and a current yield of 10 percent. what is the annual coupon rate on this bond? a.000.Preferred stock 2. what will be the price of the bond 1 year from now? a. c. b. What is the annual coupon interest rate? a. $1. The nominal required rate of return on these bonds is currently 10 percent. What is the current market value of the firm's debt? a.000 The bonds have a 4 percent coupon rate.91. c.7072 percent remains constant. 8% 6% 4% 2% 0% Bond coupon rate Answer: d Diff: M .000 $7.412.000 Future value of bond Answer: c Diff: M .531. e.064 $1.000 Common stock ($10 par) 10. and interest is paid semiannually. 10% 12% 14% 17% 21% .000.000 Total debt and equity $26. The bond has a face value of $1. Assuming that the yield to maturity of 9.000. The bonds mature in 5 years.000 $2. c. d. The current price of a 10-year.000 $1. $5. Given these facts.000 par value bond is $1.000. and the nominal annual yield is 14 percent. b. Interest on this bond is paid every six months. d. e. $1. d. d. The yield to maturity is 12 percent.000.158.000 $7. They mature exactly 10 years from today.056. c. e.706.100 $1. payable semiannually.150 Bond coupon rate Answer: c Diff: M .000 $5. You just purchased a 15-year bond with an 11 percent annual coupon. b. has 100 bonds outstanding (maturity value = $1.480. so the bonds now sell below par.000).

69 $578.69 Bond sinking fund payment Answer: d Diff: T .31 $362.000. c. b. the principal plus the interest that was not paid during the first 5 years will be paid.Tough: Bond value Answer: d Diff: T . what should the bonds sell for in the market today? a. paid annually. However. The firm was reorganized as American Hospitals Inc. filed for bankruptcy.065. no interest will be paid on the deferred interest. GP&L sold $1. $ 634. Then. 25 percent of the issue has been retired. Finally.44 $813.000 of 12 percent. interest payments will be resumed for the next 5 years. beginning in Year 11. $43. To date. The new agreement allows the firm to pay no interest for 5 years. If the required annual return is 20 percent.000 face value pays a $50 coupon every six months. d. $242. at maturity (Year 10).796 $39. What is the price of the bond? a. but they do have a sinking fund which requires GP&L to redeem 5 percent of the original face value of the issue each year ($50. spending sufficient money to redeem 5 percent of the original face value each year.422 Financial Calculator Section Multiple Choice: Problems Easy: Bond value . Recently. e. d. what is the least amount of money GP&L must put up to satisfy the sinking fund provision? a.04 . If the nominal yield to maturity (15 years remaining) on the bonds is currently 14 percent. The bond will mature in ten years.856 $50.000 $37. and the court permitted a new indenture on an outstanding bond issue to be put into effect.000). c. c. 30-year. e. The bonds are not callable.500 $43.26 $281. Ohio Hospitals Inc.18 $1. b. and has a nominal yield to maturity of 9 percent. b. The issue has 10 years to maturity and a coupon rate of 10 percent. The company can either call bonds at par for sinking fund purposes or purchase bonds on the open market.semiannual payment Answer: c Diff: E . semiannual payment bonds 15 years ago.86 $1. A corporate bond with a $1.064..

e. b. The bonds have a par value of $1. e.78% YTM = 7.57%. b.094.00 $ 739. What is the price of the bond today? a.259.5 percent and a par value of $1. $ 784.23 $1.14% 10.5 percent.36% 2. YTC = 4.000. A bond with a $1. Palmer Products has outstanding bonds with an annual 8 percent coupon.semiannual payment Answer: b Diff: E . c. What are the bond’s yield to maturity and yield to call? a.050. YTC = 7. A 12-year bond pays an annual coupon of 8. b.52% YTM = 7.05% Current yield Answer: d Diff: E . The bonds will mature in 11 years. The bond will mature in 15 years.56 Bond value . YTC = 3.89% YTM and YTC Answer: e Diff: E . The bond has a yield to maturity of 9. YTC = 14.21% Answer: b Diff: E Current yield and yield to maturity .000 and a price of $865. The bond is callable in five years at a call price of $1. b.15% 8.14%.000. d.09% 11. What is the bond’s current yield? a. $1.99 $1. YTM = 14.19 Yield to maturity Answer: a Diff: E . e.078. 10. YTC = 7.000.d. d.13% 9. A corporate bond matures in 14 years.000 face value and an 8 percent annual coupon pays interest semiannually.27 $ 781. What is the yield to maturity on the bonds? a. c.25% 8. e. The nominal yield to maturity is 11 percent. c.29%.075. The price of the bond today is $1.00% 9. e. The bond has an 8 percent semiannual coupon and a par value of $1. d. c. d.64%.14%.38 $1.95% 9.34% YTM = 6.09% YTM = 3. 6.

8. d. The bond has a face value of $1. e. d. b.00 $ 933.. yield to maturity = 8.27 $ 941.92%. c. What is the bond’s current yield and yield to maturity? a.64 $ 736.12%. Current yield = 8. An 8 percent annual coupon. yield to maturity = 7. e. e. a.000.09 $ 925.000. c. The bonds may .35 $1.080. what will be the price of the bond 5 years from now? a. Yield on semiannual bond Answer: c Diff: E .semiannual payment Answer: d Diff: M . and currently sells for $985. A corporate bond has a face value of $1. Kennedy Gas Works has bonds which mature in 10 years.e. b. If the bond’s yield to maturity remains at its current rate. and have a face value of $1.28% 8.23 Call price Answer: c Diff: M . noncallable bond has ten years until it matures and a yield to maturity of 9. The bonds have a 10 percent quarterly coupon (i.e. yield to maturity = 8. Current yield = 8.000. yield to maturity = 8.20%.20%.00 Medium: Bond value .79 $ 831.000.1 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 $1.12%. Current yield = 8.000 has a 9 percent annual coupon.090. $ 966. and pays a $50 coupon every six months (i.90% 9. b. Current yield = 8.. The bond matures in 12 years and sells at a price of $1.00%. and pays an 8 percent annual coupon.12%.86 $ 854. c. the nominal coupon rate is 10 percent). $ 898. Current yield = 8. A 20-year bond with a par value of $1. d. What is the bond’s nominal yield to maturity? a.65% 8. e. the bond has a 10 percent semiannual coupon). d.31% 10.37%.09 $ 964.. yield to maturity = 7. A bond matures in 12 years. The bond currently sells for $925.92%. c. b.37%.78% Yield to maturity and bond value--annual Answer: d Diff: E .

c. Hood Corporation recently issued 20-year bonds.025.33% 7.50% 8. e. what is the yield to call? a. The bond matures in 20 years but is callable in ten years. 8. The bond can be called in five years at a call price of $1.136. A corporate bond with an 11 percent semiannual coupon has a yield to maturity of 9 percent. 8. d.be called in five years.00 $1. The call price is $1. b. c. What is the bond’s yield to call? .5 percent. b. c. The bond can first be called four years from now.000.88% 8.00% Yield to call Answer: a Diff: M .000. A 12-year bond with a 10 percent semiannual coupon and a $1. d.77 $1. b. Also. If the yield to maturity is 7 percent.055. What is the bond's nominal yield to call? a.00% 7.000.00% Yield to call Answer: c Diff: M . c.036.00% Yield to call Answer: d Diff: M .050. e.58% 8. e.43% 8.65% 9.25% 8. A corporate bond which matures in 12 years. What is the call price on the bonds? a.000 par value has a nominal yield to maturity of 9 percent.50% 8.78 Yield to call Answer: b Diff: M . the bonds are callable in 6 years at a call price equal to 115 percent of par value.89% 10. d.98% 9. The bonds have a nominal yield to maturity of 8 percent and a yield to call of 7. $ 379.048. 4. b. The bonds have a coupon rate of 8 percent and pay interest semiannually.75% 9. The maturity value is $1.5 percent. e. has a face value of $1. The call price is $1. The par value of the bonds is $1.050.34 $1.27 $1. pays a 9 percent annual coupon. d. and a yield to maturity of 7. What is the bond's yield to call? a.

b. c.30% . A bond that matures in 11 years has an annual coupon rate of 8 percent with interest paid annually.000 bonds at par value.00% 12.97% 6. The bonds currently have a yield to maturity of 10 percent. d. b. b.41% 8. The bonds pay a 12 percent semiannual coupon and have a face value of $1. b. c. d.52% 5. What is the after-tax yield to call for an investor with a 31 percent tax rate? a. or annual basis? a. 5.94% 10.45% Yield to call Answer: b Diff: M .89% 9.07% 9. e.5 percent.060.a.5 percent. b.82% 8.60% 7.000 (i.50% 11..73% 7. c.52% Yield to maturity Answer: d Diff: M . A 15-year bond with a 10 percent semiannual coupon has a par value of $1. e. A company is issuing $1.10% 7. What is the bond's yield to maturity.86% Yield to call Answer: b Diff: M . The bonds are callable in 8 years and have a call price of $1.050. The bond’s face value is $1.89% 9.90% 6. e.050.000 and its yield to maturity is 7. The bond can be called 3 years from now at a price of $1. McGriff Motors has bonds outstanding which will mature in 12 years. d.e. 8.86% 13. stated on a nominal. The bond has a nominal yield to call of 6.54% 8. e.38% 7. What is the bond’s nominal yield to call? a. the bonds pay a $60 coupon every six months).00% After-tax yield to call Answer: c Diff: M . The bond may be called after 10 years at a call price of $1. 5. The coupon rate (and yield to maturity) on the bonds is 8 percent (with annual payments) and the bonds will mature in 10 years. What are the bonds' yield to call? a. c. 6. d.000. 9. The bonds can be called at a call premium of 5 percent above face value after 3 years.

000. The McDonald's bond has a coupon rate of 8 percent. b. d. 6. and annual interest rates on new issues of the same degree of risk are 10 percent. c. capital gains yield = 1. semiannual basis.000 par value bond for $847. d.65% Current yield = 9. You want to know how many more interest pay¬ments you will receive. e. Current yield = 8. Bond value Answer: e Diff: M .85% Current yield = 10. capital gains yield = 0. c. Assume that McDonald's and Burger King have similar $1. but the party selling the bond cannot remember. Meade Corporation bonds mature in 6 years and have a yield to maturity of 8. The coupon rate is 8 percent. b.64 . If the nominal required rate of return.75% 6.c.35%.43 $986. c.08 $712. a.50% Current yield = 9.5 percent. What is the price of the bond which pays annual interest? a.95% 7. for both bonds. e. Can you determine how many interest payments remain? a. d.000 par value bond issues outstanding. Another 6-year bond of equal risk pays 8 percent interest annually. d.35%. and it also matures in 20 years. b.10% Interest payments remaining Answer: b Diff: M . with interest paid semiannually.50%. The bonds are equally risky.00% None of the answers above is correct.88. is 12 percent.72 $992. The par value of the bonds is $1. What are the current yield and capital gains yield on the bonds for this year? (Assume that interest rates do not change over the course of the year). You have just been offered a $1. 14 15 12 20 10 Current yield and capital gains yield Answer: c Diff: M . payable annually. rd. Both bonds are non-callable and have a face value of $1.00%. Tough: Bond value Answer: d Diff: T . The Burger King bond has an annual coupon rate of 8 percent and matures 20 years from today. what is the difference in current market prices of the two bonds? $689.000). e. e.05 $980. A 6-year bond which pays 8 percent interest semiannually sells at par ($1.000. capital gains yield = -0. The bonds have a 10 percent coupon rate and pay interest on a semiannual basis. capital gains yield = 0.

c. $1. Both issues pay interest annually.89 Bond coupon payment Answer: b Diff: T . What would the quarterly interest payment be. e. The second has an identical yield to maturity as the first bond. She has asked you to determine what quarterly interest payment. You are considering investing in a security that matures in 10 years with a par value of $1. d. in dollars? a. e. c. the security has an 8 percent coupon with quarterly payments (i.000. what should be the price of the security you are considering purchasing? a. Another 10-year bond has an 8 percent semiannual coupon (i.53 $ 6.. 20-year. $45.65 $1. b. e. During the first five years. has two bond issues outstand¬ing.61 $ 943.000. the coupon payment is $40 every six months). $ 2. This bond is selling at its par value.68 $ 11. you receive $25 a quarter for the second 20 quarters).77 $17. you receive $20 a quarter for the first 20 quarters). and both sell for $701. Fish & Chips Inc. Given this information. $ 898.037.00 $22. What is the annual interest payment on the second issue? a.e. No difference.28 Bond value and effective annual rate Answer: b Diff: T . d. This bond has the same risk as the security you are thinking of purchasing. d.00 $25.22..000 par value.20 $ 3. c. b. Semiannual payment bonds with the same risk (Aaa) and maturity (20 years) as your company's bonds have a nominal (not EAR) yield of 9 percent.a.145. but only 5 years until maturity.. During the remaining five years the security has a 10 percent coupon with quarterly payments (i. c.50 . Your company's treasurer is thinking of issuing at par some $1.e.e.72 $1. b. the company would have to set in order to provide the same effective annual rate (EAR) as those on the 20-year. in dollars. quarterly payment bonds.00 $ 37. The first issue has an annual coupon rate of 8 percent and 20 years to maturity.22 $1. semiannual payment bonds.25 $27.060. After 10 years (40 quarters) you receive the par value. $120.42 $ 29. b.12 $ 56.16 Bonds with differential payments Answer: c Diff: T . d.

According to the textbook model. a. True False Stock valuation Answer: b Diff: E . False Proxy Answer: a Diff: E . A proxy is a document giving one party the authority to act for another party. a. The cash flows associated with common stock are dif¬ficult to evaluate due to the uncertainty and varia¬bility associated with them. True False Efficient markets hypothesis Answer: b Diff: E . b. . a. The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold. a. a. b. True False Supernormal growth stock Answer: a Diff: E . True False Constant growth model Answer: a Diff: E . $23.00 Total stock returns Answer: b Diff: E . a. True b. True False Common stock cash flows Answer: a Diff: E . the value an investor assigns to a share of stock is dependent upon the length of time the investor plans to hold the stock. According to the basic stock valuation model. A proxy can be an important tool relating to control of the firm. b. typically the power to vote shares of common stock. b. you would never be able to realize a rate of return on a security greater than the marginal investor's expected (or required) rate of return.e. If security markets were truly strong-form efficient. the dis¬count rate utilized to find the present value of the expected cash flows will be the same for the initial growth period as for the normal growth period. b. The constant growth model used for evaluating the price of a share of common stock may also be used to find the price of perpetual preferred stock or any other perpetuity. under conditions of nonconstant growth.

This right protects current stockholders against both dilution of control and dilution of value. b. True False Classified stock Answer: a Diff: E . any new shares sold by the firm. When a corporation's shares are owned by a few individuals who are associated with the firm's management. The OTC market is a physical exchange. a. a. True False Preemptive right Answer: b Diff: E . b. b.a. True False . a. b. dissident stockholders would have to seek to oust management through a proxy fight. b. True False OTC market Answer: b Diff: E . With¬out the preemptive right. this means that a group of stockholders can call for a meeting to replace the management. b. Founders' shares is a type of classified stock where the shares are owned by the firm's founders and they retain the sole voting rights to those shares but have restricted dividends for a specified time period. True False Closely held stock Answer: a Diff: E . we say that the stock is "closely held. b. a. True False Preemptive right Answer: a Diff: E . True False Founders' shares Answer: a Diff: E . a. The preemptive right gives current stockholders the right to purchase. on a pro rata basis. Classified stock is one tool companies can use to meet special needs such as when owners of a start-up firm need capital but don't want to relinquish control of the firm." a. where securities dealers provide trading in unlisted securities. much like the New York Stock Exchange. If a firm's stockholders are given the preemptive right.

If the proxy group is successful. current management retains control of the firm but the proxy group dictates what investments the firm makes. True False Common stock and social welfare Answer: a Diff: M . a. a. True False . which may include other corporations and institutions. After a new issue is brought to market it is the marginal investor who determines the price at which the stock will trade. True False Medium: Stock price Answer: b Diff: M . a. Its inclusion in a firm's capital structure makes the firm less vulnerable to the consequences of unanticipated declines in sales and earnings than if only debt were available. True False Going public Answer: a Diff: E . True False Proxy fight Answer: b Diff: M . a. a. a.Public company Answer: a Diff: E . b. True False Marginal investor and price Answer: a Diff: E . A proxy fight involves a battle by a shareholder or group of shareholders who seek to change the investment policy of the firm. b. b. From a social welfare perspective. When stock in a closely held corporation is offered to the public for the first time the transaction is called "going public" and the market for such stock is called the new issue market. common stock is a desirable form of financing in part because it involves no fixed charge payments. If two firms have the same current dividend and the same expected growth rate. b. their stocks must sell at the same current price or else the market will not be in equilibrium. b. A publicly owned corporation is simply a company whose shares are held by the investing public. b.

Multiple Choice: Conceptual Easy: Required returnAnswer: e Diff: E . An increase in a firm's expected growth rate would normally cause the firm's required rate of return to a. b. c. d. e. Increase. Decrease. Fluctuate. Remain constant. Possibly increase, possibly decrease, or possibly remain unchanged.

Required returnAnswer: d Diff: E . If the expected rate of return on a stock exceeds the required rate, a. b. c. d. e. The stock is experiencing supernormal growth. The stock should be sold. The company is probably not trying to maximize price per share. The stock is a good buy. Dividends are not being declared.

Constant growth model Answer: a Diff: E . Which of the following statements is most correct? a. The constant growth model takes into consideration the capital gains earned on a stock. b. It is appropriate to use the constant growth model to estimate stock value even if the growth rate never becomes constant. c. Two firms with the same dividend and growth rate must also have the same stock price. d. Statements a and c are correct. e. All of the statements above are correct. Constant growth model Answer: a Diff: E . Which of the following statements is most correct. a. The stock valuation model, P0 = D1/(rs - g), can be used for firms which have negative growth rates. b. If a stock has a required rate of return rs = 12 percent, and its dividend grows at a constant rate of 5 percent, this implies that the stock’s dividend yield is 5 percent. c. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate. d. Statements a and c are correct. e. All of the statements above are correct. Constant growth model Answer: c Diff: E

. A stock’s dividend is expected to grow at a constant rate of 5 percent a year. Which of the following statements is most correct? a. b. c. d. e. The expected return on the stock is 5 percent a year. The stock’s dividend yield is 5 percent. The stock’s price one year from now is expected to be 5 percent higher. Statements a and c are correct. All of the statements above are correct.

Miscellaneous issues Answer: c Diff: E . Which of the following statements is most correct? a. If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but the two classes must have the same voting rights. b. An IPO occurs whenever a company buys back its stock on the open market. c. The preemptive right is a provision in the corporate charter which gives common stockholders the right to purchase (on a pro rata basis) new issues of common stock. d. Statements a and b are correct. e. Statements a and c are correct. Preemptive right Answer: b Diff: E . The preemptive right is important to shareholders because it a. b. c. d. e. Allows management to sell additional shares below the current market price. Protects the current shareholders against dilution of ownership interests. Is included in every corporate charter. Will result in higher dividends per share. The preemptive right is not important to shareholders.

Classified stock Answer: e Diff: E . Companies can issue different classes of common stock. Which of the following statements concerning stock classes is most correct? a. b. c. d. e. All common stocks fall into one of three classes: A, B, and C. Most firms have several classes of common stock outstanding. All common stock, regardless of class, must have voting rights. All common stock, regardless of class, must have the same dividend privileges. None of the statements above is necessarily true.

Efficient markets hypothesis Answer: e Diff: E . Which of the following statements is most correct? a. If a market is strong-form efficient this implies that the returns on bonds and stocks should be identical. b. If a market is weak-form efficient this implies that all public information is rapidly incorporated into market prices. c. If your uncle earns a return higher than the overall stock market, this means the stock market is inefficient.

d. Both answers a and b are correct. e. None of the above answers is correct. Market efficiency Answer: c Diff: E . Which of the following statements is most correct? a. Semistrong-form market efficiency implies that all private and public information is rapidly incorporated into stock prices. b. Market efficiency implies that all stocks should have the same expected return. c. Weak-form market efficiency implies that recent trends in stock prices would be of no use in selecting stocks. d. All of the answers above are correct. e. None of the answers above is correct. Market efficiency Answer: a Diff: E . Which of the following statements is most correct? a. Semistrong-form market efficiency means that stock prices reflect all public information. b. An individual who has information about past stock prices should be able to profit from this information in a weak-form efficient market. c. An individual who has inside information about a publicly traded company should be able to profit from this information in a strong-form efficient market. d. Statements a and c are correct. e. All the statements above are correct. Market efficiency Answer: a Diff: E . 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? a. Information you read in The Wall Street Journal today cannot be used to select stocks that will consistently beat the market. b. The stock price for a company has been increasing for the past 6 months. Based on this information it must be true that the stock price will also increase during the current month. c. Information disclosed in companies’ most recent annual reports can be used to consistently beat the market. d. Statements a and c are correct. e. All of the statements above are correct. Preferred stock concepts Answer: e Diff: E . Which of the following statements is most correct? a. Preferred stockholders have priority over common stockholders. b. A big advantage of preferred stock is that preferred stock dividends are tax deductible for the issuing corporation. c. Most preferred stock is owned by corporations. d. Statements a and b are correct. e. Statements a and c are correct.

e. Market efficiency says that the actual realized returns on all stocks will be equal to the expected rates of return. Both statements b and c are correct. The company’s stock price is $10.. b. If a stock's beta increased but its growth rate remained the same. e. A stock expects to pay a year-end dividend of $2. Common stock concepts Answer: d Diff: E . Both answers b and c are correct. Which of the following statements is most correct? a. forever (i. A firm with classified stock can pay different dividends to each class of shares.. d. Preferred stock provides steadier and more reliable income to investors than common stock.00. All of the statements above are correct.e. Declining growth stock Answer: e Diff: E . The company’s expected and required rate of return is 15 percent. The dividend is expected to fall 5 percent a year. b.e. d. c. The company’s expected dividend yield 5 years from now will be 20 percent. c. then the new equilibrium price of the stock will be higher (assuming dividends continue to grow at the constant growth rate). d. e. assume that last year’s dividend has already been paid). The company’s stock price 5 years from now is expected to be $7. d. Statements a and b are correct. e. g = -5%). Statements a and b are correct. All of the statements above are correct. Which of the following statements is most correct? a. One of the advantages of financing with stock is that a firm’s debt ratio will decrease.74. D1 = $2. All of the above answers are correct.00 a share (i. c. b. One of the advantages to the firm associated with financing using preferred stock rather than common stock is that control of the firm is not diluted. Which of the following statements is most correct? a. Efficient markets hypothesis Answer: e Diff: M . b. One of the advantages to the firm of financing with preferred stock is that 70 percent of the dividends paid out are tax deductible.Preferred stock concepts Answer: e Diff: E . c. An implication of the semistrong form of the efficient markets hypothesis is that you cannot consistently benefit from trading on information reported in The Wall Street Journal. Which of the following statements is most correct? a. Statements a and c are correct. One of the advantages of financing with stock is that a greater proportion of stock in the capital structure can reduce the risk of a takeover bid. Medium: Market efficiency and stock returns Answer: c Diff: M .

d. but not strong-from efficient. stock prices are more likely to decline than increase over the next several months. Which of the following statements is most correct? a.. c. If the stock market is semistrong-form efficient. d. c. b. If the stock market is semistrong-form efficient. c. Which of the following statements is most correct? a. None of the statements above is correct. Past stock prices can be successfully used to forecast future stock returns. d. e. Investors may be able to earn returns above those predicted by the SML if they have access to information which has not been publicly revealed. None of the answers above is correct. this means that high beta stocks should have the same expected return as low beta stocks. None of the statements above is correct. All stocks should have the same expected return. Investors can outperform the market if they have access to information which has not yet been publicly revealed. e. Answers b and c are correct. e. Assume that markets are semistrong-form efficient. c. Investors can expect to earn returns above those predicted by the SML if they have access to public information. Semistrong-form efficiency Answer: e Diff: M . All stocks should have the same expected returns. Answers a and c are correct. Which of the following statements is most correct? a. In equilibrium. however. stocks and bonds should have the same expected returns. Which of the following statements is false? . Ownership and going public Answer: c Diff: M . Bonds and stocks have the same expected return. If the stock market is semistrong efficient. Each common stock has an expected return equal to that of the overall market. b. b. b. d. Statements b and c are correct. If the stock market has been performing strongly over the past several months. All stocks should have the same realized return. If the stock market is weak-form efficient this means you cannot use private information to outperform the market. e. Semistrong-form efficiency Answer: c Diff: M . Semistrong-form efficiency Answer: d Diff: M . which of the following statements is most correct? a. this means the expected return on stocks and bonds should be the same. they may have different realized returns. Assume that markets are semistrong efficient.

what is the price of the stock? a. d. d. its expected dividend yield is 5 percent as well. e.00 . The stock price is expected to be $54 a share in one year.00. e. Assume that the required rate of return on a given stock is 13 percent." b. The dividend yield on a stock is equal to the expected return less the expected capital gain. Constant growth stock Answer: d Diff: M . e. A publicly owned corporation is simply a company whose shares are held by the investing public. d. The expected rate of return on the common stock of Northwest Corporation is 14 percent. c. Which of the following statements is most correct? a. All of the answers above are correct. The stock’s dividend yield is 8 percent. If the expected long-run growth rate for this stock is 5 percent. b. The stock’s dividend is expected to grow at a constant rate of 8 percent a year. The stock price is expected to be $57 a share in one year.50 $53. Which of the following statements is most correct? a. Multiple Choice: Problems Easy: Constant growth stock Answer: c Diff: E .00. The stock currently sells for $50 a share. and if investors require an 11 percent rate of return.00 $63. e.50 $52. which may include other corporations and institutions as well as individuals. and yet not raise any additional new capital. Dividend yield and g Answer: b Diff: M . A share of common stock has just paid a dividend of $3. A stock’s dividend yield can never exceed the expected growth rate. $50. When a corporation's shares are owned by a few individuals who are associated with or are the firm's management. we say that the stock is "closely held.a. b. If the stock’s dividend is growing at a constant rate of 5 percent. c. Answers b and c are correct. The stock’s dividend yield is 7 percent. d.00 $50. The current dividend per share is $4. b. c. c. It is possible for a firm to go public. When stock in a closely held corporation is offered to the public for the first time the transaction is called "going public" and the market for such stock is called the new issue market. Going public establishes a true market value for the firm and ensures that a liquid market will always exist for the firm's shares.

after which dividends are expected to grow at a rate of 6 percent forever. 12% 18% 20% 23% 28% Preferred stock yield Answer: a Diff: E .64 $50.64 $48. $ 10 Preferred stock value Answer: d Diff: E . b. The last dividend paid by a company was $2. c. what is the nominal annual rate of return? a. e. $100 c. The cost of preferred stock (rps) is 8 percent. c. It has both common stock and non-participating preferred stock outstanding. there is a need for additional funds. Consequently. d.50.Nonconstant growth stock Answer: c Diff: E . $ 50 d. What is the current price of the stock? a. e. d. A share of preferred stock pays a quarterly dividend of $2.50 each quarter. The financial manager plans to issue preferred stock with a perpetual annual dividend of $5 per share and a par value of $30. $44.20.00 for this preferred stock. If the price of this preferred stock is currently $50.40 $48. b. $ 25 e. e. $125 $120 $175 $150 $200 Preferred stock yield Answer: c Diff: E . The Jones Company has decided to undertake a large project. The company’s stockholders require a rate of return on equity (rs) of 11 percent. and the stock has a stated dividend of 10 percent of par. What is the market value of the preferred stock? a. A share of preferred stock pays a dividend of $0.40 Preferred stock value Answer: d Diff: E . The par value of the preferred stock is $120. If you are willing to pay $20. what is your nominal (not effective) annual rate of return? . d. what should be the stock's market value? a. Johnston Corporation is growing at a constant rate of 6 percent per year. Klein's growth rate is expected to be 10 percent for one year.00 $46. c. If the required return on this stock is currently 20 percent. b. $150 b.

Thames Inc. D0 = $2. If the company’s beta is 1.00 $44.53 $118. g.a. what is the price of the stock? a.00 a share (D1 = $3. but you will receive a dividend of $9. e. A share of common stock has just paid a dividend of $2.00 $68.e. $72. and if investors require a 19 percent rate of return. The dividend is expected to grow at a rate of 6 percent per year.3..00). b. $57. Assume that you plan to buy a share of XYZ stock today and to hold it for 2 years. In addition. b.40). 10% 8% 6% 12% 14% Stock price Answer: d Diff: E . what is g? a. d.00. The stock currently sells for $30 a share. If the dividend is expected to grow at a constant rate. c. Your expectations are that you will not receive a dividend at the end of Year 1. Albright Motors is expected to pay a year-end dividend of $3.50 $62. e.06 $60. d.00% 10.86 $64.25 at the end of Year 2.14 $40. The required (and expected) rate of return on the stock is 16 percent. d. d. b. how much should you be willing to pay for this stock today? a.29 $107.’s most recent dividend was $2.74 Constant growth stock Answer: a Diff: E . you expect to sell the stock for $150 at the end of Year 2.92 Constant growth stock Answer: e Diff: E . The risk-free rate is 5 percent and the return on the market is 9 percent. e. 13. c.25 $71.35 $131.05% . c. c. b.14 $57. e. If your expected rate of return is 16 percent.40 per share (i. If the expected long-run growth rate for this stock is 15 percent.19 $ 75.57 Constant growth stock Answer: c Diff: E . b. what is the price of the stock today? a. $164.

NOPREM Inc. Since the shares will be offered to the public at large. 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. Waters Corporation has a stock price of $20 a share.00% 5. what is the amount per share that old shareholders will lose if they are excluded from purchasing new shares? a. Klein's required rate of return on equity (rs) is 12 percent. The risk-free rate (rRF) is 6 percent and the market risk premium (rM – rRF) is also 6 percent. Klein's growth rate is expected to be a constant 5 percent for 2 years.25 $50. The stock’s dividend is expected to grow at a constant rate of 7 percent a year forever. d. c. What is the stock’s beta? a. b.33% 7.00. the price is $100 per share.33 $42. $21.75 Future stock price Answer: a Diff: E .000 shares of stock outstanding.00 2. The firm currently has 1.00% Nonconstant growth stock Answer: d Diff: E . c. $90. b. c. d. The last dividend paid by Klein Company was $1. d. The stock is expected to pay a $2 dividend at the end of the year.00 0. Cartwright Brothers’ stock is currently selling for $40 a share.c.00 . The firm plans to issue an additional 1. b.00 per share. e. b.000 shares at $90. 6. is a firm whose shareholders don't possess the preemptive right. after which dividends are expected to grow at a rate of 10 percent forever.00). What is the current price of Klein's common stock? a. e.06 1. e.00 $ 5.83 1.00 $33. d. The stock’s year-end dividend is expected to be $2 a share (D1 = $2. e.16 $58. $28 $53 $27 $23 $39 Beta coefficient Answer: b Diff: E .08 New issues and dilution Answer: b Diff: E . 1. What is the expected price of the stock seven years from now? a.

b.40% 7. b. e.66 Equilibrium stock price Answer: b Diff: M .33% 5. Now assume the following changes occur: (1) The inflation premium drops by 1 percent.000 and a yield of 10 percent. and the risk-free rate is 4 percent.28 $22. The company's last dividend was $1. The required return on the market is 8 percent.50. The expected growth rate for the firm is 4 percent. which promises to pay a before-tax return of 9 percent. The company's tax rate is 40 percent.17 $17. d. (MHI) is presently in a stage of abnormally high growth because of a surge in the demand for motor homes. MHI's beta is 1. e. Motor Homes Inc.75 percent.00% 7. the return on the market is currently 12.92% 9.80 per share.c. c.6. d. The Stuart Corporation has excess cash to invest in one of two securities. What is the after-tax nominal return of the better investment alternative? a.00 $ 0 $ 2. What should be the current price per share of common stock? a. The company expects earnings and dividends to grow at a rate of 20 percent for the next 4 years. $15. e. c.00% Equilibrium stock price Answer: a Diff: M . The first alternative is a 10-year.10 $24. The last dividend paid was $0. 10 percent coupon bond (with semiannual interest payments) that has a current price of $1. 7. .3.21 $19. after which time there will be no growth (g = 0) in earnings and dividends. The second alternative is the preferred stock of Pickett Corp. Beta is 1. You are given the following data: (1) (2) (3) (4) (5) The risk-free rate is 5 percent. d. $10.50 Medium: After-tax returns Answer: a Diff: M .

What will be the change in price per share. were $4.62 $ 9.89 $10. The required rate of return on the company’s stock is expected to remain constant. and all other factors remain constant.91 .11 -$ 4. $ 7. the company anticipates that it will establish a dividend of $1. b. b.65 $16. +$12. $53. Ceejay Corporation’s stock is currently selling at an equilibrium price of $30 per share.00). $18.97 +$ 2. Mack Industries just paid a dividend of $1.87 +$ 6. d.e. D1 = $1.53 Nonconstant growth stock Answer: d Diff: M . The risk-free rate is 8 percent.e. assuming the stock was in equilibrium before the changes? a. the company's beta is 1. b.00 per share (i.. $22. $12. Analysts expect the company's dividend to grow 20 percent this year (i. D0 = $1. e.) a.. The required rate of return on the company's stock is 12 percent. c..00). The firm has been experiencing a 6 percent annual growth rate. and the market risk premium is 5 percent. $16.5. and 15 percent next year. c. and the market risk premium is 5 percent. what will be the new stock price? (Use 4 decimal places in your calculations. (3) The expected growth rate increases to 6 percent. Last year’s earnings per share.98 $11. (4) Beta rises to 1.39 d.00 per share (i.e.(2) An increased degree of risk aversion causes the required return on the market to go to 10 percent after adjusting for the changed inflation premium. Once the dividend is established.28 -$16.69 e.78 Changing beta and the equilibrium stock price Answer: d Diff: M .48 Nonconstant growth stock Answer: d Diff: M .2.36 $ 8.25 c. e. d. What should be the current price of the company's stock? a. What is the current stock price? a. E0. $21. the market expects that the dividend will grow at a constant rate of 5 percent per year forever. After two years the dividend is expected to grow at a constant rate of 5 percent. A stock is not expected to pay a dividend over the next four years.20). The risk-free rate is 5 percent. D5 = $1.59 b.00 and the dividend payout ratio is 40 percent. If market risk (beta) increases by 50 percent. Five years from now. c.33 $16.

R.e. e. D1 = $2.00). e. and it is anticipated that the dividend will grow at a constant rate of 8 percent a year thereafter.. i. and D3 = $0. D4 and D5).25 per share at the end of the year (i..2. The risk-free rate is 4 percent.25). What is the current price of Lee's stock? a.38 $100.67 Nonconstant growth stock Answer: a Diff: M . Assuming the stock is fairly priced. and the stock's beta is 1.89 $30. The dividend is expected to grow 25 percent a year until t = 3. e. the risk-free rate of interest is 6 percent.69 $59. After that time the . D1 = $0. $ 69.. McPherson Enterprises is planning to pay a dividend of $2. E. D3 = $4. What is the company’s current stock price? a.e. A stock is expected to pay no dividends for the first three years.64 $37. Stewart Industries expects to pay a $3. The risk-free rate is 8 percent and the market risk premium is 6 percent. $29. what is the current price of the stock? a. b.96 $ 79. d.20 Nonconstant growth stock Answer: a Diff: M .00 for the subsequent 2 years (i. e. The company is planning to pay the same dividend each of the following 2 years and will then increase the dividend to $3.00 per share dividend on its common stock at the end of the year (D1 = $3.5.6875 and D4 = $4. The most recent dividend (D0) was $0. c. D2 = $0.00 (i. d.e. d.9219). The stock’s beta is 1.75. He is expanding the business quickly to take advantage of an otherwise unexploited market.. and the rate of return on the market is 11 percent. Growth for his company is expected to be 40 percent for the first three years and then he expects it to slow down to a constant 15 percent.29 $53.05 Nonconstant growth stock Answer: b Diff: M .67 $19. after which time the dividend is expected to grow at a constant rate of 5 percent a year (i. The dividend for Year 4 is expected to be $5.88 $93. Lee recently took his company public through an initial public offering.51 $73. Based on the most recent returns.14 $75.d. c.e.5. b. the beta for his company is approximately 1. D4 = $5.38 $ 86.17 $67.. $77. $18.00). b. c.e.00 Nonconstant growth stock Answer: e Diff: M .31 $ 72. the market risk premium is 6 percent.

c.dividends will grow at a constant rate of 5 percent per year.50 d. c. The stock’s required rate of return is 11 percent.62 e. and the stock’s beta is 1. the situation described is impossible in that no equilibrium price can be produced. and then at a long-run normal growth rate of 10 percent forever.e. it is expected to grow forever at a constant rate of 7 percent. What is the price of the stock today? a.00 dividend two years from today (2008). e. what is its current price? a.50 $50. i. $ 82. The dividend is then expected to grow at a rate of 20 percent a year for the following three years. the risk-free rate is 6 percent. e. A share of stock has a dividend of D0 = $5. $22. The stock’s dividend is expected to grow at a rate of 10 percent a year until three years from now (t = 3). $64 d. $52 e.00). Supernormal growth stock Answer: b Diff: M . $195.00 dividend at the end of the year (D1 = $3. the stock’s dividend is expected to grow at a constant rate of 5 percent a year. d.94 Nonconstant growth stock Answer: b Diff: M . The data given in the problem are internally inconsistent. $100. b. If investors require a 10 percent return on this stock.80 $20. However. $54 c. then at a 15 percent rate for 10 more years.20 $30. If the required return on the company’s common stock is 11 percent per year. d. what is the current stock price? a.. Hadlock Healthcare expects to pay a $3. Currently. b.00 b. Rogers Robotics currently (2006) does not pay a dividend. $212.91 $21. $49 b.50 $40. market risk premium (rM – rRF) is 5 percent. After this time.16 Supernormal growth stock Answer: e Diff: M . What should be the price of the stock today? a. The dividend is expected to grow at a 20 percent annual rate for the next 10 years.41 $37. After the dividend is paid in 2011. $52. the company is expected to pay a $1.4.00 $32.35 c.82 $28. $89 Nonconstant growth stock Answer: e Diff: M .

25.S. The firm's required rate of return is 18 percent.54% 2. d. the required return on an average stock is 11 percent.50 $10. The firm's income. The firm is half as risky as the market..03.18 $20. dividends are expected to grow at the firm's normal growth rate of 6 percent. d. After this time.0. What will be the price of the company's stock three years from now? a.00. growth is expected to return to the long-run constant rate of 10 percent. d. Undervalued by $2. The expected return on the market is 14 percent.00. 3. and the yield on U. c. e. d. and it just paid a dividend of D0 = $3.03. Berg Inc. What should the dividend yield (D1/P0) be today? a. but the firm intends to declare a dividend of D3 = $2. Declining growth stock Answer: d Diff: M . 13% 10% 4% 8% -2% .93% 4. $27. has just paid a dividend of $2. The Textbook Production Company has been hit hard due to increased competition. DAA's stock is selling for $15 per share. c. Treasury bonds is 11 percent. If the market is in equilibrium. e. assets.00 at the end of the last year of its supernormal growth. c. what rate of growth is expected? a. Overvalued by $3. and stock price have been growing at an annual 15 percent rate and are expected to continue to grow at this rate for 3 more years. b.25. ABC expects to achieve a dramatic increase in its short-run growth rate. b. b. After that. Due to a new product. b. to 20 percent annually for the next 2 years. No dividends have been declared as yet. ABC Company has been growing at a 10 percent rate. The company's beta is 2. The company's analysts predict that earnings (and dividends) will decline at a rate of 5 percent annually forever. The stock is a. Correctly valued. c.23 $28. e. Its stock is now selling for $48 per share. Undervalued by $3.00. and the risk-free rate is 7 percent.17 $ 6. Assume that rs = 11 percent and D0 = $2.33% Supernormal growth stock Answer: b Diff: M .63 Stock growth rate Answer: d Diff: M . Overvalued by $2.60% 10. e.00% 7.

Dividend yield = 11.31%. Conner Corporation has a stock price of $32.57%. Capital gains yield = 7.6. Carlson has a beta coefficient of 1.e. calculate the expected capital gains yield for Chicago Bears Inc. What is the company’s capital gains yield and dividend yield? a. The company's beta is 0. Dividend yield = 7. Dividend yield = 4. e. 3. what is your expected percentage capital gain? a. . b. Carlson Products. c. e. the market risk premium is 6 percent. P0 = $25.2.: beta = 0..80% 8. e. The previous dividend was $2 (i. Dividend yield = 7.2% 2..57%. Capital gains yield = 11. d. b.35 per share. Given the following information.00%.42). The long-run growth rate for the company is a constant 7 percent. d.00.00%. c.0% 4. you have access to insider information concerning a switch in product lines which would not change the growth rate. and the required rate of return on the market is 15 percent.42 (i. Carlson's next dividend. D0 = $3. and Carlson is growing at an annual rate of 6 percent.5% Capital gains yield and dividend yield Answer: e Diff: M . a constant growth company. Capital gains yield = 7. D1. If you buy the stock at the current market price. b.00.Stock growth rate Answer: e Diff: M . Capital gains yield Answer: d Diff: M . and the risk-free rate is 9 percent. D0 = $2) and dividends are expected to grow at a constant rate.00%.8% 0% 8. a. but would cut Carlson's beta coefficient in half. Capital gains yield = 10. c. As Carlson's financial manager. d. Assume the stock is in equilibrium and exhibits constant growth.52% 5.8. e. d. rM = 15%. Dividend yield = 10.00.31%. The last dividend was $3.00%.00% 13.80% 8. has a current market (and equilibrium) stock price of $20. is forecasted to be $2.00. rRF = 8%.e. Capital gains yield = 7. c.38% Capital gains yield Answer: c Diff: M . 23% 33% 43% 53% There would be a capital loss.00%. Grant Corporation's stock is selling for $40 in the market. D1 = $2.31%. b. What is the growth rate for this stock? a. 5.

000 8% 40% = 10. and the most recent dividend. on the average. c. rM. What is the stock’s expected price five years from now? a. Swanson's beta is 2. Over the past few years. b.27 $48.000 shares 1. d. You have been given the following projections for Cali Corporation for the coming year.55 $53. rRF. what is the most likely market price and P/E ratio (P0/E1) for Swanson's stock today? a. d.0. $35. (rM – rRF). the dividend at time 0.58 $96.00 a share. a.22 $46.11 . e. c. (D1 = $3. D0. is 12 percent. b. b.Stock price and P/E ratios Answer: a Diff: M . Sales = Sales price per unit = $10 Variable cost per unit = $5 Fixed costs = Bonds outstanding = rd on outstanding bonds = Tax rate = Shares of common stock outstanding Beta = rRF = rM = Dividend payout ratio = 60% Growth rate = 8% 10. If the risk-free rate. The stock has a beta of 0. $60.000 units $10. was $1. has already been paid.) The stock’s dividend is expected to grow at a constant rate of 5 percent a year. Stock price Answer: d Diff: M . and long-run earnings growth is expected to be 10 percent.8.76 Stock price Answer: b Diff: M .4 5% 9% Calculate the current price per share for Cali Corporation. c. the ex¬pected return on the market.00 $76. is 8 percent.63 $72.50. is 5 percent.72 $59. rRF. D0. 70 percent of its earnings in the business. d. Newburn Entertainment’s stock is expected to pay a year-end dividend of $3. The risk-free rate.000 $15. The future retention rate is expected to remain at 70 percent of earnings.00. Swanson Company has retained. is 6 percent and the market risk premium. e.

Assume that the market is in equilibrium. c.00 3. From the following data you find that the beta value associated with your firm has changed from an old beta of to a new beta of _. d.00 1. but the inflation premium has increased from 4 percent to 6 percent. 2. $25. While there have been several changes in financial markets during this period.30 0. 2.0. As financial manager of Material Supplies Inc. was expected to be $2 per share.00 $37.05% and Stock X has a beta of 2.00. $68.50 3.e.17 2.50.38 $56. D1.05 0. and D0 = $2. and now the market risk premium is 3 percent instead of 2 percent.96 Beta coefficient Answer: c Diff: M . and a 10. e.50 $21. what market price gives the investor a return consis¬tent with the stock's risk? a.67. 1. (4) The next dividend. (2) The expected growth rate has been re-evaluated by security analysts.. d. c.05 7% 8 9 10 12 rM If rRF = 6.5 percent rate is considered to be more realis-tic than the previous 5 percent rate.30 0.67 Risk and stock value Answer: d Diff: M . b.30 0. 1. it would have occurred anyway. assuming the "old" 5 percent growth rate. you have recently participated in an executive committee decision to enter into the plastics business. 1. an expected constant growth rate of 7 percent.94 Answer: e Diff: M Future stock price .00. (3) The risk aversion attitude of the market has shifted somewhat. a. 1. The probability distribution for rM for the coming year is as follows: Probability 0. This change had nothing to do with the move into plastics. the price of the firm's common stock subsequently declined from $40 per share to $30 per share.72 $42. (1) The real risk-free rate is 2 percent. b. e. Much to your surprise. you are anxious to deter¬mine how the market perceives the relevant risk of your firm.50.

and its dividend yield is 5 percent.00 a share dividend on its common stock at the end of the year (i.00 a share. b. that is. $21. b.12).e.00). e.83 $47.. What is the expected stock price five years from now. the risk-free rate is rRF = 0.e.12.25 $36.32 $11. $24.08 $25.49 $70.. Its dividend is growing at a constant rate. d. d.06. $10. d..64 $35. Thereafter.2. A stock currently sells for $28 a share. What is the expected stock price.58 $11. and the expected market return is rM = 0.62 $29.65 $22. e.00 a share (i. The dividend is expected to grow at some constant rate over time. and the company's beta equals 1. d.43 $56. the stock’s dividend is expected to grow at a constant rate of 5 percent a year. b.e. The dividend is expected to grow at a constant rate of 7 percent a year. The stock’s beta is 1. what is ? a.4. e. McNally Motors has yet to pay a dividend on its common stock. However.00).. the market risk premium is 5 percent. c. c..40 $41. The required rate of return on the company’s stock is 12 percent (i. Kirkland Motors expects to pay a $2.49 $72. b. What is the expected price of the stock five years from now? a..e.21 Answer: c Diff: M New equity and equilibrium price . $52.00). e. what is ? a. the company expects to pay a $1.10 $63.99 $39. seven years from now? a.54 Future stock price Answer: b Diff: M .87 $13. Graham Enterprises anticipates that its dividend at the end of the year will be $2.78 Future stock price Answer: b Diff: M . rs = 0.00 dividend starting two years from now (i. i. The required rate of return on the company’s stock is expected to remain constant at 13 percent. The risk-free rate is 6 percent.63 $12. The stock currently sells for $20. D1 = $2. D2 = $1. D1 = $2. What is the stock’s expected price four years from now.e.98 Future stock price Answer: b Diff: M . c. c.

The risk-free rate is 8 percent. and its current required rate of return is 12. the firm's stock price dropped. Philadelphia is considering a change in policy which will increase its beta coefficient to 1. Nahanni Treasures Corporation is planning a new common stock issue of five million shares to fund a new project.52% Supernormal growth stock Answer: c Diff: T . The increase in shares will bring to 25 million the number of shares outstanding. and the dividend payout ratio is 40 percent. were $4.5 percent with the new project. The required rate of return on the market is 15 percent.06 in the market.5.75.53% 6. d.) a.6 percent.00 -$15. c. what is the change in the equilibrium stock price? a. e. the firm's cost of capital will increase to 13. c. Using the DCF growth model. Last year's earnings per share. The firm has been experiencing a 6 percent annual growth rate. b.77 -$1.85 -$0. e.66 -$0.77% 5. Nahanni's long-term growth rate is 6 percent.06 -$0. by how much will the stock price change? (Hint: Use four decimal places in your calculations.63 -$1. c. d. e. and the market risk premium is 5 percent. and the risk-free rate is 7 percent.00.5 percent. The Hart Mountain Company has recently discovered a new type of kitty litter which is extremely absorbent. 8.00 per share (D0 = $2).88% 13.33 +$ 7. On the announcement of the new equity issue. Nahanni estimates that the company's growth rate will increase to 6. and all other factors remain constant. what new constant growth rate will cause the common stock price of Philadelphia to remain unchanged? a. b. but since the project is riskier than average. The firm just paid a $1. b. It is expected that the firm will experience (begin¬ning now) an unusually high growth rate (20 percent) during the period (3 years) it has exclusive rights to the property where the .00 dividend and the stock sells for $16.14 -$15.22 +$22.85% 18. Hard Hat Construction's stock is currently selling at an equilibrium price of $30 per share. Philadelphia Corporation's stock recently paid a dividend of $2. and the stock is in equilibrium. The company has a constant growth rate of 5 percent and a beta equal to 1. If market risk (beta) increases by 50 percent. Tough: Risk and stock price Answer: a Diff: T . E0.08 Constant growth stock Answer: c Diff: T . If market conditions remain unchanged. -$ 7. d..

Club has a required rate of return of 12 percent. it should attain a 10 percent growth rate which it will sustain thereafter. was $0. and it is expecting both earnings and dividends to grow by 0 percent in Year 2.96 $71. beginning with the fourth year the firm's competition will have access to the material.85 Financial Calculator Section Multiple Choice: Problems Easy: Nonconstant growth stock Answer: d Diff: E . b.) a. It cannot be estimated without more data. However. c. e. $66.35 $2. beginning with the fifth year. and the firm's required return is 10 percent.48 $27. D1.35 $1. P0 = $49. e. and from that time on the firm will achieve a normal growth rate of 8 percent annually.78 $93. The required return on Modular is 15 percent.raw material used to make this kitty litter is found. $1. $19.00 per share. c. D1? (Hint: Draw a time line and then set up and solve an equation with one unknown. What should be the price per share of Club stock at the end of the second year. What is the expected value of the next dividend. However. the firm's dividend payout ratio will be relatively low (20 percent) in order to conserve funds for reinvest¬ment. and it sells at its equili-brium price. During the rapid growth period.06 $31.53 $61. What should be the current price of the common stock? a. d. d. and the company expects to experience no growth for the next 2 years. and at a rate of 10 percent in Year 4 and thereafter.85 $2.50 $87. just paid dividend D0. and. c. Modular Systems Inc.50 Nonconstant growth stock Answer: b Diff: T . D0. b.50. ? a. by 5 percent in Year 3. However. Club Auto Parts' last dividend. the decrease in growth in the fourth year will be accom¬panied by an increase in dividend payout to 50 percent. b. Club will grow at an annual rate of 5 percent in the third and fourth years.55 Nonconstant growth stock Answer: e Diff: T . e. d. Last year's earnings were E0 = $2.87.21 $19.98 $25.

Your company is about as risky as the average firm in the industry. b.00 .15 $110.88 $101. The company's cost of equity capital is estimated to be 15 percent.. The required rate of return on equity (rs) is 10 percent.84 $ 91. The firm's beta is 1. Your company paid a dividend of $2. The last dividend paid (D0) was $2.00 last year.21 Medium: Supernormal growth stock Answer: b Diff: M . the risk-free rate is 8 percent. $ 42. What is the value per share of your firm's stock? a. c. and this year's retained earnings net of dividends were $1. and then the growth rate is expected to be a constant 7 percent thereafter. d. 5 percent the next year.25 $110. d.00 per share (D0 = $3.4 million. What is the current stock price of Garcia Inc. c. after which growth should match the 5 percent industry average rate.37 Nonconstant growth stock Answer: c Diff: M .00 $ 88.60 $ 82. At that time. The firm maintains a 30 percent payout ratio.25. d.98 $64. and thereafter it will grow at a constant rate of 10 percent a year.55 $ 95.45 $60. Tough: Firm valuation Answer: c Diff: T . Assume an all equity firm has been growing at a 15 percent annual rate and is expected to continue to do so for 3 more years. The growth rate is expected to be 4 percent for 1 year. Analysts expect that the dividend will grow at a rate of 25 percent a year for the next three years.42 $103. c. e. b.49 $67. b. e. but it has just developed a line of innovative new products which leads you to expect that its earnings and dividends will grow at a rate of 40 percent (D1 = D0(1 + g) = D0(1. has a current dividend of $3.? a.47 $69. and its dividend yield is 4 percent. growth is expected to slow to a constant 4 percent rate. What is the current price of the common stock? a. Garcia Inc. and the market risk premium is $ 75.40)) this year and 25 percent the following year. Assume that the average firm in your company's industry is expected to grow at a constant rate of 5 percent. e. then 6 percent for the following year.00). $53.

The company is expected to maintain its current payout ratio.51 $17. The analyst estimates that the company's dividend will grow at a rate of 25 percent this year. d.25 $19. The analyst believes that the stock is fairly priced. $16. and that Fast Start's beta is 1.75. and 15 percent the following year. what is the market value of the firm's common equity (1 million shares outstand¬ing)? a.96 million $ 9. b. d.32 million Nonconstant growth stock Answer: c Diff: T .. If the market is in equilibrium. What is the current price of the stock? a.41 million $12.18 million $10. The company has a 40 percent payout ratio.50.4 percent. e.33 $18. She estimates that the current risk-free rate is 6.89 . a new high-growth company. A financial analyst has been following Fast Start Inc.53 $19. c. $ 6. The current earnings per share (EPS0) is $2. c. the market risk premium is 5 percent. b. After three years the dividend is expected to grow at a constant rate of 7 percent a year.56 million $ 7.25 percent. 20 percent next year. e.

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