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You are on page 1of 24

1. Question: Cheers Inc. operates as a partnership. Now the partners have decided to

convert the business into a corporation. Which of the following statements

is CORRECT?

Your a. Cheers’ shareholders (the ex-partners) will now be

exposed to less liability.

CORRECT

Answer:

b. Cheers will now be subject to fewer regulations.

c. Assuming Cheers is profitable, of its income will be subject

to federal income taxes.

d. Cheers’ investors will be exposed to less liability, but they

will find it more difficult to transfer their ownership.

e. Cheers will find it more difficult to raise additional capital.

Points4 of 4

Received:

2. Question:Which of the following statements is CORRECT?

Your a. Corporations generally face fewer regulations than sole

Answer: proprietor-ships.

b. Corporate shareholders are exposed to unlimited liability.

c. It is usually easier to transfer ownership in a corporation

than it is to transfer ownership in a sole proprietorship.

CORRECT

d. Corporate shareholders are exposed to unlimited liability,

but this factor is offset by the tax advantages of incorporation.

e. There is a tax disadvantage to incorporation, and there is no

way any corporation can escape this disadvantage, even if it is

very small.

Points4 of 4

Received:

3. Question:The primary operating goal of a publicly-owned firm interested in serving its

stockholders should be to_____________.

Your a. Maximize its expected total corporate income.

Answer:

b. Maximize its expected EPS.

c. Minimize the chances of losses.

d. Maximize the stock price per share over the long

run, which is the stock’s intrinsic value.

CORRECT

e. Maximize the stock price on a specific target date.

Points4 of 4

Received:

4. Question:Which of the following actions would tend to reduce conflicts of interest

between stockholders and bondholders?

Your a. Including restrictive covenants in the

Answer: company’s bond indenture (which is the contract CORRECT

between the company and its bondholders).

b. Compensating managers with more stock options

and less cash income.

c. The passage of laws that make it harder for hostile

takeovers to succeed.

d. A government regulation that banned the use of

convertible bonds.

e. Have the firm use only long-term debt, e.g., debt

that matures in 30 years or more rather than in less

than one year.

Points4 of 4

Received:

5. Question:Which of the following mechanisms would be most likely to help motivate

managers to act in the best interest of shareholders?

Your a. Decrease the use of restrictive covenants in bond

Answer: agreements.

b. Take actions that reduce the possibility of a

hostile takeover.

c. Have the board of directors allow managers

greater freedom of action.

d. Increase the proportion of executive

compensation that comes from stock options and

CORRECT

reduce the proportion that is paid as cash

salaries.

e. Eliminate a requirement that members of the

board of directors have a substantial investment in

the firm’s stock.

Points4 of 4

Received:

Unit 2:

1. Question: The U.S. Treasury offers to sell you a bond for $613.81. No payments will

be made until the bond matures 10 years from now, at which time it will be

redeemed for $1,000. What interest rate would you earn if you bought this

bond at the offer price?

Your 5.91%

Answer:

6.71%

7.10%

5.59%

5.00% CORRECT

InstructorInterest rate on a simple lump sum investment

n

ExplanatioFV = PV (1 + i)

$1,000 = $613.81 (1 + i)10

n:1.6292 = (1+i)10 ; take the 1/10th root of both sides:

1.62920.10 = 1 + i

1.0500 = 1 + i

.0500 = i or i = 5%

On a financial calculator:

N 10; PV -613.81; PMT 0; FV 1,000; I/YR ?? I/YR = 5.00%

Points4 of 4

Received:

2. Question:You want to buy a condo 5 years from now, and you plan to save $3,000 per year,

beginning one year from today. You will deposit the money in an account that pays 6%

interest. How much will you have just after you make the 5th deposit, 5 years from now?

Your $14,764.40

Answer:

$13,431.83

$16,911.28 CORRECT

$17,843.15

$15,119.76

InstructorFV of an ordinary annuity

n

ExplanatioFVA = PMT * [(1+i) - 1] /5 i

FVA = $3,000 * [(1 + .06) – 1] / .06

n:FVA = $3,000 * [1.3382 – 1] / .06

FVA = $3,000 * .3382/.06

FVA = $3,000 * 5.6371 = $16,911.28

On a financial calculator: N 5; I/YR 6; PV 0; PMT -3,000; FV ??; FV =

$16,911.28

Points4 of 4

Received:

3. Question:Your father is about to retire, and he wants to buy an annuity that will provide him

with $50,000 of income per year for 20 years, beginning a year from today. The

going rate on such annuities is 6%. How much would it cost him to buy such an

annuity today?

Your $488,349.15

Answer:

$416,110.34

$517,513.68

$615,976.84

$573,496.06 CORRECT

InstructorPV of an ordinary annuity

ExplanatioPVA = PMT * [(1 – {1 / (1+i) }) / i20]

n

n:PVA = 50,000 * [(1 – {1 / 3.271}) / .06]

PVA = 50,000 * [(1 - .3118) / .06]

PVA = 50,000 * [.6882 / .06] = 50,000 * 11.4699 = $573,496.06

On a calculator, you would enter:

N 20; I/YR 6.00; PMT -50,000; FV 0; PV ??; PV = $573.496.06

Points4 of 4

Received:

4. Question:Suppose you inherited $200,000 and invested it at 6% per year. How much could

you withdraw at the end of each of the next 15 years?

Your $24,764.40

Answer:

$23,431.83

$20,592.55 CORRECT

$17,843.15

$15,119.76

InstructorPayments on an ordinary annuity

ExplanatioPVA = PMT * [(1 – {1 / (1+i) }) / 15

n i]

200,000 = PMT * [(1 – {1 / 1.06 }) / .06]

n:200,000 = PMT * [(1 – .4173) / .06]

200,000 = PMT * 9.7122

PMT = 200,000 / 9.7122 = $20,592.

On a calculator, you would enter:

N 15; I/YR 6.00; PV -200,000; FV 0: PMT ??; PMT = $20,592.55

Points4 of 4

Received:

5. Question:An investment promises the following cash flow stream: $1,000 at Time 0; $2,000

at the end of Year 1 (or at T=1); $3,000 at the end of Year 2; and $5,000 at the end

of Year 3. At a discount rate of 5%, what is the present value of the cash flow

stream?

Your $9,324.89

Answer:

$9,591.45

$9,945.04 CORRECT

$9,011.87

$9,854.13

InstructorPV of an uneven cash flow stream

ExplanatioYou need to calculate the PV of each cash flow, then add up the PVs:

PV = 1,000 + 2,000 / 1.05 + 3,000 / 1.05 2 + 5,000 / 1.053

n:PV = 1,000 + 1,904.76 + 2,721.09 + 4,319.19 = 9,945.04

Points4 of 4

Received:

6. Question: What’s the future value of $2,000 after 3 years if the appropriate interest rate is

8%, compounded monthly?

Your $2,854.13

Answer:

$2,491.45

$2,324.89

$2,011.87

$2,540.47 CORRECT

InstructorFV of a lump sum, monthly

n*t

ExplanatioFV = PV * (1 + i/t)

FV = 2,000 * (1 + .08/12)3*12

n:FV = 2,000 * (1.00667)36

FV = 2,000 * 1.2702 = $2,540.47

On a calculator, enter:

N 36; PMT 0; I/YR 8/12 = .67; PV 2,000; FV ??; FV = $2,540.47

Points4 of 4

Received:

7. Question:Suppose you borrowed $25,000 at a rate of 8% and must repay it in 4 equal

installments at the end of each of the next 4 years. How large would your

payments be?

Your $7,691.45

Answer:

$7,548.02 CORRECT

$7,324.89

$7,011.87

$7,854.13

InstructorLoan amortization: payment

ExplanatioPVA = PMT * [(1 – {1 / (1+i) })4/ i ]

n

n:25,000 = PMT * [(1 – .7350) / .08]

25,000 = PMT * 3.3121

PMT = $7,548.02

On a calculator, enter:

I/YR 8.00; N 4; PV 25,000; PMT ??; PMT = $7,548.02

Points4 of 4

Received:

8. Question:You are buying your first house for $220,000, and are paying $30,000 as a down

payment. You have arranged to finance the remaining $190,000 30-year mortgage

with a 7% nominal interest rate and monthly payments. What are the equal

monthly payments you must make?

Your $1,513

Answer:

$1,110

$1,264 CORRECT

$1,976

$1,349

InstructorMortgage payments

ExplanatioPVA = PMT * [(1 – {1 / (1+i) }) / i ]

n

n:190,000 = PMT * [(1 – {1 / 1.005833360} / .005833]

190,000 = PMT * 150.3162

PMT = $1,264.00

On a calculator, enter:

N 360; I 7/12 = .5833; PV 190,000; PMT ??; PMT = -$1,264.00

Points4 of 4

Received:

9. Question:Your sister turned 30 today, and she is planning to save $3,000 per year for

retirement, with the first deposit to be made one year from today. She will invest in

a mutual fund, which she expects to provide a return of 10% per year. She plans to

retire 35 years from today, when she turns 65, and she expects to live for 30 years

after retirement, to age 95. Under these assumptions, how much can she spend in

each year after she retires? Her first withdrawal will be made at the end of her first

retirement year.

Your $78,976

Answer:

$91,110

$88,513

$86,250 CORRECT

$83,049

InstructorRetirement planning

ExplanatioFirst step is to find the amount that you will have saved by age 65. This is done as

the FVA problem:

n:FVA = PMT * [(1+i)n - 1] / i

FVA = 3,000 * [ 1.1035 – 1] / .10

FVA = 3,000 * 27.1024 / .10

FVA = 3,000 * 271.0244 = $813,073.11

Now, using this as your PV of an annuity, calculate the PMTs that you will receive:

PVA = PMT * [(1 – {1 / (1+i)n}) / i ]

813,073.11 = PMT * [(1 – {1 / 1.1030}) / .10]

813,073.11 = PMT * [.9427 / .10 ]

813,073.11 = PMT * 9.4269

PMT = $86,250.18

On a calculator, first:

N 35; I/YR 10; PV 0; PMT 3,000; FV ??; FV $813,073.11 then,

N 30; I/YR 10; PV 813,073.11; FV 0; PMT ??; PMT = $86,250.18

Points4 of 4

Received:

10 Question:A real estate investment has the following expected cash flows:

. Year Cash Flows

1 $10,000

2 25,000

3 50,000

4 35,000

If the discount rate is 8%, what is the investment’s present value?

Your $103,799

Answer:

$ 96,110 CORRECT

$ 95,353

$120,000

$ 77,592

InstructorPV of an uneven CF

Explanatiostream

n:NPV = $10,000/1.08 + $25,000/(1.08)2 + $50,000/(1.08)3 + $35,000/(1.08)4

= $9,259.26 + $21,433.47 + $39,691.61 + $25,726.04

= $96,110.38 » $96,110.

Financial calculator solution (using the cash flow register):

Inputs: CF0= 0; CF1 = 10000; CF2 = 25000; CF3 = 50000; CF4 = 35000; I/YR = 8.

Output: NPV = $96,110.39 » $96,110.

Unit 3:

1. Question: 1. Explain the effect of each of the following transactions on the balance sheet

of a firm:

a. It issues $2 million of new common stock

b. It buys a new plant and equipment at a cost of $3 million.

c. It reports a large loss for the year.

d. It increases the dividends paid on its common stock.

Your A.Increases the amount of cash for the comany and the stockholder

Answer: equity is increased. B. Decrease cash and increase plant & equipment

and the property since a new plant comes with property by $3 Million

Dollars. C. This would mean stockholder equity would decrease. D. If

dividends are paid out on its common stock the stockholder equity

would decrease and it would aslo decreast the amount of cash.

Instructor The first transaction increases the amount of cash the company has and also

Explanation: increases stockholder's equity. The second transaction would decrease cash

but increase Property, Plant & Equipment by the same amount. A large loss

would decrease stockholder's equity. Finally, increased dividends would

decrease cash and decrease stockholder's equity.

Points 4 of 4

Received:

2. Question: Superior Medical System's 2005 balance sheet showed total common equity of

$2,050,000. The company had 100,000 shares of stock outstanding which

sold at a price of $57.25 per share. By how much did the firm's market value

and book value per share differ?

Your $36.75 CORRECT

Answer:

$38.25

$39.50

$40.25

$51.00

InstructorBalance sheet: market value vs. book value

Explanation:Shares Outstanding 100,000

Price per share $57.25

Total common equity $2,050,000

Book value per share $20.50

Difference between book and market value $36.75

Points4 of 4

Received:

3. Question:Madison Metals recently reported $9,000 of sales, $6,000 of operating costs

other than depreciation, and $1,500 of depreciation. The company had no

amortization charges and no non-operating income. It had issued $4,000 of

bonds that carry a 7% interest rate, and its federal-plus-state income tax rate

was 40%. What was the firm's taxable, or pre-tax, income?

Your Answer: $1,180

$1,220 CORRECT

$1,260

$1,300

$1,340

Instructor Sales $9,000

Explanation: Operating costs excl depr’n $6,000

Depreciation $1,500

Operating Income (EBIT) $1,500

Interest expense ($4,000 * 7%) $280

Taxable Income $1,220

Points4 of 4

Received:

4. Question:Fine Breads Inc. paid out $26,000 common dividends during 2005, and

it ended the year with $150,000 of retained earnings. The prior year’s

retained earnings were $145,000. What was the firm's 2005 net income?

Your Answer: $30,000

$31,000 CORRECT

$32,000

$33,000

$34,000

InstructorCurrent RE = Prior RE + NI – dividends paid

Explanation:$150,000 = $145,000 + NI - $26,000

$5,000 = NI - $26,000

NI = $31,000

Points4 of 4

Received:

5. Question:Over the past year, M.D. Ryngaert & Co. had an increase in its current

ratio and a decline in its total assets turnover ratio. However, the

company's sales, cash and equivalents, DSO and its fixed assets turnover

ratio have remained constant. What balance sheet accounts must have

changed to produce the indicated changes?

Your Answer:The first thing is that this company has a decrease in asset turnover and a

increase in its current ratio, it appears the company assets has increased.

Another reflection of change would be that the cash, sales,and

equivanltes, DSO and fixed assets turnover ration have remained the

constant it must mean that the company has more inventory.

InstructorGiven that sales have not changed, a decrease in the total assets turnover

Explanation:means that the company’s assets have increased. Also, the fact that the

fixed assets turnover ratio remained constant implies that the company

increased its current assets. Since the company’s current ratio increased,

and yet, its cash and equivalents and DSO are unchanged means that the

company has increased its inventories.

Points4 of 4

Received:

6. Question:Raleigh Corp's total common equity at the end of last year was

$300,000 and its net income after taxes was $55,000. What was its

ROE?

Your Answer: 18.33% CORRECT

18.67%

19.00%

19.33%

19.67%

InstructorROE = NI /Common equity

Explanation:ROE = $55,000 / $300,000 = .1833 or 18.33%

Points4 of 4

Received:

7. Question:Rutland Corp's stock price at the end of last year was $30.25 and its

earnings per share for the year were $2.45. What was its P/E ratio?

Your Answer: 11.65

12.00

12.35 CORRECT

12.70

13.05

InstructorP/E = current stock price / earnings per share = $30.25 / $2.45

Explanation:P/E = 12.35

Points4 of 4

Received:

8. Question:Cooper Inc's latest EPS was $4.00, its book value per share was $20.00,

it had 200,000 shares outstanding, and its debt ratio was 40%. How

much debt was outstanding?

Your Answer: $2,333,333

$2,666,667 CORRECT

$3,000,000

$3,333,333

$3,666,667

InstructorFirst, we need to calculate the total equity:

Explanation:Book value per share X number of shares = total equity

$20 * 200,000 = $4,000,000

Next we need to calculate the total assets. We know the debt ratio is

40%. This tells us the equity ratio is 60%. D + E = TA

$4,000,000 / .60 = $6,666,667

Now we can calculate the total debt outstanding:

$6,666,667 - $4,000,000 = $2,666,667

Points4 of 4

Received:

9. Question:Burger Corp has $500,000 of assets, and it uses only common equity

capital (zero debt). Its sales for the last year were $600,000, and its net

income after taxes was $25,000. Stockholders recently voted in a new

management team that has promised to lower costs and get the return on

equity up to 15%. What profit margin would Burger need in order to

achieve the 15% ROE, holding everything else constant?

Your Answer: 8.00%

9.50%

11.00%

12.50% CORRECT

14.00%

InstructorWe need to calculate what income level is needed to provide a 15%

Explanation:ROE. Since there is zero debt, and D + E = TA, we know that E = TA

so, equity = $500,000

ROE = net income / stockholders equity

.15 = NI / $500,000

NI = $75,000

This represents a profit margin of:

$75,000 / $600,000 = .1250 or 12.50%

Points4 of 4

Received:

10. Question:Last year Charter Corp. had sales of $300,000, operating costs of

$265,000, and year-end assets of $200,000. The debt-to-total-assets

ratio was 25%, the interest rate on the debt was 10%, and the firm's tax

rate was 35%. The new CFO wants to see how the ROE would have

been affected if the firm had used a 60% debt ratio. Assume that sales

and total assets would not be affected, and that the interest rate and tax

rate would both remain constant. By how much would the ROE change

in response to the change in the capital structure?

Your Answer: 5.01%

5.20%

5.35%

5.57%

5.69% CORRECT

Instructor OLD NEW

Explanation: Interest rate 10% 10%

Tax rates 35% 35%

Assets $200,000 $200,000

Debt ratio 25% 60%

Total debt $50,000 $120,000

Total equity $150,000 $80,000

Operating Costs $265,000 $265,000

EBIT $35,000 $35,000

Interest Paid (Total debt X $5,000 $12,000

Interest rate)

Taxable Income $30,000 $23,000

Taxes (taxable income X tax $10,500 $8,050

rate)

Net Income $19,500 $14,950

ROE new: $14,950 / $80,000 = .1869 or 18.69%

Difference in ROE = 18.69% - 13.00% = 5.69%

Points4 of 4

Received:

Unit 4:

1. Question: Money markets are markets for

Your (

Foreign currencies.

Answer: )

Consumer automobile loans.

Corporate stocks.

Long-term bonds.

Short-term debt securities such a Treasury

CORRECT

bills.

InstructorSee page 145 of the text.

Explanation:

Points4 of 4

Received:

2. Question:Which of the following statements is CORRECT?

Your The most important difference between spot

Answer: markets versus futures markets is the maturity of

the instruments that are traded. Spot market

transactions involve securities that have maturities

of less than one year whereas futures markets

transactions involve securities with maturities

greater than one year.

Capital market transactions involve only preferred

stock or common stock.

If General Electric were to issue new stock this

year, it would be considered a secondary market

transaction since the company already has stock

outstanding.

Both Nasdaq dealers and “specialists” on the

CORRECT

NYSE hold inventories of stocks.

Money market transactions do not involve

securities denominated in currencies other than

the U.S. dollar.

InstructorCapital market transactions involve any long-term debt or equity

Explanation:instrument. If a company sells stock to directly raise money for the firm,

this is a primary market transaction, even if the company already has

stock outstanding. Money market transactions can be denominated in

any currency. They are merely very short-term, highly liquid securities.

Therefore, the only correct answer is “d” – both Nasdaq dealers and

NYSE specialists hold inventories of stocks.

Points4 of 4

Received:

3. Question: If the stock market is semistrong-form efficient, which of the following

statements would be CORRECT?

Your The required returns on all stocks are the same,

Answer: and the required returns on stocks are higher than

the required returns on bonds.

The required returns on stocks equal the required

returns on bonds.

A trading strategy in which you buy stocks that

have recently fallen in price is likely to provide

you with a return that exceeds the return on the

overall stock market.

If you have insider information about a particular

stock, you cannot expect to earn an above average

return on this information because it is already

incorporated into the current stock price.

Even if a market is semistrong-form efficient,

an investor could still earn a better return than

CORRECT

the market return if he or she had inside

information.

InstructorThe semi-strong form efficient market only addresses publicly available

Explanation:information. If an investor has inside knowledge, this would lead to an

advantage and the ability to earn superior returns. Therefore, answer “e”

is the correct answer.

Points4 of 4

Received:

4. Question:Suppose 1-year T-bills currently yield 5.00% and the future inflation rate

is expected to be constant at 3.10% per year. What is the real risk-free

rate of return, r*? Disregard cross-product terms, i.e., if averaging is

required, use the arithmetic average.

Your 1.90% CORRECT

Answer:

2.00%

2.10%

2.20%

2.30%

InstructorrT-bill = r* + IP

Explanation:5.00% = r* + 3.10%

r* = 1.90%

Points4 of 4

Received:

5. Question:Suppose the real risk-free rate is 3.50%, the average future inflation rate

is 2.25%, and a maturity premium of 0.10% per year to maturity applies,

i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of

return would you expect on a 5-year Treasury security, assuming the pure

expectations theory is NOT valid? Disregard cross-product terms, i.e., if

averaging is required, use the arithmetic average.

Your 5.95%

Answer:

6.05%

6.15%

6.25% CORRECT

6.35%

InstructorT-note yield = r* + IP + MRP

Explanation:T-note yield = 3.50% + 2.25% + .10%(5) = 6.25%

Points4 of 4

Received:

6. Question:Which of the following would be most likely to lead to a higher level of

interest rates in the economy?

Your Households start saving a larger percentage of

Answer: their income.

Corporations step up their expansion plans and

CORRECT

thus increase their demand for capital.

The level of inflation begins to decline.

The economy moves from a boom to a recession.

The Federal Reserve decides to try to stimulate

the economy.

InstructorIf households save more, this will increase savings leading to lower

Explanation:interest rates. If inflation declines, this will also lead to lower interest

rates to stimulate spending. If the economy moves from a boom to a

recession, the demand for funds would decrease, leading to less demand

for credit and lower interest rates. If the Federal Reserve is trying to

stimulate the economy, they will lower interest rates. If corporations

increase expansion plans, this will lead to an increased demand for funds

and, thus higher interest rates as businesses compete for the limited

funds.

Points4 of 4

Received:

7. Question:Assume that interest rates on 20-year Treasury and corporate bonds are as

follows:

T-bond = 7.72% A = 9.64%

AAA = 8.72% BBB = 10.18%

The differences in rates among these issues were caused primarily by

Your Tax effects.

Answer:

Default risk differences. CORRECT

Maturity risk differences.

Inflation differences.

Real risk-free rate differences

InstructorWhile there may be some interest rate differential due to the tax effects of

Explanation:the Treasury bond versus the corporate bond, the only thing that explains

the differences across the corporate bonds as well is the default risk.

Bonds with lower credit ratings, moving from AAA-rated to BBB-rated,

indicate the default risk of the company. Therefore, answer “b” is

correct.

Points4 of 4

Received:

8. Question:Describe the three different forms of market efficiency.

YourThree different forms or market efficiency: (1) weak form efficiency (2)

Answer:semi strong form efficiency (3) strong from efficiency

InstructorThe three forms, or levels, of market efficiency are: weak-form

Explanation:efficiency, semistrong-form efficiency, and strong-form efficiency. The

weak form of the EMH states that all information contained in past stock

price movements is fully reflected in current market prices. The

semistrong form of the EMH states that current market prices reflect all

publicly available information. The strong form of the EMH states that

current market prices reflect all pertinent information, whether publicly

available or privately held.

Points4 of 4

Received:

9. Question: Which fluctuate more, long-term or short-term interest rates? Why?

YourShort-term interest rates fluctuate more than long-term interest rates. The

Answer:Fed Reserve has an affect on the short-term side. These rates are are only

set for a short term and for specific purposes unlike the long-term rates

which more often are fixed for a long period of time between 20-30

years. The long term does fixed rates does not change but the adjustable

rates does.

InstructorShort-term interest rates are more volatile because (1) the Fed operates

Explanation:mainly in the short-term sector, hence Federal Reserve intervention has

its major effect here, and (2) long-term interest rates reflect the average

expected inflation rate over the next 20 to 30 years, and this average does

not change as radically as year-to-year expectations.

Points4 of 4

Received:

10. Question:Suppose interest rates on Treasury bonds rose from 5 to 9 percent as a

result of higher interest rates in Europe . What effect would this have on

the price of an average company's common stock?

YourTreasury bonds is an alternative investment to common stock along with

Answer:other types of bonds. If the rates rose from 5 to 9 percent investors could

sell stock and switch to an alternative. Then if they pull away from

treasury bonds, this would cause stock prices to fall. So, treasury bonds

would become a risky investment.

InstructorTreasury bonds, along with all other bonds, are available to investors as

Explanation:an alternative investment to common stocks. An increase in the return on

Treasury bonds would increase the appeal of these bonds relative to

common stocks, and some investors would sell their stocks to buy T-

bonds. This would cause stock prices, in general, to fall. Another way to

view this is that a relatively riskless investment (T-bonds) has increased

its return by 4 percentage points. The return demanded on riskier

investments (stocks) would also increase, thus driving down stock

prices.

Unit 5:

1. Question: The Carter Company's bonds mature in 10 years have a par value of

$1,000 and an annual coupon payment of $80. The market interest rate

for the bonds is 9%. What is the price of these bonds?

Your $935.82 CORRECT

Answer:

$941.51

$958.15

$964.41

$979.53

InstructorOn a financial calculator, enter: N 10; I/YR 9; PMT 80; FV 1,000; PV

Explanation:PV = $935.82

Alternatively, using the bond formula:

VB = COUPON [{1 – 1 / (1 + iN}} / i] + FV / (1 + i)N

VB = $80 [{1 – (1 / (1 + .09)10) }/ .09 ] + $1,000 / (1 + .09)10

VB = $80 * 6.4177 + $422.41

VB = $513.34 + $422.41 = $935.83

Points4 of 4

Received:

2. Question:Rollincoast Incorporated issued BBB bonds two years ago that provided a

yield to maturity of 11.5%. Long-term risk-free government bonds were

yielding 8.7% at that time. The current risk premium on BBB bonds

versus government bonds is half of what it was two years ago. If the risk-

free long-term government bonds are currently yielding 7.8%, then at

what rate should Rollincoast expect to issue new bonds?

Your 7.8%

Answer:

8.7%

9.2% CORRECT

10.2%

12.9%

InstructorCalculate the previous risk premium, RPBBB, and new RPBBB:

Explanation:RPBBB = 11.5% - 8.7% = 2.8%.

New RPBBB = 2.8%/2 = 1.4%.

Calculate new YTM on BBB bonds: YTMBBB = 7.8% + 1.4% = 9.2%.

Points4 of 4

Received:

3. Question: A 10-year, $1,000 face value bond has an 8.5% annual coupon. The

bond has a current yield of 8%. What is the bond’s yield to maturity?

Your 8.25%

Answer:

8.86%

7.59% CORRECT

8.50%

8.00%

InstructorData given: N = 10; I/YR = ? (This is what the problem is looking for);

Explanation:PMT = 85; PV = ? (Don't have directly, but you can calculate it from the

current yield); FV = 1,000.

Step 1: Calculate the bond's current price from information given in the

current yield.

Current yield = Coupon/Price

0.08 = $85/Price

Price = ? = $1,062.50.

Step 2: Given the bond's price, calculate the bond's yield to maturity using

your financial calculator by entering the following data as inputs:

N = 10; PV = -1062.50; PMT = 85; FV = 1000; and then solve for I/YR =

7.5859% or about 7.59%.

Points4 of 4

Received:

4. Question:You wish to purchase a 20-year, $1,000 face value bond that makes

semiannual interest payments of $40. If you require a 10% nominal yield

to maturity, what price should you be willing to pay for the bond?

Your $619

Answer:

$674

$761

$828 CORRECT

$902

InstructorWith semiannual coupon payments, you need to double the number of

Explanation:payments that you will receive over the twenty years. You also need to

divide the annual interest in half.

Financial calculator solution:

Inputs: N = 40; I/YR = 5; PMT = 40; FV = 1000.

Output: PV = -$828.41; VB » $828.

Alternatively, you could use the formula:

VB = COUPON [{1 – 1 / (1 + iN }} / i] + FV / (1 + i)N

VB = $40 [{1 – (1 / (1 + .05)40) }/ .05 ] + $1,000 / (1 + .05)40

VB = $40 * 17.1591 + $142.05

VB = $686.36 + $142.05 = $828.41

Points4 of 4

Received:

5. Question: Which of the following bonds will have the greatest percentage increase

in value if all interest rates decrease by 1%?

Your 20-year, zero coupon bond. CORRECT

Answer:

10-year, zero coupon bond.

20-year, 10% coupon bond.

20-year, 5% coupon bond.

1-year, 10% coupon bond.

InstructorStatement A. is correct, because the longer the maturity of a bond and the

Explanation:lower the coupon rate, the more sensitive its price is to a change in

interest rates. For this reason, the remaining statements are incorrect.

Points4 of 4

Received:

6. Question:Which of the following events would make it more likely that a company

would choose to call its outstanding callable bonds?

Your Market interest rates decline sharply. CORRECT

Answer:

The company’s bonds are downgraded.

Market interest rates rise sharply.

Inflation increases significantly.

The company's financial situation deteriorates

significantly.

InstructorStatement A. is true, because if rates declined the issuer could save money

Explanation:on annual coupon payments by calling the outstanding issue and issuing

new bonds. Statement b is false, because if the bonds are downgraded,

their YTM will increase meaning new debt would carry a higher coupon

rate. Statement c is false, because higher interest rates mean new bonds

issued would carry a higher coupon. Statement d is false, because an

increase in inflation will increase the bond’s YTM. Statement e is false,

because if the company’s financial situation deteriorates, its risk increases

and so does its YTM.

Points4 of 4

Received:

7. Question:Leggio Corporation issued 20-year, 7% annual coupon bonds at their par

value of $1,000 one year ago. Today, the market interest rate on these

bonds has dropped to 6%. What is the new price of the bonds, given that

they now have 19 years to maturity?

Your $1,046.59

Answer:

$1,111.58 CORRECT

$1,133.40

$1,177.78

$1,189.04

InstructorOn a financial calculator, enter:

Explanation:N 19; I/YR 6; PMT 70; FV 1,000.00; PV

PV = $1,111.58

Alternatively, you could use the formula:

VB = COUPON [{1 – 1 / (1 + iN}} / i] + FV / (1 + i)N

VB = $70 [{1 – (1 / (1 + .0619) }/ .06 ] + $1,000 / (1 + .06)19

VB = $70 * 11.1581 + $330.51

VB = $781.07 + $330.51 = $1,111.58

Points4 of 4

Received:

8. Question:Callaghan Motors' bonds have 10 years remaining to maturity. Interest is

paid annually; they have a $1,000 par value; the coupon interest rate is 8

percent; and the yield to maturity is 9 percent. What is the bond's current

market price?

Your935.82

Answer:

InstructorANSWER: $935.82

Explanation:With your financial calculator, enter the following:

N = 10; I/YR = YTM = 9%; PMT = 0.08 „e 1,000 = 80; FV = 1000; PV =

VB = ?

PV = $935.82.

Alternatively, you could solve the long way. With an 8% coupon, the

bond pays $80 annually. This is an annuity stream. The par or future

value is a lump sum to be received in 10 years. Thus, we have the PV of

an annuity plus the PV of a lump sum:

VB = COUPON [{1 ¡V 1 / (1 + iN}} / i] + FVN / (1 + i)N

VB = $80 *[{1 ¡V 1 / (1 + .09)10 }/ .09] + $1,000 / (1+.09)10

VB = $80 * [{1 ¡V 1 / 2.3674} / .09] + $422.41

VB = $80 * [{1 - .4224} / .09] + $422.41

VB = $80 * [ .5776 / .09] + $422.41

VB = $80 * 6.4177 + $422.41

VB = $513.41 + 422.41 = $935.82

Points4 of 4

Received:

9. Question:An investor has two bonds in his or her portfolio, Bond C and Bond Z.

Each matures in 4 years, has a face value of $1,000, and has a yield to

maturity of 9.6 percent. Bond C pays a 10 percent annual coupon, while

Bond Z is a zero coupon bond. Assuming that the yield to maturity of

each bond remains 9.6% over the next four years, calculate the price of

each of the bonds at the following years to maturity:

Years to Maturity Price of Bond C Price of Bond Z

4

3

2

1

0

YourPrice of Bond C: 4-->$1,012.79; 3-->1,010.02; 2-->1,006.98; 1--

Answer:>1,003.65 0-->1,000.00 Prize of Bond Z 4 --> 693.04 3 -->759.57 2 -->

832.49 1 --> 1,000.00

Instructor Years to Maturity Price of Bond C Price of Bond Z

Explanation: 4 $1,012.79 $ 693.04

3 1,010.02 759.57

2 1,006.98 832.49

1 1,003.65 912.41

0 1,000.00 1,000.00

Points4 of 4

Received:

10. Question:An investor purchased the following five bonds. Each of them had an 8

percent yield to maturity on the purchase day. Immediately after she

purchased them, interest rates fell and each then had a new YTM of 7

percent. What is the percentage change in price for each bond after the

decline in interest rates?

Price at Price at %

8% 7% Change

10-year, 10% annual

coupon

10-year zero

5-year zero

30-year zero

$100 perpetuity

Your---> 8%: ---> 7% --->% Change $1,134.21 $1,210.66 6.74% $463.20

Answer:$508.30 9.74% $680.60 $713 4.76% $99.40 $131.40 32.19% $100

Perpetuity $1,250 $1,428.57 14.29%

Instructor Price at 8% Price at 7% Change

Explanation: 10-year, 10% annual $1,134.20 $1,210.71 6.75%

coupon

10-year zero 463.19 508.35 9.75

5-year zero 680.58 712.99 4.76

30-year zero 99.38 131.37 32.19

$100 perpetuity 1,250.00 1428.57 14.29

Points4 of

Received:

Unit 6:

1. Question: Magee Company's stock has a beta of 1.20, the risk-free rate is 4.50%,

and the market risk premium is 5.00%. What is Magee's required

return?

Your 10.25%

Answer:

10.50% CORRECT

10.75%

11.00%

11.25%

InstructorRMagee = RRF + (RM – RRF)

Explanation:RMagee = 4.50% + 1.20(5.00%) = 10.50%

Points4 of 4

Received:

2. Question:Parr Paper's stock has a beta of 1.40, and its required return is 13.00%.

Clover Dairy's stock has a beta of 0.80. If the risk-free rate is 4.00%,

what is the required rate of return on Clover's stock? (Hint: First find the

market risk premium.)

Your 8.55%

Answer:

8.71%

8.99%

9.14% CORRECT

9.33%

InstructorFirst, you need to calculate the market risk premium. You can do this

Explanation:using Parr Paper information:

RParr = RRF + (RM – RRF)

13.00% = 4.00% + 1.40(RM – RRF)

6.43% = (RM – RRF)

Using this information, we can now calculate the require return for

Clover:

RClover = RRF + (RM – RRF)

RClover = 4.00% + .80(6.43%) = 9.14%

Points4 of 4

Received:

3. Question:Suppose you hold a diversified portfolio consisting of $10,000 invested

equally in each of 10 different common stocks. The portfolio’s beta is

1.120. Now suppose you decided to sell one of your stocks that has a

beta of 1.000 and to use the proceeds to buy a replacement stock with a

beta of 1.750. What would the portfolio’s new beta be?

Your 0.982

Answer:

1.017

1.195 CORRECT

1.246

1.519

InstructorWe need to calculate the beta of the portfolio’s nine stocks that we are

Explanation:keeping. These nine represent 90% of the total value of the portfolio and

90% of the beta:

.9x + .1(1.00) = 1.120

.9x = 1.02

x = 1.1333

If we add one stock with a beta of 1.75, we get:

.9(1.1333) + .1(1.75) = 1.02 + .175 = 1.195

Points4 of 4

Received:

4. Question:A mutual fund manager has a $20.0 million portfolio with a beta of 1.50.

The risk-free rate is 4.50%, and the market risk premium is 5.50%. The

manager expects to receive an additional $5.0 million which she plans to

invest in a number of stocks. After investing the additional funds, she

wants the fund’s required return to be 13.00%. What must the average

beta of the new stocks added to the portfolio be to achieve the desired

required rate of return?

Your 1.12

Answer:

1.26

1.37

1.59

1.73 CORRECT

InstructorFirst, we need to figure out what the beta of the new portfolio will be:

Explanation:Rnew = RRF + Beta(RM – RRF)

13% = 4.50% + Beta(5.50%)

8.50% = Beta(5.50%)

1.5455 = Beta of the NEW $25MM portfolio

Now we can calculate the beta of the new stocks (New Beta). We know

that the size of the portfolio will now be $25 million and that $20 million

has a beta of 1.50: (another weighted average!!!)

($20M / $25M) 1.50 + ($5M / $25M)New Beta = 1.5455

1.20 + .20(New Beta) = 1.5455

.20(New Beta) = .3455

New Beta = 1.7275 or about 1.73

Points4 of 4

Received:

5. Question:A stock is expected to pay a dividend of $1 at the end of the year. The

required rate of return is rs = 11%, and the expected constant growth rate

is 5%. What is the current stock price?

Your $16.67 CORRECT

Answer:

$18.83

$20.00

$21.67

$23.33

InstructorP0 = D1 / (rs – g)

Explanation:P0 = $1 / (.11 - .05)

P0 = $16.67

Points4 of 4

Received:

6. Question: A stock just paid a dividend of $1. The required rate of return is rs =

11%, and the constant growth rate is 5%. What is the current stock

price?

Your $15.00

Answer:

$17.50 CORRECT

$20.00

$22.50

$25.00

InstructorP0 = D1 / (rs – g)

Explanation:First, we need to calculate the dividend next year.

$1 * 1.05 = $1.05

P0 = $1.05 / (.11 - .05)

P0 = $17.50

Points4 of 4

Received:

7. Question:The Lashgari Company is expected to pay a dividend of $1 per share at

the end of the year, and that dividend is expected to grow at a constant

rate of 5% per year in the future. The company's beta is 1.2, the market

risk premium is 5%, and the risk-free rate is 3%. What is the company's

current stock price?

Your $15.00

Answer:

$20.00

$25.00 CORRECT

$30.00

$35.00

InstructorFirst, we need to calculate the required return on the stock, rs. This we

Explanation:can get from the CAPM:

Rs = RRF + (RM – RRF)

Rs = 3% + 1.2(5%)

Rs = 9%

Now we can use this in the DCF formula to calculate the current price:

P0 = D1 / (rs – g)

P0 = $1 / (.09 - .05)

P0 = $25.00

Points4 of 4

Received:

8. Question:An increase in a firm’s expected growth rate would normally cause its

required rate of return to

Your Increase.

Answer:

Decrease.

Fluctuate.

Remain constant.

Possibly increase, decrease, or have no effect. CORRECT

InstructorThe expected growth rate of a firm is only one input into the calculation

Explanation:of the required return. The other components include the price of the

stock and the expected dividend. If all else is held equal, an increase in

the growth rate will cause the required return to increase, but if the

dividend increases with the expected growth rate, this have the effect of

lowering the required return. Without knowing what happens to the

other inputs, the best answer is “e”, possibly increase, decrease or have

no effect.

Points4 of 4

Received:

9. Question:Harrison Clothiers' stock currently sells for $20 a share. It just paid a

dividend of $1.00 a share (that is D0 = $1.00). The dividend is expected

to grow at a constant rate of 6 percent a year. What stock price is

expected 1 year from now? What is the required rate of return?

Answer:

InstructorP0 = $20; D0 = $1.00; g = 6%; P1 = ?; rs = ?

Explanation:P1 = P0(1 + g) = $20(1.06) = $21.20.

rs = D1 / P0 + g = ($1.00 * 1.06) / $20 + 0.06

rs = $1.06 / $20 + 0.06 = 11.30%. rs = 11.30%.

Points4 of 4

Received:

10. Question:A stock is expected to pay a dividend of $0.50 at the end of the year (that

is, D1 = 0.50), and it should continue to grow at a constant rate of 7

percent a year. If its required return is 12 percent, what is the stock's

expected price 4 years from today?

Your$13.11

Answer:

InstructorFirst, solve for the current price.

Explanation:Po = D1/(Rs - g)

P0 = $0.50/(0.12 - 0.07)

P0 = $10.00.

If the stock is in a constant growth state, the constant dividend growth

rate is also the capital gains yield for the stock and the stock price growth

rate. Hence, to find the price of the stock four years from today:

P4 = P0(1 + g)4

P4 = $10.00(1.07)4

P4 = $13.10796 or $13.11.

Alternatively, you could solve by calculating the expected dividend five

years from now:

D5 = 0.50 * 1.074 = 0.66

P4 = 0.66 / (.12 - .07) = 13.11

Points4 of

Received:

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