You are on page 1of 24

Unit 1:

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

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


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

25,000 = PMT * [(1 – {1 / 1.08 }) / .08]


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

190,000 = PMT * [(1 – {1 / (1 + .07/12)30*12}) / (.07 / 12)]


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

Sales $300,000 $300,000


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 old: $19,500 / $150,000 = .1300 or 13.00%


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?

YourPart A: $21.20 Part B: 11.30%


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: