Exam Two; Chapters 5-8
1. You plan to
analyze the value of a potential investment by calculating the sum of
the
present values of its expected cash flows.
Which of the following would lower the calculated value
of the
investment?
a. The cash flows are in the form of a
deferred
annuity, and they total to $100,000. You
learn that the annuity lasts for only 5 rather than 10 years, hence
that each
payment is for $20,000 rather than for $10,000.
B. The discount rate
increases.
c. The riskiness of
the investment’s cash flows decreases.
d. The total amount
of cash flows remains the same, but more of the cash flows are received
in the
earlier years and less are received in the later years.
e. The discount rate decreases.
a. The periodic rate of interest is 2%
and the effective rate of
interest is 4%.
b. The periodic rate of interest is 8%
and the effective rate of
interest is greater than
8%.
c. The periodic rate of interest is 4%
and the effective rate of
interest is less than 8%.
D. The periodic rate of interest is 2% and the effective rate of interest is
greater than
8%.
e. The periodic rate of interest is 8% and the effective rate of interest is also 8%.
A. Investment A pays $250 at the beginning
of every year for the next 10 years (a total of 10 payments).
b. Investment B pays $125 at the end
of
every 6-month period for the next 10 years (a total of 20 payments).
c. Investment C pays $125 at the beginning
of every 6-month period for the next 10 years (a total of 20 payments).
d. Investment D pays $2,500 at the end
of
10 years (just one payment).
e. Investment E pays $250 at the end
of
every year for the next 10 years (a total of 10 payments).
a. $2,245.08
B. $2,363.24
c. $2,481.41
d. $2,605.48
e. $2,735.75
5. Suppose the real risk-free
rate is 2.50% and the
future rate of inflation is expected to be constant at 3.05%. What rate of return would you expect on a
5-year Treasury security, assuming the pure expectations theory is
valid? Disregard cross-product
terms, i.e., if
averaging is required, use the arithmetic average.
a. 5.15%
b. 5.25%
c. 5.35%
d. 5.45%
E. 5.55%
r
= r* + IP + DRP + LP + MRP
r = 2.50% + 3.05% = 5.55%
6. 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 1-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.
a. 5.75%
B. 5.85%
c. 5.95%
d. 6.05%
e. 6.15%
r
= r* + IP + DRP + LP + MRP
r = 3.50% + 2.25% + 0 + 0 + .10% = 5.85%
7. The real risk-free rate is
2.50%, inflation is
expected to be 3.00% this year, and the maturity risk premium is zero. Taking account of the cross-product term,
i.e., not ignoring it, what is the equilibrium rate of return on a
1-year
Treasury bond?
a. 4.975%
b. 5.175%
c. 5.375%
D.5.575%
e. 5.775%
(1+r) = (1.025) (1.03) = 1.05575 - 1 = 5.575%
a. 3.82%
b. 4.25%
c. 4.72%
D.5.24%
e. 5.77%
n = 10
i = ?
PV = -3000
PMT = 0
FV = 5000
Solve for "i" which will be 5.2410 %
9. Keys Corporation's 5-year
bonds yield 6.50%, and
T-bonds with the same maturity yield 4.40%.
The default risk premium for Keys' bonds is DRP = 0.40%, the
liquidity
premium on Keys' bonds is LP = 1.70% versus zero on T-bonds, inflation
premium
(IP) is 1.5%, and the maturity risk premium (MRP) on 5-year bonds is
0.40%. What is the real risk-free rate,
r*?
a. 2.10%
b. 2.20%
c. 2.30%
d. 2.40%
E.
. 2.50%
Simply
subtract the IP of 1.50% and the MRP of .40% from the T-bond yield of
4.40% to arrive at 2.50%
10. 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?
A. $935.82
b. $941.51
c. $958.15
d. $964.41
e. $979.53
PV = ? = $935.82
PMT = 80
FV = 1000
11. Brown Enterprises’ bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80, and a par value of $1,000. What is their yield to maturity?
a. 6.87%
b. 7.03%
c. 7.21%
d. 7.45%
E.7.61%
n = 9
i = ?
= 7.6063%
PV = -1025
PMT = 80
FV = 1000
12. Highfield Inc's bonds currently sell for $1,275 and have a par value of $1,000. They pay a $120 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,120. What is their yield to call (YTC)?
a. 7.00%
b. 7.13%
c. 7.28%
D.7.31%
e. 7.42%
n = 5
i =
?
= 7.3109%
PV = -1275
PMT = 120
FV = 1120
13. Moussawi Ltd's outstanding bonds have a $1,000 par value, and they mature in 5 years. Their yield to maturity is 9%, based on semiannual compounding, and the current market price is $853.61. What is the bond's annual coupon interest rate?
a. 5.10%
b. 5.20%
C. 5.30%
d. 5.40%
e. 5.50%
n
= 10
i = 4.5
PV = -853.61
PMT = ? =
$26.4994
FV = 1000
Annual Rate = 26.4994/1000 =
2.64994% times 2 = 5.2999%
14. 14. Which of the following statements is CORRECT?
a. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates.
b. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates.
c. The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates.
D.You hold a 10-year, zero coupon, bond and a 10-year bond that has a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the larger percentage decline.
e. You hold a 10-year, zero coupon, bond and a
10-year bond that has a 6% annual coupon.
The same market rate, 6%, applies to both bonds.
If the market rate rises from the current level,
the zero coupon bond will experience the smaller percentage decline.
15. Which of the following would be most likely to increase the coupon rate that is required to enable a bond to be issued at par?
A. Adding a call provision.
b. Adding additional restrictive covenants that limit management's actions.
c. Adding a sinking fund.
d. The rating agencies change the bond's rating from Baa to Aaa.
e. Making the bond a first mortgage bond rather
than a debenture.
16. A 12-year bond has an annual
coupon rate of 9%. The coupon rate will
remain fixed until the
bond matures. The bond has a yield to
maturity of 7%. Which of the following
statements is CORRECT?
a. The
bond is currently selling at a price below its par value.
b. If market interest
rates decline, the price of
the bond will also decline.
C. If market interest rates remain unchanged, the
bond’s price one year from now will be lower than it is today.
d. If market interest
rates remain unchanged, the
bond’s price one year from now will be higher than it is today.
e. The
bond should currently be selling at its par value.
a. $77.19
B. $81.25
c. $85.31
d. $89.58
e. $94.06
1250 * .065 = $81.2518. You sold a car
and accepted a note with the following cash flow stream as your payment. What was the effective price you received for
the car assuming an interest rate of 6.0%?
Years:
0
1
2
3
4
|
|
|
|
|
CFs:
$0
$1,000
$2,000 $2,000 $2,000
A. $5,987
b. $6,286
c. $6,600
d. $6,930
Put in CF registers with a rate of 6% and find the PV
19. Which
of the following statements is CORRECT? (Assume that the risk-free
rate is
a
constant.)
a. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
b. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
C. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
d. The effect of a change in the market risk premium depends on the level of the risk-free rate.
e. The effect of a change in the market risk
premium depends on the slope of the yield curve.
20. In the next year, the market risk premium, (rM - rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?
a. The required return for all stocks will fall by the same amount.
B. The required return will fall for all stocks, but it will fall more for stocks with higher betas.
c. The required return will fall for all stocks, but it will fall less for stocks with higher betas.
d. The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.
e. The required return on all stocks will remain
unchanged.
Stock Standard
Deviation Beta
A
20%
0.59
B
10%
0.61
C
12%
1.29
If you are a strict risk minimizer,
you would 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.
a. A; A.
b. A; B.
C. B; A.
d. C; A.
e. C; B.
a. When held in isolation, Stock A has
more risk
than Stock B.
b. Stock B must be a more desirable
addition to a
portfolio than A.
c. Stock A must be a more desirable
addition to a
portfolio than B.
D. The expected
return on Stock A should be greater than that on B.
e. The expected
return on Stock B should be greater than that on A.
23. Cooley Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?
a. 11.36%
b. 11.65%
C. 11.95%
d. 12.25%
e. 12.55%
Return = 4.25% + 1.4 (5.50%) = 11.95%
24. Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)
a..2.75%
b. 2.89%
c. 3.05%
d. 3.21%
E.
3.38%
Risk Premium is 11%
minus 4.25% = 6.75% Feed into the CAPM and you can find the
returns of 8.975% for A and 12.35% for B
A. 10.36%
b. 10.62%
c. 10.88%
d. 11.15%
e. 11.43%
11.75% = 4.30% +
1.23( Market Risk Premium)
Market Risk
Premium = (11.75% - 4.30%) divided by 1.23 = 6.06%
Return on Market
= Market Risk Premium + Risk Free = 6.06% + 4.30% = 10.36%