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FIN 534 Quiz 4 - $13.29

FIN 534 Quiz 4

•  Question 1

Which of the following statements is CORRECT?

•  Question 2

During the coming 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?

•  Question 3

Stock A's beta is 1.5 and Stock B's beta is 0.5.  Which of the following statements must be true about these securities?  (Assume market equilibrium.)

•  Question 4

Stock A has a beta = 0.8, while Stock B has a beta = 1.6.  Which of the following statements is CORRECT?

•  Question 5

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%.  Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%.  The correlation coefficient, r, between Bob's and Becky's portfolios is zero.  If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

•  Question 6

Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

•  Question 7

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5.  Which of the following statements must be true, according to the CAPM?

•  Question 8

Stock A's beta is 1.5 and Stock B's beta is 0.5.  Which of the following statements must be true, assuming the CAPM is correct.

•  Question 9

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio.  The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market.  Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75.  However, Stock A's standard deviation of returns is 12% versus 8% for Stock B.  Which stock should this investor add to his or her portfolio, or does the choice not matter?

•  Question 10

Which of the following statements is CORRECT?

•  Question 11

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2.  Portfolio P has equal amounts invested in each of the three stocks.  Each of the stocks has a standard deviation of 25%.  The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero).  Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged.  Which of the following statements is CORRECT?

•  Question 12

Which of the following statements is CORRECT?  (Assume that the risk-free rate is a constant.)

•  Question 13

Assume that the risk-free rate is 5%.  Which of the following statements is CORRECT?

•  Question 14

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

•  Question 15

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

•  Question 16

Stock X has the following data.  Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT?

Expected dividend, D1                                       $3.00

Current Price, P0                                                   $50

Expected constant growth rate                            6.0%

•  Question 17

A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00.  The dividend is expected to decline at a rate of 5% a year forever (g = -5%).  If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

•  Question 18

Stocks A and B have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

A                      B

Required return                               10%                 12%

Market price                                     $25                  $40

Expected growth                               7%                   9%

•  Question 19

If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks

•  Question 20

Which of the following statements is CORRECT, assuming stocks are in equilibrium?

•  Question 21

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

•  Question 22

An increase in a firm’s expected growth rate would cause its required rate of return to

•  Question 23

Stocks X and Y have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

X                      Y

Price                                                 $30                  $30

Expected growth (constant)              6%                   4%

Required return                               12%                 10%

•  Question 24

Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return.  Which of the following statements is CORRECT?

•  Question 25

Which of the following statements is CORRECT?

•  Question 26

Stocks A and B have the following data.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 

A                      B

Price                                                 $25                  $40

Expected growth                               7%                   9%

Expected return                               10%                 12%

•  Question 27

Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%.  Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 

A                 B

Beta                                                     1.10            0.90

Constant growth rate                         7.00%         7.00%

•  Question 28

The required returns of Stocks X and Y are rX = 10% and rY = 12%.  Which of the following statements is CORRECT?

•  Question 29

If markets are in equilibrium, which of the following conditions will exist?

•  Question 30

Which of the following statements is CORRECT?

FIN 534 Quiz 3 - $13.29

FIN 534 Quiz 3

•  Question 1

Which of the following statements is CORRECT?

•  Question 2

A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today.  The nominal interest rate is 6%, semiannual compounding.  Which of the following statements is CORRECT?

•  Question 3

Which of the following statements is CORRECT?

•  Question 4

Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT?  (Ignore taxes and transactions costs.)

•  Question 5

Which of the following bank accounts has the lowest effective annual return?

•  Question 6

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 increase the calculated value of the investment?

•  Question 7

A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today.  The nominal interest rate is 6%, semiannual compounding.  Which of the following statements is CORRECT?

•  Question 8

Your bank account pays a 6% nominal rate of interest.  The interest is compounded quarterly.  Which of the following statements is CORRECT?

•  Question 9

Your bank account pays an 8% nominal rate of interest.  The interest is compounded quarterly.  Which of the following statements is CORRECT?

•  Question 10

Which of the following statements is CORRECT?

•  Question 11

Which of the following statements is CORRECT?

•  Question 12

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

•  Question 13

Which of the following bank accounts has the highest effective annual return?

•  Question 14

Which of the following statements is CORRECT?

•  Question 15

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?

•  Question 16

A 10-year bond pays an annual coupon, its YTM is 8%, and it currently trades at a premium. Which of the following statements is CORRECT?

•  Question 17

Which of the following bonds has the greatest interest rate price risk?

•  Question 18

You are considering two bonds.  Bond A has a 9% annual coupon while Bond B has a 6% annual coupon.  Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant.  Which of the following statements is CORRECT?

•  Question 19

A 10-year corporate bond has an annual coupon of 9%.  The bond is currently selling at par ($1,000).  Which of the following statements is NOT

•  Question 20

Which of the following statements is CORRECT?

•  Question 21

Which of the following statements is NOT CORRECT?

•  Question 22

Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?

•  Question 23

Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?

•  Question 24

A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon.  Both bonds have the same yield to maturity.  If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT?

•  Question 25

An investor is considering buying one of two 10-year, $1,000 face value bonds: Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon.  Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 10 years.  Which of the following statements is CORRECT?

•  Question 26

A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity.  Which of the following statements is CORRECT

•  Question 27

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?

•  Question 28

Tucker Corporation is planning to issue new 20-year bonds.  Initially, the plan was to make the bonds non-callable.  If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return?

•  Question 29

Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?

•  Question 30

Which of the following statements is CORRECT?

FIN 534 Quiz 2 - $13.29

FIN 534 Quiz 2

Question 1

Which of the following statements is CORRECT?

Question 2

Which of the following statements is CORRECT?

Question 3

Below are the 2008 and 2009 year-end balance sheets for Wolken Enterprises:

 

Assets:                                                               2009                      2008

Cash                                                                              $    200,000              $  170,000

Accounts receivable                                                          864,000                  700,000

Inventories                                                                       2,000,000              1,400,000

Total current assets                                                     $  3,064,000             $2,270,000

Net fixed assets                                                                6,000,000              5,600,000

Total assets                                                                   $  9,064,000             $7,870,000

 

Liabilities and equity:

Accounts payable                                                          $  1,400,000             $1,090,000

Notes payable                                                                  1,600,000              1,800,000

Total current liabilities                                               $  3,000,000             $2,890,000

Long-term debt                                                                 2,400,000              2,400,000

Common stock                                                                 3,000,000              2,000,000

Retained earnings                                                              664,000                  580,000

Total common equity                                                  $  3,664,000             $2,580,000

Total liabilities and equity                                            $  9,064,000             $7,870,000

 

Wolken has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year non-callable, long-term debt in 2008.  As of the end of 2009, none of the principal on this debt had been repaid.  Assume that the company’s sales in 2008 and 2009 were the same.  Which of the following statements must be CORRECT?

Question 4

Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet?

Question 5

Which of the following statements is CORRECT?

Question 6

Which of the following items is NOT included in current assets?

 

Question 7

For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under Generally Accepted Accounting Principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations. Related to these modifications, which of the following statements is CORRECT?

Question 8

Assume that Pappas Company commenced operations on January 1, 2010, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes.  The company planned to depreciate its fixed assets over 15 years, but in December 2010 management realized that the assets would last for only 10 years. The firm's accountants plan to report the 2010 financial statements based on this new information. How would the new depreciation assumption affect the company’s financial statements?

Question 9

Which of the following statements is CORRECT?

Question 10

The Nantell Corporation just purchased an expensive piece of equipment. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years.  Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.

Question 11

Analysts who follow Howe Industries recently noted that, relative to the previous year, the company’s operating net cash flow increased, yet cash as reported on the balance sheet decreased. Which of the following factors could explain this situation?

Question 12

On its 2010 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount was shown the following year.  Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

 

Question 13

Which of the following would be most likely to occur in the year after Congress, in an effort to increase tax revenue, passed legislation that forced companies to depreciate equipment over longer lives?  Assume that sales, other operating costs, and tax rates are not affected, and assume that the same depreciation method is used for tax and stockholder reporting purposes. Answer

Question 14

A security analyst obtained the following information from Prestopino Products’ financial statements:

− Retained earnings at the end of 2009 were $700,000, but retained earnings at the end of 2010 had declined to $320,000.

− The company does not pay dividends.

– The company’s depreciation expense is its only non-cash expense; it has no amortization charges.

– The company has no non-cash revenues.

–The company’s net cash flow (NCF) for 2010 was $150,000.

On the basis of this information, which of the following statements is CORRECT?

Question 15

Which of the following statements is CORRECT?

Question 16

A firm’s new president wants to strengthen the company’s financial position.  Which of the following actions would make it financiallystronger?

Question 17

Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at a higher price. Which of the following statements is CORRECT?

Question 18

If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., “grading” the manager), which of the following situations would be likely to cause the manager to receive a better grade?  In all cases, assume that other things are held constant.

Question 19

You observe that a firm’s ROE is above the industry average, but its profit margin and debt ratio are both below the industry average.  Which of the following statements is CORRECT?

Question 20

Which of the following statements is CORRECT?

Question 21

Which of the following statements is CORRECT?

Question 22

Companies HD and LD are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company HD has the higher debt ratio.  Which of the following statements is CORRECT?

Question 23

Which of the following would, generally, indicate an improvement in a company’s financial position, holding other things constant?

Question 24

Which of the following statements is CORRECT?

Question 25

A firm wants to strengthen its financial position.  Which of the following actions would increase its current ratio?

Question 26

A firm wants to strengthen its financial position.  Which of the following actions would increase its quick ratio?

Question 27

Companies HD and LD have the same sales, tax rate, interest rate on their debt, total assets, and basic earning power.  Both companies have positive net incomes.  Company HD has a higher debt ratio and, therefore, a higher interest expense.  Which of the following statements is CORRECT?

Question 28

Which of the following statements is CORRECT?

Question 29

Which of the following statements is CORRECT?

Question 30

Considered alone, which of the following would increase a company’s current ratio?

FIN 534 Quiz 10 - $13.29

FIN 534 Quiz 10

•             Question 1

Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return.  In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return.  In the 90-day forward market, 1 British pound equals $1.65.  If interest rate parity holds, what is the spot exchange rate?

•             Question 2

Suppose one year ago, Hein Company had inventory in Britain valued at 240,000 pounds.  The exchange rate for dollars to pounds was 1£ = 2 U.S. dollars.  This year the exchange rate is 1£ = 1.82 U.S. dollars.  The inventory in Britain is still valued at 240,000 pounds.  What is the gain or loss in inventory value in U.S. dollars as a result of the change in exchange rates?

•             Question 3

If one U.S. dollar buys 1.64 Canadian dollars, how many U.S. dollars can you purchase for one Canadian dollar?

•             Question 4

Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price of $9,708.74, with a maturity value of $10,000.  The exchange rate at that time was 1.420 Swiss francs per dollar.  Today, at maturity, the exchange rate is 1.324 Swiss francs per dollar.  What is the annualized rate of return to the Swiss investor?

•             Question 5

If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the British pound will

•             Question 6

Which of the following statements is NOT CORRECT?

•             Question 7

Suppose 144 yen could be purchased in the foreign exchange market for one U.S. dollar today.  If the yen depreciates by 8.0% tomorrow, how many yen could one U.S. dollar buy tomorrow?

•             Question 8

Which of the following is NOT a reason why companies move into international operations?

•             Question 9

In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return.  In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%.  All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen.  Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?

•             Question 10

Suppose in the spot market 1 U.S. dollar equals 1.60 Canadian dollars.  6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%).  6-month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%.  If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?

•             Question 11

Suppose that currently, 1 British pound equals 1.62 U.S. dollars and 1 U.S. dollar equals 1.62 Swiss francs.  What is the cross exchange rate between the pound and the franc?

•             Question 12

Suppose hockey skates sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars.  If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States?

•             Question 13

Suppose DeGraw Corporation, a U.S. exporter, sold a solar heating station to a Japanese customer at a price of 143.5 million yen, when the exchange rate was 140 yen per dollar.  In order to close the sale, DeGraw agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction.  The terms were net 6 months.  If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would DeGraw actually receive after it exchanged yen for U.S. dollars?

•             Question 14

Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners.  If 9% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return?

•             Question 15

If one Swiss franc can purchase $0.71 U.S. dollars, how many Swiss francs can one U.S. dollar buy?

FIN 534 Quiz 1 - $13.29

FIN 534 Quiz 1

•             Question 1

Which of the following statements is CORRECT?

•             Question 2

Which of the following statements is CORRECT?

•             Question 3

Which of the following statements is CORRECT?

•             Question 4

Which of the following statements is CORRECT?

•             Question 5

Which of the following statements is CORRECT?

•             Question 6

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to

•             Question 7

Which of the following statements is CORRECT?

•             Question 8

With which of the following statements would most people in business agree?

•             Question 9

Which of the following statements is CORRECT?

 

•             Question 10

Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?

•             Question 11

You recently sold to your brother 200 shares of Disney stock, and the transfer was made through a broker, and the trade occurred on the NYSE.  This is an example of:

•             Question 12

Which of the following factors would be most likely to lead to an increase in interest rates in the economy?

•             Question 13

You recently sold 100 shares of your new company, XYZ Corporation, to your brother at a family reunion.  At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates.  Which of the following statements best describes this transaction?

•             Question 14

Which of the following statements is CORRECT?

•             Question 15

Jane Doe, who has substantial personal wealth and income, is considering the possibility of starting a new business in the chemical waste management field.  She will be the sole owner, and she has enough funds to finance the operation.  The business will have a relatively high degree of risk, and it is expected that the firm will incur losses for the first few years.  However, the prospects for growth and positive future income look good, and Jane plans to have the firm pay out all of its income as dividends to her once it is well established. Which of the legal forms of business organization would probably best suit her needs?

FIN 534 Chapter 9 - $7.50

FIN 534

Homework Chapter 9

 

1. Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?

a. Increase the dividend payout ratio for the upcoming year.

b. Increase the percentage of debt in the target capital structure.

c. Increase the proposed capital budget.

d. Reduce the amount of short-term bank debt in order to increase the current ratio.

e. Reduce the percentage of debt in the target capital structure.

 

2. LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

a. Project B, which is of below-average risk and has a return of 8.5%.

b. Project C, which is of above-average risk and has a return of 11%.

c. Project A, which is of average risk and has a return of 9%.

d. None of the projects should be accepted.

e. All of the projects should be accepted.

 

3. Which of the following statements is CORRECT?

a. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation.

b. All else equal, an increase in a company’s stock price will increase its marginal cost of retained earnings, rs.

c. All else equal, an increase in a company’s stock price will increase its marginal cost of new common equity, re.

d. Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt.

e. If a company’s tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall.

 

4. Which of the following statements is CORRECT?

a. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.

b. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.

c. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.

d. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.

e. Higher flotation costs tend to reduce the cost of equity capital.

 

5. Cranberry Corp. has two divisions of equal size: a computer manufacturing division and a data processing division. Its CFO believes that stand-alone data processor companies typically have a WACC of 8%, while stand-alone computer manufacturers typically have a 12% WACC. He also believes that the data processing and manufacturing divisions have the same risk as their typical peers. Consequently, he estimates that the composite, or corporate, WACC is 10%. A consultant has suggested using an 8% hurdle rate for the data processing division and a 12% hurdle rate for the manufacturing division. However, the CFO disagrees, and he has assigned a 10% WACC to all projects in both divisions. Which of the following statements is CORRECT?

a. While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant’s recommendation, this should not affect the firm’s intrinsic value.

b. The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time.

c. The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm’s intrinsic value over time.

d. The decision not to risk-adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time.

e. The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm’s capital structure but it will not affect its intrinsic value.

FIN 534 Chapter 8 - $7.50

FIN 534

Homework Chapter 8

 

1. Which of the following statements is CORRECT?

a. Put options give investors the right to buy a stock at a certain strike price before a specified date.

b. Call options give investors the right to sell a stock at a certain strike price before a specified date.

c. Options typically sell for less than their exercise value.

d. LEAPS are very short-term options that were created relatively recently and now trade in the market.

e. An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

 

2. Which of the following statements is CORRECT?

a. If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.

b. Call options generally sell at a price less than their exercise value.

c. If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.

d. Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.

e. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

 

3. Which of the following statements is CORRECT?

a. An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.

b. As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.

c. Issuing options provides companies with a low cost method of raising capital.

d. The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.

e. The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

 

4. The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option's value?

a. $2.43

b. $2.70

c. $2.99

d. $3.29

e. $3.62

 

5. An analyst wants to use the Black-Scholes model to value call options on the stock of Ledbetter Inc. based on the following data:

The price of the stock is $40.

The strike price of the option is $40.

The option matures in 3 months (t = 0.25).

The standard deviation of the stock’s returns is 0.40, and the variance is 0.16.

The risk-free rate is 6%.

 

Given this information, the analyst then calculated the following necessary components of the Black-Scholes model:

d1 = 0.175

d2 = -0.025

N(d1) = 0.56946

N(d2) = 0.49003

 

N(d1) and N(d2) represent areas under a standard normal distribution function. Using the Black-Scholes model, what is the value of the call option?

a. $2.81

b. $3.12

c. $3.47

d. $3.82

e. $4.20

FIN 534 Chapter 7 - $7.50

FIN 534

Homework Chapter 7

 

1. Which of the following statements is CORRECT?

a. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.

b. Two firms with the same expected dividend and growth rates must also have the same stock price.

c. It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant.

d. If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.

e. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.

 

2. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

A B

Price $25 $25

Expected growth (constant) 10% 5%

Required return 15% 15%

a. Stock A's expected dividend at t = 1 is only half that of Stock B.

b. Stock A has a higher dividend yield than Stock B.

c. Currently the two stocks have the same price, but over time Stock B's price will pass that of A.

d. Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will always be twice as high as Stock B’s.

e. The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist.

 

3. Which of the following statements is CORRECT?

a. A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.

b. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm’s common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.

c. The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.

d. One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free.

e. One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.

 

4. Church Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 25% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., g = 0. The company’s last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?

a. $26.77

b. $27.89

c. $29.05

d. $30.21

e. $31.42

 

5. Your boss, Sally Maloney, treasurer of Fred Clark Enterprises (FCE), asked you to help her estimate the intrinsic value of the company's stock. FCE just paid a dividend of $1.00, and the stock now sells for $15.00 per share. Sally asked a number of security analysts what they believe FCE's future dividends will be, based on their analysis of the company. The consensus is that the dividend will be increased by 10% during Years 1 to 3, and it will be increased at a rate of 5% per year in Year 4 and thereafter. Sally asked you to use that information to estimate the required rate of return on the stock, rs, and she provided you with the following template for use in the analysis.

Sally told you that the growth rates in the template were just put in as a trial, and that you must replace them with the analysts' forecasted rates to get the correct forecasted dividends and then the estimated TV. She also notes that the estimated value for rs, at the top of the template, is also just a guess, and you must replace it with a value that will cause the Calculated Price shown at the bottom to equal the Actual Market Price. She suggests that, after you have put in the correct dividends, you can manually calculate the price, using a series of guesses as to the Estimated rs. The value of rs that causes the calculated price to equal the actual price is the correct one. She notes, though, that this trial-and-error process would be quite tedious, and that the correct rs could be found much faster with a simple Excel model, especially if you use Goal Seek. What is the value of rs?

a. 11.84%

b. 12.21%

c. 12.58%

d. 12.97%

e. 13.36%

FIN 534 Chapter 6 - $7.50

FIN 534

Homework Chapter 6

 

1. Which of the following statements is CORRECT?

a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

b. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one.

c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.

d. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.

e. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.

 

2. Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

a. Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio.

b. The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk.

c. Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios.

d. If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's.

e. The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.

 

3. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?

a. Portfolio P has a standard deviation of 20%.

b. The required return on Portfolio P is equal to the market risk premium (rM − rRF).

c. Portfolio P has a beta of 0.7.

d. Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.

e. Portfolio P has the same required return as the market (rM).

 

4. Which of the following statements is CORRECT?

a. When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

b. Portfolio diversification reduces the variability of returns on an individual stock.

c. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.

d. The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.

e. A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.

 

5. Which of the following statements is CORRECT?

a. If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.

b. If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change.

c. An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk.

d. There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.

e. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, 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.

FIN 534 Chapter 5 - $7.50

FIN 534

Homework Chapter 5

1. Three $1,000 face value bonds that mature in 10 years have the same level of risk, hence their YTMs are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

a. Bond A’s current yield will increase each year.

b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.

c. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.

d. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.

e. Over the next year, Bond A’s price is expected to decrease, Bond B’s price is expected to stay the same, and Bond C’s price is expected to increase.

 

2. Which of the following statements is CORRECT?

a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. 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.

b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.

c. 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. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. 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.

e. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.

3. Which of the following statements is CORRECT?

a. Assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. The premium bond must have a lower current yield and a higher capital gains yield than the par bond.

b. A bond’s current yield must always be either equal to its yield to maturity or between its yield to maturity and its coupon rate.

c. If a bond sells at par, then its current yield will be less than its yield to maturity.

d. If a bond sells for less than par, then its yield to maturity is less than its coupon rate.

e. A discount bond’s price declines each year until it matures, when its value equals its par value.

4. Suppose a new company decides to raise a total of $200 million, with $100 million as common equity and $100 million as long-term debt. The debt can be mortgage bonds or debentures, but by an iron-clad provision in its charter, the company can never raise any additional debt beyond the original $100 million. Given these conditions, which of the following statements is CORRECT?

a. The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm’s total dollar interest charges will be.

b. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of debentures.

c. In this situation, we cannot tell for sure how, or whether, the firm’s total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. The interest rate on each of the two types of bonds would increase as the percentage of mortgage bonds used was increased, 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.

d. The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures.

e. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be 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.

 

5. Cosmic Communications Inc. is planning two new issues of 25-year bonds. Bond Par will be sold at its $1,000 par value, and it will have a 10% semiannual coupon. Bond OID will be an Original Issue Discount bond, and it will also have a 25-year maturity and a $1,000 par value, but its semiannual coupon will be only 6.25%. If both bonds are to provide investors with the same effective yield, how many of the OID bonds must Cosmic issue to raise $3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.

a. 4,228

b. 4,337

c. 4,448

d. 4,562

e. 4,676