FIN Exam 2

Paul wants to accumulate $14,500 for the down payment for a new condo. He plans to start investing $2,500 annually beginning today. The investment account will pay 10 percent interest compounded annually. How long would it take him to accumulate enough money to make the down payment?

4.4 years

If Rachel invests $1700 today in an account that pays 6 percent interest compounded annually, how long will it take for her to accumulate $6,500 in her account?

23.02 years

A leading bank offers an investment that pays 8 percent interest, compounded semiannually. What is the investment's effective annual rate (rEAR)?

8.16%

Five years ago, Brian had invested $14,850 in a growth fund. The investment is worth $22,000 today. If the interest was compounded annually, what is the annual rate of return earned on the investment?

8.2%

Frank purchased his house 16 years ago by taking out a 25-year mortgage for $150,000. The mortgage has a fixed interest rate of 5 percent compounded monthly. If he wants to pay off his mortgage today, how much money does he need? He made his most recent mortgage payment earlier today. (Round your intermediate calculation and your answer to two decimal places.)

$76,136.95

If Alvin invests $5,500 today in a savings account, the money will grow to $8,500 at the end of Year 4. Assuming that the interest is paid once per year, the effective annual rate of the investment is _____.

11.5%

Andrea's opportunity cost rate is 12 percent compounded annually. How much must she deposit in an account today if she wants to receive $2,100 at the beginning of each of the next seven years? Use the equation method to determine the amount.

$10,734

If the opportunity cost rate is 8 percent, compounded annually, what is the present value of $8,200 due to be received in 12 years?

$3,256

Dwayne plans to invest $4,700 in a savings account at the beginning of each of the next 12 years. If his opportunity cost rate is 7 percent compounded annually, how much will his investment be worth at the end of 12 years?

$89,961.02

Jude wants to receive $1,100 at the beginning of each of the next eight years. If his opportunity cost rate is 9 percent compounded annually, how much must he deposit in an account today? Use a financial calculator to make the calculation.

$6,636

Bill is considering investing $450 at the end of every month in a fixed income instrument. He will receive $27,000 at the end of four years. If interest is compounded monthly, what is the effective annual rate of return earned on the investment?

11.6%

Robert plans to invest $650 in a savings account at the beginning of each of the next seven years. If his opportunity cost rate is 5 percent compounded annually, how much will his investment be worth at the end of seven years?

$5,557

At the beginning of the year, William bought 20 shares of Zync Corporation at $18.50 per share. Zync pays dividend at the end of each year based on annual profits, which generally vary substantially from year to year. In its 25 years history, Zync has paid dividends every year without fail. The initial investment by William and the receipt of dividend at the end of every year are examples of a(n) _____ and a(n) _____, respectively.

lump-sum payment; uneven cash flow stream

Ross purchased a new commercial vehicle today for $25,000. The entire amount was financed using a five-year loan with a 4 percent interest rate (compounded monthly). How much will Ross owe on his vehicle loan after making payments for three years (i.e., when two years of payments remain)?

$10,602.44

Glen wants to take a holiday that costs $8,850, but currently he only has $2,750 saved. If he invests this money at 8 percent interest compounded annually, how long will he have to wait to take his holiday?

15.19 years

Liam is considering putting money in an investment plan that will pay him $52,000 in 12 years. If Liam's opportunity cost rate is 7 percent compounded annually, what is the maximum amount he should be willing to pay for the investment today?

$23,089

Shekhar plans to invest $1,820 in a mutual fund at the end of each of the next six years. If his opportunity cost rate is 8 percent compounded annually, how much will his investment be worth after the last annuity payment is made? Use the equation method to calculate the worth of the investment.

$13,351.39

Rebecca is currently working, but is planning to start a college in few years. For this purpose, she would need $20,000. Today she can start investing $750 monthly in an investment account that pays 6 percent compounded monthly. How long would it take her to have enough money to start college?

25.0 months

LeGo Financials offer two investment plans. Investment A pays 9 percent interest compounded monthly, whereas Investment B pays 10 percent interest compounded semiannually. What are the effective annual rates of Investment A and Investment B?

9.38 percent and 10.25 percent, respectively

Shaun is planning to invest $570 in a mutual fund at the end of each of the next eight years. If his opportunity cost rate is 6 percent compounded annually, how much will his investment be worth after the last annuity payment is made?

$5,642

Stephanie purchased a corporate bond that matures in three years. The bond has a coupon interest rate of 9 percent and its yield to maturity is 6 percent. If market interest rates remain constant and Stephanie sells the bond in 12 months, her capital gain from holding the bond will be:

negative because she purchased the bond at a premium and the bond price will approach its face value as it nears its maturity.

JRJ Corporation issued 10-year bonds at a price of $1,000. These bonds pay $60 interest every six months. Their price has remained the same since they were issued; that is, the bonds still sell for $1,000. Due to additional financing needs, the firm wishes to issue new bonds that would have a maturity of 10 years and a par value of $1,000 and pay $40 interest every six months. If both bonds have the same yield, how many new bonds must JRJ issue to raise additional capital of $2 million? Fractions of bonds cannot be issued. (Round the number of bonds to the nearest whole number.)

2,596

Rick bought a bond when it was issued by Macroflex Corporation 14 years ago. The bond, which has a $1,000 face value and a coupon rate equal to 10 percent, matures in six years. Interest is paid every six months; the next interest payment is scheduled for six months from today. Assuming the yield on similar risk investments is 14 percent, calculate the current market value (price) of the bond.

$841.15

Recently, Ohio Hospitals Inc. filed for bankruptcy. The firm was reorganized as American Hospitals Inc., and the court permitted a new indenture on an outstanding bond issue of face value $1,000 to be put into effect. The issue has 10 years to maturity and a coupon rate of 10 percent, paid annually. The new agreement allows the firm to pay no interest for five years. Then, interest payments will be resumed for the next five years. Finally, at maturity (Year 10), the principal plus the interest that was not paid during the first five years will be paid. However, no interest will be paid on the deferred interest. If the required return is 20 percent, what should the bonds sell for in the market today?

$362.44

Cold Boxes Corporation has 100 bonds outstanding with a maturity value of $1,000. The required rate of return on these bonds is currently 10 percent, and interest is paid semiannually. The bonds mature in 5 years, and their current market value is $768 per bond. Which of the following is the annual coupon interest rate?

4%

Which of the following statements about a bond that is selling at a discount is correct?

the market price of the bond will increase and will approach its face value as the maturity date gets closer

Devine Divots issued a bond a few years ago. The bond has a face value equal to $1,000 and pays investors $30 interest every six months. The bond has eight years remaining until maturity. If an investor requires a 7 percent rate of return to invest in this bond, what is the maximum price the investor should be willing to pay to purchase the bond?

$939.53

The current price of a 10-year, $1,000 par value bond is $1,158.91. Interest on this bond is paid every six months, and the simple annual yield is 14 percent. From the given information, calculate the annual coupon rate on the bond.

17%

In the event of liquidation, a(n) _____ has a claim on assets only after the senior debt has been paid off.

subordinated debenture

Omega Software Corporation's bond with a face value of $1,000 is currently selling at a premium in the financial markets. If the bond's yield to maturity is 11.5 percent, then the bond's:

coupon rate of interest must be greater than 11.5 percent.

Tony's Pizzeria plans to issue bonds with a par value of $1,000 and 10 years to maturity. These bonds will pay $45 interest every 6 months. Current market conditions are such that the bonds will be sold at net $937.79. What is the yield to maturity (YTM) of the issue as a broker would quote it to an investor?

10%

Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest being paid semiannually. The face value of the bond is $1,000. The required simple rate of return on this debt has now risen to 16 percent. What is the current value of this bond?

$550

A change in market conditions causes the market price of a bond to change because of changes in the bond's:

yield to maturity.

Assuming other things are held constant, which of the following is correct?

The change in the price of a bond due to a change in the interest rate is more significant in bonds with longer maturity periods.

Emily is contemplating the purchase of a 20-year bond that pays $50 interest every six months. The face value of the bond is $1,000. She plans to hold the bond for 10 years and sell it. She requires a 12 percent annual return but believes that the market will give only an 8 percent return when she sells the bond 10 years from now. Assuming she is a rational investor, how much should she be willing to pay for the bond today?

$927.68

The Securities and Exchange Commission is required to verify that:

all previous indenture provisions have been met before allowing a company to sell new securities to the public.

The indentures for publicly traded bonds are approved by:

the Securities and Exchange Commission.

A bond's principal value is also referred to as the maturity value because:

it is repaid at the maturity date.

GP&L sold $1,000,000 of 12 percent, 30-year, semiannual payment bonds with a face value of $1,000, 15 years ago. The bonds are not callable, but they do have a sinking fund, which requires GP&L to redeem 5 percent of the original face value of the issue each year ($50,000), beginning in Year 11. To date, 25 percent of the issue has been retired. The company can either call bonds at par for sinking fund purposes or purchase bonds in the open market, spending sufficient money to redeem 5 percent of the original face value each year. If the current market yield of the bonds is 14 percent, what is the least amount of money GP&L must put in to satisfy the sinking fund provision for the next redemption?

$43,796

The terms and conditions of a bond are set forth in its:

indenture.

Assume that a firm distributes all of its earnings as dividends. Which of the following is indicated by a price-earnings (P/E) ratio of 10?

It would take 10 years for an investor to recover his or her initial investment.

Which of the following stocks is a nonvoting stock and is referred to as hybrid stock?

Preferred stock

A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock? (Round intermediate calculations to two decimal places.)

$43.96

How can a firm effectively incorporate a maturity provision within a preferred stock issue?

By including a call provision

_____ is determined by subtracting the costs associated with both the debt and the equity that the firm uses from its after-tax operating income?

A firm's economic value added (EVA)

On January 3 of the current year, the per-share stock price of a firm was $25, and on January 4 of the current year, it was $19. Which of the following is a probable reason for the decrease in the stock price?

An increased rate of return

If the expected rate of return on a stock exceeds the required rate, it means that _____

the stock is a good buy.

Nahanni Treasures Corporation is planning a new common stock issue of five million shares to fund a new project. The increase in shares will bring the number of shares outstanding to 25 million. Nahanni's long-term growth rate is 6 percent, and its current required rate of return is 12.6 percent. The firm just paid a $1.00 dividend, and the stock sells for $16.06 in the market. On the announcement of the new equity issue, the firm's stock price dropped. Nahanni estimates that the company's growth rate will increase to 6.5 percent with the new project, but as the project is riskier than average, the firm's required return on stock will increase to 13.5 percent. Using the constant growth dividend discount model, what is the change in the equilibrium stock price?

–$0.85

Which of the following is true about a growth stock?

It generally pays little or no dividends because the firm retains most of its earnings to fund developmental opportunities.

Scubapro Corporation currently has 500,000 shares of common stock outstanding and plans to issue 200,000 more shares in a seasoned equity offering. The current shareholders have preemptive rights on any new issues of common stock by Scubapro Corporation. How many shares would an investor who currently has 20,000 shares, have the right to buy if she exercises her preemptive right?

8,000 shares`

The last dividend on Spirex Corporation's common stock was $4.00, and the expected growth rate is 10 percent. If you require a rate of return of 20 percent, what is the highest price you should be willing to pay for this stock?

$44.00

A firm has 1,000 shares of common stock outstanding with a par value of $15 per share. Upon liquidation, the firm has insufficient funds and requires an additional $5,000 to repay its creditors. Which of the following statements is true about the common shareholders' financial obligation?

If the share is purchased for $10, the stockholders are obligated to contribute $5 per share to the firm.

The constant growth dividend discount model (DDM) may be written as _____.

p0=D1/(r5-g)

Which of the following is true of the call provision found in preferred stocks?

The call provision gives the issuing firm right to redeem its preferred stock by incorporating a maturity option in the issue.

Which of the following provisions/features allows the firm to repurchase and retire a given percentage of its preferred stock each year?

Sinking fund

A share of common stock has a current price of $82.50 and is expected to grow at a constant rate of 10 percent. If you require a 14 percent rate of return, what is the current dividend (D0) on this stock?

$3.00

A firm most likely will repurchase shares of its common stock in the financial markets when _______.

the firm has a large amount of cash and a number of good investment opportunities that will grow the firm

What action would the management take if it wants to gain more ownership control of the firm?

Repurchase shares of common stock

Which of the following is true about the change in a stock price?

If investors demand higher returns to invest in stocks, then stock prices should fall.

Alpha's preferred stock currently has a market price equal to $80 per share. If the dividend paid on this stock is $6 per share, what is the required rate of return investors are demanding from Alpha's preferred stock?

7.5%

Which of the following statements about correlation is correct?

The weaker the positive correlation two stocks exhibit, the more risk can be reduced when they are combined in a portfolio.

Assume Danny is considering combining two investments to form a portfolio, and he is very concerned with the risk that will result from the combination. If he wants to attain the greatest effect from diversification, he would prefer that the assets _____.

are negatively related

Which of the following statements about beta is correct?

Firms with greater systematic risk volatilities than the market have betas that are greater than 1.0, and firms with smaller systematic risk volatilities than the market have betas that are less than 1.0.

For Investment A, the probability of the return being 20 percent is 0.5, 10 percent is 0.4, and –10 percent is 0.1. Compute the standard deviation for the investment with the given information.

9.0%

Darren has the option of investing in either Stock A or Stock B. There is a 45 percent chance that the return on Stock A will be 25 percent, a 25 percent chance it will be 14 percent, and a 30 percent chance it will be 4 percent. There is a 45 percent chance that the return on Stock B will be 30 percent, a 25 percent chance it will be 9 percent, and a 30 percent chance it will be2 percent. What is the expected rates of return on Stock A and Stock B?

15.95%; 16.35%

Which of the following statements about relevant risk and irrelevant risk is correct?

Relevant risk includes interest rate risk, but excludes a firm's default risk.

The Security Market Line (SML) relates the risks of individual securities to their required rate of return. If investors conclude that the inflation rate is going to increase, which of the following change would occur?

The required returns on all stocks will increase.

According to the capital asset pricing model (CAPM), _____.

investors should expect to be rewarded for only the systematic risk associated with an individual investment, which is measured by the beta coefficient

Which of the following measures captures the effects of both risk and return, which makes it a better measure than standard deviation for evaluating stand-alone risk in situations where investments differ with respect to both their amounts of total risk and their expected returns?

Coefficient of variation

The expected returns for Stocks A, B, C, D, and E are 7 percent, 10 percent, 12 percent, 25 percent, and 18 percent, respectively. The corresponding standard deviations for these stocks are 12 percent, 18 percent, 15 percent, 23 percent, and 15 percent, respectively. Which one of the securities should a risk-averse investor purchase if the investment will be held in isolation (by itself)?

E

The standard deviation of the returns of Stock A is 45.9 percent, and the standard deviation of the returns of Stock B is 52.7 percent. Which of the following statements about the stocks is correct?

Stock A has a tighter probability distribution than Stock B, and hence lower total risk.

Which of the following portfolios would have no diversification benefits?

A portfolio consisting of two perfectly positively correlated stocks

Which of the following statements about the risk-return relationship observed in investing is correct?

An increase in the expected inflation rate would lead to an increase in the required return on all the risky assets by the same amount, assuming all other things were held constant.

Which of the following statements is correct?

A stock's beta can be calculated by comparing its returns to the market's returns over some time period because the beta coefficient measures a stock's volatility relative to market.

Which of the following statements about diversification is correct?

When two perfectly positively correlated stocks with the same risk are combined, the portfolio risk is equal to the risk associated with the individual stocks.

Isabel invested in four-stock portfolio; she invested 20 percent of her money in Stock A, 30 percent of her money in Stock B, 25 percent of her money in Stock C, and 25 percent of her money in Stock D. The betas for Stock A, B, C, and D are 0.4, 1.2, 2.5, and 1.75, respectively, and their expected returns are 12 percent, 24 percent, 30 percent, and 28 percent, respectively. What is the beta of Isabel's portfolio?

1.50

Which of the following pairs of terms are names for the same risk?

Market risk and relevant risk

Which of the following is the only risk that is relevant to a rational, diversified investor, because it cannot be eliminated or reduced through diversification?

Market risk

The risk-free rate is 5 percent and the market risk premium is 8 percent. Stock Y's beta is 1.85 and the standard deviation of its returns is 62.5 percent. What should be the stock's expected rate of return for the stock price to be considered in equilibrium?

19.80%

If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J?

2.0