221 Fin Spring 2008 Exam 2 Covers Chapters 5-9.
Multiple Choice Identify the choice that best completes the statement or answers the question. 1. Which of the following statements is CORRECT? (Ch 5) A. The NYSE does not exist as a physical location; rather it represents a loose collection of dealers who trade stock electronically. B. An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift. C. Capital market instruments include both long-term debt and common stocks. D. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. E. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors.
2. You recently sold to your brother 200 shares of Disney stock, and the transfer was made through a broker. This is an example of: (Ch 5) A. A money market transaction. B. A primary market transaction. C. A secondary market transaction. D. A futures market transaction. E. An over-the-counter market transaction.
3. If the stock market is semistrong-form efficient, which of the following statements would be CORRECT? (Ch 5) A. The required returns on all stocks are the same, and the required returns on stocks are higher than the required returns on bonds. B. The required returns on stocks equal the required returns on bonds. C. A trading strategy in which you buy stocks that have recently fallen in price is likely to provide you with a return that exceed the return on the overall stock market. D. 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. E. Even if a market is semistrong-form efficient, an investor could still earn a better return than the market return if he or she had inside information.
4. If the Federal Reserve sells $50 billion of short-term U.S. Treasury securities to the public, other things held constant, what would be the most likely effect on short-term securities prices and interest rates? (Ch 6&7) A. Prices and interest rates will both rise. B. Prices will rise and interest rates will decline. C. Prices and interest rates will both decline. D. Prices will decline and interest rates will rise. E. There is no reason to expect a change in either prices or interest rates.
5. Suppose the rate of return on a 10-year T-bond is currently 5.00% and that on a 10-year Treasury Inflation Protected Security (TIP) is 2.10%. Suppose further that the MRP on a 10-year T-bond is 0.9%, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. (Ch 6) A. 1.80% B. 1.90% C. 2.00% D. 2.10% E. 2.20%
6. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT? (Ch 6) A. If the expectations theory holds, the Treasury yield curve must be downward sloping. B. If the expectations theory holds, the corporate yield curve must be downward sloping. C. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping. D. If inflation is expected to decline, there can be no maturity risk premium. E. The expectations theory cannot hold if inflation is decreasing.
7. Which of the following factors would be most likely to lead to an increase in nominal interest rates? (Ch 6) A. Households reduce their consumption and increase their savings. B. A new technology like electricity has just been introduced, and it increases investment opportunities. C. There is a decrease in expected inflation. D. The economy falls into a recession. E. The Federal Reserve decides to try to stimulate the economy.
8. Bauer 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 maturity (YTM)? (Ch 7) A. 8.78% B. 8.99% C. 9.15% D. 9.33% E. 9.41%
9. Travis Corp.'s bonds currently sell for $1,050. They have an 8% annual coupon rate and a 20-year maturity, but they can be called in 5 years at $1,120. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. Under these conditions, what rate of return should an investor expect to earn if he or she purchases these bonds? (Ch 7) A. 7.51% B. 7.71% C. 8.04% D. 8.47% E. 8.74%
10. Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds will have the largest percentage increase in price? (Ch 7) A. A 10-year bond with a 10% coupon. B. A 10-year zero coupon bond. C. An 8-year bond with a 9% coupon. D. A 1-year bond with a 15% coupon. E. A 3-year bond with a 10% coupon.
11. A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? (Ch 7) A. The bond's yield to maturity is greater than its coupon rate. B. If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850. C. The bond's current yield is equal to its coupon rate. D. The bond's current yield exceeds its yield to maturity. E. The bond's coupon rate exceeds its current yield.
12. 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, which is expected to remain constant. Which of the following statements is CORRECT? (Ch 7) A. The prices of both bonds will increase by 7% per year. B. The prices of both bonds will increase over time, but the price of Bond A will increase by more. C. The prices of both bonds will remain unchanged. D. The price of Bond A will decrease over time, but the price of Bond B will increase over time. E. The price of Bond B will decrease over time, but the price of Bond A will increase over time.
13. A 20-year, $1,000 face value bond has a 9% annual coupon. The bond currently sells for $925. If the bond's yield to maturity remains at its current rate, what will be the price of the bond 5 years from now? (Ch 7) A. $ 966.79 B. $ 831.35 C. $1,090.00 D. $ 933.09 E. $ 925.00
14. 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? (Ch 7) A. $619 B. $674 C. $761 D. $828 E. $902
15. A 16-year, $1,000 face value bond with a 10% annual coupon has a current yield of 8%. What is the bond's yield to maturity (YTM)? (Ch 7) A. 6.9% B. 7.1% C. 7.3% D. 7.5% E. 7.7%
16. Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 12.00% required return. The risk-free rate is 4.75%. You now receive another $10.00 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new $20.00 million portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.) (Ch 8) A. 10.02% B. 10.61% C. 10.91% D. 11.31% E. 12.62%
17. Jane has a portfolio of 20 randomly selected stocks, and Dick has a portfolio of 2 randomly selected stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT? (Ch 8) A. The required return on Jane's portfolio must higher be than the required return on Dick's portfolio because Jane is more diversified. B. The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. C. If the two portfolios have the same beta, Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio. D. If the two portfolios have the same beta, Jane's portfolio will have less diversifiable risk and but the same market risk as Dick's portfolio. E. 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.
18. Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% of its money in Stock A and 50% in Stock B. Which of the following statements is correct? (Ch 8) A. Portfolio P has an expected return that is less than 12%. B. Portfolio P has a standard deviation that is less than 25%. C. Portfolio P has a standard deviation that is greater than 25%. D. Portfolio P has a beta that is less than 1.2. E. Portfolio P has a beta that is greater than 1.2.
19. Assume that in recent years, both expected inflation and the market risk premium (rM rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes? (Ch 8) A. The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. B. The required returns on all stocks have fallen by the same amount. C. The required returns on all stocks have fallen, but the decline has been greater for stocks with higher betas. D. The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas. E. The required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0.
20. Which of the following statements is CORRECT? (Ch 8) A. B. C. D. E. Beta is measured by the slope of the security market. The slope of the security market line is equal to the market risk premium, (rM rRF). If a company's beta doubles, then its required return will also double. If a company's beta is halved, then its required return will also be halved. If the risk-free rate rises, then the market risk premium will also rise.
21. Given the following information, determine which beta coefficient for Stock A is consistent with equilibrium:
A
11.3%; r A. B. C. D. E. 0.86 1.26 1.10 0.80 1.35
5%; RP
5% (Ch 8)
22. A $10 million portfolio that consists of the following five stocks: Stock A B C D E Amount Invested $4 million 2 million 2 million 1 million 1 million Beta 1.2 1.1 1.0 0.7 0.5
The portfolio has a required return of 11%, and the market risk premium is 5%. What is the required return on Stock C? (Ch 8) A. B. C. D. E. 7.2% 10.0% 10.9% 11.0% 11.5%
23. The CFO of Brady Boots has estimated the returns to Brady's stock, depending on the state of the economy. He has also compiled analysts' expectations for the economy. (Ch 8) Economy Recession Below average Average Above average Boom Probability 0.1 0.1 0.4 0.2 0.2 Return -23% -8 6 17 24
Given this data, what is the company's coefficient of variation? 1.94 A. B. 25.39 2.26 C. 5.31 D. 1.84 E.
24. Wald Inc's stock has a required rate of return of 10%, and it sells for $40 per share. Wald's dividend is expected to grow at a constant rate of 7% per year. What is the expected year-end dividend, D1? (Ch 9) A. $0.90 B. $1.00 C. $1.10 D. $1.20 E. $1.30
25. The Tapley Tank Company's last dividend was $2.00. The dividend growth rate is expected to be constant at 25% for 3 years, after which dividends are expected to grow at a rate of 7% forever. Tapley's required return (r s) is 11%. What is Tapley's current stock price? (Ch 9) A. $80.64 B. $82.45 C. $84.05 D. $86.16 E. $88.45
26. Stock X has a required return of 12% and a dividend yield of 5%, and its dividend is expected to grow at a constant rate forever. Stock Y has a required return of 10%, a dividend yield of 3%, and its dividend is expected to grow at a constant rate forever. Both stocks currently sell for $25 per share. Which of the following statements is CORRECT? (Ch 9) A. Stock X pays a higher dividend per share than Stock Y. B. Stock Y pays a higher dividend per share than Stock X. C. One year from now, Stock X should have the higher price. D. Stock Y has a lower expected growth rate than Stock X. E. Stock Y has the higher expected capital gains yield.
27. Which of the following statements is CORRECT? (Ch 9) A. Preferred stockholders have a priority to income but not to liquidation proceeds over bondholders in the event of bankruptcy. B. A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation. C. Corporations cannot buy the preferred stocks of other corporations. D. Preferred dividends are not generally cumulative. E. The preferred stock of a given firm is less risky to investors than the same firm's common stock.
28. Johnston Corporation is growing at a constant rate of 6% per year. The cost of preferred stock (r p) is 8%. The par value of the preferred stock is $120, and the stock has a stated dividend of 10% of par. What is the market value of the preferred stock? (Ch 9) A. $125 B. $120 C. $175 D. $150 E. $200
29. Thames Inc.'s most recent dividend was $2.40 per share (D0 $2.40). The dividend is expected to grow at a rate of 6% per year. The risk-free rate is 5% and the market risk premium is 4%. If the company's beta is 1.3, what is the price of the stock today? (Ch 9) A. $72.14 B. $57.14 C. $40.00 D. $68.06 E. $60.57
30. An analyst is estimating the intrinsic value Harkleroad Technologies' stock. Harkleroad's free cash flow is expected to be $25 million this year, and grow at a constant rate of 7% a year. The company's WACC is 10%. Harkleroad has $200 million of long-term debt and preferred stock, and 30 million outstanding shares of common stock. What is the estimated per-share price of Harkleroad Technologies' common stock? (Ch 9) A. $ 1.67 B. $ 5.24 C. $18.37 D. $21.11 E. $27.78
31. Hard Hat Construction's stock is currently selling at an equilibrium price of $30 per share. The firm has been experiencing a 6% annual growth rate. The companys last dividend was $1.60. The risk-free rate is 8%, and the market risk premium is 5%. If market risk (beta) increases by 50%, and all other factors remain constant, by how much will the stock price change? (Ch 9) A. -$ 7.33 B. $ 7.14 C. -$15.00 D. -$15.22 E. $22.63
32. Three-year treasury securities yield 5%, 5-year treasury securities yield 6%, and 8-year treasury securities yield 7%. If the expectations theory is correct, what is the expected yield on 5-year Treasury securities three years from now? (Ch 6) A. 5.09% B. 7.00% C. 6.71% D. 8.22% E. 6.03%
33. The real risk-free rate, r*, is 3%. Inflation is expected to be 4% this year, 5% next year, and 3% per year thereafter. The maturity risk premium equals 0.1%(t 1), where t equals the bond's maturity. A 5-year corporate bond yields 8%. What is the yield on a 10-year corporate bond that has the same default risk and liquidity premiums as the 5-year corporate bond? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. (Ch 6) A. 7.2% B. 8.2% C. 8.0% D. 6.8% E. 8.4%
Fin 221 Spring 2008 Exam 2 Answer Section
MULTIPLE CHOICE 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. C C E D C A B B A B A D D D C B D B C B B C E D C A E D E D A D B