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Unformatted text preview: Econ 423, Summer 2009
Homework #6, Due 7—16—09 NameAmWM ul'l'ip’e, Chalet. MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) A basic principle of finance is that the value of any investment is 1)
A) the undiscounted sum of all future net cash ﬂows generated by the investment.
B) unrelated to the degree of risk associated with the future net cash flows generated by the
C) the present value of all future net cash ﬂows generated by the investment.
D) unrelated to the future net cash flows generated by the investment. 2) A stock currently sells for $25 per share and pays $0.24 per year in dividends. What is an investor's 2)
valuation of this stock if she expects it to be selling for $30 in one year and requires 15 percent
return on equity investments?
A) $30.24 B) $27.74 C) $26.09 D) $26.30 E) $29.03 3) In the one-period valuation model, a stock‘s value fails if the rises. 3)
B) current price
C) required return on equity
D) expected future price
E) both (b) and (c) are correct. 4) According to the Gordon growth model, what is an investor's valuation of a stock whose current 4) J E dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a
long period of time and the investor's required return is ll percent?
A) $110 B) $11 C) $10 D) $5.24 E) $100 5) Suppose the average industry PE ratio for auto parts retailers is 20. What is the current price of 5)
Auto Zone stock if the retailer's earnings per share are projected to be $1.85? A) $10.81 B) $37 C) $9.25 D) $21.85 6) Which of the following is true regarding the Gordon growth model? 6)
A) The dividend growth rate is assumed to be greater than the required return on equity. B) Dividends are assumed to grow at a constant rate forever.
C) Both A and B. D) Neither (a) nor (b). 7) A firm is expected to pay a dividend of $1.00 next year and the dividend is expected to grow at a 7)
constant rate of 4 percent over time. Some investors have required returns on investments in equity
of 12 percent, some 10 percent, and some 8 percent. The market price of this firm‘s stock will be
A) $12.50. B) $16.67. C) $18. D) $25. Note: All questions are to be completed on your own, without any assistance from others. 8) Which of the following is not an objective of the Securities and Exchange Commission? 8)
A) require firms to provide speciﬁc information to investors
B) advise investors about which particular stocks are good buys
C) maintain integrity of the securities markets
D) regulate major participants in securities markets A) Their value is based on the underlying net asset value of the stocks held in the index basket.
B) They are indexed rather than actively managed. C) They are listed and traded as individual stocks on a stock exchange.
D) All of the above. 10) A PE may indicate that the market feels the firm's earnings are very risk and is 10) therefore willing to pay a for them.
A) low; low; discount B) high; low; premium
C) high; high; discount D) high; high; premium 9) Exchange traded funds (ETFs) have which of the following features? 9) D 11) Which of the following are important ways in which mortgage markets differ from the stock and 11)
bond markets? A) Most mortgages are secured by real estate, whereas the majority of capital market borrowing
is unsecured. B) Because mortgages are made for different amounts and different maturities, developing a
secondary market has been more difficult. C) The usual borrowers in the capital markets are government entities and businesses, whereas
the usual borrowers in the mortgage markets are individuals. D) All of the above are important differences. E) Only A and B of the above are important differences. 12) Which of the following is true of mortgage interest rates? 12) E
A) In exchange for points, lenders reduce interest rates on mortgage loans.
B) Longer- term mortgages have higher interest rates than shorter—term mortgages.
C) Mortgage rates are lower than Treasury bond rates because of the tax deductibility of
mortgage interest payments.
D) All of the above are true.
E) Only A and B of the above are true. 13) During the early years of an amortizing mortgage loan, the lender applies 13) D
A) all of the monthly payment to interest on the loan.
B) the monthly payment equally to interest on the loan and the outstanding principal balance.
C) all of the monthly payment to the outstanding principal balance.
D) most of the monthly payment to interest on the loan.
E) most of the monthly payment to the outstanding principal balance. 14) Which of the following reduces moral hazard for the mortgage borrower? 14) I S
A) Down payments B) Private mortgage insurance
C) Collateral D) Borrower qualifications Page 2 of 5 Note: All questions are to be completed on your own, without any assistance from others. 15) A borrower who qualifies for an FHA or VA loan enjoys the advantage that
A) only a very low or zero down payment is required.
B) the government holds the lien on the property.
C) the cost of private mortgage insurance is lower.
D) the mortgage payment is much lower. 16) Borrowers tend to prefer to
A) fixed—rate loans; ARMs; ARMs.
C) ARMs; fixed—rate loa ns; ARMs. whereas lenders prefer 17) A borrower with a 30—year loan can create a GEM by
A) simply increasing the monthly payments beyond what is required and designating that the
excess be applied entirely to the principal.
B) converting his conventional mortgage into a (3PM.
C) converting his conventional mortgage into an ARM.
D) converting his ARM into a conventional mortgage. 18) Second mortgages serve the following purposes: A) they allow borrowers to get a tax deduction on loans secured by their primary residence or
vacation home. B) they give borrowers a way to use the equity they have in their homes as security for another
loan. C) they allow borrowers to convert their conventional mortgages into GEMs. D) all of the above. E) only A and B of the above. 19) A loan—servicing agent will
A) package the loan for an investor.
B) collect payments from the borrower.
C) hold the loan in their investment portfolio.
D) A and C.
E) B and C. 20) All of the following add to concerns about the safety and soundness of Fannie Mae and Freddie
Mac except their
A) high capital—asset ratio that gives rise to conﬂicts of interest.
B) large publicly issued debt relative to that of the federal government.
C) political influence.
D) multiple goals of profit maximization and working to further the public interest. 21) Mortgage—backed securities
A) are securities collateralized by a pool of mortgages.
B) are securities collateralized by both insured and uninsured mortgages.
C) have been growing in popularity in recent years as institutional investors look for attractive investment opportu nities.
1)) all of the above.
E) only A and B of the above. Page 3 of 5 B) fixed—rate loans; ARMS; fixed-rate loans.
D) ARMS ; fixed ~ rate loans; fixed— rate loans. 21) Note: All questions are to be completed on your own, without any assistance from others. 22) The most common type of mortgage—backed security is 22) l E
A) the mortgage pass—through, a security that has the borrower's mortgage payments pass through the trustee before being disbursed to the investors. B) collateralized mortgage obligations, a security which reduces prepayment risk. C) the securitized mortgage, a security which increases the liquidity of otherwise illiquid
mortgages. D} the participation certificate, a security which passes the borrower's mortgage payments
equally among all the owners of the certificates. 23) A loan for borrowers who do not qualify for loans at the usual market rate of interest because of a 23)
poor credit rating or because the loan is larger than justified by their income is
A) an insured mortgage. B) a subprime mortgage.
C) a graduated—payment mortgage. D) a securitized mortgage. 24) Which of the following terms are found in mortgage loan contracts to protect the lender from 24)
A) Private mortgage insurance B) Down payment
C) Collateral D) All of the above 25) What factors are used in determining a person's FICO score? 25)
A) Past payment history B) Length of credit history
C) Outstanding debt D) All of the above 26) A spot transaction in the foreign exchange market involves the 26)
A) exchange of bank deposits at a specified future date.
B) exchange of exports and imports at a specified future date.
C) immediate (wi thin two days) exchange of exports and imports. D) immediate (within two days) exchange of bank deposits. E 27) When the value of the British pound changes from $1.50 to $1.25, then the pound has 27)
and the dollar has A) depreciated; depreciated B) depreciated; appreciated
C) appreciated; appreciated D) appreciated; depreciated 28) 1f the dollar appreciates from 0.8 euros per dollar to 1.2 euros per dollar, the euro depreciates from 28)
dollars to dollars per euro.
A) 0.83,- 1.25 B) 1.25; 0.83 C) 1.50; 0.67 D) 0.67; 1.50 29) If the dollar depreciates relative to the Swiss franc, 29)
A) American computers will become less expensive in Switzerland.
B) Swiss chocolate will become more expensive in the United States. C) Swiss chocolate will become cheaper in the United States.
D) both A and B of the above. Page 4 of 5 Note: All questions are to be completed on your own, without any assistance from others. 30) When the exchange rate for the euro changes from $1.20 to $1.00, then, holding everything else 30)
c0nstant, the euro has A) appreciated and German cars sold in the United States become more expensive.
B) depreciated and American wheat sold in Germany becomes less expensive. C) depreciated and American wheat sold in Germany becomes more expensive.
D) appreciated and German cars sold in the United States become less expensive. Essays and Textbook Problems. Write your answer in the space provided or on a separate sheet of paper. 31) Derive the simplified stock valuation equation for the Gordon Growth model. In doing so, you should: I. Begin by stating and explaining the equation for a generalized dividend valuation model, and identify
the additional assumptions that the Gordon growth model imposes. 2. State and explain the reasons for any additional assumptions necessary to obtain your results.
3. Clearly identify each step needed for your derivation, both mathematically and in words. 32) (Based on Mishkin and Eakins, p. 302, Quantitative Problem #2} Describe how you would compute the face
value of a 30—year, fixed—rate mortgage with a monthly payment of $1,100, assuming a nominal interest rate of
9%. If the mortgage requires 5% down, how would you find the maximum house price? You should include all
relevant formulas and number values in your response. Though you are not required to actually compute this face value, sufficient detail should be included so that
someone with a calculator and without any prior knowledge of mortgages could perform these calculations
using only your response. 33) Mishkin and Eakins, p. 278, Quantitative Problem #4
34) Mishkin and Eakins, p. 278, Quantitative Problem #6
35) Mishkin and Eakins, p. 278, Quantitative Problem #9
36) Mishkin and Eakins, p. 278, Quantitative Problem #11
3'7) Mishkin and Eakins, p. 278, Quantitative Problem if 13
38) Mishkin and Eakins, p. 278, Quantitative Problem #16
39) Mishkin and Eakins, p. 301, Question #11 40) Mishkin and Eakins, p. 302, Quantitative Problem #14 Page 5 of 5 ...
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- Summer '08