Fin 221 Exam 2
Identify the choice that best completes the statement or answers the question.
1. Stock A and Stock B each have an expected return of 12 percent, a beta of 1.4, and a standard deviation of 25 percent. The returns on the two stocks have a correlation of 0.6. Portfolio P has half of its money invested in Stock A and half in Stock B. Which of the following statements is correct?
A) Portfolio P has an expected return of 12 percent.
B) Portfolio P has a beta of 1.4.
C) Portfolio P has a standard deviation of 25 percent
D) Both statements A and B are correct
E) All of the above are correct.
2. Universe On-line (UOL) announced that they will pay their first dividend of $1 on their common stock in a year (D1). Analysts think dividends will grow by 30% in year 2, by 40% in year 3, and by 25% in year 4 before settling into a constant growth rate of 12% in year 5 and beyond. What is the value of UOL’s stock today based on this information if the required return is 16%?
3. Ford preferred stock has a par value of $25 with a dividend yield of 10%. What is the value of this stock if the required return is 8%?
4. As a manager of the 221 Fund, a well-diversified portfolio, you have been given the following information for 4 potential new stocks to add to the 221 Fund.
Coefficient of Variation (CV)
Da Bares Enterprises
Which stock(s) would you add to the well-diversified 221 Fund portfolio based on the information given?
D) Da Bares
5. The risk-free rate is 5 percent. Stock A has a beta = 1.0 and Stock B has a beta = 1.4. Stock A has a required return of 11 percent. What is Stock B's required return?
6. In the years ahead the market risk premium is expected to fall, while the risk-free rate is expected to remain at current levels. Given this forecast, which of the following statements is most correct?
A) The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.
B) The required return will fall for all stocks but will fall less for stocks with higher betas.
C) The required return will fall for all stocks but will fall more for stocks with higher betas.
D) The required return on all stocks will remain unchanged.
E) The required return for all stocks will fall by the same amount.
7. 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, other things held constant?
A) If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
B) If inflation is expected to decline, there can be no maturity risk premium.
C) The expectations theory cannot hold if inflation is decreasing.
D) If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.
E) If the pure expectations theory holds, the corporate yield curve must be downward sloping.
8. Harbuck’s Coffee is a constant growth stock selling for its equilibrium price of $40. Harbucks has a beta of 1.2 and the current dividend is $1.20. What is Harbuck’s expected constant growth rate if the risk-free rate is 3% and the market return is 12%?
9. If the constant growth model is to give a "reasonable" valuation of a stock, which of the following isnot a valid assumption for the model?
A) A growth rate greater than the required rate of return
B) An exceptionally high required rate of return
C) A growth rate of zero
D) A negative growth rate
E) All of the above are valid assumptions for the model.
10. An analyst seeks to determine the value of Bulldog Industries. After careful research, the analyst believes that free cash flows for the firm will be $80 million in the upcoming year (year 1) and will grow at 10% annually for each of the two following years (years 2 and 3). The free cash flows will grow at a rate of 5% after year 3. What is the Terminal Value (in millions of $) of Bulldog at the end of year 3 at a WACC of 10%?
11. Commercial papaer is an example of a security traded in the ________ market.
12. The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT?
A) The conditions in the problem cannot all be true--they are internally inconsistent.
B) The yield on a 2-year T-bond must exceed that on a 5-year T-bond.
C) The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond.
D) The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.
E) The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
13. Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 9.50%, the risk-free rate is 7.00%, and the Fund's assets are as follows:
14. Which of the following (all other factors held constant) will cause an increase in a stock’s value?
A) An increase in the risk-free rate
B) A decrease in the stock’s beta
C) An increase in the market risk premium
D) A decrease in the constant growth rate in dividends
15. Grossnickle Corporation issued 20-year, noncallable, 7.8% annual coupon bonds at their par value of $1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 19 years to maturity?
16. Kholdy Inc's bonds currently sell for $1,275. They pay a $120 annual coupon and have 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. What is the difference between the bond's YTM and its YTC?
17. If current market interest rates rise, what will happen to the value of outstanding bonds?
A) They will remain unchanged.
B) They will rise.
C) They will fall.
D) There is no connection between current market interest rates and the value of outstanding bonds.
18. Which of the following factors would be most likely to lead to an increase in nominal interest rates?
A) A new technology like the Internet has just been introduced, and it increases investment opportunities.
B) There is a decrease in expected inflation.
C) The Federal Reserve decides to try to stimulate the economy.
D) The economy falls into a recession.
E) Households reduce their consumption and increase their savings.
19. Kelly Inc's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.50%. The real risk-free rate is r* = 2.5%, the default risk premium for Kelly's bonds is DRP = 0.40%, the liquidity premium on Kelly's bonds is LP = 2.6% versus zero on T-bonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium (MRP) on all 5-year bonds?
20. 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?
A) Standard deviation; correlation coefficient.
B) Coefficient of variation; beta.
C) Beta; beta.
D) Variance; correlation coefficient.
E) Beta; variance.
21. Here are the expected returns on two stocks:
What is stock X’s coefficient of variation?
22. Burns Nuclear Power common stock has a beta of 0.8 and currently pays a dividend of $3. The US Treasury bill rate is 2.5% and the market risk premium is 9.5%. What is the value of this stock if a constant annual growth rate of 4% is expected in dividends and earnings?
23. You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of:
A) A secondary market transaction.
B) A primary market transaction.
C) A money market transaction.
D) An over-the-counter market transaction.
E) A futures market transaction.
24. Company A has a beta of 0.70, while Company B's beta is 1.30. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)
25. Which of the following bonds would have the most re-investment rate risk?
A) A 20-year, 11% coupon bond
B) A 5-year, 11% coupon bond
C) A 5-year zero coupon bond
D) A 20-year zero coupon bond
26. Which of the following statements is CORRECT?
A) If a coupon bond is selling at a premium, then the bond's current yield is zero.
B) The current yield on Bond A exceeds the current yield on Bond B. Therefore, Bond A
must have a higher yield to maturity than Bond B.
C) If a coupon bond is selling at a discount, then the bond's expected capital gains yield is negative.
D) If a bond is selling at a discount, the yield to call is a better measure of the expected return than the yield to maturity.
E) If a coupon bond is selling at par, its current yield equals its yield to maturity.
27. Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. You now receive another $8.50 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)
28. Assume the pure expectations hypothesis (or theory) holds and you observe the following Treasury bond rates.
Years to Maturity
What is the expected one-year Treasury yield two years from today?
29. Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%, and a maturity risk premium of 0.07% per year to maturity applies to both corporate and T-bonds, i.e., MRP = 0.07%(t), where t is the years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 1.00% apply to A-rated corporate bonds but not to T-bonds. How much higher would the rate of return be on a 10-year A-rated corporate bond than on a 5-year Treasury bond? Here we assume that the pure expectations theory is NOT valid. Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
30. O'Brien Ltd.'s outstanding bonds have a $1,000 par value, and they mature in 25 years. Their nominal annual, not semiannual yield to maturity is 9.25%, they pay interest semiannually, and they sell at a price of $1,075. What is the bond's nominal coupon interest rate?
31. What is the meaning of a upward sloping yield curve?
A) Inflation rates are less than nominal rates.
B) Short-term interest rates are equal to long-term rates.
C) Short-term interest rates are greater than long-term rates.
D) Short-term interest rates are less than long-term rates
32. You must estimate the intrinsic value of Mega Dynamics stock in our universe. Mega Dynamics’ current free cash flow is $25 billion, and it is expected to grow at a constant annual rate of 8.5%. The company’s WACC is
11%. Mega Dynamics has $200 billion of long-term debt and preferred stock, and there are 30 billion shares of common stock outstanding. What is Mega Dynamics’ estimated intrinsic value per share of common stock?
33. A 20-year, $1,000 par value bond has a 9% annual coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now?
34. Tucker Corporation is planning to issue new 20-year bonds. The current plan is to make the bonds non-callable, but this may be changed. If the bonds are made callable after 5 years at a 5% call premium, how would this affect their required rate of return
A) There is no reason to expect a change in the required rate of return.
B) Because of the call premium, the required rate of return would decline.
C) It is impossible to say without more information.
D) The required rate of return would increase because the bond would then be more risky to a bondholder.
E) The required rate of return would decline because the bond would then be less risky to a bondholder.
35. Goode Inc.'s stock has a required rate of return of 11.50%, and it sells for $18.00 per share. Goode's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend, D ?
36. MeFirst Corporation has a cumulative preferred share issue that is suppose to pay a quarterly dividend of $2. MeFirst failed to pay 3 consecutive dividends to investors and then managed to pay a common share dividend the very next quarter. How much cash must MeFirst have paid to each preferred share holder at that time?
A) $2 per share
B) $8 per share
C) $6 per share
D) $10 per share
37. Keenan Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,150. What is the bond’s nominal yield to call?
38. Quickee-Mart sold an issue of 20-year $1,000 par value bonds to the public that carry a 8.5% coupon rate, payable semi-annually. It is now 10 years later and the current yield to maturity is 9.00%. If interest rates remain at 9.00% until Quickee-Mart’s bonds mature, what will happen to the value of the bonds over time?
A) The bonds will sell at a premium and decline in value until maturity.
B) The bonds will sell at a premium and rise in value until maturity.
C) The bonds will sell at a discount and fall in value until maturity.
D) The bonds will sell at a discount and rise in value until maturity.
39. MAD Inc.'s bond rating is downgraded by Standard and Poor's from AAA to BBB. Which of the following would occur in light of this news?
A) MAD Inc.'s bond price would fall.
B) MAD Inc.'s bond price would increase.
C) MAD Inc.'s bond price would remain the same.
D) MAD Inc.’s default risk premium would increase.
E) Both A and D would occur.
40. Which of the following is an example of a capital market instrument?
A) Commercial paper.
B) Preferred stock.
C) Banker's acceptances.
D) U.S. Treasury bills.
E) Money market mutual funds.