(6-2) Interest rate levels C H Answer: b MEDIUM

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

a. Households reduce their consumption and increase their savings.b. A new technology like the Internet 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.

(6-3) Interest rates C H Answer: b EASY

2. The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond?

a. 5.51%b. 5.80%c. 6.09%d. 6.39%e. 6.71%

(6-5) Maturity risk premium C H Answer: c MEDIUM

3. Kelly Inc's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.90%. 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 = 2.2% 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?

a. 0.73%b. 0.81%c. 0.90%d. 0.99%e. 1.09%

(6-5) Real risk-free rate C H Answer: e MEDIUM

4. Kop Corporation's 5-year bonds yield 6.50%, and T-bonds with the same maturity yield 4.40%. The default risk premium for Kop's bonds is DRP = 0.40%, the liquidity premium on Kop's bonds is LP = 1.70% versus zero on T-bonds, the inflation premium (IP) is 1.50%, and the maturity risk premium (MRP) on 5-year bonds is 0.40%. What is the real risk-free rate, r*?

a. 2.04%b. 2.14%c. 2.26%d. 2.38%e. 2.50%

(7-2) Bond coupon rate C G Answer: b MEDIUM

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

a. Adding additional restrictive covenants that limit management's actions.

b. Adding a call provision.

c. The rating agencies change the bond's rating from Baa to Aaa.d. Making the bond a first mortgage bond rather than a debenture.e. Adding a sinking fund.

(Comp.) Bond rates and prices C G Answer: e MEDIUM

6. Bond A has a 9% annual coupon, while Bond B has a 7% annual coupon. Both bonds have the same maturity, a face value of $1,000, an 8% yield to maturity, and are noncallable. Which of the following statements is CORRECT?

a. Bond A’s capital gains yield is greater than Bond B’s capital gains yield.

b. Bond A trades at a discount, whereas Bond B trades at a premium.c. If the yield to maturity for both bonds remains at 8%, Bond A’s price

one year from now will be higher than it is today, but Bond B’s price one year from now will be lower than it is today.

d. If the yield to maturity for both bonds immediately decreases to 6%, Bond A’s bond will have a larger percentage increase in value.

e. Bond A’s current yield is greater than that of Bond B.7-3) Bond valuation: annual C G Answer: d EASY

7. Ryngaert Inc. recently issued noncallable bonds that mature in 15 years. They have a par value of $1,000 and an annual coupon of 5.7%. If the current market interest rate is 7.0%, at what price should the bonds sell?

a. $817.12b. $838.07c. $859.56d. $881.60e. $903.64

(7-4) Yield to maturity C G Answer: e EASY

8. Adams Enterprises’ noncallable bonds currently sell for $1,120. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity?

a. 5.84%b. 6.15%c. 6.47%d. 6.81%e. 7.17%

7-6) Bond valuation: semiannual C G Answer: c MEDIUM

9. Moerdyk Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 6.20%, based on semiannual compounding. What is the bond’s price?

a. $1,047.19b. $1,074.05c. $1,101.58d. $1,129.12e. $1,157.35

(7-4) Yield to call C G Answer: d EASY

10. Sadik Inc.'s bonds currently sell for $1,180 and have a par value of $1,000. They pay a $105 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call

(YTC)?

a. 6.63%b. 6.98%c. 7.35%d. 7.74%e. 8.12%

(Comp.) Bond concepts C G Answer: d MEDIUM

11. Bonds A, B, and C all have a maturity of 10 years and a yield to maturity of 7%. Bond A’s price exceeds its par value, Bond B’s price equals its par value, and Bond C’s price is less than its par value. None of the bonds can be called. Which of the following statements is CORRECT?

a. If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its price.

b. Bond A has the most interest rate risk.c. If the yield to maturity on the three bonds remains constant, the

prices of the three bonds will remain the same over the next year.d. If the yield to maturity on each bond increases to 8%, the prices of

all three bonds will decline.e. Bond C sells at a premium over its par value.

Comp.) Bond concepts C G Answer: b MEDIUM

12. An investor is considering buying one of two 10-year, $1,000 face value, noncallable 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%, and the YTM is expected to remain constant for the next 10 years. Which of the following statements is CORRECT?

a. Bond B has a higher price than Bond A today, but one year from now the bonds will have the same price.

b. One year from now, Bond A’s price will be higher than it is today.c. Bond A’s current yield is greater than 8%.d. Bond A has a higher price than Bond B today, but one year from now

the bonds will have the same price.e. Both bonds have the same price today, and the price of each bond is

expected to remain constant until the bonds mature.(8-3) Portfolio beta C N Answer: e EASY

13. Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y’s beta is 0.70. What is the portfolio's beta?

a. 0.65b. 0.72c. 0.80d. 0.89e. 0.98

(8-3) Portfolio beta C N Answer: a EASY

14. Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio’s beta?

a. 1.17

b. 1.23c. 1.29d. 1.35e. 1.42

(8-4) Market risk premium C N Answer: a EASY

15. Porter Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

a. 5.80%b. 5.95%c. 6.09%d. 6.25%e. 6.40%

(8-4) CAPM: req. rate of return C N Answer: e MEDIUM

16. Company A has a beta of 0.70, while Company B's beta is 1.20. 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.)

a. 2.75%b. 2.89%c. 3.05%d. 3.21%e. 3.38%

8-2) Std. dev., prob. data C N Answer: b HARD

17. Carson Inc.'s manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns?

EconomicConditions Prob. ReturnStrong 30% 32.0%Normal 40% 10.0%Weak 30% -16.0%

a. 17.69%b. 18.62%c. 19.55%d. 20.52%e. 21.55%

(8-4) SML C N Answer: a MEDIUM

18. Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

a. The y-axis intercept would decline, and the slope would increase.b. The x-axis intercept would decline, and the slope would increase.c. The y-axis intercept would increase, and the slope would decline.d. The SML would be affected only if betas changed.

e. Both the y-axis intercept and the slope would increase, leading to higher required returns.

(8-4) SML C N Answer: e MEDIUM

19. Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?

a. The required return on a stock with beta = 1.0 will not change.b. The required return on a stock with beta > 1.0 will increase.c. The return on "the market" will remain constant.d. The return on "the market" will increase.e. The required return on a stock with beta < 1.0 will decline.

(8-4) CAPM and required return C N Answer: b MEDIUM

20. Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

a. If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase.

b. If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.

c. If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount.

d. Since the market is in equilibrium, the required returns of the two stocks should be the same.

e. If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase.(8-4) Risk & ret. relationships C N Answer: c MEDIUM

21. Over the past 75 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?

a. Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.

b. Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds.

c. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

d. U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks.

e. Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

(8-3) Portfolio risk and return C N Answer: b MEDIUM

22. Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of

50% A and 50% B. Which of the following statements is CORRECT?

a. The portfolio's beta is less than 1.2.b. The portfolio's expected return is 15%.c. The portfolio's standard deviation is greater than 20%.d. The portfolio's beta is greater than 1.2.e. The portfolio's standard deviation is 20%.

(8-3) Portfolio risk and return C N Answer: c MEDIUM

23. Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

a. Your portfolio has a standard deviation of 30%, and its expected return is 15%.

b. Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.

c. Your portfolio has a beta equal to 1.6, and its expected return is 15%.

d. Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.

e. Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.

(9-5) Required return C G Answer: e MEDIUM

24. 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 $40Expected growth 7% 9%Expected return 10% 12%

a. The two stocks should have the same expected dividend.b. The two stocks could not be in equilibrium with the numbers given in

the question.c. A's expected dividend is $0.50.d. B's expected dividend is $0.75.e. A's expected dividend is $0.75 and B's expected dividend is $1.20.

(9-5) Declining constant growth stk. C G Answer: e MEDIUM

25. 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?

a. The company’s current stock price is $20.b. The company’s dividend yield 5 years from now is expected to be 10%.c. The constant growth model cannot be used because the growth rate is

negative.d. The company’s expected capital gains yield is 5%.

e. The company’s expected stock price at the beginning of next year is $9.50.

(9-7) Corporate valuation model C G Answer: b MEDIUM

26. Which of the following statements is NOT CORRECT?

a. The corporate valuation model can be used both for companies that pay dividends and those that do not pay dividends.

b. The corporate valuation model discounts free cash flows by the required return on equity.

c. The corporate valuation model can be used to find the value of a division.

d. An important step in applying the corporate valuation model is forecasting the firm's pro forma financial statements.

e. Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value.

(9-7) Corporate valuation model C G Answer: e MEDIUM

27. Gupta Corporation is undergoing a restructuring, and its free cash flows are expected to vary considerably during the next few years. However, the FCF is expected to be $65.00 million in Year 5, and the FCF growth rate is expected to be a constant 6.5% beyond that point. The weighted average cost of capital is 12.0%. What is the horizon (or terminal) value (in millions) at t = 5?

a. $1,025b. $1,079c. $1,136d. $1,196e. $1,259

(9-7) Corporate valuation model C G Answer: a MEDIUM

28. Misra Inc. forecasts a free cash flow of $35 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5.5% thereafter. If the weighted average cost of capital (WACC) is 10.0% and the cost of equity is 15.0%, what is the horizon, or terminal, value in millions at t = 3?

a. $821b. $862c. $905d. $950e. $997

(9-8) Preferred required return C G Answer: e MEDIUM

29. Rebello's preferred stock pays a dividend of $1.00 per quarter, and it sells for $55.00 per share. What is its effective annual (not nominal) rate of return?

a. 6.62%b. 6.82%c. 7.03%d. 7.25%e. 7.47%

(9-5) Constant growth dividend C G Answer: b MEDIUM

30. Goode Inc.'s stock has a required rate of return of 11.50%, and it sells

for $25.00 per share. Goode's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend, D0?

a. $0.95b. $1.05c. $1.16d. $1.27e. $1.40

(9-5) Expected total return C G Answer: e EASY

30. If D0 = $1.75, g (which is constant) = 3.6%, and P0 = $32.00, what is the stock’s expected total return for the coming year?

a. 8.37%b. 8.59%c. 8.81%d. 9.03%e. 9.27%

(9-5) Constant growth: future price C G Answer: e EASY

31. Whited Inc.'s stock currently sells for $35.25 per share. The dividend is projected to increase at a constant rate of 4.75% per year. The required rate of return on the stock, rs, is 11.50%. What is the stock's expected price 5 years from now?

a. $40.17b. $41.20c. $42.26d. $43.34e. $44.46

Answer: B Type: Medium Page: 65 32. Casino Inc. is expected to pay a dividend of $6 per share at the end of year one and these dividends are expected to grow at a constant rate of 6% per year forever. If the required rate of return on the stock is 18%, what is current value of the stock today? A) $30 B) $50 C) $100 D) $54

Answer: B Type: Difficult Page: 67 33. Dividend growth rate for a stable firm can be estimated as: A) Plow back rate / the return on equity (ROE) B) Plow back rate * the return on equity (ROE) C) Plow back rate + the return on equity (ROE) D) Plow back rate - the return on equity (ROE)

Answer: B Type: Difficult Page: 60 34. A four-year bond has an 8% coupon rate and a face value of $1000. If the current price of the bond is $878.31, calculate the yield to maturity of the bond (assuming annual interest payments). A) 8% B) 12% C) 10% D) 6%

Answer: D Type: Easy Page: 62 35. Super Computer Company's stock is selling for $100 per share today. It is expected that this stock will pay a dividend of 5 dollars per share, and then be sold for $120 per share at the end of one year. Calculate the expected rate of return for the shareholders. A) 20% B) 15% C) 10% D) 25%