Exam 3 – Finance 3320Spring 2011
Third Examination – Finance 3320
Spring 2011 (Moore)
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Clearly Fill in the appropriate bubble on the Scantron form for each of the following questions. Choose the BEST response. There is only one answer per question.
1.A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?
a.The bond’s coupon rate exceeds its current yield.
b.The bond’s current yield exceeds its yield to maturity.
c.The bond’s yield to maturity is greater than its coupon rate.
d.The bond’s current yield is equal to its coupon rate.
e.If the yield to maturity stays constant until the bond matures, the bond’s price will remain at $850.
2.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.
3.A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?
a.If market interest rates decline, the price of the bond will also decline.
b.The bond is currently selling at a price below its par value.
c.If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today.
d.The bond should currently be selling at its par value.
e.If market interest rates remain unchanged, the bond’s price one year from now will be higher than it is today.
4.Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the largest percentage increase in price?
a.An 8-year bond with a 9% coupon.
b.A 1-year bond with a 15% coupon.
c.A 3-year bond with a 10% coupon.
d.A 10-year zero coupon bond.
e.A 10-year bond with a 10% coupon.
5.Which of the following statements is CORRECT?
a.A zero coupon bond's current yield is equal to its yield to maturity.
b.If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par.
c.All else equal, if a bond’s yield to maturity increases, its price will fall.
d.If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.
e.All else equal, if a bond’s yield to maturity increases, its current yield will fall.
6.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.$1,047.19
b.$1,074.05
c.$1,101.58
d.$1,129.12
e.$1,157.35
7.Morin Company's bonds mature in 8 years, have a par value of $1,000, and make an annual coupon interest payment of $65. The market requires an interest rate of 8.2% on these bonds. What is the bond's price?
a.$903.04
b.$925.62
c.$948.76
d.$972.48
e.$996.79
8.Assume that you are considering the purchase of a 20-year, noncallable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 8.4% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
a.$1,105.69
b.$1,133.34
c.$1,161.67
d.$1,190.71
e.$1,220.48
9.Which of the following statements is CORRECT?
a.An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.
b.The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
c.It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
d.Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
e.An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well diversified portfolio of stocks.
10.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.
11.The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?
a.If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's.
b.Stock B's required rate of return is twice that of Stock A.
c.If Stock A's required return is 11%, then the market risk premium is 5%.
d.If Stock B's required return is 11%, then the market risk premium is 5%.
e.If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's.
12.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.
13.Dothan Inc.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return?
a.7.72%
b.8.12%
c.8.55%
d.9.00%
e.9.50%
14.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 is0.70. What is the portfolio's beta?
a.0.65
b.0.72
c.0.80
d.0.89
e.0.98
15.If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks
a.the stock is experiencing supernormal growth.
b.the stock should be sold.
c.the stock is a good buy.
d.management is probably not trying to maximize the price per share.
e.dividends are not likely to be declared.
16.Mike Flannery holds the following portfolio:
StockInvestmentBeta
A$150,0001.40
B50,0000.80
C100,0001.00
D 75,0001.20
Total$375,000
What is the portfolio's beta?
a.1.06
b.1.17
c.1.29
d.1.42
e.1.56
17.Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875.
StockInvestmentBeta
A$50,0000.50
B50,0000.80
C50,0001.00
D 50,0001.20
Total$200,000
If Jill replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?
a.1.07
b.1.13
c.1.18
d.1.24
e.1.30
18.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?
Economic
ConditionsProb.Return
Strong30%32.0%
Normal40%10.0%
Weak30%-16.0%
a.17.69%
b.18.62%
c.19.55%
d.20.52%
e.21.55%
19.Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?
a.All common stocks fall into one of three classes: A, B, and C.
b.All common stocks, regardless of class, must have the same voting rights.
c.All firms have several classes of common stock.
d.All common stock, regardless of class, must pay the same dividend.
e.Some class or classes of common stock are entitled to more votes per share than other classes.
20A 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.
21.A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?
a.$23.11
b.$23.70
c.$24.31
d.$24.93
e.$25.57
22.If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock’s expected dividend yield for the coming year?
a.4.42%
b.4.66%
c.4.89%
d.5.13%
e.5.39%
23.If D1 = $1.50, g (which is constant) = 6.5%, and P0 = $56, what is the stock’s expected capital gains yield for the coming year?
a.6.50%
b.6.83%
c.7.17%
d.7.52%
e.7.90%
24.The Isberg Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company's beta is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company's current stock price, P0?
a.$18.62
b.$19.08
c.$19.56
d.$20.05
e.$20.55
25.Nachman Industries just paid a dividend of D0 = $1.32. Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What is the best estimate of the stock’s current market value?
a.$41.59
b.$42.65
c.$43.75
d.$44.87
e.$45.99
26.The preemptive right is important to shareholders because it
a.allows managers to buy additional shares below the current market price.
b.will result in higher dividends per share.
c.is included in every corporate charter.
d.protects the current shareholders against a dilution of their ownership interests.
e.protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.
27.Which of the following statements is CORRECT?
a.Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.
b.The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock.
c.Corporations cannot buy the preferred stocks of other corporations.
d.Preferred dividends are not generally cumulative.
e.A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.
28.Suppose Boyson Corporation’s projected free cash flow for next year is FCF1 = $150,000, and FCF is expected to grow at a constant rate of 6.5%. If the company’s weighted average cost of capital is 11.5%, what is the value of its operations?
a.$2,572,125
b.$2,707,500
c.$2,850,000
d.$3,000,000
e.$3,150,000
29.Kedia Inc. forecasts a negative free cash flow for the coming year, FCF1 = -$10 million, but it expects positive numbers thereafter, with FCF2 = $25 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14.0%, what is the firm’s value of operations, in millions?
a.$200.00
b.$210.53
c.$221.05
d.$232.11
e.$243.71
30.Based on the corporate valuation model, Gay Entertainment's value of operations is $1,200 million. The company’s balance sheet shows $120 million of notes payable, $300 million of long-term debt, $50 million of preferred stock, $180 million of retained earnings, and $800 million of total common equity. If the company has 30 million shares of stock outstanding, what is the best estimate of its price per share?
a.$21.90
b.$24.33
c.$26.77
d.$29.44
e.$32.39
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