FIN 100 Principles of Finance Part 2

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) The standard deviation of returns is:

8. A) 8.00%.
9. B) 7.63%.
10. C) 4.68%.
11. D) 2.76%.

Answer: D

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: standard deviation

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) What is the expected rate of return for an investment that has the following expected scenario? If there is an 18% probability of a recession, 2.0% return; if there is a 65% probability of a moderate economy, 9.5% return; if there is a 17% probability of a strong economy, 14.2% return.

11. A) 11.25%
12. B) 7.33%
13. C) 8.95%
14. D) 9.59%

Answer: C

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) What is the expected return on an investment that has the following expected scenario? If there is a 10% probability of a booming economy, $250 return; if there is a 70% probability of a moderate economy, $154 return; if there is a 20% probability of a declining economy, $50 return.

154. A) $154.00
155. B) $142.80
156. C) $65.00
157. D) $15.12

Answer: B

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

Use the following information, which describes the expected return and standard deviation for three different assets, to answer the following question(s).

Asset X Asset Y Asset Z

Expected return 9.5% 8.8% 9.5%

Standard deviation 4.9% 5.5% 5.5%

13) If an investor must choose between investing in either Asset X or Asset Y, then:

1. A) she will always choose Asset X over Asset Y.
2. B) she will always choose Asset Y over Asset X.
3. C) she will be indifferent between investing in Asset X and Asset Y.
4. D) none of the above.

Answer: A

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) If an investor must choose between investing in either Asset X or Asset Z, then:

1. A) he will always choose Asset X over Asset Z.
2. B) he will always choose Asset Z over Asset X.
3. C) he will be indifferent between investing in Asset X and Asset Z.
4. D) none of the above.

Answer: A

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) Which of the following is NOT an example of factors that affect systematic risk?

1. A) Changes in general interest rates
2. B) A firm wins a lawsuit dealing with patent infringement
3. C) Our country declares war in the Persian Gulf
4. D) Environmental awareness increases throughout the country

Answer: B

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: systematic risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) Which of the following best measures the risk of holding an asset in isolation (i.e., stand-alone risk)?

1. A) The mean co-variance
2. B) The standard deviation
3. C) The coefficient of optimization
4. D) The standard asset pricing model
5. E) The omegatron

Answer: B

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

17) What is a practical measure that is used to quantify the risk of a single investment?

1. A) The systematic variation
2. B) The Fisher effect
3. C) The IRP
4. D) The standard deviation

Answer: D

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) What is the standard deviation of an investment that has the following expected scenario? If there is an 18% probability of a recession, 2.0% return; if there is a 65% probability of a moderate economy, 9.5% return; if there is a 17% probability of a strong economy, 14.2% return.

3. A) 3.68%
4. B) 1.23%
5. C) 8.47%
6. D) 6.66%

Answer: A

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: standard deviation

Principles: Principle 2: There Is a Risk-Return Tradeoff

19) You are considering investing in a firm that has the following possible outcomes:

Economic boom: probability of 25%; return of 25%

Economic growth: probability of 60%; return of 15%

Economic decline: probability of 15%; return of -5%

What is the expected rate of return on the investment?

15. A) 15.0%
16. B) 11.7%
17. C) 14.5%
18. D) 25.0%

Answer: C

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

20) Which of the following is an adequate method of achieving portfolio diversification?

1. A) Invest in various bonds and stocks.
2. B) Invest in stocks of different industries.
3. C) Invest internationally.
4. D) All of the above.
5. E) None of the above.

Answer: D

Diff: 1

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: systematic risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

21) You have been employed by Telemetry Medical Instruments (TMI) for seven years and participate in their 401 (k) plan by having 5% of your paycheck invested in the plan. You have been so impressed with the performance of the company's stock that you currently have all of your 401 (k) money invested in TMI's common stock. What does prudent investment management suggest that you do about risk?

1. A) Close out your 401 (k) and put the money in the bank.
2. B) Increase your payroll deduction from 5% to 10% but keep all funds invested in TMI.
3. C) Close out your 401 (k) and invest in T-bills.
4. D) Take some of your investment out of TMI's common stock and invest it in the stocks and bonds of other firms.

Answer: D

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

22) You bought Chemtron stock for $45 a year ago. It is selling for $54 today. What is your holding period return?

1. A) 9%
2. B) 11%
3. C) 6%
4. D) 20%

Answer: D

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: holding period return

Principles: Principle 3: Cash Flows Are the Source of Value

23) You purchased the stock of Sargent Motors at a price of $75.75 one year ago today. If you sell the stock today for $89.00, what is your holding period return?

35. A) 35.00%
36. B) 12.50%
37. C) 17.50%
38. D) 25.00%

Answer: C

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: holding period return

Principles: Principle 3: Cash Flows Are the Source of Value

24) Which of the following statements is correct?

1. A) Portfolio diversification reduces the variability of the returns on the individual stocks held in a portfolio.
2. B) Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification, we would expect Portfolio B to have lower risk.
3. C) If an investor buys enough stocks, he or she can, through diversification, eliminate all market risk.
4. D) Diversification can be achieved by purchasing stocks that are perfectly positively correlated.

Answer: B

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

25) Your broker mailed you your year-end statement. You have $25,000 invested in Dow Chemical, $18,000 tied up in GM, $36,000 in Microsoft stock, and $11,000 in Nike. The annualized returns for these stocks is 16.5% for Dow, 12.0% for GM, 18.5% for Microsoft, and 15.3% for Nike. What is the return of your entire portfolio?

15. A) 15.60%
16. B) 18.55%
17. C) 16.25%
18. D) 9.00%

Answer: C

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

26) According to the experts, a model portfolio should consist of a mix of securities that over the long run should look something like this: cash or money market accounts, 5%; bonds, 25%; domestic stocks, 35%; international stocks, 35%. What is the determination of the proportions of various securities within a portfolio referred to as?

1. A) Risk assessment
2. B) Capital asset modeling
3. C) Beta selection
4. D) Portfolio regression
5. E) Asset allocation

Answer: E

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: portfolio composition

Principles: Principle 2: There Is a Risk-Return Tradeoff

27) By investing in different securities, an investor can lower his exposure to risk.

Answer: TRUE

Diff: 1

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

28) The greater the dispersion of possible returns, the riskier is the investment.

Answer: TRUE

Diff: 1

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: standard deviation

Principles: Principle 2: There Is a Risk-Return Tradeoff

29) For the most part, there has been a positive relation between risk and return historically.

Answer: TRUE

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

30) The benefit from diversification is far greater when the diversification occurs across asset types.

Answer: TRUE

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

31) Investing in foreign stocks is one way to improve diversification of a portfolio.

Answer: TRUE

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

32) You are considering a security with the following possible rates of return:

Probability Return (%)

0.20 9.6

0.30 12.0

0.30 14.4

0.20 16.8

1. Calculate the expected rate of return.
2. Calculate the standard deviation of the returns.

Answer: 

1. R = (0.2)(9.6) + (0.3)(12.0) + (0.3)(14.4) + (0.2 )(16.8) = 13.2%
2. s(R) = [(9.6 - 13.2)2 (0.2) + (12 - 13.2)2(0.3)

+ (14.4 - 13.2)2(0.3) + (16.8 - 13.2)2(0.2)]1/2 = 2.459%

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

33) Using the following information for McDonovan, Inc.'s stock, calculate their expected return and standard deviation.

State Probability Return

Boom 20% 40%

Normal 60% 15%

Recession 20% (20%)

Answer: Ki = Σ(Ki)(Pi) = (.20)(40%) + (.60)(15%) + (.20)(-20%)

= 8% + 9% - 4% = 13%

σi = (Σ(Ki – K)2Pi).5

σi = ((40%-13%)2(.2) + (15%-13%)2 (.6) + (-20%-13%)2 (.2)).5 = 19.13%

Diff: 2

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

8.2 Systematic Risk and the Market Portfolio

1) The capital asset pricing model:

1. A) provides a risk-return trade-off in which risk is measured in terms of the market returns.
2. B) provides a risk-return trade-off in which risk is measured in terms of beta.
3. C) measures risk as the coefficient of variation between security and market rates of return.
4. D) depicts the total risk of a security.

Answer: B

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) The appropriate measure for risk according to the capital asset pricing model is:

1. A) the standard deviation of a firm's cash flows.
2. B) alpha.
3. C) beta.
4. D) probability of correlation.

Answer: C

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) You are considering investing in Ford Motor Company. Which of the following is an example of diversifiable risk?

1. A) Risk resulting from the possibility of a stock market crash
2. B) Risk resulting from uncertainty regarding a possible strike against Ford
3. C) Risk resulting from an expected recession
4. D) Risk resulting from interest rates decreasing

Answer: B

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) Sterling Incorporated has a beta of 1.0. If the expected return on the market is 12%, what is the expected return on Sterling Incorporated's stock?

1. A) 9%
2. B) 10%
3. C) 12%
4. D) Insufficient information is provided

Answer: C

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Which of the following has a beta of zero?

1. A) A risk-free asset
2. B) The market
3. C) A high-risk asset
4. D) Both A and B

Answer: A

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Beta is a statistical measure of:

1. A) hyperbolic.
2. B) total risk.
3. C) the standard deviation.
4. D) the relationship between an investment's returns and the market return.

Answer: D

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

7) A stock's beta is a measure of its:

1. A) systematic risk.
2. B) unsystematic risk.
3. C) company-specific risk.
4. D) diversifiable risk.

Answer: A

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) If you hold a portfolio made up of the following stocks:

Investment Value Beta

Stock A $2,000 1.5

Stock B $5,000 1.2

Stock C $3,000 .8

What is the beta of the portfolio?

1. A) 1.17
2. B) 1.14
3. C) 1.32
4. D) Can't be determined from information given

Answer: B

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) Changes in the general economy, such as changes in interest rates or tax laws, represent what type of risk?

1. A) Firm-specific risk
2. B) Market risk
3. C) Unsystematic risk
4. D) Diversifiable risk

Answer: B

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) A stock with a beta greater than 1.0 has returns that are ________ volatile than the market, and a stock with a beta of less than 1.0 exhibits returns which are ________ volatile than those of the market portfolio.

1. A) more, more
2. B) more, less
3. C) less, more
4. D) less, less

Answer: B

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) You hold a portfolio with the following securities:

Percent

Security of Portfolio Beta Return

X Corporation 20% 1.35 14%

Y Corporation 35% .95 10%

Z Corporation 45% .75 8%

Compute the expected return and beta for the portfolio.

10. A) 10.67%, 1.02
11. B) 9.9%, 1.02
12. C) 34.4%, .94
13. D) 9.9%, .94

Answer: D

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) The beta of ABC Co. stock is the slope of:

1. A) the security market line.
2. B) the characteristic line for a plot of returns on the S&P 500 versus returns on short-term Treasury bills.
3. C) the arbitrage pricing line.
4. D) the characteristic line for a plot of ABC Co. returns against the returns of the market portfolio for the same period.

Answer: D

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) You are thinking of adding one of two investments to an already well diversified portfolio.

Security A Security B

Expected return = 12% Expected return = 12%

Standard deviation of returns = 20.9% Standard deviation of returns = 10.1%

Beta = .8 Beta = 2

If you are a risk-averse investor:

1. A) security A is the better choice.
2. B) security B is the better choice.
3. C) either security would be acceptable.
4. D) cannot be determined with information given.

Answer: A

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) The market (systematic) risk associated with an individual stock is most closely identified with the:

1. A) variance of the returns of the stock.
2. B) variance of the returns of the market.
3. C) beta of the stock.
4. D) standard deviation of the stock.

Answer: C

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) Which of the following is NOT an example of systematic risk?

1. A) Inflation
2. B) Recession
3. C) Management risk
4. D) Interest rate risk

Answer: C

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: systematic risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) What type of risk can investors reduce through diversification?

1. A) All risk
2. B) Systematic risk only
3. C) Unsystematic risk only
4. D) Uncertainty

Answer: C

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: unique risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

17) Which of the following statements is true?

1. A) A stock with a beta of zero has a very low level of systematic risk.
2. B) A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.
3. C) A stock with a beta less than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.
4. D) A stock with a beta less than 1.0 has higher nondiversifiable risk than a stock with a beta of 1.0.

Answer: C

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) Currently, the expected return on the market is 12.5% and the required rate of return for Alpha, Inc. is 12.5%. Therefore, Alpha's beta must be:

1. A) less than 1.0.
2. B) greater than 1.0.
3. C) equal to 1.0.
4. D) unknown based on the information provided.

Answer: C

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

19) Investment risk is:

1. A) the probability of achieving a return that is greater than what was expected.
2. B) the probability of achieving a beta coefficient that is less than what was expected.
3. C) the probability of achieving a return that is less than what was expected.
4. D) the probability of achieving a standard deviation that is less than what was expected.

Answer: C

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

20) Which of the following statements is true?

1. A) Systematic, or market, risk can be reduced through diversification.
2. B) Both systematic and unsystematic risk can be reduced through diversification.
3. C) Unsystematic, or company, risk can be reduced through diversification.
4. D) Neither systematic nor unsystematic risk can be reduced through diversification.

Answer: C

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

21) Which of the following is a good measure of the relationship between an investment's returns and the market's returns?

1. A) The beta coefficient
2. B) The standard variation
3. C) The CPI
4. D) The S&P 500 Index

Answer: A

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

22) Which of the following is generally used to measure the market when calculating betas?

1. A) The Dow Jones Transportations
2. B) The Standard & Poors 500
3. C) The Value Line Quantam Index
4. D) The Lehman Brothers Bond Index

Answer: B

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

23) Your broker mailed you your year-end statement. You have $25,000 invested in Dow Chemical, $18,000 tied up in GM, $36,000 in Microsoft stock, and $11,000 in Nike. The betas for each of your stocks are 1.55 for Dow, 1.12 for GM, 2.39 for Microsoft, and .76 for Nike. What is the beta of your portfolio?

1. A) 1.46
2. B) 1.70
3. C) 2.60
4. D) 0.41

Answer: B

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: portfolio beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

24) You are considering a portfolio of three stocks with 30% of your money invested in company X, 45% of your money invested in company Y, and 25% of your money invested in company Z. If the betas for each stock are 1.22 for company X, 1.46 for company Y, and 1.03 for company Z, what is the portfolio beta?

1. A) 1.24
2. B) 1.00
3. C) 1.28
4. D) 1.33

Answer: C

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: portfolio beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

25) Beta is a measurement of the relationship between a security's returns and the general market's returns.

Answer: TRUE

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

26) Total risk equals unique security risk times systematic risk.

Answer: FALSE

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

27) The CAPM designates the risk-return tradeoff existing in the market, where risk is defined in terms of beta.

Answer: TRUE

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

28) The relevant risk to an investor is that portion of the variability of returns that cannot be diversified away.

Answer: FALSE

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

29) Stocks with higher betas are usually more stable than stocks with lower betas.

Answer: FALSE

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

30) A stock with a beta of 1.0 would earn the risk-free rate.

Answer: FALSE

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: market return

Principles: Principle 2: There Is a Risk-Return Tradeoff

31) Unsystematic risk can be eliminated through diversification.

Answer: TRUE

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: unique risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

32) Beta is a measure of systematic risk.

Answer: TRUE

Diff: 1

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

33) The market rewards assuming additional unsystematic risk with additional returns.

Answer: FALSE

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: unique risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

34) The market rewards assuming additional systematic risk with additional returns.

Answer: TRUE

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: systematic risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

35) Betas for individual stocks tend to be stable.

Answer: FALSE

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

36) A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.

Answer: FALSE

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

37) Briefly discuss why there is no reason to believe that the market will reward investors with additional returns for assuming unsystematic risk.

Answer: Through diversification, risk can be lowered without sacrificing returns. The market rewards investors for the systematic risk that cannot be eliminated through proper asset allocation in a diversified portfolio.

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

38) Provide an intuitive discussion of beta and its importance for measuring risk.

Answer: Beta is an important measure that indicates the systematic risk of a given investment. Since systematic risk cannot be diversified away, investors are compensated for taking this risk. Beta compares the market risk of a particular investment with the market risk of the market, and the risk premium necessary for a stock is directly proportional to the risk premium for the market as a whole. When the risk premium is added to the risk free rate, this results in the required return for the stock.

Diff: 2

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

39) The stock of the Preston Corporation is expected to pay a dividend of $6 during the coming year. Dividends are expected to grow far into the future at 8%. Investors have recently evaluated future market return variance to be 0.0016 and the covariance of returns for Preston and the market as 0.00352. Assuming a required market return of 14% and a risk-free rate of 6%, at what price should the stock of Preston sell?

Answer: Beta = 0.00352/0.0016 = 2.2

K = 0.06 + 2.2(0.14 - 0.06)

K = 0.236

P = $6/(0.236 - 0.08) = $6/0.156 = $38.46

Diff: 3

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

8.3 The Security Market Line and the CAPM

1) The risk-return relationship for each financial asset is shown on:

1. A) the capital market line.
2. B) the New York Stock Exchange market line.
3. C) the security market line.
4. D) none of the above.

Answer: C

Diff: 1

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) Siebling Manufacturing Company's common stock has a beta of .8. If the expected risk-free return is 7% and the market offers a premium of 8% over the risk-free rate, what is the expected return on Siebling's common stock?

7. A) 7.8%
8. B) 13.4%
9. C) 14.4%
10. D) 8.7%

Answer: B

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) Huit Industries' common stock has an expected return of 14.4% and a beta of 1.2. If the expected risk-free return is 8%, what is the expected return for the market (round your answer to the nearest .1%)?

7. A) 7.7%
8. B) 9.6%
9. C) 12.0%
10. D) 13.3%

Answer: D

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) Tanzlin Manufacturing's common stock has a beta of 1.5. If the expected risk-free return is 9% and the expected return on the market is 14%, what is the expected return on the stock?

13. A) 13.5%
14. B) 21.0%
15. C) 16.5%
16. D) 21.5%

Answer: C

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Given the capital asset pricing model, a security with a beta of 1.5 should return ________, if the risk-free rate is 6% and the market return is 11%.

13. A) 13.5%
14. B) 14.0%
15. C) 14.5%
16. D) 15.0%

Answer: A

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) The security market line (SML) relates risk to return, for a given set of market conditions. If expected inflation increases, which of the following would most likely occur?

1. A) The market risk premium would increase.
2. B) Beta would increase.
3. C) The slope of the SML would increase.
4. D) The SML line would shift up.

Answer: D

Diff: 3

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

7) The security market line (SML) relates risk to return, for a given set of market conditions. If risk aversion increases, which of the following would most likely occur?

1. A) The market risk premium would increase.
2. B) Beta would increase.
3. C) The slope of the SML would increase.
4. D) The SML line would shift up.

Answer: A

Diff: 3

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The return on the market portfolio is 13%, and the risk-free rate is 7%. According to CAPM, what is the risk premium on a stock with a beta of 1.0?

11. A) 11.75%
12. B) 18.75%
13. C) 6%
14. D) 13%

Answer: C

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) Bell Weather, Inc. has a beta of 1.25. The return on the market portfolio is 12.5%, and the risk-free rate is 5%. According to CAPM, what is the required return on this stock?

20. A) 20.62%
21. B) 9.37%
22. C) 14.37%
23. D) 15.62%

Answer: C

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) The rate on six-month T-bills is currently 5%. Andvark Company stock has a beta of 1.69 and a required rate of return of 15.4%. According to CAPM, determine the return on the market portfolio.

11. A) 11.15%
12. B) 6.15%
13. C) 17.07%
14. D) 14.11%

Answer: A

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) You are going to invest all of your funds in one of three projects with the following distribution of possible returns:

Project 1 Project 2

Standard Deviation 12% Standard Deviation 19.5%

Probability Return Probability Return

50% Chance 20% 30% Chance 30%

50% Chance -4% 40% Chance 10%

30% Chance -20%

Project 3

Standard Deviation 12%

Probability Return

10% Chance 30%

40% Chance 15%

40% Chance 10%

10% Chance -21%

If you are a risk-averse investor, which one should you choose?

1. A) Project 1
2. B) Project 2
3. C) Project 3

Answer: C

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) The return on the market portfolio is currently 13%. Battmobile Corporation stockholders require a rate of return of 21%, and the stock has a beta of 3.5. According to CAPM, determine the risk-free rate.

1. A) 7%
2. B) 14.7%
3. C) 9.8%
4. D) 24.2%

Answer: C

Diff: 3

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) Hefty stock has a beta of 1.2. If the risk-free rate is 7% and the market risk premium is 6.5%, what is the required rate of return on Hefty?

14. A) 14.8%
15. B) 14.4%
16. C) 12.4%
17. D) 13.5%

Answer: A

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) The market risk premium is measured by:

1. A) beta.
2. B) market return less risk-free rate.
3. C) T-bill rate.
4. D) standard deviation.

Answer: B

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) Marjen stock has a required return of 20%. The expected market return is 15%, and the beta of Marjen's stock is 1.5. Calculate the risk-free rate.

1. A) 4%
2. B) 5%
3. C) 6%
4. D) 7%

Answer: B

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) You are thinking about purchasing 1,000 shares of stock in the following firms: Number of Shares Firm's Beta

Firm A 100 0.75

Firm B 200 1.47

Firm C 200 0.82

Firm D 600 1.60

If you purchase the number of shares specified, then the beta of your portfolio will be:

1. A) 1.16.
2. B) 1.35.
3. C) 1.00.
4. D) .85.
5. E) Cannot be determined with information given.

Answer: E

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

Use the following information to answer the following question(s).

Beta

Market 1

Firm A 1.25

Firm B 0.6

Market Return 10% Risk Free Rate 2%

17) The market risk premium is:

1. A) 2%.
2. B) 4%.
3. C) 6%.
4. D) 8%.

Answer: D

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) Firm A's risk premium is:

1. A) 2%.
2. B) 4%.
3. C) 6%.
4. D) 8%.
5. E) 10%.

Answer: E

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

19) Firm B's risk premium is:

2. A) 2.66%.
3. B) 4.8%.
4. C) 6.3%.
5. D) 8.1%.

Answer: B

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

20) The required rate of return for Firm A is:

1. A) 4%.
2. B) 8%.
3. C) 12%.
4. D) 16%.
5. E) Cannot be determined with information given.

Answer: C

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

21) Calculate the current beta for Mercury, Inc. The rate on 30-year U.S. Treasury bonds is currently 8%. The market risk premium is 5%. Mercury returned 18% to its stockholders in the latest year.

1. A) 1.00
2. B) 1.75
3. C) 1.25
4. D) 2.00
5. E) 1.50

Answer: D

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

22) The rate of return on the S&P 500 is 16.2%. Epsilon has a beta of 1.85. If the T-bond rate is 5.9%, what should investors expect as a rate of return on Epsilon's stock?

16. A) 16.2%
17. B) 22.1%
18. C) 18.5%
19. D) 25.0%

Answer: D

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

23) Which of the following statements is true?

1. A) An average stock has a beta of 1.0.
2. B) A stock having a beta of greater than 1.0 is a higher-than-average-risk stock.
3. C) A stock having a beta of less than 1.0 is a lower-than-average-risk stock.
4. D) All of the above.
5. E) None of the above.

Answer: D

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

24) The risk-free rate is currently 6.5%. Acid Battery Company stockholders require a rate of return of 27.5%, and the stock has a beta of 2.1. What is the current market risk premium?

6. A) 6.90%
7. B) 21.00%
8. C) 13.65%
9. D) 10.00%

Answer: D

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

25) U.S. Treasury bonds currently yield 6%. Consolidated Industries stock has a beta of 1.5. The rate of return on the S&P 500 is presently 18%. What is the rate of return that Consolidated Industries stockholders require?

1. A) 6%
2. B) 24%
3. C) 18%
4. D) 27%

Answer: B

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

26) Amalgamated Aluminum stock has a beta of 1.2. Today's market risk premium is 13%. Amalgamated Aluminum stockholders require a rate of return of 22%. What is the present risk-free rate?

6. A) 6.40%
7. B) 22.00%
8. C) 4.60%
9. D) 15.60%

Answer: A

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

27) If investors expected inflation to increase in the future, what would happen to the security market line (SML)?

1. A) The slope of the SML would rise.
2. B) The SML would shift downward, but the slope would remain the same.
3. C) The slope of the SML would fall.
4. D) The SML would shift up, but the slope would remain the same.

Answer: D

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

28) What would happen if investors became more risk averse?

1. A) The slope of the SML would rise.
2. B) The SML would shift downward but the slope would remain the same.
3. C) The slope of the SML would fall.
4. D) The SML would shift downward and the slope of the SML would fall.

Answer: A

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

29) A security with a beta of zero has a required rate of return equal to the overall market rate of return.

Answer: FALSE

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

30) The return for the market during the next period is expected to be 16%; the risk-free rate is 10%. Calculate the required rate of return for a stock with a beta of 1.5.

Answer: K = 10% + 1.5(16% - 10%) = 19%

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

31) Asset A has a required return of 18% and a beta of 1.4. The expected market return is 14%. What is the risk-free rate? Plot the security market line.

Answer: K = Krf + (Km - Krf)b

18% = X + (14% - X)1.4

18% - X =19.6% - 1.4X

.4X = 1.6%

X = 4% = Risk - free Rate = Krf

Diff: 3

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

32) Security A has an expected rate of return of 22% and a beta of 2.5. Security B has a beta of 1.20. If the Treasury bill rate is 10%, what is the expected rate of return for security B?

Answer: RA = RF + BA(Rm - Rf)

.22 = .10 + 2.5 (Rm - .10)

.12 = 2.5 (Rm - .10) = 2.5 Rm - .25

.37 = 2.5 Rm

.148 = Rm

RB = Rf + BB(Rm - Rf)

RB = .10 + 1.20(.148 - .10)

RB = .1576

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

33) AA & Co. has a beta of .656. If the expected market return is 13.2% and the risk-free rate is 5.7%, what is the appropriate required return of AA & Co. using the CAPM model?

Answer: Required Rate of Return = Risk-Free Rate + (Market Return - Risk-Free Rate) × Beta = 5.7% + (13.2% - 5.7%) × 0.656 = 10.62%

Diff: 2

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

Financial Management: Principles and Applications, 11e (Titman)

Chapter 9 Debt Valuation and Interest Rates

9.1 Overview of Corporate Debt

1) The par value of a bond:

1. A) never equals its market value.
2. B) is determined by the investor.
3. C) generally is $1,000.
4. D) is never returned to the bondholder.

Answer: C

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

2) The interest on corporate bonds is typically paid:

1. A) semiannually.
2. B) annually.
3. C) quarterly.
4. D) monthly.

Answer: A

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

3) On any given day, a bond can be issued at:

1. A) a discount.
2. B) a premium.
3. C) par.
4. D) all of the above.

Answer: D

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

4) Mortgage bonds:

1. A) are a type of debenture.
2. B) are secured by a lien on real property.
3. C) usually pay little or no interest.
4. D) can only be issued by financial institutions.

Answer: B

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Bondholders have a priority claim on assets ahead of:

1. A) common stockholders.
2. B) preferred stockholders.
3. C) both A and B.
4. D) none of the above.

Answer: C

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Which type of value is shown on the firm's balance sheet?

1. A) Book value
2. B) Liquidation value
3. C) Market value
4. D) Intrinsic value

Answer: A

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: balance sheet

Principles: Principle 3: Cash Flows Are the Source of Value

7) Which of the following is generally NOT a characteristic of a bond?

1. A) Voting rights
2. B) Par value
3. C) Claims on assets and income
4. D) Indenture

Answer: A

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

8) Common indenture provisions include:

1. A) restrictions on the issuance of common stock dividends.
2. B) restrictions on the sale or purchase of fixed assets.
3. C) constraints on additional borrowing.
4. D) all of the above.

Answer: D

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) The issuance of bonds to raise capital for a corporation:

1. A) magnifies the returns to the stockholders.
2. B) increases risk to the stockholders.
3. C) is a cheaper form of capital than the issuance of common stock.
4. D) all of the above.
5. E) none of the above.

Answer: D

Diff: 2

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) A(n)________ is used to outline the issuing company's contractual obligations to bondholders.

1. A) mortgage
2. B) debenture
3. C) bond rating
4. D) indenture

Answer: D

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) Junk bonds:

1. A) are high yield bonds.
2. B) have higher default risk.
3. C) were used to finance "fallen angels."
4. D) all of the above.

Answer: D

Diff: 2

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) Which of the following investors incurs the least risk?

1. A) Bondholders
2. B) Preferred stockholders
3. C) Common stockholders
4. D) All of the above bear equal risk

Answer: A

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) The par value of a corporate bond indicates the level of interest payments that will be paid to investors.

Answer: FALSE

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: coupon rate

Principles: Principle 1: Money Has a Time Value

14) Any unsecured long-term debt instrument is a debenture.

Answer: TRUE

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) A mortgage bond is always secured by a lien on real property.

Answer: TRUE

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) The debenture is the legal agreement between the firm issuing a bond and the bond trustee who represents the bondholders.

Answer: FALSE

Diff: 1

Topic: 9.1 Overview of Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

9.2 Valuing Corporate Debt

1) The yield to maturity on a bond:

1. A) is fixed in the indenture.
2. B) is lower for higher-risk bonds.
3. C) is the required return on the bond.
4. D) is generally equal to the coupon interest rate.

Answer: C

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

2) All of the following affect the value of a bond EXCEPT:

1. A) investors' required rate of return.
2. B) the recorded value of the firm's assets.
3. C) the coupon rate of interest.
4. D) the maturity date of the bond.

Answer: B

Diff: 1

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

3) A $1,000 par value 10-year bond with a 10% coupon rate recently sold for $900. The yield to maturity:

1. A) is 10%.
2. B) is greater than 10%.
3. C) is less than 10%.
4. D) cannot be determined.

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

4) Sterling Corp. bonds pay 10% annual interest and are selling at 97. The market rate of interest:

1. A) is less than 10%.
2. B) is greater than 10%.
3. C) equals 10%.
4. D) cannot be determined.

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: market interest rate

Principles: Principle 1: Money Has a Time Value

5) The Blackburn Group has recently issued 20-year, unsecured bonds rated BB by Moody's. These bonds are:

1. A) low-risk bonds.
2. B) debentures.
3. C) premium bonds.
4. D) mortgage bonds.

Answer: B

Diff: 1

Topic: 9.2 Valuing Corporate Debt

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

6) Colby & Company bonds pay semiannual interest of $50. They mature in 15 years and have a par value of $1,000. The market rate of interest is 8%. The market value of Colby bonds is (round to the nearest dollar):

173. A) $1,173.
174. B) $743.
175. C) $1,000.
176. D) $827.

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

7) Caldwell, Inc. sold an issue of 30-year, $1,000 par value bonds to the public. The bonds carry a 10.85% coupon rate and pay interest semiannually. It is now 12 years later. The current market rate of interest on the Caldwell bonds is 8.45%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.

1. A) $751
2. B) $1,177
3. C) $1,220
4. D) $976

Answer: C

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

8) MI has a $1,000 par value, 30-year bond outstanding that was issued 20 years ago at an annual coupon rate of 10%, paid semiannually. Market interest rates on similar bonds are 7%. Calculate the bond's price.

956. A) $956.42
957. B) $1,000.00
958. C) $1,168.31
959. D) $1,213.19

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

9) Davis & Davis issued $1,000 par value bonds at 102. The bonds pay 12% interest annually and mature in 30 years. The market rate of interest is (round to the nearest hundredth of a percent):

12. A) 12.00%.
13. B) 11.76%.
14. C) 10.12%.
15. D) 11.29%.

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: market interest rate

Principles: Principle 1: Money Has a Time Value

10) What is the yield to maturity of a nine-year bond that pays a coupon rate of 20% per year, has a $1,000 par value, and is currently priced at $1,407? Round your answer to the nearest whole percent and assume annual coupon payments.

1. A) 5%
2. B) 14%
3. C) 12%
4. D) 11%

Answer: C

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

11) What is the expected rate of return on a bond that matures in seven years, has a par value of $1,000, a coupon rate of 14%, and is currently selling for $911? Round your answer to the nearest whole percent and assume annual coupon payments.

1. A) 13%
2. B) 14%
3. C) 15%
4. D) 16%

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

12) What is the expected rate of return on a bond that pays a coupon rate of 9%, has a par value of $1,000, matures in five years, and is currently selling for $714? Round your answer to the nearest whole percent and assume annual coupon payments.

1. A) 18%
2. B) 13%
3. C) 16%
4. D) 17%

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

13) What is the value of a bond that has a par value of $1,000, a coupon rate of $80 (annually), and matures in 11 years? Assume a required rate of return of 11%, and round your answer to the nearest $10.

1. A) $320
2. B) $500
3. C) $810
4. D) $790

Answer: C

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

14) What is the value of a bond that matures in three years, has an annual coupon payment of $110, and a par value of $1,000? Assume a required rate of return of 11%, and round your answer to the nearest $10.

1. A) $970
2. B) $1,330
3. C) $330
4. D) $1,000

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

15) Bond ratings are usually not affected by:

1. A) the company's fiscal year end.
2. B) profitable operations.
3. C) variability in earnings.
4. D) firm size.

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) The discount rate used to value a bond is:

1. A) the coupon interest rate.
2. B) determined by the issuing company.
3. C) fixed for the life of the bond.
4. D) the market rate of interest.

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

17) As interest rates, and consequently investors' required rates of return, change over time, the ________ of outstanding bonds will also change.

1. A) maturity date
2. B) coupon interest payment
3. C) par value
4. D) price

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

18) Zoro Sword Company bonds pay an annual coupon rate of 9 1/2%. They have eight years to maturity and face value, or par, of $1,000. Compute the value of Zoro bonds if investors' required rate of return is 10%.

516. A) $1,516.18
517. B) $973.33
518. C) $1,027.17
519. D) $950.00

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

19) Terminator Bug Company bonds have a 14% coupon rate. Interest is paid semiannually. The bonds have a par value of $1,000 and will mature 10 years from now. Compute the value of Terminator bonds if investors' required rate of return is 12%.

114. A) $1,114.70
115. B) $1,149.39
116. C) $894.06
117. D) $1,000.00

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

20) Brookline, Inc. just sold an issue of 30-year bonds for $1,107.20. Investors require a rate of return on these bonds of 7.75%. The bonds pay interest semiannually. What is the coupon rate of the bonds?

7. A) 7.750%
8. B) 11.072%
9. C) 9.375%
10. D) 8.675%

Answer: D

Diff: 3

Topic: 9.2 Valuing Corporate Debt

Keywords: coupon rate

Principles: Principle 1: Money Has a Time Value

21) Applebee sold an issue of 30-year, $1,000 par value bonds to the public. The coupon rate of 8.75% is payable annually. It is now five years later, and the current market rate of interest is 7.25%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.

1. A) $715
2. B) $1,171
3. C) $1,225
4. D) $697

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

22) Six years ago, Colt, Inc. sold an issue of 30-year, $1,000 par value bonds. The coupon rate of 5.25% is payable annually. Investors presently require a rate of return of 8.375%. What is the current market price (intrinsic value) of the bonds? Round off to the nearest $1.

1. A) $1,050
2. B) $932
3. C) $681
4. D) $1,111

Answer: C

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

23) Frazier Fudge has a $1,000 par value bond that is currently selling for $1,300. It has an annual coupon rate of 7%, paid semiannually, and has nine years remaining until maturity. What is the annual yield to maturity on the bond? (Round to the nearest whole percentage.)

1. A) 3%
2. B) 5%
3. C) 7%
4. D) 9%

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

24) You are considering the purchase of Hytec bonds that were issued 14 years ago. When the bonds were originally sold, they had a 30-year maturity and a 14.375% coupon interest rate that is payable semiannually. The bond is currently selling for $1,508.72. What is the yield to maturity on the bonds?

8. A) 8.50%
9. B) 14.38%
10. C) 11.11%
11. D) 7.67%

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

25) Aurand, Inc. has outstanding bonds with an 8% annual coupon rate paid semiannually. The bonds have a par value of $1,000, a current price of $904, and will mature in 14 years. What is the annual yield to maturity on the bond?

15. A) 15.80%
16. B) 10.47%
17. C) 9.24%
18. D) 7.90%
19. E) 4.62%

Answer: C

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

26) Marshall Manufacturing has a bond outstanding that was issued 20 years ago at a coupon rate of 9%. The $1,000 par value bond pays interest semiannually and was originally issued with a term of 30 years. If today's interest rate is 14%, what is the value of the bond today?

654. A) $654.98
655. B) $735.15
656. C) $814.42
657. D) $941.87

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

27) A $1,000 par value bond is currently listed as selling at 92 1/8. This means:

92. A) that you can buy the bond for $92.125.
93. B) that you can buy the bond for $921.25.
94. C) that if you purchase the bond today, you will receive $921.25 when the bond matures.
95. D) none of the above.

Answer: B

Diff: 1

Topic: 9.2 Valuing Corporate Debt

Keywords: bond pricing

Principles: Principle 4: Market Prices Reflect Information

28) You paid $865.50 for a corporate bond that has a 6.75% coupon rate. What is the bond's current yield?

8. A) 8.375%
9. B) 7.800%
10. C) 15.001%
11. D) 6.667%

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: current yield

Principles: Principle 1: Money Has a Time Value

29) A $1,000 par value bond with a 12% coupon rate currently selling for $825 has a current yield of:

14. A) 14.55%.
15. B) 12.44%.
16. C) 7.27%.
17. D) 5.61%.

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: current yield

Principles: Principle 1: Money Has a Time Value

30) Bond ratings are favorably affected by:

1. A) a greater reliance on equity in financing the firm.
2. B) high variability in past earnings.
3. C) large firm size.
4. D) both A and C.

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond rating

Principles: Principle 2: There Is a Risk-Return Tradeoff

31) Miller Motorworks has a $1,000 par value, 8% annual coupon bond with interest payable semiannually with a remaining term of 15 years. The annual market yield on similar bonds is 6%. What is the bond selling for today? (Round to the nearest whole dollar.)

1. A) $1,196
2. B) $1,042
3. C) $1,000
4. D) $946

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

32) Lambda Co. has bonds outstanding that mature in 10 years. The bonds have $1,000 par value, pay interest annually at a rate of 9%, and have a current selling price of $1,125. The yield to maturity on the bonds is:

7. A) 7.20%.
8. B) 9%.
9. C) 10.12%.
10. D) 14.40%.

Answer: A

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

33) Generic, Inc. has bonds outstanding that mature in 20 years. The bonds have $1,000 par value, pay interest annually at a rate of 10%, and have a current selling price of $875.25. The yield to maturity on the bonds is:

1. A) 10%.
2. B) 8.75%.
3. C) 11.63%.
4. D) 7.24%.

Answer: C

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

34) Beta, Inc. has bonds outstanding that mature in 10 years. The bonds have $1,000 par value and pay interest annually at a rate of 10%, which is also the current required rate of return on the bonds. The bonds' duration is:

10. A) 10.00.
11. B) 6.76.
12. C) 5.
13. D) unable to be determined based on the information given.

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

35) Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and a coupon interest rate of 8%, paid semiannually. If you require a 10% rate of return on this investment, what is the maximum price that you would be willing to pay for this bond?

1. A) $619
2. B) $674
3. C) $761
4. D) $828
5. E) $902

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

36) Assume that you wish to purchase a 30-year bond that has a maturity value of $1,000 and a coupon interest rate of 9.5%, paid semiannually. If you require a 6.75% rate of return on this investment, what is the maximum price that you should be willing to pay for this bond?

1. A) $1,111
2. B) $1,450
3. C) $1,352
4. D) $675
5. E) $1,000

Answer: C

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

37) Dry Seal plans to issue bonds to expand operations. The bonds will have a par value of $1,000, a 10-year maturity, and a coupon interest rate of 9%, paid semiannually. Current market conditions are such that the bonds will be sold to net $937.79. What is the yield-to-maturity of these bonds?

1. A) 11%
2. B) 10%
3. C) 9%
4. D) 8%
5. E) 7%

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

38) You purchased Photon, Inc. bonds exactly one year ago today for $875. During the latest year, you received $65 in interest on the bonds. What is your current yield on these bonds?

11. A) 11.3%
12. B) 7.4%
13. C) 6.5%
14. D) 10.5%
15. E) 9.1%

Answer: B

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: current yield

Principles: Principle 1: Money Has a Time Value

39) You purchased Gibraltar Corp. bonds exactly one year ago today for $1,075. During the latest year, you received $85 in interest on the bonds. What is your current yield on these bonds?

11. A) 11.3%
12. B) 8.5%
13. C) 6.5%
14. D) 7.9%
15. E) 9.1%

Answer: D

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: current yield

Principles: Principle 3: Cash Flows Are the Source of Value

40) The longer the time to maturity, the more sensitive a bond's price to changes in market interest rates.

Answer: TRUE

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

41) A bond's value equals the present value of interest and principal the owner will receive.

Answer: TRUE

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

42) The higher the bond rating, the more default risk associated with the bond.

Answer: FALSE

Diff: 1

Topic: 9.2 Valuing Corporate Debt

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

43) Bond ratings measure the interest rate risk of a given bond issue.

Answer: FALSE

Diff: 1

Topic: 9.2 Valuing Corporate Debt

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

44) When referring to bonds, expected rate of return and yield to maturity are often used interchangeably.

Answer: TRUE

Diff: 1

Topic: 9.2 Valuing Corporate Debt

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

45) Junk bonds are rated BB or higher.

Answer: FALSE

Diff: 1

Topic: 9.2 Valuing Corporate Debt

Keywords: bonds

Principles: Principle 2: There Is a Risk-Return Tradeoff

46) The current yield of a bond will equal its coupon rate when the bond is selling at par value.

Answer: TRUE

Diff: 3

Topic: 9.2 Valuing Corporate Debt

Keywords: current yield

Principles: Principle 1: Money Has a Time Value

47) The better the bond rating, the lower the rate of return demanded in the capital markets.

Answer: TRUE

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

48) The sensitivity of a bond's value to changing interest rates depends on both the bond's time to maturity and its pattern of cash flows.

Answer: TRUE

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

49) Compare and contrast current yield and yield to maturity.

Answer: The current yield is a measure of the one-year return on a bond if purchased today. The current yield is calculated by taking a bond's annual coupon payment and dividing by its market price. Yield to maturity measures the return on a bond if it is held to maturity. The yield to maturity is that discount rate that would make the present value of the expected future cash flows exactly equal to the market price at time of calculation. In an efficient market, the yield to maturity will reflect the market rate of interest and required return of bondholders.

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

50) BCD's $1,000 par value bonds currently sell for $798.50. The coupon rate is 10%, paid semiannually. If the bonds have five years before maturity, what is the yield to maturity or expected rate of return?

Answer: $1,000(PVIF)

By trial and error try 8%.

$798.50 = $50 × 6.710 + $1,000 × .463

$798.50 = $798.50

Yield to maturity = (.08)(2) = .16

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

51) If you are willing to pay $1,392.05 for a 15-year, $1,000 par value bond that pays 10% interest semiannually, what is your expected rate of return?

Answer: Try 3%.

$1,392.05 = $50 × 19.601 + $1,000 × 0.412

Required rate of return = (.03)(2) = .06

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

52) DAH, Inc. has issued a 12% bond that is to mature in nine years. The bond had a $1,000 par value, and interest is due to be paid semiannually. If your required rate of return is 10%, what price would you be willing to pay for the bond?

Answer: V = 60(11.69) + 1000(.416)

V = 701.40 + 416.00

V = 1,117.40

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

53) Calculate the value of a bond that is expected to mature in 13 years with a $1,000 face value. The interest coupon rate is 8%, and the required rate of return is 10%. Interest is paid annually.

Answer: 

V = PV of interest payments as an annuity + PV of maturity value.

V = 568.27 + 289.66

V = $857.93

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

54) The market price of a 20-year, $1,000 bond that pays 9% interest semiannually is $774.31. What is the bond's yield to maturity?

Answer: By trial and error, select 6% semi-annually (12% annually).

$774.31 = ($45 × 15.046) + ($1,000 × 0.097)

$774.31 = $774.07

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

55) Garvin, Inc.'s bonds have a par value of $1,000. The bonds pay semiannual interest of $40 and mature in five years.

1. How much would you pay for Garvin bonds if your required rate of return is 10%?
2. How much would you pay if your required rate of return is 8%?

Answer: 

7. po = (40 × 7.722) + (1,000 × 0.614)

po = 922.88

8. po = (40 × 8.111) + (1,000 × 0.676)

po = 1,000

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

56) Given the following information, determine the market value of EAO Company bonds.

Par value $1,000

Coupon rate 10%

Years to maturity 6

Market rate 8%

Interest paid semiannually

Answer:

 po = (50 × 9.375) + (1,000 × 0.625)

po = 1,093.75

Diff: 2

Topic: 9.2 Valuing Corporate Debt

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

9.3 Bond Valuation: Four Key Relationships

1) If the market price of a bond increases, then:

1. A) the yield to maturity decreases.
2. B) the coupon rate increases.
3. C) the yield to maturity increases.
4. D) none of the above.

Answer: A

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

2) If current market interest rates rise, what will happen to the value of outstanding bonds?

1. A) It will rise.
2. B) It will fall.
3. C) It will remain unchanged.
4. D) There is no connection between current market interest rates and the value of outstanding bonds.

Answer: B

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: interest rate risk

Principles: Principle 1: Money Has a Time Value

3) If current market interest rates fall, what will happen to the value of outstanding bonds?

1. A) It will rise.
2. B) It will fall.
3. C) It will remain unchanged.
4. D) There is no connection between current market interest rates and the value of outstanding bonds.

Answer: A

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: interest rate risk

Principles: Principle 1: Money Has a Time Value

4) Cassel Corp. bonds pay an annual coupon rate of 10%. If investors' required rate of return is now 8% on these bonds, they will be priced at:

1. A) par value.
2. B) a premium to par value.
3. C) a discount to par value.
4. D) cannot be determined from information given.

Answer: B

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

5) Which of the following statements is true?

1. A) A bond that has a rating of AA is considered to be a junk bond.
2. B) A bond will sell at a premium if the prevailing required rate of return is less than the bond's coupon rate.
3. C) A zero coupon is a bond that is secured by a lien on real property.
4. D) The legal document that describes all of the terms and conditions of a bond issue is called a debenture agreement.

Answer: B

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

6) Quirk Drugs sold an issue of 30-year, $1,000 par value bonds to the public that carry a 10.85% coupon rate, payable semiannually. It is now 10 years later, and the current market rate of interest is 9.00%. If interest rates remain at 9.00% until Quirk's bonds mature, what will happen to the value of the bonds over time?

1. A) The bonds will sell at a premium and decline in value until maturity.
2. B) The bonds will sell at a discount and rise in value until maturity.
3. C) The bonds will sell at a premium and rise in value until maturity.
4. D) The bonds will sell at a discount and fall in value until maturity.

Answer: A

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

7) Which of the following statements is true?

1. A) When investors' required rate of return equals the bond's coupon rate, then the market value of the bond may be selling at par value.
2. B) When investors' required rate of return exceeds the bond's coupon rate, then the market value of the bond will be greater than par value.
3. C) When investors' required rate of return is less than the bond's coupon rate, then market value of the bond will be greater than par value.
4. D) When investors' required rate of return is less than the bond's coupon rate, then the market value of the bond will be less than par value.

Answer: C

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

8) A bond with a face value of $1,000 has annual coupon payments of $100 and was issued seven years ago. The bond currently sells for a premium and has eight years left to maturity. This bond's ________ must be less than 10%.

1. A) yield to maturity
2. B) current yield
3. C) coupon rate
4. D) current yield and coupon rate
5. E) yield to maturity and current yield

Answer: E

Diff: 3

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: yield to maturity

Principles: Principle 1: Money Has a Time Value

9) A bond has a coupon rate of 10% and yield to maturity of 12%. Which of the following must be true?

1. A) The bond is selling at a discount.
2. B) The bond is selling at a premium.
3. C) The bond's current yield is less than the coupon rate.
4. D) Both A and C.
5. E) Both B and C.

Answer: A

Diff: 3

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

10) Which of the following statements about bonds is true?

1. A) Bond prices move in the same direction as market interest rates.
2. B) If market interest rates change, long-term bonds will fluctuate more in value than short-term bonds.
3. C) Long-term bonds are less risky than short-term bonds.
4. D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value.
5. E) None of the above.

Answer: B

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: interest rate risk

Principles: Principle 1: Money Has a Time Value

11) Which of the following statements about bonds is true?

1. A) As the maturity date of a bond approaches, the market value of a bond will become more volatile.
2. B) Long-term bonds have less interest rate risk than do short-term bonds.
3. C) Bond prices move in the same direction as market interest rates.
4. D) If market interest rates are above a bond's coupon interest rate, then the bond will sell below its par value.
5. E) None of the above.

Answer: D

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

12) Which of the following statements about bonds is true?

1. A) The market value of a bond moves in the opposite direction of market interest rates.
2. B) As the maturity date of a bond approaches, the market value of a bond will become more volatile.
3. C) Long-term bonds are less risky than short-term bonds.
4. D) If market interest rates are higher than a bond's coupon interest rate, then the bond will sell above its par value.
5. E) None of the above.

Answer: A

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

13) Which of the following statements is FALSE?

1. A) A debenture would usually be more risky than a mortgage bond that is issued by the same firm.
2. B) A bond will sell at a discount if the prevailing required rate of return is more than the bond's coupon rate.
3. C) A short-term bond will fluctuate less in value than a long-term bond if interest rates fluctuate.
4. D) Interest rates and bond prices usually move in the same direction.

Answer: D

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

14) Which of the following statements about bonds is true?

1. A) If market interest rates are below a bond's coupon interest rate, then the bond will sell above its par value.
2. B) Long-term bonds have less interest rate risk than do short-term bonds.
3. C) Bond prices move in the same direction as market interest rates.
4. D) As the maturity date of a bond approaches, the market value of a bond will become more volatile.
5. E) None of the above.

Answer: A

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

15) Bonds cannot be worth less than their book value.

Answer: FALSE

Diff: 1

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) So long as a bond sells for an amount above its par value, the coupon interest rate and yield to maturity remain equal.

Answer: FALSE

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

17) As market interest rates increase, bond prices decrease.

Answer: TRUE

Diff: 1

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) Bonds that sell at a discount have a coupon rate lower than the market interest rate.

Answer: TRUE

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: market interest rate

Principles: Principle 1: Money Has a Time Value

19) Bonds with a longer time to maturity have less interest rate risk.

Answer: FALSE

Diff: 1

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: interest rate risk

Principles: Principle 1: Money Has a Time Value

20) As investors' required rate of return on a bond increases, the value of the bond increases also.

Answer: FALSE

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

21) As the maturity date of a bond approaches, the bond's market value approaches its par value.

Answer: TRUE

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: time to maturity

Principles: Principle 1: Money Has a Time Value

22) Shorter-term bonds have greater interest rate risk than do longer-term bonds.

Answer: FALSE

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: interest rate risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

23) Why are longer-term bonds more sensitive to changes in interest rates than shorter-term bonds?

Answer: Longer-term bonds are more price-sensitive to changes in interest rates because there are more cash flows remaining whose values are affected by the change. Since shorter-term bonds have fewer cash flows remaining, price sensitivity to change in interest rates will be lower. In addition, as the bond gets closer to maturity, the present value of the maturity payment gets less and less volatile. Duration is a measure of how responsive a bond's price is to changing interest rates. Duration is higher for long-term bonds than for short-term bonds.

Diff: 2

Topic: 9.3 Bond Valuation: Four Key Relationships

Keywords: bond pricing relationships

Principles: Principle 1: Money Has a Time Value

9.4 Types of Bonds

1) Eurobonds are:

1. A) issued in a country different from the one in whose currency the bond is denominated.
2. B) issued only in Europe.
3. C) the European equivalent of a junk bond.
4. D) none of the above.

Answer: A

Diff: 1

Topic: 9.4 Types of Bonds

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

2) Which of the following statements about zero coupon bonds is FALSE?

1. A) When the bonds mature, the issuing firm is faced with a small cash outflow relative to the cash inflow the firm receives when the bonds are initially issued.
2. B) Zero coupon bonds are disadvantageous to the issuing firm if interest rates fall.
3. C) Yields tend to be bid down on zero coupon bonds due to investor demand for the bonds.
4. D) Zero coupon bonds provide a positive annual cash flow to the issuing firm over the life of the bonds.

Answer: A

Diff: 2

Topic: 9.4 Types of Bonds

Keywords: zero coupon bond

Principles: Principle 1: Money Has a Time Value

3) Eurobonds:

1. A) are registered with the SEC.
2. B) are frequently offered to U.S. citizens and residents during their initial distribution.
3. C) take relatively longer periods of time to issue.
4. D) have none of the above characteristics.

Answer: D

Diff: 1

Topic: 9.4 Types of Bonds

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

4) Which of the following bonds is sold by a corporation at a discount and pays no interest?

1. A) An indenture bond
2. B) A zero coupon bond
3. C) A junk bond
4. D) A eurobond

Answer: B

Diff: 1

Topic: 9.4 Types of Bonds

Keywords: zero coupon bond

Principles: Principle 1: Money Has a Time Value

5) Which of the following is an advantage of zero coupon bonds?

1. A) Small cash outflow at maturity
2. B) Lower yield due to low demand
3. C) Ability to deduct annual amortization of discount
4. D) Both A and C
5. E) All of the above

Answer: D

Diff: 2

Topic: 9.4 Types of Bonds

Keywords: zero coupon bond

Principles: Principle 1: Money Has a Time Value

6) Debentures are unsecured long-term debt.

Answer: TRUE

Diff: 1

Topic: 9.4 Types of Bonds

Keywords: debenture

Principles: Principle 1: Money Has a Time Value

7) Zero coupon bonds are disadvantageous to the issuing firm if interest rates fall.

Answer: TRUE

Diff: 2

Topic: 9.4 Types of Bonds

Keywords: bond valuation

Principles: Principle 1: Money Has a Time Value

8) Eurobonds are bonds issued in a country different from the one in whose currency the bond is denominated.

Answer: TRUE

Diff: 1

Topic: 9.4 Types of Bonds

Keywords: bonds

Principles: Principle 1: Money Has a Time Value

9) The duration of a zero coupon bond is the same as the bond's maturity.

Answer: TRUE

Diff: 2

Topic: 9.4 Types of Bonds

Keywords: zero coupon bond

Principles: Principle 1: Money Has a Time Value

FIN 100 Principles of Finance Part 1

FIN 100 Principles of Finance Part 2

FIN 100 Principles of Finance Part 3

FIN 100 Principles of Finance Part 4