Final Finance Class

1)Other things held constant, the value of an option depends on the stock’s price, the risk-free rate, and the

a. Strike price.

b. Variability of the stock price.

c. Option’s time to maturity.

d. All of these.

e. None of these.

2) Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet?

a. The company issues new common stock.

b. The company pays a dividend.

c. The company gives customers more time to pay their bills.

d. The company repurchases common stock.

e. The company purchases a new piece of equipment.

3) Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at a higher price.

Which of the following statements is CORRECT?

a. Company E trades at a higher P/E ratio.

b. Company E must have a higher market-to-book ratio.

c. Company E must pay a lower dividend.

d. Company E is probably judged by investors to be riskier.

e. Company E probably has fewer growth opportunities.

4)

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

a. Adding more such stocks will increase the portfolio’s expected rate of return.

b. Adding more such stocks will reduce the portfolio’s beta coefficient and thus its systematic risk.

c. Adding more such stocks will reduce the portfolio’s market risk but not its unsystematic risk.

d. Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.

e. Adding more such stocks will have no effect on the portfolio’s risk.

5)Which of the following statements is CORRECT?

a. Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.

b. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

c. Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.

d. If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.

e. Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.

6)Which of the following statements is CORRECT?

a. Long-term bonds have less interest rate price risk but more reinvestment rate risk than short-term bonds.

b. One advantage of a zero coupon Treasury bond is that no one who owns the bond has to pay any taxes on it until it matures or is sold.

c. Relative to a coupon-bearing bond with the same maturity, a zero coupon bond has more interest rate price risk but less reinvestment rate risk.

d. Long-term bonds have less interest rate price risk and also less reinvestment rate risk than short-term bonds.

e. If interest rates increase, all bond prices will increase, but the increase will be greater for bonds that have less interest rate risk.

7)Which of the following statements is CORRECT?

a. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss.

b. The yield to maturity for a coupon bond that sells at a premium consists entirely of a positive capital gains yield; it has a zero current interest yield.

c. Rising inflation makes the actual yield to maturity on a bond greater than a quoted yield to maturity that is based on market prices.

d. The yield to maturity on a coupon bond that sells at its par value consists entirely of a current interest yield; it has a zero expected capital gains yield.

e. The market value of a bond will always approach its par value as its maturity date approaches. This holds true even if the firm has filed for bankruptcy.

8)Which of the following statements is CORRECT?

a. A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.

b. Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.

c. Corporations cannot buy the preferred stocks of other corporations.

d. The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock.

e. Preferred dividends are not generally cumulative.

9)Which of the following statements is CORRECT?

a. Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States.

b. Hedge funds have more in common with commercial banks than with any other type of financial institution.

c. The justification for the “light” regulation of hedge funds is that only “sophisticated” investors with high net worths and high incomes are permitted to invest in these funds, and such investors supposedly can do the necessary “due diligence” on their own rather than have it done by the SEC or some other regulator.

d. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia.

e. Hedge funds have more in common with investment banks than with any other type of financial institution.

10)

Which of the following statements is CORRECT?

a. Typically, a firm’s DPS should exceed its EPS.

b. If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.

c. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.

d. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.

e. Typically, a firm’s EBIT should exceed its EBITDA.

11)

Which of the following statements is CORRECT?

a. The IPO market is a subset of the secondary market.

b. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

c. If you purchased 100 shares of Disney stock from your brother-in-law, this would be an example of a primary market transaction.

d. Only institutions, and not individuals, can participate in derivatives market transactions.

e. If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction.

12)

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

a. Making the bond a first mortgage bond rather than a debenture.

b. The rating agencies change the bond’s rating from Baa to Aaa.

c. Adding a call provision.

d. Adding a sinking fund.

e. Adding additional restrictive covenants that limit management’s actions.

13)

Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)

a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.

b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.

c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.

d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.

e. The outstanding balance declines at a slower rate in the later years of the loan’s life.

14)

A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?

a. Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

b. Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.

c. Use cash to increase inventory holdings.

d. Use cash to repurchase some of the company’s own stock.

e. Reduce the company’s days’ sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.

  

1) Assume that the risk-free rate is 4.5% and that the expected return on the market is 12%. What is the required rate of return on a stock that has a beta of 0.4?

2) Needham Pharmaceuticals has a profit margin of 3% and an equity multiplier of 1.5. Its sales are $110 million and it has total assets of $58 million. What is its ROE? Round your answer to two decimal places.

3)Assume you are given the following relationships for the Clayton Corporation:

2%

5%

Sales/total assets	1.8
Return on assets (ROA)
Return on equity (ROE)

1. Calculate Clayton’s profit margin. Round your answer to two decimal places.
2. Calculate Clayton’s debt ratio. Round your answer to two decimal places.

4) Pearson Brothers recently reported an EBITDA of $6.5 million and net income of $1.95 million. It had $2.275 million of interest expense, and its corporate tax rate was 35%. What was its charge for depreciation and amortization?

5) Suppose you hold a diversified portfolio consisting of a $7,500 investment in each of 20 different common stocks. The portfolio’s beta is 2.15. Now, suppose you sell one of the stocks with a beta of 1.0 for $7,500 and use the proceeds to buy another stock whose beta is 1.95. Calculate your portfolio’s new beta. Round your answer to two decimal places.

6) What will be the nominal rate of return on a perpetual preferred stock with a $100 par value, a stated dividend of 7% of par, and a current market price of (a) $52, (b) $87, (c) $100, and (d) $136? Round the answers to two decimal places.

7) Thress Industries just paid a dividend of $4.00 a share (i.e., D0 = 4.00). The dividend is expected to grow 5% a year for the next 3 years and then at 14% a year thereafter. What is the expected dividend per share for each of the next 5 years? Round your answers to the nearest cent.

A) D1 =

B) D2 =

C) D3 =

D) D4 =

E) D5 =

8) The Moore Corporation had operating income (EBIT) of $300,000. The company’s depreciation expense is $90,000. Moore is 100% equity financed, and it faces a 40% tax rate.

a) What is the company’s net income?

b) What is its net cash flow?

9) You just purchased a bond that matures in 5 years. The bond has a face value of $1,000 and has an 8% annual coupon. The bond has a current yield of 8.21%. What is the bond’s yield to maturity? Round your answer to two decimal places.

10) While Mary Corens was a student at the University of Tennessee, she borrowed $12,000 in student loans at an annual interest rate of 8.30%. If Mary repays $1,500 per year, how long (to the nearest year) will it take her to repay the loan?

11) Assume that the average firm in your company’s industry is expected to grow at a constant rate of 7% and that its dividend yield is 8%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R&D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [D1 = D0(1 + g) = D0(1.50)] this year and 30% the following year, after which growth should return to the 7% industry average. If the last dividend paid (D0) was $2.25, what is the value per share of your firm’s stock? Round your answer to the nearest cent. Do not round your intermediate computations.

12) Wilson Wonders’s bonds have 10 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 7%. The bonds sell at a price of $985. What is their yield to maturity? Round your answer to two decimal places.

13) What is the present value of a security that will pay $20,000 in 20 years if securities of equal risk pay 5.2% annually? Round your answer to the nearest cent.

14) You have a $2 million portfolio consisting of a $100,000 investment in each of 20 different stocks. The portfolio has a beta of 1.15. You are considering selling $100,000 worth of one stock with a beta of 1.10 and using the proceeds to purchase another stock with a beta of 1.45. What will the portfolio’s new beta be after these transactions? Round your answer to two decimal places.

15) The current price of a stock is $34, and the annual risk-free rate is 4%. A call option with a strike price of $32 and 1 year until expiration has a current value of $5.80. What is the value of a put option written on the stock with the same exercise price and expiration date as the call option? Round your answer to the nearest cent.

16) Find the present value of $400 due in the future under each of the following conditions. Round your answers to the nearest cent.

A) 4% nominal rate, semiannual compounding, discounted back 5 years

B) 4% nominal rate, quarterly compounding, discounted back 5 years

C) 4% nominal rate, monthly compounding, discounted back 5 years

17) Washington-Pacific invests $2 million to buy a tract of land and plant some young pine trees. The trees can be harvested in 13 years, at which time W-P plans to sell the forest at an expected price of $4 million. What is W-P’s expected rate of return? Round your answer to two decimal places.

18) A Treasury bond that matures in 10 years has a yield of 4%. A 10-year corporate bond has a yield of 10%. Assume that the liquidity premium on the corporate bond is 0.3%. What is the default risk premium on the corporate bond? Round your answer to two decimal places.