Section 1 True/False
1) Before it matures, the price of any bond is always less than its face value.
A. True
B. False
2) A bond will trade at a discount if its coupon rate is less than its yield to maturity.
A. True
B. False
3) If you value a stock using a range of stock valuation methods and these valuations indicate a stock price that is greater than its actual market price, it is most likely that the stock is under-valued.
A. True
B. False
4) Stocks have both diversifiable risk and undiversifiable risk, but only diversifiable risk is rewarded with higher expected returns.
A. True
B. False
5) When we combine stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks face common risks and move together.
A. True
B. False
Section 2 Multiple Choice Questions
Please select the best answer for each question.
1. Which of the following would be best considered to be an agency conflict problem in the behavior of the following financial managers?
A) Bill chooses to pursue a risky investment for the company's funds because his compensation will substantially rise if it succeeds.
B) Sue instructs her staff to skip safety inspections in one of the company's factories, knowing that it will likely fail the inspection and incur significant costs to fix.
C) James ignores an opportunity for his company to invest in a new drug to fight Alzheimer's disease, judging the drug's chances of succeeding as low.
D) Michael chooses to enhance his firm's reputation at some cost to its shareholders by sponsoring a team of athletes for the Olympics.
2) Which of the following statements regarding bonds and their terms is FALSE?
A) The internal rate of return (IRR) of an investment in a zero-coupon bond is the rate of return that investors will earn on their money if they buy a default-free bond at its current price and hold it to maturity.
B) The yield to maturity of a bond is the discount rate that sets the future value (FV) of the promised bond payments equal to the current market price of the bond.
C) Financial professionals also use the term spot interest rates to refer to the default-free zero-coupon yields.
D) When we calculate a bond's yield to maturity by solving the formula,
Price of an n-period bond = + + ... + ,
the yield we compute will be a rate per coupon interval.
3) The Sisyphean Company has a bond outstanding with a face value of $1000 that reaches maturity in 5 years. The bond certificate indicates that the stated coupon rate for this bond is 8.1% and that the coupon payments are to be made semiannually.
Assuming the appropriate YTM on the Sisyphean bond is 10.6%, then this bond will trade at ________.
A) a premium
B) a discount
C) par
D) none of the above
4) A $1000 bond with a coupon rate of 6.2% paid semiannually has eight years to maturity and a yield to maturity of 8.3%. If interest rates rise and the yield to maturity increases to 8.6%, what will happen to the price of the bond?
A) The price of the bond will fall by $18.93.
B) The price of the bond will fall by $15.78.
C) The price of the bond will rise by $15.78.
D) The price of the bond will not change.
5) On a particular date, FedEx has a stock price of $89.27 and an EPS of $7.11. Its competitor, UPS, had an EPS of $0.38. What would be the expected price of UPS stock on this date, if estimated using the method of comparables?
A) $4.77
B) $7.16
C) $9.54
D) $10.50
6) The above screen shot from Google Finance shows basic stock information for PepsiCo. If you owned of PepsiCo for the period shown, how much would you have earned in dividend payments?
A) $480.00
B) $658.44
C) $584.80
D) $688.00
7) You expect KT industries (KTI) will have earnings per share of $5 this year and expect that they will pay out $1.25 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 13% and their equity cost of capital is 15%. The expected growth rate for KTI's dividends is closest to ________.
A) 11.3%
B) 9.8%
C) 5.9%
D) 3.9%
8) Which of the following statements is FALSE?
A) A firm's weighted average cost of capital, denoted rwacc, is the cost of capital that reflects the risk of the overall business, which is the combined risk of the firm's equity and debt.
B) Intuitively, the difference between the discounted free cash flow model and the dividend-discount model is that in the divided-discount model, a firm's cash and debt are included indirectly through the effect of interest income and expenses on earnings in the dividend-discount model.
C) We interpret rwacc as the expected return a firm must pay to investors to compensate them for the risk of holding the firm's debt and equity together.
D) When using the discounted free cash flow model, we should use a firm's equity cost of capital.
9) Which of the following statements is FALSE?
A) Stock returns will tend to move together if they are affected similarly by economic events.
B) Stocks in the same industry tend to have more highly correlated returns than stocks in different industries.
C) Almost all of the correlations between stocks are negative, illustrating the general tendency of stocks to move together.
D) With a positive amount invested in each stock, the more the stocks move together and the higher their covariance or correlation, the more volatile the portfolio will be.
10) Assume General Motors has a weighted average cost of capital of 9%. GM is considering investing in a new plant that will save the company $20 million over each of the first two years, and then $10 million each year thereafter. If the investment is $100 million, what is the net present value (NPV) of the project?
A) $25.8 million
B) $31.6 million
C) $28.7 million
D) $27.3 million