Risk And Profit

Chapter 4: The Valuation of Long-Term Securities

1. What is the market value of a $1,000 face-value bond with a 10 percent coupon rate when the market's rate of return is 9 percent? Answer: More than its face value.

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2. If an investor may have to sell a bond prior to maturity and interest rates have risen since the bond was purchased, the investor is exposed to __________.  Answer: interest rate risk
3. Beta Budget Brooms will pay a big $2 dividend next year on its common stock, which is currently selling at $50 per share. What is the market's required return on this investment if the dividend is expected to grow at 5% forever? Answer: 9%
4. If a coupon bond sells at a large discount from par, then which of the following relationships holds true? (P0 > represents the price of a bond and YTM is the bond's yield to maturity. ) Answer: P0; par and YTM; the coupon rate.
5. Market interest rates and the prices of bonds in the secondary market: Answer: generally move in opposite directions.
6. A $250 face value share of preferred stock pays a $20 annual dividend and investors require a 7% return on this investment. If the security is currently selling for $276, what is the difference (overvaluation) between its intrinsic and market value (rounded to the nearest whole dollar)? Answer: Approximately $10.
7. Which of the following accurately describes the behavior of bond prices? Answer: If interest rates rise so that the market required rate of return increases, the bond's price will fall.

Chapter 5: Risk and Return

1. The firm of Sun and Moon purchased a share of Acme. com common stock exactly one year ago for $45. During the past year, the common stock paid an annual dividend of $2. 40. The firm sold the security today for $85. What is the rate of return the firm has earned? Answer: 94. 2%. Return is over the two-year period and includes both dividends and capital gains.  Return = [($2. 0) + ($85 - $45)] / $45 = 94. 2%.
2. The ratio of the standard deviation of a distribution to the mean of that distribution is referred to as __________. Answer: coefficient of variation.
3. Clive Rodney Megabucks offers friend, Melanie, an interesting gamble involving giving her the choice of the contents in one of two sealed, identical-looking boxes. One box has $20,000 in cash and the second has nothing inside. There is an equal probability that the chosen box contains cash versus nothing. Melanie states that she would not call off the gamble if you offered her a certain $10,999 instead of her choice of box. However, she would be indifferent if $11,000 was offered in place of the risky gamble; and she would definitely take $11,001 to call off the gamble. We would describe Melanie as __________ in this instance. Answer: having a risk preference.
4. Which of the following portfolio statistics statements is correct? Answer: A portfolio's expected return is a simple weighted average of expected returns of the individual securities comprising the portfolio.
5.  __________ is the variability of return on stocks or portfolios not explained by general market movements. It is avoidable through diversification. Answer: Unsystematic risk
6. What is the beta for average risk security? What is the beta for a Treasury bill? Answer:1; 0.

Chapter 20: Long-Term Debt, Preferred Stock, and Common Stock

1. The sinking fund retirement of a bond issue takes __________. Answer: two forms -- (1) the corporation purchases bonds in the open market and delivers a given number of bonds to the trustee; or (2) the corporation pays cash to the trustee, who in turn calls the bonds for redemption.
2. A proposed project has normal cash flows. In other words, there is an up-front cost followed over time by a series of positive cash flows.
3. The project’s internal rate of return is 12 percent and its WACC is 10 percent. Which of the following statements is most correct? Answer: The project’s MIRR is greater than 10 percent but less than 12 percent. (In actual exam question, you have to solve and get the answer).
4. Project S costs $15,000 and is expected to produce cash flows of $4,500 per year for 5 years. Project L costs $37,500 and is expected to produce cash flows of $11,100 per year for 5 years. Calculate the two projects’ NPVs, IRRs, and MIRR assuming a cost of capital of 14%. 3 questions. NPV IRR MIRR.

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