Finance 3100- Professor Friis Test #2- Chpt. 5, 6, 7, 8

1. How much money will you have in the bank at the end of a five-year period if you invest $1,000 at 10% if you are accumulating simple interest? $1500
2. How much money will you have in the bank at the end of a five-year period if you invest $100 at 6% compounded annually? $133.82
3. When determining the present value of $100 you would receive in one year, which of the following would you use?a. Future Valueb. Discount Ratec. Compound Rated. None of the above b. Discount Rate
4. What is the compounding period rate if one were to invest $5,000 for 3 years at an interest rate of 7% compounded semiannually? 3.5%
T/F An annuity is an equal amount of payments due to or from you. True
Which of the following statements is FALSE? a. Time lines can show cash flows that occur over years, quarters, or any other periods. b. Cash flows do not have to occur for every period shown on the time line. A lump sum cash flow can be depicted as easily as annuities on a time line. c. Time lines put verbal information into a diagram that is useful for seeing the cash flows that occur, when they occur, and the interest rate used in the analysis. d. The FV as shown on a time line is always the cash flow at Time = 1. e. Time lines typically show dollars below the line and years above the line. d. The FV as shown on a time line is always the cash flow at Time = 1.
A certificate of deposit has a cost of $2,000, three years to maturity, no cash flows until maturity, and an interest rate of 5%. Which of these time lines is correct? a. PV=? FV= 2000 b. PV= 2000 FV= ? b. PV= 2000 FV= ?
A lender should prefer to lend at a rate of 10% with semiannual compounding, but a borrower would prefer a loan with a rate of 10%, annual compounding. True or false? a. True b. False a. True
Under an amortized loan, the periodic payments are all equal. However, the fraction of the payment that represents interest declines over time. True or false? a. True b. False a. True
Which of the following statements is TRUE? a. A deposit will grow faster if simple interest rather than compound interest is paid. b. It would be better to both lend and borrow money at a rate of 6%, simple interest, rather than at a rate of 6%, compound interest. c. Compound interest means that interest in future periods is earned on the interest earned in the past, whereas under simple interest, interest is earned only on the original investment. c. Compound interest means that interest in future periods is earned on the interest earned in the past, whereas under simple interest, interest is earned only on the original investment.
Is this statement true or false? A rational person should choose to receive cash flows from an annuity due of $1,000 per year rather than from a similar ordinary annuity. a. True b. False a. True
Is this statement true or false? If one set up time lines for an ordinary annuity of $1,000 per year for 3 years and a 3-year, $1,000 annuity due, the primary difference between the two time lines is that the $1,000 payments for the annuity due would begin at t = 0 and end at t = 2, whereas the ordinary annuity’s payments would begin at t = 1 and end at t = 3. a. True b. False a. True
Is this statement true or false? If you calculated the value of an ordinary annuity, you could find the value of the corresponding annuity due by multiplying the FV of the ordinary annuity by (1 + I), because this would take into account that each annuity due payment occurs one year earlier. a. True b. False a. True
What are the two items whose sum is the cost of equity?a. Inflation and dividends b. Interest and capital gains c. Dividends and capital gains d. Dividends and interest e. Interest and inflation Dividends and capital gains
An increase in either risk or inflation would likely lead to which of the following results?a. Lower interest rates. b. Unlikely to affect the level of interest rates. c. Higher interest rates Higher Interest Rates
If inflation during the last 12 months was 3% and the interest rate during that period was 5%, what was the real rate of interest?a. 2% b. 3% c. 4% d. 1% e. 5% 2%
Which of the following is most likely to occur during a recession?a. The demand for funds declines, leading to higher interest rates. b. The demand for funds increases, leading to higher interest rates. c. The demand for funds increases, leading to lower interest rates. d. The demand for funds declines, leading to lower interest rates. The demand for funds declines, leading to lower interest rates.
A positive maturity risk premium has the effect of raising interest rates on long-term bonds relative to those of short-term bonds. True or false? True
Assume that the real risk-free rate is r* = 2.5% and the average expected inflation rate is 3% for each future year. The DRP and LP for Bond X are 1% each, and the applicable MRP is 1.5%. What is Bond X’s interest rate?a. 4.5% b. 7.5% c. 10.5% d. 6.0% e. 9.0% 9.0%
If the inflation rate is expected to remain constant at the current level in the future, say 3%, which of the following best describes the shape of the yield curve? Consider all factors that affect the yield curve, not just inflation.a. The Treasury yield curve would be downward sloping, as this is the normal shape of the Treasury yield curve. b. Because the expectation of future inflation is expected to remain constant, the shape of the Treasury yield curve would be horizontal. c. Because of the existence of a positive maturity risk premium, and even though the inflation rate is expected to remain constant, the shape of the Treasury yield curve would be upward sloping. c. Because of the existence of a positive maturity risk premium, and even though the inflation rate is expected to remain constant, the shape of the Treasury yield curve would be upward sloping.
Which of the following is likely to lead to lower interest rates on U.S. securities? a. The federal government announces a larger than expected budget deficit. b. The expected trade deficit is increased. c. The Federal Reserve tightens the money supply. d. A slowdown occurs in the U.S. economy, which reduces corporate borrowing. d. A slowdown occurs in the U.S. economy, which reduces corporate borrowing.
The optimal financial policy often depends on the nature of the firm’s assets. For example, a firm with highly liquid assets would be more likely to use a greater percentage of short-term debt than a firm whose assets are illiquid. True or false? True
Foreign bonds are issued by a foreign government or a foreign corporation. An additional risk exists when bonds are denominated in a currency other than that of the investor’s home currency. True or false? True
The interest paid on a municipal bond, otherwise known as a muni, is generally exempt from federal income taxes. Therefore, the coupon rate on these bonds is considerably lower than a corporate bond of equivalent risk. True or false? True
A 20-year bond with a 6% coupon rate can have a par value of any amount that is a multiple of $1,000. The issuer will make payments of 6% of the par value each year, generally with one-half of the annual amount paid each 6 months. Bonds may include a sinking fund, which means that some of the bonds must be paid off each year rather than at maturity. Also, many bonds include a call provision, which gives the issuer the right to pay off the bonds prior to their stated maturity. True or false? True
Select one of the choices below that best completes the following sentence: If an investor sold long-term bonds and used the proceeds to purchase short-term bonds, this would increase the investor’s exposure to ________ risk and decrease the investor’s exposure to ________ risk.a. price; default b. reinvestment; price c. default; reinvestment d. price; reinvestment e. liquidity; reinvestment b. Reinvestment; price
Which of the following statements is correct?a. If you need a specific amount of money at a specific future date, you should be concerned about price risk, but you do not need to be concerned about reinvestment risk. b. Other things held constant, a 10-year bond has more reinvestment risk than a 30-year bond. c. If you need a specific amount of money at a specific future date, you could invest in a number of different kinds of bonds, but the one type of bond that you should avoid is a zero coupon bond, because such bonds do not pay any interest. b. Other things held constant, a 10-year bond has more reinvestment risk than a 30-year bond.
Butcher Company plans to issue bonds to raise $10 million to finance expansion. It could use 10-year mortgage bonds backed by the firm’s fixed assets, 10-year debentures that are not backed by any specific assets but are backed by the firm’s general earning power, or 10-year subordinated debentures that would be subordinated to all of the firm’s other debt. If it uses mortgage bonds, they would be rated A by Moody’s and S&P, and their market interest rate would be 7.5%. Given this information, which of the following statements is most correct?a. The subordinated debentures would be rated highest, probably AA. b. Since bond ratings are highly subjective, information about the rating and interest rate on the A-rated bond tells us nothing about how the two types of debentures would be rated, or about their likely interest rates. c. Given the 7.5% interest rate on the mortgage bonds, the plain debentures might carry an interest rate of 8.0% and the subordinated debentures a rate of 8.5%. d. The debentures would be rated highest, probably AA. e. Given the 7.5% interest rate on the mortgage bonds, the subordinated debentures might carry an interest rate of 8.0% and the plain debentures a rate of 8.5%. c. Given the 7.5% interest rate on the mortgage bonds, the plain debentures might carry an interest rate of 8.0% and the subordinated debentures a rate of 8.5%.
Two key sections of the Bankruptcy Act are Chapter 7, which relates to liquidating firms and allocating the proceeds among its creditors, and Chapter 11, which deals with reorganizing businesses that are thought to be worth more as operating enterprises than they would bring in from liquidation of firms’ assets. Troubled firms’ managements generally try to reorganize, but if no feasible reorganization plan can be developed, then the bankruptcy judge will order liquidation. True or false? True
Is the following statement true or false? There is a fundamental trade-off between risk and return: to entice investors to take on more risk, you have to provide them with higher expected returns. True
The probability distribution for a stock would list the stock’s set of possible returns and the probability of each return. We could use this data to find both the stock’s expected rate of return and the standard deviation of that return, which is one measure of risk. True or false? True
If two assets are perfectly positively correlated, then their returns will move up and down exactly in sync with one another. True or false? True
If two assets are held in a portfolio, the assets will generally be less risky than if they were held in isolation. True or false? True
The higher the positive correlation between two assets’ returns, the greater is the risk reduction from holding them in a portfolio. True or false? False
Suppose the standard deviation of expected returns for a given corporate project is quite high, and the project’s returns are also highly correlated with returns on the firm’s other assets. This suggests that the project is quite risky. However, if the project is not perfectly positively correlated with returns on other stocks in the market, then the project’s true risk to stockholders might not be very large. True or false? True
In response to concerns about the CAPM’s validity, some researchers have developed models that include more explanatory variables than just beta. While these models are promising, the basic CAPM is still the most widely used method for estimating required rates of returns on stocks. True or false? True
If all investors were completely indifferent to risk, i.e., if they had no aversion to risk at all, then the SML would plot as a horizontal line. True or false? True
People differ with regard to their willingness to bear risks. However, if two stocks have the same expected rate of return, then most individuals would prefer the less risky to the more risky stock. This is called risk aversion. True or false? True
Most bonds are owned by and traded among large financial institutions, and it is relatively easy for bond dealers to arrange the transfer of large blocks of bonds among the millions of large and small bondholders on the exchanges rather than the over-the counter market. True or false? False
True/False Risk can be evaluated and even attractive if an investor perceives a higher than normal return. True
True/False Stand-Alone Risk is the risk of a stock if it is held by an investor who holds a pool of stocks. False
True/False The tighter the probability distribution of expected future returns the smaller the risk of a given investment. True
True/False Historical stock data is used to predict future risk. True
True/False The Capital Asset Pricing Model indicates is a stock value equal to the risk-free rate of return plus a premium. True
True/False Diversifiable risk is risk mitigated through the acquisition of many stocks. True
True/False Market risk is the risk relevant to stock market activities. True
True/False Beta measures an individual stock’s sensitivity to the movement of the stock market as a whole. True
True/False A Putable Bond converts to equity when put back to the issuer. False
True/False A Zero Coupon Bond allows an investor to buy the Par Value of the bond at a discount. True
True/False A Bond is an equity instrument. False
True/False A Performance Bond generates income from which to pay the bond holder. True
True/False A Bond is attractive to investors because it generates a fixed interest only that is investor attractive. False
True/False A Call provision allows the bond issuer to pay the bond before the maturity date. True
True/False Corporate Bonds are equally safe investments as municipals bonds. False
True/False A Coupon Payment is the period of time when payments are made. False
True/False A Treasury Bond is issued by state governments. False
True/False A Bond has a risk as established by rating agencies. True

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