3 (AAR and GAR): The price of a security is $100 at time 0, $50at time 1, and $100 at time 2. Whatâs the AAR and GAR?
4 (FETY): A tax-exempt bond has a yield of 6%, exempt from bothfederal taxes (30%) and state taxes (10%). Whatâs the FETY of acorporate bond on which both federal and state taxes apply?
5 (yields): A 90-day T-bills pays $10,000 at maturity, thecurrent price is $9875. Whatâs the bank discount rate? The bondequivalent yield? Effective annual yield?
7. (CAPM): Whatâs the expected return for a security withbeta=0.8? The market risk-premium is 4% and risk-free rate is 0.5%.Now the actual return of the security is 4%, is it a buy signal ora sell signal?
3 (AAR and GAR): The price of a security is $100 at time 0, $50at time 1, and $100 at time 2. Whatâs the AAR and GAR?
4 (FETY): A tax-exempt bond has a yield of 6%, exempt from bothfederal taxes (30%) and state taxes (10%). Whatâs the FETY of acorporate bond on which both federal and state taxes apply?
5 (yields): A 90-day T-bills pays $10,000 at maturity, thecurrent price is $9875. Whatâs the bank discount rate? The bondequivalent yield? Effective annual yield?
7. (CAPM): Whatâs the expected return for a security withbeta=0.8? The market risk-premium is 4% and risk-free rate is 0.5%.Now the actual return of the security is 4%, is it a buy signal ora sell signal?
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Related questions
Instructions: Use the formula below to compute the problems: âPlease Read the question carefully.â
Kd = Yield (1 â T)
1. Telecom Systems can issue debt yielding 8 percent. The company is in a 35 percent bracket. What is its after-tax cost of debt?
2. After-tax cost of debt: Royal Jewelers Inc., has an aftertax cost of debt of 6 percent. With a tax rate of 40 percent, what can you assume the yield on the debt is?
3.
Cash flow: Assume a corporation has earnings before depreciation and taxes of $100,000, depreciation of $50,000, and that it has a 30 percent tax bracket. Compute its cash flow using the format below.
Earnings before depreciation and taxes _____
Depreciation _____
Earnings before taxes _____
Taxes @ 30% _____
Earnings after taxes _____
Depreciation _____
4.
Cost of preferred stock: Medco Corporation can sell preferred stock for $80 with an estimated flotation cost of $3. It is anticipated the preferred stock will pay $6 per share in dividends.
a. Compute the cost of preferred stock for Medco Corp.
b. Do we need to make a tax adjustment for the issuing firm?
5. Cost of preferred stock: The Meredith Corporation issued $100 par value preferred stock 10 years ago. The stock provided an 8 percent yield at the time of issue. The preferred stock is now selling for $75. What is the current yield or cost of the preferred stock? (Disregard flotation costs.)
6. Costs of retained earnings and new common stock: Barton Electronics wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $1.20 per share, and the current price of its common stock is $30 per share. The expected growth rate is 9 percent.
a. Compute the cost of retained earnings (Ke). Use Formula 11-6.
b. If a $2 flotation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-7.
7. A firm's cost of preferred stock is equal to the preferred dividend divided by market price plus the dividend growth rate (Kp= D/Po+ g).
8. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.
a. True
b. False
9. The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.
a. True
b. False
10. The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.
a. True
b. False
11. You have the following data on three stocks:
Stock | Standard Deviation | Beta |
A | 20% | 0.59 |
B | 10% | 0.61 |
C | 12% | 1.29 |
If you are a strict risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio.
a. A; A.
b. A; B.
c. B; A.
d. C; A.
e. C; B.
12. A portfolioâs risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
a. True
b. False
13. You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?
a. The price of Bond B will decrease over time, but the price of Bond A will increase over time.
b. The prices of both bonds will remain unchanged.
c. The price of Bond A will decrease over time, but the price of Bond B will increase over time.
d. The prices of both bonds will increase by 7% per year.
e. The prices of both bonds will increase over time, but the price of Bond A will increase at a faster rate.
14. A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?
a. If market interest rates decline, the price of the bond will also decline.
b. The bond is currently selling at a price below its par value.
c. If market interest rates remain unchanged, the bondâs price one year from now will be lower than it is today.
d. The bond should currently be selling at its par value.
e. If market interest rates remain unchanged, the bondâs price one year from now will be higher than it is today.
15. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 5.14%
b. 5.42%
c. 5.70%
d. 5.99%
e. 6.28%
16. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 3.80%
b. 3.99%
c. 4.19%
d. 4.40%
e. 4.62%
17. Assume that interest rates on 20-year Treasury and corporate bonds are as follows:
T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%
The differences in these rates were probably caused primarily by:
a. Tax effects.
b. Default and liquidity risk differences.
c. Maturity risk differences.
d. Inflation differences.
e. Real risk-free rate differences.
18. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?
a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
b. The discount rate increases.
c. The riskiness of the investmentâs cash flows decreases.
d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
e. The discount rate decreases.
19. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?
a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
b. If the pure expectations theory holds, the corporate yield curve must be downward sloping.
c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.
d. If inflation is expected to decline, there can be no maturity risk premium.
e. The expectations theory cannot hold if inflation is decreasing.
20. Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
a. True
b. False
What is the taxable equivalent yield on a municipal bond with a yield to maturity of 4.5 percent for an investor in the 39 percent marginal tax bracket?
1.76 percent
4.50 percent
7.38 percent
11.54 percent
Rank the following bonds in order from lowest credit risk to highest risk all with the same time to maturity, by their yield to maturity: JM Corporate bond with yield of 12.25 percent, IB Corporate bond with yield of 4.49 percent, TC Corporate bond with yield of 8.76 percent, and B&O Corporate bond with a yield of 5.99 percent.
JM bond, TC bond, B&O bond, IB bond
IB bond, B&O bond, TC bond, JM bond
TC bond, B&O bond, IB bond, JM bond
JM bond, IB bond, B&O bond, TC bond
A 5.75 percent coupon bond with 12 years left to maturity is offered for sale at $978.83. What yield to maturity is the bond offering? (Assume interest payments are paid semi-annually and par value is $1,000.)
3.00 percent
3.09 percent
5.75 percent
6.00 percent
A client in the 28 percent marginal tax bracket is comparing a municipal bond that offers a 3.25 percent yield to maturity and a similar-risk corporate bond that offers a 4.10 percent yield. Which bond will give the client more profit after taxes?
The municipal bond.
The corporate bond.
Both give the client equal profits after taxes.
There is not enough information given to determine answer.
Portfolio Weights An investor owns $15,000 of Adobe Systems stock, $15,500 of Dow Chemical, and $17,000 of Office Depot. What are the portfolio weights of each stock?
Adobe System = 0.3333, Dow Chemical = 0.3333, Office Depot = 0.3333
Adobe System = 0.3158, Dow Chemical = 0.3263, Office Depot = 0.3579
Adobe System = 0.3263, Dow Chemical = 0.3158, Office Depot = 0.3579
Adobe System = 0.2667, Dow Chemical = 0.3333, Office Depot = 0.4000
Portfolio Return Year-to-date, Company O had earned a -7.4 percent return. During the same time period, Company V earned 9.65 percent and Company M earned 2.68 percent. If you have a portfolio made up of 20 percent Company O, 40 percent Company V, and 40 percent Company M, what is your portfolio return?
4.93%
6.41%
3.45%
19.73%
Average Return The past five monthly returns for K and Company are 4.55 percent, 4.72 percent, -.65 percent, -.15 percent, and 9.30 percent. What is the average monthly return?
3.874%
1.614%
1.481%
3.554%
Portfolio Weights If you own 270 shares of Air Line Inc at $18.95, 170 shares of BuyRite at $9.9, and 370 shares of Motor City at $45.95, what are the portfolio weights of each stock?
Air Line = .2700, BuyRite = .1700, MotorCity = .3700
Air Line = .3333, BuyRite = .3333, MotorCity = .3333
Air Line = .3333, BuyRite = .2099, MotorCity = .4568
Air Line = .2150, BuyRite = .0707, MotorCity = .7143
Portfolio Return At the beginning of the month, you owned $6,500 of Company G, $8,900 of Company S, and $2,800 of Company N. The monthly returns for Company G, Company S, and Company N were 8.15 percent, -1.59 percent, and -.14 percent. What is your portfolio return?
2.14%
6.42%
3.29%
2.13%
The standard deviation of the past five monthly returns for PG Company are 2.75 percent, -0.75 percent, 4.15 percent, 6.29 percent, and 3.84 percent. What is the standard deviation?
2.309 percent
2.581 percent
3.256 percent
3.406 percent
Rank the following three stocks by their risk-return relationship, best to worst. Rail Haul has an average return of 10 percent and standard deviation of 19 percent. The average return and standard deviation of Idol Staff are 12 percent and 22 percent; and of Poker-R-Us are 11 percent and 25 percent.
Idol Staff, Rail Haul, Poker-R-Us
Rail Haul, Idol Staff, Poker-R-Us
Idol Staff, Poker-R-Us, Rail Haul
Poker-R-Us, Rail Haul, Idol Staff
Which of the following statements is correct?
A single stock has a lot of diversifiable risk.
A single stock has more market risk than a diversified portfolio of stocks.
Bonds and stocks have a high correlation because they are both financial assets.
None of these statements is correct.
Which of the following statements is correct with regards to diversification?
Diversifying reduces the return of the portfolio.
Diversifying reduces the market risk of the portfolio.
Diversifying reduces the dollar return of the portfolio.
None of these statements is correct.
Expected Return Compute the expected return given these three economic states, their likelihoods, and the potential returns:
Economic State | Probability | Return |
Fast Growth | .1 | 29% |
Slow Growth | .8 | 14% |
Recession | .1 | -29% |
14.0%
14.3%
11.2%
17.0%
Risk Premium If the annual return on the S&P 500 Index was 14.00 percent. The annual T-bill yield during the same period was 6.50 percent. What was the market risk premium during that year?
20.50%
14.00%
7.50%
6.50%
CAPM Required Return A company has a beta of .69. If the market return is expected to be 13.9 percent and the risk-free rate is 5.95 percent, what is the company's required return?
11.44%
15.54%
17.39%
9.59%
Portfolio Beta You have a portfolio with a beta of .94. What will be the new portfolio beta if you keep 40 percent of your money in the old portfolio and 60 percent in a stock with a beta of 1.54?
1.24
1.00
1.30
2.48
Under/Over Valued Stock A manager believes his firm will earn a 17.8 percent return next year. His firm has a beta of 1.68, the expected return on the market is 15.8 percent, and the risk-free rate is 5.8 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is under-valued or over-valued.
22.6%, under-valued
27.544%, under-valued
27.544%, over-valued
22.6%, over-valued
What is the taxable equivalent yield on a municipal bond with a yield to maturity of 4.5 percent for an investor in the 39 percent marginal tax bracket?
1.76 percent
4.50 percent
7.38 percent
11.54 percent
Rank the following bonds in order from lowest credit risk to highest risk all with the same time to maturity, by their yield to maturity: JM Corporate bond with yield of 12.25 percent, IB Corporate bond with yield of 4.49 percent, TC Corporate bond with yield of 8.76 percent, and B&O Corporate bond with a yield of 5.99 percent.
JM bond, TC bond, B&O bond, IB bond
IB bond, B&O bond, TC bond, JM bond
TC bond, B&O bond, IB bond, JM bond
JM bond, IB bond, B&O bond, TC bond
A 5.75 percent coupon bond with 12 years left to maturity is offered for sale at $978.83. What yield to maturity is the bond offering? (Assume interest payments are paid semi-annually and par value is $1,000.)
3.00 percent
3.09 percent
5.75 percent
6.00 percent
A client in the 28 percent marginal tax bracket is comparing a municipal bond that offers a 3.25 percent yield to maturity and a similar-risk corporate bond that offers a 4.10 percent yield. Which bond will give the client more profit after taxes?
The municipal bond.
The corporate bond.
Both give the client equal profits after taxes.
There is not enough information given to determine answer.
Portfolio Weights An investor owns $15,000 of Adobe Systems stock, $15,500 of Dow Chemical, and $17,000 of Office Depot. What are the portfolio weights of each stock?
Adobe System = 0.3333, Dow Chemical = 0.3333, Office Depot = 0.3333
Adobe System = 0.3158, Dow Chemical = 0.3263, Office Depot = 0.3579
Adobe System = 0.3263, Dow Chemical = 0.3158, Office Depot = 0.3579
Adobe System = 0.2667, Dow Chemical = 0.3333, Office Depot = 0.4000
Portfolio Return Year-to-date, Company O had earned a -7.4 percent return. During the same time period, Company V earned 9.65 percent and Company M earned 2.68 percent. If you have a portfolio made up of 20 percent Company O, 40 percent Company V, and 40 percent Company M, what is your portfolio return?
4.93%
6.41%
3.45%
19.73%
Average Return The past five monthly returns for K and Company are 4.55 percent, 4.72 percent, -.65 percent, -.15 percent, and 9.30 percent. What is the average monthly return?
3.874%
1.614%
1.481%
3.554%
Portfolio Weights If you own 270 shares of Air Line Inc at $18.95, 170 shares of BuyRite at $9.9, and 370 shares of Motor City at $45.95, what are the portfolio weights of each stock?
Air Line = .2700, BuyRite = .1700, MotorCity = .3700
Air Line = .3333, BuyRite = .3333, MotorCity = .3333
Air Line = .3333, BuyRite = .2099, MotorCity = .4568
Air Line = .2150, BuyRite = .0707, MotorCity = .7143
Portfolio Return At the beginning of the month, you owned $6,500 of Company G, $8,900 of Company S, and $2,800 of Company N. The monthly returns for Company G, Company S, and Company N were 8.15 percent, -1.59 percent, and -.14 percent. What is your portfolio return?
2.14%
6.42%
3.29%
2.13%
The standard deviation of the past five monthly returns for PG Company are 2.75 percent, -0.75 percent, 4.15 percent, 6.29 percent, and 3.84 percent. What is the standard deviation?
2.309 percent
2.581 percent
3.256 percent
3.406 percent
Rank the following three stocks by their risk-return relationship, best to worst. Rail Haul has an average return of 10 percent and standard deviation of 19 percent. The average return and standard deviation of Idol Staff are 12 percent and 22 percent; and of Poker-R-Us are 11 percent and 25 percent.
Idol Staff, Rail Haul, Poker-R-Us
Rail Haul, Idol Staff, Poker-R-Us
Idol Staff, Poker-R-Us, Rail Haul
Poker-R-Us, Rail Haul, Idol Staff
Which of the following statements is correct?
A single stock has a lot of diversifiable risk.
A single stock has more market risk than a diversified portfolio of stocks.
Bonds and stocks have a high correlation because they are both financial assets.
None of these statements is correct.
Which of the following statements is correct with regards to diversification?
Diversifying reduces the return of the portfolio.
Diversifying reduces the market risk of the portfolio.
Diversifying reduces the dollar return of the portfolio.
None of these statements is correct.
Expected Return Compute the expected return given these three economic states, their likelihoods, and the potential returns:
Economic State | Probability | Return |
Fast Growth | .1 | 29% |
Slow Growth | .8 | 14% |
Recession | .1 | -29% |
14.0%
14.3%
11.2%
17.0%
Risk Premium If the annual return on the S&P 500 Index was 14.00 percent. The annual T-bill yield during the same period was 6.50 percent. What was the market risk premium during that year?
20.50%
14.00%
7.50%
6.50%
CAPM Required Return A company has a beta of .69. If the market return is expected to be 13.9 percent and the risk-free rate is 5.95 percent, what is the company's required return?
11.44%
15.54%
17.39%
9.59%
Portfolio Beta You have a portfolio with a beta of .94. What will be the new portfolio beta if you keep 40 percent of your money in the old portfolio and 60 percent in a stock with a beta of 1.54?
1.24
1.00
1.30
2.48
Under/Over Valued Stock A manager believes his firm will earn a 17.8 percent return next year. His firm has a beta of 1.68, the expected return on the market is 15.8 percent, and the risk-free rate is 5.8 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is under-valued or over-valued.
22.6%, under-valued
27.544%, under-valued
27.544%, over-valued
22.6%, over-valued
What is the taxable equivalent yield on a municipal bond with a yield to maturity of 4.5 percent for an investor in the 39 percent marginal tax bracket?
1.76 percent
4.50 percent
7.38 percent
11.54 percent
Rank the following bonds in order from lowest credit risk to highest risk all with the same time to maturity, by their yield to maturity: JM Corporate bond with yield of 12.25 percent, IB Corporate bond with yield of 4.49 percent, TC Corporate bond with yield of 8.76 percent, and B&O Corporate bond with a yield of 5.99 percent.
JM bond, TC bond, B&O bond, IB bond
IB bond, B&O bond, TC bond, JM bond
TC bond, B&O bond, IB bond, JM bond
JM bond, IB bond, B&O bond, TC bond
A 5.75 percent coupon bond with 12 years left to maturity is offered for sale at $978.83. What yield to maturity is the bond offering? (Assume interest payments are paid semi-annually and par value is $1,000.)
3.00 percent
3.09 percent
5.75 percent
6.00 percent
A client in the 28 percent marginal tax bracket is comparing a municipal bond that offers a 3.25 percent yield to maturity and a similar-risk corporate bond that offers a 4.10 percent yield. Which bond will give the client more profit after taxes?
The municipal bond.
The corporate bond.
Both give the client equal profits after taxes.
There is not enough information given to determine answer.
Portfolio Weights An investor owns $15,000 of Adobe Systems stock, $15,500 of Dow Chemical, and $17,000 of Office Depot. What are the portfolio weights of each stock?
Adobe System = 0.3333, Dow Chemical = 0.3333, Office Depot = 0.3333
Adobe System = 0.3158, Dow Chemical = 0.3263, Office Depot = 0.3579
Adobe System = 0.3263, Dow Chemical = 0.3158, Office Depot = 0.3579
Adobe System = 0.2667, Dow Chemical = 0.3333, Office Depot = 0.4000
Portfolio Return Year-to-date, Company O had earned a -7.4 percent return. During the same time period, Company V earned 9.65 percent and Company M earned 2.68 percent. If you have a portfolio made up of 20 percent Company O, 40 percent Company V, and 40 percent Company M, what is your portfolio return?
4.93%
6.41%
3.45%
19.73%
Average Return The past five monthly returns for K and Company are 4.55 percent, 4.72 percent, -.65 percent, -.15 percent, and 9.30 percent. What is the average monthly return?
3.874%
1.614%
1.481%
3.554%
Portfolio Weights If you own 270 shares of Air Line Inc at $18.95, 170 shares of BuyRite at $9.9, and 370 shares of Motor City at $45.95, what are the portfolio weights of each stock?
Air Line = .2700, BuyRite = .1700, MotorCity = .3700
Air Line = .3333, BuyRite = .3333, MotorCity = .3333
Air Line = .3333, BuyRite = .2099, MotorCity = .4568
Air Line = .2150, BuyRite = .0707, MotorCity = .7143
Portfolio Return At the beginning of the month, you owned $6,500 of Company G, $8,900 of Company S, and $2,800 of Company N. The monthly returns for Company G, Company S, and Company N were 8.15 percent, -1.59 percent, and -.14 percent. What is your portfolio return?
2.14%
6.42%
3.29%
2.13%
The standard deviation of the past five monthly returns for PG Company are 2.75 percent, -0.75 percent, 4.15 percent, 6.29 percent, and 3.84 percent. What is the standard deviation?
2.309 percent
2.581 percent
3.256 percent
3.406 percent
Rank the following three stocks by their risk-return relationship, best to worst. Rail Haul has an average return of 10 percent and standard deviation of 19 percent. The average return and standard deviation of Idol Staff are 12 percent and 22 percent; and of Poker-R-Us are 11 percent and 25 percent.
Idol Staff, Rail Haul, Poker-R-Us
Rail Haul, Idol Staff, Poker-R-Us
Idol Staff, Poker-R-Us, Rail Haul
Poker-R-Us, Rail Haul, Idol Staff
Which of the following statements is correct?
A single stock has a lot of diversifiable risk.
A single stock has more market risk than a diversified portfolio of stocks.
Bonds and stocks have a high correlation because they are both financial assets.
None of these statements is correct.
Which of the following statements is correct with regards to diversification?
Diversifying reduces the return of the portfolio.
Diversifying reduces the market risk of the portfolio.
Diversifying reduces the dollar return of the portfolio.
None of these statements is correct.
Expected Return Compute the expected return given these three economic states, their likelihoods, and the potential returns:
Economic State | Probability | Return |
Fast Growth | .1 | 29% |
Slow Growth | .8 | 14% |
Recession | .1 | -29% |
14.0%
14.3%
11.2%
17.0%
Risk Premium If the annual return on the S&P 500 Index was 14.00 percent. The annual T-bill yield during the same period was 6.50 percent. What was the market risk premium during that year?
20.50%
14.00%
7.50%
6.50%
CAPM Required Return A company has a beta of .69. If the market return is expected to be 13.9 percent and the risk-free rate is 5.95 percent, what is the company's required return?
11.44%
15.54%
17.39%
9.59%
Portfolio Beta You have a portfolio with a beta of .94. What will be the new portfolio beta if you keep 40 percent of your money in the old portfolio and 60 percent in a stock with a beta of 1.54?
1.24
1.00
1.30
2.48
Under/Over Valued Stock A manager believes his firm will earn a 17.8 percent return next year. His firm has a beta of 1.68, the expected return on the market is 15.8 percent, and the risk-free rate is 5.8 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is under-valued or over-valued.
22.6%, under-valued
27.544%, under-valued
27.544%, over-valued
22.6%, over-valued