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Fin 221 Fall 2006 Exam 3 Multiple Choice Identify the choice that best completes the statement or answers the question. 1) Ken Williams Ventures' recently issued bonds that mature in 15 years. They have a par value of $1,000 and an annual coupon of 6%. If the current market interest rate is 8%, at what price should the bonds sell? A. $801.80 B. $814.74 C. $828.81 D. $830.53 E. $847.86 2) Brown Enterprises' bonds currently sell for $1,025. They have a 9-year maturity, an annual coupon of $80, and a par value of $1,000. What is their yield to maturity? A. 6.87% B. 7.03% C. 7.21% D. 7.45% E. 7.61% 3) Kholdy Inc's bonds currently sell for $1,275. They pay a $120 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,120. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between the bond's YTM and its YTC? A. 1.48% B. 1.54% C. 1.68% D. 1.82% E. 1.91% 4) A 20-year, $1,000 par value bond has a 9% annual coupon. The bond currently sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years from now? A. $933.09 B. $941.86 C. $951.87 D. $965.84 E. $978.40 5) Which of the following statements is CORRECT? A. The shorter the time to maturity, the greater the change in the value of a bond in response to a given change in interest rates. B. The longer the time to maturity, the smaller the change in the value of a bond in response to a given change in interest rates. C. The time to maturity does not affect the change in the value of a bond in response to a given change in interest rates. D. You hold a 10-year, zero coupon, bond and a 10-year bond that has a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the larger percentage decline. E. You hold a 10-year, zero coupon, bond and a 10-year bond that has a 6% annual coupon. The same market rate, 6%, applies to both bonds. If the market rate rises from the current level, the zero coupon bond will experience the smaller percentage decline. 6) Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds? A. Market interest rates decline sharply. B. The company's bonds are downgraded. C. Market interest rates rise sharply. D. Inflation increases significantly. E. The company's financial situation deteriorates significantly. 7) Which of the following would be most likely to increase the coupon rate that is required to enable a bond to be issued at par? A. Adding a call provision. B. Adding additional restrictive covenants that limit management's actions. C. Adding a sinking fund. D. The rating agencies change the bond's rating from Baa to Aaa. E. Making the bond a first mortgage bond rather than a debenture. 8) A 12-year bond has an annual coupon rate 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. The bond is currently selling at a price below its par value. B. If market interest rates decline, the price of the bond will also decline. C. If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today. D. If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today. E. The bond should currently be selling at its par value. 9) Which of the following statements is CORRECT? A. All else equal, if a bond's yield to maturity increases, its price will fall. B. All else equal, if a bond's yield to maturity increases, its current yield will fall. C. If a bond's yield to maturity exceeds its coupon rate, the bond will sell at a premium over par. D. If a bond's yield to maturity exceeds its coupon rate, the bond will sell at par. E. If a bond's required rate of return exceeds its coupon rate, the bond will sell at a premium. 10) A bond that matures in 12 years has a 9% semiannual coupon and a face value of $1,000. The bond has a nominal yield to maturity of 8%. What is the price of the bond today? A. $ 927.52 B. $ 928.39 C. $1,073.99 D. $1,075.36 E. $1,076.23 11) Niendorf Corporation's stock has a required return of 13.00%, the risk-free rate is 7.00%, and the market risk premium is 4.00%. Now suppose there is a shift in investor risk aversion, and the market risk premium increases by 2.00%. What is Niendorf's new required return? A. 14.00% B. 15.00% C. 16.00% D. 17.00% E. 18.00% 12) Assume that you are the portfolio manager of the Delaware Fund, a $4 million mutual fund that contains the following stocks: Stock Amount Beta A $ 400,000 1.50 B $ 600,000 0.50 C $1,000,000 1.25 D $2,000,000 0.75 The required rate of return in the market is 14.00% and the risk-free rate is 6.00%. What rate of return should investors expect (and require) on their investment in this fund? A. 10.90% B. 11.50% C. 12.10% D. 12.70% E. 13.30% 13) Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.) A. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. B. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0. C. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0. D. The effect of a change in the market risk premium depends on the level of the risk-free rate. E. The effect of a change in the market risk premium depends on the slope of the yield curve. 14) Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.) A. When held in isolation, Stock A has more risk than Stock B. B. Stock B would be a more desirable addition to a portfolio than Stock A. C. Stock A would be a more desirable addition to a portfolio than Stock B. D. In equilibrium, the expected return on Stock A will be greater than that on Stock B. E. In equilibrium, the expected return on Stock B will be greater than that on Stock A. 15) Which of the following statements best describes what would be expected to happen as you randomly select stocks and add them to your portfolio? A. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk. B. Adding more such stocks will reduce the portfolio's beta. C. Adding more such stocks will increase the portfolio's expected return. D. Adding more such stocks will reduce the portfolio's market risk. E. Adding more such stocks will have no effect on the portfolio's risk. 16) Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky has a $50,000 portfolio with a beta of 0.8, an expected return of 9.2%, and her standard deviation is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. Bob and Becky are engaged to be married. Which of the following best describes their combined $100,000 portfolio? A. The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. B. The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. C. The combined portfolio's beta will be equal to a simple average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. D. The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%. E. The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. 17) The risk-free rate is 5%. Stock A has a beta 1.0 and Stock B has a beta 1.4. Stock A has a required return of 11%. What is Stock B's required return? A. 12.4% B. 13.4% C. 14.4% D. 15.4% E. 16.4% 18) Ripken Iron Works faces the following probability distribution: Stock's Expected State of Probability of Return if this the Economy State Occurring State Occurs Boom 0.25 25% Normal 0.50 15 Recession 0.25 5 What is the coefficient of variation on the company's stock? A. 0.06 B. 0.47 C. 0.54 D. 0.67 E. 0.71 19) A stock just paid a dividend of $1. The required rate of return is rs 11%, and the constant growth rate is 5%. What is the current stock price? A. $15.00 B. $17.50 C. $20.00 D. $22.50 E. $25.00 20) The Lashgari Company is expected to pay a dividend of $1 per share at the end of the year, and that dividend is expected to grow at a constant rate of 5% per year in the future. The company's beta is 1.2, the market risk premium is 5%, and the risk-free rate is 3%. What is the company's current stock price? A. $15.00 B. $20.00 C. $25.00 D. $30.00 E. $35.00 21) You must estimate the intrinsic value of Gallovits Technologies' stock. Gallovits's end-of-year free cash flow (FCF) is expected to be $25 million, and it is expected to grow at a constant rate of 8.5% a year thereafter. The company's WACC is 11%. Gallovits has $200 million of long-term debt plus preferred stock, and there are 30 million shares of common stock outstanding. What is Gallovits' estimated intrinsic value per share of common stock? A. $22.67 B. $24.00 C. $25.33 D. $26.67 E. $28.00 22) The P. Born Company's last dividend was $1.50. The dividend growth rate is expected to be constant at 20% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If Born's required return (rs) is 13%, what is the company's current stock price? A. $25.16 B. $27.89 C. $28.26 D. $30.34 E. $32.28 23) If a stock's expected return exceeds its required return, this suggests that A. The stock is experiencing supernormal growth. B. The stock should be sold. C. The company is probably not trying to maximize price per share. D. The stock is probably a good buy. E. Dividends are not being declared. 24) Stock A has a beta of 1.1 and Stock B has a beta of 0.9. The market risk premium is 6%, and the risk-free rate is 6.3%. Both stocks have a constant dividend growth rate of 7% a year. If the market is in equilibrium, which of the following statements is CORRECT? A. Stock A must have a higher dividend yield than Stock B. B. Stock A must have a higher stock price than Stock B. C. Stock B's dividend yield equals its expected dividend growth rate. D. Stock B must have the higher required return. E. Stock B could have the higher expected return. 25) Cartwright Brothers' stock is currently selling for $40 a share. The stock is expected to pay a $2 dividend at the end of the year. The dividend growth rate is expected to be a constant 7% per year, forever. The risk-free rate and market risk premium are each 6%. What is the stock's beta? A. 1.06 B. 1.00 C. 2.00 D. 0.83 E. 1.08 Fin 221 Fall 2006 Exam 3 Answer Section MULTIPLE CHOICE 1) C 2) E 3) C 4) A 5) D 6) A 7) A 8) C 9) A 10) E 11) C 12) E 13) C 14) D 15) A 16) C 17) B 18) B 19) B 20) C 21) D 22) E 23) D 24) A 25) B