1/29/2021 Final Exam
Final Exam Total points 20/60
BUS635.1 Fall 2020
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of this form.
The required return of an equity security depends on - 0/1
the risk-free rate
the market risk premium
the stock’s beta.
all of the above
None of the above
Correct answer
all of the above
The real risk-free interest rate is the rate that a hypothetical risk-less security 1/1
pays each moment if zero inflation were expected.
True
False
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Summit’s bonds have 10years remaining to maturity. Interest is paid annually, 1/1
the bonds have a $1,000 par value, and the coupon interest rate is 9%. The
bonds sell at a price of $850. Their estimated YTM is found to be 11.61%
Cannot be determined; need more data.
True
False
Founders’ shares are owned by the firm’s founders that carries sole voting 1/1
rights but restricted dividends for a specified number of years.
True
False
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A 1 yr TIPS is offering 2.5% return. Inflation is expected to be 2% this year, 3% 0/1
next year and 4% during the third year. Assume that the maturity risk
premium is zero for one year, 0.5% for two years and 0.7% for three years. If
real risk free rate is constant over the next three years, what is the yield on 2-
year Treasury securities?
4.5%
5.5%
5.75%
6.0%
6.25%
Correct answer
5.5%
The relationship between the yields on securities and the securities’ 1/1
maturities is known as the term structure of interest rates.
True
False
Keeping everything else same, if the sustainable growth rate, g, decreases, 1/1
the stock price decreases.
True
False
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If β < 1.0, stock is riskier than average 1/1
True
False
In market equilibrium, required return will never be equal to expected return 0/1
of a security.
True
False
Correct answer
False
B2C co. is expected to pay a $2.50 per share dividend at the end of this year. 0/1
The dividend is expected to grow at a constant rate of 5% a year. The required
rate of return on the stock is 12%. What is the estimated value per share of
STS’s stock?
$20.8
$35.7
$37.5
$50.0
Correct answer
$35.7
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The expected rate of return on a bond held to maturity is defined as the 0/1
bond’s YTC,
True
False
Correct answer
False
Z2A’s tax rate is 35%, rd = 6.8%, rps = 6.2%, and rs = 11%. If Z2A has a target 0/1
capital structure of 35% debt, 15% preferred stock, and 50% common stock,
what is its WACC?
6.99%
7.98%
8.18%
8.81%
Correct answer
7.98%
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City bonds have 8 years remaining to maturity. The bonds have a face value of 1/1
$1,000 and a yield to maturity of 8%. They pay interest annually and have a 7%
coupon rate. City bonds are selling at -
par
discount
premium
None of the above
The average investor is risk averse that does not imply- 0/1
he or she will never hold risky assets
he or she must be compensated for holding risky assets
riskier assets have higher required returns than less risky assets
less risky assets have relatively less required returns comapred to assets with high
risk
None of the above
Correct answer
he or she will never hold risky assets
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PHP co. is expected to pay a $2.5 per share dividend at the end of this year. 0/1
The dividend is expected to grow at a constant rate of 6% a year. The required
rate of return on the stock is 10%. What is the estimated value per share of
PHP’s stock?
$20.8
$41.7
$44.2
None of the above
Correct answer
None of the above
Which of the following is not correct? 0/1
The average of all stocks’ betas is equal to 1
The beta of the market also is equal to 0
A stock with a beta less than 1 contributes less risk to a portfolio than does the
average stock
A stock with a beta greater than 1 contributes more risk to a portfolio than does the
average stock
Beta determines how much risk a stock contributes to a well-ldiversified portfolio
A well-diversified portfolio has only market risk.
Correct answer
The beta of the market also is equal to 0
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A firm will typically call a bond if interest rates fall substantially below the 1/1
coupon rate.
True
False
Which of the following is true? 0/1
TIPS is not free from inflation risk
T-bill is free from all the risks, including inflation risk.
Floating rate bond has interest rate risk
Corporate yield curves are not necessarily parallel to the Treasury curve
Correct answer
Corporate yield curves are not necessarily parallel to the Treasury curve
The expected rate of return on a bond held to maturity is defined as the 0/1
bond’s YTC,
True
False
Correct answer
False
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The spread between a corporate yield curve and the Treasury curve ____ as 1/1
the corporate bond rating ____
widens, increases
widens, decreases
shrinks, does not change
shrinks, decreases
widens, does not change
Like bonds, preferred stock dividends can be omitted without fear of pushing 0/1
the firm into bankruptcy
True
False
Correct answer
False
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John has a $1.5 million portfolio consisting of a $150,000 investment in each 0/1
of 10 different stocks. The portfolio has a beta of 1.2. He is considering selling
$150,000 worth of one stock with a beta of 0.85 and using the proceeds to
purchase another stock with a beta of 1.5. What will the portfolio’s new beta
be after these transactions?
0.965
1.065
1.165
1.265
1.365
1.465
None of the above
Correct answer
1.265
The expected rate of return on a callable bond held to its call date is defined 0/1
as the YTM.
True
False
Correct answer
False
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G2G co. has a target capital structure of 60% debt and 40% equity. The yield 0/1
to maturity on the company’s outstanding bonds is 10%, and the company’s
tax rate is 30%. G2G’s CFO has calculated the company’s WACC as 11.5%.
What is the company’s cost of equity capital?
10%
11.5%
12.5%
14.5%
17.2%
18.3%
Correct answer
18.3%
Keeping everything else same, if the required rate of return on stock, rs, 0/1
increases, the stock price of a company increases.
True
False
Correct answer
False
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Typically, company wants reorganization, but creditors may prefer liquidation. 1/1
True
False
Roy Medicine Supplies can issue perpetual preferred stock at a price of $40 a 0/1
share with an annual dividend of $2.50 a share. Ignoring flotation costs, what
is the company’s cost of preferred stock?
5.00%
6.25%
16.00%
20.00%
Correct answer
6.25%
Corporate bonds as well as municipal bond have default risk. 0/1
True
False
Correct answer
True
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The quoted interest rate on debt is the rate needed to fairly compensate 1/1
investors for purchasing or holding debt, taking into consideration its cash
flows’ risk and timing.
True
False
Stock A has a beta of 0.7, Stock B has a beta of 1.7, the expected rate of return 0/1
on an average stock is 10%, and the risk-free rate is 6%. By how much does
the required return on the riskier stock exceed that on the less risky stock?
0.01
0.04
0.08
0.128
0.23
None of the above
Correct answer
0.04
The purpose of the convertibility is to provide for the orderly retirement of the1/1
issue.
True
False
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A company currently pays a dividend of $1.5 per share. It is estimated that the 0/1
company’s dividend will grow at a constant rate of 7%. The company’s stock
has a beta of 1.1, the risk-free rate is 5.5%, and the market risk premium is
4.5%. What is your estimate of the stock’s current price?
$26.34
$31.97
$43.48
$46.52
Correct answer
$46.52
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You have a $4 million portfolio consisting of investment in stocks A & B 1/1
according to the following. Please find out the portfolio return.
6%
7.25%
8%
29%
The estimated value of equity is the total value of the company plus the value 1/1
of the debt and preferred stock.
True
False
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A 1 yr TIPS is offering 2.5% return. Inflation is expected to be 2% this year, 3% 0/1
next year and 4% during the third year. Assume that the maturity risk
premium is zero for one year, 0.5% for two years and 0.7% for three years. If
real risk free rate is constant over the next three years, what is the yield on 1-
year Treasury securities?
2.0%
2.5%
4.5%
5.0%
YYY Inc will issue common stock to the public for $20. The expected dividend 0/1
a year from now and the growth in dividends are $3.00 per share and 6%,
respectively. What is the cost of external equity, re?
12.29%
12.67%
15.43%
16.0%
20.15%
21.00%
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Unlike corporate bonds, treasury bonds are NOT exposed to default risk 1/1
True
False
Operating assets include short-term investments in marketable securities and 0/1
noncontrolling interests in the stock of other companies.
True
False
Correct answer
False
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John has a $1.5 million portfolio consisting of a $150,000 investment in each 0/1
of 10 different stocks. The portfolio has a beta of 1.5. He is considering selling
$150,000 worth of one stock with a beta of 1.2 and using the proceeds to
purchase another stock with a beta of 0.85. What will the portfolio’s new beta
be after these transactions?
0.965
1.065
1.165
1.265
1.365
1.465
None of the above
If a company is liquidated, which of the following will get the HIGHEST 0/1
payment priority?
Preferred stock
Common stock
Unsecured creditors
Secured creditors
Correct answer
Secured creditors
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Z2A’s tax rate is 35%, rd = 6.8%, rps = 6.2%, and rs = 11%. If Z2A has a target 0/1
capital structure of 50% debt, 15% preferred stock, and 35% common stock,
what is its WACC?
6.99%
7.98%
8.18%
8.81%
Correct answer
6.99%
A company is expected to pay a dividend of $2 per share a year from now. It is 0/1
estimated that the company’s dividend will grow at a constant rate of 6%. The
company’s stock has a beta of 1.2, the risk-free rate is 5.0%, and the market
risk premium is 6.0%. What is your estimate of the stock’s current price?
$29.2
$32.3
$34.3
None of the above
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TIPS have no inflation risk. 1/1
True
False
If Sunshine Inc. has earnings per share of $1.50 and if the average P/E of 1/1
comparable stocks is 21.0, estimate a value for Sunshine's stock using the P/E
as a valuation multiple.
$1.50
$21.0
$14
$31.5
The beta of a portfolio is nothing but the weighted average of the betas of the 1/1
individual securities in the portfolio.
True
False
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Given that ρi,M=0.5, σi=0.3, and σM=0.1, the estimated value of βi will be - 0/1
0.1
0.3
0.5
1.5
A 1 yr TIPS is offering 2.5% return. Inflation is expected to be 2% this year, 3% 0/1
next year and 4% during the third year. Assume that the maturity risk
premium is zero for one year, 0.5% for two years and 0.7% for three years. If
real risk free rate is constant over the next three years, what is the yield on 3-
year Treasury securities?
6.0%
6.2%
6.6%
7.2%
7.6%
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City bonds have 8 years remaining to maturity. The bonds have a face value of 1/1
$1,000 and a yield to maturity of 7%. They pay interest annually and have a 8%
coupon rate. What is their current price and current yield respectively?
$1000, 7%
$943, 7.4%
$943, 7.6%
$1060, 7.4%
$1060, 7.6%
$1000, 8%
HTC Inc will issue common stock to the public for $30. The expected dividend 0/1
a year from now and the growth in dividends are $2.00 per share and 6%,
respectively. What is the cost of external equity, re?
12.29%
12.67%
15.43%
16.0%
20.15%
21.00%
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B2B co. is expected to pay a $1.5 per share dividend at the end of this year. 0/1
The dividend is expected to grow at a constant rate of 5% a year. The required
rate of return on the stock is 12%. What is the estimated value per share of
B2B’s stock?
$15
$30
$31.5
None of the above
A sinking fund provision gives the issuing corporation the right to redeem the 0/1
bonds prior to maturity under specified terms.
True
False
Correct answer
False
Zero coupon bonds pay no annual interest but are issued at a premium. 0/1
True
False
Correct answer
False
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Stockholder's preemptive right never protects the present stockholders’ 1/1
control and prevents dilution of their value.
True
False
XYZ Inc will issue common stock to the public for $20. The expected dividend 0/1
a year from now and the growth in dividends are $2.00 per share and 6%,
respectively. What is the cost of external equity, re?
12.29%
12.67%
15.43%
16.0%
20.15%
21.00%
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Which of the following is true? 0/1
Short-term bonds have high interest rate risk but, low reinvestment rate risk
Long -term bonds have high reinvestment rate risk but, low interest rate risk
MRP is more affected by reinvestment rate risk than by interest rate risk
Yields on longer term bonds usually are greater than on shorter term bonds
MRP is less affected by interest rate risk than by reinvestment rate risk
Correct answer
Yields on longer term bonds usually are greater than on shorter term bonds
Which of the following is correct? 0/1
Effect of market risk can be eliminated by diversification.
Market risk may arise from events that are unique to the particular firm.
Diversifiable risk may arise from war and inflation.
Most, if not all, stocks are affected by factors such as recession and high interest
rates.
A stock held as part of a portfolio is generally less risky than the same stock held in
isolation.
Correct answer
A stock held as part of a portfolio is generally less risky than the same stock held in
isolation.
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CBD Inc's currently outstanding 12% coupon bonds have a yield to maturity of 0/1
10%. CBD believes it could issue new bonds at par that would provide a similar
yield to maturity. If its marginal tax rate is 40%, what is CBD’s after-tax cost of
debt?
4%
4.8%
6%
7.2%
10%
12%
40%
60%
The extra rate of return that an investor would require to invest in the stock 0/1
market instead of purchasing the risk-free securities, is termed as -
market risk premium
equity risk premium
equity premium
all of the above
None of the above
Correct answer
all of the above
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You have a $4 million portfolio consisting of investment in stocks A & B 0/1
according to the following. Please find out the portfolio β
0.5
1.125
1.5
4.5
The total market value of a stock is the sum of the value of operations and the 0/1
non-operating assets.
True
False
Correct answer
False
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