Essentials Of Finance Exam 2

Front 1

What does historical data suggest about the nature of short-term and long-term interest rates?

Back 1

Sometimes short-term rates are higher and sometimes long-term rates are higher.

Front 2

Bonds are:

Back 2

1) Interest-only loans

2) Issued by both corporations and governments

Front 3

Equity represents an ________ interest of the firm while debt is ________ an ownership in the firm.

Back 3

Ownership

not

Front 4

The model that precisely specifies the relationship between the nominal rate and the real rate is:

R= the nominal rate

r= the real rate

h= the rate of inflation

Back 4

(1+R) = (1+ r) x (1+h)

Front 5

What is a real rate of return?

Back 5

1) A percentage change in buying power

2) It is a rate of return that has been adjusted to remove inflation

Front 6

A corporate bond's yield to maturity...

Back 6

1) Changes over time

2) Is usually not the same as a bond's coupon rate

Front 7

As an investor in the bond market, why should you be concerned about changes in interest rates?

Back 7

Changes in interest rates cause changes in bond prices

Front 8

The US govt borrows money by issuing:

Back 8

Treasury bonds

Treasury notes

Front 9

If you are in the 20% federal income tax bracket, what is your after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes.

Back 9

5%

Front 10

What is the definition of a bond's time to maturity?

Back 10

It is the number of years until the face value is paid off

Front 11

What is the nominal rate of return on an investment?

Back 11

It is the actual percentage change in the dollar value of an investment unadjusted for inflation

Front 12

As a general rule, which of the following are true of debt and equity?

Back 12

1) Equity represents an ownership interest

2) The maximum reward for owning debt is fixed

Front 13

What are common shapes for the term structure of interest rates?

Back 13

1) Upward sloping (most common)

2) Downward sloping

3) humped

Front 14

What is the equation for approximating the nominal rate of return?

R= nominal rate of interest

r= the real rate of interest

h= the inflation rate

Back 14

R= r+h

Front 15

A part of the indenture limiting certain actions during the term of the loan are termed ________

Back 15

Protective covenants

Front 16

What are features of municipal bonds?

Back 16

1) They are issued by state and local governments

2) The interest on municipal bonds is exempt from federal taxes

3) The interest on municipal bonds is, in some cases exempt from state taxes in the state of issue

Front 17

The degree of interest rate risk depends on _________

Back 17

The sensitivity of the bond's price to interest rate changes

Front 18

The term structure of interest rates describes the _____________

Back 18

1) the pure time value of money

2) the relationship between nominal rates and time to maturity

Front 19

A zero- coupon bond is a bond that _________

Back 19

makes no interest payments

Front 20

A zero-coupon bond is a bond that __________

Back 20

makes no interest payments

Front 21

What is an asked price?

Back 21

1) the price at which a dealer is willing to sell a particular security

2) the price at which an investor can buy a particular security from a dealer

Front 22

What does the clean price for a bond represent?

Back 22

The quoted price excluding accrued interest

Front 23

What four variables are required to calculate the value of a bond?

Back 23

1) coupon rate

2) yield to maturity

3) time remaining to maturity

4) par value

Front 24

What does the dirty price represent?

Back 24

The quoted price and accrued interest

Front 25

What is the coupon rate on a bond that has a par value of $1,000, a market value of $1,100, and a coupon interest payment of $100 per year?

Back 25

10%

Front 26

What is a bid price?

Back 26

1) It is the price an investor will receive of he sells a bond to a dealer

2) It is the price at which a dealer is willing to buy securities

Front 27

ABC Co. Issued 1 million 6 percent annual coupon bonds that mature in 10 years. The face value is $1,000 per bond. What are the expected cash flows from one of these bonds?

Back 27

$60 in interest at the end of each year for 10 years and a $1,000 repayment of principal at the end of 10 years

Front 28

What is a bond's face value?

Back 28

It is the principal amount repaid at maturity

it is also known as the par value

Front 29

What does the AAA rating assigned by S&P mean?

Back 29

The firm is in a strong position to meet its debt obligations

Front 30

When interest rates in the market rise, we can expect the price of bonds to _______

Back 30

Decrease

Front 31

What are the three components that influence the Treasury yield curve?

Back 31

1) The real rate of return

2) Expected inflation

3) The interest rate risk premium

Front 32

The bid-ask spread represents the __________

Back 32

dealer's profit

Front 33

The sensitivity of a bond's price to interest rate changes is dependent on what two variables?

Back 33

1) Coupon rate

2) time to maturity

Front 34

What is the price of a US Treasury bond that is listed at 90 of the par value is $1,000?

Back 34

$900

Front 35

What does a bond's rating reflect?

Back 35

The ability of the firm to repay its debt and interest on time

Front 36

What is usually included in a bond's indenture?

Back 36

1) basic terms of the bonds

2) total amount of bonds issued

3) description of property used as security

4) the repayment arrangements

5) the call provisions

6) details of the protective covenants

Front 37

What is required to calculate the value of a bond?

Back 37

Market Yield to maturity

Coupon rate

Remaining life of bond

Front 38

What is the current yield on a $1,000 par value bond that sells for $900 if the coupon rate is 10 percent?

Back 38

11.11%

(.10* 1000)/ 900 = 11.11

Front 39

What are features of the OTC market for bonds?

Back 39

1) The OTC has no designated physical location

2) OTC dealers are connected electronically

Front 40

If the present value of the interest payments on a bond is $320 and the present value of the par value to be paid at maturity is $900, the total value of the bond must be ________

Back 40

$1,220

Front 41

If you are holding two identical bonds, except that one matures in 10 years and the other matures in 5 years, which bond's price will be more sensitive to interest rate risk?

Back 41

The 10 year bond, The longer the term, the greater the interest rate sensitivity

Front 42

What are differences btwn US Treasury bonds and Corp bonds?

Back 42

1) Treasury bonds are issued by the gov while corp bonds are issued by corps

2) Treasury bonds are considered free of default risk while corp bonds are exposed to default risk

3) Treasury bonds offer certain benefits to investors that corp bonds cannot offer

Front 43

If you are in the 20% federal income tax bracket, what is your after-tax yield on a municipal bond that is currently trading at par to yield 5%. Assume there are no state or local taxes.

Back 43

5%

Interest income from munis is exempt from federal income tax

Front 44

What are the two major forms of long-term debt?

Back 44

1) private issue

2) public issue

Front 45

The constant-growth model assumes that __________

Back 45

The dividends change at a constant rate

Front 46

In the dividend discount model, the expected return for investors comes from which two sources?

Back 46

1) growth rate

2)Dividend yield

Front 47

For investors in the stock market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guaranteed.

True or false

Back 47

False

Neither dividends nor capital gains are fixed or guaranteed

Front 48

The NYSE differs from the NASDAQ primarily because the NYSE has:

Back 48

1) A physical location

2) a face-to-face auction market

Front 49

What is the total return for a stock that currently sells for $100, is expected to pay a dividend in one year of $2, and has a constant growth rate of 8%?

Back 49

9.8%

R=(2/100)+.08

Front 50

What ratios might be used to estimate the value of a stock?

Back 50

1) the price/sales ratio

2) the price/earnings ratio

Front 51

A person who brings buyers and sellers together is called a(n) __________________

Back 51

Broker

Front 52

The value of a firm is a function of its ______ and its _________ rate

Back 52

growth, discount

Front 53

Preferred stock has preference over common stock in the:

Back 53

1) distribution of corp assets

2) payment of dividends

Front 54

What are rights of common stock holders?

Back 54

1) the right to share proportionally in any residual value in the event of liquidation

2) the right to vote on matters of importance

3) the right to share proportionally in any common dividends paid

Front 55

This type of growth describes a company that grows quickly at first, then slower in future years

Back 55

non constant

Front 56

What are three special case patterns of dividend growth?

Back 56

1) Constant growth

2) non constant growth

3) zero growth

Front 57

The fundamental business of the NYSE is to attract __________

Back 57

Order flow

Front 58

What are examples of secondary markets in the US?

Back 58

NASDAQ

The NYSE

The CSE

Front 59

Initial public offerings of stock occur in the __________ market.

Back 59

Primary

Front 60

A benchmark PE ratio can be determined using:

Back 60

1) A company's own historical PEs

2) the PE's of similar companies

Front 61

When voting for the board of directors, the number of votes a shareholder is entitled to is generally determined as:

Back 61

One vote per share held

Front 62

What equation represents the valuation of stock using a zero growth model?

Back 62

Dividend/ Discount rate = D/r

Front 63

The dividend yield is determined by dividing the expected dividend (D1) by:

Back 63

The current price (Po)

Front 64

The _________ can be interpreted as the capital gains yield.

Back 64

growth rate

in the formula R= dividend yield plus capital gains yield, dividend yield = D/P and capital gains yield =g

Front 65

If a zero-dividend stock is purchased for $80 and sold one year later for $84, the 1 year return is ______ percent

Back 65

5

(84/80)-1 - 5%

Front 66

The trading of existing shares occurs in the ______ market

Back 66

secondary

Front 67

What are reasons that make valuing a share of stock more difficult than valuing a bond?

Back 67

1) stock has no set maturity

2) the required rate of return is unobservable

3) dividends are unknown and unceratain

Front 68

NASDAQ has what features?

Back 68

1) comp network of securities dealers

2) multiple market maker system

Front 69

What are cash flows to investors in stocks?

Back 69

1) dividends

2) capital gains

Front 70

What is the total return for a stock that currently sells for $50, just paid a $1.75 dividend and has a constant growth rate of 8%?

Back 70

11.78%

R= [ (1.75* (1.08))/50 ] +.08

Front 71

A PE ratio that is based on estimated future earnings is known as a ________ PE ratio

Back 71

forward

Front 72

All else constant, the dividend yield will increase of the stock price ____________

Back 72

decreases

Front 73

NYSE DMM (designated market makers) were formally called ___________

Back 73

specialists

Front 74

a zero growth stock pays a dividend of $2 per share and has a discount rate of 10%. What will the stock's price be?

Back 74

20

Po= 2/.10

Front 75

Inside quotes represent the ___ and the ___

Back 75

highest bid price, lowest ask price

Front 76

What is the total return for a stock that currently sells for $100, is expected to pay a dividend in one year of $2 and has a constant growth rate of 8%?

Back 76

10%

Front 77

For investors in the market, dividends from stocks are fixed and guaranteed, while capital gains are variable and not guarunteed.

true or false

Back 77

false

Front 78

If the growth rate (g) is zero, the capital gain yield is _________

Back 78

zero

Front 79

Using a benchmark PE ratio against current earnings yields a fore casted price called a _______ price

Back 79

target

Front 80

Stock price reporting has increasingly moved from traditional print media to the ______ in recent years

Back 80

internet

Front 81

Cash flows should always be considered on a(n) ________ basis.

Back 81

after-tax

Front 82

What are some examples of "managerial options"?

Back 82

The option to to wait

the option to abandon

the option to expand

Front 83

One of the most important steps in estimating cash flows is to determine the ____________ cash flows.

Back 83

relevant

Front 84

Once cash flows have been estimated, what investment criteria can be applied to them?

Back 84

IRR

NVP

Payback period

Front 85

The difference between a firm's cash flows with a project versus without the project

Back 85

incremental cash flows

Front 86

When we estimate the best-case, worst-case, and base-case cash flows and calculate the corresponding NPVs, we are engaging in:

Back 86

scenario analysis and asking what-if questions

Front 87

To investigate the impact on NPV of a change in one variable, you would employ _______ analysis.

Back 87

Sensitivity

Front 88

An option on a real asset rather than a financial asset is known as a:

Back 88

Managerial option and a real option

Front 89

What is the equation for estimating operating cash flows using the tax shield approach?

Back 89

= (sales - costs) * (1-tax rate) + depreciation * tax rate

Front 90

What technique will provide the most consistently correct result?

Back 90

Net Present Value (NPV)

Front 91

What are components of project cash flow?

Back 91

Capital spending

Operating cash flow

Change in net working capital

Front 92

Soft rationing is typically internal in that the firm allocates funds to divisions for capital projects

Hard rationing implies the firm is unable to raise funds for projects

Back 92

relative to capital rationing

Front 93

Among the three main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?

Back 93

The operating cash flows from net sales over the life of the project

Front 94

The primary risk in estimation errors is the potential to ____________

Back 94

make incorrect capital budgeting decisions

Front 95

What is operating cash flow is a function of?

Back 95

Taxes

EBIT

Depreciation

Front 96

Side effects from investing in a project refer to cash flows from:

Back 96

Erosion effects

Beneficial spillover effects

Front 97

If a new project requires an investment in net working capital when it is launched, then at the end of the project, NWC will be...

Back 97

100% reversed

Front 98

If a firm's sales estimate used in its base case analysis is 1,000 units per year and they anticipate the upper and lower bounds to be +/- 15%, what is the "best case" for units sold per year?

Back 98

1150 units

Front 99

What are reasons why NPV is considered a superior capital budgeting technique?

Back 99

It considers the riskiness of the project

it properly chooses among mutually exclusive projects

it considers time value of money

it considers all the cash flows

Front 100

A positive NPV exists when the market value of a project exceeds its cost. Unfortunately, most of the time the market value of a project:

Back 100

cannot be observed

Front 101

Opportunity costs are classified as ________ costs in project analysis.

Back 101

relevant

Front 102

What are needed for cash flow estimation?

Back 102

Selling price per unit

Unit sales per period

Variable cost per unit

Front 103

Cost of equipment and rent on a production facility are examples of what type of costs?

Back 103

Fixed costs

Front 104

When using ______________, all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable.

Back 104

Sensitivity analysis

Front 105

According to the ______ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "mini-firm"

Back 105

Stand- alone

Front 106

The goals of risk analysis in capital budgeting include:

Back 106

Assessing the degree of financing risk

Identifying critical components

Front 107

Though depreciation is a non-cash expense, it is important to capital budgeting for what reasons?

Back 107

It affects a firm's annual tax liability

It determines the book value of assets which affects net salvage value

It determines taxes owed on fixed assets when they are sold

Front 108

Suppose a project's operating cash flow is $150. The firm anticipates a $30 investment in net working capital and $80 in capital spending. What is the projects' cash flow?

Back 108

$40

PCF= 150 - 30-80

Front 109

Given the following data, what is the operating cash flow?

EBIT = $80

Depr. = $20

Taxes =$30

Back 109

$70

OCF= 80+ 20 - 30