Answer Options:
a. True
b. False
Answer: a. True
Question: The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a profit, may be estimated by determining future cash flows and then discounting them back to the present.
Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following bonds would have the greatest percentage increase in value if all interest rates in the economy fall by 1%?
a. 10-year, zero coupon bond.
b. 20-year, 10% coupon bond.
c. 20-year, 5% coupon bond.
d. 1-year, 10% coupon bond.
Answer Options:
a. False
b. False
c. False
d. False
e. True
Answer: e. True
Question: A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?
Answer Options:
a. The annual payments would be larger if the interest rate were lower.
b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.
c. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.
d. The last payment would have a higher proportion of interest than the first payment.
e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.
Answer: c. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.
Question: A portfolio’s 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.
Answer Options:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Options:
a. A time line is not meaningful unless all cash flows occur annually.
b. Time lines are not useful for visualizing complex problems prior to doing actual calculations.
c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.
d. Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.
e. Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.
Answer: c. Time lines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.
Question: You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?
Answer Options:
a. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE.
b. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.
c. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.
d. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD.
e. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.
Answer: a. A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.
Question: Restrictive covenants are designed primarily to protect bondholders by constraining the actions of managers. Such covenants are spelled out in bond indentures.
Answer Options:
a. True
b. False
Answer: a. True
Question: As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).
Answer Options:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
a. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
b. Liquidity premiums are generally higher on Treasury than corporate bonds.
c. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
d. Default risk premiums are generally lower on corporate than on Treasury bonds.
e. Reinvestment risk is lower, other things held constant, on long-term than on short-term bonds.
Answer Options:
a. False
b. False
c. False
d. False
e. True
Answer: e. True
Question: If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?
a. An upward-sloping yield curve would imply that interest rates are expected to be lower in the future.
b. If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now.
c. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond.
d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
e. Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds.
Answer Options:
Answer: d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
Question: Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that
a. Long-term interest rates are more volatile than short-term rates.
b. Inflation is expected to decline in the future.
c. The economy is not in a recession.
d. Long-term bonds are a better buy than short-term bonds.
e. Maturity risk premiums could help to explain the yield curve’s upward slope.
Answer Options:
Answer: e. Maturity risk premiums could help to explain the yield curve’s upward slope.
Question: 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.
Answer Options:
a. True
b. False
Answer: b. False
Question: Which food amounts “count as 1 cup of vegetables”? (Hints: “EAT HEALTHY” → “VEGETABLES” → “Cup of Vegetable Table”) [Note: There are more than one correct answer.]
Answer Options:
[A] 1/4 cup broccoli florets
[B] 3/4 cup cooked plantains
[C] 1 cup mashed sweet potato
[D] 1 medium carrots
[E] 2 small tomatoes
Answer: 1 cup mashed sweet potato
2 small tomatoes
Question: Is it possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.
Answer Options:
a. True
b. False
Answer: a. True
Question: The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.
a. True
b. False
Answer Options:
Answer: True
Question: Which of the following statements is CORRECT?
a. If a 10-year, $1,000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1,000 par value.
b. If a 10-year, $1,000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1,000 par value.
c. Other things held constant, including the coupon rate, a corporation would rather issue noncallable bonds than callable bonds.
d. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond because it would have a shorter expected life.
e. Bonds are exposed to both reinvestment risk and price risk. Longer-term low-coupon bonds, relative to shorter-term high-coupon bonds, are generally more exposed to reinvestment risk than price risk.
Answer Options:
a. True
b. True
c. True
d. False
e. False
Answer: b. True
Question: The slope of the SML is determined by the value of beta.
a. True
b. False
Answer Options:
Answer: False
Question: Which of the following statements is CORRECT?
a. A zero coupon bond’s current yield is equal to its yield to maturity.
b. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at par.
c. All else equal, if a bond’s yield to maturity increases, its price will fall.
d. If a bond’s yield to maturity exceeds its coupon rate, the bond will sell at a premium over par.
e. All else equal, if a bond’s yield to maturity increases, its current yield will fall.
Answer Options:
a. False
b. False
c. True
d. False
e. False
Answer: c. True
Question: Your sister is thinking about starting a new business. The company would require $375,000 of assets, and it would be financed entirely with common stock. She will go forward only if she thinks the firm can provide a 13.5% return on the invested capital, which means that the firm must have an ROE of 13.5%. How much net income must be expected to warrant starting the business?
Answer Options:
a. $41,234
b. $43,405
c. $45,689
d. $48,094
e. $50,625
Answer: e. $50,625
Question: If the pure expectations theory holds, which of the following statements is CORRECT?
a. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.
b. The yield on a 2-year corporate bond must always exceed the yield on a 2-year Treasury bond.
c. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
d. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond.
Answer Options:
Answer: b. The yield on a 2-year corporate bond must always exceed the yield on a 2-year Treasury bond.