Answer Options:
a. 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.
b. The effect of a change in the market risk premium depends on the slope of the yield curve.
c. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
d. 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.
e. The effect of a change in the market risk premium depends on the level of the risk-free rate.
Answer: d
Question: Which of the following statements is CORRECT?
a. All else equal, secured debt is more risky than unsecured debt.
b. The expected return on a corporate bond must be greater than its promised return if the probability of default is greater than zero.
c. All else equal, senior debt has more default risk than subordinated debt.
d. A company’s bond rating is affected by its financial ratios but not by provisions in its indenture.
e. Under Chapter 7 of the Bankruptcy Act, the assets of a firm that declares bankruptcy must be liquidated, and the proceeds must be used to pay off claims against it according to the priority of the claims as spelled out in the Act.
Answer: e
Question: Which of the following statements is CORRECT?
a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.
b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar noncallable bond.
c. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if noncallable bonds with the same maturity were used.
d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.
e. The actual life of a callable bond will always be equal to or less than the actual life of a noncallable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.
Answer: a
Question: Which of the following statements is CORRECT?
a. One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the use of debt until the bonds mature.
b. Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.
c. Once a firm declares bankruptcy, it must be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and legal fees.
d. Income bonds must pay interest only if the company earns the interest. Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than “regular” bonds.
e. A firm with a sinking fund that gives it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.
Answer: d
Question: Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?
a. The yield curve for U.S. Treasury securities will be upward sloping.
b. A 5-year corporate bond must have a lower yield than a 5-year Treasury security.
c. A 5-year corporate bond must have a lower yield than a 7-year Treasury security.
d. The real risk-free rate cannot be constant if inflation is not expected to remain constant.
e. This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.
Answer: a
Question: Bonds A, B, and C all have a maturity of 10 years and a yield to maturity of 7%. Bond A’s price exceeds its par value, Bond B’s price equals its par value, and Bond C’s price is less than its par value. None of the bonds can be called. Which of the following statements is CORRECT?
a. If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its price.
b. Bond A has the most price risk.
c. If the yield to maturity on the three bonds remains constant, the prices of the three bonds will remain the same over the next year.
d. If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline.
e. Bond C sells at a premium over its par value.
Answer: d
Question: Which of the following factors would be most likely to lead to an increase in nominal interest rates?
a. Households reduce their consumption and increase their savings.
b. A new technology like the Internet has just been introduced, and it increases investment opportunities.
c. There is a decrease in expected inflation.
Answer: b
Question: Which of the following is a primary market transaction?
a. You sell 200 shares of IBM stock on the NYSE through your broker.
b. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker; you just give him cash and he gives you the stock.
c. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.
d. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction.
e. IBM sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years.
Answer: c
Question: Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.
True
False
Answer: False
Question: Firms generally choose to finance temporary current assets with short-term debt because
a. matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.
b. short-term interest rates have traditionally been more stable than long-term interest rates.
c. a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
d. the yield curve is normally downward sloping.
e. short-term debt has a higher cost than equity capital.
Answer Options:
a. matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.
b. short-term interest rates have traditionally been more stable than long-term interest rates.
c. a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
d. the yield curve is normally downward sloping.
e. short-term debt has a higher cost than equity capital.
Answer: a