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# Chapter 3

Riley

1. BSW Corporation has a bond issue outstanding with an annual coupon rate of 6.4
percent paid quarterly and four years remaining until maturity. The par value of the bond
is \$1,000. Determine the fair present value of the bond if market conditions justify a 13.5
percent, compounded quarterly, required rate of return. \$783.30

## Calculations (BA II PLUS Calculator):

N= (4x4)= 16
I/Y= (13.5/4)= 3.375
PMT = (6.4/4) = 1.6 =
16 FV = 1000

## 2. Calculate the yield to maturity on the following bonds.

a. A 8.1 percent coupon (paid semiannually) bond, with a \$1,000 face value and 21
years remaining to maturity. The bond is selling at \$890. 9.13%
b. An 5.2 percent coupon (paid quarterly) bond, with a \$1,000 face value and 10
years remaining to maturity. The bond is selling at \$916. 6.36%
c. An 7.2 percent coupon (paid annually) bond, with a \$1,000 face value and 8
years remaining to maturity. The bond is selling at \$1,066. 6.13%

Calculations:
a. N= (21x2) =
42 PV = -890
PMT = 81
FV = 1000
b. N= 10

c. N= 8 PV
= -1066
PMT = 72
FV = 1000

3. Calculate the fair present values of the following bonds, all of which pay interest
semiannually, have a face value of \$1,000, have 12 years remaining to maturity, and
have a required rate of return of 11.5 percent.
a. The bond has a 7.8 percent coupon rate. \$765.40
b. The bond has a 9.8 percent coupon rate. \$892.21
c. The bond has a 11.5 percent coupon rate. \$1000

Calculations:
a. N= 12
I/Y = 11.5
PMT = 78
FV = 1000
b. N= 12
I/Y = 11.5
PMT = 98
FV = 1000
c. N= 12
I/Y = 11.5
PMT = 115
FV = 1000
4. A \$1,000 par value bond with five years left to maturity pays an interest payment
semiannually with a 9 percent coupon rate and is priced to have a 8.3 percent yield to
maturity. If interest rates surprisingly increase by 0.5 percent, by how much would the
bond's price change? Bond's price DECREASED by \$19.91

Calculations:
N= 5
I/Y = 8.3
PMT = 90
FV = 1000
PV = ?
PV = 1027.73
N= 5
I/Y = 8.8 (8.3 + .05)
PMT = 90
FV = 1000
PV = ?
PV = 1007.82
1027.73-1007.82 = 19.91

5. A preferred stock from Hecla Mining Co. (HLPRB) pays \$2.40 in annual dividends. If the
required rate of return on the preferred stock is 6 percent, what is the fair present value
of the stock? \$40

Calculations:
P1 = [D0 (1+g)]/(i-g)
= 2.40/.06 = 40

6. Financial analysts forecast Limited Brands (LTD) growth for the future to be 11.2 percent.
LTD's most recent dividend was \$1.10. What is the fair present value of Limited Brands's
stock if the required rate of return is 15.2 percent? \$30.58

Calculations:
P1 = [D0 (1+g)]/(i-g)
= [1.10 (1+.112)] / (.152-.112)
= 30.58

7. A stock you are evaluating just paid an annual dividend of \$3.60. Dividends have grown
at a constant rate of 1.2 percent over the last 15 years and you expect this to continue.
a. If the required rate of return on the stock is 13.7 percent, what is its fair present
value? \$29.15
b. If the required rate of return on the stock is 16.7 percent, what should the fair
value be four years from today? \$24.65

Calculations:
a. P1 = [D0 (1+g)]/(i-g)
= [3.60 (1+.012)] / (.137-.012)
= 29.15
b. P4= [\$3.60(1 + 0.012)^5] / (0.167 − 0.012) = 24.65

8. A company recently paid a \$1.00 dividend. The dividend is expected to grow at a 15.7
percent rate. At a current stock price of \$89.29, what return are shareholders expecting?
17.00%

Calculations:
P1 = [D0 (1+g)]/(i-g)
89.29= [1.00 (1+.157)]/ (i-.157)
89.29(i-.157) = 1.157
i-.157 = .0129
i=.1699
9.
a. What is the duration of a two-year bond that pays an annual coupon of 10.4
percent and has a current yield to maturity of 12.5 percent? Use \$1,000 as the
face value. 1.90 years
b. What is the duration of a two-year zero-coupon bond that is yielding 11.5 percent?
Use \$1,000 as the face value. 2 years

Calculations:
a. Year 1 CF = 104
1/(1+0.125)^t = 0.8889
PV of CF = 92.44

PV of CF x t =
92.44 Year 2
CF = 1104
1/(1+0.125)^t = 0.7901
PV of CF = 872.30 PV
of CF x t = 1744.59
PV of CF for year 1 and 2 = 964.74
PV of CF x t for year 1 and 2 = 1837.04
Duration = 1837.04/964.74 = 1.9042 years
b. zero coupon bond = year to maturity

## 10. Consider the following.

a. What is the duration of a four-year Treasury bond with a 5.5 percent semiannual
coupon selling at par? 3.64 years
b. What is the duration of a three-year Treasury bond with a 5.5 percent semiannual
coupon selling at par? 2.81 years
c. What is the duration of a two-year Treasury bond with a 5.5 percent semiannual
coupon selling at par? 1.92 years
Calculations:
a. 3644.70/1000 = 3.64
b. 2806.29/1000 = 2.81
c. 1921.13/1000 = 1.92
11. You have discovered that when the required rate of return on a bond you own fell by 0.5
percent from 9.1 percent to 8.6 percent, the fair present value rose from \$955 to \$965.
What is the duration of this bond? Assume annual payments. 2.3 years

Calculations:
We know −D = [ΔPb/Pb]/[Δrb/(1+ rb)], so −D = (10/955)/(−0.005/1.091) = −2.28 years;
D = 2.3 years.

1. Duration is the weighted average time to maturity of the bond's cash flows.

2. Which of the following bond terms are generally positively related to bond price volatility?

## I. Coupon rate II.

Maturity
III.YTM
IV. Payment frequency

II only

3. A security has an expected return less than its required return. This security is selling
for more than its PV.

## 4. You would want to purchase a security if P ≤ PV or E(r) ≥ r.

5. A 10-year annual payment corporate bond has a market price of \$1,050. It pays annual
interest of \$100 and its required rate of return is 9 percent. By how much is the bond
mispriced? Underpriced by \$14.18

6. A 12-year annual payment corporate bond has a market price of \$925. It pays annual
interest of \$60 and its required rate of return is 7 percent. By how much is the bond
mispriced? Overpriced by \$4.43

7. An eight-year corporate bond has a 7 percent coupon rate. What should be the bond's
price if the required return is 6 percent and the bond pays interest semiannually?
\$1,062.81

8. A corporate bond has a coupon rate of 10 percent and a required return of 10 percent.
This bond's price is \$1,000.00.

9. A 10-year annual payment corporate coupon bond has an expected return of 11 percent
and a required return of 10 percent. The bond's market price is less than its PV.

10. An eight-year annual payment 7 percent coupon Treasury bond has a price of \$1,075.
The bond's annual E(r) must be 5.80 percent.

11. Corporate Bond A returns 5 percent of its cost in PV terms in each of the first five years
and 75 percent of its value in the sixth year. Corporate Bond B returns 8 percent of its
cost in PV terms in each of the first five years and 60 percent of its cost in the sixth year.
If A and B have the same required return, which of the following is/are true?

## I. Bond A has a bigger coupon than Bond B.

II.Bond A has a longer duration than Bond B.
III.Bond A is less price-volatile than Bond B.
IV. Bond B has a higher FPV than Bond A.

II and IV only

12. A corporate bond returns 12 percent of its cost (in PV terms) in the first year, 11 percent
in the second year, 10 percent in the third year and the remainder in the fourth year.
What is the bond's duration in years? 3.32 years

13. A semiannual payment bond with a \$1,000 par has a 7 percent quoted coupon rate, a 7
percent promised YTM, and 10 years to maturity. What is the bond's duration? 7.35
years

14. If an N year security recovered the same percentage of its cost in PV terms each year,
the duration would be sum of the years/N.

15. You bought a stock three years ago and paid \$45 per share. You collected a \$2 dividend
per share each year you held the stock and then you sold the stock for \$47 per share.
What was your annual compound rate of return? 5.84 percent

16. A four-year maturity 0 percent coupon corporate bond with a required rate of return of 12
percent has an annual duration of 4.00 years.

## 17. A decrease in interest rates will increase the bond's duration.

18. A six-year maturity bond has a five-year duration. Over the next year maturity will decline
by one year and duration will decline by less than one year.

19. An annual payment bond has a 9 percent required return. Interest rates are projected to
fall 25 basis points. The bond's duration is 12 years. What is the predicted price change?
2.75 percent

Candru

## 1. The required rate of return on a bond is

A. the interest rate that equates the current market price of the bond with the
present value of all future cash flows received.
B. equivalent to the current yield for non-par bonds.
C. less than the E(r) for discount bonds and greate than the E(r) for premium bonds.
D. inversely related to a bond's risk and coupon.
E. none of the options.

2. Duration is
A. the elasticity of a security's value to small coupon changes.
B. the weighted average time to maturity of the bond's cash flows.
C. the time until the investor recovers the price of the bond in today's dollars.
D. greater than maturity for deep discount bonds and less than maturity for premium
bonds.
E. the second derivative of the bond price formula with respect to the YTM.

3. Which of the following bond terms are generally positively related to bond price volatility?

## I. Coupon rate II.

Maturity
III.YTM
IV. Payment frequency

A. II and IV only
B. I and III only
C. II and III only
D. II only
E. II, III, and IV only

4. The interest rate used to find the present value of a financial security is the
A. expected rate of return.
B. required rate of return.
C. realized rate of return.
D. realized yield to maturity.
E. current yield.

5. A security has an expected return less than its required return. This security is
A. selling at a premium to par.
B. selling at a discount to par.
C. selling for more than its PV.
D. selling for less than its PV.
E. a zero coupon bond.

6. A bond that you held to maturity had a realized return of 8 percent, but when you bought
it, it had an expected return of 6 percent. If no default occurred, which one of the
following must be true?
A. The bond was purchased at a premium to par.
B. The coupon rate was 8 percent.
C. The required return was greater than 6 percent.
D. The coupons were reinvested at a higher rate than expected.
E. The bond must have been a zero coupon bond.

## 7. You would want to purchase a security if P ____________ PV or E(r) ____________ r.

A. ≥; ≤
B. ≥; ≥
C. ≤; ≥
D. ≤; ≤
8. A 10-year annual payment corporate bond has a market price of \$1,050. It pays annual
interest of \$100 and its required rate of return is 9 percent. By how much is the bond
mispriced?
A. \$0.00
B. Overpriced by \$14.18
C. Underpriced by \$14.18
D. Overpriced by \$9.32
E. Underpriced by \$9.32

9. A 12-year annual payment corporate bond has a market price of \$925. It pays annual
interest of \$60 and its required rate of return is 7 percent. By how much is the bond
mispriced?
A. \$0.00
B. Overpriced by \$7.29
C. Underpriced by \$7.29
D. Overpriced by \$4.43
E. Underpriced by \$4.43

10. An eight-year corporate bond has a 7 percent coupon rate. What should be the bond's
price if the required return is 6 percent and the bond pays interest semiannually?
A. \$1,062.81
B. \$1,062.10
C. \$1,053.45
D. \$1,052.99
E. \$1,049.49

11. A 15-year corporate bond pays \$40 interest every six months. What is the bond's price if
the bond's promised YTM is 5.5 percent?
A. \$1,261.32
B. \$1,253.12
C. \$1,250.94
D. \$1,263.45
E. \$1,264.79

12. A corporate bond has a coupon rate of 10 percent and a required return of 10 percent.
This bond's price is
A. \$924.18.
B. \$1,000.00.
C. \$879.68.
D. \$1,124.83.
E. not possible to determine from the information given.

13. A 10-year annual payment corporate coupon bond has an expected return of 11 percent
and a required return of 10 percent. The bond's market price is
A. greater than its PV.
B. less than par.
C. less than its E(r).
D. less than its PV.
E. \$1,000.00.

14. An eight-year annual payment 7 percent coupon Treasury bond has a price of \$1,075.
The bond's annual E(r) must be
A. 13.49 percent.
B. 5.80 percent.
C. 7.00 percent.
D. 1.69 percent.
E. 4.25 percent.
15. A six-year annual payment corporate bond has a required return of 9.5 percent and an 8
percent coupon. Its market value is \$20 over its PV. What is the bond's E(r)?

A. 8.00 percent
B. 10.21 percent
C. 9.98 percent
D. 9.03 percent
E. 3.53 percent

16. Corporate Bond A returns 5 percent of its cost in PV terms in each of the first five years
and 75 percent of its value in the sixth year. Corporate Bond B returns 8 percent of its
cost in PV terms in each of the first five years and 60 percent of its cost in the sixth year.
If A and B have the same required return, which of the following is/are true?

## I. Bond A has a bigger coupon than Bond B.

II.Bond A has a longer duration than Bond B.
III.Bond A is less price-volatile than Bond B.
IV. Bond B has a higher FPV than Bond A.

A. III only
B. I, III, and IV only
C. I, II, and IV only
D. II and IV only
E. I, II, III, and IV

17. A corporate bond returns 12 percent of its cost (in PV terms) in the first year, 11 percent
in the second year, 10 percent in the third year and the remainder in the fourth year.
What is the bond's duration in years?
A. 3.68 years
B. 2.50 years
C. 4.00 years
D. 3.75 years
E. 3.32 years

18. A semiannual payment bond with a \$1,000 par has a 7 percent quoted coupon rate, a 7
percent promised YTM, and 10 years to maturity. What is the bond's duration?
A. 10.00 years
B. 8.39 years
C. 6.45 years
D. 5.20 years
E. 7.35 years

19. An annual payment bond with a \$1,000 par has a 5 percent quoted coupon rate, a 6
percent promised YTM, and six years to maturity. What is the bond's duration?
A. 5.31 years
B. 5.25 years
C. 4.76 years
D. 4.16 years
E. 3.19 years

20. If an N year security recovered the same percentage of its cost in PV terms each year,
the duration would be
A. N.
B. 0.
C. sum of the years/N.
D. N!/N2.
E. none of the options.
21. The ___________ the coupon and the ______________ the maturity; the __________
the duration of a bond, ceteris paribus.
A. larger; longer; longer
B. larger; longer; shorter
C. smaller; shorter; longer
D. smaller; shorter; shorter
E. None of the options presented

22. You bought a stock three years ago and paid \$45 per share. You collected a \$2 dividend
per share each year you held the stock and then you sold the stock for \$47 per share.
What was your annual compound rate of return?
A. 8.89 percent
B. 8.51 percent
C. 5.84 percent
D. 4.44 percent
E. 2.96 percent

23. A four-year maturity 0 percent coupon corporate bond with a required rate of return of 12
percent has an annual duration of _______________ years.
A. 3.05
B. 2.97
C. 3.22
D. 3.71
E. 4.00

## 24. A decrease in interest rates will

A. decrease the bond's PV.
B. increase the bond's duration.
C. lower the bond's coupon rate.
D. change the bond's payment frequency.
E. not affect the bond's duration.

25. A 10-year maturity coupon bond has a six-year duration. An equivalent 20-year bond
with the same coupon has a duration
A. equal to 12 years.
B. less than six years.
C. less than 12 years.
D. equal to six years
E. greater than 20 years.

26. A six-year maturity bond has a five-year duration. Over the next year maturity will decline
by one year and duration will decline by
A. less than one year.
B. more than one year.
C. one year.
D. N years.
E. N/(N-1) years.

27. An annual payment bond has a 9 percent required return. Interest rates are projected to
fall 25 basis points. The bond's duration is 12 years. What is the predicted price change?
A. -2.75 percent
B. 33.33 percent
C. 1.95 percent
D. -1.95 percent
E. 2.75 percent
28. A bond that pays interest annually has a 6 percent promised yield and a price of \$1,025.
Annual interest rates are now projected to fall 50 basis points. The bond's duration is six
years. What is the predicted new bond price after the interest rate change? (Watch your
rounding.)
A. \$1,042.33
B. \$995.99
C. \$1,054.01
D. \$987.44
E. None of the options presented

29. A bond that pays interest semiannually has a 6 percent promised yield and a price of
\$1,045. Annual interest rates are now projected to increase 50 basis points. The bond's
duration is five years. What is the predicted new bond price after the interest rate change?
A. \$1,020.35
B. \$1,069.65
C. \$1,070.36
D. \$1,019.64
E. None of the options presented

## 30. Convexity arises because

A. bonds pay interest semiannually.
B. coupon changes are the opposite sign of interest rate changes.
C. duration is an increasing function of maturity.
D. present values are a nonlinear function of interest rates.
E. duration increases at higher interest rates.

## 31. The duration of a 180-day T-Bill is (in years)

A. 0.493.
B. 0.246.
C. 1.
D. 0.
E. indeterminate.

32. For large interest rate increases, duration _____________ the fall in security prices, and
for large interest rate decreases, duration ______________ the rise in security prices.
A. overpredicts; overpredicts
B. overpredicts; underpredicts
C. underpredicts; overpredicts
D. underpredicts; underpredicts
E. None of the options presented

Kaywood

## 1. The dividend yield is defined as:

A. the current annual cash dividend divided by the current market price per share.
B. the current annual cash dividend divided by the current book value per share.
C. next year's expected cash dividend divided by the current market price per share.
D. next year's expected cash dividend divided by the current book value per share.
E. next year's expected cash dividend divided by next year's expected market
price per share.

## 2. The capital gains yield equals which one of the following?

A. Total yield
B. Current discount rate
C. Market rate of return
D. Dividend yield
E. Dividend growth rate
3. Kate could not attend the last shareholders meeting and thus she granted the authority
to vote on her behalf to the managers of the firm. Which one of the following terms is
used to describe the method by which Kate's shares were voted?
A. Straight
B. Cumulative
C. Consent-form
D. Proxy
E. In absentia

4. What is the market called that allows shareholders to resell their shares to other
investors?
A. Primary
B. Proxy
C. Secondary
D. Inside
E. Initial

## 5. The price of a stock at year 4 can be expressed as:

A. D0 / (R + G4).
B. D0 × (1 + R)5.
C. D1 × (1 + R)5.
D. D4/(R-g).
E. D5/(R-g).

6. The required return on a stock is equal to which one of the following if the dividend on
the stock decreases by 1 percent per year?
A. (P0/D1)-g
B. (D1/P0)/g
C. Dividend yield + capital gains yield
D. Dividend yield - capital gains yield
E. Dividend yield × capital gains yield

7. Computing the present value of a growing perpetuity is most similar to computing the
current value of which one of the following?
A. Non-dividend-paying stock
B. Stock with a constant dividend
C. Stock with irregular dividends
D. Stock with a constant growth dividend
E. Stock with growing dividends for a limited period of time

8. The Glass Ceiling paid an annual dividend of \$2.20 per share last year. Management
just announced that future dividends will increase by 2.8 percent annually. What is the
amount of the expected dividend in year 5?
A. \$2.39
B. \$2.41
C. \$2.46
D. \$2.53
E. \$2.58

9. The Pancake House pays a constant annual dividend of \$1.25 per share. How much are
you willing to pay for one share if you require a 15 percent rate of return?
A. \$7.86
B. \$8.33
C. \$10.87
D. \$11.04
E. \$11.38
10. Klaus Toys just paid its annual dividend of \$1.40. The required return is 16 percent and
the dividend growth rate is 2 percent. What is the expected value of this stock five years
from now?
A. \$11.04
B. \$11.26
C. \$11.67
D. \$12.41
E. \$12.58

11. Blackwell Ink is losing significant market share and thus its managers have decided to
decrease the firm's annual dividend. The last annual dividend was \$0.90 a share but all
future dividends will be decreased by 5 percent annually. What is a share of this stock
worth today at a required return of 15 percent?
A. \$4.07
B. \$4.28
C. \$4.49
D. \$4.72
E. \$4.95

12. The common stock of Tasty Treats is valued at \$10.80 a share. The company increases
its dividend by 8 percent annually and expects its next dividend to be \$0.20 per share.
What is the total rate of return on this stock?
A. 8.64 percent
B. 9.12 percent
C. 9.40 percent
D. 9.85 percent
E. 10.64 percent

13. Which one of the following types of securities has no priority in a bankruptcy proceeding?
A. Convertible bond
B. Senior debt
C. Common stock
D. Preferred stock
E. Straight bond

14. Newly issued securities are sold to investors in which one of the following markets
A. Proxy
B. Stated value
C. Inside
D. Secondary
E. Primary

## 15. To be a member of the NYSE, you must:

A. be a primary dealer.
B. buy a seat.
D. be registered as a floor trader.
E. be a specialist.

## 16. Discounted cash flow valuation is the process of discounting an investment's:

A. assets.
B. future profits.
C. liabilities.
D. costs.
E. future cash flows.
17. The payback period is the length of time it takes an investment to generate sufficient
cash flows to enable the project to:

## A. produce a positive annual cash flow.

B. produce a positive cash flow from assets.
C. offset its fixed expenses.
D. offset its total expenses.
E. recoup its initial cost.

18. Which one of the following defines the internal rate of return for a project?
A. Discount rate that creates a zero cash flow from assets
B. Discount rate which results in a zero net present value for the project
C. Discount rate which results in a net present value equal to the project's initial cost
D. Rate of return required by the project's investors
E. The project's current market rate of return

## 19. Which one of the following can be defined as a benefit-cost ratio?

A. Net present value
B. Internal rate of return
C. Profitability index
D. Accounting rate of return
E. Modified internal rate of return

20. The greater the standard deviation, the greater the risk

## 21. The net present value:

A. decreases as the required rate of return increases.
B. is equal to the initial investment when the internal rate of return is equal to the
required return.
C. method of analysis cannot be applied to mutually exclusive projects.
D. is directly related to the discount rate.
E. is unaffected by the timing of an investment's cash flows.

22. Which one of the following is generally considered to be the best form of analysis if you
have to select a single method to analyze a variety of investment opportunities?
A. Payback
B. Profitability index
C. Accounting rate of return
D. Internal rate of return
E. Net present value

## 23. Which one of the following statements is correct?

A. The net present value is a measure of profits expressed in today's dollars.
B. The net present value is positive when the required return exceeds the internal
rate of return.
C. If the initial cost of a project is increased, the net present value of that project will
also increase.
D. If the internal rate of return equals the required return, the net present
value will equal zero.
E. Net present value is equal to an investment's cash inflows discounted to today's
dollars.

## 24. Which one of the following statements is correct?

A. A longer payback period is preferred over a shorter payback period.
B. The payback rule states that you should accept a project if the payback period is
less than one year.
C. The payback period ignores the time value of money.
D. The payback rule is biased in favor of long-term projects.
E. The payback period considers the timing and amount of all of a project's cash
flows.
25. An investment has conventional cash flows and a profitability index of 1.0. Given this,
which one of the following must be true?
A. The internal rate of return exceeds the required rate of return.
B. The investment never pays back.
C. The net present value is equal to zero.
D. The average accounting return is 1.0.
E. The net present value is greater than 1.0.

## 26. Which one of the following is an indicator that an investment is acceptable?

A. Modified internal rate of return equal to zero
B. Profitability index of zero
C. Internal rate of return that exceeds the required return
D. Payback period that exceeds the required period
E. Negative average accounting return

27. The internal rate of return is unreliable as an indicator of whether or not an investment
should be accepted given which one of the following?
A. One of the time periods within the investment period has a cash flow equal to
zero
B. The initial cash flow is negative
C. The investment has cash inflows that occur after the required payback period
D. The investment is mutually exclusive with another investment under
consideration
E. The cash flows are conventional

28. A project has expected cash inflows, starting with year 1, of \$2,200, \$2,900, \$3,500 and
finally in year four, \$4,000. The profitability index is 1.14 and the discount rate is 12
percent. What is the initial cost of the project?
A. \$7,899.16
B. \$8,098.24
C. \$8,166.19
D. \$9,211.06
E. \$9,250.00

29. You are considering the following two mutually exclusive projects. The required return on
each project is 14 percent. Which project should you accept and what is the best reason
for that decision?
A. Project A; because it pays back faster
B. Project A; because it has the higher profitability index
C. Project B; because it has the higher profitability index
D. Project A; because it has the higher net present value
E. Project B; because it has the higher net present value

## 30. Consider the following two mutually exclusive projects:

Whichever project you choose, if any, you require a 14 percent return on your
investment. If you apply the payback criterion, you will choose investment _____, if you
apply the NPV criterion, you will choose investment _____; if you apply the IRR criterion,
you will choose investment ____; if you choose the profitability index criterion, you will
choose investment ____. Based on your first four answers, which project will you finally
choose?

A. A; B; A; A; B
B. A; A; B; B; A
C. A; A; B; B; B
D. B; A; B; A; A
E. B; A; B; B; A
31. Which one of the following is true if the managers of a firm only accept projects that have
a profitability index greater than 1.5?
A. The firm should increase in value each time the firm accepts a new project.
B. The firm is most likely steadily losing value.
C. The price of the firm's stock should remain constant.
D. The net present value of each new project is zero.
E. The internal rate of return on each new project is zero.

32. Based on the most recent survey information presented in your textbook, CFOs tend to
use which two methods of investment analysis the most frequently?
A. Payback and net present value
B. Payback and internal rate of return
C. Internal rate of return and net present value
D. Net present value and profitability index
E. Profitability index and internal rate of return

33. Mary has just been asked to analyze an investment to determine if it is acceptable.
Unfortunately, she is not being given sufficient time to analyze the project using various
methods. She must select one method of analysis and provide an answer based solely
on that method. Which method do you suggest she use in this situation?
A. Internal rate of return
B. Payback
C. Average accounting rate of return
D. Net present value
E. Profitability index

34. What is the NPV of the following set of cash flows at a discount rate of zero percent?
What if the discount rate is 15 percent?
A. \$41,700; -\$8,665.07
B. \$41,700; \$1,208.19
C. \$0; \$1,208.19
D. \$2,500; \$1,208.19
E. \$2,500; -\$8,665.07

35. Baker's Supply imposes a payback cutoff of 3.5 years for its international investment
projects. If the company has the following two projects available, should it accept either
of them?
A. Accept both Projects A and B
B. Accept Project A but not Project B
C. Accept Project B but not Project A
D. Both Project A and B are acceptable but you can only select one project
E. Reject both Projects A and B

36. The Tool Box needs to purchase a new machine costing \$1.46 million. Management is
estimating the machine will generate cash inflows of \$223,000 the first year and
\$600,000 for the following three years. If management requires a minimum 12 percent
rate of return, should the firm purchase this particular machine? Why or why not?
A. Yes; because the IRR is 10.75 percent
B. Yes; because the IRR is 12.74 percent
C. No; because the IRR is 10.75 percent
D. No; because the IRR is 12.74 percent
E. The answer cannot be determined as there are multiple IRRs.

37. Which one of the following is the positive square root of the variance?
A. Standard deviation
B. Mean
C. Risk-free rate
D. Average return
E. Real return
38. Investors require a 4 percent return on risk-free investments. On a particular risky
investment, investors require an excess return of 7 percent in addition to the risk-free
rate of 4 percent. What is this excess return called?
B. Required return
C. Real return
D. Average return

39. Which one of the following is defined as a bell-shaped frequency distribution that is
defined by its average and its standard deviation?
A. Arithmetic average return
B. Variance
C. Standard deviation
D. Probability curve
E. Normal distribution

40. Over the period of 1926-2008, which one of the following investment classes had the
highest volatility of returns?
A. Large-company stocks
B. U.S. Treasury bills
C. Small-company stocks
D. Long-term corporate bonds
E. Long-term government bonds

## 41. Over the period of 1926-2008:

A. the risk premium on large-company stocks was greater than the risk premium on
small- company stocks.
B. U.S. Treasury bills had a risk premium that was just slightly over 2 percent.
C. the risk premium on long-term government bonds was zero percent.
D. the risk premium on stocks exceeded the risk premium on bonds.
E. U. S. Treasury bills had a negative risk premium.

42. The rate of return on which one of the following is used as the risk-free rate?
A. Long-term government bonds
B. Long-term corporate bonds
C. Inflation, as measured by the Consumer Price Index
D. U.S. Treasury bill
E. Large-company stocks

43. Which one of the following categories has the widest frequency distribution of returns for
the period 1926-2008?
A. Small-company stocks
B. U.S. Treasury bills
C. Long-term government bonds
D. Inflation
E. Large-company stock

44. The standard deviation measures the _____ of a security's returns over time.
A. average value
B. frequency
C. volatility
D. mean
E. arithmetic average
45. New Labs just announced that it has received a patent for a product that will eliminate all
flu viruses. This news is totally unexpected and viewed as a major medical advancement.
Which one of the following reactions to this announcement indicates the market for New
Labs stock is efficient?
A. The price of New Labs stock remains unchanged.
B. The price of New Labs stock increases rapidly and then settles back to its pre-
announcement level.
C. The price of New Labs stock increases rapidly to a higher price and then
remains at that price.
D. All stocks quickly increase in value and then all but New Labs stock fall back to
their original values.
E. The value of all stocks suddenly increase and then level off at their higher values.

46. A stock has yielded returns of 6 percent, 11 percent, 14 percent, and -2 percent over the
past 4 years, respectively. What is the standard deviation of these returns?
A. 5.52 percent
B. 5.86 percent
C. 6.05 percent
D. 6.47 percent
E. 6.99 percent

47. You purchased 1,300 shares of LKL stock 5 years ago and have earned annual returns
of 7.1 percent, 11.2 percent, 3.6 percent, -4.7 percent and 11.8 percent. What is your
arithmetic average return?
A. 4.47 percent
B. 5.80 percent
C. 6.23 percent
D. 6.47 percent
E. 6.98 percent

48. Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that
stock. Which one of the following best describes the 16.5 percent rate?
A. Expected return
B. Real return
C. Market rate
D. Systematic return

## 49. Which one of the following best describes a portfolio?

A. Risky security
B. Security equally as risky as the overall market
C. New issue of stock
D. Group of assets held by an investor
E. Investment in a risk-free security

50. Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms
applies to the 28 percent?
A. Portfolio variance
B. Portfolio standard deviation
C. Portfolio weight
D. Portfolio expected return
E. Portfolio beta

## 51. Which one of the following describes systemic risk?

A. Risk that affects a large number of assets
B. An individual security's total risk
C. Diversifiable risk
D. Asset specific risk
E. Risk unique to a firm's management
52. The systematic risk principle states that the expected return on a risky asset depends
only on which one of the following?
A. Unique risk
B. Diversifiable risk
C. Asset-specific risk
D. Market risk
E. Unsystematic risk

53. Which one of the following measures the amount of systematic risk present in a
particular risky asset relative to that in an average risky asset?
A. Squared deviation
B. Beta coefficient
C. Standard deviation
D. Mean
E. Variance

## 54. Which one of the following is an example of systematic risk?

A. Major layoff by a regional manufacturer of power boats
B. Increase in consumption created by a reduction in personal tax rates
C. Surprise firing of a firm's chief financial officer
D. Closure of a major retail chain of stores
E. Product recall by one manufacturer

55. Which one of the following portfolios will have a beta of zero?
A. A portfolio that is equally as risky as the overall market.
B. A portfolio that consists of a single stock.
C. A portfolio comprised solely of U. S. Treasury bills.
D. A portfolio with a zero variance of returns.
E. No portfolio can have a beta of zero.

## 56. Portfolio diversification eliminates which one of the following?

A. Total investment risk
B. Portfolio risk premium
C. Market risk
D. Unsystematic risk
E. Reward for bearing risk

## 57. Systematic risk is:

A. totally eliminated when a portfolio is fully diversified.
B. defined as the total risk associated with surprise events.
C. risk that affects a limited number of securities.
D. measured by beta.
E. measured by standard deviation.

58. Worth While Entertainment has common stock with a beta of 1.46. The market risk
premium is 9.1 percent and the risk-free rate is 4.6 percent. What is the expected return
on this stock?
A. 16.31 percent
B. 16.67 percent
C. 17.40 percent
D. 17.89 percent
E. 18.23 percent

59. A stock has a beta of 1.68, the expected return on the market is 14.72, and the risk-free
rate is 4.65. What must the expected return on this stock be?
A. 15.67 percent
B. 16.75 percent
C. 17.10 percent
D. 18.46 percent
E. 21.57 percent
Ismariew

1. What are the two key lessons from capital market history?
1.1. There is a reward for bearing risk
1.2. The greater the potential reward, the greater the risk

## 3. Capital Gains = Price Received - Price Paid

4. % Return = \$Return/\$Invested

## 7. Risk is measured by the dispersion, spread or volatility of returns.

8. Geometric average < Arithmetic average unless all returns are equal.

## 10. The geometric average is overly pessimistic for short horizons

11. If the Efficient Market Hypothesis is true you should NOT be able to earn "abnormal"
or "excess" returns

12. Efficient markets do NOT imply that investors cannot earn a positive return in the
stock market

13. In Strong Form Efficiency, prices reflect all information, including public and private

14. In Strong Form Efficiency, investors can NOT earn abnormal returns regardless of
the information they possess

15. Empirical evidence indicates that markets are NOT Strong Form Efficient.

## 16. In Semi-Strong Form Efficiency, prices reflect all publicly available

information,trading information, annual reports, press releases, etc.

17. In Semi-Strong Efficiency, investors can NOT earn abnormal returns by trading on
public information

18. Semi-Strong Efficiency implies that fundamental analysis will not lead to abnormal
returns

19. In Weak-Form Efficiency, prices reflect all past market information such as price and
volume

20. In Weak-Form Efficiency, investors can NOT earn abnormal returns by trading on
market information

21. Weak-Form Efficiency implies that technical analysis will not lead to abnormal
returns

22. Empirical evidence indicated that markets are generally Weak Form Efficient.

23. Efficient Market Hypothesis does NOT mean that you can't make money
24. Efficient Market Hypothesis does mean that on average, you will earn a return
appropriate for the risk undertaken, there is no bias in prices that can be exploited
to earn excess returns, market efficiency will not protect you from wrong choices
if you do not diversify (you still don't want to put al your eggs in one basket)

25. Studying market history can reward us by demonstrating that There is a reward for
bearing risk, The greater the potential reward is, the greater the risk

26. The two potential ways to make money as a stockholder are through dividends and
capital appreciation

27. Dividends are the income component of the total return from investing in a stock.

## 28. A capital gain on a stock results from an increase in the price

29. The total dollar return on a stock is the sum of dividends and capital gains

30. The dividend yield for a one-year period is equal to the annual dividend amount divided
by the beginning stock price

31. The capital gain yield can be found by finding the difference between the ending stock
price and the initial stock price and dividing it by the initial stock price

32. Suppose you bought 100 shares of Banks & Bower, Inc. for \$50 a share. During the year
B&B paid a \$0.50 per share dividend. At year end, B&B was selling for \$60 a share.
What is your total percentage return? 21%

(60-50+0.50)/50

33. The Ibbotson-Sinquefield data show that over long-term small-company stocks had
the highest risk level, T-bills, which had lowest risk, generated lowest return and
small-company stocks generated the highest average return

34. Treasury Bills yielded a nominal average return over 86 years of 3.6% versus an
average inflation rate of 3.1% over the same period. This makes the real return on T-bills
equal to: 0.5%

(3.6-23.1%)=0.5%

35. The risk-return relationship states that a riskier investment should demand a higher
return.

## 37. The standard deviation is the square root of the variance.

38. An efficient market is one in which any change in available information will be reflected
in the company's stock price immediately

39. The efficient markets hypothesis contends that well-organized capital markets such as
the NYSE are efficient.

## 40. When a company declares a dividend, shareholders generally receive cash

41. You buy a stock for \$100. In one year its price rises to \$114, and it pays a \$1 dividend.
Your capital gains yield is: 14%

(\$114-100)/\$100

42. The percentage change in the price of a stock over a period of time is called its capital
gain yield
43. One year ago, Ernie purchased shares of RTF common stock for \$100 a share. Today
the stock paid a dividend of \$1 per share. If the stock currently sells for \$114 per share,
what is Ernie's total return? 15%

(\$114-100+1)/\$100

44. The Ibbotson-Singquefield data shows that U.S. T-Bills had the lowest risk or
variability and Long-term corporate bonds had less risk or variability than stocks

45. Historically, the real return on Treasury bills has been quite low

46. The excess return is the difference between the rate of return on a risky asset and the
risk-free rate.

47. A share of common stock currently sells for \$100 and will pay a dividend of \$2 at the
end of the year. If the price is expected to increase to \$113 at the end of one year, what
is the stock's current dividend yield? 2%

(\$2/\$100)

48. Treasury Bills yielded a nominal average over 86 years of 3.6% versus an average
inflation rate of 3.1% over the same period. This makes the real return on T-bills
approximately equal to: 5%

49. You buy a stock for %50. Its price rises to \$55, and it pays a \$2 dividend in a year. You
do not sell the stock. Your dividend yield is: 4%

(\$2/\$50)

50. Arrange the following investments from highest to lowest risk (standard deviation) based
on what our study of capital market history from 1926-2011 has revealed:
1. small-company common stock
2. large-company common stocks
3. long-term corporate bonds
4. long-term government bonds
5. U.S. treasury bills

51. 2008 was a bad year for markets worldwide. One of the worst hit was the Icelandic
Exchange where shares priced dropped 76% in one day.

52. Two ways of calculating average returns are the arithmetic average and the
geometric average.

53. In an efficient market, firms should expect to receive fair value for the securities they sell.

54. The geometric average rate of return is approximately equal to the arithmetic mean
minus half of the variance

55. The second lesson from studying capital market history is that risk is handsomely
rewarded

56. If stock GHI has returns of 6% and -2% over 2 years, the geometric average rate of
return is: 1.92%

[(1.06)(0.98)]^.5-1

57. If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent,
then the probability of earning a negative return is approximately 2.5 percent.

## 58. In 2008, the S&P 500 plunged 37%.

59. What is the arithmetic average for a stock that had annual returns of 8%, 2%, and 11%
for the past three years? 7%

60. Which of the following are needed to describe the distribution of stock returns? the
mean return and the standard deviation of returns

61. In 2008, the prices on long-term U.S. Treasury bonds gained 40%

62. Which of the following are true? common stocks frequently experience negative
returns and T-Bills sometimes outperform common stocks

63. If you use a geometric average to project short-run wealth levels, your results will most
likely be pessimistic

64. The year 2008 was one of the worst years for stock market investors in U.S. history

65. Percentage returns are more convenient that dollar returns because they apply to any
amount invested and allow comparison against other investments

66. If stock ABC has a return of 10 percent with a standard deviation of 5 percent, the the
probability of earning a return greater than 15 percent is about 16 percent.

Prob(R>15%)= (1-.68)/2=16%

67. If a stock has returns of 10 percent and 20 percent over 2 years, the geometric average
rate of return can be calculated by [(1.10)(1.20)]^.5-1

68. Bonds were a bright spot for U.S. investors during 2008.

69. What type of stock price adjustment time path occurs when there is a bubble (price run
up) in the path followed by a decline after the market receives information about the
stock? overreaction and correction

70. The average return on the stock market can be used to compare stock returns with
the returns on other securities

71. The probability of a return being +/ one standard deviation of the mean in a normal
distribution is approximately 68 percent.

72. Bonds used in Ibbotson-Sinquefield's long-term U.S. government bond portfolio had
maturities of 20 years.

73. In the Ibbotson-Sinquefield studies, U.S. treasury bills data is based on T-bills with a
maturity of one month(s).

## 74. The geometric rate of return takes compounding into account.

75. If the dispersion of returns on a particular security is very spread out form the security's
mean return, the security is highly risky

76. From 1900 to 2010, the US ranked in the middle when compared internationally in
terms of highest equity risk premium.

77. If the annual stock market returns from Berry Company were 19 percent, 13 percent,
and -8 percent, what was the arithmetic mean for those 3 years? 8%

78. If your total dollar return was \$7 and your divided was \$2, then the price change on your
stock must have been +\$5

79. More volatility in returns produces a larger difference between the arithmetic and
geometric averages.
80. What will the dividend income be on 1,000 shares of XYZ stock if XYZ distributes \$.20
per share dividend? \$200

## \$.20 X 1,000 = \$200

81. If stock ABC has a mean return of 10 percent with a standard deviation of 5 percent,
then the probability of earning a negative return is approximately 2.5 percent.

82. The price of a stock drops from \$50 to \$40 per share. If you own 50 shares, your total
capital loss is \$500

83. The standard deviation for large-company stock returns from 1926-2011 is 20.3%

84. Which of the following is commonly used to measure inflation? The Consumer Price
Index (CPI)

85. The probability of being 2 standard deviations below the mean in a normal distribution is
approximately 2.5%

(100%-95%)/2

86. If you receive \$2 a dividend per share on your 100 shares, you total dividend income is
\$200

87. If the market changes and stock prices instantly and fully reflect new information, which
path does such a change exhibit? an efficient market reaction

88. You bought one share of stock for 4100 and received a \$2 dividend. If the price of the
stock rose to \$103, then your total dollar return would be? \$5

\$103-100+2=\$5

89. What is the definition of expected return? It is the return that an investor expects to
earn on a risky asset in the future

90. Systematic risk is the only risk important to the well diversified investor.

91. What does variance measure? The riskiness of a security's returns and the spread
of the sample of returns

92. The minimum required return on a new project is known as the cost of capital

## 93. The calculation of variance requires these 4 steps:

1. Calculate the expected return
2. Calculate the deviation of each return from the expected return
3. Square each deviation
4. Calculate the average squared deviation

94. If you wish to create a portfolio of stocks, what is the required minimum number of
stocks? You must invest stocks of at least 2 corporations

95. What does the security market line depict? It is a graphical depiction of the capital
asset pricing model (CAPM)

96. The risk of owning an asset comes from unanticipated events and surprises

97. Unsystematic risk will affect firms in a single industry and a specific firm

98. Some examples of information that may impact the risky return of a stock are the fed's
decision on interest rates at their meeting next week and the outcome of an
application currently pending with the Food and Drug administration
99. What is the expected return of a portfolio consisting of stock A and B if the expected
return is 10 percent for A and 15 percent for B? Assume you are equally invested in both
the stocks 12.5%

.5x10% + .5x15%

1. A portfolio can be described by its portfolio weights which are defined as the
percentage of dollars invested in each asset

2. As more securities are added to a portfolio, what will happen to the portfolio's total
unsystematic risk? it is likely to decrease and it may eventually be almost totally
eliminated

3. What is the slope of the security market line (SML)? the market risk premium

4. If security ABC has a beta of 1.5 and security XYZ has a beta of 1, what is the beta of a
portfolio that is equally invested in both securities? 1.25

5. What is a risk premium? It is additional compensation for taking risk, over and
above the risk-free rate

6. What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4% and
the expected return on the market is 12%? 13.6%

4%+1.2(12%-4%)

7. The systematic risk principle argues that the market does NOT reward risks that are
diversifiable and borne unnecessarily

portfolio

## 10. It is possible for unsystematic risk to be reduced almost to zero. True

11. According to the capital asset pricing model (CAPM), what is the expected return on a
security with a beta of zero? the risk-free rate of return

## 12. When an investor is diversified only systematic risk matters.

13. The following are examples of a portfolio: investing \$100,000 in the stocks of 50
publicly traded corporations, investing \$100,000 in a combination of stocks and
bonds, investing \$100,000 in a combination of US and Asian stocks

14. An investment will have a negative NPV when its expected return is less than what the
financial markets offer for the same risk

15. What two factors determine a stock's total return? expected return and unexpected
return

16. By definition, what is the beta of the average asset equal to? 1

17. Which of the following types of risk is not reduced by diversification? systematic, or
market risk

18. Which of the following are examples of unsystematic risk? changes in management
and labor strikes

## 19. If the variance of a portfolio is .0025, what is the standard deviation? 5%

20. Systematic risk is the only risk important to the well diversified investor.

21. If an asset has a reward-to-risk ratio of 6.0%, that means it has a risk premium of 6.0%
per unit of systematic risk

22. What are the two components of risky return in the total return equation? market risk
and unsystematic risk

23. Which of the following are examples of systematic risk? regulatory changes in tax
rates and future rates of inflation

24. If investors are risk averse, it is reasonable to assume that the risk premium for the stock
market will be positive

25. What is the expected return for a security if the risk-free rate is 5%, the expected return
on the market is 9%, and the security's beta is 1.5? 11%

5+1.5x(9-5)

26. Historical return data indicated that as the number of securities in a portfolio increases,
the standard deviation of returns for the portfolio declines

27. Since the CAPM equation can be used only for individual securities, it cannot be used
with portfolios. False

28. Systematic risk will not change when securities are added to a portfolio

29. How are the unsystematic risks of two different companies in two different industries
related? there is no relationship

30. When a dollar in the future is discounted to the present it is worth less because of the
time value of money, but when a news item is discounted, it means that the market
already knew about most of the news item

## 31. A well-diversified portfolio will eliminate ALL risks. False

32. WAAC is used to discount cash flows

33. To estimate a firm's equity cost of capital using the CAPM, we need to know the stock's
beta, market risk premium and risk-free rate

34. To apply the dividend discount model to a particular stock, you need to estimate the
growth rate and dividend yield

35. If a firm uses its overall cost of capital to discount cash flows from projects in higher risk
divisions, it will accept too many projects.

36. What will happen over time if a firm uses its overall WACC to evaluate all projects,
regardless of each project's risk level? the firm will overall become riskier, it will
reject projects that it should have accepted and it will accept projects that it
should have rejected

37. The return an investor in a security receives equal to the cost of the security to the
company that issued it

38. The following are components used in the construction of the WACC: cost of common
stock, cost of debt and cost of preferred stock

39. For a firm with outstanding debt, the cost of debt will be the yield to maturity on that
debt

40. MNO preferred stock pays a dividend of \$2 per year and has a price of \$20. If MNO's tax
rate is 40%, the after-tax rate of return on its preferred stock is 10%
41. Suppose a firm's capital structure consists of 30% debt, 10% preferred stock and 60%
equity. The firm's bonds yield 10% on average before taxes, the cost of preferred stock
is 8% and the cost of equity is 16%. Calculate the firm's WACC assuming a tax rate of
40%. 12.50%

0.6x16%+0.3x10%x(1-.04)+0.1x8%

42. WACC was used to compute the following project NPVs: Project A=\$100, Project B=-
\$50, Project C=-\$10, Project D=\$40. Which projects should the firm accept? A and D

43. If the firm is all-equity, the discount rate is equal to the firm's cost of equity capital

44. If a firm is funded with \$400 in debt and \$1,200 in equity, the weight of equity is 75% and
the weight of debt is 25% to be used to compute the WACC

45. The growth rate of dividends can be found using security analysts' forecasts AND
historical dividend growth rates

46. The rate used to discount project cash flows is known as the required return, discount
rate and cost of capital

47. Projects should always be discounted at the firm's overall cost of capital. False

48. The discount rate for the firm's project equals the cost of capital for the firm as a whole
when all projects have the same risk as that of the firm overall

49. The WACC is the minimum required return for the overall firm

50. The following is true about the cost of debt it is easier to estimate than the cost of
equity and yields can be calculated from observable data

51. To estimate the dividend yield of a particular stock, we need the current stock price,
the last dividend paid, D0, and forecasts of the dividend growth rate, g

52. If an all equity firm discounts a project's cash flows with the firm's overall weighted
average cost of capital even though the project's beta is less than the firm's overall beta,
it is possible that the project might rejected, when it should be accepted

## 53. Coupon interest paid on bonds is tax-deductible to the firm

54. If a firm has multiple projects, each project should be discounted using a discount rate
commensurate with the project's risk

55. Preferred stock pays a constant dividend and pays dividends in perpetuity

56. The most appropriate weights to use in the WACC are the market value weights

57. Dividends paid to common stockholders cannot be deducted from the payer's taxable
income for tax purposes

58. Some risk adjustments to a firm's WACC for projects of differing risk, even if it is
subjective, is probably better than no risk adjustment

59. What can we say about the dividends paid to common and preferred stockholders?
dividends to common stockholders are not fixed and dividends to preferred
stockholders are fixed

60. If the risk-free rate is 4 percent, an all-equity firm's beta is 2, and the market risk
premium is 6 percent, what is the firm's cost of capital? 16%

4%+2x6%=16%
61. Other companies that specialize only in projects similar to the project your firm is
considering are called pure plays

62. Finding a firm's overall cost of equity is difficult because it cannot be observed directly

63. Suppose the risk-free rate is 5 percent, the market rate of return is 10 percent, and beta
is 2. Find the required rate of return using the CAPM. 15%

64. A firm's capital structure consists of 30 percent debt and 70 percent equity. Its bonds
yield 10 percent, pretax, its cost of equity is 16 percent, and the tax rate is 40 percent.
What is its WACC? 13%

Roseek

1. What is the name given to the model that computes the present value of a stock by
dividing next year's annual dividend amount by the difference between the discount rate
and the rate of change in the annual dividend amount?
A. Stock pricing model
B. Equity pricing model
C. Capital gain model
D. Dividend growth model
E. Present value model

2. Which one of the following types of securities has no priority in a bankruptcy proceeding?
A. convertible bond
B. senior debt
C. common stock
D. preferred stock
E. straight bond

3. Which one of the following generally pays a fixed dividend, receives first priority in
dividend payment, and maintains the right to a dividend payment, even if that payment is
deferred?
A. cumulative common
B. noncumulative common
C. noncumulative preferred
D. cumulative preferred
E. senior common

4. What is the market called that allows shareholders to resell their shares to other
investors?
A. primary
B. proxy
C. secondary
D. inside
E. initial

5. A specialist is a(n):
A. employee who executes orders to buy and sell for clients of his or her brokerage
firm
B. individual who trades on the floor of an exchange for his or her personal account
C. NYSE member who functions as a dealer for a limited number of securities
D. broker who buys and sells securities from a market maker
E. trader who only deals with primary offerings

6. Which one of the following will increase the current value of a stock?
A. decrease in the dividend growth rate
B. increase in the required return
C. increase in the market rate of return
D. decrease in the expected dividend for next year
E. increase in the capital gains yield
7. Which one of the following statements is correct?
A. both preferred stock and corporate bonds can be callable
B. both preferred stock and corporate bonds have a stated liquidation value of
\$1,000 each
C. interest payment to bondholders as well as dividend payments to preferred
shareholders are tax deductible expenses for the issuing firm
D. bondholders generally receives a fixed payment while preferred shareholders
receive a variable payment
E. preferred shareholders receive preferential treatment over bondholders in a
liquidation

8. On which one of the following dates do dividends become a liability of the issuer for
accounting purposes
A. first day of the fiscal year in which the dividend is expected to be paid
B. twelve months prior to the expected dividend payment date
C. on the declaration date
D. on the date of record
E. on the date of payment

9. Keller Metals common stock is selling for \$36 a share and has a dividend yield of 3.2
percent. What is the dividend amount?
A. \$0.32
B. \$1.15
C. \$ 3.49
D. \$11.25
E. \$11.52

10. The payback period is the length of time it takes an investment to generate sufficient
cash flows to enable the project to:
A. produce a positive annual cash flow
B. produce a positive cash flow from assets
C. offset its fixed expenses
D. offset its total expenses
E. recoup its initial cost

11. Which one of the following indicates that a project is expected to create value for its
owners?
A. profitability index less than 1.0
B. payback period greater than the requirement
C. positive net present value
D. positive average accounting rate of return
E. internal rate of return that is less than the requirement

12. Which one of the following is generally considered to be the best form of analysis if you
have to select a single method to analyze a variety of investment opportunities?
A. payback
B. profitability index
C. accounting rate of return
D. internal rate of return
E. net present value

13. Which one of the following indicates that a project should be rejected?
A. average accounting return that exceeds the requirement
B. payback period that is shorter than the requirement period
C. positive net present value
D. profitability index less than 1.0
E. internal rate of return that exceeds the required return
14. Which one of the following statements is correct?
A. a longer payback period is preferred over a shorter payback period
B. the payback rule states that you should accept a project if the payback period is
less than one year
C. the payback period ignores the time value of money
D. the payback rule is biased in favor of long-term projects
E. the payback period considers the timing and amount of all a project's cash flows

15. What is the net present value of a project with the following cash flows if the discount
rate is 14%?

0 -\$39,400 1
\$12,800 2
\$21,700 3
\$18,100

A. \$742.50
B. \$801.68
C. \$823.92
D. \$899.46
E. \$901.15