Suppose you and most other investors expect the inflation rate to be 7% next year, to fall to 5% during the following year, and then to remain at a rate of 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term securities (those that mature in a few days) to a level of 0.2 percentage points for 1-year securities. Furthermore, maturity risk premiums increased 0.2 percentage points for each year to maturity, up to a limit of 1.0 percentage point on 5-year or long-term T-notes and t-bonds a. Calculate the interest rate on 1-, 2-, 3-, 4-, 5-, 10-, and 20-year Treasury securities, and plot the yield curve. b. Now suppose ExxonMobil’s bonds, rated AAA, have the same maturities as the Treasury bonds. As an approximation, plot an ExxonMobil yield curve on the same graph with the Treasury bond yield curve. (Hint: Think about the default risk premium on ExxonMobil’s long-term versus short-term bonds.) c. Now plot the approximate yield curve of Long Island Lighting Company, a risky nuclear utility.
> a. Suppose Asset A has an expected return of 10% and a standard deviation of 20%. Asset B has an expected return of 16% and a standard deviation of 40%. If the correlation between A and B is 0.35, what are the expected return and standard deviation for a
> Differentiate between (a) stand-alone risk and (b) risk in a portfolio context. How are they measured and are both concepts relevant for investors? What is securitization? How is securitization supposed to help banks and S&Ls manage risks and increas
> The Zinn Company plans to issue $10,000,000 of 20-year bonds in June to help finance a new research and development laboratory. The bonds will pay interest semiannually. It is now November, and the current cost of debt to the high-risk biotech company is
> What are the advantages of the corporate for mover a sole proprietorship or a partnership? What are the disadvantages of this form?
> What is presumed to be the primary goal of financial management? How is this goal related to other societal goals and considerations? Is this goal consistent with the basic assumptions of microeconomics? Are managers’ actions always consistent with this
> What was the global economic crisis? This is a really big question, so specifically, explain how in our interconnected global economy a decrease in housing prices in large U.S. cities ended up bankrupting Norwegian retirees.
> Assume that you recently graduated and have just reported to work as an investment advisor at the brokerage firm of Balik and Kiefer Inc. One of the firm’s clients is Michelle Della Torre, a professional tennis player who has just come to the Unite
> Differentiate between (a) stand-alone risk and (b) risk in a portfolio context. How are they measured, and are both concepts relevant for investors? What is presumed to be the primary goal of financial management? How is this goal related to other societ
> What is the Capital Asset Pricing Model (CAPM)? What are some of its key assumptions? Has it been empirically verified? What is the role of the Security Market Line in the CAPM? Suppose you had to estimate the required rate of return on a stock using the
> Assume you have just been hired as a financial analyst by Tennessee Sunshine Inc., a mid-sized Tennessee company that specializes in creating exotic sauces from imported fruits and vegetables. The firm’s CEO, Bill Stooksbury, recently returned from an in
> a. Differentiate between the terms expected rate of return, required rate of return, and historical rate of return as they are applied to common stocks. b. If you found values for each of these returns for several different stocks, would the values for
> If investors’ aversion to risk increased, would the risk premium on a high beta stock increase by more or less than that on a low-beta stock? Explain.
> Define the following terms, using graphs or equations to illustrate your answers where feasible. a. Risk in general; stand-alone risk; probability distribution and its relation to risk b. Expected rate of return, r⁄ c. Continuous probability d
> If a company’s beta were to double, would its expected return double?
> Edmund Enterprises recently made a large investment to upgrade its technology. Although these improvements won’t have much of an impact on performance in the short run, they are expected to reduce future costs significantly. What impact will this investm
> What is a firm’s fundamental, or intrinsic, value? What might cause a firm’s intrinsic value to be different from its actual market value?
> What are the three principal forms of business organization? What are the advantages and disadvantages of each?
> Security A has an expected return of 7%, a standard deviation of returns of 35%, a correlation coefficient with the market of 20.3, and a beta coefficient of 21.5. Security B has an expected return of 12%, a standard deviation of returns of 10%, a corre
> The probability distribution of a less risky return is more peaked than that of a riskier return. What shape would the probability distribution have for (a) completely certain returns and (b) completely uncertain returns?
> Hager’s Home Repair Company, a regional hardware chain that specializes in “do it yourself” materials and equipment rentals, is cash rich because of several consecutive good years. One of the alternat
> Sam Strother and Shawna Tibbs are vice presidents of Mutual of Seattle Insurance Company and co_directors of the company’s pension fund management division. An important new client, the North-Western Municipal Alliance, has requested that Mutual of Seat
> Assume that you have just been hired as a financial analyst by Triple Play Inc., a mid-sized California company that specializes in creating high-fashion clothing. Because no one at Triple Play is familiar with the basics of financial options, you have b
> The current price of a stock is $20. In 1 year, the price will be either $26 or $16. The annual risk-free rate is 5%. Find the price of a call option on the stock that has a strike price of $21 and that expires in 1 year. (Hint: Use daily compounding.)
> Use the Black-Scholes Model to find the price for a call option with the following inputs: (1) current stock price is $30, (2) strike price is $35, (3) time to expiration is 4 months, (4) annualized risk-free rate is 5%, and (5) variance of stock ret
> Assume that you have been given the following information on Purcell Industries: According to the Black-Scholes option pricing model, what is the option’s value? Current stock price = $15 Time to maturity of option = 6 months Varian
> The exercise price on one of Flanagan Company’s options is $15, its exercise value is $22, and its time value is $5. What are the option’s market value and the price of the stock?
> The current price of a stock is $15. In 6 months, the price will be either $18 or $13. The annual risk-free rate is 6%. Find the price of a call option on the stock that has a strike price of $14 and that expires in 6 months. (Hint: Use daily compounding
> Arnot International’s bonds have a current market price of $1,200. The bonds have an 11% annual coupon payment, a $1,000 face value, and 10 years left until maturity. The bonds may be called in 5 years at 109% of face value (call price 5 $1,090). a. What
> Suppose Hillard Manufacturing sold an issue of bonds with a 10-year maturity, a $1,000 par value, a 10% coupon rate, and semiannual interest payments. a. Two years after the bonds were issued, the going rate of interest on bonds such as these fell to 6%.
> Because of a recession, the inflation rate expected for the coming year is only 3%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3%. Assume that the real risk-free rate is r*= 2% for all maturities a
> Does interest rate parity imply that interest rates are the same in all countries?
> Assume that the real risk-free rate, r*, is 3% and that inflation is expected to be 8% in Year 1, 5% in Year 2, and 4% thereafter. Assume also that all Treasury securities are highly liquid and free of default risk. If 2-year and 5-year Treasury notes bo
> The real risk-free rate is 2%. Inflation is expected to be 3% this year, 4% next year, and then 3.5% thereafter. The maturity risk premium is estimated to be 0.0005 × (t-1), where t = number of years to maturity. What is the nominal interest rate on a 7-
> An investor has two bonds in his portfolio. Each bond matures in 4 years, has a face value of $1,000, and has a yield to maturity equal to 9.6%. One bond, Bond C, pays an annual coupon of 10%; the other bond, Bond Z, is a zero coupon bond. Assuming that
> A bond trader purchased each of the following bonds at a yield to maturity of 8%. Immediately after she purchased the bonds, interest rates fell to 7%. What is the percentage change in the price of each bond after the decline in interest rates? Fill in t
> Absalom Motors’ 14% coupon rate, semiannual payment, $1,000 par value bonds that mature in 30 years are callable 5 years from now at a price of $1,050. The bonds sell at a price of $1,353.54, and the yield curve is flat. Assuming that interest rates in t
> A bond that matures in 7 years sells for $1,020. The bond has a face value of $1,000 and a yield to maturity of 10.5883%. The bond pays coupons semiannually. What is the bond’s current yield?
> You just purchased a bond that matures in 5 years. The bond has a face value of $1,000 and has an 8% annual coupon. The bond has a current yield of 8.21%. What is the bond’s yield to maturity?
> A 10-year, 12% semiannual coupon bond with a par value of $1,000 may be called in 4 years at a call price of $1,060. The bond sells for $1,100. (Assume that the bond has just been issued.) a. What is the bond’s yield to maturity? b. What is the bond’s cu
> The Brownstone Corporation’s bonds have 5 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 9%. a. What is the yield to maturity at a current market price of: (1) $829 or (2) $1,
> The Garraty Company has two bond issues outstanding. Both bonds pay $100 annual interest plus $1,000 at maturity. Bond L has a maturity of 15 years, and Bond S has a maturity of 1 year. a. What will be the value of each of these bonds when the going rate
> What is a Eurodollar? If a French citizen deposits $10,000 in Chase Bank in New York, have Eurodollars been created? What if the deposit is made in Barclays Bank in London? Chase’s Paris branch? Does the existence of the Eurodollar market make the Federa
> Thatcher Corporation’s bonds will mature in 10 years. The bonds have a face value of $1,000 and an 8% coupon rate, paid semiannually. The price of the bonds is $1,100. The bonds are callable in 5 years at a call price of $1,050. What is their yield to ma
> Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds mature in 8 years, have a face value of $1,000, and a yield to maturity of 8.5%. What is the price of the bonds?
> The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-year Treasury security yields 6.3%. What is the maturity risk premium for the 2-year security?
> A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of 9%. Assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond?
> The real risk-free rate of interest is 4%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury secur
> Heath Foods’ bonds have 7 years remaining to maturity. The bonds have a face value of $1,000 and a yield to maturity of 8%. They pay interest annually and have a 9% coupon rate. What is their current yield?
> Jackson Corporation’s bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 9%. What is the current market price of these bonds?
> “Short-term interest rates are more volatile than long-term interest rates, so short-term bond prices are more sensitive to interest rate changes than are long-term bond prices.” Is this statement true or false? Explain.
> Seven years ago, Goodwynn & Wolf Incorporated sold a 20-year bond issue with a 14% annual coupon rate and a 9% call premium. Today, G&W called the bonds. The bonds originally were sold at their face value of $1,000. Compute the realized rate of return fo
> Should firms require higher rates of return on foreign projects than on identical projects located at home? Explain.
> Wilson Wonders’ bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $1,000 par value, and the coupon interest rate is 10%. The bonds sell at a price of $850. What is their yield to maturity?
> If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.
> The rate of return on a bond held to its maturity date is called the bond’s yield to maturity. If interest rates in the economy rise after a bond has been issued, what will happen to the bond’s price and to its YTM? Does the length of time to maturity af
> a. Bond; Treasury bond; corporate bond; municipal bond; foreign bond b. Par value; maturity date; coupon payment; coupon interest rate c. Floating-rate bond; zero coupon bond; original issue discount bond (OID) d. Call provision; redeemable bond; sink
> A sinking fund can be set up in one of two ways. Discuss the advantages and disadvantages of each procedure from the viewpoint of both the firm and its bondholders.
> Define each of the following terms: a. Option; call option; put option b. Exercise value; strike price c. Black-Scholes option pricing model
> Describe the effect on a call option’s price that results from an increase in each of the following factors: (1) stock price, (2) strike price, (3) time to expiration, (4) risk-free rate, and (5) standard deviation of stock return.
> Why do options sell at prices higher than their exercise values?
> Security A has an expected rate of return of 6%, a standard deviation of returns of 30%, a correlation coefficient with the market of −0.25, and a beta coefficient of −0.5. Security B has an expected return of 11%, a standard deviation of returns of 10%,
> A call option on the stock of Bedrock Boulders has a market price of $7. The stock sells for $30 a share, and the option has a strike price of $25 a share. What is the exercise value of the call option? What is the option’s time value?
> Why do U.S. corporations build manufacturing plants abroad when they could build them at home?
> The Nelson Company has $1,312,500 in current assets and $525,000 in current liabilities. Its initial inventory level is $375,000, and it will raise funds as additional notes payable and use them to increase inventory. How much can Nelson’s short-term deb
> Assume you are given the following relationships for the Haslam Corporation: Sales/total assets 1.2 Return on assets (ROA) 4% Return on equity (ROE) 7% Calculate Haslam’s profit margin and l
> Ace Industries has current assets equal to $3 million. The company’s current ratio is 1.5, and its quick ratio is 1.0. What is the firm’s level of current liabilities? What is the firm’s level of inventories?
> Gardial & Son has an ROA of 12%, a 5% profit margin, and a return on equity equal to 20%. What is the company’s total assets turnover? What is the firm’s equity multiplier?
> Needham Pharmaceuticals has a profit margin of 3% and an equity multiplier of 2.0. Its sales are $100 million and it has total assets of $50 million. What is its ROE?
> Reno Revolvers has an EPS of $1.50, a cash flow per share of $3.00, and a price/cash flow ratio of 8.0. What is its P/E ratio?
> Winston Washers’s stock price is $75 per share. Winston has $10 billion in total assets. Its balance sheet shows $1 billion in current liabilities, $3 billion in long-term debt, and $6 billion in common equity. It has 800 million shares of common stock o
> Vigo Vacations has $200 million in total assets, $5 million in notes payable, and $25 million in long-term debt. What is the debt ratio?
> What is free cash flow? Why is it the most important measure of cash flow?
> Explain the difference between NOPAT and net income. Which is a better measure of the performance of a company’s operations?
> a. Multinational corporation b. Exchange rate; fixed exchange rate system; floating exchange rate c. Trade deficit; devaluation; revaluation d. Exchange rate risk; convertible currency; pegged exchange rate e. Interest rate parity; purchasing power parit
> If a “typical” firm reports $20 million of retained earnings on its balance sheet, can the firm definitely pay a $20 million cash dividend?
> Define each of the following terms: a. Annual report; balance sheet; income statement b. Common stockholders’ equity, or net worth; retained earnings c. Statement of stockholders’ equity; statement of cash flows d. Depreciation; amortization; EBITDA e
> If you were starting a business, what tax considerations might cause you to prefer to set it up as a proprietorship or a partnership rather than as a corporation?
> Define each of the following terms: a. Proprietorship; partnership; corporation b. Limited partnership; limited liability partnership; Professional Corporation c. Stockholder wealth maximization d. Production opportunities; time preferences for consumpti
> How do you think each of the following items would affect a company’s ability to attract new capital and the flotation costs involved in doing so? a. A decision of a privately held company to go public b. The increasing institutionalization of the “buy s
> The SEC attempts to protect investors who are purchasing newly issued securities by making sure that the information put out by a company and its investment banks is correct and is not misleading. However, the SEC does not provide an opinion about the re
> Define each of the following terms: a. Going public; new issue market; initial public offering (IPO) b. Public offering; private placement c. Venture capitalists; roadshow; spread d. Securities and Exchange Commission (SEC); registration statement; shelf
> Before entering a formal agreement, investment banks carefully investigate the companies whose securities they underwrite; this is especially true of the issues of firms going public for the first time. Because the banks do not themselves plan to hold th
> Define each of the following terms: a. Proxy; proxy fight; preemptive right; classified stock; founders’ shares b. Estimated value / market price / c. Required rate of return, / expected rate of return, / actual, or realized, rate of return, / d. Ca
> A bond that pays interest forever and has no maturity date is a perpetual bond, also called a perpetuity or a consol. In what respect is a perpetual bond similar to: (1) a no-growth common stock and (2) a share of preferred stock?
> Why might purchasing power parity fail to hold?
> A. Fethe Inc. is a custom manufacturer of guitars, mandolins, and other stringed instruments and is located near Knoxville, Tennessee. Fethe’s current value of operations, which is also its value of debt plus equity, is estimated to be $5 million. Fethe
> International Associates (IA) is about to commence operations as an international trading company. The firm will have book assets of $10 million, and it expects to earn a 16% return on these assets before taxes. However, because of certain tax arrangemen
> Schwarzentraub Industries’ expected free cash flow for the year is $500,000; in the future, free cash flow is expected to grow at a rate of 9%. The company currently has no debt, and its cost of equity is 13%. Its tax rate is 40%. (Hint: Use Equations 17
> Companies U and L are identical in every respect except that U is unlevered while L has $10 million of 5% bonds outstanding. Both firms have an EBIT of $2 million. Assume that all of the MM assumptions are met. a. Suppose that both firms are subject to
> Companies U and L are identical in every respect except that U is unlevered while L has $10 million of 5% bonds outstanding. Assume that: (1) all of the MM assumptions are met, (2) both firms are subject to a 40% federal-plus-state corporate tax rate,
> Companies U and L are identical in every respect except that U is unlevered while L has $10 million of 5% bonds outstanding. Assume that: (1) there are no corporate or personal taxes, (2) all of the other MM assumptions are met, (3) EBIT is $2 million,
> Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few
> An unlevered firm has a value of $800 million. An otherwise identical but levered firm has $60 million in debt at a 5% interest rate. Its cost of debt is 5% and its unlevered cost of equity is 11%. After Year 1, free cash flows and tax savings are expect
> An unlevered firm has a value of $600 million. An otherwise identical but levered firm has $240 million in debt. Under the Miller model, what is the value of the levered firm if the corporate tax rate is 34%, the personal tax rate on equity is 10%, and t
> Sheldon Corporation projects the following free cash flows (FCFs) and interest expenses for the next 3 years, after which FCF and interest expenses are expected to grow at a constant 7% rate. Sheldon’s unlevered cost of equity is 13% it
> Suppose that the exchange rate is 0.60 dollars per Swiss franc. If the franc appreciates 10% against the dollar, how many francs would a dollar buy tomorrow?
> What is an exchange rate? What is the difference between direct and indirect rates? What is a cross rate?
> On October 1, 2017, Harvey Company adopted a stock-option plan that granted options to key executives to purchase 30,000 shares of the company’s $10 par value common stock. The options were granted on January 2, 2018, and were exercisable 2 years after t
> The following information is available for the Albany Corporation for the year 2017: Actual and expected return on plan assets ……………………. $12,000 Benefits paid to retirees ……………………………………………… $40,000 Contributions to the fund ……………………………………………. $95,000 In
> George Company purchased land for use as its corporate headquarters. A small factory that was on the land when it was purchased was torn down, and before the new building’s foundation could be constructed, a substantial amount of rock had to be blasted a
