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introduction to financial accounting
Questions and Answers of
Introduction To Financial Accounting
The treasurer of the KSiR Corporation is attempting to manage risks using options.a. What option strategy can the treasurer take to protect against a rise in the cost of one of the company’s inputs
How does the price of an option and the exercise price affect the payoff from an option.
Suppose that the price of the underlying is $40 and that the option price is $5.a. If the exercise price for a put option is $42, what are the intrinsic value and the time premium for this option?b.
Orono Bank and the Portland Manufacturing Corp. enter into the following seven-year swap with a notional amount of $75 million and the following terms: Every year for the next seven years, Orono Bank
What are the four major asset classes?
Distinguish between policy asset allocation and dynamic asset allocation.
What is meant by “market cap,” and how does this affect common stock portfolio decisions?
What distinguishes a passive portfolio strategy from an active portfolio strategy?
How does price efficiency influence the decision to pursue an active or passive portfolio strategy?
What is the primary problem with the arithmetic average rate of return in evaluating a portfolio’s performance?
If you want to evaluate the performance of a portfolio manager, which would be more appropriate to use in calculating subperiod returns: the dollar-weighted average or the time-weighted average? Why?
Consider a portfolio that has a value of $5 at the beginning of January, with returns of –5%, 10%, and 10% in January, February, and March, respectively. If there are no cash contributions or
Consider a portfolio that has a value of $5 at the beginning of January, with returns of –5%, 10%, and 10% in January, February, and March, respectively. If there are no cash contributions or
What is the purpose of a performance attribution model?
In terms of the price-to-book (P/B) ratio, why are value stocks generally considered those with low P/B ratios?
Comment on the following statements:a. “All one needs to know about a portfolio manager’s ability is to compare the return on the portfolio to the return on the benchmark.”b. “By looking at
What type of constraints may a client impose on a portfolio manager?
If an investment in stock has a value of $3,000 at the beginning of the year and $3,500 at the end of the year, and paid a dividend of $250 at the end of the year, what is the return on the stock for
Consider an investment with the following returns:What is the time-weighted annual return for this investment for the four-year period? Year Return 1234 5% -3% 4% 5%
What is meant by a utility function?
If two assets’ returns are positively correlated, what is the covariance between the returns of these two assets?
What is the relation between the correlation between and among assets and diversification?
How does an efficient portfolio relate to a feasible portfolio?
What information does the semivariance convey?
What is a safety-first rule?
What is prospect theory?
What is meant by framing and how may this affect an investor’s decision making?
Identify three safety-first methods.
What is a cognitive bias and how might it affect investors’ decision making?
The covariance of returns on Asset A and Asset B are negative.a. What does this tell us about the correlation coefficient for their returns?b. If we form a portfolio comprised of Asset A and Asset B,
Consider the following stocks and their expected returns and standard deviations:a. Between Stock A and Stock B, which would a risk-averse investor prefer? Explain.b. Between Stock C and Stock D,
If the economy recovers next year, analysts expect Stock X’s return for the year to be 20%; if the economy does not recover, analysts expect Stock X’s return for the year to be −5%. If there is
If the economy recovers next year, analysts expect Stock Y’s return for the year to be 15%; if the economy does not recover, analysts expect Stock Y’s return for the year to be −15%. If there
Consider a portfolio comprised of two securities, M and N. The correlation of the returns on these securities is 0.25. And suppose that these securities have different standard deviations. Explain
What is diversifiable risk?
What is the role of diversification in the capital asset pricing model?
If investors are risk averse, which would they prefer: a stock with an expected return of 5% with a beta of 1.2 or a stock with an expected return of 6% with a beta of 1.3? Explain.
If a stock has both diversifiable risk and nondiversifiable risk, which, if any, of these risks are considered in the pricing of the asset?
In the context of the CAPM, what is the term represented by E(RM) − Rf?
Explain what beta represents in terms of asset pricing.
If asset A’s beta is greater than asset B’s beta, does this mean that asset A has more risk than asset B? Explain.
What is the difference between the security market line and the capital market line?
If a stock’s return and risk are such that this would plot above the security market line, is this stock overpriced or underpriced?
Suppose you expected the return on the market to be 10% and the return on the risk-free asset to be 2%. If you are considering a stock with a beta of 1.2, what is the expected return on this stock
How should an investor construct an efficient portfolio in the presence of a risk-free asset?
What is the theoretical problem inherent in verifying the CAPM empirically?
Why is the CAPM’s assumption that investors can borrow and lend at the risk-free rate questionable?
What is meant by the “homogeneous assumption” in the CAPM?
What is meant by the law of one price, and what does it imply about a package of securities and a given security that have the same payoff?
What are the fundamental principles underlying the APT model?
What are the advantages of the APT model relative to the CAPM?
What are the difficulties of applying the arbitrage pricing theory model in practice?
Indicate why you agree or disagree with the following statements:a. “As a percentage of the total risk, the unsystematic risk of a diversified portfolio is greater than that of an individual
“In the CAPM, investors should be compensated for accepting systematic risk; for the APT model, investors are rewarded for accepting both systematic risk and unsystematic risk.” Do you agree with
What is the base interest rate?
Suppose the yield on a 10-year corporate bond is 6.2% and the yield on a similar-maturity Treasury security is 4.5%.a. What is the yield spread for this corporate bond?b. Why is there a yield spread
How does a conversion provision on a debt obligation provide an option to the investor?
If the yield on a Treasury security is 3% and that of a similar-maturity municipal bond is 2.5%, what is the muni-Treasury yield ratio for this municipal bond?
Explain the relation between a tax-exempt yield and a taxable yield for bonds with similar maturity and features.
What is a maturity spread?
If a three-year security has a yield of 5%, and a two-year Treasury security has a yield of 4.5%, what is the one-year forward rate two years from now?
What is the shape of the normal yield curve?
List the possible explanations for observed yield curves.
What is the relevance of the swap rate curve?
Typically, how do market participants gauge the credit risk associated with a bond issue?
What is the relationship between credit risk and the risk premium?
Suppose that the one-year spot rate is 4.1% and the two-year spot rate is 4.6%. What is the one-year forward rate one year from now?
Comment on the following statement: “Forward rates are good predictors of future interest rates.”
Why can forward rates be viewed as hedgeable rates?
Consider the following yields to maturity:a. Graph the yield to maturity against the time to maturity.b. Is this yield curve consistent with any of the yield curve theories?Explain. Years to Maturity
A corporate treasurer is considering borrowing funds for 10 years. How can the corporate treasurer use forward rates in determining whether to borrow today or postpone borrowing?
Why are “biased” expectation theories of the term structure of interest rates biased?
Comment on the following: “There is no theory of the term structure of interest rates that would explain a yield curve in which interest rates increase with maturity for the first two years,
If a company maintains a constant rate of growth for the dividends per share that it pays, what is the likely effect on the company’s dividend payout ratio?
What is the relationship between the discount rate applied to a stock’s future cash flows and the value of a stock?
If the dividends per share of a stock are not expected to grow, what effect does this have on the valuation of the stock?
Suppose the dividends of a company are $2 in one year and $3 three years following. What is the average annual growth in dividends over these three years?
In the constant growth dividend discount model, what is the relationship between the required rate of return and the expected growth rate of dividends?
If a company’s dividends are expected to decline, is it possible to still use the constant growth dividend discount model?
What is the relation between the expected return on a stock and the stock’s dividend yield?
Concerning a dividend valuation model with multiple stages of growth,a. Why would an investor use a multiphase dividend discount model?b. In a three-phase dividend discount model, what are the three
If the average P/E multiple for comparables is 15 and the company you want to value has expected earnings per share of $2, what is the estimate of this company’s price per share of stock?
Why might you prefer to use a measure of cash flow generating ability such as earnings instead of sales in relative valuation?
If an analyst expects a company’s dividend to be $2.50 next year, $3 in two years, and then constant at $3.25 forever, what is the value of the company’s stock if investors require a return of 8%?
If investors expect a return of 12% on a stock that is expected to have a dividend yield of 4% next year, what is the expected growth rate on this stock?
Explain whether you agree or disagree with the following statement:“Unlike a dividend discount model, relative valuation seeks to explain the factors that determine the observed value of a share of
To what extent is the procedure similar for valuation based on discounting cash flows and valuation by multiples?
List the four inputs needed to value a bond.
When valuing a zero-coupon bond, why are semiannual periods used in discounting?
Describe the relationship between the price of a bond and the yield to maturity of the bond.
Suppose a bond has a coupon rate of 6% and a yield to maturity of 8%. Will this bond be priced as a discount bond or a premium bond?Explain.
Why may a bond’s price change simply because of the passage of time?
What is the difference between a bond’s current yield and its yield to maturity?
What is the yield to worst?
Concerning reinvestment of interest on a bond,a. What assumption is made about reinvestment of cash flows when using the yield to maturity?b. What characteristics of a bond affect its reinvestment
If a bond is putable, what type of option does the investor in this bond have?
Suppose a bond has a market price of $90 and has five years remaining to maturity. If the bond is priced to yield 5%, is its coupon rate greater than, less than, or equal to 5%? Explain your
Complete the following table, providing the dollar price of the following bonds: Market Price Par Value Dollar Price $94.0 $102.00 $1,000 $100,000 $75.50 $10,000 $86.40 $1,000,000
Consider a bond with coupon rate of 7% and a par value of $1,000.The maturity for this bond is greater than one year. Also assume that the required yield by the market for this bond is 8%. For the
Suppose that two years ago a 10-year bond in your portfolio was selling for $1,100. Today, the same bond is selling for $1,050. You have researched the price of 10-year bonds of the same credit
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