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fundamentals of financial management

Questions and Answers of Fundamentals Of Financial Management

Describe how the annual payment bond valuation formula is changed to evaluate semiannual coupon bonds, and write the revised formula.
Hartwell Corporation’s bonds have a 20-year maturity, an 8% semiannual coupon, and a face value of $1,000. The going nominal annual interest rate (rd) is 7%. What is the bond’s price?
Differentiate between price risk and reinvestment risk.
To which type of risk are holders of long-term bonds more exposed? Short-term bondholders?
What type of security can be used to minimize both price risk and reinvestment risk for an investor with a fixed investment horizon? Does this security protect the real payoff? Explain.
Differentiate between mortgage bonds and debentures.
Name the major rating agencies, and list some factors that affect bond ratings.
Why are bond ratings important to firms and investors?
Do bond ratings adjust immediately to changes in credit quality? Explain.
Why do most bond trades occur in the over-the-counter (OTC) market?
How is accrued interest calculated?
It is now January 1, 2021, and you are considering the purchase of an outstanding bond that was issued on January 1, 2019. It has an 8% annual coupon and had a 30-year original maturity. (It matures
We looked at how interest rates impact bond valuation. The following questions are designed to help you understand how bond values are affected by different interest rate levels. Here, we will access
Briefly explain the fundamental trade-off between risk and return.
What do the slopes of the risk-return lines illustrated in Figure 8.1 indicate? FIGURE 8.1 Panel a: The Individual Investor's Perspective Investment Return The Trade-Off between Risk and Return Good
Does the average investor’s willingness to take on risk vary over time? Explain.
What do you think the average investor’s risk perception is now? In what types of investments do you think the average investor is investing currently?
Should companies completely avoid high-risk projects? Explain.
What does investment risk mean? Set up an illustrative probability distribution table for an investment with probabilities for different conditions, returns under those conditions, and the expected
Which of the two stocks graphed in Figure 8.3 is less risky? Why? Identify the three measures of stand-alone risk discussed in this section. Briefly explain what each measure indicates.Figure 8.3
How does risk aversion affect rates of return?An investment has a 50% chance of producing a 20% return, a 25% chance of producing an 8% return, and a 25% chance of producing a 212% return. What is
What is meant by perfect positive correlation, perfect negative correlation, and zero correlation?Explain the statement: An asset held as part of a portfolio is generally less risky than the same
What is an average-risk stock? What is the beta of such a stock?An investor has a two-stock portfolio with $25,000 invested in Stock X and $50,000 invested in Stock Y. X’s beta is 1.50, and Y’s
Why is it argued that beta is the best measure of a stock’s risk?An investor has a two-stock portfolio with $25,000 invested in Stock X and $50,000 invested in Stock Y. X’s beta is 1.50, and
Differentiate between a stock’s expected rate of return (r⁄), required rate of return (r), and realized, after-the-fact historical return (r). Which would have to be larger to induce you to buy
What is meant by the term, positive alpha? Negative alpha?
What happens to the SML graph when risk aversion increases or decreases?
What would the SML look like if investors were indifferent to risk, that is, if they had zero risk aversion?
How can a firm influence the size of its beta?
A stock has a beta of 1.2. Assume that the risk-free rate is 4.5%, and the market risk premium is 5%. What is the stock’s required rate of return?
Have there been any studies that question the validity of the CAPM? Explain.
How does the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk?The stand-alone risk of an individual corporate project may be quite high,
What are some important concepts for individual investors to consider when evaluating the risk and returns of various investments?The stand-alone risk of an individual corporate project may be quite
Define each of the following terms using graphs or equations to illustrate your answers whenever feasible: a. Risk; stand-alone risk; probability distribution b. Expected rate of return, c. Standard
Stocks A and B have the following historical returns:a. Calculate the average rate of return for each stock during the period 2016 through 2020. Assume that someone held a portfolio consisting of 50%
ECRI Corporation is a holding company with four main subsidiaries. The percentage of its capital invested in each of the subsidiaries(and their respective betas) is as follows:a. What is the holding
Assume that the risk-free rate is 5.5% and the required return on the market is 12%. What is the required rate of return on a stock with a beta of 2?
Assume that the risk-free rate is 3.5% and the market risk premium is 4%. What is the required return for the overall stock market?What is the required rate of return on a stock with a beta of 0.8?
Stocks A and B have the following probability distributions of expected future returns: Probability 0.1 0.2 0.4 0.2 0.1 A (10%) 2 12 20 38 B (35%) 0 20 25 45
Bartman Industries’s and Reynolds Inc.’s stock prices and dividends, along with the Winslow 5000 Index, are shown here for the period 2015–2020. The Winslow 5000 data are adjusted to include
Chapter 8 discussed the basic trade-off between risk and return. In the capital asset pricing model (CAPM) discussion, beta was identified as the correct measure of risk for diversified
What is the preemptive right, and what are the two primary reasons for its existence?Identify some actions that companies have taken to make takeovers more difficult.
What are some reasons a company might use classified stock?
What is the difference between a stock’s price and its intrinsic value?
Why do investors and managers need to understand how to estimate a firm’s intrinsic value?
What are two commonly used approaches for estimating a stock’s intrinsic value?How do they differ in their focus?
What are the two parts of most stocks’ expected total return?Whereas a bond contains a promise to pay interest, a share of common stock typically provides an expectation of but no promise of
If D1 5 $2.00, g 5 6%, and P0 5 $40.00, what are the stock’s expected dividend yield, capital gains yield, and total expected return for the coming year?Whereas a bond contains a promise to pay
Is it necessary for all investors to have the same expectations regarding a stock for the stock to be in equilibrium?Whereas a bond contains a promise to pay interest, a share of common stock
What would happen to a stock’s price if the “marginal investor” examined a stock and concluded that its intrinsic value was greater than its current market price?Whereas a bond contains a
Write out and explain the valuation formula for a constant growth stock.
Describe how the formula for a zero growth stock can be derived from the formula for a normal constant growth stock.
Firm A is expected to pay a dividend of $1.00 at the end of the year. The required rate of return is rs = 11%. Other things held constant, what would the stock’s price be if the growth rate was 5%?
Firm B has a 12% ROE. Other things held constant, what would its expected growth rate be if it paid out 25% of its earnings as dividends? 75%?
If Firm B had a 75% payout ratio but then lowered it to 25%, causing its growth rate to rise from 3% to 9%, would that action necessarily increase the price of its stock?Why or why not?
Explain how one would find the value of a nonconstant growth stock.
Explain what is meant by horizon (terminal) date and horizon (continuing)value.
Write out the equation for free cash flows and explain it.
Why might someone use the corporate valuation model for companies that have a history of paying dividends?
What steps are taken to find a stock price using the corporate valuation model?
Why might the calculated intrinsic value differ from the stock’s current market price?Which would be “correct,” and what does “correct” mean?
Is the equation used to value preferred stock more like the one used to value a bond or the one used to value a “normal” constant growth common stock? Explain.Explain the following statement:
Define the following terms:a. Proxy; proxy fight; takeoverb. Preemptive rightc. Classified stock; founders’ sharesd. Marginal investor; intrinsic valuee. Required rate of return, expected rate of
Fletcher Company’s current stock price is $36.00, its last dividend was $2.40, and its required rate of return is 12%. If dividends are expected to grow at a constant rate, g, in the future, and if
Snyder Computers Inc. is experiencing rapid growth. Earnings and dividends are expected to grow at a rate of 15% during the next 2 years, at 13% the following year, and at a constant rate of 6%
Shome Industries retains and reinvests all its earnings. So, Shome does not pay any dividends, and it has no plans to pay dividends any time soon. A major pension fund is interested in purchasing
What three areas of finance does this book cover? Are these areas independent of one another, or are they interrelated in the sense that someone working in one area should know something about each
Who is the CFO, and where does this individual fit into the corporate hierarchy? What are some of his or her responsibilities?
Does it make sense for not-for-profit organizations such as hospitals and universities to have CFOs? Why or why not?
What is the relationship among economics, finance, and accounting?
What are the key differences among proprietorships, partnerships, and corporations?
How are LLCs and LLPs related to the other forms of organization?
What is an S corporation, and what is its advantage over a C corporation? Why don’t firms such as IBM, GE, and Microsoft choose S corporation status?
What are some reasons why the value of a business other than a small one is generally maximized when it is organized as a corporation?
What’s the difference between a stock’s current market price and its intrinsic value?
Do stocks have known and “provable” intrinsic values, or might different people reach different conclusions about intrinsic values? Explain.
Should managers estimate intrinsic values or leave that to outside security analysts?Explain.
If a firm could maximize either its current market price or its intrinsic value, what would stockholders (as a group) want managers to do? Explain.
Should a firm’s managers help investors improve their estimates of the firm’s intrinsic value? Explain.
What are three techniques stockholders can use to motivate managers to maximize their stock’s long-run price?
Should managers focus directly on the stock’s actual market price or its intrinsic value, or are both important? Explain.
Why might conflicts arise between stockholders and debtholders?
How might astute bondholders react if stockholders take on risky projects?
How can bondholders protect themselves from managers’ actions that negatively impact bondholders?
Is maximizing shareholder value inconsistent with being socially responsible?Explain.
When Boeing decides to invest $5 billion in a new jet airliner, are its managers certain of the project’s effects on Boeing’s future profits and stock price? Explain.
How would you define business ethics?
Can a firm’s executive compensation plan lead to unethical behavior? Explain.
Unethical acts are generally committed by unethical people. What are some things companies can do to help ensure that their employees act ethically?
Define each of the following terms:a. Sarbanes-Oxley Actb. Proprietorship; partnership; corporationc. S corporation; limited liability company (LLC); limited liability partnership (LLP)d. Intrinsic
Name three ways capital is transferred between savers and borrowers.
Why are efficient capital markets necessary for economic growth?
Distinguish between physical asset markets and financial asset markets.
What’s the difference between spot markets and futures markets?
Distinguish between money markets and capital markets.
Differentiate between private and public markets.
What’s the difference between a commercial bank and an investment bank?
List the major types of financial institutions, and briefly describe the primary function of each.
What are some important differences between mutual funds, exchange-traded funds, and hedge funds? How are they similar?
What are the differences between the physical location exchanges and the NASDAQ stock market?

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