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principles corporate finance

Questions and Answers of Principles Corporate Finance

Bond price Consider 30-year bonds that pay semiannual coupons and have 7 years left until maturity. If you bought the bonds, you would receive a coupon payment of $49.43 each 6 months. The bonds have
Bond underwriting Compare and contrast the processes of going public in the equity markets and debt markets.
Bond investment As an investor, what is the appeal of investing in bonds?What are the cash flows that you can look forward to in the future?
Bond price What is the price of an 18-year coupon bond that has been outstanding for the past 10 years, if the current YTM is 12.43 % and the coupon rate is 10.4 %, paid semiannually?
Bond types Structurally speaking, what is a coupon paying bond? What type of loan? Answer by drawing comparisons between coupon bonds and personal loans.
Bond costs Judy’s Makeup Shop, Inc., just issued 20-year bonds that pay coupons of 5.89 % on a face value of $1,000. How much is it going to cost Judy, in total throughout the life of the bond to
Bond indenture Discuss the following features that may be included in a bond contract: (1) call provision, (2) sinking fund provision, (3) security clause, and(4) restrictive covenants. For each, be
Bond ratings What are the benefits of bond ratings? How do they affect both the issuing firm and the investor?
Coupon rates Suppose you have a 25-year coupon semiannual paying bond selling for $895.68. The bond is currently selling at a yield of 8.5 % and has 16 years left until maturity. What is the coupon
Bond income Your grandma is searching for some investments that will generate a stream of income in her elderly years. She needs $16,000 to cover her living expenses. Her advisor has just used her
YTM and CR Define both the yield to maturity and the coupon rate. What do each tell the investor and the issuing firm? How does the relationship between the two interact with the price of the bond?
Bond maturity Suppose you have a bond with a current selling price of$1,123.26. It is a 30-year bond currently selling at 7.06 %. If the coupon rate is 8.6 % paid semiannually, how many years are
Government bonds How do government bonds differ from corporate bonds.Why would an investor be interested?
Bond yields Consider a coupon bond that is currently selling for $897.07. If the bond pays a coupon rate of 7.1 % and has 18 years left until maturity, what is the current YTM on these bonds?
STRIPS What is a STRIPS bond? How is it created and what purpose does it serve?
Rates and prices What is the relationship between rates and prices? Why is this, both in a mathematical and practical sense? Which variable is the driving force behind the other?
Bond yields Consider a 30-year bond that was issued 14 years ago. The bond is callable in 5 years at 104.Currently, it is selling at $976.39. The coupon rate is 8.10 %, the face value is $1,000, and
Bond yields In the above (#9), what is the YTC on the bond?
Zero-coupon bonds You want to buy zero-coupon bonds with face value of$1,000 and 14 years left until maturity. The bonds have a YTM of 4.33 %, compounded semiannually. What is the current price?
Zero-coupon bonds You have just purchased a debt security that has no coupon payments and expires in 8 years. The security has a face value of$800 and currently sells for $524.98. What is the annual
Clean and dirty prices Consider a bond that is currently quoted at 102.5. The bond pays a 6 % coupon, semiannually. You bought this bond one-fourth of the way through a coupon cycle. How much would
STRIPS What is the YTM on a coupon STRIPS that will mature in 15 years.The parent bond pays a semiannual coupon based upon a coupon rate of 8.6 % and face value of $1,000. The 15-year coupon STRIP is
STRIPS Consider an issuance of government bonds that have 20 years until maturity. The bond pays semiannual coupons based upon a CR of 5.2 % and face value of $1,000. Suppose the bonds get
Bond prices You buy 30 STRIPs that have 12 years left until maturity and a required return of 7.43 %. In addition, you buy twelve 5 % coupon bonds that have 10 years left until maturity and yield 6.3
Callable bonds Consider a bond that is callable at 102.If the current YTC is 7.4 %, the CR is 6.9 %, and the bond has 14 years left until earliest call. If you believe the bond is going to be called
Callable bond yields Consider Bond XYZ, which is currently priced at$986.76 and is callable in 2 years at 102.It pays a coupon rate of 7.54 % in semiannual coupons. It will expire in 4 years and has
Bond portfolio yield Suppose you have just created a bond portfolio made up of 3 bond holdings. You bought 100 corporate bonds that have coupon rates of 7.4 %, compounded semiannually, with 14 years
Gordon Growth Model A firm just paid a dividend of $1.45. If the growth rate is a constant 5.42 % and the required return is 6.4 %, what is the current price of a share of stock, according to the GGM?
Bond portfolios Exactly 3 years ago, you started a portfolio. The portfolio was made up of 12 coupon bonds and 14 zero-coupon bonds:• The coupon bonds have a coupon rate of 6.69 %, paid
Equity Define to someone who has never heard the notion exactly what equity is. Do so from both the firm and investor perspective.
Public equity What distinguishes public equity from private equity? Why would a firm want either, or both?
Gordon Growth Model Suppose Scotty is expected to pay a dividend of $1.75 next year. If the required return is 5.47 % and the expected growth rate is 3.64 %, what is the expected price at time 6?
Common stock Your grandpa doesn’t understand why anyone would want to invest in the stock market instead of just putting their money in the bank.Explain to him the benefits of investing in common
Gordon Growth Model The current price of share of common stock is $25.80.If the company expects perpetual growth of 3.6 % and has a required return of 8 %, what dividend could be expected at time 4?
Equity valuation Why is equity valuation more difficult than bond valuation?Create an analogy to help explain to a beginner.
Common stock valuation Suppose a firm is expected to pay a dividend of$1.25 in each of the next 4 years and then never pay a dividend again. If the firms required return is 5.4 %, at what price would
Dividends What is the difference between current dividends and expected dividends? When would you use each, and why?
Common stock valuation Ned’s Aquarium Hut, Inc., plans to pay a constant dividend of $.40 in each of the next 4 years. At that point, he plans to increase the dividend at a constant rate of 6 %
Preferred stock Your investing buddy says to you, “Why not buy preferred stock? It says right in the name that we should prefer them over common stock.” How do you respond?
Required rate of return Judy’s Fabric Emporium has a capital gains yield of 6.1 %, is expected to pay dividends of $3.15, and has a current market price of$15.51. What is Judy’s required return?
Gordon Growth Model What is the mathematical basis underlying the dividend growth model? If the required return increases, does this increase or decrease the stock price?
Required rate of return Suppose a firm has a current price of $43.53 and expect growth of 4 %. The firm expects constant growth of 5 % from this point forward. If the required rate of return on the
Gordon Growth Model Show three ways the Gordon Growth Model can be used, from either firm’s or investor’s perspective.
Required rate of return Henry’s Hammer Shop, Inc., has common stock that is currently selling for $28.06. They just paid a dividend of $1.78 and expect to increase this amount by $.15 in each of
Required return What are the two components to the required return on common stock? What do they mean for the firm? What about for the investor?
Multiple growth rates A share of common stock paid a dividend exactly 5 years ago of $1.85 and have increased this by $.18 each year until now.They are now planning on growth of 10 % for the next 3
Required return What is the relationship between required returns and growth rates in the Gordon Growth Model?
Multiple growth rates Greta’s Garden and Variety began issuing common stock 12 years ago. Eight years ago, Greta issued her first dividend at $.10 per share. For each year since then, she had
Dividends Detail the four dates of concern dealing with dividend payments.From an investor’s perspective, when would you have to buy to receive the dividend?
Multiple growth rates Tyler’s Doggie Park, Inc., was founded exactly 10 years ago. For the first 7 years, they paid no dividend, as they sought to increase their market share first. However, at
Dividends CEO Davidson knows the firm is falling into a financial black hole but refuses to reduce the dividend. Why is he being so stubborn? Is there any reason why he is correct in his stubbornness?
Common stock valuation Suppose you have a firm that plans to pay a constant dividend of $.45 during each of the next 6 years and then never pay dividends again. At that time, the price will be $3.64.
Stock exchanges Compare and contrast the NYSE and Nasdaq. How do they work, and what role do they play in the financial landscape?
Common stock valuation Hattie’s Hat Emporium just went public at a price of$12.90 per share. They do not plan to pay a dividend for the next 3 years but then plan to pay a special one-time dividend
Stock exchanges Your best friend, Betty, just burst into your apartment with the following proclamation. “I just saw the movie ‘Wall Street,’ and I was so blown away by all the action on the
Multiple growth rates Consider Firm ABC. They just paid a dividend of $.23 per share. They plan to increase this by 12 % during each of the next 3 years. In addition, during the third time period,
Equity portfolios Suppose you buy 180 shares of Stock A and 100 shares of Stock B. Stock A pays a constant dividend of $.20 and will do so forever. They have a required rate of return of 7.42 %.
Equity portfolios Suppose you are creating an investment portfolio. You have decided upon two assets:(a) Fifty shares of common stock in Firm A. The stock just paid a dividend of$1.25. However, they
Portfolio required return Suppose you have a portfolio made up of 55 %common stock A and 45 % preferred stock B. The common stock is expected to pay a dividend of $4.54 and is currently selling for
Risk and return What is the theoretical relationship between risk and return?
Dollar return Suppose you bought 100 shares of Stock ABC at $105.65.Today, they are selling for $102.31. You received dividends of $.26 per quarter for each of the 5 years you have owned the stock.
Risk and return Your best friend just said that she took a large risk last year and lost money. She is angry at you because she says you told her that higher risk equaled higher return. What is your
Holding period return Suppose you bought 20 shares of Stock XYZ 10 years ago for $5.31. For the first 5 years, Stock XYZ did not pay any dividends. For the remaining 5 years, they paid a dividend of
Returns Define both dollar returns and percentage returns. In what situations would you prefer one over the other?
Bond dollar return You just sold 300 bonds that pay an annual coupon of $76.When you bought them, exactly 3 years ago, they were selling at $956.28.Today they are selling at $854.24. How is your
Physical asset percentage return Suppose you paid $30,000 for a work truck and have used it for 15 years. During each of those 15 years, the truck earned you a profit of $2,000. Today you are selling
Returns What are the two components of returns? Describe how each relates to the value of the asset. Also describe the two components from both the investor and firm perspective.
Returns Bob just calculated a return of 3.86 % last year on Asset A. However, Asset A’s stock price decreased by $3 last year. So, what must have happened?
Dollar return Exactly three and a half years ago, you began your portfolio using $10,000 given to you by your grandfather. You bought 40 shares of Stock A, which was selling at $83.00. You also
Risk What is the difficulty in calculating risk? Describe the process through which one estimates the risk of an asset.
Returns Describe the differences between arithmetic and geometric returns. In what situation would you prefer to calculate one over the other?
Holding period return If the HPR on a stock throughout time t is 18.26 % and the beginning price is $11.50, what is the ending price? Assume that $2.10 in dividends was paid throughout time t.
Holding period return Suppose you entered into an investment 8 years ago.You just sold your entire position of 8,000 shares and have calculated you received a total dollar return of $13,590. You sold
Confidence intervals What purpose does the confidence interval serve? How does it help extend the application of risk and reward?
Holding period returns 4 years ago, you bought 100 shares of Stock A at$23.99 per share and 200 shares of Stock B at $12.90 per share. During the first year, Stock A paid a dividend of $.85 per share
Assets and risk You want a safe portfolio. Given that, should you invest primarily in equity or debt? Why? What makes the difference in relation to risk levels?
Geometric returns Suppose a company has had returns over the past 4 years of 6 %, 8 %, 7.5 %, and 2.5 %, respectively. What is the geometric average return for this stock?
Assets and risk Are small assets riskier or safer than large, all else equal?Why?
Geometric cumulative returns Over the past 4 years, Stock CCC had returns of 5.04 %, 16.14 %, 1.85 %, and 5.78 %. If you invested $1,000 at the beginning of those 4 years and all returns can be
Assets and risk Debt can be issued by corporations or governments. Which is riskier and why?
Historical standard deviation The return on Stock A has been 3.45 %,-5.33 %, 6.43 %, and 2.84 % for the last 4 years, respectively. Given this, what is the historical standard deviation?
Expected returns What exactly is meant by expected return? What are the components to the expected return and how are they used in the calculation?
Confidence intervals Suppose a stock had returns of 10 %, 1 %, 8%, 3 %, and 11 % over the past 5 years. What is the 95 % confidence interval?
Portfolios risk What makes portfolio risk difficult to calculate? Why is it important to consider all correlation between pairs of assets?
Confidence intervals Suppose you have managed a mutual fund for the last 5 years, with returns of 15.4 %, 13.5 %, 18.4 %, 9.87 %, and 10.32 % in each of them. There is approximately a 2.5 % chance
Correlation and diversification You just started your retirement portfolio and went to your dad for advice. He said to simply, “diversify, diversify, diversify.”What did he mean by that? Why
Confidence intervals Suppose you have average returns over the last 25 years of 15.65 %, while the variance of those returns is 17.98 %. Given this, what is the probability your return next year will
Unexpected risk What is the difference between systematic and unsystematic risk?
Expected returns Over the past 50 years, Stock AAA has an average return of 6.4 % during normal economies. The return is half this during recessionary years. Contrarily, the return is double this
Diversification Your finance professor just stated that if you diversify correctly, you can eliminate, over time, losses from your investment mistakes. Is that correct? What are the conditions for
Expected returns Over the past 25 years, the average return for Stock ABC has been 12.43 % per year. However, during booming economies, this return is 45 % higher. On the other hand, during
Beta You have three assets, A, B, and C. The beta of Asset A is 1.35, the beta of Asset B is .13, and the beta of Asset C is .77. Describe what should happen to each if the market goes up by 2 %.
Security market line What is the security market line? What is the slope?What is the y-intercept? Answer both in mathematical and definitional terms.
Portfolio returns Suppose you have an expected return on the portfolio of 15.6 %. You are invested in only two stocks, A and B. The expected return on A is 18.55 %, and the expected return on B is
Cost of equity How does the CAPM help in estimating the cost of equity?Discuss the implications of the answer for both the firm and the investor.
Portfolio risk Your portfolio is made up of 75 % Stock A and 25 % Stock B. Stock A has a variance of 31.36 %, while Stock B has a standard deviation of 6.25 %. The covariance between them is 6.8 %.
Portfolio risk Consider a two-asset portfolio. Stock A has a standard deviation of 15 %, and Stock B has a standard deviation of 25 %. You own 14,000 share of Stock A, which is currently selling at
Portfolio risk Consider the following historical returns for stocks R, S, and T.If you have weights of 45 % R, 25 % S, and 20 % T, what is your portfolio standard deviation? Year Stock R Stock S 1
Beta A stock has a beta of 1.43. If the current stock price is $18.02, what would you expect the price to be if the market goes up by 1.4 %?
Beta Suppose Firm VIP has a covariance of 84.87 % with the market. The standard deviation of the market is 22.90 % and the standard deviation of Firm VIP is 16.89 %. What is the beta of Firm VIP?

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