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principles of finance

Questions and Answers of Principles Of Finance

3. (YTM, continuous vs. discrete) You have been offered a U.S. Treasury bill.The face value of the bill is $10,000, and the price is $9,925. The bill matures in 6 months. Compute the YTM of the bill
b. Use Excel’s XIRR function to compute the bond’s yield to maturity (YTM).
a. Use Excel’s IRR function to compute the bond’s yield to maturity (YTM).
Bond’s face value repaid on last coupon date
Bond price: $1,252.00
Coupon payments: Once a year on 1 August 2002, 2003, . . ., 2012
Coupon rate: 6%
Face value: $1,000.00
2. (YTM) On 1 August 2015, you are offered the following bond:
c. Can you conclude that “the longer- term bond’s price is more sensitive to changes in the market interest rate?” Explain using a graph
b. Make a table comparing the bond prices when the market interest rate varies from 0%, 1%, . . ., 5%, 6%, . . ., 20%. Use the template below, which may be found on the companion website. Make sure
a. Assume the market interest rate is 6%. What is the price of each bond?
The preferred stock is listed on the TRACE platform (a platform of professional trade securities that are not traded on a stock exchange). The price varies with market interest rates and the
The preferred stock’s dividend is 6.25% of its par value, which is 6.25%*100,000 = $6,250 annually. A 6- month period of this annual dividend,$3,125, is paid twice a year, on 15 June and 12
The par value of the stock is $100,000.
Basis is the number of days in a year (sounds stupid, but there are different conventions). The answer of “3” used here tells Excel to use the actual number of days.
Frequency is the number of coupon payments per year.
Redemption is the redemption value per $100 face value.
Pr is the price per $100 face value. In our example, a $1,000 face- value ABC bond is selling for $1,050; this is $105 for each $100 of face value.
Rate is the annual coupon rate on the bond.
Maturity is the maturity date of the bond.
The Settlement is the date that the bond is purchased (cell A12). Notice that Excel translates this date to 42097; to understand this translation, refer to Chapter 26.
22. (Market efficiency— expectation vs. realization) A recent finding shows that low- rated bonds have earned lower returns in the last 60 years than government bonds. Does this fact contradict
b. What would you advice the entrepreneur to do with his software?
a. Do you think that brokerage houses should buy the new software?
21. (Market efficiency—prediction of prices) An entrepreneur is marketing new software that estimates the prices of stocks according to a new model.
b. Can you think of an explanation that is consistent with market efficiency that will explain the new issue puzzle?
a. Is Ritter’s explanation consistent with market efficiency?
20. (Market efficiency— patterns) The “new issue puzzle” is a phenomenon according to which the returns from investing in firms that issue stocks is lower than other stocks 5 years after the
19. (Market efficiency patterns) In Upper Fantasia, a well- known professor showed that during the last 50 years, stocks whose prices rose for three consecutive days will tend to go down on the
c. What should have been the market response if market efficiency holds?
b. What type of market efficiency does the sentence contradict? Try to distinguish between two possibilities.
a. Explain why this sentence contradicts market efficiency.
18. (Market efficiency— reaction to news) “Due to the unexpected positive earnings report, the price of GLZ shares rose on each trading day in the past week.”
17. (Market efficiency— reaction to news) The “DEF” company recruited one of the best CEOs in the country to its service in an unanticipated move.However, the price of the “DEF” stocks fell
b. Do you have a reasonable explanation as to why the anomaly persists and does not disappear due to the arbitrageurs’ actions?
a. Do the results contradict market efficiency?
16. (Market efficiency—patterns) One of the puzzling phenomena of financial markets is the “weekend effect.” According to this phenomena, stock returns on Monday are lower than every other day
15. (Market efficiency—public information) Two years after the MBC Company went public, it was found that the company tampered with the accounting reports. As a result of this finding, the price of
14. (Market efficiency— trading on inside information) The CEO of Monkey Business Corporation (MBC) and his nephew were arrested after it was found out that the nephew bought $1,000,000 worth of
13. (Market efficiency— trading on inside information) The workers of a large factory in Michigan received information according to which the price of the Monkey Business Corporation (MBC) stock is
11. (Market efficiency— reaction to news) One of the earliest tests of market efficiency was to examine the returns of stocks around the publication of their companies’ earnings reports. The
10. (Market efficiency— reaction to news) On 17 July 2015, ABC Corporation reported an increase of 2 cents in earnings per share (EPS). Nevertheless, the price of the stock dropped by $1.50. In
9. (Market efficiency— general) Assume that markets are efficient. Do you expect that the average return of mutual funds will be higher, lower, or equal to the market return?
d. The higher the transaction costs, the more mispricing is expected.
c. Arbitrageurs are key players in preserving market efficiency.
b. A price drop of 60% in 1 day implies that the market is inefficient.
a. Studying a company is a waste of effort because all information is incorporated in the company’s stock prices.
8. (Market efficiency statements) Are the following statements true or false?Explain.
e. During the month of January, stocks earn higher returns than in other months.
d. When the founder of a company unexpectedly retires from his management position, the firm’s stocks tends to go up.
c. Firms that announce a dividend cut continue to under-perform similar stocks 6 months after the announcement date.
b. Only 35% of mutual funds earned higher returns than the S&P 500.
a. Stocks that perform best in January perform worst in February.
7. (Market efficiency statements) Which of the following results support/contradict market efficiency
b. The following day, the price of Goggle drops by 5%, the price of General Electric drops by 2%, and the price of Yahoo remains the same. The price of BTM was $117. Does the price additivity rule
a. If the price of a BTM share is $122.48, does the price additivity rule hold?
6. (Price additivity) Beat The Market (BTM) is an open-end mutual fund. The fund’s portfolio consists of 10,000 Yahoo Inc. stocks traded for $36.14 as well as 15,000 stocks of Google Inc. traded
5. (The law of one price) In country A, short selling is allowed, whereas in country B, it is illegal. If all other things are equal, where do you anticipate more frequent mispricing? Explain.
4. (One price principle, cross- listed stock) Teva is a pharmaceutical company traded both on the Tel Aviv stock exchange and on the Nasdaq. At 9:30 Eastern time (when both exchange markets are
3. (The rule of one price) One pound of apples is sold for $2.50 in Ashville and for $4.20 in Alaska. Does this fact violate the one price rule?
2. (One price principle with transaction costs) Continuing with the previous problem: If the transaction costs in London are 0.25% per transaction and 0.5% in Asheville, is the strategy still
b. Assume that the arbitrageur invests £100,000 in the strategy. How much money will he gain from implementing it?
a. Show a strategy that will enable the arbitrageur to make arbitrage profits.
1. (One price principle) On 27 October, an arbitrageur in London was following the exchange rates in Asheville. At that time, $1 was traded for €0.8251 and £0.4111 (you can’t change directly
b. Suppose investors actually believe the stock will sell for $54 at yearend.Is the stock a good or bad buy? What will investors do? At what point will the stock reach an equilibrium at which it
a. What is the investors’ expectation of the price of the stock at the end of the year?
18. (Stock expected price) A stock with a beta of 0.75 now sells for $50. Investors expect the stock to pay a year- end dividend of $3. The T- bill rate is 2%, and the market risk premium is 5%.
d. The company should proceed with the investment unless the company’s beta is less than 1.25
c. The company should proceed with the investment unless the company’s beta is greater than 1.25.
b. The company should proceed with the investment regardless of the company’s beta.
a. The company should not proceed with the investment.
16. (rE with investments) A company is deciding whether to issue stock to raise money for an investment project which has the same risk as the market and an expected return of 15%. If the risk- free
b. You estimate that the stock beta of the Korbell Brandy Corp. is 1.8.Korbell is purely in the brandy business, its debt-to-equity ratio is 2/ 3, and its bond beta is 0.2. Korbell is subjected to
a. What are the equity betas of typical projects implicit in the discount rates used by the two divisions?
15. (rE, and WACC) The current risk- free rate is rf = 4%, and the expected rate of return on the market portfolio is E rM ( ) = 10%. The Brandywine Corporation has two divisions of equal market
14. (WACC using asset beta) Use the data above to calculate Boeing’s WACC using an asset asset. Assume Boeing’s debt beta is 0.
c. What is Boeing’s WACC?
b. Calculate Boeing’s cost of equity (rE).
a. Calculate Boeing’s cost of debt (rD).
c. What is Amgen’s WACC?
b. Calculate Amgen’s cost of equity (re).
a. Calculate Amgen’s cost of debt (rd).
c. Assume that rf = 3% and the E rM ( ) = 8%. Compute MSFT’s cost of equity rE.
b. Find MSFT’s recent stock price and its number of shares, and use them to compute MSFT’s market equity value. Does this accord with the Yahoo computation?
a. What is Microsoft’s price–earnings (P/ E) ratio, its β, and its debt to equity ratio? (Use the trailing P/ E ratio.)11
8. (rE,, beta, and P/ E ratio) Using the Yahoo profile for Microsoft (MSFT) (given below):
d. Calculate Cobra’s WACC
c. What was Cobra’s cost of equity and cost of debt?
b. What was Cobra’s capital structure as of 2015 (market value of debt and equity)?
a. Calculate the mean return, the annual standard deviation (sigma), and the beta of the market portfolio and Cobra.
The looking forward, risk- free rate of interest at the end of 2015 was rf = 2.16%.
Cobra’s corporate tax rate was 36%.
Cobra’s debt at year- end 2015 is $44,500,000, and its debt at year- end 2014 was $35,000,000. The amount of interest paid in 2015 by the company was $4,323,000.
Cobra has 1,500,000 shares. The share price at the end of 2015 was $12.00.
How do we calculate the firm’s corporate tax rate, TC?
How do we calculate the firm’s cost of borrowing, rD?
How do we calculate the market value of a firm’s debt, D?
How do we calculate the risk- free rate, rf?
How do we calculate the expected return on the market, E(rM)?

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