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INSTRUCTIONS:!Choose&the&BEST&answer.&Assume&all&bonds&have&a&par&value&of& $1,000&and&pay&interest&annually,&unless&otherwise&specified.&Please&make&sure&your& financial&calculator&is&set&to& &Mode.&! !! DETERMINING.THE.VALUE.OF.FIXED.INCOME.SECURITIES! ! 1. You!are!considering!purchasing!a!bond!with!a!5%!coupon!and!10=years!left! to!maturity.!Similar!bonds!are!paying!6%!interest!currently.!What!is!the! appropriate!price!of!this!bond?! !!!!! 2. What!would!your!answer!be!to!#1!if!the!current!interest!rate!environment! were!4%?! !!!!! 3. What!would!your!answer!be!to!#1!if!the!bond!made!semi=annual!payments?! !!!!!! 4. Is!the!bond!in!#1!trading!at!a!premium!or!discount?! !!!! 5. What!will!happen!to!the!price!of!the!bond!as!it!approaches!maturity! assuming!everything!else!stays!the!same?!

INSTRUCTIONS:!Choose&the&BEST&answer.&Assume&all&bonds&have&a&par&value&of&

$1,000&and&pay&interest&annually,&unless&otherwise&specified.&Please&make&sure&your&

financial&calculator&is&set&to&&Mode.&!

!!

DETERMINING.THE.VALUE.OF.FIXED.INCOME.SECURITIES!

!

1. You!are!considering!purchasing!a!bond!with!a!5%!coupon!and!10=years!left!

to!maturity.!Similar!bonds!are!paying!6%!interest!currently.!What!is!the!

appropriate!price!of!this!bond?!

!!!!!

2. What!would!your!answer!be!to!#1!if!the!current!interest!rate!environment!

were!4%?!

!!!!!

3. What!would!your!answer!be!to!#1!if!the!bond!made!semi=annual!payments?!

!!!!!!

4. Is!the!bond!in!#1!trading!at!a!premium!or!discount?!

!!!!

5. What!will!happen!to!the!price!of!the!bond!as!it!approaches!maturity!

assuming!everything!else!stays!the!same?!

!!!! 6. Is!the!bond!in!#2!trading!at!a!premium!or!discount?!

7. What!will!happen!to!the!price!of!the!bond!as!it!approaches!maturity!

assuming!everything!else!stays!the!same?!

!!!!

8. Bond!prices!are!inversely!related!to!interest!rates.!That!is,!as!interest!rates!

go!up,!bond!prices!go!down!and!vice!versa.!

a. True!

b. False!

!

9. The!rate!of!return!on!a!bond!if!it!is!held!until!maturity!is!its!Yield!to!Maturity!

(YTM).!What!is!the!YTM!of!a!bond!that!can!be!bought!for!$900,!has!an!annual!

coupon!of!5%!and!10!years!until!maturity?!

!!!!!

10. What!is!the!current!yield!of!the!bond!in!the!prior!problem?!

!!!!!!

ESTIMATING.THE.VALUE.OF.EQUITY.SECURITIES!

!

1. A!stocks!last!dividend!was!$2.00!per!share.!Expected!growth!of!5%!in!this!

dividend!is!expected!to!be!constant.!The!required!rate!of!return!on!equity!is!

10%!and!the!WACC!is!8%.!What!is!the!appropriate!price!of!this!stock?!

!!!!!

2. FastGro,!Inc.!is!expected!to!grow!its!current!$2.00!dividend!by!10%!for!the!

next!three!years.!Growth!beyond!that!year!is!expected!to!be!constant!at!5%.!

The!required!rate!of!return!is!10%.!What!is!the!appropriate!price!of!this!

stock?!

!!!!!

3. Small!changes!in!either!expected!dividend!growth!or!required!rate!of!return!

results!in!very!large!changes!in!estimated!value.!

a. True! ! ! ! ! !b.!!False!

!

4. You!work!in!the!treasury!department!of!a!large!corporation.!Your!boss!asks!

you!to!estimate!the!expected!return!of!the!stocks!in!the!companys!

investment!portfolio.!The!first!stock!you!examine!is!expected!to!pay!a!

dividend!of!$2.00!this!year!and!currently!trades!at!!$50.!You!check!analyst!

estimates!and!learn!that!long=term!growth!is!expected!to!be!6%!for!this!

company.!Based!upon!this!information,!what!return!would!you!expect!this!

stock!to!have!in!the!coming!year?!

!!!!!

5. Sometimes!firms!do!not!pay!dividends.!More!importantly,!dividend!policy!is!

discretionary!and!may!change!at!managements!whim.!Therefore,!a!superior!

and!more!common!way!to!value!a!firm!(and,!ultimately!its!equity!or!stock!

price)!is!via!a!Discounted!Cash!Flow!(DCF)!analysis.!!In!a!DCF,!you!must!

estimate!the!Free!Cash!Flow!(FCF)!of!the!firm!for!several!years!into!the!

future!(usually!at!least!5!and!often!10!or!more).!What!is!the!value!of!a!firm!

with!the!following!characteristics?!

FCF1!=!100!

FCF2!=!120!

FCF3!=!140!

Growth!in!FCF!after!year!3!of!5%!per!year!

WACC!=!8%!

! !

6. Relativity,!Inc.!has!the!following!financial!data:!

EPS!=!$2.00!

DIV!=!$1.00!

BVPS!=!$10.00!

!

A!group!of!peer!companies!trade!at!the!following!multiples,!on!average:!

P/E!=!14x!!

Dividend!Yield!=!3%!

P/B!=!3x!

!

What!estimate!of!stock!price!do!you!get!for!Relativity,!Inc.!using!each!of!these!

data?!

!!!!!!

!!

THE.EFFICIENT.MARKET.HYPOTHESIS!

!

1. There!are!three!forms!of!market!efficiency.!Which!form!of!efficiency!states!

that!all!information!in!past!price!movements!are!reflected!in!current!market!

prices?!That!is,!the!study!of!charts!and!price!patterns!will!not!help!you!

predict!future!stock!price!movements?!

a. Weak=Form!Efficiency!

b. Semi=Strong=Form!Efficiency!

c. Strong=Form!Efficiency!

!

2. There!are!three!forms!of!market!efficiency.!Which!form!of!efficiency!states!

that!current!stock!(e.g.!market)!prices!reflect!all!publicly!available!

information!about!a!company?!

a. Weak=Form!Efficiency!

b. Semi=Strong=Form!Efficiency!

c. Strong=Form!Efficiency!

!

3. There!are!three!forms!of!market!efficiency.!Which!form!of!efficiency!states!

that!current!stock!(e.g.!market)!prices!reflect!all!publicly!and!privately!

available!information!about!a!company?!

a. Weak=Form!Efficiency!

b. Semi=Strong=Form!Efficiency!

c. Strong=Form!Efficiency!

4. Given!what!you!know!about!market!efficiency,!does!technical!analysis!(the!

study!of!past!price/volume!charts!in!the!hopes!of!predicting!future!price!

movements)!work?!

a. Yes,!but!only!in!the!weak=form.!

b. No.!Even!weak=form!efficiency!suggests!that!technical!analysis!can!not!

help!you!predict!future!stock!price!movements.!

!

5. Given!what!you!know!about!market!efficiency,!can!stock!analysts!

consistently!determine!future!price!movements!and!outperform!the!market?!

a. Yes,!but!only!in!the!weak=form.!

b. Yes,!but!only!in!the!semi=strong=form.!

c. Yes.!Analysts!are!smart!and!can!predict!the!market!in!any!form.!

d. No.!Analysts!are!idiots.!

!

6. Evidence!suggests!that!the!market!is!highly!efficient!in!what!form?!

a. The!Weak=form!

b. The!Semi=strong=form!

c. The!Strong=form!

!

7. Evidence!suggests!the!market!is!reasonably!efficient!in!what!form?!

a. The!Weak=form!

b. The!Semi=strong=form!

c. The!Strong=form!

!

8. Evidence!suggests!the!market!is!NOT!efficient!in!what!form?!

a. The!Weak=form!

b. The!Semi=strong=form!

c. The!Strong=form!

!

CREDIT.AND.INTEREST.RATE.RISK.

!

1. The!longer!the!maturity!of!a!bond!the!more!its!price!will!change!in!response!

to!a!given!change!in!interest!rates.!This!is!called!interest!rate!risk.!

a. True! ! ! ! b.!!False!

2. Bonds!with!short!maturities!face!reinvestment!rate!risk!where!future!

interest!rates!might!be!lower!as!short=term!bonds!become!due.!This!means!

that!investors!would!be!reinvesting!their!maturing!bonds!at!lower!and!lower!

interest!rates.!!

a. True! ! ! ! b.!!False!

3. Why!does!a!normal!yield!curve!usually!slope!upward?!

a. Default!risk!is!greater!the!longer!you!must!wait!to!get!your!money!back!

b. Inflation!risks!are!greater!the!longer!you!must!wait!to!get!your!money!

back!

c. Interest!rate!risk!is!higher!for!longer!term!bonds!

d. All!of!the!above!

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