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FINA3317-002 Homework1 Spring 2016 FINA3317-003 Homework 1 Chapter 01 Introduction True / False Questions 1 Primary markets are markets in which users of funds raise cash by selling securities to funds' suppliers. True False 2 The New York Stock Exchange (NYSE) is an example of a secondary market. True False 3 Money markets are the markets for securities with an original maturity of one year or less. True False 4 There are three types of major financial markets today: primary, secondary, and derivatives markets. The NYSE and NASDAQ are both examples of derivatives markets. True False Multiple Choice Questions 5 What factors are encouraging financial institutions to offer overlapping financial services such as banking, investment banking, brokerage, etc.? I. Regulatory changes allowing institutions to offer more services II. Technological improvements reducing the cost of providing financial services III. Increasing competition from full-service global financial institutions IV. Reduction in the need to manage risk at financial institutions A. I only B. II and III only C. I, II, and III only D. I, II, and IV only E. I, II, III, and IV 6 A corporation seeking to sell new equity securities to the public for the first time in order to raise cash for capital investment would most likely A. conduct an IPO with the assistance of an investment banker. B. engage in a secondary market sale of equity. C. conduct a private placement to a large number of potential buyers. D. place an ad in the Wall Street Journal soliciting retail suppliers of funds. E. none of the options. 7 The diagram below is a diagram of the 1 FINA3317-002 Homework1 Sprin ng 2016 A. B. C. D. E. Secondary markets. primary markets. money markets. derivatives markets. commodities markets. 8 Match the intermediary with the characteristic that best describes its function. I. Provide protection from adverse events. II. Pool funds of small savers and invest in either money or capital markets. III. Provide consumer loans and real estate loans funded by deposits. IV. Accumulate and transfer wealth from work period to retirement period. V. Underwrite and trade securities and provide brokerage services. 1. Thrifts 2. Insurers 3. Pension funds 4. Securities firms and investment banks 5. Mutual funds A. 1, 3, 2, 5, 4 B. 4, 2, 3, 5, 1 C. 2, 5, 1, 3, 4 D. 2, 4, 5, 3, 1 E. 5, 1, 3, 2, 4 9 A. B. C. D. E. Which of the following is/are money market instrument(s)? Negotiable CDs Common stock T-bonds 4-year year maturity corporate bond Negotiable CDs, common stock, and T-bonds T 10 Liquidity risk at a financial intermediary (FI) is the risk A. that promised cash flows from loans and securities held by FI FIss may not be paid in full. B. incurred by an FI when the maturities of its assets and liabilities do not match. C. that a sudden surge in liability withdrawals may require an FI to liquidate assets quickly at fire sale prices. D. incurred by an FI when its investments in technology do not result in cost savings or revenue growth. 2 FINA3317-002 Homework1 Spring 2016 E. risk that an FI may not have enough capital to offset a sudden decline in the value of its assets. Chapter 02 Determinants of Interest Rates True / False Questions 11 The real risk-free rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption. True False 12 If you earn 0.5 percent a month in your bank account, this would be the same as earning a 6 percent annual interest rate with annual compounding. True False 13 Earning a 5 percent interest rate with annual compounding is better than earning a 4.95 percent interest rate with semiannual compounding. True False 14 An increase in the marginal tax rates for all U.S. taxpayers would probably result in reduced supply of funds by households. True False 15 The risk that a security cannot be sold at a predictable price with low transaction costs at short notice is called liquidity risk. True False 16 The unbiased expectations hypothesis of the term structure posits that long-term interest rates are unrelated to expected future short-term rates. True False Multiple Choice Questions 17 An investment pays $400 in one year, X amount of dollars in two years, and $500 in three years. The total present value of all the cash flows (including X) is equal to $1,500. If i is 6 percent, what is X? A. $749.67 B. $789.70 C. $600.00 D. $822.41 E. $702.83 18 An insurance company is trying to sell you a retirement annuity. The annuity will give you 20 payments with the first payment in 12 years when you retire. The insurance firm is asking you to pay 3 FINA3317-002 Homework1 Sprin ng 2016 $50,000 today. If this is a fair deal, what must the payment amount be (to the dollar) if the interest rate is 8 percent? A. $9,472 B. $10,422 C. $12,824 D. $5,093 E. $11,874 19 You go to the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have decreased. The yield decreases may be explained by which one of the following? A. Newly expected decline in the value of the dollar B. Increases in the U.S. government budget deficit C. Decreased Japanese purchases of U.S. Treasury bills/bonds D. An increase in current and expected future returns of real corporate investments E. A decrease in U.S. inflationary expectations 20 YIELD CURVE FOR ZERO COUPON BONDS RATED AA Assume that there are no liquidity premiums. You just bought a 15-year year maturity Xerox corporate bond rated AA with a 0 percent coupon. You expect to sell the bond in eight years. Find the expected interest rat ratee at the time of sale (watch out for rounding error). A. 8.85 percent B. 11.00 percent C. 12.80 percent D. 13.92 percent E. 12.49 percent 21 A. B. C. D. Of the following, the most likely effect of an increase in income tax rates would be to decrease the savings ngs rate. decrease the supply of loanable funds. increase interest rates. All of the options. 22 Investment A pays 8 percent simple interest for 10 years. Investment B pays 7.75 percent compound interest for 10 years. Both require an initial $ $10,000 10,000 investment. The future value of A minus the future value of B is equal to ______________ (to the nearest penny). A. -$3,094.67 4 FINA3317-002 Homework1 Spring 2016 B. C. D. E. $3,094.67 $1,643.32 $2,500.00 -$2,500.00 23 You want to have $5 million when you retire in 40 years. You believe you can earn 9 percent per year on your investment. How much must you invest each year to achieve your goal when you retire? (Ignore all taxes.) A. $10,412 B. $11,619 C. $14,798 D. $15,295 E. None of the options 24 Classify each of the following in terms of their effect on interest rates (increase or decrease): I. Covenants on borrowing become more restrictive. II. The Federal Reserve increases the money supply. III. Total household wealth increases. A. I increases, II increases, III increases B. I increases, II decreases, III decreases C. I decreases, II increases, III increases D. I decreases, II decreases, III decreases E. None of the options 25 A 15-payment annual annuity has its first payment in nine years. If the payment amount is $1,400 and the interest rate is 7 percent, what is the most you should be willing to pay today for this investment? A. $6,416.67 B. $12,751.08 C. $6,935.74 D. $5,825.11 E. $7,421.24 Chapter 03 Interest Rates and Security Valuation True / False Questions 26 If interest rates increase, the value of a fixed income contract decreases and vice versa. True False 27 At equilibrium, a security's required rate of return will be less than its expected rate of return. True False 5 FINA3317-002 Homework1 Spring 2016 28 Suppose two bonds of equivalent risk and maturity have different prices such that one is a premium bond and one is a discount bond. The premium bond must have a greater expected return than the discount bond. True False 29 All else equal, the holder of a fairly priced premium bond must expect a capital loss over the holding period. True False 30 The longer the time to maturity, the lower the security's price sensitivity to an interest rate change, ceteris paribus. True False 31 A 10-year maturity zero coupon bond will have lower price volatility than a 10-year bond with a 10 percent coupon. True False Multiple Choice Questions 32 The required rate of return on a bond is A. the interest rate that equates the current market price of the bond with the present value of all future cash flows received. B. equivalent to the current yield for non-par bonds. C. less than the E(r) for discount bonds and greater than the E(r) for premium bonds. D. inversely related to a bond's risk and coupon. E. none of the options. 33 A. B. C. D. E. Duration is the elasticity of a security's value to small coupon changes. the weighted average time to maturity of the bond's cash flows. the time until the investor recovers the price of the bond in today's dollars. greater than maturity for deep discount bonds and less than maturity for premium bonds. the second derivative of the bond price formula with respect to the YTM. 34 A. B. C. D. E. The interest rate used to find the present value of a financial security is the expected rate of return. required rate of return. realized rate of return. realized yield to maturity. current yield. 35 A security has an expected return less than its required return. This security is 6 FINA3317-002 Homework1 Spring 2016 A. B. C. D. E. selling at a premium to par. selling at a discount to par. selling for more than its PV. selling for less than its PV. a zero coupon bond. 36 A. B. C. D. You would want to purchase a security if P ____________ PV or E(r) ____________ r. ; ; ; ; 37 A 10-year annual payment corporate bond has a market price of $1,050. It pays annual interest of $100 and its required rate of return is 9 percent. By how much is the bond mispriced? A. $0.00 B. Overpriced by $14.18 C. Underpriced by $14.18 D. Overpriced by $9.32 E. Underpriced by $9.32 38 An eight-year corporate bond has a 7 percent coupon rate. What should be the bond's price if the required return is 6 percent and the bond pays interest semiannually? A. $1,062.81 B. $1,062.10 C. $1,053.45 D. $1,052.99 E. $1,049.49 39 A corporate bond has a coupon rate of 10 percent and a required return of 10 percent. This bond's price is A. $924.18. B. $1,000.00. C. $879.68. D. $1,124.83. E. not possible to determine from the information given. 40 An eight-year annual payment 7 percent coupon Treasury bond has a price of $1,075. The bond's annual E(r) must be A. 13.49 percent. B. 5.80 percent. C. 7.00 percent. 7 FINA3317-002 Homework1 Spring 2016 D. E. 1.69 percent. 4.25 percent. 41 A semiannual payment bond with a $1,000 par has a 7 percent quoted coupon rate, a 7 percent promised YTM, and 10 years to maturity. What is the bond's duration? A. 10.00 years B. 8.39 years C. 6.45 years D. 5.20 years E. 7.35 years 42 You bought a stock three years ago and paid $45 per share. You collected a $2 dividend per share each year you held the stock and then you sold the stock for $47 per share. What was your annual compound rate of return? A. 8.89 percent B. 8.51 percent C. 5.84 percent D. 4.44 percent E. 2.96 percent 43 A. B. C. D. E. A decrease in interest rates will decrease the bond's PV. increase the bond's duration. lower the bond's coupon rate. change the bond's payment frequency. not affect the bond's duration. 8