SECTION I

Conceptual Questions 8 Points each

1. The required rate of return on an asset is a function of

A) The risk associated with the return from the given asset

B) The established risk-free rate of interest

C) The market equilibrium

D) Both a and b above are correct

ANSWER:

2. At any point in time before maturity of a bond, the bond could be selling at

A) A premium

B) At a discount

C) At par

D) Any of the above

E) None of the above

ANSWER:

3.. A zero coupon bond is a bond that

a. originally sold at a discount

B. will sell for a premium

c.. is a premium value bond

d.. has a high current yield

ANSWER:

4.. With respect to a corporate bond, a sinking fund allows the issuer to

A) redeem an entire debt issue prior to maturity

B) purchase a portion of the debt each year in the open market or call a portion of the debt for mandatory redemption

C) call the entire debt issue

D) accumulate interest expenses into a sinking fund account

ANSWER:

5. Users of preferred stock include (Hint: see Chapter 6 in the e-text):

a. Utility companies

b.. Acquiring firm in mergers and acquisitions

c. Large commercial banks

d. All of the above

e. None of the above

ANSWER:

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Section II

7. (10 Points) What is the yield to maturity for the Cornwall Linkage Company zero coupon $1,000 bond that matures in 14 years assuming that the bond is currently selling for $530.00 (hint: this bond does not have a coupon rate and therefore, only a maturity value and no regular cash flows)?

$___________

8. (30 points). Cornwall Agency issued $50 million of 20-year corporate bonds in 2010. The bonds were issued in $1000 denominations with an annual coupon interest rate of 8%. Give your answers to a, b, and c below:

What is the current rate of return also called the current yield on these bonds if they are purchased at a current price of $900 each?

$___________

b.. Value the bond, that is, find the intrinsic value (Vb) of the $1,000 bond assuming a client is requiring an interest rate of 11.5%. You could use the Excel spreadsheet, a financial calculator or the formula as we did in the study of time value of money (TVM). Note that the bond has 13 more years to expire and therefore N = 13 and the market price is $900.

$___________

c.. From the results in (b) above would you recommend her to invest in the bond?

YES ________ NO _______

YOUR REASONING IS:

SECTION III

(20 Points). In 15 years time you wish to purchase a house in Avalon Park, FL currently valued at $180,000. The value of the asset is expected to increase at a growth rate of 2.75% per year. You wish to set aside equal end-of-monthly payments so that in 15 years time you would buy the house for cash. What is the equal monthly amounts to set aside, assuming that you could earn a 9% return on your set aside amounts over the period? This simulation is best handled in two parts, as we did in class, as follows:

Projected asset value:

.$_________

Set Aside end-of-month payments (PMT) would be:

... $___________