1. An American put option gives its holder the right to _________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at the exercise price only at the expiration date

C. sell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at the exercise price only at the expiration date

2. An American call option gives the buyer the right to _________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at the exercise price only at the expiration date

C. ell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at the exercise price only at the expiration date

3. A European call option gives the buyer the right to _________.

A. buy the underlying asset at the exercise price on or before the expiration date

B. buy the underlying asset at the exercise price only at the expiration date

C. sell the underlying asset at the exercise price on or before the expiration date

D. sell the underlying asset at the exercise price only at the expiration date

4. You purchase one IBM July 120 call contract for a premium of $5.

You hold the option until the expiration date when IBM stock sells for $123 per share. You will realize a ______ on the investment.

A. $200 profit

B. $200 loss

C. $300 profit

D. $300 loss

5. At contract maturity, the value of a call option is ___________ where X equals the option’s strike price and ST is the stock price at contract expiration.

A. Max(0, ST – X)

B. Min(0, ST – X)

C. Max(0, X – ST)

D. Min(0, X – ST)

1 1. C 2. A 3. B 4. B 5.

A Long Call Profit = Max[0,($123 – $120)(100)] – $500 = -$200

A firm that has an ROE of 12% is considering cutting its dividend payout. The stockholders of the firm desire a dividend yield of 4% and a capital gain yield of 9%. Given this information which of the following statement(s) is/are correct?

I. All else equal the firm’s growth rate will accelerate after the payout change

II. All else equal the firm’s stock price will go up after the payout change

III. All else equal the firm’s P/E ratio will increase after the payout change A. I only. I and II only. II and III only. I, II, and III.

1. A firm cuts its dividend payout ratio. As a result, you know that the firm’s _______.

A. return on assets will increase

B. earnings retention ratio will increase

C. earnings growth rate will fall.

D. stock price will fall

2. An underpriced stock provides an expected return which is ____________ the required return based on the capital asset pricing model (CAPM).

A. less than

B. equal to

C. greater than

D. greater than or equal

3. Stockholders of Dog’s R Us Pet Supply expect a 12% rate of return on their stock. Management has consistently been generating an ROE of 15% over the last 5 years but now believes that ROE will be 12% for the next five years. Given this, the firm’s optimal dividend payout ratio is now ______.

A. 0%

B. 100%

C. between 0% and 50%

D. between 50% and 100%

4. The constant growth dividend discount model (DDM) can be used only when the ___________.

A. growth rate is less than or equal to the required return.

B. growth rate is greater than or equal to the required return

C. growth rate is less than the required return.

D. growth rate is greater than the required return.

5. Suppose that in 2009 the expected dividends of the stocks in a broad market index equaled $240 million when the discount rate was 8% and the expected growth rate of the dividends equaled 6%. Using the constant growth formula for valuation, if interest rates increase to 9% the value of the market will change by _____.

A. -10%

B. -20%

C. -25%

D. -33%

6. You are considering acquiring a common share of Sahali Shopping Center Corporation that you would like to hold for one year. You expect to receive both $1. 25 in dividends and $35 from the sale of the share at the end of the year. The maximum price you would pay for a share today is __________ if you wanted to earn a 12% return.

A. $31. 25.

B. $32. 37

C. $38. 47

D. $41. 32

7. Eagle Brand Arrowheads has expected earnings of $1. 5 per share and a market capitalization rate of 12%. Earnings are expected to grow at 5% per year indefinitely. The firm has a 40% plow back ratio. By how much does the firm’s ROE exceed the market capitalization rate?

A. 0. 5%

B. 1. 0%

C. 1. 5%

D. 2. 0%

8. A preferred share of Coquihalla Corporation will pay a dividend of $8. 00 in the upcoming year, and every year thereafter, i. e. , dividends are not expected to grow. You require a return of 7% on this stock. Using the constant growth DDM to calculate the intrinsic value, a preferred share of Coquihalla Corporation is worth _________.

A. $13. 50

B. $45. 50

C. $91. 0

D. $114. 29 10.

9. Brevik Builders has an expected ROE of 25%. Its dividend growth rate will be __________ if it follows a policy of paying 30% of earning in the form of dividends.

A. 5. 0%

B. 15. 0%

C. 17. 5%

D. 45. 0%

10. Cache Creek Manufacturing Company is expected to pay a dividend of $3. 36 in the upcoming year. Dividends are expected to grow at 8% per year. The riskfree rate of return is 4% and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalization rate, and the constant growth DDM to determine the value of the stock. The stock’s current price is $84. 0. Using the constant growth DDM, the market capitalization rate is _________.

A. 9%

B. 12%

C. 14%

D. 18%

11. Ace Ventura, Inc. has expected earnings of $5 per share for next year. The firm’s ROE is 15% and its earnings retention ratio is 40%. If the firm’s market capitalization rate is 10%, what is the present value of its growth opportunities?

A. $25

B. $50

C. $75

D. $100

12. Flanders, Inc. has expected earnings of $4 per share for next year. The firm’s ROE is 8% and its earnings retention ratio is 40%. If the firm’s market capitalization rate is 15%, what is the present value of its growth opportunities?

A. -$6. 33

B. $0

C. $20. 34

D. $26. 67 14.

13. Cache Creek Manufacturing Company is expected to pay a dividend of $4. 20 in the upcoming year. Dividends are expected to grow at a rate of 8% per year. The riskfree rate of return is 4% and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalization rate on the stock, and the constant growth DDM to determine the intrinsic value of the stock. The stock is trading in the market today at $84. 00. Using the constant growth DDM and the CAPM, the beta of the stock is _________.

A. 1. 4

B. 0. 9

C. 0. 8

D. 0. 5.

14. Westsyde Tool Company is expected to pay a dividend of $2. 00 in the upcoming year. The risk-free rate of return is 6% and the expected return on the market portfolio is 12%. Analysts expect the price of Westsyde Tool Company shares to be $29 a year from now. The beta of Westsyde Tool Company’s stock is 1. Using a one-period valuation model, the intrinsic value of Westsyde Tool Company stock today is _________.

A. $24. 29

B. $27. 39

C. $31. 13

D. $34. 52

15. Todd Mountain Development Corporation is expected to pay a dividend of $2. 50 in the upcoming year. Dividends are expected to grow at a rate of 8% per year. The risk-free rate of return is 5% and the expected return on the market portfolio is 12%. The stock of Todd Mountain Development Corporation has a beta of 0. 75. Using the CAPM, the return you should require on the stock is _________.

A. 7. 25%

B. 10. 25%

C. 14. 75%

D. 21. 00%

16. Interior Airline is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at a rate of 10% per year. The risk-free rate of return is 4% and the expected return on the market portfolio is 13%. The stock of Interior Airline has a beta of 4. 00. Using the constant growth DDM, the intrinsic value of the stock is _________.

A. $10. 00

B. $22. 73

C. $27. 78

D. $41. 67

17. Everything equal, which variable is negatively related to the intrinsic value of a company?

A. D1

B. D0

C. g

D. k 19.

18. A common stock pays an annual dividend per share of $1. 80. The risk-free rate is 5 percent and the risk premium for this stock is 4 percent. If the annual dividend is expected to remain at $1. 80 per share, what is the value of the stock?

A. $17. 78

B. $20. 00

C. $40. 00

D. None of the above

19. Stock is priced at $45 per share. The stock has earnings per share of $3. 00 and a market capitalization rate of 14%. What is the stock’s PVGO?

A. $23. 57

B. $15. 00

C. $19. 78

D. $21. 34

20. If a firm has a free cash flow equal to $50 million and that cash flow is expected to grow at 3% forever, what is the total firm value given a WACC of 9. 5%?

A. $679 million

B. $715 million

C. $769 million

D. $803 million

21. Next year’s earnings are estimated to be $5. 00. The company plans to reinvest 20% of its earnings at 15%. If the cost of equity is 9%, what is the present value of growth opportunities?

A. $9. 09

B. $10. 10

C. $11. 11

D. $12. 21

1. A2. B3. C4. B5. C6. D7. B8. A9. D10. C11. B12. A13. A14. B15. B16. B17. A18. D19. B20. A21.

1. Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pay interest of $120 annually. Bond A will mature in 5 years while bond B will mature in 6 years. If the yields to maturity on the two bonds change from 12% to 14%, _________.

A. both bonds will increase in value but bond A will increase more than bond B

B. both bonds will increase in value but bond B will increase more than bond A

C. both bonds will decrease in value but bond A will decrease more than bond B

D. both bonds will decrease in value but bond B will decrease more than bond A 2.

2. Everything else equals the __________ the maturity of a bond and the __________ the coupon the greater the sensitivity of the bond’s price to interest rate changes.

A. longer; higher

B. longer; lower

C. shorter; higher

D. shorter; lower

3. A __________ bond is a bond where the issuer has an option to retire the bond before maturity at a specific price after a specific date.

A. callable

B. coupon

C. puttable

D. treasury

4. In an era of particularly low-interest rates, which of the following bonds is most likely to be called?

A. Zero-coupon bonds

B. Coupon bonds selling at a discount

C. Coupon bonds selling at a premium

D. Floating rate bonds

5. A coupon bond that pays interest of 4% annually, has a par value of $1,000, matures in 5 years, and is selling today at $785. The actual yield to maturity on this bond is _________.

A. 7. 2%

B. 8. 8%

C. 9. 1%

D. 9. 6%

6. A coupon bond that pays interest of $60 annually, has a par value of $1,000, matures in 5 years, and is selling today at $75. 25 discount from par value. The current yield on this bond is _________.

A. 6. 00%

B. 6. 49%

C. 6. 73%

D. 7. 00%

7. A coupon bond that pays interest semi-annually has a par value of $1,000, matures in 8 years, and has a yield to maturity of 6%. If the coupon rate is 7%, the intrinsic value of the bond today will be __________ (to the nearest dollar).

A. $1,000

B. $1,063

C. $1,081

D. $1,100

8. A treasury bond due in one year has a yield of 6. 3% while a treasury bond due in 5 years has a yield of 8. 8%. A bond due in 5 years issued by High Country Marketing Corporation has a yield of 9. 6% while a bond due in one year issued by High Country Marketing Corporation has a yield of 6. 8%. The default risk premiums on the one-year and 5-year bonds issued by High Country Marketing Corp. are respectively __________ and _________.

A. 0. 4%, 0. 3%

B. 0. 4%, 0. %

C. 0. 5%, 0. 5%

D. 0. 5%, 0. 8%

9. A zero-coupon bond has a yield to maturity of 5% and a par value of $1,000. If the bond matures in 16 years, it should sell for a price of __________ today.

A. $458. 00

B. $641. 00

C. $789. 00

D. $1,100. 00

10. You can be sure that a bond will sell at a premium to par when _________.

A. its coupon rate is greater than its yield to maturity

B. its coupon rate is less than its yield to maturity

C. its coupon rate equal to its yield to maturity

D. its coupon rate is less than its conversion value

11. Consider a 7-year bond with a 9% coupon and a yield to maturity of 12%. If interest rates remain constant, one year from now the price of this bond will be _________.

A. higher

B. lower

C. the same

D. indeterminate

12. The yield to maturity on a bond is ________.

I. above the coupon rate when the bond sells at a discount, and below the coupon rate when the bond sells at a premium

II. the discount rate that will set the present value of the payments equal to the bond price

III. equal to the true compound return on investment only if all interest payments received are reinvested at the yield to maturity

A. I only

B. II only

C. I and II only

D. I, II, and III 13.

13. Assuming semiannual compounding, a 20-year zero-coupon bond with a par value of $1,000 and a required return of 12% would be priced at _________.

A. $97

B. $104

C. $364

D. $732 14.

14. The yield to maturity of a 10-year zero-coupon bond, with a par value of $1,000 and a market price of $625, is _____.

A. 4. 8%

B. 6. 1%

C. 7. 7%

D. 10. 4% 15.

15. If the quote for a Treasury bond is listed in the newspaper as 98:09 bid, 98:13 ask, the actual price for you to purchase this bond given a $10,000 par value is _____________.

A. $9,828. 12

B. $9,809. 38

C. $9,840. 62

D. $9,813. 42 16.

16. The price on a treasury bond is 104:21 with a yield to maturity of 3. 5%. The price on a comparable maturity corporate bond is 103:11 with a yield to maturity of 4. 59%. What is the approximate percentage value of the credit risk of the corporate bond?

A. 1. 14%

B. 3. 45%

C. 4. 59%

D. 8. 04% 17.

17. You buy an 8 year $1000 par value bond today that has a 6% yield and a 6% annual payment coupon. In one year promised yields have risen to 7%. Your one-year holding period return was ___.

A. 0. 61%

B. -5. 39%

C. 1. 28%

D. -3. 25%

18. If the coupon rate on a bond is 4. 50% and the bond is selling at a premium, which of the following is the most likely yield to maturity on the bond?

A. 4. 30%

B. 4. 50%

C. 5. 20%

D. 5. 50% 19.

19. All other things equal, which of the following has the longest duration?

A. A 30 year bond with a 10% coupon

B. A 20 year bond with a 9% coupon

C. A 20 year bond with a 7% coupon

D. A 10 year zero coupon bond

20. All other things equal, which of the following has the shortest duration?

A. A 30 year bond with a 10% coupon

B. A 20 year bond with a 9% coupon

C. A 20 year bond with a 7% coupon

D. A 10 year zero coupon bond

21. (Challenge question) A pension fund must pay out $1 million next year, $2 million the following year, and then $3 million the year after that. If the discount rate is 8% what is the duration of this set of payments?

A. 2. 00 years

B. 2. 15 years

C. 2. 29 years

D. 2. 53 years

22. All other things equal, which of the following has the longest duration?

A. A 20 year bond with a 10% coupon yielding 10%

B. A 20 year bond with a 10% coupon yielding 11%

C. A 20 year zero coupon bond yielding 10%

D. A 20 year zero coupon bond yielding 11%

23. Because of convexity, when interest rates change the actual bond price will ____________ the bond price predicted by duration.

A. always be higher than

B. sometimes be higher than

C. always be lower than

D. sometimes be lower than

24. Duration is a concept that is useful in assessing a bond’s _________.

A. credit risk

B. liquidity risk

C. price volatility

D. convexity risk 25.

25. A pension fund has an average duration of its liabilities equal to 15 years. The fund is looking at 5-year maturity zero-coupon bonds and 4% yield perpetuities to immunize its interest rate risk. How much of its portfolio should it allocate to the zero-coupon bonds to immunize if there are no other assets funding the plan?

A. 52%

B. 48%

C. 33%

D. 25%

26. You own a bond that has a duration of 6 years. Interest rates are currently 7% but you believe the Fed is about to increase interest rates by 25 basis points. Your predicted price change on this bond is ________.

A. +1. 40%

B. -1. 40%

C. -2. 51%

D. +2. 51%

27. A bank has an average duration of its liabilities equal to 2 years. The bank’s average duration of its assets is 3. 5 years. The bank’s market value of equity is at risk if _______________________.

A. interest rates fall

B. credit spreads fall

C. interest rates rise

D. the price of all fixed income securities rises

28. Banks and other financial institutions can best manage interest rate risk by _____________.

A. maximizing the duration of assets and minimizing the duration of liabilities

B. minimizing the duration of assets and maximizing the duration of liabilities

C. matching the durations of their assets and liabilities

D. matching the maturities of their assets and liabilities

29. The duration of a portfolio of bonds can be calculated as _______________.

A. the coupon weighted average of the duration of the individual bonds in the portfolio

B. the yield weighted average of the duration of the individual bonds in the portfolio

C. the value-weighted an average of the duration of the individual bonds in the portfolio

D. average of the duration of the longest and shortest duration bonds in the portfolio

30. Rank the interest sensitivity of the following from most sensitive to an interest rate change to the least sensitive.

I. 8% coupon, noncallable 20-year maturity, par bond

II. 9% coupon, currently callable 20-year maturity, premium bond

III. Zero-coupon, 30-year maturity bond

A. I, II, III

B. II, III, I

C. III, I, II

D. III, II, I

31. A bank has $50 million in assets, $47 million in liabilities, and $3 million in shareholders’ equity. If the duration of its liabilities is 1. and the bank wants to immunize its net worth against interest rate risk and thus set the duration of equity equal to zero, it should select assets with an average duration of _________.

A. 1. 22

B. 1. 50

C. 1. 60

D. 2. 00 A bond pays annual interest. Its coupon rate is 9%. Its value at maturity is $1,000. It matures in four years. Its yield to maturity is currently 6%.

32. The duration of this bond is _______ years.

A. 2. 44

B. 3. 23

C. 3. 56

D. 4. 10

33. The modified duration of this bond is ______ years.

A. 4. 00

B. 3. 56

C. 3. 36

D. 3. 05

34. A bond with a 9-year duration is worth $1,080. 0 and its yield to maturity is 8%. If the yield to maturity falls to 7. 84%, you would predict that the new value of the bond will be _________.

A. $1,035

B. $1,036

C. $1,094

D. $1,124

35. When interest rates increase, the duration of a 20-year bond selling at a premium _________.

A. increases

B. decreases

C. remains the same

D. increases at first then decline

36. Duration facilitates the comparison of bonds with differing ___________

A. default risk

B. conversion ratios

C. maturities

D. yields to maturity

37. The historical yield spread between the AA bond and the AAA bond has been 25 basis points. Currently, the spread is only 9 basis points. If you believe the spread will soon return to its historical levels you should ________________________.

A. buy the AA and short the AAA

B. buy both the AA and the AAA

C. buy the AAA and short the AA

D. short both the AA and the AAA

38. The duration of a bond normally increases with an increase in _________.

I. term-to-maturity

II. yield-to-maturity.

III. coupon rate

A. I only

B. I and II only

C. II and III only

D. I, II and III

39. Compute the modified duration of a 9% coupon, a 3-year corporate bond with a yield to maturity of 12%.

A. 2. 45

B. 2. 75

C. 2. 88

D. 3. 00

40. An 8%, a 30-year bond has a yield-to-maturity of 10% and a modified duration of 8. 0 years. If the market yield drops by 15 basis points, there will be a __________ in the bond’s price.

A. 1. 15% decrease

B. 1. 20% increase

C. 1. 53% increase

D. 2. 43% decrease

41. To create a portfolio with a duration of 4 years using a 5-year zero-coupon bond and a 3 year 8% annual coupon bond with a yield to maturity of 10%, one would have to invest ________ of the portfolio value in the zero-coupon bond.

A. 50%

B. 55%

C. 60%

D. 75%

42. Which of the following set of conditions will result in a bond with the greatest price volatility?

A. A high coupon and short maturity.

B. A high coupon and long maturity.

C. A low coupon and short maturity.

D. A low coupon and long maturity.

43. An investor who expects declining interest rates would maximize their capital gain by purchasing a bond that has a ___ coupon and a ___ term to maturity.

A. low; long

B. high; short

C. high; long

D. zero; long

44. A zero-coupon bond is selling at a deep discount price of $430. 00. It matures in 13 years. If the yield to maturity of the bond is 6. 7%, what is the duration of the bond?

A. 6. 7 years

B. 8. 0 years

C. 10 years

D. 13 years

45. Convexity implies that duration predictions _______.

I. underestimate the % increase in bond price when the yield falls

II. underestimate the % decrease in bond price when the yield rises

III. overestimates the % increase in bond price when the yield falls

IV. overestimates the % decrease in bond price when the yield rises

A. I and III only

B. II and IV only

C. I and IV only

D. II and III only

1. D2. B3. A4. C5. D6. B7. B8. D9. A10. A11. A12. D13. A14. A15. C16. A17. A18. A19. A20. D21. C22. C23. A24. C25. A27. C28. C29. C30. C31. A32. C33. C34. C35. B36. C37. C38. A39. A40. B41. B42. D43. D44. D45. C