Multiple Choice
Identify the choice
that best completes the statement or answers the question.
1.
Stock
A and Stock B each have an expected return of 12 percent, a beta of 1.4, and a
standard deviation of 25 percent. The returns on the two stocks have a
correlation of 0.6. Portfolio P has half of its money invested in Stock A and
half in Stock B. Which of the following statements is correct?
A)
Portfolio
P has an expected return of 12 percent.
B)
Portfolio
P has a beta of 1.4.
C)
Portfolio
P has a standard deviation of 25 percent
D)
Both
statements A and B are correct
E)
All
of the above are correct.
2.
Universe Online (UOL)
announced that they will pay their first dividend of $1 on their common stock
in a year (D_{1}).
Analysts think dividends will grow by 30% in year 2, by 40% in year 3, and by
25% in year 4 before settling into a constant growth rate of 12% in year 5 and
beyond. What is the value of UOL’s stock today based on this information if the
required return is 16%?
A)
$34.59
B)
$39.43
C)
$28.00
D)
$25.00
E)
$63.70
3.
Ford preferred stock has
a par value of $25 with a dividend yield of 10%. What is the value of this
stock if the required return is 8%?
A)
$31.25
B)
$30.00
C)
$28.75
D)
$25.00
E)
$20.00
4.
As a manager of the 221
Fund, a welldiversified portfolio, you have been given the following
information for 4 potential new stocks to add to the 221 Fund.
Stock 
Expected 
Required 
Coefficient of 
Acme, 
15% 
13% 
1.0 
Bubba 
21% 
24% 
1.5 
CosmoCola 
17% 
18% 
0.9 
Da 
20% 
25% 
1.4 
Which
stock(s) would you add to the welldiversified 221 Fund portfolio based on the
information given?
A)
Acme
B)
CosmoCola
C)
Bubba
D)
Da
Bares
5.
The
riskfree rate is 5 percent. Stock A has a beta = 1.0 and Stock B has a beta =
1.4. Stock A has a required return of 11 percent. What is Stock B’s required
return?
A)
13.4%
B)
15.4%
C)
12.4%
D)
14.4%
E)
16.4%
6.
In
the years ahead the market risk premium is expected to fall, while the
riskfree rate is expected to remain at current levels. Given this forecast,
which of the following statements is most correct?
A)
The
required return will increase for stocks with a beta less than 1.0 and will
decrease for stocks with a beta greater than 1.0.
B)
The
required return will fall for all stocks but will fall less for stocks with
higher betas.
C)
The
required return will fall for all stocks but will fall more for stocks with
higher betas.
D)
The
required return on all stocks will remain unchanged.
E)
The
required return for all stocks will fall by the same amount.
7.
Assume
that inflation is expected to decline steadily in the future, but that the real
riskfree rate, r*, will remain constant. Which of the following statements is
CORRECT, other things held constant?
A)
If
the pure expectations theory holds, the Treasury yield curve must be downward
sloping.
B)
If
inflation is expected to decline, there can be no maturity risk premium.
C)
The
expectations theory cannot hold if inflation is decreasing.
D)
If
there is a positive maturity risk premium, the Treasury yield curve must be
upward sloping.
E)
If
the pure expectations theory holds, the corporate yield curve must be downward
sloping.
8.
Harbuck’s Coffee is a
constant growth stock selling for its equilibrium price of $40. Harbucks has a
beta of 1.2 and the current dividend is $1.20. What is Harbuck’s expected constant
growth rate if the riskfree rate is 3% and the market return is 12%?
A)
14.0%
B)
10.8%
C)
14.4%
D)
10.5%
E)
13.8%
9.
If the constant growth
model is to give a “reasonable” valuation of a stock, which of the
following isnot
a valid assumption for the model?
A)
A
growth rate greater than the required rate of return
B)
An
exceptionally high required rate of return
C)
A
growth rate of zero
D)
A
negative growth rate
E)
All
of the above are valid assumptions for the model.
10.
An
analyst seeks to determine the value of Bulldog Industries. After careful
research, the analyst believes that free cash flows for the firm will be $80
million in the upcoming year (year 1) and will grow at 10% annually for each of
the two following years (years 2 and 3). The free cash flows will grow at a
rate of 5% after year 3. What is the Terminal Value (in millions of $) of
Bulldog at the end of year 3 at a WACC of 10%?
A)
1,936
B)
2,033
C)
1,016
D)
2,274
11.
Commercial
papaer is an example of a security traded in the ________ market.
A)
stock
B)
money
C)
capital
D)
futures
12.
The
real riskfree rate is expected to remain constant at 3% in the future, a 2%
rate of inflation is expected for the next 2 years, after which inflation is
expected to increase to 4%, and there is a positive maturity risk premium that
increases with years to maturity. Given these conditions, which of the
following statements is CORRECT?
A)
The
conditions in the problem cannot all be true–they are internally inconsistent.
B)
The
yield on a 2year Tbond must exceed that on a 5year Tbond.
C)
The
yield on a 7year Treasury bond must exceed that of a 5year corporate bond.
D)
The
Treasury yield curve under the stated conditions would be humped rather than
have a consistent positive or negative slope.
E)
The
yield on a 5year Treasury bond must exceed that on a 2year Treasury bond.
13.
Consider
the following information and then calculate the required rate of return for
the Global Investment Fund, which holds 4 stocks. The market’s required rate of
return is 9.50%, the riskfree rate is 7.00%, and the Fund’s assets are as
follows:
Stock 
Investment 
Beta 
A 
$200,000 
1.50 
B 
$300,000 
0.50 
C 
$500,000 
1.25 
D 
$1,000,000 
0.75 
A)
8.91%
B)
10.42%
C)
6.77%
D)
10.06%
E)
8.64%
14.
Which of the following (all other
factors held constant) will cause an increase in a stock’s value?
A)
An
increase in the riskfree rate
B)
A
decrease in the stock’s beta
C)
An
increase in the market risk premium
D)
A
decrease in the constant growth rate in dividends
15.
Grossnickle
Corporation issued 20year, noncallable, 7.8% annual coupon bonds at their par
value of $1,000 one year ago. Today, the market interest rate on these bonds is
5.5%. What is the current price of the bonds, given that they now have 19 years
to maturity?
A)
$1,165.62
B)
$1,507.70
C)
$1,114.94
D)
$1,266.98
E)
$1,064.26
16.
Kholdy
Inc’s bonds currently sell for $1,275. They pay a $120 annual coupon and have a
20year maturity, but they can be called in 5 years at $1,120. Assume that no
costs other than the call premium would be incurred to call and refund the
bonds, and also assume that the yield curve is horizontal, with rates expected
to remain at current levels on into the future. What is the difference between
the bond’s YTM and its YTC?
A)
1.68%
B)
1.54%
C)
1.82%
D)
1.91%
E)
1.48%
17.
If
current market interest rates rise, what will happen to the value of
outstanding bonds?
A)
They
will remain unchanged.
B)
They
will rise.
C)
They
will fall.
D)
There
is no connection between current market interest rates and the value of
outstanding bonds.
18.
Which
of the following factors would be most likely to lead to an increase in nominal
interest rates?
A)
A
new technology like the Internet has just been introduced, and it increases
investment opportunities.
B)
There
is a decrease in expected inflation.
C)
The
Federal Reserve decides to try to stimulate the economy.
D)
The
economy falls into a recession.
E)
Households
reduce their consumption and increase their savings.
19.
Kelly
Inc’s 5year bonds yield 7.50% and 5year Tbonds yield 4.50%. The real
riskfree rate is r* = 2.5%, the default risk premium for Kelly’s bonds is DRP
= 0.40%, the liquidity premium on Kelly’s bonds is LP = 2.6% versus zero on
Tbonds, and the inflation premium (IP) is 1.5%. What is the maturity risk
premium (MRP) on all 5year bonds?
A)
0.56%
B)
0.40%
C)
0.38%
D)
0.50%
E)
0.59%
20.
Which
is the best measure of risk for a single asset held in isolation, and which is
the best measure for an asset held in a diversified portfolio?
A)
Standard
deviation; correlation coefficient.
B)
Coefficient
of variation; beta.
C)
Beta;
beta.
D)
Variance;
correlation coefficient.
E)
Beta;
variance.
21.
Here are the expected returns on two
stocks:
Probability 
X 
Y 

0.1 
20% 
10% 

0.8 
20 
15 

0.1 
40 
20 
What is stock
X’s coefficient of variation?
A)
1.56
B)
0.96
C)
0.78
D)
0.64
E)
1.32
22.
Burns Nuclear Power
common stock has a beta of 0.8 and currently pays a dividend of $3. The US
Treasury bill rate is 2.5% and the market risk premium is 9.5%. What is the
value of this stock if a constant annual growth rate of 4% is expected in
dividends and earnings?
A)
$51.15
B)
$64.82
C)
$73.17
D)
$49.18
E)
$76.10
23.
You
recently sold 200 shares of Disney stock, and the transfer was made through a
broker. This is an example of:
A)
A
secondary market transaction.
B)
A
primary market transaction.
C)
A
money market transaction.
D)
An
overthecounter market transaction.
E)
A
futures market transaction.
24.
Company
A has a beta of 0.70, while Company B’s beta is 1.30. The required return on
the stock market is 11.00%, and the riskfree rate is 4.25%. What is the
difference between A’s and B’s required rates of return? (Hint: First find the
market risk premium, then find the required returns on the stocks.)
A)
4.05%
B)
3.73%
C)
4.90%
D)
4.74%
E)
3.60%
25.
Which
of the following bonds would have the most reinvestment rate risk?
A)
A
20year, 11% coupon bond
B)
A
5year, 11% coupon bond
C)
A
5year zero coupon bond
D)
A
20year zero coupon bond
26.
Which
of the following statements is CORRECT?
A)
If
a coupon bond is selling at a premium, then the bond’s current yield is zero.
B)
The
current yield on Bond A exceeds the current yield on Bond B. Therefore, Bond A
must have a higher
yield to maturity than Bond B.
C) If a coupon bond is selling at a discount, then the
bond’s expected capital gains yield is negative.
D) If a bond is selling at a discount, the yield to
call is a better measure of the expected return than the yield to maturity.
E) If a coupon bond is selling at par, its
current yield equals its yield to maturity.
27. Assume that you manage a $10.00 million mutual fund
that has a beta of 1.05 and a 9.50% required return. The riskfree rate is
4.20%. You now receive another $8.50 million, which you invest in stocks with
an average beta of 0.65. What is the required rate of return on the new
portfolio? (Hint: You must first find the market risk premium, then find the
new portfolio beta.)
A) 8.57%
B) 9.00%
C) 7.80%
D) 8.14%
E) 7.97%
28. Assume the pure expectations hypothesis (or theory)
holds and you observe the following Treasury bond rates.
Years to Maturity 
Yield 
1 
2.0% 
2 
3.2% 
3 
4.0% 
What is the expected oneyear
Treasury yield two years from today?
A) 2.00%
B) 6.18%
C) 4.00%
D) 5.62%
E) 5.58%
29. Suppose the real riskfree rate is 3.25%, the
average future inflation rate is 4.35%, and a maturity risk premium of 0.07%
per year to maturity applies to both corporate and Tbonds, i.e., MRP =
0.07%(t), where t is the years to maturity. Suppose also that a liquidity
premium of 0.50% and a default risk premium of 1.00% apply to Arated corporate
bonds but not to Tbonds. How much higher would the rate of return be on a
10year Arated corporate bond than on a 5year Treasury bond? Here we assume
that the pure expectations theory is NOT valid. Disregard crossproduct terms,
i.e., if averaging is required, use the arithmetic average.
A) 1.61%
B) 1.81%
C) 1.52%
D) 1.85%
E) 1.89%
30. O’Brien Ltd.’s outstanding bonds have a $1,000 par
value, and they mature in 25 years. Their nominal annual, not semiannual yield
to maturity is 9.25%, they pay interest semiannually, and they sell at a price
of $1,075. What is the bond’s nominal coupon interest rate?
A) 11.93%
B) 9.62%
C) 10.63%
D) 9.12%
E) 10.02%
31.
What is the meaning of a upward sloping
yield curve?
A)
Inflation
rates are less than nominal rates.
B)
Shortterm
interest rates are equal to longterm rates.
C)
Shortterm
interest rates are greater than longterm rates.
D)
Shortterm
interest rates are less than longterm rates
32.
You
must estimate the intrinsic value of Mega Dynamics stock in our universe. Mega
Dynamics’ current free cash flow is $25 billion, and it is expected to grow at
a constant annual rate of 8.5%. The company’s WACC is
11%. Mega Dynamics has $200 billion of longterm
debt and preferred stock, and there are 30 billion shares of common stock
outstanding. What is Mega Dynamics’ estimated intrinsic value per share of
common stock?
A)
$26.67
B)
$29.50
C)
$22.67
D)
$28.00
E)
$24.00
33.
A
20year, $1,000 par value bond has a 9% annual coupon. The bond currently sells
for $925. If the yield to maturity remains at its current rate, what will the
price be 5 years from now?
A)
$941.86
B)
$978.40
C)
$951.87
D)
$965.84
E)
$933.09
34.
Tucker
Corporation is planning to issue new 20year bonds. The current plan is to make
the bonds noncallable, but this may be changed. If the bonds are made callable
after 5 years at a 5% call premium, how would this affect their required rate
of return
A)
There
is no reason to expect a change in the required rate of return.
B)
Because
of the call premium, the required rate of return would decline.
C)
It
is impossible to say without more information.
D)
The
required rate of return would increase because the bond would then be more
risky to a bondholder.
E)
The
required rate of return would decline because the bond would then be less risky
to a bondholder.
35.
Goode
Inc.’s stock has a required rate of return of 11.50%, and it sells for $18.00
per share. Goode’s dividend is expected to grow at a constant rate of 7.00%.
What was the last dividend, D ?
A)
$0.77
B)
$0.76
C)
$0.57
D)
$0.62
E)
$0.92
36.
MeFirst
Corporation has a cumulative preferred share issue that is suppose to pay a
quarterly dividend of $2. MeFirst failed to pay 3 consecutive dividends to
investors and then managed to pay a common share dividend the very next
quarter. How much cash must MeFirst have paid to each preferred share holder at
that time?
A)
$2
per share
B)
$8
per share
C)
$6
per share
D)
$10
per share
37.
Keenan
Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal
coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50%
nominal yield to maturity, but it can be called in 6 years at a price of
$1,150. What is the bond’s nominal yield to call?
A)
6.54%
B)
6.75%
C)
6.89%
D)
6.61%
E)
8.54%
38.
QuickeeMart
sold an issue of 20year $1,000 par value bonds to the public that carry a 8.5%
coupon rate, payable semiannually. It is now 10 years later and the current
yield to maturity is 9.00%. If interest rates remain at 9.00% until
QuickeeMart’s bonds mature, what will happen to the value of the bonds over
time?
A)
The
bonds will sell at a premium and decline in value until maturity.
B)
The
bonds will sell at a premium and rise in value until maturity.
C)
The
bonds will sell at a discount and fall in value until maturity.
D)
The
bonds will sell at a discount and rise in value until maturity.
39.
MAD
Inc.’s bond rating is downgraded by Standard and Poor’s from AAA to BBB. Which
of the following would occur in light of this news?
A)
MAD
Inc.’s bond price would fall.
B)
MAD
Inc.’s bond price would increase.
C)
MAD
Inc.’s bond price would remain the same.
D)
MAD
Inc.’s default risk premium would increase.
E)
Both
A and D would occur.
40.
Which
of the following is an example of a capital market instrument?
A)
Commercial
paper.
B)
Preferred
stock.
C)
Banker’s
acceptances.
D)
U.S.
Treasury bills.
E)
Money
market mutual funds.