FINA 3000 Pope UGA Test 1

T/F: A perpetuity is an annuity that never ends.

True

T/F: When a borrower makes extra payments to principal, interest payments are accelerated to make up for losses to the bank.

False

T/F: One result of increasing leverage is that shareholders will expect a greater return on their investment because their position is now riskier.

True

T/F: For an investor, there is greater risk in forming a sole proprietorship versus a corporation.

True.

Corporations give investors limited liability whereas sole proprietorships, the sole investor has all the risk and return.

T/F: If we increase the interest rate, the present value of an ordinary annuity increases.

False

the present value will decrease!!

T/F: As the number of periods increases, present value decreases

True

FUTURE value would increase!!

T/F: A zero coupon bond is considered a discount bond.

True

T/F: A bond that matures in ten years would have a greater interest rate risk than a bond that matures in five years.

True

T/F: Suppose that Moody's changes the credit rating for Big Cat Fireworks from BBB to BB. We would expect the price of Big Cat bonds to increase.

False.

Their credit worthiness rating has gone down, meaning that they are less likely to pay back their creditors. therefore, their stock price would go DOWN

Suppose that Moody's upgrades the credit rating on Disney bonds from AA to AAA. We would expect the coupon rate on future Disney bonds to be lower.

True

risk goes in hand with returns --> when credit ratings are higher, risk is lowered, so the coupon rate/return is lower too

T/F: For an annuity due, each payment is received one period sooner than with an ordinary annuity.

True

T/F: Suppose you are looking at two different car loans. One offers a term of 60 payments while the other offers a term of 84 payments. Both loans have the same annual percentage rate (APR). It is true that you will pay more interest with the 84 payment loan (assuming same priced car).

True

as the number of payments increase, you will pay more in interest!

T/F: Government bonds generally have higher yields to maturity than corporate bonds because government bonds are very safe.

False.

Govt bonds have low rates of return because they are safe. Higher risk = higher return.

YTM = theoretical IRR earned by an investor who buys the bond today at the market price, assuming that the bond will be held until maturity, and that all coupon and principal payments will be made on schedule.

T/F: The future value of an annuity due is greater than the future value of an ordinary annuity (assuming same number of payments and interest rate).

True

an annuity due will have one extra payment than an ordinary annuity so it's value will be higher

T/F: The tax benefits of owning a house increase over time.

False

homeowners can deduct mortgage interest from their federal taxable income but interest payments DECREASE over time.

T/F: The interest portion increases and the principal portion decreases over time under a typical loan amortization schedule

False

Interest decreases and principal increases

T/F: For firms with slow moving inventory, the quick ratio is a better measure of liquidity than the current ratio.

True

T/F: A liquidity ratio measures the firm's ability to meet short-term cash obligations.

True

T/F: The effective annual rate (EAR) measures the annual compounded return on investment

True

T/F: a zero coupon bond has no value because the firm is bankrupt

False

a zero-coupon bond is when you do not receive any coupon payments on the bond!

T/F: From a finance perspective, we consider shareholder equity as reported on the balance sheet as a more useful measure of value than market capitalization.

False

market cap = value w/ most accurate & current share price @ the present

the balance sheet is less accurate because it shows historical values

T/F: Finance places more emphasis on book values rather than market values

False

it's all about market values & what's happening in the present!

T/F: If the bond's yield to maturity is greater than its coupon rate, we say that the bond trades at a discount.

True

T/F: The current yield for a bond will increase if the bond's YTM decreases.

False.

T/F: The term, residual claim, refers to existing shareholders having the right to participate in any new share offering.

False

Residual claim - The right of a shareholder or some other party to the profit of a company after all prior obligations have been paid.

current yield

a bond's annual return based on its annual coupon payments and current price (as opposed to its original price or face)

annual coupon / trading price

how to calculate interest paid

per period interest rate x outstanding principal

when do you use an effective interest rate as opposed to APR?

if payments are being made in yearly increments but the account the money is in compounds monthly, you need to account for the monthly compounding and would use EAR to do that!

EAR > APR!

how do you find yield to maturity / IRR for a bond?

set pmt = coupon value

pv = current trading price of bond (negate this!)

fv = face value of bond

n = time to maturity (multiply by # of times a coupon is paid per year)

solve for i/y and multiply by # of times a coupon is paid per year)

The __________ an initial value is compounded, the greater the power of compounding

longer

Why is a dollar worth less tomorrow than today?

People prefer present consumption

Monetary inflation → value of the dollar decreases over time

uncertainty/risk

how is the PV of future cash flows related to the magnitude of the interest rate used for discounting?

↑ interest, ↓ PV of future cash flows

↓ interest, ↑ PV of future cash flows

what are the 5 guiding principles of finance?

Maximization of Wealth - the creation of as much wealth as possible with the available resources.

Time value of money - the opportunity cost of tying up funds in projects, stocks, or other assets & the approach to valuing future cash flows in today's dollars

Risk vs Return - The expected return versus risk trade off is the concept that greater risks yield higher returns

Leverage - the concept of how much debt a firm issues for its projects

Diversification - the idea of removing risk from a portfolio of stocks or other investments

debt

an agreement between a borrower and lender to repay principal + interest on loan

Five basic characteristics:

- Maturity date

- Set interest payment dates

- Fixed payment amount (unless loan terms change)

- No ownership in the company

- No voting rights

equity

an ownership claim in the issuer.

Five basic characteristics:

- Ownership (proportional to equity given)

- Voting rights - whoever has the most shares controls the board

- Variable dividend - could be cash or more shares

- Residual claim - last in line for payment

- Pre-emptive rights - the right to buy/participate in any new share offering

what is another name for days sales outstanding/DSO ratio?

collections ratio

acct rec / (sales/365)

accounts receivable turnover ratio?

sales / accts rec

T/F: a company is more likely to call in an outstanding bond issue when interest rates are decreasing in the economy

True.

the main reason a bond is called is a drop in interest rates. after calling a bond, companies can reissue those bonds @ the new, lower interest rate and pay smaller coupons

T/F: from a finance perspective, ROE (return on equity) is a more useful measure than the stock price for a company

False

ROE is a historical value and finance looks at market values like stock prices

T/F: Bonds that have low default risk will have a higher yield to maturity.

False

Discount Bond

a bond issued or traded for less than its par (face) value, allowing investors to purchase it at a lower price and receive the full face value upon maturity.

Annuity Due

a series of equal, periodic payments—such as rent, lease, or insurance premiums—that are made at the

beginningof each payment period. Unlike an ordinary annuity, where payments are made at the end of a period