Conceptual Questions Finance Exam 2 Prep

The future value of an annuity due is always greater than the future value of an
otherwise identical ordinary annuity for interest rates greater than zero. True or false?
Why?
A) False; Because every payment gets one less period of compounding.
B) True; Because every payment is already one period further ahead in time.
C) False: Because every payment is one period further from the end.
D) True; Because every payment gets one extra period of compounding.

 

True; Because every payment gets one extra period of compounding.

The determination of the equal periodic loan payments necessary to provide a lender with a specified interest return and to repay the loan principal over a specified period refers to __________.

 

loan amortization

 

loan securitization

 

loan modernization

 

loan commercialization

 

loan amortization

The future value of a dollar ________ as the interest rate increases and ________ the longer the money remains invested.

 

decreases; decreases

 

increases; increases

 

decreases; increases

 

increases; decreases

 

increases; increases

________ is the amount earned on a deposit that has become part of the principal at the end of a specified time period.

 

Discount interest

 

Compound interest

 

Primary interest

 

Simple interest

Compound interest

The rate of interest agreed upon contractually charged by a lender or promised by a borrower is the ________ interest rate.

 

effective

 

discounted

 

nominal

 

continuous

nominal

The time value concept/calculation used in amortizing a loan is ________.

 

future value of a dollar

 

future value of an annuity

 

present value of a dollar

 

present value of an annuity

 

present value of an annuity

A bond will sell at ___________ when the stated rate of interest exceeds the required rate of return, at ___________ when the stated rate of interest is less than the required rate of return, and at ___________ when the stated rate of interest is equal to the required return.

 

a premium; par value; a discount

 

a discount; a premium; par value

 

a premium; a discount; par value

 

par value; a premium; a discount

a premium; a discount; par value

Interest rate risk is the risk that a bond's _________ will change when market interest rates change. Generally, ___________ bonds have higher interest rate risk than ____________ bonds.

 

coupon; perpetuity; annuity

 

par value; municipal; government

 

maturity; primary; secondary

 

value; long-term; short-term

value; long-term; short-term

Assume the following returns and yields: U.S. T-bill = 0.15%, 5-year U.S. T-note = 0.28%, 10-year U.S. T-note = 0.36%, 15-year U.S. T-bond = 0.32%, 20-year U.S. T-bond = 0.27%, and 25-year U.S. T-bond = 0.23%. Based on this information, the shape of the yield curve is ________ and reflects the ______________.

 

upward sloping; expectation theory

 

downward sloping; liquidity preference theory

 

humped; market segmentation theory

 

normal; interest rate theory

 

humped; market segmentation theory

You are comparing three different bond issues from a single firm:
 
Issue A: Grants the issuer the right, but not obligation, to repurchase bonds prior to their stated maturity.
Issue B: Includes a provision that allows bondholders to redeem bonds at a stated price prior to maturity.
Issue C: Allows bondholders to exchange bonds for shares of the issuer’s common stock.
 
What general features of bonds do these issues exemplify and, all else equal, which bond is likely to have the highest yield to maturity (i.e., required return)?

 

Purchase; Redeem; Exchange; Issue B

 

Call; Put; Conversion; Issue A

 

Income; Extend; Float; Issue C

 

Put; Call; Swap; Issue B

 

Call; Put; Conversion; Issue A

A certain bond was issued a few months ago, but since then the company that issued the bond has fallen on hard times, and investors perceive the bond to be riskier than it was when it was issued. We should expect that compared to when the bond was issued ________.

 

its price is now lower and its expected return is lower

 

its price is now higher and its expected return is lower

 

its price is now lower and its expected return is higher

 

its price is now higher and its expected return is higher

its price is now lower and its expected return is higher

Rank the following bonds from lowest to highest in value:
 

Bond	Par Value	Stated Interest Rate	Years to Maturity	Yield to Maturity
A	$1,000	15%	24	9%
B	$1,000	8%	7	9%
C	$1,000	15%	24	15%
D	$1,000	8%	7	10%

 

CDAB

 

ABCD

 

DBCA

 

BADC

DBCA

Which of the following is a disadvantage of issuing preferred stock from the common stockholders' perspective?

Group of answer choices

There is a seniority of preferred stockholder's claim over common stockholders.

The preferred stockholders have superior voting rights in the selection of board of directors.

The preferred stockholders are always paid a higher proportion of dividend payments.

Issuance of preferred stocks will result in a higher risk, to the disadvantage of common stockholders.

There is a seniority of preferred stockholder's claim over common stockholders.

If an asset's expected return is less than its required return, rational investors will ________.

Group of answer choices

buy the asset, which will drive the price up and cause expected return to reach the level of the required return

sell the asset, which will drive the price down and cause the expected return to reach the level of the required return

sell the asset, which will drive the price up and cause the expected return to reach the level of the required return

buy the asset, since price is expected to increase

sell the asset, which will drive the price down and cause the expected return to reach the level of the required return

______________ allow common stockholders to prevent the dilution of their economic and control stakes when the firm issues new securities.

Group of answer choices

Protective shares

Cumulative shares

Preemptive rights

Stakeholder rights

Preemptive rights

Regarding the tax treatment of payments to securities holders, it is true that ________.

Group of answer choices

interest and preferred stock dividends are not tax-deductible ,while common stock dividends are tax deductible

interest and preferred stock dividends are tax-deductible, while common stock dividends are not tax-deductible

common stock dividends and preferred stock dividends are tax-deductible, while interest is not tax-deductible

common stock dividends and preferred stock dividends are not tax-deductible, while interest is usually tax-deductible

Common stock dividends and preferred stock dividends are not tax-deductible, while interest is usually tax-deductible.

Explanation:
Companies can deduct interest payments on debt when calculating taxable income, which lowers taxes.
However, dividends paid to common or preferred shareholders are not tax-deductible, since they are distributions of profit, not business expenses.

Your roommate has recently taken an interest in day-trading and is attempting to identify undervalued firms.  After scouring the online discussion boards, your roommate decides to use the book value method, because of the public availability of balance sheet data and the ease of calculation.  What best summarizes any possible reservations you may have about the common stock valuation model proposed?

Group of answer choices

Your roommate’s estimates are likely to overestimate the value of the firm, because the book value method is based on historical earnings data, rather than the expectation of the firm’s future accounting performance.

Your roommate’s estimates are likely to underestimate the value of the firm, because the book value method is based on historical accounting data, rather than the expectation of the firms’ future earnings.

Your roommate’s estimates are likely to accurately estimate the value of the firm, because the book value method is based on historical accounting data, which is a strong predictor of the firm’s expected future earnings.

Your roommate’s estimates are likely to accurately estimate the value of the firm, because the book value method is based on historical earnings data, which is a strong predictor of the firm’s future accounting performance.

Your roommate’s estimates are likely to underestimate the value of the firm, because the book value method is based on historical accounting data, rather than the expectation of the firms’ future earnings.

________ research has documented various anomalies—outcomes that are inconsistent with efficient markets—in stock returns. For example, the tendency of the stock market to overreact to trends and the role of investor sentiment in the pricing of certain types of mutual funds.

Group of answer choices

Behavioral finance

Managerial finance

Corporate finance

Personal finance

Behavioral finance

According to the efficient market hypothesis, prices of actively traded stocks ________.

Group of answer choices

can be under- or over-valued in an efficient market

can only be under-valued in an efficient market

do not differ from their true values in an efficient market

can only be over-valued in an efficient market

do not differ from their true values in an efficient market