Finance Exam II

In 2024, annual personal consumption expenditures per capita is approximately 60,000 and the annual inflation rate is 2.59%. If inflation remains at this level, then how many dollars does the average person need to spend in 2074 to maintain the same standard of living?

How would you solve this?

Enter 50 in N, 2.59 in I%, 60,000 in PV, and solve for FV

The percent increase in dollars the investor receives from investing

nominal interest rate

The percent increase in goods and services the investor can buy from investing

real interest rate

A graph or a table showing the interest rates (APR) of different bonds against their maturities on a single date

yield

quoted interest rate

nominal rate

rate of change in the general price level

inflation

rate of decline in the purchasing power of one dollar

inflation

cents on the dollar that a borrower pays and a saver receives

nominal interest rate

rate of change in the purchasing power from borrowing or saving

real interest rate

Which yield curve is a signal that a recession is coming (in about a year)

inverted

Lower interest rates in the short term and higher interest rates in the long term is an example of which type of yield curve

normal

higher interest rates in the short term and lower interest rates in the long term is an example of which type of yield curve

Inverted

What is a normal yield curve an indicator of

market is expecting economic expansion

With this type of yield curve, investors demand a premium for longer-term bonds

normal

Why does a yield curve invert when a market is expecting a recession?

because the federal reserve lowers interest/short-term rates when they expect a recession

What are the determinants of interest rates

productivity, time, maturity, and and inflation (treasury bond “risk free”), and risk of default

The present value of a bond’s cash flows, coupon payments (an annuity) and the par value (lump sum)

Bond price

What are the two attributes of coupon bonds that do NOT change

coupon rate and par value (c stays the same)

A bond matures in in 10 years and compounds semi-annually. You want to find how much the PV will be in 1 year. What will you enter for N

18

(20 years until maturity - 2 periods). 18 periods until maturity will mean 1 year has passed

If YTM < coupon bond, then the bond price is ____

greater than par value

If YTM > Coupon rate, then the bond price

less than par value

If YTM = Coupon, then the bond price___

is equal to par value

If YTM < Coupon rate, then the bond price > par value. This is a ____bond

premium

If YTM > Coupon rate, then the bond price < par value. This is a ____bond

discount

If YTM = Coupon rate, then the bond price = par value. This is a ____bond

par

Bond prices move ____ with change in interest rate (YTM)

intensely

Bond sensitivities to interest rate changes differ based on their maturities and coupon rates. ____ maturity bonds’ prices and ____ coupon rate bonds’ prices are more sensitive to interest rate changes. This is called ___ risk

Longer, lower, price

Bonds with shorter maturities and higher coupon rates are subject to more ____ rate risk, the risk that cash will have to be reinvested at lower rates if interest rates fall

reinvestment

What is generally the dominant risk when talking about interest rate risk

price risk

If you see x% coupon bond, what is the %

coupon rate NOT r or YTM

is coupon rate the same as r or YTM

no

The YTM on a 4% semiannual bond that matures in 20 years jumped from 5 to 6%. What is the percent change. What do you enter in financial calc first

N = 40, I% = 2.5 (5%/2), PMT = 20 (1000 × 0.04), FV = 1000. Next, you make I% = 6%/2

is I% YTM or r

r (you must convert YTM to r)

Premium bonds must _____ over time

depreciate

Discount bonds must _____ over time

appreciate

If price increases over time, is that premium, par, or discount bond

discount

If price decrease over time, is that premium, par, or discount bond

discount

Callable bonds include provisions that give the right to the issuer to buy back the bond (to “call the bond”) at a ____price (the “call” price) at any time after a particular future date ("the call” date)

fixed

What is the yield to call of a 20 year, 12% semiannual $1000 par value coupon bond selling for $1,235? it can be called in 4 years for $1060

What do you enter into financial calculator

N = 8 (4 × 2)
PV = -1235
PMT = 60 (1000 × 12%/2)
FV = 1060

Solve for I%, then multiply by 2

The investor in a ____ bond receives interest through purchasing it at a discount (originally issued discount bonds) or pure discount bonds

zero coupon

A coupon bond and a zero-coupon bond have the same maturity. Which one has more price risk?

zero coupon bond

What rights does a stock owner have

1. cash flow rights

2. voting rights

In finance, “stock” and “equity” refer to _____ stock. A ________ share is in a category of its own, distinct pure equity and debt

common, preferred

The price of a stock should be the _____ ______ of the ______ dividends that a stock is expected to pay _______ of who the owners of the stock will be.

present value, future, regardless

How long will stocks pay dividends for?

forever

If earnings per share (EPS) does not change, but D1 decreases, then what happens to P0

If ROE is high enough, P0 increases

What are stockholders paid in? Bond holders?

Dividends. Coupons, par value

Match to each (common stock vs bond): Percentage of profits,

stock

Match to each (common stock vs bond vs preferred stock ): fixed

bond and preferred stock

Match to each (common stock vs bond): Growth in cash flows

stock

Match to each (common stock vs bond vs preferred stock): Constant cash flows

bond and preferred stock

Match to each (common stock or bond or preferred stock): Taxed

common and preferred stock

Match to each (common stock, bond, and/or preferred stock): Not taxed

bond

Match to each (common stock vs bond vs preferred stock): No recourse if dividend is not paid

Stock (common and preferred)

Match to each (common stock vs bond): Can seize assets and sue company if payment is not made

Bond

Match to each (common stock vs bond): Lowest priority

stock

Match to each (common stock vs bond): Highest priority

Bond

Match to each ( common stock vs bond): Vote

Stock

Match to each (common stock vs bond vs preferred stock): No vote

Bond and preferred stock

Match to each (common stock vs bond vs preferred stock): Medium priority

preferred stock

What does a higher retention rate mean

lower dividends today, higher dividends in the future

If there are opportunities for growth, should you retain earnings or pay dividends

Sacrifice near-term dividends for greater future dividends

If you are in a declining industry, should you retain earnings or pay dividends

Pay out all earnings as dividends now