978-0134083308 Chapter 4 Part 2

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3) If the risk-free rate of return is less than the inflation rate, the real rate of return is negative.

influence investment choices

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

4) It is not possible for the nominal risk-free rate of return to be lower than the rate of inflation.

influence investment choices

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

5) Short-term U. S. Treasury bills are yielding 0.5%. The expected inflation rate is 2%.

Therefore, the real rate of interest must be negative 1.5%.

influence investment choices

AACSB: 3 Analytical thinking

Question Status: New Question

Learning Goal: Learning Goal 3

6) One reason that the holding period return should not be used to compare long-term

investments is that it does not consider the time value of money.

influence investment choices

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

7) The holding period return is especially useful comparing investments with unequal holding

periods.

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AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

8) The closest approximation to the real, risk-free rate of interest is

A) the short-term Treasury bill rate plus the inflation rate.

B) the short-term Treasury bill rate minus the inflation rate.

C) the 10 year Treasury bond rate minus the inflation rate.

D) the 10 year Treasury bond rate minus the 1 year Treasury bill rate.

influence investment choices

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

9) The risk-free rate is equal to the real rate of return plus

A) an expected inflation premium.

B) a risk premium.

C) both an inflation and a risk premium.

D) the prevailing prime rate.

influence investment choices

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

10) The markets in general are paying a 2% real rate of return. Inflation is expected to be 3%.

ABC stock commands a 6% risk premium. What is the expected rate of return on ABC stock?

A) 2%

B) 5%

C) 8%

D) 11%

influence investment choices

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

11) The required rate of return on the Cosmos Corporation’s common stock is 10%, the current

real rate of return in the market is 1%, and the inflation rate is 3%. In this case, the risk

premium associated with Cosmos stock is

A) 5%.

B) 6%.

C) 7%.

D) 8%.

influence investment choices

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

12) Which one following will lower required rates of return?

A) higher rates of inflation

B) higher risk premiums

C) lower rates of inflation

D) lower dividend yields

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AACSB: 3 Analytical thinking

Question Status: Previous Edition

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13) The required return on Beta stock is 14%. The risk-free rate of return is 4% and the real rate

of return is 2%. How much are investors requiring as compensation for risk?

A) 8%

B) 10%

C) 12%

D) 14%

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AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

14) Which of the following is(are) issue characteristics of an investment?

I. type of investment such as stocks or bonds

II. financial condition of the issuer

III. coupon or dividend payments

IV. time to maturity

A) I and II only

B) III only

C) I, III and IV only

D) I, II, III and IV

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AACSB: 6 Diverse and multicultural work environments.

Question Status: Revised

Learning Goal: Learning Goal 3

15) A holding period return is calculated by adding the current income to the capital gains and

dividing this sum by the

A) average investment value.

B) beginning investment value.

C) total income received.

D) selling price of the investment.

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AACSB: 3 Analytical thinking

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Learning Goal: Learning Goal 3

16) Lauren purchased a stock for $28 a share and sold it six months later for $31. While she

owned the stock, Lauren received two quarterly dividends of $0.35 per share. Brittany’s holding

period return on this stock is

A) 13.2%.

B) 10.7%.

C) 11.9%.

D) 26.4%.

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AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

17) In which of the following circumstances would it be most appropriate to use the holding

period return?

A) to compare the capital gains on a house held for 8 years and a mutual fund held for 6 years

B) to compare the calendar year performance of stocks purchased in March to stocks purchased

in September

C) to compare the dividend yield of stocks to the interest rate on bonds

D) to compare the performance of several stocks, each of which was held throughout an entire

year

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AACSB: 3 Analytical thinking

Question Status: Previous Edition

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18) Christopher purchased 200 shares of ABC stock at $21.25 per share. After nine months, he

sold all of his shares at a price of $19.88 a share. Christopher received a total of $0.55 per share

in dividends during the time he owned the shares. Jake’s holding period return is

A) -6.4%.

B) -3.9%.

C) 2.6%.

D) 9.7%.

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AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

19) The holding period return (HPR) can appropriately be used to

A) compare the yield on investments held for any time period.

B) compare returns among investments that are held for the same period of time.

C) isolate realized capital gains.

D) determine the required reinvestment rate for long-term investments.

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AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 3

20) Jason purchased ABC stock at $40 per share and DEF stock at $35 per share on the same

day in 2015. Exactly 6 months later, the ABC stock is worth $42.00 per share and has not paid

a dividend while the DEF stock is worth $36 per share and has paid 2 quarterly dividends of

$0.50 each. The holding period returns are

A) ABC, $2.00 and DEF $2.00.

B) ABC 5% and DEF 2.9%.

C) ABC 5% and DEF 5.7%.

D) The holding period return cannot be determined because we do not know the discount rate.

influence investment choices

AACSB: 3 Analytical thinking

Question Status: New Question

Learning Goal: Learning Goal 3

21) Briefly explain the holding period return (HPR) and give several characteristics of this

measure.

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AACSB: 3 Analytical thinking

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Learning Goal: Learning Goal 3

4.4 Learning Goal 4

1) The internal rate of return is the rate of return that causes a project to have a zero net present

value.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Revised

Learning Goal: Learning Goal 4

2) The internal rate of return on an investment is the discount rate that produces a present value

of benefits greater than the cost of the investment.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Revised

Learning Goal: Learning Goal 4

3) The internal rate of return is a less meaningful measure of an investment’s performance than

holding period return if the holding period is other than 1 year.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Revised

Learning Goal: Learning Goal 4

4) The present value of an investment must be computed by discounting cash flows at the

internal rate of return.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Revised

Learning Goal: Learning Goal 4

5) When using a financial calculator or electronic spreadsheet to calculate an investment’s

yield, the amount invested is expressed as a negative number.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 4

6) The internal rate of return is the correct method to use when an investor wants to determine

an investment’s average annual yield.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 4

7) If you own an investment providing periodic returns, your actual yield on the investment will

depend on the reinvestment rate you are able to obtain.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 4

8) A suitable investment should have an internal rate of return equal to or greater than its

required rate of return.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: New Question

Learning Goal: Learning Goal 4

9) When computing an investment’s internal rate of return using a financial calculator or

spreadsheet such as Excel, which of the following should be entered as a negative number?

A) the number of time periods

B) dividend or interest payments

C) the price at which the investment is sold

D) the initial cost of the investment

decision rules such as IRR and Payback

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Table 1

Year

Cash Flow

$(5,000)

$4,000

$3,000

10) Given a spreadsheet similar to the one shown in Table 1, the command to compute the

internal rate of return would be

A) =RATE(3,B3,B4,B2).

B) =IRR(B2:B4).

C) =IRR(B3:B4)-B2.

D) =TVM(A2:B4).

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: New Question

Learning Goal: Learning Goal 4

11) Six years ago, Miguel invested $3,500. Today his investment is worth $5659. The internal

rate of return on this investment is

A) -7.69%.

B) error 5.

C) 8.34%.

D) 10.28%.

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 4

12) Alexis bought a stock for $34 a share two years ago. The stock does not pay any dividends.

Today she sold the stock for $28.50 a share. What was her internal rate of return on this

investment?

A) 9.22%

B) -9.22%

C) 19.30%

D) -8.44%

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 4

13) An investment costs $3,500 today. This investment is expected to produce annual cash

flows of $1,200, $1,400, $1,300 and $1,100, respectively, over the next four years. What is the

internal rate of return on this investment?

A) 8.1%

B) 9.33%

C) 14.6%

D) 16.2%

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 4

14) The following investment cash flows have been entered into cells B5 through B9 of an

EXCEL spreadsheet. B5 $(5,200 ), B6 $2,100, B7 $1,300, B8 $1,800, B9 $1,200, where

$(5,200) is the cost of the investment and the following amounts are cash flows at the end of

years one through four. The correct function for computing the yield on this investment is

A) =irr(B6:B9)+B5.

B) =irr(B5:B9).

C) =rate(4,0,-5200, 1200).

D) =ytm(B5, B6:B9).

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 4

15) The Sorka Corp. has paid annual dividends of $0.60, $0.63, $0.65, $0.68 and $0.72,

respectively, over the past five years. What is the dividend growth rate?

A) 4.7%

B) 5.2%

C) 5.4%

D) 5.9%

decision rules such as IRR and Payback

AACSB: 3 Analytical thinking

Question Status: Previous Edition

Learning Goal: Learning Goal 4