WEB CHAPTER 29—BASIC FINANCIAL TOOLS
1. Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
a.
True
b.
False
False
Compounding
2. Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven
amounts.
a.
True
b.
False
True
Compounding
3. If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the
future value of the same series.
a.
True
b.
False
False
4. Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present
value.
a.
True
b.
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
False
5. If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate.
a.
True
b.
False
True
6. A “growing annuity” is a cash flow stream that grows at a constant rate for a specified number of periods.
a.
True
b.
False
True
7. A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells initially) at par. These bonds
provide compensation to investors in the form of capital appreciation.
a.
True
b.
False
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
8. The market value of any real or financial asset, including stocks, bonds, or art work purchased in hope of selling it at a
profit, may be estimated by determining future cash flows and then discounting them back to the present.
a.
True
b.
False
True
9. For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures.
a.
True
b.
False
10. A bond that had a 20-year original maturity with 1 year left to maturity has more interest rate price risk than a 10–year
original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates,
and they cannot be called.)
a.
True
b.
False
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
11. Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally
be subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.
a.
True
b.
False
False
12. The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as
measured by its standard deviation.
a.
True
b.
False
False
13. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is
a standardized measure of the risk per unit of expected return.
a.
True
b.
False
True
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
14. When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of
correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the
portfolio’s risk.
a.
True
b.
False
True
15. Diversification will normally reduce the riskiness of a portfolio of stocks.
a.
True
b.
False
True
16. An individual stock’s diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the
portfolio in which the stock is held.
a.
True
b.
False
False
17. Managers should under no conditions take actions that increase their firm’s risk relative to the market, regardless of
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
how much those actions would increase the firm’s expected rate of return.
a.
True
b.
False
False
18. One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering
both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of
the asset held in isolation is not relevant under the CAPM.
a.
True
b.
False
True
19. According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of
individual stocks held in isolation. Thus, the relevant risk of a stock is the stock’s contribution to the riskiness of a well-
diversified portfolio.
a.
True
b.
False
True
20. According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value
of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
flows during the subsequent constant growth period.
a.
True
b.
False
True
21. The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum
investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date.
a.
True
b.
False
False
Compounding
22. Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security
B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than
twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)
a.
True
b.
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
23. The present value of a future sum decreases as either the discount rate or the number of periods per year increases,
other things held constant.
a.
True
b.
False
True
24. All other things held constant, the present value of a given annual annuity decreases as the number of periods per year
increases.
a.
True
b.
False
25. If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the
periodic rate by the number of periods per year.
a.
True
b.
False
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
26. As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the
nominal rate on the deposit (or loan).
a.
True
b.
False
False
27. When a loan is amortized, a relatively low percentage of the payment goes to reduce the outstanding principal in the
early years, and the principal repayment’s percentage increases in the loan’s later years.
a.
True
b.
False
True
Amortization
28. The payment made each period on an amortized loan is constant, and it consists of some interest and some principal.
The closer we are to the end of the loan’s life, the greater the percentage of the payment that will be a repayment of
principal.
a.
True
b.
False
True
Amortization
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
29. A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and
is not expected to default. The bond should sell at a premium if interest rates are below 10% and at a discount if interest
rates are greater than 10%.
a.
True
b.
False
True
30. You have funds that you want to invest in bonds, and you just noticed in the financial pages of the local newspaper
that you can buy a $1,000 par value bond for $800. The coupon rate is 10% (with annual payments), and there are 10
years before the bond will mature and pay off its $1,000 par value. You should buy the bond if your required return on
bonds with this risk is 12%.
a.
True
b.
False
31. The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds,
other things held constant.
a.
True
b.
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
32. Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return
from the expected return, it is always larger than its square root, its standard deviation.
a.
True
b.
False
True
Variance
33. Because of differences in the expected returns on different investments, the standard deviation is not always an
adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows
investors to make better comparisons of investments’ stand-alone risk.
a.
True
b.
False
True
34. A stock’s beta measures its diversifiable risk relative to the diversifiable risks of other firms.
a.
True
b.
False
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
35. A stock’s beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who
holds a well-diversified portfolio.
a.
True
b.
False
False
36. If the returns of two firms are negatively correlated, then one of them must have a negative beta.
a.
True
b.
False
True
37. It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is
negative.
a.
True
b.
False
True
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
38. Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would
expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.
a.
True
b.
False
True
39. Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion
to its market value. Because of its diversification, Portfolio B will by definition be riskless.
a.
True
b.
False
False
40. A portfolio’s risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is
this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
a.
True
b.
False
False
a.
True
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
b.
False
False
42. If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in
owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.
a.
True
b.
False
False
43. The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because
betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This
is one of the strengths of the CAPM.
a.
True
b.
False
False
CAPM
44. Under the CAPM, the required rate of return on a firm’s common stock is determined only by the firm’s market risk. If
its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to
calculate the firm’s required rate of return.
a.
True
b.
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
False
45. Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will
likely have an impact on the stock’s price, other things held constant.
a.
True
b.
False
True
46. The slope of the SML is determined by the value of beta.
a.
True
b.
False
False
47. If you plotted the returns of a company against those of the market and found that the slope of your line was negative,
the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-
diversified investor, assuming that the observed relationship is expected to continue in the future.
a.
True
b.
False
True
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
48. If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression
line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk–
free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.
a.
True
b.
False
False
49. The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free
rate.
a.
True
b.
False
True
50. The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on
an average (b = 1) stock is zero.
a.
True
b.
False
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
51. Since the market return represents the expected return on an average stock, the market return reflects a certain amount
of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is
required to compensate stock investors for assuming an average amount of risk.
a.
True
b.
False
True
52. Midway through the life of an amortized loan, the percentage of the payment that represents interest must be equal to
the percentage that represents repayment of principal. This is true regardless of the original life of the loan or the interest
rate on the loan.
a.
True
b.
False
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
53. A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is
CORRECT?
a.
The bond is selling below its par value.
b.
The bond is selling at a discount.
c.
If the yield to maturity remains constant, the bond’s price one year from now will be lower than its current
price.
d.
The bond’s current yield is greater than 9%.
e.
If the yield to maturity remains constant, the bond’s price one year from now will be higher than its current
price.
54. Which of the following statements is CORRECT?
a.
If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%,
this implies that the stock’s dividend yield is also 5%.
b.
The stock valuation model, P0 = D1/(rs − g), can be used to value firms whose dividends are expected to
decline at a constant rate, i.e., to grow at a negative rate.
c.
The price of a stock is the present value of all expected future dividends, discounted at the dividend growth
rate.
d.
The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain
constant over time.
e.
The constant growth model is often appropriate for evaluating start-up companies that do not have a stable
history of growth but are expected to reach stable growth within the next few years.
United States – OH – Default City – TBA
Bloom’s: Comprehension
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
55. Which of the following bonds would have the greatest percentage increase in value if all interest rates fall by 1%?
a.
20-year, 10% coupon bond.
b.
20-year, 5% coupon bond.
c.
1-year, 10% coupon bond.
d.
20-year, zero coupon bond.
e.
10-year, zero coupon bond.
56. Assume that all interest rates in the economy decline from 10% to 9%. Which of the following bonds would have the
largest percentage increase in price?
a.
A 1-year bond with a 15% coupon.
b.
A 3-year bond with a 10% coupon.
c.
A 10-year zero coupon bond.
d.
A 10-year bond with a 10% coupon.
e.
An 8-year bond with a 9% coupon.
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
57. Which of the following bonds has the greatest interest rate price risk?
a.
A 10-year, $1,000 face value, zero coupon bond.
b.
A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
c.
All 10-year bonds have the same price risk since they have the same maturity.
d.
A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.
e.
A 10-year $100 annuity.
58. If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in
value?
a.
A 1-year bond with an 8% coupon.
b.
A 10-year bond with an 8% coupon.
c.
A 10-year bond with a 12% coupon.
d.
A 10-year zero coupon bond.
e.
A 1-year zero coupon bond.
for this question.