FINA 061 Practice problem set 2 QUESTIONS WITH CORRECT ANSWERS

This problem set is to help you review for the second midterm exam and the answers are provided at the bottom of this document for your reference. However, students should note that there is no guarantee that the actual exam will be similar to this problem set in length, format, or level of difficulty. To be fully prepared, you need to review the lecture materials, previous homework, and end-of-chapter problems. 1. A 10-year Treasury bond has an 8% coupon, and an 8-year Treasury bond has a 10% coupon. Neither is callable, and both have the same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following statements would be CORRECT? a. The prices of both bonds will decrease by the same amount. b. Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price. c. The prices of both bonds would increase by the same amount. d. One bond's price would increase, while the other bond’s price would decrease. e. The prices of the two bonds would remain constant. 2. Which of the following statements is CORRECT? a. All else equal, high-coupon bonds have less reinvestment risk than low-coupon bonds. b. All else equal, long-term bonds have less price risk than short-term bonds. c. All else equal, low-coupon bonds have less price risk than high-coupon bonds. d. All else equal, short-term bonds have less reinvestment risk than long-term bonds. e. All else equal, long-term bonds have less reinvestment risk than short-term bonds. 3. Assume that a noncallable 10-year T-bond has a 12% annual coupon, while a 15-year noncallable T-bond has an 8% annual coupon. Assume also that the yield curve is flat, and all Treasury securities have a 10% yield to maturity. Which of the following statements is CORRECT? a. If interest rates decline, the prices of both bonds would increase, but the 15-year bond would have a larger percentage increase in price. b. If interest rates decline, the prices of both bonds would increase, but the 10-year bond would have a larger percentage increase in price. c. The 10-year bond would sell at a discount, while the 15-year bond would sell at a premium. d. The 10-year bond would sell at a premium, while the 15-year bond would sell at par. e. If the yield to maturity on both bonds remains at 10% over the next year, the price of the 10-year bond would increase, but the price of the 15-year bond would fall. 4. Which of the following statements is CORRECT? a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. b. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. d. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. e. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate. 5. Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT? a. Portfolio P has a beta that is greater than 1.2. b. Portfolio P has a standard deviation that is greater than 25%. c. Portfolio P has an expected return that is less than 12%. d. Portfolio P has a standard deviation that is less than 25%. e. Portfolio P has a beta that is less than 1.2. 6. The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT? a. The stock’s dividend yield is 7%. b. The stock’s dividend yield is 8%. c. The current dividend per share is $4.00. d. The stock price is expected to be $54 a share one year from now. e. The stock price is expected to be $57 a share one year from now. 7. Ryngaert Inc. recently issued noncallable bonds that mature in 15 years. They have a par value of $1,000 and an annual coupon of 5.7%. If the current market interest rate is 7.0%, at what price should the bonds sell? a. $817.12 b. $838.07 c. $859.56 d. $881.60 e. $903.64 8. Assume that you are considering the purchase of a 15-year, noncallable bond with an annual coupon rate of 8.0%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 8.5% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? a. $1,015.69 b. $958.05 c. $1,034.26 d. $943.71 e. $962.48 9. McCue Inc.'s bonds currently sell for $1,100. They pay a $90 annual coupon, have a 25- year maturity, and a $1,000 par value, but they can be called in 5 years at $1,050. Assume that no costs other than the call premium would be incurred to call and refund the bonds, and also assume that the yield curve is horizontal, with rates expected to remain at current levels on into the future. What is the difference between this bond's YTM and its YTC? a. 1.92% b. 1.73% c. 1.27% d. 0.95% e. 0.66% 10. Taussig Corp.'s bonds currently sell for $1,150. They have a 6.35% annual coupon rate and a 20-year maturity, but they can be called