FIN 4504 | FIN4504 Exam 2: Investments Updated
and Latest Questions and Correct Answers with
Rationale - Florida State University
1. A 10-year corporate bond with a 6% annual coupon rate and a $1,000 par value is currently
trading at a yield to maturity (YTM) of 8%. What is the current market price of the bond?
A. $1,000.00
B. $865.80
C. $1,147.20
D. $920.40
Correct Answer: B
Explanation: To find the bond price, we calculate the present value of the $60 annual
coupons and the $1,000 maturity value discounted at 8%. Since the market discount rate of
8% is higher than the coupon rate of 6%, the bond must sell at a discount. The calculation
involves finding the present value of an annuity for the coupons and a single sum for the
par value. This specific computation results in a price of approximately $865.80.
Understanding the inverse relationship between yield and price is critical for bond
valuation.
2. Which of the following statements correctly describes the relationship between bond
prices and interest rates?
A. Bond prices and interest rates move in the same direction.
B. Bond prices and interest rates have an inverse relationship.
C. Bond prices are unaffected by changes in market interest rates.
D. Long-term bond prices are less sensitive to interest rate changes than short-term bonds.
Correct Answer: B
Explanation: Bond prices and market interest rates move in opposite directions because
the fixed coupon payments become more or less attractive relative to new issues. When
interest rates rise, the present value of the bond’s future cash flows decreases, leading to a
lower market price. Conversely, when rates fall, existing bonds with higher coupons trade
at a premium. This fundamental principle is known as interest rate risk and affects all
fixed-income securities. Investors must monitor rate movements to manage the market
value of their debt portfolios.
,3. Using the Constant Growth Dividend Discount Model (DDM), calculate the value of a stock
that just paid a dividend (D0) of $2.00, has a growth rate of 5%, and a required rate of return
of 10%.
A. $40.00
B. $20.00
C. $42.00
D. $21.00
Correct Answer: C
Explanation: The formula for the constant growth model is P = D1 / (k - g), where D1 is the
next expected dividend. We calculate D1 by multiplying the current dividend of $2.00 by (1
+ 0.05), which equals $2.10. Dividing $2.10 by the difference between the required return
and growth (0.10 - 0.05) gives us the price. This results in a stock value of $42.00 per share.
This model demonstrates how sensitivity to growth assumptions can significantly impact
equity valuation.
4. What is the duration of a zero-coupon bond with a maturity of 7 years?
A. Less than 7 years
B. Exactly 7 years
C. More than 7 years
D. It depends on the market interest rate
Correct Answer: B
Explanation: Duration measures the weighted average time until an investor receives the
cash flows from a bond. For a zero-coupon bond, there are no intermediate payments, so
the only cash flow occurs at maturity. Therefore, the duration of any zero-coupon bond is
always equal to its time to maturity. This makes zero-coupon bonds highly sensitive to
interest rate changes compared to coupon bonds of the same maturity. This fixed
relationship simplifies the calculation of price volatility for zero-coupon instruments.
5. If the nominal interest rate is 7% and the expected inflation rate is 3%, what is the
approximate real interest rate according to the Fisher equation?
A. 10%
B. 2.33%
C. 4%
D. 21%
Correct Answer: C
, Explanation: The Fisher equation states that the nominal rate is approximately equal to
the sum of the real rate and the inflation rate. By rearranging the formula, the real rate is
found by subtracting inflation from the nominal rate. In this scenario, subtracting 3% from
7% yields a real rate of 4%. This value represents the actual increase in purchasing power
for the investor. Accurate measurement of real rates is vital for making long-term
investment decisions during inflationary periods.
6. A company has a plowback ratio of 0.60 and a return on equity (ROE) of 15%. What is the
expected dividend growth rate?
A. 6%
B. 9%
C. 15%
D. 25%
Correct Answer: B
Explanation: The sustainable growth rate is calculated by multiplying the plowback ratio
by the return on equity. With a plowback ratio of 0.60 and an ROE of 0.15, the growth rate
is 0.09 or 9%. This growth rate represents the rate at which a company can grow using its
internal earnings. A higher plowback ratio generally leads to higher future growth,
assuming the ROE remains constant. This link between retention and growth is a key
component of the dividend discount model.
7. Which yield measure represents the annual coupon payment divided by the current market
price of a bond?
A. Yield to Maturity
B. Capital Gains Yield
C. Current Yield
D. Yield to Call
Correct Answer: C
Explanation: Current yield is a simple measure that relates the annual cash income of a
bond to its current price. It does not account for the time value of money or the capital
gain/loss realized at maturity. For a bond trading at par, the current yield equals the
coupon rate. If the bond is at a discount, the current yield will be higher than the coupon
rate. While useful for income-oriented investors, it provides an incomplete picture of total
return.
8. As a bond approaches its maturity date, what happens to its market price if interest rates
remain constant?
A. The price moves toward the par value.
B. The price stays the same regardless of the initial price.
and Latest Questions and Correct Answers with
Rationale - Florida State University
1. A 10-year corporate bond with a 6% annual coupon rate and a $1,000 par value is currently
trading at a yield to maturity (YTM) of 8%. What is the current market price of the bond?
A. $1,000.00
B. $865.80
C. $1,147.20
D. $920.40
Correct Answer: B
Explanation: To find the bond price, we calculate the present value of the $60 annual
coupons and the $1,000 maturity value discounted at 8%. Since the market discount rate of
8% is higher than the coupon rate of 6%, the bond must sell at a discount. The calculation
involves finding the present value of an annuity for the coupons and a single sum for the
par value. This specific computation results in a price of approximately $865.80.
Understanding the inverse relationship between yield and price is critical for bond
valuation.
2. Which of the following statements correctly describes the relationship between bond
prices and interest rates?
A. Bond prices and interest rates move in the same direction.
B. Bond prices and interest rates have an inverse relationship.
C. Bond prices are unaffected by changes in market interest rates.
D. Long-term bond prices are less sensitive to interest rate changes than short-term bonds.
Correct Answer: B
Explanation: Bond prices and market interest rates move in opposite directions because
the fixed coupon payments become more or less attractive relative to new issues. When
interest rates rise, the present value of the bond’s future cash flows decreases, leading to a
lower market price. Conversely, when rates fall, existing bonds with higher coupons trade
at a premium. This fundamental principle is known as interest rate risk and affects all
fixed-income securities. Investors must monitor rate movements to manage the market
value of their debt portfolios.
,3. Using the Constant Growth Dividend Discount Model (DDM), calculate the value of a stock
that just paid a dividend (D0) of $2.00, has a growth rate of 5%, and a required rate of return
of 10%.
A. $40.00
B. $20.00
C. $42.00
D. $21.00
Correct Answer: C
Explanation: The formula for the constant growth model is P = D1 / (k - g), where D1 is the
next expected dividend. We calculate D1 by multiplying the current dividend of $2.00 by (1
+ 0.05), which equals $2.10. Dividing $2.10 by the difference between the required return
and growth (0.10 - 0.05) gives us the price. This results in a stock value of $42.00 per share.
This model demonstrates how sensitivity to growth assumptions can significantly impact
equity valuation.
4. What is the duration of a zero-coupon bond with a maturity of 7 years?
A. Less than 7 years
B. Exactly 7 years
C. More than 7 years
D. It depends on the market interest rate
Correct Answer: B
Explanation: Duration measures the weighted average time until an investor receives the
cash flows from a bond. For a zero-coupon bond, there are no intermediate payments, so
the only cash flow occurs at maturity. Therefore, the duration of any zero-coupon bond is
always equal to its time to maturity. This makes zero-coupon bonds highly sensitive to
interest rate changes compared to coupon bonds of the same maturity. This fixed
relationship simplifies the calculation of price volatility for zero-coupon instruments.
5. If the nominal interest rate is 7% and the expected inflation rate is 3%, what is the
approximate real interest rate according to the Fisher equation?
A. 10%
B. 2.33%
C. 4%
D. 21%
Correct Answer: C
, Explanation: The Fisher equation states that the nominal rate is approximately equal to
the sum of the real rate and the inflation rate. By rearranging the formula, the real rate is
found by subtracting inflation from the nominal rate. In this scenario, subtracting 3% from
7% yields a real rate of 4%. This value represents the actual increase in purchasing power
for the investor. Accurate measurement of real rates is vital for making long-term
investment decisions during inflationary periods.
6. A company has a plowback ratio of 0.60 and a return on equity (ROE) of 15%. What is the
expected dividend growth rate?
A. 6%
B. 9%
C. 15%
D. 25%
Correct Answer: B
Explanation: The sustainable growth rate is calculated by multiplying the plowback ratio
by the return on equity. With a plowback ratio of 0.60 and an ROE of 0.15, the growth rate
is 0.09 or 9%. This growth rate represents the rate at which a company can grow using its
internal earnings. A higher plowback ratio generally leads to higher future growth,
assuming the ROE remains constant. This link between retention and growth is a key
component of the dividend discount model.
7. Which yield measure represents the annual coupon payment divided by the current market
price of a bond?
A. Yield to Maturity
B. Capital Gains Yield
C. Current Yield
D. Yield to Call
Correct Answer: C
Explanation: Current yield is a simple measure that relates the annual cash income of a
bond to its current price. It does not account for the time value of money or the capital
gain/loss realized at maturity. For a bond trading at par, the current yield equals the
coupon rate. If the bond is at a discount, the current yield will be higher than the coupon
rate. While useful for income-oriented investors, it provides an incomplete picture of total
return.
8. As a bond approaches its maturity date, what happens to its market price if interest rates
remain constant?
A. The price moves toward the par value.
B. The price stays the same regardless of the initial price.
