Towson UniversityDepartment of FinanceFin331Dr. M. Rhee2010 SpringNAME:ID#:1. If the interest is compounded quarterly with 8% APR, which of the following statements is CORRECT?a. The periodic rate of interest is 2% and the effective rate of interest is 4%.b. The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.c. The periodic rate of interest is 4% and the effective rate of interest is less than 8%.d. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.e. The periodic rate of interest is 8% and the effective rate of interest is also 8%.Answer: d2. What is the coefficient of variation for security a? Probability Ra(State=?)Rb(State=?)Boom 35% 0.30 0.06Average 40% 0.10 0.06Recession 25% --0.15 -0.05a. 1.00b. 1.25c. 1.36d. 1.73e. 1.90Answer: d3. You plan to save $6,400 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. How much will you have 4 years from today?a. $22,980.31b. $22,685.69c. $26,221.12d. $29,461.93e. $31,524.26Answer: d BEGIN ModeN 4 Alternative setup:I/YR 5.7% 0 1 2 3 4 PV $0.00 $6,400 $6,400 $6,400 $6,400PMT -$6,400 NFV = $29,461.93FV $29,461.934. Which of the following investments would have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same and is greater than zero.a. Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).b. Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).c. Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).d. Investment D pays $2,500 at the end of 10 years (just one payment).e. Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).Answer: aA dominates B because it provides the same total amount, but it comes faster, hence it can earn more interest over the 10 years. A also dominates C and E for the same reason, and it dominates D because with D no interest whatever is earned. We could also do these calculations to answer the question: FV Interest # PMT Each PMTA $4,382.79 Largest EFF% 10.00% 10 -250B $4,081.59 NOM% 9.76% -125C $4,280.81 -125D $2,500.00 -2500E $3,984.36 -2505. Your uncle has $300,000 invested at 7.5%, and he now wants to retire. He wants to withdraw $35,000 at the end of each year, starting at the end of this year. He also wants to have $25,000 left to give you when he ceases to withdraw funds from the account. For how many years can he make the $35,000 withdrawals and still have $25,000 left in the end?a. 13.48b. 14.96c. 15.71d. 16.49e. 17.32Answer: a 6. Suppose you just won the state lottery, and you have a choice between receiving $2,550,000 today or a 20-year annuity of $250,000, with the first payment coming one year from today. What rate of return is built into the annuity? Disregard taxes.a. 7.12%b. 7.49%c. 7.87%d. 8.26%e. 8.67%Answer: bN 20PV $2,550,000PMT -$250,000FV $0.00I/YR 7.49%7. Which indenture provision may affect the price of the bond differently? a. convertibilityb. sinking fundc. calld. restrictions on dividendse. collateralAnswer: c Investors do not like a call provision => they want to pay less or expect a higher return. What about other indenture provisions? All others are advantageous to investors8. Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 4.80%. Assuming the pure expectations theory is correct, what is the yield on a 1-year T-bond expected to be one year from now?a. 5.61%b. 5.72%c. 6.22%d. 5.44%e. 6.11%Answer: ar1-year4.00%r2-year4.80%r1-year 1 year from now X in the equation (1.04)(1 + X) = (1.048)2 = 1.0983X = (1.048)2/(1.040) − 1.0 = r1-year in 1 year 5.61%9. Which of the following factors would be most likely to lead to an increase in nominal interest rates?a. Households reduce their consumption and increase their savings.b. A new technology like the Internet has just been introduced, and it increases investment opportunities.c. There is a decrease in expected inflation.d. The economy falls into a recession.e. The Federal Reserve decides to try to stimulate the economy.Answer: b If the new technology were so efficient that it takes an underdeveloped economy from a subsistence level, where savings are necessarily low and rates high, to a level where people can afford to save, thismight cause interest rates to decline. However, it would take time for this to occur.10. You are comparing saving $100 every month for a year vis-à-vis $1,200 at the beginning of the year. How much extra will you have at the end of the year by saving $ 1,200 at the beginning of the year instead of saving $100 each month at the end of each month. Use 6% interest rate.a. $35.51 b. $38.44c. $60.90d. $63.90e. $76.71Answer: b 11. The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. IBM stock has a risk premium of 0.9%. What is the equilibrium rate of return on a 1-year Treasury bond?a. 5.51%b. 5.80%c. 6.09%d. 6.39%e. 6.71%Answer: bNote: you need to find the yield on 1-year Treasury bond not IBM’s stockReal risk-free rate, r* 3.05%Inflation this year 2.75%1-year bond yield: rRF = r* + IP 5.80%The theoretically more precise answer is (1 + r*)(1 + I) – 1 = 5.884%12. Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%, and a maturity risk premium of 0.07% per year to maturity applies to both corporate and T-bonds, i.e., MRP = 0.07%(t), where t is the years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 0.90% apply to A-rated corporate bonds but not to T-bonds. How much higher would the rate of return be on a 10-year A-rated corporate bond than on a 5-year Treasury bond? a. 1.75%b. 1.84%c. 1.93%d. 2.03%e. 2.13%Answer: aReal risk-free rate, r* 3.25%IP 4.35%MRP, 5-year T-bond Per year: 0.07% Years: 5 0.35%MRP, 10-year corporate Per year: 0.07% Years: 10 0.70%LP 0.50%DRP 0.90%T-bond yield rT-bond = r* + IP + MRP + DRP + LP 7.95%A bond yield rCorp = r* + IP + MRP + DRP + LP 9.70%Difference 1.75%13. Dyl Inc.'s bonds currently sell for $1,180 and have a par value of $1,000. They pay a $65 annual coupon and have a
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