MGT 3040 C Midterm 2
Conceptual (40 % of total grade, 2 points each)
1- Which of the following comparison statements is (are) true?
I. An annuity has equal payments, a perpetuity does not.
II. Both an annuity and a perpetuity have equal payments.
III. An annuity covers a longer period of time than a perpetuity.
IV. An annuity has a constant rate of return, a perpetuity does not.
A) I only
B) II only
C) I and III only
D) II and IV only
E) I and IV only
2- Which of the following will increase the effective annual rate?
I. Increasing the frequency of the compounding
II. Decreasing the frequency of the compounding
III. Increasing the annual percentage rate
IV. Decreasing the annual percentage rate
A) I only
B) II only
C) I and III only
D) I and IV only
E) II and IV only
3- Which one of the following statements concerning an ordinary annuity is true?
A) An ordinary annuity consists of equal payments that occur at the beginning
of each period over a set period of time.
B) If two annuities are equal in every way except that one is an ordinary
annuity and one is an annuity due, then the ordinary annuity will have a
larger future value than the annuity due.
C) The future value of an ordinary annuity can be computed by dividing the
future value of an annuity due by (1+r).
D) If two annuities are equal in every way except that one is an ordinary
annuity and one is an annuity due, then the ordinary annuity will have a
larger present value than the annuity due.
E) Most financial calculators can compute ordinary annuity problems but not
annuity due problems.
4- If you are borrowing money, which one of the following rates would you prefer?
A) 9% paid annually
B) 9% compounded semi-annually
C) 9% compounded quarterly
D) 9% compounded monthly
E) 9% compounded continuously
5- Which one of the following is correct concerning the annual percentage rate (APR)?
A) The APR is greater than the effective annual rate.
B) The APR formula for rate disclosure is [1 + (r / m)]m - 1.
C) The APR is the rate which lenders are required to disclose.
D) The APR is best used to compare offers from various lenders.
E) The APR considers all the effects of compounding.
6- A bond indenture is likely to include which of the following?
I. Maturity date
II. Sinking fund provision
III. Protective covenants
IV. Security or collateral
A) I and II only
B) I, II, and III only
C) I, II, and IV only
D) II, III, and IV only
E) I, II, III, and IV
7- Which of the following is NOT a typical negative bond covenant?
A) The firm must limit dividend payments.
B) The firm cannot merge with another firm.
C) The firm cannot issue additional long-term debt.
D) The firm cannot allow its bond rating to fall below its initial level.
E) The firm cannot pledge any assets to other lenders.
8- Which of the following risks do debt ratings specifically attempt to assess?
I. Interest rate risk
II. Default risk
III. The risk of a call being made
A) I only
B) II only
C) I and II only
D) II and III only
E) I, II, and III
9- All else equal, which bond will tend to have the most stable market value if interest
rates fluctuate?
A) Zero coupon, short-term bond
B) Floating-rate, short-term bond
C) Long-term, low coupon bond
D) AAA rated, intermediate term bond
E) Canadian Government bond
10- Which of the following are common features of most callable bonds?
I. A call premium is paid if the bond is redeemed early.
II. The bond is generally redeemed on the original date of maturity.
III. The right to call the bond is deferred for a period of time.
IV. The call premium increases as the time to maturity decreases.
A) I and III only
B) I and IV only
C) II and III only
D) I, III, and IV only
E) II, III, and IV only
11- Which one of the following is designed to benefit the corporation rather than the
bondholder?
A) Positive covenant
B) Sinking fund
C) Call provision
D) Negative covenant
E) Call premium
12- A supernormal growth stock generally:
A) Is associated with a company that is experiencing rapid contraction.
B) Tends to increase its dividends per share by 30% or more for an extended
number of years.
C) Has high growth dividends only for a limited number of years.
D) Has dividends that grow at a high rate for the life of the stock.
E) Is valued using the preferred stock valuation technique.
13- If the required rate of return used in the dividend growth model is increased, then:
A) The dividend amount must also increase.
B) The current value of the stock will decrease.
C) P0 will increase.
D) The supernormal model must be used to value the stock.
E) The growth rate must also increase.
14- If the management of a corporation wants to raise equity capital while maintaining
control over the corporation and limiting their cash outflows, they should issue
shares of:
A) Non-voting preferred stock.
B) Voting preferred stock.
C) Voting common stock.
D) Non-voting common stock.
E) Zero coupon bonds.
15- Which one of the following statements is correct concerning the differences between
preferred and common stock?
A) Common shareholders have first right of priority after creditors in
liquidation.
B) Preferred shares carry voting rights while common shares do not.
C) Common shareholders generally have more control over a corporation than
preferred shareholders.
D) Common dividends in arrearage must be paid prior to any additional
preferred stock dividends.
E) Common stock is a form of equity while preferred stock is a form of debt
from a legal standpoint.
16- There are three seats open on the board of directors of ABC, Inc. Ann owns voting
shares of ABC common stock. If ABC uses cumulative voting, the maximum
number of shares that Ann can vote for any one position is equal to:
A) The number of open seats.
B) One-third of the number of shares owned.
C) The number of shares owned.
D) Three times the number of shares owned multiplied by the number of open
seats.
E) The number of seats open times the number of shares owned.
17- Which of the following is/are important in choosing a venture capitalist?
I. The financial strength of the venture capitalist.
II. References regarding how successful the venture capitalist has been in the
past.
III. The venture capitalist's exit strategy.
A) I only
B) I and III only
C) I and II only
D) II and III only
E) I, II, and III
18- A publicly traded firm has decided to issue 1 million new shares of common stock at
the current market price of $10 per share. An underwriting syndicate pays the firm
$9.3 million for the entire issue and then markets the shares at $10 each. This is
an example of a(n):
A) Indirect cost.
B) Lock-up agreement pricing.
C) Firm commitment underwriting.
D) A best-efforts underwriting.
E) An underpricing situation.
19- The option to purchase shares of newly issued stock in order to maintain your current
ownership percentage is done:
A) By placing a subscription agreement with the lead underwriter.
B) By placing a standing order with your personal broker to buy shares at the
offer price.
C) Through a rights offering as set forth by the preemptive rights provision in
the articles of incorporation.
D) Through an options process as agreed to by the shareholders in a special
proxy vote.
E) Through the transfer agent as set forth in the Green Shoe provision of the
articles of incorporation.
20- The legal fees paid by a firm are a(n) ___________ of issuing securities.
A) direct cost
B) spread cost
C) abnormal return
D) indirect cost
E) Green Shoe option cost
Problems (60% of total grade)
1- Mr. Smith just won a "Name That Tune" contest with a grand prize of $250,000.
However, the contest stipulates that the winner will receive $100,000
immediately, and $15,000 at the end of each of the next 10 years. Assuming that
he can earn 5% on his money, how much has he actually won?
2- Analysts expect Marble Comics to pay shareholders $1.00 per share annually for the
next five years. After that, the dividend will be $1.50 annually forever. Given a
discount rate of 10%, what is the value of the stock today?
3- What is the future value in 10 years of $1,000 payments received at the beginning of
each year for the next 10 years? Assume an interest rate of 5.625%.
4- Your recently departed rich, eccentric uncle has left for you in his will a large sum of
money. Unfortunately, rather than give you this sum of money immediately, he
has instructed the executor of the will to pay you $10,000 in one year. This
payment is to grow by 9% each year and to be made each year forever. If the
appropriate discount rate is 10%, how much have you actually inherited?
5- Bond J is a 3% coupon bond. Bond S is a 12% coupon bond. Both bonds have 8 year
to maturity, make semiannual payments, and have YTM of 7%. If interest rates
suddenly rise by 2%, what is the percentage price change of these bonds?
6- If the nominal rate is 8% and the expected inflation rate is 3% during the next year,
what real rate of return does the investor expect? What is the approximate real
rate of return?
7- Suppose you know that a company’s stock currently sells for $70 per share and the
required return on the stock is 18%.You also know that the total return on the
stock is evenly divided between capital gains yield and dividend yield. If it is the
company’s policy to always maintain a constant growth rate in its dividends, what
is the current dividend per share?
8- ThisExamisEasy Inc., just paid a dividend of $3 per share on its stock. The dividends
are expected to grow at a constant rate of 5% per year, indefinitely. If investors
require a 12% return on the stock, what is the stock’s current price? What will the
price be in 15 years?