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∙ Exam 2 consists of 30 multiple choice questions. You will have 2 hours to complete the exam at the testing center or with your proctor. ∙ Double-check your appointment time prior to the first day of the testing window to be sure you remember it correctly and do not miss your appointment, as rescheduling may be impossible during the testing window and makeups aDon't forget about the age old question of illusioning
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re not available due to missed appointments without validated circumstances outside of your control. ∙ Make sure that you take your FSU ID card and your financial calculator with you to the exam and arrive at or before your scheduled time. ∙ Follow all testing center rules, which include no electronic devices being available during testing. Violating testing center rules during an exam will disallow you from taking a makeup exam for that particular test. (This means you should LEAVE YOUR PHONE OUTSIDE the testing center ORTURN IT OFF prior to entering the testing center.) Exam 2 Study Guide (not exhaustive) Chapter 7: What is debt capital? What are characteristics of debt? Define the following terms related to bonds: indenture, par value, face value, face amount, coupon, coupon rate, security, protective covenant, seniority, sinking fund, call provision, put provision, debenture, note How frequently are corporate coupons paid? What compounding period is used when valuing U.S. corporate bonds? Compare and contrast public bonds and private placements How are ratings used with respect to bonds? What is unique about U.S. Treasury securities? Municipal bonds? What are sovereign bonds? What is a zero coupon bond? What is a convertible bond? How are bond markets different from equity markets? Be able to calculate the following for a bond: current yield, yield to maturity, bond value (clean price), accrued interest and dirty price, yield to first call Describe the relationships that exist between the market interest rate, coupon rate, yield to maturity, and current yield for a bond trading at both a discount and a premium What are the 2 sources of return from investing in a bond? What is interest rate risk? How does it vary with coupon level and time to maturity? Define nominal rate, real rate, and inflation premium. Be able to calculate each, given others (Fisher effect) What is the term structure of interest rates? The yield curve? What are the 3 components of the term structure? Explain the conditions that would need to exist for the Treasury yield curve to be downward and upward sloping Define liquidity risk, default risk, and taxability risk and explain how these risks relate to bond yieldsWith respect to corporate bond coupons, what is the common base rate? What is a credit spread? What are components of each? Chapter 8: ∙ What is equity capital? o Equity ownership of stock (invested money) Common stockgeneral ownership interest of the company Preferred Stock ∙ What are characteristics of equity? Shareholders Rights ∙ Primary right elect corporate directors who set corporate policy and select operating management o Shareholders do not select management directly but through the election of corporate directors ∙ Other rights o 1. Share proportionately in dividends paid (on a quarterly basis) o 2. Share proportionately in any liquidation value Worst case scenario for a company: ∙ Is sold as either an operating company to a set of owner or its assets are liquidated ∙ Debtholders would we paid first and what’s left is for shareholders (usually very little to nothing left) o 3. Vote on matters of importance annually and onetime (e.g., auditors, mergers) o 4 (possible right). Preemptive right the right to purchase a pro rata share of any new stock issue Maintain % ownership of the company ∙ Discuss the structure of a corporation (shareholders, board of directors, management) ∙ What is a proxy? o Giving your right to vote to another group (e.g., management, or group of investor who are trying to make changes in the company) ∙ Explain why minority shareholders might prefer cumulative voting over straight voting o Straight (majority) voting each shareholder would have one vote for every seat on the board of directors. Cast their vote on that particular person or not o Cumulative voting a system of voting in an election in which each voter is allowed as many votes as there are candidates and may give all to one candidate or varying numbers to several. o With straight voting, you have a number of votes equal to the number of shares you have, and you vote on each director’s seat separately. But with cumulative voting, the number of votes you have is the number of shares you have times the number of directors’ seats there are. o for every seat that is of a board member that is up for election at any point in time, each shareholder has one vote for that seat but if there are multiple seats up for voting, a shareholder has multiple votes they are just placed for separate seats. o Cumulative voting allows minority shareholders to have more influence and get someone on the board that supports their point of view ∙ Explain characteristics of dividends o Notes on common stock: Payment of dividends is at the discretion of the board ∙ Common shareholder has no right to receive dividends Dividends are not tax deductible for the paying firm ∙ Distributed after taxes Dividends received by individuals are taxed based on the holding period of the stock (ordinary income vs. capital gains) ∙ What is preferred stock? o Preferred stockholders do not have the right to vote for the board o Precedence over common stock in the payment of dividends and in liquidation o There is no date that it must be paid o Receives a quarterly dividend payment o Dividend is usually fixed (stated as percent of par value standard par = $100) o Receives a quarterly dividend payment o Most commonly pay cumulative dividends ∙ What is a dividend yield? o ∙ What is a PE ratio? ∙ What are the 2 sources of return from investing in common stock? Know how to calculate the value of a share of stock given assumptions about future dividends What is the theory behind why expected dividends can be used to value a share of stock? In the long run, why is this a valid assumption? What are the issues with this method of valuing equity? How are earnings or sales multiples used to value stock as an alternative to future dividend models? Chapter 9: What is the purpose of capital budgeting analysis? Define each of the following, describe strengths and weaknesses, and be able to calculate: Net Present Value, Profitability Index, Payback Period, Discounted Payback Period, Average Accounting Return (no calculation), Internal Rate of Return Which of the other various decisionmaking tools provide the same answer as NPV? Does it matter if the cash flows are conventional or not? What is the problem with using IRR with nonconventional cash flows? With mutually exclusive projects? What is an NPV Profile? What is the crossover point on an NPV profile? Be able to calculate. Be able to choose, from a group of projects, which ones to invest in given various statistics about the projects and a limited amount of cash to invest.EXTRA QUESTIONS 1. Greenbrier Industrial Products' bonds have a 7.60% semiannual coupon. The face value is $1,000 and the current market price is $1,062.50 per bond. The bonds mature in 16 years. What is the yield to maturity? 2. Oil Well Supply offers 7.5% coupon bonds with semiannual payments and a yield to maturity of 7.68%. The bonds mature in 6 years. What is the market price per bond if the face value is $1,000? 3. You are purchasing a 25year, zerocoupon bond from Gem, Inc. The yield to maturity is 8.68% and the face value is $1,000. What is the current market price? 4. A 16year, 4.5% coupon bond pays interest semiannually. The bond has a face value of $1,000. What is the percentage change in the price of this bond if the market yield to maturity rises to 5.7% from the current rate of 5.5%? 5. Blackwell bonds have a face value of $1,000 and are currently quoted at 98 3/8% of par. The bonds have a 5% coupon rate. What is the current yield on these bonds? 6. A Treasury bond is quoted at a price of 101 & 14/32% of par with a current yield of 7.236%. What is the coupon rate if the par value is $1,000? 7. The semiannual, 8year bonds of Soprano Music are selling at par and have a yield to maturity of 8.6285%. What is the amount of each coupon payment if the face value of the bonds is $1,000? 8. Superior Markets has bonds outstanding that pay a 5% semiannual coupon, have a 5.28% yield to maturity, and a face value of $1,000. The current rate of inflation is 4.1%. What is the real rate of return on these bonds? 9. The yield to maturity on a bond is currently 8.46%. The real rate of return is 3.22%. What is the rate of inflation? 10. Upper Crust Bakers just paid an annual dividend of $2.80 a share and is expected to increase that amount by 4% per year. If you are planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of security is 11.50% at the time of your purchase? 11. Show Boat Dinner Theatres has paid annual dividends of $0.32, $0.48, and $0.60 a share over the past three years, respectively. The company now predicts that it will maintain a constant dividend since its business has leveled off and sales are expected to remain relatively flat. Given the lack of future growth, you will only buy this stock if you can earn at least a 16% rate of return. What is the maximum amount you are willing to pay for one share of this stock today?12. Denver Shoppes will pay an annual dividend of $1.46 a share next year with future dividends increasing by 4.2% annually. What is the market rate of return if the stock is currently selling for $38.90 a share? 13. Great Lakes Health Care common stock offers an expected total return of 9.2%. The last annual dividend was $2.10 a share. Dividends increase at a constant 2.6% per year. What is the dividend yield? 14. Atlas Mines has adopted a policy of increasing the annual dividend on its common stock at a constant rate of 2.75% annually. The firm just paid an annual dividend of $1.67. What will the dividend be six years from now? 15. Home Canning Products common stock sells for $44.96 a share and has a market rate of return of 12.8%. The company just paid an annual dividend of $1.04 per share. What is the dividend growth rate? 16. Winter Time Adventures is going to pay an annual dividend of $2.86 a share on its common stock next year. This year, the company paid a dividend of $2.75 a share. The company adheres to a constant rate of growth dividend policy. What will one share of this common stock be worth five years from now if the applicable discount rate is 11.7%? 17. Combined Communications is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 15% per year for the next 4 years and then altering the growth rate to 3.5% per year. The company just paid its annual dividend in the amount of $0.20 per share. What is the current value of one share of this stock if the required rate of return is 15.5%? 18. KL Airlines paid an annual dividend of $1.42 a share last month. The company is planning on paying $1.50, $1.75, and $1.80 a share over the next 3 years, respectively. After that, the dividend will be constant at $2 per share per year. What is the market price of this stock if the market rate of return is 10.5%? 19. Dexter Metals, paid its first annual dividend yesterday in the amount of $0.18 a share. The company plans to double each annual dividend payment for the next 3 years. After that time, it plans to pay $1.25 a share for 2 years and then pay a constant dividend of $1.60 per share indefinitely. What is one share of this stock worth today if the market rate of return on similar securities is 10.24%? 20. What is the net present value of a project with the following cash flows if the required rate of return is 12%?21. You are considering the following two mutually exclusive projects. The required rate of return is 14.6% for project A and 13.8% for project B. Which project should you accept and why?
22. Day Interiors is considering a project with the following cash flows. What is the IRR of this project?
23. An investment has the following cash flows and a required return of 13%. Based on IRR, should this project be accepted? Why or why not?
24. What is the profitability index for an investment with the following cash flows given a 14.5% required return?
25. It will cost $6,000 to acquire an ice cream cart. Cart sales are expected to be $3,600 a year for three years. After the three years, the cart is expected to be worthless as the expected life of the refrigeration unit is only three years. What is the payback period of this investment? 26. Scott is considering a project that will produce cash inflows of $2,100 a year for 4 years. The project has a 12% required rate of return and an initial cost of $5,000. What is the discounted payback period? SOLUTIONS 1. 6.95% 2. 991.47 3. 119.52 4. 2.17% 5. 5.08% 6. 7.34% 7. 43.14 8. 1.13% 9. 5.08% 10. $40.38 11. $3.75 12. 7.95% 13. 6.6% 14. $1.97 15. 10.25% 16. $45.19 17. $2.49 18. $18.2419. $13.20 20. $842.12 21. Project A (NPV is higher) 22. 7.03% 23. Yes; The IRR exceeds the required return. 24. 1.02 25. 1.67 years 26. 2.97