BFIN 300 Financial Management FA14 Quiz 2 Solutions
1. The capital gains yield plus the dividend yield on a security is called the total return. 2. Unsystematic risk can be effectively eliminated through portfolio diversification. 3. The excess return required from a risky asset over that required from a risk-free asset is called the risk premium. 4. The market risk premium is computed by subtracting the risk-free rate of return from the market rate of return. MRP = Return of the market – Risk-free rate. 5. The Zolo Co. just declared that it is increasing its annual dividend from $1.00 per share to $1.25 per share. If the stock price remains constant, then the dividend yield will increase. This is because the denominator in dividend yield remains unchanged, but the numerator increases. 6. A bond that makes no coupon payments and is initially priced at a deep discount is called a zero-coupon bond. 7. A symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation is the Normal distribution. 8. Which one of the following is a correct statement concerning risk premium? The greater the volatility of returns, the greater the risk premium. 9. Estimates using the arithmetic average will probably tend to overestimate values over the long-term while estimates using the geometric average will probably tend to underestimate values over the short-term. 10. The risk premium for an individual security is computed by multiplying the security's beta by the market risk premium. CAPM = RFR + Beta x (MRP) 11. Standard deviation measures total risk.
12. Which one of the following would indicate a portfolio is being effectively diversified? A decrease in the portfolio standard deviation 13. The intercept point of the security market line is the rate of return which corresponds to the risk free rate of return. (the y-intercept here, from the formula for the slope of a line) 14. The principal amount of a bond that is repaid at the end of the loan term is called the bond's face value (note the question asks for principal amount, not date) 15. Which one of the following statements is correct concerning the expected rate of return on an individual stock given various states of the economy? The expected return is a weighted average where the probabilities of the economic states are used as the weights. 16. The Capital Market Line is the pricing relationship between the optimal portfolio and the standard deviation of portfolio return. (extra credit question) Quantitative questions:
17. The Lo Sun Corporation offers a 6% bond with a current market price of $875.05. The yield to maturity is 7.34%. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond matures? PV
RATE or i/y
NPER or n
8x2 = 16
18. Six months ago, you purchased 100 shares of stock in ABC Co. at a price of $43.89 a share. ABC stock pays a quarterly dividend of $.10 a share. Today, you sold all of your shares for $45.13 per share. What is the total amount of your capital gains on this investment?
The information about the dividends is not needed to solve for capital gains. 19. The common stock of Eddie's Engines, Inc. sells for $25.71 a share. The stock is expected to pay $1.80 per share next month when the annual dividend is distributed. Eddie's has established a pattern of increasing its dividends by 4% annually and expects to continue doing so. What is the market rate of return on this stock?
This is a constant growth or Gordon growth model problem.
20. Fred Flintlock wants to earn a total of 10% on his investments. He recently purchased shares of ABC stock at a price of $20 a share. The stock pays a $1 a year dividend. The price of ABC stock needs to _____ if Fred is to achieve his 10% rate of return.
Total return = dividend yield + capital gains yield
10% = 1/20 + cap gains yld =...
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