Deck 5: Financial Instruments and Markets

Question 1

Chapter 5 presents evidence that the average annual rate of return on common stocks over many years has exceeded the return on government bonds in the United States,while returns on common stocks have also exhibited more volatility than returns on U.S.government bonds.Suppose that last year,the realized rate of return on government bonds exceeded the return on common stocks.Your colleague suggests that "last year shows us that investors are now willing to settle for lower returns on stocks than on bonds." How would you interpret this result?

Answer 1

The fact that government bonds earned a higher rate of return than common stocks in one year is not evidence that investors are suddenly willing to settle for lower returns on stocks than bonds.It means that investors' expectations were not met or,alternatively,that investors were surprised.To take on additional risk,risk-averse investors require additional expected return.But expected returns are not the same as realized returns.Because stocks and bonds are risky,their returns will fluctuate from year to year,and bonds will earn higher returns than stocks in some years.But the expected returns of common stocks should always be higher than the expected returns of government bonds.

Question 2

Which one of the following statements is false?

A) Financial executives must design financial securities to meet the needs of the firm and its investors.
B) Financial instruments are subject to full disclosure requirements.
C) Financial instruments are greatly constrained by law and regulation.
D) Financial instruments are claims against a company's cash flows and assets.
E) None of the above.

Answer 2

Financial instruments are greatly constrained by law and regulation.

Question 3

You bought a yen-denominated corporate bond at the beginning of the year for ¥100,000.The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end.The exchange rate was $1 = ¥100 at the beginning of the year and $1 = ¥97 at year-end.What would be your U.S.dollar holding return on the bond?

A) 3.09%
B) 6.09%
C) 13%
D) 16.49%
E) 30%
F) None of the above.

Answer 3

16.49%

Question 4

You bought a yen-denominated corporate bond at the beginning of the year for ¥100,000.The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end.The exchange rate was $1 = ¥100 at the beginning of the year and $1 = ¥122 at year-end.What holding period return,measured in yen,did you earn on the bond?

A) -18.03%
B) -7.38%
C) -5.03%
D) 3.0%
E) 10.0%
F) None of the above.

Question 5

Which of the following securities has a purely fixed claim against a firm's cash flows?

A) preferred stock
B) options
C) common stock
D) bonds
E) None of the above.

Question 6

Mike just purchased a bond which pays $40 each year in interest.The $40 interest payment is also called the:

A) coupon.
B) par value.
C) discount.
D) call premium.
E) yield.
F) None of the above.

Question 7

Which of the following securities has a purely residual claim against a firm's cash flows?

A) preferred stock
B) callable bonds
C) common stock
D) non-callable bonds
E) None of the above.

Question 8

Himmel Corp.wants to raise $100 million in a new stock issue.Its investment banker indicates that the sale of new stock will require 12 percent underpricing and a 7 percent spread.(Hint:
The underpricing is 12 percent of the current stock price,and the spread is 7 percent of the issue price.)
a.Assuming Himmel's stock price does not change from its current price of $50 per share,how many shares must the company sell and at what price to the public?
b.How much money will the investment banking syndicates earn on the sale?
c.Is the 12 percent underpricing a cash flow?
Is it a cost?
If so,to whom?

Question 9

At the end of fiscal year 2011,Crane Industries,Inc.'s stock price was $30.75.A year later it was $34.88.Per share dividends over the year were $0.55,while earnings per share were $1.33.What was the dividend yield in fiscal year 2012?

A) 1.79%
B) 4.33%
C) 13.43%
D) 15.22%
E) 17.76%
F) None of the above.

Question 10

Which one of the following accurately orders the rate of return on financial securities from highest to lowest over most of recorded market history (the 1900-2010 period)?

A) Short-term government bills, long-term corporate bonds, long-term government bonds, common stocks
B) Long-term corporate bonds, long-term government bonds, common stocks, short-term government bills
C) Common stocks, long-term government bonds, long-term corporate bonds, short-term government bills
D) Common stocks, long-term corporate bonds, long-term government bonds, short-term government bills
E) Long-term corporate bonds, common stocks, short-term government bills, long-term government bonds
F) None of the above.

Question 11

Which one of the following statements is true?

A) Equity securities offer fixed claims on future cash payouts.
B) Unlike bondholders, for their returns, shareholders rely entirely on price appreciation.
C) In theory, common shareholders exercise very little control over company decisions.
D) Historically, common shareholders have earned a risk premium as compensation for risk borne in excess of government bonds.
E) Preferred shareholders are the first investors to be repaid in bankruptcy liquidation.
F) None of the above.

Question 12

At the end of fiscal year 2011,Crane Industries,Inc.'s stock price was $30.75.A year later it was $34.88.Per share dividends over the year were $0.55,while earnings per share were $1.33.What rate of return did the common stock owners earn in fiscal year 2012?

A) 1.79%
B) 4.33%
C) 13.43%
D) 15.22%
E) 17.76%
F) None of the above.

Question 13

At the end of fiscal year 2011,Crane Industries,Inc.'s stock price was $30.75.A year later it was $34.88.Per share dividends over the year were $0.55,while earnings per share were $1.33.What was the percentage change in the share price in fiscal year 2012?

A) 1.79%
B) 4.33%
C) 13.43%
D) 15.22%
E) 17.76%
F) None of the above.

Question 14

Which of the following statements are true?
I.Underwriters help private companies access public stock markets through IPOs.
II.Shelf registrations and private placements are examples of seasoned security issues.
III.Issue costs for debt are typically greater than issue costs for equity.
IV.Private equity financing is a common source of financing for startup firms.

A) I and II only
B) I and III only
C) I, II, and IV only
D) I, III, and IV only
E) I, II, III, and IV
F) None of the above.

Question 15

You bought a yen-denominated corporate bond at the beginning of the year for ¥100,000.The bond paid 3 percent annual interest and was trading for ¥110,000 at year-end.The exchange rate was $1 = ¥100 at the beginning of the year and $1 = ¥122 at year-end.What was your U.S.dollar holding period return on the bond?

A) 3%
B) 7%
C) 10%
D) 13%
E) 30%
F) None of the above.

Question 16

Individuals who continually monitor the financial markets seeking mispriced securities:

A) earn excess profits over the long-term.
B) make the markets increasingly more efficient.
C) are never able to find a security that is temporarily mispriced.
D) are overwhelmingly successful in earning abnormal profits.
E) are always quite successful using only historical price information as their basis of evaluation.
F) None of the above.

Question 17

Zack owns a bond that will pay him $35 each year in interest plus a $1,000 principal payment at maturity.The $1,000 principal payment is called the:

A) coupon.
B) par value.
C) discount.
D) yield.
E) call premium.
F) None of the above.

Question 18

Which one of the following statements is true?

A) Debt instruments offer residual claims to future cash payouts.
B) Bonds with call provisions will have lower coupon rates than otherwise identical bonds.
C) Bondholders enjoy a direct voice in company decisions.
D) Bonds are low-risk investments that do well in inflationary periods.
E) Preferred shareholders are the first investors to be repaid in bankruptcy liquidation.
F) None of the above.

Question 19

Which of the following are the most likely reasons for why a stock price might not react at all on the day that new information related to the stock issuer is released?
I.Insiders knew the information prior to the announcement
II.Investors need time to digest the information prior to reacting
III.The information has no bearing on the value of the firm
IV.The information was anticipated

A) I and II only
B) I and III only
C) II and III only
D) II and IV only
E) III and IV only
F) None of the above.

Question 20

Which of the following statements related to market efficiency tends to be supported by current evidence?
I.Markets tend to respond quickly to new information.
II.It is difficult for the typical investor to earn above-average returns without taking above-average risks.
III.Short-run prices are difficult to predict accurately based on public information.
IV.Markets are most likely weak form efficient.

A) I and III only
B) II and IV only
C) I and IV only
D) I, III, and IV only
E) I, II, and III only
F) None of the above.

Question 21

You believe interest rates will soon fall.
a.Would you rather own a three-year,6 percent coupon,fixed-rate bond or an equivalent-risk,three-year,floating-rate bond currently paying 6 percent interest?
b.Would your answer to (a)change if you were contemplating issuing a bond rather than owning one?
If so,how?
c.Would your answer to (a)change if,as an investor,you believed interest rates would soon rise?
If so,why?

Question 22

If the stock market in the United States is efficient,how do you explain the fact that some people make very high returns?
Would it be more difficult to reconcile very high returns with efficient markets if the same people made extraordinary returns year after year?