Finance Exam 2 HW review Stein

A bond’s _________ refers to the interest payment or payments paid by a bond.

coupon payment

A bond issuer is said to be in ______ if it does not pay the interest or the principal in accordance with the terms of indenture agreement or if it violates one or more of the issue’s restricted covenants.

default

The contract that describes the terms of borrowing arrangement between a firm that sells a bond issue and the investors who purchase the bonds is called an _______

indenture

A bond’s _____________ allows a bondholder or preferred stockholder to convert their bond or preferred share, respectively, into a specified number or value of common shares.

convertibility provision

If the price of a bond is initially discounted and offers no coupon payments, the bond is called a ___________

zero coupon

Which term is used to describe a call provision in which the issuer is prevented from calling a portion or the entire issue for several years during the early years of the bond issue?

A) sinking fund provision
B) Declining Call Provision
C) Deferred call provision

C) Deferred call provision

Fill in the Blank:
Remember, a bond’s coupon rate partially determines the interest-based return that a bond ______ pay, and a bondholder’s required return reflects the return that a bondholder _______ to receive from a given investment.

will would like

Fill in the Blank:
When the bond’s coupon rate is equal the the bondholder’s required return, the bond’s intrinsic value will equal its par value, and the bond will trade _______.

at par

Fill in the Blank:
When the bond’s coupon rate is greater to the bondholder’s required return, the bond’s intrinsic value will _________ its par value, and the bond will trade at a premium.

exceed

Fill in the Blank:
When the bond’s coupon rate is less than the bondholder’s required return, the bond’s intrinsic value will be less than its par value, and the bond will trade at _________.

a discount

Yield to Maturity (YTM) is the rate of return expected from a bond held until its maturity date. However, the YTM equals the expected rate of return under certain assumptions. Which of the following is one of these assumptions?

A) The bond will not be called.
B) The bond has an early redemption feature.

A) The bond will not be called.

Frank Barlowe is retiring soon, so he is concerned about his investments providing him steady income every year. He is aware that if interest rates ______, the potential earnings power of the cash flow from his investments will increase. In particular, he is concerned that a decline in interest rates might lead to ____ annual income from his investments. What kind of risk is Frank most concerned about protecting against?

A) Reinvestment rate risk
B) Interest rate risk

increase less A) Reinvestment rate risk

True or False:
Assuming all else is equal, short-term securities are exposed to higher reinvestment rate risk than long-term securities.

True

Characteristic: This is the rate on short-term U.S. Treasury securities, assuming there is no inflation.

Component: Real risk-free rate Symbol: r*

Characteristic: This is the premium that reflects the risk associated with changes in interest rates for a long-term security.

Component: Maturity Risk Premium Symbol: MRP

Characteristic: This is the rate on a Treasury bill or a Treasury bond.

Component: Nominal risk-free rate Symbol: Rrf

Characteristic: Over the past several years, Germany, Japan and Switzerland have had lower interest rates than the US due to lower values of this premium.

Component: Inflation premium Symbol: IP

Characteristic: It is based on the bond’s marketability and trading frequency; the less frequently the security is traded, the higher the premium added, thus increasing the interest rate.

Component: Liquidity risk premium Symbol: LP

Characteristic: This is the premium added as a compensation for the risk that an investor will not get paid in full.

Component: Default risk premium Symbol: DRP

Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?

A) Higher inflation expectations increase the nominal interest rate demanded by investors.
B) A BBB-rated bond has a lower default risk premium as compared to a AAA- rated bond.

A) Higher inflation expectations increase the nominal interest rate demanded by investors.

Based on the pure expectations theory, is the following statement true or false?

The pure expectations theory assumes that investors do not consider long-term bonds to be riskier than short-term bonds.

True

A financial planner is examining the portfolios held by several of her clients. Which of the following portfolios is likely to have the smallest standard deviation?

A) a portfolio consisting of about three randomly selected stocks form different sectors
B) A portfolio containing Microsoft, Apple, and Google Stock
C) a portfolio containing only Microsoft stock.

A) A portfolio consisting of about three randomly selected stocks from different sectors.

True or False:
When returns on Stock A increase, returns on Stock B also increase. In general, this would mean that Stocks A and B are positively correlated.

True

True or False:
The market risk component of the total portfolio risk can be reduced by randomly adding stocks to the portfolio.

False

True or False:
The risk in a portfolio will increase if more stocks that are negatively correlated with other stocks are added to the portfolio.

False

True or False:
The portfolio’s risk is not the weighted average of the individual stock’s standard deviations.

True

A stock’s contribution to the market risk of a well-diversified portfolio is called ________ risk. It can be measured by a metric called the beta coefficient, which calculated the degree to which a stock moves with the movements in the market.

relevant

True or False:
Stock A’s beta is 1.0; this means that the stock moves in the same direction and magnitude as the market.

True

True or False:
Higher-beta stocks are expected to have lower required returns.

False

True or False:
A stock that is more volatile than the market will have a beta of more than 1.0.

True

The SML helps determine the level of risk aversion among investors. The higher the level of risk aversion, the _____ the slope of the SML.

steeper

Which kind of stock is most affected by changes in risk aversion?
A) Low-beta stocks
B) Medium-beta stocks
C) All stocks affected the same, regardless of beta
D) High-beta stocks

D) High beta stocks