Multiple Choice

1. Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8 percent, and a standard deviation of 25 percent. Becky has a $50,000 portfolio with a beta of 0.8, an expected return of 9.2 percent, and a standard deviation of 25 percent. The correlation coefficient, r, between Bob's and Becky's portfolios is 0. Bob and Becky are engaged to be married. Which of the following best describes their combined $100,000 portfolio?

a. The combined portfolio's expected return is a simple average of
the expected returns of the two individual portfolios (10%).

b. The combined portfolio's beta is a simple average of the betas of the two individual portfolios (1.0).

c. The combined portfolio's standard deviation is less than a
simple average of the two portfolios' standard deviations (25%), even though
there is no correlation between the returns of the two portfolios.

d. Statements a and b are correct.

e. All of the statements above are correct.

2. You hold a diversified portfolio consisting of a $10,000 investment
in each of 20 different common stocks (that is, your total investment is
$200,000). The portfolio beta is equal to 1.2. You have decided to sell one of
your stocks that has a beta equal to 0.7 for $10,000. You plan to use the
proceeds to purchase another stock that has a beta equal to 1.4. What will be
the beta of the new portfolio?

a. 1.165

b. 1.235

c. 1.250

d. 1.284

e. 1.333

3. At an inflation rate of 9 percent, the purchasing power of $1 would
be cut in half in 8.04 years. How long to the nearest year would it take the
purchasing power of $1 to be cut in half if the inflation rate were only 4
percent?

a. 12 years

b. 15 years

c. 18 years

d. 20 years

e. 23 years

**Financial Calculator Section**

4. You want to borrow $1,000 from a friend for one year, and you propose
to pay her $1,120 at the end of the year. She agrees to lend you the $1,000,
but she wants you to pay her $10 of interest at the end of each of the first 11
months plus $1,010 at the end of the 12th month. How much higher is the
effective annual rate under your friend's proposal than under your proposal?

a. 0.00%

b. 0.45%

c. 0.68%

d. 0.89%

e. 1.00%

5. You just bought a house and have a $150,000 mortgage. The mortgage is
for 30 years and has a nominal rate of 8 percent (compounded monthly). After 36
payments (3 years) what will be the remaining balance on your mortgage?

a. $110,376.71

b. $124,565.82

c. $144,953.86

d. $145,920.12

e. $148,746.95

PAGE 2

6. You are considering two Treasury bonds. Bond A has a 9 percent annual
coupon, and Bond B has a 6 percent annual coupon. Both bonds have a yield to
maturity of 7 percent. Assume that the yield to maturity is expected to remain
at 7 percent. Which of the following statements is most correct?

a. If the yield to maturity remains at 7 percent, the price of both bonds will increase by 7 percent per year.

b. If the yield to maturity remains at 7 percent, the price of
both bonds will increase over time, but the price of Bond A will increase by
more.

c. If the yield to maturity remains at 7 percent, the price of
both bonds will remain unchanged.

d. If the yield to maturity remains at 7 percent, the price of
Bond A will decrease over time, but the price of Bond B will increase over
time.

e. If the yield to maturity remains at
7 percent, the price of Bond B will decrease over time, but the price of Bond A
will increase over time.

**Financial Calculator Section**

7. A 15-year bond with a 10 percent semiannual coupon has a par value of
$1,000. The bond may be called after 10 years at a call price of $1,050. The
bond has a nominal yield to call of 6.5 percent. What is the bond's yield to
maturity, stated on a nominal, or annual basis?

a. 5.97%

b. 6.30%

c. 6.75%

d. 6.95%

e. 7.10%

8. Stock X has a required return of 12 percent, a dividend yield
of 5 percent, and its dividend will grow at a constant rate forever. Stock Y
has a required return of 10 percent, a dividend yield of 3 percent, and its
dividend will grow at a constant rate forever. Both stocks currently sell for
$25 per share. Which of the following statements is most correct?

a. Stock X pays a higher dividend per share than Stock Y.

b. Stock X has a lower expected growth rate than Stock Y.

c. One year from now, the two stocks are expected to trade at the
same price.

d. Statements a and b are correct.

e. Statements a and c are correct.

9. NOPREM Inc. is a firm whose shareholders don't possess the preemptive
right. The firm currently has 1,000 shares of stock outstanding; the price is
$100 per share. The firm plans to issue an additional 1,000 shares at $90.00
per share. Since the shares will be offered to the public at large, what is the
amount per share that old shareholders will lose if they are excluded from
purchasing new shares?

a. $90.00

b. $ 5.00

c. $10.00

d. $ 0

e. $ 2.50

(c) 2001 by
Harcourt, Inc. All rights reserved.

PAGE 1

ANSWER KEY FOR TEST - SU02_T2S

1. e

Portfolio risk and return

Chapter:6 QUESTION: 9

2. b

Portfolio beta

1.2 = 1/20(0.7) + (9/20)b

b is average beta for other 19 stocks.

1.165 = (19/20)b.

New Beta = 1.165 + 1/20(1.4) = 1.235.

Chapter:6 QUESTION: 59

3. c

Effect of inflation

Time Line:

0 1 n = ?
Years

4%

³ÄÄÄÄÄÄÄÄÄÄÄÄāÄÄÄÄÄÄ ś ś
ś ÄÄÄÄÄÄÄ³

-1.00 0.50

Tabular solution:

0.5 = $1(PVIF_{4%,n})

PVIF_{4%,n} = 0.5

PVIF_{4%,18} = 0.4936; PVIF_{4%,17} = 0.5134

n ÷ 18 years.

Although a financial calculator or interpolation might be used to solve
precisely, statement c is clearly the closest and best answer of those given.

Financial calculator solution:

Inputs: I = 4; PV = -1; PMT = 0; FV = 0.50.

Output: N = -17.67 ÷ 18 years.

Chapter:7 QUESTION: 27

PAGE 2

4. c

Effective annual rate

Your proposal:

EAR1 = $120/$1,000

EAR1 = 12%.

Your friend's proposal:

Interest is being paid each month ($10/$1,000 = 1% per month), so
it compounds, and the EAR is higher than kNom
= 12%:

. “ 0.12Ć12

.EAR2 = ³1 + ÄÄÄÄ³ - 1 = 12.68%.

12 Å

Difference = 12.68% - 12.00% = 0.68%.

You could also visualize your friend's proposal in a time line
format:

0 1 2
11 12

i = ?

³ÄÄÄÄÄÄÄÄÄÄÄāÄÄÄÄÄÄÄÄÄÄāÄÄÄÄÄ ś ś ś ÄÄÄÄÄÄÄÄāÄÄÄÄÄÄÄÄÄÄ³

1,000 -10 -10 -10
-1,010

Insert those cash flows in the cash flow register of a calculator
and solve for IRR. The answer is 1%, but this is a monthly rate. The nominal
rate is 12(1%) = 12%, which converts to an EAR of 12.68% as follows:

Input into a financial calculator the following:

P/YR = 12; NOM% = 12; and then solve for EFF% = 12.68%.

Chapter:7 QUESTION: 54

5. d

Remaining mortgage balance

Solve for the monthly payment as follows:

N = 30 š 12 = 360; I = 8/12 = 0.667; PV = -150,000; FV = 0; and
then solve for PMT = $1,100.65/month.

Use the calculator's amortization feature to find the remaining
principal balance:

3 š 12 = 36 payments

1 INPUT 36 ” AMORT

= displays Int: $35,543.52

= displays Prin: $4,079.88

= displays Bal: $145,920.12.

Chapter:7 QUESTION: 63

PAGE 3

6. d

Bond yields and prices

If the YTM is 7 percent, this is the market interest rate.
Therefore, Bond A's coupon rate is higher than the market rate, so it must be
selling above par (at a premium). Bond B's coupon rate is lower than the market
rate, so it must be selling below par (at a discount).

Statement a is false. If the YTM remains the same, the price of
Bond A will fall, and the price of bond B will rise. The total yield of 7
percent on both bonds will consist of a capital gains yield and a current
yield. The sum of these two yields will be 7 percent. Statements b, c, and e
are false for the reason mentioned above. Therefore, the correct answer is
statement d.

Chapter:8 QUESTION: 20

7. d

Yield to maturity - semiannual bond

Step 1: First determine what the bond is selling for today based
on

the information
given about its call feature:

N = 10(2) = 20; I =
6.5/2 = 3.25; PMT = 100/2 = 50; FV =

1,050; and then
solve for PV = -$1,280.81. V_{B} = $1,280.81.

Step 2: Use this current price solution to solve for the YTM:

N = 15(2) = 30; PV
= -1,280.81; PMT = 100/2 = 50; FV = 1,000;

and then solve for
I = 3.4775%.

Step 3: Since this is a semiannual rate, multiply it by 2 to solve
for

the nominal, annual
YTM:

YTM = 3.4775%(2) =
6.955% ÷ 6.95%.

Chapter:8 QUESTION:101

PAGE 4

8. e

Constant growth stock

If Stock X has a required return of 12 percent and a dividend
yield of 5 percent, we can calculate its growth rate:

k_{s} = D_{1}/P_{0}
+ g

12% = 5% + g

7% = g.

If Stock Y has a required return of 10 percent and a dividend
yield of 3 percent, we can calculate its growth rate:

k_{s} = D_{1}/P_{0}
+ g

10% = 3% + g

7% = g.

Since both stocks have the same price and Stock X has a higher
dividend yield than Stock Y, its dividend per share must be higher. Therefore,
statement a is true. We just showed above, that both stocks have the same
growth rate, so statement b must be false. One year from now, the stocks will
both trade at the same price. They are starting at the same price today, and
will be growing at the same rate this year, so they will end up with the same
stock price one year from now. Therefore, statement c must also be true. Since
both statements a and c are true, the correct choice is statement e.

Chapter:9 QUESTION: 24

9. b

New issues and dilution

*Calculate current and new market value of firm after new stock
issue*

1,000 shares š $100 per share
= $100,000

Plus 1,000 new shares @ $90 each
+ __ 90,000__

New firm market
value $190,000

ĶĶĶĶĶĶĶĶ

*Calculate new market share price*

$190,000/2,000 shares = $95.00 per share

*Dilution* Old shareholders lose
$100 - $95 = $5.00 per share.

Chapter:9 QUESTION: 54

(c) 2001 by Harcourt,
Inc. All rights reserved.