1. Short term bonds have interest rate (price) risk and reinvestment rate risk.
ID: 2651532 • Letter: 1
Question
1. Short term bonds have interest rate (price) risk and reinvestment rate risk.
A) high; high
B) low; high
C) high; low
D) low; low
2. IF a project's cost of capital increased, what effect would that have on the IRR?
A) The IRR will increase
B) Not enough infomation to determine
C) The IRR may increase or decrease depending on the firm's profitablity
D) The IRR will decrease
E) The IRR will not change
3. You obtain the following data from a stock: D1 = $2.00, g (which is constant) = 6%, and P0= $40. What is the stocks expected dividend yeild for the coming year?
A) 7.0%
B) 8.0%
C) 5.0%
D) 6.0%
E) 4.0%
Explanation / Answer
1.Short Term bonds will have (low) interest rate risk & (low) reinvestment rate risk
(D) Low:Low
It is because in a short time, there is little likelihood of interest rates going down. Hence, once can have expected yield on investment with interest rate stability and hence accordingly, reinvestment rate risk is also low on accounting of little changes in the interest rate in the short run.
2. If a projects cost of capital increased, it will not affect IRR
(E) The IRR will not change
It is because of the fact that IRR is a discount rate that makes NPV=0. Change in cost of capital doesn’t impact IRR. Infact, IRR is compared with cost of capital to ascertain the viability of a project. A low cost of capital in relation to IRR would put a project in an acceptable domain whereas if IRR is less than cost of capital, the project is not undertaken.
3. Dividend = $2
Growth rate = 6%
Price = $ 40
Expected dividend yield = Dividend/ Price+growth rate
= 2/40+0.06
= 0.05+0.06 = 0.11 or 11%
The options seem to be incorrect.
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