11. Companies E and P each reported the same earnings per share (EPS), but Compa

Question

11. Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at a higher price. Which of the following statements is CORRECT?
A) Company E probably has fewer growth opportunities.
B) Company E is probably judged by investors to be riskier.
C) Company E must have a higher market-to-book ratio.
D) Company E must pay a lower dividend.
E) Company E trades at a higher P/E ratio.

12. Which of the following statements is CORRECT?
A) A time line is not meaningful unless all cash flows occur annually.
B) Time lines are not useful for visualizing complex problems prior to doing actual calculations.
C) Time lines cannot be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.
D) Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities.
E) Time lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity.

13. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?
A) The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
B) The discount rate increases.
C) The riskiness of the investment’s cash flows decreases.
D) The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
E) The discount rate decreases.

14. Which of the following statements is CORRECT?
A) The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
B) If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.
C) The cash flows for an annuity due must all occur at the ends of the periods.
D) The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month.
E) If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.

15. Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?
A) The periodic rate of interest is 1.5% and the effective rate of interest is 3%.
B) The periodic rate of interest is 6% and the effective rate of interest is greater than 6%.
C) The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%.
D) The periodic rate of interest is 3% and the effective rate of interest is 6%.
E) The periodic rate of interest is 6% and the effective rate of interest is also 6%.

16. Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds?
A) The company’s bonds are downgraded.
B) Market interest rates rise sharply.
C) Market interest rates decline sharply.
D) The company's financial situation deteriorates significantly.
E) Inflation increases significantly.

17. A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT?
A) If the yield to maturity remains constant, the bond’s price one year from now will be higher than its current price.
B) The bond is selling below its par value.
C) The bond is selling at a discount.
D) If the yield to maturity remains constant, the bond’s price one year from now will be lower than its current price.
E) The bond’s current yield is greater than 9%.

18. Tucker Corporation is planning to issue new 20-year bonds. Initially, the plan was to make the bonds non-callable. If the bonds were made callable after 5 years at a 5% call premium, how would this affect their required rate of return?
A) Because of the call premium, the required rate of return would decline.
B) There is no reason to expect a change in the required rate of return.
C) The required rate of return would decline because the bond would then be less risky to a bondholder.
D) The required rate of return would increase because the bond would then be more risky to a bondholder.
E) It is impossible to say without more information.

19. Which of the following bonds has the greatest interest rate price risk?
B) A 10-year, $1,000 face value, zero coupon bond.
C) A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
D) All 10-year bonds have the same price risk since they have the same maturity.
E) A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.

20. A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?
A) Either A or B, i.e., the investor should be indifferent between the two.
B) Stock A.
C) Stock B.
D) Neither A nor B, as neither has a return sufficient to compensate for risk.
E) Add A, since its beta must be lower.

Explanation / Answer

11.       EPS      = Earnings avalible to shareholders/No of shareholders.       E) is correct. Company E trades at a higher P/E ratio. 12.    Option E) is correct. Times lines can be constructed where some of the payments constitute an annuity but others are unequal and thus are not part of the annuity. 13.    Option B) is correct. With increasing the discount rate we would less present value because of more discount rate trends to decrease the payments. 14. Option D) is correct.Because the annuity cash flows must occurs at constant payments and a fixed no of periods. 15.       Option B) is correct. Periodic rate of interest is nothing but Nominal rate of interest. and the                         Effective rate of interest always greater than then Nominal rate because calculated as compounding would occurs more frequent. 16.       Callable bonds are called because of the interest chages in the market. It the higher the interest charges then we can call the bonds before maturity and reinvest in anthor bonds.    Option B) is correct. Market interest rates rise sharply. 17.    Option A) is correct. If the going rate of interest is below the coupon rate then the bonds are sell for premium. Therefore the bonds higher than the current price after one year. 18.    Option D) is correct. The required rate of return would increase because the bond would then be more risky to a bondholder. 19.    The prices of long-term bonds decline whenever interest rates rise.    Option E) All 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments. 20    Option C) is corrected. Because Stock B is with less S.D therefore it is less risk and gives same return as Stock A. Therefore stock B could be choosen.                  

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