8. Suppose the Dividend Discount Model is used by investors to price a stock (be

Question

8. Suppose the Dividend Discount Model is used by investors to price a stock (because it is a mature company). The rket price is 40/share. Earnings per share are 2.5, and the risk-fire rate is 1.25%. what is the (implied) risk premium? a) 1.25% b) 2.5% c) 5% d) 6.25% 39. Which of the following statements is(are) necessarily true (all else the same): a) The lower the investor's tax bracket, the more attractive municipal bonds compared to otherwise similar corporate b) c) d) bonds The lower the coverage ratio of the company, the wider the corporate bond's crodit sprcad The longer the maturity of a Treasury bond, the higher its yield (interest rate) The more senior a bond is, the narrower its credit spread 210. Which of the following is a sensible pattern of cause-and-effect? a) b) People expect the cconomy to expand -profits are expected to increase-stock prices should rise Pcople expect the economy to expand -profits are expected to decrease stock prices should rise c expect the conomy to expand-profits are expected to increase stock prices should fall d) People expect the conormy to expand profits are cxpected to decrease stock prices should fall 11. Shares in which of the following can be purchased in the stock exchange? a) public corporation b) private corporation c) closed-cnd mutual fund d) open-end mutual fund 512. A company starts with S1 billion in assets, $400 million in owners' equity & $600 million in debt. It draws down $100 million from its bank credit line and uses the funds to purchase its own shares in the stock markct. Wha does this do to the balance sheet? a) increases book valuc b) decreases book vale c) increases leverage ratio d) decreases leverage ratio c) increases assets f decreases assets g) incrcases markct valuc h) deccases markct valuc 14. Here is information about Company ABC for 2015: Revenue COGS Rent 100 million 55 million 5 million Interest Profits taxes 10 million 12 million

Explanation / Answer

8.

To find the Risk premium, we first need to find the rate of return on the stock which can be found by:

(EPS/Price) = 2.5/40 *100 = 6.25%

Risk premium = Return on stock - Risk-free rate

Risk premium = 6.25-1.25= 5%

39.

Municipal bonds are tax exempt so they will be preferred by investors in the higher tax bracket so statement a is incorrect.

As coverage ratio represents the company's ability to meet its debt obligations, therefore lower coverage ratio means that company has lower ability to meet its debt obligation and therefore the credit spread will be higher and so, statement b is correct

In case of a normal yield curve, upward sloping, longer maturity bonds have higher yields, therefore, statement c is correct

As senior debt have the first right to company's assets and income, the credit spread will be lower, therefore statement d is correct.

So statements b, c, d are correct and a is incorrect.

210.

Statement a is the correct combination of cause and effect because when the economy expands, profits are expected to increase and price also increases. This automatically invalidates all other options.

11. Shares in a public corporation can be bought on the stock exchange. Private corporation's stocks don't trade on the stock exchange so the cant be purchased there. Mutual funds shares are bought from the fund manager or through a brokerage house

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