Financial Management and Investment Analysis Principles

Chapter 2: Time Value of Money and Amortization

To reach $50,000 in 4 years with a nominal interest rate of 6% compounded monthly, how much must be set aside every month? ($924.21).

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• An amortized loan is a loan that is repaid in equal payments over its life (T). (True)
• Midway through the life of an amortized loan, the percentage of the payment that represents the repayment of principal must be greater than or equal to the percentage that represents the payment of interest. (False)
• Common types of amortized loans include business loans and retirement plans. (True)
• The periodic rate is the rate of interest charged per period. (True)
• To compare investments with different compounding intervals, you must look at their nominal rates. (False)
• An annuity due has cash flows occurring at the end of the period. (False)
• An annuity is a series of equal cash flows at fixed intervals for a specified number of periods. (True)

Chapter 3: Interest Rates and Risk Premiums

If the real risk-free rate (r*) is 2.5%, inflation is 2% for the next 2 years, 3% for the following year, and 5% thereafter, and a 5-year T-bond currently yields 8% (rRF,t), what is the maturity risk premium (MRP) for the 5-year T-bond? (2.1%).

• The yield curve slopes upward due to increasing expected inflation and a decreasing MRP. (False)
• The yield curve slopes upward due to a decrease in expected inflation and an increasing MRP. (False)
• The spread between corporate and treasury yields narrows as the corporate rating increases. (True)
• The spread between corporate and treasury yields widens as the corporate rating increases. (False)
• The yield curve is always upward sloping due to an increasing maturity risk premium and expected inflation. (False)
• A default risk premium is applied to the rate of interest on corporate securities. (True)
• If a security cannot be sold readily, it should command a liquidity premium. (True)

For the next 5 years, the real risk-free rate (r*) is 1%, IP is 2%, LP is 5%, MRP is 0.5% per year, and DRP is 0.2% per year. What is the interest rate for a treasury security with 4 years to maturity? (5%).

Chapter 4: Bond Valuation and Yields

For a 10-year coupon bond with an 8% annual coupon rate and a par value of $1,000 priced at a YTM of 10%, what will be its current yield 2 years later? (8.96%).

• The Yield to Maturity (YTM) is fixed on the bond certificate and cannot be changed. (False)
• At maturity, the value of any bond must exceed its par value. (False)
• For any positive required rate of return, zero-coupon bonds must be issued at a discount. (True)
• The YTM of a bond is equal to an investor's required rate of return. (True)
• The payment frequency of a bond must be fixed at issue. (True)

For a 10-year bond with a 9% annual coupon and a par value of $2,000, selling at a price with a YTM of 11.4%, what is the expected capital gains yield for the coming year? (1%).

[Yield to Maturity = Current Yield + Capital Gains Yield]

Chapter 5: Risk, Return, and the CAPM

Stock A has a required return of 8% and a beta of 0.75. Stock B has a required return of 11% and a beta of 1.15. Stock C has a beta of 1.8. If investors raise inflation expectations by 3%, what is the required return for Stock C? (24.28%).

• Stand-alone risk cannot be reduced by diversification. (True)
• Diversifiable risk is caused by idiosyncratic events of a company. (True)
• There will always be diversification benefits when combining stocks into a portfolio. (False)
• To obtain the beta of a portfolio, a value-weighted average can be taken. (True)
• To obtain the returns of a portfolio, a value-weighted average can be taken. (True)
• To obtain the standard deviation of a portfolio, a value-weighted average can be taken. (False)

Stock A has a beta of 2.0 and a required return of 10%. Stock B has a beta of 0.5 and a required return of 3%. What is the market return? (5.33%).

Chapter 6: Stock Valuation and Market Efficiency

Jardine does not expect to pay any dividends for the next 2 years. At the end of year 3, it is expected to pay a $0.80 dividend with a constant growth rate of 3%. If the required rate is 8%, what is the intrinsic value of Jardine stock? ($13.72).

• When a market is efficient, the market must also be in equilibrium. (False)
• When a market is in equilibrium, the intrinsic value must also be equal to the current market stock price. (True)
• When a market is in equilibrium, expected returns must also be equal to required returns. (True)
• When calculating stock returns, we should include any dividends paid. (True)
• Investors are interested in the intrinsic value of a firm because it helps them decide whether to buy or sell. (True)
• Investors can still achieve their required return even if there is a capital loss. (True)

You plan to purchase a stock that pays $5 dividends at the end of each year for 5 years. At the end of year 5, you expect to sell the stock for $50. If the annualized effective required return is 5%, how much should you be willing to pay today? ($60.83).