Practice Exam 1 2020 PDF

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1.

 Award:

Problems? Adjust credit for all students.

Which of the following correctly describes a repurchase agreement? The sale of a security with a commitment to repurchase the same security at a specified future date nd a designated price. The sale of a security with a commitment to repurchase the same security at a future date left nspecified, at a designated price. The purchase of a security with a commitment to purchase more of the same security at a specified future date.

 Explanation: A repurchase agreement is the sale of a security with a commitment to repurchase the same security at a specified future date and a designated price.

References

Worksheet



Difficulty: 1 Easy

Learning Objective: 02-01 Describe the differences among the major assets that trade in money markets and in capital markets.

2.

 Problems? Adjust credit for all students.

Award:

A municipal bond carries a coupon rate of 4.25% and is trading at par. What would be the equivalent taxable yield of this bond to a taxpayer in a 35% combined tax bracket? (Round your answer to 2 decimal places.) Equivalent taxable yield

6.54

%

 Explanation:

Equivalent taxable yield =

=

rm 1−t

=

0.0425 1 − 0.35

Rate on municipal bond 1 - Tax rate = 0.0654 or 6.54%

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-01 Describe the differences among the major assets that trade in money markets and in capital markets.

3.

 Problems? Adjust credit for all students.

Award:

Suppose that short-term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after-tax yield if your combined tax bracket is: Higher After-Tax Yield a. Zero

Taxable bond

b. 10%

Taxable bond

c.

Neither

20%

d. 30%

Municipal bond

 Explanation: After-tax yield = Rate on the taxable bond × (1 − Tax rate) a. The taxable bond. With a zero tax bracket, the after-tax yield for the taxable bond is the same as the before-tax yield (5%), which is greater than the 4% yield on the municipal bond. b. The taxable bond. The after-tax yield for the taxable bond is: 0.05 × (1 − 0.10) = 0.045 or 4.50%. c. Neither. The after-tax yield for the taxable bond is: 0.05 × (1 − 0.20) = 0.04 or 4%. The after-tax yield of taxable bond is the same as that of the municipal bond. d. The municipal bond. The after-tax yield for the taxable bond is: 0.05 × (1 − 0.30) = 0.035 or 3.5%. The municipal bond offers the higher after-tax yield for investors in tax brackets above 20%.

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-01 Describe the differences among the major assets that trade in money markets and in capital markets.

4.

 Award:

Problems? Adjust credit for all students.

An investor is in a 30% combined federal plus state tax bracket. If corporate bonds offer 9% yields, what yield must municipals offer for the investor to prefer them to corporate bonds? (Round your answer to 1 decimal place.) Minimum municipals offer

6.3

%

 Explanation: The after-tax yield on the corporate bonds is: 0.09 × (1 – 0.30) = 0.063 or 6.3%. Therefore, the municipals must offer at least 6.3% yields.

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-01 Describe the differences among the major assets that trade in money markets and in capital markets.

5.

 Problems? Adjust credit for all students.

Award:

Find the equivalent taxable yield of the municipal bond for tax brackets of zero, 10%, 20%, and 30%, if it offers a yield of 4%. (Round your answers to 2 decimal places.) Equivalent Taxable Yield a. Zero

4.00

%

b. 10%

4.44

%

c.

20%

5.00

%

d. 30%

5.71

%

 Explanation:

Using the formula of Equivalent taxable yield (r) =

rm (1 – t)

, we get:

a. r=

0.04 1−0

= 0.04 or 4.00%

b. r=

0.04 1 − 0.10

= 0.0444 or 4.44%

0.04 1 − 0.20

= 0.05 or 5.00%

0.04 1 − 0.30

= 0.0571 or 5.71%

c. r=

d. r=

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-01 Describe the differences among the major assets that trade in money markets and in capital markets.

6.

 Problems? Adjust credit for all students.

Award:

Refer to Figure 2.3 and look at the Treasury bond maturing in February 2043. a. How much would you have to pay to purchase one of these bonds? (Round your answer to 2 decimal places.) Purchase price

$ 1,054.84

b. What is its coupon rate? (Round your answer to 3 decimal places.) Coupon rate

3.125

%

c. What is the current yield (i.e., coupon income as a fraction of bond price) of the bond? (Round your answer to 2 decimal places.) Current yield

2.96

%

 Explanation: a. You would have to pay the asked price of: 105.48 = 105.48% of par = $1,054.84 b. The coupon rate is 3.125%, implying coupon payments of $31.25 annually or, more precisely, $15.625 (= 31.25/2) semiannually. c. Given the asked price and coupon rate, we can calculate current yield with the formula: Current yield =

Annual coupon income Price

= 3.125/105.4844 = 0.0296 = 2.96%

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-01 Describe the differences among the major assets that trade in money markets and in capital markets.

7.

 Problems? Adjust credit for all students.

Award:

Refer to Figure 2.8 and look at the listing for General Dynamics. a. Assuming that the table gives today's prices, what was the firm's closing price yesterday? (Round your answer to 2 decimal places.) Yesterday's closing price

$ 194.18

b. How many shares could you buy for $5,000? (Round your answer to 2 decimal places.) Number of shares

25.70

c. What would be your annual dividend income from those shares? (Round your answer to 2 decimal places.) Annual dividend income

$ 86.35

d. What must be General Dynamics’ earnings per share? (Round your answer to 2 decimal places.) Earnings per share

$ 9.71

 Explanation: a. The closing price today is $194.55, which is $0.37 above yesterday’s price. Therefore, yesterday’s closing price was: $194.55 − $0.37 = $194.18. b. You would buy 25.70 shares: $5,000/$194.55 = 25.70. c. Your annual dividend income on 25.70 shares would be 25.70 × $3.36 = $86.35. d. Earnings per share can be derived from the price-earnings (PE) ratio: Given price/Earnings = 20.03 and Price = $194.55, we know that Earnings per Share = $194.55/20.03 = $9.71.

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-01 Describe the differences among the major assets that trade in money markets and in capital markets.

8.

 Problems? Adjust credit for all students.

Award:

Consider the three stocks in the following table. P t represents price at time t, and Q t represents shares outstanding at time t. Stock C splits two-for-one in the last period.

A B C

P0 90 50 100

Q0 100 200 200

P1 95 45 110

Q1 100 200 200

P2 95 45 55

Q2 100 200 400

a. Calculate the rate of return on a price-weighted index of the three stocks for the first period (t = 0 to t = 1). (Do not round intermediate calculations. Round your answer to 2 decimal places.) Rate of return

4.17

%

b. What will be the divisor for the price-weighted index in year 2? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Divisor

2.34

c. Calculate the rate of return of the price-weighted index for the second period (t = 1 to t = 2). Rate of return

0 %

 Explanation: a. At t = 0, the value of the index is: ($90 + $50 + $100)/3 = 80 At t = 1, the value of the index is: ($95 + $45 + $110)/3 = 83.33 The rate of return is:

V1 V0

– 1 = (83.33/80) – 1 = 0.0417 or 4.17%

b. In the absence of a split, stock C would sell for $110, and the value of the index would be the average price of the individual stocks included in the index: ($95 + $45 + $110)/3 = $83.33. After the split, stock C sells at $55; however, the value of the index should not be affected by the split. We need to set the divisor (d) such that: 83.33 = ($95 + $45 + $55)/d d = 2.34 c. The rate of return is zero. The value of the index remains unchanged since the return on each stock separately equals zero.

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-02 Describe the construction of stock market indexes.

9.

 Problems? Adjust credit for all students.

Award:

Consider the three stocks in the following table. P t represents price at time t, and Q t represents shares outstanding at time t. Stock C splits two-for-one in the last period. P0 90 50 100

A B C

Q0 100 200 200

P1 95 45 110

Q1 100 200 200

P2 95 45 55

Q2 100 200 400

Calculate the first-period rates of return on the following indexes of the three stocks: (Do not round intermediate calculations. Round answers to 2 decimal places.) a. A market value–weighted index Rate of return

3.85

%

b. An equally weighted index Rate of return

1.85

%

 Explanation: a. Total market value at t = 0 is: ($90 × 100) + ($50 × 200) + ($200 × 100) = $39,000 Total market value at t = 1 is: ($95 × 100) + ($45 × 200) + ($110 × 200) = $40,500 Rate of return =

V1 V0

− 1 = ($40,500/$39,000) − 1 = 0.0385 or 3.85%

b. The return on each stock is as follows: RA =

V1 V0

− 1 = ($95/$90) − 1 = 0.0556 or 5.56%

RB =

V1 V0

− 1 = ($45/$50) − 1 = −0.10 or −10.00%

RC =

V1 V0

− 1 = ($110/$100) − 1 = 0.10 or 10.00%

The equally-weighted average is: [5.56% + (−10.00%) + 10.00%]/3 = 1.85%

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-02 Describe the construction of stock market indexes.

10.

 Problems? Adjust credit for all students.

Award:

A T-bill with face value $10,000 and 87 days to maturity is selling at a bank discount ask yield of 3.4%. a. What is the price of the bill? (Use 360 days a year. Do not round intermediate calculations. Round your answer to 2 decimal places.) Price of the bill

$ 9,917.83

b. What is its bond equivalent yield? (Use 365 days a year. Do not round intermediate calculations. Round your answer to 2 decimal places.) Bond equivalent yield

3.48

%

 Explanation: a. Bank discount of 87 days: 0.034 ×

87 days 360 days

= 0.008217

Price: $10,000 × (1 – 0.008217) = $9,917.83 b. Face value – Purchase price Purchase price × T

Bond equivalent yield =

=

$10,000 – $9,917.83 87 days $9,917.83 × 365 days

= 0.0348 or 3.48%

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-01 Describe the differences among the major assets that trade in money markets and in capital markets.

11.

 Award:

Problems? Adjust credit for all students.

Which security should sell at a greater price? a. A 10-year Treasury bond with a 5% coupon rate or a 10-year T-bond with a 6% coupon. 10-year Treasury bond with a 5% coupon rate A 10-year T-bond with a 6% coupon

b. A three-month expiration call option with an exercise price of $40 or a three-month call on the same stock with an exercise price of $35. three-month expiration call option with an exercise price of $40 A three-month call on the same stock with an exercise price of $35

c. A put option on a stock selling at $50 or a put option on another stock selling at $60. (All other relevant features of the stocks and options are assumed to be identical.) put option on another stock selling at $60 A put option on a stock selling at $50

 Explanation: a. The higher coupon bond: The 10-year T-bond with a 6% coupon. b. The call with the lower exercise price: The call with the exercise price of $35. c. The put option on the lower priced stock: The put on the stock selling at $50.

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-03 Calculate the profit or loss on investments in options and futures contracts.

12.

 Award:

Problems? Adjust credit for all students.

Look at the futures listings for corn in Figure 2.11. Suppose you buy one contract for December 2017 delivery at the closing price. If the contract closes in December at a price of $3.95 per bushel, what will be your profit or loss? (Each contract calls for delivery of 5,000 bushels.) (Round your answer to 2 decimal places.) $ 462.50

Profit

 Explanation: The December maturity futures price is $3.8575 per bushel. If the contract closes at $3.95 per bushel in December, your profit / loss on each contract (for delivery of 5,000 bushels of corn) will be: ($3.95 − $3.8575) × 5000 = $ 462.50 gain.

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-03 Calculate the profit or loss on investments in options and futures contracts.

13.

 Problems? Adjust credit for all students.

Award:

Refer to the stock options on Apple in the Figure 2.10. Suppose you buy an June expiration call option on 100 shares with the excise price of $140. a-1. If the stock price in June is $144, will you exercise your call? es No

a-2. What is the net profit/loss on your position? (Input the amount as a positive value.) Net loss

of

$ 80

a-3. What is the rate of return on your position? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.) Rate of return

(16.67)

%

b-1. Would you exercise the call if you had bought the Junecall with the exercise price $135? es No

b-2. What is the net profit/loss on your position? (Input the amount as a positive value.)

Net profit

of

$ 95

b-3. What is the rate of return on your position? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

Rate of return

11.80

%

c-1. What if you had bought an Juneput with exercise price $140 instead? Would you exercise the put at a stock price of $140? es No

c-2. What is the rate of return on your position? (Negative value should be indicated by a minus sign.) Rate of return

(100)

%

rev: 01_25_2019_QC_CS-154928  Explanation: a. Yes. As long as the stock price at expiration exceeds the exercise price, it makes sense to exercise the call. Gross profit is: ($144 − $140) × 100 shares = $400 Net profit = ($4 − $4.80) × 100 shares = $80 loss Rate of return = −$.80/$4.80 = −0.1667 or 16.67% loss

b. Yes, exercise. Gross profit is: ($144 − $135) × 100 shares = $900 Net profit = ($9 − $8.05) × 100 shares = $95 gain Rate of return = $0.95/$8.05 = 0.1180 or 11.80% gain c. A put with an exercise price of $140 would expire worthless for any stock price equal to or greater than $140 (in this case $144). An investment in such a put would have a rate of return over the holding period of −100%.

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-03 Calculate the profit or loss on investments in options and futures contracts.

14.

 Award:

Problems? Adjust credit for all students.

What options position is associated with: a. The right to buy an asset at a specified price? ong call hort call hort put Long put

b. The right to sell an asset at a specified price? ong call hort call ong put Short put

c. The obligation to buy an asset at a specified price? ong put ong call hort call Short put

d. The obligation to sell an asset at a specified price? ong put hort put hort call Long call

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-03 Calculate the profit or loss on investments in options and futures contracts.

15.

 Problems? Adjust credit for all students.

Award:

Both a call and a put currently are traded on stock XYZ; both have strike prices of $50 and maturities of six months. a. What will be the profit/loss to an investor who buys the call for $4 in the following scenarios for stock prices in six months? (Loss amounts should be indicated by a minus sign. Round your answers to 2 decimal places.) Stock Price

Profit/Loss

a.

$40

b.

$45

c.

$50

d.

$55

$ (4.00) $ (4.00) $ (4.00) $ 1.00

e.

$60

$ 6.00

b. What will be the profit/loss in each scenario to an investor who buys the put for $6? (Loss amounts should be indicated by a minus sign. Round your answers to 2 decimal places.) Stock Price a.

$40

b.

$45

c.

$50

d.

$55

e.

$60

Profit/Loss $ 4.00 $ (1.00) $ (6.00) $ (6.00) $ (6.00)

 Explanation: a. Long call for $4:

a. b. c. d. e.

Value of Call at Expiration 0 0 0 5 10

Initial Cost 4.00 4.00 4.00 4.00 4.00

Profit/Loss −4.00 −4.00 −4.00 1.00 6.00

b. Long put for $6:

a. b. c. d. e.

Value of Call at Expiration Initial Cost 10 6.00 5 6.00 0 6.00 0 6.00 0 6.00

Profit/Loss 4.00 −1.00 −6.00 −6.00 −6.00

References

Worksheet



Difficulty: 2 Medium

Learning Objective: 02-03 Calculate the profit or loss on investments in options and futures contracts.

16.

 Award:

Problems? Adjust credit for all students.

Find the after-tax return to a corporation that buys a share of preferred stock at $40, sells it at year...