NAME: _________________________ MULTIPLE CHOICE.

Choose the one alternative that best completes the statement or answers the question. 1) Which of the following statements is true about the time value of money? A) The present value of a future amount will be greater if funds earn 12% instead of 6%. B) The present value of a future amount will be greater if funds earn 5% instead of 10%. C) The present value of a future amount will be unaffected by how far in the future funds would be received. D) The present value of a single sum will be unaffected by the rate of return at which funds grow. 2) U.S. Treasury bonds currently yield 6%. Consolidated Industries stock has a beta of 1.5. The rate of return on the S&P 500 is presently 18%. What is the rate of return that Consolidated Industries stockholders require? A) 27% B) 24% C) 6% D) 18%

3) You intend to purchase your dream PC upon graduation in two years. It will have a cost of $2,975, including all attachments and sales tax. You just received a $3,000 pregraduation gift from your rich uncle that you intend to deposit in a money market account that pays 6% interest, compounded monthly. How much of your pregraduation gift will you need to deposit in order to have $2,975 available for the purchase of the PC upon graduation? (Round to the nearest $1) A) $2,588 B) $2,639 C) $1,567 D) $2,975 E) $1,275

4) What does the agency problem refer to? A) The conflict that exists between stockbrokers and investors B) The problem associated with financial managers and Internal Revenue agents C) The problem that results from potential conflicts of interest between the manager of a business and the stockholders D) The conflict that exists between the board of directors and the employees of the firm E) None of the above 5) How much money must you pay into an account at the beginning of each of five years in order to have $5,000 at the end of the fifth year? Assume that the account pays 12% per year, and round to the nearest $10. A) $1,550 B) $ 790 C) $ 700 D) $ 1,390

6) Consider the timing of the profits of the following certain investment projects: Profit L Year 1 Year 2 $0 $ 3,000 S $ 3,000 $0

A) Project S and L are equally desirable B) Project S is preferred to Project L. C) Project L is preferred to Project S. D) A goal of profit maximization would favor Project S over Project L.

7) Stock A has expected return of 10% and standard deviation of 12%. Stock B has expected return of 14% and standard deviation of 17%. Correlation coefficient is 0.6. What will be the standard deviation of a portfolio that consists of 30% of Stock A and 70% of stock B? (Round to 0.01%) A)10.22% B)13.84% C)14.35% D)15.41% E)None of the above

8) Your parents are planning to retire in Phoenix, AZ in 20 years. Currently, the typical house that pleases your parents costs $ 200,000, but they expect inflation to increase the price of the house at a rate of 4% over the next 20 years. In order to buy a house upon retirement, what must they save each year in equal annual end-of-year deposits if they can earn 10% annually? (Round to the nearest $10) A) $ 10,020 B) $ 21,910 C) $ 7,650 D) $ 14,715

9) Corporations receive money from investors with: A) seasoned new issues B) initial public offerings D) A and B E) all of the above

C) primary market transactions

10) George and Barbara will be retiring in four years and would like to buy a lake house. They estimate that they will need $ 150,000 at the end of four years to buy this house. They want to make four equal payments into an account at the end of each of year. If they can earn 16% on their money, compounded annually, over the next four years, how much must they invest at the end of each year for the next four years to have accumulated $ 150,000 by retirement? Round to the nearest $100 A) $ 46,200 B) $ 25,400 C) $ 29,600 D) $ 37,500 E) $ 43,500

11) The appropriate measure of risk according to the capital asset pricing model is: A) beta B) the standard deviation of a firms cash flows C) market returns D) the probability of correlation 12) You have borrowed $ 70,000 to buy a sports car. You plan to make monthly payments over a 15-year period. The bank has offered you a 9% interest rate compounded monthly. Calculate the total amount of interest you will pay the bank over the life of the loan. Assume end-of-month payments and round your answer to the nearest $100. A) $ 51,600 B) $ 47,500 C) $ 57,800 D) $ 54,700

13) You are considering investing in Ford Motor Company. Which of the following is an example of diversifiable risk? A) Risk resulting from uncertainty regarding a possible strike against Ford B) Risk resulting from interest rates decreasing C) Risk resulting from the possibility of a stock market crash D) Risk resulting from an expected recession 14) You are considering investing in a project with the following possible outcomes: States Probability of Occurrence Investment Returns

State 1: Economic boom State 2: Economic growth State 3: Economic decline State 4: Depression

15% 45% 25% 15%

16% 12% 5% -5%

Calculate the expected return and standard deviation of returns for this investment.(round to the nearest 0.01%) A) 8.30%, 16.15% B) 9.82%, 7.05% C) 8.30%, 6.66% D) 7.25%, 43.68%

15) You bought Chemron stock for $ 45 a year ago. It is selling for $ 54 today. The stock paid no dividend. What is your holding period return? A) 9% B) 6% C) 11% D) 20%

16) If you hold a portfolio made up of the following stocks: Investment Stock A Stock B Stock C Value $ 2,000 $ 5,000 $ 3,000 Beta 1.5 1.2 0.8

What is the beta of the portfolio? A) 1.32 B) 1.14 C) 1.17 D) Cant be determined from the information given

17) Amalgamated Aluminum stock has a beta of 1.2. Todays market risk premium is 13%. The firms stockholders require a rate of return of 22%. What is the present risk-free rate? A) 6.4% B) 4.6% C) 15.6% D) 22.0%

18) The beta of ABC Co. stock is the slope of A) the characteristic line for a plot of ABC Co. returns against the returns of the market portfolio for the same period B) the arbitrage pricing line C) the characteristic line for a plot of returns on the S&P 500 versus returns on short-term Treasury bills D) the security market line 19) Harold Hawkins bought a home for $ 320,000. He made a down payment of $ 45,000; the balance will be paid off over 30 years at a 6.775% rate of interest. What will be the outstanding loan balance after Harold makes his first monthly payment? (Keep four decimals in your calculations, and round the answer to the nearest $10.) A) $ 274,840 B) $ 274,760 C) $ 273,990 D) $ 273,210

20) Your savings account offers a (monthly compounded) annual rate i, and the APY of this account is 3%. Find i. (Round your answer to the nearest 0.01%) A) 2.96% 2.98% 3.02% 2.89% None of the above is correct 3

ANSWERS AND SOLUTIONS

1) B 2) B 3) B 4) C 5) C 6) B 7) C 8) C 9) E 10) C 11) A 12) C 13) A 14) C 15) D 16) B 17) A 18) A 19) B 20) A

2) CAPM implies that: return = risk free rate + beta * (market return risk free rate) Therefore, return = 6% + 1.5 * (18% 6%) = 24%

3) You need to have $2,975 at the end of two years and you have to deposit some money in the bank today for this to happen. This is a simple discounting problem where you try to bring the future amount of $2,975 to the present. Of course, you have to realize that the money is compounded monthly. Therefore, the monthly interest rate is 6% /12 = 0.5% and there are 24 months until the maturity. PV = 2,975 / (1.005^24) = $ 2,639.377

5) Since you are going to pay the money into the account at the beginning of each year, this is an annuity due problem. FV of annuity due = PMT * 1.12 * { (1.12^5) 1 } / 0.12 ; 5,000 = PMT * 7.115 ==> PMT = $ 702.722 ~ $ 700

7)

pf

= sqrt ( 0.32*122 + 0.72*172 + 2*0.3*0.7*12*17*0.6) = sqrt (205.978) = 14.351937 ~ 14.35%

8) Since inflation will increase the value over the time, the parents should have $ 438,225 (=200,000 * 1.04^20) at the end of 20 years. The payments that are going to be made by the parents is an example of an ordinary annuity. The future value of this ordinary annuity should be equal to $438,225 and using a 10% interest rate can be expressed as: $ 438,225 = PMT * { (1.1^20) 1 } / 0.1 ; $ 438,225 = PMT * 57.275 ==> PMT = $ 7,651.244 ~ 7,650 4

10) The $150,000 is a future value of the ordinary annuity, therefore: $150,000 = PMT * { (1.16^4) 1 } / 0.16 ; $150,000 = PMT * 5.066496 ; == > PMT = $ 29,606.26 ~ 29,606

12) Since you borrow the money today, the present value of your loan is $ 70,000. You are going to pay this back as an ordinary annuity with 180 (=12*15) monthly installments. The monthly interest rate is 0.75% (=9% / 12). Therefore, the present value of the ordinary annuity is $ 70,000 = PMT * { 1 (1/1.0075^180) } / 0.0075; $70,000 = PMT * 98.59341 ; => PMT = $ 709.9866. This is what you pay monthly for 180 months. In total, you have paid $ 709.9866 * 180 = $ 127,797.6 $70,000 of this amount is simply the repayment of the amount that you have borrowed, therefore the rest is the total interest that you have paid over 15 years: $127,797.6 $ 70,000 = $57,797.6 ~ 57,800

14) Expected return: (0.15*16% + 0.45*12% + 0.25*5% + 0.15* 5%) = 8.3% Variance 0.15*(16 8.3)^2+ 0.45*(12 8.3)^2 + 0.25*(5 8.3)^2 + 0.15*( 5 8.3)^2 = 44.31 Standard deviation = (44.31)^(0.5) = 6.6566 % ~ 6.66%

15) Holding period return = (54 45) / 45 = 0.2 = 20%

16) The total value of the investment is $ 10,000. Since we know how much money we invest in each stock, we can calculate the portfolio weights. They are 0.2, 0.5 and 0.3 for Stock A, Stock B and Stock C, respectively. Therefore, the portfolio beta is the weighted average of the individual stock betas: 0.2*1.5 + 0.5*1.2 + 0.3*0.8 = 1.14

17) CAPM implies that: required return = risk free rate + beta * (market return risk free rate) Also, market (risk) premium is defined as the difference between the market return and the risk free rate. Therefore, 22% = risk free rate + (1.2 * 13%) => risk free rate = 6.4%

19) Harold Hawkins gets a loan of $ 320,000 to buy the house and makes a down payment of $45,000. This means that the present value of the loan is $275,000 = 320,000 45,000. He is going to pay this loan back by making monthly payments in an ordinary annuity. The monthly interest rate is 6.775% / 12 = 0.5646% and there are 360 months until the last payment. The present value of the ordinary annuity is $275,000 = PMT * { 1 (1/1.005646^360) } / 0.005646 ; $275,000 = PMT * 153.7845 ; PMT = $1,788.2171 The interest portion of the first monthly payment is: = 0.005646 * 275,000 = 1,552.6042 Therefore, the loan repayment portion of the first monthly payment is: = $1,788.2171 1,552.6042 = $235.6130 And the outstanding loan balance after first monthly payment will be: = $275,000 $235.6130 = $ 274,764.3870 ~ $ 274,760

20) APY = (1 +i/m) m

1,
12

therefore 0.03 = (1 + i/12)

1, and you need to solve for i.

i = { (1+0.03) 1/12 1 } *12 ; I = 0.029595237 = 2.9595237% ~ 2.96%