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BA 323 SDSU EXAM 2 | ALL QUESTIONS AND
CORRECT ANSWERS | GRADED A+ | NEWEST
VERSION | VERIFIED ANSWERS
Why T-bills considered to be risk-free assets? Are they risk free? If not, which risk factor are they exposed to? ---------CORRECT ANSWER----------- ------Considered risk-free because you're promised XYZ return regardless of economy. They are not risk free, still exposed to inflation. Risk-free in the default sense of the word. Sharpe ratio equation ---------CORRECT ANSWER-----------------(return - risk-free rate) / standard deviation (mean Rp - Rf) / std dev Rp Sharpe ratio of zero would be a beta of zero! Sharpe Ratio ---------CORRECT ANSWER-----------------Reward-to-volatility ratio; ratio of portfolio excess return to standard deviation. "How good is the investment?" A risk-free asset would have a ratio of "0". Higher standard deviation on a stock? ---------CORRECT ANSWER----------- ------More risky! Because there's more possible outcomes! Risk premium ---------CORRECT ANSWER-----------------the difference between the return on a risky asset and risk-less asset, which serves as compensation for investor to hold riskier securities.
Risk aversion ---------CORRECT ANSWER-----------------assumes investors dislike risk and require higher rates of return to encourage them to hold riskier securities. *Though some investors like to gamble! If two stocks have a perfect correlation, would a portfolio consisting of these two stocks have more, less, or the same amount of risk as a portfolio consisting of only one of these stocks? ---------CORRECT ANSWER---------- -------Same. Perfect correlation means no benefit to adding additional security. What correlation coefficient would an investor most want? --------- CORRECT ANSWER-----------------As low as possible! When do the diversification benefits of adding stocks to a portfolio tend to decrease? ---------CORRECT ANSWER-----------------σp decreases as stocks are added, because they would not be perfectly correlated with the existing portfolio. Expected return of the portfolio would remain relatively constant. Eventually the diversification benefits of adding more stocks dissipates (after about 40 stocks), and for large stock portfolios, σp tends to converge to » 20%. CAPM (Capital Asset Pricing Model) ---------CORRECT ANSWER------------- ----a model based on the proposition that any stock's required rate of return is equal to the risk-free rate of return plus a risk premium that reflects only the risk remaining after diversification
Present Value ---------CORRECT ANSWER-----------------The value today of a future cash flow or series of cash flows Compounding ---------CORRECT ANSWER-----------------The arithmetic process of determining the final value of a cash flow or series of cash flows when compound interest is applied Know how to solve for the future value, present value, the interest rate, or time. ---------CORRECT ANSWER-----------------FVn = PV(1+ I)^n N: Time / Number of years, I: Interest rate per year • Aside: use annual compounding §PV, FV: • Amount of Money Starting With (PV) or Ending With (FV) Value of an annuity ---------CORRECT ANSWER-----------------the sum of all deposits plus all interest paid. KEY POINT: • To solve, we use PMT and set either Future value or present value to zero Understand how different compounding periods impact cash flows (which compounding period would you prefer?) ---------CORRECT ANSWER-------- ---------Daily! Interest on interest! Bond ---------CORRECT ANSWER-----------------A long-term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the holders of the bond.
What are the five key features of a bond? ---------CORRECT ANSWER------ -----------Par value, coupon interest rate, maturity date, issue date, and yield to maturity. par value ---------CORRECT ANSWER-----------------the amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity. Par value = Future value coupon interest rate ---------CORRECT ANSWER-----------------the percentage of a bond's par value that will be paid annually, typically in two equal semiannual payments, as interest. (stated interest rate paid by the issuer. Multiply by par value to get dollar payment of interest.) Mature Date ---------CORRECT ANSWER-----------------years until the bond must be repaid. issue date ---------CORRECT ANSWER-----------------when the bond was issued yield to maturity ---------CORRECT ANSWER-----------------the rate of return a bondholder will receive if the bond is held to maturity. "promised yield".
Reinvestment Risk ---------CORRECT ANSWER-----------------The risk that a decline in interest rates will lead to a decline in income from a bond portfolio. ( the concern that rates will fall, and future CFs will have to be reinvested at lower rates, hence reducing income) Price Risk ---------CORRECT ANSWER-----------------the concern that rising interest rates will cause the value of a bond to fall. Long-term bonds have more! Do long-term bonds have small or large reinvestment risk? What about short-term bonds? ---------CORRECT ANSWER-----------------LT: Small! Lock in those rates. ST: More, because your rates aren't locked in and might change with interest rates. Risk of high coupon bonds? Low coupon bonds? ** ---------CORRECT ANSWER-----------------HC: They'll be called by the corporation! LC: Low investment risk. High-coupon / short-term bonds have highest reinvestment risk. Opposite for Low-coupon / long-term. convertible bonds ---------CORRECT ANSWER-----------------Bonds that can be converted into common stock at the bondholder's option
warrant bond ---------CORRECT ANSWER-----------------long-term option to buy a stated number of shares of common stock at a specified price. (You keep the bond). Putable Bonds ---------CORRECT ANSWER-----------------bonds with a provision that allows investors to sell them back to the company prior to maturity at a prearranged price indexed bond ---------CORRECT ANSWER-----------------a bond that has interest payments based on an inflation index so as to protect the holder from inflation zero coupon bond ---------CORRECT ANSWER-----------------a bond that makes no coupon payments and is thus initially priced at a deep discount What is the priority claim if a company liquidate? ---------CORRECT ANSWER-----------------Secured creditors. Trustees costs (lawyers) Wages, subject to limits Taxes (government) Unfunded pension liabilities Unsecured creditors (bond holders generally) Preferred Stock Common Stock Chapter 11 Bankruptcy ---------CORRECT ANSWER-----------------protects an insolvent firm from creditors during a period of reorganization to restore profitability
market risk premium ---------CORRECT ANSWER-----------------The additional return over the risk-free rate needed to compensate investors for assuming an average amount of risk. Two factors that influence the market risk premium? ---------CORRECT ANSWER-----------------Size depends on the perceived risk of the stock market and investors' degree of risk aversion. Three approaches for estimating the value of a common stock? --------- CORRECT ANSWER-----------------Discount Dividend Model, Corporate Valuation Model, and models based on market multiples. Security Market Line and what does it illustrate? ---------CORRECT ANSWER-----------------states that a stock's required return equals the risk- free return plus a risk premium that reflects the stock's risk after diversification. Illustrates the relevant riskiness of a stock is its contribution to the riskiness of a well-diversified portfolio. Discount Dividend Model ---------CORRECT ANSWER-----------------Value of a stock is the present value of the future dividends expected to be generated by the stock. Corporate Valuation Model ---------CORRECT ANSWER-----------------Also called the free cash flow method. Suggests the value of the entire firm equals the present value of the firm's free cash flows.
proxy ---------CORRECT ANSWER-----------------(n.) an agent, substitute; a written permission allowing one person to act in another's place Market Multiple Analysis ---------CORRECT ANSWER-----------------A method of valuing a target company that applies a market determined multiple to net income, earnings per share, sales, book value, and so forth. Common multiples are: P/E, P/CF, P/Sales Earnings per share * PE ratio proxy fight ---------CORRECT ANSWER-----------------an attempt by a person or group to gain control of a firm or win a corporate vote. Most are settled Class A stock ---------CORRECT ANSWER-----------------Stock sold to public. preferred stock ---------CORRECT ANSWER-----------------Hybrid security with features of a stock and bond. Like bonds, preferred stockholders receive a fixed dividend that must be paid before dividends are paid to common stockholders However, companies can omit preferred dividend payments without fear of pushing the firm into bankruptcy. Value of preferred stock equation ---------CORRECT ANSWER----------------- Vp = D/rP Dividend payment + required rate of return on common stock.
Be able to rank the following investment categories by highest to lowest rate of return: T-bills, cash, corporate bonds, small-cap stocks, large-cap stocks ---------CORRECT ANSWER-----------------1. Small-cap
- Large-cap
- Corporate Bonds
- T-Bills
- Cash (Money market) Mutual Funds ---------CORRECT ANSWER-----------------an investment program funded by shareholders that trades in diversified holdings and is professionally managed. Exchange Traded Funds ---------CORRECT ANSWER----------------- collections of stocks, bonds, and other investments that are traded on exchanges but are traded more like individual stocks than like mutual funds Know how to calculate the yield to maturity and the yield to call of a bond -- -------CORRECT ANSWER-----------------***
