Multiple Choice 1. If its yield to maturity declined by 1%, which of the followi

Question

Multiple Choice

1. If its yield to maturity declined by 1%, which of the following bonds would have the largest percentage increase in value?
A. A 10-year bond with an 8% coupon
B. A 10-year zero coupon bond

C. A 10-year bond with a 12% coupon

Which of the following statements is CORRECT?
A. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
B. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
C. The effect of a change in the market risk premium depends on the slope of the yield curve

Stock A’s beta is 0.5 and Stock B’s beta is 1.5. Which of the following statements must be true, assuming the CAPM is correct
A. In equilibrium, the expected return on Stock A will be smaller than that on B
B. Stock B would be a more desirable addition to a portfolio than A
C. Stock A would be a more desirable addition to a portfolio then B

Under normal conditions, which of the following would be most likely to increase the coupon rate required for a bond to be issued at par?
A. The rating agencies change the bond’s rating from Baa to Aaa
B. Adding a call provision

C. Adding additional restrictive covenants that limit management’s actions

Warr Corporation just paid a dividend of $1.50 a share (that is, D0 = $1.50). The dividend is expected to grow 7% a year for the next 3 years and then at 5% a year thereafter. What is the expected dividend per share for the 4th years?
A. $1.9294
B. $1.8376
C. $1.6050

Explanation / Answer

Solution for question 1

If its yield to maturity declined by 1%, a 10-year bond with a 12% coupon bonds would have the largest percentage increase in value.

Hence, Option (C) is correct answer.

Solution for question 2

In a CAPM model require rate of return is calculated by following formula:

Required rate of return = Risk free rate + Risk premium × Beta

Hence, if the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.

Hence, Option (A) is correct answer.

Solution for question 3

If Stock A’s beta is 0.5 and Stock B’s beta is 1.5 then Stock A would be a more desirable addition to a portfolio than B because market risk for Stock A is lesser than Stock B.

Hence, Option (C) is correct answer.

Solution for question 4

Under normal conditions if management adding a call provision then it would be most likely to increase the coupon rate required for a bond to be issued at par.

Hence, Option (B) is correct answer.

Solution for question 4

Current Dividend = $1.50

The dividend is expected to grow 7% a year for the next 3 years and then at 5% a year thereafter

So Expected dividend in forth year = [$1.50 × (1 + 7%) ^3] × (1 + 5%)

                                                       = $1.50 × 1.2250 × 1.05

                                                        = $1.9294

Dividend in forth year will be $1.9294.

Hence, option (B) is correct answer.

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