Version A - page 1
FIN 301 Financial Management
Sample Questions for Midterm 2 –Version A
1. The following information represents historical returns for Hotlix Inc.
What is the standard deviation of Hotlix’s returns?
2. If the required return is less than the coupon rate, a bond will sell at
b) a discount
c) a premium
d) book value
e) cannot be determined.
3. Which of the following statements about the time value of money is/are true?:
I. Present value of a lump-sum is typically less than its future value.
II. All else equal, the future value of a lump-sum decreases as the interest (discount) rate
III. EAR is greater than APR with annual compounding.
a) I only
b) I and III
c) II only
d) III only
e) I and II
4. Wayward Inc. has a beta of 1.42. The expected return on the S&P 500 index for the next
year is 11.87% and a one-year T-bill that pays $1,000 at maturity is currently selling for
Version A - page 2
$945 (there are no coupon interest payments). What is the expected return for Wayward Inc.
in the coming year?
5. The APA Co. currently pays a $1.00 annual dividend. Investors believe that dividends will
grow at 15% next year, 10% annually for the two years after that, and 5% annually thereafter.
Assume the required return is 10%. What is the current market price of APA’s stock? (Note:
Do not round off your dividends, etc. or your answer will differ slightly from the correct
6. Which of the following statements is most correct?
a) An investment that compounds interest semiannually, and has a nominal rate of 10 percent,
will have an effective rate less than 10 percent.
b) The present value of a three-year $100 annuity due is less than the present value of a three-
year $100 ordinary annuity.
c) The proportion of the payment of a fully amortized loan that goes towards interest declines
d) Statements (a) and (c) are correct.
e) None of the answers is correct.
Version A - page 3
7. King Kong Inc. has 300,000 shares outstanding and paid a dividend of $ 1.27/share yesterday.
Today’s price per share is $28 and the company expects an annual dividend growth rate of
10% forever. What is the expected return to the shareholders of King Kong Inc.?
8. Which of the following statements is most correct?
a) The beta coefficient of a stock is normally found by running a regression of past returns on
the stock against past returns on a stock market index. One could also construct a scatter
diagram of returns on the stock versus those on the market, estimate the slope of the line of
best fit, and use it as beta.
b) It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0,
then at least in theory, its required rate of return would be equal to the riskless (default-free)
rate of return, kRF.
c) If you found a stock with a zero beta and held it as the only stock in your portfolio, you
would by definition have a riskless portfolio (meaning zero total risk). Your 1-stock
portfolio would have even less total risk if the stock has a negative beta.
d) The beta of a portfolio of stocks is always larger than the betas of all the individual stocks
comprising the portfolio.
e) All of the above statements are true.
9. As the discount rate increases without limit, the present value of the future cash inflows
a) Gets larger without limit.
b) Stays unchanged.
c) Approaches zero.
d) Gets smaller without limit, i.e., approaches minus infinity.
e) Goes to ekn.
Version A - page 4
10. The stock of Ivy Enterprises is forecast to provide the following returns for various
economic conditions in the coming year:
Boom Steady Growth Recession
Return 13% 8% -4%
Probability 27% 34% 39%
What is the expected return on Ivy Enterprises stock?
11. Jack borrowed $42,000 and bought a new Volvo 850 GLT. The loan required six equal,
end-of-year payments, at an APR of 6%. Immediately after making his third payment,
Jack gets an offer of $30,000 for the car. If he accepts the offer, and repays the balance
on the loan, how much of the $30,000 does Jack have left?
12. Which of the following statements is/are true?:
I. The market risk for an individual firm will be the same for all firms in the same industry.
II. Beta is used to estimate market risk.
III. Market risk is always greater than diversifiable risk.
a) I only
b) II only
c) III only
d) I and II only
e) I and III only
Version A - page 5
13. Given no change in required returns, the price of a stock whose dividend is constant will:
a) Increase over time at a rate of RE%.
b) Decrease over time at a rate of RE%.
c) Increase over time at a rate equal to the dividend growth rate.
d) Decrease over time at a rate equal to the dividend growth rate.
e) Remain unchanged.
14. Congratulations! You have just won first prize in the Publisher’s Clearinghouse contest.
You are given the following payoff options:
Option 1. $10,000,000 today
Option 2. $1,000,000 today plus $500,000 per year forever beginning one year from today.
At what interest rate are you indifferent between Options 1 and 2?
15. You buy a bond today for $900. The bond matures in one year and pays no interest, but
has a face value of $1,000. If the current return on T-Bills is 5% and the expected return on
market portfolio for the coming year is 12%, what is the bond’s beta?
Version A - page 6
16. The following table gives the expected returns for two stocks:
Probability Stock X Stock Y
0.1 -20% 10%
0.8 20% 15%
0.1 40% 20%
If you form a 50-50 portfolio of the two stocks, what is the portfolio’s standard deviation?
Use the following information to answer Questions 17 and 18:
You borrow $2,000 today and promise to repay the loan over the next year with 12 equal, end-
of-month payments starting one month from today. The interest rate is 9% APR compounded
17. What is the amount of each payment?
18. How much of the second month’s payment is interest?
Version A - page 7
19. IBM stock trades currently at $15 per share and pays no dividend. The stock has a beta
of 0.60. The expected return on the market is 8.56% and Treasury bills currently yield
3.25%. What is the expected price of IBM stock in one year?
20. Calculate the value of a $1,000 bond which has 10 years until maturity and pays quarterly
interest at an annual coupon rate of 12 percent. The required return on similar-risk bonds is
21. What is the present value (i.e., t=0) of a $200 monthly perpetuity that begins (i.e. the first
payment occurs) exactly three months from today? The appropriate discount rate is 8%
APR with monthly compounding.
a) $ 2,500.00
22. You borrow $25,000 today for a new car. You are required to make 10 annual, end-of-
year payments, at an APR of 8.5%. How much will each payment be?
e) This question cannot be answered with the information given.
Version A - page 8
23. Dividends on the common stock of Sable Inc. are expected to grow at a constant rate
forever. If you are told Sable’s most recent dividend paid, its dividend growth rate, and a
discount rate, you can calculate __________.
I. the price today
II. the price five years from now
III. the dividend that is expected to be paid ten years from now
a) I only
b) I and II only
c) I and III only
d) II and III only
e) I, II, and III
24. Given the following information, what is the portfolio standard deviation?
State Probability Return
Boom .2 .30
Good .6 .21
Recession .2 .08
25. The principle of diversification tell us that:
a) Concentrating an investment in two or three large stocks will eliminate all of your risk.
b) Spreading an investment across many diverse assets cannot (in an efficient market) eliminate
c) Spreading an investment across many diverse assets will eliminate all of the risk.
d) Spreading an investment across many diverse assets will eliminate some of the risk.
e) None of the above are correct.
Version A - page 9
26. A firm has experienced a constant annual rate of dividend growth of 9 percent on its
common stock and expects the dividend per share in the coming year to be $2.70. The firm can
earn 12 percent on similar risk investments. The value of the firm’s common stock is _____.
e) Cannot be determined from the information given.
27. Which of the following statements is/are correct?
a) Market participants are able to eliminate virtually all market risk if they hold a large
diversified portfolio of stocks.
b) Market participants are able to eliminate virtually all company-specific risk if they hold a
large diversified portfolio of stocks.
c) It is possible to have a situation where the market risk of a single stock is less than that of a
well diversified portfolio.
d) Answers (a) and (c) are correct.
e) Answers (b) and (c) are correct.
28. You are going to deposit $175 in your bank account every six months (with the first
deposit being made six months from today) for the next 16 years. In other words, you will
make a total of 32 semiannual deposits. After that, you will make no more deposits into
the account. How much will you have in your account 18 years from today if you take no
money out of the account? Assume that the bank will pay you an interest rate of 7.50%
APR compounded semiannually for the whole 18 year period.
Version A - page 10
29. Which of the statements following is/are correct?
I. The largest diversification benefit occurs when the correlation is zero.
II. Diversifiable risk is also called systematic or market risk.
III. Diversification reduces total risk in a portfolio.
a) I only
b) II only
c) III only
d) I and II
e) I and III
30. A common stock currently has a beta of 1.3, the annual rate of return on a U.S. T-bill is
6 percent, and the annual rate of return on the S&P500 is 12 percent. The stock is expected to
generate per-share cash flow of $5.20 in one year’s time and for the foreseeable future. A toxic
spill results in a lawsuit and potential fines, and the beta of the stock increases to 1.6. The new
price of the stock
a) will be $37.68.
b) will be $43.33.
c) cannot be determined from the information given.
d) will be $33.33.
e) will be $5.20.
Version A - page 11
Total capital = MV of debt + MV of equity + MV of preferred
Total risk = firm-specific risk + market risk = diversifiable risk + non-diversifiable risk
1 − 1 /(1 + YTM / m)t 1
Bond Value = $COUPON PMT + FACE VALUE t
YTM / m (1 + YTM / m)
∑ (R −R
Std. Dev. = σ =
t Avg )2
Std. Dev. = σ =
∑ (R − R )
T −1 i =1
σPortfolio = [ (σA2) wA2 + (σB2) wB2 + 2(σA) (σB) wA wB ρA,B ] 1/2
Coefficient of variation = CV = ˆ
FV = PV X (1 + r/m)T
PV = FV / (1 + r/m)t
1 − 1 /(1 + r / m)t (1 + r / m)t −1
PV of annuity = $ PMT FV of Annuity =$ PMT
PMT = PMT =
1 − 1 /(1 + r / m)t , (1 + r / m)t −1
Version A - page 12
PMTt +1 PMTt +1
PV of perpetuityt = PV of a growing perpetuity = PVt =