FIN 301

1. One of the benefits of a Corporation is that…

a) Ownership can be easily transferred by selling the shares of the corporation.

b) It avoids double taxation on the firm and the individual level.

c) All shareholders are jointly liable for any damages.

d) Shareholders are managing the corporation.

e) Typically the principle-agent problem is smallest compared to other legal forms because ownership is dispersed.

2. Managers using their firms’ corporate jets for their private vacation trips is an example of:

a) Positive covenants

b) Negative covenants

c) Agency problems

d) Limited liability

e) Capital budgeting

3. A positive bond covenant…

a) Is the part of the loan agreement that limits certain actions a company might otherwise wish to take during the term of the bond.

b) Is the part of the loan agreement that requires a company to take certain actions during the term of the bond.

c) Is an account managed by the bond trustee for the purpose of repaying the bonds.

d) Is a description of the property used as security (or collateral).

e) Allows the company to repurchase all or part of a bond issue at stated prices over a specific period.

4. Suppose you visit the RBC website and see that the posted (quoted) rate on RBC High Interest eSavings accounts is 0.8%. The 0.8% rate is an example of…

a) A real interest rate

b) A coupon rate

c) A mortgage rate

d) A nominal interest rate

e) The rate of inflation

5. You are comparing two savings accounts: Account A has an APR, quarterly compounded; and Account B has an APR, semi-annually compounded. Account A’s effective quarterly rate (EQR) is 3%, and Account B’s quoted APR is 12%. You should choose:

a) Account B because it has the higher effective quarterly rate.

b) Account A because it has the higher APR.

c) Account B because it has the higher APR.

d) Account A because it has the higher EAR.

e) Indifferent, because both accounts have the same APR.

6. Your savings account currently pays 12% (APR, monthly compounded). Your neighborhood bank offers you a savings account with quarterly compounding. What APR, quarterly compounded would they need to offer you that would make you indifferent between keeping your money in your current savings account or bringing your money to your neighborhood bank? In other words, what is the APR, quarterly compounded that is equivalent to an APR of 12%, monthly compounded?

a) 12.00%

b) 12.12%

c) 12.68%

d) 11.98%

e) 11.68%

7. If you invest $10,000 today in a savings account, how long does it take until you will have $30,000 in your account? Assume the only withdrawal you make is $5,000 in two years from now. The interest rate is 11% (EAR).

a) 15.5 years

b) 10.5 years

c) 17.2 years

d) 13.3 years

e) 12.5 years

Use the following information to answer Multiple Choice Problems 8 to 12:

The Belforts are interested in purchasing a house listed at $630,000. They will make a down payment of $90,000 and will finance the rest with a mortgage.

8. The Mortgage Bank offers a mortgage rate of 3.99% (APR, semi-annually compounded) with monthly payments and a 25-year amortization period. What would be the effective monthly rate (EMR) of a mortgage from The Mortgage Bank?

a) 0.3990%

b) 0.3298%

c) 0.3325%

d) 1.9950%

e) 0.3350%

9. TB Bank is offering a mortgage rate of 3.49% (APR, semi-annually compounded) with monthly payments and a 20-year amortization period. Based on the stated 3.49% mortgage rate, the effective monthly rate (EMR) of the mortgage is 0.2887%. What would be the Belfort’s monthly mortgage payments if they took out a mortgage from TB Bank? They would make the first payment in one month from today.

a) $3,121.9

b) $2,693.1

c) $3,642.2

d) $2,250.0

e) $18,851.0

10. A friend of the Belforts tells them that they could take out a mortgage at the King’s Bank with an effective monthly rate (EMR) of 0.25%, a 30-year amortization period (= 360 payments), and monthly mortgage payments of $2,276.66. The first payment is due in one month from today. What would be the outstanding principle balance in 5 years from today (right after the monthly payment) if the Belforts took out a mortgage from King’s Bank?

a) $540,000

b) $450,000

c) $403,400

d) $480,094

e) $662,025

11. Suppose the Belforts took out a mortgage from the King’s Bank with the same mortgage terms as in the previous question. If the interest rate portion of their 121 th mortgage payment is $1,026.27, what would be the principle portion of their 121 th mortgage payment?

a) $1,023.1

b) $1,250.4

c) $1,253.5

d) $1,247.3

e) $2,276.7

12. Suppose the mortgage offered by the King’s Bank has a special feature: “The Belforts are allowed to miss up to three payments without incurring a penalty.” Assume the Belforts missed the scheduled 100th and 200th payment. How much would they still owe the bank in 30 years (right after the 360th scheduled monthly payment)? Assume the same mortgage terms as in question 10) above.

a) $7,752.2

b) $4,553.3

c) $7,771.6

d) $3,155.3

e) The mortgage will be paid off after 30 years in full.

Use the following information to answer Multiple Choice Problems 13 to 16:

You have just won the lottery and you can choose between the following payout options. The annual interest rate (EAR) is 8%.

Option 1: Ten annual payments of $50,000; the first payment is made in two years from today.

Option 2: Ten payments of $100,000 received every three years; the first payment is made two years from today (i.e., payments are at t = 2, 5, 8, …, 29).

Option 3: Nine annual payments; the first payment of $30,000 is received in one year from today, and then the payments are growing at an annual rate of 8% (i.e., the second payment is 30,000×1.08, the third payment is 30,000×1.082 , etc.).

Option 4: Quarterly payments of $5,000 to perpetuity; first payment is made in one quarter from today.

13. What is the present value (value today) of the payments of Option 1?

a) $500,000

b) $362,344

c) $335,504

d) $310,652

e) $287,640

14. What is the present value (value today) of the payments of Option 2?

a) $321,090

b) $374,520

c) $346,777

d) $621,303

e) $456,298

15. What is the present value (value today) of the payments of Option 3?

a) $300,000

b) $231,481

c) $250,000

d) $270,000

e) No present value exists because r=g.

16. What is the present value (value today) of the payments of Option 4?

a) $257,380

b) $345,370

c) $277,050

d) $62,500

e) $250,000

Use the following information to answer Multiple Choice Problems 17 to 19:

Karl and Victoria want to realize their dream and purchase a cabin in the mountains when Victoria retires in 10 years from today. They expect that such a cabin will cost $150,000 at the time when Victoria retires. Karl bought a 10-year zero-coupon bond with a face value of $50,000 three years ago and he will hold it until maturity. At maturity of the bond, Karl will invest the proceeds he receives in a bank account and will use it as a payment for the cabin. Assume interest rates are 12% (APR, monthly compounded).

17. What is Karl’s contribution to the purchase price of the cabin in 10 years from today? In other words, what is the future value of the proceeds of the zero-coupon bond in 10 years?

a) $115,336

b) $150,000

c) $50,000

d) $70,246

e) $71,538

18. Regardless of Karl’s contribution, Victoria wants to have enough money saved in 10 years that she alone could pay for the cabin. What are her equal monthly contributions she needs to make to her savings account to have $150,000 in ten years from today? She makes the first payment in one month from today and the last in 10 years from today.

a) $2,152

b) $652

c) $8,548

d) $2,099

e) $1,376

19. Suppose interest rates were not 12% (APR, monthly compounded) but 20% (EAR). How would your answer to the previous question change? Note, no calculations needed to answer this question.

a) Victoria’s contributions would be bigger because interest rates increased.

b) Victoria’s contributions would not change.

c) Victoria’s contributions would be smaller.

d) Victoria’s contributions would be bigger because the present value of the cabin will be smaller.

e) Victoria’s contributions would be smaller because the future value of the cabin will be bigger.

Use the following information to answer Multiple Choice Problems 20 to 25:

Six years ago, Junk Removal Services (JRS) issued high-yield bonds at par with a maturity of 12 years and a face value of $1,000. Today, the bonds just paid their semi-annual coupons of $70.

20. At the time when the bonds were issued, six years ago, what was the yield-to-maturity (APR, semi-annually compounded) of these bonds?

a) 10%

b) 14%

c) 12%

d) 7%

e) Unable to calculate because the bond price is not given.

21. Today, suppose the yield-to-maturity (APR, semi-annually compounded) is 12%. What would be the price of one JRS bond today (right after the 12th coupon payment)?

a) $1,000

b) $1,049

c) $1,084

d) $1,072

e) $1,053

22. Suppose six months before maturity of the bond (right after the bond made its 23rd coupon payment), the yield-to-maturity (APR, semi-annually compounded) is 20%. If you bought a bond right after it made its 23rd coupon payment and held it until maturity, what would be your return on this investment?

a) 6%

b) 10%

c) 20%

d) 7%

e) Zero

23. Today, Bond Analyst Corp. uses the duration concept to approximate what happens to JRS bond prices if interest rates change. They predict that if interest rates increased by 1 percentage point, the price of JRS bonds would decline by 4.3%. Based on this information, what is the duration Bond Analyst Corp. calculated for JRS bonds?

a) A duration of 1 year.

b) A duration of 8.6 years.

c) The duration is bigger than the one of a 5-year zero coupon bond.

d) A duration of 4.3 years.

e) The duration is less than the one of a 3-year amortized loan.

24. Suppose in 5.5 years from now, you must invest $195,000 in bonds. You can choose between JRS bonds (they just paid their 23th coupon) or 6-month zero coupon bonds with a yield-to-maturity of 5%. If you want to bet on a decrease in interest rates, which bonds would you purchase (you can purchase fractions of these bonds)?

a) Zero coupon bonds because they have the shorter duration.

b) JRS bonds because they have the shorter duration.

c) Zero coupon bonds because they have the longer duration.

d) JRS bonds because they have the longer duration.

e) Indifferent between the two, both have the same exposure to interest rate changes.

25. Which one of the following statements about duration is true?

a) The bigger the coupon rate, the longer the duration (holding everything else the same).

b) Duration is less than the yield-to-maturity of a bond.

c) Duration is a conservative measure of bond price changes to changes in interest rates and underestimates gains and overestimates losses.

d) The longer the maturity of a bond, the shorter the duration (holding everything else the same).

e) Duration of a coupon bond at par is the same as the duration of a zero coupon bond with the same maturity.