Question: A call provision on a bond allows

> How can a change in interest rates affect the profitability of financial institutions?

> What is a lien, and when is it used in mortgage lending?

> Compute the face value of a 30-year fixed-rate mortgage with a monthly payment of $1,100, assuming a nominal interest rate of 9%. If the mortgage requires 5% down, what is the maximum house price?

> A mortgage on a house worth $350,000 requires what down payment to avoid PMI insurance?

> A 30-year variable-rate mortgage offers a first-year teaser rate of 2%. After that, the rate starts at 4.5%, adjusted based on actual interest rates. The maximum rate over the life of the loan is 10.5%, and the rate can increase by no more than 200 basis

> Consider a 5-year balloon loan for $100,000. The bank requires a monthly payment equal to that of a 30-year fixed-rate loan with a nominal annual rate of 5.5%. How much will the borrower owe when the balloon payment is due?

> Consider a 30-year fixed-rate mortgage of $100,000 at a nominal rate of 9%. What is the duration of the loan? If interest rates increase to 9.5% immediately after the mortgage is made, how much is the loan worth to the lender?

> Consider a 30-year fixed-rate mortgage for $100,000 at a nominal rate of 9%. An S&L issues this mortgage on April 1 and retains the mortgage in its portfolio. However, by April 2 mortgage rates have increased to a 9.5% nominal rate. By how much has the v

> Consider a 30-year fixed-rate mortgage for $100,000 at a nominal rate of 9%. If the borrower pays an additional $100 with each payment, how fast will the mortgage be paid off?

> Consider a 30-year fixed-rate mortgage for $100,000 at a nominal rate of 9%. If the borrower wants to pay off the remaining balance on the mortgage after making the 12th payment, what is the remaining balance on the mortgage?

> Compute the required monthly payment on an $80,000 30-year fixed-rate mortgage with a nominal interest rate of 5.80%. How much of the payment goes toward principal and interest during the first year?

> Calculate the duration of a $1,000, 6% coupon bond with three years to maturity. Assume that all market interest rates are 7%.

> You are working with a pool of 1,000 mortgages. Each mortgage is for $100,000 and has a stated annual interest rate (nominal) of 6.00%. The mortgages are all 30-year fixed rate and fully amortizing. Mortgage servicing fees are currently 0.25% annually. C

> Rusty Nail owns his house free and clear, and it’s worth $400,000. To finance his retirement, he acquires a reverse annuity mortgage (RAM) from his bank. The RAM provides a fixed monthly payment over 15 years on 70% of the value of his home at 5%. The pa

> Consider a growing equity mortgage on a $250,000 mortgage with yearly payments. The stated interest rate on the mortgage is 6%, but this only applies to the first annual payment. Thereafter, the annual payment will grow by 5.5797%. Develop an amortizatio

> Consider a 30-year graduated-payment mortgage on a $250,000 mortgage with yearly payments. The stated interest rate on the mortgage is 6%, but the first annual payment is calculated assuming a 3% rate for the life of the loan. Thereafter, the annual paym

> Consider a shared-appreciation mortgage (SAM) on a $250,000 mortgage with yearly payments. Current market mortgage rates are high, running at 13%, of which 10% is annual inflation. Under the terms of the SAM, a 15-year mortgage is offered at 5%. After 1

> Two mortgage options are available: a 30-year fixedrate loan at 6% with no discount points, and a 30-year fixed-rate loan at 5.75% with points. If you are planning on living in the house for 12 years, what is the most you are willing to pay in points for

> Two mortgage options are available: a 30-year fixed rate loan at 6% with no discount points, and a 30-year fixed-rate loan at 5.75% with 1 discount point. How long do you have to stay in the house for the mortgage with points to be a better option? Assum

> Two mortgage options are available: a 15-year fixed-rate loan at 6% with no discount points, and a 15-year fixed rate loan at 5.75% with 1 discount point. Assuming you will not pay off the loan early, which alternative is best for you? Assume a $100,000

> Consider the following options available to a mortgage borrower: What is the effective annual rate for each option? Loan Type of Discount Rate (%) Mortgage Points Amount Interest ($) 30-year fixed Option 1 100,000 6.75 none 30-year fixed Option 2 1

> Consider a 30-year fixed-rate mortgage for $500,000 at a nominal rate of 6%. What is the difference in required payments between a monthly payment and a bimonthly payment (payments made twice a month)?

> “Because corporations do not actually raise any funds in secondary markets, they are less important to the economy than primary markets.” Comment.

> Identify the cash flows available to an investor in stock. How reliably can these cash flows be estimated? Compare the problem of estimating stock cash flows to estimating bond cash flows. Which security would you predict to be more volatile?

> What basic principle of finance can be applied to the valuation of any investment asset?

> Consider the following security information for four securities making up an index: What is the change in the value of the index from Time 5 0 to Time 5 1 if the index is calculated using a value-weighted arithmetic mean? Shares Outstanding (milli

> Suppose Microsoft, Inc., is trading at $27.29 per share. It pays an annual dividend of $0.32 per share, which is double last year’s dividend of $0.16 per share. If this trend is expected to continue, what is the required return on Microsoft?

> Huskie Motors just paid an annual dividend of $1.00 per share. Management has promised shareholders to increase dividends at a constant rate of 5%. If the required return is 12%, what is the current price per share?

> LaserAce is selling at $22.00 per share. The most recent annual dividend paid was $0.80. Using the Gordon growth model, if the market requires a return of 11%, what is the expected dividend growth rate for LaserAce?

> Suppose Microsoft, Inc., is trading at $27.29 per share. It pays an annual dividend of $0.32 per share, and analysts have set a one-year target price around $33.30 per share. What is the expected return of this stock?

> Suppose SoftPeople, Inc., is selling at $19.00 and currently pays an annual dividend of $0.65 per share. Analysts project that the stock will be priced around $23.00 in one year. What is the expected return?

> The shares of Misheak, Inc., are expected to generate the following possible returns over the next 12 months: Return……………………Probability 5%..........................................0.10 5%.........................................0.25 10%................

> Two common statistics in IPOs are underpricing and money left on the table. Underpricing is defined as percentage change between the offering price and the first day closing price. Money left on the table is the difference between the first day closing p

> Some economists suspect that one of the reasons that economies in developing countries grow so slowly is that they do not have well-developed financial markets. Does this argument make sense?

> If the investment bankers retained $1.26 per share as fees, what were the net proceeds to eBay? What was the market capitalization of the new shares of eBay?

> The projected earnings per share for Risky Ventures, Inc., is $3.50. The average PE ratio for the industry composed of Risky Ventures’ closest competitors is 21. After careful analysis, you decide that Risky Ventures is a little more risky than average,

> Compute the price of a share of stock that pays a $1 per year dividend and that you expect to be able to sell in one year for $20, assuming you require a 15% return.

> An index had an average (geometric) mean return over 20 years of 3.8861%. If the beginning index value was 100, what was the final index value after 20 years?

> Suppose Microsoft, Inc., reports earnings per share of around $0.75. If Microsoft is in an industry with a PE ratio ranging from 30 to 40, what is a reasonable price range for Microsoft?

> Analysts are projecting that CB Railways will have earnings per share of $3.90. If the average industry PE ratio is about 25, what is the current price of CB Railways?

> Nat-T-Cat Industries just went public. As a growing firm, it is not expected to pay a dividend for the first five years. After that, investors expect Nat-T-Cat to pay an annual dividend of $1.00 per share (i.e., D6 5 1.00), with no growth. If the require

> Macro Systems just paid an annual dividend of $0.32 per share. Its dividend is expected to double for the next four years (D1 through D4), after which it will grow at a more modest pace of 1% per year. If the required return is 13%, what is the current p

> Gordon & Co.’s stock has just paid its annual dividend of $1.10 per share. Analysts believe that Gordon will maintain its historic dividend growth rate of 3%. If the required return is 8%, what is the expected price of the stock next year?

> The U.S. Treasury issues bills, notes, and bonds. How do these three securities differ?

> Why is a share of Microsoft common stock an asset for its owner and a liability for Microsoft?

> Distinguish between the primary market and the secondary market for securities.

> What are the primary capital market securities, and who are the primary purchasers of these securities?

> Contrast investors’ use of capital markets with their use of money markets.

> What is the document called that lists the terms of a bond?

> In addition to Treasury securities, some agencies of the government issue bonds. List three such agencies, and state what the funds raised by the bond issues are used for.

> As interest rates in the market change over time, the market price of bonds rises and falls. The change in the value of bonds due to changes in interest rates is a risk incurred by bond investors. What is this risk called?

> A bond provides information about its par value, coupon interest rate, and maturity date. Define each of these.

> Describe the two ways whereby capital market securities pass from the issuer to the public.

> What is a sinking fund? Do investors like bonds that contain this feature? Why?

> How does risk sharing benefit both financial intermediaries and private investors?

> Consider the two bonds described below: a. If both bonds had a required return of 8%, what would the bonds’ prices be? b. Describe what it means if a bond sells at a discount, a premium, and at its face amount (par value). Are these

> A zero-coupon bond has a par value of $1,000 and matures in 20 years. Investors require a 10% annual return on these bonds. For what price should the bond sell? (Note: Zero-coupon bonds do not pay interest. Review Chapter 3.)

> A bond makes an annual $80 interest payment (8% coupon). The bond has five years before it matures, at which time it will pay $1,000. Assuming a discount rate of 10%, what should be the price of the bond?

> Your company owns the following bonds: If general interest rates rise from 8% to 8.5%, what is the approximate change in the value of the portfolio? Bond Market Value Duration A $13 million 2 В $18 million 4 C $20 million

> A 10-year $1,000 par value bond has a 9% semiannual coupon and a nominal yield to maturity of 8.8%. What is the price of the bond?

> A one-year discount bond with a face value of $1,000 was purchased for $900. What is the yield to maturity? What is the yield on a discount basis? (See Chapters 3 and 12.)

> A $1,000 par bond with an annual coupon has only one year until maturity. Its current yield is 6.713%, and its yield to maturity is 10%. What is the price of the bond?

> A 10-year, $1,000 par value bond with a 5% annual coupon is trading to yield 6%. What is the current yield?

> If the municipal bond rate is 4.25% and the corporate bond rate is 6.25%, what is the marginal tax rate, assuming investors are indifferent between the two bonds?

> The yield on a corporate bond is 10%, and it is currently selling at par. The marginal tax rate is 20%. A par value municipal bond with a coupon rate of 8.50% is available. Which security is a better buy?

> “In a world without information and transaction costs, financial intermediaries would not exist.” Is this statement true, false, or uncertain? Explain your answer.

> Consider the following cash flows. All market interest rates are 12%. a. What price would you pay for these cash flows? What total wealth do you expect after 2.5 years if you sell the rights to the remaining cash flows? Assume interest rates remain con

> A two-year $1,000 par zero-coupon bond is currently priced at $819.00. A two-year $1,000 annuity is currently priced at $1,712.52. If you want to invest $50,000 in one of the two securities, which is a better buy?

> A 20-year $1,000 par value bond has a 7% annual coupon. The bond is callable after the 10th year for a call premium of $1,025. If the bond is trading with a yield to call of 6.25%, what is the bond’s yield to maturity?

> A seven-year, $1,000 par bond has an 8% annual coupon and is currently yielding 7.5%. The bond can be called in two years at a call price of $1,010. What is the bond yielding, assuming it will be called (known as the yield to call)?

> Assume the debt in the previous question is trading at $1,035. How can you earn a riskless profit from this situation (arbitrage)? Data from Question 8: M&E, Inc., has an outstanding convertible bond. The bond can be converted into 20 shares of common e

> M&E, Inc., has an outstanding convertible bond. The bond can be converted into 20 shares of common equity (currently trading at $52/share). The bond has five years of remaining maturity, a $1,000 par value, and a 6% annual coupon. M&E’s straight debt is

> Distinguish between a term security and a demand security.

> Why do banks not eliminate the need for money markets?

> Is a Treasury bond issued 29 years ago with six months remaining before it matures a money market instrument?

> What characteristics define the money markets?

> If you are an employer, what kinds of moral hazard problems might you worry about with your employees?

> Why are banker’s acceptances so popular for international transactions?

> Who issues commercial paper and for what purpose?

> Does the Federal Reserve directly set the federal funds interest rate? How does the Fed influence this rate?

> Who issues federal funds, and what is the usual purpose of these funds?

> Distinguish between competitive bidding and noncompetitive bidding for Treasury securities.

> Which of the money market securities is the most liquid and considered the most risk-free? Why?

> Why are more funds from property and casualty insurance companies than funds from life insurance companies invested in the money markets?

> What purpose initially motivated Merrill Lynch to offer money market mutual funds to its customers?

> Why do businesses use the money markets?

> What motivated regulators to impose interest ceilings on bank savings accounts? What effect did this eventually have on the money markets?

> Why do loan sharks worry less about moral hazard in connection with their borrowers than some other lenders do?

> Why does the U.S. government use the money markets?

> If you want to earn an annualized discount rate of 3.5%, what is the most you can pay for a 91-day Treasury bill that pays $5,000 at maturity?

> If the Treasury also received $750 million in noncompetitive bids, who will receive T-bills, in what quantity, and at what price? (Refer to the table in problem 11.) Table from Problem 11: Bid Amount Bidder ($ million) Price ($) 1 500 0.9940 750 0.

> In a Treasury auction of $2.1 billion par value 91-day T-bills, the following bids were submitted: If only these competitive bids are received, who will receive T-bills, in what quantity, and at what price? Bid Amount Bidder ($ million) Price ($) 1

> How much would you pay for a Treasury bill that matures in 182 days and pays $10,000 if you require a 1.8% discount rate?

> The price of 182-day commercial paper is $7,840. If the annualized investment rate is 4.093%, what will the paper pay at maturity?

> What is the annualized discount and investment rate % on a Treasury bill that you purchase for $9,900 that will mature in 91 days for $10,000?

> What are the annualized discount rate % and your annualized investment rate % on a Treasury bill that you purchase for $9,940 that will mature in 91 days for $10,000?

> What would be your annualized discount rate % and your annualized investment rate % on the purchase of a 182-day Treasury bill for $4,925 that pays $5,000 at maturity?

> The annualized yield is 3% for 91-day commercial paper and 3.5% for 182-day commercial paper. What is the expected 91-day commercial paper rate 91 days from now?

> If you suspect that a company will go bankrupt next year, which would you rather hold, bonds issued by the company or equities issued by the company? Why?

> The annualized discount rate on a particular money market instrument is 3.75%. The face value is $200,000, and it matures in 51 days. What is its price? What would be the price if it had 71 days to maturity?