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Foundations of Financial Markets and Institutions, 4e (Fabozzi/Modigliani/Jones)Chapter 9 Properties and Pricing of Financial AssetsMultiple Choice Questions1 Properties of Financial Assets1) Which of the below is NOT one of the eleven properties of financial assets?A) moneynessB) multiplicity and denominationC) reversibilityD) cash flowAnswer: BComment: The eleven properties of financial assets are (1) moneyness, (2) divisibility and denomination, (3) reversibility, (4) cash flow, (5) term to maturity, (6) convertibility, (7) currency, (8) liquidity, (9) return predictability, (10) complexity, and (11) tax status.Diff: 2Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status2) Which of the below is NOT one of the eleven properties of financial assets?A) convertibilityB) currencyC) liquidity predictabilityD) tax statusAnswer: CComment: The eleven properties of financial assets are (1) moneyness, (2) divisibility and denomination, (3) reversibility, (4) cash flow, (5) term to maturity, (6) convertibility, (7) currency, (8) liquidity, (9) return predictability, (10) complexity, and (11) tax status.Diff: 2Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status3) Which of the below are THREE of the eleven properties of financial assets?A) return predictability, complexity, and tax statusB) convertibility, currency, liquidityC) liquidity, reversibility, and cash flowD) money, divisibility, and denominationAnswer: DComment: The 11 properties of financial assets are (1) moneyness, (2) divisibility and denomination (these are only ONE property and not TWO), (3) reversibility, (4) cash flow, (5) term to maturity, (6) convertibility, (7) currency, (8) liquidity, (9) return predictability, (10) complexity, and (11) tax status.Diff: 2Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status4) Which of the below statements is TRUE?A) Near money is a financial asset that is used as a medium of exchange or in settlement of transactions.B) In the United States, money consists of currency and a very few forms of deposits that permit check writing.C) Near money is very close to money in that it can be transformed into money at little cost, delay, or risk.D) Faraway money, in the case of the United States, includes (i) time and savings deposits and (ii) a security issued by the U.S. government called a Treasury bill.Answer: CComment: Money is a financial asset that is used as a medium of exchange or in settlement of transactions. In the United States, money consists of currency and all forms of deposits that permit check writing. Near money, in the case of the United States, includes (i) time and savings deposits and (ii) a security issued by the U.S. government called a Treasury bill. Diff: 2Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status5) _ relates to the minimum size in which a financial asset can be liquidated and exchanged for money.A) ReversibilityB) DenominationC) ConvertibilityD) DivisibilityAnswer: DDiff: 1Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status6) Reversibility is referred to as _.A) the cost of investing in a financial asset and then getting out of it but not back into cash again.B) the cost of investing in a financial asset instead of investing in cash.C) one-way costD) turnaround costAnswer: DComment: Reversibility refers to the cost of investing in a financial asset and then getting out of it and back into cash again. Consequently, reversibility is also referred to as turnaround cost or round-trip cost.Diff: 2Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status7) The _, the greater the probability of the market maker _ in excess of a stated bound between the time of buying and reselling the financial asset.A) greater the variability; incurring a lossB) lesser the variability; incurring a lossC) lesser the variability; incurring a large gainD) greater the variability; incurring no loss or gainAnswer: AComment: The greater the variability, the greater the probability of the market maker incurring a loss in excess of a stated bound between the time of buying and reselling the financial asset. Diff: 2Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status8) The return that an investor will realize by holding a financial asset depends on all the _ that the financial asset will pay its owners; this includes dividends on shares and coupon payments on bonds.A) stock distributions B) cash distributions C) cash convertibilityD) liquid inventoriesAnswer: BDiff: 1Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status9) Return _ is a basic property of financial assets, in that it is a major determinant of their value.A) convertibilityB) divisibilityC) predictability D) complexityAnswer: CDiff: 1Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status10) A _ asset is one that provides options for the issuer or the investor, or both, and so represents a combination of simpler assets.A) complexB) taxableC) predictable and divisibleD) liquidAnswer: ADiff: 1Topic: 9.1 Properties of Financial AssetsObjective: 9.1 the many key properties of financial assets: moneyness; divisibility and denomination; reversibility; cash flow and return; term to maturity; convertibility; currency; liquidity; return predictability or risk; complexity; and tax status2 Principles of Pricing of Financial Assets1) The fundamental principle of finance is that the true or correct price of an asset equals the _ of all cash flows that the owner of the asset expects to receive during its life.A) present valueB) future valueC) projected valueD) asset valueAnswer: ADiff: 1Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.7 the principles that reveal how the properties of an asset affect its value, either through the discount rate or through its expected cash flow2) The correct price for a financial asset can be expressed as follows: P = + where _.A) P = the price of the cash flowB) CFt = the financial asset in year t (t = 1, ,N)C) N = the maturity of the financial assetD) r = the appropriate cash rateAnswer: CComment: The correct price for a financial asset can be expressed as follows: P = + whereP = the prince of the financial asset; CFt = the cash flow in year t (t = 1, ,N); N = the maturity of the financial asset; and, r = the appropriate discount rate.Diff: 2Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.5 the principles of valuing complex financial assets3) The appropriate discount rate, r, is the return that the market or the consensus of investors requires on the asset. A convenient (but approximate) expression for the appropriate discount rate is this: r = RR + IP + DP + MP + LP + EPP where _.A) IP= the real rate of interest, which is the reward for not consuming and for lending to other users.B) MP = the maturity risk premium, which is the reward for taking on the risk of default in the case of a loan or bond or the risk of loss of principal for other assets.C) LP = the liquidity premium, which is the reward for not consuming and for lending to other users.D) EP= the exchange-rate risk premium, which is the reward for investing in an asset that is not denominated in the investors home currency.Answer: DComment: The appropriate discount rate, r, is the return that the market or the consensus of investors requires on the asset. A convenient (but approximate) expression for the appropriate discount rate is this: r = RR + IP + DP + MP + LP + EP whereRR = the real rate of interest, which is the reward for not consuming and for lending to other users;IP = the inflation premium, which is the compensation for the expected decline in the purchasing power of the money lent to borrowers;DP = the default risk premium, which is the reward for taking on the risk of default in the case of a loan or bond or the risk of loss of principal for other assets;MP = the maturity premium, which is the compensation for lending money for long periods of time;LP = the liquidity premium, which is the reward for investing in an asset that may not be readily converted to cash at a fair market value; and,EP= the exchange-rate risk premium, which is the reward for investing in an asset that is not denominated in the investors home currency.Diff: 2Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.2 the components of an assets discount rate or required rate of return4) DP is the default risk premium, which is the _.A) reward for investing in an asset that may not be readily converted to cash at a fair market value.B) reward for taking on the risk of default in the case of a loan or bond or the risk of loss of principal for other assets.C) compensation for lending money for long periods of time.D) reward for investing in an asset that is not denominated in the investors home currency.Answer: BComment: DP is the default risk premium, which is the reward for taking on the risk of default in the case of a loan or bond or the risk of loss of principal for other assets.MP is the maturity premium, which is the compensation for lending money for long periods of time.LP is the liquidity premium, which is the reward for investing in an asset that may not be readily converted to cash at a fair market value.EP is the exchange-rate risk premium, which is the reward for investing in an asset that is not denominated in the investors home currency.Diff: 1Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.4 how the discount rate is structured to encompass the components of an assets risk5) Assume that the market thinks the real rate is 2.00%, the inflation premium is 2.70%, the bonds default risk justifies a premium of 2.10%, the maturity premium is 0.50%, and the liquidity premium is 1.10%. Since the cash flows are denominated in euros, the foreign-exchange rate premium is 1.50%. What is the discount rate?A) 8.90%B) 9.70%C) 9.90%D) None of theseAnswer: CComment: We have: RR = 2.00%, IP = 2.70%, DP = 2.01%, MP = 0.50%, LP = 1.01%, EP = 1.50%. Thus, we have this value for the discount rate: r = 2.0% + 2.7% + 2.1% + 0.5% + 1.1% + 1.5% = 9.90% or 0.0990.Diff: 2Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.4 how the discount rate is structured to encompass the components of an assets risk6) Suppose the cash flows for a bonds coupon payment for years 1 through 4 are $100. That is, CFt = $100 for t (t = 1, . ,4). Further assume the the discount rate is 9.00% and at the end of year the bond will pay back the bonds par value of $1,000. To the nearest dollar, what is the correct price for this bond?A) $866B) $932C) $1,012D) $1,032Answer: DComment: The correct price for the bond can be expressed as follows: P = + . + where P = the prince of thebond; CFt = the cash flow in year t (t = 1, , N); N = the maturity of the bond; and, r = the appropriate discount rate. Inserting our given values, where CF1 = CF2 = CF3 = $100, CFN = CF4 = $1,000 + $100 = $1,100 and r = 9.00% or 0.09, we have:P = + + + = $91.7431 + 84.168 + $77.21835 + $779.2677 = $1,032.40.Diff: 3Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.7 the principles that reveal how the properties of an asset affect its value, either through the discount rate or through its expected cash flow7) Suppose the cash flows for a financial assets payment for years 1 through 4 are $100. That is, CFt = $100 for t (t = 1, . ,4). Further assume the the discount rate is 8.00% and at the end of four years that the financial asset will pay $1,000 in addition to the $100. Finally, assume a brokers commission of $30 is imposed by brokers to buy or sell the bond. To the nearest dollar, what is the correct price for this financial asset?A) $1,014B) $1,000C) $994D) None of theseAnswer: AComment: The correct price for a financial asset can be expressed as follows: P = + where P = the prince of the financial asset; CFt = the cash flow in year t (t = 1, ,4); 4 years is the maturity of the financial asset; and, r = the appropriate discount rate. For this case we must subtract $30 at the beginning (t = 0) and subtract out $30 at t = 4. Inserting our given values, where CF1 = CF2 = CF3 = $100, CF4 = $1,000 + $100 - $30 = $1,070, and r = 8.00% or 0.08, we have:P = -$30 + += -$30+ $92.59259 + $85.73388 + $79.38322 + $786.4819 = $1,014.19.Diff: 3Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.7 the principles that reveal how the properties of an asset affect its value, either through the discount rate or through its expected cash flow8) Suppose the cash flows for a financial assets payment for years 1 through 5 are $80. That is, CFt = $80 for t (t = 1, . ,5). Further assume the the discount rate is 8.00% and at the end of the five years that the financial asset will pay back $1,000 in addition to the $80. Finally, assume a brokers commission of $30 is imposed by brokers to buy or sell the financial asset and that a government entity imposes a transfer tax of $20 on each transaction. To the nearest dollar, what is the correct price for this financial asset?A) $912B) $914C) $916D) $918Answer: CComment: The correct price for a financial asset can be expressed as follows: P = + where P = the prince of the financial asset; CFt is the cash flow in year t (t = 1, ,5); 5 years is the maturity of the financial asset; and, r is the appropriate discount rate. For this case we must subtract $30 and $20 at the beginning (t = 0) and also subtract out $30 and $20 at t = 5. Inserting our given values, where CF1 = CF2 = CF3 = CF4 =$80, CF5 = $1,000 +$80 - $30 - $20 = $1,030, and r = 8.00% or 0.08, we have:P = -$30 -$20 + + = -$30 -$20 + $74.0741 + $68.5871 + $63.5066 + $58.8024 + $701.0007 = $915.97. Diff: 3Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.7 the principles that reveal how the properties of an asset affect its value, either through the discount rate or through its expected cash flow9) Suppose the cash flows for a financial assets payment for years 1 through 5 are $90. That is, CFt = $90 for t (t = 1, . ,5). Further assume the the discount rate is 7.00% and at the end of the five years that the financial asset will pay back $1,000 in addition to the $90. Finally, assume a brokers commission of $40 is imposed by brokers to buy or sell the financial asset and that a government entity imposes a transfer tax of $25 on each transaction. To the nearest dollar, what is the correct price for this financial asset?A) $962B) $971C) $986D) $1,002Answer: BComment: The correct price for a financial asset can be expressed as follows: P = + where P = the prince of the financial asset; CFt is the cash flow in year t (t = 1, ,5); 5 years is the maturity of the financial asset; and, r is the appropriate discount rate. For this case we must subtract $40 and $25 at the beginning (t = 0) and also subtract out $30 and $20 at t = 5. Inserting our given values, where CF1 = CF2 = CF3 = CF4 =$90, CF5 = $1,000 +$90 - $40 - $25 = $1,025, and r = 7.00% or 0.07, we have:P = -$40 -$25 + + + + + = -$40 -$25 + $84.1121 + $78.6095 + $73.4668 + $68.6606 + $730.8108 = $970.66.Diff: 3Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.7 the principles that reveal how the properties of an asset affect its value, either through the discount rate or through its expected cash flow10) Suppose that a bond is granted a favorable tax treatment such that the interest and any capital gain from this bond would not be taxed. Suppose that the marginal tax rate on otherwise equivalent taxable bonds is 25% and the appropriate discount rate is 7%. What is the after-tax discount rate?A) 5.25%B) 5.35%C) 5.65%D) 5.75%Answer: AComment: The after-tax discount rate is: pretax discount rate * (1 - marginal tax rate) = 0.09 * (1 - 0.25) = 0.052500 = 5.25%.Diff: 2Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.2 the components of an assets discount rate or required rate of return11) Although we use a single discount rate to discount each cash flow, there are theoretical reasons that suggest this is _.A) not practical.B) always correct but not practical.C) suitable.D) inappropriate.Answer: DDiff: 1Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.4 how the discount rate is structured to encompass the components of an assets risk12) The appropriate _ can often be approximated as the sum of rewards for the various risks an asset poses to its buyer.A) reward premiumB) discount rateC) risk premiumD) coupon rateAnswer: BDiff: 2Topic: 9.2 Principles of Pricing of Financial AssetsObjective: 9.4 how the discount rate is structured to encompass the components of an assets risk3 Price Volatility of Financial Assets1) A fundamental principle is that a financial assets price changes in _.A) the same direction of the change in the required rate of return.B) the same direction of the change in the required yield.C) unknown and unpredictable ways compared to the change in the required yield.D) the opposite direction of the change in the required rate of return or the required yield.Answer: DDiff: 1Topic: 9.3 Price Volatility of Financial AssetsObjective: 9.6 the inverse relationship between an assets price
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