Test Bank For Foundations of Finance, 10TH Edition By Keown/Martin/Petty

Test Bank For Foundations of Finance, 10TH Edition By Keown/Martin/Petty. Within the financial markets, explain what we mean by "private placements" and name the advantages and disadvantages. Answer: Private placements are an alternative to the sale of securities to the public or to a restricted group of investors through a privileged subscription. Any type of security can be privately placed (directly placed). The major investors in private placements are large financial institutions. Based on the volume of securities purchased, the three most important investor groups are (1) life insurance companies, (2) state and local retirement funds, and (3) private pension funds. Private placements have advantages and disadvantages compared with public offerings. The advantages associated with private placements are: 1. Speed: The firm usually obtains funds more quickly through a private placement than a public offering. The major reason is that registration of the issue with the SEC is not required. 2. Reduced costs: These savings result because the lengthy registration statement for the SEC does not have to be prepared, and the investment-banking underwriting and distribution costs do not have to be absorbed. 3. Financing flexibility: In a private placement, the firm deals on a face-to-face basis with a small number of investors. This means that the terms of the issue can be tailored to meet the specific needs of the company. The following disadvantages of private placements must be evaluated. 1. Interest costs: It is generally conceded that interest costs on private placements exceed those of public issues. Whether this disadvantage is enough to offset the reduced costs associated with a private placement is a determination the financial manager must make. 2. Restrictive covenants: A firm's dividend policy, working capital levels, and the raising of additional debt capital may all be affected by burdensome provisions especially in the private placement debt contract. 3. The possibility of future SEC registration: If the lender (investor) should decide to sell the issue to a public buyer before maturity, the issue must be registered with the SEC. Some lenders, then, require that the issuing firm agree to a future registration at their option. Diff: 1 Page Ref: 31, 32, 33 Keywords: Private Placement Learning Obj.: L.O. 2.2 AACSB: Reflective Thinking Learning Objective 2.3 1) Over time, there has been a high correlation between actual rates of return on securities and the securities' standard deviations of returns. Answer: TRUE Diff: 1 Page Ref: 35 Keywords: Risk-Return Trade-off, Standard Deviation, Actual Return Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 2) The rate of return available on the next best investment alternative for the saver refers to the opportunity cost of funds. Answer: TRUE Diff: 1 Page Ref: 34 Keywords: Opportunity Cost of Funds Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 3) Investors expect to receive the highest returns from government-issued securities because the government will not default on securities that it has issued. Answer: FALSE Diff: 2 Page Ref: 35 Keywords: Risk-Return Trade-off Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 4) A basis point is equal to A) one percent. B) one-tenth of one percent. C) one-hundredth of one percent. D) one-half of one percent. Answer: C Diff: 1 Page Ref: 36 Keywords: Basis Point Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 5) The real rate of return is the return earned above the A) default risk premium. B) risk-adjusted return. C) inflation risk premium. D) variability of returns measured by standard deviation. Answer: C Diff: 2 Page Ref: 34, 35 Keywords: Real Rate of Return, Inflation Risk Premium Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 6) The risk premium would be greater for an investment in an oil and gas exploration in unproven fields than an investment in preferred stock because A) oil and gas exploration investments have a greater variability in possible returns. B) the preferred stock is more liquid. C) the inflation rate would vary more with oil and gas exploration investments. D) both A and B Answer: D Diff: 3 Page Ref: 35 Keywords: Variability of Returns, Liquidity Premium, Risk Premium Learning Obj.: L.O. 2.3 AACSB: Analytical Thinking 7) What was the average annual rate of return on 3-month U.S. Treasury bills during the period 1990 to 2017? A) 2.15% B) 4.23% C) 2.78% D) 5.68% Answer: C Diff: 2 Page Ref: 36 Keywords: U.S. Treasury Bills, Rate of Return Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 8) What was the average annual rate of return on long-term government bonds (30-year Treasury bonds) during the period 1990 to 2017? A) 4.14% B) 5.88% C) 5.22% D) 7.82% Answer: C Diff: 2 Page Ref: 36 Keywords: Long-term Government Bonds, Rate of Return Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 9) What was the average annual rate of return on long-term corporate bonds during the period 1926 to 2017? A) 8.3% B) 6.5% C) 6.08% D) 7.00% Answer: C Diff: 2 Page Ref: 35 Keywords: Long-term Government Bonds, Rate of Return Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 10) What was the average annual rate of return on common stocks during the period 1926 to 2017? A) 15.4% B) 18.6% C) 10.1% D) 9.5% Answer: C Diff: 2 Page Ref: 35 Keywords: Small Firm Common Stocks, Rate of Return Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 11) Over the period 1926 to 2017, the standard deviation of returns has been the greatest for which of the following? A) Treasury bills B) corporate bonds C) government bonds D) common stocks Answer: D Diff: 1 Page Ref: 35 Keywords: Small Firm Common Stocks, Standard Deviation Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 12) Which of the following represents the correct ordering of returns over the period 1926 to 2017 (from lowest to highest return)? A) Treasury bills, long-term government bonds, long-term corporate bonds, common stocks B) common stocks, long-term government bonds, long-term corporate bonds, Treasury bills C) Treasury bills, common stocks, long-term corporate bonds, long-term government bonds D) long-term corporate bonds, Treasury bills, long-term government bonds, common stocks Answer: A Diff: 2 Page Ref: 35 Keywords: Rate of Return, Risk-Return Tradeoff Learning Obj.: L.O. 2.3 AACSB: Analytical Thinking 13) Which of the following represents the correct ordering of standard deviation of returns over the period 1926 to 2014 (from highest to lowest standard deviation of returns)? A) Treasury bills, long-term corporate bonds, long-term government bonds, common stocks B) common stocks, long-term government bonds, long-term corporate bonds, Treasury bills C) Treasury bills, long-term government bonds, long-term corporate bonds, common stocks D) Treasury bills, long-term government bonds, common stocks, long-term corporate bonds Answer: B Diff: 2 Page Ref: 35 Keywords: Standard Deviation, Risk-Return Tradeoff Learning Obj.: L.O. 2.3 AACSB: Analytical Thinking 14) During the period 1990 to 2017, the average yield on 3-month U.S. Treasury bills was 2.78%, the average inflation rate was 2.48%, the average yield on 30-year Treasury bonds was 5.22%, and the average return on 30-year Aaa-rated corporate bonds was 6.08%. The real risk-free short-term interest rate is A) 0.30%. B) 2.13%. C) 2.97%. D) 4.76%. Answer: A Diff: 2 Page Ref: 37 Keywords: Real Risk-Free Interest Rate, Inflation Risk Premium Learning Obj.: L.O. 2.3 AACSB: Analytical Thinking 15) Which of the following securities will likely have the highest liquidity premium? A) U.S. Treasury bond maturing in 2030 B) Bbb-rated corporate bond maturing in 2023 actively traded on a major exchange C) Aaa-rated corporate bond maturing in 2019 not actively traded D) U.S. Treasury bill Answer: C Diff: 2 Page Ref: 37 Keywords: Liquidity Premium Learning Obj.: L.O. 2.3 AACSB: Analytical Thinking 16) Which of the following securities will likely have the highest default risk premium? A) U.S. Treasury bond maturing in 2030 B) Bbb-rated corporate bond maturing in 2023 actively traded on a major exchange C) Aaa-rated corporate bond maturing in 2019 not actively traded D) U.S. Treasury bill Answer: B Diff: 2 Page Ref: 37 Keywords: Default Risk Premium Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 17) Suppose the following rates are averages for banks in your area: interest checking accounts pay 1%, savings accounts pay 2%, and one-year certificates of deposit pay 3%. All accounts are federally insured by the FDIC. The difference in rates can be explained mainly by A) liquidity premiums. B) default risk premiums. C) maturity premiums. D) inflation risk premiums. Answer: A Diff: 2 Page Ref: 37 Keywords: Liquidity Premium Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 18) Examine the securities below and identify the security with the highest liquidity premium, the highest default risk premium, and the highest maturity premium. a. 30-year U.S. Government Treasury bond maturing in 2025 b. 25-year Bbb-rated corporate bond maturing in 2030, actively traded on the New York Exchange c. 10-year Aaa-rated corporate bond maturing in 2020, thinly traded on a regional exchange d. 3-month U.S. Treasury bill Answer: The 10-year Aaa-rated corporate bond has the highest liquidity premium because it is not actively traded and may be difficult to turn into cash on short notice. The Bbb-rated corporate bond has the highest default risk premium. The U.S. Government securities are virtually default risk free, and the other corporate bond is Aaa rated. The 25-year Bbb-rated corporate bond maturing in 2030 has the highest maturity premium. Although the Treasury bond had a longer maturity when issued, currently the 25-year Bbb bond has the longest time left to maturity. Diff: 2 Page Ref: 37 Keywords: Risk Premium, Liquidity Premium, Maturity Premium Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 19) Distinguish between the concepts of the inflation premium and the default-risk premium. Answer: Inflation premium is a premium to compensate for anticipated inflation that is equal to the price change expected to occur over the life of the bond or investment instrument. Default-risk premium is the additional return required by investors to compensate them for the risk of default. It is calculated as the difference between a U.S. Treasury bond and a corporate bond of the same maturity and marketability. Diff: 2 Page Ref: 37 Keywords: Risk Premium Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking 20) Distinguish between the concepts of the maturity-risk premium and the liquidity-risk premium. Answer: Maturity-risk premium is the additional return required by investors in longer-term securities to compensate them for greater risk of price fluctuations on those securities caused by interest rate changes. Liquidity-risk premium is the additional return required by investors for securities that cannot be quickly converted into cash at a reasonably predictable price. Diff: 2 Page Ref: 37 Keywords: Risk Premium Learning Obj.: L.O. 2.3 AACSB: Reflective Thinking Learning Objective 2.4 1) The term structure of interest rates usually indicates that longer terms to maturity have higher expected returns. Answer: TRUE Diff: 2 Page Ref: 44 Keywords: Term Structure of Interest Rates Learning Obj.: L.O. 2.4 AACSB: Reflective Thinking 2) In response to the banking crisis and economic collapse of 2007 and 2008, the U.S. government moved to increase interest rates in order to attract foreign capital seeking high returns in U.S. banks. Answer: FALSE Diff: 2 Page Ref: 44 Keywords: Interest Rates, Term Structure Learning Obj.: L.O. 2.4 AACSB: Reflective Thinking 3) A liquidity-risk premium is the additional return required by investors in longer-term securities to compensate them for the greater risk of price fluctuation on those securities caused by interest rate changes. Answer: FALSE Diff: 2 Page Ref: 38 Keywords: Nominal Rate of Interest, Inflation Premium, Real Rate of Interest Learning Obj.: L.O. 2.4 AACSB: Reflective Thinking 4) A real interest rate is the interest rate on a fixed-income security that has no risk in an economic environment of high inflation. Answer: FALSE Diff: 2 Page Ref: 39 Keywords: Nominal Rate of Interest, Inflation Premium, Real Rate of Interest Learning Obj.: L.O. 2.4