EXAM 2 COB 300B QUESTIONS WITH
CORRECT ANSWERS
Mortgage Bonds - Answer-A bond backed by fixed assets. First mortgage bonds are
senior in priority to claims of second mortgage bonds.
Indenture - Answer-A formal agreement between the issuer and the bond holder
Debenture - Answer-A long-term bond that is not secured by a mortgage on specific
property
Subordinated debentures - Answer-bonds having a claim on assets only after the senior
debt has been paid in full in the event of liquidation
Investment Grade Bonds - Answer-Bonds rated triple-B or higher; many banks and
other institutional investors are permitted by law to hold only investment-grade bonds
Junk Bonds - Answer-High-risk, high-yield bonds.
Immunization - Answer-The process of selecting bonds with coupons and maturities so
that the benefits or losses from changes in reinvestment rates are exactly offset by
losses or gains in the prices of bonds
Rebalanced - Answer-The process of periodically adjusting the composition of bond
portfolio due to interest rate changes so that the portfolio due to interest rates changes
so that the portfolio remains immunized against adverse effects of changes in interest
rates.
Risk - Answer-The chance that some unfavorable event will occur
Stand-alone risk - Answer-The risk an investor would face if he or she held only one
asset.
Probability - Answer-Listings of possibel outcomes or events with a probability (chance
of occurrence) assigned to each outcome
expected rate of return - Answer-the rate of return expected to be realized from an
investment; the weighted average of the probability distribution of possible results
Standard deviation - Answer-A statistical measure of the variability of a set of
observations
,Sharpe Ratio - Answer-A measure of standalone risk that compares the assets realized
excess returns to tis standard deviation over a specified period. An investment with a
higher ratio has performed better than one with a lower ratio.
Risk Aversion - Answer-Risk averse investors dislike risk and require higher rates of
return as an inducement to buy riskier securities
Risk Premium (RP) - Answer-the difference between the expected rate of return on a
given risky asset and that on a less risky asset
Capital Asset Pricing Model (CAPM) - Answer-A model based on the proposition that
any stocks required rate of return is equal to the risk-free rate of return plus a risk
premium that reflects only the risk remaining after diversification.
expected return on a portfolio - Answer-the weighted average of the expected returns
on the assets held in the portfolio
Realized rates of return - Answer-Returns that were actually earned during some past
period. Actual returns usually turn out to be different from expected returns except for
riskless assets.
Relevant risk - Answer-the risk that remains once a stock in a diversified portfolio is its
contribution to the portfolios market risk. It is measured by the extent to which the stock
moves up and down with the market.
beta coefficient - Answer-A metric that shows the extent to which a given stocks returns
move up and down with the stock market. Beta measures market risk.
Average stocks beta - Answer-By definition, bA=1 because an average-risk stock is one
that tends to move up and down in step with the general market
^
r i - Answer-expected rate of return on the ith stock
r i - Answer-required rate of on the ith stock. Note that if ri is less than ri, the typical
investor will not purchase this stock or will sell if he or she owns it. If the ri is greater
than ri, the investor will purchase the stock because it looks like a bargain. Investors will
be
indifferent if
^
ri=ri. Buying and selling by investors tends to force the expected return to equal the
required return, although the two can differ from time to time before the adjustment is
completed.
,-
ri - Answer-realized, after-the-fact- return A person obviously does not know ri hat at the
time he or she is considering the purchase of a stock.
rRF - Answer-risk-free rate of return. In the context, rRF is is generally measured by the
return on U.S. Treasury Securities. Some analysts recommend that short-term T-bills be
used; other recommend long-term T bonds. We generally use T-bonds because their
maturity is closer to average investors holding period
Market Risk Premium, RPm - Answer-The additional return over the risk-free rate
needed to compensate investors for assuming an average amount of risk.
Security Market Line (SML) - Answer-An equation that shows the relationship between
risk as measured by beta and the required rates of return on individual securities.
Proxy - Answer-a document giving one person the authority to act for another, typically
the power to vote shares of common stock
Proxy fight - Answer-An attempt by a person or group to gain control of a fir by getting
its stockholders to grant that or group the authority to vote its shares to replace the
current management.
Takeovers - Answer-An action whereby a person or group succeeds in ousting a firm's
management and taking control of the company.
Preemptive right - Answer-A provision in the corporate charter or bylaws that gives
common stockholders the right to purchase on a pro rata basis new issues of common
stock (or convertible securities)
Classified Stock - Answer-Common stock that is given a special designation such as
Class A or Class B to meet special needs of the company.
Founders shares - Answer-stock owned by the firm's founders that enables them to
maintain control over the company without having to own a majority of stock
Marginal Investor - Answer-A representative investor whose actions reflect the beliefs of
those people who are currently trading a stock. It is the marginal investor who
determines a stock's price.
Market Price - Answer-The price at which a stock sells in the market.
Growth Rate g - Answer-The expected rate of growth in dividends per share
rs - Answer-required or minimum acceptable rate of return on the stock considering its
riskiness and the returns available on other investments
, expected rate of return
^
rs - Answer-The rate of return on a common stock that a stockholder expects to receive
in the future.
Rate of return
-
rs - Answer-The rate of return on a common stock actually received by stockholders in
some past period,
-
rs may be greater or less than
^
rs or rs
Dividend yield D1/P0 - Answer-The expected dividend divided by the current price of a
share of stock
Expected Capital gains yield
^
(P1 - P0) / P0 - Answer-The capital gain during a given year divided by the beginning
price.
expected total return - Answer-the sum of the expected dividend yield and the expected
capital gains yield
constant growth or Gordon model - Answer-Used to find the value of a constant growth
stock.
Zero Growth Stock - Answer-A common stock whose future dividends are not expected
to grow at all; that is, g=0
Supernormal, or nonconstant growth - Answer-The part of the firm's life cycle in which it
grows much faster than the economy as a whole
Horizon, or terminal, date - Answer-The date when the growth rate becomes constant.
At this date, it is no longer necessary to forecast the individual dividends.
horizon, or continuing, value - Answer-the value at the horizon date of all dividends
expected thereafter
Corporation Valuation Model - Answer-A valuation model used as an alternative to the
discounted dividend model to determine a firm's value, especially one with no history of
CORRECT ANSWERS
Mortgage Bonds - Answer-A bond backed by fixed assets. First mortgage bonds are
senior in priority to claims of second mortgage bonds.
Indenture - Answer-A formal agreement between the issuer and the bond holder
Debenture - Answer-A long-term bond that is not secured by a mortgage on specific
property
Subordinated debentures - Answer-bonds having a claim on assets only after the senior
debt has been paid in full in the event of liquidation
Investment Grade Bonds - Answer-Bonds rated triple-B or higher; many banks and
other institutional investors are permitted by law to hold only investment-grade bonds
Junk Bonds - Answer-High-risk, high-yield bonds.
Immunization - Answer-The process of selecting bonds with coupons and maturities so
that the benefits or losses from changes in reinvestment rates are exactly offset by
losses or gains in the prices of bonds
Rebalanced - Answer-The process of periodically adjusting the composition of bond
portfolio due to interest rate changes so that the portfolio due to interest rates changes
so that the portfolio remains immunized against adverse effects of changes in interest
rates.
Risk - Answer-The chance that some unfavorable event will occur
Stand-alone risk - Answer-The risk an investor would face if he or she held only one
asset.
Probability - Answer-Listings of possibel outcomes or events with a probability (chance
of occurrence) assigned to each outcome
expected rate of return - Answer-the rate of return expected to be realized from an
investment; the weighted average of the probability distribution of possible results
Standard deviation - Answer-A statistical measure of the variability of a set of
observations
,Sharpe Ratio - Answer-A measure of standalone risk that compares the assets realized
excess returns to tis standard deviation over a specified period. An investment with a
higher ratio has performed better than one with a lower ratio.
Risk Aversion - Answer-Risk averse investors dislike risk and require higher rates of
return as an inducement to buy riskier securities
Risk Premium (RP) - Answer-the difference between the expected rate of return on a
given risky asset and that on a less risky asset
Capital Asset Pricing Model (CAPM) - Answer-A model based on the proposition that
any stocks required rate of return is equal to the risk-free rate of return plus a risk
premium that reflects only the risk remaining after diversification.
expected return on a portfolio - Answer-the weighted average of the expected returns
on the assets held in the portfolio
Realized rates of return - Answer-Returns that were actually earned during some past
period. Actual returns usually turn out to be different from expected returns except for
riskless assets.
Relevant risk - Answer-the risk that remains once a stock in a diversified portfolio is its
contribution to the portfolios market risk. It is measured by the extent to which the stock
moves up and down with the market.
beta coefficient - Answer-A metric that shows the extent to which a given stocks returns
move up and down with the stock market. Beta measures market risk.
Average stocks beta - Answer-By definition, bA=1 because an average-risk stock is one
that tends to move up and down in step with the general market
^
r i - Answer-expected rate of return on the ith stock
r i - Answer-required rate of on the ith stock. Note that if ri is less than ri, the typical
investor will not purchase this stock or will sell if he or she owns it. If the ri is greater
than ri, the investor will purchase the stock because it looks like a bargain. Investors will
be
indifferent if
^
ri=ri. Buying and selling by investors tends to force the expected return to equal the
required return, although the two can differ from time to time before the adjustment is
completed.
,-
ri - Answer-realized, after-the-fact- return A person obviously does not know ri hat at the
time he or she is considering the purchase of a stock.
rRF - Answer-risk-free rate of return. In the context, rRF is is generally measured by the
return on U.S. Treasury Securities. Some analysts recommend that short-term T-bills be
used; other recommend long-term T bonds. We generally use T-bonds because their
maturity is closer to average investors holding period
Market Risk Premium, RPm - Answer-The additional return over the risk-free rate
needed to compensate investors for assuming an average amount of risk.
Security Market Line (SML) - Answer-An equation that shows the relationship between
risk as measured by beta and the required rates of return on individual securities.
Proxy - Answer-a document giving one person the authority to act for another, typically
the power to vote shares of common stock
Proxy fight - Answer-An attempt by a person or group to gain control of a fir by getting
its stockholders to grant that or group the authority to vote its shares to replace the
current management.
Takeovers - Answer-An action whereby a person or group succeeds in ousting a firm's
management and taking control of the company.
Preemptive right - Answer-A provision in the corporate charter or bylaws that gives
common stockholders the right to purchase on a pro rata basis new issues of common
stock (or convertible securities)
Classified Stock - Answer-Common stock that is given a special designation such as
Class A or Class B to meet special needs of the company.
Founders shares - Answer-stock owned by the firm's founders that enables them to
maintain control over the company without having to own a majority of stock
Marginal Investor - Answer-A representative investor whose actions reflect the beliefs of
those people who are currently trading a stock. It is the marginal investor who
determines a stock's price.
Market Price - Answer-The price at which a stock sells in the market.
Growth Rate g - Answer-The expected rate of growth in dividends per share
rs - Answer-required or minimum acceptable rate of return on the stock considering its
riskiness and the returns available on other investments
, expected rate of return
^
rs - Answer-The rate of return on a common stock that a stockholder expects to receive
in the future.
Rate of return
-
rs - Answer-The rate of return on a common stock actually received by stockholders in
some past period,
-
rs may be greater or less than
^
rs or rs
Dividend yield D1/P0 - Answer-The expected dividend divided by the current price of a
share of stock
Expected Capital gains yield
^
(P1 - P0) / P0 - Answer-The capital gain during a given year divided by the beginning
price.
expected total return - Answer-the sum of the expected dividend yield and the expected
capital gains yield
constant growth or Gordon model - Answer-Used to find the value of a constant growth
stock.
Zero Growth Stock - Answer-A common stock whose future dividends are not expected
to grow at all; that is, g=0
Supernormal, or nonconstant growth - Answer-The part of the firm's life cycle in which it
grows much faster than the economy as a whole
Horizon, or terminal, date - Answer-The date when the growth rate becomes constant.
At this date, it is no longer necessary to forecast the individual dividends.
horizon, or continuing, value - Answer-the value at the horizon date of all dividends
expected thereafter
Corporation Valuation Model - Answer-A valuation model used as an alternative to the
discounted dividend model to determine a firm's value, especially one with no history of
