2024 Exam II Finance Questions and Answers 100% Correct(Counts 20% of Course Grade) :

2024 Exam II Finance Questions and Answers 100%
Correct(Counts 20% of Course Grade) :

1. What is equity? What are some characteristics of equity?
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a. Explain the following statement: "Whereas a bond contains a promise to pay interest, common stock
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provides an expectation but no promise of dividends."
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b. What is the significance of the par value of a preferred stock? Of a common stock? - ANSW -equity is
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ownership - residual interest in assets after deducting liabilities - representing amount of capital owned -
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includes type of share, par value, preemptive rights
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firm has no obligation to pay dividends on common stock, can choose to re-invest.
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par value of preferred stock is the amount due to investors if firm is liquidated
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par value of common stock is the amount of minimum financial obligation by the investor if the firm is
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liquidated and its debts are repaid
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Discuss the explanations for various shapes of yield curves. - ANSW -Normal curve is upward sloping and
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indicates that the long-term rates are greater than the short-term rates.
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If the rates are equal or similar, the slope will be fairly horizontal.
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A downward facing slope is considered an abnormal or inverted slope.
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Does the length of time to maturity affect the extent to which a given change in interest rates affects a
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bond's price? - ANSW -Yes, the longer the term of the bond, the more significantly the bond's price will be
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affected.
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Explain abnormal curve - ANSW -downward facing slope, indicates long term rates are less than short term
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rates.
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Explain how the Federal Reserve changes the money supply in the United States through open market
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operations. If the Fed wants to increase interest rates, would it buy or sell government securities? Explain
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your answer. - ANSW -Fed can affect the money supply by conducting open market operations, which
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, l affects the federal funds rate. In open operations, the Fed buys and sells government securities in the
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l open market. l l




If the Fed wants to increase the money supply, it buys government bonds. This supplies the securities
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dealers who sell the bonds with cash, increasing the overall money supply.
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Conversely, if the Fed wants to decrease the money supply, it sells bonds from its account, thus taking in
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cash and removing money from the economic system.
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Explain normal curve - ANSW -upward facing slope, indicates short term rates are less than long term rates
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Following are the yields on three Treasury bonds. Using the expectations theory, compute the expected
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one-year interest rates in
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(a) the second year (Year 2 only) and
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(b) the third year (Year 3 only).
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The bonds have no risk premiums.
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Type of Bond Yield l l l




1-year 0.2% l




2-year 0.3 l




3-year 0.5 - ANSW -0.3% = (0.2% + x) / 0.2%
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0.6% = 0.2% + x l l l l




expected one-year interest rate for year 2 = 0.4% l l l l l l l l




0.5% = (0.4% + x) / 3 l l l l l l




1.5% = 0.6% + x l l l l




expected one-year interest rate for year 3 = 0.9% l l l l l l l l




For what type of risk is an average investor rewarded? - ANSW -investors should be rewarded for relevant
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risk only, that is, market/systematic risk.
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How are bond prices determined? - ANSW -Bond price is determined by (i) the cash flow it generates, and
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(ii) the rate of return.
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How are bond yields determined? - ANSW -Total yield = current yield + capital gains yield
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