1.3.

7 Module Evaluation
1. The "yield curve" shows the relationship between bonds' maturities and their yields. 
-True
2. If investors expect the rate of inflation to increase sharply in the future, then we should not be
surprised to see an upward-sloping yield curve.
-True
3. During periods when inflation is increasing, interest rates tend to increase, while interest rates
tend to fall when inflation is declining. 
-True
4. If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term
U.S. Treasury bond should be equal to the real risk-free rate, r*. 
-True
5. An upward-sloping yield curve is often call a "normal" yield curve, while a downward-sloping
yield curve is called "abnormal." 
-True
6. The standard deviation is a better measure of risk than the coefficient of variation if the
expected returns of the securities being compared differ significantly.
-False
7. A stock's beta is more relevant as a measure of risk to an investor who holds only one stock
than to an investor who holds a well-diversified portfolio.
-False
8. Managers should under no conditions take actions that increase their firm's risk relative to the
market, regardless of how much those actions would increase the firm's expected rate of return.
-False
9. The realized return on a stock portfolio is the weighted average of the expected returns on the
stocks in the portfolio.
-False
10. The tighter the probability distribution of its expected future returns, the greater the risk of a
given investment as measured by its standard deviation.
-False
11. Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 3.10%,
and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t
is the number of years to maturity, hence the pure expectations theory is NOT What rate of
return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if
averaging is required, use the arithmetic average.
-7.70%
12. Which of the following statements is CORRECT?
-If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater
than zero, the Treasury bond yield curve must be upward sloping.
13. Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be
constant at 4.10%. What rate of return would you expect on a 5-year Treasury security, assuming
the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is
required, use the arithmetic average.
-6.60%
14. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be
constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-
product terms, i.e., if averaging is required, use the arithmetic average.
-3.80%
15. Assume that interest rates on 20-year Treasury and corporate bonds are as follows:
T-bond = 7.72%
AAA = 8.72%
A = 9.64%
BBB = 10.18%
The differences in these rates were probably caused primarily by:
-Default and liquidity risk differences.
16. Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an
expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market
risk premium, rM − rRF, is 6%. Assume that the market is in equilibrium. Portfolio AB has 50%
invested in Stock A and 50% invested in Stock B. The returns of Stock A and Stock B are
independent of one another, i.e., the correlation coefficient between them is zero. Which of the
following statements is CORRECT?
-  Stock A's beta is 0.8333.
17. You have the following data on three stocks:

Standard
Stock Beta
Deviation
A 20% 0.59
B 10% 0.61
C 12% 1.29

If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and
Stock ____ if it is to be held as part of a well-diversified portfolio.
-B;A
18. Consider the following information for three stocks, A, B, and C. The stocks' returns are
positively but not perfectly positively correlated with one another, i.e., the correlations are all
between 0 and 1.

Expected Standard
Stock Beta
Return Deviation
A 10% 20% 1.0
B 10% 10% 1.0
C 12% 12% 1.4

Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has
one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market
is in equilibrium, so required returns equal expected returns. Which of the following statements
is CORRECT?
-Portfolio ABC's expected return is 10.66667%.
19. Which of the following statements is CORRECT?
-An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-
diversified portfolio of stocks.
20. Which is the best measure of risk for a single asset held in isolation, and which is the best
measure for an asset held in a diversified portfolio?
-Coefficient of variation; beta.
 
 3.3.6 Module Evaluation
1. According to the non-constant growth model discussed in the textbook, the discount rate used
to find the present value of the expected cash flows during the initial growth period is the same
as the discount rate used to find the PVs of cash flows during the subsequent constant growth
period.
-True
2. Projected free cash flows should be discounted at the firm’s weighted average cost of capital
to find the firm’s total corporate value.
- True
3. Preferred stock is a hybrid – a sort of cross between a common stock and a bond – in the sense
that it pays dividends that normally increase annually like a stock but its payments are
contractually guaranteed like interest on a bond.
-False
4. If a stock’s market price exceeds its intrinsic value as seen by the marginal investor, then the
investor will sell the stock until its price had fallen down to the level of the investor’s estimate of
the intrinsic value.
-True
5. The cash flow associated with common stock are more difficult to estimate than those related
to bonds because stock has a residual claim against the company versus a contractual obligation
for a bond.
-True
6. A call provision gives bondholders the right to demand, or “call for” repayment of a bond.
Typically, companies call bonds if interest rates rise and do not call them if interest rates decline.
-False
7. The market value of any real or financial asset, including stocks, bonds, or art work purchased
in hope of selling it at a profit, may be estimated by determining future cash flows and then
discounting them back to the present.
-True
8. Junk bonds are high risk, high-yield debt instruments. They are often used to finance
leveraged buyouts and mergers, and to provide financing to companies of questionable financial
strength.
-True
9. A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to
maturity, cannot be called, and is not expected to default. The bond should sell at a premium if
market interest rates are below 10% and at a discount if interest rates are greater than 10%.
-True
10.If the required rate of return on a bond (rd) is greater than its coupon interest rate and will
remain above that rate, then the market value of the bond will always be below its par value until
the bond matures, at which time its market value will equal its par value.
-True
11. Shinra Enterprises' bonds currently sell for $1,050. They have a 6-year maturity, an annual
coupon of $75, and a par value of $1,000. What is their current yield?
-7.14%
12. A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently
sells for $925. If the yield to maturity remains at its current rate, what will the price be 5 years
from now?
-$930.11
13. Murdock Corporation's bonds have a 15-year maturity, a 7.25% semiannual coupon, and a
par value of $1,000. The going interest rate (rd) is 6.20%, based on semiannual compounding.
What is the bond's price?
-$1,101.58
 14. The Isolet Company just paid a dividend of $0.75 per share, and that dividend is expected to
grow at a constant rate of 5.50% per year in the future. The company's beta is 1.15, the market
risk premium is 5.00%, and the risk-free rate is 4.00%. What is the company's current stock
price, P0?
-$18.62
15. Exusai Inc.'s stock has a required rate of return of 10.25%, and it sells for $57.50 per share.
The dividend is expected to grow at a constant rate of 6.00% per year. What is the expected year-
end dividend, D1?
-$2.44
16. Kale Inc. forecasts the free cash flows (in millions) shown below. If the weighted average
cost of capital is 11.0% and FCF is expected to grow at a rate of 5.0% after Year 2, what is the
firm's total corporate value, in millions? 

Year 1 2

Free
cash −$50 $100
flow

-$1,456
17. Siege Inc.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per share.
Goode's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend,
D0?
-$1.05
18. Rekos Inc. has an outstanding issue of perpetual preferred stock with an annual dividend of
$7.50 per share. If the required return on this preferred stock is 6.5%, at what price should the
stock sell?
-$115.38
 19. Politia Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal
coupon, semiannual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to
maturity, but it can be called in 6 years at a price of $1,120. What is the bond's nominal yield to
call?
-6.53%
 20. Rhodes Inc. recently issued noncallable bonds that mature in 15 years. They have a par value
of $1,000 and an annual coupon of 5.7%. If the current market interest rate is 7.0%, at what price
should the bonds sell?
-$881.60