Exam 4 Flashcards
Beth and Bob Martin have a total take-home pay of $4,600 a month. Their monthly expenses total $3,450. Calculate the minimum amount this couple needs to establish an emergency fund. How did you calculate this amount?
$3,450 ×3 months (minimum) = $10,350
Inflation risk
During periods of high inflation, the financial return on an investment may not keep pace with the inflation rate. Therefore, you lose purchasing power.
Interest rate risk
The value of an investment (such as government or corporate bonds) with a fixed rate of return decreases (increases) when overall interest rates in the economy increases (decreases).
Business failure risk
Bad management, unsuccessful products, competition, and the economy may cause the business to be less profitable; affects stocks, corporate bonds, and mutual funds that invest in stocks or bonds.
Market risk
Prices fluctuate because of systematic risk, unsystematic risk, and behaviors of investors.
Three years ago, you purchased 220 shares of IBM stock for $124 a share. Today, you sold your IBM stock for $142 a share. For this problem, ignore commissions that would be charged to buy and sell your IBM shares and dividends you might have received as a shareholder.
a) What is the amount of profit you earned on each share of IBM stock?
b) What is the total amount of profit for your IBM investment?
a) $142 -$124 = $18 per share
b) $18 profit per share ×220 shares = $3,960.
Betty and John Martinez own 180 shares of McDonald’s common stock. McDonald’s annual dividend is $4.04 per share. What is the amount of the dividend check the Martinez couple will receive for this year?
$4.04 x 180 = $727.20
In March, stockholders of Herbalife Nutrition approved a 2-for-1 stock split. After the split, how many shares of Herbalife Nutrition stock will an investor have if she or he owned 160 shares before the split?
After the stock split, he/she owned:
160shares x 2 = 320 shares
Tammy Jackson purchased 100 shares of All-American Manufacturing Company stock at $31.50 a share. One year later, she sold the stock for $38 a share. She paid her broker a $15 commission when she purchased the stock and a $29 commission when she sold it. During the 12 months she owned the stock, she received $160 in dividends. Calculate Tammy’s total return on this investment.
- Total costs of Initial investment = ($31.50 x 100) + $15 = $3,165
- Dividend income = $160
- Ending value = ($38 x 100) -$29 = $3,771 … from the sale of stock
- CapitalGain=$3,771-$3,165=$606
- Total return = Dividend Income + Capital Gain = $160 + $606 = $766
Assume you own shares in Walmart and that the company currently earns $3.28 per share and pays annual dividend payments that total $2.08 a share each year. Calculate the dividend payout for Walmart.
Dividend Payout = Dividend amount/Earnings per share = $2.08/$3.28 = 0.6341 or 63.41%
As a stockholder in Bozo Oil Company, you receive its annual report. In the financial statements, the firm has reported assets of $9 million, liabilities of $5 million, after-tax earnings of $2 million, and 750,000 outstanding shares of common stock.
a) Calculate the earnings per share of Bozo Oil’s common stock.
b) Assuming that a share of Bozo Oil’s common stock has a market value of $40, what is the firm’s price-earnings ratio?
c) Calculate the book value of a share of Bozo Oil’s common stock.
a) Calculate the earnings per share of Bozo Oil’s common stock. EPS = After Tax Income / Number of Shares Outstanding EPS = $2,000,000 / 750,000 shares = $2.67 per share
b) What is the firm’s price-earnings ratio? P/E Ratio = Price per share / Earnings per share = $40.00/$2.67 = 15
c) Book value = (Assets − Liabilities) / Number of shares outstanding Book value = ($9,000,000 -$5,000,000) / 750,000 = $5.33 per share
Thompson Home Remodeling has a 1.30 beta. If the overall stock market increases by 9 percent, how much will the stock for Thompson Home Remodeling change?
Volatility for a stock = Increase in overall market ×Beta for a specific stock
9% x 1.30 = 11.7% increase for Thompson Home Remodeling stock
Common stock
most basic form of ownership for a corporation
Equity financing
Money received from the sale of shares of ownership in a business
Dividend
distribution of money, stock, or other property that a corporation pays to stockholders
proxy
legal form that lists the issues to be decided at a stockholders’ meeting and requests that stockholders transfer their voting rights to some individual or individuals
Record date
The date on which a stockholder must be registered on the corporation’s books in order to receive dividend payments
corporate bond
A corporation’s written pledge that it will repay a specified amount of money, with interest.
Face value
dollar amount the bondholder will receive at the bond’s maturity.
Between the time of purchase and the maturity date, the corporation pays ________ to the bondholder—usually every six months.
interest
Maturity date
- for a corporate bond, the date on which the corporation is to repay the borrowed money.
- generally range from 1-30 years.
bond indenture
legal document that details all of the conditions relating to a bond issue
debenture
bond that is backed only by the reputation of the issuing corporation
mortgage bond
(sometimes called a secured bond) a corporate bond that is secured by various assets of the issuing firm
convertible bond
bond that can be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stock
Jackson Metals, Inc., issued a $1,000 convertible corporate bond. Each bond is convertible to 22 shares of the firm’s common stock. What price must the common stock reach before investors would consider converting their bond to common stock?
$1,000 ÷22 shares = $45.45
In order for investors to convert this bond to common stock, the stock price must be $45.45 or higher.
A corporate bond has a face value of $1,000 and an annual interest rate or coupon rate of 3.6%. What is its annual interest amount and the semiannual interest payment?
Annual interest amount = $1,000 x 3.6% = $36
Semiannual interest payment = $36 ÷2 = $18
Jean Miller purchased a $1,000 corporate bond for $880. The bond paid 4 percent annual interest. Three years later, she sold the bond for $960. Calculate the total return for Ms. Miller’s bond investment.
Annual interest = $1,000 ×0.04 = $40
Three years interest = $40 ×3 = $120
Capital gain = $960 − $880 = $80
Total return = $120 Three years interest + $80 Capital gain = $200
government bond
written pledge of a government or a municipality to repay a specified sum of money, along with interest
Sandra Waterman purchased a 52-week, $1,000 T-bill issued by the U.S. Treasury. The purchase price was $984.
a. What is the amount of the discount?
b. What is the amount Ms. Waterman will receive when the T-Bill matures?
a) Discount = $1,000 maturity value − $984 purchase price = $16
b) Ms. Waterman will receive $1,000, the face value of the T-Bill.
Calculate the purchase price for a 52-week, $1,000 treasury bill with a stated interest rate of 1.80 percent.
Discount = $1,000 ×0.0180 = $18
•T-bill Purchase price = $1,000 − $18 = $982
Assume that you are in the 37 percent tax bracket and purchase a 3.90 percent, tax-exempt municipal bond. What is the taxable equivalent yield for this investment?
Tax equivalent yield = 3.90 percent / (1 –0.37) = 6.19 percent
What is the current price for a $1,000 bond that has a price quote of 91?
$1,000 ×91 percent = $1,000 ×0.91 = $910
A $1,000 face value bond with a 6% interest rate is currently selling for $1,040. What is this bond’s current yield?
Current yield = interest income/market value
Annual interest income = $1,000 x 6% = $60
Current yield = $60/$1,040 = 5.77%
Closed-end fund
fund whose shares are issued by an investment company only when the fund is organized.
Open-End Funds
mutual fund whose shares are issued and redeemed by the investment company at the request of investors.
Given the following information, calculate the net asset value (NAV) for the Boston Equity mutual fund.
•Total assets = $966 million
•Total liabilities = $6 million
•Total number of shares = 38 million
Net asset value (NAV) = (Assets –Liabilities) / Total number of shares
Net asset value = ($760 million − $30 million) / 50 million = $14.60 per share
Exchange-traded fund (ETF)
fund that generally invests in the stocks or other securities contained in a specific stock or securities index
Load fund
mutual fund in which investors pay a commission (as high as 8.5%) every time they purchase shares.
No-load funds
mutual fund for which the individual investor pays no sales charge
Contingent deferred sales loan
1-5% charge that shareholders pay when they withdraw their investment from a mutual fund.
Julie Martin is investing $48,000 in the Invesco Charter mutual fund. The fund charges a 5.50 percent commission when shares are purchased. Calculate the amount of commission Julie must pay.
Dollar amount of commission = Original investment ×Commission stated as a percentage
•The commission = $48,000 ×0.055 = $2,640
•The commission is also referred to as the sales load.
12b-1 fee
fee that an investment company levels to defray the costs of distribution and marketing a mutual fund and commissions paid to brokers who sell shares in the mutual fund
Mathew Johnston invested a total of $52,000 in the New Colony Pacific Region mutual fund. The management fee for this particular fund is 0.80% of the total asset value. Calculate the management fee Mathew must pay this year.
$52,000 total investment ×0.0080 management fee = $416 management fee
Mr. Johnston must pay a $416 management fee.
In the prospectus for the Brazos Aggressive Growth fund, the fee table indicates that the fund has a 12b-1 fee of 0.35 percent and an expense ratio of 1.55 percent that is collected once a year on December 1. Joan and Don Norwood have shares valued at $63,000 on December 1.
a. What is the amount of the 12b-1 fee this year?
b. What is the amount they will pay for expenses this year?
a. $63,000 ×0.0035 = $220.50
b. $63,000 ×0.0155 = $976.50
Assume that one year ago you bought 100 shares of a mutual fund for $13.50 per share, you received a $0.42 per-share capital gain distribution during the past 12 months, and the market value of the fund is now $17.
a. Calculate the total return for this investment if you were to sell it now.
b. Calculate the percentage of total return for your $1,350 investment.
a.
(1) Capital gain distributions = $0.42 ×100 shares = $42
(2) Change in market value = $1,700 sales price − $1,350 purchase price = $350
(3) Total dollar return = $42 + $350 = $392
b. Rate of return = $392 ÷$1,350 = 0.2904 = 29.04%
An example of ____________ risk occurs when the financial return on an investment does not keep up with prices that are increasing in the overall economy.
inflation
The ability of an investment to be converted to cash without a substantial loss in dollar value is called:
liquidity
If interest rates in the overall economy decrease, what will happen to the market value of a corporate bond with a fixed interest rate?
The value of the bond will increase
What is the primary goal of asset allocation?
risk reduction
If you invest $2,000 in a stock and the stock pays you $35 in dividends each year and is worth $2,150 at the end of one year, then what is your rate of return?
[($2,150 − $2,000) + $35] / $2,000 = 0.0925
9.25%
Christopher Pratt just bought shares of common stock. Which one of the following is he entitled to based on his ownership of these shares?
Right to vote at annual meetings
The federal government requires that a corporation selling a new issue of securities must disclose information about the company and its finances in a(n):
prospectus
Mellon Manufacturing has after-tax income of $6 million. It also has 4 million shares of stock outstanding. What is the corporation’s earnings per share?
$1.50
If the board of directors approves a two-for-one stock split, an investor who owns 125 shares before the split will own ____________ shares after the split.
250
True or false? Investors should be concerned about the corporation’s ability to earn profits and pay dividends in the future.
True
True or false? Board members are appointed by a company’s management.
False
True or false? Stockholders receive a tax break on dividend income.
False
True or false? If a cash dividend is declared by the board of directors, each stockholder will receive a different dollar amount per share.
False
True or false? Corporate dividends are always paid in cash.
False
Which one of the following statements is true regarding bond characteristics?
Long-term corporate bonds have maturities over 10 years.
If a bond is quoted in the newspaper at 103, the current price of a $1,000 face value bond is:
$1,030.00
What is the current yield for a $1,000 corporate bond that pays 6 percent and has a current market value of $600?
10%
True or false? There is no need to evaluate mutual fund investments, because investment companies hire the best professional managers they can to manage their funds.
False
True or false? The responsibility for choosing the right mutual fund rests with the individual investor.
True
True or false? Investors should evaluate their investments on a regular basis.
True
True or false? Individual investors should be involved in choosing a mutual fund, because they know how the objectives of a mutual fund match their own investment objectives.
True
Which one of the following is true with respect to closed-end funds?
Shares are traded on security exchanges similar to stocks.
Together, all the different management fees, 12b-1 fees, and additional operating costs for a specific fund are referred to as a(n):
expense ratio
The Capitalist Mutual Fund’s portfolio is valued at $40 million. The fund has liabilities of $2 million, and the investment company sponsoring the fund has issued 1,250,000 shares. What is the fund’s net asset value?
$30.40
