1.   Suppose your broker offers you the following deal: Invest $1,000 today, and you will receive $10,000 in ten years from today. What is the implied interest rate of this deal expressed as an APR, semi- annually compounded?

a)   125.9%

b)   24.4%

c)   25.9%

d)   18.8%

e)   1,000%

2.   Consider a loan of $100,000 that is paid off annually over the next ten years. This involves ten equal annual payments, starting one year from today. Assuming an interest rate of 6% (EAR), what is the second annual payment?

a)   $13,587

b)   $8,042

c)   $10,000

d)   $6,000

e)   $12,000

3.   How much money will you be having in 17 years if you invest $2,300 five years from now at an effective annual rate (EAR) of 7%?

a)   $2,461

b)   $4,841

c)   $5,315

d)   $5,180

e)   $5,543

4.   You are comparing interest rates on consumer loans from two banks. Bank A quotes a monthly compounded APR, and Bank B quotes a quarterly compounded APR. If the quoted rates of both banks are 7%, you can say that:

a)   The EARs of both banks are the same

b)   The quoted APR of Bank A is greater than the quoted APR of Bank B

c)   It is cheaper to borrow from Bank A

d)   The quoted APR of Bank A is less than the quoted APR of Bank B

e)   It is cheaper to borrow from Bank B

5.   Which of the following bonds is the least price-sensitive to an unexpected change in the market interest rate? Assume a market interest of 8% (EAR) for all the bonds.

a)   A zero coupon bond (discount bond) with 7 years to maturity

b)   A coupon bond with semi-annual coupons, a 10% coupon rate, and 7 years to maturity

c)   A zero coupon bond (discount bond) with 10 years to maturity

d)   A coupon bond with annual coupons, a 5% coupon rate, and 7 years to maturity

e)   A coupon bond with annual coupons, a 10% coupon rate, and 7 years to maturity

6.   Forever Inc. just paid its annual dividend and its stock is currently traded at $50 (after the dividend payment). Investors expect next year’s dividend to be $3, and their required rate ofreturn is 11% (EAR). Assuming Forever Inc.’s dividend growth rate is constant forever, what was the dividend Forever Inc. just paid per share today?

a)   $3.00

b)   $2.70

c)   $2.83

d)   $2.55

e)   $2.86

7.   What is the payback period (in years) of a project that requires an investment of $75,000 today (t=0) and promises annual cash flows of $16,000 to perpetuity, starting in one year (t=1)?

a)   No payback period

b)   3 years

c)   4 years

d)   5 years

e)   6 years

8.   What is the IRR of Project A, which has the following cash flows (no financial calculator is needed to answer this question):

a)   0%

b)   13%

c)   4%

d)   This project has multiple IRRs

e)   This project has no IRR

9.   Aurum Inc. pays perpetual dividends of $2 per share (D1 = D2 = Dt = $2); next dividend is expected in one year (at t=1). Aurum’s current stock price is $25, it has an equity beta of 1.2, the market risk premium is 5%, and the risk-free rate is 3%. Which of the following statements is true:

a)   The stock is undervalued, and plots above the security market line

b)   The stock is overvalued, and plots above the security market line

c)   The stock’s return is lower than what it should be based on its risk

d)   The stock’s return is higher than what it should be based on its risk

e)   Both A) and D)

10. As the number of stocks in a portfolio increases,

a)   Firm-specific (unsystematic) risk decreases and approaches zero

b)   Market risk decreases

c)   Firm-specific (unsystematic) risk decreases and becomes equal to market risk

d)   Total risk decreases and approaches zero

e)   Systematic risk decreases

11. You are evaluating a call option with an exercise price of $45. The underlying stock will be worth either SD = $35 or SU = $70 when the option expires in one year. The risk-free rate is 4%. In order to replicate the option’s payoff, you need to borrow an amount of money B at the risk-free rate and invest in the following number of stocks ():

a)   1.00

b)   -0.29

c)   0.68

d)   0.71

e)   0.43

12. On January 20, 2010, Fashion Inc. declared a cash dividend of 75 cents per share. On March 18, 2010, Fashion’s stock went ex-dividend (i.e., the ex-dividend date is March  18), and on April  15, 2010 Fashion Inc. will pay the dividend to its shareholders. You bought 100 shares on March 17, 2010. What is the total dividend payment you will receive from Fashion on April 15?

a)   None, because you bought the stock only one day before the ex-dividend date, and it takes two days to register your stock ownership

b)   None, because you bought the stock after the declaration date

c)   None, because you bought the stock before, and not after the ex-dividend date

d)   $75

e)   None of the above

13. Stock A has an expected return of 5% and a standard deviation of 9%. Stock B has an expected return of 8% and a standard deviation of 12%. Stock A and B’s returns are perfectly negatively correlated, i.e., pA,B  = - 1. You want to invest $1,000 in a portfolio that consists of Stock A and B, such that your portfolio has zero risk. How much of your money (in dollars) will you invest in Stock B?

a)   $385

b)   $429

c)   $498

d)   $571

e)   Portfolio risk cannot be reduce beyond the systematic risk of those two stocks

14. A firm’s WACC is 10%, its pre-tax cost of debt is 8%, and its cost of equity is 12%. What is the firm’s debt-to-equity ratio (D/E) if the corporate tax rate is 50%?

a)   No debt

b)   0.33

c)   0.50

d)   0.75

e)   0.25

15. Which of the following would increase the value of a call option: (i) the current stock price increases, (ii) the time-to-maturity is increased, (iii) the strike price is increased, (iv) the volatility of the stock price increases.

a)   (i) only

b)   (iii) only

c)   (i) and (ii) only

d)   (ii), (iii), and (iv) only

e)   All except (iii)

16. Suppose you combine the following two securities (with equal weights) into a portfolio: Stock A (expected return = 12%, variance of returns = 9%, covariance with the market portfolio = 9%) and a risk-free bond (expected return = 5%). What’s the standard deviation of that portfolio?

a)   4.5%

b)   9.0%

c)   15.0%

d)   22.5%

e)   30.0%

17. John is a financial advisor and he always tells his clients that he does not think anyone can devise a consistently successful stock trading strategy based on publicly available information alone (such as financial statements, etc.). Based on this, it is reasonable to conclude that John thinks the stock market is:

a)   Strong-form efficient

b)   Semi-strong form efficient

c)   Weak form efficient

d)   Both A) and B)

e)   Both B) and C)

18. Rights issues (or rights offerings):

a)   Involve “rights” similar to put options

b)   Reduce the number of shares outstanding

c)   Increase the number of shares with no impact on the firm’s total equity

d)   Allow existing shareholders to buy new shares at a specified price

e)   Allocate rights to new shareholders

Use the following information to answer Multiple Choice Problems 19 to 22:

JG Corporation, a firm with a 30% corporate tax rate and a cost of capital of 15%, is considering an investment in a new production machine. The project is expected to last 5 years. You spent $10,000 on a feasibility study that provides the following information:

Incremental (before tax) sales and expenses of the new project are provided in the following table (in $ millions):

19. What is the initial cash outlay (i.e., the total after-tax cash flow at t=0; excluding any CCA tax shield)?

a)   -$1.50 million

b)   -$1.61 million

c)   -$1.57 million

d)   -$1.60 million

e)   -$1.58 million

20. What is the total after-tax cash flow in year 3 (at t=3; excluding any CCA tax shield)?

a)   $0.80 million

b)   $0.56 million

c)   $1.00 million

d)   $1.40 million

e)   $1.16 million

21. What is the total after-tax cash flow in year 5 (at t=5; excluding any CCA tax shield)?

a)   $1.70 million

b)   $1.49 million

c)   $0.49 million

d)   $1.34 million

e)   $0.99 million

22. What is the CCA in year 2 (at t=2)?

a)   $0.371 million

b)   $0.157 million

c)   $0.111 million

d)   $0.675 million

e)   $0.219 million

Use the following information to answer Multiple Choice Problems 23 to 29:

Sunvalley Inc. stock is currently trading at $32. The standard deviation of Sunvalley’s stock returns is 45%, and the continuously compounded risk-free rate is 5%.

23. Consider a European call option on Sunvalley’s stock with an exercise price of $30 and a time to maturity of 2 years. Using the Black-Scholes formula to value this call option, what would be d1?

a)   0.125

b)   0.577

c)   -0.060

d)   0.325

e)   0.486

24. Consider a European call option on Sunvalley’s stock with an exercise price of $40 and a time to maturity of 9 month. Using the Black-Scholes formula, you calculate a d1  of -0.2815 and an N(d2) of 0.2510. Based on this information, what would be the Black-Scholes call option premium (price of the option)? Use the cumulative normal distribution table attached at the end of the exam. Round d1 to the nearest d in the table, do not interpolate?

a)   3.65

b)   1.59

c)   6.07

d)   2.80

e)   4.25

Currently, European call options on Sunvalley stock with an exercise price of $40 and a time to maturity of 7 months are trading at $2.10. European put options with the same exercise price and time to maturity are trading at $9.00. Assume that one option give the right to purchase or sell one stock.

Suppose your broker suggests the following investment strategy: Write one Sunvalley call option and buy one Sunvalley put option (both with an exercise price of $40 and a time to maturity of 7 months).

25. What would be the payoff diagram for the short call option?

26. What would be the payoff diagram of your broker’s option strategy?