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University of Santo TomasAlfredo M. Velayo - College of Accountancy A.Y. 2016-2017 REVIEWER FOR FINANCIAL MANAGEMENT I. NOTES Sole Partnership Corporation Introduction to Financial Management Proprietorship (General) Finance consists of 3 inter-related areas: easy and inexpensive to form Tedious to money and capital markets form investments difficult to find financing/raise easy to find financial management capital financing Kinds of organizations: unlimited personal liability limited personal Sole Proprietorship liability Partnership - There’s always must be at least one limited life unlimited life general partner. When there are no no corporate subject to corporate income general partners, it is called an LLC. income tax tax Corporation - may be subject to double taxation on regulated by regulated by SEC DTI income: corporate income tax on the income and tax on dividends when income no separate has a separate judicial is distributed judicial personality - Publicly listed company: corporations personality whose shares are offered to the public and subject to few subject to traded in the stock market. Corporations government stricter that already went through initial public regulations government offerings (IPO). regulations - Privately owned company: corporations whose shares are NOT traded in the stock difficult to easy to market. Also called as closely held transfer transfer corporations or privately held ownership ownership corporations. represents stockholders expectations concerning riskiness of to manage the corporation additional future assets Chief Financial Officer (CFO) . including custody of financial records and considered a capital market because interpretation of financial data.creditors lend funds at rates based on: riskiness of firm's existing assets Board of Directors . except they are in the form of a corporation Stockholders VS Creditors .partnership formed for the SOLE purpose of exercising their common profession of which Agency problems NO part of the income is derived from trade or business problems that arise because of conflicts of interests Limited Partnerships Stockholders VS Managers . and Financial Market . maintaining good banking relationships.not allowed in the Philippines bankruptcy Financial Managers of a Corporation . responsible for expectations concerning future financial planning and formulation of capital structure decisions financial corporate strategies. Controller .market for financial assets.Other kinds of organizations: maximizing earnings/profits is only a way toward the goal of maximizing the General Professional Partnership (GPP) corporation's stock price . The CFO supervises the Treasurer and Controller.Bond Market the corporation's stock price market for debt securities . equity securities and debt securities.like a GPP. The Financial Environment Treasurer .handles the accounting and . raising and managing funds.creditors have claim on firm's assets upon .also known as existing capital structure Vice President of Finance.handles the financial aspect of Different Types of Markets the corporation including credit policies.some mechanisms used to motivate Limited Liability Company managers to follow stockholders' best .maximize .partnerships where there is at least one .Stock Market budgeting aspect of the corporation market for equity securities.partnerships where all partners are limited interest: partners managerial compensation .not allowed in the Philippines direct intervention by shareholders threat of firing threat of takeover Professional Corporations .what managers want does not always align limited partner with what the stockholders want . stocks are long-term securities because stocks generally do not have a maturity Goals of a corporation period Stockholder wealth maximization . t-bonds and t. Investment Financial notes. consumer credit loans. life .the price determined today is the price to be Stock Markets used in the future Initial Public Offering VS Season Offering Option contract .when securities bought are of deposit bought directly from issuer. leases Bank Intermediary use of Physical Market .Money Market standardized of product made Market for short-term securities. negotiable certificates Direct transfer . kept or sold securities Spot Market VS Future Market sold to clients back in the bought are market Spot Market Future Market other Price is securities sold their own Today Today companies' determined to clients securities securities Delivery Today Future Examples of Financial Intermediaries: commercial banks.Capital Market Indirect transfer through Investment Bank VS Market for long-term securities. corporation third…) . money market Financial Institutions mutual funds. Private Market Public Market Characteristic unique/tailor- . Financial Intermediary examples: common and preferred stocks. corporate bonds. mutual funds.market for real assets yes no underwriters or tangible assets.the price determined today which is the price to be used in IPO SO the future is OPTIONAL shares are after first time issued by the first time (second. also called fixed income market Private Market VS Public Market because of the fixed income brought by periodic interest payments. . commercial papers. mortgages.Types of Future Market: insurance companies Forward contract . Examples life insurance stock market (short term = 1 year or less) examples: T-bills. 000 payable sold by issuer semi-annually.1 cost of money .premium imposed to account for the APR APY possibility of non-payment of principal by cos t of fi nancing that cos t of fi nancing that borrower cons iders only the cons iders s i mple i nterest compounding . What is APR? Interest Rates APR = 3.interest rate that represents risk-free to be ma de security w/ inflation .if cross term format.inflation Real risk free interest rate (r*) .not present in government bonds .interest rate that represents risk-free security w/o inflation Nominal and Effective Interest Rate Inflation Premium (IP) Nomi na l Interes t Ra te Effecti ve Interes t Ra te . r = r* + IP + (r* x IP) Percentage Yield (APY) Default Risk Premium (DRP) .production opportunities .Primary Market VS Secondary Market Primary Secondary Example: anyone other Manfin issued a bond with a value of shares are issuer than the PHP100.present in corporate bonds a l so known as .time preferences for consumption .1 I = i nterest a mount i = nomi nal annual interest .not present in government bonds Effecti ve Annual Rate Liquidity Premium (LP) APR = I / (PxT) APY = [1+(i /m)] m .000)(180/360) APR = 6% Interest What is APY? APY = [1+(i/m)] m .000 with an interest PHP3.000 / (100. r = r* + IP Annual Percentage Rate (APR) and Annual . m = number of periods in a .p.premium imposed on interest rate to s ta ted rate/coupon effective rate/discount account for inflation ra te ra te Risk free interest rate (r) represents the ra te represents the present s ta ted on the bond va l ue of the payments .premium imposed to account for the P = pri ncipal ra te convertibility of the security into cash T = ti me period (year.) Components of Nominal Interest Rate .1 borrowed APY = 6.i.present in corporate bonds us ually 360) yea r .risk NIR = r + DRP + LP + MRP .09% factors that affect the cost of money (interest rates): (t.r.if simple format.price for the money APY = [1+(6%/2)] 2 . [(3%)(20%)] profit earned on investment rate of return (%) ERR = 3.premium imposed to account for the ARR = 4% interest rate risk .8% investment . he sold it for PHP104.000 .(amount received or current value of RRR = 4% > ERR = 3.Interest rate risk .amount invested) / amount invested IDILY Co. Corporate issued 4% 50% . Corporate issued .NIR = r + DRP + LP -3% 20% Long term. 6% in over time the second year. the fluctuations of interest rates and prices She expects to earn 7% in the first year. Government issued regarding the investment's return: . What is the rate of return? .2 P placement.8% .present in both LONG-term government ERR = 5.000 .. Should they invest on the merchandising firm? Returns ERR = [(8%)(30%)] + [(4%)(50%)] . What .NIR = r + DRP + LP + MRP Risk and Returns IDILY has a RRR of 4%. the higher is her expected rate of return? the MRP ERR = 7% + 6% + 4% / 3 . is considering to invest on a Nominal Interest Rate of Securities: merchandising firm with a series of probabilities Short-term. return expected to be realized Required Rate of Return (RRR) = minimum Risk rate of return acceptable by the investor chance of loss Actual Rate of Return (ARR) = rate actually earned Risk in a Single asset Market Equilibrium = when RRR is equal to Stand Alone risk .the possible loss due to (b) Carson invested in a stocks of Lasinga Co. and 4% in the third year. Market Risk Premium (MRP) ARR = (104.67% and corporate bonds (c) IDILY Co.NIR = r + MRP 8% 30% Short-term.000) / 100.risk when holding only one ERR on an investment asset Example: Standard Deviation (σ) .000.NIR = r Return Probability Long-term. Government issued .a tool to determine level of risk (a) Dio invested PHP100.000 in a money market .100.the longer the maturity period. should not invest on the merchandising firm because the ERR doesn't Expected Rate of Return (ERR) = rate of meet or surpass the RRR. After a year.σ = √∑ . 8% 0.rf = risk-free rate of return or return on Standard Deviation ( √∑ .3.represent the relative level of risk.r = required return on the security 2 .r = rf + β(MRP).more meaningful basis for comparison β = 1. ) .does nothing to reduce risk if the portfolio is equal to the results to a results to a consists of perfectly positively correlated change in the lower change higher change stocks return on the in the return in the return investment on the on the .000002 the risk-free rate of return plus a risk = 0.004624 0.reduces risk but does not eliminate it investment investment . the higher the risk.0 β < 1.measure of risk per return . .3. or **P = Probability .rf).8% 0.8% = 0.0 when the expected returns on two alternatives are not the same average beta defensive/ aggressive beta conservative Risk in a Portfolio beta Diversification change in change in change in .)2 . eliminated by proper diversification Market Risk . example).rm = market rate of return or return on risky securities Coefficient of Variation (CV) .82% .0 β > 1. the higher .r = rf + β(rm . riskiness of a portfolio will probability of experiencing different decline as the number of stocks in the amounts of return portfolio increases .CV = σ / .001764 0.as a rule.MRP = market risk premium . Return Capital Asset Pricing Model (CAPM) 8% 8% .measures the riskiness the higher the CV. Hence.risk that can be merchandising firm (from IDILY Co. of a security . P) riskless securities = 0.2% stock’s required rate of return is equal to 4% 4% .the higher standard deviation.r = rf + Risk Premium Variance ( ∑ .3.risk that cannot be eliminated Expected .001456 .000529 .2% premium that reflects only the risk remaining after diversification -3% -3% .) 2P** by diversification. or .038157568 or 3.8% CAPM formula: 0.impossible to form completely riskless Example: stock portfolios Find the standard deviation of the return on the Diversifiable Risk .investing in more securities to reduce risk market return market return market return .A model based on the proposition that any 4.001456 . 2 P) = 0.000925 = -6.000004 0. Beta Coefficient (β) . market rate = same .market rate = changes .MRP = change .risk free rate = same ma rket risk premium RRR ri s k free rate β .Security Market Line (SML) graphically depict the interaction between Beta and Required Rates of Returns (RRR) l i ne representing ma rket ra te RRR ma rket risk premium β ri s k free rate change in SML due to change in inflation .MRP = same .risk free rate = changes ma rket risk premium RRR ri s k free rate β change in SML due to investors' behavior . 8. transaction if he contracted with the seller at 7. Life insurance is a private market potential because of poor management. Conflicts between stockholders and creditors of a corporation can exist. 13. 1. C if both True or False statements are correct. corporation is also a private market 15. Underwriters facilitate issuance of securities in direct transfers of securities. can be done without making an Initial Public 3. 5. Treasury notes are capital market 12. stakeholders are stockholders. mortgages are also sold on physical 10. The primary goal of a corporation's 2. Introduction to Financial Management second statement is correct. Hence. 4. 4. Hostile takeovers most likely occur when a firm's stock is undervalued relative to its 6. Sale of bonds by a private 14. problem if the managers of the firm own 2017. General Partnerships are treated like corporations regarding 30% corporate 3. 1. Creditors are not prioritized over transactions. You can set up a Limited Liability Company in the same corporation. 8. transaction. 2017. Hedging is an example of a derivative. Interest rates can affect stock price. Stocks of a corporation can be sold in a management is to maximize the primary market. The Controller does not handle the investing asset markets because they are claims on decisions of the corporation. accounting aspect of the corporation. if she buys 50 pieces of iPhone S7 at March 6. between a partnership and a corporation. Carson engages in a spot market transaction income tax. The Controller does not handle the products are real assets like house and lots. Physical asset markets are those where the 9. 2017 to buy 50 kilos of rice in the stock at a stated price within a specified date's current price but agreed with the time. Dio engages in a futures market 100% of the common stock. Executive stock options are options to sell March 12. be sold in a secondary market. . capital market transactions. Questions B. real assets. 7. and D if none of the statements are correct. A Seasoned Offering the Philippines legally. treasury bills are stockholders in the event of bankruptcy. Limited Liability Companies is a hybrid Offering first. II. seller to deliver the goods on June 14. The corporation will not suffer an agency 12. 2017 but arrives in her shop at March 14. All stockholders are stakeholders and all transaction. B if the A. Corporate earnings may be subject to double taxation. Hedging is an example of a forward contract. Underwriters are unnecessary in direct transfers of securities. Initial Public Offering can be done twice by 2. Stocks of a corporation can corporation's profit. Similarly. The Financial Environment Theories Write A if the first statement is correct. 5. Maximizing earnings per share is the same as maximizing stock price per share. 11. Financial intermediaries 8. The lesser the production opportunities of a Stockholders also earn fixed income from borrower. the lower the rate. 1. continuously. 15. for selling securities. there is a 4. Default risk premiums act as a compensation 3. market transactions. The term structure of interest rates pertain the real risk free interest rate is infused with to the relationship between bond yields and inflation premium. Identification 15. Common stocks are just like the borrower’s production capital market transactions. Investment banks are merely intermediaries risks of a portfolio. direction as the market change. securities that are fairly more difficult to 2. 9. It is the additional interest provided for in case a borrower will default. 13. opportunities. extent it contributes to the market risks. 1. 11. money market transactions. Due to diversification. 3. return. Risk and Returns & Interest Rates of risks. Bonds are riskier than common stock. degree of change in stock. we take into account all of the possible risks that may exist. the maturity of the bonds. we are only concerned to the regarding the securities they buy. may ask for higher returns. Common stocks are less risky than preferred stocks. You can invest in the securities issued by a 6. 13. If we measure the risk of an asset in a are not intermediaries to their investors portfolio. Mutual funds pools money from investors to 10. It is the state where the required rate equals premium. A change in investor behavior will shift the buy a portfolio of securities. are investment banks. the direction of 6. 4. 9. they don't issue their own securities. Mutual funds security market line. True or False 2. the wider and flatter the graph. one may not simply get the weighted average of the standard 14. When we measure risk. The term used to pertain to the rate where 5. You can't invest in the incorporated in calculating rates is to reflect securities of an investment bank because the interest rate risk. Corporate bonds are also risks of portfolios. Systematic risks are those that may be earning at a net profit for several years eliminated through diversification. has a direct relationship with interest rate. 11. When a market change will cause a higher convert into cash. Market return determines market risk 5. It is the beta when stocks respond directly to movement of shares shall be in the same fluctuations in the market. Bondholders have a fixed income. It is the interest rate that does not consider compounding effects. A behavior wherein investors generally do not want risks but with considerable amount C. their shares if the corporation has been 14. The higher the standard deviation. Preferred stocks are classified as money 12. It is the relative level of risk per unit of defensive beta. The reason why maturity risk premium is financial intermediary. Measuring the risks of a standalone instrument is the same as measuring the 10. 12. . 7. the expected rate. D. 7. In all the three types of beta. Commercial papers are money market deviation of each instrument to measure the transactions. Lender’s time preference for consumption. This measures portfolio riskiness and D. Investors who are willing to take risks when D. Upward sloping 13. A and B D. Market risk premium determines A. A normal term structure of a bond is to its existence in the market. Which is incorrect? A. Due to their high prices. The method in calculating the interest rate 4. Variable returns may be based on simple averages or on probabilities 2. Correlation coefficient is measured 11. A defensive beta has a beta that is C. invest yearly. 8. luxury goods B. the security market line’s slope to higher returns are offered become flatter A. Risk Takers 3. the security market line’s slope to become steeper 8. Either a or b A. Calculating the weighted average of the inflation premium are relatively high and standard deviations will determine material. Market portfolios contain diversifiable 10. What are the possible reasons for a shift in risks the security market line? D. Neither a or b B. Risk is about the dispersal of the B. Less than zero C. the security market line to shift market rate downwards D. What is the premium not incorporated in the B. What does a negative beta suggest? invest in a long-maturity security than to A. Equal to one D. The portfolio is that of luxury goods E. If market performance gets better. It is the risk which states that it is better to 6. Defensive beta A. the security market line to shift are less volatile and have betas less upwards than one C. The portfolio is that of inferior goods 1. A. Risk Averse B. Aggressive beta possible returns rather than the loss C. It is the particular risk of a security in relation 5. Diversification makes more sense in a rates of sovereign state-issued and perfectly positive relationship government-issued securities? C. A change in investor behavior causes C. C. More than one . portfolio risks and volatility 9. What are the possible reasons for a change through roh in the slope of a security market line? 12. Which is correct? used when the real risk free interest rate and A. Less than one D. Multiple Choice C. Humped 14. returns will be higher B. Consistent volatility 15. The beta that causes a higher degree of change in stock when the market changes 7. It is the minimum rate of return acceptable B. Conservative beta itself D. Downward sloping for an investor on a portfolio investment. None of the above B. 7685 b. P12.3572 b.00 c. P12. Standard deviation = 10% possible returns: d. P12. beta of 0. Default risk premium with all other investments the same. Investment D: Expected return = 11%. This premium depends on the several credit characteristics ultimately embodied in some 3. 9. Neither A or B following distribution? F. P18. 21. given the D. 1. Maturity risk premium a. the change in market risk possible returns (and their likelihood of premium is not the same as the rate of occurring) for the Icahn Trust Corporation change in slope stock. Problems Scenario 1: probability = 20%. 56. return = -40% Scenario 2: probability = 50%.12% 11%.6578 10.56% prefer? c. B. 0. 1. Standard deviation = 10% standard deviation of these possible returns c. return = 0% Risk and Returns Scenario 3: probability = 30%. B.0909 rate changes at the same rate B. If the real risk free rate change. beta of 1.000. and C. Investment A: Expected return = d. Which is true about the security market line? c. If an investor becomes more risk 4. 35. market d. 0. given the following 11%. P20. P12. Investment B: Expected return = 5. considering the amount invested Normal 50% +P10 in each security and the individual security Bomb 30% -P10 betas? Security A: Invested P30.000. return = 30% 1. Liquidity premium Joe's portfolio beta? D. What is the beta of his Success 20% +P50 portfolio. P21. Consider Joe Investor once again (the credit scores or ratings previous problem).78% investment would a risk averse investor b. 1.50 a.000 in Security C (instead of P20.9123 d.8900 b.4789 c. An analyst has provided information on averse.000.26% a.000). Joe Investor has invested in three securities: A. Which a. 1.50 a. Inflation premium P100.8997 A. Consider the following investments.8806 Security C: Invested P20. Both A and B expected returns for this stock. Investment C: Expected return = for the Pizza Palace.8943 . 24. Standard deviation = 11% Possible dollar Scenario Probability return 2. What is the standard deviation of the C. 0. P22. beta of 2. what is C.6789 Security B: Invested P20. 0. Calculate the expected peso return and the 10%. If he had invested A.2098 d. Standard deviation = 12% b. 13.55% d.e.2% c. Clive Rodney Megabucks offers your friend.999 instead of her choice of and the beta of the industry of which the box. 194. For an interest rate of 2% per month. of course. being risk averse 8.82% .75. an interesting gamble involving 12. The firm of Sun and Moon purchased a b.55% box has P20. the effective a. the required return on Plaid Pants' not call off the gamble if you offered her a common stock should be.6 percent. Plaid Pants. The market beta is. and the required certain P4.62% that the chosen box contains cash versus d.75. 26. she would be indifferent if P5.2 percent and she would definitely take P5. more than 0.000 a. identical-looking boxes. 1. 7. 4% c. return on Acme's common stock should be However. 7.10 b. Espinosa Coffee & Trading. but less than 1. the giving her the choice of the contents in one effective semiannual rate is closest to: of two sealed.95 {i.00 + 1.6.6 percent.999 instead of her choice of box. common stock has a beta Yunyoung. 12% nothing inside. During the past year the common stock paid an annual dividend Interest Rates of P2. 9. b. she would be indifferent if company is a part is 1. Clive Rodney Megabucks offers your friend. However. 9.001 to call off the gamble. 11.10)} 10. One expected return on the market is 10 box has P20. Melanie.10 a.75 instance.000 in cash and the second has b.80. 88. 12% d.68% 9.001 to call c. There is an equal probability c.10. that adjusted P11. 14. nothing inside.0 percent. 23. 5.3% interest rate per year is closest to: b. being risk indifferent share of Acme. Yunyoung states that she would above.0 percent off the gamble. equal to 1.2% a. The of two sealed. having a risk preference one year ago for P45.000 in cash and the second has percent. (1/3) x (0. b.9% b. We would describe d. 94. If Merrill Lych P11. less than 0. 12.0 percent. For an interest rate of 12% per year has earned? compounded quarterly. equal to 0. One a. 18. The firm sold the security today for P85. an interesting gamble involving of 0. We would beta would most likely be describe Melanie as __________ in this a.000 was offered in place of the risky were to calculate an "adjusted beta" for gamble. 12. identical-looking boxes. 3. a. while Acme Dynamite Company giving her the choice of the contents in one common stock has a beta of 1.'s common nothing. Melanie states that she would not stock measured beta is calculated to be call off the gamble if you offered her a 0.0 percent Yunyoung as __________ in this instance.75 + c. Inc.90. 12.00 certain P10. having a risk preference 1. What is the rate of return the firm 11.. There is an equal probability According to the capital-asset pricing model that the chosen box contains cash versus (CAPM) and making use of the information nothing. and she would definitely take Espinosa's common stock. and the risk-free rate is 6 percent. Inc.40.2 percent was offered in place of the risky gamble.com common stock exactly c. being risk indifferent d. being risk averse c. Nominal 1% per month compounded continuously. What is an a. 3% per quarter. An interest rate of 12% per year compounded continuously is the same as: a. An interest rate of effective 12% per year compounded monthly is nearest to: 19. Effective 12. 14. None of the above .04% per quarter. d. Today’s WSJ reports 30-day T-bills year compounded quarterly is the same as: are currently yielding 2.39% per year compounded monthly. Determine the nominal risk-free rate of same as: return if the risk-free rate is 3% and the rate a. an LP of 1% and an MRP of 16. Nominal 12% per year compounded monthly. The interest rate must be converted equipment retail store. Effective 12. b. The real risk-free rate is 6% per year. 15.08% per month compounded continuously. $50k loan from your bank. nominal 1% per month. the expected inflation rate is 2% per year. d.15% per semiannual period.68% per year. Nominal 11. 20. c. into an annual rate. c. b. Jungle Jim’s Outfitters.683% per year compounded continuously. An interest rate of 1% per month is the 18. b. 12. d. Nominal 3% per quarter of inflation is 3%. b. 17. 6. compounded monthly. None of the above. All of the above. 1% per month. wants a 1-year. c. a local outdoor c.3%. appropriate interest rate for this loan? b. and a.13. 3. effective 1% per month. When interest is compounded continuously: a. already determined that this firm warrants an DRP of 5%. The cash flow must also occur continuously. You have d. An interest rate stated as nominal 12% per 0. Effective 1. What is the annual nominal rate of interest? c. The cash flow must be converted into continuous cash flow.5%. d.683% per year compounded monthly. What is an appropriate interest rate for this loan? 27. Find r* equivalent to a nominal interest rate of 22.3%. 1- What is the default risk premium on the year Treasury securities will yield 6%. market anticipates that 1 year from now. The real risk-free rate is 3%. Real risk-free rate You read in The Wall based on 12.5%. respectively? What is the monthly in-law. Assume that the liquidity 30. $500k loan expected to be 3% for the next 2 years.(nos. 28 .2%. Find IP 8.5% and the following year’s inflation is e pected to be 3%. a broker at Safe and Sound interest rate? Securities.6% Maturity risk premium 1. rate. The premium on the corporate bond is 0. A 2- from your bank. 21-23) Jihad Jim’s Travel Adventures. security? Inflation for the rest of this year is expected to remain at 2 %.5%. Find r 28. Calculate the effective annual interest rate 21. what is your monthly Street Journal that 30-day T-bills are interest rate and annual effective interest currently yielding 5. A Treasury bond that matures in 10 years has a yield of 6%. what is the effective annual rate? 25. Ne t year’s inflation is e pected to be 2. compounded monthly 23. a 26. What is that this firm warrants an DRP of 10%. One-year Treasury securities yield 5%. what is the real risk-free rate of return? 29. Today’s WSJ reports 30-day T-bills are currently yielding 2. what is the yield today for 2-year Treasury securities? . From no. Your brother.25% Liquidity premium 0.5 percent. wants a 3-year. You have already determined year Treasury security yields 6. A 10-year corporate bond has a yield of 8%. If your credit card calculates the interest 24.5% APR. has given you the following estimates of current interest rate premiums: Inflation premium 3.15% On the basis of these data.75% p. and inflation is new travel agency. If the corporate bond? pure expectations theory is correct.8% Default risk premium 2. Today is 2 January.a. an LP of the maturity risk premium for the 2-year 3% and an MRP of 1. F 2. T 10. Inflation (A change in risk free rate or 14. A 7. D 8. F 10. F 8. 12. F 3. 13. Beta 5. T 6. C 3. Market Equilibrium 9. A 12. F 4. C C. Average Beta 11. T Theories: 12. Risk free interest rate 12. 4. F 8. Answer Key 10. T market rate) 15. D 11. D 13. F 7.III. A E. Coefficient of Variation 8. Risk Aversion 5. T 6. T 14. C 9. T 2. Liquidity Premium 7. B 6. T 7. T 9. T 5. C 4. T A. A change in investor behavior or a change in risk aversion B. Reinvestment rate risk 6. F 4. T D. Nominal interest rate 6. Default Risk Premium 13. F . B 10. T 3. C 10. Cross term format 9. 7. B 2. Required rate of return 4. A 14. A 9. T 3. D risk 2. 1. D 15. Systematic/Non-diversifiable/Market 1. F 11. T 2. A 15. B 8. C 3. A 14. F 15. T 5. F 11. C 1. T 1. A 5. F 1. C 13. Thus the expected value = the 0.000/P150.0589) = 0.00 0.000 6. Answer: C P45 = 94. Problems 5.2)(P50) + Since it provides the greater return for (0. Return = [(P2. So.06)] = 0.8806 P70.2426 or 24.0589 certainty equivalent.5) + toward the beta of the market portfolio (0.4286 Merrill Lych would adjust for the tendency of measured betas to revert Portfolio beta = (0.00005 she was indifferent at a guarantee of 0.000 / P70. Expected return = .80 + 2.2% p x return p x (return .000 = 0.26% .10 – 0.5714 + adjusted beta would end up higher than 0.3)(-P10) = P12 the lowest risk (in comparison with the other three investments) Variance = 288.2857)(0.1429 0. Answer: B Portfolio beta = 1. its Portfolio beta = 0.90)(0.4286)(1.10 – 0.01 or 1% Standard deviation = square root (0.10.06)] = 0. Answer: C return)2 -0. Answer: B Proportion invested in Security A = P30.000 = 0.F.06 + P150.01 0.00 + 145.5) or toward the beta of the industry to which the company is a part.8997 includes both dividends and capital gains.00 2.20 = 436.02520 P10.40) + (P85 .000 [(1.5 = P20.03360 Melanie would have had to tell us that 0. 7. Answer: C Expected dollar return = (0.132 Proportion invested in Security A = 8.2857)(2.P45)] / 4.5)(P10) + (0.09 0. Answer: A Standard deviation = Total investment in the portfolio is 436.3572 Plain required return = 0.000.6429 + 0. but never more than 1. Answer: C [(0. Answer: D 1.8)(0.2000 Return is over the two-year period and Portfolio beta = 0.000.0) + (0.096 Total investment in the portfolio = Acme required return = 0.06 + 3.08 0.Expected 9. Answer: D P30.75. is: IP3 = (2% + 2.5% same as 12%/4 = 3% nominal per quarter compounded monthly. Answer: 17.3% monthly equivalent to an effective 12% 24.5% For a nominal rate compounded = 17.03) x (1 + 0.3% . which is the 22. Answer: C r = rRF + DRP + LP + MRP i = (1+.55 % 20. DRP = LP = 0.In) / n nominal 12% compounded monthly.3% + 2. computing the effective rate for IPn= ( I1 + I2 + I3 …….000.39% r = 0. T-bill rate = r* + IP 0. Answer: D rT10 = 6% = r* + IP10 + MRP10 . Answer: A 17.12) 1/12 = (1 + r/12) r* =2. find r.5% = r* + 3.62% 21.03) .09% that she was indifferent at a guarantee of P10.12/6)^6 – 1 = 2.5% = 8. Answer: 11. Answer: A Yunyoung would have had to tell us 18. = 6.3% 13. Answer: C rC10 = 8% = r* + IP10 + DRP + 0.1% i = (1+.3% + 5% + 1% + 0.12683 All values listed are correct. Answer: 0. Answer: C 19.5% + 10% +3% + 1.3% r = r* + IP + DRP + LP + MRP 14..2% = 0.06) x (1. Answer: 2. 23. Thus the expected value = Rnominal = (1 + 0.1 the certainty equivalent.12 = (1 + r/12) 12 – 1 5. Also. Answer: 8.02) .5% 15.12/12) 12 – 1 = 0. Answer: D r* =rRF .1 = 8.25% (1. Answer: 6. Because both bonds are 10-year bonds the inflation premium and maturity risk .5% + MRP10.00949 r =11. Answer: 8.39% 25.25% compounded monthly.8% 12.25% r/12 = 0.8% = 12.12/4)^4 – 1 Nominal rate = (1. 16. Answer: 1. Answer: 2.5% + 3%)/3 = 2.5% (1 + 0.1% = 12.Current Inflation Rate 1% per month is a nominal 12% per r* = 2.10.09% 11.3% year compounded monthly. 1rT1 = 6%. 1 (2nd Ed) r* + IP10 + MRP10 = 6% by Bagayao. 27.2%.1% i = (1+ . and Houston But we know from above that: Financial Management Vol.113 1 + rT2 = 1. Answer: 9.5% rT1 = 5%. DRP = 1.0417% 29.2% Nicole Gimarino Jeanne Marie Vicente rT2 = 3% + 3% + MRP2 = 6. rT2= ? (1 + rT2 ) 2 = (1. Answer: 0.2% Kyle Patrick Mallare Venz Zeus Baba rT2 = r* + IP2 + MRP2 = 6. Therefore.5% + DRP PREPARED BY: So. premium on both bonds are equal.05)(1.055 rT2 = 5 .0417% i = (12.0875/12)^12 – 1 = 9.5%/12) = 1. Layug and Manalo.06) (1 + rT2 ) 2 = 1. Answer: 13.5% + DRP.5% 26.24% i = (1+0.010417) 12 = 13. The SOURCES: only difference between them is the Fundamentals of Financial liquidity and default risk premiums.1 % 28.2% MRP2 = 0. Answer: 1. Management 12th Edition by Brigham rC10 = 8% = r* + IP + MRP + 0. Answer: 5.24% 30. rC10 = 8% = 6% + 0.