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1) You have decided you want to join the International Budding Finance Professionals Union and have decided on a lifetime membership. As a membership test, you must correctly decide between paying your lifetime dues as a single payment today of $800 or paying $100 per year at the end of each of the next 10 years. If the relevant interest rate is 7%, which alternative should you choose to minimize your cost of joining?
2) You have decided to make a single deposit today to pay for your daughter’s college education nine years from now (i.e. the tuition payment must be made at the end of years 9 through 12). You estimate college tuition costs to be $18,000 each of the four years. If you will earn 4% per year on your investment, how much will you have to deposit today to achieve your goal? (HINT: Draw a time line)
3) You expect interest rates to be 2% per year for the next three years. You expect interest rates to then rise to 5% per year for the subsequent three years. You wish to have $80,000 accumulated at the end of the six-year period. You plan to make three equal deposits at the end of each of the next three years (i.e. years 1 through 3). How much must you invest each year to achieve your goal? (HINT: Draw a time line).
4) A friend asks you to lend him $10,000 today and agrees to pay you back $14,693.28 at the end of 5 years. Assuming the loan will not default, what is the annual rate of return you are being promised?
5) A four year corporate bond issues by Orion Industries carries a coupon rate of 7% and pays interest semiannually. The bond has a par value of $1,000 and is rated Aa by Moody’s and AA by Standard and Poor’s. Bonds with similar ratings are priced to yield 9%. What should be the market price of this bond?
6) The common stock of Arcturus Industries currently pays a dividend of $1.50 per share. The dividends are expected to grow at a 4% annual rate forever. Assume that your required rate of return on the common stock of Arcturus Industries is 12% per annum. What is the most you are willing to pay for a share of Arcturus common stock?
7) The common stock of Lincoln Industries is expected to pay the following dividends at the end of the next three years. D1 = $2.00, D2 = $2.40, D3 = $2.88. After the third year, the dividends are expected to grow at a constant rate of 5% per year, forever. If you require a 10% rate of return on Lincoln’s stock, how much are you willing to pay for a share of the stock?
8) Assume the risk-free rate is 3% and the market risk premium is 5%. What is the expected rate of return for the overall stock market, and what is the required rate of return on a stock that has a beta of 1.4?
9) If you had to summarize in a single sentence the goal of the financial management function in a modern, publicly traded corporation, what would that sentence be?
10) We discussed the idea of beta as a measure of risk and why an investor should focus on beta rather than the total risk of the security. Why should an investor concentrate on beta rather than the total risk of a particular security? .
11) The security market line (SML) shows the required rate of return on a security as a function of the risk of the security as measured by beta. Briefly describe the effects on the SML and required rates of return of: a) an increase in the general level of interest rates, i.e. assume the Federal Reserve raises rates; and b) an increase in the general level risk aversion on the part of investors.
12) In an interest rate swap agreement, one party exchanges floating rate payments for fixed rate payments with a second party. A typical swap agreement may call for semiannual payments over the next 5 years. Assume you are to receive the fixed-rate payments. Briefly describe how you would value this fixed rate portion of the swap
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