Question

1) A bond's yield to maturity takes into consideration:
A. current yieldbut not price changes of a bond.
B. price changesbut not current yield of a bond.
C. both currentyield and price changes of a bond.
D. neither current yield nor price changes of a bond.

2: 3) What price will be paid for a U.S. Treasury bond with an ask price of 135:20?
A. $1,350.20
B. $1,350.31
C. $1,350.63
D. $1,356.25

8) What can be expected to happen when stocks having the same expected risk do nothave the same expected return? A. At leastone of the stocks becomes temporarily mispriced. B. This is a common occurrence indicating that one stock has more PVGO. C. This cannothappen if the shares are traded in an auction market. D. The expected risk levels will change until the expected returns are equal.

16) The manager of XYZ Corp. feels that a dividend increase will increase stock price because many investors value stock with a dividend-discount model. Why might MM disagree with this assertion?
A. The increased dividend makes the firm much riskier.
B. Future dividendgrowth may slow due to lower retained earnings.
C. Investors prefer capital gains over dividends.
D. Dividend increaseswill increase the book value but not the market value of the firm.

17) The cost of a merger may outweigh the potential gain if the: A. present value of the acquired firm exceeds the price paid for it. B. presentvalue of the merged firms is greater than the sum of their individual values. C. merger allows cost savings to occur. D. acquired firm'sshareholders receive more than the value of their firm.

18) The shareholders of firm A have offered 1 million shares valued at $10 each to acquire firm B. After the merger is announced, stock A trades for $9 per share. Which of the following statements is not correct? A. Firm A appears to have overbid for firm B. B. The NPV of the merger may differ from expectations. C. Shareholdersof firm A absorb all additional "cost." D. Firm A's stockholders are better off than if the merger were cash financed for $10 million.

Please explain why to those questions. Thank you.

Answer 1

Question - 1 ...........C. both current yield and price changes of a bond.
Because, for computing YTM, both coupon payments and price of the bond are inputs. Thus current yield which is defined as coupon payment / price of the bond also considers price changes of a bond.

Question - 2 ............ D. $1,356.25

In bond price conventions, we use 1/32 fraction to add the premium. Here 135:20 means that, 135 + 20/32 = 135.625

Thus, ask price of a bond with 1000 face value = 1000 * 135.625 / 100 = 1356.25

Question - 8 ........A. At least one of the stocks becomes temporarily mispriced.

Have same risk implies that both the securities should fall on the same SML. Otherwise one of them is either overprice or under priced.

Question - 16 ........ B. Future dividend growth may slow due to lower retained earnings.

If high dividends are paid, it automatically decreases the growth rate that can be maintained by a firm. Because, growth = retention ratio * ROE. Thus a decrease in retention ratio due to increase in dividends is the reason for MM disagree with the assertion.

Question - 17 ....... D. acquired firm's shareholders receive more than the value of their firm.

Cost of merger set-off against the premium received in merger process, by paying less than what acquired firm receive.

Question - 18 ..... C. Share holders of firm A absorb all additional "cost."

This is the reason for fall in price of share, since cost of merger is completely charged against the firm - A alone.