PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

Number of Items: 60 items

Duration: 3:30pm to 5:30 pm (2 hours)
Grace Period for Submission: 5:30 -6:00 pm (30mins)

Direction: Answer this exam with all honesty.

1. The Philippine Stock Exchange is primarily
a. A secondary market.
b. A physical location auction market.
c. Statements a and b are incorrect.
d. Statements a and b are correct.

2. Which of the following statements is most correct?

a. If an investor sells 100 shares of Microsoft to his brother-in-law, this is a primary market
transaction.
b. Private securities are generally less liquid than publicly traded securities.
c. Money markets are where short-term, liquid securities are traded, whereas capital markets
represent the markets for long-term debt and common stock.
d. Statements b and c are correct.

3. Money markets are markets for

a. Consumer automobile loans.
b. Corporate stocks.
c. Long-term bonds.
d. Short-term debt securities.

4. Which of the following investments will have the highest future value at the end of 5 years?
Assume that the effective annual rate for all investments is the same.
a. Aaron pays P50 at the beginning of every 6-month period for the next 5 years (a total of 10
payments).
b. Bryan pays P500 at the end of 5 years (a total of one payment).
c. Carlo pays P100 at the end of every year for the next 5 years (a total of 5 payments).
d. Dina pays P100 at the beginning of every year for the next 5 years (a total of 5 payments).

5. Frank Lewis has a 30-year, P100,000 mortgage with a nominal interest rate of 10 percent and
monthly compounding. Which of the following statements regarding his mortgage is most correct?
a. The monthly payments will decline over time.
b. The proportion of the monthly payment that represents interest will be lower for the last
payment than for the first payment on the loan.
c. The total peso amount of principal being paid off each month gets larger as the loan
approaches maturity.
d. Statements b and c are correct.

6. The capital asset pricing model (CAPM) states that:

a. The expected risk premium on an investment is proportional to its beta.
b. The expected rate of return on an investment is proportional to its beta.
c. The expected rate of return on an investment depends on the risk-free rate and the market
rate of return.
d. The expected rate of return on an investment is dependent on the risk-free rate.

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

7. The component of the risk-adjusted discount rate that is derived from the risk of Treasury
securities is:
a. risk premium
b. call premium
c. cost of capital
d. risk-free rate

8. The market risk premium is:

a. The difference between the rate of return on an asset and the risk-free rate.
b. The difference between the rate of return on the market portfolio and the risk-free rate.
c. The risk-free rate.
d. The market rate of return.

9. Financial risk refers to the:

a. risk of owning equity securities
b. risk faced by equity holders when debt is used
c. general business risk of the firm
d. possibility that interest rates will increase

10. The extent to which fixed costs are used in a firm’s operations is called its:
a. financial leverage.
b. financial leverage.
c. operating leverage.
d. foreign risk exposure.

11. The discount rate that makes the present value of a bond's payments equal to its price is termed
the:
a. rate of return
b. current yield
c. yield to maturity
d. coupon rate

12. What is the rate of return for an investor who pays P1,054.47 for a three-year bond with a 7%
coupon and sells the bond one year later for P1,037.19?
a. 5.00%
b. 6.46%
c. 5.33%
d. 7.00%

13. The price of a stock is:

a. the future value of all expected future dividends discounted at the dividend growth rate.
b. the present value of all expected future dividends discounted at the dividend growth rate.
c. the future value of all expected future dividends discounted at the investor’s required
return.
d. the present value of all expected future dividends discounted at the investor’s required
return.

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

14. In calculating the cost of common stock equity, the model having the stronger theoretical
foundation is:
a. the constant growth model.
b. the variable growth model.
c. the Gordon model.
d. the capital asset pricing model.

15. The major benefit of diversification is to:

a. increase the expected return.
b. remove negative risk assets from the portfolio.
c. reduce the portfolio's systematic risk.
d. reduce the expected risk

16. Stocks that have high financial rewards are generally accompanied by:
a. high dividend payments
b. low dividend payments because of internally generated growth
c. high risk
d. All the above

17. What will be the price of a bond in which the YTM is higher than the coupon rate?
a. Below face value
b. At face value
c. Above face value
d. Cannot be determined

18. Which of the following statements is correct?

a. Bond prices and interest rates move in the same direction, i.e., if interest rates rise, so will
bond prices.
b. The market price of a discount bond will approach the bond's par value as the maturity date
approaches. Barring changes in the probability of default, the value of the bond cannot fail
to increase each year as the time to maturity approaches.
c. The "current yield" on a noncallable discount bond will normally exceed the bond's yield to
maturity.
d. The "current yield" on a noncallable discount bond will normally exceed the bond's coupon
interest rate.

19. You are considering the purchase of a bond with a 13% coupon rate paid and compounded
semiannually. The bond will mature in 8 years, and has a P1,000 face value. The bond currently
sells for P867. Calculate the annual yield to maturity for this bond. (Round to nearest percentage.)
a. 8 percent
b. 13 percent
c. 9 percent
d. 16 percent

20. The dividend growth model, when used, assumes that the total return on a share of common
stock is comprised of a:
a. capital gains yield and a dividend growth rate.
b. capital gains growth rate and a dividend growth rate.

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

c. dividend yield and the expected price next year.

d. dividend yield and a capital gains yield.

21. You are planning to invest in common stock of Eagle, Inc. Lately, the firm paid a dividend of
P7.80. You have projected that dividends will grow at a rate of 9.0% per year indefinitely. If you
want an annual return of 24.0%, what is the most you should pay for the stock now?
a. P52.00
b. P32.50
c. P56.68
d. P35.43

22. The Wind Company’s last dividend was P3.00; its growth rate is 6 percent and the stock now
sell for P36. New stock can be sold to net the firm P32.40 per share. What is Wind Company’s cost
of new common stock?
a. 14.83 percent
b. 15.26 percent
c. 15.81 percent
d. 9.69 percent

23. OPQ Company is considering buying common shares in Oceanic Company. OPQ has projected
that the next dividend the company will pay will equal P4.00 and that dividends will grow at a rate
of 7.0% per year thereafter. The firm's beta is 1.75, the risk-free rate is 7.5%, and the market return
is 11.3%. What is the most you should pay for the stock now?
a. P30.25
b. P55.94
c. P59.86
d. P89.12

24. The overall weighted average cost of capital is used instead of costs for specific sources of funds
because
a. use of the cost for specific sources of capital would make investment decisions inconsistent.
b. a project with the highest return would always be accepted under the specific cost criteria.
c. investment funded by equity or debt is not relevant to this question
d. None of the above.

25. The most expensive source of financing for a firm is:

a. Debt
b. retained earnings
c. preferred stock
d. new common stock

26. Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a
beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at P10 a share and adding
it to your portfolio. Alpha has an expected return of 13.0% and a beta of 1.50. The total value of
your current portfolio is P90,000. What will the expected return and beta on the portfolio be after
the purchase of the Alpha stock?
a. 10.64%; 1.17
b. 11.20%; 1.23

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

c. 11.76%; 1.29
d. 12.35%; 1.36

27. Calculate the required rate of return for Climax Inc., assuming that (1) investors expect a 4.0%
rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is
5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the
last 5 years.
a. 10.29%
b. 10.83%
c. 11.40%
d. 12.00%

28. Porter Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the
risk-free rate is 5.00%, what is the market risk premium?
a. 5.80%
b. 5.95%
c. 6.09%
d. 6.25%

29. Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock
market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's
required rates of return? (Hint: First find the market risk premium, then find the required returns
on the stocks.)
a. 2.75%
b. 2.89%
c. 3.21%
d. 3.38%

30. Kollo Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00%
future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return?
a. 9.43%
b. 9.67%
c. 9.92%
d. 10.17%

31. Moon Software Inc. is planning to issue two types of 25-year, noncallable bonds to raise a total
of P6million, P3 million from each type of bond. First, 3,000 bonds with a 10% semiannual coupon
will be sold at their P1,000 par value to raise P3,000,000. These are called "par" bonds. Second,
Original Issue Discount (OID) bonds, also with a 25-year maturity and a P1,000 par value, will be
sold, but these bonds will have a semiannual coupon of only 6.25%. The OID bonds must be offered
at below par in order to provide investors with the same effective yield as the par bonds. How many
OID bonds must the firm issue to raise P3,000,000? Disregard flotation costs, and round your final
answer up to a whole number of bonds.
a. 4,228
b. 4,337
c. 4,448
d. 4,562

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

32. Kebt Corporation's Class Semi bonds have a 12-year maturity and an 8.75% coupon paid
semiannually (4.375% each 6 months), and those bonds sell at their P1,000 par value. The firm's
Class Ann bonds have the same risk, maturity, nominal interest rate, and par value, but these bonds
pay interest annually. Neither bond is callable. At what price should the annual payment bond sell?
a. P 937.56
b. P 961.60
c. P 986.25
d. P1,010.91

33. Keenan Industries has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon,
semiannual payments, and a P1,000 par value. The bond has a 6.50% nominal yield to maturity, but
it can be called in 6 years at a price of P1,120. What is the bond's nominal yield to call?
a. 6.20%
b. 6.53%
c. 6.85%
d. 7.20%

34. Taussig Corp.'s bonds currently sell for P1,150. They have a 6.35% annual coupon rate and a 20-
year maturity, but they can be called in 5 years at P1,067.50. Assume that no costs other than the
call premium would be incurred to call and refund the bonds, and also assume that the yield curve
is horizontal, with rates expected to remain at current levels on into the future. Under these
conditions, what rate of return should an investor expect to earn if he or she purchases these
bonds?
a. 3.42%
b. 3.60%
c. 3.79%
d. 4.20%

35. Grossnickle Corporation issued 20-year, noncallable, 7.5% annual coupon bonds at their par
value of P1,000 one year ago. Today, the market interest rate on these bonds is 5.5%. What is the
current price of the bonds, given that they now have 19 years to maturity?
a. P1,113.48
b. P1,171.32
c. P1,201.35
d. P1,232.15

36. Huang Company's last dividend was P1.25. The dividend growth rate is expected to be constant
at 15% for 3 years, after which dividends are expected to grow at a rate of 6% forever. If the firm's
required return (rs) is 11%, what is its current stock price?
a. P30.57
b. P31.52
c. P32.49
d. P33.50

37. Ackert Company's last dividend was P1.55. The dividend growth rate is expected to be constant
at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's
required return (rs) is 12.0%. What is the best estimate of the current stock price?
a. P37.05

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

b. P38.16
c. P39.30
d. P40.48

38. Church Inc. is presently enjoying relatively high growth because of a surge in the demand for its
new product. Management expects earnings and dividends to grow at a rate of 25% for the next 4
years, after which competition will probably reduce the growth rate in earnings and dividends to
zero, i.e., g = 0. The company's last dividend, D0, was P1.25, its beta is 1.20, the market risk
premium is 5.50%, and the risk free rate is 3.00%. What is the current price of the common stock?
a. P26.77
b. P27.89
c. P29.05
d. P30.21

The next three questions are based on the following information.

ABC Corporation's present capital structure consists of 20% debt, 10% preferred equity, and 70%
common equity. This capital structure is considered optimal and ABC Corporation wishes maintain
it. For the coming year, ABC Corporation is planning to invest in an P80M project that will be
financed according to desired capital structure Currently, ABC Corporation has P2OM cash available
for the project.

39. The percentage of P80M that will come from long-term debt is

a. 22.5%
b. 20%
c. 15%
d. none of these

40. The percentage of P80M that will come from a new issuance of common stock is
a. 52.5%
b. 40.8%
c. 45%
d. 70%

41. If the company will maintain the optimal capital structure to finance the project, and preferred
stocks are issued, the proceeds should be
a. P6M
b. P8M
c. 7.5%
d. 10%

42. Vicky Corporation has preferred stocks that pay dividends of P6.72 per share. If the cost of
funds (capital) coming from preferred stocks is 15% and the income tax rate is 30%, what is
the price of the preferred stocks?
a. P1.01
b. P2.23
c. P44.08
d. P56

43. PP Corporation expects to pay dividends of P5 per share at the end of this year. The expected
growth rate is 12%. Using the dividend growth model, what is the stock's market price if the
cost of capital (common stocks) is 26%?

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

a. P35.71
b. P21
c. P33.33
d. none of these

44. X Corporation XYZ expects to pay dividends of P4.80 per share at the end of the current year.
The dividend growth rate is 10% and the cost of common equity capital is 14%.
If the dividend growth model is used to appraise XYZ Corporations shares of stocks, the price
of the stocks to the public is

a. 14.00%.
b. 15.40%.
c. P5.28 per share
d. P120.00 per share.

45. What is the rate of return for an investor who pays P1,054.47 for a three-year bond with a 7%
coupon and sells the bond one year later for P1,037.19?

a. 5.00%
b. 5.33%
c. 6.46%
d. 7.00%

46. FGH Corporation's common stocks currently sell at P40 per share. The estimated dividend
payment at the end of this year is P4 per share. The expected growth rate is 10 %. Using the
dividend growth model, the cost of capital is

a. 10%
b. 22%
c. 12%
d. 20%

47. The expected return on Globe Oil stock is 18.95%. If the market premium is 8.5% and the
risk-free rate is 6.4%, what is the beta of Globe Oil stock?

a. 1.30
b. 1.53
c. 1.48
d. 2.96

48. What is the current price of a share of stock when the current dividend is P4.75, the growth
rate is 7%, and the investor's required rate of return is 10%?

a. P 43.25
b. P 169.42
c. P118.75
d. P127.06

49. What is the estimated required rate of return for equity investors if a stock sells for P40 and
will pay a P4.40 dividend that is expected to grow at a constant rate of 5%?
a. 7.6%
b. 16.0%

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

c. 17.6%
d. 15.0

50. Given a stock price of P39.90 and an expected return to shareholders of 12.4%, what is the
likely growth rate if the annual dividend next year is expected to be P3.50?
a. 0.0%
b. 3.6%
c. 3.7%
d. 12.4%

51. If a stock is purchased for P25 per share and held one year, during which time a P3.50 dividend
is paid and the price climbs to P28.50, the nominal rate of return is:
a. 27.00%
b. 13.00%
c. 14.00%
d. 28.00%

The next two questions are based on the following information.

The return on market portfolio is 12% and the risk-free is 6%. The beta coefficient is 1.3.

52. Using the capital asset pricing model, what is the cost of capital (or required rate of return)?

a. 12.8%
b. 13.8%
c. 14%
d. 14.8%

53. If the beta coefficient increases to 1.6, the required rate of return will increase (decrease) by
a. 1.2%
b. 1.4%
c. 1.6%
d. 1.8%

54. What is the expected YTM on a bond that pays a P150 coupon annually, has a P1,250 par value,
and matures in six years if the current price of the bond is P978?
a. 13.9%
b. 14.14%
c. 15.6%
d. 16.9%

55. Which of the following statements is incorrect?

a. Capital structure is the mix of the long-term sources of funds used by the firm.
b. Capital structure consists of the firms long-term financing. i.e., long-term debt and
stockholders' equity.
c. Debt is cheaper than equity, but excessive use of debt increases the firm's risk and drives up
the weighted average cost of capital.
d. The optimum capital structure is a combination of long-term debt and equity that
minimizes the cost of capital and value of the firm.

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 PHINMA UNIVERSITY OF ILOILO

FIN 072: FINANCIAL MARKETS

Midterm Examination
April 19, 2021

“Being honest may not get you many friends, but it will always get you the right ones”

56. A decrease in the debt ratio will least likely affect:

a. business risk
b. financial risk
c. systematic or market risk
d. total risk

57. Financial risk refers to the:

a. risk of owning equity securities
b. general business risk of the firm
c. possibility that interest rates will increase
d. risk faced by equity holders when debt is used

58. Which of the following is an advantage of equity financing in comparison to debt financing?
a. Issuance costs are greater than for debt.
b. Ownership is given up with respect to the issuance of common stock.
c. The company has no firm obligation to pay dividends to common shareholders
d. Dividends are not tax deductible by the corporation whereas interest is tax deductible

59. Which one of the following statements is true regarding the beta coefficient?
a. Beta is a measure of unsystematic risk.
b. A beta of one indicates an asset is totally risk-free.
c. Generally speaking, the higher the beta the higher the expected return.
d. A beta greater than one represents less systematic risk than the market.

60. The market risk premium is the:

a. risk-free rate.
b. market rate of return.
c. difference between the rate of return on an asset and the risk-free rate.
d. difference between the rate of return on the market portfolio and the risk-free rate.

***END OF EXAMINATION***

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