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Business Finance – Test 2, 2026 – Study Material
and Practice Questions
Annuity - ANS✔✔ A level stream of cash flows for a fixed period of time. Perpetuity - ANS✔✔ An annuity in which the cash flows continue forever. Sometimes called consuls. Perpetuity Formula - ANS✔✔ Cash Flow/Rate Growing Perpetuity - ANS✔✔ A perpetuity cash flow increasing at a constant rate, "G", each period. Growing Perpetuity Formula - ANS✔✔ PV = Specific C/(r-g) What is the only time that the Growing Perpetuity Formula works? - ANS✔✔ When R is greater than G. Annual Percentage Rate - ANS✔✔ The stated annual rate which ignores compounding, calculated as the periodic rate * the number of periods. Effective Annual Rate - ANS✔✔ The Annual rate that would be equivalent to the periodic rate once compounding is taken into account. What is an amortized loan? - ANS✔✔ Where the payments pay down the balance of the loan over time.
"As you increase the length of time involved, what happens to the present value of an annuity? What happens to the future value?" - ANS✔✔ Assuming positive cash flows, both the present and the future values will rise. "What happens to the future value of an annuity if you increase the rate r? What happens to the present value?" - ANS✔✔ Assuming positive cash flows, the present value will fall and the future value will rise. "If you were an athlete negotiating a contract, would you want a big signing bonus payable immediately and smaller payments in the future, or vice versa? How about looking at it from the team's perspective?" - ANS✔✔ If the total money is fixed, you want as much as possible as soon as possible. The team (or, more accurately, the team owner) wants just the opposite. "Suppose two athletes each sign 10-year contracts for $80 million. In one case, we're told that the $80 million will be paid in 10 equal installments. In the other case, we're told that the $80 million will be paid in 10 installments, but the installments will increase by 5 percent per year. Who got the better deal?" - ANS✔✔ The better deal is the one with equal installments. EAR formula - ANS✔✔ (1+APR/m)^m- "Is it true that a U.S. Treasury security is risk-free?" - ANS✔✔ No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury securities have substantial interest rate risk. "How does a bond issuer decide on the appropriate coupon rate to set on its bonds?" - ANS✔✔ Bond issuers look at outstanding bonds of similar maturity/risk when setting coupon rates. The yields on such bonds are used to establish the coupon rate necessary for a particular issue to initially sell for par value. Bond issuers also ask potential purchasers what coupon rate would be necessary to attract them.
The price of a bond is equal to the BLANK of the bond's BLANK. - ANS✔✔ Present Value ; Cash Flows Current Yeild - ANS✔✔ a bond's annual coupon divided by its price True or false ; a current yield is a rate or return - ANS✔✔ Fasle What can a current yield be used for? - ANS✔✔ Comparing a bonds ability to generate income per $ invested. What are Zero-Coupon Bonds? - ANS✔✔ A bond with no coupons, so you only receive the principal. How do you calculate the price of Zero-Coupon Bonds? - ANS✔✔ Discounting Cash Flows Interest Rate Risk - ANS✔✔ The risk of a change in value of a bond because of a change in interest rate. Bond prices and market interest rates move in BLANK directions - ANS✔✔ Opposite All else being equal, the longer the time to maturity, the BLANK the interest rate risk. - ANS✔✔ Greater All else being equal, the higher the coupon rate, the BLANK the interest rate risk. - ANS✔✔ Lower When a bond's coupon rate is BLANK the YTM, the bond's price will be greater than its par value. - ANS✔✔ Greater than
When a bond's coupon rate is BLANK the YTM, the bond's price will be equal to its par value. - ANS✔✔ Equal to When a bond's coupon rate is BLANK the YTM, the bond's price will be less than its par value. - ANS✔✔ Less than Term Structure - ANS✔✔ The relationship between interest rates and the of a debt security. Factors that affect yields on Bonds - ANS✔✔ Real interest rate Inflation premium Interest rate risk premium Default risk premium Liquidity premium real interest rate - ANS✔✔ Extra return investors require for forgoing consumption inflation premium - ANS✔✔ a premium to compensate for anticipated inflation that is equal to the price change expected to occur over the life of the bond or investment instrument interest rate risk premium - ANS✔✔ Compensates bond investors for the risk of changing interest rates that affect their bonds Default risk premium - ANS✔✔ The difference between the interest rate on a U.S. Treasury bond and a corporate bond of equal maturity and marketability.
Yield to call and call premium are parts of.. - ANS✔✔ Call provision High Grade Bond Rating - ANS✔✔ Moody's Aaa and S&P AAA Moody's Aa and S&P AA medium grade bond rating - ANS✔✔ Moody's A and S&P A Moody's Baa and S&P BBB low grade bond rating - ANS✔✔ Moody's Ba, B, and Caa S&P BB, B, CCC very low grade bond rating - ANS✔✔ S&P C, CC, D (and below) and Moody's , ca, c (and below) Debt - ANS✔✔ Not an ownership interest Creditors do not have voting rights Interest is considered a cost of doing business and is tax deductible Creditors have legal recourse if interest or principal payments are missed Excess debt can lead to financial distress and bankruptcy Equity - ANS✔✔ • Ownership interest
- Common stockholders vote for the board of directors and other issues
- Dividends are not considered a cost and are not tax deductible
- Dividends are not a liability of the firm and stockholders have no legal recourse if dividends are not paid
- An all equity firm can not go bankrupt The price of a bond is equal to the BLANK of the bond's BLANK cash flows. - ANS✔✔ Present Value ; Future The price of a share is equal to the BLANK of the stock's BLANK cash flows - ANS✔✔ Present Value ; Future Common Stock Cash Flows: - ANS✔✔ Dividends Sell Price Patterns of Dividend Growth - ANS✔✔ • No growth
- Constant growth
- Non-constant growth No growth - ANS✔✔ Dividends do not increase in dollar amount Constant Growth - ANS✔✔ Dividends increase at a fixed rate, g, each period. D1?/r-g
Preferred Stock - ANS✔✔ • May have voting right, but often only if dividends have been missed
- Stated Dividends (Cumulative and Non-cumulative)
- Stated Liquidating Value Primary Market - ANS✔✔ market for selling financial assets that can only be redeemed by the original holder secondary market - ANS✔✔ market for reselling financial assets Dealers - ANS✔✔ link buyers and sellers by buying and selling securities at stated prices brokers - ANS✔✔ Independent firms or individuals whose principal function is to bring buyers and sellers together to make sales NYSE - ANS✔✔ A stock exchange based in New York City, which is considered the largest equities-based exchange in the world based on total market capitalization of its listed securities. NASDAQ - ANS✔✔ A nationwide electronic system that links dealers across the nation so that they can buy and sell securities electronically.
