PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Textbook Question
Chapter 7, Problem 6PS
Stocks vs. bonds Each of the following statements is dangerous or misleading. Explain why.
- a. A long-term U.S. government bond is always absolutely safe.
- b. All investors should
prefer stocks to bonds because stocks offer higher long-runrates of return . - c. The best practical
forecast of future rates of return on the stock market is a 5- or 10-year average of historical returns.
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Students have asked these similar questions
Consider the following scenario analysis
A. Is it reasonable to assume that treasury bonds will provide higher returns in recessions than in booms?
B. Calculate the expected rate of return and standard deviation for each investment.
C. What investment would you prefer?
b. Assume tḥat you maintain bonds and money market securities in your portfolio and you suddenly
believe that long-term interest rates will rise substantially tomorrow (even though the market
does not share the same view), while short term interest rates will remain the same.
i. How would you rebalance your portfolio between bonds and money market securities?
Assess the following statement:
1. If investors were indifferent to maturities, the return of any security should equal the
compounded yield of consecutive investments in shorter-term securities.
II. The forward rate is sometimes used as an approximation of the market's consensus
interest rate forecast. The reason is that, if the market had a different
perception, the demand and supply of today's existing two-year and one-year
securities would adjust to capitalize on this information.
III. According to pure expectations theory, the term structure of interest rates is
determined solely by expectations of interest rates.
O Only one statement is correct.
All statements are correct.
O No answer text provided.
O Only one statement is incorrect.
Chapter 7 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 7 - Rate of return The level of the Syldavia market...Ch. 7 - Real versus nominal returns The Costaguana stock...Ch. 7 - Arithmetic average and compound returns Integrated...Ch. 7 - Risk premiums Here are inflation rates and U.S....Ch. 7 - Risk Premium Suppose that in year 2030, investors...Ch. 7 - Stocks vs. bonds Each of the following statements...Ch. 7 - Expected return and standard deviation A game of...Ch. 7 - Standard deviation of returns The following table...Ch. 7 - Average returns and standard deviation During the...Ch. 7 - Prob. 10PS
Ch. 7 - Prob. 11PSCh. 7 - Diversification Here are the percentage returns on...Ch. 7 - Risk and diversification In which of the following...Ch. 7 - Prob. 14PSCh. 7 - Portfolio risk To calculate the variance of a...Ch. 7 - Portfolio risk a) How many variance terms and how...Ch. 7 - Portfolio risk Table 7.8 shows standard deviations...Ch. 7 - Portfolio risk Hyacinth Macaw invests 60% of her...Ch. 7 - Stock betas What is the beta of each of the stocks...Ch. 7 - Stock betas There are few, if any, real companies...Ch. 7 - Portfolio betas A portfolio contains equal...Ch. 7 - Portfolio betas Suppose the standard deviation of...Ch. 7 - Portfolio risk Here are some historical data on...Ch. 7 - Portfolio risk Suppose that Treasury bills offer a...
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- Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? Calculate the expected rate of return and standard deviation for each investment. Which investment would you prefer?arrow_forwardRisk free rate can be derived from a triple A rated commercial bonds and the estimated price of options is dependent on the expected return of an investor. true or false? Volatility of the financial markets can be measured using the historical prices of an investment while payoff values in the Monte Carlo Simulation are summed then discounted in today's value. true or false? Financial models are accurate. true or false?arrow_forwardD3) Finance Suppose Bond A carried a higher yield than comparable Bond B because of investors’ uncertainty about the future of company B. If you were an investment manager who thought the market was overplaying these fears. In particular, if you thought that yields on Bond A would fall by 50 basis points. Which bonds would you buy or sell? Explain in words.arrow_forward
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- An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. If the real risk-free rate is 3% and inflation is expected to be 17% each of the next 4 years, what is the yield on a 4-year security with no maturity, default, or liquidity risk?arrow_forwardAssume that inflation is expected to steadily increase in the years ahead, but that the real risk-free rate r*, is expected to remain constant. Which of the following statements is most correct? None of the answers are correct. The treasury yield curve must be upward sloping. If the expectations theory holds, the treasury yield curve must be downward sloping. If the expectations theory holds, the yield curve for corporate securities must be downward sloping.arrow_forwardYou expect market interest rates to increase, while the rest of the market believes there will be a decrease. Which of the following statements about fixed-coupon bonds is most correct? a. Bond yields and prices are expected to rise b. At the maturity date, regardless of changes in market interest rates, a bond price will be equal to the face value plus the coupon. c. You expect the company to increase the coupon payment in response to the increase in market rates. d. As the coupons are fixed, the interest rate change will have no impact on the bond. e. You should invest in long-term bonds rather than short-term securitiesarrow_forward
- What is the biggest cause for the orange county failure? (100 words) Which of the following is false about the convexity of interest rate risk. Convexity demonstrates the nonlinear relationships between bond price and yield Convexity implies that bond prices and interest rates are inversely related Convexity implies a non-linear relationship between interest rates and bond prices. What is the duration of a zero-coupon bond with $100 face value and 3 years term to maturity? Fixed coupon bonds are not exposed to interest rate risk. Select one: True False The yield curve contributes to the interest rate spread between retail borrowing and lending. Select one: True Falsearrow_forwardWhich statement is TRUE regarding the riskiness of money market instruments and capital market instruments? * Changing economic prospects can cause very large changes in current stock values. Distant cash flows for stocks can be known with certainty, make them riskier than money market instruments. Money market instruments have predictable cash flows and mature in one year or less, so they are much more risky. The prices of long-term capital market instruments are less sensitive to changes in interest rates than prices of short-term instruments.arrow_forwardFor the cost of equity (stock) is it better to use the current US Treasury bill rate or a longer-termgovernment bond rate as the risk-free rate of return?Does the rate you use as the risk-free rate have an impact on what market premium might beappropriate? Historically, large-company stocks have earned an average return of 12.1% per annum, while US Treasury bills and long-term government bonds have earned average returns of 3.5% and5.9% respectively.arrow_forward
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