1 "My husband and I are in the process of securing a $32,000 home equity loan through an out-of-state lender at an interest rate of 12.5%....[T]he processing costs will be about $5,000. Does that sound reasonable?" Evaluate this loan, assuming that it is an amortized 30-year loan with monthly payments and that it is not repaid early. If it were repaid after 15 years, would the effective interest rate be higher or lower?

2 "Firms that commanded [high/low] price-to-earnings ratios could purchase firms with [higher/lower] P/Es because in an equity exchange the buyer's EPS increased. But the reverse transaction was anathema in the boardroom because it lowered earnings per share. This was the height of naivete, since the combined firms were [worth more if the first firm did the acquiring/worth more if the second firm did the acquiring/worth exactly the same no matter who did the acquiring]." (Joel M.ĘStern, Forward to Al Ehrbar, EVA: The Real Key to Creating Wealth, John Wiley & Sons, 1998, p. 3.) Circle the correct words in each of the three bracketed parts of this quotation.

3 Would an unexpected increase in the unemployment rate increase or reduce the spread between the interest rates on Treasury bonds and BBB bonds? Explain your reasoning.

4 Suppose that a firm with no debt and one million shares outstanding has annual earnings of $5 million, on which $2 million is paid out as dividends and $3 million is invested in new capital that earns a rate of return r. For what values of r do this firm's earnings per share increase? Why might the firm's shareholders be worse off even though the firm's earnings per share increase?

5 Which of the following futures contracts would you expect to have the larger percentage cost of carry: A bond selling for par or the S&P 500? Explain carefully.

6 Which of the following has the longer duration: a consol bond with a $10 quarterly coupon and an 8% yield to maturity or a no-growth stock that will pay a $5 quarterly dividend forever and is priced with a shareholders' required return of 12%? Explain your reasoning.

7 Here are two graphs showing the return from two combination strategies involving stock and options, as a function of the price of the stock at expiration. Identify each of these combination strategies (e.g., buy 1 share of stock and sell two call options with an exercise price equal to the current price of the stock)

8 Suppose that a one-year zero has an 8% annual return, a two-year zero has a 9% annual return, and a three-year zero has a 9% annual return. You want to buy one of these bonds now and hold it for a year. If one year from now, the annual yield on one-year zeros is 8% and the annual yield on two-year zeros is 9%, which of these three bonds will be the most profitable investment for you? Show your work.

9 Consider the following data on the value of a market index and the price of stock B: January 1, 1995 January 1, 2000 market 5000 10000 Stock B 50 200

10 In 1986, The Wall Street Journal reported that, "Falling interest rates prompt corporations to refinance short-term, high-cost debt with bonds with lower rates and longer maturities, reducing costs and making them less vulnerable to interest-rate moves....Still, many corporations delay refinancing, expecting interest rates to drop further." Why might long-term debt have lower interest rates than short-term debt? In what way are those who borrow long-term still vulnerable to interest rate moves?