Question 1

Your corporation has the following cash flows:  If the applicable income tax rate is 40 percent, and if 70 percent of dividends received are exempt from taxes, what is the corporation's tax liability?

Accepted Answer

To calculate the corporation's tax liability, we need to first calculate the taxable income.

Taxable income = Total cash flows - Exempt dividends

Total cash flows = R200,000 + R150,000 + R100,000 = R450,000

Exempt dividends = 70% of R100,000 = R70,000

Taxable income = R450,000 - R70,000 = R380,000

Now, we can calculate the tax liability:

Tax liability = Taxable income * Tax rate 
Tax liability = R380,000 * 40% = R152,000

Therefore, the answer is B) R88,400.

Question 2

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 3

If the expectations theory of the term structure of interest rates is correct, and if the other term structure theories are invalid, and we observe a downward sloping yield curve, which of the following is a true statement?

Accepted Answer

According to the expectations theory, a downward sloping yield curve is an indication that investors expect short-term rates to decrease in the future. This theory assumes that long-term rates are determined by the market’s expectations of future short-term rates. Therefore, the downward sloping yield curve indicates that the market expects a decline in short-term rates in the future.

Question 4

Assume that a 3-year Treasury note has no maturity premium, and that the real, risk-free rate of interest is 3 percent.If the T-note carries a yield to maturity of 13 percent, and if the expected average inflation rate over the next 2 years is 11 percent, what is the implied expected inflation rate during Year 3?

Accepted Answer

The answer of Assume that a 3-year Treasury note has...

Question 5

If the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a 1-year T-bond?

Accepted Answer

When the yield curve is downward sloping, it indicates that investors expect interest rates to fall in the future. In such a scenario, the yield to maturity on a longer-term bond such as a 10-year Treasury coupon bond will be lower than the yield on a shorter-term bond like a 1-year T-bond. This is because investors are locking in a lower yield for a longer period of time, expecting rates to decrease in the future. Therefore, the correct option is A.

Question 6

Amandla Corporation can (1) build a new plant which should generate a before-tax return of 11 percent, or (2) invest the same funds in the preferred shares of FPL, which should provide Amandla with a before-tax return of 9%, all in the form of dividends.Assume that Amandla's marginal tax rate is 25 percent, and that 70 percent of dividends received are excluded from taxable income.If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximise Amandla's effective return on the money invested?

Accepted Answer

The answer of Amandla Corporation can (1) build a new...

Question 7

Assume that expected rates of inflation over the next 5 years are 4 percent, 7 percent, 10 percent, 8 percent, and 6 percent, respectively.What is the average expected inflation rate over this 5-year period?

Accepted Answer

The average expected inflation rate over the 5-year period is calculated by adding the expected rates of inflation for each year and then dividing by the number of years. So, (4% + 7% + 10% + 8% + 6%) / 5 = 35% / 5 = 7%.

Question 8

As a corporate investor paying a marginal tax rate of 34 percent, if 70 percent of dividends are excludable, what would be your after-tax dividend yield on preferred shares with a 16 percent before-tax dividend yield?

Accepted Answer

The answer of As a corporate investor paying a marginal...

Question 9

The normal yield curve is upward sloping implying that

Accepted Answer

The upward slope of the yield curve indicates that investors demand higher returns for tying up their money for longer periods of time, implying that the return on short-term securities are lower than the return on long-term securities of similar risk.

Question 10

Assume that the current yield curve is upward sloping, or normal.This implies that

Accepted Answer

An upward sloping (normal) yield curve typically implies that long-term interest rates are higher than short-term rates, reflecting expectations of future economic growth, potential inflation, or higher interest rates in the future. It does not necessarily imply any of the specific conditions listed in options A, B, C, or D.

Question 11

Assume that r* = 1.0%; the maturity risk premium is found as MRP = 0.2%(t - 1) where t = years to maturity; the default risk premium for AT&T bonds is found as DRP = 0.07%(t - 1); the liquidity premium is 0.50% for AT&T bonds but zero for Treasury bonds; and inflation is expected to be 7%, 6%, and 5% during the next three years and then 4% thereafter.What is the difference in interest rates between 10-year AT&T bonds and 10-year Treasury bonds?

Accepted Answer

The difference in interest rates between 10-year AT&T bonds and 10-year Treasury bonds can be calculated by considering the default risk premium (DRP), the liquidity premium (LP), and the maturity risk premium (MRP) for AT&T bonds, since Treasury bonds do not have DRP or LP and both types of bonds would have the same MRP. For a 10-year bond, the DRP = 0.07%(10 - 1) = 0.63%, the LP = 0.50%, and the MRP does not contribute to the difference since it affects both types of bonds equally. Therefore, the total difference = DRP + LP = 0.63% + 0.50% = 1.13%.

Question 12

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 13

You read in The Financial Mail that 30-day T-bills currently are yielding 8 percent.Your brother-in-law, a broker at Khumalo Securities, has given you the following estimates of current interest rate premiums:  Based on these data, the real risk-free rate of return is

Accepted Answer

The answer of You read in The Financial Mail that...

Question 14

Treasury securities that mature in 6 years currently have an interest rate of 8.5%.Inflation is expected to be 5% each of the next three years and 6% each year after the third year.The maturity risk premium is estimated to be 0.1%(t - 1), where it is equal to the maturity of the bond (i.e., the maturity risk premium of a one-year bond is zero).The real risk-free rate is assumed to be constant over time.What is the real risk-free rate of interest?

Accepted Answer

The nominal interest rate is the sum of the real risk-free rate, expected inflation, and the maturity risk premium. Given the nominal rate is 8.5%, expected inflation is 5% for the first three years and 6% for the next three years, and the maturity risk premium is 0.5% (0.1% * (6 - 1)), the real risk-free rate can be calculated as 8.5% - (average inflation rate over 6 years) - 0.5%. The average inflation rate is (5%*3 + 6%*3)/6 = 5.5%. Therefore, the real risk-free rate is 8.5% - 5.5% - 0.5% = 2.5%.

Question 15

Which of the following is not one of the four fundamental factors that affect the cost of money?

Accepted Answer

The answer of Which of the following is not one...

Question 16

Interest rates on 1-year, 2-year, and 3-year Treasury bills are 5%, 6%, and 7% respectively.Assume that the pure expectations theory holds and that the market is in equilibrium.Which of the following statements is most correct?

Accepted Answer

The answer of Interest rates on 1-year, 2-year, and 3-year...

Question 17

You are given the following data:  Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant.Given these conditions, the nominal risk-free rate for T-bills is __________, and the rate on long-term Treasury bonds is __________.

Accepted Answer

The answer of You are given the following data: ...

Question 18

Assume that the expectations theory holds, and that liquidity and maturity risk premiums are zero.If the annual rate of interest on a 2-year Treasury bond is 10.5 percent and the rate on a 1-year Treasury bond is 12 percent, what rate of interest should you expect on a 1-year Treasury bond one year from now?

Accepted Answer

The answer of Assume that the expectations theory holds, and...

Question 19

Carter Corporation has some money to invest, and its treasurer is choosing between City of Tshwane municipal bonds and S.A.Treasury bonds.Both have the same maturity, and they are equally risky and liquid.If Treasury bonds yield 6 percent, and Carter's marginal income tax rate is 40 percent, what yield on the Tshwane municipal bonds would make Carter's treasurer indifferent between the two?

Accepted Answer

The answer of Carter Corporation has some money to invest,...

Question 20

If the South African Reserve Bank sells R50 billion worth of short-term S.A.Treasury securities to the public, other things held constant, what will this tend to do to short-term security prices and interest rates?

Accepted Answer

When the South African Reserve Bank sells R50 billion worth of short-term S.A.Treasury securities to the public, the supply of securities in the market increases, and this leads to a shift in the demand and supply curve. This increase in the supply of the securities will cause a decline in prices, and since prices and interest rates have an inverse relationship, it will lead to an increase in interest rates. Therefore, prices will decline, and interest rates will rise. The correct answer is D.

Quiz 5: The Cost of Money

Your corporation has the following cash flows: If the applicable income tax rate is 40 percent, and if 70 percent of dividends received are exempt from taxes, what is the corporation's tax liability?

Which of the following statements is correct?

If the expectations theory of the term structure of interest rates is correct, and if the other term structure theories are invalid, and we observe a downward sloping yield curve, which of the following is a true statement?

If the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a 1-year T-bond?

Assume that expected rates of inflation over the next 5 years are 4 percent, 7 percent, 10 percent, 8 percent, and 6 percent, respectively.What is the average expected inflation rate over this 5-year period?

As a corporate investor paying a marginal tax rate of 34 percent, if 70 percent of dividends are excludable, what would be your after-tax dividend yield on preferred shares with a 16 percent before-tax dividend yield?

The normal yield curve is upward sloping implying that

Assume that the current yield curve is upward sloping, or normal.This implies that

Which of the following statements is correct?

You read in The Financial Mail that 30-day T-bills currently are yielding 8 percent.Your brother-in-law, a broker at Khumalo Securities, has given you the following estimates of current interest rate premiums: Based on these data, the real risk-free rate of return is

Which of the following is not one of the four fundamental factors that affect the cost of money?

Interest rates on 1-year, 2-year, and 3-year Treasury bills are 5%, 6%, and 7% respectively.Assume that the pure expectations theory holds and that the market is in equilibrium.Which of the following statements is most correct?

You are given the following data: Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant.Given these conditions, the nominal risk-free rate for T-bills is , and the rate on long-term Treasury bonds is .

If the South African Reserve Bank sells R50 billion worth of short-term S.A.Treasury securities to the public, other things held constant, what will this tend to do to short-term security prices and interest rates?