Question 1

The discount rate depends on the market's perceived level of risk associated with an individual security.

Accepted Answer

The discount rate is determined by the level of risk associated with a particular investment or security. The higher the perceived risk, the higher the discount rate, and vice versa. This is because investors demand a greater return to compensate for taking on more risk.

Question 2

The yield to maturity is always equal to the interest payment of a bond.

Accepted Answer

The yield to maturity represents the total return that an investor can expect to receive from a bond, including both interest payments and capital gains/losses. It takes into account the bond's current price, face value, coupon rate, and time to maturity. Therefore, it may or may not be equal to the bond's interest payment, depending on various factors such as market conditions, credit risk, inflation, and time value of money.

Question 3

The total required real rate of return is equal to the real rate of return plus the inflation premium.

Accepted Answer

The total required real rate of return is equal to the nominal rate of return minus the inflation premium, not the sum of the real rate of return and the inflation premium.

Question 4

When the interest rate on a bond and its yield to maturity are equal, the bond will trade at par value or equal to its principal amount.

Accepted Answer

When the interest rate on a bond and its yield to maturity are equal, it indicates that the bond is being traded at its fair market value, which is equal to its principal amount or par value.

Question 5

The market-determined required rate of return is the appropriate discount rate used in valuation calculations.

Accepted Answer

The market-determined required rate of return reflects the current market conditions and expectations for a particular investment. It is used as a discount rate to determine the present value of future cash flows in valuation calculations.

Question 6

The appropriate discount rate for valuation of bonds is called the yield to maturity.

Accepted Answer

Yield to maturity is the discount rate used to value bonds because it accounts for the current market price, face value, coupon payments, and the remaining time until maturity.

Question 7

Most bonds promise both a periodic return and a lump-sum payment.

Accepted Answer

Most bonds pay a periodic interest payment and a lump-sum payment at maturity.

Question 8

The coupon rate is used to calculate the bond's interest amount, while the yield is used to calculate the present value of both the interest amount and principal amount of the bond.

Accepted Answer

This is correct. The coupon rate is the fixed percentage rate at which interest is paid on a bond's face value, and it is used to calculate the interest amount. The yield, on the other hand, is the rate of return earned by an investor holding the bond, and it is used to calculate the present value of both the interest and principal payments. So, both concepts are related to the bond's interest, but they serve different purposes.

Question 9

Historically, the real rate of return has been about 2% to 3%.

Accepted Answer

This statement is generally true. However, the real rate of return can vary depending on the time period, investment type, and other factors.

Question 10

When a bond trades at a discount to par, the yield to maturity on the bond will exceed the required return.
In bond valuation, "Yield to Maturity" and "Required Rate of Return" are synonymous, all other things equal.

Accepted Answer

Yield to maturity is the rate of return that an investor will receive if the bond is held to maturity, taking into account its current price, coupon payments, and the principal value. Required rate of return, on the other hand, is the rate of return that an investor requires to invest in a bond, taking into account factors such as risk, opportunity cost, and market conditions. While they are related, they are not synonymous. When a bond trades at a discount to par, the yield to maturity will be higher than the coupon rate, but it may or may not exceed the required rate of return, depending on market conditions and investor preferences.

Question 11

The coupon rate or required return of bonds is equal to the stated rate on the bond's contract.

Accepted Answer

The coupon rate is the interest rate stated on the bond contract that the issuer promises to pay the bondholder. This rate does not necessarily equal the required return or yield that investors demand in the market, which may fluctuate based on factors such as interest rate movements, credit risk, and inflation expectations. Thus, while the coupon rate is a contractual obligation of the bond issuer, it may not reflect the actual return received by investors who buy and sell bonds on the secondary market.

Question 12

The required rate of return is the payment demanded by the investors for foregoing their ability to use the funds themselves.

Accepted Answer

The required rate of return is the minimum return that investors expect to receive for investing their money in a particular project or investment. It reflects the investors' opportunity cost of investing their money in one project instead of another.

Question 13

The valuation of a financial asset is based on the concept of determining the present value of future cash flows that this financial asset will accumulate.

Accepted Answer

The valuation of a financial asset is indeed based on the present value of future cash flows it is expected to generate. This is a fundamental concept in finance and financial analysis.

Question 14

The prices of financial assets are based on the expected value of future cash flows, the discount rate, and past dividends.

Accepted Answer

The answer of The prices of financial assets are based...

Question 15

The price of a bond is equal to the present value of all future interest payments added to the present value of the principal.

Accepted Answer

This statement is true according to the basic principles of bond valuation. The present value of each future interest payment is calculated using the current market interest rate and the time remaining until payment, while the present value of the principal is calculated using the face value of the bond and the same market interest rate. These present values are added together to determine the price of the bond.

Question 16

You hold a long-term bond yielding 10%. If interest rates fall before you sell the bond, you will sell at a higher price than if interest rates had been constant.
Since the interest rates on a bond are fixed, a decrease in yields available on similar bonds means that this bond is more desirable, and would therefore increase its price.

Accepted Answer

When interest rates fall, the bond you hold becomes more desirable due to its higher yield, leading to an increase in its price. As a result, you will be able to sell the bond at a higher price than if interest rates had remained constant.

Question 17

In estimating the market value of a bond, the coupon rate should be used as the discount rate.

Accepted Answer

The discount rate used to estimate the market value of a bond should reflect the current market interest rate, not the coupon rate. The coupon rate is only used to calculate the periodic interest payments received by the bondholder.

Question 18

By using different discount rates, the market allocates capital to companies based on their risk, efficiency, and expected returns.

Accepted Answer

Different discount rates reflect varying levels of risk and expected returns, allowing the market to allocate capital to more efficient and promising companies. This helps to promote a more effective and productive economy.

Question 19

An increase in the yield of a bond compared to the coupon rate would be associated with an increase in the price of a bond.
Since the interest rates on a bond are fixed, an increase in yields available on similar bonds means that this bond is less desirable, and would lower its price.

Accepted Answer

An increase in the yield of a bond compared to the coupon rate would be associated with a decrease in the price of a bond. As yields increase, the bond becomes less attractive and its price falls. Conversely, if yields decrease, the bond becomes more attractive, and its price rises.

Question 20

A 10-year bond pays 6% annual interest in semi-annual payments. The current market yield to maturity is 4%. The appropriate interest factors used to calculate the sales price of this bond should be in the TVM tables under 2% for 20 periods.

Accepted Answer

Since the bond pays interest semi-annually, the annual market yield of 4% is divided by 2, resulting in a 2% yield per period. The bond has 10 years to maturity, with 2 periods per year, totaling 20 periods. Therefore, the interest factors should be under 2% for 20 periods.

Quiz 10: Valuation and Rates of Return