Question 1

Given that dividends on a share are expected to remain indefinitely at $1 p.a.and that the required rate of return for the level of risk on such a share is 15%,the correct price for this share:
A)cannot be ascertained from this information.
B)cannot be ascertained without regard to the management structure of the firm.
C)is $1.
D)is $6.67.

Accepted Answer

The correct price of the share can be calculated using the Gordon growth model, which states that the price of a share is equal to the dividend expected next period divided by the difference between the required rate of return and the expected constant growth rate of dividends. Since dividends are expected to remain indefinitely at $1 p.a., the expected constant growth rate of dividends is 0%. Therefore, the price of the share can be calculated as follows:
Price = $1 / (0.15 - 0) = $6.67
Hence, the correct answer is D.

Question 2

At what interest rate would investing $1000 in a bank leave you as well off as receiving $1078 in 12 months' time?
A)5%
B)78%
C)10%
D)7.8%

Accepted Answer

Using the formula for simple interest:

Simple interest = Principal x Rate x Time

Let's assume the interest rate is "r"

For investing $1000, the simple interest earned after 12 months would be: 
$1000 x r x 1 = $1000r

For receiving $1078, the simple interest earned in 12 months would be: 
$1000 x 0.078 x 1 = $78

To find the interest rate that would make the two options equivalent:

$1000r = $78

r = 0.078 or 7.8%

Therefore, the best choice is D, with an interest rate of 7.8%.

Question 3

The periodic cash flows from an investment in shares are called:
A)coupons.
B)interest.
C)capital gains.
D)dividends.

Accepted Answer

Periodic cash flows from an investment in shares are called dividends. Coupons and interest are associated with bonds, and capital gains represent the increase in the value of an investment over time.

Question 4

If an investor is prepared to pay $600 for an asset that returns $700 at the end of two years,what annual rate of return is the investor receiving?
A)16.7%
B)$100
C)8%
D)8.3%

Accepted Answer

The annual rate of return can be calculated using the formula for compound interest: $ FV = PV \times (1 + r)^n $. Here, $ FV = 700 $, $ PV = 600 $, and $ n = 2 $. Solving for $ r $, we get $ r \approx 0.08 $ or 8%.

Question 5

A decision to buy an asset implies a simultaneous decision to forego:
A)future consumption.
B)less consumption.
C)current consumption.
D)none of the given options.

Accepted Answer

When you buy an asset, it typically requires a payment or investment upfront, which means that you will have to forego current consumption to make that payment or investment. This is because the money that you spend on the asset could have been used for other purposes, such as buying goods or services for immediate consumption. By choosing to buy the asset, you are choosing to allocate your resources towards a long-term investment rather than immediate consumption.

Question 6

A flat term structure implies that investors expect future short-term interest rates to:
A)decrease.
B)increase.
C)be the same as the current rate.
D)none of the options given.

Accepted Answer

A flat term structure means that yields on bonds of different maturities are relatively the same, indicating that investors expect short-term interest rates to remain the same as the current rate in the near future. This is because the yield curve usually slopes upwards, meaning that long-term bonds pay higher yields than short-term bonds, to compensate investors for the added risk of holding a bond for a longer period of time. When the yield curve flattens, it indicates that investors are not expecting any significant changes in the interest rate environment in the short term.

Question 7

A Ltd pays a dividend of 90 cents per share.If A Ltd retains 40% of its earnings each year and these are reinvested to earn a 25% return,what is the price of A Ltd?
A)$1.22
B)$4.40
C)$19.80
D)More information is needed.

Accepted Answer

The price of A Ltd cannot be determined with the information provided. To calculate the price of a stock using the dividend discount model or any other valuation model, we need to know the required rate of return or the growth rate of dividends, neither of which is provided in the question.

Question 8

The price effect and the reinvestment effect are both sources of:
A)default risk.
B)term structure.
C)interest rate risk.
D)default risk structure.

Accepted Answer

The price effect and the reinvestment effect are both sources of interest rate risk. The price effect refers to the impact that changes in market interest rates have on the value of a fixed income security. The reinvestment effect refers to the impact that changes in market interest rates have on the cash flows generated by a fixed income security. Both effects can result in losses or gains for investors, depending on the direction of interest rate movements. Therefore, the correct answer is C.

Question 9

If you were able to earn 10% p.a.interest on money invested in a bank,how much money would you be willing to receive in 12 months' time,rather than $1000 now,so that you are indifferent between the two options?
A)$1500
B)$909
C)$900
D)$1100

Accepted Answer

To be indifferent between receiving money now or in 12 months, the future amount should equal the present amount plus the interest earned over the year. At 10% p.a., $1000 would grow to $1000 * (1 + 0.10) = $1100 in 12 months.

Question 10

If you have $1000 to invest and are able to earn 8% p.a.interest on money invested in a bank,how much will you be willing to receive in two years' time to be indifferent between the two options?
A)$840
B)$1160
C)$1166
D)$1500

Accepted Answer

To find the future value of an investment, you can use the formula FV = PV(1 + r)^n, where FV is the future value, PV is the present value, r is the annual interest rate, and n is the number of years. Plugging in the values: FV = $1000(1 + 0.08)^2 = $1000 * 1.1664 = $1166.

Question 11

Given that dividends on a share are expected to remain indefinitely at $0.50 p.a.and that the required rate of return for the level of risk on such a share is 10% and the interest rate is 6%,the correct price for this share is:
A)$8.33.
B)$5.
C)$3.
D)none of the options given.

Accepted Answer

The price of the share can be calculated using the constant growth formula:

Price = Dividend / (Required Rate of Return - Dividend Growth Rate)

Given that the dividend is expected to remain constant at $0.50 p.a., the dividend growth rate is 0. Therefore, using the values provided:

Price = $0.50 / (0.10 - 0) = $5

Thus, the correct price for this share is $5. Option B is the correct choice.

Question 12

Assume that for the past 10 years the growth rate in A Ltd's dividends per share has been 10% p.a.Also assume that this growth rate is to be maintained indefinitely.The latest dividend of 90 cents was paid yesterday.What is the value of A's shares?
A)$18.00
B)$6.60
C)$19.80
D)$3.96

Accepted Answer

The formula to calculate the value of a stock using the constant growth model is:

P = D / (r - g)

Where, 
P = Price of the stock
D = Dividend per share
r = Required rate of return
g = Growth rate of dividends

Using the given information, we can calculate the required rate of return (r) as follows:

r = 10% + 3% (expected inflation rate) 
r = 13%

Now, we can use the formula to calculate the price of the stock (P):

P = 0.90 / (0.13 - 0.10)
P = $19.80

Therefore, the value of A's shares is $19.80. Option C is the correct answer.

Question 13

In general,an upward-sloping term structure implies that investors expect future short-term interest rates to:
A)decrease.
B)increase.
C)be the same as the current rate.
D)increase by a minimum of 5bp.

Accepted Answer

An upward-sloping term structure, also known as a normal yield curve, indicates that investors expect future short-term interest rates to increase. This expectation is reflected in the higher yields offered by longer-term bonds compared to shorter-term bonds. This makes sense as investors would demand a higher return to tie up their money for a longer period of time if they anticipate interest rates to rise in the future.

Question 14

A Ltd is currently paying a dividend of 90 cents per share.Assume that the investors expect this dividend to be maintained indefinitely and that they require a return of 15% on the investment.What is the value of A's shares?
A)$0.14
B)$16.66
C)$6.00
D)$1.05

Accepted Answer

The value of A's shares can be calculated using the constant growth formula:

Share Value = Dividend / (Required Rate of Return - Dividend Growth Rate)

Since the dividend is expected to be maintained indefinitely, the dividend growth rate is zero. Therefore:

Share Value = 90 cents / (0.15 - 0) = $6.00

So the correct answer is C.

Question 15

Moody's and Standard and Poor's provide ratings of short-term debt on a:
A)three-point scale.
B)five-point scale.
C)19-point scale.
D)four-point scale.

Accepted Answer

Moody's and Standard and Poor's provide ratings of short-term debt on a four-point scale, which includes: Prime-1, Prime-2, Prime-3, and Not Prime.

Question 16

In general,a downward-sloping term structure implies that investors expect future short-term interest rates to:
A)decrease.
B)increase.
C)be the same as the current rate.
D)none of the options given.

Accepted Answer

When the term structure is downward-sloping, the yield curve suggests that investors expect future short-term interest rates to decrease. This is because the current short-term interest rate is already high compared to expected future rates, causing investors to expect a decline in interest rates in the future.

Question 17

When valuing shares under uncertainty,the price can be written as:
A) 
B) 
C) 
D)

Accepted Answer

The answer of When valuing shares under uncertainty,the price can...

Question 18

You have a choice between receiving $500 now and $530 in six months' time.Current interest rates are 10% p.a.(simple interest).As a rational investor,which option would you choose and why?
A)$500 now,because receiving $530 in six months' time is equivalent to earning only 6% interest,whereas in the bank you can earn 10% interest.
B)$530 in six months' time,because $500 invested for six months is only worth $525.
C)$500 now,because it would be worth $550 in six months' time.
D)$500 now,because you have the option to invest or consume goods.

Accepted Answer

If you choose to receive $530 in six months' time, the effective interest rate you will earn is (530-500)/500*100% = 6%. However, if you invest the $500 now at 10% p.a. simple interest for six months, you will have (500*10%*6/12) = $25 interest and a total of $525 in six months' time. Therefore, it is better to choose option B and receive $530 in six months' time.

Question 19

The appropriate value of K_e is determined using the concept of: A)risk and return models. B)internal rate of return. C)cost of capital. D)opportunity cost of capital.

Accepted Answer

The concept of opportunity cost of capital involves determining the rate of return that could be earned from the best alternative investment with a similar risk profile. This is relevant in determining the appropriate value for K_e, as it ensures that the investment is attractive relative to other options available. Risk and return models, internal rate of return, and cost of capital may also be relevant in investment analysis, but they are not directly related to determining the appropriate value for K_e.

Question 20

The connection between term and interest rates is called:
A)interest rate risk.
B)price risk.
C)term structure of interest rates.
D)default structure of interest rates.

Accepted Answer

The connection between term and interest rates is referred to as the term structure of interest rates. This refers to the relationship between the interest rates on bonds with differing maturities. It is also known as the yield curve. Option A refers to the risk that results from changes in the interest rates, while option B refers to the risk that results from changes in the price of a security. Option D refers to the structure of interest rates for borrowers depending on creditworthiness.

Quiz 4: Applying the Time Value of Money to Security Valuation

Given that dividends on a share are expected to remain indefinitely at $1 p.a.and that the required rate of return for the level of risk on such a share is 15%,the correct price for this share:

At what interest rate would investing $1000 in a bank leave you as well off as receiving $1078 in 12 months' time?

The periodic cash flows from an investment in shares are called:

If an investor is prepared to pay $600 for an asset that returns $700 at the end of two years,what annual rate of return is the investor receiving?

A decision to buy an asset implies a simultaneous decision to forego:

A flat term structure implies that investors expect future short-term interest rates to:

A Ltd pays a dividend of 90 cents per share.If A Ltd retains 40% of its earnings each year and these are reinvested to earn a 25% return,what is the price of A Ltd?

The price effect and the reinvestment effect are both sources of:

If you were able to earn 10% p.a.interest on money invested in a bank,how much money would you be willing to receive in 12 months' time,rather than $1000 now,so that you are indifferent between the two options?

If you have $1000 to invest and are able to earn 8% p.a.interest on money invested in a bank,how much will you be willing to receive in two years' time to be indifferent between the two options?

Given that dividends on a share are expected to remain indefinitely at $0.50 p.a.and that the required rate of return for the level of risk on such a share is 10% and the interest rate is 6%,the correct price for this share is:

Assume that for the past 10 years the growth rate in A Ltd's dividends per share has been 10% p.a.Also assume that this growth rate is to be maintained indefinitely.The latest dividend of 90 cents was paid yesterday.What is the value of A's shares?

In general,an upward-sloping term structure implies that investors expect future short-term interest rates to:

A Ltd is currently paying a dividend of 90 cents per share.Assume that the investors expect this dividend to be maintained indefinitely and that they require a return of 15% on the investment.What is the value of A's shares?

Moody's and Standard and Poor's provide ratings of short-term debt on a:

In general,a downward-sloping term structure implies that investors expect future short-term interest rates to:

When valuing shares under uncertainty,the price can be written as:

You have a choice between receiving $500 now and $530 in six months' time.Current interest rates are 10% p.a.(simple interest) .As a rational investor,which option would you choose and why?

The appropriate value of K_e is determined using the concept of:

The connection between term and interest rates is called: