Deck 10: Valuation and Rates of Return

Question 1

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

Answer 1

True

Question 2

The market determined required rate of return is also called the discount rate.

Answer 2

True

Question 3

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

Answer 3

True

Question 4

You hold a long-term bond yielding ten percent. If interest rates fall shortly before you sell the bond, you will sell at a higher price than if interest rates had been constant.

Question 5

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

Question 6

When a bond trades at a discount to par, the yield to maturity on the bond will exceed the required return.

Question 7

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

Question 8

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

Question 9

The inflation premium is based on past and current inflation levels.

Question 10

A 10-year bond pays 6% annual interest in semi-annual payments. The current market yield to maturity is 4%. The appropriate interest factors should be in the tables under 2% for 20 periods.
i = 4%/2 = 2%, n = 10 x 2 = 20

Question 11

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

Question 12

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

Question 13

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

Question 14

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

Question 15

The risk-free rate of return is equal to the inflation premium plus the real rate of return.

Question 16

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

Question 17

The required rate of return is payment demanded by the investor for foregoing present consumption.

Question 18

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

Question 19

An increase in yield to maturity would be associated with an increase in the price of a bond.

Question 20

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

Question 21

An increase in inflation will cause a bond's required return to rise.

Question 22

When inflation rises, preferred stock prices fall.

Question 23

As time to maturity increases, bond price sensitivity decreases.

Question 24

Valuation of a common stock with no dividend growth potential is treated in the same manner as preferred stock.

Question 25

The higher the yield to maturity on a bond, the closer to par the bond will trade.

Question 26

The risk premium is primarily concerned with business risk, financial risk, and inflation risk.

Question 27

There is a negative correlation between risk and the return the investors demand.

Question 28

The price of preferred stock is determined by dividing the fixed dividend payment by the required rate of return.

Question 29

The longer the maturity of a bond, the greater the impact on price to changes in market interest rates.

Question 30

Preferred stock is compensated for not having ownership privileges by offering a fixed dividend stream supported by a binding contractual obligation.

Question 31

The risk premium is equal to the required yield to maturity minus both the real rate of return and the inflation premium.

Question 32

High-risk corporate bonds are as risky as junk bonds.

Question 33

Business risk relates to the inability of the firm to meet its debt obligations as they come due.

Question 34

Preferred stock would be valued the same as a common stock with a zero dividend growth rate.

Question 35

When inflation rises, bond prices fall.

Question 36

The further the yield to maturity of a bond moves away from the bond's coupon rate the greater the price-change effect will be.

Question 37

The variable growth model is useful for firms in emerging industries.
ownership.

Question 38

The value of a share of stock is the present value of the expected stream of future dividends.

Question 39

The constant dividend growth valuation formula is

Question 40

Risk premiums are higher for riskier securities, but the risk premium cannot be higher than the required return.

Question 41

Even though the IRS tries to minimize occurrences, small business owners often intermingle business and personal expenses in order to minimize taxable income.

Question 42

The price-earnings ratio is another tool used to measure the value of common stock.

Question 43

Which of the following is not one of the components that makes up the required rate of return on a bond?

A) Risk premium
B) Real rate of return
C) Inflation premium
D) Maturity payment

Question 44

To use a dividend valuation model, a firm must have a constant growth rate and the discount rate must not exceed the growth rate.

Question 45

A 20-year bond pays 6% on a face value of $1,000. If similar bonds are currently yielding 5%, what is the market value of the bond? Use annual analysis.

A) Over $1,100
B) Under $1,000
C) Under $900
D) Not enough information given to tell

Question 46

Which of the following financial assets is likely to have the highest required rate of return based on risk?

A) Corporate bond.
B) Treasury bill.
C) Certificate of Deposit.
D) Common stock.

Question 47

The variable growth dividend model can be used for both constant and variable growth stocks.

Question 48

A stock that has a high required rate of return because of its risky nature will usually have a high P/E ratio.

Question 49

Firms with bright expectations for the future, tend to trade at high P/E ratios.

Question 50

The market allocates capital to companies based on

A) risk.
B) efficiency.
C) expected returns.
D) all of these

Question 51

Firms with an expectation for great potential tend to trade at low P/E ratios.

Question 52

A 10-year zero-coupon bond that yields 5% is issued with a $1000 par value. What is the issuance price of the bond (round to the nearest dollar)?

A) $614
B) $64
C) $6,140
D) None of these

Question 53

The drawback of the future stock value procedure is that it does not consider dividend income.

Question 54

Valuation of financial assets requires knowledge of

A) future cash flows.
B) appropriate discount rate.
C) past asset performance.
D) a and b.

Question 55

A 15-year zero-coupon bond was issued with a $1000 par value to yield 8%. What is the approximate market value of the bond?

A) $597
B) $315
C) $275
D) $482

Question 56

A ten-year bond, with par value equals $1000, pays 7% annually. If similar bonds are currently yielding 6% annually, what is the market value of the bond? Use semi-annual analysis.

A) $700.00
B) $927.50
C) $1,074.70
D) $1,520.70

Question 57

Future stock value is equal to P_o=
assuming constant growth in dividends.

Question 58

A bond which has a yield to maturity greater than its coupon interest rate will sell for a price

A) below par.
B) at par.
C) above par.
D) what is equal to the face value of the bond plus the value of all interest payments.

Question 59

In a general sense, the value of any asset is the

A) value of the dividends received from the asset.
B) present value of the cash flows received from the asset.
C) value of past dividends and price increases for the asset.
D) future value of the expected earnings discounted by the asset's cost of capital.

Question 60

The fact that small businesses are usually illiquid does not affect their valuation process.

Question 61

Which of the following does not influence the yield to maturity for a security?

A) Required real rate of return.
B) Risk free rate.
C) Business risk.
D) Historic yields.

Question 62

An issue of preferred stock is paying an annual dividend of $1.50. The growth rate for the firm's common stock is 5%. What is the preferred stock price if the required rate of return is 7%?

A) $21.43
B) $30.00
C) $22.50
D) None of these

Question 63

Will an increase in inflation have a larger impact on the price of a bond or preferred stock?

A) The bond.
B) The preferred stock.
C) The impact will be the same.
D) There is not enough information to determine the relative impact.

Question 64

If the inflation premium for a bond goes up, the price of the bond

A) is unaffected.
B) goes down.
C) goes up.
D) need more information.

Question 65

The price of preferred stock may react strongly to a change in k_pbecause

A) preferred stock may be cumulative.
B) preferred stock dividends have to be paid before common stock dividends.
C) there is no maturity date.
D) corporate recipients of preferred stock dividends may receive a partial tax exemption.

Question 66

Preferred stock has all but which of the following characteristics?

A) No stated maturity.
B) A fixed dividend payment that carries a higher precedence than common stock dividends.
C) The same binding contractual obligation as debt.
D) Preferred lacks the ownership privilege of common stock.

Question 67

An increase in the riskiness of a particular security would NOT affect

A) the risk premium for that security.
B) the premium for expected inflation.
C) the total required return for the security.
D) investors' willingness to buy the security.

Question 68

A ten-year bond pays 7% interest on a $1000 face value annually. If it currently sells for $1,195, what is its approximate yield to maturity?

A) 9.33%
B) 3.46%
C) 5.34%
D) 4.52%

Question 69

Which is a characteristic of the price of preferred stock?

A) Since preferred stock dividends are fixed, they are tax deductible.
B) Because preferred stock has no maturity, the price analysis is similar to that of debt.
C) Preferred stock is valued as a perpetuity.
D) None of these.

Question 70

A bond pays 7% yearly interest in semi-annual payments for 10 years. The current yield on similar bonds is 9%. To determine the market value of this bond, you must

A) find the interest factors (IFs) for 20 periods at 9%.
B) find the interest factors (IFs) for 10 periods at 7%.
C) find the interest factors (IFs) for 10 periods at 4.5%.
D) find the interest factors (IFs) for 20 periods at 4.5%.

Question 71

The relationship between a bond's price and the yield to maturity

A) changes at a constant level for each percentage change of yield to maturity.
B) is an inverse relationship.
C) is a linear relationship.
D) a and b.

Question 72

The growth rate for the firm's common stock is 7%. The firm's preferred stock is paying an annual dividend of $3. What is the preferred stock price if the required rate of return is 8%?

A) $3.00
B) $37.50
C) $50.00
D) None of these

Question 73

The return measure that an investor demands for giving up current use of funds, without adjusting for purchasing power changes or the real rate of return, is the

A) risk premium.
B) inflation premium.
C) dividend yield.
D) discount rate.

Question 74

A higher interest rate (discount rate) would

A) reduce the price of corporate bonds.
B) reduce the price of preferred stock.
C) reduce the price of common stock.
D) all of these.

Question 75

The risk premium is likely to be highest for

A) U.S. government bonds.
B) corporate bonds.
C) utility company stock.
D) either b or c.

Question 76

The longer the time to maturity:

A) the greater the price increase from an increase in interest rates.
B) the less the price increase from an increase in interest rates.
C) the greater the price increase from a decrease in interest rates.
D) the less the price decrease from a decrease in interest rates.

Question 77

What is the approximate yield to maturity for a five-year bond that pays 4% interest on a $1000 face value annually if the bond sells for $952?

A) 5.4%
B) 4.3%
C) 6.5%
D) 5.1%

Question 78

A 15-year bond pays 9% on a face value of $1,000. If similar bonds are currently yielding 6%, what is the market value of the bond? Use annual analysis.

A) Over $1,000
B) Under $1,000
C) Over $1,200
D) Not enough information to tell

Question 79

A 10-year bond pays 5% on a face value of $1,000. If similar bonds are currently yielding 10%, what is the market value of the bond? Use annual analysis.

A) Less than $900
B) More than $900 and less than $1100
C) More than $1100
D) Not enough information to tell

Question 80

If the yield to maturity on a bond is greater than the coupon rate, you can assume:

A) interest rates have decreased
B) the price is below the par
C) the price is above the par
D) risk premiums have decreased