Question 1

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 is the basic principle behind bond valuation using a discounted cash flow approach. The present value of all future cash flows (interest payments and principal) is calculated using a discount rate that reflects the risk and return expectations of the investor.

Question 2

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

Accepted Answer

This statement is generally true, as the real rate of return (adjusted for inflation) on long-term investments such as stocks has averaged around 2% to 3% over time. However, it is important to note that this can vary significantly in the short term and that past performance is not necessarily indicative of future results.

Question 3

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

Accepted Answer

When the interest rate on a bond and its yield to maturity are equal, the bond will trade at par value. This means the price of the bond will be equal to its face value.

Question 4

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 refers to the total return anticipated on a bond if it is held until it matures, including interest payments and any price appreciation or depreciation. Required rate of return, on the other hand, is the minimum rate of return an investor demands to invest in a bond. While these two concepts are related, they are not synonymous. Yield to maturity will only exceed the required rate of return if the bond is trading at a discount to par value.

Question 5

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

Accepted Answer

The yield to maturity represents the total return anticipated on a bond if held until it matures and is used as the discount rate in bond valuation.

Question 6

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 security. If a security is considered high-risk, the discount rate will be higher to reflect this perception of risk. If a security is considered low-risk, the discount rate will be lower. Therefore, the discount rate does depend on the market's perceived level of risk associated with a security.

Question 7

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

Accepted Answer

The inflation premium is primarily based on expectations of future inflation, not just past or current levels.

Question 8

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 TVM tables under 2% for 20 periods.
i = 4%/2 = 2%, n = 10 × 2 = 20

Accepted Answer

The given information is correct and the interest factor for 2% for 20 periods can be found in the TVM tables.

Question 9

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

Accepted Answer

The answer of The total required real rate of return...

Question 10

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

Accepted Answer

Most bonds pay interest periodically (usually semi-annually) and promise a lump-sum payment at maturity.

Question 11

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

Accepted Answer

The discount rate used in estimating the market value of a bond should be the required rate of return, which takes into account factors such as the risk of the bond and current market conditions, not just the coupon rate.

Question 12

An increase in yield to maturity 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 yield to maturity would be associated with a decrease in the price of a bond. As the yield on similar bonds increase, the fixed interest rate on the original bond becomes less attractive, resulting in a lower demand for that bond, and therefore a lower price.

Question 13

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 yield on similar bonds decreases, making the higher yielding bond more attractive and increasing its price. Therefore, if you sell the bond after interest rates have fallen, you can sell it at a higher price than if interest rates had remained constant.

Question 14

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

Accepted Answer

The present value of future cash flows is used to determine the current value or price of a financial asset.

Question 15

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 16

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, also known as the cost of equity, is the appropriate discount rate used in valuation calculations like the discounted cash flow method. It is determined by the risk and expected returns of the overall market and comparable investments.

Question 17

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

Accepted Answer

The required rate of return is the compensation expected by investors for deferring the use of their money and forgoing present consumption. It represents the minimum return that an investor expects to earn for compensating the risk and opportunity cost involved in investing their money in a particular asset or security. Therefore, option A is correct.

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, which affects how capital is allocated to different companies in the market. Companies that are more efficient and have higher expected returns are typically able to attract more capital at lower discount rates, while riskier companies will have to offer higher returns to convince investors to allocate capital to them.

Question 19

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

Accepted Answer

The yield to maturity takes into account both the interest payment and any capital gains or losses that may be realized upon maturity of the bond. It is the total return expected from the bond over its entire life.

Question 20

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

Accepted Answer

The formula for calculating the risk-free rate of return is:

Risk-Free Rate of Return = Inflation Premium + Real Rate of Return.

Therefore, the statement is true.

Quiz 10: Valuation and Rates of Return