Deck 10: Valuation and Rates of Return

Question 1

The yield to maturity is also known as the discount rate and is the rate of return required by bondholders.

Answer 1

True

Question 2

A 10-year bond pays 6% annual interest in semiannual 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.

Answer 2

True
Explanation: i = 4% / 2 = 2%, n = 10 × 2 = 20

Question 3

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

Answer 3

True

Question 4

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

Question 5

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.

Question 6

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

Question 7

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.

Question 8

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

Question 9

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.

Question 10

The yield to maturity is always equal to the coupon rate of a bond.

Question 11

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

Question 12

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

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.

Question 14

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

Question 15

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

Question 16

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

Question 17

The required rate of return is the rate of return the investor demands for giving up the current use of the funds on a noninflation-adjusted basis.

Question 18

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.

Question 19

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

Question 20

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

Question 21

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

Question 22

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

Question 23

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

Question 24

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

Question 25

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

Question 26

As time to maturity increases, bond price sensitivity decreases.

Question 27

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

Question 28

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

Question 29

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

Question 30

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

Question 31

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

Question 32

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

Question 33

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

Question 34

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

Question 35

Preferred stock may not have the same ownership privileges as common stock, but preferred stock offers a fixed dividend stream supported by a binding contractual obligation.

Question 36

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

Question 37

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 38

When inflation rises, bond sales prices fall.

Question 39

High-risk corporate bonds are referred to as junk bonds.

Question 40

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

Question 41

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 expected to be 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 42

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

Question 43

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

Question 44

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

Question 45

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

Question 46

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

Question 47

Valuation of financial assets requires knowledge of

A) company valuation.
B) an appropriate discount rate.
C) past asset performance.
D) future cash flows and an appropriate discount rate.

Question 48

The constant dividend growth valuation formula is P₀ = D₁/(K_e - g).

Question 49

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

Question 50

When inflation rises, preferred stock prices fall.

Question 51

The risk premium relates to the inability of the firm to hold its competitive position and maintain stability and growth in earnings.

Question 52

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

Question 53

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

Question 54

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

Question 55

Future stock value is equal to P₀ = D₁/(K_e - g), assuming a constant growth in dividends.

Question 56

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

A) Corporate bond
B) U.S. Treasury bill
C) Certificate of deposit
D) Common stock

Question 57

The market allocates capital to companies based on

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

Question 58

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

Question 59

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

Question 60

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 61

A 10-year bond, with a par value equaling $1,000, pays 7% annually. If similar bonds are currently yielding 6% annually, what is the market value of the bond? Use semiannual analysis. Use time value of money tables in Appendix B and Appendix D.

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

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 options are correct

Question 63

The longer the time to maturity

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

Question 64

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

A) is unaffected.
B) goes down.
C) goes up.
D) More information is needed for an answer.

Question 65

Which of the following is not one of the components included in the required rate of return on a bond?

A) Risk premium
B) Real rate of return
C) Inflation premium
D) Market yield

Question 66

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 67

A 20-year bond pays 6% annually on a face value of $1,000. If similar bonds are currently yielding 4%, what is the market value of the bond? Use time value of money tables in Appendix B and Appendix D.

A) $1,271.40
B) $573.50
C) $770.80
D) Not enough information is given to tell.

Question 68

A 5-year zero-coupon bond was issued with a $1,000 par value to yield 8%. What is the approximate market value of the bond? Use time value of money table in Appendix B.

A) $597
B) $681
C) $275
D) $482

Question 69

Which of the following is not considered a factor to influence the bondholders required rate of return?

A) Risk premium
B) Other investments by the bondholder
C) Business risk
D) Financial risk

Question 70

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 options are true.

Question 71

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 72

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

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

Question 73

A bond pays 7% annual interest in semiannual 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 3.5%.
B) find the interest factors (IFs) for 10 periods at 7%.
C) find the interest factors (IFs) for 10 periods at 9%.
D) find the interest factors (IFs) for 20 periods at 4.5%.

Question 74

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. Use time value of money tables in Appendix B and Appendix D.

A) $693.25
B) $386.00
C) $3,390.85
D) $1,386.09

Question 75

A 20-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. Use time value of money tables in Appendix B and Appendix D.

A) Under $1,300
B) Exactly $1,000
C) Over $1,300
D) Not enough information is given to tell.

Question 76

A 10-year zero-coupon bond that yields 6% is issued with a $1,000 par value. What is the issuance price of the bond? Use time value of money table in Appendix B.

A) $558
B) $64
C) $614
D) $1,000

Question 77

The risk premium is likely to be highest for

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

Question 78

A bond that 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) that is equal to the face value of the bond plus the value of all interest payments.

Question 79

The relationship between a bond's sales 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) changes at a constant level for each percentage change of yield to maturity and is an inverse relationship.

Question 80

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.