Question 1

What is the approximate yield to maturity for a $1000 par value bond selling for $1120 that matures in 6 years and pays 12 percent interest annually?

Accepted Answer

The yield to maturity (YTM) is calculated using the bond's current price, par value, coupon interest rate, and time to maturity. Given the bond's price is above par, the YTM will be lower than the coupon rate of 12%. Calculating the YTM using the formula or a financial calculator gives approximately 9.4 percent.

Question 2

An 8 percent preferred stock with a market price of $110 per share and a $100 par value pays a cash dividend of __________.

Accepted Answer

The dividend yield can be calculated by dividing the annual dividend by the market price per share. The annual dividend is 8% of the par value, which is $8 ($100 x 0.08). So the dividend yield is $8/$110, which is approximately 0.0727, or 7.27%. Therefore, the cash dividend is $8 per share.

Question 3

A firm has an expected dividend next year of $1.20 per share, a zero growth rate of dividends, anda required return of 10 percent. The value of a share of the firm's common stock is _________.

Accepted Answer

The value of a stock with zero growth is calculated using the formula: Value = Dividend / Required Return. Here, it's $1.20 / 0.10 = $12.

Question 4

A bond will sell __________when the stated rate of interest exceeds the required rate of return,when the stated rate of interest is less than the required return, and ___________ when thestated rate of interest is equal to the required return.

Accepted Answer

When the stated rate of interest exceeds the required rate of return, investors will be attracted to the bond and will therefore be willing to pay a premium for it. When the stated rate of interest is less than the required return, investors will not be interested in the bond and will only be willing to buy it at a discount. However, when the stated rate of interest is equal to the required return, the bond is being offered at a fair price and there is no premium or discount involved. Therefore, the bond will sell at par value.

Question 5

A business that is expected to generate $160,000 in cash flows for shareholders next year, withperpetual growth expectations of 3% per year, is selling for $1,400,000. Given the business'variability in historical returns, beta is estimated to be 1.1. The current risk free rate is 4% and the current market risk premium is 7.2%. In a competitive market, which of the following is true?

Accepted Answer

The business is underpriced; buy. The WACC is 7.68% and the implied growth rate is 7.68% which is higher than the expected growth rate of 3%.

Question 6

Generally, long-term loans have higher interest rates than short-term loans because of

Accepted Answer

Long-term loans typically have higher interest rates due to greater demand relative to supply, lender preferences for liquidity, and expectations of higher future inflation, all of which contribute to increased risk and cost over time.

Question 7

In the Gordon model, the value of the common stock is the

Accepted Answer

The Gordon model assumes that dividends will grow at a constant rate in perpetuity. Therefore, the value of the common stock is the present value of a constant, growing dividend stream. Options A and D do not reflect the assumption of constant growth in perpetuity, while option C is not relevant to the calculation of the stock price in the Gordon model.

Question 8

The_________ rate of interest creates an equilibrium between the supply of savings and the demandfor investment funds.

Accepted Answer

The equilibrium between the supply of savings and the demand for investment funds is based on the real rate of interest, which adjusts for inflation. Only option D, which refers to the real interest rate, takes into account the inflationary effects on the equilibrium.

Question 9

The _________value of a bond is also called its face value. Bonds which sell at less than face value are priced at __________, while bonds which sell at greater than face value sell at __________.

Accepted Answer

The par value of a bond is its face value. Bonds selling for less than face value are at a discount, while those selling for more are at a premium.

Question 10

The longer the time to maturity for a bond, the_________interest rate risk.

Accepted Answer

The longer the time to maturity for a bond, the greater the interest rate risk. This is because there is more time for interest rates to change, potentially causing fluctuations in the bond's value.

Question 11

A downward-sloping yield curve that indicates generally cheaper long-term borrowing costs thanshort-term borrowing costs is called

Accepted Answer

An inverted yield curve is a rare phenomenon that occurs when short-term borrowing costs exceed long-term borrowing costs, resulting in a downward-sloping yield curve. This can indicate a negative economic outlook and higher uncertainty about the future.

Question 12

At any time, the slope of the yield curve is affected by

Accepted Answer

The slope of the yield curve is influenced by all of the factors mentioned in options A, B, and C. The comparative equilibrium of supply and demand in the short-term and long-term market segments affects the yield curve because if there is high demand for short-term bonds, prices will go up, and yields will decline, causing the yield curve to become flatter. If demand is high for long-term bonds, the yield curve will become steeper as investors demand higher yields. Inflationary expectations also have a significant impact on the yield curve because investors will demand higher yields to compensate for expected inflation, which in turn can lead to a steeper yield curve. Finally, liquidity preferences affect the slope of the yield curve because investors may prefer shorter-term bonds that provide more liquidity in uncertain economic times, causing the yield curve to flatten.

Question 13

The value of a bond is the present value of the

Accepted Answer

The value of a bond is the present value of the interest payments (which are received periodically) and the maturity value (which is received at the end of the bond's life). Therefore, the correct answer is D, as it includes both interest payments and maturity value.

Question 14

Generally, an increase in risk will result in __________required return or interest rate

Accepted Answer

An increase in risk will result in a higher risk level.

Question 15

Which type of company would have a high P/E ratio?

Accepted Answer

A high P/E (price-to-earnings) ratio typically signifies that investors have high expectations for a company's future earnings growth. This would generally be the case for a respected growth company that is expected to continue expanding and delivering strong profits. Companies on the verge of failure or mature companies may have lower P/E ratios, while new companies may not have a P/E ratio at all due to lack of historical earnings data.

Question 16

The current price of DEF Corporation stock is $26.50 per share. Earnings next year should be $2 per share and it should pay a $1 dividend. The P/E multiple is 15 times on average. What price would you expect for DEF's stock in the future?

Accepted Answer

To calculate the future stock price using the P/E multiple:
Future stock price = (Expected earnings per share x P/E multiple) + Expected dividend per share
= ($2 x 15) + $1
= $31
Therefore, the closest answer choice is D: $30.00.

Question 17

Company XYZ just paid a $2 dividend, and future dividends are expected to grow at a rate of 4%forever. If the required rate of return on similar stocks is 12%, what is the value of a share of stockin Company XYZ?

Accepted Answer

The answer of Company XYZ just paid a $2 dividend,...

Question 18

Over the period of 1948 to 1999, an investment of $1 in the TSX 300 composite index grew to$357.34. The annual compounded return earned by investors would have been

Accepted Answer

The answer of Over the period of 1948 to 1999,...

Question 19

The three theories cited to explain the general shape of the yield curve are all of the followingEXCEPT

Accepted Answer

The security markets theory is not one of the theories used to explain the shape of the yield curve. The other three options are commonly cited theories: market segmentation theory, liquidity preference theory, and expectations hypothesis.

Question 20

Which of the following is an accurate statement about the difference between debt and equity?

Accepted Answer

Debt represents borrowed money that must be paid back with interest, while equity represents ownership in the company and does not require interest payments. A is incorrect because equity represents ownership, while debt represents a liability. B is incorrect because interest payments on debt are tax deductible for the issuer, not equity. D is incorrect because financial distress can affect both debt and equity holders, but in different ways.

Quiz 8: Valuation of Financial Securities