Question 1

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

Accepted Answer

The discount rate is the rate of return used to determine the present value of future cash flows. It takes into account the perceived level of risk associated with an individual security, so the statement is true.

Question 2

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

Accepted Answer

The market determined required rate of return is the rate of return that investors require to invest in a particular asset or security. This is also referred to as the discount rate, as it is used to discount future cash flows to their present value. By discounting the future cash flows, investors can determine the current value of the investment and make decisions about whether to invest in it. Therefore, the two terms, market determined required rate of return and discount rate, are interchangeable.

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.

Accepted Answer

This is the fundamental concept of bond pricing. The price of a bond depends on the present value of all future cash flows, which includes both coupon payments and the principal repayment.

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.

Accepted Answer

When interest rates fall, the value of existing bonds with higher yields (like your ten percent bond) increases in the market. This is because investors are willing to pay a higher price for these bonds to lock in the higher yield before it becomes unavailable due to falling interest rates. Therefore, if you sell your bond when interest rates have fallen, you will sell at a higher price than if rates had been constant.

Question 5

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

Accepted Answer

The coupon rate is only one of several factors used to determine the market value of a bond. The discount rate should reflect the current market interest rates, credit quality of the issuer, and other factors.

Question 6

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

Accepted Answer

In bond valuation, "Yield to Maturity" and "Required Rate of Return" are synonymous, all other things equal.

Question 7

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

Accepted Answer

The yield to maturity represents the total return anticipated on a bond if it is held until it matures, and this includes both the annual interest payments and any capital gains or losses. It is the appropriate discount rate for bonds because it factors in the time value of money and the bond's current market price.

Question 8

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 9

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 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

Accepted Answer

The given information is correct and calculates the appropriate interest factors for 2% for 20 periods.

Question 11

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

Accepted Answer

The valuation of a financial asset involves estimating the present value of all expected future cash flows associated with the asset. This is done through various methods such as discounted cash flow analysis or comparative valuation techniques.

Question 12

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

Accepted Answer

Yes, by using different discount rates, investors and lenders can allocate capital to companies according to their risk level, efficiency, and expected returns. Higher discount rates are usually applied to riskier investments, while lower rates are used for safer ones. This process helps to ensure that capital is directed towards the most promising and deserving businesses, while also encouraging companies to become more efficient and profitable in order to attract funding.

Question 13

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

Accepted Answer

Historically, the real rate of return on investments such as stocks and bonds has averaged around 2 to 3% after accounting for inflation.

Question 14

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

Accepted Answer

The prices of financial assets are primarily based on the expected value of future cash flows and the discount rate, but past dividends are not a direct factor in determining current prices.

Question 15

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.

Question 16

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 price of the bond will be equal to its par value. Therefore, the bond will trade at par value.

Question 17

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

Accepted Answer

The required rate of return is an investor's expected return on an investment given the amount of risk taken. It is the minimum return an investor expects to receive in order to compensate for giving up the opportunity to spend the money today. Therefore, the statement is true.

Question 18

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 payments and the final principle payment of a bond, whereas the interest payment only represents a portion of the bond's overall return.

Question 19

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

Accepted Answer

An increase in yield to maturity would actually result in a decrease in the price of a bond, as investors demand a higher return in order to compensate for the increased risk. This inverse relationship between yield and price is known as bond price/yield inverse relationship.

Question 20

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

Accepted Answer

Most bonds, such as regular corporate bonds, promise both a periodic interest payment and a lump-sum payment of the principal amount at maturity.

Quiz 10: Valuation and Rates of Return