Question 1

Which of the following is not a component of the Gordon (or constant dividend growth rate) model for valuing stocks?

Accepted Answer

The Gordon model does not include next year's expected earnings as a component. Instead, it only requires next year's expected dividend, a constant dividend growth rate, and a discount rate that reflects the riskiness of the stock.

Question 2

When the market interest rate falls below the coupon rate for a particular quality of bond, the "current yield":

Accepted Answer

When the market interest rate falls below the coupon rate, the bond's price increases, causing the current yield (annual coupon payment divided by the bond's current price) to be below the coupon rate.

Question 3

Ameritech has just issued a $1,000 par value bond that will mature in 10 years. This bond pays interest of $45 every six months. If the annual yield to maturity of this bond is 8%, what is the price of the Ameritech bond if the market is in equilibrium?

Accepted Answer

The bond pays $45 every six months, so the semi-annual yield is 4% (8% annual yield divided by 2). The bond has 20 periods (10 years * 2). The price is calculated using the present value of annuity formula for the interest payments and the present value of a lump sum for the par value, resulting in approximately $1,067.96.

Question 4

According to the Gordon dividend model, which of the following variables would not affect a stock's price?

Accepted Answer

The Gordon dividend model only considers the expected growth rate in dividends and the shareholder's required return to determine the stock price. The number of shares outstanding does not directly impact the stock price according to this model. However, it can indirectly impact the stock price if it affects the expected growth rate in dividends. Therefore, option B would not affect a stock's price.

Question 5

Consolidated Edison has just paid an annual dividend of $3 per share. If the expected growth rate for Con Ed is 10%, and your required rate of return is 16%, how much are you willing to pay for this stock?

Accepted Answer

The answer of Consolidated Edison has just paid an annual...

Question 6

Actions by a sovereign nation to interrupt or change the value of cash flows accruing to foreign investments.

Accepted Answer

The answer of Actions by a sovereign nation to interrupt...

Question 7

When the market interest rate rises for a particular quality of bond, the price of the bond falls, which gives investors a new:

Accepted Answer

When the market interest rate rises for a particular quality of bond, the price of the bond falls, which results in a higher yield to maturity for investors. The yield to maturity is the total return anticipated on a bond if it is held until it matures. Therefore, the correct choice is C - yield to maturity.

Question 8

Fluctuating interest rates lead to varying asset prices.

Accepted Answer

Fluctuating interest rates can lead to changes in the value of assets such as bonds, causing interest rate risk. Exchange rate risk refers to the risk that a change in exchange rates will negatively impact an investment, political risk refers to the risk of changes in a country's political environment affecting investments, and rollover risk refers to the risk that a borrower will not be able to refinance their debt at the end of its term.

Question 9

The immediate value of a share of stock, currently selling for $100, after it has a 5 for 1 split is:

Accepted Answer

In a 5 for 1 stock split, each share is divided into 5, so the price per share is divided by 5. Therefore, $100 divided by 5 equals $20.

Question 10

A bond that is selling in over its par value.

Accepted Answer

A premium bond is a bond that is selling for more than its par value. This occurs when the bond's interest rate is higher than the prevailing market interest rate. Investors are willing to pay more for a bond with a higher interest rate, leading to the bond's price being above its par value.

Question 11

When the market interest rate rises above the coupon rate for a particular quality of bond, the "current yield":

Accepted Answer

When the market interest rate rises above the coupon rate, the price of the bond falls below its face value to adjust for the lower yield, making the current yield (annual coupon payments divided by the current market price) higher than the original coupon rate.

Question 12

Fluctuating rates lead to varying levels of U.S. dollar-denominated cash flows.

Accepted Answer

Fluctuating rates refer to the risk of exchange rate movements, which can lead to varying levels of U.S. dollar-denominated cash flows. This is known as exchange rate risk. Political risk refers to the risk of political developments impacting investments, rollover risk refers to the risk of a borrower defaulting on a loan when it matures, and interest rate risk refers to the risk of changes in interest rates impacting investments or borrowing costs.

Question 13

What is the value of HM stock which currently has a dividend of $2 and is growing at 7 percent? The investor's required rate of return is 11 percent.

Accepted Answer

The answer of What is the value of HM stock...

Question 14

The value of a share of stock currently selling for $100 after it has a 5 for 1 split is:

Accepted Answer

After a 5 for 1 split, each original share is divided into 5 shares, so the new price per share is $100 divided by 5, which equals $20.

Question 15

A bond that is selling below par value.

Accepted Answer

A bond that is selling below par value is known as a discount bond. It means that the market interest rate is higher than the coupon rate of the bond. This results in the bond being sold at a price lower than its face value, creating a discount.

Question 16

The last dividend on GTE stock was $4, and the expected growth rate is 10%. If you require a rate of return of 20%, what is the highest price you should be willing to pay for GTE stock?

Accepted Answer

The answer of The last dividend on GTE stock was...

Question 17

Fluctuating interest rates cause coupon or interest payments to be reinvested at different interest rates over time.

Accepted Answer

The answer of Fluctuating interest rates cause coupon or interest...

Question 18

The constant dividend growth model assumes:

Accepted Answer

The constant dividend growth model, also known as the Gordon Growth Model, assumes that dividends will grow at a constant rate indefinitely and that the discount rate must be greater than the dividend growth rate to ensure a finite valuation.

Question 19

A firm's stock is expected to pay a $2 annual dividend next year, and the current $50 stock price is expected to rise to $53 over the next year. What is the expected return?

Accepted Answer

To calculate the expected return, we use the following formula:

Expected return = (dividend yield + capital gains yield)

Dividend yield = Dividend / Current stock price 
Dividend yield = $2 / $50 = 0.04 or 4%

Capital gains yield = (Ending price - Beginning price) / Beginning price 
Capital gains yield = ($53 - $50) / $50 = 0.06 or 6%

Expected return = (4% + 6%) = 10%

Therefore, the expected return is 10%, which corresponds to choice B.

Question 20

A firm's stock is expected to pay a $3 annual dividend next year, the current stock price is $60, and the expected growth rate in dividends is 8 percent. Using the Gordon approach, what is the expected return?

Accepted Answer

The Gordon Growth Model formula for expected return is: Expected Return = (Dividend/Current Price) + Growth Rate. Here, it is ($3/$60) + 8% = 5% + 8% = 13%.

Quiz 10: Bonds and Stocks: Characteristics and Valuations