Question 1

If interest rates remain below the coupon on a bond, the bond will sell at a premium right up through its maturity.The maturity value will include the bond's face value plus a maturity premium equal to the face value times the percentage of the bond's life during which it sold for a premium.

Accepted Answer

Bonds selling at a premium due to lower interest rates than the coupon rate will still mature at their face value, not with an added maturity premium. The premium reflects market value before maturity, not an additional payout at maturity.

Question 2

The realized rate of return on a stock is always equal to expected rate of return when the stock is purchased at the current market value.

Accepted Answer

The realized rate of return on a stock may be higher or lower than the expected rate of return, depending on market conditions and other factors that affect the stock's performance.

Question 3

If two bonds have the same maturity and the same expected rate of return, but one has a higher coupon, the price of the low coupon bond will be more affected by a given change in interest rates.

Accepted Answer

This is because the low coupon bond is generating less income, so a change in interest rates has a greater impact on its attractiveness relative to the higher coupon bond. As interest rates increase, the lower coupon bond becomes even less attractive, leading to a greater decrease in price compared to the higher coupon bond.

Question 4

The value of a financial asset is positively related to the size of the cash flows and the discount rate appropriate for the riskiness of the cash flows.

Accepted Answer

The value of a financial asset is positively related to the size of the cash flows but negatively related to the discount rate appropriate for the riskiness of the cash flows. Higher discount rates reduce the present value of future cash flows.

Question 5

You have just noticed in the financial pages of the local newspaper that you can buy a bond ($1,000 par) for $800.If the coupon rate is 10 percent, with annual interest payments, and there are 10 years to maturity, you should make the purchase if your required return on investments of this type is 12 percent.

Accepted Answer

The bond is priced lower than its par value, which means that its yield to maturity is higher than the coupon rate. Since the required return on investment is 12 percent, which is higher than the coupon rate of 10 percent, the investor should purchase the bond at a discount to earn a higher return. Additionally, the annual interest payments will also contribute to the overall return. Therefore, it is a good investment decision to purchase the bond at $800, despite the discount.

Question 6

All else equal, a higher coupon rate on a bond results in a higher market price for the bond.

Accepted Answer

A higher coupon rate means that the bond pays a higher interest rate, which makes it more attractive to investors. As a result, they are willing to pay more for the bond, driving its market price up.

Question 7

According to the textbook model, under conditions of nonconstant growth, the discount rate utilized to find the present value of the expected cash flows will be the same for the initial growth period as for the normal growth period.

Accepted Answer

The answer of According to the textbook model, under conditions...

Question 8

If the required rate of return on a bond is greater than its coupon interest rate (and r_d remains above the coupon rate), the market value of that bond will always be below its par value until the bond matures, at which time its market value will equal its par value.(Accrued interest between interest payment dates should not be considered when answering this question.)

Accepted Answer

When the required rate of return on a bond is greater than its coupon interest rate, the bond's market value will be less than its par value. This happens because investors can get a higher return elsewhere, so they won't be willing to pay full price for the bond. Over time, as the bond approaches maturity, its market value will gradually increase and eventually reach its par value at maturity.

Question 9

All else equal, a higher required rate of return on a financial asset results in a higher price for that asset.

Accepted Answer

All else equal, a higher required rate of return on a financial asset results in a lower price for that asset. This is because investors will demand a higher return on their investment to compensate for the increased risk, which in turn lowers the price they are willing to pay for the asset.

Question 10

A $1,000 face value bond with a $100 annual interest payment with five years to maturity (not expected to default) would sell for a premium if interest rates were below 9% and would sell for a discount if interest rates were greater than 11%.

Accepted Answer

When interest rates are below the coupon rate of the bond (9% in this case), it becomes more valuable and sells for a premium. When interest rates are above the coupon rate, it becomes less valuable and sells for a discount. Therefore, if interest rates are below 9%, the bond would sell for a premium, and if interest rates are above 11%, the bond would sell for a discount.

Question 11

According to the basic stock valuation model, the value an investor assigns to a share of stock is dependent upon the length of time the investor plans to hold the stock.

Accepted Answer

The basic stock valuation model takes into account several factors such as dividends, earnings, and growth rates to determine the intrinsic value of a stock. The length of time an investor plans to hold the stock is not the only factor considered in this model.

Question 12

All else equal, higher expected cash flows associated with a financial asset results in a higher required rate of return on that financial asset.

Accepted Answer

Higher expected cash flows associated with a financial asset typically result in a lower required rate of return, as investors are willing to pay a higher price for the asset if they expect to receive more cash flows in the future.

Question 13

A premium bond is a bond whose par value is greater than the market value of that bond.

Accepted Answer

A premium bond is a bond whose market value is greater than the par value of that bond.

Question 14

The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things equal and held constant.

Accepted Answer

This is because high-coupon bonds provide a higher fixed income stream that is unaffected by changes in interest rates, whereas low-coupon bonds have a larger proportion of their cash flows tied to the prevailing interest rate, making them more sensitive to rate changes.

Question 15

If two firms have the same current dividend and the same expected growth rate, their stocks must sell at the same current price or else the market will not be in equilibrium.

Accepted Answer

The current price of a stock also depends on other factors such as the risk associated with the firm, the overall market conditions, and investor sentiment. Therefore, even if two firms have the same current dividend and expected growth rate, their stocks may not necessarily sell at the same current price.

Question 16

All else equal, a higher required rate of return on a firm's stock will result in a higher market price for that firm's stock.

Accepted Answer

A higher required rate of return on a firm's stock reflects a higher perceived risk associated with that stock, which would result in a lower market price for the stock to compensate for the increased risk.

Question 17

The common stock valuation model, as shown below, gives no consideration to expected capital gains.

Accepted Answer

The common stock valuation model does consider expected capital gains through the use of the expected growth rate.

Question 18

Regardless of what interest rates do in the future, the bond's price will approach the par value of the bond as it nears its maturity date.

Accepted Answer

This is because as a bond nears its maturity date, the remaining interest payments and principal repayment become more certain, and therefore the bond's price becomes less sensitive to changes in interest rates. At maturity, the bond will be redeemed at its par value, so the price will approach this value.

Question 19

The prices of outstanding bonds are typically very close to the par value of the bond.

Accepted Answer

The prices of outstanding bonds can be above or below the par value, depending on factors such as interest rates, creditworthiness of the issuer, and market demand for the bond.

Question 20

A discount bond is a bond that sells below its par value.

Accepted Answer

A discount bond is a bond that is sold below its par value, meaning the price of the bond is less than the face value of the bond. This could be due to a variety of reasons such as changes in interest rates or market perceptions of the creditworthiness of the issuer.

Quiz 10: Valuation Concepts