Deck 10: Valuation and Rates of Return

Question 1

The required rate of return is payment given to the investor for forgoing present consumption.

Answer 1

True

Question 2

A rise in yield to maturity would be coupled with an increase in the price of a bond.

Answer 2

False

Question 3

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

Answer 3

False

Question 4

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 5

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

Question 6

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

Question 7

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

Question 8

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

Question 9

A 20-year bond pays 12% annual interest in semi-annual payments. The current market yield to maturity is 10%. The appropriate interest factors should use 5% for 20 periods (by tables or calculator).

Question 10

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

Question 11

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

Question 12

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

Question 13

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

Question 14

The yield to maturity is always equal to the interest payment of a bond.

Question 15

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

Question 16

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

Question 17

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

Question 18

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

Question 19

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

Question 20

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

Question 21

Preferred stock is compensated for not having ownership privileges with a fixed dividend stream supported by a binding contractual obligation (of interest on debt).

Question 22

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

Question 23

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

Question 24

Firm's with bright expectations for the future, tend to trade at high P/E ratios.

Question 25

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

Question 26

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

Question 27

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

Question 28

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 29

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

Question 30

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

Question 31

As time to maturity increases, bond price sensitivity decreases.

Question 32

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

Question 33

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

Question 34

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

Question 35

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

Question 36

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 37

The constant growth valuation formula is P_o= D₁/g-K_e.

Question 38

Future share value is equal to P_o=D₁/K_e-g, assuming constant growth in dividends.

Question 39

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

Question 40

When the interest rate on a bond and its yield to maturity are equal, the bond will trade at par value.

Question 41

Valuation of financial assets requires knowledge of

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

Question 42

If expected dividends grow at 8% and the appropriate discount rate is 12%, what is the value of a share with an expected dividend of $2.33?

A) $62.88
B) $19.41
C) $29.12
D) $58.25

Question 43

An issue of common stock is expected to pay a dividend of $4.80 at the end of the year. Its growth rate is equal to 8%. If the required rate of return is 13%, what is its current price?

A) $103.68
B) $36.92
C) $96.00
D) none of the other answers are correct

Question 44

A 20-year bond pays 12% on a face value of $1,000. If similar bonds are currently yielding 9%, what is the market value of the bond?

A) over $1,000
B) under $1,000
C) over $1,200
D) not enough information given to tell

Question 45

The market allocates capital to companies based on

A) risk.
B) efficiency.
C) expected returns.
D) all of the other answers are correct

Question 46

An issue of common stock has just paid a dividend of $3.75. Its growth rate is 8%. What is its price if the market's rate of return is 16%?

A) $25.01
B) $46.88
C) $50.63
D) $54.38

Question 47

The higher the growth rate during a period of supernormal growth, the higher the share's value.

Question 48

Supernormal growth implies that the number of the company's employees is rising rapidly.

Question 49

The relationship between a bond's 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 50

A 4-year bond pays 4% annual interest (paid semiannually). It currently sells for $872.25. What is the bond's yield to maturity?

A) 4.00%
B) 4.59%
C) 6.06%
D) 7.78%

Question 51

The value of a common stock is based on its

A) past performance.
B) divided yield.
C) current earnings.
D) future benefits to the holder.

Question 52

A 14-year zero-coupon bond was issued with a $1,000 par value and a yield to maturity of 9%. If similar bonds are currently yielding 12%, what is the approximate market value of the bond?

A) $205
B) $299
C) $801
D) $1,000

Question 53

A 10-year bond pays 8% annual interest (paid semiannually). If similar bonds are currently yielding 6% annually, what is the market value of the bond?

A) $1,000.00
B) $1,147.20
C) $1,148.77
D) $1,080.00

Question 54

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) yields of similar securities

Question 55

An issue of preferred stock is paying an annual dividend of $5. The growth rate for the firm's common stock is 14%. What is the preferred stock price if the required rate of return is 11%?

A) $45.45
B) $41.67
C) $35.71
D) none of the other answers are correct

Question 56

A 10-year bond pays 11% interest on a $1,000 face value annually. If it currently sells for $1,195, what is its approximate yield to maturity?

A) 8.33%
B) 12.95%
C) 11.00%
D) 8.08%

Question 57

If a share has supernormal growth for five years, only the present value of the first four years needs to be calculated.

Question 58

The cost of common stock is usually greater than the simple dividend yield because

A) investors perceive risk in common stock.
B) investors expect both a current dividend and future growth.
C) dividends are not tax-deductible.
D) the company must make profits before it can pay dividends.

Question 59

An issue of common stock is selling for $57.20. The year-end dividend is expected to be $2.32 assuming a constant growth rate of 6%. What is the required rate of return?

A) 10.3%
B) 10.1%
C) 4.1%
D) 6.0%

Question 60

The price of a supernormal growth stock includes the present value of the stock's price at the end of the supernormal growth period.

Question 61

The risk premium is likely to be highest for

A) government bonds.
B) corporate bonds.
C) gold mining expedition.
D) either b or c

Question 62

The dividend valuation model stresses the

A) importance of earnings per share.
B) importance of dividends and legal rules for maximum payment.
C) relationship of dividends to market prices.
D) relationship of dividends to earnings per share.

Question 63

Stock valuation models are dependent upon

A) expected dividends, future dividend growth, and an appropriate discount rate.
B) past dividends, flotation costs, and bond yields.
C) historical dividends, historical growth, and an appropriate discount rate.
D) all of the other answers are correct

Question 64

Which of the following is not a component of a bond's required rate of return?

A) risk premium
B) real rate of return
C) inflation premium
D) maturity payment

Question 65

A bond pays 9% yearly interest in semiannual payments for 6 years. The current yield on similar bonds is 12%. To determine the market value of this bond, you must

A) find the interest factors (IFs) for 12 periods at 12%.
B) find the interest factors (IFs) for 6 periods at 9%.
C) find the interest factors (IFs) for 6 periods at 6%.
D) find the interest factors (IFs) for 12 periods at 6%.

Question 66

A 15-year bond pays 11% on a face value of $1,000. If similar bonds are currently yielding 8%, what is the market value of the bond?

A) over $1,000
B) under $1,000
C) over $1,200
D) not enough information to tell

Question 67

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 68

Which is a characteristic of the cost of preferred stock?

A) since preferred stock dividends are fixed, they are tax deductible
B) because preferred stock has no maturity, the cost analysis is similar to that of debt
C) preferred stock is valued as a perpetuity
D) none of the other answers are correct

Question 69

A common stock which pays a constant dividend can be valued as if it were

A) corporate bond.
B) stock paying a growing dividend.
C) preferred stock.
D) discount bond.

Question 70

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 expected cash flows received from the asset.
C) value of past dividends and price increases for the asset.
D) future value of the expected cash flows to be received from the asset.

Question 71

A bond which 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 72

The price of preferred stock may react strongly to a change in k_p because

A) preferred stock may be cumulative.
B) preferred stock dividends have to be paid before common stock dividends.
C) there is no maturity date.
D) preferred stock dividends pass tax free between corporations.

Question 73

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

A) is unaffected.
B) goes down.
C) goes up.
D) need more information

Question 74

Preferred stock has all but which of the following characteristics?

A) no stated maturity
B) a fixed dividend payment that carries a higher precedence than common stock dividends
C) the same binding contractual obligation as debt
D) preferred lacks the ownership privilege of common stock

Question 75

If in determining the yield to maturity on a bond at a given interest rate, you get a value below the current market price, in the next calculation you should use

A) a higher interest rate.
B) a lower interest rate.
C) a longer maturity.
D) a higher coupon payment.

Question 76

If a company's stock price (P_o) goes up, and nothing else changes, K_e (the required rate of return) should

A) go up.
B) go down.
C) remain unchanged.
D) need more information

Question 77

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

A) corporate bond
B) Treasury bill
C) preferred share
D) common share

Question 78

The cost of capital for common stock is K_e= (D₁/P_o)+g. What are the assumptions of the model?

A) growth (g) is constant to infinity
B) the price earnings ratio stays the same
C) the firm must pay a dividend to use this model
D) all of the answers are assumptions of the model

Question 79

The return measure that an investor demands for giving up current use of funds, without adjusting for purchasing power changes, is the

A) risk premium.
B) inflation premium.
C) real rate of return.
D) discount rate.

Question 80

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 the other answers are correct